CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Royal Bank of Canada's (RY) Long- and Short-term Issuer Default Ratings (IDRs) at 'AA' and 'F1+', respectively. The Rating Outlook remains Negative.
This rating action follows Fitch's periodic review of the Canadian Banks Peer Group, which includes: Bank of Montreal (BMO), Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CIBC), Caisse Centrale Desjardins (CCD), National Bank of Canada (NBC), Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD).
Company specific rating rationales for the other banks will be published separately. For further discussion of the Canadian Banks sector, please refer to the special report titled 'Canadian Bank Peer Review' at www.fitchratings.com.
Recently, the Ministry of Finance has announced important changes to the housing finance system in Canada. These entail the introduction of a lender risk sharing policy, tighter requirements for mortgage insurance, and tax changes targeted at speculative and foreign buyers. The most impactful for Canadian banks, and non-bank mortgage lenders, is the introduction of lender risk sharing. Coupled with other measures being introduced by governmental entities, such as the likely introduction of mortgage risk-weight floors for Canadian banks, they are meant to temper a further run-up in housing prices. To the extent that this creates an orderly slowdown in the pace of home price appreciation, this may be viewed as supportive to current Canadian bank ratings. Alternatively, should the cumulative effects of these initiatives cause potentially more significant disruptions to the Canadian mortgage market, this may negatively impact Canadian Bank ratings and rating outlooks; however, Fitch would assess the materiality of the impact on each bank individually.
KEY RATING DRIVERS
IDRs, VR AND SENIOR DEBT
Today's rating affirmation reflects RY's strong domestic franchise, sound funding and liquidity position, consistently good earnings performance, and adequate capital ratios, all of which help to support RY's high ratings.
RY's historical earnings performance continues to remain good. This operating performance has been supported by low provision expense, as credit losses have been generally manageable to this point even considering some higher provisioning related to the oil & gas sector over the last year. This is important because net interest margins remain under pressure amid low interest rates in Canada. RY's performance track record has also been augmented over time by growth in the company's Capital Markets and Wealth Management segments.
RY's ratings are supported by its strong franchise market share positioning in Canada across various product segments. This competitive positioning and good historical performance supports the company's comparatively good liquidity position.
The bank has a leading deposit market share throughout Canada, and attractive access to multiple funding sources globally. This includes senior debt issuances, senior deposit notes, securitizations, and covered bond issuance. In addition, RY is also in compliance with the Liquidity Coverage Ratio (LCR) standards.
Fitch continues to view RY's further expansion of wealth management in the U.S. markets via its recent acquisition of City National Bank (CNB) favorably. So far it appears that the integration of CNB has gone well, and this franchise should continue to offer RY growth avenues in both wealth management offerings as well as lending opportunities in the U.S. market. However, given regulatory and capital requirements in the U.S. relative to the Canadian marketplace, the CNB acquisition may be modestly dilutive to RY's overall return on equity (ROE) over time.
The CNB acquisition also provides some capacity for incremental capital markets revenue growth, as management has stated that it does not want capital markets earnings to exceed 25% of total earnings.
However, Fitch believes that future growth for RY's capital markets businesses may necessitate incrementally higher risk appetite as the company competes more against larger and more entrenched global players. This, combined with what Fitch expects to be slower growth from RY's Canadian Banking segment, could introduce higher levels of volatility to RY's overall earnings profile relative to both global and Canadian peers.
RY's Rating Outlook remains Negative given Fitch's view that the bank's future credit performance and earnings volatility may be higher than Canadian bank peer averages as well as in comparison to similarly rated global financial institutions. However, RY's capital markets segment has not incurred a loss in the last 10 years.
Fitch views RY's future credit performance in the capital markets business to be potentially lumpier than similarly rated peers. Combined with potentially higher earnings volatility, given the variable nature of many capital markets businesses, this could over time become inconsistent with the RY's high level of ratings.
In addition, RY's regulatory and tangible capital ratios, while satisfactory and supportive to the rating, compare less favorably to other similarly rated financial institutions across the globe.
This is particularly important given that RY's risk-weighted assets (RWA) on its uninsured mortgage portfolio, which is proportionately larger than for other Canadian Banks, under the Basel III Advanced Approach, is less conservative than in some other global jurisdictions. This could indicate the denominator of RY's regulatory capital ratios could be less conservative than some other global peer banks.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and other hybrid capital issued by RY and its subsidiaries are all notched down from the common VR in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles.
RY's subordinated debt is notched one level below its VR of 'aa' for loss severity in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles.
LONG- AND SHORT-TERM DEPOSIT RATINGS
City National Bank's uninsured long-term deposit ratings are rated one notch higher than the company's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default.
SUBSIDIARY AND AFFILIATED COMPANY
All of the subsidiaries and affiliated companies including City National Bank and Royal Bank of Canada, Sydney Branch are reviewed as part of the Canadian Bank peer review factor in a high probability of support from parent institutions to the subsidiaries. This reflects that performing parent banks have very rarely allowed subsidiaries to default. It also considers the high level of integration, brand, management, financial and reputational incentives to avoid subsidiary defaults.
