Bank of Nova Scotia (BNS) 2015 Q3 法說會逐字稿

Good morning, and welcome to Scotiabank's 2015 third-quarter results presentation.

My name is Jake Lawrence. I'm the Senior Vice President of Investor Relations for the Bank. Presenting to you this morning is Brian Porter, Scotiabank's President and Chief Executive Officer; Sean McGuckin, our Chief Financial Officer; and Stephen Hart, the Bank's Chief Risk Officer. Following our comments, we'll be glad to take your questions. Also in the room with us to take questions are Scotiabank's Business Line Group Heads, James O'Sullivan from Canadian Banking; Dieter Jentsch from International Banking; and Mike Durland from Global Banking and Markets.

Before we start, on behalf of those speaking today I'd like to refer you to slide number 2 of our presentation, which contains our caution regarding forward-looking statements. With that, I'll now turn the call over to Brian Porter.

Thank you, Jake. And good morning, everyone. I'll start on slide 4.

We are pleased with our solid Q3 results. We had strong earnings growth across our personal and commercial businesses in Canada and internationally. These results were partially offset by weaker results in Global Banking and Markets. Despite some challenging economic conditions, our well-diversified businesses and our increased focus on customers contributed to the solid growth.

Before I comment on the results this quarter, I want to highlight that we recently reached an agreement to acquire Citigroup's retail and commercial banking businesses in Panama and Costa Rica for $360 million, subject to regulatory approval. This transaction will make us a better bank in these markets. It will significantly increase our presence in the two countries by tripling our customer base and increasing our credit card market share to 18% in Panama and 15% in Costa Rica. While overall modest in size, these acquisitions are consistent with our strategy to increase scale within our existing footprint, leading to profitable market share gains, as well as cross-sell opportunities with new customers.

Now turning to our results this quarter, we earned CAD1.8 billion of net income and delivered diluted earnings per share of CAD1.45, up 4% from the same period last year. We had strong results in our personal and commercial banking businesses, which generate approximately 75% of our earnings.

The very strong performance in Canadian Banking reflected growth in our commercial, auto, and credit card businesses. Our wealth management business in Canada also performed very well. In international banking we are seeing strong asset and deposit growth in our Pacific Alliance countries, as well as an improved contribution from Thanachart. In Global Banking and Markets this quarter there were noticeable headwinds in investment banking and from the repositioning of our lending business in Asia.

Our Common Equity Tier 1 ratio is 10.4% and the Bank's capital levels remain very strong. We are well positioned to continue growing the Bank, both organically and through acquisitions. Reflective of our solid earnings growth and strong capital position this quarter, we announced a 3% increase in the dividend to CAD0.70 per share.

Overall, we remain confident that we have the right strategies in place to achieve our medium-term financial objectives. In a few moments I'll make some additional comments about this quarter's performance and our outlook for our businesses.

For now, I'll pass the call over to Sean to discuss the financial results.

Thanks, Brian.

I'll begin on slide 6, which shows our key financial performance metrics for the current quarter and comparative periods. Q3 from last year excludes the impact from a notable gain on sale. As Brian mentioned, diluted earnings per share was CAD1.45, up 4% year over year. Revenue growth continues to be good at 5% year over year, with solid asset growth in Canadian Banking and International Banking. Revenues were also positively impacted by foreign currency translation, higher fee income, and contribution from associated corporations. Partially offsetting this growth was lower net gains on investment securities and lower underwriting and advisory fees.

Our core banking margin was stable at 2.40%. Expenses were up 6% year over year. About half of this increase was driven by the negative impact of foreign currency translation and acquisitions. The balance was due to higher volume-related expenses, increases in technology and project spend reflecting business investments and efficiency initiatives.

Benefits from last year's restructuring charge have been tracking to plan, and amounted to approximately CAD40 million year to date with roughly another CAD20 million expected next quarter. These benefits, along with other initiatives, will drive a more efficient Bank and fund the increased investment we are making in technology. On a year-to-date basis, operating leverage was minus 1.1%. We expect to have flat to slightly negative operating leverage on a whole-year basis for 2015.

Moving to capital on slide 7, as Brian mentioned, the Bank continues to have a strong capital position with a Common Equity Tier 1 ratio of 10.4%. The 20-basis point decline this quarter was primarily a result of our acquisition of Cencasud's financial services business in Chile, as well as the retail and commercial operations of Citibank in Peru.

The internal capital generation was invested primarily in organic growth of risk-weighted assets from higher lending volumes, and to a lesser extent by shares repurchased in the quarter. The Common Equity Tier 1 risk-weighted assets were up CAD19 billion, or 6%, from last quarter to CAD348 billion. The increase was due mostly to the impact of the weaker Canadian dollar, as well as growth in personal and business lending and acquisitions. Our Basel III leverage ratio was 4.1%, unchanged from last quarter.

