Source: The Canadian Press

Moody’s Investors Service said Tuesday it has put its ratings for Royal Bank on review for possible downgrade, and affirmed its ratings for Toronto-Dominion Bank, albeit with a negative outlook, as the rating agency remains concerned about the possibility of growing capital markets exposures for the Canadian banks.

Earlier, Moody’s issued a report indicating that it believes wholesale banking activities pose heightened risks for the Canadian banks, including the risks associated with concentrated positions, high leverage, confidence sensitivity and opacity. Capital market activities also involve “tail risks” if controls fail, it notes, adding that these risks are hard to manage. “Moreover, as market conditions improve and competitive pressures increase, managers at investment banks may relax their disciplines and venture into more complex products,” it says.

The rating agency says that its review of RBC’s ratings will focus on the bank’s commitment to capital markets and its growth plans for the business. Moody’s will also examine the bank’s controls on these businesses, including its limits on position concentrations and less-liquid assets. It notes that RBC management aims to generate 25% to 30% of earnings from the capital markets segment, which Moody’s considers high for a bank with its current ratings.

“Royal Bank and many other investment banks have recently de-risked, but shareholder demands will inevitably cause firms to increase risk and complexity over the next market cycle” said Peter Nerby, a Moody’s senior vice president.

Royal Bank holds a triple-A rating for long-term deposits and senior debt.

Similarly, Moody’s says that its negative outlook on TD reflects the potential risks associated with TD’s growth in U.S. retail banking and its commitment to capital markets businesses. The rating agency cites TD’s recent $3 billion commitment to BHP Billiton’s acquisition bid for Potash Corp of Saskatchewan as an example of the concentration risks associated with wholesale banking. That said, Moody’s notes that TD appears to have conservative aspirations in building up its capital market trading platforms.

For TD, the concern seems to more focused on its US expansion efforts. “If poorly executed, these initiatives may result in earnings volatility that is inconsistent with its very high B+ unsupported bank financial strength rating,” it says, noting that TD has been expanding rapidly in the U.S., and recently agreed to acquire a troubled Southeastern bank without FDIC assistance.

“TD is one of a handful of triple-A rated banks globally and its business mix and the controls it has displayed around business growth continue to support that rating,” observed Nerby.

IE