TOP CONTRIBUTORS

Jonathan J. Smith

Andrew Liyana

Jennifer G

BNS AT A GLANCE

P/E ► 14.1 AVG EV/EBITDA ► 2.96 LOW ROA ► 3.6% VERY HIGH ROE ► 14.4% HIGH Debt to Equity ► 21.3 HIGH Interest Coverage Ratio ► 1.31 AVG

 

 

 

 

 

 

Scotiabank (TSX: BNS NYSE: BNS), formally known as The Bank of Nova Scotia is one of Canada's Big Five banks - the third largest bank in Canada by assets (behind the Royal Bank Of Canada (RY) and Toronto-Dominion Bank (TD)), and the second largest by market capitalization (behind Royal Bank of Canada).^[1] It is also the country's most international bank, having over 1,850 branches in 48 countries -- a number that outmatches the international presence of the other large Canadian banks.^[2] Unlike its competitor, Royal Bank of Canada, Scotiabank has avoided banking operations in the United States. Instead, it has built a network in the Caribbean, Central America, and Mexico.^[1] This region accounted for 25% of BNS's revenue generated in FY 2008.^[1]

Scotiabank, like the rest of the Canadian banks, has been negatively affected by the 2008 Financial Crisis. For FY 2008, the bank wrote down 1,211m before taxes. Decline in Collateralized debt obligation (CDO) valuations led to 516m in writedowns. BNS was also one of Lehman Brothers' creditors, so LEH's downfall cost BNS upwards of $120 million, when BNS had written down C$899-million from Q3 07 to Q3 08 due to the 2007 Credit Crunch^[3] In response to the crisis, Canada has given hints that it will increase the Tier 1 Capital Ratio% minimum to 10% from the current 7%.^[4] The Tier 1 Capital Ratio, the ratio of the bank's equity to its total risk weighted assets, is a measurement to determine the adequacy of a bank. Scotiabank, the only bank of the Big Five that has not announced a plan to increase capital, needs to raise $2.255 billion to get to 10% - a challenge for any company at a time when credit and equity markets are so heavily constrained.^[5]

Despite BNS suffering writedowns of 1,211m from the 2008 Financial Crisis, the bank competes in a highly regulated Canadian banking sector that has limited Leverage and required conservative lending practices, which has left the Canadian Banks relatively unscathed through 2008.^[6] Canadian banks only accounted for 2% of the estimated 720 billion in writedowns by global banks and brokers during 2008.^[7] In fact, the Geneva-based World Economic Forum placed Canadian banks as the soundest in the World.^[8] The US was ranked 40th in the survey of 12,000 corporate executives. Focusing on banks' balance sheets, Canadian banks fair much better than their US and European counter-parts. Canadian banks average a Tier 1 Risk-based Capital Ratio of 9.8%, or twice that of the average American Investment Bank and three times greater than the mean of European commerical banks.^[9] The Canadian Government issued $75 billion in mortgage issuance to keep the international playing field level as other countries (especially the US and European nations) provided guarantees to bank assets.^[9]

Business Financials

BNS operates in three main business segments:

Canadian Banking (50.3% of Revenue, 46.6% of Net Income)

The Canadian Banking segment provides banking and investing products to more than 7 million customers in Canada.^[2] This segment is broken down into three divisions: Retail and Small Business Banking, Wealth Management, and Commercial Banking. Retail and Small Business Banking provides mortgages , loans, credit cards , and insurance products. Wealth Management provides retail brokerage, investment management, and mutual funds. Commercial Banking provides banking and lending products to medium and large businesses.^[2] From 2007 to 2008, Canadian Banking net income increased 10%^[2] due to the global Visa restructuring, when the company formed Visa Inc., held an Initial Public Offering (IPO), and made it's European unit separate from the rest of the company.^[10]

International Banking (35.6% of Revenue, 32.1% of Net Income)

