Better Banking Through Geography

06/16/2011 8:30 am EST

Focus: GLOBAL

David Dittman

Chief Investment Strategist, Australian Edge, Canadian Edge, & Utility Forecaster

Scotiabank has been able to transform its emerging-market expansion into a robust profit center, writes David Dittman in Canadian Edge.

Since the official start of the recession in the United States, the Bank of Nova Scotia (BNS)—better known as Scotiabank on the Main Street level—has bested broad stock-market indexes such as the S&P 500 and the S&P/Toronto Stock Exchange, as well as all of its major Canadian peers.

Of course, it’s trounced big American banks, too.

And it was one of three Big Six Canadian banks that exceeded fiscal 2011 second-quarter expectations, and left analysts looking forward to sustainable growth in quarters ahead.

That the world is undergoing profound political and economic changes is more evident every day. The US will remain the epicenter of global power, but that power is becoming more diffuse. This shift coincides with the rise of new economic engines in what were once underserviced regions of the world—new middle classes in Latin America and Asia.

This is the key to the long-term investment story in Canada.

The US—with which it forms, still, the largest bilateral trade relationship in the world—will always be a key to Canada’s growth. But inexorable demand for resources has Canada at the crossroads of emerging and developed markets. Its stable institutions make sure wealth is built for the long term.

International Exposure
I’d slapped a generic “buy” recommendation on Scotiabank in April 2007, “for the healthy yield and its effective entry into the global banking market.” These investments continue to pay off.

Scotiabank has long been our favorite among Canadian banks. Fiscal 2011 second-quarter results demonstrate that it is a model for a country that is, and should be, reorienting its own economy to capitalize on new realities.

Although National Bank of Canada (NTIOF) again stole some of the spotlight by boosting its dividend, Scotiabank’s international exposure shines—in particular, operations in Mexico and Chile, but also emerging markets in Southeast Asia.

The expansion points a clear path to continued increases in lending, and opportunities to boost net interest income (what banks receive in interest on assets such as commercial loans and personal mortgages, minus what they pay out for interest on liabilities such as bank accounts).

Bank of Montreal (BMO) also exceeded forecasts, but it, like National Bank, is more deeply rooted in North America than Scotiabank. The same goes for Royal Bank of Canada (RY), the country’s biggest, as well as Toronto-Dominion Bank (TD) and Canadian Imperial Bank of Commerce (CM), the second- and fifth-largest.

Margins are shrinking at home and in the US, the Big Six are undercutting each other on mortgages and commercial lending to win market share. This is starting to erode what makes up the lion’s share of profits for the banks.

Scotiabank wasn’t immune to local troubles—like the other Canadian banks, trading revenue was soft, and North American margins deteriorated. But its greater exposure to international markets set it apart, as Peru, Mexico, and Chile generated fatter margins and growing loan volumes.

Global Profits
The bank reported cash earnings per share of C$1.12, up 8% from a year ago and 3 cents better than the consensus forecast. Net income for the three months ended April 30 climbed 41%, to a record C$1.54 billion (C$1.36 per share), from C$1.1 billion (C$1.02 per share) a year ago.

One of the pillars of the Canadian story from an American perspective is diversity: Canada is a vehicle to gain exposure to emerging markets while building wealth over the long term. Scotiabank in many ways embodies this; its diversification reduces vulnerability and provides other sources of growth.

The major banks all reported a drop in net interest margins in their Canadian operations. Scotiabank’s retail banking profits fell 1.6% to C$444 million, as its net interest margin declined to 2.32% in the second quarter from 2.42% the first quarter and 2.58% a year ago.

The international front was a much different story. Net interest margin was 4.44 percent, up from 4.29% in the first quarter and 4.04% a year ago, driving a record profit of C$376 million. Cash earnings from international operations rose 46%.

Bank of Nova Scotia is a buy up to $60, based on its geographic diversity. [Shares have experienced some chop of late as they brush against $60, and were trading at $58.25 midday on Wednesday—Editor.]

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