Canadian Banks Midyear 2018 Outlook: Bail-In, Mortgage Tightening, Tax Reform, And IFRS Affecting The Canadian Banks - S&P Global Ratings
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Canadian Banks Midyear 2018 Outlook:
Bail-In, Mortgage Tightening, Tax Reform, And IFRS Affecting The Canadian Banks
August 17, 2018
AUTHORS
Lidia Parfeniuk Shameer Bandeally
Nikola Swann Michael Leizerovich
Amit Tiwari Michael ForbesContents
Key Takeaways 3
BICRA 4
Ratings Snapshot 6
Bail-In And Impact On Ratings 7
Domestic Net Interest Margins 9
Uninsured Mortgages 12
Outlook 14
Related Research 15
Analytical Contacts 16
August 17, 2018 2Canadian Banks: Key Takeaways
Key Expectations
We expect our stable outlooks on most rated Canadian banks to remain unchanged for the balance of 2018 and leading into 2019.
Operating performance is likely to continue on a positive trajectory, with strong contributions from the banks’ domestic, U.S., and
international businesses.
We expect asset quality metrics to remain stable and operating leverage to be positive.
Key Assumptions
A favorable domestic environment will continue to promote positive revenue and earnings growth.
Rising interest rates will benefit operating performance, though mortgage growth will slow further. A neutral to positive global macro
environment will add to the banks’ international operations.
A benign credit environment will benefit earnings, and revenue growth will continue to outpace expense growth due to disciplined
cost management.
Key Risks
A sudden and precipitous decline in home prices and a rise in unemployment would lead to higher loan losses.
Evolving changes to the North American Free Trade Agreement (NAFTA) could negatively affect a number of industries to which the
Canadian banks lend.
Global macroeconomic instability could affect the Canadian banks given market interconnectedness.
August 17, 2018 3BICRA Snapshot: Canada
BICRA Brief: Canada
BICRA group: ‘2’
Economic risk/trend: 3/stable
Industry risk/trend: 2/stable
What’s Changed In 2018:
Economic risk lowered to ‘3’ from ‘2’
Economic risk trend revised to stable
from negative
Looking Ahead:
We expect economic and industry risk
trends to remain stable over the
course of 2018 and leading into 2019.
The downgrade of the
economic risk score reflects
our concerns over high
consumer indebtedness and
elevated house prices leaving
the Canadian banks more
vulnerable to downside risks.
A BICRA (Banking Industry Country Risk Assessment) is scored on a scale from ‘1’ to ’10’, ranging
from the lowest-risk banking systems (group ‘1’) to the highest-risk (group ‘10’).
Source: S&P Global Ratings.
August 17, 2018 4Economic Backdrop: Canada
House Price Index
300
280
260
240
220
200
180
160
140
120
100
Composite Vancouver Toronto Montreal
S&P Global Ratings’ Economic Outlook – Select Economic Indicators
2013 2014 2015 2016 2017 2018F
Heavy consumer debt burdens could constrain credit growth
Real GDP (%) 2.5 2.9 1.0 1.4 3.0 2.0 and consumer spending.
CPI (%) 0.9 1.9 1.1 1.4 1.6 2.2
Rising rates and new mortgage stress tests should further
slow residential investment.
Unemployment (%) 7.1 6.6 6.9 7.0 6.3 5.9 NAFTA renegotiations may pick up in the third quarter; the
Short-Term Rate 1.2 1.2 0.8 0.8 1.1 1.8 application of auto tariffs may see as much as 15% of CAN-
U.S. exports affected.
Long-Term Rate 2.3 2.2 1.5 1.3 1.8 2.3
Note: Composite index includes 11 of the 15 largest metropolitan areas in Canada.
Sources: S&P Global Ratings, Teranet, and Bank of Canada.
