The Bank of Nova Scotia (BNS) Presents at NBF 20th Annual Financial Services Conference (Transcript)

The Bank of Nova Scotia (NYSE:BNS) NBF 20th Annual Financial Services Conference March 22, 2022 9:45 AM ET

Company Participants

Dan Rees - Group Head, Canadian Banking

Conference Call Participants

Gabriel Dechaine - National Bank Financial

Gabriel Dechaine

All right. Thank you for coming to our next session. I’d like to present Dan Rees, Group Head of Canadian Banking at Scotiabank. Thanks for joining us, Dan. I appreciate the visit.

And before I get the Q&A going -- or the formal questions anyway, if you have any -- just an overview of the business, how you’re seeing your business evolving in the current landscape, that would be a good way to start, I think.

Dan Rees

Sure, happy to. I don’t know for those who have dialed in, this room is packed. So, first of all, for those who are thinking, are people interested in getting back to the office, this is kind of evidence for us right here. Look, I think -- from my perspective, I think the Bank in general has been really pleased with how the Canadian bank has performed over the last couple of years. I’m pleased to sit here with another good quarter under our belt. But I think much of the reason for that is the business had a bit of work to do a few years ago. We lost our footing in a couple of key areas. Mortgages and commercial stand out as big examples. And so, I’m pleased to say, the turnaround that you’ve seen over the last couple of years has also now turned into a bit of a growth story. So, very pleased to see our operating leverage performance for several quarters in a row.

And the big things are working. I called out mortgages and commercial, but we’re seeing credit cards coming back, automotive we might talk about. And the business bank, our commercial franchise, which includes Roynat, which was founded here in Montreal, I think, about 60 years ago. These two businesses have been spectacular for us for several years, and pipelines are robust for the rest of this year, at least. So, I’m very pleased to see that the financial performance has turned around. The growth is now part of our story. And the customers have been very, very appreciative of the approach we took during the pandemic. So, we’re actually pretty optimistic about the business for the back half of the year, notwithstanding some of the complexities at the backdrop.

Question-and-Answer Session

Q - Gabriel Dechaine

Well, okay. That’s a good way to set things up. Mortgage business, the growth has been phenomenal. Everybody knows that. One thing I’m curious about is how much of the growth that we’ve seen, which is way above average, has been from housing price inflation versus units? I suspect it’s the latter. And we don’t really get stats on that in Canada, like Australians are lucky that way, but...

Dan Rees

Is that a request for disclosure or...

Gabriel Dechaine

CBA access or something.

Dan Rees

Yes. Look, price inflation has certainly helped balance growth. No doubt about that. I mean, in our business, we continue to see good unit expansion. But the bulk of it has definitely been through dollars. Our -- particularly the last three quarters, you’ve seen us outpace the market in pure balance growth. The main drivers for that are we decided strategically a couple of years ago to build a proprietary channel. We’re most known for mortgages plus branches. We’ve done -- almost increased the sales capacity of our proprietary channel by 50% and dollar balances have doubled in the last three years through that channel.

So, a lot of the balance growth is through the expansion of the sales system. And frankly, we also lost our footing a little bit in retention. So, the key in these accrual businesses is to manage the stock that comes up for renewal. And so, our renewal and retention rates have been improving steadily the last number of quarters. So, units have not been as much of a driver as pricing. And I think pricing is going to continue to be an opportunity for dollars.

Gabriel Dechaine

Okay. So, the next question I have is on more of the regulatory angle. OSFI is looking at the combined mortgage and HELOC products. First question, do you think the -- if there is a regulatory tightening of some sort, do you think it’s going to be more on the capital requirement side or on the underwriting criteria side, because B20 might be reviewed again or both? What’s your perspective?

Dan Rees

Yes. We certainly had lots of conversations with OSFI about this. They do a great job, I think, of facilitating input from industry. We don’t want to speculate too much about where this is going to ultimately land. On the HELOC side, we’re not a big player in that business. And so, if either underwriting or capital is tightening, we’ll be pretty good at adjusting and probably would feel the pain a little less than some of the peers. I do think there’s a big opportunity, though, to generate revenue by cross-selling off our STEP product, which I think you’ve heard me talk about a few times before.

So, the STEP product is a global umbrella limit in which you’d see a mortgage piece, which can be multiple terms, not just one, secured line of credit, credit card, personal line, et cetera. So, it’s an umbrella product. So, if there are changes to the combined loan product capital attribution, it would only be to the secured line piece, not to STEP. And we still have opportunities for cross-selling and activating some of those revolving lines inside the STEP umbrella. And the last thing I would say there, Gabe, is that we know that our STEP active customers are substantially more profitable than otherwise, and we’re still activating at a level that’s below what I’m expecting for this year. So, I’m not nervous about the regulatory change.