Turning now to the business line results beginning on slide 8, Canadian Banking had a strong quarter with adjusted net income of CAD863 million, up 15% year over year. These results are adjusted for the notable gain and its related contribution in last year's comparatives, as well as higher taxes on certain insurance activities as the result of a tax legislation change this year.

Loan volumes increased 3% year over year, driven by double-digit growth in credit cards, auto lending, and commercial lending. Adjusting for the Tangerine mortgage runoff, loan growth was up 6% from Q3 last year. Deposits increased 3% year over year, with retail checking and savings balances up 9% and 8% respectively. The net interest margin rose 8 basis points year over year, primarily due to a shift in asset mix towards higher margin earning assets and the runoff of lower spread Tangerine mortgages.

Compared to Q2 the margin was down 1 basis point as the benefit from continued asset mix changes was more than offset by the reduction in deposit spreads. Importantly, we maintain the step-up in margin realized last quarter.

Our performance in wealth continues to be strong. AUM and AUA levels were up 13% and 7% respectively versus the same period last year. Provisions for credit losses were up CAD21 million year over year, increasing the loan loss ratio 2 basis points to 23 basis points. The increase was primarily due to growth in relatively higher spread retail assets. As a result of the shift in asset mix, our risk adjusted margin was up 6 basis points year over year.

Expenses increased 2% year over year, primarily due to increased technology and project-related spending to support business growth, salary increases, and an increase in wealth management volume related expenses. This was partly offset by lower advertising costs and efficiency gains. Overall, Canadian Banking delivered adjusted positive operating leverage of 3.2% year to date.

Turning to the next slide on International Banking, net income increased 11% year over year reflecting strong operating performance in Latin America and higher contributions from Asia. This quarter included our acquisitions in Chile and Peru. The acquisition-related impact of bottom-line earnings was nil, but there were impacts to various revenue and expense lines, which are detailed in the appendix of our investor presentation.

Our international business continued to deliver strong loan growth, up 13% year over year, driven by both retail and commercial loans. Excluding the impact of foreign currency translation, total loan growth was up 8%, driven by 10% growth in retail loans. Latin America continued its strong loan growth, up 12% on a constant FX basis. Deposit growth in international was up 16% versus last year, or 11% adjusting for the impact of foreign currency translation.

The net interest margin at 4.77% was up 10 basis points from Q2, slightly above our range of 4.65% to 4.75%. The quarter-over-quarter increase was driven primarily due to the positive impact from acquisitions, and we expect our margin to be more in line with the range moving forward. Non-interest income reflected solid fee income growth, the benefit of acquisitions, the higher contribution from associated corporations and the positive impact of foreign currency translation.

Provisions for credit losses were up CAD51 million year over year, mostly from acquisition-related impacts, including the higher margin credit card exposures in Cencosud. Underlying PCL growth was in line with retail asset growth, while commercial improved.

Expenses were up 12% year over year, but excluding the impact of acquisitions and FX expense growth was up 6%. The increase was driven by strong business volume growth, strategic investments in growth-related initiatives and inflation, partly offset by some efficiency gains. Expense management remains a key priority for the Bank, and we expect flat to slightly positive operating leverage in International Banking for 2015.

Moving to slide 10, Global Banking and Markets, net income of CAD375 million was down 20% from last year's very strong performance. Compared to Q3 2014, this quarter had lower contributions from both investment banking, reflective of market conditions, and our lending business in Asia. Furthermore, last year benefited from an investment banking gain and a securities gain in US lending. Trading revenues increased slightly from last year.

Net interest margin was down 9 basis points year over year, due mainly to lower spreads in the US, Asia and Europe portfolios, partly offset by higher spreads in Canada. Total corporate loan volumes were up 9%. Growth in Canada, US, Europe and the positive impact of foreign currency translation was partly offset by the lower volume in Asia. Provisions for credit losses increased CAD10 million from last year, but remained at low levels. The modest increase related to transportation in Europe.

Expenses were down 3% over last year, due mostly to lower performance-based compensation. Although expense growth was well controlled, year-to-date operating leverage was negative 3.4%, reflecting lower revenue growth.

I'll now turn to the Other segment on slide 11, which incorporates the results of group treasury, smaller operating units, and certain corporate adjustments. The results include the net impact of asset and liability management activity. The Other segment reported an adjusted net income of CAD72 million this quarter, unchanged from the same quarter last year. Higher net gains on investment securities, benefits from foreign currency translation, and lower taxes were partly offset by lower results from asset liability management activity and higher expenses.

This concludes my review of our financial results. I'll now turn over to Stephen, who will discuss risk.

Thanks, Sean.

The underlying fundamentals of the Bank's risk portfolios remains solid. Before discussing current credit metrics, I would like to discuss the condition of our retail corporate and commercial credit portfolios.

Starting with retail in Canada, our delinquency rates are at the lowest levels in the past decade. Furthermore, overall credit quality is stable, with recent vintages of credit cards and auto loans performing better than prior. Utilization rates in Canadian retail are largely unchanged from last year. And we have not seen any unusual or unexpected growth in either the secured or unsecured revolving credit. As a reminder, more than 90% of this portfolio is secured against real estate and autos.

