Canada’s banks experienced a lacklustre year in 2019 with an uncertain economic outlook and cooler housing market weighing upon their performance. Among the worst performers was Bank of Nova Scotia (TSX:BNS)(NYSE:BNS), which ended 2019 up by a mere 8%. Only Canadian Imperial Bank of Commerce performed worse.
There are many reasons for Scotiabank’s inability to deliver value for shareholders, including the impact of rising geopolitical risk in Latin America as well as a softer housing market and economic outlook for Canada. It is feared that 2020 will be another difficult year for the bank, which missed analyst earnings estimates for the first two quarters of 2019.
Improving outlook in Latin America
Scotiabank has become Canada’s most international bank, having established a considerable presence in Latin America and the Pacific Alliance nations of Mexico, Colombia, Peru, and Chile. For the bank’s fourth-quarter 2019 results, combined revenue from the Pacific Alliance nations soared by 9% year over year while net income grew by 5% on the back of solid loan and deposit growth.
A key issue the bank is facing is the unexpected outbreak of civil unrest in Latin America, notably in Colombia and Chile where it is the fifth- and third-largest privately owned bank, respectively. Toward the end of 2019, Colombia and Chile were convulsed by protests and national stoppages, and it was feared these would impact economic growth in the Latin American nations. While the civil unrest appears to have dissipated it still poses a threat to growth in two of the region’s strongest economies, which have been responsible for driving most of Scotiabank’s international growth.
Nonetheless, the political climate and unrest in both Latin American nations appears to be easing. That, combined with a range of other factors including signs of renewed economic growth, bodes well for the performance of Scotiabank’s international operations in 2020.
Colombia’s third-quarter 2019 GDP expanded by 3.3%, significantly exceeding expectations, and was the country’s highest rate of growth since 2015. That was primarily the result of a marked increase in domestic consumption and greater business confidence. This has triggered a notable rally in the local stock market to see the COLCAP index up by around 25% over the last year and poised for further gains.
Increased business and consumer confidence, which should lead to greater demand for credit and other financial products, has seen many Colombian financial stocks soar as investors price in a more positive outlook. Banking conglomerate Grupo AVAL and the Andean nation’s largest bank, Bancolombia, rallied even higher to be up by 50% and 45% respectively. This bodes well for Scotiabank’s performance in Colombia.
There is a similar trend occurring across much of South America, with Chile’s GDP expected to grow by 2.5% and Peru’s by 2.6%, which will further boost the bank’s regional earnings.
Hotter Canadian housing
It is also anticipated that Canada’s housing market will heat up during 2020, leading to greater mortgage demand, which will act as an important growth driver for Scotiabank and the other big five. That, along with an improving economic outlook, will spark greater domestic demand for credit and other financial products, further bolstering bank revenues.
Scotiabank’s push to digitize its operations and drive greater operational efficiencies will boost profitability. These plans have been responsible for the bank’s steadily improving productivity ratio, which for the fourth quarter of 2019 had fallen by 0.5% year over year to 52.7%. This ratio, also known as the efficiency ratio, is an important measure of how effectively a bank uses its resources to generate revenue, and the lower the ratio the better with its optimal value level being around 50%.
Scotiabank is poised to deliver considerable value in 2020 with an improving economic outlook and stronger growth in Latin America set to give earnings a healthy lift. When that is coupled with growing profitability and greater efficiencies, the bank’s earnings should grow at a solid clip, which will cause its stock to appreciate. While waiting for that to occur, patient investors will be rewarded by Scotiabank’s sustainable dividend, which yields a very tasty 4.9%.