With total revenues of C$4,597m in 2008, Scotiabank is Canada's most international bank. The bank has a large presence in Peru and Mexico. The international banking sector of BNS earned C$1,186m during 2008.^[1]

International Banking provides Scotiabank's commercial and retail banking products in more than 40 countries worldwide. In 2008, International Banking added over 90 branches (including 48 in Mexico) and has increased its presence in Peru, by increasing Scotiabank Peru ownership to 98% and acquiring 47.5% of Profuturo -- Peru's fourth-largest private pension fund.^[2] From 2007 to 2008, International Banking net revenue grew 15% largely due to the acquisition of Banco del Desarollo in Chile and strong growth in Peru, but net income decreased 5% to C$1,186m due to a strengthening Canadian Dollar (CAD) and valuation adjustments.^[2]

Scotiabank is the 3rd largest bank in Peru and the 6th largest bank in both Mexico and Chile.^[1]

Scotia Capital (14.1% of Revenue, 21.3% of Net Income)

The Scotia Capital segment provides products ranging from corporate lending to equity sales, trading and research. Scotia Captial offers these services to North American consumers, as well as niche markets in Europe and Asia.^[2] The capital markets division of BNS focuses on Energy and Mining sectors.^[11] In 2008, Scotia Capital was named the Best Foreign Exchange Bank in Canada for the fourth year in a row by Global Finance magazine.^[2] From 2007 to 2008, Scotia Capital net income decreased 30% as it has been the division most affected by the 2008 Financial Crisis.^[2] The fixed income and currency trading groups had a record year, but C$623m in charges from the Lehman Bankruptcy and widening credit spreads hurt overall revenue and net income^[1]

Income/Revenue Sources

Interest Income (65% of 2008 revenue)

BNS's loans are diversified across residential, business, personal, and government borrowers. Scotiabank's total loan portfolio accounted for 59% of its total assets, or $C300b, in 2008.^[1]

At 64%, Canadian loans form the majority of BNS's loan portfolio. The United States, Caribbean, Latin America, and Mexico also account for significant portions.^[1]

Scotiabank makes money by lending money for more than it pays to borrow it. The difference between the cost of borrowing and the revenue generated from loans is referred to as the Net Interest Rate Spread. While overall net income has grown from C$6,197m in 2005 to C$7,990m in 2008, the net interest margin has decreased from 2.00% to 1.75%.^[1] The growth in net income, while margins decreased, is explained by the overall increase in loans. Through a series of acquisitions and new loan originations, BNS loans assets have expanded to C$300b in 2008 from C$178b in 2005.^[1] Of these loans, 64% are domestic. Latin America accounts for the second largest portion at 8%. By sector, residential forms the largest percentage at 40% and business loans are 32% of BNS loan portfolio.^[1]

Non-interest income formed 35%, or C$4,302m, of BNS's 2008 total revenue. This broad category contains everything BNS does outside of lending money. Money that BNS earns for holding deposit accounts and clearing payment services formed 20% of BNS's non-interest income in 2008.^[1]

Non-Interest Income (35%)

Non-interest income includes deposit and payment services, retail brokerage commissions and investment advisory fees. Trading revenues and investment banking revenues also fall into this category. Increasing Mergers and acquisitions (M&A) activity, higher trading volume, and expanding Assets Under Management (AUM) help boost non-interest income. For 2008, deposit and payment services was the largest source of non-interest income at C$862m. Credit fees had the biggest percentage increase at 9.2% compared to 2007, while trading revenues plummeted C$262m to C$188m during FY 2008.^[1]

‎From 2007 to 2008, BNS revenue decreased 4.9%, total cost increased 3.4%, and net income decreased 22.4%. In 2007, BNS lead the Money Center Banks industry in return on equity (18.42%).^[1]

Combined

Following the GAAP method, total revenue was C$11,876m in 2008, which is down 5% from 2007.^[1] Interest income increased C$476m, but non-interest income dropped $1,009m. The sharp decline in non-interest income was primarily due to C1,059m in total charges arising from the 2008 Financial Crisis and a C$80m reduction from currency translation.^[1]