In international, the retail credit performance leading indicators are stable. We operate a diverse number of portfolios across different geographies. Some books are performing better than others. For example, improved credit performance in Peru has been offset by some deterioration in Colombia, which we expect to normalize next quarter. Overall delinquency rates are generally stable across international retail, and utilization rates are largely unchanged.

In both Canada and international, we have made investments in our collection capabilities, which have strengthened our overall lending businesses. In Canada these investments are showing good results, particularly in our higher growth portfolios of automotive and credit cards.

Looking at our corporate and commercial loan books, the overall credit quality continues to be solid. Loss levels are near historic lows and formations continue to be reasonable. The energy sector continues to be one that we are monitoring closely, and I will have more to say on our exposures in a moment.

I also want to provide a brief comment on our Puerto Rican exposure, which is detailed in the appendix of our investor presentation. Our total lending exposure in Puerto Rico is small and represents approximately 1% of the Bank's total loan book. And we feel our risks are well contained.

Now looking at this quarter's credit metrics. Quarter over quarter the all-Bank loan loss ratio increased 1 basis point to 42 basis points. Gross impaired loans were up 6% quarter over quarter. Once you exclude the impact of foreign currency translation, the gross impaireds were up 3% and our gross impaired ratio was stable. Looking at our market risk, which remains low, our average one-day all-Bank VaR was CAD10.5 million, unchanged from the prior quarter.

Slide 14 shows the trend in loss rates over the past five quarters for each of our businesses. Year over year Canadian Banking's PCL ratio increased 2 basis points due to higher retail provisions, primarily from the changes in asset mix which Sean has noted earlier, while commercial loan loss rates improved. Compared to last quarter, the PCL ratio was down 1 basis point.

Meanwhile, International Banking's loss rates increased 8 basis points quarter over quarter and year over year. Excluding the Colpatria credit mark, the International Banking PCL ratio actually fell 1 basis point from Q3 2014, but rose 9 basis points from last quarter. The increase in retail loss rates from last quarter was largely due to our acquisitions in Chile and Peru. Quarter over quarter, there were also some lower recoveries in commercial.

Looking at Global Banking and Markets, the PCL ratio remains very low at 8 basis points, up from low levels last year and unchanged from Q2. Overall, the Bank's loss rate remains low, well within our expectations, and the credit portfolios are in good condition.

Turning to slide 15, I wanted to provide an update on our energy exposure, which as noted on previous calls we have been actively managing over the past year. At CAD15.8 billion, our drawn exposures are up 2% quarter over quarter. Excluding the impact of foreign exchange, our exposures actually declined 3% from last quarter. Our undrawn oil and gas commitments stand at roughly CAD13.5 billion, up from CAD12 billion in Q2, of which CAD800 million was due to foreign exchange movements.

The credit quality of this portfolio has remained stable, with 58% of the drawn facilities being rated investment grade. Our oil and gas exposure represents just over 3% of our loan book. We have conducted stress tests at current and realistic oil prices, and have also considered secondary impacts. The stress tests indicate that any potential losses are very manageable and within our risk expectation.

As we have noted previously, companies in the energy sector have taken many steps to actively manage their financial condition, be it accessing capital markets, cutting CapEx, reducing dividends or hedging production. There have been little asset sales to date, but we would expect this activity to increase in importance as a potential source of liquidity.

This quarter we recorded no significant formations. We would expect higher formations in this sector in the coming quarters if oil and gas prices remain depressed. Given our senior secured positions, the potential related losses, as confirmed by our stress tests, would be very manageable.

With that, I'll now turn the call back to Brian.

Thanks, Stephen.

I'd like to comment briefly on each business line's performance this quarter and make some brief remarks on the outlook. Canadian Banking had a very strong quarter. All of our key business segments: retail, small business banking, commercial banking, and wealth management delivered very good growth. We had solid asset volume growth with particular strength in commercial lending, automotive, and credit cards. Our focus on these products is deliberate, as they earn us a greater risk-adjusted return for our shareholders, while also deepening relationships with our customer base.

As an example, much of our growth in credit cards has occurred with existing Scotiabank customers. Over the past year we have increased the percentage of Scotiabank customers using our cards from 20% to 30%, and we have clear plans in place to take this number higher. We have also increased our focus on deposits, with another quarter of core deposit growth.

Wealth management in Canada continues to deliver strong earnings growth, driven this quarter by continued AUA and AUM growth, as well as higher brokerage fees. As we enter the final quarter, we have had a strong year to date. Many of our businesses are performing very well, and we expect to build on this strong performance in 2016.

Looking at International Banking, we are pleased with our results. The business momentum that we had signaled earlier this year has in fact translated into solid bottom-line growth this quarter. We expect this trend to continue in Q4. We again had good volume growth in both loans and deposits. For the division overall, loans increased 8% on a constant currency basis.

