The Bank of Nova Scotia (NYSE:BNS) Q1 2023 Earnings Call Transcript

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The Bank of Nova Scotia (NYSE:BNS) Q1 2023 Earnings Call Transcript February 28, 2023

John McCartney: Good morning, and welcome to Scotiabank's 2023 First Quarter Results Presentation. My name is John McCartney. I'm Head of Investor Relations here at Scotiabank. Presenting 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. 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; Glenn Gollan from Global Wealth Management; Nacho Deschamps from International Banking; and Jake Lawrence from Global Bank and Markets. Before we start and on behalf of those speaking today, I'll 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.

Scott Thompson: Thank you, John, and good morning, everyone. We appreciate you joining us today. Given this is my first quarterly investor call, I would like to begin with sharing some early observations on the bank after 4 weeks in the CEO role. My approach has always been about transparency and partnership, and I'm committed to working with the investment community in this manner. I've had the opportunity to spend time with the leadership team as well as to meet with many employees and customers across Canada and in Mexico, Chile, Peru and Colombia. I have been energized by meeting our teams across the bank. Our people are highly engaged, proud and committed Scotiabankers. In addition to a rock-solid foundation, a diversified revenue base last year of approximately $32 billion and net profits of over $10 billion, we have many competitive advantages, unique areas of strength and opportunities for growth in the bank, including the credit quality of our loan book, our Scene+ loyalty program, which will be a key enabler in diversifying our Canadian P&C business mix.

The long-term commercial banking growth opportunity across our platform, an outstanding wealth management franchise, the GBM platform across the Americas, and our performance in Mexico and the upside potential by improving the connectivity across Canada, the U.S. and Mexico. But we have not delivered the level of total shareholder return that our shareholders should expect of us. To drive better shareholder returns, my focus will be on delivering profitable and sustainable growth through an even stronger customer orientation by building our solid foundation aligning on enterprise-wide focus areas and consistently executing with operational excellence. And I really do want to underscore the word's consistent execution as that is what we expect to measure ourselves on with established milestones and targets.

To do this, I'm aligning our leadership teams around 3 areas of focus: first, purposely allocating capital. We need to build more discipline in our approach to capital allocation, and we need to view this through an enterprise-wide Second is focusing on long-term deposit growth, increasing our core deposits is critical. The current environment of rapidly rising rates and an inverted yield curve highlights the challenges with the structure of our balance sheet. Increasing deposits not only reduces funding costs, but it deepens our relationships with our customers, allowing for a more detailed understanding of their needs, thereby enhancing the multiproduct opportunity. Payroll and cash management capabilities, as an example, could be an area that becomes a higher priority across the platform.

Third, we will improve our business mix and profitability, building towards profitable and sustainable growth means leading less with the balance sheet alone, but also a focus on prioritizing long-lasting, multiproduct, mutually beneficial relationships that enable our customers to succeed. This journey will take time and will require a shift in orientation from the way we reward our people to how we collaborate among our business lines, to how we allocate our capital to customers and segments. Encouragingly, we have a great foundation to build upon as our customer relationships are strong, and our leadership team recognizes the opportunity in front of us. I am convinced that with an enterprise-wide focus, combined with our continued lean and agile approach to expense management, we will strengthen our results and deliver the performance our shareholders deserve.

Turning to our Q1 results. The bank's financial performance in the first quarter of 2023 reflects both the merits of a diversified platform, but also the continued relative pressure on our profitability given our funding profile. Going forward, we must be consistent and deliberate in our long-term deposit strategies to continue our journey to reduce our reliance on wholesale funding. Rapid loan growth, coupled with high cost funding sources has adversely impacted profitability. And going forward, we will be cognizant of the need to pace loan growth, particularly in less profitable product segments. The negative operating leverage in the bank certainly warrants attention. Higher personnel costs and spend on certain technology projects primarily drove the expense growth in the quarter.

