Fitch Ratings has affirmed Scotiabank Chile S.A.'s (SBC) Local and Foreign Currency Long-Term (LT) and Short-Term (ST) Issuer Default Ratings (IDRs) at 'A+' and 'F1+', respectively.

The Rating Outlook on the LT IDRs remains Stable. At the same time, Fitch has affirmed the National LT and ST ratings for SBC at 'AAA(cl)' and 'N1+(cl)', respectively, with a Stable Outlook.

Key Rating Drivers

VR, IDRS AND NATIONAL RATINGS

SBC's IDRs are based on expected support from its parent, The Bank of Nova Scotia (BNS). SBC' role in its group and its integration with its parent have a high influence in Fitch support assessment. SBC's IDR of 'A+' are one notch below the parent's IDR as it is considered a strategically important subsidiary for BNS, SBC's ST IDRs corresponds to the highest point in the rating correspondence table, driven by its LT IDR, which is equalized to the ST rating of the support provider.

As the bank's IDRs are based on support, SBC's intrinsic financial profile has a limited influence on its ratings. Nevertheless, the smooth merger execution between former BBVA Chile and SBC has strengthened the bank's business profile, which has a high influence on its Viability Rating (VR) of 'bbb+'. According to Fitch's assessment, the bank's business profile has a stronger impact on the assigned VR than the weighting would suggest (20%).

The bank's proven risk diversified business profile, currently at 'bbb+', will have a positive impact on its financial metrics beyond that currently captured in the Key Rating Driver scores over the long term. SBC is the fourth largest private-sector bank in Chile, with 14.7% market share in loans, and is the largest BNS investment in Latin America (17% of BNS's international subsidiaries and affiliates).

The Stable Outlook on the LT IDRs is in line with the Outlook on its parent's IDRs. A revision of the parent's Outlook would likely prompt a similar action on SBC's IDRs.

SBC' asset quality metrics remained sound. The bank's NPL ratio declined to a record low of 1.00% at June 2022, with a four-year average of 1.50%. The contribution of the consolidated bank's better risk profile and an effective credit-collection effort supported this favorable trend. SBC's conservative risk appetite included additional voluntary loan loss reserves of CLP186 billion as of June 2022 (0.76% of risk-weighted average [RWA]), which maintained an adequate loan loss reserve coverage at 1.63x impaired loans (1.61x at YE 2021). Fitch expects the level of impaired loans to slightly increase, although it will remain in line with the bank's risk profile.

The bank's 2Q22 results remained solid, driven by high net interest margins and inflation and still low, though increasing credit costs. SBC's operating income in 2Q22 benefited from tailwinds from the bank's strong results in 2021, despite a slight increase in loan impairment charges slightly begun to raise during 2022. Higher interest rates and increase on inflation largely offset higher funding costs and credit costs during 1H22. Fitch believes that operating profits will remains strong but not as high as 2021, due to increasing credit costs in a lower economic growth environment.

Fitch views SBC's capitalization levels as adequate for its current rating based on expected ordinary support from its ultimate parent BNS. SBC's common equity Tier 1 (CET1)/RWA ratio stood at 9.3% in June 2022, relatively low compared with similarly rated international peers (9.9%). The CET1 ratio was affected by higher RWAs and the negative effect on hedge accounting on capital accounts, related to higher interest rates, along with greater expectations of inflation.

Although Chilean banks reported total RWA under Basel III since December 2021, a more conservative asset risk weightings under a customized standardized approach penalize Chilean banks' capital adequacy and profitability metrics relative to international peers. Fitch expects that the bank's stable retained earnings, improved core revenues and cost controls to maintain capitalization levels over the rating horizon.