Despite commodity and currency volatility, our Latin American operations continue to benefit from relatively robust growth, evidenced by loan volume growth of 12% locally. This quarter was the first to include our acquisitions of Cencosud's financial services business in Chile and Citibank's operations in Peru, which added a meaningful number of customers for the Bank and will help us grow in these two important markets.

The Caribbean continues to have mixed results, with some countries performing better than others. As we move into the final quarter of 2015 we are pleased with the improved performance in International Banking. While we have seen some moderation in economic growth across the Pacific Alliance region, we can continue to run, growing and profitable banks with GDP growth for these countries in the 2% to 3% range.

In our Global Banking and Markets division we had a weaker quarter with several factors contributing to this result. As we have mentioned, market conditions provided the backdrop for lower investment banking results, which we expect to improve in coming quarters. The repositioning of our business in Asia from a transactional to a more customer-focused lending business we expect to have completed by the end of the second half of 2016 also provided headwinds to earnings growth this quarter.

On the plus side, we had stronger results in our global equities businesses. The results in Global Banking and Markets this quarter are likely at the lower end of the earnings power we see for this business. As an extremely efficient business operation already, we expect improved revenues to drive a better bottom line. For the final quarter of 2015, our wholesale platform will remain focused on improving this quarter's results.

As we look forward, we expect the global economy to be stronger next year. That also includes a stronger Canadian economy. While there is much focus around the commodity complex, I'd like to make a couple of points. Mining and oil, gas make up less than 8% of Canada's GDP. Many of the other industries that make up more than 90% of Canada's GDP will benefit from lower commodity prices. For example, we are seeing good growth in other sectors, many related to manufacturing such as automotive, transportation, and agriculture. And lower commodity prices should ultimately be supportive of higher global growth.

With that, I'll turn the call back to Sean.

Thanks, Brian. That concludes our prepared remarks. We will now be pleased to take your questions.

(Caller Instructions)

Operator, can we have the first question on the phone, please?

Thank you. The first question comes from Robert Sedran of CIBC. Please go ahead.

Good morning. Just wanted to ask about that operating leverage in Canada. I know it's been strong for a while, but 500 basis points or so, I don't think, James, you're going to call that sustainable for foreseeable future. Can you just give some sense of what you think about the quarter, where you think it's going and perhaps also, just because you're adding some higher margin lines, like credit card and auto, is the higher level of operating leverage sustainable for your business? Maybe not 500, but more than we'd otherwise assume?

I'd say this. We're certainly not done. Let me back up a bit. We have, as you know, three all-Bank priorities. The first is being more customer-focused. The second is developing great leaders. And the third is serving customers better by reducing structural costs.

So it's that third priority, reducing structural cost, that I think's driving multiple initiatives right now across Canadian Banking and wealth. We've done a lot in Canadian Banking. We've done a lot in wealth. And there's no question you see that in the operating leverage. I feel very strongly that there's more to do.

We had our Investor Day about 14 months ago. We laid out a target, I think it was CAD150 million of improvement in expense reduction. And I think that's a number, Rob, that over the next couple of quarters we will revisit, and we'll revisit with a view to increasing it. When I look at our productivity ratio excluding wealth at 47.7% and benchmark that, I think there's still room for improvement. So this is going to be a focus for several quarters, and frankly for a few years ahead.

We've generally been assuming those efficiency gains end up getting reinvested into other growth initiatives, whether it's on the technology side or the disrupter side, whatever it is. You're suggesting that this should -- more of it should flow through to the bottom line, like we should see the operating leverage flow through?

I think it's going to be a bit of both. When I think about -- within Canadian Banking, one of our areas of focus is customer experience. And associated with customer experience is going to be a very meaningful investment in technologies. So I view structural cost reductions as doing two things. One, funding a stepped-up technology investment. And two, also driving positive operating leverage. So our goal would be to do both, step up investment in technology and continue to show a positive operating leverage story.

Thank you.

Next question, please.

Thank you. The next question comes from Mario Mendonca of TD Securities. Please go ahead.

Good afternoon, or morning, rather. A question for Stephen and perhaps Sean. When you think about what's going on in domestic retail, the strong growth we're seeing in II because of the strategic shift you're making, is there any potential that the increase in credit losses could be more back-end loaded? Specifically that as these books of business mature, you're getting the NII today, but you'll see higher PCLs later?

Thanks, Mario. It's Stephen. I'll take the first part. Certainly from a credit loss basis, actually it works the other way. In credit cards, as you will have noted over the last couple of quarters, our credit losses actually spike up, which we actually expect it's in the first 18 months as you have new campaigns and bring on new clients that you actually go through that winnowing process. And then they tend to normalize, which is what you're starting to see this quarter with our credit card PCLs starting to come down. It actually tends to be, at least on the unsecured area, an upfront basis.

As I said with regard to new vintages, both in auto and in credit cards, we've, because of the experiences we've had, we've tightened up our scoring, got better in our credit analytics. And we're actually seeing that show up in the vintages now, which are coming in much lower than previous years.

