The Bank of Nova Scotia (NYSE:BNS) Barclays Global Financial Services Conference September 13, 2022 9:00 AM ET
Company Participants
Raj Viswanathan – Chief Financial Officer
Conference Call Participants
John Aiken – Barclays
John Aiken
Okay. Ladies and gentlemen, we’re going to kick off the Canadian content morning for Tuesday. Very happy to have Raj Viswanathan, he’s CFO of Scotia. Raj, thank you very much for joining us.
Raj Viswanathan
Likewise, John. Thank you very much.
Question-and-Answer Session
Q – John Aiken
So, Raj, it’s good to have you in-person after an extended absence. I wanted to start off by talking about what makes Scotia different. Your growth strategy is very differentiated amongst your peer group. And I wanted you to elaborate on what the bank is focusing on for growth over, call it, the next five years or so?
And I think more importantly, how has your strategy changed over time? Has it been a major evolution or a bit more tweaking around the edges, given the fact that Brian has had a fairly long tenure for a CEO?
Raj Viswanathan
No, that’s a great question, John, and a great opening question. Thank you. Our strategy has definitely been different. It has been different for a very long period of time amongst the Canadian Banking peers and continues to be different than many of our peers.
Before I get into the individual business line, at the bank level what we have done in many respects and when you refer back 10 years, is to produce what we would call diversified sustainable, but good growth in earnings, and we have delivered that.
We’ve done a lot of repositioning, as you talked about in the last four, five years specifically, because we have looked at it and said, we want to grow the wealth business. For example, we invested inorganically. We bought a couple of companies in Canada, in — sometime in 2018 and those have done exceptionally well. So the wealth business becomes an exceptionally good growth engine for the bank and something that we’re very proud of what we’ve built from something which is really small.
So specifically, it is about diversification at the bank level, four strong business lines. The Canadian bank will always be the strongest engine from our perspective, because they’re a very large Canadian bank and have been for a very long period of time.
I’ll talk a little bit about the individual business lines, how we are diversified within those lines? And what’s the growth opportunity looking forward. Wealth management, I talked about.
International Banking is a differentiating factor in many respects for us. And that the international banking franchise we reorganized quite a bit in the last three, four years and we believe it is for the better, back to being diversified and having sustainable earnings.
And finally, GBM. GBM, is a very simple approach from our perspective. We’re a corporate banker in many, many respects and have been for a very long period of time, but we’ve continued to grow our capital markets business. And that is across geography, client and product, the three verticals we talk about and we’re investing in all three.
But then specifically, let me speak about the individual business lines. Canadian Banking. Canadian Banking, we’ve always been strong as a secured lender and we continue to be that. 95% of our retail portfolio is secured. We are the market leader in auto financing and we have really gained market share in mortgages throughout the last three, four years.
Dan Rees set out, we need to go to being the leader of the Canadian bank, a few things which was important, but when you look back, have been really effective. One of which is, we want to grow our commercial book, maybe in under index for a very long period of time in the verticals that we like. So it’s not about expanding risk appetite in any way, it’s more about acquiring more business with the same high-quality customers that we have. And he has done that very effectively, a lot more left to do, okay?
We’re still the number five, after all the growth that you have seen. So it tells you how far behind we were and how much the opportunity in front of us. That will continue on for some time.
Auto, like I mentioned, we are the market leader. We’ll always be the market leader. I think that has been a core strength of this institution, again, for a very long period of time. And the auto business has been slow growth for the last three years and we know at some point that growth will have to come back to more normal levels. That should be really good. Mortgages, I think we’re well positioned. We know that the housing market is slowly slowing as the term we’ve used. It’s exactly how it’s playing out and that’s not a bad thing. We have good quality. Everybody is over 800 FICO score generally. We have very little portfolio, which is below that. So credit quality is not an issue.
And finally, when we think about the Canadian bank what other opportunities are there, being an unsecured lender in these uncertain times, it’s probably not a bad thing being a small unsecured lender I should say and that’s going to play to our benefit in the event that we have some macro headwinds that might translate into difficult credit environment. The credit quality is fantastic. Our corporate commercial book which includes GBM the highest quality by far amongst any of our peers. So downturn, if it were to happen I think we are well positioned. You saw it through the pandemic, we didn’t have big losses.
