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

DBRS Limited (DBRS Morningstar) confirmed the ratings of The Bank of Nova Scotia (Scotiabank or the Bank) and its related entities, including Scotiabank’s Long-Term Issuer Rating at AA and Short-Term Issuer Rating at R-1 (high). The trend on all ratings is Stable. Scotiabank’s Long-Term Issuer Rating, which is composed of an Intrinsic Assessment (IA) of AA (low) and a Support Assessment (SA) of SA2, reflects the expectation of timely, systemic support from the Government of Canada (rated AAA with a Stable trend by DBRS Morningstar). With the SA2 designation, this results in a one-notch lift to the Bank’s Long-Term Issuer Rating. Once the Bank has issued a sufficient level of Bail-inable Senior Debt to provide for an adequate buffer for nonbail-inable obligations under the Canadian Bank Recapitalization Regime, DBRS Morningstar expects to remove the uplift from systemic support.

KEY RATING CONSIDERATIONS
The ratings are underpinned by Scotiabank’s highly diversified franchise, which includes an international banking franchise that is focused on the high-growth markets of Mexico, Peru, Chile, and Colombia (the Pacific Alliance region). While the Bank ranks as the third largest in Canada based on total assets, Scotiabank generates one of the highest percentage of earnings outside of Canada at 45% compared with its Canadian bank peers. In addition, the Bank’s ratings are supported by Scotiabank’s conservative risk profile with sound risk-management practices; a well-managed funding and liquidity profile, which benefits from a stable deposit base; and strong capital levels. The ratings also consider the potential for some earnings volatility, reflecting the larger contribution to earnings from the Bank’s international markets, although Scotiabank has exited over 20 countries that were viewed as either low-return, small in scale, or high-risk operations.

DBRS Morningstar will continue to monitor the developing situation and potential impact of the Coronavirus Disease (COVID-19) pandemic as it will negatively impact the Bank's revenue, earnings, and asset quality, reflecting the wide and growing scale of the economic disruption it has caused. Nevertheless, there has been unprecedented support measures put in place by governments and regulators around the globe, which will mitigate some of the negative impacts of this crisis. Additionally, Scotiabank is entering this downturn from a position of strength with a strong balance sheet.

RATING DRIVERS
Given the coronavirus pandemic, an upgrade is unlikely at this time. Conversely, the ratings would be downgraded if there is a sustained deterioration in asset quality, especially from deficiencies in risk management or a prolonged adverse impact from the coronavirus pandemic, which would have a significant impact on profitability.

RATING RATIONALE
Scotiabank generates solid underlying earnings, which is supported by its highly diversified franchise and contributes to the Bank's ability to absorb credit losses. In F2019, earnings were $8.8 billion, generating a solid return on average common equity of 13.1%. DBRS Morningstar notes that the operating environment remains highly pressured due to the coronavirus pandemic, which will negatively impact the Bank's earnings, revenue and asset quality metrics.

DRBS Morningstar views Scotiabank's risk profile as conservative given its historically strong asset quality. Nonetheless, the Bank has slightly weaker asset quality metrics compared with its Canadian bank peers, which reflects Scotiabank's greater exposure to emerging markets including the Pacific Alliance region. However, DBRS Morningstar notes that this credit risk has been historically well managed as a result of its long-standing operating history in this region. In addition, the Bank has simplified its operating structure and geographical footprint by exiting a number of countries that were not considered core or where it lacked scale, thereby reducing overall operational risk. We will continue to monitor the adverse impact of the coronavirus pandemic on the economies of both Canada and the Pacific Alliance region as well as its potential impact on Scotiabank’s credit fundamentals.

The Bank has a strong funding and liquidity profile, which benefits from a solid retail deposit base. Scotiabank also makes use of wholesale funding, with this usage being slightly above the Canadian bank peer average. Nonetheless, DBRS Morningstar views this usage as within an acceptable range and notes that over the last few years, Scotiabank has strategically reduced its wholesale funding reliance while remaining focused on raising additional deposit funding. In addition, the Bank ensures that its international banking subsidiaries are funded in their local markets. Liquidity at Scotiabank remains strong with a liquidity coverage ratio in Q1 2020 of 127%, which is well above the regulatory minimum.

Scotiabank's capitalization remains strong reflecting its significant levels of internal capital generation, which provides the Bank the ability to support its customers during this ongoing pandemic. Scotiabank's Common Equity Tier 1 (CET1) ratio of 11.4% in Q1 2020 remains well above regulatory minimums and is also in line with the Canadian bank peer average. On March 13, 2020, the Office of the Superintendent of Financial Institutions (OSFI) lowered the Domestic Stability Buffer (DSB) requirement for Domestic Systemically Important Banks (D-SIBs) to 1.0%, which effectively reduces the CET1 regulatory minimum to 9.0% for D-SIBs. As the DSB was intended, OSFI is providing the D-SIBs with more flexibility to extend loans to their customers during the coronavirus pandemic. Simultaneously, OSFI announced that it expects all D-SIBs to halt any new dividend increases and common share buyback activity.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

The Grid Summary Grades for The Bank of Nova Scotia are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Strong; Risk Profile – Strong; Funding & Liquidity – Strong; Capitalization – Very Strong/Strong.

DBRS Morningstar notes that this press release was amended on July 6, 2020, to incorporate the link to the methodology.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 11, 2019; https://www.dbrsmorningstar.com/research/346375/global-methodology-for-rating-banks-and-banking-organisations).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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.dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar 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 (DBRS Morningstar) 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 April 26, 2019, when DBRS Morningstar confirmed the Bank’s ratings.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

For further information on DBRS Morningstar 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
Rating Committee Chair: Michael Driscoll, Managing Director
Initial Rating Date: December 31, 1980

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