DBRS Limited (DBRS Morningstar) confirmed the ratings of National Bank of Canada (National or the Bank) and its related entities, including the Bank’s Long-Term Issuer Rating at AA (low) and Short-Term Issuer Rating at R-1 (middle). DBRS Morningstar also changed the trend on all ratings to Stable from Positive. National’s Long-Term Issuer Rating is composed of an Intrinsic Assessment of A (high) and a Support Assessment of SA2, reflecting the expectation of timely systemic support from the Government of Canada (rated AAA with a Stable trend by DBRS Morningstar). The SA2 designation results in a one-notch uplift to the Long-Term Issuer Rating. Once the Bank has issued a sufficient level of Bail-inable Senior Debt to provide for an adequate buffer for other obligations under the Canadian Bank Recapitalization Regime, DBRS Morningstar expects to remove the uplift from systemic support.
KEY RATING CONSIDERATIONS
The change in trend to Stable from Positive reflects DBRS Morningstar’s concern regarding the negative impact of the Coronavirus Disease (COVID-19) pandemic on 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, National is entering this downturn from a position of strength with a strong balance sheet.
The ratings recognize National’s dominance in its home province, the Province of Québec (Québec; rated AA (low) with a Stable trend by DBRS Morningstar), which has experienced strong economic growth in recent years, in addition to the successful expansion of the Bank’s footprint in targeted markets across the rest of Canada, especially in Wealth Management (WM) and Financial Markets (FM). Furthermore, the Bank benefits from strong pre-provision earnings, to which Personal and Commercial (P&C) and WM are now larger contributors, while transformation efforts in its P&C business and growth of its WM business have driven growth in client deposits. The ratings also consider the small yet growing contribution of the U.S. Specialty Finance and International (USSF&I) segment, which DBRS Morningstar views as having a higher risk profile, as well as more volatile earnings. Lastly, DBRS Morningstar notes that National’s FM business segment is an important contributor to the Bank’s franchise and could benefit from market volatility. However, although the majority of transactions are client driven, the segment’s activities could expose the Bank to increased capital markets risk from significant market downturns or other adverse events like the coronavirus pandemic.
An upgrade is unlikely in the short-term given the recent change in trend and challenging operating environment. However, an upgrade could occur should National manage to continue building its franchise and improving its operating performance while limiting the adverse impact on asset quality from the economic downturn.
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.
National continues to enjoy positive earnings momentum buoyed by the strong performance of the Canadian and Québec economies and the efficiencies generated by transformation initiatives across its major segments. Net income reached $2.3 billion in F2019, translating into a return on common equity ratio of 17.9%, the highest level among large Canadian banks peers, giving the Bank ample room to absorb potential credit losses. While a smaller contributor within National’s diverse business mix, the USSF&I segment continues to add to profitability, and contributes 11% of earnings. DBRS Morningstar notes that the operating environment remains highly pressured due to the coronavirus pandemic, which will negatively affect the Bank's earnings, revenue and asset quality metrics.
In DBRS Morningstar’s view, prudent risk management and a conservative lending culture enable National to maintain strong asset-quality metrics. Gross impaired loans remained at a low of 0.43% of gross loans as of Q1 2020 — better than the Bank’s large Canadian bank peers — as the majority of National’s credit exposure is underwritten in Québec, which has experienced a relatively benign credit environment in recent years. Furthermore, although credit in the USSF&I segment is in riskier sectors or geographies, DBRS Morningstar notes the segment’s loans only form 6% of the Bank’s total portfolio and this credit risk has been historically well managed. DBRS Morningstar will continue to monitor the adverse impact of the coronavirus pandemic on the economies of both Canada and Québec, which will result in asset quality deterioration and higher provisioning needs.
The Bank has a strong funding profile with a growing retail and commercial deposit base. This includes an increase in the client’s share of wallet through various coordinated initiatives among the Bank’s P&C, WM, and FM divisions. As a result, according to DBRS Morningstar’s calculation, retail and commercial deposits make up 54% of total funding, one of the highest levels among large Canadian peers. Additionally, National has ready access to a wide range of wholesale funding sources to supplement deposit funding with a diverse international investor base. Meanwhile, the Bank enjoys the strongest liquidity level amongst peers with a Liquidity Coverage Ratio of 144% for Q1 2020.
Capitalization is strong as National continues to organically generate sufficient capital to support its balance sheet growth and enable the Bank to support its customers during this period. As at January 31, 2020, National’s Common Equity Tier 1 ratio stood at 11.7%, well above the Office of the Superintendent of Financial Institutions’ (OSFI) minimum requirements and at the top range of large Canadian bank peers. On March 13, 2020, 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%. 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.
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 National are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Strong; Risk Profile – Strong; Funding & Liquidity – Strong; and Capitalisation – Strong.
DBRS Morningstar notes that this press release was amended on July 6, 2020, to incorporate the link to the methodology.
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 July 29, 2019, when DBRS Morningstar confirmed all ratings and changed the trend to Positive from Stable.
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: Maria-Gabriella Khoury, Senior Vice President
Rating Committee Chair: Chair: Michael Driscoll, Managing Director
Initial Rating Date: February 29, 2000.
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.
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