If I could just add to that, Mario. As Brian mentioned, a lot of the credit card growth is with our own customers. So we have very good sight lines on their credit paying ability. They would have other products with us, be it say a mortgage or day-to-day banking, wealth management. So we're growing this very thoughtfully, and we're doing it within our own risk appetite and we think that the losses will be contained. To your point, should these high growth levels come to a halt, then there would be some catch-up, but we're not projecting that at all.

Okay. Quick question for Mike Durland. So underwriting and advisory obviously weak. What I'm struggling with a little is to understand this all volume-based or whether this was something more of a mark-to-market nature related to some kind of transaction that may have driven this? Or is it truly just all volume?

Yes, it's all volume-based.

Thank you.

Next question, please.

Thank you. The next question comes from John Aiken of Barclays Capital. Please go ahead.

Good morning. Sean, wanted to ask a couple questions about slide number 18 in your a appendix which talks about the recent acquisitions. Obviously we saw the contribution to PCLs which ticked up the relative rank within international. Is the accounting for these acquisitions a little bit different from what we saw from the Colombia acquisitions? And I guess where I'm going from this is, are we going to see PCL increase just from accounting metrics or is this, all else being equal, this is the run rate that we should expect from these acquisitions?

We haven't finalized what we call the purchase price equation for this. But we would not expect the same phenomenon that we saw with Colombia. There will be some of that, but you'll see more -- the provisions we book on these transactions generally more in line with what the local run rate is. You won't have the similar cliff effect like we've had with the Colpatria.

Understood. Can you give us some sense of what the size of the acquisition integration costs were? I know you don't like being specific, but those being absent would we have had a sizable increase in the net income contribution?

I think this quarter's about CAD10 million or so. They'll continue on for the next quarter and a bit.

Great. Thank you.

Next question, please.

Thank you. The next question comes from Gabriel Dechaine of Canaccord Genuity. Please go ahead.

Good morning. A few questions about your international business macro. Can you give me a breakdown, maybe country by country, some of the big ones, anyway, the borrowing exposure that's denominated in US dollars? And then how those borrowers are managing the higher cost of servicing those debts, possibly? And then as global growth slows down, maybe there's another round of rate cuts coming in some of your key geographies. How are you positioning yourself for those potential outcomes?

Gabriel, it's Dieter. How are you doing? Our overall exposures on the lending side, we've about 30% linked to the US dollar, and that will be predominate to the large corporates who borrow in international markets, investment-grade borrowers, and they're holding up well. They have offsetting US revenues to deal with the US expenses. We feel very comfortable with the quality of the US dollar book and we see no deterioration in that quality going forward.

As to the interest rate cuts, it (inaudible) depends on what's happening in the inflation environment in Chile and in Peru. At this point we would hold the rate structure relatively flat, but if inflation starts to creep up we'll see the central banks moving perhaps to increase the rates a little bit. But I wouldn't include it in our forecast. And in Mexico, we largely see that following the US trends, depending on what happens to the Fed. Overall we see a fairly balanced rate environment, again, depending on inflationary pressures and what happens in the US.

Thanks. And I assume the corporates, you've probably worked at hedging their exposures as well, selling them hedging products?

We sell them the full range of products to build their hedging, and these corporates are large corporates. They're sophisticated borrowers. They have either internal hedging processes or we involve (inaudible) or swaps to help them manage their exposures.

Just a quick one on the Citi acquisition, the Panama one. What's the profitability of that business?

We see it being [incremental] when it closes sometime in January, adding between [CAD10 million] and [CAD15 million] on a run rate basis. We'll close that sometime between January and March of next year.

That's annual?

That's annual.

Okay. Thank you.

Next question, please.

Thank you. The next question comes from Steve Theriault of Bank of America Merrill Lynch. Please go ahead.

Thanks very much. Just if I could quickly just follow up to Gabriel's question. Dieter, the 30% linked to US dollars, how much of that is retail, or did you say and maybe I missed it?

The majority of that would be business banking.

So 5% to 10% retail?

Yes, that's correct.

Okay. And then just wanted to follow up with Stephen. Was also noticing the same, you added a slide on Puerto Rico, added a risk statement in the report to shareholders. So just thinking, are you flagging an increased concern that we may see some charges coming in the next little while, or are you just being ultra-conservative and giving us some additional information?

Quite frankly, we're looking to give you some context about how it relates to our total portfolio. As you know, we have taken -- we've always indicated that Puerto Rico is probably the weak link in the Caribbean and one that we've been watching the most carefully. We have taken -- there was a formation that we took this quarter in Puerto Rico with regard to a real estate project. But it really is to the latter point, that we just want to show in context where it is and it's quite manageable.

Okay. If I could just finish asking Sean, I maybe didn't see it in the disclosures, but can you tell us how much FX added to international in terms of earnings year on year?

