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Scotiabank books best gains in sunnier climes

The best place for a Canadian bank to be right now is somewhere other than North America.

As Canadian banks face shrinking margins at home and in the U.S. and undercut each other on mortgages and commercial lending to win market share, the trend has begun eating into profits.

But outside North America, in places like Peru, Mexico and Chile, Bank of Nova Scotia international operations are basking in fatter margins and growing loan volumes, with none of its closest rivals to fend off.

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"We saw some increase in margin in a couple of our countries, particularly Peru and Mexico," Brian Porter, group head of international banking at Scotiabank, said Tuesday as Canada's third-largest bank reported a 40-per-cent increase in profit.

But in Canada, tougher competition for customers, particularly on mortgage rates, is eroding margins and made for a dramatically different trend in domestic operations during the second quarter. The major banks all reported a drop in net interest margins in their Canadian operations, which is the difference between what banks collect in interest on loans and what they pay out to customers on deposits.

Scotiabank's Canadian banking operations were no different. Its retail banking profits fell nearly 2 per cent to $444-million, due to the squeeze. The bank's net interest margin in Canada shrunk to 2.32 per cent in the second quarter, from 2.42 per cent the previous quarter, and 2.58 per cent a year ago.

The international front was a much different story, where the bank saw net interest margins expand briskly to 4.44 per cent, up from 4.29 per cent in the first quarter, and a significant gain on 4.04 per cent a year ago. The low-cost, high-return nature of lending in South America helped drive that trend.

A record profit in the international division, which made $376-million, excluding gains related to recent acquisitions, helped drive Scotiabank's $1.54-billion profit in the quarter. Earnings in the international division rose 46 per cent, or $119-million, compared with last year.

The movements in net interest margins may seem tiny, but multiplied across the bank's entire lending portfolio, they add up to large profits. Scotiabank has spent the past few decades expanding rapidly in international markets and now operates in roughly 50 countries.

"Scotia's earnings and [share]valuation continue to be rewarded from its international diversification," said analyst John Aiken of Barclay's Capital in a note to clients on Tuesday. "In fact, the international banking contribution this quarter … helped take much of the attention away from the disappointing results in its Canadian banking segment."

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Uncertainty over upcoming elections in Peru helped fuel loan growth in that country, said Mr. Porter said. Many commercial borrowers arranged lines of credit ahead of the June 5 election, much of which sit undrawn.

There are concerns in Peru about a significant change to the country's business landscape should former army renegade Ollanta Humala defeat congresswoman Keiko Fujimori in the runoff. It is expected Mr. Humala would pursue policies that could hinder foreign investment in the mining and energy sectors, an area upon which Scotiabank has built a lot of its commercial business.

However, Mr. Porter said the bank is not too concerned. "Peru is an important country for us," he told analysts on a conference call. "But we have a history of operating in a bunch of different political environments over time."

The strong Canadian dollar has put pressure on revenue at Scotiabank's international operation, though, since the profits are reported in Canadian funds. The bank took an $11-million hit in the quarter due to foreign exchange, Mr. Porter said.

Scotiabank's $1.54-billion profit in the second quarter was equal to $1.36 a share, compared with $1.12-billion or $1.02 a year ago. Revenue rose 17 per cent to $4.52-billion.

In addition to profits from its international banking and wealth management divisions, Scotiabank benefited from a significant accounting change that boosted its earnings in the quarter.

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The earnings included a $286-million gain associated with recent acquisitions, such as Scotiabank's November buyout of the remaining 82 per cent of DundeeWealth Inc. it did not own. That made up $260-million of the accounting gain, which saw Scotiabank revalue the original 18-per-cent stake in DundeeWealth based on the price associated with the deal.

Without the accounting change, Scotiabank made $1.10 a share. Analysts on average expected Scotiabank to make $1.08 a share in the quarter.

Provisions for credit losses, the amount of money banks set aside to cover bad loans, fell to $262-million, from $269-million last quarter and $338-million a year ago.

At Scotiabank's global wealth management division, the buyout of DundeeWealth pushed profit to $489-million from $199-million a year ago, due mostly to the $260-million accounting gain. Scotia Capital reported a profit of $357-million, down 9 per cent from a year ago. The bank said the drop was driven by lower trading revenues, which were below the unusually high levels seen a year ago.

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Grant Robertson is an award-winning journalist who has been recognized for investigative journalism, sports writing and business reporting. More

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