October 27, 2017 / 5:43 PM / a year ago

Fitch Affirms The Bank of Nova Scotia's IDRs at 'AA-/F1+'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, October 27 (Fitch) Fitch Ratings has affirmed Bank of Nova Scotia (The) (BNS) Long- and Short-Term Issuer Default Ratings (IDRs) at 'AA-' and 'F1+', respectively. The Rating Outlook is Stable. 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 Quebec's (FCDQ), National Bank of Canada (NBC), Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD). For additional information, please see "Fitch Affirms Canadian Banks; Fundamentals Outweigh Persistent Housing Risks" at 'www.fitchratings.com.'. KEY RATING DRIVERS IDRS, VR's, AND SENIOR DEBT The affirmation of BNS's ratings reflects the company's strong and stable operating performance over an extended period, its strong capital ratios, and good funding profile. These strengths continue to be counterbalanced by Fitch's view of Canadian Banking credit costs near trough levels as well as BNS's higher exposure to foreign currencies and energy and commodities loans relative to its Canadian Bank peer group. Additionally, the Canadian Mortgage and Housing Corporation (CMHC) insurance plays an important role in supporting the balance sheets of all Canadian Banks. 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. This 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 these changes. Fitch views BNS's earnings profile to be fairly balanced and stable over time. This reflects the company's geographic diversity, international operations accounting for 38% of overall revenue and 29% of overall net income as of the third quarter of 2017 (3Q17). Moreover, BNS earnings have been fairly stable as evidenced by the company's operating performance measured by operating income divided by risk weighted assets averaging 2.75% over the last 10 years, a full 29 basis points better the peer group average. In addition, the standard deviation of BNS's operating performance over the last 10 years is 0.30%, which is at the top of the peer group. Given Fitch's expectation for slower growth within the Canadian Banking segment due in part still low interest rates in Canada, Fitch believes that BNS's earnings diversity could help to support the company's overall operating performance particularly relative to those peers that are more domestically focused. That said, Fitch notes that these operations do expose BNS to comparatively higher geopolitical and foreign exchange risk than other similarly rated domestic and global peer banks, although to date these risks have been well managed. Further supporting today's rating action is BNS's strong capital position. While the company's 3Q17 Fitch Core Capital (FCC) to risk-weighted asset ratio of 11.63% is near the peer group average, Fitch believes this ratio is more conservative than peers given the higher risk-weighted asset density relative to peers. As of 3Q17, BNS's risk weighted assets divided by total assets was 40.3%, the second highest of the peer group. This is primarily driven by significantly higher risk weights on international related assets, as BNS has a large uninsured Canadian residential mortgage portfolio which carries a risk-weight of zero. Fitch views BNS's diverse funding profile to be a rating strength. While BNS's Fitch adjusted loan-to-deposit ratio is higher than some similarly rated institutions, the company's Liquidity Coverage Ratio (LCR) of 125% as of 3Q17 is considered strong. While BNS has a higher reliance on wholesale funding than peers, its wholesale funding profile viewed by both product and geography is considered diverse. The company also maintains a significant proportion of unencumbered liquid assets, which amounted to $178 billion, approximately 20% of total assets as of 3Q17, which can be pledged to satisfy the company's funding needs. BNS's ratings also incorporate the company's comparatively higher exposure to geopolitical risk, foreign currencies, and energy and commodities related loans relative to peer banks. Fitch notes that this exposure has been well-managed for an extended period, and that current ratings incorporate currency fluctuations to be managed without a large impact (either positively or negatively) on overall operating performance going forward. SUPPORT RATING AND SUPPORT RATING The affirmation of the BNS's SR at '2' and SRF at '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 through the CDIC Act, have wide latitude 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 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 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 BNS 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. BNS'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. Scotia Bank Capital Trust's preferred stock is four 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. LONG-TERM DEPOSIT RATINGS BNS's long-term deposit ratings are equalized with the company's long-term IDR. RATING SENSITIVITIES IDRS, VR, AND SENIOR DEBT Given the already high level of BNS's ratings, Fitch notes that potential upside for ratings is viewed as limited. 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. While BNS's high ratings have been supported by the contribution to earnings from less developed markets, its ratings would be sensitive should the overall revenue contribution from non-Canadian markets comprise more than 50% of BNS's revenue, as Fitch could view this as altering the company's overall risk profile. Additionally, should foreign currencies or economic conditions begin to fluctuate in BNS's larger international markets such that Fitch believes it will result in higher earnings volatility over as measured by a 25% movement in the standard deviation of the company's overall annual earnings over a two year time horizon, could also be a catalyst for a negative rating action. BNS's ratings would also be sensitive in the event that the company makes a large acquisition that either erodes FCC ratios or alters the company's risk profile such that Fitch would view operating performance metrics becoming more volatile as a result of a transaction. While overall impaired loan ratios for BNS --and peer banks--have declined as potential losses to energy related credits have abated as oil prices have increased and troubled assets have been able to be restructured, Fitch notes that overall impaired loan ratios remain near troughs. As such, Fitch believes that impaired loan ratios will likely increase over time due to a mix of either higher loss rates within the core Canadian market and/or higher loss rates in larger international markets such as Mexico, Chile, Peru, and Columbia. Modest rating pressure could ensue should BNS's credit performance deteriorate evidenced by impaired loan and losses trending to levels significantly above its 10 year average of 1.05% and 0.39%, respectively. Fitch notes that 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. 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 banks (or bank subsidiaries). The preferred securities of Scotia Bank Capital Trust are trust preferred securities, which Fitch gives five notches from BNS's VR given management and regulatory authorities' powers to suspend dividends. LONG- AND SHORT-TERM DEPOSIT RATINGS The ratings of long-term deposits issued by BNS are primarily sensitive to any change in BNS's IDR. Fitch has affirmed the following ratings: Bank of Nova Scotia --Long-term IDR at 'AA-', Outlook Stable; --Short-term IDR at 'F1+'; --Market-linked notes at 'AA- emr'; --Long-term deposits at 'AA-'; --Senior debt at 'AA-'; --Subordinated debt at 'A+'; --Short-term debt at 'F1+'; --VR at 'aa-'; --Support Rating at '2'; --Support Rating Floor at 'BBB-'. Scotiabank Capital Trust --Trust Securities at 'BBB'. 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