Fitch Ratings has affirmed Scotiabank Colpatria S.A.'s (SBC) Long-Term (LT) Foreign Currency (FC) and Local Currency (LC) Issuer Default Ratings (IDRs) at 'BBB-' and 'BBB', respectively, its Shareholder Support Rating (SSR) at 'bbb-' and its Viability Rating (VR) at 'bb'.

Fitch has also affirmed the bank's National Long- and Short-Term Ratings at 'AAA(col)' and 'F1+(col)', respectively. The Rating Outlook for the Long-Term ratings is Stable.

Key Rating Drivers

Shareholder Support: SBC's IDRs and national ratings are based on the support it would receive from its parent, The Bank of Nova Scotia (BNS), should it be required, as reflected in the shareholder support rating (SSR) of 'bbb-'. Fitch believes that the parent's propensity to support SBC is high due to the strategic role that it plays in BNS' regional goals. There is also significant management and operational integration between the two companies. SBC's LT IDR is two notches above Colombia's sovereign rating, which is in line with Fitch's parent/subsidiary criteria. The FC IDR is constrained at 'BBB-' by Colombia's Country Ceiling.

Parent's Ability to Support: BNS' ability to provide support to SBC is linked to its 'AA-'/Stable IDR and to the relatively small size of SBC's operations, which represents less than 1% of the group's consolidated assets. However, ability to support is limited at a level several notches below the parent's IDR based on the sovereign rating and Country Ceiling under Fitch's criteria.

Viability Rating: SBC's VR is driven by its standalone performance, which considers its evolving business model, negative performance affected by increased delinquency and tight capital metrics compared to peers in this rating category.

Increased Loan Restructures: As of December 2023, the bank's NPL ratio improved slightly to 3.2% from 3.5% in December 2022, with restructuring loans rising to 5% of the gross portfolio. The increase in restructures, mainly retail loans, has led to higher provisions, improving the loan loss allowances ratio. Fitch expects that the NPL ratio will stabilize to around 3% due to enhanced underwriting standards. However, asset quality is still impacted by a high concentration risk, with the top 20 debtors accounting for 3.1x the bank's common equity Tier 1 ratio (CET1).

Negative Performance Persists: SBC's profitability in 2023 was negatively impacted by high delinquency rates, with loan impairment charges exceeding operating profits, leading to negative results. Despite increases in non-interest income and improved operational efficiency, the high costs of loan impairments are likely to continue to drag on profitability into 2024.

Income also suffered from reduced business volume and tighter net interest margins due to higher funding costs, with operating profit to RWA at -1.6%. Fitch expects a slow recovery due to improved client payment behavior and market interest rate cuts, which will ease profit pressures. However, we believe that core profitability will remain negative through 2024 and then improve in 2025.

Tight CET1 Ratio: Fitch considers potential support from SBC's parent company when assessing its tight capital metrics. SBC's CET1 to RWA ratio was 7.7% as of December 2023, below industry averages, despite a capital boost from BNS and a lowered APR. The bank's regulatory capital ratio stood at 11.8%, which subordinated and additional tier 1 (AT1) bonds. While the CET1 ratio is expected to stay low, potential support keeps SBC's capitalization score at 'bb-' with a stable outlook.

Adequate Funding Profile: The bank's funding and liquidity also benefit from the parent support, particularly in the form of direct credit lines and bond issuances. Nonetheless, its main source of funding comes from customer deposits, which have proven relatively stable in recent years. As of December 2023, the loans to customer deposits ratio was 107.2% (4-year average: 102.5%), comparing similar to its major local peers.

Rating Sensitivities

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

SBC's IDRs are subject to sovereign rating and/or Country Ceiling considerations and could be affected by a negative sovereign rating action;

SBC's VR could be negatively affected if the bank's asset quality continues to deteriorate, further impacting its financial performance;

SBC's national ratings, including debt, could be downgraded following a similar action on the bank's IDR.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

An upgrade of SBC's Long-Term LC IDR is unlikely in the near future. A positive rating action on Colombia's sovereign rating or Country Ceiling could result in a positive action for SBC's IDRs.

The VR has limited upside potential in the short-to mid-term. However, a return to significantly enhanced profitability ratios, along with a CET1 ratio that is consistently maintained above 10%, could lead to an upgrade.

The national ratings do not have upside potential as they are already at the highest possible local rating.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

Senior Unsecured Debt

SBC's national rated senior unsecured debt is in line with its LC LT IDR, which maps with a local national rating of 'AAA(col)'. The likelihood of default for the debt issuance is the same as the likelihood of default for the bank.

SBC's subordinated debt national rating is two notches below what Fitch considers the appropriate anchor rating, the bank's LT LC IDR of 'BBB', since this is a local currency issue program. The two-notch difference reflects the loss severity, given the characteristics (no coupon flexibility). The global rating maps have the local national rating of 'AAA(col)'.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

SBC's national rated debt could be downgraded by a similar action to the bank's IDR.

VR ADJUSTMENTS

Fitch has assigned a Capitalization and Leverage score above the implied score due to the following adjustment reason: Capital Flexibility and Ordinary Support (positive).

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

Ratings are shareholder support driven (The Bank of Nova Scotia; AA-).

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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