Cross-border bank deal takes leap of faith
Refiles to remove extraneous line saying “Full view will be published shortly”. The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By John Foley
NEW YORK, Aug 12 (Reuters Breakingviews) -Banks rarely back other banks. There’s good reason: regulators deliberately make such deals fiddly. U.S. regional lender KeyCorp KEY.N should therefore be doubly pleased with the $2.8 billion cash injection from Scotiabank BNS.TO, an investment that has more obvious appeal for the recipient of the money than its supplier.
KeyCorp isn’t in dire straits, but it is in a capital rut. Investment securities it owns have lost $4 billion in value as interest rates climbed. If the bank offloaded them today, its common equity tier 1 ratio, a measure authorities watch closely, would be 7.3%, about half the U.S. bank average, according to Federal Deposit Insurance Corp data. The gap has weighed on KeyCorp shares, which lagged the KBW Banks Index this year until Scotiabank came along.
A slug of cash in return for a nearly 15% stake will help KeyCorp CEO Chris Gorman. He plans to use half the windfall to absorb losses as the bank sells some of its weaker holdings, lifting its equity ratio to about 9.3%. Reinvesting sale proceeds in higher-yielding securities should increase its net interest income by some 10%.
The direct benefits for Scotiabank are less apparent. In return for paying an 18% premium to $15 billion KeyCorp’s closing share price on Friday, it will get two board seats and a reasonable implied return of roughly 10%, based on the approximately $250 million of earnings Scotiabank expects will accrue to it. It also anticipates that its own regulatory capital should be made whole within about five years.
Joining forces might bring extra goodies. KeyCorp has branches in U.S. states that neighbor Canada and might provide a decent perch for Scotiabank to serve customers across North America. If these sorts of partnerships made clearer sense, however, they would be appealing with or without Scotiabank owning a stake. Meanwhile, KeyCorp’s value will depend on things over which Scotiabank has no control, ranging from U.S. interest rates to the creditworthiness of borrowers.
Scotiabank is most likely playing a longer game. It might get all kinds of synergistic benefits if it bought KeyCorp outright, which it is allowed to do after a five-year standstill agreement expires. Boss Scott Thomson says the two banks are culturally kindred; he now has a better shot at gauging the hypothesis. But it’s KeyCorp that now has valuable time on its side.
CONTEXT NEWS
Scotiabank said on Aug. 12 that it agreed to buy a 14.9% stake in U.S. regional bank KeyCorp for $2.8 billion in a two-part deal. The Canadian lender is paying $17.17 per share, an 18% premium to the $14.61 closing price on Aug. 9.
KeyCorp said it would use about half of the capital to absorb losses from selling a portion of its portfolio of investment securities, which have lost value over time because of rising interest rates. It would then reinvest the proceeds into higher-yielding securities.
Scotiabank will get two board seats at KeyCorp, and said it was keen to pursue “mutually beneficial strategic opportunities.” The bank has previously said it wanted to increase its exposure to developed markets, and the United States in particular.
KeyCorp shares rose 13% to $16.56 in early trading on Aug 12, while Scotiabank’s fell 4.3% to C$60.95.
Editing by Jeffrey Goldfarb and Pranav Kiran
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