August 17, 2018 5Ratings Snapshot: Canada
Business Capital & Risk Funding & Group Sovereign ICR &
Anchor SACP
Position Earnings Position Liquidity Support Support Outlook
Bank of Montreal a- Adequate Adequate Strong Adequate a Mod. High A+/Stable
Bank of Nova Scotia bbb+ Strong Adequate Strong Adequate a Mod. High A+/Stable
Canadian Imperial
a- Adequate Adequate Adequate Adequate a- Mod. High A+/Stable
Bank of Commerce
Central 1 a- Weak Very Strong Moderate Strong a- A-/Stable
Desjardins Group a- Adequate Strong Adequate Adequate a Moderate A+/Stable
Home Trust Company a- Very Weak Strong Weak Moderate b+ B+/Positive
HSBC Bank Canada a- Moderate Adequate Adequate Adequate bbb+ Core AA-/Stable
Laurentian Bank of
a- Weak Adequate Adequate Adequate bbb BBB/Negative
Canada
Manulife Bank of
a- Weak Very Strong Moderate Adequate bbb+ Strategic A+/Stable
Canada
National Bank of Canada a- Adequate Adequate Adequate Adequate a- Moderate A/Stable
Royal Bank of Canada a- Strong Adequate Strong Adequate a+ Mod. High AA-/Stable
Toronto-Dominion Bank a- Strong Adequate Strong Adequate a+ Mod. High AA-/Stable
Movements From The Anchor: What’s Changed In 2018:
Very Weak (-5)
Weak (-2) Laurentian Bank ratings removed from CreditWatch negative; outlook is negative
Moderate (-1)
Adequate (0) Royal Bank of Canada’s outlook revised to stable from negative
Strong (+1) BMO’s risk position assessment revised to strong from adequate, resulting in a
Very Strong (+2) revised stand-alone credit profile (SACP) to ‘a’ from ‘a-‘, with no change to the issuer
credit rating
Source: S&P Global Ratings.
August 17, 2018 6Bail-In Regime: Ratings Neutral…For Now
Key Takeaways From Resolution Regime Review
Canadian Systemically Bail-in applies to the six DSIBs (below) and takes effect Sept. 23, 2018.
Important Banks Ratings And No changes to issuer credit ratings or outlooks on DSIBs.
Outlooks Are Unchanged No change in our government support assessment on Canada (“supportive”).
Following Release Of Draft Bail-
In Regulations, June 19, 2017
No resolution counterparty ratings assigned to DSIBs.
We view Canada’s resolution regime as “effective,” defined in our ALAC criteria.1
The only DSIB that could obtain more ALAC uplift than the uplift it receives today is NA,
but we do not expect the bank to reach the 8% threshold required.
A Closer Look At How
Proposed Bail-in Regulations
May Affect Canadian Bank We expect to assign issue-level ratings on bail-in-eligible senior
Ratings, July 14, 2017 debt, upon issuance, at a level one notch below the SACPs.
BMO BNS CM NA RY TD
Anchor a- bbb+ a- a- a- a-
Canadian Systemically
Important Banks Ratings And SACP a a a- a- a+ a+
Outlooks Are Unchanged On
Release Of Final Bail-In Systemic Importance +1 +1 +2 +1 +1 +1
Regulations, April 20, 2018 ICR A+ A+ A+ A AA- AA-
TLAC / RRWA2 21.5% 21.5% 21.5% 21.5% 21.5% 21.5%
ALAC / SPRWA 6.4% 6.1% 5.7% 5.1% 7.1% 7.0%
Review Of Canadian Bank TLAC WB / RRWA3 24.5% 24.5% 24.5% 24.5% 24.5% 24.5%
Resolution Regime Completed;
ALAC WB / SPRWA 8.3% 8.0% 7.5% 6.8% 9.0% 8.9%
Ratings And Outlooks On
Systemically Important Banks 1 ”Bank
Rating Methodology And Assumptions: Additional Loss-Absorbing Capacity,” April 27, 2015.
Unchanged, Aug. 16, 2018 2 Regulatoryrequirement from Nov. 21, 2021.
3 WB--With buffer; assumes DSIBs maintain a 300 bps buffer over the regulatory minimum.
Sources: S&P Global Ratings.
7Regulatory And Other Changes Affected Capital, Earnings, And Asset Quality
Δ Basel I
Q218 The elimination of the Basel I Floor in first-quarter 2018 had a positive impact on the
Floor
CET1 large Canadian banks’ common equity Tier 1 (CET1) ratios.
