Canada’s banks are attracting considerable negative publicity because of a recent report from the Bank of International Settlements that Canada is one nation that is most at risk of a banking crisis. Much of the negative sentiment being expressed over the health of Canada’s financial system is centered on high levels of household debt and concerns that housing prices remain frothy despite cooling in recent months. That has seen the major banks roughly handled by the market in recent months. Bank of Nova Scotia (TSX: BNS)(NYSE: BNS) is down by almost 2% over the last three months.
Now what?
There are signs, however, that the bank could avoid much of the fallout from any financial crisis and is positioned to grow solidly, easily outperforming the S&P/TSX Composite Index.
Bank of Nova Scotia has a long history of beating the market, delivering a return of 90%, including dividends, over the years compared to 21% for the index.
There is every sign that Bank of Nova Scotia will continue to outperform the broader market.
This can in part be attributed to the bank’s strategy of investing in expanding its operations in Latin America, which now sees it generating almost a third of its net income in the region. Many nations in Latin America have seen their economies return to growth because of firmer oil and metals prices. Chile’s economy, where Bank of Nova Scotia has been investing heavily in recent years to boost its franchise, is expected to expand by 3% during 2018 and the same again in 2019.
Meanwhile, Colombia — the bank recently announced that it intends to acquire Citibank’s consumer and small-business banking businesses there — should see its gross domestic product also grow by 3% this year and in the next.
As those economies return to growth, business confidence will rise, and consumption will firm, causing demand for credit to grow. It should also drive improved credit quality as employment and income rises.
That will cause Bank of Nova Scotia’s net interest income to grow and the value of provisions for credit losses to fall, thereby reducing the cost of credit and boosting margins, which will all work together to drive a firmer bottom line. Higher growth in the region will also cause interest rates to rise, further boosting the bank’s net interest margin (NIM) for international banking, which, at 4.66%, is almost double its domestic NIM.
Domestically, the bank is also focused on making further acquisitions and continuing to diversify into wealth management. During the first quarter 2018, Bank of Nova Scotia announced the acquisition of Jarislowsky, Fraser Limited, which, in conjunction with its existing asset management business, will create the third-largest active asset manager in Canada.
That deal will go a long way to aligning Bank of Nova Scotia’s asset management business with institutional investors, boosting that segment to 31% of the value of assets under management. Wealth management is highly profitable business in which to operate, so this deal should give the bank’s bottom line a healthy bump while reducing its reliance on mortgages and consumer credit as growth drivers.
Importantly, Bank of Nova Scotia’s credit quality remains high.
For the first quarter, the value of gross impaired loans fell by $200 million year over year to $5 billion. This trend will continue as the economy picks up.
It is also important to note that 42% of its Canadian mortgages are insured; along with a loan-to-valuation ratio of 53% for uninsured mortgages, this provides a solid safety net for Bank of Nova Scotia should Canadian households become financially stressed.
So what?
Bank of Nova Scotia is an attractive addition to any portfolio. The bank is positioned to perform well, as the global economic upswing continues. Much of the risk associated with its lending activities is mitigated by high credit quality, mortgage insurance, and a low loan-to-valuation ratio for uninsured mortgages. It is easy to see Bank of Nova Scotia performing strongly and outperforming the market, especially when its juicy 4% dividend yield and long history of dividend hikes is taken into account.