Gabriel Dechaine

And okay, I guess, that answers my next question. So, if there were -- there was some tightening, and that would be on the secure...

Dan Rees

I think it’s just that piece.

Gabriel Dechaine

Then the overall STEP program growth, you don’t think would be negative?

Dan Rees

Keep going. And I think back to mortgage brokers, we’re by far the number 1 player in that market. And that is the market that customers have been telling us for years they prefer as the means of engaging with a bank. And we took market share again this quarter, and we did not do it on pricing. We did it on the speed of fulfillment. Two years ago, mortgage brokers would originate less than 50% of new product in the STEP umbrella, now it’s over 80%. And so, the big message to shareholders, do not think that the broker channel is a high acquisition cost, no cross-sell. That’s a myth we’re dispelling. They’re selling creditor insurance, secured lines of credit, STEP, et cetera. So, we’re supporting that channel because our customers are asking for it.

Gabriel Dechaine

I believe -- I think the point we’re highlighting on the broker channel, and this is vague memory, but Scotia’s approach is not just a pure distribute, you actually handle the paperwork more and the renewals for broker origination.

Dan Rees

Yes, for sure. Because we’ve been so big for so long, like that -- they want to manage the client side and we want to manage the whole piece. It’s been a big differentiator for us. And I think during COVID, what we chose to do was to fund the portal that the brokers use. And so, for those of you that have the thesis that digital sales are great, I don’t today count mortgage broker sales is digital because there’s a person involved. But we hardly touched a piece of paper in there. So, it would be pretty easy for me to make the case that basically half of my origination mortgage is all digital.

Gabriel Dechaine

Another aspect of the mortgage business, prepayment. So, I suspect last year would have been a big year for prepayment. And this year, probably not just because of the direction of rates. Like how big of an impact was that on your revenues last year, say, or was it not?

Dan Rees

It was a little bit on revenues. It was more, I would say, complicated to manage operationally because what we saw were consumers coming in way before term expiry and insisting on lower rates. And so, what that does in the system, and a retail is a system, like the key is to put the pieces of the puzzle together. We did see a lot of pressure early in the pandemic when we saw ultra-low rates on retention rates. So, high payout pressure on retention. So, that’s why I was calling out earlier, our retention rates have improved. Paydowns and payouts fell substantially in our book in Q1, which we like to see.

Gabriel Dechaine

Right. Okay. Auto lending, that’s a business where -- I mean, it hasn’t dropped as much as cards, but it certainly hasn’t recovered as fast as mortgages, obviously, supply chain issues that we know what’s going on. Is there any reason to expect that business to start cranking up again?

Dan Rees

As a market leader, I’m really happy you asked about this because it has been a sector pre-COVID that was under pressure on unit sales, back to your question on mortgages. But in F’21, auto revenue dollars had a record year, because we did a great job managing costs out of the system. We consolidated a lot of mid-office work. We automated a lot of the process. Again, that’s an indirect channel, right? So it’s digital, portal-based. And frankly, we benefited from tight inventory, meant higher price per unit, right? And so, spread actually grew during F’21, and that turn continued into Q1 even.

So, we’re optimistic even in a tight supply environment that the auto business will have, again, another positive revenue dollar year this year. It would be spectacular. It would be spectacular to see the supply chain ease for that business. Because if you look at, call it, the inflation environment, today, people are nervous about fuel prices, but car prices are way up. And I think with the trend on immigration, the first major purchase an immigrant wants to make is a vehicle. And so, I think when we see the supply chain ease, which I think feels more like 2023 than the mid to back half of this year, I think you’ll see the revenue pickup that we had lost during the pre-COVID period in auto, probably carry us quite a bit in margin in dollars in ‘23.

Gabriel Dechaine

So what -- the used versus new, was that a big spread differential?

Dan Rees

Well, used would be 25% to 30% of bookings, units and dollars. Spreads would actually be pretty similar. The spread difference is mostly a function of the risk rating of the borrower as opposed to the nature of the asset. That’s probably the easiest way to put it.

Gabriel Dechaine

Okay. And then, the other part of the auto lending business is the dealer financing. And that’s probably pretty low compared to pre-COVID, I imagine. But from a -- it’s lower spread business, correct?

