BNSPF - The Bank of Nova Scotia (BNS) RBC Capital Markets Canadian Bank CEO Conference

2024-01-09 11:25:06 ET

The Bank of Nova Scotia (BNS)

RBC Capital Markets Canadian Bank CEO Conference

January 9, 2024 9:20 AM ET

Company Participants

Scott Thomson - President and Chief Executive Officer

Conference Call Participants

Darko Mihelic - RBC Capital Markets

Presentation

Darko Mihelic

Okay. Join me on the stage now is Scott Thomson, the CEO of Scotiabank.

Question-and-Answer Session

Q - Darko Mihelic

And Scott, I think I'm going to start in a similar place with you this morning in terms of the questioning. Starting I think on the macro side and the big changes that we've seen in interest rates and it's a bit -- I think it's going to be a little bit more nuanced for you in terms of my questioning, just given Scotiabank’s history with net interest margin, balance sheet positioning and so on. So maybe just first right off the bat, can you talk about how we should think about the new Scotia in the new world with falling interest rates where we're all familiar with the balance sheet structure and you should be sort of benefiting from falling rates? So maybe you can just talk about a quick overview of your position, your NIM expectations, and we'll chip away a little bit about how to think about the Scotiabank now under your watch?

Scott Thomson

Sure. Thanks, Darko, and thanks for having me this morning. So first, I think you mentioned that we're uniquely positioned to benefit when rates come down, and that is because of the structure of our balance sheet. And so that's, I think, an important takeaway for this audience. As we think about, how we think about the rate environment. We've forecasted 75 basis points of rate reduction into 2024 backend loaded, I think 25 basis points in Q3 and 50 basis points in Q4.

To the extent that, that actually happens sooner, then that will be helpful for us. So as I think about the sensitivity for The Bank of Nova Scotia on an annualized basis, every 100 basis point reduction in the front end is about $200 million of NII. And so that would be modest benefit. It was a little early in ‘24, but it does underpin the 5% to 7% EPS growth expectations that we've highlighted at our investor day for 2025.

I think the second thing to note around NIM for next year, which we do think will expand materially, is the asset repricing that we'll see on the mortgage book. And so as we think about mortgages repricing the ones that are coming up for renewal and we have 90% plus renewal rates. You know, you're seeing the 200 basis point expansion on the yield too. So as we think to 2024 and then obviously more into 2025 you're going to see significant NIM expansion of the Bank of Nova Scotia.

Darko Mihelic

And one of the things that always, as long as I can remember covering Scotiabank, what differentiated you was a willingness to take a position in front of interest rate changes? And I get the sense that, that may have changed. Maybe you can talk a little bit about your willingness or unwillingness to have your treasury department sort of make a bit of a call on rates to either enhance the interest margin or if you get it wrong, hurt. So over to you on…

Scott Thomson

Yes, no, there's definitely been a philosophy change at the bank. And I think historically, we compensated for the lack of interest rate sensitivity through bets on the direction of interest rates, and the majority of that time that worked. But obviously in 2022, 2023, the higher for longer rate environment had an impact on us. And so you saw pretty early last year, the philosophical change where we moved to the treasury function being a protection of profitability as opposed to an enhancement of profitability. And the objective for me and the team now is to go away and fix those structural deficiencies that caused the lack of sensitivity to interest rate rises. And that is around deposits and primary clients.

And I was really pleased with the progress that we made in the last year. I think the last year at this time, I was up talking about deposits and our objective to grow deposits. And the question came back was, how are you going to do it? And I think we proved last year with 9% outsized growth of deposits that, you know, when you focus an organization on doing something that can come true in pretty quick order. And so we saw a big reduction, 100 basis points in wholesale funding ratio, deposit increases, and loan to deposit ratio growing in line, which is a commitment I also made at this time last year. And so philosophy changed for sure, and we're going to continue to keep that change as we move forward.

Darko Mihelic

And so that brings up an interesting sort of angle with Scotiabank, because, you know, you have an anticipation that with lower interest rates, you'll actually have some NIM expansion, and you are also aggressively trying to grow your deposit book, right? So the question that I often get asked is, does the balance sheet positioning allow you to continue to fight aggressively for deposits and win the deposit market share by simply offering higher rates?

