Macquarie Research analyst Sumit Malhotra upgraded Bank of Nova Scotia to Neutral from Underperform, noting that the stock has declined a sector-worst 9% in 2010.
He told clients that its valuation no longer warrants an Underperform rating, particularly given the positive outlook on the progress of BNS building out its underrepresented business lines, and the smaller exposure it has to both capital markets and the United States as a whole – the areas that face the greatest regulatory risk.
Both non-performing loan formations and provisions for capital losses declined in the fourth quarter for Scotiabank’s international segment, which Mr. Malhotra calls a signficant development given that its differentiated operations are important to investor sentiment. Similarly, the analyst noted that Citigroup Inc. cited “improving economic conditions” as a factor that aided the quarter-over-quarter decline in Latin America credit losses.
In terms of the Basel proposals and the impact on the bank’s Tier 1 ratio, he said it should decline from 10.67% currently to 7.17% – one of the lowest in the sector. So while capital uncertainty will likely limit deployment in the interim, Mr. Malhotra noted that Scotiabank should be able to recover more than 200 basis points of Tier 1 in 2010-2012.
The lower Tier 1 ratio also reflects in large part management’s decision not to issue common equity at depressed levels in 2008. In fact, the bank’s share could is up just 4% since the end of 2007, compared to 11% to 20% gains for its peers.
“Though BNS faces its share of challenges (managing with lower capital, slowing loan growth, uncertain credit outlook), we believe the bank has the revenue and expense levers to generate a more-than-respectable level of profitability in 2010,” the analyst said. “We have always believed that BNS should trade at a premium to the sector, it was just question of how much.”
His target price on the stock is $45.50.