It's on page, I think, 5 of our MD&A. On a year-to-date basis -- sorry, year over year it was CAD30 million, but down CAD8 million from Q2.

Okay. Thanks for that.

Next question, please.

Thank you. The next question comes from Stefan Nedialkov of Citigroup. Please go ahead.

Yes, guys. Hi, it's Stefan from Citi. I had a question on hedging. If you can just again maybe briefly overview your hedging policy, and how should we think about the rollover of the hedges as the end of the year? Thank you.

I'll take that. So we've chatted a bit about this in the past. You have to separate our foreign operating subsidiaries from our US earnings that we earn throughout our main Bank, mostly in GBM and that. So on that one, we have ongoing discussions of how much we want to hedge. On that one we're kind of exposed to the spot rate at the end of the quarter. So we do various levels of hedging on that piece of the book.

We've had a view all along that the Canadian dollar will weaken this year against the US dollar. So we have not hedged as much as we have had in the past, take advantage of that view. In terms of our international operations, the Mexicos, Colombias, Chiles of the world, we would hedge a small portion of that on an ongoing basis, anywhere between 20% and 30%. Those would just keep rolling over on a regular basis. So that's the earnings --

And do you expect --

Go ahead.

Do you expect any sort of cliff event in terms of hedging cost as you approach the end of the existing hedges?

No. When we do decide how much we want to hedge, we do look a t the cost of the hedges versus our view of what the markets may depreciate by. But at this point we don't see any cliff effects as we roll over hedges.

Okay. Thank you.

Next question, please.

Thank you. The next question comes from Peter Routledge of National Bank Financial. Please go ahead.

Good morning. I guess first question for either Dieter or Steve. What percent of your commercial borrowers in the International Banking segment borrow in US dollars?

What we said earlier on the question from one of your colleagues, 30% would be accessing the US markets are more in US dollars.

And what -- is that like Peru, mainly, or --

It can be Colombia, Mexico. It's a diversified corporates who do have regional and global operations that would be commodity linked and would actually be paid in US dollars that would generally borrow in US dollars.

Do you send the -- pardon me, sell them like currency hedge as well as a matter of standard policy?

As a matter of course they would have a wide range of capital market's products, swaps, hedges, forwards, whatever they require to mitigate the market influences. And these are well-managed investment-grade operations that are world-class operations and very sophisticate borrowers.

You're not worried about the currency movement?

We monitor it. It's part of our part of our credit exercise and due diligence as we put the credits on in an ongoing basis. We feel very comfortable with how the risk is being managed. Peter, I think you should think more about it as a market -- the large corporations in Latin America have access to the US market and they'll go to the US market for liquidity purposes, but they also have access to the hedge market. So they're looking for the best cost of funds, the best liquidity, and they're able to do that on a hedge basis.

Peru's partially dollarized, but you're not doing anything with small players or small companies in US dollars demonized (multiple speakers)?

Some of the, as you appreciate, some of the -- 40% of the US economy in Peru is in US dollars. There is a very strong policy direction to move to more of a local currency, [sols]. And the smaller borrowers that do have US dollar exposures, we know who they are. We're actively moving in line with policy to move into local currency. At this point the quality of those books is good. We see no significant deterioration in any of those borrowings.

And you can see it in our PCL numbers overall. You'll go flat Q over Q on a ratio basis and we're actually down from last year, year over year by 7 basis points if you take out our credit mark and acquisitions. So our book overall is very stable and we see no significant deterioration in any of our portfolios, with the exception of some isolated pockets whether it be Colombia or in the Bahamas.

Thanks very much. I'll requeue.

Next question, please.

Thank you. The next question comes from Meny Grauman of Cormark Securities. Please go ahead.

Hi, good morning. Just wanted to know your view about which unit you think is more exposed to low oil prices, is it Canada or international? When you do your stress testing, in what unit do you see a higher increase in the loan loss ratio under a stressed oil scenario for an extended period of time?

Hey, Meny. It's Stephen. I'll take that. As it relates to units, it's not so much a geographic basis. We see, as we've mentioned before, that the oil-field services, which is one of our smallest sectors, is probably the one that is going to be hit earliest and through a long cycle, the hardest. In fact, our watch list has gone up marginally in this entire sector, and it's really just due to the oil-field services part of it. So that's what we see from a sector viewpoint.

Geographically we're not seeing much difference between Canada and the US. As I said, we didn't really have any formations whatsoever the last two quarters. I would say the Canada is more of a gas play than an oil play, and quite frankly the gas prices have not been as volatile as you've seen in oil.

Next question, please.

Thank you. The next question comes from Sohrab Movahedi from BMO Capital Markets. Please go ahead.

Thank you. Stephen, can I just clarify one thing? The stress testing that you do, you mentioned there isn't much difference between Canada and the US as far as the direct lending is concerned. But in the losses that transpire in your most severe scenarios, what percentage would be attributable to your non-North American lending?

