DBRS Confirms Bank of Nova Scotia at AA with a Stable Trend

DBRS Limited (DBRS) confirmed the ratings of the Bank of Nova Scotia (Scotiabank or the Bank) and its related entities, including Scotiabank’s Long-Term Issuer Rating of AA and Short-Term Issuer Rating of R-1 (high). The trend on all ratings is Stable. Scotiabank’s Long-Term Issuer Rating is composed of an Intrinsic Assessment (IA) of AA (low) and a Support Assessment (SA) of SA2, reflecting the expectation of timely, systemic support from the Government of Canada (rated AAA with a Stable trend by DBRS). The SA2 designation results in a one-notch lift to the Long-Term Issuer Rating. However, following the finalization of the Canadian Bank Recapitalization Regime, DBRS eventually expects to remove the uplift from systemic support. This will be actioned once a sufficient level of bail-inable senior debt is issued, thereby providing an adequate buffer for non-bail-inable obligations, which is then expected to offset the removal of systemic support (see the press release “DBRS Takes Rating Actions on Six Canadian Banking Groups after Finalization of Bail-In Regime,” dated April 19, 2018).

KEY RATING CONSIDERATIONS
The confirmation of the ratings reflects Scotiabank’s highly diversified franchise, which is underpinned by its position as one of Canada’s largest banks, with total assets of $926.3 billion as at April 30, 2018. In addition, Scotiabank has a fast-growing international banking franchise that is focused on high growth markets such as Mexico, Peru, Colombia and Chile (the Pacific Alliance region). The Bank continues to expand its international business through recently announced acquisitions that will enhance Scotiabank’s market position. Of the large Canadian banks, Scotiabank generates the highest percentage of earnings outside of Canada at 44% in F2017 compared with the average for its Canadian bank peers of 31%. In addition, Scotiabank’s ratings are further supported by its strong risk culture, a diverse mix of funding, a strong liquidity profile and robust capitalization. Scotiabank’s retail lending in Canada, similar to its Canadian bank peers, exposes it to a potential downturn in the consumer segment, reflecting any adverse changes in the Canadian real estate market or Canadian consumer behaviour. Furthermore, the ratings reflect the potential for greater economic volatility in Scotiabank’s international markets.

RATING DRIVERS
DBRS views Scotiabank as being well placed in its current rating category. Over the longer term, DBRS sees the potential for positive rating pressure if Scotiabank successfully integrates recent international acquisitions, which leads to a significant increase in the financial performance of its international franchise without substantially increasing its risk profile. In addition, positive rating pressure could arise if Scotiabank outperforms its global peers while maintaining sound underwriting standards.

Negative rating pressure could arise if there is a severe downturn in the economy that leads to a sustained deterioration in asset quality, especially from deficiencies in risk management or underwriting. Moreover, a significant increase in risk appetite in Scotiabank’s international banking franchise that leads to a material increase in impaired loans could pressure the rating.

RATING RATIONALE
Scotiabank’s diversified business model continues to support earnings growth and contributes to the Bank’s ability to absorb even significant credit losses. In H1 2018, Scotiabank’s earnings of $4,514 million increased a strong 11% compared with the same period last year. In F2017, the Bank derived about half (49%) of its consolidated earnings from the Canadian Banking business, while the International Banking business accounted for approximately 29% of earnings and the Global Banking and Markets business contributed 22% of total earnings. While the nature of the Global Banking and Markets business is potentially more volatile given its exposure to capital markets, 50% of the revenue for this segment is derived from Business Banking, which is viewed as more stable.

Asset quality remains sound with provisions for credit losses and impaired loans remaining at low levels, reflecting Scotiabank’s strong risk culture and the benign credit environment. As of April 30, 2018, gross impaired loans (GIL) as a percentage of gross loans and acceptances were at a manageable 0.95%, which was an improvement of 11 basis points (bps) compared with last year. In addition, the annualized H1 2018 provision for credit losses (PCL) as a percentage of average loans and acceptances was 0.42%, which is in line with the Bank’s five-year average. Given Scotiabank’s greater exposure to emerging markets, credit quality metrics tend to be higher than its Canadian bank peers. However, DBRS views credit risk as being well managed by the Bank. Scotiabank, along with the other large Canadian banks, adopted IFRS 9 at the beginning of F2018, and DBRS expects this may lead to more volatility in PCL. Moreover, the credit environment remains strong, and DBRS expects the PCL and GIL ratios to revert to a higher level over time.

DBRS remains concerned over elevated housing prices, particularly in and around Toronto and Vancouver, and the potential impact of a real estate market correction on the Canadian economy and consumer-related loan portfolios, especially given the level of Canadian household indebtedness. As a result, Scotiabank may be susceptible to any adverse changes in the Canadian real estate market. Scotiabank’s exposure to real estate-secured lending in Canada, which is composed of residential mortgages and home equity lines of credit, represented 43% of total loans and acceptances as at April 30, 2018. This is in line with Canadian bank peers where Canadian real estate-secured lending represents, on average, 46% of their respective loan portfolios. Nonetheless, similar to all large Canadian banks, Scotiabank’s real estate-secured portfolio appears conservatively underwritten, with 43% of Scotiabank’s Canadian real estate-secured lending portfolio insured. In addition, the uninsured portfolio has a loan-to-value ratio of 54%.

Scotiabank’s strong funding and liquidity profile is underpinned by a diverse mix of retail deposits and wholesale funding. The Bank’s use of wholesale funding, as per DBRS’s definition, is at the high end of Canadian bank peers, although it is still in an acceptable range. In addition, DBRS notes that Scotiabank’s strategy is to ensure that its international banking subsidiaries are funded in their local markets. The Bank’s liquidity remains strong with a Liquidity Coverage Ratio of 127% in Q2 2018.

Capitalization remains robust, as Scotiabank continues to generate significant internal capital, which supports balance sheet growth and positions the Bank for ongoing business expansion. Scotiabank reported a Common Equity Tier 1 (CET1) ratio of 12.0% at April 30, 2018, which increased 80 bps compared with the prior quarter, largely reflecting the removal of the Basel I floor and strong internal capital generation. In addition, Scotiabank’s Leverage Ratio of 4.8% in Q2 2018 improved 20 bps compared with the linked quarter. DBRS notes that both the Bank’s CET1 and leverage ratio are comfortably above regulatory minimums and are ahead of the large Canadian bank peer average of 11.4% and 4.3%, respectively. DBRS does expect capital ratios to decline as the Bank completes pending acquisitions.

The Grid Summary Grades for Scotiabank are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Very Strong/Strong; Risk Profile – Strong; Funding & Liquidity – Strong; Capitalisation – Very Strong/Strong.

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 methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017), which can be found on dbrs.com under Methodologies.

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

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

Lead Analyst: Robert Colangelo, Senior Vice President, Canadian Banking Financial Institutions - Global Financial Institutions Group
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer - Global FIG and Sovereign Ratings
Initial Rating Date: December 31, 1980

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Bank of Nova Scotia and related entities: