Bank of Nova Scotia

Bank of Nova Scotia reported strong fiscal third-quarter results, with adjusted net income growing 20% year over year. The results translated into an adjusted return on equity of 14.2%, reaching its medium-term target of 14%-plus ahead of its original fiscal 2028 plan.

Why it matters: The global banking and markets, or GBM, segment was the brightest spot, booking record earnings of CAD 647 million, up 37% year over year. Global wealth management also delivered solid growth of 23%. Diving deeper into the GBM segment, the bank booked a record level of underwriting and advisory revenue. We are glad to see Scotiabank has gained exposure to high-profile Canadian deals, such as the Apotex IPO. Markets revenue was also at a record level of CAD 1.1 billion, with equities trading as the biggest driver. Although the third quarter is usually seasonally weaker in the trading business, we surmise high-profile US IPO filings and artificial intelligence-related trade were both strong drivers for higher equity trading volume.

The bottom line: As we incorporate third-quarter results, we plan to increase our CAD 104/USD 75 fair value estimates for narrow-moat-rated Scotiabank by around a mid- to high-single-digit percentage. We continue to view shares as overvalued. The valuation increase will be primarily driven by higher wealth management and underwriting and advisory fee income, as well as higher net interest income growth in fiscal 2026, partially offset by higher compensation expense growth.

Between the lines: Amid the latest tariff announcements between the US and Canada, Scotiabank did not make material changes to its credit guidance in fiscal 2026, similar to peer Bank of Montreal, which also reported earnings Aug. 25. Management expressed that it was comfortable with the bank's current allowance levels and alluded to its original guidance of a lower impaired provision for credit loss ratio in the second half of fiscal 2026.

A maintained and severe tariff situation would lead to higher credit costs and lower balance sheet growth for Bank of Nova Scotia as well as other Canadian banks. That said, potential government-supportive measures would help alleviate the negative impact on Canadian banks' profitability and returns. Scotiabank also has a strong capital position to weather potentially higher credit costs, with the bank ending the third quarter of fiscal 2026 at a common equity Tier 1 ratio of 13.1%, 210 basis points above its current regulatory minimum of 11.0%.

The bank's investment in its domestic wealth management business is yielding results. Management noted that the bank's current retail penetration of asset management is around 11.6%, which improved 160 basis points compared with the 10% in fiscal 2023. While this still lags wide-moat peer Royal Bank of Canada's retail mutual fund penetration rate of 16% (per RBC's 2025 investor day disclosure), increasing fee income penetration in retail banking clients will increase customer switching costs and drive higher profitability and returns. The global wealth management segment reported a strong return on equity of 18.6% in the third quarter and up 290 basis points year over year, though market appreciation was a very constructive factor.

We are increasing our fair value estimate to USD 78 per share from USD 75. We now incorporate higher investment banking and asset-based fee growth. We now expect the bank to grow its total fee income at a five-year CAGR of 4.6% from 2025 to 2030, excluding the impact of divestitures and up 80 basis points compared with our prior model. We also increase our five-year net interest income CAGR to 4.1% from 3.6% over the same time period. Partially offsetting higher revenue growth, we also raise our expense growth forecast, though our normalized efficiency ratio still improves by 50 basis points to 52.6%. Our fair value estimate is equivalent to 2.1 times tangible book value as of July 2026. We use an exchange rate of USD 0.72/CAD 1.

Scotiabank’s loan growth has been below 2% in the past three years, reflecting its international optimization efforts. We now expect loan growth to reaccelerate in 2027, mostly driven by the international banking segment's divestitures. We project net interest income to increase 6.2% in 2026 and expect net interest margin to rise to 1.61%, up 2 basis points from 1.59% in 2025. From 2027 through 2030, we forecast net interest margin of 1.64%-1.65%.

We expect credit costs to remain elevated in fiscal 2026 and forecast a provision for credit losses ratio of 55 basis points, down from 62 basis points in 2025. We expect around 52 basis points of provision for credit losses ratio in 2027.

We project adjusted noninterest income to grow at a 4.6% CAGR from 2025 to 2030. We now expect 2026 underwriting and advisory fee income to grow 20% from 2025. Predicting capital markets revenue is inherently challenging, and we still think the capital markets business is highly volatile. We caution investors that a reduction in the revenue base will lead to a much larger decline in profitability, given the business' high operating leverage. We also raise our 2026 wealth management fee income growth to 13.7% from 11.8%, driven by the strong inflows and market appreciation.

We forecast adjusted expense growth of 5.1% in 2026, excluding the CAD 1.4 billion impairment loss and CAD 373 million of restructuring charges. This represents a meaningful slowdown from 8.6% growth in 2025, which was driven largely by higher headcount and variable compensation. We expect Scotiabank’s efficiency ratio to normalize at approximately 52.5%, above management’s long-term target of 50%. Our assumptions imply an average return on tangible common equity of 16.8% over the next five years. We apply a 9.3% cost of equity, including 90 basis points of country risk premium due to Scotiabank’s elevated international exposure.

We assign Bank of Nova Scotia a Morningstar economic moat rating of narrow because it possesses durable cost advantages and switching costs that are consistent with our bank moat framework. We assign a narrow moat instead of wide because the bank has lower relative exposure to Canada (roughly 55% of revenue) and its market share in Canada is less dominant than that of its larger peers. Additionally, the bank has a large Latin America footprint with more volatile and often dilutive returns to the group. That said, we are confident that the bank will earn a normalized return on tangible common equity around 16.8% through the cycle, comfortably above its 9.3% cost of equity.

Bank moats are derived primarily from cost advantages and switching costs, and we believe the Canadian banking environment offers systemic cost advantages and switching costs that lead to returns above the cost of capital, allowing the big banks operating under its jurisdiction to possess moats. In Canada, switching costs stem from a tightly regulated oligopolistic market structure (Big Six Canadian banks control more than 95% market share), which limits competition, stabilizes pricing, and reduces customer incentive to switch banks. Cost advantages stem from a low-cost deposit base, strong operating efficiency, and conservative underwriting, reinforced by a Canadian regulatory environment favorable to the big banks. This combination produces lower operating, credit, and regulatory costs, along with lower and better-diversified risk, supporting higher risk-adjusted returns for the big Canadian banks.

Canada's favorable banking environment stems from several factors. First, barriers to entry are very high. Nonresidents may not own more than 25% of a bank's shares without government approval, and foreign banks face operating restrictions. Domestic competition is also controlled, as exclusive federal chartering control has entrenched a few large banks. Second, a protective, efficient regulatory system also drives cost advantages through risk reduction. Regulators need only monitor the Big Six banks, far simpler than overseeing thousands of US banks, fostering collaboration and coordinated responses to strain. Regulators also help control mortgage pricing, limiting pricing wars that erode underwriting standards. Rules curb bad credit issuance through mandatory insurance on riskier mortgages, the absence of a GSE-like subsidized securitization market, and requirements that banks hold more risk on the balance sheet. A higher-tax, stronger safety-net model has fostered a more stable middle class, supporting political stability and further reducing systemic risk. Combined with government subsidies on deposits and mortgage insurance, and the implicit too-big-to-fail subsidy (all Big Six banks are domestic systemically important banks at a minimum), these factors create an environment where excess bank returns are almost certain in Canada.

Scale further reinforces these cost advantages. Larger scale spreads fixed costs, improving efficiency, as the five largest Canadian banks are all bigger than the largest US regional bank. Nationwide branch networks lower customer acquisition costs. The banks span nearly every major financial product, generating economies of scope on top of economies of scale.

Within the Canadian banking system, Scotiabank ranks as the third-largest bank behind RBC and TD, but it still has a domestic deposits market share in the midteens and loan market share in the high teens. The bank derived around half of its earnings from domestic banking. Scotiabank's Canadian segment's operating efficiency is better than smaller peers like CIBC and National Bank of Canada, though it lags wide-moat peers like RBC and TD. Looking ahead, we expect Scotiabank’s Canadian banking business to earn well above its cost of equity with historical returns on equity generally above midteens.

Beyond Canada, Scotiabank has a large international footprint, mostly in Latin America, which contributed to around one-third of its 2025 earnings. The bank also had around 18% and 19% of earnings from wealth management and capital markets.

We don't assess Scotiabank's international banking business as moaty. Scotiabank tends to have higher credit costs than its Canadian peers due to its Latin American exposure. While the bank's international exposure is often in higher-growth markets, its scale often lags local leaders. In these markets, the largest players with the most scale tend to earn the best returns and be the moatiest (such as Banco de Chile, BBVA in Mexico, and Santander in multiple locations). The bank is improving its scale in some of its international markets and divesting some of its lower-return markets, but we would like to see more progress (higher profitability and less volatile returns) before awarding a moat to its international banking business.

We think Scotiabank's wealth management business segment is worthy of a narrow moat from switching costs. The bank expanded its domestic asset-based businesses through several acquisitions, which enhanced its scale and market share. In addition, Big Six banks and Big Three life insurers have taken shares from pure-play asset managers, a trend we expect to continue given their larger distribution networks and more fungible pricing across their broader product sets.

Lastly, we think Scotiabank's capital markets business has brand recognition that provides a competitive advantage for garnering investment banking deals and recruiting top talent. While we don't view its trading business as moaty, it's deeply intertwined with its investment banking and business and serves as a crucial part of the bank's value proposition to institutional clients.

The bank’s incremental capital allocated to Canada should allow it to earn more domestic share and improve its return profile.

Scotiabank’s investment in client primacy has led to an increase in multiproduct Canadian client relationships, which should be accretive to the overall bank's returns.

Scotiabank's international banking segment has improved its return profile over the past two years, thanks to its optimization efforts and decision to exit some subscale markets.

Scotiabank's loan growth has lagged its Canadian peers for the past several quarters, and it's hard to tell when the bank will see an acceleration in loan growth.

Scotiabank is aiming to increase its Canadian credit card market share, which might lead to higher credit costs if the unemployment rate increases significantly.

Scotiabank has a Mexico earnings exposure in the low teens, which puts it at more risk of higher credit costs if US-Mexico tariffs are enacted after delays.