The Bank of Nova Scotia Q2 2023 Earnings Call
Speaker 2: I.
Speaker 1: Please stand by, your conference will begin momentarily. To ask a question, this conference is being recorded. This conference is being recorded.
Speaker 3: Good morning and welcome to Scotiabank's 2023 second quarter results presentation. My name is John McCartney and I'm head of investor relations here at Scotiabank. Presenting to you this morning are Scott Thompson, Scotiabank's president and chief executive officer, Raj Viswanathan our chief financial officer and Phil Thomas our chief risk officer.
Speaker 3: Following our comments, we will be glad to take your questions.
Speaker 3: 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.
Speaker 3: Before we start, and on behalf of those speaking today, I will refer you to slide 2 of our presentation, which contains Scotiabank's caution regarding forward-looking statements. With that, I will now turn the call over to Scott. Thank you, John . Good morning, everyone. We appreciate you joining us today.
Speaker 3: Before I begin, I want to take a moment to acknowledge the ongoing impact of the wildfires in Western Canada. The Bank has made a donation to the Canadian Red Cross to support the relief efforts, and we have initiatives in branches across Canada to raise additional funds.
Speaker 3: I would like to thank our teams for supporting our customers and the communities that have been impacted.
Speaker 3: As the situation evolves, our top priority is the safety of our employees and ensuring we continue to support customers as they recover from these fires.
Speaker 3: Despite the challenging market conditions this quarter, the Bank delivered resilient operating performance reflecting the stability of our business model, while absorbing the impact of elevated funding costs and higher operating expenses.
Speaker 3: Our common equity tier one capital ratio strengthened in the corridor to 12.3%.
Speaker 3: The capital bill this quarter brings us above our 12% target sooner than expected and we will aim to remain at 12% or above until we have more conviction on the macroeconomic outlook and regulatory expectations.
Speaker 3: This morning we also announced a 3% increase to our quarterly dividend, bringing it to $1.06 per share.
Speaker 3: The bank also made progress in strengthening its liquidity position with deposits outpacing loan growth quarter over quarter.
Speaker 3: Our liquidity coverage ratio was a healthy 131% at quarter end, up from 122% in the prior quarter.
Speaker 3: The events in March in the U.S. regional banking sector and in Europe highlighted the stability and security of the Canadian banking system.
Speaker 3: Throughout our America's footprint, customer confidence in Scotiabank was reflected through deposit balance stability during this time of dislocation.
Speaker 3: Our Diversified Global Business Model is a competitive advantage for our business.
Speaker 3: I was particularly pleased to see the improvement in deposit growth across our platform.
Speaker 3: Year-over-year deposits increased by 11% or approximately $68 billion, and on a sequential basis deposits increased by 2%.
Speaker 3: Importantly, our overall loan-to-deposit ratio improved modestly quarter-over-quarter, driven by improved results in Canadian and international banking. Deposit growth in Canada accelerated to 11% year-over-year and 3% quarter-over-quarter, outpacing loan growth for the second consecutive quarter.
Speaker 3: Throughout our international banking footprint, we experience solid deposit growth above our loan growth on both a year over year and quarter over quarter basis.
Speaker 3: The loan-to-deposit ratio improved by approximately 250 basis points quarter over quarter.
Speaker 3: The credit quality of our loan book continues to be high. Our retail loan portfolio is primarily secured and the corporate lending book is mostly investment rate.
Speaker 3: However, in light of a more uncertain macroeconomic outlook and given the significant growth in our loan book over the last year, we are taking a more conservative view and increasing our performing loan allowances and thereby building our overall ACL coverage.
Speaker 3: Specific to our commercial real estate exposure, we provided additional disclosures related to the composition of the portfolio.
Speaker 3: Our exposure and recent growth are heavily weighted to the residential and industrial segments, which together comprise 75% of the portfolio.
Speaker 3: The office segment represents less than 10% of our overall commercial real estate exposure, with U.S. exposure at only $300 million.
Speaker 4: Looking ahead.
