DBRS Morningstar Confirms The 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 is composed of an Intrinsic Assessment (IA) of AA (low) and a Support Assessment (SA) of SA2, which reflects the expectation of timely systemic support from the Government of Canada (rated AAA with a Stable trend by DBRS Morningstar). As a result of the SA2 designation, the Bank’s Long-Term Issuer Rating benefits from a one-notch uplift.

KEY RATING CONSIDERATIONS
Scotiabank’s ratings are underpinned by its highly diversified franchise, with the Bank’s large presence in Canada complemented by an international banking franchise that is focused on the high-growth markets of Mexico, Peru, Chile, and Colombia (the Pacific Alliance region). Scotiabank ranks as the third-largest bank in Canada as measured by total assets. In F2020, the Bank generated 36% of earnings outside of Canada. Although this is down from 48% in the prior year, over the last five years, the Bank has generated the highest average earnings contribution from its operations outside of Canada compared with the average of its Canadian bank peers. DBRS Morningstar notes that Scotiabank has simplified its operating structure and geographical footprint, as the Bank exited a number of countries that were not considered core or where it lacked scale, reducing its overall operational risk as well as enhancing earnings stability. Scotiabank’s ratings are also supported by the Bank’s conservative profile reflecting a sound risk culture; a well-managed funding and liquidity profile, which benefits from a stable deposit base; and strong capital levels that are sufficient to support Scotiabank's balance sheet and business growth initiatives.

The ratings also consider the challenging economic environment because of the Coronavirus Disease (COVID-19) pandemic, which has had an adverse impact on profitability and asset quality. Despite the impact the pandemic has had on the broader economy, housing activity in Canada has been robust, which has resulted in recent home price appreciation following a period where prices had stabilized, reflecting actions taken over the last several years by regulators to tighten mortgage rules. DBRS Morningstar remains concerned about the combination of highly leveraged consumers and elevated home prices, particularly in the greater Toronto and Vancouver areas. DBRS Morningstar believes that housing prices remain vulnerable and, as a result, views Scotiabank, like its Canadian bank peers, as susceptible to any adverse changes in the Canadian real estate market. Positively, DBRS Morningstar views Scotiabank's loan portfolio as conservatively underwritten, reflecting the Bank's strong risk culture.

RATING DRIVERS
DBRS Morningstar views Scotiabank as being well placed in its current rating category. Over the longer term, the Bank’s ratings would be upgraded if Scotiabank continues to build the depth and scale of its franchise, resulting in a sustained improvement in financial performance, without substantially increasing its risk appetite. Conversely, the ratings would be downgraded if there were a sustained deterioration in earnings or asset quality, especially from deficiencies in risk management. Additionally, significant operational issues, particularly in the Pacific Alliance region where Scotiabank has made numerous acquisitions, would lead to a downgrade of the ratings.

RATING RATIONALE
Supported by its well-diversified franchise, Scotiabank generates solid underlying earnings, which contribute to the Bank's ability to absorb credit losses. In F2020, earnings were $6.9 billion, down 22% compared with the prior year largely because of the impact of the pandemic, particularly in Scotiabank's International Banking segment. As a result, return on average common equity declined to 10.4% from 13.1% in F2019. Unprecedented support measures put in place through monetary and fiscal stimulus have mitigated some of the negative impacts of this crisis; however, near-term challenges remain for both Canada as well as the Pacific Alliance region, given the scale of the economic disruption, challenges related to vaccine rollout, and varying levels of government support in the Pacific Alliance region.

DBRS Morningstar views Scotiabank's risk profile as conservative, exhibited by its strong asset quality with a manageable level of provisions for credit losses and impaired loans. However, the Bank exhibits slightly weaker asset quality metrics compared with its Canadian bank peers, reflecting Scotiabank's exposure to emerging markets including the Pacific Alliance region. Positively, this credit risk has historically been well managed, reflecting the Bank’s conservative underwriting and knowledge gleaned from its long-standing operating history in this region. In addition, Scotiabank’s exiting of a number of countries that were not considered core or where it lacked scale has reduced overall operational risk.

Overall, Scotiabank has a strong funding and liquidity profile, which benefits from a solid retail deposit base. Scotiabank also makes use of wholesale funding, which DBRS Morningstar views as acceptable given the Bank's business model and that Scotiabank ensures that its international banking subsidiaries are funded in their local markets. Over the last few years, Scotiabank has strategically reduced its wholesale funding reliance while remaining focused on raising additional deposit funding. As a result, the Bank's usage of wholesale funding is more in line with its Canadian bank peers. At the onset of the pandemic, Scotiabank accessed several Government of Canada programs as well as programs offered by governments in other regions in which the Bank operates to supplement its funding. Most of these borrowings have been repaid with certain facilities maturing through the second and third quarters of 2021. In addition, liquidity at Scotiabank remains strong as it reported a Q1 2021 liquidity coverage ratio of 138%, well above the regulatory minimum. Effective Q1 2021, the Bank began disclosing its net stable funding ratio (NSFR), which DBSR Morningstar views as a better gauge of funding resilience over the medium to longer term. Scotiabank’s NSFR was 115%, which was above the regulatory minimum of 100%.

DBRS Morningstar views the Bank's capitalization as strong, reflecting current capital levels as well as its significant internal capital generation. In Q1 2021, Scotiabank's CET1 ratio was 12.2%. At this level, the Bank's CET1 ratio was well above the regulatory minimum of 9% for Domestic Systemically Important Banks (D-SIBs), reflecting the Office of the Superintendent of Financial Institutions’ (OSFI) reduction in the Domestic Stability Buffer to 1.0% at the onset of the pandemic. Moreover, DBRS Morningstar expects Scotiabank's capital levels to continue to build over the near term, largely reflecting the restrictions placed by OSFI on capital management activities for D-SIBs. Additionally, the Bank reported a leverage ratio of 4.7% in Q1 2021 that was above the regulatory minimum of 3% and in line with its Canadian bank peers; however, DBRS Morningstar notes that this metric remains somewhat weaker than many global peers.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 8, 2020; https://www.dbrsmorningstar.com/research/362170). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

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 for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed ratings:

Each of the principal methodologies employed in the analysis addressed one or more particular risks or aspects of the rating and were factored into the rating decision. Specifically, the Global Methodology for Rating Banks and Banking Organisations (June 8, 2020) was used to evaluate the Issuer, and DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021) was used to assess ESG factors.

The last rating action on this issuer took place on April 24, 2020, 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

Lead Analyst: Robert Colangelo, Senior Vice President
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG
Initial Rating Date: December 31, 1980

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

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577