Removal
BMO +45 bps 11.3% Despite early hits to earnings due to deferred tax asset (DTA) revaluations, the U.S. tax
reform is expected to overall benefit the Canadian banks’ U.S. businesses’ operating
BNS +50 bps 12.0% performance in 2018.
CM +16 bps 11.2% The transition from IAS 39 to IFRS 9 in first-quarter 2018 led to higher reserving levels
and lower nonperforming assets (NPAs). Some volatility in earnings is expected as a
result of IFRS 9.
RY +5 bps 10.9%
DSIBs – Loan Loss Reserves / NPAs
TD +120 bps 11.8%
120%
100%
Effective Tax Effective Tax
Rate Q417 Rate Q1 2018 80%
BMO Financial 63.7% 24.6% 60%
40%
CIBC Bank USA 86.6% 32.6%
20%
RBC USA Holdco 34.9% 22.3% 0%
2011 2012 2013 2014 2015 2016 2017 2018
Q2
TD Bank US Holdings 24.2% 6.8%
The U.S. tax reform is expected to result in an
average tax rate of 22% on the Canadian banks’
U.S. operations.
Sources: S&P Global Ratings and company filings.
August 17, 2018 8Rising Interest Rates Are Pushing NIMs Higher
DSIBs - Average Domestic NIMs
The Bank of Canada has enacted four
2.60%
increases to the overnight rate over the
past 12 months, which has benefited the
Canadian banks’ net interest margins
(NIMs), though funding costs are rising.
2.55%
2.50% S&P Global Ratings expects a
further increase in interest rates
in 2018, with the Bank of
Canada policy rate likely to
2.45% reach 1.75% from 1.5%.
2.40%
Q1 17 Q2 17 Q3 17 Q4 17 Q1 18 Q2 18
Source: S&P Global Ratings.
August 17, 2018 9Wealth Management Continues To Grow In Importance
Revenues By Business Line
For the fifth straight year, the proportion
100% 4% of wealth management to total revenues
6% 10%
14% 10% grew.
80% 30% 31% 24% Wealth management has increased in
17% 27% revenue contribution to 25.4% in 2018
from 20.5% in 2014.
60% 20%
17% 25% Recent bank acquisitions, such as TD
21% and Scottrade and CIBC and Private
92% Bancorp, are adding to the banks’ wealth
40% management positions in the U.S.
71%
We expect wealth management
58% 48% 44% 42% revenues to gain further importance in
20% revenue contribution.
Conversely, we expect capital markets
0% revenues (average for the big six banks
-8% -1% -2% is 18.3% of total revenues) to decline as
wealth management and retail and
commercial businesses grow at a faster
-20% pace.
BMO BNS CM NA RY TD
Commercial & Retail Trading & Sales Wealth Management Other
Note: TD includes wealth management within commercial and retail revenues; “other” refers to corporate and
technology segments of the banks; BMO “other” includes insurance CCPB.
Sources: S&P Global Ratings and company filings.
August 17, 2018 10Capitalization Is Expected To Remain Neutral To Bank Ratings
S&P Global Ratings’ Risk-Adjusted Capital (RAC) Ratio Before
Diversification The big six banks’ risk-adjusted capital
Q4 2016 Q2 2017 Q4 2017 (RAC) ratios averaged 8.6% in fourth-
quarter 2017.
The downgrade of the economic risk
10.2
score to ‘3’ from ‘2’ in 2018 has had a 40
9.7
bps-50 bps negative impact on the
9.3
banks’ RAC ratios, bringing the average
8.8
8.7
8.6
8.6
8.6
8.6
8.4
8.4
8.3
8.2
8.1
down to 8.2% in second-quarter 2018.
8.0
7.9
7.9
7.7
Decent internal capital generation could
outstrip loan growth adding to capital.
We expect banks to continue modest
dividend increases and opportunistic
share repurchases consistent with their
current capital and earnings
assessments.
We expect the Canadian DSIBs to
maintain their RAC ratios within our
adequate range of 7%-10%.
BMO BNS CIBC NBC RBC TD
Source: S&P Global Ratings.
August 17, 2018 11Banks Are Originating Uninsured Mortgages…
With stricter mortgage lending and approval rules, including
Insured Mortgages / Total Mortgages (%) the requirement of stress tests for borrowers, mortgage
80% origination volumes have declined.