Dan Rees

Yes. So floor planning, so financing the inventories of dealers is about a little less than 10% of our total drawn exposures in automotive. So, even when it’s tight, it doesn’t have a big impact on the total. And the spreads in the retail paper, which is where all the flow is, is multiples higher of commercial. And I think when we emerge back to unit growth, straight unit growth in vehicles, I think the lift is going to be on retail. So, even if commercial inventories remain tight, which we think -- again, if I put myself in the dealer spot, good for them to managing their work and process down, right, I don’t see the utilization picking up substantially on floor planning, even as retail paper reemerges.

Gabriel Dechaine

Do you see -- maybe not autos because dealers are pretty good businesses, but maybe other businesses that just don’t have enough inventory of whatever they’re selling. Is there any financial stress developing where -- I mean there’s a bike store near my house, anecdotal, they closed down because they just couldn’t sell enough bikes. They didn’t have enough despite the demand. Is there anything like that you’re seeing in your commercial book more broadly?

Dan Rees

Well, certainly, we saw -- yes, I mean, inventory -- businesses, generally speaking, anticipated inflation for the most part. And so, a number of them would have hedged early, a number of them would have accumulated -- where it’s an inventory business, accumulated inventory early if they could get it. And we have not seen any major issues in any major clients or industries with regards to friction of passing the pricing through so far to add the business on the other end of the transaction or the consumer. So, so far, it’s been okay. The persistent nature of inflation, particularly I think on the back of the conflict in Ukraine, does have us more sensitive, I’d say, to that issue for the back half of the year.

Gabriel Dechaine

Okay. Commercial lending has been a double-digit growth business for -- loan growth that is, across the board, and Scotia has certainly participated in that. I’ll just play devil’s advocate and say, it’s a one trick pony. CRE, the housing market is hot, so it’s CRE that’s driving it all. Is that accurate? Or what are some of the underappreciated drivers of commercial growth in Canada?

Dan Rees

Well, I think commercial real estate lending, CRE, has been an oversized contributor to our net advances in commercial lending, 100%. So, too have deposits. This is a self-funded business. So, if I’m over-indexing on commercial, I’m getting deposits. So, I love the fact that it’s oversized. The two pieces I would call out from an industry perspective beyond real estate would be agriculture, which I know matters a lot in this province, where we are under-indexed across a number of segments, and technology and transportation. I mean, I think the -- one of the major takeaways for business is the complexity and the cost of moving products from A to B, particularly now the cost of fuel has been underappreciated.

So, we’ve been investing heavily in all the tech hubs that you see in the top 10 Tier 1 cities. In Canada, Roynat is a brand that’s been very active in that regard. It’s a great fee business that goes along with that, as well as transportation. And I think the permanent -- I hope the permanent shift towards climate change being now much more appreciated, I think it’s going to create a whole series of technologies related to transportation. And we’ll be a big participant there, just as we have been this past year.

Gabriel Dechaine

You’ve mentioned Roynat a couple of times, now just a random question on it. I don’t -- I haven’t really spent much time thinking about it and it’s embedded in your commercial business. Like what’s the secret sauce there?

Dan Rees

Look, it’s a multi-hundred million-dollar bottom line business. It’s got ROEs well in advance of the Bank’s level. It’s growing at a rate that’s consistent with what you’d see publicly on the commercial side. It’s priced as well the risk. It’s got an entrepreneurial culture. It plays heavily in the tech space, partners extremely well with commercial and with wealth management. I think one of the earlier presenters was talking about private takeouts essentially generating opportunities for investment portfolio. So, Roynat’s secret sauce is the fact that it’s got 27 locations in Canada. It’s deeply embedded in the big cities, and the big Tier 2 cities, where there’s a lot of manufacturing happening, which I think is going to be a trend for some time, growth in Canada manufacturing and industrial, and Roynat has been a great participant there, including on the fee side.

Gabriel Dechaine

Expenses, the exciting topic to talk about. We’re going into more initiative spending, obviously dialed back during the pandemic. What’s the -- is there a way to quantify how much initiative spending contributes to your overall expected expense growth rate in your business? And then, is this year, 2022, because there’s probably some catch-up element to it, that proportion could be a bit higher.

Dan Rees

It could be a bit higher. So, I think, many of the peers have guided to higher expenses to catch up, to use your term. I think, if you’re not -- if your expense -- my personal view, especially in retail, is if your expense growth is not exceeding inflation, you’re probably not investing in the future of the business. All things being equal, we’re trying to self-fund as much of that growth as possible. Having been the head of operations globally before this job and run the structural cost transformation program, there’s always opportunity in these big franchises to take dollars out of the base budgets and sort of simplify how we operate.