SUPPORT RATING AND SUPPORT RATING FLOOR
The affirmation of the RY's Support Rating (SR) of '2' and Support Rating Floor (SRF) of 'BBB-' reflect Fitch's view that the likelihood of support remains high for Canadian banks due to their systemic importance in the country, significant concentration overall of Canadian banking assets amongst the institutions noted above, which account for over 90% of total banking assets, the large size of the banking sector with banking assets at 2.1x Canada's GDP, and the Canadian banks' position as key providers of financial services to the economy. In Fitch's view, Canadian banking authorities through the CDIC Act, have wide latitude to resolve a troubled bank including re-capitalizing an institution, creating a bridge bank, or imposing losses on creditors.
Fitch recognizes that the government's willingness to provide support for Domestic Systemically Important Financial Institutions (D-SIFI's) in Canada has been reduced as demonstrated by a Department of Finance consultation paper which outlines the proposed bail-in regime as banking regulators seek to protect tax payers from the risk of a large financial institution failing. This is evidenced by the proposed issuance of non-viable contingent capital (NVCC) instruments, resolution powers given regulatory authorities under the CDIC Act, and other initiatives that demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward.
RATING SENSITIVITIES
VR, IDRs, AND SENIOR DEBT
RY's ratings are at the top of Fitch's Global Bank Rating Universe, and as such, there is very little upside to current ratings.
Today's rating actions also incorporate the view that Fitch believes uncertainties remain on what the impact of recent mortgage reform announcements will be to the broader mortgage market, particularly as lenders (including non-banks) and even borrowers pull back on mortgage lending activity while they evaluate the potential impact. As such, a faster price correction that is prolonged and/or a slowdown in the housing market will likely impact earnings growth for all the banks. This would also affect the broader economy through the link between housing wealth and consumer consumption, and the real estate sector, which are important drivers of GDP growth. Fitch notes that the Canadian banks ratings are sensitive to these changes.
As indicated by the maintenance of the Rating Outlook at Negative, potential risks to RY's ratings include: higher earnings volatility in the context of its slightly lower regulatory capital and tangible capital ratios, both relative to similarly rated Global peers.
Specifically, RY's ratings are primarily sensitive to Fitch's view of potential earnings volatility as measured by return on assets and equity (ROA and ROE) relative to domestic and highly rated international peers.
RY's ratings could be downgraded one notch should earnings measures exhibit significantly higher volatility. For example, a 25% change in the standard deviation of earnings measured over multiple quarters, absent a significant increase in both regulatory and tangible capital ratios could be indicative of heightened volatility outside of Fitch's expectations for the company's ratings.
Alternatively, should RY be able to manage future provisioning and capital markets volatility with minimal standard deviation of ROA or ROE, all while retaining internally generated capital to boost both regulatory and tangible capital ratios the Rating Outlook could be revised back to Stable in the next 12 months.
RY's ratings are also sensitive to its ability to continue to integrate CNB into its operations consistent with the expectations it set-out at the consummation of the transaction. The ratings are also sensitive to RY generating forecasted results from the CNB acquisition over time.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The subordinated debt and hybrid capital ratings are primarily sensitive to any change in the VRs of the banks (or bank subsidiaries).
LONG- AND SHORT-TERM DEPOSIT RATINGS
The ratings of long- and short-term deposits issued by City National Bank and its subsidiaries are primarily sensitive to any change in RY's IDR.
SUBSIDIARY AND AFFILIATED COMPANY
The subsidiary and affiliated company ratings including City National Bank and Royal Bank of Canada, Sydney Branch are primarily sensitive to any change in the VRs of the banks.
SUPPORT RATING AND SUPPORT RATING FLOOR
SR of '2' incorporates Fitch's expectation that there could be some level of support for the Canadian Banks going forward, although it has been weakened given bail-in legislation. Although Canadian authorities have taken steps to improve resolution powers and tools, they intend to maintain a flexible approach to bank resolution.
Fitch's assessment of continuing support for Canadian D-SIFI's has to some extent relied upon resolution powers granted regulators under the CDIC ACT as well as the potential size, structure, and feasibility of NVCC implementation. Further, continued regulatory action to ensure sufficient contingent capital has been implemented for all Canadian banks.
Fitch has affirmed the following ratings and has maintained the Rating Outlook at Negative.
Royal Bank of Canada
--Long-Term IDR at 'AA'; Outlook Negative;
--Viability Rating at 'aa';
--Short-Term IDR at 'F1+';
--Short-Term debt at 'F1+';
--Senior unsecured debt at 'AA';
--Subordinated debt at 'AA-';
--Market-Linked Securities at 'AAemr';
--Support Rating at '2';
--Support Rating Floor at 'BBB-'.
City National Bank
--Long-Term IDR at 'AA-'; Outlook Negative
--Short-Term IDR at 'F1+';
--Long-Term Deposits at 'AA';
--Short-Term Deposits at 'F1+';
--Subordinated debt at 'A+';
--Support at '1'.
Royal Bank of Canada, Sydney Branch
--Long-term senior unsecured debt at 'AA'.
Additional information is available on www.fitchratings.com.
Applicable Criteria
Global Bank Rating Criteria (pub. 15 Jul 2016)
https://www.fitchratings.com/site/re/884135
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