The Bank of Nova Scotia (NYSE:BNS) Q3 2023 Earnings Call Transcript August 29, 2023
The Bank of Nova Scotia beats earnings expectations. Reported EPS is $1.73, expectations were $1.28.
John McCartney: Good morning, and welcome to Scotiabank’s 2023 Third Quarter Results Presentation. My name is John McCartney, I’m Head of Investor Relations, here at Scotiabank. Presenting to you this morning are Scott Thomson, Scotiabank’s President, CEO; Raj Viswanathan, our Chief Financial Officer; and Phil Thomas, our Chief Risk Officer. Following our comments, we’ll be glad to take your questions. Also present to take questions are the following Scotiabank executives: Dan Rees from Canadian Banking; Glen Gowland from Global Wealth Management; Francisco Aristeguieta from International Banking; and Jake Lawrence from Global Banking and Markets. Before we start, and on behalf of those speaking today, I’ll refer you to slide two of our presentation, which contains Scotiabank’s caution regarding forward-looking statements. With that, I will now turn the call over to Scott.
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Scott Thomson: Thank you, John, and good morning, everyone. We appreciate you joining us today. The bank reported Q3 adjusted earnings of $2.2 billion or $1.73 per share, up 2% sequentially. Pre-tax, pre-provision earnings of $3.5 billion were up 5% compared to the prior quarter. The bank’s Q3 results reflect both the resilient performance of our retail and commercial businesses and modest improvement in our market-sensitive capital markets and wealth businesses. Although the operating environment has stabilized following the Q2 market dislocation, deposit migration to term products and Central Bank rate increases continue to increase our funding costs. Importantly, we strengthened our capital, liquidity and deposit metrics as we prepare the bank for our next phase of profitable, sustainable growth.
We continue to build capital this quarter, resulting in a common equity Tier 1 capital ratio of 12.7%. Our liquidity coverage ratio was a strong 133% at quarter end, up from 122% in the prior year. Deposits once again outpaced loan growth in the period from a sustained focus on deposit growth initiatives across our businesses, improving our loan-to-deposit ratio. Year-over-year deposits increased by 9% or approximately $55 billion. On a sequential basis, deposits grew in our Canadian Banking and International Banking franchises. Lending volumes in the quarter reflect a more cautious environment from both a household confidence and business investment perspective as seen in activity levels across our various segments and geographies. The impact of these macroeconomic realities coupled with a more selective and deliberate approach to new originations, has resulted in a moderation of our loan growth.
Expense growth was flat to last quarter and will be a priority as we strive to achieve our medium-term objective of delivering positive operating leverage. Disciplined expense management has always been a core competency of our bank. The higher for longer interest rate environment that has played out across our operating geographies has already and will continue to impact consumer health. Through our advanced data and analytics, we are closely monitoring customer behavior and have observed a very rational and responsible shift in spending as households manage through this period of reduced discretionary income. In our core international banking markets, where the interest rate tightening cycle has led most other global economies, we are seeing the impact of recessionary conditions, which are reflected in our elevated provisions.
With the Chilean economy, for example, now in a recession, is Central Bank cut rates with a 100 basis point policy rate decrease in late July and additional rate cuts are expected in the near term. Overall, we remain confident that the investment grade bias to our corporate and commercial portfolios, coupled with our conservative underwriting standards, has the bank very well positioned to manage through this phase of the rate cycle. We continue to build performing allowances and improve our ACL coverage as the longer-term macroeconomic outlook continues to be uncertain. From a business line performance perspective, I was particularly encouraged by our revenue-led pre-tax, pre-provision growth in each of Canadian Banking and International Banking, both up year-over-year and quarter-over-quarter.
GBM and wealth both showed positive trends as market volatility stabilized. In our Canadian Banking business, as expected, profitability was impacted by higher provisions. However, we saw healthy net interest margin expansion supported by another quarter of double-digit deposit growth. Our Scene+ loyalty program reached 14 million members in the quarter and has been a strong contributor to new primary client relationships and deeper product penetration with existing customers. Just this month, Home Hardware was added to the Scene+ program, providing members the opportunity to earn and redeem Scene+ points at one of Canada’s largest home improvement retailers. The Scene+ program was an important driver of the strong growth this quarter in Canadian banking deposits and clients who use us as their primary bank for day-to-day payments through credit cards.