Scott Thomson

Yes, this is not a high rate issue. And if you look at the last year, we were not winning these deposits through price. You know, it's focusing the organization is providing the right cash management capabilities, it's providing the right incentives, providing the right partners, scene plus, big addition to the overall portfolio to allow us to get those core deposits. And so you do need to differentiate between deposits and primary clients. I mean, there's a North star vision here to get primary clients. We put out in our investor day the ambitious targets around the primary clients, that 10-year North star is not going to change, with it will become deposits.

When you get to the rate-sensitive deposits, you will make that judgment around wholesale funding versus price-sensitive deposits as you go through the piece. And that's why that will be helpful for us as we look into ‘24, ‘25. You look at a place like Mexico where you've seen 650 basis points of interest rate reductions. You've got some price sensitive deposits there as well as self-funding. As you see rates come down, that will actually help us from an NII perspective. And so please do differentiate between primary clients and deposits.

Darko Mihelic

And so with that, I think the one difficulty that I've always had with Scotia and modeling is the NIM and interest margin expectation for your international business?

Scott Thomson

Yes.

Darko Mihelic

So what can you tell us there, if anything, on how we should expect the NIM to evolve? And what like you mentioned it, right? 650 base points in Mexico, like, how do we see that rate environment evolving in those markets and your NIM for international?

Scott Thomson

Yes, well, when you think about the rate environment in LatAm that actually moved earlier and more significantly than what we saw in North America. And so rates of 10%, 11%, 12% across Mexico, Chile, and Peru, Colombia. And those started to come off quicker as well. And so in Chile, you've already seen 350 basis points of reduction. In Colombia, you've seen 25 basis points. In Peru, you've seen 25 basis points. Mexico, you haven't yet. I suspect they'll wait till the Fed reduces before they start to reduce. But that obviously, for the reasons that we discussed, will help when we have a loan to deposit ratio of 200% in our international business.

But again, as we look forward, the same strategy around primary client focus, affluent segments, high value segments, incremental capital going into more developed markets versus developing markets. And that all will help long-term over both RAM, Risk Adjusted Margin and NIM.

Darko Mihelic

So the last, kind of, thing I wanted to talk about with these rates coming down is, as we chatted earlier on the mortgage renewal situation. But in your case, it's a bit different, right? One of the things that there's some discussion at your investor day about sort of level setting the mortgage book and perhaps seeing a decline in your mortgage book for a little bit further and going into a period where your mortgage balances may be declining and interest rates are falling. Now that's going to help your variable rate mortgagers’ with lower mortgage payments. But where I'm going with this is we've heard, you know, it’s a 14%, 15% of mortgages will be renewing this year, not a big deal, but as we get into 2025 and 2026, a lot of mortgages are coming through? Is that part of the strategy to aggressively grow your mortgage book in the great renewal years as you sort of level set the mortgage? Or maybe you can walk me through that?

Scott Thomson

Couple of things to your question. One, I do believe mortgages are a core product and an important product in driving privacy. And so there's not a philosophical change around mortgages. That being said, you know, multi-product clients with multi-product are much more valuable than monoline clients. And we had two significant of focus on volume and monoline as opposed to primary and, you know, multi-product. And so that is why you saw the slowing of the mortgage book over the last year.

Now, I think what Aris had said at the investor day is you're going to start to see that pick up in the back half of this year and I’m really pleased with some of the things that are happening in that channel with this new philosophy around multi-products. So in the last quarter like 65% of mortgages originated or with multi-product, three-products or more and frankly through our mortgage channel -- our broker channel almost 80% are multi-product and so that shift and approach is having an impact and you will start to see that pickup in mortgages.

As you think about our renewal, you know, about 11%, well first the variable rate mortgage is a unique differentiator for Scotiabank, 33% of our mortgages are our VRM mortgages and those have already been repriced and we've actually seen our clients navigate through that issue pretty, you know, pretty well, pretty well, frankly. But as you look at the fixed mortgages 11% of our mortgages renew in 2024, so about $35 billion. 22% renew in 2025, so about $65 billion, and then there's about 35% in 2026.

