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Fitch Affirms National Bank of Canada at 'A+/F1'; Outlook Stable
October 27, 2017 / 5:43 PM / in 23 days

Fitch Affirms National Bank of Canada at 'A+/F1'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, October 27 (Fitch) Fitch Ratings has affirmed National Bank of Canada's (NBC) long- and short-term Issuer Default Ratings (IDRs) at 'A+' and 'F1', respectively. The Rating Outlook remains Stable. Fitch also affirmed NBC's Viability Rating (VR) at 'a+'. A full list of rating actions follows at the end of this release. This rating action follows Fitch's periodic review of the Canadian Banks Peer Group, which includes Bank of Montreal (BMO), Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CIBC), Federation des caisses Desjardins du Quebec (FCDQ), National Bank of Canada (NBC), Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD). For additional information, please see "Fitch Completes Review of Canadian Banks" at 'www.fitchratings.com'. Company-specific rating rationales for the other banks are published separately. For additional information, please see "Fitch Affirms Canadian Banks; Fundamentals Outweigh Persistent Housing Risks" at 'www.fitchratings.com'. KEY RATING DRIVERS IDRS, VRs AND SENIOR DEBT Today's affirmation reflects NBC's continued strong asset quality, its solid franchise within its operating markets and its good capital levels in the context of the bank's risk appetite and current rating. Today's affirmation is further supported by improving earnings which continue to converge upward with NBC's primary competitors. Fitch continues to believe that the bank's ratings are near the top of their potential given the continued outsized presence of capital markets activities relative rated domestic and global peers and relative geographic concentration in Quebec. Additionally, the Canadian Mortgage and Housing Corporation (CMHC) insurance plays an important role in supporting the balance sheets of all Canadian banks. NBC's ratings are supported by its solid deposit market share, strong market position and brand recognition in its primary market of Quebec. NBC continues to have a deposit share of about 20% in Quebec, as well as leading positions in the small and medium-sized enterprise (SME) and corporate markets. Still, while NBC's franchise in Quebec presents some competitive advantages in its core market, NBC is particularly sensitive to any idiosyncratic stress in Quebec's economy due to its relative lack of geographic diversity. NBC continues to report strong asset quality. At 3Q17, gross impaired loans (GILs) to gross loans stood at 0.36%, essentially flat over the last year and well-below the peer average of 0.52%. Fitch generally views NBC's underwriting as relatively disciplined which has led to a lower absolute level of impaired loans over time as well lower volatility of credit losses. NBC's higher exposure to the province of Quebec, which tends to have a less volatile economy, is also considered a factor in the bank's good credit performance over time. However, NBC's high level of loan growth relative to peers is a rating constraint in the near to medium term, especially as the bank's loan portfolio mix has modestly shifted toward business and government lending. Moreover, while NBC's residential loan portfolio is still heavily related to its core market of Quebec (55% of residential loans), the bank has generated notable growth in Ontario and British Columbia. On an absolute, sequential basis, residential loans in Ontario and British Columbia grew 9.4% on a sequential basis between 2Q17 and 3Q17. There is a growing presence of loans and revenue associated with NBC's Credigy Ltd. Subsidiary, which purchases or finances purchases of unsecured personal loans on a global basis, although its recent focus has mostly been on the U.S. Credigy-related revenue now represents 6.7% of total revenue and loans account for 4.2% of average loans. While the strategy provides revenue and loan diversity for NBC, it also points toward modestly higher risk appetite given the level and nature of the growth. Moreover, Fitch remains skeptical of the through-the-cycle credit quality of current unsecured personal lending within North America. Further constraining NBC's rating is its earnings profile, which has a relatively high level of capital markets-related revenue as a proportion of total revenue compared to peers. On average, around 25% of total revenues come from capital markets, compared to the peer median of about 20%. The financial markets segment includes corporate lending, institutional brokerage, investment banking and trading services with a focus on the broader Canadian market, which Fitch views as less stable than NBC's earnings from its retail and wealth management segments. Financial markets activities come with incremental operational risks and require comparatively elevated capital allocation due to their intrinsic volatility. NBC's capital levels continue to improve on an absolute and relative basis which is reflected into today's rating affirmation and Outlook Stable. Since last year, the bank's Common Equity Tier 1 (CET1) ratio has improved 130bps to 11.2% as of 3Q17 and is now more in line with peers as opposed to being lowest in the group. Management has stated that it intends to manage capital at levels more in-line with peers over time and is only comfortable doing share buybacks with a CET1 ratio above 10.75%. Fitch views this stance as prudent given NBC's level of loan growth and its aforementioned capital markets activities. Funding and liquidity continue to be solid and supportive of the bank's rating. Similar to peers, NBC has shown success in building its level of customer deposits although wholesale funding continues to account for an outsized proportion of its funding relative to rated peers. NBC reports a strong liquidity coverage ratio (LCR) within the Canadian bank peer group at 134% and continues to have strong on-balance-sheet unencumbered liquidity at over 20% of total assets. SUPPORT RATING AND SUPPORT RATING FLOOR The affirmation of the NBC's SR of '2' and SRF of 'BBB-' reflect Fitch's view that the likelihood of support remains high for Canadian banks due to their systemic importance in the country, significant concentration overall in of Canadian banking assets amongst the institutions noted above, which account for over 90% of