The Bank of Nova Scotia (BNS) Earnings Call Transcript & Summary

[Audio Gap] Results could differ materially from forecasts, projections or conclusions in these statements. Listeners can find additional details in the public filings of Scotiabank.

So with the formality out of the way, Brian, why don't we talk about your targets and the achievability of your medium-term targets for 2020. I think that's a good place to start, and then we can dive into many other things from there.

Sure. Well, our targets are set for the medium term. So that's 3 to 5 years. But if you look at what we've accomplished in the bank over the past couple of years in terms of our acquisitions and divestitures, we think have been significant. If you look at the overall bank today, is that we generate 87.5% of our net income from Canada, the U.S., Mexico, Peru, Chile and Colombia. So we've dramatically simplified the bank. If you add the Caribbean into that, it's actually 95% of our net income. So we simplified the bank a lot. We've reduced operational risk by exiting a number of countries, if you look at the Eastern European -- or Eastern Caribbean countries we exited. CAGR, 5-year CAGR of net income was negative 3.5%. So these were a distraction from what we've done. Credit quality wasn't great. And operational risk is ever present. So again, we think we've produced -- we've improved the earnings quality of the bank. We've reduced credit risk, if you just take Puerto Rico and El Salvador, and El Salvador will close later this month. Puerto Rico closed on December 31. As many of you know is that on a $1 trillion balance sheet, just getting rid of 2 jurisdictions, which account for $3.5 billion of assets, reduce the bank's gross impaired loans by 10% and our net impaired loans by 10.5%. So again, quality of earnings go up with the acquisitions we made in wealth management in Chile and operational risk goes down and credit quality improves throughout the piece. So we feel very comfortable. Revenues in the bank grew 7% last year. Our productivity ratio as a bank is 53.1%, which I think is the lowest of our peer group. And we see further room for improvement there. If you look at some of the countries we operate in, and I'd isolate the LatAm countries we operate, these are 20% ROE jurisdictions. We earn an ROE of over 20% in Mexico today, over 20% in Peru and Colombia and Chile would be adjusted for good will be in the mid-teens. So we like those jurisdictions. We see good potential for revenue growth. And if you look at GDP forecast for the coming year, they're better for 2020 than they were for 2019. So we like our revenue outlook. There's further room we can do in terms of enhancing our expense management capability throughout the bank. So we're looking forward to 2020.

Does that mean that we can look forward to you achieving the 7% EPS growth and positive operating...

Well, again, these are medium-term targets. What we said on our Q4 call, Darko, is that we said that ex of the divestiture in Thailand that we produced mid-single digits increase in net income, and we're going to stick by that. But I think you'll see -- we'll see how the year unfolds.

Okay. Now I was going to launch in a bunch of other questions, but yesterday, you guys put out a press release, just a bit of an update, there's sort of 4 parts to it. Maybe you can just provide a little bit of color on the gain on sale in Thailand, an increase in the allowance for credit losses, there's a derivative valuation adjustment and an impairment charge. So maybe just provide a little bit of color around what you guys are messaging to the Street.

Sure. Well, this is something we've been thinking about as a management team for some time and some of these divestitures took longer to close than we anticipated, but we've also -- of all the divestitures we've done for the bank, starting with CI management, through to the ones I mentioned earlier today, we produced a gain for our shareholder, and we didn't think it was recognized in our stock price. So we said to ourselves, is there a more effective way we can use the shareholders' capital here. So if you look at our allowances for credit losses in the bank, and we think the bank's had a long history of provisioning early and provisioning conservatively, there are $5.1 billion of allowances in the bank. So if you look at the pretax number of $150 million, that's 3% of our overall allowances. So it's not a big number, but the market was concerned about forward-looking indicators. So we developed a more pessimistic scenario about a stressed Canadian economic environment, a stressed U.S. economic environment, oil prices, et cetera, and we added that into our forward-looking indicators. So that's where we are. So we just thought it was good management more than anything. In terms of the derivative valuation, in terms of ex [ V O ] was -- as these things evolve, practices evolve, we just felt it was -- this is for uncollateralized derivatives that we do for clients, that we just thought it was a good practice to enhance, and that led to an after-tax charge of $90 million. So I don't want to be flippant. These are big sums of money, but we just thought it was good housekeeping and an appropriate time of the year to do it.

