Morningstar DBRS Confirms National Bank of Canada’s Long-Term Issuer Rating at AA Following Canadian Western Bank Acquisition Announcement; Trends Remain Stable

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 credit 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). The credit ratings action follows the June 11, 2024, announcement that National has entered into a definitive agreement to acquire Canadian Western Bank (CWB, rated A (low) with a Stable trend), subject to approval by CWB shareholders and receipt of required regulatory approvals.

KEY CREDIT RATING CONSIDERATIONS
The credit ratings confirmation and Stable trends reflect Morningstar DBRS’ view that the acquisition makes strategic sense and will bolster diversification of revenue, both geographically and by product. Indeed, CWB helps National become less reliant on Québec, significantly bolstering National’s presence in Western Canada, including British Columbia and Alberta. The acquisition is also aligned with National’s Canadian growth aspirations for its Personal and Commercial Banking, and Wealth Management segments, which should further diversify revenue streams when National’s expanded products and services are offered to CWB customers. At almost 10% of pro forma assets, Morningstar DBRS notes that this is National’s largest acquisition to date, having previously relied primarily on organic growth in Canada. As a result, there is increased operational risk given a limited track record of integrating significant acquisitions. Somewhat mitigating this integration risk is CWB’s relatively less complex business model. Given the concurrent capital raise anchored by a top Canadian pension fund, the pro forma Common Equity Tier 1 (CET1) ratio is expected to remain sound at more than 12.75% upon closing.

CREDIT RATING DRIVERS
Over the longer term, Morningstar DBRS would upgrade the credit ratings if the Bank were to further build scale and diversification, both geographically as well as by revenues, while maintaining a similar risk profile.

Conversely, National’s credit ratings would be downgraded if there were significant integration issues with the acquisition. A sustained deterioration in asset quality or an inability to rebuild capital post acquisition, would also result in a credit ratings downgrade.

CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Strong
The acquisition adds approximately $42 billion in total assets, $33 billion in deposits, and 65,000 clients. Overall, Morningstar DBRS views the announced acquisition as improving the franchise strength of National’s operations through better scale and an enhanced presence across Canada, especially in Western Canada, potentially increasing National’s Canadian lending portfolio outside of Québec by 37%. The transaction is valued at approximately $5 billion and is expected to close by the end of 2025, subject to customary approvals.

Earnings Combined Building Block (BB) Assessment: Strong
Pro forma income at Q2 2024 increases by 30%, helping to mitigate the dependence on some potentially more volatile business segments such as Financial Markets. The Bank has identified approximately $270 million pretax annual cost and funding synergies and expects to incur pretax integration costs of approximately $400 million. Cost savings will come from integration of systems and technology infrastructure and other shared services. In addition, there will be opportunities to automate and streamline centralized functions, improving operational efficiency. Revenue synergies are not included in National’s assumptions; although, these could be significant as the Bank accelerates its growth strategies in the Personal and Commercial, Wealth Management, and Financial Markets segments.

Risk Combined Building Block (BB) Assessment: Strong
Despite the current operating environment, both banks have been performing well in recent periods. The combination incrementally increases National’s commercial banking pro forma portfolio to 36% from 28%. Morningstar DBRS considers this as a manageable increase because of CWB’s resilient portfolio and strong credit performance; although, an increased exposure to commercial real estate can make National more susceptible to asset quality deterioration in the event of a sustained economic downturn.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong
National’s deposit mix is strong and relatively less affected by absorbing CWB’s weaker deposit composition that relied more heavily on brokered deposits. Overall, pro forma total deposits would increase by 13%.

Capitalization Combined Building Block (BB) Assessment: Strong
In connection with the transaction, National intends to complete an equity financing, composed of a public offering and concurrent private placement to Caisse de dépôt et placement du Québec for gross proceeds totalling approximately $1.0 billion. National intends to use the proceeds to support regulatory capital ratios following the closing of the transaction, to fund any cash consideration and to pay transaction expenses. We expect capital levels to be rebuilt, and the Bank expects the CET1 ratio to be more than 12.75% at the closing of the transaction, comfortably above the regulatory minimum.

Further details on the Scorecard Indicators and Building Block Assessments can be found at: https://dbrs.morningstar.com/research/434375

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) 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 (January 23, 2024), https://dbrs.morningstar.com/research/427030.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 4, 2024), https://dbrs.morningstar.com/research/433881. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024), https://dbrs.morningstar.com/research/427030, in its consideration of ESG factors.

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

The credit ratings were initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for these credit rating actions.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with these credit rating actions.

These are solicited credit ratings.

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, Vice President
Rating Committee Chair: Michael Driscoll, Managing Director
Initial Rating Date: March 31, 1981

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

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