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

Great. Good morning. Welcome back, everyone. Our next presentation, we have with us Phil Thomas, Chief Risk Officer. Welcome, Phil.

Thanks, Brian.

You recently reported 3Q results and your impaired PCL ratio came in well below what you had guided to during 2Q's call. Can you remind us what drove that improvement? Why are you cautious about reading too much into that as you look out into Q4?

Sure, Brian. Thank you. And listen, it's a real pleasure to be here today, and thanks for everybody for attending. Maybe before I get into that question, maybe just a few comments. And we had a great quarter last quarter, really proud of how the bank performed. I think you heard on the call, Scott really is starting to shift us towards a growth discussion. And I think that's important to maybe dig into that a little bit. And if you look at our Canadian retail business, there's a tremendous opportunity to continue to enhance and expand that business. Today, we have about 30% of our retail customers that we would consider primary. And primacy for us right now, we're trying to get back to basics, focusing on banking 101 and really trying to deepen relationships with existing clients, and we see that as a huge opportunity. And if I double-click on that, look at specific segments that we're focused on credit cards, Scotiabank is underweight on credit cards compared to peers, small business, mid-market commercial. These are all businesses and segments that we could generate more net interest margin to really improve the profitability of that business. And from a risk perspective, we've significantly invested in the area over the last 12, 24 months. We've brought in new talent, introduced new technology, enhanced our collections capabilities. Really, really focus on a model enhancement as well. And so we feel from a risk perspective, we're in a really great place to support that level of growth. And then lastly, maybe a couple of comments on international, an area of the bank I know quite well. I spent a good part of my career in that business on the business side. And the focus right now is on top -- 3 top-tier segments. So we're very focused on affluent, emerging affluent and the very top of the mass segment. And that's gone very well. There's been a big shift towards that primary customer focus in that business. And again, from a risk perspective, very much involved with Francisco and his team to try to drive that opportunity to build that business over the coming years. Now going back to Q3 to your question. Yes, it was -- I was very pleased with the results, particularly on the impaired side this quarter. If -- maybe tell you how I think -- if I think about international, we had -- I would probably describe the quarter as stable. And we've seen that business performing well from an impaired PCL perspective quarter-over-quarter, we've seen marginal improvements. And I like where we are right now with that business. If I think about the nonretail business, we were down about $14 million quarter-over-quarter. It is a lumpy business. As you know, you have 1 or 2 credits that could potentially throw things off. I'm very focused on the Canadian commercial business right now, just given the uncertainties around trade. And I would say there's nothing in that business that particularly worries me. There's no systemic issue. There's a few files that management is just digesting the new reality of this sort of the tariff headwinds that they're facing. And then maybe turning to Canadian retail. Lastly, that is where we saw the largest improvement on impaired PCLs in the quarter. And that was primarily driven by 2 portfolios. Although every portfolio was either flat to improved on the impaired side this quarter but our auto book, we saw significant improvements in impaired, and that was mainly driven by pardon the pun, by the cohorts that were originated in 2022, 2023 at the tail end of the pandemic when you had a lot of -- not a lot of used cars, people buying -- or sorry, not a lot of new cars, people buying used vehicles. And that portfolio is aging and we should see that migrating out of our portfolio -- good lines of credit. We're also quite down this quarter. But so were credit cards, mortgages, mortgage delinquency was essentially flat quarter-over-quarter. We did see some uptick in variable rate -- or sorry, in fixed rate and a big improvement in variable rate. But I would say, Brian, generally, if I look back at the quarter, very happy with the -- how impaired PCLs have been trending.

And then maybe looking beyond Q4, how do you think impaired PCL ratio is likely to evolve from here? Have we seen the peak? And if so, should we expect a slow decline from here? And what are the factors at play in this assessment?