And when that renewal occurs, we do expect to see rates similar to what you heard from the last speaker, rates coming down. Right now with our client base on renewals, you still see about a $400 million to $500 million per month increase and the FICO scores on our fixed term customers are very high, 90% are prime plus clients. So we don't see significant credit issues and we will be in a position to renew with these clients in a multi-product emphasis going forward, which will help drive our primary objectives.

And then the last thing I would say is, as you look through this renewal, it is having a contributing factor to NIM. And you're starting to see that in the last couple quarters, actually our NIM expansion in Canada, again, has been differentiated relative to some of the other financial institutions and that will continue in 2024 and 2025.

Darko Mihelic

So maybe that can dovetail that the sort of non-concern of credit with falling rates helping mortgages into an overall view on credit quality. And this is, you know, a few things jumped out at me with your Q4, with your investor day. So I wanted to just sort of pick away a little bit on credit and sort of how you see it evolving? You've given us guidance on -- in terms of what to expect for 2024, but the thing that's resonating in my mind is as I think about the whole sort of strategy, there are going to be some portfolios that are going to be run down here over the period of the next few years. Maybe some exits in some LatAm countries? And so on the one hand, you built a nice reserve at the end of the year, which is great. Solid balance sheet now?

But as we think about Scotia going forward and as you run down some of the unsecured books, as your mix shift changes, how might that affect your provisions for credit losses and could we see like a lumpy kind of progression where you remove some unsecured portfolio and we have to have a release of that reserve or how should I think about that going forward in 2024 and 2025? Or should we expect a more level, kind of, build of provisions until we hit a peak loss. [Multiple Speakers]

Scott Thomson

Yes, I mean, on the ladder, Darko, I mean, I don't think you're going to see a big release of provisions. I think the steady hand, which you just highlighted around provisioning is going to be more of the philosophy going forward. In 2023, there was a big build, right? I mean, we had $1.1 billion of ACL build, which I think $780 million was performing. I've heard a lot of questions around IB, our investment -- our international bank, and wondering if there's more to come in that regard. I'd highlight that we already built $440 million of ACL in 2024. And we will see in 2024 higher PCLs as we business mix transition from monoline clients to more primary clients.

But you're also seeing these economies in their international markets rates coming down already off of the peak. And so that should help provide a little bit of tailwind. And we are going to get out of some of these businesses or focus less on some of these businesses, consumer finance businesses. So for example, Scotia Credit, which is our Peru consumer finance business, that business we will exit, and that will provide a tailwind to PCLs as we look forward. And so, you know, I don't see any provision release. I do see more of a steady hand as we look at provisions going forward.

Darko Mihelic

Okay, and the question I get a lot around Scotia is really, would think about the capital sort of situation. And you're the only bank really that's noticeably impacted by the floor now today and the floor is going to be rising over time. So I think maybe we can talk a little bit about your capital position. How we watch the floor impact, what you can do, and at the same time you do have a high capital ratio coming down, but then rebuilding, you have a drip going, so there's a lot of questions on capital, maybe you can walk me through how you guys are going to manage around the floor? And does it necessitate you keeping the drip on longer? Or could we see a situation in which your drip is actually removed earlier than anticipated?

Scott Thomson

So when I was up here last year, I think our capital ratio, ACL ratio was 11.4% and I said the number one objective was to build up that capital and we ended the year at 13% and that was done with the recognition that the floor was going to impact us and that floor impact will be 75 basis points in the Q1 and that will then put us in squarely in that 12% to 12.5% range which is where I want to be with the recent OSFI guidance. So I think that's good.

The objective is to get off of the drip by the end of the year. That is an objective that we have. We're going to wait until we see what happens in June, but we're going to do what we can to shut that drip off at the end of the year. In terms of why the floor is impacting us, and it will impact everybody eventually, but it's impacting us first, is the focus on corporate and commercial and leading with the balance sheet, right? And those have been done in investment grade, high credit quality clients where the RWA density is a little bit lower. But then as you move to a standardized approach where you have a little bit more of a blunt instrument, that floor impacts us. And if you look at the disclosure, it's mostly around that corporate and commercial book.