Likewise, our retail book, the Canadian retail book is at par with all our peers. And in the event you’re going to have some sort of downturn having a more secured book is also going to protect us. And I think we are very well placed from a Canadian banking perspective and they’ve generated positive operating leverage for pretty much seven quarters now and that will continue. So managing expenses in line with revenue. I think they check a lot of boxes are very pleased how it is performing and we’re also very pleased as we look forward.
The international bank, we don’t talk a lot about the Caribbean, right? Because the Caribbean, the bank has been there forever. The Caribbean is kind of a regular engine that generates money for us, but it’s also a very strong deposit franchise. The Caribbean in the most recent quarter you saw exceptionally good performance, great growth whichever metric you look at. That’s the diversification we have within IB. We talk a lot about Pacific Alliance, which is really important in all the four countries. But really when you look at it the Caribbean, it is easily $100 million to $125 million a quarter, P&L generator.
Very good asset quality again over there, an exceptionally good clientele long time they’ve been in the region. So what we’ve done within International Banking after all the repositioning, selling a lot, but also buying — expanding our Chilean ownership stake over there. We think we’re very well positioned. To be diversified within the business and also in the jurisdictions that we’d like to operate for whatever reasons economic growth, young population, digital adoption I can call out a lot of things. So I think that business line is well set to continue to grow in line with our Investor Day targets.
We talked about 9% growth and so on. That asset quality has also gotten better. It’s about 73%, 74% secured now within the retail book. The corporate commercial book is really $86 billion of the $154 billion, which is very high quality like I referred to. And within the retail about $42 billion of mortgages again. So we’re really talking about unsecured lending between credit cards and personal loans about $20 billion, but it gets the most attention as you probably know quite well. It’s the one that’s least understood and people want to know more, but that asset quality I think is significantly better pre-COVID to now as well. So that will continue to be a good growth strategy for that business line.
I talked a bit about wealth, but wealth is very well diversified within its own subsegments. Assets under management, we are number three and we were not anywhere close to that a few years back. And assets under administration, we’re number two in Canada. So that’s a huge achievement.
And if we look back to where we are today that will continue to grow. The biggest growth opportunity we have is two specific things I’d call out. One is we want to buy a US dollar platform. So it’s not a large acquisition. We’ve talked about it a lot. It might be a few hundred million dollars. That’s going to be very impactful, because it’s going to provide us connectivity between the Caribbean wealth where we’ve had for a long time; the Pacific Alliance wealth where we continue to grow Chile and Mexico, we call it as two countries you should see more growth; and connect the Canadian Wealth Management where we made great progress. So once we fill that small gap that we have likely over the next six months or so, I think that business is well set to continue to grow. And GBM like I said we’re a corporate lender. So, we love the corporate book very high quality. We don’t deal with leverage lending and all those higher risk exposures, we have not done for at least 10 years and that’s by choice right what we’d like to do.
Our asset quality is like by far superior to everybody else. The growth rates whether it’s in Latin America, the United States, or even within Canada, and a bit in Europe too, we’re very pleased with how it’s growing. The ancillary business which is really the capital markets business. Those could have ups and downs. As you saw in this most recent quarter we’re okay with that because that’s part of that business as long as we are in line with our peers. I think we are fine.
If you put this all together, I think we feel like we have well diversified businesses. We believe these are strong businesses asset quality or earnings quality all those things. And we believe that when we look forward even if there is a slow growth, which is what most of us expect in 2023, our growth level should be very comfortably in line with what our expectations are. It’s a bit of a long-winded answer, but I thought I’d over all the businesses.
John Aiken
Raj fantastic overview when I think I’ve slashed about three quarters of my questions now but that’s — one of the other things I wanted to talk about is your relative capital level. And I raised this not as a criticism I actually — I’m a big fan of you running at a relatively lower level of capital because I think that the Canadian banks off are much safer than the market gives them credit for, therefore shouldn’t run at capital levels. But can you discuss why you think running at levels you are as prudent? And whether or not this may change if we get negative outlook for where the economy is heading more so than more base cases?
