The Bank of Nova Scotia (BNS)

Executive Summary / Key Takeaways

• BNS's two-year strategic transformation from volume-driven growth to client primacy is delivering measurable results: ROE improved 110 basis points year-over-year to 12.4% in Q3 2025, while the CET1 capital ratio strengthened by 140 basis points since late 2022, creating a foundation for sustained earnings expansion.

• The bank's "value over volume" strategy is fundamentally changing its business mix: International Banking reduced risk-weighted assets by $9 billion while improving ROE to 15%, and Global Wealth Management delivered record earnings of $1.6 billion in 2024, demonstrating that disciplined capital allocation can drive profitability even in challenging macro environments.

• Capital returns have resumed with a $0.04 quarterly dividend increase and a 20 million share buyback program, signaling management's confidence that internal capital generation of 15-20 basis points per quarter can fund growth while returning cash to shareholders.

• The new U.S. cash management platform (ScotiaConnect®) and AI-driven digital initiatives position BNS to capture cross-border trade flows and improve efficiency, but execution risk remains as fintech competitors pressure traditional banking models.

• Trading at 1.44x book value with a 4.56% dividend yield, BNS offers a compelling risk/reward profile for patient investors, though Canadian consumer stress and trade uncertainty could pressure credit performance in the near term.

Setting the Scene: A 193-Year-Old Bank Reinvents Itself

The Bank of Nova Scotia, founded in 1832 and headquartered in Toronto, is one of Canada's Big Five banks, but its story today is not about heritage—it's about transformation. Since late 2022, BNS has embarked on a deliberate strategic reset, moving away from the volume-centric model that defined its past toward a "value over volume" approach centered on client primacy. This matters because Canadian banking is a mature oligopoly where pure loan growth offers diminishing returns, and the real economic value lies in deepening relationships with primary clients who generate more than five times the revenue of non-primary customers.

The bank's International Banking segment, historically a source of both growth and volatility, operates across Latin America and the Caribbean with over 1,300 branches—an asset no other Canadian bank can match. This footprint provides unique access to cross-border trade flows between North and South America, a $1.4 trillion annual market that BNS is now targeting with renewed focus. However, emerging market exposure has also meant elevated credit costs and capital intensity, which is why the strategic pivot toward optimization rather than expansion represents a fundamental rethinking of how to extract value from this network.

Industry dynamics are shifting rapidly. Canadian regulators are scrutinizing market concentration, fintechs are eroding deposit margins, and macro uncertainty—particularly around USMCA trade negotiations and potential tariffs—has created a challenging operating environment. Against this backdrop, BNS's decision to strengthen its balance sheet by building $1.6 billion in additional credit allowances and improving its CET1 ratio by 140 basis points was not conservative posturing; it was a prerequisite for sustainable growth. The bank needed fortress-like capital levels to weather potential storms while investing in the digital capabilities required to compete with nimbler rivals.

Technology, Products, and Strategic Differentiation: The Primacy Play

BNS's competitive moat in Canada rests on two interlocking initiatives: Mortgage+ and Scene+. Mortgage+ provides preferred mortgage rates to customers who maintain a day-to-day account and at least one other product, and it now accounts for 90% of new mortgage originations. This matters because it transforms a commoditized mortgage product into a multi-relationship anchor: 95% of new clients retain their day-to-day accounts after one year, and average balances per client are 1.5 times standard acquisitions. The strategy directly addresses the "value over volume" mandate by sacrificing some loan spread to capture deposit relationships and cross-sell opportunities that drive lifetime value.

Scene+, the bank's loyalty program with 15 million members, functions as a customer acquisition engine that deepens engagement. With 25% of members now holding a Scotiabank payment product, the program creates switching costs that pure-play fintechs cannot replicate. This is critical because Canadian consumers are showing signs of stress—particularly younger demographics—and are holding more cash while reducing debt appetite. In this environment, retaining primary relationships becomes more valuable than chasing new loan volume.

Internationally, BNS is executing a regionalization strategy that segments retail clients to improve experience, boost revenue growth, and lower cost-to-serve. The bank has reduced risk-weighted assets by over $9 billion while improving ROE by 360 basis points since Q4 2023, proving that smaller can be more profitable. The sale of banking operations in Colombia, Costa Rica, and Panama to Davivienda (DVI.CX) for a 20% ownership stake is capital-neutral but strategically significant: it exits lower-return markets while retaining earnings upside through equity participation, freeing management to focus on higher-priority geographies like Mexico, Chile, and Peru.

