Transcript - Focus Americas Podcast Ep. 1: Q4 earnings reflect Pacific Alliance resilience
Welcome to Focus Americas, the new podcast brought to you by Scotiabank Perspectives. Focus Americas examines economic and political developments affecting countries across the Americas. Host Phil Smith, head of Investor Relations at Scotiabank, talks to thought leaders inside and outside the bank for their insights on forces that are driving those developments, from Canada in the north to Chile in the south.
Philip Smith: Hello, and welcome to Focus Americas. Today we’ll be discussing the fourth quarter and 2020 year-end financial results for the bank’s International Banking Division. My name is Philip Smith, head of Investor Relations, and I’m joined today by Nacho Deschamps, Executive Vice President and group head of International Banking and Digital Transformation, who’ll be discussing the results of international banking. I’m also joined by Jean-Francois Perrault, Scotiabank’s chief economist, who’ll be discussing the economic situation and outlook for the Pacific Alliance in Latin America. Before I begin, I would like to draw your attention to Scotiabank’s caution regarding forward looking financial statements, which appears on page 2 of the bank’s Q4 investor presentation.
I’d like to start the podcast off by talking to JF about the economic situation in the Pacific Alliance. JF, could you provide a quick economic update on each of the Pacific Alliance countries with a focus on the status of COVID and the status of lockdowns today?
Jean-Francois Perrault: Sure thing. The big picture is the Pacific Alliance countries are recovering rapidly and, if anything, they’ve been surprising on the upside, so, generally speaking, pretty good news. The most recent GDP prints confirm that a strong rebound occurred in the third quarter, and a range of higher frequency data confirmed that this is extending into year end. Like other economies, however, no one’s out of the woods. There remains risk associated with the virus, which, for the most part, has yet to surge again in the Pacific Alliance countries and may not in fact do so. Also, for all countries in the region, the global rebound observed to date and in particular the strength in China has left a significant increase in commodity prices, which, of course, benefits the region as a whole. Now, if I go through each country individually, let’s start with Chile.
Chile is the least affected by the pandemic and the country that’s rebounding the most. Economic activity fell by a little bit more than 5% in 2020 and is going to rebound by a similar amount in 2021. Chile is expected to return to 2019 Q4 levels of economic activity as soon as the first quarter of 2021. That’s extremely rapid and much more rapidly than most other major countries. Business confidence, retail sales, unemployment are at or higher than they were pre-pandemic, and we expect that to continue. There are of course risks associated with the constitutional referendum, but these appear quite manageable at present.
In Columbia, the virus and the decline of oil prices generated a 7.5% reduction in economic activity this year, but a strong rebound is also underway given the easing of lockdown restrictions. Employment, manufacturing activity, and retail sales have all returned to close to pre-pandemic levels, and incoming data are also generally surprisingly on the upside. We’re looking for growth of around 5% in 2021.
Peru has been one of the worst hit economies, with economic activity expected to contract by around 11.5% owing to the virus. While it took some time for authorities to gain control over COVID, it’s now under control and the economy is rapidly recovering. We anticipate growth of 8.7% next year as industrial activity continues to rise as well as residential and nonresidential construction. Cement sales are currently above those seen in 2019 and auto sales are well above the 2018-19 average. The presidential transition came as a surprise, of course, but the new government seems likely to ensure stable economic policy until the election.
In Mexico, managing the economic impacts of the virus has been more challenging there given the government’s insistence on maintaining fiscal probity in light of the pandemic. Economic activity likely fell around 9% this year and is expected to rebound by more than 3% in 2021. A rebound is clearly underway with the GDP expanding by 12% in the third quarter but the strength of the recovery lags that of other Pacific Alliance countries owing to the lack of direct policy support. We look for recovery to gain momentum in the next few months, and there is a possibility that a Biden fiscal expansion, if it occurs, will greatly benefit Mexico. We’re already seeing signs of industrial rebound in Mexico as demonstrated by the sharp rebound in manufacturing exports, which are in fact above pre COVID levels.
Philip Smith: So, JF, if you look at the outlook for 2021, what are the major macroeconomic factors that investors should be focused on, in your opinion?
Jean-Francois Perrault: There’s a couple of really big things. The first is the global rebound. So, we’re clearly experiencing, as I said, a rebound in global economic activity. What we’re waiting for is to see how President Biden’s policies affect US economic growth. We anticipate that’s going to be positive, which would be a good thing for everybody, but also if the US and China both surpass expectations next year, which is quite possible given a relaxation in trade tensions and the vaccine, we should see the reflected commodity prices and demand for Pacific Alliance products. We’re also looking at the global risk environment. Risk perceptions have been a major driver of currencies and capital flows over the last year, and we generally expect a reduction in risk to continue, putting downward pressure on the US dollar and of course upward pressure on capital flows and on currencies of other countries, including those of the Pacific Alliance in general.
Philip Smith: There’s a lot of focus right now certainly in banking and financial services in general on the interest rate environment. What’s the outlook for interest rates and inflation in the Pacific Alliance?
Jean-Francois Perrault: All central banks have cut rates in response to the pandemic, its impact on growth and inflation dynamics. The rate cutting process has been remarkably smooth from a capital market perspective as has a reaction to the wide range of policy measures implemented by Pacific Alliance countries. Policy rates are expected to remain at current levels in Mexico and Chile through 2021, though we think the Chilian Central Bank may try to flatten the yield curve at its December meeting owing to the downward pressure on inflation. In Columbia, rates should remain at current levels until the second half of next year, at which point they’re expected to rise gradually to keep inflation at the central bank’s 3% target. A similar dynamic is expected in Peru.
