Canada’s largest bank and its biggest life insurer have been humbled by a pair of ratings downgrades that executives at both firms suggested was unwarranted.
The ratings of Manulife Financial and Royal Bank of Canada were downgraded Monday by Standard & Poor’s and Moody’s Investors Service, respectively, on concerns about the risks embedded in each of the financial giants.
RBC had been one of only a half-dozen banks in the world rated triple-A by Moody’s. The agency downgraded the bank one notch, to double-A1, citing the risk that its expanding capital-markets business will expose the bank to more volatility.
The downgrade of Manulife and its key operating units was the third such cut the insurance giant has suffered since early 2009, and resulted from what S&P said was a diminished outlook for the insurer’s U.S. operations, and volatile capital and profit levels.
The downgrades signal that Canadian financial institutions, which have come through the financial crisis in better shape than peers in many developed countries, still face headwinds. But the moves also signal new caution that credit rating agencies are applying to their decisions in the wake of the crisis, which they have been partially blamed for. Investors are placing new pressure on agencies like Moody’s, S&P and DBRS Ltd. to keep up with the risks that companies face after those agencies failed to downgrade a number of debt securities whose values plunged.
RBC chief executive officer Gordon Nixon said he thought the downgrade was unwarranted because the bank has been operating more conservatively in recent years, even as it expands in the capital markets business. To balance off its investment banking growth, RBC has been expanding in wealth management, he said.
“We’re disappointed because if you actually look at the bank’s capital levels, the bank’s leverage levels, the size and complexity of our balance sheet, they are all more conservative today than they were three or four years ago,” Mr. Nixon said. “So we have a hard time understanding the rationale.”
Moody’s has been the most willing of all the agencies to give banks top ratings, but it would appear the firm is now culling its ranks in the top tier. With the RBC downgrade, only five global banks now have triple-A ratings. They include Toronto-Dominion Bank, Bank of New York Mellon in the U.S., Banque et Caisse d'Epargne de l'Etat of Luxembourg, Rabobank Nederland and Zuercher Kantonalbank of Switzerland.
RBC has a large capital markets arm around the world, which can be susceptible to market fluctuations. Trading revenues, for example, soared a year ago, but are now in the doldrums for Canadian banks, affecting RBC in the most recent quarter.
Moody’s noted that RBC’s capital markets unit comprises 45 per cent of its balance sheet, while the bank attributes about 25 per cent of its common equity to that division. Mr. Nixon said that strategy was nothing new, however.
“Our objective of 25-per-cent contribution from capital markets has been a consistent strategy for the last 10 years, and remains our strategy going forward.”
Prior to the financial crisis, Manulife’s U.S. division historically generated about half of the insurer’s profits, but S&P said it doesn’t think that will continue.
While Manulife is making positive moves to reduce its stock market and interest rate exposure, its leverage ratio is relatively high at 31 per cent. That makes its ratings vulnerable should markets move against it before it can sufficiently reduce its risks, S&P said. It put the rating on review again in early November, suggesting that another cut could be on the way. Manulife’s rating is now double-A-minus.
At Manulife, CEO Don Guloien has been working to cut exposure to interest rates, stock market fluctuations, and riskier products, but rating agencies have determined that the moves aren’t sufficient to maintain the firm’s ratings.
Manulife executives have been in active discussions with the agencies, working to persuade them that the strategic course the company is now on is the right one for its future.
“We believe we have a strong case for maintaining the current ratings,” Manulife chief financial officer Michael Bell told analysts on Nov. 19. “The ratings are very important to us, not just in terms of how we financially manage the company, but how we protect the brand out in the marketplace.”
Manulife lost almost $1-billion in its latest quarter, after taking a $1-billion goodwill charge on its U.S. business and a charge of more than $2-billion stemming from updates it made to its actuarial methods and assumptions.
Moody’s had downgraded Manulife, to A1 from double-A3, following that quarterly loss.Report Typo/Error