Canada’s finance minister is questioning the world’s largest ratings company over its warning banks will become riskier investments if the country relieves taxpayers from the burden of potential bailouts.
Moody’s Investors Service reduced the outlooks on Royal Bank of Canada, Bank of Nova Scotia and five other lenders to negative on June 11, citing similar bail-in rules in Europe and the U.S. that would impose losses on bondholders in a crisis.
“I don’t quite follow the logic, to tell you the truth,” Joe Oliver said in a June 11 interview at Bloomberg’s New York headquarters. “What the bail-in would do would be to enhance the viability of the banks. That’s the whole point. You move debt to equity, that’s what keeps them going.”
Canada’s banks, which escaped the financial crisis without failures, wouldn’t be able to count on sovereign support as regulators seek to prevent a rerun of 2008’s global rescues where taxpayer cash was used to prop up lenders and safeguard the wider economy, New York-based Moody’s said. The country’s finance department, which first disclosed plans for the regime in March 2013, hasn’t said when the rules will be introduced. It would legislate that bondholders convert certain debt to equity if a bank was close to insolvency.
“The intention of the government is clearly to encourage prudent risk-taking and the maintenance of a strong credit profile,” David Beattie, senior credit officer at Moody’s Investors Service in Toronto, said by e-mail June 13. “However, should adverse developments require a future bank recapitalization in Canada, which is a very remote probability, the government also wants to reduce the public cost of a bank resolution by having the ability to impose losses on senior creditors.”
The decision to limit government support could trigger a downgrade of as much as two levels to bank bonds, Beattie said. Based on its assumption the Canadian government would bail out a troubled bank, Moody’s currently assigns ratings that are two ratings higher than the stand-alone credits of banks suggest. Toronto-Dominion Bank, for example, which has the highest rating at Aa1, would drop to Aa3 without government support. A negative outlook is a signal any rating change will be lower.
TD’s C$2 billion of 2.44 percent notes due April 2019 basis points yielded 74 basis points more than government benchmarks at 10 a.m. in Toronto, compared with 72 basis points before the ratings action.
“It’s appropriate to at least indicate once the bail-in regime is announced it will have a negative impact,” Beattie said.
Standard & Poor’s cut the outlooks of 15 European banks to negative in April on the prospect that governments are less likely to provide aid. In November, Moody’s downgraded Morgan Stanley (MS), Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co. (JPM) and Bank of New York Mellon Corp. (BK), citing plans by U.S. regulators that would pave the way for them to allow bank failures without stepping in, imposing losses on investors.
Canadian banks have ranked as the world’s soundest for six straight years according to the World Economic Forum, the Geneva-based institution that promotes public-private cooperation and hosts an annual meeting in Davos.
In Canada, bank chiefs may react to the new bail-in rules by bolstering their balance sheets, said Peter Routledge, an industry analyst at National Bank Financial. Canadian banks have been ahead of global counterparts in adopting capital rules.
“If you’re the CEO of a bank and you know bail-in is now here you say I don’t want a shadow of a doubt getting into my balance sheet,” Routledge, formerly a ratings analyst at Moody’s, said. “While things are good I’m going to bulk up capital beyond what I’m required to. So when things do turn there’s no blood in the water with respect to my institution, so the predatory investors will go pick on somebody else.”
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