Bank of Nova Scotia: Lots of catalysts ahead – The Bank of Nova Scotia (NYSE: BNS) –

Bank of Nova Scotia: Lots of catalysts ahead – The Bank of Nova Scotia (NYSE: BNS)


Note: This idea was discussed in greater depth with members of my private investment community, Banking on Financials. Go here for more information.

The Bank of Nova Scotia (BNS) is the third Canadian bank with a presence in Latin America, the Caribbean and Central America, and in Asia. As in other Canadian banks, Scotiabank shares have performed stellarly in the last two years.

Source: Bloomberg

That said, we still expect several important catalysts for the stock.

The acquisition of BBVA Chile

On November 28, BNS announced that it had agreed to buy a 68.2% stake in BBVA Chile, one of the top 10 Chilean banks. As noted above, BNS already has a presence in the country, and the agreement should double its market share, which makes the Bank of Nova Scotia the third largest private bank in Chile. As shown below, by total badets, BBVA Chile is even larger than Scotiabank Chile. It also operates an extensive network of branches.

Source: Bloomberg

BNS said it would pay $ 2.2bn for the Chilean operations of BBVA. According to the company, this offer values ​​BBVA Chile with a P / B of 2.1x and 18 times the subsequent profits. Although this valuation is certainly rich, we note that Chilean banks are expensive compared to other Latin American banks. For example, Santander-Chile (BSAC) and Banco de Chile (BCH) are currently trading at more than 2.5 times the book value advanced. As such, the price of BBVA Chile seems reasonable. It could be argued that Santander Chile and Banco do Chile have been the LatAm banks with the best results since the beginning of the year and, as such, Scotiabank purchases BBVA Chile in high cycle valuations. In addition, the growth of profits in Chilean banks is slowing down due to high levels of credit penetration, low inflation, slow loan growth, worsening badet quality indicators and short-term difficulties on the macroeconomic front. Although these are valid concerns, we believe that the agreement is of added value for BNS, thanks to the synergy benefits and attractive long-term prospects of the Chilean banking sector.

In addition, BBVA Chile has a greater participation in the main deposits and that should be positive for the cost of financing BNS.

Nick Stogdill

Okay, thanks. If you could ask for one more on BBVA Chile, only if you look at the Scotia deposit loan index, is there a little bit of difference with BBVA Chile. So, the question of the balance on the side of deposit in that market – I guess having more scale will improve your deposit-collecting capabilities?

Nacho Deschamps

Absolutely, they are important. And these, of course, would have a positive impact on the cost of the funds if you look at the largest banks in Chile, they have a larger mix of major deposits.

Source: earnings call Q417

Finally, Bank of Nova Scotia has an excess of capital and deploying it in faster growth markets is an excellent decision, from our point of view. The agreement also makes sense for BBVA (BBVA), given that the Spanish banking group needs to improve its capital position.

Within Latin America, Scotiabank also has operations in Mexico, Colombia and Peru. In Mexico, the BNS subsidiary is the fifth largest bank by key operating metrics. Currently, the Mexican banking sector faces several obstacles, such as pressure on margins, weak credit growth and problems of badet quality. A possible break in NAFTA also represents a threat to Mexico's economic growth and the credit portfolio of the banking sector. In August, we downgraded Santander México (BSMX) and we still believe that the risk / reward for Mexican banks is biased downwards. That said, from a longer-term perspective, Mexico continues to be one of the most attractive banking markets in Latin America, especially given its low credit penetration, measured as the total of bank loans against GDP. As shown below, Mexico is still very little ahead of Peru, Colombia, Brazil and Chile. In other words, there is still a lot of room for Mexican banks to grow.

Source: Company data

In Colombia, several indicators show that the worst has happened for the country's economy, and the macroeconomic environment should improve gradually by 2018. Clearly, Colombian banks would benefit from that. The increase in oil prices should also help, since Colombia continues to be an economy driven by commodities. The results of the third quarter of Colombian banks were weak in general, but it is likely to be an early sign that operating trends are about to turn the corner. Although credit penetration in Colombia is higher than in Mexico and Argentina, the country's banking sector remains attractive mainly due to its profile financed by deposits, resilient margins and an oligopoly environment.

In Peru, while Credicorp (BAP) the undisputed market leader, Bank of Nova Scotia, has the opportunity to grow its consumer loan portfolio, which still represents only 3% of Peru's GDP.

In summary, there is enormous potential in Latin America and the Bank of Nova Scotia is well-positioned to take advantage of the growth opportunities there. It is important to note that exposure to sub-penetrated markets in Latin America is what differentiates the bank from its Canadian peers.

Loans more widespread in Canada and LatAm to support NIM

As shown below, depending on the dynamics of NIM, there is a clear divergence between Bank of Nova Scotia (the red line) and other Canadian banks.

Source: Bloomberg

We believe that this can be attributed to the fact that BNS has focused on higher margin loans in Canada, particularly personal loans and credit cards, in the last 2 years. In fact, the proportion of personal loans and credit cards has been constantly increasing.

Source: Company data

We believe that the trend still has advantages, especially since credit cards, which are the highest performing segment, represent only 2.4% of BNS's total retail loans. As shown below, this is the lowest participation among the large Canadian banks.

Source: Company data

In Latin America, the bank's margin has been weak lately. After several years of inflation higher than the target, regulators in Mexico, Colombia and Peru are becoming more peaceful and some of them have already begun to cut interest rates. The lower rates put pressure on the margins of LatAm banks and, as a result, the NIM of BNS in the region has decreased by 33 bp since Q217.

Source: Company data

Having said that, it should come as no surprise that margins are falling in the initial stage of the credit cycle. As the credit cycle develops and matures, margins should gradually stabilize. More importantly, the BNS margin in LatAm is higher than in Canada by almost 230bps. We expect the spread to persist due to an environment of higher interest rates and a banking system financed by deposits in Latin America.

BNS Canada

Source: Company data

There is still room to reduce costs

At the group level, BNS has a cost / income ratio of 52%, which is one of the best metrics among Canadian banks. The caveat here is that the group's cost-efficiency ratio in Canada is much better than that of Latin America.

BNS Canada

BNS Latin America

Source: Company data

In other words, while the bank's Canadian operations are one of the most efficient in developing markets, its LatAm division senses poorly, compared to other Latin American banks. In comparison, Santander México has an efficiency ratio of 42%, while the Colombian unit of Bancolombia (CIB) has a cost / income of 46%. BNS management seems to be aware of this gap as the group is focusing more and more on better cost efficiency in the region.

Does the agreement represent a threat to dividends?

We believe that the acquisition of BBVA Chile does not represent a threat to the dividends and repurchases of BNS since the bank has an excess of capital. The following table shows that BNS has the second highest Tier1 ratio among the Canadian banks listed and the highest metric among the Big-5. In fact, such a strong capital position allows BNS to make acquisitions in higher growth markets.

Canadian banks: Tier1 Capital index

Source: data from Bloomberg, Company

BNS also has the lowest leverage rate, measured as total badets against total equity. We believe that it should give investors more convenience since BNS's low leverage underpins its strong capital position.

Canadian banks: total badets in total capital

Source: Bloomberg data, Company

Loans to bank deposits are slightly above 80%, which we also consider a comfortable and conservative relationship.

Canadian Banks: Deposit Loans Ratio

Source: Bloomberg, data from the company

Profitability and valuation

Although BNS has a significant exposure to LatAm, its RoE is relatively low, compared to other Canadian banks.

Canadian banks: Return on capital

Source: data from Bloomberg, Company

Canadian ba nks: return on tangible capital

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