Chile highlights Scotia’s upside international risk
Four years after Scotiabank last took its investor day on the road, the bank put on a show in Santiago in January to highlight the advances it has made in its international banking strategy.
Around 90% of the investors and analysts who gathered together in Chile at the end of January for a two-day Scotiabank investor conference had never been to South America before, according to one of the host’s senior management team.
But following Scotiabank’s acquisition of BBVA’s bank in Chile in 2018, the bank’s president and chief executive, Brian Porter, was keen to improve awareness of the increasing importance of the Latin American trade bloc known as the Pacific Alliance (formed by Chile, Colombia, Mexico and Peru) in the bank’s international focus.
“We were pleased to showcase our operations across the Americas at Scotiabank’s investor day in Santiago, Chile,” Porter tells Euromoney. “Our investors understand that Scotiabank is focused on the Americas. We have built leading market positions in North America and in high-growth LatAm countries where we see opportunities for high returns and strong growth. Today we are operating from a position of strength and we were happy to showcase that to investors.”
There was concern that the widespread popular protests that started in Chile in October and flashed across the world’s media would undermine the bank’s argument that the country (and the Pacific Alliance in general) was a resilient growth opportunity and one that will help the bank outperform its peers.
“Our commitment remains unchanged in Chile,” says Ignacio Deschamps, group head of international banking and digital transformation at Scotiabank. “We have been here almost 30 years now, and it has a bright future – it’s a great country with solid progress, more than any other country in the region. [The country is now] responding to new social expectations, but I am confident Chile will come out of [these challenges] even stronger.”
Deschamps describes the acquisition of BBVA as “a once-in-a-lifetime opportunity” – and it’s easy to understand why. Both legacy Scotiabank and BBVA had a 7% market share in loans. Simple arithmetic would place a combined entity in joint third place in the banking system, equal to the 14% market share of Banco Estado and Banco Credito. This would make the bank a big player, not too far back from leaders Santander (19% market share) and Banco do Chile (17%)
Even so, the bank was wary of execution risk. Francisco Sardón de Taboada, country head of Chile for Scotiabank, says the bank conducted a study into all the Chilean banking mergers, and its findings were worrying.
“On average, these took four years and the combined entity lost 200 basis points in market share,” he says.
To maximize the success of BBVA’s integration, Scotiabank started by appointing a leadership team.
“These same leaders were in charge of running the [day-to-day operations of the] bank and integrating the two entities,” says Sardón de Taboada. “This provided clear accountability and helped success by reducing any tensions.”
The bank broke the integration into five distinct stages, with the last being the integration of the core systems. That was completed in November last year – just 16 months after the merger began – swift by anyone’s standard.
“We began with a target of zero attrition, which caused certain nervousness in head office, but we couldn’t afford to lose any clients or market share,” Sardón de Taboada says.
Not all emerging markets are created equal. The Pacific Alliance stands out for its solid fundamentals and vigorous growth - Ignacio Deschamps, Scotiabank
In fact, the bank managed to increase market share during the integration process by 36bp and has already generated 80% of the C$150 million ($113 million) of targeted synergies (with 42 branches closed by the end of 2018).
The remaining 20% will be captured by the end of 2020.
Scotiabank Chile is already a distinctly different proposition to the pre-BBVA bank. Just five years ago Scotiabank was ranked seventh largest and generated a 7% return on equity (ROE) with C$130 million. It now has an ROE just shy of 14% as calculated under Chilean GAAP (generally accepted accounting principles).
The challenge now is to grow deposits to improve its funding costs relative to its competitors.
Its C$24 billion of deposits and C$47 billion in loans point to an unbalanced balance sheet; Sardón de Taboada hints that failure to increase deposits would frustrate credit lending growth.
“We have limits, and we will stick to those limits,” he says about the reliance on wholesale funding, adding the bank has plans to boost core deposits by targeting corporate relationships through payroll services to boost deposit accounts.
The bank’s goal is to improve annual net income by C$40 million within three years through a better funding mix. It has adjusted its Chilean goals to achieve annual growth in net income attributable to equity holders of 10%, reduce the efficiency ratio below 41% (it is currently 43.4%) and maintain positive operational leverage.
However, while Chile is unquestionably the standout story of Scotiabank’s international business of the last two years (only its Peruvian bank is bigger and more profitable than the new Chilean entity), it is the broader Pacific Alliance story that the bank is keen to emphasize.
“We have sharpened our geographical footprint and are now focused on footprint optimization,” says Deschamps.