Speaker 3: Although I continue to remain cautious on the outlook for the remainder of the year, there are some encouraging signs that lead us to believe our revenue and pre-tax, pre-provision profits should improve modestly in the coming quarters.
Speaker 3: First, the bank's net interest margin modestly improved in Q2, driven by loan re-pricing in Canada and international banking, which should continue.
Speaker 3: Net interest margin in Canadian banking was up 4 basis points and an international up 12 basis points, with a strong Caribbean contribution where we are competitively advantaged from a deposit perspective as the lead relationship bank in many of our markets.
Speaker 3: Second, with the exception of Canadian mortgages, we expect to see modest quarter-over-quarter loan growth across the bank for the balance of the year.
Speaker 3: Finally, on the expense line, we expect quarter over quarter growth to be modest.
Speaker 3: We will continue to be vigilant on expense growth for the remainder of the year.
Speaker 3: Overall, we believe Q2 will be a low point for our profitability in 2023, with modest improvement going forward.
Speaker 3: Lastly, given the increased probability for rates to remain higher for longer, we have modified our interest rate positioning.
Speaker 3: Even with this repositioning, we stand to meaningfully benefit from declining rates because of the structure of our balance sheet.
Speaker 3: Going forward, our three priority areas are focusing on primary customer growth to drive long-term multi-product profitable relationships.
Speaker 3: purposely allocating capital to improve our business mix and support profitability, and operate in an efficient and agile fashion to drive both revenues and reduce costs.
Speaker 3: I would like to make a few observations on our business performance in the context of these objectives.
Speaker 3: First, focusing on customer orientation.
Speaker 3: This quarter we completed the national rollout of our ScenePlus program in Empire Stores with the Quebec rollout in March.
Speaker 3: Later this summer, we will continue to add to this market-leading loyalty program with the addition of home hardware, building off the success of adding Expedia and Rakuten last year.
Speaker 3: The deposit growth and the rollout of ScenePlus are key components of our strategy to grow primary relationships with our customers in Canada. And so far, the ScenePlus program is exceeding our expectations.
Speaker 3: ScenePlus has in excess of 13 million members in climbing with Quebec driving an oversized share of that growth.
Speaker 3: Since the national launch began, we've added over 600,000 new Scotia debit and credit card accounts into the ScenePlus program.
Speaker 3: Our data confirms that customers who are C-plus members are four times more likely to have three or more products with the bank.
Speaker 3: Tanjureen is now the sixth largest personal deposit banking Canada with $47 billion in deposits and assets under management of $6.1 billion.
Speaker 3: Our success to date can be attributed to a strong brand, a market leading digital customer experience, and an unrelenting focus on growing deposits.
Speaker 3: Given Tangerine's limited overlap with Scotia Banks customer base, this franchise presents a great opportunity for us to win market share and grow our presence in the Canadian market with a digital first approach.
Speaker 3: In international banking, we continue to focus on priority customer segments, strengthening digital and improving customer experience to drive customer privacy and long-term deposit growth.
Speaker 3: Digital remains instrumental in driving our customer engagement with digital sales reaching almost 70% in the quarter.
Speaker 3: We have seen improvements in customer experience metrics across all of our international markets.
Speaker 3: GBM continues to build capabilities in order to provide a growing product suite to clients.
Speaker 3: To further capitalize on the growing private capital space, we recently announced the hiring of a US-based private credit structuring, syndication, and sales team.
Speaker 3: In addition, our domestic Canadian ECM and DCM businesses have moved to leading market share positions in recent quarters. Our US DCM business continues to gain share and the Pacific Alliance countries we rank second year to date in the DCM league tables. Our global wealth business continues to execute on the total wealth strategy bringing fully integrated solutions to our high net worth clients.
Speaker 3: The business was recognized by global finance as the best private bank for net worth between 1 million and 25 million, and by EuroMoney as the best domestic private bank in Canada.
Speaker 3: Encouragingly, the international wealth business continues to grow at double-digit rates with 19% growth year-over-year.
Speaker 3: In short, Q2 was a period of progress on client franchise initiatives already underway.
Speaker 3: The second objective, purposely allocating capital to improve our business mix and support profitability.
Speaker 3: We continue to build more discipline in our approach to capital allocation and we are viewing this through an enterprise-wide lens.
Speaker 3: We will prioritize relationships where we can provide value beyond just the balance sheet.
Speaker 3: I was encouraged to see the improvement in multi-product relationships in Canada during the quarter and pleased to see the discipline around client prioritization in our GBM business.
Speaker 3: And finally, operational excellence.
Speaker 3: As part of my objective to drive operational excellence throughout the bank, I remain committed to discipline cost management.
Speaker 3: Strong expense management has long been an important hallmark of the bank's culture.
Speaker 3: It is notable this quarter that our expenses grew much faster than our revenues.
Speaker 3: I was encouraged to see the deceleration of expense growth on a sequential basis in our Canadian and GBM franchises, but as a management team we recognize the need to deliver positive operating leverage over time. By focusing on these strategic priorities will be a more efficient and more profitable bank.
Speaker 3: Before concluding, I wanted to make a comment on our recent leadership announcement. I am thrilled to welcome Fransisco Ristigieta as our head of international banking. Francisco joins us with a career of experience in highly successful leadership roles in global banks and brings significant operating experience throughout our international footprint.
Speaker 3: Francisco officially joined the bank early this month and is with us here today on the call. Welcome Francisco.
Speaker 3: I will now turn the call over to Raj for a more detailed presentation on the financial results.
Speaker 5: Thank you Scott and good morning everyone. All my comments that follow will be on an adjusted basis for the usual acquisition related costs.
Speaker 5: I'll begin with a review of the performance of the quarter on slide five.
Speaker 5: The bank reported quarterly adjusted earnings of $2.2 billion and diluted earnings per share of $1.70.
Speaker 5: The return on equity was 12.4%.
Speaker 5: All banks' pre-tax, pre-provision profit decreased 11% year over year, driven mainly by higher expenses relating to personal costs,
Speaker 5: and relating to business development initiatives. Net interest income was in line as growth in mortgages and business banking balances, as well as the benefit from foreign exchange was offset by margin compression to this significant increase in cost of funds year over year.
Speaker 5: Let interest margin decline 10 basis points year over year, mostly from higher funding costs.
Speaker 5: Quarter over quarter, an Edinburgh margin improved by two basis points from higher margins in both international banking and Canadian banking that expanded to all basis points and four basis points respectively.
Speaker 5: Non-interest income was $3.5 billion in Q2 in line with last year, as higher banking revenues and other fee and commission would offset by lower wealth management revenues, which were down 4%.
Speaker 5: The PCL ratio was 37 basis points for the quarter. The performing PCL ratio was 4 basis points as the bank continues to prudently build allowances reflecting the uncertain macroeconomic environment.
Speaker 5: Extenses increased by 10% here over year, or 7% excluding the unfavorable impact of foreign currency translation.
Speaker 5: So, flattening the continued investment for business growth and inflationary impact across most expense categories.
Speaker 5: Quarter over quarter expenses were up 2.5% or a modest 1.3% excluding the impact of unfavorable foreign exchange.
Speaker 5: The productivity ratio was 57.5% this quarter, resulting in a year-to-date negative operating leverage of 8.5%.
Speaker 5: The effective tax rate for the bank was 18.4% this quarter compared to 22.9% a year ago, driven by higher income from lower tax rate jurisdictions and higher tax exempt income in the quarter.
Speaker 5: Slide 6 provides an evolution of the common equity tier 1 ratio over the quarter, as well as the quarter's changes and risk weighted assets.
Speaker 5: The bank reported a common equity tier 1 ratio of 12.3% and increase of approximately 80 points quarter to quarter.
Speaker 5: The ratio benefited from the adoption of revised Basel III requirements by 56 basis points.
Speaker 5: Net internal capital generation was strong at 14 basis points, while the recently introduced dividend reinvestment plan contributed 9 basis points.
Speaker 5: Risk-weighted assets declined $20 billion during the quarter.
Speaker 5: The adoption of revised Basel III requirements reduced the pre-floor risk-weighted assets by approximately $31.7 billion.
