Bank of Nova Scotia’s acquisition of Citigroup Inc.’s banking operations in Panama and Costa Rica is a credit negative as it ramps up the bank’s reliance on foreign operations, Moody’s Investors Service says in a new report.
The price on the deal has not been publicly disclosed by either bank, but Moody’ does not believe that the transaction is financially material, according to the report from the credit rating agency.
Nevertheless, he deal is credit negative for Scotia “because the bank’s deployment of capital to incremental international operations increases its reliance on non-domestic earnings,” the report says, adding that Moody’s expects that the transaction will reduce Scotia’s common equity Tier 1 capital ratio by approximately 15 basis points.
Scotiabank’s international operations typically dilute the stronger credit quality of its core domestic operations, “reflecting the relatively challenging operating environments of these countries and [Scotia’s] weaker franchise strength in these markets,” the report notes.
Currently, international operations account for about 26% of net income, Moody’s reports; and, they “have demonstrated consistent performance, despite the fact that most countries in which [Scotia] operates have riskier operating environments than that of Canada,” the report says.
Notwithstanding the concern about increasing international exposure the transaction will strengthen Scotia’s existing operations in the Panama and Costa Rica, the report notes, nearly tripling its customer base in the two countries to 387,000 from approximately 137,000. “The profitability and scale of both Scotia Panama, the country’s sixth-largest bank, and Scotia Costa Rica, the fourth-largest bank, will benefit from the addition of Citigroup’s loan book, which has above-average margins in both markets,” the report says.
The transaction will also “provide a significant lift” to Scotia’s market share in credit cards, the report says, although it cautions that this space is generally characterized by higher probability of default and higher loss given default than secured forms of consumer credit.
The deal also carries execution risk, “given that management will need to focus on improving [Scotia’s] poor operating efficiency in Panama and Costa Rica as it takes on all of Citi’s retail and commercial banking employees in both countries,” the report adds.
In addition, both banks will face “challenging operating environments as asset quality faces negative pressure from lower economic growth, and the likelihood of higher interest rates in the U.S.,” the report concludes.