Our Tangerine franchise is performing well from a deposit gathering and profitability perspective and is increasingly focused on deepening client relationships through card and wealth management cross-sell. Importantly, over 80% of our Tangerine deposit flows in Q3 originated from digitally engaged multiproduct clients. And once again, the business delivered double-digit revenue and earnings growth on a year-over-year basis. International Banking delivered solid performance against a challenging economic backdrop with strong revenue growth and good expense control. Earnings were impacted by higher provisions and a normalizing tax rate. Our Mexico business continues to show great momentum, delivering 16% pre-tax, pre-provision growth year-over-year and a return on equity of 25%.
We are well positioned to strategically support both local and multinational clients in Mexico as a wave of supply chain-related foreign direct investment drives outsized industrial activity and economic growth. Global Wealth Management earnings grew 4% from the prior quarter, strong relative investment performance and continued momentum in our international wealth business tempered the impact of a negative industry investment fund flows. Global Banking and Markets delivered solid results on stronger capital markets activity in conjunction with moderating loan growth as the business continues efforts to optimize capital allocation with a focus on return metrics. Inclusive of continued strong results in GBM Lat Am, GBM delivered earnings of $748 million, up 31% year-over-year and 11% sequentially, driven largely by growth in our fee and client underwriting and advisory business.
In summary, results across our businesses reflect the bank’s ability to generate solid earnings through a period of economic uncertainty and transition. Our results also reflect early actions in support of the priority initiatives I have previously outlined, primary client growth, purposeful capital allocation and excellence in operating efficiency. Growing client privacy is critical to delivering on our strategy, which means bringing the entire bank to our clients to earn core relationships. In each of our business lines, we are evaluating our approach to relationship building and our opportunity for relationship deepening. We will look to prioritize markets where we have scale opportunity and target client segments where we have the product capability and connectivity to be a lead financial services provider.
Allocating capital to the businesses where we have the highest return through a disciplined approach will result in profitable growth for the bank. Operational excellence will entail continuing to digitize and streamline the way we do business to create efficiency across our bank. We want to make it easier to do business with us through continued digitization, simplified internal processes and enhanced client interactions. We are committed to ongoing productivity initiatives and a collaborative culture that positions us to win for our shareholders, colleagues and communities. In closing, I would like to welcome Jacqui Allard, who joins us next week as our Deputy Head, Global Wealth Management and will assume leadership of that business early next year.
Jacqui will work closely through a transition period with Glen Gowland, who has done a fantastic job building our wealth business to scale in recent years. I look forward to having Glen work closely with me on strategic initiatives across the organization in his new role as a Vice Chair of the bank. And finally, I wanted to acknowledge the devastating wildfires in the Northwest territories and my home province of British Columbia. I want all our employees and clients to know that we’re thinking of them and here to support. We have made a donation to the Canadian Red Cross, the United Way Northwest Territories and the Kelowna Firefighters to support relief and recovery efforts, and we are raising additional funds through our branches across Canada.
We remain focused on the safety of our employees and ensuring we’re here to support our clients during this difficult time. With that, I will turn the call over to Raj for a more detailed review of our financials.
Raj Viswanathan: Thank you, Scott, and good morning, everyone. All my comments that follow will be on an adjusted basis for the usual acquisition-related costs. I’ll begin with a review of the performance for the quarter on Slide 5. The bank reported quarterly adjusted earnings of $2.2 billion and diluted EPS of $1.73 and return on equity was 12.2%. All bank pre-tax, pre-provision profit decreased 2% year-over-year but increased 5% quarter-over-quarter. Year-over-year, the decline was driven mainly by higher funding costs, which is recorded in the other segment and lower wealth management results driven by challenging market conditions. Net interest income was $4.6 billion, down 2% year-over-year as loan growth and the positive impact of foreign currency translation were offset by lower margins.
