Five big Canadian banks and a credit union were downgraded Monday by Moody's rating agency, which believes they will be more vulnerable than in the past if there's a major shock to the economy.
The downgrades, which Moody's had warned were likely to happen, reflect the agency's ongoing concern that Canadian household debt has risen to historical highs -- putting pressure on the institutions' mortgage businesses.
"The Canadian consumer is leveraged almost to the extent that the U.S. consumer was ahead of the housing crash down there some years ago," said Moody's vice-president David Beattie.
As a result, Moody's thinks it's likely that consumers will slow down their borrowing, a major source of business for the banks.
There's also a remote possibility defaults could jump to a dangerous level for the banks if there's a major economic shock that causes a lot of unemployment and a dramatic drop in real estate prices, he said.
"If we thought it was a higher probability, we wouldn't rank the banks as high as we do," Beattie said.
He noted the five banks and the Quebec-based Desjardins credit union remain among the most highly rated of those tracked by Moody's.
Toronto-Dominion Bank (TSX:TD) is the highest rated of the six, at AA1 (down from AAA). Scotiabank and Desjardins drop to AA2 (from AA1), CIBC (TSX:CM), Bank of Montreal (TSX:BMO) and National Bank (TSX:NA) slip to AA3 (from AA2).
A downgrade by a credit rating agency usually means investors will demand a higher interest rate when a company goes to raise cash by issuing bonds or other debt.
The rating agency said National, BMO and Scotiabank face additional risk from the amount of their profit that comes from capital markets operations, which lend large amounts to corporations and advise businesses on debt and stock issues.
Royal Bank wasn't on the list because its long-term deposit rating had already been dropped to Aa3 from Aa1 in June as part of a move to cut the credit ratings of 15 of the world's largest banks, including Bank of America, JPMorgan Chase, Citigroup and Goldman Sachs.