DBRS Morningstar Confirms National Bank of Canada’s Ratings at AA with Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the ratings of National Bank of Canada (National or the Bank) and its related entities, including the Bank’s Long-Term Issuer Rating at AA and Short-Term Issuer Rating at R-1 (high). The trend on all ratings is Stable. 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 ratings confirmations and Stable trends recognize National’s pan-Canadian universal banking model with footprints in targeted markets and niches across the country, especially in Wealth Management (WM) and Financial Markets (FM). 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). Furthermore, the Bank benefits from strong pre-provision earnings, with Personal and Commercial (P&C) and WM now contributing a larger portion of earnings, placing the Bank at the top of its peer range in terms of profitability metrics. Additionally, modernization and 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 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.

RATING DRIVERS
Over the longer term, DBRS Morningstar would upgrade the ratings if the Bank continues building the scale and diversity of its franchise without a commensurate increase in risk and while maintaining strong financial performance.

Conversely, DBRS Morningstar would downgrade the ratings if there is a sustained deterioration in asset quality, especially from deficiencies in risk management or a prolonged decline in profitability metrics.

RATING RATIONALE
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, particularly in Western Canada. In addition, the Bank has a few small international investments, including in the United States and Cambodia.

Earnings Combined BB Assessment: Strong
With its focused franchise and leading position in Québec, National generates strong underlying earnings, including a healthy proportion of fee income, which contribute to the Bank's ability to absorb credit losses. In F2022, earnings reached $3.4 billion, up 7% compared with the prior year despite an increase in provisions for credit loss as strong volumes across business lines, coupled with higher net interest income drove an increase in revenue. The Bank continues to record profitability metrics that are at the top of the peer range, with a return on average assets of 0.9% and a return on average equity of 16.7% in F2022.

Risk Combined 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 inched up to 0.59% of gross loans as of Q1 2023 as the credit cycle began to resume a normal rhythm. Overall, as with peers, asset-quality metrics remain at unsustainably low levels, and modest deterioration is expected as credit conditions normalize; however, DBRS Morningstar notes that the majority of National’s credit exposure is underwritten in Québec, which has not witnessed the very high 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 8% of the Bank’s total portfolio and that this credit risk has been historically well managed.

Funding and Liquidity Combined 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 151% for Q1 2023, and a net stable funding ratio of 121%, both well above the regulatory minimums. Unrealized losses of $473 million on its $11 billion investment securities portfolio remain manageable.

Capitalization Combined BB Assessment: Strong
Capitalization is strong as National continues to organically generate sufficient capital to support balance sheet growth. As at January 31, 2023, National’s Common Equity Tier 1 (CET1) ratio stood at 12.6%, in the middle of its Canadian bank peer range. At this level, the Bank's CET1 ratio was well above the regulatory minimum of 11% for Domestic Systemically Important Banks (D-SIBs). In Q1 2023, National’s risk-based total loss-absorbing capacity ratio was at 28.7%, above the regulatory threshold of 24.5%. The Bank reported a leverage ratio of 4.54% in Q1 2023 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/413302.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organizations (https://www.dbrsmorningstar.com/research/398692/global-methodology-for-rating-banks-and-banking-organisations; June 23, 2022). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022) in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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 rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is a solicited credit rating.

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:

The last rating action on this issuer took place on April 30, 2022, when DBRS Morningstar upgraded the ratings of National 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.

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: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.
For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

Lead Analyst: Maria-Gabriella Khoury, CFA, Senior Vice President, North American Financial Institutions
Rating Committee Chair: John Mackerey, Senior Vice President
Initial Rating Date: February 29, 2000

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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