The proportion of insured mortgages continues to decline as
portfolio insurance falls away, which is resulting in higher
originations of uninsured mortgages, slowly elevating the
70%
banks’ credit risk.
Banks’ LTVs on uninsured mortgages, however, remain
conservative at around 55%, somewhat mitigating the
60% growing risk.
DSIB Quarterly Mortgage Volume Δ
(Bil. C$)
50%
25.00
20.00
40% 15.00
10.00
5.00
30%
2013 2014 2015 2016 2017 2018 Q2
0.00
BMO BNS CM NA RY TD Q117 Q217 Q317 Q417 Q118 Q218
Source: Company filings.
August 17, 2018 12…But Asset Quality Remains Strong
NPAs & NCOs: Canadian Banks
1.60%
1.40%
Adj. NPAs / Customer Loans +
OREO (%)
1.20%
Net Charge-Offs / Average
Customer Loans
1.00%
0.80%
0.60%
A benign credit
environment is keeping
credit quality issues at
0.40% bay. But if
unemployment begins
0.20%
to rise, losses would
start to creep up.
0.00%
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Q2
Sources: S&P Global Ratings and company filings.
August 17, 2018 13The Outlook For Canadian Banks Is Stable
Improving Neutral Worsening
We expect mid-single-digit revenue growth, in part reflecting slower mortgage origination, with about 50% of the
Revenues banks’ loan portfolios representing mortgages, but overall domestic retail and commercial franchises to continue their
steady revenue contributions, in addition to good revenue growth from the banks’ wealth management operations.
We expect expense control to remain a key focus, given slower revenue growth, and to produce overall positive
Expenses operating leverage.
We expect profitability to benefit slightly from rising interest rates and a benign credit environment and the banks’
Profitability U.S. and international operations to continue to produce strong results given neutral to positive global economic
conditions.
We expect asset quality metrics to remain strong and stable, though a sharp decline in home prices and rising
Asset Quality unemployment would lead to higher loan losses in the banks’ consumer loan portfolios.
We expect the large Canadian banks (DSIBs) to build toward OSFI’s minimum total loss-absorbing capacity (TLAC)
Capital and leverage ratios, beginning in September. We believe that capital management will remain a priority with a low
probability of large M&A activity.
We expect funding requirements to align with the banks’ needs with ease of access to global markets and the banks
Funding &
to begin issuing bail-in-able securities in fourth-quarter 2018. We expect the banks to continue to build liquidity on
Liquidity strong core deposit growth.
August 17, 2018 14Related Research
Review Of Canadian Bank Resolution Regime Completed; Ratings And Outlooks On Systemically Important Banks Unchanged, Aug.
16, 2018
Bank of Montreal, BMO Financial Corp. 'A+/A-1' Issuer Credit Ratings Affirmed; SACPs Raised On Stronger Risk Profile, Aug. 14,
2018
Americas Economic Snapshots, July 25, 2018
Royal Bank of Canada Outlook Revised To Stable From Negative On Maintenance Of Strong Credit Quality Metrics, June 27, 2018
Laurentian Bank of Canada Ratings Affirmed; Off CreditWatch; Outlook Negative On Concentrated Mortgage Exposure, April 27,
2018
Canada Economic Risk Higher On Elevated House Prices And Household Debt And Mortgage Fraud; No Ratings Affected, Feb. 23,
2018
Canadian Bank 2018 Outlook: Elevated Housing Prices And Consumer Leverage Are The Downside Risks To Mostly Stable
Operating Performance, Dec. 19, 2017
How IFRS 9's Expected Credit Loss Framework Will Affect Canadian Banks' Loss Provisioning In 2018 And Beyond, Dec. 18, 2017
August 17, 2018 15Analytical Contacts
Lidia Parfeniuk Nikola Swann
Toronto Toronto
+1 416 507 2517 +1 416 507 2582
lidia.parfeniuk@spglobal.com nikola.swann@spglobal.com
Amit Tiwari Shameer Bandeally
Toronto Toronto
+1 416 507 3224 +1 416 507 3230
amit.tiwari@spglobal.com shameer.bandeally@spglobal.com
Devi Aurora
New York
+1 212 438 3055
devi.aurora@spglobal.com
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