Are the world's bank watchers re-evaluating their long love affair with Canadian financial institutions?
It certainly appears that way, if the latest downbeat assessment from Moody's Investors Service is anything go by.
The big bond-rating agency has changed its outlook on Canada's banking system to negative from stable on the grounds Ottawa has no appetite to bail out too-big-to-fail institutions using taxpayers' money in the event of a crisis. Instead, the government is proceeding with a so-called bail-in strategy that could force bondholders to shoulder part of the burden of any future restructuring.
The rating agency signalled this sentiment shift a month ago when it similarly downgraded its outlook to negative on senior debt and uninsured deposits of the seven biggest banks, which control a whopping 93 per cent of the assets in the financial system.
Never mind that none of Canada's well-regulated banks needed such emergency relief even during the darkest days of the global financial meltdown and the worst economic downturn since the Great Depression. And ignore the fact that this country's cozy financial oligopoly is better capitalized and more profitable than ever.
The major Canadian banks emerged with a flood of admirers and a rather overblown reputation as paragons of banking virtue, a model for the rest of world to follow. Moody's hasn't veered far from that script, acknowledging that Canada retains one of the world's highest-rated banking systems and that "the banks' strong capital positions provide significant capacity to withstand unexpected stresses."
But the debt monitor is paid to warn bondholders about the possibility of any heightened risks to the safety of their investments, and the federal government's crisis strategy counts as one. The result could be a slightly higher cost for future bank financings.
Moody's has raised the caution flag over Ottawa's bail-in plan, under which senior bondholders could get dinged in a restructuring through the rapid conversion of certain debt instruments into equity capital.
The change in outlook "reflects our view that the Canadian government's plan to introduce a bail-in regime for senior debt, combined with the accelerating global trend towards explicit inclusion of burden-sharing with senior debtholders as a means of reducing the public cost of bank resolutions, could reduce the predictability of support being provided to the senior debtholders and uninsured depositors of the large Canadian banks," Moody's warns.
This isn't the first time some expert has decided the Canadian banks are more vulnerable than they used to be. Last year, a handful of intrepid hedge fund speculators became convinced that one or more of Canada's financial juggernauts would come to grief as the housing bubble finally blew up, the slide in resources steepened and record consumer debt ratios took a heavy toll. They took a bath on their short bets.
To keep the good times rolling, Canadian banks are expanding other business channels, including wealth management, and increasing their exposure in the U.S. and other foreign markets where the battered local competition has left opportunities. TD and BMO are particularly well-positioned to take advantage of a sturdier recovery of demand in the U.S. market.
That, too, raises concerns, Moody's says.
"The risks associated with the banks' diversification strategies, which dilute their strong domestic credit profiles, are reflected in their current ratings but still represent a growing risk to the stability of the Canadian banking system."
Maybe so. But betting against the banks remains a bad investment idea.