Yes. Listen, it's -- there's so much uncertainty right now in the macro. We had an unemployment print at 7.1 this past week, which obviously, that has an impact to the consumer. If you dig into that unemployment number, it's actually quite interesting. If you look first geographically, you're seeing Ontario, which is where we have our largest customer base, quite flat in terms of unemployment. You have the Western BC and Alberta that are up slightly. Atlantic Canada, which is flat to down, Quebec, which is improving. And so if you look at where we have our biggest market shares in Ontario, Atlantic Canada, and where we have opportunity to grow is probably in the western part of the country. That will have some impact, but it will be balanced and managed. And so you take all these different factors that are coming at us. The other, I would say, on unemployment, the other area of watch is young Canadians are tending to be more impacted through this. I think the segment is between 15 and 24. And you're seeing some of that in our portfolio as well. As I mentioned on the call, it's usually young Canadians that we're seeing that are having some stress. Now for us, that's not a significant part of our portfolio. It's less than 1% or 2% of the portfolio. So it's not a significant worry, but it's a watch and a bellwether for what's going on in the economy. So as I look into Q4, you have all these variables that are happening. I like the impaired PCLs are trending, but we have all of this macroeconomic uncertainty. And so I would say we'll give guidance on the Q4 call. But if impaired were plus or minus or up a little bit, I think that would probably be a good outcome still.

And then maybe what is the current state of the Canadian consumer? It appears that things are looking better versus Q2, but the labor market is still challenged and trade uncertainty has not gone away. What are spending trends telling you right now?

Yes, it's a good question. I think the general pulse, there's still -- people are still trying to digest what's going on with the trade uncertainty. And whether you're speaking to large corporate clients, commercial clients or just the average Canadian that's looking at buying a mortgage. And they're not sure given the impact of trade uncertainty, what's going to happen. I will say there's positive signs in the market. We are really encouraged by what the Carney government is doing and how they're bringing large infrastructure projects to bear. I think defense spending, increase in defense spending will add a shot in the arm for the Canadian economy as well. And so we view these things as very positive. Lots of still constructive discussions about interprovincial trade barriers. And so there's a lot going on, and there's very much a pent-up demand to deploy capital into the market, and we're very encouraged by that. In terms of spend patterns, we -- for this quarter, we actually saw discretionary spending increase for the first time since Liberation Day, and I think that's also positive. However, we're seeing certain things that we see more Canadians spending more money at home, less travel into the U.S. We see border communities in the U.S. that normally we would see spending in our consumers. That's not happening as much. And so I think the sooner we can get some stability around the trade situation and the better it is for both the U.S. and the Canadian economies.

Great. And then focusing in on Canada. The Canadian housing market has been very resilient for a very long time. But it does feel like prices are under more pressure than they have been in a long time as well, especially in the condo market. Can you give us an update on the state of the market right now?

Yes. I mean I think, again, we're mindful and it's an area that we monitor and watch very carefully as well. The Canadian mortgage market is very resilient, and it's a cornerstone of how the Canadian economy operates. I would say from a condo perspective, at least as it relates to Scotiabank, we don't have a great exposure. We've been very purposeful on the developer side how we've been lending into that business. So we've been very focused over the last 5 years on Tier 1 developers in Tier 1 cities. We're not seeing a lot of customers walking away from condos, which I think is fairly consistent with what's happening within the industry. And so as we look at the market, we'll continue to be guided. We're doing our ongoing stress tests. And frankly, it's not -- it wouldn't be in the biggest area of concern for me right now.

It doesn't sound like you or any of your peers are particularly worried about the impact of housing on credit performance. Why is that? And despite that, what areas of the market are you most concerned about?

I would say, even with this new unemployment number coming out, there's -- I think the market is priced in about an 80% probability that interest rates will continue to go down, and that's credit positive as we look at repayment rates in the mortgage business. I think right now, the average payment increase from point of origination to current payment is about $200. And so that's -- we view that as manageable. Next year, that number goes down to about $130. Now these are averages. And so obviously, you could have a number at the higher end or the lower end of that. But we view that on average to be quite manageable. And I think my peers would probably agree with that. Sorry, what was the second part of your question, Brian?

Just what areas of the markets are you most concerned about?

I mentioned Canadian commercial right now. But I think again, I'm worried -- I'm not -- I wouldn't say I'm worried about it. I would say, I am -- we're watching it very carefully because it's not a systemic issue. Again, it's certain businesses just digesting the uncertainty as it relates to trade. And so we're working with our customers as we always do during periods of stress. But as I said, I'm encouraged by the infrastructure projects that Canadian government is pushing. I am encouraged by the opportunities that we have in the defense sector. And I think that, as I said, there's a pent-up demand to deploy capital. So I still hold myself cautiously optimistic that we'll get through this period in really good shape as a country.

All right. Given the move down in rates, investors seem to be less concerned about payment shocks in the big mortgage renewal years of 2026 and 2027. But can you give us an update on what kind of shock your customers are likely to experience? Can you talk about the tail risk here?

