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. Under the new Canadian Bank Recapitalization Regime, DBRS expects to eventually remove the uplift from systemic support once the Bank has issued a sufficient level of bail-inable senior debt, which would thereby provide an adequate buffer for non-bail-inable obligations and would then be expected to offset the removal of systemic support.

KEY RATING CONSIDERATIONS
The ratings reflect Scotiabank’s highly diversified franchise, which is underpinned by its position as the third-largest bank in Canada, with total assets of $1,034 billion as at January 31, 2019. With its expanding international banking franchise that is focused on high-growth markets such as Mexico, Peru, Chile and Colombia, Scotiabank generates the highest percentage of earnings outside of Canada (at 44% in F2018) compared with Canadian bank peers. In addition, Scotiabank’s ratings are supported by the Bank’s conservative risk profile with sound asset quality, a well-managed funding and liquidity profile and solid capital levels. The ratings also consider the potential for greater volatility in earnings given the larger contribution to earnings from the Bank’s international markets, as well as the challenging operating environment that is constrained by moderating global growth, low interest rates, weakness in oil prices and the potential for a housing downturn in Canada.

RATING DRIVERS
DBRS views Scotiabank as being well placed in its current rating category. Over the longer term, DBRS sees positive ratings pressure if Scotiabank successfully integrates recent acquisitions and continues to build its franchise strength resulting in a sustained improvement in the financial performance of the Bank without substantially increasing its overall risk profile.

Negative ratings pressure could arise if there is a perceived increase in risk appetite or a sustained deterioration in asset quality, especially from deficiencies in risk management. A sustained weakening of profitability metrics could also result in negative ratings pressure.

RATING RATIONALE
Scotiabank has continued to generate solid underlying earnings, supported by its well-diversified franchise. Specifically, net income for F2018 was $8.7 billion, which increased 6% compared with last year (up 9% on an adjusted basis). The increase in earnings largely reflects solid revenue growth, disciplined expense management and the impact of recent acquisitions. Overall, Scotiabank generated solid returns with a return on average common equity of 14.4% in F2018, which was flat compared with last year (up 20 basis points on an adjusted basis to 14.9%). In F2018, the Bank’s Canadian Banking business contributed almost half (49%) of consolidated earnings, while the International Banking and Global Banking and Markets businesses accounted for approximately 31% and 20%, respectively, of total consolidated earnings. DBRS acknowledges that Scotiabank’s capital markets and international businesses can add some volatility to earnings. Nonetheless, these businesses have been well managed and profitable over the long term.

Overall, Scotiabank has a conservative risk profile with strong asset quality as well as manageable levels of provisions for credit losses (PCL) and impaired loans. This reflects the Bank’s strong risk culture and the current benign credit environment. In Q1 2019, gross impaired loans (GIL) as a percentage of gross loans and acceptances and PCL as a percentage of average loans and acceptances remained relatively stable at 0.90% and 0.47%, respectively. DBRS views these metrics as manageable and in line with the Bank’s five-year average for these ratios. Scotiabank’s credit quality metrics tend to be slightly weaker than its Canadian bank peers, which reflects the Bank’s greater exposure to emerging markets such as the Pacific Alliance region; however, DBRS views this credit risk as historically well managed by Scotiabank given its lengthy operating history in this region. The Bank has been exiting countries where it lacks scale, or which are considered non-core, in an effort to simplify Scotiabank’s geographic footprint and reduce operational risk. Moreover, while the current credit environment remains strong, DBRS expects the Bank’s PCL and GIL ratios to revert to a higher level over time, although these ratios are expected to remain within manageable levels. In addition, given the size and number of acquisitions Scotiabank has made in recent periods, the Bank is exposed to an increasing level of integration risk. However, this exposure is somewhat mitigated, as the acquisitions are largely in different areas of the Bank, and Scotiabank has a track record of successfully integrating previous acquisitions.

DBRS remains concerned over the combination of highly leveraged consumers and elevated home prices in the Greater Toronto Area (GTA) and the Greater Vancouver Area (GVA). Currently, new regulations and higher interest rates are having manageable impacts in both of these markets. DBRS notes that home sales were down in 2018 in both the GTA and GVA. Overall home prices declined in March 2019, particularly in the GVA, whereas prices rose modestly in the GTA. Prices remain vulnerable to a correction. As a result, DBRS views Scotiabank, like its Canadian bank peers, as also susceptible to any adverse changes in the Canadian real estate market. Overall, the Bank’s exposure to real estate-secured lending in Canada, which comprises residential mortgages and home equity lines of credit, represented 40% of total loans and acceptances as at January 31, 2019, compared with the Canadian bank peer average of 44%. Also similar to the large Canadian banks, Scotiabank’s real estate-secured portfolio appears conservatively underwritten, with 39% of the Canadian real estate-secured lending portfolio insured. Moreover, the uninsured portfolio has a loan-to-value ratio of 55%.

DBRS views Scotiabank as having a sound and well-managed funding and liquidity profile given that it is underpinned by a diverse mix of retail deposits and wholesale funding. Scotiabank maintains ready access to both retail and wholesale funding. While Scotiabank’s use of wholesale funding (as per DBRS’s definition) is slightly above the Canadian bank peer average, it remains within an acceptable range. Over the past two years, the Bank has made progress reducing its reliance on wholesale funding by increasing deposits. Scotiabank’s funding strategy ensures that its international banking subsidiaries are funded in their local markets. In addition, the Bank’s liquidity remains strong, with high-quality liquid assets representing 15.2% of total assets as at January 31, 2019. Scotiabank’s Q1 2019 Liquidity Coverage Ratio was 128%, well above the regulatory minimum of 100% and in line with its Canadian bank peers.

Capitalization at Scotiabank remains strong, as the Bank generates a significant level of internal capital, which supports its balance sheet growth. As at January 31, 2019, Scotiabank’s CET1 ratio was 11.1%, which was well above the minimum of 9.75% required by the Office of the Superintendent of Financial Institutions for domestic systemically important banks. In addition, Scotiabank’s Q1 2019 Leverage Ratio of 4.4% was well above the regulatory minimum of 3% and in line with its Canadian bank peers.

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.

DBRS notes that the above press release was amended on December 11, 2019, to adjust the language of the National Instrument 25-101 disclosure. The amendment was minor and would not impact the understanding of the reader.

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

The applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2018), which can be found on our website under Methodologies & Criteria.

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 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. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on this issuer took place on July 5, 2018, when DBRS confirmed the Bank’s ratings.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Lead Analyst: Robert Colangelo, Senior Vice President, Canadian Banking Financial Institutions - Global Financial Institutions Group
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG, Global Financial Institutions Group

Initial Rating Date: December 31, 1980

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

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