Speaker 5: That was partly offset by the floor add-on of $5.1 billion, resulting in a net reduction of $26.6 billion.
Speaker 5: mostly related to non-retail credit risk due to the elimination of the scalar and adoption of the foundational approach.
Speaker 5: During the quarter, risk-related assets grew $1.4 billion, excluding effects, mostly in market risk.
Speaker 5: In addition, the bank's liquidity coverage ratio improved 9% to 131% this quarter.
Speaker 5: Turning now to the business line results beginning on slide 7. Canadian banking reported earnings of $1.1 billion, a decrease of 10% year-over-year due to higher provision for credit losses and higher non-interest expenses.
Speaker 5: Pre-tax-free provision profit grew 6% year-over-year, driven by strong revenue growth of 8%.
Speaker 5: Net interest income increased 9% year-over-year as loans grew 6% while deposits grew a strong 11% supporting year-over-year margin expansion of 8 basis points.
Speaker 5: Low margin expansion resulted in the margin expanding by 4 basis points quarter over quarter.
Speaker 5: Loan growth was 6% year over year as mortgages grew a modest 3%.
Speaker 5: Business loans grew 18%, automotive 8%, credit card 16%, and personal loans 6%, all higher yielding portfolios.
Speaker 5: Quarter over quarter, average loans were in line with Q1 as the decline in mortgage balances offset growth in other higher yielding loan categories.
Speaker 5: Average deposits grew a strong 11% year-over-year, driven by a 15% increase in personal deposits and a 5% increase in non-personal deposits, reflecting the strategic focus of the business.
Speaker 5: The loan-to-deposit ratio improved to 132%.
Speaker 5: Non-interest income increased by 5% year over year, driven by higher private equity gains and higher insurance revenue.
Speaker 5: Expenses increased 10% year-over-year, driven by higher portionals.
Speaker 5: and advertising and business development costs as the business continues to invest in growth areas.
Speaker 5: Expenses were up a modest 1% quarter over quarter, largely due to higher personal costs.
Speaker 5: The PCL ratio was 20 basis points, a slight increase of 1 basis point, quarter over quarter.
Speaker 5: Turning now to global wealth management on slide 8.
Speaker 5: Earnings of $359 million declined 13% year over year, primarily due to the Canadian wealth being down 17%, while international wealth earnings grew a strong 19%.
Speaker 5: Revenue decline 4% year-over-year, due primarily to lower mutual fund and brokerage revenues, partially offset by strong private banking loan growth and higher deposit margins across our Canadian and international businesses.
Speaker 5: Expenses were up a modest 2% year-over-year and quarter-over-quarter relating to sales force expansion and technology investments offset by strong expense controls despite the inflationary environment.
Speaker 5: Assets under management increased 1% year-over-year to $330 billion driven by market appreciation, while assets under administration increased 5% to $624 billion as a result of higher net sales and market appreciation. The bank maintained its number two ranking in investment funds.
Speaker 5: 401 million, down 18% compared to the prior year.
Speaker 5: While revenues grew 7%, earnings were impacted by higher operating expenses and increased performing provision for credit losses.
Speaker 5: Solid business banking performance was supported by a growth of 29%, primarily in Canada and the United States, while average deposits grew 11%.
Speaker 5: Capital Markets revenue was in line with last year. Net interest income grew 7% year over year as a result of the strong loan and deposit growth and the positive impact of foreign currency translation.
Speaker 5: Non-interest income also grew 7% year-over-year, primarily due to higher fee income earned in fixed income and prime services businesses while trading income was lower. Expenses were down 3% quarter-over-quarter mainly from lower performance-based compensation and a shorter quarter.
Speaker 5: On a year-over-year basis, expenses were up 15%, due mainly to higher personal costs and technology investments.
Speaker 5: both related to business growth and the negative impact of foreign currency translation.
Speaker 5: The provision for credit losses was $53 million, almost all relating to performing loans.
Speaker 5: GPM Latin America, which is reported as part of international banking, had another strong quarter reporting earnings of $276 million, up 49% year-over-year, driven by good performance in Mexico, Chile and Brazil.