Raj Viswanathan
Sure John. I think capital is something we’re very passionate about in this bank. I’m personally very passionate. I’ve been in all the capital for a very long period of time. So, we manage our capital levels very closely in this bank. I think it wouldn’t be an exaggeration to say managing down to the basis point is important to us. And there are a few reasons for that why we feel comfortable.
I spoke a couple of times about asset quality. When asset quality is very good capital is expected to pick up orders unexpected loss, right? By definition how do you quantify it? And how can you have sufficient capital in case it showed up? Our expected losses which is our ACL on the balance sheet is about $5.2 billion $5.3 billion.
At our excess capital to the maximum capital levels that the regulator can incorporate this 10.5% is roughly $4.8 billion, 11.4% to the 10.5%. You put that together, the asset quality has to really deteriorate one factor of what we already hold across the portfolio which is over $750 million for that capital to get enrolled.
And very unlikely event it can only happen because of macro, right? Because I don’t think we have an idiosyncratic risk. So, we are if anything we have probably the best asset quality. It gives us a lot of comfort saying if it were to happen, I think it’s very unusual. You can stress anything to any number you want to. We don’t stress test. We don’t see that scenario happening. We feel very comfortable.
We’re also very conscious that capital costs money right? I mean 10% cost of capital. If you take it on $1 billion excess the shareholder gets impacted $100 million. That’s a lot of money right to put on the shareholder for us not being confident about how we’d like to manage.
And we have sufficient like $5 billion is a lot of excess capital to have in a bank that has between $60 billion and $65 billion of capital. There’s a lot of excess that we run in our minds although it might be the lowest capital ratio.
And finally, we believe there’s a lot of talk. If we look back three, four years we call it the arms race on capital has probably been done in some respects. There’s a lot of proof, that you don’t need this kind of capital to run. So we have deployed capital, in line with what we told everybody in November. We started with 12.3%, and we have taken it down to 11.4% in the most recent quarter. Very simple math John. We said we will deploy in organic risk-weighted asset growth. That was our first priority has always been.
We generated 90 basis points of capital. We deployed 90 basis points of capital on organic risk-weighted asset growth. So that’s a wash, right? Lots of opportunities to grow. So that took up that kind of thing. The remaining decline is really relating to the buybacks that we executed. We bought back about 31 million shares. We have ability to buy up to 36 million shares, so almost down. That’s about 3% of the company. So buying back 3% of the company, yes, you can never time it to be perfect or when you buy then IB’s very rich man individually, if I could do that.
But we think, we’ve deployed it appropriately to reduce the number of shares we had issued as part a few acquisitions in 2018. And we actually think that that’s obviously adding 3% to the earnings and all those good things over there. But it also was driven by saying, what we think is optimal capital that we feel comfortable, 11.4, 11.5, we feel very comfortable operating at this time. And we’ll look at it every quarter or every year as we look forward to see what might be the macro that might come across and we might take it up 10 or take it down 10 basis points, depending on how we feel like it. That’s one thing we feel very comfortable about, how we manage capital. I think we look back. We managed it quite effectively through various cycles. And I think looking forward, we feel confident to.
John Aiken
And then, if a couple of acquisitions go through, you’ll find yourself in the middle of the pack with your peer group as opposed to the low end. Can I get the first polling question, please? How do you view Scotia’s International Banking is folks in the Pacific Alliance region? Favorably, but more acquisitions need to build further scale? Favorably that the bank is rightsized? Unfavorably and they need to grow or unfavorably in the bank, but they make so to focus on its current footprint? Here we want to build scale. I’m actually a little surprised by that particularly since in your preamble, you said the acquisitions are going to be in Wealth Management, maybe all wealth management Pacific Alliance, but — can you — Raj, I just want to reiterate, what has actually happened in the Pacific Alliance and how you’ve rebalanced your portfolio in the region?