The net interest margin declined 12 basis points year-over-year and 3 basis points quarter-over-quarter, mostly from higher funding costs due to central bank rate increases. Recall, given the increased probability for rates to remain higher for longer, last quarter, we modified our interest rate positioning while remaining positioned to benefit meaningfully from declining interest rates. For the second quarter in a row, deposit growth outpaced loan growth, resulting in a loan-to-deposit ratio of 114%, an improvement of approximately 140 basis points quarter-over-quarter. Non-interest income was $3.5 billion, up 12% year-over-year, mainly due to higher banking revenues, trading-related revenues in fixed income and equities, underwriting and advisory fees and wealth management revenues.
The PCL ratio was 42 basis points this quarter, of which 4 basis points was performing PCLs. Phil will cover PCL in more detail later. Quarter-over-quarter expenses were flat or down 1% excluding the unfavorable impact of foreign currency translation, driven by lower share and performance-based compensation and employee benefits, partly offset by the 3 additional days in the quarter. Expenses increased 9% year-over-year or 5%, excluding the unfavorable impact of foreign currency translation, reflecting growth in staffing-related costs, technology costs, amortization and advertising and business development. The productivity ratio was 56.1% this quarter, an improvement of 140 basis points quarter-over-quarter as revenue growth outpaced expenses.
Year-to-date operating leverage was negative 7.4%. The effective tax rate was 18.4% this quarter compared to 18.9% a year ago, driven by higher income in lower tax rate jurisdictions and higher tax exempt income in the quarter, partly offset by lower inflationary adjustments in International Banking. Turning to Slide 6. This slide provides an evolution of the common equity Tier 1 ratio over the quarter as well as the quarter’s changes in risk-weighted assets. The bank reported a common equity Tier 1 ratio of 12.7%, an increase of approximately 40 basis points. Net internal capital generation were strong at 37 basis points, including a lower risk-weighted asset number. Under the dividend reinvestment plan, the bank issued 7 million shares that contributed 11 basis points.
Risk-weighted assets were $439.8 billion [ph] during the quarter, a decrease of approximately $11.3 billion from the previous quarter. Lower business loan growth, a reduction in the capital floor add-on of approximately $7 billion and the benefits from the inaugural Synthetic risk transfer transaction reduced the risk-weighted assets during the quarter. The bank’s capital ratios are expected to continue to grow in Q4. In addition, the bank’s liquidity coverage ratio or LCR improved 200 basis points quarter-over-quarter to 133% this quarter and was significantly up from 122% last year. Turning now to the business line results beginning on Slide 7. Canadian Banking reported earnings of $1.1 billion, a decrease of 13% year-over-year due to higher provision for credit losses and non-interest expenses.
Pre-tax, pre-provision profit grew 2% year-over-year as revenue growth of 3% was partly offset by expense growth of 5%. Pre-tax, pre-provision profit increased a strong 5% quarter-over-quarter. Net interest income increased 4% year-over-year as deposits grew a strong 11% and earning assets grew amount of 3%. Quarter-over-quarter margin expanded by 5 basis points due primarily to higher deposit margins. Average loans and acceptances grew 3% year-over-year. We saw continued growth in our higher-yielding portfolios as business loans grew 13%, personal loans grew 4% and credit cards increased 17%. This was offset by a decline of 1% in residential mortgage balances. Average loan balance was in line with last quarter as the decline in mortgage balances was offset by growth in business, personal and credit cards.
We continue to see strong deposit growth, with average deposits again up 11% year-over-year and 2% quarter-over-quarter. Year-over-year, personal deposits grew 13%, primarily in term products and non-personal deposits increased 6%. The loan-to-deposit ratio has improved to 129% from 139% last year in this segment. Non-interest income was down 1% year-over-year, driven by lower card revenue and reduced income from associated corporations. Expenses increased 5% year-over-year, primarily due to higher personnel costs from increased client-facing staff and inflationary adjustments. Quarter-over-quarter expenses were down a modest 1%. The PCL ratio was 27 basis points, an increase of 7 basis points quarter-over-quarter. Turning now to Global Wealth Management on Slide 8.