I would be surprised if you don’t see a lot of peers in the 5% plus expense rate for some time. Wage inflation is the biggest driver. It’s the biggest controllable, and everyone knows that’s moving in that direction. So, I think you’ll see us continue to deliver on the main message of operating leverage is the measure that matters more than expense growth. And I think two or three years ago, we had a revenue challenge. I think we’ve dealt with that. We’ve shown that we can deliver operating leverage. So clearly, the operating piece is intact and tight. I think we’re going to be focused on growth more than expense growth rate.

Gabriel Dechaine

Got it. And then just -- you alluded to your global operations role previously. Sometimes you look at Scotia -- not just sometimes, frequently. But if I look at the consolidated picture, expense growth can be very low for several quarters. I mean, it looks like, oh, they’re under-investing, but behind the scenes, there’s robbing Peter to pay Paul, I suspect.

Dan Rees

We don’t do a lot of robbing in the -- I don’t know Peter...

Gabriel Dechaine

…analogy for banking…

Dan Rees

But one of the things we have done intentionally, and we made this marker known strategically about five years ago, is to leverage our international footprint for the Canadian franchise. And this was a spectacular result for us during COVID, because COVID arrived in countries at different levels and different rates at different times. And so, 50% of our Canadian consumers enjoy contact center calls from the Dominican, from Mexico, from Colombia, and as well as collections and fraud and hauling. [Ph] These kinds of centers that we’ve created offshore provide us with a tremendous cost advantage, a higher employee satisfaction. I’m not outsourcing anybody, so I can control recruiting the experience and all -- and toggle capacity. So that, frankly, we can satisfy customers even when there are surge scenarios. And I do think that is unique for Scotia and it’s perhaps an undertold story.

Gabriel Dechaine

Got it. Well, maybe another venue. The margin outlook, I mean, this is one where prior to what happened in Eastern Europe, we’re gearing up for a big rate hike cycle. Is there any reason -- or are you thinking of maybe a slower pace of rate increases from the Bank of Canada at this point?

Dan Rees

No. I think they’re on a trajectory that’s pretty clear now. They’ve started the wind up. Like our latest forecast is 200 basis points, I think, before the end of the year or at least in the next 12 months. The jobs number, I think, was staggeringly positive for Canada. So, that’s a huge piece of evidence that we’ve got capacity going to it that will probably trigger that rate piece. What we’re looking to find in balance is margin compression and mortgages probably to continue and automotive credit cards to come back. And ideally, those come back in sync and that allows us to manage margin in a manner that’s stable. Mortgage margin pressure, though, is going to be, I think, a challenge for the industry for at least a couple of months based on cost of funds rising.

Gabriel Dechaine

Right. Just in time for mortgage season. The prior speaker had a comment on expectations for revolver rates in the cards business. I think at least it’s not getting where it’s going to plateau, or is that what you’re seeing as well?

Dan Rees

Yes. And I think we’ve had three quarters now of sequential raw balance growth, most of that’s on the back of spend levels. Revolve balances have stabilized. This is particularly important to us because even though you would all see our balanced position being the smallest of the Canadian banks, the big banks, our yield is one of the highest. So, we’re actually quite -- our revenue line is actually quite sensitive to utilization and draws on the revolver side, the lens side of cards. And so, we’d like to see that come back a little bit faster.

We do participate in pick-up out of our Canadian Tire equity position. They run a great business. It’s a credit card portfolio that’s got about $6 billion in receivables. So, you see that show up in our fee line, which I think had a great year last year, probably the best thing you saw to the Canadian bank was fees. So, right now, it was part of that story. Canadian Tire is part of that story. And frankly, our relationship with wealth management and the referrals, whether it’s investment products as a category or mutual funds in particular, we had a spectacular year last year, including in Tangerine. So, I think we want that investment story to keep going because it’s evidence for you guys that the advice positioning we got in the marketplace still has traction.

Gabriel Dechaine

So the wealth cooperation, it’s shifting deposits into mutual funds or something else? Is that...

Dan Rees

Yes. And so, even we’ve organized now in the treasury department, this sounds like it’s an inside baseball comment. But as you think about the deposit picture of the Canadian Bank P&C segment, you want to think about it together with wealth management because customers move between the two segments, and we don’t want that to be a barrier to customer. So, Treasury looks at deposits and both as one combined opportunity.

And so, the relationship with wealth management has been excellent. In Tangerine, where we put -- we now have just over $6 billion in AUM and put $1 billion on last year; in commercial, where it’s always been tight, but we had our best year ever last year; and then, in retail in terms of funds, I think we’re number two in the marketplace. So, you would not have put Scotia in such a strong position five years ago as we are now with our wealth management franchise. And part of that is the relationship -- part of it is the relationship with the Canadian Bank.