Technology investments are accelerating. The rollout of "Ask AI" to all Canadian retail branches and the external chatbot handling 125,000 monthly inquiries represent early steps toward automation that could materially reduce cost-to-serve. More importantly, the October 2025 launch of ScotiaConnect®, the modernized U.S. cash management platform, addresses a critical gap. For years, BNS lacked the treasury management capabilities to serve multinational clients across the North American corridor; this platform, combined with a coordinated sales force across commercial and GBM, creates a differentiated value proposition that neither pure-play U.S. banks nor domestic Canadian competitors can easily replicate.

Financial Performance: Evidence of Strategy Working

BNS's Q3 2025 adjusted earnings of $2.5 billion ($1.88 per share) grew 15% year-over-year, while pre-tax pre-provision earnings increased 17%. This matters because it demonstrates that the bank can grow earnings even while holding a conservatively provisioned balance sheet. The ROE of 12.4%, up 110 basis points year-over-year, shows the capital optimization is translating into shareholder returns, though it remains below the bank's 14%+ medium-term target and well below peers like TD (TD) (17.63%) and RBC (RY) (14.73%).

Segment performance reveals the transformation's depth. Canadian Banking earnings of $959 million declined 2% year-over-year, but pre-tax pre-provision profit rose 7% quarter-over-quarter, indicating that core operating performance is strengthening despite higher credit costs. Net interest margin expanded two basis points sequentially to 247 basis points, a modest but important inflection after quarters of compression from Bank of Canada rate cuts. The segment's year-to-date operating leverage is negative 2.2%, reflecting heavy technology investments, but management expects positive operating leverage in 2026 as these investments generate returns.

Global Wealth Management delivered Q3 earnings of $424 million, up 13% year-over-year, with assets under management reaching $407 billion (up 12%). This segment is the "glue" in the primacy strategy, driving referrals and deepening client relationships. The 1.9% year-to-date operating leverage and 15.7% ROE demonstrate that wealth management can deliver both growth and profitability, a rare combination in today's market.

International Banking's Q3 earnings of $675 million rose 7% year-over-year, with ROE hitting 15% (up 180 basis points). The segment achieved this while reducing loans 3% and keeping deposits flat, proving that balance sheet optimization works. Net interest margin expanded 13 basis points to 4.54%, driven by lower funding costs from central bank rate cuts in Latin America. The Global Banking and Markets business within International Banking generated $313 million in earnings, up 12%, showing that the capital reallocation toward higher-returning activities is paying dividends.

Global Banking and Markets (GBM) delivered the strongest performance, with Q3 earnings of $473 million up 29% year-over-year despite a 14% decline in loan balances. This is the purest expression of "value over volume": by focusing on fee income, capital markets revenue, and advisory services, GBM increased pre-tax pre-provision earnings 29% and ROE by 310 basis points. The U.S. business contributed 42% of GBM earnings, validating the North American corridor strategy.

The consolidated loan-to-deposit ratio improved to 104% from 116% in Q4 2022, while wholesale funding to total assets fell 280 basis points to 18.8%. These improvements matter because they reduce funding costs and liquidity risk, directly boosting net interest margin and earnings stability. The bank's economists forecast no further rate cuts in 2025, which should stabilize deposit margins while the benefits of prior cuts continue flowing through wholesale funding costs.

Outlook, Guidance, and Execution Risk

Management's guidance frames 2025 as a transitional year, with EPS growth of 5-7% (including KeyCorp benefits) accelerating to double-digit growth in 2026. This outlook assumes a stable macro environment and no meaningful tariff implementation. The target of 14%+ ROE over the medium term remains intact, with management expressing confidence that the bank is "tracking at or above what we said we were going to do" seven quarters ago at Investor Day.

The capital deployment framework is clear: growth first, then credit migration, then buybacks. With internal capital generation of 15-20 basis points per quarter expected through 2026 and into 2027, BNS has ample firepower to fund loan growth while returning capital. The 13.3% CET1 ratio provides a 70-80 basis point buffer above the bank's 12.5% target, representing $3.5 billion in deployable capital. The 20 million share buyback authorization, worth approximately $1.5 billion at current prices, offers optionality to return capital if valuation remains depressed.

Credit performance will be the critical swing factor. Management built $470 million in performing allowances year-to-date, bringing the total ACL ratio to 96 basis points. This conservative positioning matters because it provides a buffer against potential deterioration from Canadian consumer stress or trade-related economic disruption. The Q3 impaired PCL ratio of 51 basis points improved 6 basis points quarter-over-quarter, but management remains cautious, noting that if tariffs are imposed, the impact would likely be a lagged 2026 event rather than immediate.