Earnings of $373 million declined 3% year-over-year, primarily due to Canadian wealth being down 7%. International wealth earnings grew a strong 26% year-over-year. Earnings grew 4% quarter-over-quarter in spite of difficult market conditions. Revenue grew 2% year-over-year and 3% quarter-over-quarter due primarily to higher mutual fund and brokerage revenues. Expenses were up 6% year-over-year from expansion of revenue-generating sales force and 3% quarter-over-quarter driven by higher volumes. Assets under management increased 4% year-over-year to $331 billion as market appreciation was partly offset by net redemptions. Assets under administration increased 9% over the same period to $631 billion from both market appreciation and higher net sales.
While investment funds in Canada remain in net redemptions, Scotia Global Asset Management investment results continue to perform well against their benchmarks, and the bank maintained its number two ranking in investment funds in Canada. International Wealth generated earnings of $60 million driven by higher net interest income and business volume growth. International Wealth Management, AUA grew 21% year-over-year to $130 billion. Turning to Slide 9, Global Banking and Markets, generated earnings of $434 million, up 15% year-over-year. Revenues grew 17% year-over-year, outpacing expense growth of 16%. Capital markets revenue was up 41% year-over-year as FICC grew 52% and global equities grew 28%. Business banking revenues grew 2% and the loans grew 13% year-over-year.
Net interest income was down 17% year-over-year as a result of lower corporate lending and deposit margins and lower loan fees. Non-interest income grew $259 million or 35% year-over-year, primarily due to higher underwriting and advisory fees and growth in trading-related revenue in fixed income and equities. Expenses were up a modest 1% quarter-over-quarter, mainly from higher performance-based compensation and salaries. On a year-over basis, expenses were up 16% due mainly to higher personnel costs and technology investments both related to business growth. The provision for credit losses was a recovery of $6 million driven by Stage 3 recoveries. The U.S. business generated earnings of $217 million this quarter. GBM Latin America, which is reported as part of International Banking had another strong quarter, reporting earnings of $314 million, up 64% year-over-year, driven by Mexico, Chile and Brazil.
Moving to Slide 10 for a review of International Banking. My comments that follow are on an adjusted and constant dollar basis. The segment reported net income of $635 million, down 8% year-over-year. However, pre-tax, pre-provision profit grew a strong 11%. The Pacific Alliance was up 10%, with strong growth in Mexico of 16% and 19% growth in Caribbean and Central America. Revenue was up 8% year-over-year, driven by good loan growth, higher net interest margin and strong capital markets and corporate banking revenues in Mexico and Chile. Year-over-year loan growth moderated at 5%. Mortgages were up 10%. Personal loans and credit cards grew 3% and business banking was up 3%. Deposits grew a strong 8% year-over-year and 1% quarter-over-quarter, reducing the loan-to-deposit ratio by approximately 400 basis points year-over-year.
Net interest margin expanded 15 basis points year-over-year. The margin was down 2 basis points quarter-over-quarter, mostly from lower inflation benefits in Chile and Uruguay. The provision for credit losses was 118 basis points of $516 million, up 15 basis points from last quarter. On a quarter-over-quarter basis, expenses were down 1% due to lower salaries and employee benefits. On a year-over-year basis, non-interest expense were up 5%, driven mainly by the inflationary impacts on personnel costs. The tax rate of 22.9% for the quarter increased from 20.7% in the prior quarter due to lower inflationary adjustments in Chile and Mexico. Turning to Slide 11. The Other segment reported an adjusted net loss attributable to equity holders of $299 million, an improvement of $24 million compared to the prior quarter.
Quarter-over-quarter, higher funding costs, mainly driven by continued rate increases were more than offset by higher income from liquid assets and lower expenses. I’ll now turn the call over to Phil to discuss risk.
Phil Thomas: Thank you, Raj, and good morning, everyone. While we continue to operate in an environment of heightened uncertainty, we believe our business is well positioned to navigate this successfully. PCLs in Q3 were $819 million, up $110 million quarter-over-quarter, translating to a PCL ratio of 42 basis points. Our PCL ratio reflects 4 basis points of performing allowance build, reflecting the continued uncertain macroeconomic outlook. The fifth consecutive quarter of performing allowance build contributes to our balance sheet strength with a total ACL coverage now at 78 basis points. Stage 3 PCL also increased non-performing provisions of $738 million, up $117 million quarter-over-quarter. The largest increase was in Chile and Colombia unsecured retail, where the economies continue to slow.