We will be even more thoughtful about expense control across the bank for the remainder of the year. In the Canadian business, I was pleased to see the continued progress with our commercial customers and encouragingly, deposit growth of 10% outpaced 9% year-over-year loan growth. Dan's vision of diversifying Canada's revenue mix beyond mortgages and autos is the right one and will pay dividends over time. Turning to International Banking. I was encouraged by the performance this past quarter, driven by strong results in retail, commercial and our GBM business as well as positive operating leverage. Nacho, Jake and I were in the region recently and the businesses we have built in LatAm are impressive with a digital-first mindset that will increasingly facilitate better customer and employee experience at a lower productivity ratio.

However, while we've allocated significant capital to our international bank in the last few years, the returns are not commensurate with our expectations in certain countries. I see areas of strength, and I also see segments where we were underpenetrated like commercial, affluent retail and other high-value segments that have a good profitability and risk profile. We are in the process of assessing our international business mix so that going forward, we allocate our capital to customer segments where we can get appropriate returns for our shareholders. Global Wealth Management saw resilient results in the face of volatile markets and continued industry-wide funds flow challenges in the asset management segment. Glenn and the team have built a very strong franchise and it's nice to see the quarter-over-quarter uptick in net income and strong operating leverage performance.

I'm also pleased to see the continued momentum in the International Wealth Management business. GBM also delivered a solid quarter. I was particularly pleased to see the contribution from Capital Markets revenue with a close to equal split between business banking and capital markets. Record GBM contribution inclusive of GBM LatAm demonstrates the continued progress in our efforts to build an Americas wholesale platform. Lastly, we continue to observe strong credit metrics across our portfolios. I will now turn the call over to Raj for a more detailed presentation on the financial results.

Raj Viswanathan: Thank you, Scott, and good morning, everyone. This quarter's net income was impacted by the $579 million income tax expense payable for the Canada recovery dividend of $0.48 of earnings per share and about 12 basis points in the common equity Tier 1 ratio, and this was recorded in the other segment. So all my comments on the banks and the other segment that follow will be on an adjusted basis for this item and the usual acquisition-related costs. I will now review the performance for the quarter on Slide 5. The bank reported quarterly adjusted earnings of $2.4 billion and diluted earnings per share of $1.85. The return on equity was 13.4%. All bank pretax pre-provision profit decreased to 8% year-over-year, driven mainly by the impact of higher funding costs.

Revenues were down 1% year-over-year, driven by lower noninterest income, which was down 8%, driven primarily from lower wealth management revenues and underwriting and advisory fees, although banking revenues were up a strong 11%. Net interest income grew 5% as a result of strong asset growth across all business lines, offset by a lower net interest margin. However, quarter-over-quarter, net interest income was down a more modest 1%. Net interest margin declined 5 basis points year-over-year. Interest expense grew $6.5 billion or over 300%, while interest income only grew 105%. The decline in margin was mostly driven by higher funding costs and higher balances of high-quality, low-margin liquid assets. Looking ahead, we believe that we are at the tail end of rate increases and expect to see margin expansion when interest rates stabilize.

I'll elaborate further on the higher funding costs in my comments in the other segment. The PCL ratio was 33 basis points for the quarter, in line with our outlook. Year-over-year, adjusted expenses increased by 6% or 4% excluding the impact of the unfavorable impact of foreign currency translation, primarily driven by higher personnel and technology spend to support business growth. The productivity ratio was elevated at 55.7% this quarter, resulting in the bank generating negative operating leverage of 6.7%. We will be even more thoughtful about expense control across the bank for the remainder of the year. Slide 6 provides an evolution of the common equity Tier 1 ratio over the quarter as well as the quarter changes in risk-weighted assets.