Raj Viswanathan
Sure. I think — as we look at the international banking as a whole, we exited some markets between 2018 and 2020 by the time all these exits happen and they’re largely done. The philosophy behind it was quite simple, John. We didn’t think, these were the high-growth markets, really profitable entities, don’t get me wrong. But when we look forward, we didn’t see the growth opportunity. What the risk that we take, should be paying us back. Easy example is like an El Salvador or a Puerto Rico as a country. So we had capital stock over there. We said, we want to take out that capital.
The second thing we did was, through the pandemic, we reacted a lot to our revised consumer demands. Most of them obviously, lots of liquidity in the system, but they wanted to invest in secured products like whether it’s a mortgage or auto over there. So we responded to that. And we said, okay, this is great, because it’s in line with our risk capital in many respects. There were some unsecured portfolios. I’ll call out one which is in Peru. We looked at it and say probably a little too outsized for our risk appetite, the way the portfolio behaved during the pandemic. So we have reached a deal to sell it. That contributed to about 40% of the losses that we had in COVID one portfolio, right? So, it tells you, you learn something out of every event, particularly like a pandemic. So we sold that portfolio. Part of the reason why we said, we are comfortable giving PCL ratio guidance through till 2023, and we’ve given guidance both for the bank as well as for the international bank, which is significantly lower than our history to show how the risk profile has been changed by actions that management has taken, because we think that provides diversified sustainable earnings everything that I mentioned in the beginning.
So the international banking footprint today is about 95% relating to the Caribbean as well as the poor Pacific Alliance countries. Now, we call the Pacific Alliance countries together, because there are portfolios where as we are concerned, and there is a lot of connectivity between the four countries current they have this record. But really, Mexico and Chile are the growth engines for us. Mexico is going to benefit in many, many respects from what is happening in the United States, and has benefited even through the pandemic, they dealt with the pandemic differently than anybody else in the world in many respects, right? So they didn’t build up a debt, like a country debt that many of us did both in Canada, as well as the United States as well. And they’re going to benefit from that.
From our perspective, the GDP growth is going to be fine. The rebound was fine. Chile is different. They funded it through the pension plans to support the population, but Chile has got a V-shaped recovery as you’ve seen between 2020 and 2021, 2022 will be fine. 2023 will be slow growth, because you’ve had this level of growth it’s expected to slow. So we like Chile. We increased our stake as I mentioned earlier in the bank that, we own there. We think Chile is fine okay in many, many respects. And Chile is very progressive and is also supported by commodities, which the world wants copper those kind of things.
Peru is going through what we think a period, where we want the politics to stabilize and we have reacted appropriately okay. We like Peru to make maybe $130 million a quarter. It makes roughly between $90 million and $100 million. Now we are fine, right? We’ll wait. That’s the power of diversification back to it, right? We know that, in a quarter, or in a year when every country every business line grows it’s going to be fantastic, right? But if it happens great, but the likelihood of that happening, there’s always going to be some challenges in some markets.
Pros going through one of those. Are we confident? Absolutely, about DC countries. Colombia we have more work to do. I think, the bank that we own is skewed a little bit towards unsecured lending. That’s what we bought. And so we continue to invest in it to grow the corporate book over there lots of opportunities as infrastructure investments are happening in that world. So we feel quite confident, but more goodness to come rather than what is happening today.
The Caribbean I talked about. We like the Caribbean footprint, how we have repositioned it after the divestitures. We have really good leadership over there. We think the Caribbean is only going to continue to grow. And we are not in some of the assets that created big losses for us in the global financial crisis such as resort lending, those kind of things. We have a much more balanced portfolio be it retail or corporate commercial, and the quality of the portfolio is very good.
International Banking this quarter we declared $631 million of earnings. You should see that continuing to grow. The difficulty we face is, there is a requirement that every quarter it has to grow a certain percentage in every metric, right? It’s a combination of countries in some respects. This quarter the Caribbean was great. The Pacific Alliance had a few challenges, because of cost of funding. That will happen from time-to-time. So, we try to balance it out to show what we think is a good trajectory of growth in that business for the risk we take.
