DBRS Limited (DBRS Morningstar) upgraded the ratings of National Bank of Canada (National or the Bank) and its related entities, including the Bank’s Long-Term Issuer Rating to AA from AA (low) and Short-Term Issuer Rating to R-1 (high) from R-1 (middle). Additionally, DBRS Morningstar changed the trends on all ratings to Stable from Positive. National’s Long-Term Issuer Rating is composed of an Intrinsic Assessment of AA (low) and a Support Assessment of SA2, which reflects the expectation of timely systemic support from the Government of Canada (rated AAA with a Stable trend by DBRS Morningstar). As a result of the SA2 designation, the Bank’s Long-Term Issuer Rating benefits from a one-notch uplift.
KEY RATING CONSIDERATIONS
The upgrades and Stable trends recognize National’s successful expansion of its footprint in targeted markets and niches across Canada, especially in Wealth Management (WM) and Financial Markets (FM). In addition, the Bank’s strong performance over the last few years, with Personal and Commercial (P&C) and WM now contributing a larger portion of earnings, has placed National at the top of its peer range in terms of profitability metrics.
The ratings also reflect National’s dominance in its home province, the Province of Québec (Québec; rated AA (low) with a Stable trend by DBRS Morningstar), which had experienced strong economic growth prior to the Coronavirus Disease (COVID-19) pandemic and is now showing a healthy rebound. Furthermore, the Bank benefits from strong preprovision earnings, while the transformation efforts in its P&C business and growth of its WM business have driven growth in client deposits. The ratings also consider the small yet growing contribution of the U.S. Specialty Finance and International (USSF&I) segment, which DBRS Morningstar views as having a higher risk profile, as well as potentially more volatile earnings. Lastly, DBRS Morningstar notes that National’s FM business segment is an important contributor to the Bank’s franchise and has benefitted from the market volatility experienced in the last couple of years. Although the majority of transactions are client driven, the segment’s activities could expose the Bank to increased capital markets risk from significant market downturns.
The ratings also consider that government support measures have largely mitigated the negative economic impacts of the pandemic. Positively, economic performance has rebounded, and the labour market is essentially at full capacity; however, headwinds persist from a potentially aggressive interest rate tightening cycle to combat inflation, geopolitical tensions related to the Russia-Ukraine conflict, supply-chain disruptions, and the pandemic. Furthermore, DBRS Morningstar remains concerned about the combination of high Canadian household debt levels that have reached an all-time high and elevated home prices that have been driven by housing market imbalances and robust demand during the pandemic (particularly in the greater Toronto and Vancouver areas). Housing prices remain vulnerable and, as a result, National and its Canadian peers remain susceptible to adverse changes in the Canadian real estate market. Positively, DBRS Morningstar views National’s residential mortgage loan portfolio as conservatively underwritten, reflecting the Bank's strong risk culture.
Given National’s recent rating upgrade and high rating level, a further rating upgrade is unlikely. Conversely, the ratings would be downgraded if there is a sustained deterioration in asset quality, especially from deficiencies in risk management or a prolonged decline in profitability metrics.
Franchise Combined Building Block (BB) Assessment: Strong
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 especially through its WM and FM businesses. In addition, the Bank has a few small international investments, including in the United States and Cambodia.
Earnings Combined Building Block (BB) Assessment: Strong
With its focused franchise and leading position in Québec, National generates strong underlying earnings, which contribute to the Bank's ability to absorb credit losses. In F2021, earnings reached $3.2 billion, up 53% compared with the prior year due to provision for credit loss reversals as well as strong volumes across business lines. As a result, return on average common equity increased to 20.7% from 14.9% in F2021 and remains ahead of peers. Unprecedented support measures put in place through monetary and fiscal stimulus have mitigated some of the negative impacts of this crisis; however, near-term challenges remain across the Bank’s footprint given the scale of the aforementioned headwinds.
Risk Combined Building Block (BB) Assessment: Strong
In DBRS Morningstar’s view, prudent risk management and a conservative lending culture enable National to maintain strong asset-quality metrics. Gross impaired loans remained at a low of 0.32% of gross loans as of Q1 2022—better than some of the Bank’s larger Canadian peers—as the majority of National’s credit exposure is underwritten in Québec, which has experienced a relatively benign credit environment in recent years and has not witnessed the real estate price appreciation seen in other provinces. Furthermore, although credit in the USSF&I segment is in riskier sectors or geographies, DBRS Morningstar notes that the segment’s loans form only 7% of the Bank’s total portfolio and that this credit risk has been historically well managed. Overall, as with peers, asset-quality metrics are at unsustainably low levels, and DBRS Morningstar expects to see modest deterioration as credit conditions normalize.
Funding and Liquidity Combined Building Block (BB) Assessment: Strong
The Bank has a strong funding profile with a growing retail and commercial deposit base. This includes an increase in the client’s share of wallet through various coordinated initiatives among the Bank’s P&C, WM, and FM divisions. As a result, according to DBRS Morningstar’s calculation, retail and commercial deposits make up 54% of total funding, at the top range of its large Canadian peers. Additionally, National has ready access to a wide range of wholesale funding sources with a diverse international investor base. Meanwhile, the Bank enjoys the highest liquidity level among peers as measured by the Liquidity Coverage Ratio, which was 149% for Q1 2022, and a net stable funding ratio of 117%, both well above the regulatory minimums.
Capitalisation Combined Building Block (BB) Assessment: Strong
Capitalization is strong as National continues to organically generate sufficient capital to support balance sheet growth. As at January 31, 2022, National’s Common Equity Tier 1 (CET1) ratio stood at 12.7%, in the middle of its Canadian bank peer range. At this level, the Bank's CET1 ratio was well above the regulatory minimum of 10.5% for Domestic Systemically Important Banks (D-SIBs). In Q1 2022, National’s risk-based total loss-absorbing capacity ratio was at 27.8%, above the regulatory threshold of 24.0%. The Bank reported a leverage ratio of 4.4% in Q1 2022 that was above the regulatory minimum of 3% and in line with its Canadian bank peers; however, DBRS Morningstar notes that this metric remains somewhat weaker than that of many global peers.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/396149.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (July 19, 2021; https://www.dbrsmorningstar.com/research/381742). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).
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.dbrsmorningstar.com.
The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar 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 United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed ratings:
Each of the principal methodologies/principal asset class methodologies employed in the analysis addressed one or more particular risks or aspects of the rating and were factored into the rating decision. Specifically, the Global Methodology for Rating Banks and Banking Organisations (July 19, 2021) was used to evaluate the issuer, and DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021) was used to assess ESG factors.
The last rating action on this issuer took place on April 30, 2021, when DBRS Morningstar confirmed all ratings and changed the trend to Positive from Stable.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.
For further information on DBRS Morningstar 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.
Lead Analyst: Maria Gabriella-Khoury, Senior Vice President
Rating Committee Chair: John Mackerey, Senior Vice President
Initial Rating Date: February 29, 2000
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