Our portfolio is, as you know, fairly diverse. About 55% of it across the entire energy spectrum is North American. So 45% is between Asia, Europe, and Latin America. Quite frankly, a lot of that is in the refinery and pipeline areas where we don't see any real potential for loan losses.

Okay. Thank you very much.

Next question?

Thank you. The next question comes from Mario Mendonca of TD Securities. Please go ahead.

Just one thing to clarify. You said that 58% of the exposure is investment grade. That was the drawn. Did you provide an undrawn number?

No, I didn't, but it's actually about 73%.

Thank you very much.

Next question.

Thank you. The next question comes from John Aiken of Barclays Capital. Please go ahead.

Good morning. Just taking a look at your exposure to China trade financing, down significantly in the quarter and this has been an ongoing trend. Was there any cost to reducing that portfolio, and did that have -- was that one of the negative factors on capital markets revenues in the quarter?

Definitely with volumes down fairly significantly that did have a negative bottom line impact to (inaudible). But it's just a pure volume.

So no actual losses on reducing the positions?

There's no PCLs. It's just lower volumes and lower net interest income contribution.

Great. Thanks.

Next question, please.

Thank you. The next question comes from Darko Mihelic from RBC Capital Markets. Please go ahead.

Hi, good morning. Two lines of questioning. The first is with respect to the global -- the investment banking operations. You mentioned Asia will be done by the end of second half 2016 and it's going to create some headwinds. So presumably there must be some loans there that are running off. Is the impact or the headwind going to come in the form of a PCL, or is it just going to come in the form of lower revenues from Asia?

It's a revenue issue. We're pivoting that portfolio. We started about this time last year. We probably have another couple of quarters left to go. Most of it's actually done. So within the next couple of quarters you'll start to see that number stabilize and start to grow again.

Start to grow again. So the concept is you're not actually exiting Asia per se, it's just as you mentioned, pivoting? Is that the best way --

It's more of a repositioning, So less trade finance, fewer accounts, more focused on our ability to cross-sell, more of a corporate banking focus.

Okay. And I guess along those lines, then, is the operation -- the end result, is it going to be smaller and will there be expense -- any changes in the expense line item?

It with be smaller and the expenses probably will come down accordingly. And a lot of that, again, has been initiated, and again we think that will be completed within the next couple of quarters.

Okay. Thanks for that. With respect to the credit quality, just a question with respect to the oil and gas portfolio. Have you seen any change in the watch list so far? And what can you tell us about what you're expecting when you go through redeterminations?

Sure. With regard to the watch list. As I mentioned, the watch list for the oil -- actually the watch list overall for the Bank has come down on the corporate commercial side. So we've actually had an improvement in the overall portfolio. As it relates to the oil and gas sectors, as I indicated it has moved up to about maybe 2.5% of the total portfolio, and this has been solely due to the oil-field services area, which as we mentioned before is the one that we consider the most vulnerable on a long-term basis.

I guess where I'm coming from is I'm wondering, is that taking into account in the watch list that what's moved to the watch list is oil-field services, I get it. With respect to the borrowing basis declining, is the expectation, should we expect that next quarter we see a large move in the watch list? And if that's the case, why not move them now?

We're at the point now where just as you've discussed with the other banks, the next borrowing base determination is coming up in October. We're setting our price decks now in anticipation of that. As you would expect, they are going to be coming down vis-a-vis where they were back in March. We do expect there will be a lot of discussions with various companies. As I indicated, some of that's already been handled because they have gone to the capital markets and beefed up their liquidity. We do expect going forward that they will have to look at some asset sales going forward. You've already seen some M&A activity that started in that sector. So we view those as all positive.

Okay. And just one last question, and I apologize for drilling into this a little bit. Your book is actually only up because of currency.

That's right.

As we roll forward, should we expect to see that go down in a more meaningful way, or is it just not that important and we should expect that this exposure will more or less remain around this size?

We've been managing the exposure. While the dollar amounts are effectively the same as they were last quarter, the actual names, I mean, we've culled some names. Some names have left because they've been able to refinance or because they've had capital markets. We've actually entered into some new relationships with some high I-grade IG investment-grade clients who we think will do well in this cycle. So there's always going to be a movement of names in and out of the portfolio, but quite frankly I don't actually see it dropping significantly over the next two quarters.

Okay. I guess that's what I was getting at. I just want to make sure that the risk appetite is more or less the same, irrespective of the oil and gas.

Exactly. We're a long-term lender and we've gone through a number of these cycles before.

Okay. That's great. Thank you very much.

Next question, please.

Thank you. The next question comes from Peter Routledge of National Bank Financial. Please go ahead.

Hi, thanks. Steve, I think in your prepared remarks you had a comment regarding Canadian retail that recent vintages are performing better than prior vintages. Did I hear that right? And if so, can you give us some color as to what's happening there?