SBC's main funding source is time deposits and its loans/deposits ratio (169% in June 2022) is higher than the system average and the benchmark range for similarly rated banks, mostly due to its high proportion of mortgage loans. At the same date, the bank's consolidated liquid coverage ratio was 158%, below its private-sector domestic peer average. SBC's approach is conservative, matching long-term mortgage loans with long-term senior unsecured bonds and to a lesser degree with subordinated bonds. Market risk is characterized by a low-risk appetite. Funding with Central Bank of Chile reached about 9% of total, a figure in line with its domestic peers.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

VR, IDRs AND NATIONAL RATINGS

Any negative action on BNS's IDRs would also lead to a similar action to SBC's IDRs;

SBC's IDRs could also be downgraded if Fitch's assessment of BNS's willingness to support SBC changes, which could widen the gap between the parent's and the subsidiary's IDRs;

The VR could be downgraded in the event of a sustained deterioration in SBC's core metrics, specifically, an operating profit to RWA ratio below 1%, an increase in the impaired loans ratio above 3% or a decline in the CET1 ratio below 8%.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

VR, IDRs AND NATIONAL RATINGS

An upgrade of SBC's IDRs is unlikely in the near future as the ratings recently returned to Stable Outlook and the LT IDR is capped by the country ceiling. Over the medium term, the local currency LT IDR could be upgraded if the parent's ratings are upgraded, or if Fitch revises its support assessment of SBC to an equalization of its IDRs with those of its parent;

Even in the event of a consolidation of the positive trends in the bank's current company profile, a VR upgrade is unlikely as it is now at the same level of the operating environment, and Fitch views the bank's current financial profile as commensurate for its rating level;

Given the current National ratings are at the top of the National scale, there is no upside potential.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

SENIOR UNSECURED, SUBORDINATED DEBT AND EQUITY RATINGS

The senior unsecured bonds are rated at the same level as the bank's LT IDRs and National LT Rating of of 'A+' and (AAA[cl]) respectively, as the senior debt's likelihood of default is the same as that of the issuer. The National LT Rating of mortgage notes is based on SBC's National Rating for senior unsecured debt.

Fitch rates SBC's subordinated debt at 'AA(cl)' on the National scale, two notches below its National LT Rating. The two-notch difference considers the loss severity due to its subordinated nature (after default), and no additional notching for non-performance risk given the subordinated debt's going-concern feature, which is triggered after the point of nonviability.

The rating of SBC's common shares of 'Primera Clase Nivel 3(cl)' considers the bank's solvency, reflected in its 'AAA(cl)' National Rating, the shares' poor liquidity and the bank's market value.

SHAREHOLDER SUPPORT RATING

The Shareholders Support Rating (SSR) of 'a+' is based on shareholder's propensity to support with its role in the group and integration being of high importance factors in the SSR.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade

SENIOR UNSECURED, SUBORDINATED DEBT AND EQUITY RATINGS

Senior and subordinated debt ratings would generally move together with the bank's LT ratings. The subordinated debt remains two notches below the bank's National LT rating;

The rating of SBC's common shares could be affected by a multiple notch downgrade of the bank's National LT rating or a significant decrease of the liquidity of the shares or of the market value of the bank.

Factors that could, individually or collectively, lead to positive rating action/upgrade

SENIOR UNSECURED, SUBORDINATED DEBT AND EQUITY RATINGS

Senior and subordinated debt ratings would generally move together with the bank's LT ratings. The subordinated debt remains two notches below the bank's National LT rating;

Potential upside would likely be supported from a significant increase in the shares' liquidity or the bank's market value.

SHAREHOLDER SUPPORT RATING

The SSR are also sensitive to a change in Fitch's views on BNS's ability and propensity to provide support.

VR ADJUSTMENTS

The VR of 'bbb+' has been assigned above the 'bbb' implied VR due to the following adjustment reasons: Business Profile (positive).

The Capitalization & Leverage score of 'bbb' has been assigned above the 'bb' category implied score due to the following adjustment reasons: Capital Flexibility and Ordinary Support and Regulatory Capitalization (positive).

The Funding and Liquidity score of 'bbb' has been assigned above the 'bb' category implied score due to the following adjustment reasons: Non-Deposits Funding and Liquidity Access and Ordinary Support (positive).

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

Scotiabank Chile ratings is driven by The Bank of Nova Scotia;

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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