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Rating Action:

Moody's Affirms Canada's Aaa Rating; Maintains Stable Outlook

02 Nov 2016

New York, November 02, 2016 -- Moody's Investors Service ("Moody's") has today affirmed Canada's Aaa government issuer ratings, the Aaa senior unsecured rating, the (P)Aaa senior unsecured MTN and shelf ratings, and the (P)P-1 short-term rating. The stable outlook is maintained.

The main factors supporting the rating affirmation are:

1. Canada's flexible and competitive economy, supported by exceptionally strong institutions and economic policy management, which underpins its capacity to absorb negative economic shocks and bolsters its robust growth potential

2. Moody's expectation that government debt ratios, including a low federal debt burden, will remain stable in the next two years and decline gradually in subsequent years, alongside the demand for Canadian assets from long-term investors which we expect to continue to foster stable financing conditions

3. Strong institutions that underpin a well regulated financial system that would absorb a potential housing shock with minimal fiscal costs for the government

The ongoing adjustment to a prolonged period of low oil and gas prices and somewhat slower growth in the US, combined with financial risks from rising house prices and household debt levels pose downside risks to our economic and fiscal projections. However, we base our stable outlook on the expectation that continued vigilance by Canadian authorities reflective of very strong institutions will succeed in mitigating such risks, thereby preserving Canada's Aaa sovereign credit profile.

A full list of affected ratings is provided towards the end of this press release.

RATINGS RATIONALE

FIRST DRIVER -- CONTINUED ECONOMIC RESILIENCE

Canada's flexible and competitive economy, supported by exceptionally strong institutions and economic policy management, bolsters its capacity to absorb negative economic shocks, as illustrated in the adjustment to lower oil and gas prices.

Prior to the oil price slump, nearly one third of fixed capital formation in the country had been in the energy sector. The decline in investment has resulted in weaker real GDP growth.

However, we expect the economy's flexibility and dynamism to generate sustained growth in household incomes and overall GDP. We expect GDP growth to average 1.7% annually in 2016-2018, broadly in line with the Aaa median, supported by domestic consumption, fiscal stimulus, accommodative monetary policy, and, to a lesser extent, a rebound in non-oil trade.

Adjustment has been facilitated by Canada's flexible exchange rate. The weaker Canadian Dollar (CAD) resulting from the terms of trade shock supports non-oil exports and dampens demand for imported goods. Meanwhile, ongoing robust growth in employment and wages supports incomes and consumption.

Over the longer term, Canada's growth potential is robust, underpinned by steady increases in the working age population, including a regular flow of immigrants. High competitiveness also points to robust productivity growth. Overall, we expect real GDP growth to average around 1.7% in the medium term, somewhat higher than in some other Aaa-rated sovereigns.

SECOND DRIVER --GOVERNMENT DEBT TO REMAIN STABLE, INCLUDING LOW FEDERAL DEBT BURDEN; OFFICIAL INVESTOR DEMAND FOR CANADIAN ASSETS FOSTERING STABLE FINANCING CONDITIONS

A number of features support fiscal strength at levels consistent with a Aaa rating. These include (a) the essentially stable general government debt burden in recent years and over the period 2016-17, followed by a gradual fall in subsequent years, (b) demand for Canadian assets for official reserve management purposes which supports debt affordability, and (c) relatively low direct obligations of the federal government relative to GDP and a very low probability that the federal government would need to provide substantial financial support to the provinces.

Canada's federal budget for fiscal 2016-2017 estimates a deficit of 1.2% of GDP, driven by a fiscal stimulus program to boost growth. The current Liberal government's budget represents a change in fiscal policy from the previous Conservative government, which had focused on budget surpluses. However, the projected deficits are relatively small and we expect them to narrow from 2018 onwards, a trend that will be reinforced by fiscal consolidation at the sub-sovereign level. The temporary shift in fiscal policy stance has not altered our view of the federal government's balance sheet strength.

We forecast that general government debt will remain essentially unchanged as a ratio to GDP in the next two years, before falling gradually as the fiscal stimulus is phased off after 2017 and nominal growth strengthens.

Furthermore, although the ratio of general government debt, at 78% of GDP as of year-end 2015, is higher than the 38% median for Aaa-rated sovereigns, the federal government's own ratio is only 34%. The proportion of provincial and municipal debt in total general government debt is the highest of any country rated Aaa by Moody's. Provinces have high stand-alone ratings, indicating a very low probability that financial support from the federal government would be needed.

Furthermore, we note that Canada is increasingly benefiting from demand for Canadian dollar-denominated assets for official reserves management. The IMF's data on the currency composition of official foreign exchange reserves indicate that foreign central bank holdings of Canadian dollar assets (mainly federal government securities, but also some provincial securities) have risen to the equivalent of USD149 billion, equal to about one fourth of federal debt. Increased demand from foreign central banks and sovereign wealth funds has expanded the investor base for Canada's bonds, fostering stable financing conditions for the government.

