KeyCorp says $2.8B deal with Scotiabank will help it be 'front-footed'

The Bank of Nova Scotia is investing $2.8 billion in KeyCorp , a deal aimed at fixing the latter bank's profitability woes while enabling the Canadian lender to step into the U.S. consumer banking market.

Toronto-based Scotiabank would get a 14.9% stake, making it the largest shareholder in KeyCorp and planting its flag in a market that its Canadian rivals have long found attractive. For KeyCorp, the deal pumps more capital into the $187 billion-asset company, giving it space to reposition its bond portfolio and accelerate a much-hoped-for return to better profits.

The Canadian bank has a large footprint in Mexico, and its executives said the deal gives Scotiabank options in its quest to build a North American corridor.

As part of the deal, Scotiabank agreed to not bump its ownership above 19.9% for five years, quashing any speculation that it would soon acquire KeyCorp in its entirety.

Instead, KeyCorp executives laid out near-term benefits, most notably giving the bank the ability to play a bit of offense after spending much of last year on defense.

"There's no doubt that this additional capital enables us to be front-footed," KeyCorp Chairman and CEO Chris Gorman told analysts Monday.

That would help KeyCorp pick up business that its competitors may shed, Gorman said, noting the industry may "go through a reset" as it prepares for tougher rules from the Federal Reserve.

The company's preparedness for higher capital requirements from the Fed is a question that has "dogged Key for some time," Piper Sandler analyst Scott Siefers wrote in a note to clients. But getting more capital from Scotiabank appears to resolve that issue while "greatly enhancing flexibility" for the bank, he wrote.

Scotiabank approached KeyCorp about the possibility of investing, Gorman said, noting the Cleveland-based bank wasn't seeking capital and was comfortable with its standing. The bank had a tough 2023, when the sharp rise in interest rates caught it off-guard, but executives have been anticipating a turning point soon as some investments gradually roll off its balance sheet.

The deal accelerates that turning point, Gorman said. The bank has been stuck with some low-yielding bonds it bought a couple of years ago, and it has been unable to replace them with higher-paying ones without taking a loss.

But with Scotiabank's investment, KeyCorp would get more wiggle room for a "potential repositioning" of its bond portfolio, the company said in a press release. The bank would use up about half of Scotiabank's investment to offset the loss from the repositioning, though the company said it would pull forward some $400 million in interest income from buying higher-paying bonds.

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The objective of the restructuring would be "accelerating the timing of expected profitability, liquidity and capital improvements, and generally increasing resiliency," the company said.

Scotiabank would make the minority investment at a price of $17.17 a share, an almost 18% premium to KeyCorp's closing price on Friday. The stock opened at $17.07 on Monday before pulling back, recently trading up 8.8%.

The investment will happen in two stages, and Scotiabank can choose two members to add to KeyCorp's board.

Gorman emphasized that KeyCorp would retain flexibility under the deal, painting it as a financial investment in the bank rather than a broader undertaking.

"This is a strategic investment at a premium," Gorman said. "It just so happens that it happens to be by an industry participant."

For Scotiabank, the bigger question is whether KeyCorp is the best use of investors' funds — or whether there are better ways for the Canadian bank to deploy its cash.

Scotiabank's shares were recently down 3.8%. Investors are "likely going to require tangible proof … before throwing full support" behind Scotiabank's purchase, Jefferies analyst John Aiken wrote in a note to clients.

The deal is a "very different approach to gaining traction in the U.S. market" than its peers have taken, Aiken wrote Monday. Rather than taking minority investments, Toronto-Dominion Bank, the Bank of Montreal and the Royal Bank of Canada got branch networks in the U.S. by buying American banks.

Scott Thomson, president and CEO of Scotiabank, told analysts Monday the deal is an "important early step" toward the bank's vision of expanding its footprint. It already has a major presence in Mexico and the Caribbean, but an "enhanced U.S. presence will be necessary over time to fully execute on our North American vision," Thomson said.

The deal offers "attractive financial returns" in the short term for Scotiabank shareholders, he said. But there are also "mutually beneficial strategic opportunities in the future," Thomson said, such as partnerships in wealth management, payments innovation and services for commercial clients.

In the latter space, the two have complementary businesses, Thomson said, noting KeyCorp is more focused on middle-market clients while Scotiabank works with larger corporate clients.

Scotiabank will make an initial $800 million under the deal that would give it 4.9% ownership of KeyCorp. The follow-on $2 billion investment would require approval from the Federal Reserve, which the companies said they expect to receive in the first quarter of 2025.