Bank of Nova Scotia (TSX:BNS) is up more than 20% in 2024. Investors who missed the rally are wondering if BNS stock is still undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio focused on dividends and total returns.
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Bank of Nova Scotia stock price
Bank of Nova Scotia trades near $77 per share at the time of writing. The stock generated most of its 2024 gains in the past five months, rising from $61 in August to as high as $80 at the end of November before giving back a bit in recent weeks.
Despite the big bounce, Bank of Nova Scotia is still well below the $93 it reached in early 2022 at the peak of the first bank rally that occurred after the pandemic crash.
Earnings
Rising provisions for credit losses (PCL) due to soaring interest rates in 2022 and 2023 triggered a pullback in bank stocks. The Bank of Canada and the U.S. Federal Reserve had to increase interest rates aggressively to get inflation under control.
Higher interest rates are generally positive for banks due to the better interest margins that the banks can generate, but the size of the rate increases over such a short period of time caused problems for borrowers with too much debt. This led to a rise in PCL, which reduces profits.
In its fiscal fourth-quarter (Q4) 2024 results, Bank of Nova Scotia reported PCL of $1.03 billion, compared to $1.26 billion in the same quarter in 2023. For the year, however, fiscal 2024, PCL came in at $4.05 billion compared to $3.42 billion in 2023.
Rate cuts by the Bank of Canada in the second half of 2024 helped fuel the rally in the share price as investors assumed that lower rates would lead to declining PCL. Payments on variable-rate loans drop immediately when the central bank reduces interest rates. This helps businesses and households with lines of credit. In the coming quarters, additional rate cuts are expected. This should lead to lower PCL at the banks.
Bank of Nova Scotia generated good 2024 results. Reported adjusted net income came in at $8.63 billion for fiscal 2024 compared to $8.36 billion in 2023. The company’s common equity tier one (CET1) ratio at the end of fiscal Q4 was 13.1%, so the bank has a strong capital position to ride out additional market turbulence.
Risks
Rates on fixed-rate mortgages are largely linked to bond yields. These have dropped from their 2023 highs but are still elevated compared to the lows that occurred in 2020 and 2021. In the past three months, bond yields have actually drifted higher, even as the Bank of Canada and the U.S. Federal Reserve cut interest rates. This suggests that the market expects the central banks to slow down or even halt rate cuts next year.
Inflation increased in the United States in the past two months. If that trend continues, and the economy remains strong, the U.S. Federal Reserve might be forced to actually raise interest rates in 2025. One catalyst for this could be the implementation of tariffs on goods entering the United States.
Canadian government bonds tend to follow the movements of U.S. bonds, even when the economic conditions are different. A jump in bond yields south of the border due to an increase in interest rates would probably drive up bond yields in Canada. This would put upward pressure on rates offered on fixed-rate mortgages.
Millions of mortgages taken at low rates in 2020 and 2021 will have to be renewed in 2025 and 2026. If rates remain high, the Canadian banks could see defaults increase, especially if unemployment continues to trend higher on a weakening Canadian economy.
Is BNS stock a buy today?
Near-term volatility is expected for the market as a whole, but Bank of Nova Scotia remains very profitable and should be a solid buy-and-hold pick at this level. Investors currently get a dividend yield of 5.5% from BNS stock, so they get paid well to ride out potential additional downside.
