Although this is not the deal of this week for this deal took place almost a year ago however this deal is certainly not as boring as the Blackberry sale likely to take place very soon (If I had been a Blackberry shareholder, that day would be my Christmas eve). Bank of Nova Scotia acquired ING Direct, ING's Canadian retail and commercial banking business, in 2012. The deal was announced on the 29th of August 2012 and was completed on the 15th of November 2012. The deal is interesting at least from three perspectives - How the deal took place, What is in it for Scotia, and How the banking industry is shaping up in Canada.
The Global Banking Industry
The banking industry across the globe has undergone a phenomenal shift aftermath of Lehman crisis and amidst the onslaught of Global Financial Crisis. Changing environment, both political and economic, has brought about changing demographics (including social and cultural behavior), changing customer needs and expectations, and changing reputation of the industry. These trends have forced the industry monitors across the globe to bring about regulatory changes and strict surveillance on the progress and this is one stage in the history of banking industry when the regulatory changes are jurisdiction specific and so international banks needed to take this in to consideration. The industry has undergone a largest ever consolidation in its history and today a few banks, in each of the dominant economies in the world, hold majority of the market share. For e.g. in the US, the top six banks hold about US$ 9.8 trillion of the ~ US$ 14 trillion assets and contribute to about 65% of the total banking activity in the country. Similarly in Canada, the top six banks account for 90% of the total banking operations and control more than 90% of the total ~ C$ 4.5 trillion assets. As a result of the financial crisis, the banking industry diversified from its traditional retail and commercial banking operations in to wealth and asset management. Aging population particularly in the western world has further increased the need for wealth management products. In addition, concentration of wealth in the hands of few individuals (particularly during the crisis, the rich get richer and the poor get poorer) has encouraged the banks across the globe in offering moderate risk and high reward wealth management products. We have also seen a huge reduction in the loan to deposit ratio and banks have become more conscious about proprietary trading activities, which typically require large amount of capital and is a high risk high reward game. Large banks have also intensified their Investment Banking operations as a result of M&A activities in many other sectors such as Telecommunications, Transportation, Information Technology, and Pharmaceuticals. Particularly in Canada, the banking system continues to support the M&A activity in the economy. It is estimated that the banking industry is likely to grow at a CAGR of 8% to reach ~ US$ 163 trillion by 2017 however it goes to see how the industry shapes itself to the changing environmental landscape.
ING Direct Canada
In 2008, after the financial crisis, ING group (Netherlands) together with all other major banks in Netherlands took capital injection from the Dutch government. The support increased ING's capital ratio above 8% however as a condition of Dutch state aid, EU demanded many structural changes. The Dutch government provided ING with Euro 10 billion and as against this aid, EU required ING to divest its Insurance and Investment management operations by end of 2013. In addition, the Dutch government also held securities and veto rights on major operational and investment operations that ING would carry out. This forced ING to divest its Insurance business in Latin America, Asia, Canada, Australia, and New Zealand. As a requirement, ING sold its ING Direct US business to Capital One for about US$ 600 million, ING Direct Canada to Bank of Nova Scotia for C$ 3.1 billion, and ING Direct UK to Barclays bank for about GBP 10 billion. In 2009, ING raised Euro 7.3 billion through shares and repurchased securities equivalent to half of the capital injection and in 2011, it repurchased securities equivalent to Euro 2 billion leaving the state aid to Euro 3 billion. So the sale of ING Direct US and Canada is just going to take care of repurchasing the remaining Euro 3 billion equivalent securities.
ING Direct Canada was one of the most innovative banking concepts in Canada. It is aimed at those customers who want to save more and spend less on fees and other statutory engagements. So the Bank did not operate any physical branches rather had five ING Direct cafes and a few ATM machines. Customers were paid healthy interest rates (typically more than other banks) and all that customers needed to do was go online and complete transactions. ING Direct served customers via internet, contact centers, and mobile devices by offering savings, chequing, mortgages, and four mutual fund products. As of 2012, ING Direct Canada was the 8th largest bank in Canada and had 1.8 million customers with C$ 30 billion in deposits and C$ 40 billion in assets. The bank had a healthy mortgage portfolio with 59% of its mortgage insured and the average loan to value ratio on uninsured mortgages was 53%.
Bank of Nova Scotia
Bank of Nova Scotia is the most international bank in Canada with operations in 55 countries. The bank had 81000 employees and had 70% of its income coming from traditional personal and commercial banking activities and the remaining 30% from wholesale operations. Scotia bank operates in four major categories namely - Canadian retail banking, International retail banking, Global wealth management, and Global markets. In 2012, the bank reported a revenue of C$ 19.7 billion with an operating income of C$ 9.3 billion. Between 2008 and 2012, revenue growth averaged 13.6% per year however growth rate in operating income during this period averaged 20% thus indicating that the bank improved its efficiency ratio (Operating expenses to sales), one of the key measures of a bank. Between 2008 and 2012, Net income increased by 106% at an average of 19.9% per year to reach C$ 6.5 billion in 2012. The difference between the operating profit margin growth and net profit margin growth indicates that the statutory losses such as provision for credit loss was very minimal. As of 2012, Scotia bank managed total assets worth C$ 668 billion and was the third largest bank in Canada behind RBC (Royal Bank of Canada) and TD Bank (Toronto Dominion Bank) in terms of assets under management. The bank reported a ROA of 1.4% in 2012 and has remained the same all through 2008 to 2012. In 2012, Scotia bank reported a ROE of 16%, which was marginally lesser than the 17% it reported in 2008 and 18% it reported in 2010. Part of this decline was because of the dilution by issue of more common shares in 2011 and 2012. Assets to Shareholder equity (Asset to capital multiple), another important measure post the Basel III regulations declined from 23.5 in 2008 to 16.9 in 2012 mainly because of the growth in the asset base relative to growth in equity. However since the risk bearing assets in Scotia were not as significant, the bank was able to improve its Tier I capital ratio (capital to risk bearing asset ratio) from 9.3% in 2008 to 13.6% in 2012 and thus was well above the Basel III threshold of 7.5%. Finally the loan to deposit ratio, that in a way guides the credit rating agencies in rating the banks, declined from 87% in 2008 to 76% in 2012. Part of the reason for this decline could also be softening housing prices and saturation in the retail lending space because of very high debt to disposable income within the Canadian population (164.6%). In fact in January 2013, Moody's cut credit ratings of TD Bank, Scotia Bank, Bank of Montreal, CIBC, and National Bank of Canada by one level citing concerns over consumer debt and housing prices.