Philip Smith: So, just to close off the questions for you and away from just the near term outlook and maybe a more fundamental question, has the pandemic changed the attractiveness of the Pacific Alliance as a market, in your opinion?
Jean-Francois Perrault: Not at all. I think of it this way. The economies have experienced an incredible stress test, and much like the advanced world they’re coming out of this historic event at a pretty good pace. You know, the deep fundamentals have not changed. They’re a young population, a rapidly growing population in middle class, they’re globally connected economies with lots of trade deals, they’ve got sound and now very clearly tested policy frameworks. If anything, the pandemic has demonstrated the resilience of these policy frameworks and the authority’s ability to manage incredibly challenged economic circumstances. So, to those who look at these markets as risky and somewhat untested, what we’ve experienced in recent months should be quite comforting.
Philip Smith: Thanks, JF. Maybe now switching away from the macro outlook and toward the performance of international banking specifically. Nacho, could you walk us through the performance of international banking in Q4 in 2020 and maybe in your remarks focus a little bit, as well, on the outlook for 2021?
Nacho Deschamps: For sure, Phil. Well, in Q4 20, we had a material improvement in our earnings compared with Q3, mainly driven by reduction of PCL. Our revenues had a positive development increase by 2%, mainly driven by improvement in noninterest income, and these positive effects were partially offset by a declining net interest income aligned with lower loan balances in the quarter. Loan reduction was mainly driven by the decline of business loans as our customers repaid their short-term funding lines. Despite this decline, we grew business loans 10% year over year. Expenses were high this quarter but still went down 2% year over year. The increase in the quarter was due to the implementation of cost savings and digital initiatives mainly in the retail business that will give us future savings. Looking at whole year results and putting things in perspective, the Pacific Alliance countries have shown significant resilience. Pre-tax/pre-provision whole year was almost flat despite a historic recession. Our loans grew 10%, driven by commercial and mortgages, while deposits grew at a similar pace. Earnings were materially down compared to last year, mainly due to PCL, as we built allowances to cover estimated future credit losses. In fact, since Q1 20, our total ACL has increased by 1.5 billion. In terms of outlook, as JF mentioned, the Pacific Alliance countries are already recovering, and we expect 2021 will be a transition year. We anticipate mid-single digit loan growth, relatively stable at current levels, expenses going down as digital adoption accelerates in retail, and we expect our earnings to be above $500 million by the end of 2021 and reach normal run-rate levels by 2022.
Philip Smith: Thanks for that, Nacho. Maybe changing subjects slightly here. A major feature of 2020 and a major focus for investors was customer assistance programs. Can you provide an update on the status of those programs in international banking?
Nacho Deschamps: Yes, Phil. The customer assistant programs are now basically closed for all of our markets. As of October 31, active retail deferral balances were $6 billion, and we estimate that as of November 30, it will decline to less than $3 billion with 50% related to mortgages and concentrated in Mexico and Chile where the programs started later or were extended by regulation. In other words, by November, close to 90% of the balances would have expired. For those customers who have expired, we have seen a good payment behavior with 90% current. In Peru and Chile, regulatory approval for consumers to withdraw early their pensions for more than $35 billion has been positive for their payment trends. Overall, assistant programs are performing better than expected, have played an important role, and are having a positive impact for a customer’s financial health.
Philip Smith: Thanks, Nacho. Maybe turning a second to digital banking. Certainly, digital has played an important role during COVID, allowing a lot of customers globally to access banking services. Can you just talk about the impact digital has had in international banking and customer behavior related to digital?
Nacho Deschamps: Well, what has happened with COVID is remarkable because consumers have adopted technology at a very accelerated pace, particularly in the Pacific Alliance countries where our customer’s average age is around 30 years. In fact, digital adoption in the Pacific Alliance countries climbed from 35% to 46% within the year with Columbia and Chile above 60%. Retail sales through digital channels increased from 30% to 50% in one year in the Pacific Alliance countries. We have digitized onboarding for core products like deposit accounts and personal loans in branches with end-to-end digital solutions that have had positive benefits in customer experience and sales productivity. We are confident that digital will allow us to continue growing retail volumes and revenues while reducing our expenses like we have done in 2020 with NPS scores improving consistently. In summary, during the year we leapfrogged in digital, leveraging our investment and digital factories across our global footprint, and this digital dividend can only accelerate in 2021 and beyond.
Philip Smith: You mentioned the impact of COVID on digital adoption. Certainly, COVID has been the story of 2020 and the major focus in banking given its impact. There’s a second wave happening right now in the Northern Hemisphere. Could you provide an update on the status of COVID in Latin America?
Nacho Deschamps: For sure. I think it’s relevant because the dynamics are very different. While the second wave of COVID is taking place in North America and Europe, in Latin America, COVID cases are decreasing. In the Pacific Alliance countries, COVID cases reached a peak in August with around 30,000 new daily cases compared to approximately half of that today. Hospitalization capacity is manageable at around 40%, so the Pacific Alliance countries are doing relatively well, and they have secured vaccines for next year. It’s very important to also highlight that South America is starting the summer and experts believe there is a good chance that when their winter arrives, vaccination could avoid or mitigate a potential second wave. Even if there is a second wave, we don’t expect severe restrictions like in the first one. So, in general, I think this is positive, and the declining trend of COVID is a tailwind that we expect will have a positive impact in our performance.
Philip Smith: Thank you, Nacho. Those are all my questions for today. For more information on Scotiabank or its international banking division, please refer to Scotiabank’s website at www.scotaibank.com/investorrelations. I’d like to thank everyone for listening in today. This concludes today’s podcast.