If Bank of Nova Scotia’s BNS-T strategic review last year lacked some detail in its big-picture effort to drive profitability, investors now have something far more substantial to chew on: Scotiabank is buying an ownership stake in KeyCorp, pushing the United States to the top of its growth aspirations.
Should investors embrace this new vision?
The deal, announced Monday morning, entails Scotiabank buying a 14.9-per-cent stake in KeyCorp, a regional U.S. financial firm based in Cleveland, Ohio, at a price of US$2.8-billion or US$17.17 a share.
An initial investment of 4.9 per cent is expected to close before the end of this year; the remaining 10 per cent should close in 2025.
However, neither bank stock reflected a sustained upsurge in investor optimism.
Though KeyCorp’s share price jumped nearly 16 per cent at the start of trading, to a high of US$16.92, it slumped to US$15.95 by the end of the day, trimming its gain to 9.2 per cent. The share price is more than 7 per cent below the announced deal.
Scotiabank’s share price fell 3.4 per cent, even as executives touted the benefits of the deal in a call with analysts.
Scott Thomson, Scotiabank’s chief executive officer, said the ownership slice would contribute to the bank’s profits immediately and offer potential collaboration in commercial lending, capital markets activity and wealth management.
The deal will also bolster Scotiabank’s presence in the so-called North American corridor, the economic powerhouse that includes Canada, Mexico and United States.
“We have been clear that an enhanced U.S. presence will be necessary over time to fully execute on our North American vision,” Mr. Thomson told analysts.
For KeyCorp, the bank gains an influx of capital at a time when many U.S. regional lenders have been struggling to repair balance sheets damaged by fleeing deposits.
Gabriel Dechaine, an analyst at National Bank of Canada, said in a note that he believes most investors now expect Bank of Nova Scotia to use this initial deal as a stepping-stone to take greater control of KeyCorp eventually, after a five-year standstill agreement ends.
“As a result, Scotiabank could be perceived as being in capital conservation mode over the next few years, which will likely curb alternative capital deployment strategies,” Mr. Dechaine said in his note.
In other words, he believes the bank may be less inclined to buy back its own shares – a popular alternative to dividends that reduces the number of outstanding shares and lifts earnings on a per-share basis – as it builds capital for further deal-making opportunities.
As well, dividend growth could be further constrained, given that Scotiabank’s current payout ratio – which compares the dividend to earnings – is north of 60 per cent, and above the historical range of 40 per cent to 50 per cent.
The KeyCorp deal follows a rough period for Scotiabank. The stock has underperformed the average for the Big Six banks by nearly 19 percentage points over the past three years. Profitability has lagged and investor enthusiasm for Scotiabank’s forays into developing markets, including Mexico, Chile, Peru and Colombia, has waned.
The shares trade at just 9.8 times estimated earnings over the next 12 months, according to S&P Global Market Intelligence. That marks a steep discount to Royal Bank of Canada shares, which trade at 12.7 times earnings.
This discount has made Scotiabank look like a bargain among Canadian bank stocks, especially when its leading 6.7-per-cent dividend yield is added to the mix. But it also suggests that investors have taken a decidedly cautious stance on the bank.
Its investment in KeyCorp, according to John Aiken, an analyst at Jefferies, might not change this view of the stock until investors gain some confidence that the touted benefits of the deal, including collaboration, go well beyond the ownership stake.
“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,” Mr. Aiken said in a note.
For now, then, Scotiabank is a stock that continues to beckon contrarian investors with a low valuation and attractive dividend yield – but there are a whole lot of unknowns about whether its bet on U.S. regional banking will pay off.