And so highlighting, you know, the investor day messaging around moving away from just a balance sheet led volume based approach to a relationship value based approach, where yes, you know, you are a bank and you are lending, but you're also making sure that comes with cash management, that comes with advisory, that comes with multi-product relationships. And this is why this approach and this client, frankly, a client deselection approach that we're going to have to go through in the corporate and the commercial side, which will help us manage the floor impacts and get us to a place where we can turn that drip off. And that's an objective that both Raj and I have.

Darko Mihelic

And so just to sort of clarify and circle back on this and sort of end the topic, but you want to manage 12 to 12.5 until June until you sort of really understand. And so that extra 50 basis, I mean, we had Dave [Indiscernible] up here just a moment ago saying he's going to be at 12 and you're kind of saying 12 to 12.5, so that extra 50 basis points is just for uncertainty or an OSFI maybe the floor impact or…

Scott Thomson

Remember I have a floor impact in 2020 next January and the next January after that as well 40 basis points and so I have to be prepared for that. And I want to understand what OSFI is going to do in June. Now I think they've come to the end of their capital raising cycle, but I also you know they've got another announcement in June so we'll -- we won't do anything before that with the objective of getting off the drip by the end of the year.

Darko Mihelic

Okay, okay, great. Awesome. Just one page here. I wanted to touch a little bit on some of the other discussions that we had at your investor day. You know, some possible dispositions and sort of some short-term loss of earnings power. And I wanted to sort of bring this all in for, I mean, there's going to be a lot of decisions made throughout 2024 with respect, and you haven't finalized any of these decisions. But I guess what we're all wondering and sort of tying this back to the sort of capital discussion is, as you exit these businesses, what's a little unclear is whether or not we get capital relief or capital pain as you exit some of these businesses and/or geographic regions? So what is your -- what can you tell us about that potential in this year or even into 2025?

Scott Thomson

Yes, so when you look at our investor day at the end of December, we had bucketed our businesses into various descriptors and one was turnaround or exit and in that bucket was Columbia, Central America and consumer finance businesses of which Credit Scotia already talked about. So we're working hard to turn around those businesses right now. And if you think of Columbia as an example, we had 12%, 13% inflation, yet costs were down 7% or 8% as that team executed on a productivity agenda to help on the net income side. And we've got a commitment from our partner to continue to make those that progress to see if we can turn it around.

However, if we can't turn it around, and this would be the same for Central America as well, we won't be afraid to act to address those issues in terms of different actions. Now, I think from a shareholder perspective, it's important to know right now, Colombia has zero net income contribution and Central America has $80 million annually from a net income contribution and so the impact to our net income which is different than I think what happened through four years ago when we disposed is not material.

On the capital side, again, I think it actually could result in capital relief, frankly, because of the RWA piece. And so you may have a gain or a loss, the loss being associated with the goodwill potentially, but you will have capital relief on the RWA side. And so there won't be an impact to [Indiscernible] that's material. In fact, it could actually be beneficial as you exit those markets.

Darko Mihelic

Okay, great. I think I'll take a time here to just take a look at the questions here. I didn't get to as many I think what I have to do apologies. I wasn't -- I'm going to move over. While I'm waiting for this to update, why don't I go on to a different question. So one of the interesting parts of the investor day was the idea or the conceptually the idea that you would move capital from GBM LatAm into GBM U.S. And it's probably the most discussed topic that I've had with investors since. So we've had some flavor of some of the things that you intend to do in the U.S. with respect to some of that. A little bit of levered lending. We don't think that's very big.

But conceptually, I guess the question is you'll need to build out some capabilities in the U.S. And it's going to be a hot year. It feels like it's going to be a good year in capital markets. And so is there a potential here to sort of watch capital markets revenues, sort of, move better, improve and you accelerate some of your intentions in the U.S. while you have got strong earnings, we can see maybe the expense growth rise with it. Or do I have the view wrong? And do you have a more modest view on capital markets, especially coming out of the U.S.?

Scott Thomson

Yes. So a couple of things, one is this GBM LatAm reallocation of capital and the rational for that. And so we have perused a volume base strategy in our IB markets both in the PNC businesses and in the GBM business. And that has resulted in a GBM LatAm business that is a leader in loans, but at a lower ROWA, Return On Risk Weighted assets, than what we should be or what we are getting in Canada and U.S. And so the question is, you know, should we be doing that or should we be reallocating some of that capital out, taking more of a value based approach and redeploying that capital into our PNC businesses and also into our GBM U.S. business, so that would be point one and that seems like a pretty obvious decision.

