A pedestrian walks past a Scotiabank branch in downtown Calgary, Alta., Friday, Sept. 16, 2022.Jeff McIntosh/The Canadian Press
Bank of Nova Scotia BNS-T surprised markets Monday with a multibillion-dollar investment in U.S. regional bank KeyCorp., providing its first exposure to retail banking in the United States through a strategy no Canadian bank has tried before.
The lender will pay US$2.8-billion in cash for a 14.9-per-cent ownership stake in Cleveland-based KeyCorp KEY-N, which operates roughly 1,000 branches across 15 states under the name KeyBank National Association. It is by far the boldest decision Scotiabank chief executive officer Scott Thomson has made since the lender stunned Bay Street in 2022 by selecting him – a board member with no previous bank executive experience – to succeed Brian Porter as CEO in 2023.
While the deal makes good on a promise Mr. Thomson made in late 2023 to shift more money into North America, it also represents a major departure from the U.S. expansion strategies pursued by his rivals. Instead of buying direct control of an American bank – as every other large Canadian bank has done in recent decades –Scotia is taking the unusual step of acquiring a minority stake in KeyCorp and has even promised to keep its stake below 20 per cent for at least the next five years.
Given the unique nature of the transaction, analyst reaction has been highly skeptical.
“The market is likely going to require proof (and a build-back of capital) before throwing full support behind the investment,” Jefferies analyst John Aiken said in a Monday note to clients in which he called the deal positive for Scotia. “What will be critical for investors will be to see whether the proposed strategic benefits can accrue to both parties, or if this is simply an investment.”
Scotiabank is betting big on the U.S., but investors are slow to applaud
In an earlier note describing his initial reaction, Mr. Aiken said the investment was “a surprising move” and “may not be how investors want BNS to deploy capital.”
Scotiabank shares closed 3.4 per cent lower Monday on the Toronto Stock Exchange, while the TSX-listed stocks of other major Canadian banks were largely flat. Shares of KeyCorp closed more than 9 per cent higher on the New York Stock Exchange on Monday.
“While management had suggested one of its goals during its most recent investor day was to expand its North American operations, we had thought that it would initially be focused on building out its wealth management and/or capital markets businesses in the region, rather than announcing an interest in a U.S. regional bank,” Cormark Securities analyst Lemar Persaud said in a Monday morning note to clients.
“We do like the use of excess capital to fund acquisition related growth generally, however the U.S. banking environment is characterized by very high competition.,”
Despite the deal including a standstill agreement that requires Scotia to keep its ownership stake in KeyCorp below 20 per cent for at least five years, the possibility of the Canadian bank acquiring the entire U.S. company has already become a subject of open speculation.
“People are going to assume you’re going to want to buy 100 per cent of this thing, ultimately,” National Bank Financial analyst Gabriel Dechaine said on on a Monday-morning conference call with Scotiabank executives. Mr. Dechaine followed up with a Monday afternoon note to clients in which he said most investors will view the “initial stake as a stepping stone to eventually acquire 100% of KEY.”
In response, Mr. Thomson said on the call that the purpose of the deal was simply to deploy capital from developing to developed markets in a low-risk, low-cost way.
“It is not any more complicated than that,” he said.
KeyCorp CEO Chris Gorman adamantly denied the possibility of Scotia eventually taking control of the U.S. bank in his own Monday-morning call with analysts.
“This isn’t a step to a sale of the business,” he said. “We never contemplated a sale of the business. This is a strategic financing.”
Wells Fargo analyst Mike Mayo said on the KeyCorp call that he could see how the deal benefits KeyCorp, but not Scotia.
“If we go in a recession, you have more capital to absorb unforeseen problems. You’ll be in a position of strength, you can capitalize,” Mr. Mayo said. “And if we’re in a good environment, then you can do more of your lending, I think that’s what you’re saying, but it’s hard to see why Scotiabank is doing this.”
Mr. Thomson and Scotiabank chief financial officer Raj Viswanathan both said the deal gives Scotia more options to pursue as it seeks to expand its U.S. presence, though neither of them specified exactly what options this deal creates and analysts consistently pointed to the five-year standstill agreement as a potentially limiting factor.
The deal grants Scotia the right to appoint two members of KeyCorp’s board of directors, one of which can be a Scotiabank executive while the other must be a third-party individual deemed “reasonably acceptable” to KeyCorp, according to the transaction agreement.
Scotia has historically been considered Canada’s most international bank, with a major presence in the Caribbean, Latin America and South America. However, during Scotia’s December, 2023, investor day, Mr. Thomson made it clear he saw more profit potential in staying closer to home.
“The return profile of the international bank has not been commensurate with the risk and it’s been a drag on overall returns,” he told reporters during a media round table at the time. “Committing to allocating more capital to that North American corridor and asking our international bank to optimize their capital is a meaningful shift.”
More than three-quarters of KeyCorp’s profit comes from commercial banking activities such as lending and investment banking, though Mr. Thomson noted that 59 per cent of the U.S. bank’s US$146-billion in total deposits is from consumers.
Scotia expects the investment will add up to $350-million to its annual earnings as of 2026, though Mr. Thomson said the deal should also provide more opportunities for the two banks to work together.
“Over time in the future, there will be areas to collaborate, we are hopeful, around wealth, commercial, and on the capital markets side,” he said.