Trends and Forces

BNS was Exposed to the Collapse of Lehman and is Suffering Because of the 2008 Financial Crisis

During the 2008 Financial Crisis, BNS took hits in their equity and fixed-income markets. These declines were amplified by the Lehman Brothers (LEH) collapse, as BNS is one of Lehman Brothers' creditors. The Lehman collapse cost BNS $115 million in trading revenues.^[12] From Q3 2007 to Q3 2008, Scotiabank had written down C$899-million, representing 4.8% of its common equity, due to the 2007 Credit Crunch ^[13] Comparatively, Royal Bank has written down C$1.086-billion, representing 4% of its common equity, in that time period. Further, the fourth quarter was very volatile for the markets with equities, credit, foreign exchange and commodities all impacted. BNS lost $370 million due to their securities losing value and $110 million due to derivatives, which it hopes to hedge in three years.^[12]

Scotiabank economists predict the recession will last until 2011,^[14], so BNS will make changes to prevent another $890 million hit, as it did in Q4.^[15] The bank has vowed to be more careful with giving loans, and as Scotiabank's chief risk officer claimed, "focus on credit, credit, credit."^[15] Also, Scotiabank plans to sell preferred shares to raise capital.^[15] However, BNS has more than $20 billion in exposure to the auto industry, which is plummeting.^[15]

At the end of October 2008, BNS had a Tier 1 Risk-based Capital Ratio of 9.3% - only Royal Bank Of Canada (RY) was lower. BNS is also the only bank of the Big Five that has not announced a plan to increase capital.^[1]

Canadian Banks are Seen as Less Risky than American Banks

With C$1.2b in writedowns during FY 2008, BNS's loss due to the financial crisis has been minimal compared to losses U.S. banks have suffered. Canadian banks as a whole have lost $11.7 billion due to subprime investments -- which is a fraction of the total that U.S. banks have lost.^[16] Further, the World Economic Forum published its survey of 12,000 corporate executives in October 2008, which showed that these company heads ranked Canadian banks as the soundest in the World; US banks ranked 40th on the list. Canada achieved a score of 6.8 (7.0 indicates a perfect score). In comparison, the US scored 4.0.^[8] Canadian banks have also profited from winning deposits and accounts as clients leave shaky U.S. banks.^[17]

Canada Requires that their Banks Maintain Tier 1 Capital Ratio%.

Canada requires banks to maintain a tier-1 capital ratio of at least 7%. The ratio is a measure of equity and retained earnings to risk-adjusted assets and provides a general guide for determining a bank's financial health.^[5]

BNS had a Tier 1 capital ratio of 9.3% at the end of the year ended Oct. 31. That compares with a ratio of 10.5% posted by Canadian Imperial Bank of Commerce (CM). BNS has the ability to easily issue about C$800 million ($648.8 million) in notes, adding about 30 basis points to its Tier 1 capital ratio.^[18]

Out of the big five Canadian banks (BNS, RY, BMO, TD, and CM), BNS is the only one that has not issued common equity this year.^[19] Canada has announced that the tier 1 requirements will increase to 10% to prevent a credit crisis. Royal Bank announced that it will issue as much as $2.3-billion in common equity to bring its Tier 1 capital ratio above 10%. Scotiabank must raise $2.255-billion to get to 10%.^[5]

Flucuations in the Canadian Dollar (CAD) impacts operating revenue and net income.