I think coming out of the pandemic it’s growing really well. It’s obviously significantly high because of the V-shaped recoveries over there. Looking forward, it should grow in line with initial data, which is a 9% plus. We like the footprint where we are. The audience seem to think we should buy more acquisitions. Yes, looking forward, five years or so as you were talking, I’m talking more in the immediate future in the next year or so, where we like the wealth acquisition. Internationally, if you find the right asset in line with our strategy at the right time, sure.
John Aiken
It’s touching on that. A lot of the conversation more recently has evolved away from where is the loan growth going to come from versus to margin expansion, which is — it’s very good to talk about something different, I guess, but it’s actually been more topical for Scotia ahead of your peer group, because of LatAm. And I mean I know you’ve talked on the quarters about the experience and what you’re looking for. But can you talk to expectations for interest rates margins in LatAm and Canada moving forward?
Raj Viswanathan
Yes, I won’t reiterate a couple of things, right? The first two quarters in the International Banking margin expanded quite a bit 16, 17 basis points, we saw 369 all the way to 386. That was a quick recovery, because significant rate increases in the footprint as you know whether it’s Chile or Peru for that matter. So we saw that early.
What we saw in this most recent quarter where we had one basis point compression. So really like in line with last quarter was perceived negatively and I understand why — it primarily came from the deposit side of the balance sheet. So, deposit repricing happened significantly faster. And that’s just people catching up and saying, savings a contract can get 2% on a term deposit, I can get 8%, 9%, what were the numbers? I’m going to shift because inflation is high on the other side. I want to earn more on my savings, very simple.
Asset repricing actually also happen in the Pacific Alliance except that it got significantly outpaced by deposit cost increases and that resulted in this one basis point margin compression or 20 basis points within the Pacific Alliance. We know that deposit cost increases are probably going to plateau in Q4, because we’re not looking for more administered rate increases and so on. It’s going to stabilize, okay, as a matter of fact in my opinion.
Asset repricing is going to continue, because that portfolio like I mentioned it’s $154 billion, exclude the corporate commercial which will actually reprice faster, because it their repricing happens every three months. That’s what $86 billion. The mortgages and the unsecured lending book will continue to reprice. So Q4 like I mentioned on the call likely to be stable. NIMs not increasing. But really looking into 2023, we should see expansion.
The last point I’d make on that is, in November we gave guidance saying the NIM will be between 380 to 390. It was 386 in Q2 and it was 385 in Q3. So it’s well within the guidance. I can’t remember who asked me the question on the Q2 call, asking you if I would revise the guidance up? And I said no, because we saw deposits the behavior changing — and we also knew that there is multiple countries multiple factors. It’s not like Canada where you track on NIM of the United States. You track on NIM. This is a portfolio of countries.
Some are dependent on the US dollar rate changes, which is — has been happening, as you know, the Fed rate changes. Some are dependent on local countries. And a lot of it is uncertain, because of the trajectory of inflation. So we try to give it as much analysis to support our outcome. The range I think is certainly intact for this year. We’ll probably otherwise range in November. It should be higher.
John Aiken
And then for Canada the outlook?
Raj Viswanathan
Canada the outlook, we saw seven basis points expansion in the Canadian bank this quarter, almost all of it coming from the deposit margin expansion which is a very simple way to look at it.
Asset margins are still under pressure. Lots of competition, plus it doesn’t reprice as fast or same concept. The Canadian Banking margin, we should see expansion through each quarter. We have no doubt. And depending on the trajectory of the unsecured lending book in our case credit card and we are a very small unsecured lender and a smallest among all the banks being 95% secured in the retail book. That 5% unsecured as the revolver start increasing in the credit card book, we should see margin expansion coming from there. But that I think will be somewhere into 2023 likely in the second half of 2023. But you should see margin expansion happening each quarter looking forward.
John Aiken
Fantastic. And that actually leads into the second point question, if we could please. After another 75 basis point hike the Bank of Canada or rate to 3.25%, where do you think the rate will be at year-end, stay at 3.25% between 3.25% less or 4% or greater than 4%? Actually Raj I forget what’s discussion I have a host view on?
