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Scotiabank’s chief executive officer, Brian Porter, said on a Tuesday conference call with analysts that the bank faces 'a less certain economic outlook.'Fred Lum/The Globe and Mail

Bank of Nova Scotia BNS-T fell short of expectations for its third-quarter earnings as mounting economic uncertainty put pressure on key parts of its business, but executives said consumers and businesses look financially healthy in spite of the headwinds.

Canada’s third-largest bank, the first major lender to report results for the quarter that ended July 31, eked out a 2-per-cent rise in profit. That was bolstered by strong demand for loans in its retail banking units.

However, weak capital-markets activity and surging deposit costs in key Latin American markets dampened some sources of revenue for Scotiabank, and clouded the outlook for lending margins even as interest rates rise rapidly. As a result, the bank’s quarterly profit missed analysts’ estimates and its share price tumbled nearly 5.3 per cent lower on Tuesday on the Toronto Stock Exchange.

Scotiabank’s chief executive officer, Brian Porter, said on a Tuesday conference call with analysts that the bank faces “a less certain economic outlook.” The bank’s executives are watching consumers’ finances and spending habits closely for early signs of stress as high inflation drives up prices for a range of goods, he said.

But so far, customers are still showing “strong financial health,” chief risk officer Phil Thomas said. And the bank does not see signs that its business clients are pulling back significantly on spending or investments.

“The typical indicators of softening demand, or data to suggest business confidence in the real economy is trending lower, is just not present,” Mr. Porter said.

For the three months that ended July 31, Scotiabank earned $2.59-billion or $2.09 a share, compared with $2.54-billion or $1.99 in the same quarter a year earlier.

Adjusted to exclude certain items, Scotiabank said it earned $2.10 a share, below the $2.13 analysts had expected, according to Refinitiv.

Scotiabank took a cautionary step by increasing its provisions for credit losses – the funds banks set aside to cover loans that may default – to $412-million in the quarter. That compared with provisions of $380-million a year earlier and $219-million in the second quarter.

Banks set aside provisions both for loans that are past due and for loans that are still being repaid based on forecasts and models of future delinquencies. Scotiabank’s third-quarter provisions included $23-million earmarked against performing loans, spurred by weakening economic forecasts. In each of the previous four quarters, Scotiabank recovered some performing provisions as the bank released money from large reserves built during the COVID-19 pandemic.

But the $389-million in provisions set aside to cover impaired loans that are past due is still very low by historical standards. Rates of delinquencies and writeoffs are still running at about half what they were before the COVID-19 pandemic, Mr. Thomas said.

“We do not think [provisions for credit losses] will be a major part of the narrative for this quarter,” Darko Mihelic, an analyst at RBC Dominion Securities Inc., said in a note to clients. “Instead, we see revenue weakness across many segments as the challenge.”

Capital markets were a soft spot after generating soaring profits last year, as analysts expected. A sharp slowdown in activity by many clients dragged profit from the global banking and markets division down 26 per cent year over year, to $378-million. Equity issuances were down more than 80 per cent in Canada and the U.S. in the quarter, and debt issuances fell by more than 60 per cent.

“That’s the lowest issuance levels we’ve seen in these markets at any point in the past five years,” Jake Lawrence, group head of global banking and markets, said on Tuesday’s conference call. “In terms of outlook, we have already started to see it rebound.”

Sharp declines in equity and bond markets during the quarter also ate into fee income in the bank’s wealth-management division, where profit declined 3 per cent to $376-million.

By contrast, profit from Canadian banking was up 12 per cent to $1.2-billion. Loan balances increased rapidly, with business loans up 23 per cent and residential mortgages up 14 per cent even as housing markets have cooled.

International banking profits were also up 28 per cent to $625-million, with demand for loans similarly strong. But revenue from the division – which is concentrated in Mexico, Peru, Chile and Colombia – was up only 3 per cent to $2.4-billion. And lending margins in the division contracted by one basis point, as rapid interest-rate increases by central banks in the region pushed deposit rates up faster than the bank could raise interest rates on loans.

Interest rates in Latin America “are peaking,” Mr. Porter said. But the bank’s international experience, where central banks raised rates sooner and faster than in Canada and the U.S., shows how the forceful approach central banks have had to adopt to try and tame high inflation can affect lending margins and demand for new borrowing.

In Canada and internationally, Scotiabank’s customers have moved about $4-billion from core deposit accounts that pay very little interest to higher-paying term deposit products, squeezing profit margins in some areas.

“The demand for credit is strong,” Mr. Porter said. “Asset repricing is happening now and will continue through the balance of fiscal 2023.”

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