A weakening Canadian dollar helps support the Canadian economy, which relies heavilty on exports. With 64% of Scotiabank's loans being held in Canada, BNS relies on the health of the Canadian economy to grow revenue and limit losses on loans and other investments.^[20]

BNS's business operations, as well as its ADR share prices are effected by fluctuations in the Canadian Dollar (CAD). As of October 31, 2008, a one percent change in the Canadian dollar against all other currencies in which the Bank operates (primarily the USD) leads to a C$174m increase, net of hedging, in unrealized foreign currency translation losses.^[1] On one hand, a rise in U.S. Dollar (USD) compared to the Canadian dollar translates to higher asset values of its American portfolio of loans, but also reduces the dividend paid on the ADR all else equal. Similar, BNS's loans in Mexico increase in value if the Mexican Peso (MXN) strengthens relative to the Canadian Dollar (CAD). On the other hand, the Canadian economy is largely linked to exports of natural resources.^[21] As the the CAD depreciates, it boosts domestic revenue for Canadian resources. For instance, if oil trades for $50USD/bl, and the USD/CAD is 1, then a Canadian exporter receives $50CAD/bl for his oil. Now if the CAD depreciates 20% relative to the USD and oil does not move, he would then receive $60CAD/bl for the same oil; thus, improving his return. In a nutshell, a weak Canadian dollar can boost the domestic economy and cushion the impact of falling natural resource prices. Therefore, Canada's economic health is dependent on the USD/CAD relationship. As of December 21, 2008, the Canadian dollar is worth 82 cents of the US dollar. In early December 2008, the Bank of Canada expressed concern that a strengthening Canadian dollar could hurt Canadian banks by leading to a worse recession in Canada.^[6] Higher unemployement and decreasing natural resource prices would lead to lower repayment of loans and decreasing financial activity among energy and mining companies.

The Canadian Banking System

General Structure and Environment

The Canadian banking system is structured differently the United States. Whereas in the States, banks operate as bank holding companies, Canadian banks follow a parent company approach, which leaves enough shares to influence management. The industry is much more consolidated than in the US. The Big Five in Canada control 90% of Canadian domestic banking assets, whereas, in the United States, the five biggest banks accounted for 9.7% of total American banking assets in 2002.^[22] The "Big Five", RBC, Bank of Nova Scotia (BNS), Toronto Dominion Bank (TD), Canadian Imperial Bank of Commerce (CM), and Bank Of Montreal (BMO) dominate the remaining 14 domestic banks in terms of Total Assets.^[23] In fact the the 5th largest bank, Bank Of Montreal (BMO), is about 3 times the size of the 6th largest bank, National Bank of Canada (NA-T).^[24] The top five banks all ranked in the top 200 global banks by Forbes.^[25]

Canadian Banks and the 2008 Financial Crisis

The Canadian banking system has not been immune to the 2008 Financial Crisis as Royal Bank Of Canada (RY), Toronto-Dominion Bank (TD), and Canadian Imperial Bank of Commerce (CM) have wrote down more than C$2 billion^[9], but the Bank of Canada and Geneva's based World Economic Forum acknowledge the resilance of the Canadian banking sector. In a December 2008 report, the Bank of Canada published their Financial System Review Report^[6], which explains how lower leverage and more conservative lending practices helped Canada's 19 domestic banks^[23] weather the financial turmoil. The World Economic Forum published its survey of 12,000 corporate executives in October 2008. The report showed that these head of companies ranked Canadian banks as the soundest in the World; US banks ranked 40th on the list. Canada achieved a score of 6.8. 7.0 indicates a perfect score, which means banks are seen as entirely healthy and in no need of government assistance. 1.0 means the bank is in dire need of government aid due to insolvency. The US scored 4.0.^[8] Canadian banks average a tier 1 capital ratio of 9.8%, which compares favorably to US Investment Banks that average 4% and European commerical banks at 3.3%.^[9]

Canada versus the US Financial Health

While Canada is geographically located next to the United States, the difference in levels of trade imbalances, consumer and country indebtness vary greatly. The financial health of a country's citizens impact their ability to pay debt owned by banks. With 64% of BNS's of loan portfolio held by Canadians, it is important for Canadians to be in solid financial shape.^[1]

