Moody’s Investors Service says it views Bank of Nova Scotia’s planned acquisition of Siam City Bank as a negative in the short-term, but that it is consistent with the bank’s successful international strategy.

Last week, Scotia announced that it would support its 49%-owned Thailand-based subsidiary, Thanachart Bank in acquiring Siam City Bank. Moody’s said on Monday that it views this as a negative in the short-term “given the size of its investment and the low financial strength of the target bank.”

“That said, the acquisition is not inconsistent with Scotiabank’s international expansion strategy which has been successful to date,” it added.

Under the terms of the proposed deal, Scotiabank will contribute approximately $650 million in support of this transaction, thereby maintaining its 49% stake in the combined entity, which will be the fifth largest in Thailand, Moody’s says. As a result, Scotiabank’s total exposure to its Thai subsidiary will rise to $1.2 billion when this transaction closes, which, in Moody’s view, represents a sizable single-name concentration accounting for 6% of its tangible common equity.

SCIB’s low financial strength moderately intensifies Scotiabank’s risk, the rating agency adds. “While the combined entity will have a stronger local franchise, it will remain challenged by poor asset quality, weak risk positioning, and high credit concentrations. In the near term, Moody’s does not believe the merger between TBank and SCIB will materially improve SCIB’s financial strength,” it adds.

The rating agency points out that there is a low but material probability that the Thai bank will require external support at some point in the future. “If such a situation were to occur, Scotiabank could find itself obliged to provide support to protect both its reputation in Asia and its large investment in TBank. Thus, Moody’s argues Scotiabank’s effective risk is higher than its minority stake implies,” it says.

“That said, a systemic issue in Thailand would be the more problematic scenario for Scotiabank. Were the combined entity to suffer an idiosyncratic challenge, Scotiabank’s contingent commitment could be limited to its pro-rata share in the entity with other investors supplying the balance of support,” it notes.

Moody’s points out that Scotiabank has maintained an exceptionally consistent approach to its international expansion strategy — one which it views as the most effective of all the Canadian banks.

“If Thailand’s economy grows and its financial system matures, this investment could have a positive impact on Scotiabank’s credit profile in the long-term. In the short-term, however, Moody’s views this risk concentration as having negative credit implications,” it concludes.

IE