total banking assets, the large size of the banking sector with banking assets at 2.1 times Canada's GDP, and the Canadian banks' position as key providers of financial services to its local economy. In Fitch's view, Canadian banking authorities have wide latitude through the CDIC Act to resolve a troubled bank including re-capitalizing an institution, creating a bridge bank, or imposing losses on creditors. Nonetheless, bail-in initiatives demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward. Fitch recognizes that the Canadian government's willingness to provide support for D-SIFI's in Canada has been reduced demonstrated by Department of Finance recent Resolution Framework, which has received parliament approval. The proposal seeks to protect tax payers from the risk of a large financial institution failing through the guidelines recently published by OSFI for issuing non-viability contingent capital (NVCC) instruments and defining securities that could be used for "bail-in". In Fitch's view, bail-in proposal enhances resolution powers given to regulatory authorities under the CDIC Act. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Subordinated debt and other hybrid capital issued by NBC and its subsidiaries are all notched down from the common VR in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles, which vary considerably. NBC's subordinated debt is notched one level below its VR of 'aa-' for loss severity in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles. NBC's preferred stock is five notches below the VR, made up of two notches down for non-performance and three notches down for loss severity. These ratings are in accordance with Fitch's criteria and assessment of the instruments non-performance and loss severity risk profiles and have thus been affirmed due to the affirmation of the VR. SUBSIDIARY AND AFFILIATED COMPANY All of the subsidiaries and affiliated companies reviewed as part of the Canadian bank peer review factor in a high probability of support from parent institutions to the subsidiaries. This reflects that performing parent banks have very rarely allowed subsidiaries to default. It also considers the high level of integration, brand, management, financial and reputational incentives to avoid subsidiary defaults RATING SENSITIVITIES IDRS, VRs AND SENIOR DEBT Fitch views NBC's current rating as well-situated for the near to medium term. Today's rating action incorporates Fitch's view that uncertainties remain on what the impact of recent mortgage reform announcements will be to the broader mortgage market. As such, a faster price correction that is prolonged and/or a slowdown in the housing market will likely impact earnings growth for all the banks. Further, these changes would also affect the broader economy through the link between housing wealth and consumer consumption, and the real estate sector, which are important drivers of GDP growth. Fitch notes that the Canadian banks' ratings are sensitive to negative pressures in the housing market. Modest rating pressure could also ensue should NBC's credit performance deteriorate evidenced by impaired loans and loan losses trending to levels above its 10 year average of 0.51% and 0.28%, respectively. This could be potentially become more severe should macroeconomic risks continue such as unexpected increases in interest rates, a severe housing price correction as well as macroeconomic weakness in the overall Canadian economy that leads to a material rise in unemployment. NBC's ratings are highly sensitive to its earnings profile and credit quality. As noted above, the bank has reported very consistent credit quality over time relative to its peers, and this supports its rating. With growing exposure to Ontario and British Columbia in its residential loan portfolio as well as growth within Credigy, NBC's ratings would be sensitive should Fitch observe credit quality converging with peers, particularly in markets outside of Quebec. Moreover, Fitch would view the following as credit negatives, especially if earnings performance becomes more volatile: capital markets revenue nearing or surpassing 30% of total revenue or if the combined international exposure exceeds 10% of overall earnings. SUPPORT RATING AND SUPPORT RATING FLOOR SR of '2' incorporates Fitch's expectation that there could be some level of support for the Canadian banks going forward, although it has been weakened given bail-in legislation. Although Canadian authorities have taken steps to improve resolution powers and tools, they intend to maintain a flexible approach to bank resolution. Fitch's assessment of continuing support for Canadian D-SIFI's has to some extent relied upon resolution powers granted regulators under the CDIC ACT as well as the potential size, structure, and feasibility of NVCC and TLAC implementation. Further, continued regulatory action to ensure sufficient contingent capital has been implemented for all Canadian banks. Therefore, SRs and SRFs are sensitive to the implementation of TLAC requirements. To the extent that these are deemed more than sufficient to recapitalize a non-viable bank, SRs and SRFs may be lowered. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The subordinated debt and hybrid capital ratings are primarily sensitive to any change in the VRs of the bank (or bank subsidiaries). SUBSIDIARY AND AFFILIATED COMPANIES The subsidiary and affiliated company ratings are primarily sensitive to any change in the VRs of the banks. Fitch has affirmed the following ratings with a Stable Outlook: National Bank of Canada --Long-term IDR at 'A+'; --Short-term IDR at 'F1'; --VR at 'a+'; --Senior debt at 'A+'; --Short-term senior debt at 'F1'; --Subordinated debt at 'A'; --Preferred stock at 'BBB-'; --Short-term deposits at 'F1'; --Support Rating at '2'; --Support Rating Floor at 'BBB-'. National Bank of Canada New York Branch --Short-term IDR at 'F1'; --Commercial paper at 'F1'. NBC Asset Trust --Preferred Stock at 'BBB-'. Contact: Primary Analyst Bain K. Rumohr, CFA +1-312-368-3153 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Doriana Gamboa Senior Director +1-212-612-0865 Committee Chairperson Sean Pattap Senior Director +1-212-908-0642 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Global Bank Rating Criteria (pub. 25 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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