International Banking's transformation should complete by end-2025, with management expecting to "grow with the market" in 2026 after the client deselection program ends. The focus on Global Transaction Banking as a key growth engine leverages BNS's universal bank model in Latin America—providing payroll services across multiple countries at scale, something neither U.S. nor Canadian competitors can easily replicate. This positions the bank to capture cross-border trade flows as USMCA uncertainty resolves.

Risks and Asymmetries

The primary risk is external: Canadian consumer health is "really mixed," with rising delinquencies in fixed-rate mortgages offsetting improvements in variable-rate clients. The 90-day mortgage delinquency rate held steady at 24 basis points in Q3, but this stability masks diverging trends. Younger demographics (18-26) show particular stress, and credit card performance requires close monitoring. If unemployment rises meaningfully or trade tensions escalate, the $470 million in performing allowances may prove insufficient, forcing material provision builds that could derail the 5-7% EPS growth target.

Trade policy uncertainty represents a binary risk. Management's base case assumes modest tariffs (5% on half of Canadian imports, 10% on half of Mexican imports), but a more severe scenario would require additional expert credit judgment overlays. The bank's International Banking segment is most exposed, particularly in Mexico, where management expects negative GDP growth in 2025. While diversification across Chile, Peru, and the Caribbean provides some buffer, a synchronized regional downturn could pressure the 15% ROE achieved in Q3.

Execution risk on digital transformation remains material. While Mortgage+ and Scene+ show strong early metrics, the bank's year-to-date negative operating leverage in Canadian Banking (-2.2%) reflects heavy investment in cloud, payment platforms, and channels. If these investments fail to generate the anticipated returns in 2026, the bank could face a prolonged period of margin compression just as macro headwinds intensify. Competitors like TD and RBC are further along in their digital journeys, potentially giving them a cost advantage that BNS cannot close.

The KeyCorp (KEY) investment, while immediately accretive, introduces concentration risk. A 20% ownership stake ties BNS's fortunes to a regional U.S. bank facing its own credit and interest rate challenges. If KeyCorp's performance disappoints, the expected earnings pickup could fall short, though the capital-neutral structure limits downside.

Valuation Context

At $69.29 per share, BNS trades at 1.44x book value and 18.58x trailing earnings, a significant discount to historical levels for a bank of its quality. The 4.56% dividend yield is among the highest in the Canadian banking sector, providing downside protection while investors wait for the transformation to fully materialize. The price-to-free-cash-flow ratio of 6.55x and price-to-operating-cash-flow of 6.43x suggest the market is pricing in minimal growth, creating potential upside if management delivers on its 14%+ ROE target.

Relative to peers, BNS's valuation reflects its lower ROE (8.58% TTM, but 12.4% in Q3) and EM exposure. RBC trades at 2.44x book with 14.73% ROE, while TD commands 1.64x book with 17.63% ROE. However, BNS's forward P/E of 13.64x is in line with TD's 14.50x and below RBC's 16.62x, suggesting the market is beginning to price in the turnaround. The key asymmetry is that BNS's valuation doesn't yet reflect the potential for double-digit EPS growth in 2026, while peers are priced for continued steady-state performance.

The bank's strong capital position (13.3% CET1) and improving funding profile (loan-to-deposit ratio at 104%) provide valuation support. Unlike during the 2022 period when wholesale funding reached 21.6% of assets, the current 18.8% level reduces vulnerability to market volatility. This improved balance sheet quality justifies a higher multiple than the market currently assigns, particularly as credit costs normalize and operating leverage turns positive.

Conclusion

Bank of Nova Scotia's strategic reset represents a fundamental rethinking of how a 193-year-old bank creates value. The transformation from volume-driven growth to client primacy, combined with disciplined capital allocation and balance sheet optimization, is delivering measurable improvements in ROE, capital efficiency, and earnings quality. While the market remains focused on near-term macro headwinds and Canadian consumer stress, the underlying metrics—140 basis points of CET1 improvement and $9 billion in RWA reduction—tell a story of a bank building a durable competitive advantage.

The critical variables to monitor are credit performance in Canadian retail and the pace of digital investment payback. If management can navigate the current macro uncertainty while delivering on its 2026 double-digit growth target, the valuation gap with peers should close, providing meaningful upside from current levels. The 4.56% dividend yield offers compensation for patience, while the resumed buyback program demonstrates conviction that the transformation is working. For investors willing to look beyond near-term noise, BNS offers a compelling combination of improving fundamentals, attractive valuation, and strategic optionality that is rare in today's banking landscape.