Moody’s: BNS On Review-Negative

Moody’s Investors Service has announced that it:

has placed the long term ratings, Counterparty Risk Assessment and Baseline Credit Assessment of Bank of Nova Scotia (BNS, Aa2/Aa2 negative, a1) and its subsidiaries on review for downgrade, and affirmed BNS’s Prime-1 short-term deposit rating, short-term Counterparty Risk Assessment and other short term ratings.

Moody’s said the review was prompted by BNS having taken significant measures to increase its profitability that signal a fundamental shift away from the bank’s traditionally low risk appetite. These strategic actions are intended to enhance current profitability (BNS reports the lowest domestic net interest margin of the six largest Canadian banks), but in Moody’s view increase the prospect of future incremental credit losses when the credit cycle turns.

Over the last two years, BNS has accelerated the growth in its credit card and auto finance portfolios, in accordance with its strategic initiatives to expand these portfolios, both of which are particularly prone to rapid deterioration during an economic shock and exhibit higher defaults and loss severities than mortgage portfolios. Personal and credit cards loans grew at a CAGR of 8% over the past two years, the highest among the six large Canadian peer banks. In addition, BNS has made a series of acquisitions away from its strong domestic franchise towards higher-growth but less stable international markets.

During the review period, Moody’s will review the likelihood that BNS’s increased risk tolerance and strategic imperative to increase profitability by shifting the asset mix towards higher yielding categories of consumer credit, both domestically and in international operations, will persist. Moody’s will also undertake further analysis of the operating environments of the regions outside of Canada where BNS operates, and the bank’s strategy and performance in these regions. Moody’s will also assess the implications of the shift in risk tolerance, balanced against the strategic plan to enhance profitability and shareholder returns.

Given the direction of the review, upward pressure on the rating is unlikely. Downward pressure will depend upon our assessment of the items noted above as the focus of our review.

Doug Alexander of Bloomberg observes:

Debtholders already weighed in on the Toronto-based bank: Scotiabank’s Canadian dollar bonds are the worst performing among Canada’s six largest lenders this year.

Scotiabank is rated Aa2 by Moody’s, surpassed only by Toronto-Dominion Bank’s Aa1 grade. Royal Bank of Canada, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank of Canada carry Aa3 ratings. Moody’s last downgraded Scotiabank in January 2013.

Canadian consumers, already saddled with record household debt, have pushed the ratio of debt to disposable income to almost double that of the nation’s last severe recession in 1992, when unemployment hit 11.7 percent. Canadian card losses typically average around 3 percent of overall balances and soar to 7.5 percent in troubled times, whereas losses from mortgages are about 0.02 percent and have reached 0.1 percent in recessions, Moody’s said.

Scotiabank’s Canadian dollar bonds had a year-to-date total return of 1.5 percent as of Nov. 6, trailing the returns of Canada’s other so-called Big 6 lenders.

Scotia has a raft of preferred shares currently extant which could potentially be downgraded: BNS.PR.A, BNS.PR.B, BNS.PR.C, BNS.PR.D, BNS.PR.L, BNS.PR.M, BNS.PR.N, BNS.PR.O, BNS.PR.P, BNS.PR.Q, BNS.PR.R, BNS.PR.Y and BNS.PR.Z.

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