Just How Disappointing Were Bank of Nova Scotia’s Recent Results?

It is bank-reporting season once again, and Canada’s most international bank, Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) reported some disappointing results this week. Both lower economic growth and the protracted slump in crude weighed heavily on its results.

However, these somewhat disappointing results do not change the positive long-term outlook for the bank. It has some of the best growth prospects among Canada’s major banks.

Now what?

For the second quarter 2016, net income fell by almost 12% compared with the same period in 2015, and a key measure of profitability–its return on equity–slumped to 12.1%, or 3% lower than it was a year earlier.  This can be attributed to an after-tax restructuring charge of $278 million and growing loan loss provisions triggered primarily by sharply weak oil prices.

You see, Bank of Nova Scotia has the largest direct exposure to the beleaguered energy patch of all the major banks, with its drawn and undrawn commitments totaling almost $28 billion.

As a result, the bank had to boost its provisions for bad loans by a massive 68% year over year to $752 million, and the bad news doesn’t stop there.

There are also growing concerns among analysts over whether or not this amount will be sufficient to cover the bank’s losses caused by the ongoing slump in crude; it’s estimated that up to a third of all oil companies globally could file for bankruptcy in 2016.

Nevertheless, despite the somewhat pessimistic results, the bank’s core operations continued to perform well.

Canadian Banking, which is responsible for generating over 60% of Bank of Nova Scotia’s net income, reported a solid 18% increase in net income year over year. This is particularly impressive when it is considered just how adversely the oil slump has affected domestic economic growth; it’s estimated by the Bank of Canada that Canada’s GDP will only expand by 1.7% in 2016.

More importantly, Bank of Nova Scotia’s key growth engine, International Banking continued to perform well. Its net income shot up by a remarkable 12% year over year, primarily because of strong deposit and loan growth in its primary market of Latin America.

Meanwhile, the value of impaired loans in International Banking fell by almost 3% for the same period, highlighting that Bank of Nova Scotia’s proactive approach to managing credit risk continues to deliver results.

In fact, the ratio of impaired loans to total loans only comes to 1%, which is well within acceptable limits and considerably lower than many of Bank of Nova Scotia’s global peers.

Furthermore, its total direct exposure to crude, including drawn and undrawn loans, only amounts to 6% of the total value of its loan portfolio. With over 50% of those loans rated as investment grade and Bank of Nova Scotia proactively monitoring their status, it is highly unlikely that there will be a considerable volume of defaults.

So what?

On the surface, the results don’t appear to be that impressive as lower economic growth and the bank’s considerable exposure to crude are of considerable concern.

Regardless, the value of impaired loans compared to total loans remains low, and the bank has taken a conservative approach to managing risk; it set aside more provisions than what may be required. This means that as the economic picture improves and oil prices eventually bounce back, those provisions can be released, helping to boost its bottom line.

Moreover, its core operations are performing well and, as a result, once there is an uptick in economic growth and oil finally rebounds, I expect to see Bank of Nova Scotia’s performance improve considerably.

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Fool contributor Matt Smith has no position in any stocks mentioned.

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