Fitch Ratings has affirmed Bank of Nova Scotia's (The) (BNS) long- and short-term Issuer Default Ratings (IDRs) at 'AA-' and 'F1+' respectively. This affirmation reflects BNS's good earnings performance, earnings diversity, strong funding and liquidity position, and above peer median capital ratios. At the same time, Fitch has kept the Rating Outlook for BNS at Stable.
This rating action follows a periodic review of the Canadian Banking sector. Fitch will publish the main findings of this review in a report 'Canadian Banks: Nearing a Tipping Point' available at www.fitchratings.com in the near future.
KEY RATING DRIVERS - IDRS, VR's, AND SENIOR DEBT
The affirmation of BNS' ratings reflects the company's good earnings performance over multiple operating cycles and comparatively good earnings diversity given its international deposit and lending platforms throughout Latin America, The Carribean, Central America, South America, and Asia.
Fitch believes this earnings diversity could help to support the company's earnings should there be weakness in the company's Canadian operations due to either a slowing consumer and/or housing market or the impact of lower oil prices on the company's commercial lending operations. That said, Fitch does note that BNS' operations in largely emerging international countries do expose the company to an elevated geopolitical and foreign exchange risk, which to date Fitch believes has been well managed.
Further supporting today's rating action is the company's above peer median Basel III Common Equity Tier 1 (CET1) ratio, which increased in the wake of the company's sale of its stake in CI Investments, an asset manager in Canada. Fitch believes this additional capital should help shelter the company's balance sheet in the event of economic stress. However, should the company deploy this capital into a large acquisition, Fitch would closely monitor the impact on the balance sheet and capital.
Fitch believes that BNS - as well as other Canadian Banks - benefit from a strong and diverse funding profile which supports today's affirmation and Stable Outlook.
Fitch believes, however, that all Canadian banks, including BNS, are vulnerable to credit deterioration in their domestic loan portfolios given high levels of consumer indebtedness in Canada, combined with Fitch's view of some overvaluation in the Canadian housing market. This limits housing affordability and makes consumers particularly susceptible to negative shocks to their income levels. Should the rapid decline in global oil prices cause an economic slowdown in Canada that affect employment levels this could hasten potential credit deterioration.
However, Canadian Mortgage and Housing Corporation (CMHC) insurance plays an important role in supporting the balance sheets of all Canadian Banks, including BNS, which should help shelter the company's balance sheet and capital ratios in the event of a consumer and/or housing market correction.
BNS, however, has increased its focus on increasing its personal and credit card loan balances given its partnership with Canadian Tire Financial Services (CTFS). Given the level of personal indebtedness in Canada, growth in personal unsecured loan balances at this stage of the credit cycle could potentially increase both the probability and severity of losses should the economy or the consumer market weaken.
RATING SENSITIVITIES - IDRS, VR's, and SENIOR DEBT
Given the already high level of BNS' ratings, Fitch does not expect any upside to ratings over a medium-term time horizon.
Ratings could be modestly downgraded should BNS' credit performance deteriorate at a faster rate than other Canadian banks as the housing market and consumer eventually slows and given sizable mortgage balances as well as growth in personal and unsecured credit. .
Fitch notes that this could be hastened or potentially more severe should largely exogenous macroeconomic risks occur, such as continued pressure in the global oil and gas markets, unexpected increases in interest rates which impact consumers' ability to service debt obligations, as well as macroeconomic weakness in China or Europe that flows through to the Canadian economy. This could also have an impact on credit performance of BNS' wholesale credit loan portfolio given the strong growth it has also had over the last couple of years.
Additionally, relative to other Canadian banks, BNS is susceptible to geopolitical or foreign currency risks in some of its emerging market exposures. While to date, these have been well managed in Fitch's opinion, should any of these risks cause a consolidated loss to BNS' overall capital ratios, ratings could be downgraded.