The bank reported a common equity Tier 1 ratio of 11.5%, unchanged from the prior quarter. Internal capital generation of 5 basis points, combined with 9 basis points from revaluation of securities offset the 12 basis point impact of the Canada recovery dividend. Risk-weighted assets grew $9.1 billion or $6.5 billion, excluding foreign exchange. This was driven largely by lending risk-weighted asset growth in retail of approximately $1.9 billion and business lending of approximately $2.3 billion. The adoption of Basel III reforms in Q2 2023 is estimated to benefit capital by approximately 20 to 30 basis points. Our priority remains to deploy capital to support profitable organic growth initiatives, while prudently managing capital in the face of a less certain economic outlook.

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, largely driven by higher provision for credit losses. Pretax pre-provision profit grew 7% year-over-year, driven by revenue growth of 10%. Net interest income increased 12% year-over-year as loans grew 9%, while deposits grew 10%. The net interest margin grew 7 basis points year-over-year due to higher deposit spreads, reflecting the 425 basis points of Bank of Canada rate increases, partly offset by lower spreads across all loan products. Loan growth moderated to 9% year-over-year, driven by a 22% increase in business loans and 7% increase in residential mortgages. Loans grew a modest 1% quarter-over-quarter.

Deposits grew a strong 10% year-over-year, driven by a 13% increase in personal deposits and a 4% increase in nonpersonal deposits. Noninterest income decreased by 5% year-over-year, driven by higher private equity gains and higher banking revenue. Expenses increased 13% year-over-year, driven by higher personnel and technology costs to support business growth. The PCL ratio was 19 basis points, an increase of 4 basis points compared to the prior quarter or 22 basis points compared to the prior year. Turning now to Global Wealth Management on Slide 8. Earnings of $392 million declined 6% year-over-year, primarily due to lower fee income and the impact of elevated seasonal performance fees in the prior year. Revenue declined 7% year-over-year due primarily to lower fee income, driven by a decline in trading volumes and lower assets under management, partly offset by strong loan growth in private banking and higher deposit margins.

Building, real estate, business
Building, real estate, business

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The division had positive operating leverage this quarter as expenses declined 7% year-over-year, driven by prudent expense management. The productivity ratio improved to 59.9%. Assets under management decreased 7% year-over-year to $322 billion, primarily due to market depreciation, while assets under administration increased 1% to $607 billion. We saw strong growth in our key international markets with double-digit earnings growth across the Pacific Alliance and the Caribbean Wealth Management businesses. Despite investment funds in Canada seeing 10 consecutive months of net redemptions, we continue to be ranked number 2 by assets in the Canadian retail mutual fund industry. Investment results continue to be strong with 69% of 1832 Asset Management funds in the top 2 quartiles over a 5-year period.

Referring to Slide 9. Global Banking and Markets generated earnings of $519 million, down 7% compared to the prior year, but up 7% compared to the prior quarter. Results were driven by strong loan and deposit growth as loans grew 33% year-over-year, while deposits grew 12%. Revenue increased 7% as net interest income grew 22% year-over-year, driven by solid business banking performance with strong loan and deposit growth and improving margins. Noninterest income grew a modest 2% as higher trading and banking revenues were partially offset by lower investment banking revenues. Expenses were up 15% year-over-year due mainly to higher personnel costs, cost to support business growth and regulatory initiatives and the negative impact of foreign currency translation.

GBM Latin America, which is reported as part of international banking, reported record earnings of $301 million, up 50% year-over-year with another quarter of strong results from Chile, Mexico and Brazil. Slide 10 highlights this quarter's strong international banking results. My comments that follow are on an adjusted and constant dollar basis. The segment reported net income of $661 million, up 18% year-over-year. Pretax pre-provision grew 11% year-over-year with the Pacific Alliance growing 5% and the Caribbean and Central America up a strong 36%. Year-over-year, loans grew 13% with mortgages up 14% and commercial loans up 13%, while personal loans and credit cards also grew 9%. Revenue was up 8% year-over-year, driven by higher net interest margin and strong net fee and commissions.

