Moody's affirms Scotiabank's Peru ratings, outlook stable

The following ratings and assessments assigned to Scotiabank Peru were affirmed:

The affirmation considers Scotiabank Peru's strong and increasing capitalization, stable asset quality, ample and resilient core profitability, improved funding profiles, and its rising market share. The rating also considers the probability that the bank will benefit from support from both its parent, Bank of Nova Scotia (BNS, rated A1 negative), and/or the Peruvian government in an event of financial stress.

Thanks to its diversified portfolio of commercial and retail loans, the bank's risk profile has remained stable overall in recent years despite a relatively high appetite for risk coupled with significant deterioration of its book of loans to small and medium-sized companies.

While delinquencies remain higher than peers, non-performing loans (NPLs) rose just 5 bps to 3.5% of total loans in the two year period ending June 2017 in spite of soft economic activity and the severe flooding caused by Coastal El Niño climate system earlier this year.

Though this ratio benefited from a sharp rise in net charge-offs, to 2.8% of gross loans on an annualized basis in the first six months of 2017 from 1.8% in calendar year 2016 and just 1.2% in 2015, loan loss reserves nevertheless continued to total a comfortable 141% of NPLs. The bank's asset risk profile has also benefited from a decrease in the dollarization of its loans to SMEs and consumers, whose earnings are largely in local currency.

Notwithstanding a sharp deceleration in lending growth that began in 2016 and a continued increase in credit costs, the bank's profitability ratios have also remained relatively stable in recent quarters, with net income equal to a robust 1.9% of tangible assets, supported by ample net interest margins of almost 6%. The bank's total lending book nevertheless expanded more rapidly than its peers, by almost 10% year-on-year as of June 2017 - versus 2.2% for the system as a whole, driven by growth in personal loans. This has enabled the bank to consolidate its position as Peru's third-largest bank with a loan market share of 18%.

Supported by continued strong profitability, moderate dividend payout ratios, and despite the bank's lending growth, the bank's adjusted capital ratio rose to 13% as of June 2017 from 11.8% as of year-end 2015, providing it the strongest loss absorption capacity of its local peers.

Moreover, the bank also benefits from a large and growing base of granular, low-cost deposits. This has allowed it to lower its reliance on market funds, which have fallen steadily to just 12% of tangible assets as of June 2017 from nearly 21% as of year-end 2014. Nearly half of the bank's deposits came from individuals, limiting the bank's exposure to less reliable and more cost-sensitive institutional deposits. In addition, 47% of deposits were dollar-denominated as of June, down from almost 58% at the end of 2015, reducing the bank's balance sheet currency mismatches and leaving it less dependent on Central Bank currency swaps.

The bank's ratings also capture the high probability that its parent, will provide financial support in an event of stress, reflecting the Peruvian operation's strategic importance to BNS given its role as a regional hub coupled with the parent's focus on Pacific Alliance members, which include Mexico, Chile and Colombia, as well as Peru. In addition, the rating considers a moderate probability of support from the Peruvian government given the bank's importance in the domestic banking system as the country's third-largest deposit taker, its market visibility, and the material systemic consequences of an unsupported failure.

Notwithstanding the negative outlook on BNS, the outlook on Scotiabank Peru's deposit ratings remains stable in line with the stable outlook on the Peruvian government, thanks to support from both the parent and the government.

Scotiabank Peru's baseline credit assessment (BCA) could face upward pressure if the bank's asset quality and profitability remain stable, and if the recent improvements in capitalization and funding prove sustainable as loan growth starts to accelerate. On the other hand, significant deterioration in Scotiabank Peru's asset quality, capital, or funding profile could lead to downward pressure on its BCA. However, neither a one-notch increase or decrease in either the bank's BCA or in BNS's rating would affect Scotiabank Peru's deposit or subordinated debt ratings. At this point, only a change of the Peru's sovereign rating would lead to a change of the bank's deposit rating.