Raj Viswanathan
Yes, we do. It’s more on category number two. We think it will be around 3.75…
John Aiken
Okay.
Raj Viswanathan
Is our current economists’ view, but hey, between 3.75 and 4, it’s within striking distance.
John Aiken
Raj, well not to play the audience but that’s a – number three is actually in my call but we’ll see what happens on that. Before I carry on I wanted to pause to see if there’s actually any questions from the audience for Raj. No, sorry. And this one is webcast so we do have to wait for the microphone.
Unidentified Analyst
Thank you very much for the presentation Raj. Maybe we could ask you a Canada question. Lots of discussion around – maybe in Canada and the US around the consumer, say to the consumer, how they are coming out of COVID? What people are watching? I’m just curious to see what are you watching when you think about the health of the consumer, not just in your own loan book but in terms of just broader economic indicators with debt to disposable income or any of these other metrics that are on your mind as you look? Thank you.
Raj Viswanathan
Sure. Thank you for the question. So I’ll start with what we know about the Canadian customer and then I’ll bring it down to our own portfolio in some respects. Through the pandemic what we saw in the Canadian consumer was prudents. Lots of checks were written like who was written here in the United States. Lots of savings, lots of deposits going up, less spending.
We saw it through our own book, where we saw credit card or debit card transactions slow down but recover afterwards. The revolvers are still not happening. The people are still being prudent paying off their bills and so on, which we see. And I believe it’s consistent across all the banks over there.
I think there is a lot of concern around the Canadian consumer, primarily relating to the mortgage book, the level of borrowing, the house price increase that most of us have seen over there, it doesn’t matter which part of Canada it is in. And that’s been a topic of discussion for a long time.
The structural problem that Canada has in some respects is purely a supply demand issue on the mortgage market. We have a lot of immigrants coming in and they’ll start coming in now once all these travel restrictions have been lifted, it’s going to be higher than our normal run rate. We don’t build as many homes to support the level of info that is happening or has been happening.
The demand supply as we know, one exceeds, the other price goes up, we saw a lot of it. Was there a little excessive price increase over the last two years? Most people would say yes. And the reality of the situation is cost of borrowing was quite cheap and there was a lot of demand. It wasn’t a lot of speculation. I think there’s a lot of upgrading going on. Somebody lives in a 2,000 square feet day like a 3,000 square feet and they know they can afford it, because rates have been low and so on. So, that fueled a lot of it. You’re quickly seen the correction happening, at this time. You’ve seen many markets, where the prices have come down even as high as 10%, sometimes even a little higher than that in some markets. That’s a good correction from all our perspective.
The Canadian consumer is not a speculator in general. There’s always going to be outliers, when I’m talking about the breadth of the population. They tend to be prudent to investors. Real estate is something that is a very favored asset in that country, for obvious reasons. And what we have noticed over there is, the quality of the portfolio has actually been very high, in our book notes switching to it.
Most of our book is over 800 FICO score, which is very high quality. And because we are more a secured lender, when we look at what is the unsecured products they have with us or which we are aware over there, we feel there’s a lot of prudence in borrowing. Finally, what we saw in our specific book is, the deposit levels that the Canadian consumer has in our book is about 14% higher than what it was pre-pandemic. There’s a lot of liquidity, a lot of support and prudence which will play its part in ensuring that there isn’t an event that people will be worried about the Canadian consumer.
Finally, what I would say, specifically to the mortgage book the loan-to-value ratio in our book is about 46% 47% most recent quarter. Pre-pandemic it used to be in the mid-50s. So simple math will tell you, even if there was a 20% correction in the collateral and we don’t do collateral-based lending in Canada, it’s all income-based lending. When it comes to mortgage. It’s a collateral is a nice add on to have, in the event that is unemployment of people lose share income.
You put all this together, even if there is a 20% correction in the denominator or the asset price it will come back to an LTV ratio in the mid-50s. So it feels like, yes, there’s a lot of stuff that has happened quickly, but I don’t believe there is a consumer issue that we are seeing be it in the small business sector or in the retail sector. I think, that’s quite consistent. There might be other parts of the Canadian economy like shadow lenders, who might feel the impact of a quick correction that will happen. I don’t believe the major banking system.