The second piece is in the U.S., you know, it is 10% of the overall net income of the business right now. The guidance we gave the investors at investor day, was we’re going to grow that at a compound annual growth rate of 9% over the next five years. And so we're not talking about big bets. This is an organic driven GBM strategy. And it obviously comes down to capabilities, because I'm highly cognizant of the fact that there's been a lot of Canadian banks that have gone to the U.S. and haven't done that well.

And so this journey of building out the GBM capabilities has been in process for the last three or four years and we've done a good job actually building out you know balance sheet capabilities for sure, but DCM capabilities FX capabilities you know right now we've got a great REIT business down there we've got a great pipeline and utility business down there and so we are seeing a mix of the advisory fee income and the loan income is what I'm striving to accomplish.

And so I do feel like that U.S. business could be allocated some more capital, but it's not going to be a redeployment of all the capital in IB to the U.S. That redeployment or reallocation, we've said 90% of incremental capital is going to come to developed markets of Canada, U.S., and Mexico. It's going to be in that order frankly. Candan, U.S., and then Mexico.

Darko Mihelic

And just so maybe just tie in your outlook though for 2024. I mean, I've had some discussions in the last couple of days and last week, coming back from Christmas, that the view is the pipelines are building the view is that what we're seeing is significant activity that might be bolstered a little bit with falling rates. Is that do you share that view? Or…

Scott Thomson

Yes, I think it's too early to tell. I mean, we're on January 8 and there’s just a lot of uncertainty in the market, which obviously holds back clients, CFOs and CEOs from making decisions, you know, 100 basis points move in the 10-year over last month and a half. And as we start the year here, it's back up a little bit. So I do think there's still too much uncertainty in the market too, to agree with what you said around increased activity in 2024.

Darko Mihelic

So maybe just touching on expenses, because I can't get the Slido thing to work by the way. So if there's somebody in the back room here that can give me a hand with the Slido iPad, that would be fantastic. Maybe we can have a chat on the expenses and think about I mean there was some movement, a charge I guess at the end of the year. And you know many banks are telling me a couple of things, they're saying number one, there it's more difficult to manage expenses to look forward. Two, therefore they're likely to be more charges and more work done in 2024 and 2025 and beyond. And there is a genuine sort of view that longer term, we have to be a little more thoughtful with expenses and really try and keep expense growth tied to the strength of the business.

Philosophically, maybe you can talk a little bit about your expense expectations for 2024, and maybe speak to how you see this sort of playing out over 2024 and 2025?

Scott Thomson

Well, as you think, as we started the last year, our expenses were ramping. And we started to slow that down. And in the second quarter, Raj and I thought it was important to get the restructuring charge behind us in the first year and so we did that and it was a significant one that was you know 4,000 employees it was a meaningful charge that wasn't only just labor it was also some of the things that we wanted to clean up. And so it was helpful to get that behind us in 2023. As we look forward, we've projected positive operating leverage across the business, which I think is what we've strived to do mid-term, but we will get there in 2024.

And I was really pleased to see on the back half of last year in the fourth quarter, the IB business has already gotten there. And so the IB business revenue is coming down, but expenses was below the growth rate in revenue. And so it was good to see positive operating leverage on IB. Now IB was one of the regions that had actually taken the biggest chunk of expenses out through that restructuring charge. So that's good to see it come through in the fourth quarter. And we'll see a good full-year view of that into 2024.

Darko Mihelic

But sticking with the whole conceptually, is it going to be a more difficult thing to do going forward, especially in Canada, where some rules have changed, things have happened since the pandemic? Do you see it as something where restructuring charges are things of the past and we sort of have to get…

Scott Thomson

I think one of the things you're going to see better, faster and at a lower cost. I mean, we're going to have a relentless focus on operational excellence and that's going to be around a big part of that's going to be around cost management and I think we can do that. I think we can run this bank in a more efficient fashion. You saw the productivity projection that we put out in our investor day, which was ambitious, but this relentless focus on managing the cost base is going to be a consistent theme of my leadership.