Okay. And there's an impairment charge as well on the software.

Yes, we had some Moody's software in our risk unit, which was discontinued, which was an annoyance more than anything. But -- so we took the hit and drove on.

Okay. So the update on the divestiture. As you mentioned, it was a very busy year for you, both acquisition and disposition in 2019. So wanted to dive into both elements of that, if we could. One of the things that caught my eye is in your shareholder -- your letter to shareholders, you mentioned that you -- through a series of dispositions, you went from 54 countries to 33. That's a big reduction, a; but b, 33 still seems like a lot to me. So I think when you mentioned the journey on going towards the dispositions, part of it was -- it could be a bit of a distraction, as you mentioned, in the Eastern Caribbean, could be a bit of a distraction to the management team. Is 33 countries still the right number? Is there still some...

Well, I'd go back to the comment I made earlier, Darko, is it was a busy year. And it's a lot of work to get from 54 to 33, I can tell you that. But we're proud of what we've done. You get a more focused bank at the end of the day. Some of these jurisdictions, as I mentioned, Puerto Rico and El Salvador is that you have to make the determination, am I better managing -- is Scotia better managing this particular business? Or is it better in the hands of a local bank? And we came to the determination, it was better in the hands of a local bank. And getting back to streamlining our business. So 95% of our net income today comes from the Americas, from Canada down to the tip of Chile. We can focus on those countries where we earn a great ROE, focus on our clients, and we'll get a better return for our shareholders going forward. So the other jurisdictions you talk about, I would describe as pieces of our wholesale business, whether they're in India or Asia, which all tie into our business if they're doing business in the Americas. So if we're lending to a large entity in Tokyo, Japan, they'd have to be doing business and have connectivity to the rest of our franchise in the Americas.

Okay. So then switching over to the acquisition side, which we were busy as well, quite a bit going on there. And I know we're going to get a very good update later this month in Chile. So let's -- instead of diving too much into Chile at the moment, let's talk a little bit about Jarislowsky Fraser and MD Financial. Can you provide a bit of an update there? I think there's still some view in the marketplace that, on the MD side, there's intense competition for doctors. Maybe you can provide a bit of an update and maybe some new -- is there any metrics you can share that help us think about where you've taken that since you've acquired it?

Sure. I'll tie all 3 together for a minute, because they're recent acquisitions, BBVA Chile, Jarislowsky Fraser and MD Financial. So we gave guidance when we did these acquisitions that would be an incremental net income to the shareholder in 2019 of $150 million. That number was actually $253 million. And we see it for 2020 growing in double digits. So we're very comfortable with the quality of the acquisitions in terms of what we acquired, whether it's AUM, the people we acquired, the cultures that we acquired, and how we've integrated these businesses. And we'll give you more color on Chile when we're there later this month. But in terms of Jarislowsky Fraser, the business has gone very well and would be ahead of our expectations in terms of integration. AUM is up, regardless of market. So organic AUM, it's an iconic brand and franchise and one that we think we can continue to grow and develop and put more products on the shelf. So we're very comfortable with that business. MD Financial. AUM is up. Customer retention is 98% plus. Adviser retention is the same type of number. And culturally, a very good fit for the bank. So we like the wealth business, that's why we're separating it out as a fourth business line. And today, it provides about 13% to 14% of the bank's overall net income, but the complexion of our wealth business has changed. We felt it was, if you will, a little too Canadian and a little bit too retail skewed towards mutual funds. AUM is up in the last 5 years from $164 million to over -- $164 billion to over $300 billion. So the business is performing well and growing very well, and we see a very bright future for the business. We like the business.

