Bank of Nova Scotia Soars, But Rate Risk a Concern
Bank of Nova Scotia rode declining interest rates to unexpectedly strong earnings in the first quarter, spurring shares to hit a new 52-week high.
But just as falling rates boost earnings, the big Toronto bank could suffer if rates turn against it, analysts warned.
When the Toronto Stock Exchange closed Wednesday, the bank's shares were trading at $17.875 Canadian, or $15.62 a share in U.S. dollars. That was 44% higher than at the start of the year.
A Rate Play for Investors
At a time when more and more banks are matching their assets and liabilities to reduce rate sensitivity, Scotia Bank's parent is an exception.
Although other factors, notably its real estate exposure, affect its performance, BNS is one bank that offers investors an opportunity to make an old-fashioned interest rate play.
Scotia Bank was the only one of the five major Canadian banks reporting quarterly results by Wednesday to exceed analysts' expectations. It earned $163.3 million (Canadian), or 73 cents a share in the quarter, compared to $133.1 million, or 61 cents a share in the same quarter last year.
Investors responded positively to the strong results, said Kevin R. Choquette, an analyst at First Boston Co.
Nevertheless, Mr. Choquette was not sufficiently impressed to change his "hold" rating. "I view it as a trading stock with a lot of volatility," he said.
The shares were trading above $19 (Canadian) in mid-1989, Mr. Choquette said, but they reached a low of about $10.75 six months ago.
The bank performs better when interest rates fall, Mr. Choquette said, because rates the bank pays on liabilities change more often than the interest received on assets. A bank subject to this kind of repricing is "negatively gapped."
With rates declining for six months, the bank's earning power has been stronger, and that is reflected in the share price, Mr. Choquette said.
Margin Widens by 47 Points
As a result of its gap position and changes in rates, the bank's interest margin - the spread between what it pays for money and the rate at which it makes loans - widened by 47 basis points in the quarter, to 299 basis points. The result: net interest income of $632 million.
These gains far outweigh deterioration in the bank's credit quality. Nonperforming assets rose by about 7.2% in the quarter, to about $1.4 billion, or 2.4% of loans. Like others in Canada, Scotia Bank has had such upticks in loan problems lately. It is especially exposed in the U.S. market, where it has about 40% of its realty portfolio. [Graph Omitted]