• According to RBC Economics Research in June of 2008, Canadian household debt as percentage of disposable income is 137% versus 182% in the US.^[26]
• As reported by Statistics Canada in December 2007, homeowner's equity as a percentage of total real estate assets is 70% in Canada versus 48% in the US.^[26]
• Loan delinquency rates in Canada is 0.29% compared to 2.20% in the US as published by the CBA, Mortgage Bankers' Association in July 2008.^[26]

In addition, the US continues to build its trade and fiscal deficits, but Canada has had 10 consecutive quarters of fiscal surpluses, its net foreign indebtness is at the lowest level since 1945, and it has had 9 consecutive quarters of current account surpluses.^[26]

Competition

Comparing the Big Five

Data as of latest Quarterly/Annual Report December 24, 2008:

Write-downs

According to the Bank of Canada and a survey by the World Economic Forum, Canadian banks weathered the 2008 Financial Crisis better than peers in outside nations.^[6] Nevertheless, they are not immune. Between 2007 and as of quarter ended Oct 31 (4Q FY2008 for most banks), Canadian banks had written down C$16.17 billion compared to global banks and brokers having written down USD$720 billion.^[7] Canadian Imperial Bank of Commerce (CM) has written down the largest amount in 2008 at C$4.969 billion,^[31] while RBC made C$2.79 billion of writedowns as of December 2008. BNS took an after-tax writedown of C$595 million for its 4th quarter of fiscal year 2008.^[32] The remaining two of Canada's big five are not unschathed as well. Between the third quarter of 2007 and November 19, 2008, Bank Of Montreal (BMO) has written down C$899 million and Toronto-Dominion Bank (TD) C$65 million.^[31]

Market Share

As Canada's third largest bank in terms of total assets and market capitalization, BNS is bigger than Bank Of Montreal (BMO) and Canadian Imperial Bank of Commerce (CM) but smaller than Toronto-Dominion Bank (TD) and Royal Bank Of Canada (RY). These five banks, all included in Forbes Top 200 Banks, dwarf the remaining 14 domestic banks in terms of market cap and assets; BNS is ranked 92nd.^[24]

BNS's operations are not limited to Canada. With 35% of 2008 revenue being generated outside Canada, BNS is Canada's most international bank.^[1] Scotiabank is 3rd largest bank in Peru and 6th largest bank in both Mexico and Chile.^[1] Scotiabank competes with Royal Bank Of Canada (RY) in the Caribbean market. BNS also competes against American Investment Banks, like Goldman Sachs Group (GS), for energy and mining Mergers and acquisitions (M&A) business.^[11]

Scotiabanks competes with wealth management divisions of the other big five as does it with large investment companies like Manulife Financial (MFC). In 2008, BNS was #4 in the Canadian mutual fund industry in net long-term fund sales, and as of July 2008, accounted for 3.22% of the mutual fund market.^[11]

Financial Services

• Toronto-Dominion Bank (TD) -- Canada's second largest bank in terms of assets.^[33]
• Bank Of Montreal (BMO) -- Canada's fourth largest bank in terms of assets.^[34]
• Royal Bank Of Canada (RY) RY is Canada's largest bank in terms of total assets and market cap.^[35]
• Wells Fargo (WFC) -- The first bank in the U.S., WFC offers financial products ranging from retail mortgages to small business loans to insurance products.^[36]
• Bank of America (BAC) -- BAC has about half of all the wealthy households in the U.S. as customers, and holds the leading share of the market for small business banking.^[37]
• Citigroup (C) -- The world's most diversified financial services firm, C competes with BNS in retail and commercial segments.^[38]

