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Morningstar | Digital investment and efficiency gains should pay off for Bank of Nova Scotia.

Bank of Nova Scotia is the third-largest bank in Canada by assets, and is one of six Canadian banks that collectively hold almost 90% of the nation's banking deposits. The bank is known as Canada’s most international bank as it derives half of its revenue from Canada, over 40% from international operations (primarily Latin America), and a single-digit percentage from the United States. Its domestic operations are more concentrated in mortgages and auto lending, with leading market share in autos. The bank is also expanding its domestic wealth operations significantly with its latest acquisitions. The international exposure gives the bank the potential for higher growth and return opportunities compared with peers. However, it also opens the bank to more risks. While the Latin America region has been more stable in the past decade, there are risks that this may not continue. A return to political instability, higher credit losses, and inflation have higher likelihoods than for more mature markets. Bank of Nova Scotia remains focused on increasing its international operations in Latin America) and is paring some of its operations in Asia. We highlight that some of the prices paid for acquisitions in Latin America have been on the higher end, and Scotiabank often is not one of the top market share holders in these markets. This tends to limit returns, even if the strategy may result in higher growth rates. After numerous acquisitions, the bank is in the middle of rationalizing its many back-end systems and improving efficiency bankwide. By 2021 we believe the bank should be on the verge of breaking through a 50% efficiency ratio and overall should be one of the most efficient Canadian Banks on a bankwide basis. We also like the bank’s digital efforts. While all banks in Canada are engaged in similar ongoing investments, Bank of Nova Scotia has been spending the most on its technology and communication expenses. We think these efforts will ultimately pay off in the form of improved operating efficiency, customer engagement, and internal sales coordination. This leads us to believe that returns on equity near 14%-15% are sustainable over the medium term for the bank.