Gabriel Dechaine

Okay. Branch question, and I think this question is maybe most relevant to Scotia, notwithstanding the relative size of the network. But what we saw from the international business last year was a substantive move to reduce the branch footprint across several countries. And the justification was digitization is ramping up, so we don’t need these branches, this number of branches. And markets are different, of course, but why can’t the same rationale be applied to the Canadian business where digitization is also ramping up and has been for years?

Dan Rees

Yes. Look, I think our view is, remains in Canada that we should be -- we should do a better job, I think, as an industry of explaining the role in the branch. And so, who goes to the branch today? Seniors, which is about 35% of the Canadian population. Small business owners, cash is not dead, okay? Small business owners are in there all the time. Our commercial real estate developers want to deposit the deposits for their condo sales at the neighboring branch. And frankly, privacy, branches offer a private conversation for mid-market customers to have a financial plan. And every piece of research will tell you that the vast majority of that mid-market Canadian segment is extremely anxious about their financial position. They’re not going to have a meeting in a coffee shop or a meeting in their living room on that, this is not happening.

And so, we’re going to continue to invest in the advisor network, invest in the digital tools they get to use and invest in the mobile technologies that allow them to fulfill when they’re on the move. And frankly, while we did see a slight decline in branch traffic and we were the branch system that kept open the most percent of branches in Canada during the pandemic, there’s a tremendous amount of foot traffic. It’s just off a little bit. And I think just like today, people want to come back in and see their advisor, right, whites of the eyes and so forth, and have that conversation. So you’re not going to see us reduce the branch count substantially in Canada.

We made an announcement recently that we’re closing 10 branches in Atlanta, Canada. We’re going to open branches more of them here in Quebec, where we’re under-indexed, in B.C. And obviously, formats are changing. But it’s a vessel in which advisors and clients want to interact. And I don’t see that changing. In international, the environment is different. They’re not selling mutual funds. They don’t need a private office for that. The mortgage market is not as advanced. And the consumer, frankly, is younger and more interested in credit cards and debit cards online. And we’re selling tons of those digitally in Canada. So product mix, consumer, et cetera.

Gabriel Dechaine

All right. Well, good timing. I guess that -- one question from...

Unidentified Analyst

[Question Inaudible]

Dan Rees

I don’t know think you hear that question on the call…

Gabriel Dechaine

Oh! I should. Yes. The question was about wealth is -- I’m paraphrasing, but the wealth business is going right now because it’s catering to boomers and their needs. But as they transition to millennials and lower-touch, lower-cost service providing, how does that affect the financials of the business, I guess.

Dan Rees

Okay. I think this is going to sound like a TV commercial kind of answer, but...

Gabriel Dechaine

We do have a break after, so.

Dan Rees

We want people to come for the advice and stay for the performance. So, younger individuals who don’t want to take advice and want to go DIY on their own. Generally speaking, those don’t work out that well, right? That said, we also know that we have sophisticated investors who do want to run their own money as part of managing their overall portfolio, so they may have a relationship with a portfolio manager and run 15% on their own, in our case in an iTRADE account. And we want to support both of those positions.

And I think what you’re going to continue to see, I think, is us introducing more channel options to address the different needs of each of those segments. I would say as a fiduciary, and we are very clear about this with the regulators, we are nervous about the propagation of -- you can build your own portfolio and retire 15 years earlier by saving a few dollars on fees. We think it’s a very dangerous message to send to Canadians at a time where they’re very anxious even about their mortgage debt. People should remember, it’s very important for Canadians to get advice on banking, investments, insurance and debt, not just investments. And I think as we begin to see more and more feedback from young Canadians about how are they going to save for a mortgage, save for a house, they have to come in for a conversation on that. They can’t do that on their own around the kitchen table. Historically speaking, it’s not successful.

Unidentified Analyst

[Question Inaudible]

Dan Rees

When the stock market is going like that, no advice looks great. When the stock market goes like this, things could turn. I don’t want either of those scenarios to happen for any of your customers or ours, but it’s very important for people to have a balanced longer-term perspective. And I think there’s a bit of exuberance in the market at the moment that it’s pretty easy to make money on your own. That’s my main message.

Gabriel Dechaine

Okay. With that, Dan, I appreciate the Q&A. Always a good time to catch up. And...

Dan Rees

Yes. Thanks, Gabe.

Q - Gabriel Dechaine

Go to break.

Dan Rees

Great turnout. Thanks a lot.

Gabriel Dechaine

You bet.