And I think a couple of the things that -- with respect to Jarislowsky Fraser and MD Financial, a couple of things that we were looking forward to was -- one was, I think part of it was that you could take the Jarislowsky Fraser model and implement it globally. Have we seen any evidence of that? And then secondarily, on MD Financial, I think the thought process was that you would migrate them and make them banking customers. Is there any progress there?

Yes, for sure, there is. And that's a very important question, and it was -- key in our thinking about this is we banked 40% to 50% of the dental community in Canada before we bought MD Financial. So we saw people through dental school, helped them -- lent the money to buy their practice, and then enjoyed the wealth management business and everything throughout the life cycle of that client. That gave us a lot of impetus when we looked at MD Financial. So when you look at the CMA, the CMA has 110 million -- 110,000 physicians as members, 67,000 of those are MD clients. So it's -- and they have complex financial needs. And private banking is a really integral part of this. And I think we've done this very well. If you look at our wealth business away from AUM growth, is the private banking component is the fastest-growing component of our wealth business. And what we do differently is our private banking is part of our wealth management business, and we put trained, experienced commercial bankers in these businesses. So in the MD -- 48 MD offices, you'll see a trained commercial banker that understands private banking, understands the complexity, knows how to structure complex needs because people may have -- they may want to help their children buy a home and they don't want to incur a tax event. There's some complex scenarios that come out of these things. So private banking has been an important underlying theme in these wealth acquisitions, and you'll see continued growth there.

So switching then, just a quick -- again, because you have that Investor Day coming in international, I don't want to try and steal too much of the thunder. I know there's going to be a lot of information. But just from the outside looking at a very high level, from the outside looking in, looks like there's some political issues in Peru, weakness economically in Mexico, some issues arising in Chile, even Bolivia and other countries in the entire area seem to be having -- going through some difficulties. There's a temptation because I'm not there often to think that this is bad. Is it overblown in the media? What is your -- you have boots on the ground, what can you tell us about...

We've got to get you there more often, Darko.

Fair enough.

It's -- the press loves to write negative things, it's about Latin America. That's just the way it is. But again, the Brazilian economy is coming back. I mentioned, the Peruvian economy is going to grow at 3%. The Colombian economy is going to grow at 3.5%. Mexico is coming back. All these -- what people forget is there's a tremendous -- when you've got countries on population basis, Mexico is 129 million people, is there's a lot of internal consumption. So even though GDP forecasts were down for Mexico last year, and it grew at something like 0.3%, our financial performance was flat the year before, which was a record year. You take out the tax credits that we had. So our business continues to operate pretty well. There's a lot of internal generation for credit in these economies as the population expands. So again, these are 20% ROE countries for banks. And we like them. We know how to manage the risk, and we know how to manage the events. In Chile, I'll make a comment about Chile, is we don't have any regrets about our investment in Chile. We acquired a great bank, great assets, good people and very good technology. And the integration has gone seamlessly and exceedingly well. And we're ahead of our targets. It's unfortunate what happened in Chile. We view it as a Q1 event, which we provided for from a credit perspective in Q4. And the long-term prospects for Chile remain intact. If you go back to 1990, at the end of the Pinochet regime, 40% of Chileans lived in poverty. Today, it's less than 10%. Per capita GDP, it's USD 24,000. Chile is an economic success story. Unfortunately, the middle class was feeling pinched around pensions, university tuition and health care. And the Piñera government made the appropriate responses, and there will be changes to the constitution and changes to how these get funded and paid for going forward. So unfortunate is there were a lot of external factors in terms of the violence imported from other countries that happened, that's another discussion. But from -- our operations in Chile, they're back to normal. And we would view it as a Q1 event. It's unfortunate, but life goes on and Chile will continue to prosper and succeed as a country from here.

And the interest rate environment, we've seen some cuts down there. What are the expectations for NIM and NII? What should we think about...

Yes, the forecast we gave for NIM in our international business -- and keep in mind, there's hundreds of components that go into our NIM given our different businesses there. But we said, give or take, 450 basis points, plus or minus 10 basis points a quarter, and we stand by that. There's been -- 92 central banks around the country have cut -- around the world have cut rates. Rates have been cut in our 4 major markets there, but our balance sheets were positioned for stable or declining rates. So we don't see a great impact in terms of our NIM going forward. We'll manage it accordingly. And we've got lots of tools at our disposal to do that. So I wouldn't be worried about NIM compression in our international business going forward for the next year. So as I said, we've got lots of different tools to manage that.

So I want to turn the focus to credit. But before I do, I want to touch on one of the things that you mentioned a couple of times last year was that you were getting the bank to be downturn ready. Can you elaborate a little bit on what that means? Does it mean big reserves? Does it mean preparedness? How should we think about when you say Scotia is downturn ready?

Well, look, we like consistency and predictability, and we think our shareholders do, too. And as I said, that we've always had a strong credit focus in our institution. That continues today. If we see a problem, we tend to provision early, and we tend to be very conservative on our provision. The other way to look at PCLs is not just an income statement issue, a balance sheet issue. So if you look at -- we've got $5.1 billion of allowances in the bank, that covers more than 8 quarters of losses in terms of credit losses. But it's also, if you look at the OSFI buffer from 10.25% to 11.5%, that's another $6 billion of capital. So looking at it from a balance sheet perspective is important as well. But I'd go back at the adoption of IFRS 9 is that we view that this was a onetime event. So we took a $600 million charge through our capital blocks at the time. And so the starting point -- some other banks actually had releases, which I don't understand because we view this as a onetime event. And we were very conservative of how we did it. So the starting point on IFRS 9 is critically important. And so when you look at our bank, I'd like to use the term, follow the cash. So if you look at net charge-offs throughout the course of the year, they've been flat. Delinquencies are flat, relatively flat throughout our business, throughout any country we operate in. So we put a premium on credit quality. If you look at some of the flash points that you might have read about in the press in Canada in terms of recent loan losses, our name is not associated with them. And I'm not to say, we're going to have loan losses. That's a cost of goods sold. But we haven't been reaching for business. We're not in the leveraged loan business in the U.S. As a young capital markets executive, I was -- spent some time in New York, cleaning it up in 2001, 2002. When you clean something up, you learn a lot. And we're not in the leveraged loan business today because it's an expensive business to operate. You take a lot of pieces of credit, might be $15 million, $20 million, $30 million, $40 million. But if you've got $40 million of those that goes sideways, it's hard to manage. So we're not in that business. Our balance sheet in the U.S. is about $130 billion in terms of lending assets. And it's basically to the Fortune 500. We like credit quality and if you look at the originations in our GBM business last year, is that 82% of those would have been investment grade.

So in other words, downturn ready means you've simply got [indiscernible]...

It's how we operate day in and day out. It goes back to the divestitures I talked about in terms of reducing operational risk, reducing the number of countries we operate in. I gave you the example of gross impaired loans in the divestitures. So it's looking at our overall business, how do we deliver consistency and predictability for our shareholder. And we look at -- as I said, we look at credit as a cost of goods sold. And we monitor it accordingly. And it's not just credit, it's all the other risks we operate in, whether it's market risk, operational risk, liquidity risk, all those other things are key to our thinking or deployment of capital and how we allocate capital.

So we've heard this term thrown around quite a bit, late cycle behavior is late economic cycle. What are you seeing on the ground with respect -- and commercial growth, in particular, has been very strong. So there's some concern out there that people are competing on pricing on terms that the commercial borrower is getting levered up that maybe holds are higher. Is there anything that you guys are seeing there on that front that we should be concerned about? And then we talk about consumer delinquencies now.

Yes, I'd bring up 2 issues. One is, and again, we're not a participant in it, but you can see that we're, at this point of the cycle, on the leveraged loan market, just keeping an eye on it, is 7 is the new 6. So things are getting stretched for sure in that marketplace. In the commercial market in Canada, some institutions are being a little aggressive in terms of terms, conditions, amortizations, all those things that are important. And in a stressed environment, those things matter. If -- and at some stage, things will soften. So -- and you have to look at incentive plans. Incentive plans in these businesses incent behavior. So if you're looking for asset growth, and the incentive plan is aligned to that, that's what you're going to get. That's not what we do.

And on the consumer side, we've seen some insolvencies rise here in Canada. We know you've had some pretty good credit card growth. So what should we think about on the Canadian side with what we're seeing on the consumer? Is there any concern there?

Well, when I was -- I came into this role, we were #8 in credit cards in Canada. Today, we're #5. And Darko, we've done that in a consistent, thoughtful way. Our risk-adjusted return is fine. And from a credit perspective, we've managed it very well. We acquired the JPMorgan credit card portfolio. But today, 85% of our credit card originations are from our existing clients. So we obviously know their credit. We know their behavior. We know how they act. And they're either super prime or prime clients, and we like that type of business. So again, it gets back to predictability. And we like that in our business. And so I was told when we bought it that we were late cycle, and here we are 5 years later. And we like the credit card business for all the obvious reasons. We like the margin in the business. We like the return in the business. That's where we are in Canada. In Colombia, we're the #1 credit card operation. And we are a strong credit card provider in Chile and Peru, and our performance has been the same. It's been consistent and predictable. So these are sophisticated businesses. You have to know how to use data, you have to know how to use analytics, you have to know how to underwrite. And we spend a lot of time and focus on making sure we've got the right people, we've got the right technology, and we've got the right processes and collections in place. So getting back to your question about insolvencies or bankruptcies rising, you can adjust your collection strategies accordingly. And that's what we've done.

So switching gears a little bit to the capital markets business, there was a -- it was a tough year last year for all players, a lot of change over at Scotia. Maybe you can talk a little bit about the outlook for 2020. And has anything happened that would change your expectations from this business going forward and what you're challenging them with in terms of your targeted returns? Or is it now at a state where we should expect growth?

It's in a good state. And there's a couple of comments here I want to make that are important is that the leadership we have in the business in James Neate and Jake Lawrence, these are individuals that have worked closely with me over the last 5 years. I know them exceedingly well. They understand risk. They understand liquidity. They're focused on our customers, and they're doing a great job. They bring a lot of energy and focus, client focus to the job, and they'll continue to do that within our risk appetite. But all the adjustments we made to ScotiaMcleod and Trade Finance in Asia, those had to be done for risk reasons, and we're through that. And the business will predictably in this type of environment contribute $400 million per quarter. In terms of net income, it might be $390 million one quarter, it might be $420 million the next. But again, that's what we think the business will produce. The other important thing, and we're going to start in 2020 is breaking out our GBM business in LatAm. And we'll talk more about that at our Investor Day, but this is a business that makes roughly $120 million a quarter. It's been growing much faster than our traditional businesses in Canada and the U.S., again, within our risk appetite. And investors, analysts will be able to see the growth potential of that business. But if you look at LatAm, and this would include Brazil, over the last 3 years and being a lead arranger in the loan business, every quarter, we've been either 1, 2 or 3 as a lead arranger. Our DCM profile has gone way up. I think we're #4 or 5, some quarters we're 3, and our ECM profile has gone up. So competition's not quite as intense as it would be in the U.S. or Canada, so it's been a very good business for us and a very good business for our shareholders, and we'll continue to grow.

Is that to say that we should see more balance sheet extension there? And -- or is it not really balance sheet focused into [ Latin America ]?

Well, there's a balance sheet extension you're going to see, but it's investment-grade quality largely in Latin America. And these are existing relationships we have. Our relationships are deep. And I just think you're going to see better growth rates in LatAm than you will in Canada or the U.S.

And you have to grow some teams there? Is there...

Our team is largely in place than it has been. This is, again, goes back to the investment we've made in this business over the course of the last 5 years in terms of people, process and technology is paying off.

Okay. Great. So we'll turn now to the questions that were being asked from the audience, and we'll hit the first one that's been up voted. Yesterday's ACL build comes just 1 month after releasing fiscal '19 audited financial statements. How did your auditors allow this? Why was this not done at IFRS 9 adoption? I'm not sure about the last part of it, but maybe just talk to...

Well, I think that, as I stated, this is something that we've been contemplating for some time on these divestitures. You never know when they're going to close. And a lot of these have taken us a lot of time. We thought some of them would get done in Q3 last year. Q3 turned into Q4, which turned into Q1. But I'd keep in mind the materiality of it, it's 3%. So our allowances are $5.1 billion. On a pretax basis, this is $150 million. Again, I don't want to slide it. It's a lot of money. But we just felt it was prudent to go ahead and do it now and get it out of the way. The marketplace is really concerned about credit, normalization of credit levels. Personally, I didn't feel this was -- I went along with it that I felt that it was -- investors were overly concerned about credit this point of the cycle, we don't see it in our books. But you have to plan for the future. So we felt it was prudent. So we went ahead and did it. But again, it's 3% of our reserves on a pretax basis. So I'd put it in that context.

And then a similar question relates also to the disclosure yesterday, which is that the opaqueness of derivative exposures is always nerve racking for analysts. You just announced the $90 million charge. How does that happen? How can analysts possibly assess this risk ahead of time?

Well, look, it comes with -- I would view this as a refinement of -- I think, another bank did this in Q4. It's been something that we've been working with internally on for some period of time. And we're happy to sit down and go through our derivatives book and how we run our book. Again, it's very conservative, as you would expect. But we just felt it was a refinement and allows us to better manage and stay current with what the new principles are. So I would view this as a onetime event. You're not going to see us on PCL's institute of fifth scenario next year. We think that we've done what we had to do in this, and this is what happens when you change accounting standards. There's going to be refinement as you go here and the same thing in terms of derivative contracts.

Okay. Capital. So we touch on capital. I've got a question here for you, myself on capital. Given that -- I guess you guys have been pretty active on the buyback. We've had the domestics ability buffer raised, possibly raising again next June. So from your standpoint, a, what is the proper level? B, what do you do from here? Do you continue with buybacks in an aggressive manner? Maybe you can just talk about the capital plan for 2020, just generally. And as per the question, any excess dollar that you have, does it go to international business? Does it go to the newly created wealth business? Does it go to Canada? Where does it go from here?

Well, there's different ways for us to deploy capital as everybody in the room knows. We're investing in our businesses, and we're going to continue to invest in all of them to grow our businesses for sure. But in terms of -- we think our stock is inexpensive here, and we're going to buy back stock. We issued 34 million shares to do the Jarislowsky and MD acquisitions. I think to date, we bought 25 million shares back. So we'd like to finish that off. So we're going to be active in terms of our buyback. We don't have any other plans for M&A or capital deployment of that sort right now. So again, if the market provides the opportunity, we'll seize it.

Okay, great. So as I've been doing with every speaker, I throw the floor back to you for some final key messages. I am looking forward to, by the way, go into Chile. So that's changed. And my first time there. But over to you for some key messages that you'd like to leave with shareholders.

Okay. Well, thank you, Darko, and it's been a pleasure to be here. I'd just summarize by saying that the last 2 years have been very active for the bank in terms of acquisitions and divestitures. The dust is settling, and once we get El Salvador closed, but we're -- we've delivered on what we said we'd do. We've simplified the bank. We've improved credit quality, we've lowered operational risk, and we've improved earnings quality. And even Thailand, I'll give you an example, is away from the specials in that -- of income coming out of Thailand is if you look at a 5-year CAGR, the growth rate in net income was around 5% to 6%. So we can do better in our existing portfolio without the geopolitical risk and the risk that comes along with that. So the dust is settling, we're very comfortable with our platform. And we've made some significant investments in people, process and technology over the last 5 years, and you're starting to see the dividend in that. And away from that, in terms of expense management, same thing is that our productivity ratio is 53.1%. That's down 100 basis points in the last 2 years. In the international bank, it's down 3.4, and we continue to see room to do that. So in an environment where revenues are going to be a little harder to come by for some, we'll manage expenses. We'll take our cue from revenues and manage expenses aggressively, and we look forward to 2020.

Okay. All right. Thank you very much.

Thank you, Darko.