DBRS Morningstar Confirms The Bank of Nova Scotia at AA with Stable Trends

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 and Stable trends are underpinned by its highly diversified franchise, with the Bank’s Canadian operations complemented by its International Banking (IB) business segment that is focused on the high-growth markets of Mexico, Peru, Chile, and Colombia (the Pacific Alliance region). By total assets, Scotiabank ranks as the third-largest bank in Canada. In F2021, the Bank generated almost one-third of its earnings outside of Canada, remaining in the top tier among 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. Nonetheless, we view the Bank’s exposure to emerging markets as inherently riskier, heightening the risk profile and potentially adding some earnings volatility. Overall, we view the risk profile as well managed.

The ratings also consider that government support measures have largely mitigated the negative economic impacts of the Coronavirus Disease (COVID-19) pandemic. Positively, economic performance has rebounded, and the labour market is essentially at full capacity; however, headwinds persist from a potential aggressive interest rate tightening cycle to combat inflation, geopolitical tensions related to the Russia-Ukraine conflict, supply chain disruptions, and the pandemic. Furthermore, DBRS Morningstar remains concerned about the combination of high Canadian household debt levels that have reached an all-time high and elevated home prices that have been driven by housing market imbalances and robust demand during the pandemic (particularly in the greater Toronto and Vancouver areas). Housing prices remain vulnerable and, as a result, Scotiabank and its Canadian peers remain susceptible to adverse changes in the Canadian real estate market. Positively, DBRS Morningstar views Scotiabank's residential mortgage loan portfolio as conservatively underwritten, reflecting the Bank's strong risk culture.

RATING DRIVERS
Over the longer term, the Bank’s ratings would be upgraded if Scotiabank were to continue to build the depth and scale of its franchise, resulting in a sustained improvement in financial performance without substantially increasing its risk profile.

Conversely, the Bank's ratings would be downgraded if there were a sustained deterioration in earnings or asset quality, especially caused by deficiencies in risk management or an increase in risk profile. Significant operational issues, particularly in the Pacific Alliance region, would also lead to a downgrade of the ratings.

RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Very Strong
The ratings are underpinned by the Bank’s highly diversified business mix that includes consumer and wholesale banking services, wealth management and capital markets businesses, which all contribute to Scotiabank’s overall franchise strength. The Bank has essentially maintained its market position in Canadian Banking, ranking first in automotive lending, third in real estate secured lending and personal loans, and fifth in credit cards and business loans. In IB, the Bank has simplified its operational structure and geographical footprint, focusing on gaining scale in its core Pacific Alliance markets of Chile (third market position), Mexico (fifth), Peru (third), and Colombia (sixth). Furthermore, DBRS Morningstar sees the Bank’s scalable business model and full banking capabilities as supportive for continued growth, particularly for Global Wealth Management (third position in Canada) and Global Banking and Markets in the IB footprint. Scotiabank’s scale and diversification provide significant versatility, allowing the Bank to leverage its strengths in response to changing market opportunities.

Earnings Combined Building Block (BB) Assessment: Strong/Good
Scotiabank generates solid underlying earnings, which contribute to the Bank's ability to absorb credit losses. In F2021, earnings were $9.96 billion, up 45% compared with the prior year as earnings were boosted by provision for credit loss (PCL) reversals. The Bank has had five consecutive quarters of earnings above pre-pandemic levels, and IB’s earnings have started to show a turnaround with two solid quarters of earnings (Q4 2021 and Q1 2022) that were the highest since the pandemic began. As a result, return on average common equity in F2021 increased to 14.7% from 10.4% in F2020. 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 across the Bank’s geographical footprint given the scale of the aforementioned headwinds.

Risk Combined Building Block (BB) Assessment: Strong/Good
DBRS Morningstar views Scotiabank's risk profile as conservative, exhibited by its strong asset quality with a manageable level of PCLs 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 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. The Bank has also had a favourable shift toward a more secured business mix in its Retail portfolios (i.e.; Canadian Banking Retail was 95% secured at Q1 2022 compared with 93% at Q1 2019, while IB was at 72% compared with 66%). Asset quality metrics are at unsustainably low levels and modest deterioration is expected as credit conditions normalize.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong/Good
Overall, Scotiabank has a solid funding and liquidity profile, which benefits from a substantial 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 IB 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. Wholesale funding usage is returning to pre-pandemic levels (21.3% of total assets at Q1 2022, compared with 16.9% at Q1 2021 and 23.5% at Q1 2020) driven by asset growth, partially offset by deposit retention. In addition, liquidity at Scotiabank remains strong as it reported a Q1 2022 liquidity coverage ratio of 123% and a net stable funding ratio of 108%, both comfortably above the regulatory minimums.

Capitalization Combined Building Block (BB) Assessment: Strong
DBRS Morningstar views the Bank's capitalization as strong, reflecting current capital levels as well as its significant internal capital generation. In Q1 2022, Scotiabank's CET1 ratio was 12.0%. At this level, the Bank's CET1 ratio was well above the regulatory minimum of 10.5% for Domestic Systemically Important Banks (D-SIBs). On February 28, 2022, the Bank announced the $1.3 billion acquisition of Grupo Said's remaining 16.8% stake in Scotiabank Chile that is expected to reduce the CET1 ratio by approximately 10 basis points and is anticipated to be offset by internal capital generation. Additionally, it is anticipated that there will be additional share buybacks in F2022, with the Bank increasing the number of common shares that it may repurchase for cancellation under its normal course issuer bid on March 28, 2022, from 24 million to 36 million (approximately 3% of outstanding common shares). Thus far, 20.2 million common shares have been repurchased (as at March 28, 2022). In Q1 2022, Scotiabank's risk-based total loss-absorbing capacity ratio was at 28.3%, well above the regulatory threshold of 24.0%. The Bank reported a leverage ratio of 4.4% in Q1 2022 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.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/395564.

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.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organizations (July 19, 2021; https://www.dbrsmorningstar.com/research/381742). 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).

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/principal asset class 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 (July 19, 2021) 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 22, 2021, 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: Carl De Souza, 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.

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