In the long run, Canada's benign debt trajectory will also be supported by its largely funded pension systems. A total asset base of approximately 21% of GDP has been accumulated by government public sector pension plans, including 5% of GDP at the federal level. Separately, the Canada Pension Plan (CPP), Canada's universal social insurance program, has accumulated CAD 348 billion in assets (CAD 279 billion in net terms). The latest actuarial assessment puts CPP's funding level at 99.6%, indicating that the system is sustainable without additional injections from the federal government or legislative changes to taxes or benefits.

THIRD DRIVER -- STRONG INSTITUTIONS THAT UNDERPIN A FINANCIAL SYSTEM WELL PLACED TO DEAL WITH POTENTIAL HOUSING SHOCK

With persistently high profitability, capitalization levels and asset quality, Canada's banking system continues to maintain high intrinsic strength. At a2, the system's asset-weighted average Baseline Credit Assessment (BCA) -- banks' standalone intrinsic strength, without external support - is currently among the highest in the world.

Although mortgage debt nearly doubled in the past 10 years, reaching 65% of GDP in 2015, several structural features of the system minimize the risk stemming from the housing market from both banks' and the sovereign's perspective. In particular, legal requirements on down-payments limit the risks that a significant proportion of households would fall into negative equity. Moreover, insurance on high loan-to-value ratio mortgages is mandatory. This implies that uninsured residential mortgages represent only 11% of the system's balance sheet. Prevalence of full-recourse mortgages, low levels of securitization, and the small size of the subprime segment further minimize the likelihood of systemic distress. In addition, our analysis indicates that, even in scenarios of severe housing market stress, the two largest mortgage insurers, which cover 95% of the market, will remain compliant with the minimum capital test ratio.

Prudent financial oversight prevented the formation of a large subprime mortgage market and proliferation of sub-standard lending practices in the run-up to the global financial crisis. More recently, the government has been adopting new macro prudential policies to safeguard itself, the banking system, and households from risks related to rising housing prices and household debt. The measures range from enhanced stress testing, to stricter mortgage insurance standards, to, potentially, new risk sharing arrangements.

RATIONALE FOR STABLE OUTLOOK

The outlook for Canada's rating is stable supported by Canada's very strong institutions that foster a timely and effective response to shocks. In particular, while GDP growth would likely slow should house prices fall significantly as construction activity fell and negative wealth effects dampened consumption, banks' and mortgage insurers' financial strength would limit the fiscal costs to the government to minimal amounts. More generally, demonstrated capacity to adjust fiscal, monetary and economic policy to buffer the economic impact of negative shocks points to resilience of Canada's credit metrics at levels consistent with a Aaa rating.

Canada's net international investment surplus provides additional resilience to its economy and credit profile. This is the result of greater outward investment, a depreciating Canadian dollar (a considerable portion of the liabilities are denominated in Canadian dollars, while the assets are in foreign currencies), and strong equity returns in the US.

FACTORS THAT COULD LEAD TO A RATING DOWNGRADE OR NEGATIVE OUTLOOK

Canada's rating is unlikely to move down in the near future, as the stable rating outlook suggests. Over the long term, should the political consensus on maintaining sound public finances erode and government debt ratios rise further to elevated levels, the government's rating could come under pressure. In addition, material deterioration of Canada's long-term economic potential and resilience to economic shocks, that impairs affordable financing from international investors and the health of the financial system, would be credit negative.

GDP per capita (PPP basis, US$): 45,602 (2015 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 1.1% (2015 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 1.3% (2015 Actual)

Gen. Gov. Financial Balance/GDP: -1.3% (2015 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -3.2% (2015 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: Very High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 31 October 2016, a rating committee was called to discuss the rating of the Government of Canada. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially weakened. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer has become less susceptible to external event risks.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2015. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

LIST OF AFFECTED RATINGS

Issuer: Government of Canada

..Affirmations:

.LT Issuer Rating, Affirmed Aaa

.Senior Unsecured Regular Bond/Debenture, Affirmed Aaa

.Senior Unsecured MTN, Affirmed (P)Aaa

.Senior Unsecured Shelf, Affirmed (P)Aaa

.Other Short Term, Affirmed (P)P-1

.Outlook, Remains Stable

Issuer: Strait Crossing Finance, Inc.

..Affirmations:

.BACKED Senior Unsecured, Affirmed Aaa

.No Outlook

Issuer: Petro-Canada Ltd.

..Affirmations:

.BACKED Senior Unsecured, Affirmed Aaa

.BACKED Senior Unsecured Shelf, Affirmed (P)Aaa

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Gabriel Torres
VP - Senior Credit Officer
Financial Institutions Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Atsi Sheth
MD - Sovereign Risk
Financial Institutions Group
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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