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Scotia downgraded, RBC’s outlook revised as rating agencies see risks

Two of Canada’s biggest banks have attracted the attention of credit rating agencies. Bank of Nova Scotia was downgraded one notch by Moody’s over what it calls a “shift away from the bank’s traditionally low risk appetite.”

This comes amid Scotia’s growth in credit card and auto finance activities – both of which Moody’s says are especially prone to deterioration when the economy weakness.

The move came just a few hours after Fitch revised its outlook on RBC to negative due to potential earnings volatility.

Moody’s Investors Service downgraded the long-term debt of Bank of Nova Scotia on Monday evening, by one notch, but it wasn’t out of concern about the bank’s exposure to low oil prices and the weak Canadian economy.

Instead, the downgrade was related to the bank’s expansion into credit cards and auto loans.

Moody’s lowered its rating on Scotiabank to Aa3 from Aa2, putting the former second-highest-rated bank debt on the same level as Royal Bank of Canada, Bank of Montreal and Canadian Imperial Bank of Commerce.

The credit rating agency had put Scotiabank under review for a potential downgrade in November, warning that the bank was moving beyond its traditional low-risk domestic operations and into businesses that can be more profitable during good times but also vulnerable to economic downturns.

“Over the last two years, in accordance with its strategic initiatives, Scotiabank has accelerated the growth in its credit card and auto finance portfolios – both of which are particularly prone to deterioration during an economic downturn and exhibit higher defaults and loss severities than mortgage portfolios,” Moody’s said in a release accompanying Monday’s downgrade.

It also noted that some of these initiatives have been made in international markets that Moody’s says are higher growth but less stable, perhaps alluding to the 2015 deal for the Chilean financial services division of Cencosud SA, a Latin American retailer.

“Scotiabank has aspirations to continue to grow its international earnings, which in Moody’s view adds to bondholder risk,” the agency said.

As for subsequent changes, Moody’s believes that the bank’s high credit rating – only Toronto-Dominion Bank is rated higher, among the Big Six banks – makes an upgrade unlikely. Downward pressure, though, could come from an additional push into these higher-risk areas.

Scotiabank executives made it clear during the bank’s recent investor day presentations in Mexico City that it was keen to expand further into the four-nation Pacific Alliance of Mexico, Colombia, Chile and Peru, where credit cards hold a particular attraction. Indeed, they expect the bank will increase its profit from the region between 9 per cent and 11 per cent a year over the next three-to-five years.

“But, to be clear, the way we manage risk in international banking is similar to Canada,” Dieter Jentsch, group head of international banking, said last week. “We have the same risk management principles, oversight, and governance in both retail, corporate and commercial banking that parallel what we have in Canada.”

Meanwhile, Fitch revised Royal Bank’s outlook to negative from stable. The ratings agency said RBC’s credit performance and future earnings volatility may be higher than its global and domestic peers.

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