KEY RATING DRIVERS - SUPPORT RATINGS AND SUPPORT RATING FLOORS
The affirmation of the BNS' SRs and SRFs reflect Fitch's expectation that there remains an extremely high probability of support from the Canadian government (rated 'AAA', Outlook Stable) if required. This expectation reflects Canada's extremely high ability to support its banks especially given its financial flexibility, though the propensity is becoming less certain.
Specific to BNS, Fitch's view the likelihood of support is based mostly on the banks' systemic importance in Canada, significant concentration overall of Canadian banking assets amongst the institutions noted above which account for over 90% of banking assets, the large size of the banking system with banking assets at 2.1x Canada's GDP, and the Canadian Banks' position as key providers of financial services to the Canadian economy. BNS' IDRs and senior debt ratings do not benefit from support because their Viability Ratings (VRs) are all currently above their SRFs.
However, in Fitch's view, there is a clear intention to reduce support for D-SIFIs in Canada, as demonstrated by commentary and actions from Canadian banking regulators seeking to protect taxpayers from the risk of a large financial institution failing. This is further supported by the proposed issuance of non-viable contingent capital (NVCC) instruments, resolution powers given to regulatory authorities under the CDIC Act, and other initiatives that demonstrate the Canadian government's progress toward reducing the possibility of state support for banks going forward. Fitch believes this increases the likelihood of NVCC and potential senior debt losses if one or more of the Canadian Banks run afoul of solvency assessments.
RATING SENSITVITIES - SUPPORT RATING AND SUPPORT RATING FLOOR
Fitch is classifying Canada as a Path 2 country as defined in its September 2013 report, Bank Support: Likely Rating Paths, and, given the factors noted above, Fitch expects there to be some level of support for BNS going forward, and as such does not expect the SR to be impacted.
The SRF ratings are more likely to be affected and are sensitive to progress made in completing NVCC issuances and any additional regulatory initiatives that may be imposed on the Canadian D-SIFIs. 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 implementation.
Fitch expects that the continued regulatory action to ensure sufficient contingent capital will be implemented for all Canadian banks in the near term, but regardless, Fitch believes that sufficient regulatory progress continues to be made over the ratings time horizon. Therefore, Fitch expects to downgrade BNS' SRFs to 'BBB-' at some point over the next 12 months.
Absent a material in change economic conditions or the companies' stand-alone credit profiles, a downgrade of the SRFs to 'BBB-' would mean no change to the BNS' long-term IDR and debt ratings because their VRs are all above the SRF.
KEYRATING DRIVERS - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and other hybrid capital issued by the banks and by various issuing vehicles are all notched down from the banks' (or bank subsidiaries') VRs in accordance with Fitch's assessment of each instrument's respective nonperformance and relative loss severity risk profiles.
KEY RATING SENSITIVITIES - SUBORDINATED DEBT AND PREFERRED SECURITEIS
The subordinated debt ratings are primarily sensitive to any change in the VRs of the banks (or bank subsidiaries).
The preferred securities ratings of Scotia Capital Trust are trust preferred securities, which Fitch gives five notches from the VR given management and regulatory authorities powers to suspend dividends.
Fitch has affirmed the following ratings:
Bank of Nova Scotia
--Long-term IDR at 'AA-', Outlook Stable;
--Short-term IDR at 'F1+';
--Long-term deposits at 'AA-';
--Senior debt at 'AA-';
--Subordinated debt at 'A+';
--Short-term debt at 'F1+';
--VR at 'aa-';
--Support Rating at '1';
--Support Rating Floor at 'A-'.
Scotiabank Capital Trust
--Trust Securities at 'BBB'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Global Financial Institutions Rating Criteria' (January 2015
-- 'The Evolving Dynamics of Support for Banks' (September2013)
-- 'Bank Support: Likely Rating Paths' (September2013)
--2015 Outlook: Canadian Banks (December 2014)
Applicable Criteria and Related Research:
2015 Outlook: Canadian Banks (Stable RatingOutlook, Negative Sector OutlookRemains for 2015)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=810389
Bank Support: Likely Rating Paths
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715001
The Evolving Dynamics of Support for Banks
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715000
Global Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=978295
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