Higher Funding Costs Bite Scotiabank’s Q1 Earnings

Narrow-moat-rated Bank of Nova Scotia BNS reported weaker fiscal first-quarter results. Revenue came in at CAD 7.98 billion, down 1% year over year, while expenses came in at CAD 4.46 billion, up 6% year over year. On an adjusted basis, pretax preprovision profits, or PTPP, were down 8% year over year as expenses rose, fees dropped, and net interest income is now stalling out.

We expect this quarter and ultimately this year to be a bit of a transition year for the Canadian banks. Loan growth is likely to slow, more credit strain is likely to emerge, and net interest income remains in a state of flux as rate changes slowly feed through the balance sheets. Many of these patterns were present for Scotiabank in the quarter, and Scotiabank’s uniquely poor net interest income, or NII, positioning was on full display. While other banks have struggled with rising funding costs, Scotiabank has struggled more, and the bank saw a sequential decrease in NII once again. This was despite a sequential increase in average earning assets of just over 4%. The bank’s disclosures continue to predict rate hikes having a negative effect on NII, although the effect is coming in even worse than we expected. As a result, we plan to decrease our NII outlook for the year. The bank should benefit when rates initially decline, although it is difficult to predict when that will occur, and it could take some time.

Expenses also shot up a bit more than we were expecting, and we think it may be difficult for the bank to hit the 4% annual growth in 2023 that we were hoping for. We plan to increase our annual expense outlook a bit.

New CEO Scott Thomson laid out a preview of his plans, and our impression is that a lot of work is set to be done. While this is good in one sense, in another sense, this will not be a quick improvement story. Overall, we expect updates to our forecasts will cause our fair value estimate for Scotiabank of CAD 79/USD 59 to decrease by a mid-single-digit percentage.