References

1. ↑ ^{1.00 1.01 1.02 1.03 1.04 1.05 1.06 1.07 1.08 1.09 1.10 1.11 1.12 1.13 1.14 1.15 1.16 1.17 1.18 1.19 1.20 1.21} Scotiabank (BNS) FY 2008 10-K Annual Report
2. ↑ ^{2.0 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8} BNS 2008 Annual Report
3. ↑ Seeking Alpha, "The Year of the Canadian bank Writedowns," 11/20/08
4. ↑ Seeking Alpha, "Bank of Montreal's Announcement Confirms Tier 1 Ratios Will Rise," 12/17/08
5. ↑ ^{5.0 5.1 5.2} Financial Post, "10% tier 1 ratio will be costly for Scotia," 12/10/08
6. ↑ ^{6.0 6.1 6.2 6.3} Bank of Canada “Financial System Review “Highlights – December 2008”
7. ↑ ^{7.0 7.1} Bloomberg "Royal Bank Drops Forecast as Writedowns Cut Profit" By Doug Alexander, Dec. 5, 2008
8. ↑ ^{8.0 8.1 8.2} Reuter’s “Canada rated world’s soundest bank system: survey” October 2008
9. ↑ ^{9.0 9.1 9.2 9.3} Time Magazine "Why Canada's Banks Don't Need Help" Erik Heinrich Nov 10, 2008
10. ↑ Energy Business Review, "Visa Announces Major Global Restructuring"
11. ↑ ^{11.0 11.1 11.2} Scotiabank Company Presentation “Uniquely Positioned in a Challenging Environment” September 11-12, 2008
12. ↑ ^{12.0 12.1} CTV, "Scotiabank takes $595M hit related to financial turmoil," 11/18/08
13. ↑ Seeking Alpha, "The Year of the Canadian bank Writedowns," 11/20/08
14. ↑ CTV, "Scotiabank predicts long and deep recession"
15. ↑ ^{15.0 15.1 15.2 15.3} National Post, "Bank of Nova Scotia pulls back on lending," 12/2/08
16. ↑ Forbes, "In Crisis, Canadian Banks Strive and Thrive," 12/11/08
17. ↑ Seeking Alpha, "Canadian Banks Benefit from Market Turmoil," 11/01/08
18. ↑ Bloomberg, "Bank of Nova Scotia May Raise Regulatory Capital, Analysts Say," 12/15/08
19. ↑ Seeking Alpha, "Bank of Montreal's Announcement Confirms Tier 1 Ratios Will Rise," 12/17/08
20. ↑ FutureSouce.com Commodity Quotes and Charts
21. ↑ Library of Parliament, "Energy Resources: Boon or Curse For the Canadian Economy" By Philippe Bergevin, 31 March 2008
22. ↑ Wikipedia.org "Canadian and American economies compared" Accessed 1-Jan-09
23. ↑ ^{23.0 23.1} Excise Duty Memoranda Series 2.2.4 "Approved Financial Institutions and Acceptable Bonding Companies"
24. ↑ ^{24.0 24.1} Statistics Canada "Canada's Banks" August 2002
25. ↑ Helium “Why Canada’s Banking System is so stable” Dr. Jones October 2008
26. ↑ ^{26.0 26.1 26.2 26.3} “RBC Company Presentation” “December 2008 Facts” December 2008
27. ↑ Bank of Nova Scotia FY 2008 10-K
28. ↑ Bank of Montreal FY 2008 10-K
29. ↑ TD FY 2008 10-K
30. ↑ CIBC FY 2008 10-K
31. ↑ ^{31.0 31.1} FP Trading Desk, "The year of bank writedown", By David Pett, November 19, 2008
32. ↑ Morningstar.com "Bank Nova Scotia To Take C$595 Million in 4Q Writedowns" Dow Jones Newswires 11-18-08
33. ↑ ^{33.0 33.1} TD 2008 Annual Report
34. ↑ ^{34.0 34.1} BMO 2008 Annual Report
35. ↑ ^{35.0 35.1} RBC 2008 Annual Report
36. ↑ Wells Fargo website, "About Us"
37. ↑ Bank of America website, "About Bank of America"
38. ↑ Citigroup website, "About Us"
39. ↑ BNS 2007 Annual Report
40. ↑ WFC 2007 10-k, Item 6: Selected Financial Data, page 14
41. ↑ BAC 2007 10-k, Item 6: Selected Financial Data
42. ↑ Citigroup 2007 Annual Report