John Aiken
I just have a follow on to that. What metrics are you actually following at the bank for the consumer? Do you look at, is it unemployment levels. Sorry, that’s what I look at almost religiously and only when I’m worried about consumer credit. But is there anything else that…
Raj Viswanathan
No. unemployment, I think is key in the number one factor, we use other things like whether it’s house price index, or CPI inflation effect on people spending we have invested a lot in data analytics in this bank. Going back to 2017, we’ve got exceptionally good professionals over there. So we do a lot of data mining and data teaches you a lot you can get lost in it, but it teaches you a lot.
What the data tells us in many respects is, where are the flows coming? Where is the outflow is going? And how do we think about various segments of our retail population? And most of the data will tell you, okay, there’s always a tail risk, right? That’s, what we’re looking for. We’re not looking for the big bell curve, because we know we’ll be okay, if you just focus on the bell curve. We focus a lot on the tail and Phil Thomas, was he talked to you a lot about tail risk and how he looks at it. And the tail is exceptionally thin from what we look at.
But we focus on those. We use some of our consumer assistance programs, where people call and say “You might want to reduce this or you might want to pay up more on something, as you tie through the situation in which you’re going through.” And I think that level of granularity has been a big help to the Canadian bank, to focus their efforts on which consumers they need to be focused on. A lot of metrics. Unemployment is the key metric. As long as people have income and a reasonable level of income, I believe that the retail consumer will be fine. The cohort that may have some susceptibility to unemployment that’s a cohort we focus on and that’s really thin
John Aiken
And then Raj, with the Canadian residential mortgages, there’s been a lot of discussion with variable rate. And what is very interesting is Scotia again seems to be breaking from the group, where your variable rate mortgages if I understand correctly reset every time there’s a change in prime. What was the philosophy behind that? And what have you seen in terms of consumer behavior as those mortgage rates have actually been increasing?
Raj Viswanathan
No, it is. Yeah we are exceptional — an exception of how we deal with variable mortgage. Yeah and exceptional too. To us a variable rate mortgage is a variable rate mortgage by definition, okay? This product has been there for I don’t know 20 years plus. It’s not new at all. We actually have both products, one which is a true variable rate, which happens to be I would call it almost 99% of our book. And that’s about 1% of the book where the variable rate does not impact your payments. So you extend the amortization, which many of our peers are doing.
We actually do not see much of a concern over there. It is actually a positive in many respects for us. I’ll tell you why in a couple of instances. We are a big secured lender. And when we — we know if there is a default happening in a consumer that’s not where it starts. It starts with an unsecured product, okay? So risk is off us in some respects over there. And we have a variable rate mortgage product that is well-understood. When rates go up or when rates come down you have a communication saying your payment is going to change by so much, because there’s a 25 basis point change or whatever. So I think consumer awareness is not an issue.
But to answer your second part of your question, historically I’ve seen this, John. We went back many, many years not because of what happened more recently but we constantly track this. Canadian consumers prefer variable rate when they sign up their first mortgage or when they switch over or whatever it might be with us. They always transition to fixed. So our book is about 73% fixed, about 36% variable, so 74% fixed right — sorry 64% my bad over there.
So — but the origination has always been skewed towards variable. And there may be a few reasons for it. I’m not the mortgage expert, but the reason is there’s always been a gap between what you can get a variable rate and a fixed rate mortgage most times. The gap sometimes is small. Right now it’s getting smaller in some respects. So people want to play the rate game and say, how long can I benefit? And then there comes a point of saying, I want to switch to fix now because I don’t want the uncertainty relating to it. That’s exactly what you’re seeing right now.
Last quarter we saw about 11% or 12% of our mortgages moved to fixed. Sometimes we call outbound saying this might be the time you want to move to fix back to some of Dan Rees’ initiatives advice. Advice is not just about a financial planner and so on over, the advice relates to each product to what is right for you. So we do a lot of that.
