DBRS Places RBC’s Non-Cumulative First Preferred Shares, Series W Under Review – Negative

DBRS has today placed the Non-Cumulative First Preferred Shares, Series W (the Convertible Preferred Security) of Royal Bank of Canada (RBC or the Bank) Under-Review with Negative Implications. The Convertible Preferred Security is convertible to common equity at the issuer’s option. Today’s action applies only to the Convertible Preferred Security that DBRS rates; all other preferred share ratings of the Bank are unaffected.

The rating action follows the revision of how DBRS views the elevated risk of conversion in an environment where the Office of the Superintendent of Financial Institutions Canada (OSFI) is encouraging Canadian banks to put in place resolution mechanisms, including the release of the OSFI Advisory on Non-Viability Contingent Capital, issued August 16, 2011 (NVCC Advisory), and the regulator’s ongoing push toward loss absorption from capital instruments, including convertible preferred securities, to generate common equity prior to the declaration of non-viability by OSFI. On conversion, there is the potential for the holder of this instrument to incur losses.

Historically, DBRS did not distinguish between series of preferred securities that had or did not have a covenant to convert into common shares at the option of the issuer. This rating action does not reflect any specific credit event for the issuer or related entities.

The primary source of guidance in resolving the Under Review status will be the application of DBRS’s existing rating methodology Rating Bank Subordinated Debt and Hybrid Capital Instruments with Contingent Risks. In this methodology, DBRS looks to the likelihood of conversion and the expected losses as a result of the conversion.

Our review will consider the changing Canadian regulatory landscape as it relates to resolution mechanisms, the ability of the issuer to convert the preferred shares into common equity and the expected losses incurred as a result of the conversion. Additionally, the review will incorporate whether convertible preferred securities will have wider notching, based on the global standard notching for preferred shares, because of additional risk associated with conversion. As guidance, subordinated debt non-viability contingent capital will likely be rated no higher than the standard rating for preferred shares and the preferred share non-viability contingent capital will likely be rated one notch below the standard rating for preferred shares.

For clarity, global standard notching for preferred shares means the starting point for notching preferred share ratings is the intrinsic assessment (IA) rating rather than the final senior debt rating, and the degree of notching from the IA rating to the preferred share rating widens to reflect our perception of the increased risk in these capital instruments. The base notching policy is three notches for AA, four notches for “A” and five notches for BBB and lower IA ratings. Note that when DBRS implemented the changes in the preferred share methodology, on June 29, 2009, to increase the base notching at even the strongest rating categories and the expansion of the base notching as the credit quality of the bank migrates downward, most banks in Canada had their preferred share ratings downgraded to only one notch above the global standard notching for preferred shares.

The principal methodologies applicable are the Global Methodology for Rating Banks and Banking Organisations (January 2010), Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments (February 2009), Rating Bank Preferred Shares and Equivalent Hybrids (June 2009) and Rating Bank Subordinated Debt and Hybrid Capital Instruments with Contingent Risks (April 2010), which can be found on www.dbrs.com under Methodologies.

The sources of information used for this rating action include information provided by Royal Bank of Canada, the Office of the Superintendent of Financial Institutions Canada, the Basel Committee on Banking Supervision and the Financial Stability Board. DBRS considers the information available to it for the purposes of providing this rating action to be of satisfactory quality.

For additional information on this rating, please see DBRS Limited: Banks and Banking Organisations Linking Document by clicking the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.

Lead Analyst: Brenda Lum
Rating Committee Chair: Kent Wideman
Initial Rating Date: January 31, 2005
Most Recent Update: July 15, 2011