Canadian Investors: Should You Be Worried About Scotiabank Stock?

Scotiabank (TSX:BNS) stock slipped 6.4% in the first half of March, as the news of the failure of three U.S. banks created a selloff in bank stocks. The three U.S. banks failed due to loose regulatory controls and concentration in one sector. While the Federal Deposit Insurance Corporation (FDIC) cleared all withdrawals of insured and uninsured depositors of the failed banks, depositors of other banks also started withdrawing. These failures have once again brought the U.S. banking system into the limelight. 

Canada felt the after-effects of the U.S. banking crisis. Bank of Nova Scotia stock took the lowest hit because of its low exposure to the United States among the Big Six. The bank earns only 6.9% of its revenue from the United States.

But even before the U.S. bank crisis triggered, Scotiabank stock fell 5.7% on February 28. Should you be worried about the Scotiabank holdings in your portfolio? 

Scotiabank’s business model

Founded in 1832, Scotiabank takes deposits, gives loans, and earns from the difference in the interest rates and service fees. It also provides global wealth management and wholesale banking services. While the other Big Five banks expanded in the United States, Bank of Nova Scotia went further south in the Pacific Alliance countries (Mexico, Chile, Peru, and Columbia). 

Scotiabank provides personal and commercial banking services in these higher growths and high return on equity banking markets. Its presence in these countries makes it a preferred bank for cross-border solutions. The bank diversifies across services and geographies, reducing its exposure to the U.S. bank crisis. 

But the bank funds most of its loans from non-customers. This type of wholesale funding has a higher interest rate, and this rate rises faster as the market interest rate rises. Its significant exposure to wholesale funding has been putting pressure on Scotiabank’s margins. In its latest first-quarter earnings ended January 31, 2023, the bank’s revenue surged 5%. But its net income fell 15% because of higher interest expenses and a dip in wealth management income. 

Should you worry about Scotiabank? 

The most pressing concern for investors today is a bank’s liquidity. Does the bank have enough money to fund cash outflow? Scotiabank has a liquidity coverage ratio of 122%, which means it has enough cash to fund its next 30-day outflow. These are predictable outflows, and a bank keeps a buffer for any extra withdrawals. But a bank run (a large number of customers withdrawing at the same time) can put any bank’s liquidity under stress. Liquidity risk is a little lower with Scotiabank, as it has a diversified customer base that slightly reduces the risk of a bank run. 

However, Scotiabank has a higher interest rate risk because of wholesale funding. While the bank is not immune to risks, it has necessary risk controls and adequate capital. The bank’s balance sheet would benefit when interest rates fall, as wholesale bank responds faster to such dips. 

Is this bank stock a buy-the-dip opportunity? 

With high risk comes high yield. Among the Big Six, Scotiabank has the highest dividend yield of over 6.8%. It has been paying a dividend since 1833 and even increased it in 43 of the last 45 years. It maintained a stable dividend per share for two years (2020 and 2021) when the interest rate was at a record low. 

The bank grew its dividend annually in the 1980 stagflation, which was triggered by a 14.5% inflation after an energy crisis, leading to an inverted yield curve. The current scenario is slightly similar, but the markets are more efficient now. 

Long story short, now is a good time to buy this stock and lock in a high dividend yield and a seat in the bank’s long-term dividend growth. But keep your portfolio diversified across sectors and asset classes to ensure returns under all market cycles. 

The post Canadian Investors: Should You Be Worried About Scotiabank Stock? appeared first on The Motley Fool Canada.

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Fool contributor Puja Tayal has no position in any of the stocks mentioned. The Motley Fool recommends Bank Of Nova Scotia. The Motley Fool has a disclosure policy.

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