Darko Mihelic

Okay, and I think, you know, one of the other things that really stuck out for me, there was some discussion at your investor day on the Caribbean and you know, the view is that it's fantastic, others don't share that view. So I just wanted to sort of circle back a little bit on that part of international which is not necessarily getting more capital, but you view as a core sort of part of the business, and you maybe touch on that a little bit. It's just something that's still sticking with me as I think about your longer term view with IB?

Scott Thomson

Anytime you go through one of these strategic reviews, you have to think about competitive advantages. You know, what competitive advantage do you have that others don't that can allow you to move the business forward. And the Caribbean was an interesting one for the team because as we looked at it and we saw the trust and the client primacy that we do have, which is different and unique in the overall Scotiabank. I think the numbers, 30% of the region's deposits are with the Bank of Nova Scotia were more trusted than the government in some cases. And so when you look at what we're trying to achieve in some of our other businesses. We actually have that in the Caribbean, and we are the Gorilla in that region. We are the best in that region. And so others might not like it because we are the best, right?

And so why would you give that up? Why would you give it up when you're the best at something? And so we don't talk about that a lot. But you know, we should highlight the fact that, that is a core business, it ties in with the whole developed market North America corridor, particularly with a lot of people spending time in the Caribbean from Canada. And so you're right, it's not going to receive a lot of incremental capital, but it is going to be a core part of the portfolio going forward.

Darko Mihelic

And from a growth perspective, when we should, sort of…

Scott Thomson

I think GDP has growth, I mean it had outsized growth here on the back of SVB and rates and the pandemic and that has contributed pretty mightily to our IB results, but realistically as rates come down more GDP-ish type growth in the Caribbean.

Darko Mihelic

Okay, so we touched on the two parts that were bit surprising to me investor day. I thank you covered them well. So running out of time, so I think as always I like to sort of turn the floor back over to you for any sort of key thoughts or messages that you want to leave shareholders and investors what’s today.

Scott Thomson

Yes, well, you mentioned the investor day and we had a you know it was a big day for our employees shareholders all stakeholders on December 13th. I think a couple of pieces of feedback that I've received, interestingly from our employees, it was very positively received. I think we had 6,000 employees watching on that day and their recognition that or appreciation for the recognition that we had things to do, but we had a great platform and can execute and it actually taken really positive steps in 2023 to rectify some of the balance sheet concerns that people have had. I think that was good feedback.

I think that the resonating piece of moving from developing markets to developed markets, and trying to create that North star vision of the preeminent financial institution in North America, which plays to the mega trend of what we're seeing with capital deployment. That is a key message that I want people to take away, because incremental capital is going to go to those regions. And we have a competitive advantage to create that connectivity across that corridor for our wealth clients, for our corporate clients, for our multinational clients, and for our commercial clients.

I think the second piece that was important is this philosophical change from balance sheet led volume to relationship value. And you're starting to see the benefits of that through the NIM expansion. You'll continue to see the benefits of that in 2024 and 2025.

The third piece is this relentless focus on faster, better, and at a lower cost. You know, we have a real opportunity here to create value for shareholders through management of discipline costs. That doesn't mean we're not going to invest in this business. We're actually going to invest more in our Canadian business, and we gave you some forecasts on doubling the capital spend to be able to meet some of these primary client ambitious targets that we put out. And that is, you know, a big focus for me around this North Star vision of primary clients, ambitious targets of over 2 million additional primary clients and $200 billion of deposits between now and 2028. That will change the trajectory of this company for a long time when we accomplish that.

Then the last piece just to leave, it is all about talent. It is all about talent. And we have a great opportunity with the internal talent we have and the contribution from the new external talent that is joined to execute, because at the end of the day, the investor day did resonate with people, but it was around execution that's going to tell the tale on whether we're successful or not. And as a management team, we recognize that you need the talent to do that. And I'm confident we have the internal and external talent to execute.

And then lastly, around culture, you know, I think we've made a lot of progress this year through the strategy refresh to break down some of the silos taking enterprise wide view, allocate capital to places that are going to provide the best returns for our shareholders and ultimately that will pay dividends for all stakeholders going forward.

Darko Mihelic

Okay. That's great. With that I'm going to wrap up the session. Thank you very much, Scott.

Scott Thomson

Thanks, Darko.

For further details see: