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

Okay. So why don't we start right away because we're trying to keep -- kind of keep on time here. So thanks, Scott, for joining me this morning. Before we begin -- and I should have said this with Royal, but this does apply for the entire conference. Scott, your comments today may include forward-looking statements. Actual results could differ materially from forecast, projections or conditions and statements -- conclusions in these statements. Listeners can find additional details in the public filings of Scotiabank and Royal. So with that out of the way, Scott, thanks again for joining us today. You took over as President at Scotiabank on December 1. You've been on the board for 6 years, and we know there's still about a month or so before you're officially the CEO. You are known to a lot of investors that are in this room. You've had time at BCE, Talisman and Finning, of course. But why don't we take this opportunity -- because this is actually only the second time I've ever seen, Scott. So why don't you take this opportunity here to maybe let us get to know you a bit better, and maybe focus on your experiences and sort of how it's shaped you and prepared you for this new role?

Great. Thanks, Darko, and welcome, everyone. And I feel very honored and privileged to be here today and humbled to be -- ability to step into this role and build on the great work that Brian has done and the legacy that he's left. So I look forward to working with all of you going forward. As you mentioned, Darko, I've varied experience that across a large number of industries. And I think there's 2 themes across those experiences set, and one is the ability to step into complex organizations at a senior level and build teams, lead teams, motivate teams with success. So that would be one theme. The second theme across those experiences would be customer. As you think about my financial industry's experience, learn the importance of relationships, importance of advice. And then most recently, in a customer-facing organization with Finning, we spent a lot of time on that -- over that 9 years, thinking about the customer, developing solutions and insights for that customer to get obviously a great outcome for the customer, but also a great outcome for the company and for the shareholders. And then lastly, from a customer lens, I've also been a customer. So I have a good sense of what my expectations are from a customer perspective. Why do I think, I am the right person for this job at the right time. I guess a couple of things. One is, I've got a track record of success, leading teams, building, retaining, developing, attracting talent in a collaborative fashion and an inclusive fashion to deliver a great outcome. Two, capital allocation. It's been a forefront of how I think about running businesses, and I think we have an opportunity here from a capital allocation perspective to really make a difference. Three would be operational excellence. We've seen the power of operational excellence around execution and building good businesses and seeing the returns that come with building those businesses. And then lastly, I've been a CEO of a global organization with an emphasis in Latin America and obviously, not only through my Finning experience, but also the Talisman experience. I've been in these markets for 15 years, and I know them well.

Okay. That's a lot for me to work with. You've been there for a month. What have you seen?

So I guess, first, the -- it's been a little bit more than a month. So the announcement was in September, and I've spent a lot of time around the bank since then. So the focus has primarily been internal and primarily been with employees. And what I would say is, I've been really impressed with the passion, the enthusiasm and the openness with which the employee base, 90,000 Scotiabankers, have accepted me. So that would be the first and foremost. Two, I think there is a lot of competitive strengths with this platform, and Brian deserves a lot of credit for it, but the strengthening of the earnings quality across the platform has been very successful. The strengthening of the core, the functions that allow the business to be successful has been a real achievement. Addressing the technology deficit has been an achievement as well, and places us well for success going forward. And then I do believe we're a leader in ESG, and I think that will become increasingly important going forward. So I think there's a lot of checks along the way that Brian should be really pleased with. As I look at 2 areas or I guess 3 areas that I'm digging into, and I think there's opportunities for. 1 is on this deposit and funding franchise, and I do think we have an opportunity -- our loan-to-deposit ratio is high. We have an opportunity to continue to build out the deposit franchise for this business, and I think that helps from 2 perspectives. One, obviously, funding less reliant on high-cost wholesale funding. And that helps in the short term, obviously, but I think if you take a longer-term North Star view, that importance of the deposit, the importance of that customer relationship is extremely important as you move from a product orientation to a relationship orientation. So that would be one first impression. The second first impression will be around business mix, and business mix would be both at the enterprise level in terms of geographies and then within the business lines. So from an enterprise perspective, we spent a lot of -- deployed a lot of capital into the international markets over the last 10 years and that the returns on that capital have not been commensurate with the risk that we've taken. And there's a lot of reasons for that, and we'll come back, and I know you're going to want to talk about the international business. A lot of geopolitical reasons, a lot of macro reasons, a lot of execution reasons, but that's something that we need to be really thoughtful about going forward. And then within the business lines, I think there's a business mix opportunity as well. I think we've -- we're evolving from a product to a customer orientation. So we've got a heavy emphasis, for example, in our Canadian business on mortgages and autos relative to our peers. And then even in the corporate business, a heavy orientation to loans rather than ancillary businesses. So as I think forward, the great opportunity here is the team that's around me gets it. As I think about what Dan Rees is doing in Canada, and he's been in that role now for 2 years, building out the scene platform, which thinks about getting a more holistic relationship with the customer, thinking about cross-sell, wealth and our Canadian core franchise, thinking about the under penetration we have in commercial and small business which comes with great deposits. And then also thinking about the under penetration we have in Quebec and B.C. That's all leading us to a better business mix outcome with a less focus on the product and more focus on the customer. Similarly, as I think about Jake and what he's doing in the GBM business, we're making great progress, not just leading with the loan, but also tying up that ancillary revenue around that loan. So moving less from the product and more to the customer focus. Now those evolutions were early in stage, right? I mean both of those leaders, as an example, have been in the roles for 2 years. So we're early in that evolution, and there's a lot more to go. But the great thing is the team is on it and understands the opportunity.

Okay. More stuff to work with there. Thank you for that answer. In your previous answer, you mentioned that one of the things -- one of your strengths is really about capital allocation. And here we are today, in a world where the regulator has increased the domestic stability buffer, widened the range. When I look at Scotiabank, your capital ratio, relative to the other companies that I cover, is on the low end. So maybe a 3-part question. First, as I think about it, at 11.5%, how do you see your capital evolve -- maybe what Dave McKay gave us is a bit of a waterfall. I'm not necessarily saying -- pinning you to a waterfall, but how do you see it sort of evolving this year? Are you at risk of potentially raising equity? And what levers are available to you to prevent an equity raise?

So obviously, capital is very important topic of the day. And as I think about our capital and how I want to run this business, optionality is important, right? You don't want to have enough buffer so that you can execute on not only organic, but if anything outside of the organic came off, you'd be able to have that optionality. And that's not going to be the focus necessarily, but it is -- trying to give you a sense that I do believe optionality on capital is important. We ended the year at 11.5%, and as I look forward, we're going to build to 12% by the end of the year. And we feel comfortable that we're going to get there through a combination of slowing RWA growth, internal capital generation, and then we have the same Basel reform benefit that all the other financial institutions, I assume, will have into the second quarter, and that's going to be meaningful. So we feel very comfortable on internally getting to that 12% type level by the end of the year. So I don't see the need to issue equity. And as I think right now, there's 2 banks out there that don't have a DRIP in place. We're one of them. From what I see today, we don't -- that's always available to us, but that's not a tool that we need to use right now from what I see today. So I mean, Darko, I feel pretty comfortable of getting that 12-type percent level by the end of the year, and I think that's appropriate for the environment that we find ourselves in.

What if the regulatory increases the DSP all the way up to 4?

Yes. So then you start to think about higher buffers and whether you need a higher buffer or a lower buffer. My expectation is, that will take some time, but that will result in getting to that kind of 12-plus range, which I feel comfortable in us getting to. I also share the view that Dave had highlighted before is that if you are in a scenario where we have a recession that's a little bit more problematic, then I think we're all forecasting right now. And I think what you hear from Peter today at lunch is that he'll be open to actually reducing the capital requirements because that's actually makes sense, right, in terms of how you want to run the economy. So the 12%, slightly higher is the right place to be from our perspective, and that's what we're going to shoot for by the end of the year.

And then so maybe just switching from capital to credit, but sort of building on it, I guess, in that way. I mean one of the things that we can worry about is, what if there's a mistake along the way? What if credit costs spike on you? How do you think about the balance sheet? And similar for me, when I look at Scotiabank's reserves, your Stage 2 -- Stage 1 and 2 performing allowances, they look about the same to pre-pandemic. So it doesn't look as though the balance sheet is actually positioned for a worse environment. Maybe you can talk a little bit about some of these...

Yes. Actually I should have mentioned this in my opening impressions. I've sat on the Risk Management Committee of the Board. I have watched Brian managed the company over the last 9 years through a risk lens. And now in the guts of the business, that's been one of the areas I've gone to first, given some of the risks on the horizon and the credit quality of this bank is strong, full stop. And I think it's a great credit to Brian on what have run this bank, but we do have great credit quality. If you think about the Canadian book, 95% of the book is secured. If you think about the international book, we had some challenges in the unsecured international portion through COVID and that has been adjusted. And so the security of that book has now gone up 70%, 72%, 73%. A lot of the dispositions along the way have been Brian's view of derisking that area of the bank. And as you look at the corporate side and the PD bands where we play, we play at a very high corporate investment-grade credit. So I do think the credit quality of the bank is strong. Now that being said, there's different views on where we're heading from a recessionary perspective. And we're going to be very thoughtful about our pessimistic scenario, the options and the emphasis that we put into that. I think what you'll see is -- or what the guidance was, was kind of mid-30s PCLs for next year. That seems to make sense, a normalization of the PCLs, and probably, more emphasis on performing as opposed to non-performing loans. So that's the type of framework that we're thinking about for next year, Darko.

And so...

And by the way, ACLs have gone up as you think relative to pre-pandemic to where we are today, ACLs have gone up. So I think there's been a business mix issue less secured to more secured plus an ACL build, which gives us comfortable about our provisions.

So what about the vulnerabilities that are facing I mean the Canadian consumer, your mortgage book, how should we think about that if we enter a recessionary scenario, what comfort can you give us that your mortgage book is well positioned?

It was interesting because I listen to days, I mean I would share the same view on that Dave has around the vulnerability of the consumer. I mean, right now, we have a lot of liquidity in the system with our consumers. 40% of our book is variable, and I think they have about 30% more deposits than they did going into the pandemic, and as you know, our variable book resets. So unlike the deferred or amortization of some of our peers, ours is continually resetting, which I think is helpful to continue along the journey with your customers. And then 60% of our book is fixed with 8% renewing in next year and another 8% in 2024. So we're really looking at the 2025 issue where a lot of our customers see the impact of that. We also look at the vulnerable customers. So those customers that have higher LTV, lower FICO, lower deposits in their checking accounts and then also house prices that are seem vulnerable, and we have about 20,000 of those. So as you think about the tail risk, we have about 20,000 vulnerable customers, which would be 2.5%. So I think Dave mentioned low single digits, we'd be about the same, 2.5% of our mortgage book would be vulnerable. And so that is a manageable type situation for us on mortgages. I think the first place this is going to go, if it does go, is areas like credit cards, right? And that is -- again, we're not seeing signs of that yet. We're seeing actually people not reduce their -- or sorry, not build their revolver level. They're actually starting to reduce it. So you could argue that, that's a kind of a leading indicator. But again, from a Bank of Nova Scotia perspective, we're underweight in credit cards. So for us, I think that's a competitive advantage if you are looking at it solely through a credit lens. And then lastly, on the auto book. You're starting to see used prices come down a bit in the U.S. I think that's a precursor of potentially being very careful about used, and we have a very small $3 billion near prime book that we're watching very closely. So that's the areas that I think you're going to see it first before the mortgages.

And so when I sit back and I think about 2023 for Scotiabank, we've got a situation where PCLs are normalizing. Earnings per share is declining. And part of that is also a non-expansion of the NIM. So maybe we can talk a little bit about, a, where you see if there's any potential areas where net interest margin, net interest income can grow your current positioning on net interest income and think about -- is it just simply in the cars that you're going to have negative EPS growth this year just because PCLs are normalizing? Or is there somewhere something that will help offset and at least create some EPS growth this year? And can it be through the net interest margin or net interest income line item?

Yes. So when I think of 2022, we benefited from abnormally low PCLs, and we benefited from a very low IB, International Banking, tax rate. And we benefited from strong loan growth. So as we think about 2023, you're going to see a normalization on all of those accounts. So higher taxes, higher PCLs and slowing loan growth as well. You're going to see the full year impact of inflation come through in 2023, which we had part of that in 2022. And then I look at the NIM commentary that you've highlighted. We are -- as I've mentioned, we're very dependent on wholesale funding. The cost of that funding has increased significantly, and so that is also going to be a headwind in 2023. So as I think about 2023 earnings, I am very cautious on the outlook for 2023. As I think a little bit longer term into when rates stabilize and I think that's an important kind of pivot rate stabilization, I think we look relatively better in that environment. So the combination of rate stabilization with asset repricing, which starts to accelerate in the back half of 2023 and 2024, then I do think we get into a better situation. But 2023, I'm cautious until those rates stabilize from an earnings perspective.

What if rates fall.