Scotiabank fourth-quarter profit falls short as loan-loss reserves, expenses rise

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Bank of Nova Scotia BNS-T posted lower fourth-quarter profit that missed analysts’ estimates as a spike in loan loss reserves and expenses dragged on results even as the bank slashed costs ahead of the launch of its turnaround plan.

Canada’s fourth-largest lender dramatically increased its provisions for loans that could default as the high cost of borrowing threatens to derail homeowners who have mortgages coming up for renewal over the next few years. The bank has been focused on reining in mounting expenses and building its deposit base as it prepares to unveil its new strategic plan in December under new chief executive officer Scott Thomson.

“I realize 2023 has been a difficult year financially, but the actions taken have been decisive, deliberate and necessary,” Mr. Thomson said during a conference call with analysts. “A strong balance sheet, a relentless focus on becoming more efficient and appropriate allowances will set the bank up for success going forward. As I look to 2024, I am confident earnings will increase driven by benefits from the productivity initiatives and a more stable rate environment.”

In the quarter ended Oct. 31, Scotiabank set aside $1.3-billion in provisions for credit losses – the funds banks set aside to cover loans that may default. That was higher than analysts anticipated, and included $454-million for loans that are still being repaid but which may default, according to models that use economic forecasting to predict future losses. In the same quarter last year, Scotiabank had a set aside of $529-millions in provisions.

The rise in provisions for those performing loans is positive “as it suggests that the bank has taken on a more conservative stance with respect to reserves as the economic environment is expected to become weaker,” Royal Bank of Canada analyst Darko Mihelic said in a note to clients.

Scotiabank bolstered its loan loss provisions to hedge against the impact of higher interest rates, which the lender expects will remain elevated until the end of 2024. It is also preparing for the wave of coming fixed-rate mortgage renewals, many of which will send mortgage payments soaring over the next few years.

While overall delinquencies are still within the range of historical levels, chief risk officer Phil Thomas said that consumer health in Canada is weakening, and defaults are edging higher across the bank’s lending products. Variable rate mortgage (VRM) customers who have already been hit by the steep increase in rates, have cut their spending by 11 per cent year-over-year, more than double the 5-per-cent drop in spending among clients with fixed rate mortgages.

“Those customers are feeling the pinch now and they’re making tradeoffs,” Mr. Thomas said during the call. “But we’re very conscious of the fact that in 2024, we have about a 10 per cent of our fixed rate portfolio repricing, and that moves into 20 per cent in 2025 and another 20 per cent in 2026. We’re watching the consumer trends and behaviours in the VRMs and able to extrapolate some expectations of what may happen on the fixed rate book.”

The bank’s profit slumped 34 per cent to $1.4-billion, or $1.02 per share, in the three months that ended Oct. 31. Adjusted to exclude certain items, the bank said it earned $1.26 per share, below the $1.65 per share analysts expected, according to Refinitiv.

Scotiabank’s share price fell 4.5 per cent in Toronto on Tuesday, underperforming the S&P TSX Composite Index, which edged higher slightly.

Scotiabank is the first major Canadian bank to report earnings for the fiscal fourth quarter. Royal Bank of Canada RY-T, Toronto-Dominion Bank TD-T and Canadian Imperial Bank of Commerce CM-T will release results on Thursday. Bank of Montreal BMO-T and National Bank of Canada NA-T will close out the week on Friday.

The lender also booked more than $590-million in charges as it cuts 3 per cent of its global work force, trims its real estate premises, and took a writedown of the value of an investment in China-based Bank of Xi’an Co. Ltd. The cost-cutting measures, previously announced in October, marked Mr. Thomson’s first major move to slash costs since taking on the top job in February.

Scotiabank’s employee base fell 1.7 per cent from the previous quarter to more than 89,400. While the cuts were spread across its businesses, capital markets underwent the most significant culling, with its team decreasing 4.6 per cent from the third quarter.

The bank also posted a gain of $319-million on the sale of its stake in Canadian Tire’s Financial Services business.

A key focus of Scotiabank’s turnaround plan involves building up its deposit base, which is an important source of funding for bank loans. Deposits grew 8 per cent from the same quarter a year earlier and 9 per cent in the fiscal year ended Oct. 31, largely in its Canadian and international banking divisions. Fixed-term products drove the increase as customers stash cash into savings accounts with higher interest rates.

Next year, Scotiabank expects deposit growth to ease as consumers are expected to tuck away less money and the lender balances its deposit growth with tepid loan demand.

Total revenue rose 9 per cent in the quarter to $8.3-billion. But expenses surged 22 per cent to $5.5-billion, which the bank said was driven by increases in employment costs – such as performance-based compensation – and technology and taxes. Profits tumbled across the bank’s business, ranging from a 10-per-cent decline in its wealth management unit to a 31-per-cent drop in its Canadian banking division.