In Canada, despite two additional rate increases in Q3, variable rate mortgage customers remain resilient. These customers have adjusted quickly with spending down 15% year-over-year, driven by a reduction in discretionary areas. We remain comfortable in our retail, commercial and corporate customers ability to manage through this credit cycle. Moving to international retail. Our secured balances remained stable at 73% of total loans for the third consecutive quarter. While inflation is beginning to ease, the absolute levels of price pressures on consumers remain high. This erosion of purchasing power is impacting the financial health of consumers in the Pacific Alliance. In particular, in Chile, this is compounded by a gradual rise in unemployment given the decline in economic activity.
Overall, 90-day delinquency increased 8 basis points quarter-over-quarter within expectations. In Q3, the International Banking retail PCL ratio is 215 basis points compared to 185 basis points in Q2. Turning to business banking. This portfolio continues to perform well. The segment reported PCLs of 18 basis points, down from 21 basis points in Q2. International Commercial was stable quarter-over-quarter, while we had a small release in GBM driven by a recovery on one account. In Canada, we built performing allowances being cautious on macroeconomic outlook and headwinds facing commercial real estate. Our global commercial real estate portfolio is $66.2 billion, down 1% quarter-over-quarter, representing approximately 8% of our loan portfolios.
We remain focused on undersupplied asset classes with 72% of our CRE exposure in residential and industrial. Office exposure represents less than 1% of our total loans, and we have built performing allowances that the longer-term impact of flexible work remains uncertain. We continue to proactively manage maturities and credit events. Moving to Slide 13. Gross impaired loans were up 3 basis points quarter-over-quarter to 70 basis points, but remain below pre-pandemic levels. GILs were primarily driven by new formations in retail, specifically in Chile and Colombia. Business Banking yields were relatively unchanged this quarter. Canadian commercial GILs increased quarter-over-quarter. However, GBM and international commercial GILs were lower.
Moving to Slide 14. Canadian Banking reported PCLs of $307 million, a PCL ratio of 27 basis points reflects a performing build of 4 basis points. The quarter-over-quarter increase was due to continued uncertain macroeconomic outlook a performing build in commercial and higher impairments in Canadian Commercial and Prime Auto. International Banking PCLs were $516 million, translating to a PCL ratio of 118 basis points. The quarter-over-quarter increase was primarily due to retail driven by delinquency and net write-offs mainly in Chile and Colombia. In international, ACL coverage is now at 218 basis points, up 9 basis points quarter-over-quarter. We continue to build prudent allowances across our portfolios with the all-bank ACL ratio of 78 basis points, up 3 basis points quarter-over-quarter.
We expect key macroeconomic indicators in Chile and Colombia to remain challenged in the near term, owing to a lagged impact of higher interest rates and the loss of purchasing power associated with high inflation. We continue to closely monitor our portfolio and we’ll respond with adjustments to allowances as appropriate. We remain prudent with new exposures and will focus on high-quality borrowers. With that, I will pass the call back to John for Q&A.
John McCartney: Great. Thank you, Phil. Operator, if we could queue for questions.
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Q&A Session
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Operator: Thank you. Our first question is from Ebrahim Poonawala with Bank of America. Please go ahead.
Ebrahim Poonawala: Good morning. I guess I just wanted to narrow down on the Canadian Banking segment, Raj. I think you referenced the loan to deposit ratio. If we look at loan and deposit balances relative to year-end, loans have been relatively flat, you’ve grown deposits. And I know deposits growth in deposits, a big priority for Scott. Just give us a sense of is there a targeted loan-to-deposit ratio that you want that business to get to before we see loan balances grow? Like is that intentional? And what is the – and the strategy around the deposit customers who are coming on, are those really sticky customers that you can convert into a multi-prong relationship? Or is it driven by rates and it’s TBD [ph] in terms of whether this becomes a lasting relationship for the bank? Thank you.
