DBRS Confirms National Bank of Canada at AA (low); Trend Remains Negative

DBRS Limited (DBRS) has today confirmed the ratings of National Bank of Canada (National or the Bank) and its related entities, including its Issuer Rating and Deposits & Senior Debt rating at AA (low) and the Short-Term Instruments rating at R-1 (middle). Trends on senior long-term debt and subordinated debt remain Negative, while trends on short-term instruments and other capital instruments are Stable. Confirmation of the ratings follows a detailed review of the Bank’s operating results, financial fundamentals and future prospects.

National’s ratings are supported by its super-regional presence with particular strength in its home province of Québec. National businesses include Wealth Management and Financial Markets. The Bank’s strong earnings are well diversified by business and include a high component of fee-based revenues. Moreover, the balance sheet remains sound, underpinned by currently healthy asset quality, funding and capital. The ratings also consider National’s relative concentration in Québec, as well as its relatively large capital markets business segment that could contribute to more volatile earnings.

The Bank’s Deposits & Senior Debt rating of AA (low) is composed of an intrinsic assessment of A (high) and support assessment of SA2, reflecting the expectation of timely, systemic support by the Government of Canada (rated AAA, Stable trend by DBRS). The SA2 ranking results in a one-notch benefit to the Deposits & Senior Debt rating. The continued Negative trend reflects DBRS’s view that anticipated changes in Canadian legislation and regulation mean that the potential for timely support for systemically important institutions is declining and is likely to eventually result in a change in DBRS’s support assessment to SA3 from SA2 for this institution. The legislation enacting the bank recapitalization, or bail-in, regime is moving forward, but DBRS does not yet have sufficient clarity on the details of the implementation to remove the benefit of systemic support from the affected ratings.

National’s currently strong earnings power benefits from a very good revenue mix, modestly improving expense levels and generally low credit costs. However, National reported two issues in 2016 that have negatively affected earnings, including the $164 million pre-tax write-down of its investment in Maple Financial Group (MFG) and a $250 million pre-tax sectoral provision related to its oil & gas portfolio. Please see the DBRS commentaries on these two events dated May 5, 2016, and February 8, 2016, for more information.

Notwithstanding recent challenges in oil & gas, asset quality metrics have remained generally strong. Indeed, credit quality indicators such as gross impaired loans and write-offs indicate that National is currently performing at or near the top end of the peer group. Nevertheless, its portfolio is less diverse geographically than the other large banks, making the Bank more susceptible to economic weakness in Canada, especially within Québec. While market risk appears well controlled, the growing importance of National’s capital markets business segment also exposes National to increased risk from significant market downturns or other adverse events.

The funding and liquidity profile for National remains favourable as a result of its diversified funding base, with a reasonable level of wholesale funding and a strong liquidity level as measured by the Liquidity Coverage Ratio, which was 135% for the quarter ended April 30, 2016, the highest of the Canadian large banks.

Capital levels are strong, although the recently increased minimum requirements instituted by the Office of the Superintendent of Financial Institutions (OSFI) have reduced the Bank’s excess capital buffers. The MFG write-down and the large sectoral provision had an adverse impact on capital levels, although a $300 million common equity issuance in Q4 2015 largely mitigated the impact. Overall, National reported a sound CET 1 Ratio of 9.75% at April 30, 2016, which trails the other large Canadian banks but is 175 basis points above the OSFI minimum.

RATING DRIVERS
If support is removed, National’s long-term ratings would likely be downgraded. On an intrinsic basis, upward ratings momentum is unlikely, as DBRS views the Bank as being well placed within its rating category. Over the longer term, increased geographic diversification within Canada may be viewed positively. Conversely, an increase in risk appetite or evidence of a significant increase in risk in the capital markets business would likely have negative ratings implications.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrs.com.

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (December 2015), Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016) and DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2016), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial LC. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

For more information on this credit or on this industry, visit www.dbrs.com.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.

Lead Analyst: Robert Long
Rating Committee Chair: Roger Lister
Initial Rating Date: March 31, 1981
Most Recent Rating Update: July 16, 2015