Fitch Ratings thinks Canadian consumers' debt is unsustainable and that the housing market is somewhat overvalued. Developments such as these have made the ratings agency less optimistic than before about the outlook for the country's largest financial institutions.
Canadian banks' credit ratings are among the highest in the world, Fitch notes in its 2014 outlook report on Canadian lenders. But although 2013 was a better year than expected, the precarious Canadian housing market has caused the ratings agency to take a negative view of the sector next year.
"Should a housing correction be more severe than a plateauing or modest cooling of the market, there could be an impact to bank capital ratios," the report notes. Even a gradual steadying of the markets could lead to reduced earnings and a "deterioration in credit quality" for these institutions.
While worries about the hot Canadian housing market aren't new, the rating agency's concerns have been heightened in the past year, said analyst Justin Fuller. The market has not shown expected signs of steadying, even with Ottawa stepping in to try to slow the market. Mortgage rates have increased, but mortgage balances and covered bond issuances have also shown continued strength, making Mr. Fuller more wary.
The trouble with the housing market is exacerbated by the over-stretched Canadian consumer.
"With some of the improved employment we would have expected, in aggregate, consumers to pay down some of the debt, but we haven't really seen that," Mr. Fuller said.
Aside from these macro risks, Fitch notes that capital markets revenue has become a bigger source of earnings growth for the Canadian banks since the global financial crisis. Royal Bank of Canada, for example, has expanded its capital markets business in the U.S., which changes the bank's earnings profile and makes it a bit riskier. This business has a history of volatility, and "is not necessarily consistent with very, very high ratings," Mr. Fuller said.
For now, though, Fitch is maintaining a "stable" rating of the sector, which continues to post strong earnings results and maintain safe levels of regulatory capital and liquidity.