DBRS Confirms National Bank at AA (low) and R-1 (middle)

DBRS has today confirmed the ratings of National Bank of Canada (National or the Bank), including its Deposits & Senior Debt at AA (low) and Short-Term Instruments at R-1 (middle); the trends are Stable. National continues to maintain its strong regional franchise in Québec, with particular emphasis on its retail, small business, commercial banking and wealth management businesses. While strong market shares in the home province remain a key strength of the Bank, the rating reflects the Bank’s regional concentration in Québec, which accounted for 68% of its revenues in 2010, up from an average of 64% over the previous four years. National’s revenue is diversified by business line: the Bank generated 48% of earnings for the first three quarters of 2011 (excluding the Other segment) from the personal and commercial banking unit, 39% of earnings from the financial markets business and 13% from its wealth management operations.

National is more exposed to capital market and trading revenue than its peers, which could result in earnings volatility. While the Bank continues to have material exposure to Master Asset Vehicle notes (the MAV Notes), which were created by the conversion of non-bank-sponsored asset-backed commercial paper (ABCP) covered under the Montréal Accord, further material deterioration from current levels would be necessary to have capital implications for the Bank.

National has been active in the acquisition area, with the July 2011 purchase of Wellington West Holdings Inc. (Wellington West) and the announcement of a deal to acquire the full-service investment advisory business of HSBC Securities (Canada) Inc. (HSBC) in September 2011 (scheduled to close in December 2011, pending regulatory approvals). Both acquisitions augment the Bank’s wealth management division and both improve geographic diversification outside of Québec. The acquisitions increase the scale of National Bank Financial’s existing business, with the number of investment advisors rising from 775 at year end to approximately 1,060 (including the HSBC advisors).

National’s adjusted income increased 20% in the first nine months of 2011 compared with the same prior-year period on generally strengthening revenues, lower expense growth than revenue growth and lower loan loss provisions. The adjusted return on equity strengthened from 16.6% to 17.4% in the first nine months of 2011 compared with the first nine months of 2010, following an improvement from 15.6% in 2009 to 17.0% in 2010.

National’s asset quality metrics with respect to its lending operation outperformed most of its peers through the recession and continue to do so, in part reflecting the Québec economy’s comparative resilience through the downturn.

The Bank’s capital metrics are solid and largely stronger than its peers. Management is well advanced in assessing the impact of Basel III, with the Q3 2011 Tier 1 ratio of 13.90% expected to be the equivalent of a Basel III common equity Tier 1 ratio of 8.00% (including the effect of International Financial Reporting Standards (IFRS)). The proposed acquisition of the full-service investment advisory business of HSBC will reduce the ratio by a further 40 basis points, although it is still in excess of 7.0%.

National’s Deposits & Senior Debt rating at AA (low) is composed of an intrinsic assessment of A (high) and a support assessment of SA2 (reflecting the expectation of systemic and timely external support by the government of Canada), which results in a one-notch increase from the intrinsic assessment for both the Deposits & Senior Debt and the Subordinated Debt ratings.

Notes:
The Cumulative Preferred Shares rating is notional as there are no outstanding shares.

All figures are in Canadian dollars unless otherwise noted.

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations, Rating Bank Preferred Shares and Equivalent Hybrids and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, which can be found on the DBRS website under Methodologies.