Sure. As I indicated earlier, our credit card initiative that we started two years ago on a very strong growth plan, as indicated we went out, we've doubled, almost doubled the portfolio. That has given us more experience in taking a look, and we brought the American Express card on. So we've had some good data that we've been a able to sit there and start mining over the last 1.5 years. And from that we've been able to better reflect our data analytics as it relates to our scoring going forward. As well we beefed up, as I indicated, our collection activity, which is actually very critical in the retail side. Origination is key but the collection -- you have to have the lifecycle effect.

So we've improved both our analytics and the resources we put into the collection side. And that's really shown in an improvement with the vintages. So what we're seeing now is that the delinquencies 90 days into the loan -- into the credit card or the auto loan are below those of a year ago.

Just in terms of core operating discipline, analytics plus (technical difficulties)

Block and tackle.

Yes. I guess the next follow-on would be, when I hear Scotia is growing its unsecured retail and indirect auto share, at this stage of the credit cycle I think the vintages are going to be a lot worse. The losses and loans you're making today, the loss content is much higher. How would you respond to that?

I have to go by what we've been seeing in the book so far. What we have noticed, we've actually signed on the indirect auto, and I could leave it to James, but we signed on with a number of good OEM dealers. So our market share has picked up through that aspect of it because of our service capabilities. And quite frankly, we have an award-winning market position in indirect auto and it's been very good for us.

I would just add to that, that just as a reminder, our credit card initiative, it really has to be viewed as a part of our strategy to be much more relevant in payments generally, whether that's credit card, debit card, checks, e-transfer, we want to be there. I'd remind you that 85% of the marginal sales are to existing customers. And I think it's important also to point out that credit card balances of CAD5 billion currently, that's in the context of an CAD850 billion balance sheet. So it's hard work and it's not easy, but we actually think it's a goal on the credit card side that's been quite prudently laid out.

And as for the auto side, that business is performing well overall. It's an important business for us. It is true that loan growth is moderating somewhat due to economic conditions. And frankly, margins are under some pressure. But the overall portfolio continues to perform quite well, and that's a commitment we made at Investor Day. We're not looking to grow every portfolio at strong double-digit rate, but commercial, auto and credit cards are three that we very much are.

And there is news in the mortgage broker market about a small number of productive brokers and the veracity of their income verification procedures. You guys are big in that mortgage broker market. Have you or are you going back and double- or triple-checking or doing random testing in reaction to that news?

Obviously the issue that happened there, quite frankly their broker channel fraud was mainly related to non-prime mortgages, which is a business that we don't do. In our own mortgage channel, I should indicate that through all three channels that we use, all of it comes through my own central adjudication group. It doesn't matter which point of touch the client hits. It's the same process once it comes within to the risk area. We do require independent verification of income and we need two different sources for that. That can include pay stubs, employment letters, tax returns and occasionally verbal employee confirmation. We also are probably unique that we also have a prefunding independent group that reviews all the documentation for compliance and fraud prior to any funding.

Okay. Okay, thank you.

Next question, please.

Thank you. The next question comes from Gabriel Dechaine of Canaccord Genuity. Please go ahead.

A quick follow-up for Dieter and then one for Brian. The Citi profitability contribution you quantified, is that inclusive of integration charges you expect next year?

No, what was the answer to the question was, what would be our annual run rate, and once we (multiple speakers) That was the answer to that one.

Okay. And Brian, just from a capital perspective, I need something from a capital section in my note. How important is it for Scotiabank to have capital ratios in the upper echelons of the peer group? It wasn't always the case, but post the CI stake sale you've been consistently at the upper end of the group range. Is it important to the Board and to management to be at the upper end of that range?

Good morning. We've been very clear in terms of our -- how we deploy capital in this Bank, and we generate about 60 basis points of capital organically through earnings. We divested of the CI stake a year ago, as you mentioned. We've thoughtfully made some acquisitions, whether it's Canadian Tire Financial, Cencasud, the purchases from Citi. So we're incrementally adding to expand our market share in these important markets.

If we saw the right acquisition, we could go below the peer group average and earn our way back. Or if it's something significant that we think is on strategy and very important for the Bank going forward, we might access the capital market. But it depends on the acquisition, how appealing it is. Things are coming to us. As bank valuations around the world readjust, given what's gone on in markets, and valuations in all the Pacific Alliance countries have come down, we like optionality and we're poised and ready for any opportunities that come our way.

I was asking more maybe not so much in the M&A sphere but if the bar was raised for one of your peers because of a global standard of some sort that may not directly impact you, but would you or the Board feel compelled to move up in that direction as well?

No. The answer is no.

Okay. Thank you, and have a good weekend.

Same to you.

Thanks.

Thank you for all your questions on the call. I'll now pass it back to Brian for some brief closing comments.

Thank you everybody for participating on our call today. Despite challenging capital market conditions and a negative market tone for banks, we believe we've delivered very solid results for our shareholders this quarter and increased our dividend by 3%. Thank you again for your participation. We look forward to hearing from you in Q4.

Ladies and gentlemen, this does conclude the conference call for today. You may now disconnect your line, and have a great day.