The bank has exited 20 countries and non-core businesses to focus on becoming “the bank of the Americas – from the north of Canada to the southern tip of Chile.”
We are the only bank with a significant presence in all the major countries in the Americas corridor: Canada, the US, Mexico, Peru, Chile and Colombia - Brian Porter, Scotiabank
This rationalization has meant a mix of geographical focus (the bank exited Thailand despite its operations there being profitable) and consolidation. Scotiabank has culled very small operations in places such as Antigua, Guyana, Belize, Puerto Rico and El Salvador and now its reduced central America and Caribbean business is focused on Dominican Republic (where the bank has recently bought Banco del Progresso), Jamaica, Trinidad & Tobago, Costa Rica and Panama. Between them, these five countries account for 65% of this region’s earnings.
While this smaller region is being consolidated it is also being downsized in importance by the growth of the Pacific Alliance countries, which combined generate around 80% of all of Scotiabank’s international earnings.
Scotiabank’s president and chief executive Brian Porter
“Today, we are the only bank with a significant presence in all the major countries in the Americas corridor: Canada, the US, Mexico, Peru, Chile and Colombia,” says Porter. “Our six core markets represent more than 85% of our earnings. If you include our refocused Caribbean and central American operations, that number rises to 95%.
“We will remain focused on countries that offer scale, stability, the right demographics and long-term growth.”
Deschamps believes the logic of the bank’s focus on the Pacific Alliance to drive its international banking earnings is clearly sound.
“Not all emerging markets are created equal,” he says. “The Pacific Alliance stands out for its solid fundamentals and vigorous growth, they are all democracies with open economies and central banks that are committed to low debt and low and stable inflation.”
Seen as a single market, the Pacific Alliance is attractive. It has a population of 225 million, with an average age of 30, of which 40 million entered the middle class in the last two decades (taking the total to 70 million).
As a bloc, its economy would be the sixth largest, behind Germany, with an annual value of $4,254 billion and projected GDP growth of 3% a year to 2024.
Banking penetration is generally low; Chile leads the way with 74% of its citizens holding a bank account, followed by Colombia (46%), Peru (43%) and Mexico (37%).
Not that the Pacific Alliance is all long-term promise. In many ways the Canadian bank’s bet on the region is already paying off. Return on equity in the Pacific Alliance is far ahead of that in its core market already (at 19.1% versus 15.3% respectively). The rest of the international business is further behind, with an ROE of 12.1% in the US, 11% in Asia and just 6.7% in Europe.
The Pacific Alliance is also the engine of the bank’s international earnings, which have been growing at a compound annual growth rate of 13% since 2014 (compared with the Canadian bank at 6%). Loans in the Pacific Alliance have grown at a CAGR of 21% since 2016, compared with 2% elsewhere in international banking. Deposits have grown by 18% in the region compared with 1% elsewhere, while net income has grown 15% in the Pacific Alliance in the last three years.
And all this has been achieved while the region’s growth has slowed – last year the area’s GDP grew at just 1.6% – because of market share gains in each country.
Chile grew its market share by 790bp to move from seventh position nationally in loans to third, while Peru maintained its third-place position locally and grew market share organically by 80bp. Mexico moved up to sixth (from seventh) in its banking system with a 180bp grab of market share and Colombia jumped two spots to become the fifth-largest bank with a gain of 100bp, thanks to the acquisition of Citi’s consumer and small and medium-sized enterprise banking operations in the country.
Mexico and Colombia
As impressive as this growth is, however, the challenge for Scotiabank is to get its Mexican and Colombian operations to a scale similar to Peru and now Chile.
Colombia is the weakest link. There the bank lacks both scale and diversification and it suffered disproportionately in the recent economic slowdown, with its ROE collapsing from an industry-matching 16% in 2016 to just 5% in 2018 (compared with a system average of 11%), before recovering to 7% ROE last year (when the system’s was 13%).
Scotiabank is aiming to propel that to 16% by 2022. Its strategy is to leverage its strong corporate and wholesale relationships to build a more representative retail presence. The acquisition of Citi will also help, as that added 500,000 retail customers, mainly in the affluent sector.
Mexico is arguably the most interesting of the bank’s Pacific Alliance operations. Its management, led by Adrián Otero, receives plaudits from the chief executives of the bank’s competitors, while it has improved its market share without weakening its credit profile. But in such a competitive market it will be hard to grow organically to a size that puts Scotiabank on a par with the second tier of banks in the country, let alone the market leaders.
Scotia is ranked sixth in loans, with a 7.5% market share, close to HSBC’s 7.7%, but still a long way from second-tier firms such as Banorte (13.7%), Santander (13.2%) or Citi (12.2%). BBVA is the market leader with 22.9%.