The net interest margin was 400 basis points, up 13 basis points, mainly from asset mix and spread expansion, offset by the impact of lower inflation. The margin was down 8 basis points compared to the prior quarter, entirely due to lower inflation, primarily in Chile. The provision for credit loss ratio was 96 basis points for the segment. Noninterest expenses increased 6%, driven by business growth and inflationary impact, partially offset by strong digital progress. The tax rate of 19.7% for the quarter benefited primarily from higher inflationary adjustments in Mexico and Chile and changes in earnings mix. We expect the tax rate to continue to increase, in line with reduction in inflation. Turning to Slide 11. The Other segment reported an adjusted net loss attributed to equity holders of $334 million.

This was due mainly to lower revenues of $663 million, partly offset by lower expenses and taxes. Approximately 3/4 of the lower revenue relates to treasury activities due mainly to higher funding costs and lower income from hedges, reflecting the bank's interest rate position to benefit from declining rates. This was partially offset by higher income from liquid assets. Also contributing to the lower revenue was lower income from associated corporations and lower investment gains. Quarter-over-quarter, approximately half of the lower revenue relates to lower treasury activities due mainly to lower funding costs and lower income from hedges, partially offset from higher income from liquid assets. I'll now turn the call over to Phil to discuss risk.

Phil Thomas: Thank you, Raj. Good morning, everyone. As I outlined last quarter, we expect to be in the mid-30s PCL range for fiscal 2023. Our outlook remains the same as our credit -- strong credit practices and high-quality portfolio position us well during this time of economic uncertainties. Overall, the performance of our loan portfolios remain strong, and we are seeing a continued normalization of credit trends as customers adjusted to a higher inflation and borrowing costs. In our commercial and corporate book, we see healthy demand for credit as underwriting opportunities for high-quality borrowers during this quarter were strong. In retail, low levels of unemployment across most of our core geographies is a driving factor for the stability of household incomes despite inflationary pressures.

Turning to Consumer Health. We note that our customers are responding to a higher cost of living by making trade-offs to manage their spending habits. Spending for customer is down approximately 2% quarter-over-quarter as customers are increasingly moderating their discretionary spending on travel, dining and entertainment, which saw a decline of 3% quarter-over-quarter, notably over the holiday period. This was partially offset by grocery, where spending is up 3% quarter-over-quarter and 10% year-over-year. Despite variable rate mortgage customers seeing higher payments with a cumulative 425 basis point rate increase, given the structure of our variable rate product, deposits for this group remain above pre-pandemic levels. Variable rate mortgages remained stable at 37% of our total mortgage portfolio.

International Banking, geopolitical tensions, inflation and rising rates have resulted in softer GDP growth. However, we see positive employment trends in our major markets. Average core deposits per customer increased 2% quarter-over-quarter, while term decreased 2% quarter-over-quarter, while term deposits decreased 3% quarter-over-quarter as Pacific Alliance customers drew down savings to adapt to inflationary pressures. For our Canadian and international retail portfolios, 90-day delinquencies for all Canadian mortgages are still at historic lows of 11 basis points or approximately half prepandemic levels. International retail overall continues to perform well and much better than pre-pandemic. However, normalization continued in Q1 as delinquency increased by 5 basis points, quarter-over-quarter driven by Chile unsecured portfolios.

Turning to credit performance during the quarter on Slide 15. Our PCL ratio was 33 basis points or a provision of $638 million. Our impaired PCL ratio was 29 basis points or $562 million. We added $76 million in performing loans to reflect volume growth and the impact of a less favorable macroeconomic outlook. Total PCLs increased $109 million quarter-over-quarter, driven by portfolio growth and higher retail formations in both Canada and international. Canadian Banking retail PCLs increased quarter-over-quarter, primarily driven by automotive, as we see the normalizing of this portfolio. The increase in international banking and retail PCLs was driven by Chile and Colombia as consumers adopt to the inflationary environment. Impaired PCLs and GBM declined from the prior quarter while performing PCLs increased due to a less favorable macroeconomic outlook.

