Ratings on the subordinated capital of the Canadian banks could be lowered two or three notches as a result of a change in its rating methodology, Moody’s Investors Service said Tuesday.

The rating agency stresses that neither bank financial strength ratings nor deposit ratings would change as a result of implementing its bank subordinated capital ratings proposal.

“These potential rating actions do not reflect on the underlying financial strength of the Canadian banking system, which Moody’s views as one of the soundest globally,” said Moody’s senior vice president, Peter Routledge. “Rather, they would capture the risk that subordinated capital generally does not benefit from systemic support and take into consideration the risk posed by each instrument’s features.”

The announcement comes after another rating agency, DBRS, did lower its ratings on the banks’ preferred shares and innovative Tier 1 instruments earlier today, also in response to changes in its rating methodology.

Back on June 16 Moody’s proposed notching hybrid securities including preferred stock using a bank’s stand-alone rating as a starting point rather than its supported rating. The supported rating includes Moody’s view of likely government support for systemically important banks.

“Before the current financial crisis, Moody’s had assumed that any support provided by national governments and central banks to shore up a troubled bank and restore investor confidence would not just benefit the bank’s senior creditors but, at least to some extent, investors in its subordinated capital,” it reports. However, it notes that recent government interventions outside Canada have left investors in certain types of subordinated capital to absorb losses. And, in some cases, support packages have been contingent upon the banks’ suspension of coupon payments on these instruments as a means to preserve capital.

“Moody’s does not presently see compelling evidence to suggest that the Canadian government would take different decisions on supporting bank subordinated capital investors than those taken most recently by other G7 and OECD countries,” says Moody’s Routledge. “In other words, the Canadian government would be likely to have bank subordinated capital investors share in the expense of recapitalizing a troubled Canadian bank in the future, in our opinion.”

It is seeking comments on the proposal by July 10.

IE