Yes. So as I mentioned before, that's that $200 per payment. That's what that shock is right now. And so if you think about it, maybe that's you go out to dinner with somebody, you're spending that much money. So maybe it's -- we're seeing -- it's those type of choices that people have to make in their day-to-day to be able to afford that. And as I said, into 2026, that number declines down to about $130 per monthly payment. And so again, quite manageable. If I think about tail risk, it's still below 1%. And so again, still quite manageable.

All right. Maybe taking a deeper dive into your International Banking segment. The impaired PCL ratio there was 129 basis points in 3Q, down from 131 in 2Q and 146 in 3Q of 2024. What has driven that improvement? And how sustainable is that?

Yes. A number of things have driven the improvement. As I've mentioned in my opening remarks, this push towards primacy is very helpful. And you do see when you have the primary relationship with the customer, there's more -- there's a higher propensity for repayment. And so we like that from a risk perspective. Within that number also is the sale of CrediScotia, which is a microfinance business that we had in Peru. So that's contributing to that number as well. But I think primarily, what I like about what I'm seeing in International is that shift -- is the strategy shift away from that mass market lower-end growth to that affluent -- emerging affluent and top of mass. And that's really the space that Scotiabank wants to play in, in these markets moving forward.

All right. Despite the decline in the impaired PCL ratio in your IB segment, we can clearly see delinquencies rising in mortgages. Is that all in Mexico? And can you help us understand what's going on in that portfolio?

Yes, that's a great question. And that is really -- it's similar to some of the comments I made about Canadian auto. That is the write-off policy in Mexico is a 5-year write-off policy. And so that is just us aging through mortgages that were deferred through the pandemic. So again, it's just working through and seasoning of that portfolio. That's the only issue that's driving that number.

All right. In Q3, we saw GIL formations rise in both Canadian and international commercial. Starting with the Canadian commercial, what is driving that?

Yes. I mean as I mentioned, we're seeing some stress in that Canadian commercial portfolio. But it's important to note that increases in GILs don't lead to a 1:1 increase in impaired PCLs. And most of the lending that we do, we're very focused on having strong collateral. And so again, it's just us working through difficult times with the customers. And it's similar if you look at in Chile, as an example, where we had stress in the commercial real estate portfolio in that market. We are in a process right now of working with our customers trying to finish the projects that they have ongoing in order for us to be able to -- or for them and us to be able to sell out and to get out of those loans. Now in Chile, you see there's a demand for housing that market is really starting to come back. And so as I said, we're working with developers to finish the projects, and so that those GILs will not result in losses. And as I've said publicly, but we're not going to lose any money in these businesses in Chile.

All right. So you're not -- it doesn't sound like you're very concerned about.

No. And if I go back to Mexico again, and just in the commercial space, I actually view that as an opportunity. We've spent a lot of time with the business team and the risk teams trying to figure out what is the right spot that we want to play in, in that business in Mexico. We've invested in both talent and in tools and technology and controls in that business to really restart how we think about acquiring customers in Mexico commercial. As I said -- as Scott has said and others, our portfolio -- our strategy rather, is really focused around this North American corridor, so Canada, U.S. and Mexico, and we want to be a player in that space in Mexico, and we see an opportunity to do that.

So -- and I say in overall, then why don't you expect this to lead to elevated impaired PCLs going forward?

Yes. So as I said, strong collateral. We -- Scotiabank tends to be a more conservative lender. And so while there's some stress in these portfolios, we're not expecting them to lead to losses for the reasons I stated earlier.

On the call, you talked about younger demographics facing challenges. How big is your exposure to this particularly hard hit cohort?

Yes. I think I mentioned earlier, it's less than 1% or 2%. And so I mean, we're not a big credit card player. As you know, as I said earlier, I think it's a big opportunity for this bank to go deeper into credit cards. And usually with younger -- that younger demographic, it's usually an unsecured line of credit or a credit card. I said it's 1% to 2%. So it's not a significant portion of our portfolio. But I think if you -- again, you look at what -- where unemployment rates are headed in the country, that data, it's easy to understand where -- that's where the stress is coming in the economy.

On credit card, do you think there's much difference between the dynamics in the card market in Canada versus the U.S.? When you look at U.S., I mean that's not a little bit credit focused, but a lot of the cards are driven by rewards programs. If you think about -- as you look at your risk in cards, are there areas that you think that where you're going to like maybe take market share that way?