The product itself is not new. Like I said the product itself is not risky. Frankly we would argue it’s the right thing for the customer in many, many respects, because you don’t come back for a renewal in five years and somebody tells you paid down $1 because everything else went to interest has a very extreme example.
Our customers have always accepted it and understood it’s a product we’ve had for a very long time. And we use that to determine, which consumers might be at risk as prices go — sorry, as rates go up and the payments might go up $50, $100, $200, whatever it might be. And when we look at quartile of customers back to the tail comment, we still believe the tail is actually smaller than what it was pre-pandemic. So we feel good about our portfolio. We respect to how our product is different from the others.
John Aiken
Fantastic. Well, we’re bumping up. I think we’ve got time for one last question.
Unidentified Analyst
Two questions. One, what percentage of the mortgages are investor property loans? And then the second one is there has been for some time a short seller thesis that a lot of equity, the home equity that people use or the borrowers used to fund their paydowns, are actually borrowed from someone else. So, it’s not you as a mortgage provider who is funding it. There’s some third party, which is funding it and it doesn’t show up as the actual leverage on those LTV numbers. I mean how much are you — how much of that is actually a concern or how much of that is true? Or do you know if there are equity loans that are not on your books or you may be underestimating the LTVs on those portfolios?
Raj Viswanathan
Sure. I’ll try to answer both questions, but I’ll keep it at a very high level to be clear. On the first one, income property lending is something that has always been in our books, but has been really small. Without giving you exact numbers, I would say it’s less than 10%.
And it’s always a factor, because it depends on how you determine income property lending. Sometimes you talk about it is it your second property, third property, fourth property, or is it part of a building where you have four units that kind of stuff. And I don’t think there is a common definition to it. So we watch that very closely.
Income property lending, by definition is not bad to be very clear, right? There are people who invest. It’s part of like, you put money in the stock market and the bond market, some people like to do in the real estate market, because they want to get rental income or price appreciation whatever that might be.
Really small. It’s not always a big part of the portfolio and that’s something that we track separately to see what should be the oversight we should have as we think about the affordability of these people and so on. That’s not an issue. And it’s also not become outsized as you look back a few years. It’s always been a percentage of our book. It continues to be.
On your second question, do they borrow from elsewhere and therefore we don’t know? This is about knowing your customer totally. The biggest advantage you have for knowing customers is if you have the checking account and you can see the flows that is happening, generally you will be able to catch this.
When we do analysis and we look at it, it’s always at the client level rather than at the product level. We want to see what is the behavior of the customer, back to the data analytics comment I made earlier and we’re getting better and better at it. Would there be — and this is speculation, I’m going to say it before I say it. Would there be some percentage of everybody’s mortgage book where they would have borrowed some money to support their down payment from other sources over there?
I suspect there will be, particularly when you have a hot market and significantly increasing prices. I have not heard about it being a concern across the industry anytime in the past, certainly not at this time. Would there be a small segment likely will be there.
John Aiken
But again, protected right now by the loan-to-value ratios that you…
Raj Viswanathan
Takes time. Like I said, at 45%, 47% that we have 20% price correction, you have is still 55%. Canada has never had a problem where you’ve got to repossess properties, sell it and therefore recover your money that does not exist. Because the LTV ratio is so small, it easy you sell your own property pay back to me, keep the rest of the money.
John Aiken
Right.
Raj Viswanathan
I think in our case, we have a step product Scotia Total Equity Plan, where you can borrow up to 80%. And there is a mix that you can have between your mortgage and your home equity line of credit. So, both are secured under the mortgage. The LTV ratio, I’m putting you, is including both, so significantly lower than.
John Aiken
Yes. And then, the liquidity within the Canadian households is such that you’re still not seeing huge draws on human?
Raj Viswanathan
No. No, like I mentioned, 14% deposit increases across the board. When you look at a pre-pandemic to now, I think that’s a huge factor. We know that that will stagnate at some point depending on how the economy goes, but we feel very comfortable.
End of Q&A
John Aiken
Raj, that was fantastic very comprehensive. And thank you very much for your time. Appreciate it.
Raj Viswanathan
Likewise. Thanks for the opportunity.
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