Speaker 5: Moving to slide 10 for a review of international banking results. My comments that follow are on an adjusted and constant dollar basis.
Speaker 5: The segment reported net income of $650 million in line with last year. Pre-tax pre-provision profit grew 6% with the Caribbean and Central America a strong 27%.
Speaker 5: Revenue was up 8% year-over-year, driven by good loan growth, higher net interest margin, and strong capital markets revenues.
Speaker 5: Year over year loans grew 9% with mortgages up 12% and business banking up 8% while personal loans and credit cards grew 8% as well.
Speaker 5: Deposits grew a strong 10% year-over-year and 2% quarter-over-quarter that reduced the loan-to-deposit ratio by approximately 250 basis points.
Speaker 5: Compared to the last quarter, the net interest margin was up a strong 12 basis points, with net interest margin expanding in the Caribbean and Central America and Pacific Alliance countries by 32 basis points and 14 basis points respectively.
Speaker 5: We expect the margin to remain at or slightly above these levels for the rest of the year.
Speaker 5: The provision for credit losses was $436 million, up from $422 million last quarter.
Speaker 5: On a quarter-over-quarter basis, expenses were down 1% due to lower business taxes.
Speaker 5: partly offset by higher personal costs.
Speaker 5: On a year-over-year basis, non-interest expenses were up 9%, driven mainly by the inflationary impacts on compensation, offset by the benefits of efficiency initiatives.
Speaker 5: The tax rate of 20.7% for the quarter increased from 19.6% in the prior quarter due to lower inflationary adjustments in Mexico and Chile.
Speaker 5: We expect the tax rate to continue to increase in line with reduction in inflation.
Speaker 5: Turning to slide 11, the other segment reported an adjusted net loss attributable to equity holders of $323 million in line with the previous quarter.
Speaker 5: Quarter over quarter, net interest income was impacted by higher funding costs due to the full quarter impact of previous rate increases.
Speaker 5: partly offset by better returns on high quality liquid assets.
Speaker 5: Non-interest income benefited from higher investment gains and income from associated investments.
Speaker 5: I'll now turn the call over to Phil to discuss risk.
Speaker 5: on the call over the phone to discuss risk. Thanks, Raj, and good morning, everyone.
Speaker 6: The bank's balance sheet continues to be well diversified across business lines, customer segments, and geographies. As we adapt to the evolving landscape, we remain proactive in building our allowances. As such, our PCL this quarter was 709 million, or 37 basis points, including performing PCL of 88 million, or 4 basis points.
Speaker 6: The higher provisions quarter over quarter is due to a more unfavourable macroeconomic outlook.
Speaker 6: and provisioning scenarios that reflect more pessimistic GDP forecasts in our key markets, compared to the prior quarter.
Speaker 6: This is driven by our assumptions around the following potential headwinds.
Speaker 6: increased risk of a recession and a potentially more challenging credit cycle, sustained elevated inflation causing a higher for longer rate environment, which may impact retail consumers and commercial operating budgets.
Speaker 6: While the quality of our book and our risk appetite remain stable, the recent market turmoil in the U.S. has added an element of financial uncertainty.
Speaker 6: Starting with our Canadian retail portfolio, customer delinquency of 20 basis points in the quarter remained stable, within expectations and well below pre-pandemic delinquency of approximately 30 basis points.
Speaker 6: Our Canadian Mortgage Book remains solid, with stable performance despite 36% of balances being from our Variable Rate Portfolio.
Speaker 6: As you would recall, our variable rate mortgages reprice with monthly payment increases tied to policy rate changes.
Speaker 6: This gives us confidence in understanding our customers' ability to stay current with mortgage payments while maintaining the contractual amortization period.
Speaker 6: Our variable rate portfolio continues to be of high credit quality, with customers FICO scores of approximately 800.
Speaker 6: We continuously monitor the deposit balances of these customers, which on average remain higher than our fixed rate portfolio.