Yes. It's a wonderful question. Thank you for it. We have this fantastic asset called Scene+ in Canada. And we have this wonderful partnerships with travel, with groceries through the Empire brand with Cineplex and movies and others. And there's right now, 15-plus million people in this loyalty program. And we haven't yet penetrated that to a great extent. And so I do think from a credit card perspective, as we look at expanding the credit card portfolio, it will first happen with our own customers. As I mentioned, we only have 30% primacy with our current customer base. And so there's an opportunity to go deeper with those customers by leveraging Scene+. It's a fantastic loyalty program. I think it's very difficult for anyone on the street to compete with that. And we need to do a better job in talking about it and marketing it and then really deepening that with our customers. It's a great asset that we have yet to fully exploit.

All right. And then have you done any stress testing on this scenario where like the U.S., Mexico and Canada agreement is not renewed? What would the impacts be? Have you done the exposure to tariff exposed industry?

We sure have. That's definitely been a big focus for us over the last 2 or 3 quarters. And so obviously, we do the macro stress tests. And then we've also been through portfolio by portfolio and then customer by customer to see the impact. And so for us, on the corporate or nonretail side, corporate and commercial side of the business that really equates to about 8% or 9%. And so probably very similar across the Canadian peer groups, but that would be what we would consider potential tariff-impacted industries. And again, if you look at -- as I start to look at customer by customer, and we've been doing this on quite a consistent basis, you have -- many of our customers, even those that are impacted by tariffs are well capitalized, lots of liquidity and strong collateral. So we're -- I think we're -- obviously, there's going to be potential headwinds coming up. But as I said before, I'm cautiously optimistic.

Talking about the USMCA agreement, even though it doesn't -- it renews in July, you're going to start seeing like U.S. trade representative has to file with -- in the CFR and make a review, I think, by the end of the year or starting in October this process. Do you think that could be like a catalyst of in terms of improved reduction of the uncertainty around trade?

I hope so. I mean I hope that whether it's the Sheinbaum, the Carney and the Trump administration can really come up with a solid plan for USMCA moving forward because I think it's far none probably one of the best trade arrangements globally. And again, I'm really encouraged by the meetings that we've had with the Carney government or recently with the Sheinbaum government administration. And I think there's a willingness to work bilaterally and trilaterally with. And I think as someone who's had the opportunity to work in each one of these markets, I think there's -- it's a huge opportunity for us to be a powerhouse as a trading block. And Scotiabank's so uniquely positioned because we're the only bank that operates in Mexico, the U.S. and Canada and to be able to -- it's a great opportunity for us to be able to leverage that platform, especially for our corporate and commercial clients that want to have that multilateral trade arrangements across geographies.

Speaking of the Scotiabank's North American corridor strategy, it's been about a year since the investment in Key. And one of the things we talked a lot about is like partnerships with Key. Can you talk about how -- like from your perspective as a Chief Risk Officer, aligning kind of risk visions, culture and strategies of that partnership with Key?

I think Key is a great bank. And I was involved in the due diligence when we're looking at partnering with Key, and I was very impressed with how they think about risk. And in fact, the Chief Risk Officer was up visiting us in Toronto a few weeks ago, and he and I had a wonderful discussion. We had a bit of a roundtable with his direct reports and my direct reports. Just talking about the economic outlook, the regulatory outlook. And there's a lot of great thinking. And one of the things I loved about Key when we were first talking with them is just the cultural fit between BNS and Key. And certainly, from a risk perspective, very similar thinking about how to take risk, where we want to take risk. And so again, I think it's -- I think Key is a tremendous business, and I think we're really lucky to have that partnership with them.

Great. Before we open up to the audience, is there any other areas that you'd like to mention or talk about?

Again, I think I go back to some of my earlier comments about the Canadian bank. And I really think that the retail business there, there's a couple of tremendous assets that we have to be able to exploit. And I mentioned Scene+. And certainly, from a risk perspective, we're very much getting geared up to support credit card growth, small business and mid-market commercial. And we think that getting the basics right is important in that business, really focused on the proper credit landscape, the proper credit lens, but really working with the bankers to be able to grow that in a really profitable and healthy way. And so that's going to be a large part of my and my team's focus as we look forward into 2026.

Great. I open up any questions in the audience? Very quiet. I pretty much covered it. Thank you very much, Phil, everyone. Please join me in thanking Phil for his presentation.