Morningstar DBRS Confirms National Bank of Canada’s Long-Term Issuer Rating at AA, Stable Trend

DBRS Limited (Morningstar DBRS) confirmed its credit ratings on National Bank of Canada (National or the Bank) and its related entities, including the Bank's Long-Term Issuer Rating at AA and Short-Term Issuer Rating at R-1 (high). The trend on all ratings is Stable. National's Long-Term Issuer Rating is composed of an Intrinsic Assessment of AA (low) and a Support Assessment of SA2, which reflects the expectation of timely systemic support from the Government of Canada (rated AAA with a Stable trend by Morningstar DBRS). As a result of the SA2 designation, the Bank's Long-Term Issuer Rating benefits from a one-notch uplift.

KEY RATING CONSIDERATIONS
The credit rating confirmations and Stable trends recognize National's pan-Canadian universal banking model with footprints in targeted markets and niches across the country, especially in Wealth Management (WM) and Financial Markets (FM). The ratings also reflect National's dominance in its home province, the Province of Québec (Québec; rated AA (low) with a Stable trend by Morningstar DBRS). Furthermore, the credit ratings also consider the growing contribution of the U.S. Specialty Finance and International (USSF&I) segment, which Morningstar DBRS views as having a higher risk profile, as well as potentially more volatile earnings.

The Bank benefits from strong pre-provision earnings, with Personal and Commercial (P&C) and FM contributing a larger portion of earnings, placing the Bank at the top of its peer range in terms of profitability metrics. Additionally, modernization and transformation efforts in its P&C business and growth of its WM business have driven growth in client deposits. Lastly, Morningstar DBRS notes that National's FM business segment is an important contributor to the Bank's franchise, although the segment's activities could expose the Bank to increased capital markets risk from significant market downturns.

RATING DRIVERS
Over the longer term, Morningstar DBRS would upgrade the credit ratings if the Bank were to continue building the scale and diversity of its franchise without a commensurate increase in risk and while diversifying earnings sources.

Conversely, Morningstar DBRS would downgrade the credit ratings if there were a sustained deterioration in asset quality, especially from deficiencies in risk management or a prolonged decline in profitability metrics.

RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Strong
National operates a pan-Canadian franchise with a dominant position its home province of Québec. While its P&C banking businesses maintain leading market shares in Québec, the Bank has successfully expanded its footprint across the country, especially through its WM and FM businesses, particularly in Western Canada. In addition, the Bank has a few international investments with strong growth, including in the United States and Cambodia. In F2023, USSF&I accounted for 11% of the bank's total revenue and 15% of net income.

Earnings Combined BB Assessment: Strong
With its focused franchise and leading position in Québec, National generates strong underlying earnings, including a healthy proportion of fee income, which contribute to the Bank's ability to absorb credit losses. In F2023, earnings reached $3.3 billion, down 1.4% compared with the prior year. An increase in total revenue (up 5.4% year-over-year) was offset by both higher expenses and provision for credit losses. The Bank continues to record profitability metrics that are at the top of the Canadian-bank peer range, with a return on average assets of 0.8% and a return on average equity of 14.8% in F2023.

Risk Combined BB Assessment: Strong
In Morningstar DBRS' view, prudent risk management and a conservative lending culture enable National to maintain solid asset-quality metrics, despite some normalization. Gross impaired loans increased to 0.72% of gross loans as of Q4 2023 driven by a 24.6% increase in gross impaired loans, primarily from the ABA and commercial portfolios. However, the Bank's loss metrics remain better than some of its larger Canadian peers, reflecting its conservative underwriting. Furthermore, although credit in the USSF&I segment is in riskier sectors or geographies, Morningstar DBRS notes that the segment's loans form less than 9% of the Bank's total portfolio and that this credit risk has been historically well managed.

Funding and Liquidity Combined BB Assessment: Strong
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 Morningstar DBRS calculation, retail and commercial deposits make up 55% of total funding, at the top range of its large Canadian peers. Additionally, National has ready access to a wide range of wholesale funding sources with a diverse international investor base. Meanwhile, the Bank enjoys the highest liquidity level among peers as measured by the Liquidity Coverage Ratio, which was 145% for Q1 2024, and a net stable funding ratio of 117%, both well above the regulatory minimums.

Capitalization Combined BB Assessment: Strong
Capitalization is strong as National continues to organically generate sufficient capital to support balance sheet growth. As at January 31, 2024, National's Common Equity Tier 1 (CET1) ratio stood at 13.1%, well-positioned versus average of its peers. At this level, the Bank's CET1 ratio was well above the regulatory minimum of 11.5% for Domestic Systemically Important Banks. In Q1 2024, National's risk-based total loss-absorbing capacity ratio was at 28.1%, above the regulatory threshold of 25%. The Bank reported a leverage ratio of 4.3% in Q1 2024 that was above the regulatory minimum of 3.5% and in line with its Canadian bank peers.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/431975

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS   
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.
 
A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (15 April 2024) https://dbrs.morningstar.com/research/431155/global-methodology-for-rating-banks-and-banking-organisations. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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 dbrs.morningstar.com

The credit rating was initiated at the request of the rated entity.
The rated entity or its related entities did participate in the credit rating process for this credit rating action.
Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.
This is a solicited credit rating.

These credit ratings are 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 credit ratings:

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

Lead Analyst: Jiani Wu, CFA, Vice President,
Rating Committee Chair: John Mackerey, Senior Vice President, Sector Lead,
Initial Rating Date: March 31, 1981

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

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