Speaker 6: Our customers are managing through this period of heightened interest rates by making tradeoffs. For example, discretionary spending such as retail spending and entertainment is down 10% year over year for our variable rate customers.
Speaker 6: The strong performance of our Canadian mortgage portfolio is reflective of our customers' prudent financial management as they navigate higher rate environments.
Speaker 6: The strong performance of our Canadian mortgage portfolio is reflective of our customers' prudent financial management as they navigate higher rate environments. Thank you.
Speaker 6: The total international retail banking 90-plus day delinquency rate of 2.56% has increased modestly by 4 basis points quarter over quarter. However, it is still below pre-pandemic levels of 3.22%.
Speaker 6: International banking maintained its focus on driving secured growth with balances remaining at 73% of the portfolio, up from 65% pre-pandemic. We continue to leverage our data analytics and collections practices to proactively manage through the credit cycle.
Speaker 6: Specifically in Chile and Colombia, we are working with our customers as unsecured delinquencies continue their upward trend as customer budgets are strained due to sustained inflation.
Speaker 6: Turning to business banking, the underlying portfolio continues to perform well. Our direct exposure to U.S. regional banks is immaterial, and our well-diversified business lines, customer segments, and geographies give us confidence in our balance sheets and liquidity positions. With respect to commercial real estate, our
Speaker 6: Our exposure was $67 billion as of Q2, and of this, Office represents approximately 10%, and two-thirds of the portfolio is investment-grade.
Speaker 6: The bank's real estate portfolio is strong, with 75% of our exposure being residential and industrial.
Speaker 6: These exposures are primarily with top-tier developers where we have long-standing relationships. We remain comfortable with our business banking portfolio but remain prudent based on forward-looking macroeconomic indicators. Starting with slide 13.
Speaker 6: We saw modest increases in gross impaired loans in Canadian banking and international banking, with slight improvements in GBM. Overall, gills were marginally higher at 67 basis points this quarter. In Canada, the new formations were mainly in prime auto and commercial.
Speaker 6: Overall, the Canadian banking's 30-day and 90-day delinquency rates continue to trend up modestly.
Speaker 6: In international, gross impaired loans were up $139 million quarter over quarter as a result of foreign exchange and higher retail formations primarily in the Pacific Alliance region.
Speaker 6: Moving to slide 14, PCLs in Q2 were 709 million or 37 basis points.
Speaker 6: In Canadian banking, total PCLs were stable this quarter at $218 million, translating to a PCL ratio of 20 basis points.
Speaker 6: In international banking, PCLs increase moderately to $436 million, primarily a result of higher delinquencies and challenging market conditions in Chile and Colombia.
Speaker 6: International commercial remains stable quarter over quarter. This translated into an international banking PCL ratio of 103 basis points.
Speaker 6: While credit quality in GBM is solid, given the potential headwinds and sizable asset growth the business has achieved over the past year, we attributed approximately two basis points of the build this quarter to GBM, all in Stage 1 ACL.
Speaker 6: This adjustment will offer greater stability in the median term. From a balance sheet perspective, the bank's Q2 ACL ratio was 75 basis points, or $5.9 billion, up 3 basis points quarter over quarter. Similar to Q1, we continue to build performing allowances this quarter.
Speaker 6: and we expect this trend to continue for the remainder of the year.
Speaker 6: expect this trend to continue for the remainder of the year. In closing,
Speaker 6: Given the current economic outlook, we expect PCLs to remain elevated for the remainder of the year. We believe in the strength of our balance sheet which will offer stability in the medium term. We continue to be cognizant of the current operating environment, but are comfortable with how we have positioned our book to perform through economic cycles. With that, I will pass it back to John .
Speaker 7: Thank you, Phil. You'll now be pleased to take your questions. Please limit yourself to one question and then rejoin the queue to allow everyone the opportunity to participate in the call.
Speaker 8: Operator, can we have the person on the phone, please? So, Janine, thank you. Our first question is from Ibrahim Punawala from Bank of America. Please go ahead.
Speaker 9: Good morning. So I guess maybe just for the one question on capital, so Raj, maybe for you, maybe Scott wants to add anything.