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Moody's RBC Downgrade Nothing But a Sideshow

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The Moody's Ratings agency announced late Wednesday that it was considering a downgrade of a number of euro zone, U.S., and Canadian banks including Canada's largest and arguably its most venerable banking institution: the Royal Bank of Canada (RBC). Readers might recall that Moody's stripped the RBC of its Aaa rating in December 2010.

At the time this was not much of a surprise because the bank had been placed on negative credit watch earlier in that year largely due to an announcement by the RBC that it was seeking to generate a larger share of its total bottom line from its own Capital Markets businesses. The downgrade also occurred despite RBC having emerged from the global financial crisis relatively unscathed and in much better shape than most of its offshore competitors. Other agencies soon followed suit with their own downgrades for the bank.

The RBC is currently rated AA- by S&P and Aa1 by Moody's. Fitch Ratings and Dominion Bond Rating Service, the other major agency and Canada's domestic credit watchdog respectively, both peg the RBC credit quality at AA. Thus while the latest Moody's announcement will bring their ratings assessment into line with their major competitor, it still remains above the credit assessment given by the two smaller agencies.

The recent ratings action again pays reference to that fact that RBC's announced business plans are running into strong headwinds, not in the least due to the furor over implementation of the Volcker rule, but also because the markets it is seeking to exploit in the search for revenues are running into difficulties in the form of widening spreads, lower volumes, poor funding conditions, and deteriorating investor appetite.

Other banks under review for possible downgrades include Citigroup, Bank of America, Goldman Sachs, JPMorgan Chase, and Morgan Stanley; Moody's said it is extending its reviews on whether to lower ratings on Credit Suisse, Macquarie, Nomura, UBS, Barclays, BNP Paribas, Credit Agricole, Deutsche Bank, HSBC, Royal Bank of Scotland, and Societe Generale. Moody's also extended ongoing reviews for downgrades on 11 companies.

Pointing to regulatory, balance sheet, and liquidity concerns, a spokesperson for the agency said in a statement after markets closed last night: "These difficulties, together with inherent vulnerabilities such as confidence-sensitivity, interconnectedness, and opacity of risk, have diminished the longer term profitability and growth prospects of these firms."

The Moody's news came hard on the heels of credit downgrades for a number of euro zone countries -- including Italy, Portugal, and Spain -- because of uncertainty over the weakening profile of economic activity in Europe and a growing credibility gap regarding the advisability of the polices being forced on debtor countries by the EU/ECB/IMF "Troika."

In our opinion here at Recovery Partners, this latest wheeze from the ratings agencies is comparable to the fevered activity of Balinese pool boys trying to rearrange deck chairs in the middle of a force 5 Typhoon.

While EU leaders have droned on for the last several years about their intentions of putting a "firewall" around the banks and nations most afflicted by the euro zone debt crisis, nothing of the sort has occurred. In fact, the recent Long Term Repo Operation (LTRO) in Europe and ongoing easements in collateral rules make a massive outbreak of contagion more rather than less likely.

This is because systemic risk is increasingly becoming a function of the credit quality of the weakest banks, rather than the strongest. The ratings agencies' recent focus on the stronger banks such as the RBC only serve to underscore the point that these announcements are largely a sideshow.

Is the world now "safer" from financial calamity?

Nothing could be further from the truth.

As we know, mark-to-market rules have either been overtly suppressed by regulators in Europe and North America or ignored.

In fact, given the unrelenting stresses in the interbank markets in Europe and elsewhere, we are wondering whether we are close to an overt "event of diktat" similar to what was recently announced by the Chinese authorities. Not widely publicized, a particular example of how bad things are is given by China.

The authorities there have recently commanded the banks to roll over maturing loans to local authorities in full knowledge that they are non-performing and cannot be, and will not be, paid back even under the rosiest of scenarios because they are backed by asset positions that are largely worthless and non-income producing. In the wake of the global financial crisis, Chinese Banks lent the equivalent of 25 per cent of Chinese GDP to local authorities. This is not a small problem.

Having the central government tell the Chinese banks to pretend that the loans are sound will not make them pay off nor reduce the eventual hit that the banks will have to take. It only postpones the inevitable day of reckoning and contributes to further uncertainty.

A notch or two off RBC's rating or on the ratings of similar banks is hardly an issue that anyone should lose sleep over.

Around the Web

RBC at risk of two-notch downgrade: Moody's - The Globe and Mail

Moody's may downgrade RBC, other major banks - CBC.ca

Moody's reviewing ratings of RBC, other big banks | CTV News

RBC: Moody's action 'unwarranted' | FP Street | News | Financial Post

Royal Bank of Canada Credit Rating - Moody's