Bank of Nova Scotia’s determination to chase greater profits by expanding its portfolio of unsecured auto and charge card loans, and branching out into higher-growth but less stable geographies, has resulted in a one notch ratings downgrade from Moody’s Investors Service.
Canada’s third-largest bank has taken “significant measures to improve its profitability that signal a fundamental shift from the bank’s traditionally safe appetite,” Moody’s vice-president David Beattie said inside a statement released late Monday, after Moody’s completed a 90-day overview of Scotia’s operations.
“While the bank’s strategic actions usually are meant to enhance current profitability- in Moody’s view, they boost the prospect of future incremental credit losses,” he wrote, noting that Scotia’s strategy reflects its position of getting the lowest domestic net interest margin of Canada’s six largest banks.
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The debt-rating agency highlighted Scotia’s growing reliance upon charge card and car loan debt because those categories are “particularly prone to deterioration during an downturn in the economy and exhibit higher defaults and loss severities than mortgage portfolios.”
Late last year, when the overview of Scotia began, Moody’s said the bank’s personal and credit card loans has risen in a compound annual rate of growth of eight per cent in the last two years, the greatest among Canada’s largest banks.
In addition, the ratings agency said, Scotia made a number of acquisitions in higher growth, yet less stable international markets from its strong domestic franchise.
Aspirations to carry on to develop its international earnings, which in Moody’s view adds to bondholder risk
The bank “has aspirations to continue to grow its international earnings, which in Moody’s view contributes to bondholder risk,” Beattie wrote this week within the statement downgrading the long-term debt and deposit ratings of Bank of Nova Scotia and its subsidiaries to Aa3 from Aa2.
The bank is not shying away from its international expansion, and it is actually touting expectations for growth. Executives hosted an investor conference in Mexico City this month, where they targeted double-digit development in four Latin American markets.
Scotia has traditionally commanded a very high rating from Moody’s because it was considered a very conservative bank, even among Canadian banks, a group that’s generally regarded as more risk averse than many global counterparts.
Even using the downgrade, the financial institution remains among the highest rated on the planet, said Diane Flanagan, vice-president of corporate communications at Scotia.
“The Bank has a strong risk culture and prudent business design diversified by geography, products and customers,” she said in an emailed statement.
There is little coming that will cause upgrading to Moody’s rating on the bank, according to Beattie’s assessment.
“Moody’s believes it is likely- [the] increased risk tolerance and strategic imperative to increase profitability by shifting the asset mix towards higher yielding categories of credit, both domestically and in international operations, will persist,” he wrote.
The Bank has a strong risk culture and prudent business model diversified by geography, products and customers
The ratings agency’s outlook for Scotia’s ratings is negative, along with the rest of Canada’s large banks. This longstanding stance reflects Moody’s view the government support for banks has shifted “to the down-side.”
In response to the financial crisis of 2008, governments around the world, including Canada, moved towards bail-in regimes that would shift the burden of the failing bank to that particular institution’s securities holders and reduce taxpayer exposure.
In contrast to the Moody’s assessment, rival ratings agency Fitch now held firm around the default ratings assigned to Canada’s big banks.
The outlook was also maintained as stable, with one exception. Fitch changed its outlook on Royal Bank of Canada’s to negative from stable.
The ratings agency said the change is made because Royal Bank’s “future earnings volatility may be higher than Canadian bank peer averages plus comparison to similarly rated global financial institutions.”