December 14, 2010
Moody's downgrades Royal Bank of Canada
TORONTO--Moody's Investors Service has downgraded the ratings of Royal Bank of Canada, driven principally by the bank's commitment to its sizeable and growing capital markets business, which potentially exposes bondholders to increased earnings volatility and poses significant risk management challenges . The bank's deposit rating was lowered to Aa1 from Aaa. (See below for a full list of rating changes.) RBC's unsupported bank financial strength rating was lowered to B from B+. The rating outlook is stable.
A bank financial strength rating of B equates to an unsupported baseline credit assessment of Aa3. RBC's senior debt and deposit ratings are Aa1 - two notches higher than the baseline credit assessment - as a result of Moody's very high assumption of systemic support for RBC.
As part of its universal banking strategy, RBC management is selectively expanding upon its strong domestic investment banking and trading capabilities to build a global investment banking platform. Tactically, RBC has been able to exploit the continuing disarray at many of its investment banking competitors to upgrade and build out its banking, sales and trading capabilities outside Canada.
"Shareholders and bank managers are attracted to the growth potential of capital markets businesses, but these businesses can expose bank bondholders to hidden tail risks," said Peter Nerby, a Moody's Senior Vice-President.
Although Moody's expects RBC's other businesses will provide a substantial buffer against these risks, the rating agency believes the opacity and the potential volatility associated RBC's enlarged and expanding capital markets operations are not consistent with its former B+ unsupported bank financial strength rating.
RBC already has a substantial commitment to the capital markets business. At year end 2010, the capital markets segment represented roughly 45% of the bank's consolidated balance sheet, and management is attributing roughly 25% of the firm's $33 billion in common equity to the capital markets segment. Over the long run, management has signaled that the contribution from capital markets businesses could be as much as 30% of overall revenue and earnings through the cycle.
The stable outlook on the ratings reflects the bank's commanding Canadian franchises. In Canada, RBC has a top-tier position in numerous products, including deposits, residential mortgages, brokerage, mutual funds, middle market commercial lending, institutional custody, and capital market activities. These franchises have produced high and relatively predictable pre-provision, pre-tax earnings, which should provide a strong defense against asset quality deterioration or potential earnings volatility.
"The strength and diversification of RBC's domestic earnings streams provide strong support to the B unsupported bank financial strength rating and justify a stable outlook", Nerby observed. He added that "Even after the downgrade, Royal Bank enjoys one of the highest ratings globally amongst banks with substantial capital markets operations."
RBC's 2010 results were demonstrative of its franchise strength. Overall, RBC reported core (pre-tax, pre-provision) earnings of C$8.8 billion, with a ratio of core earnings to average risk-adjusted assets of 3.5%.
Moody's continues to assume a very high likelihood of systemic support for the Royal Bank of Canada. This assumption results in two notches of uplift to the bank's Aa1 deposit rating from its unsupported baseline credit assessment of Aa3.
Moody's last rating action on Royal Bank of Canada was on October 25, 2010, when it placed the company's ratings on review for possible downgrade.
The principal methodologies used in this rating were "Bank Financial Strength Ratings: Global Methodology" published in February 2007, and "Incorporation of Joint-Default Analysis into Moody's Bank Ratings: A Refined Methodology" published in March 2007, and "Moody's Guidelines for Rating Bank Hybrid Securities and Subordinated Debt" published in November 2009.
Royal Bank of Canada is headquartered in Toronto Canada and its reported assets were C$726 billion as of October 31, 2010.