When asked about the prospects for Mexico, one official says that the bank will continue its patient organic growth while waiting for an acquisition to appear that will boost its market share.
Scotia believes that, ultimately, there are banks below the universals that hold a couple of percentage points of market share that will struggle to maintain their competitiveness as the market grows.
Given strong growth in the Pacific Alliance, there is a natural question about whether or not the bank would extend its horizons to other south American markets. The retrenchment from small central American and Caribbean markets is rational, but what about the potential of other larger markets that neighbour the existing operations in Latin America?
“We are happy and confident with how Scotiabank is positioned,” responds Porter. “We have a long history operating in these countries and very strong local management.
‘Our scale allows us to absorb fixed costs more effectively and lowers some funding costs. It facilitates diversification by product and service, which deepens customer relationships. It more effectively allows for investment in technology and digital banking capabilities. Finally, it enhances our competitive advantages in each market. As our bank grows, so do the opportunities to further leverage our scale.”
We have a C$128 billion loan portfolio and, just given this size, we believe that Latin America provides significant opportunity - Jake Lawrence, Scotiabank
Brazil, where the bank does limited wholesale banking and which today generates 3% of the bank’s C$5 billion global wholesale and investment banking revenues, is too large for retail banking acquisitions.
Argentina is too dysfunctional at the best of times and perhaps memories are still sufficiently painful of the C$540 million write-down the bank had to book in 2002 when it closed its subsidiary.
But what about the possibility of leveraging Scotiabank’s investment in digital technology, optimized for multiple country deployment, to launch purely digital banks in South American jurisdictions where the bank does not have a physical presence?
Again, Porter remains guarded.
“We are studying this closely,” he says. “At present, our digital banking efforts are focused on our core markets where we see significant opportunities.”
That digital investment has been heavy, but it is revolutionizing the cost structure of Scotiabank’s Latin American operations. Internet usage has jumped in the Pacific Alliance in recent years to reach penetration levels of 64% in 2018. The bank has capitalized on this.
The spreading of costs across markets is also raising the tentative prospect that cross-border economies of scale might be realizable. The bank has been trying to generate such savings by creating a common platform called ScotiabankPro and creating multinational teams that share code across borders to share development costs.
“A great example is our award-winning digital banking app,” says Porter. “We have been able to use the technology developed at our digital factory and deploy it across jurisdictions, reducing costs and improving the customer experience. Customers in Mexico are using the same product as customers in Canada but tailored to the local market. This provides economies of scale.”
Another cross-border competitive advantage is being sought in wealth management. Scotiabank believes there are synergies to be had between its Canadian wealth management business and building a similar platform for Latin America’s wealthy.
The bank is in the planning stages for this Latin American business, hiring Raquel Costa, HSBC’s former executive director of retail banking and wealth management, in August last year. She has relocated from Mexico City to Toronto to join Scotiabank’s international unit as a senior vice-president of wealth management
The bank has big revenue hopes for this segment in the region.
Scotiabank also hopes to increase its wholesale and investment banking business in the region. It wants to grow both its capital markets origination business and increase flows for its trading desks.
The bank is confident it can increase share of wallet among the US and Canadian corporations active in Latin America, as well as those internationally focused multinationals based in the Pacific Alliance. It already has more than 500 Scotiabank employees in its global banking and markets (GBM) business based in the Pacific Alliance, serving more than 5,000 local companies and delivering “significant double-digit growth,” the firm says.
“We have a C$128 billion loan portfolio and, just given this size, we believe that Latin America provides significant opportunity,” says Jake Lawrence, co-head of GBM at Scotiabank, who adds that he is projecting 5% annual increases in net profit for his business, but that also includes “the lot of opportunity left in the US”.
At the end of the second day of presentations, many of the investors and analysts filed out impressed by the bank’s identification of an earnings-boosting international strategy (in the face of other banks’ retrenchment); by the refocusing on the stable and strong markets of the Pacific Alliance; and by the bank’s ability to deliver on its three-year targets in the region, despite patchy economic growth during this time.
Will they be similarly impressed after the next trip south in 2024? The strategy is already delivering accretive results, while local management has proved its ability to deliver on a simplified, more focused international strategy. But the extent to which Colombia and Mexico will be able to match Scotiabank’s operations in Peru and Chile as growing and profitable leaders will almost certainly depend on successful acquisitions.
That will require luck. But as Scotiabank demonstrated this year, with a bit of time and effort, luck can be made.