Scotia bank expanded internationally particularly in the Latin America after it acquired 51% stake in Columbia's fifth largest bank. This expansion gave the bank access to Latin American markets including Brazil, Mexico, and Chile and It is expected that the Latin American countries are likely to experience significant grow rates relative to the US and Canada. The growth in the wealth management and global markets space was something to observe between 2008 and 2012. Between this period, income from Canadian retail banking declined from 42.6% to 31% and income from International retail banking operations declined from 29.3% to 25% thus indicating the growth in the wealth management and global markets space. The global wealth management operations grew from 0% in 2008 to 18.3% in 2012 and the global banking and markets operations grew from 19.5% in 2008 to 24% in 2012.
Even though Scotia bank was able to grow internationally, it's policy of seeking 50% income from Canada and the remaining 50% internationally was not getting satisfied for reasons such as limited domestic growth opportunities and profitability of domestic banking business. Since the big six banks in Canada were well capitalized with high levels of liquidity and readily accessible funding in the Canadian capital markets (In 2012, Scotia bank issued C$ 4 billion of common shares at two times the book value to fund acquisitions) at extremely low rates as compared to global standards, the Canadian banks were able to diversify through acquisitions within Canada so as to increase their market share and Internationally in to high growth economies such as Latin America and Africa. As a result, Scotia bank acquired Dundee wealth for US$ 3.2 billion in 2011 and the acquisition of ING Direct in Canada would have helped it to overtake CIBC as the third largest bank in terms of deposits. So the ING Direct deal was critical not just for Scotia bank but also for other banks operating in the Canadian market for it gave market share in addition to the innovative business model that ING Direct had in the country.
How the deal happened
Having understood the rational behind why ING wanted to sell ING Direct in Canada and why Scotia and other banks wanted to buy ING Direct, let us examine how this process was conducted. It is important to understand that whenever a company is forced in to selling its business, it will sell the best business it has. So without any doubts, ING Direct Canada was ING's cherry. The sale process was a 2 stage auction where in the first stage, bidders were invited to submit their bids and the bids would undergo screening by the Investment bank appointed by ING and the successful bids will go to the second and final stage. Considering the competition to secure this deal, it was not surprising that 28 banks bid for ING Direct. Only three banks made it to the second stage where intense discussions and negotiations led to ING selecting Scotia bank to takeover ING Direct in Canada. It was made to understand that the bank that would take over ING Direct was not just offering the best price (in fact there were banks in the first round that offered better price than what Scotia bank was offering) but also had sound management to manage the target.
This is one of a kind of process of deal making and is very interesting because this process is particularly applicable when you are selling one of your most important and strategic business units and the target company has an upper hand right from the announcement of the auction.
Deal structure
Scotia bank agreed to pay ING C$ 3.1 billion in cash and will also clear C$ 320.5 million of subordinated debt that ING Direct held with the state. This meant that the net investment that Scotia bank will be making on this deal was C$ 1.9 billion after netting of the capital that ING Direct carried on its balance sheet. To support the deal, Scotia bank issued common shares of 29 million (4.35 million additional shares can be issued in case of over subscription) at a price of C$ 52 per share. The proceeds of this issue was carried out by Scotia Capital Inc. This meant that the gross proceeds raised under the share offering would be about C$ 1.73 billion.
After the deal
At the end of the deal, Scotia bank became the third largest bank in terms of deposits overtaking CIBC and just behind RBC and TD Bank. This also improved its deposits by 9.1% (YTD 2013) to reach C$ 506 billion by third quarter of 2013. ING Direct still continues to operate as a wholly owned subsidiary and Scotia bank had promised that it will not cross sell any of its products to ING Direct customers. However this deal helped Scotia bank enter the much needed internet banking space, which is not very efficient within the big bank circle. In addition, Scotia bank was allowed to retain the ING logo and brand name for a period of 18 months from the conclusion of the deal so in six months from now, Scotia bank will have to re-brand ING Direct and this could be a challenge for the Scotia bank management. We are likely to see a lot of customer poaching activity during this period particularly from TD Bank, which has good internet banking facilities within the country. At the end of third quarter of 2013, Scotia bank reported revenues of C$ 15.9 billion with an operating income of C$ 7.3 billion and a net income of C$ 5 billion. With one more quarter for year end closing and lots of activities to be carried out by Scotia bank to merge ING Direct completely in to itself, it will be an interesting time in the banking space particularly with respect to product offerings and channels of customer engagements.
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