Raj Viswanathan: Great. Thanks, Ebrahim. I’ll just start simplistically on the loan-to-deposit ratio, and I’ll pass it on to Dan to talk about customers and how we are approaching deposits and loans from a client primacy perspective. What we have seen in the reduction in loan-to-deposit ratio, both in IB as well as in the Canadian bank is what we are going to continuously ask [indiscernible] to achieve. And like you point out, there’s two sides to it, loans and deposits. So the deposit drive, I think, will continue because we do need to build our deposit base, something we’ve been quite clear about since Scott talked about it. I think in January, February of this year, you’ll see that momentum continue. On the entire relationship, we’ll be more thoughtful about how we want to grow the share of the wallet and so on. So I’m going to pass it on to Dan, he can talk about it in greater detail.
Dan Rees: Great. Thanks, Raj. Thank you, Ebrahim, Dan here. Look, a couple of things I would call it. We are aiming for an ongoing improvement in the LDR ratio in the CB segment. We’re 129 this quarter. We were 139 a year ago. So that’s a substantial change. Clearly, decelerating loan growth, particularly in mortgages, has had an important impact of that as well as the market appetite for term on the personal deposit side. I would call out a few key planks of our mission towards deepening with clients or improving our client primacy. I know Scott off the top referred to the importance of Scene. We have seen on the back of that customer loyalty program about 0.5 million new day-to-day accounts opened in the last year. Those would be core deposit, low-price sticky accounts, which are often the result of cross-selling off the existing stock.
That would be point one. We’ve also seen substantial improvements in our market share position with new Canadians as a result of targeted value propositions for those. Our improvement in Tangerine has also been noticeable. Scott called out in his remarks, the deepening on core there. And obviously, we’ve been improving our deposit growth in commercial for quite some time and in this quarter, again, at a faster growth rate than loans. So we are intensely decelerating our mortgage growth in favor of clients. And we launched in Q3 a really important pilot to deepen the deposit cross-sell off mortgages at time of origination. So I think we’re being very intentional here as we signaled a number of quarters ago, and we’re really pleased with the cost of that deposit growth.
As Raj mentioned, deposit margin improved again this quarter.
Ebrahim Poonawala: Got it. That was helpful. And just separately, in terms of when we think about expense management, not that it was a big issue this quarter, we are hearing from peers around restructuring charges we saw one this quarter. There’s probably more coming from others going into 4Q. Maybe just top of the house, your headcount is somewhat flattish, about 2% up relative to the end of ’21. Give us a sense of just how you’re thinking about expense management, rightsizing the franchise for the current revenue backdrop/
Scott Thomson: Thanks, Ebrahim. This is Scott. And I think it’s clear to say – clear for me that operational excellence will be an important component of the refreshed strategy. And I was pleased to see the cost discipline in the quarter, but also recognize there’s more work to do to align the organization and resources around our focus areas for growth. So good progress, but more to do as we look forward.
Ebrahim Poonawala: Got it. Thank you.
Operator: Thank you. Our next question is from Gabriel Dechaine with National Bank Financial. Please go ahead.
Gabriel Dechaine: I’d like to follow on the balance sheet management question – line of questioning in Canada. I mean you’ve clearly pointed out that mortgages and decelerating growth, even shrinking that book is a big part of the plan. Just wondering, considering it is mortgages, I don’t – I wouldn’t expect a big impact to your revenue base in the Canadian business. And equally, wondering if the declines we’ve seen this quarter and prior were the main drivers of the decline in the capital risk floor add-on?
Raj Viswanathan: I’ll start with the capital risk floor, and then Dan can probably talk about the business in a little more detail than he did, okay. The capital risk floor is actually driven by three different components. And I think it’s an important factor that will impact what the floor add-on is quarter after quarter because there are drivers that impact the standardized risk weight, there’s drivers that impact the ARB calculation. So you’re going to see that movement every quarter, not necessarily every quarter down like you saw this quarter. This quarter has three components grade. It’s actually quite simple, when you break it down. We did the Synthetic risk transfer, so that benefited the floor, and that gave us about $2 billion benefit in the $6.9 billion that we have called out in the slide.
