DBRS Limited (DBRS) changed the trend on all ratings of National Bank of Canada (National or the Bank) and its related entities to Positive from Stable, as well as confirmed all ratings, including the Bank’s Long-Term Issuer Rating at AA (low) and Short-Term Issuer Rating at R-1 (middle). National’s Long-Term Issuer Rating is composed of an Intrinsic Assessment of A (high) and a Support Assessment of SA2, reflecting the expectation of timely systemic support from the Government of Canada (rated AAA with a Stable trend by DBRS). The SA2 designation results in a one-notch uplift to the Long-Term Issuer Rating. Under the Canadian Bank Recapitalization Regime, DBRS expects to eventually remove the uplift from systemic support once the Bank has issued a sufficient level of bail-inable senior debt, which would provide an adequate buffer for non-bail-inable obligations and is expected to offset the removal of systemic support.
KEY RATING CONSIDERATIONS
The Positive trend and confirmation of the ratings recognize National’s dominance in its home province, the Province of Québec (Québec; rated A (high) with a Positive trend by DBRS), which continues to experience strong economic growth, in addition to the successful expansion of the Bank’s footprint in targeted markets across the rest of Canada, especially in Wealth Management (WM) and Financial Markets (FM). Furthermore, the Bank benefits from strong earnings, to which Personal and Commercial (P&C) and WM are now larger contributors, while transformation efforts in its P&C business and growth of its WM business have driven growth in client deposit capture.
The ratings also consider the longevity of the current credit cycle and the potential negative impacts on the Québec economy that might arise due to escalations in trade disputes between Canada, the United States and China. Lastly, DBRS notes that National’s FM business segment is an important contributor to the Bank’s franchise. Although the majority of transactions are client driven, which DBRS views positively, the segment’s activities do expose the Bank to increased capital markets risk from significant market downturns or other adverse events.
Continued franchise momentum and positive performance while maintaining sound asset quality would likely lead to an upgrade in the ratings.
Although DBRS does not see any near-term negative rating pressure, a sustained deterioration in asset quality, particularly from deficiencies in risk management, could lead to a negative rating action. Additionally, an increase in National’s risk appetite or a shift toward a potentially more volatile earnings mix could pressure the ratings.
National operates a pan-Canadian franchise with a dominant position its home province of Québec. While its P&C banking businesses maintain leading market shares in Québec, the Bank has successfully expanded its footprint across the country through its WM and FM businesses. In addition, the Bank has a few small international investments, including in the United States and Cambodia.
Earnings continue to benefit from the positive performance of the Québec economy and the efficiencies generated by transformation initiatives over the last few years. Net income was up 2% year over year (YOY) to $558 million in Q2 2019, as positive momentum in the P&C banking and WM businesses was tempered by lower capital markets activities. While a smaller contributor within National’s diverse business mix, the U.S. Specialty Finance and International division continues to grow strongly, posting a 14% YOY increase in net income to $72 million in Q2 2019. Meanwhile, profitability metrics continue to outperform the large Canadian bank peers with return on common equity at 17.8% for Q2 2019.
Both prudent risk management and a conservative lending culture enable National to maintain solid asset-quality metrics. Gross impaired loans stood at a manageable 0.42% of gross loans as of Q2 2019 — better than the Bank’s large Canadian bank peers — and the annualized provisions for credit losses as a percentage of average net loans and leases is a low 0.23%. While current loan performance reflects, in part, the benign credit environment in Québec and Canada, DBRS views these levels as being near cyclical lows and likely not sustainable over the longer term.
DBRS remains concerned over the combination of high Canadian household indebtedness and elevated housing prices, particularly in and around Vancouver and Toronto, and the potential impact of a housing downturn on the Canadian economy as well as on other consumer-related loan portfolios. Nonetheless, National only has 26% of its retail mortgage and home equity line of credit portfolio in the Province of Ontario (rated AA (low) with a Stable trend by DBRS) and 7% in the Province of British Columbia (rated AA (high) with a Stable trend by DBRS). National’s footprint is predominantly in Québec, and the bulk of residential real estate exposure is in Montréal, a market that has not experienced as significant of a rise in house prices. Furthermore, the Bank’s residential-secured portfolio, like all the large Canadian banks, appears conservatively underwritten or is insured. Specifically, 40% of National’s Canadian residential-secured portfolio is insured, while the average loan-to-value ratio of the uninsured portion is a conservative 60%.
The Bank has a strong funding profile. After placing more emphasis on growing its retail and commercial deposit base, National’s funding profile has improved and is now better aligned with the other large Canadian banks. This includes an increase in the client’s share of wallet through various initiatives at both P&C and WM. As a result, according to DBRS’s calculation, retail and commercial deposits now make up 59% of total funding versus 47% five years ago. Additionally, National has ready access to a wide range of wholesale funding sources to supplement deposit funding. Meanwhile, the Bank’s liquidity levels are strong with a Liquidity Coverage Ratio of 141% for Q2 2019, near the top of the peer range.
Capitalization is strong as National continues to organically generate sufficient capital to support its balance sheet growth and provide a sufficient cushion to absorb potential losses. As at April 30, 2019, National’s Common Equity Tier 1 ratio reached 11.5%, a 20-basis-point improvement from the previous year and well above the Office of the Superintendent of Financial Institution’s (OSFI) minimum requirements. Nonetheless, as with the other large Canadian banks, overall capital metrics remain lower than some global peers. Meanwhile, the Bank has begun issuing Bail-inable Senior Debt as part of the Canadian bail-in regime. It is expected that the Bank will exceed the total loss absorbing capacity requirements issued by the OSFI as it replaces maturing legacy senior debt.
The Grid Summary Grades for National are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Strong; Risk Profile – Strong; Funding & Liquidity – Strong; and Capitalisation – Strong.
DBRS notes that the above press release was amended on July 30, 2019, to reflect National’s Earnings Power as Strong rather than Very Strong in the Grid Summary. The amendment was minor and would not impact the understanding of the reader.
DBRS notes that the above press release was amended on October 7, 2019, to add a note regarding the previous rating action date. The amendment was minor and would not impact the understanding of the reader.
All figures are in Canadian dollars unless otherwise noted.
The applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2019), which can be found on our website under Methodologies & Criteria.
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 www.dbrs.com.
The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This rating is endorsed by DBRS Ratings Limited for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:
The last rating action on this issuer took place on July 26, 2018, when DBRS confirmed all ratings and the Stable trend.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS’s outlooks and ratings are monitored.
For further information on DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.
Lead Analyst: Maria-Gabriella Khoury, Senior Vice President, Global FIG
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer Global FIG and Sovereign
Initial Rating Date: February 29, 2000
For more information on this credit or on this industry, visit www.dbrs.com.
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