Allowances for credit losses increased $169 million to $5.7 billion, mostly in Stage 1 and 2. And the ACL ratio was stable quarter-over-quarter despite net write-offs increasing slightly quarter-over-quarter to 29 basis points, we remain well below pre-pandemic norms of 54 basis points. We remain comfortable with our ACL coverage given the high-quality retail portfolio and focus on investment-grade lending and business banking. Finally, we continue to see resilience in our customers. Our highly secured portfolios with strong credit and underwriting fundamentals and higher quality customer mix have positioned us well to manage uncertainty across our core markets. The credit portfolio remains strong and well provisioned, and we are well equipped from a collections perspective to work with our customers.

We continue to monitor economic indicators and the health of our customers. With that, I will pass the call back to Scott.

Scott Thompson: Thank you, Phil. We remain cautiously optimistic on the 2023 operating environment in our key geographies, anchored by a resilient employment and proactive monetary policies that are having the desired impact on inflation. The interest rate tightening phase appears to be nearing its conclusion in Canada, which should lead to more favorable consumer sentiment and a continuation of the relatively high business confidence we see from our corporate and commercial customers. In the Pacific Alliance countries, growth is moderating in response to the historically aggressive tightening that characterized 2022. Inflation in the region is slowing with GDP growth expected to continue to be modestly positive this year throughout the region, except for Chile, where a modest slowdown in 2023 is expected to be followed by a rebound in 2024.

We have been encouraged by the economic resilience of the region and our own credit performance throughout this period of interest rate and political volatility, which has been instructive as we consider how to best position this business for the future. As we look forward, our leadership team and I are underway on a collaborative review of the strategy that will result in enterprise-wide objectives and business line initiatives in support of these shared goals. Our intention is to provide a formal strategy update to investors and the analyst community before the end of the calendar year. In the interim, a few notable near-term focus areas. From an all-bank perspective, achieving a 12% CET1 ratio by fiscal year-end is important. 11.5% was a good outcome for the quarter, and we will continue to see internal capital generation throughout the year as well as the benefits from Basel III implementation next quarter.

However, to be prudent, we have introduced a 2% DRIP discount given changing rate expectations and our desire to support business growth once we have aligned on our priority organic growth initiatives. From an all-bank perspective, we will also be focused on better matching our growth in loans with our growth in deposits. In our Canadian business, we'll be focused on the acquisition of primary multiproduct customers. New to bank acquisition in Canadian Banking is accelerating with the Scene+ program, which is already delivering meaningful impact. The percentage of customers entering the Canadian bank as Scene+ customers doubled versus a year ago and a significantly higher percentage of those customers enter the bank with 3 or more Scotia products.

Over time, we will also see continued expansion of our commercial banking business to our natural share in Canada, resulting in a larger contribution to the Canadian bank. We will also pursue targeted commercial growth within the international banking footprint in the coming years. Our total wealth model, which leverages our capabilities across private banking and wealth advisory will enable us to capture greater value within the expanding high net worth client segment across our Americas platform. We will continue to leverage our footprint and grow fee revenue to improve profitability and expect to continue to see double-digit growth in our International Wealth Management business. We will also continue to build our GBM Americas capabilities throughout the U.S. and Latin America to fully capitalize on our sector expertise and the established Scotiabank brand.

We are particularly focused on improving the underwriting and advisory revenue to lending revenue ratio as we work to close the gap to our peers. In summary, our results this quarter are a reminder that while we have a powerful banking franchise, we also have opportunities for improvement, which are highlighted in this current rate environment. We have a strong senior leadership team and over 90,000 Scotiabankers across our footprint who are passionate and committed to delivering for our customers, communities and each other and importantly, our shareholders. Although I remain cautious on our near-term earnings outlook, I'm confident we'll come out of this year with a strong balance sheet and refresh priorities, supported by a macroeconomic backdrop that will allow us to deliver profitable, sustainable growth for you, our shareholders.

John McCartney: Thank you, Scott. We will now be pleased to take your questions. Operator, can we have the first question on the phone, please.

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