The average bank has a dividend yield of approximately 2.5%, with the SPDR S&P Bank ETF (NYSEMKT: KBE) as a proxy for the industry. What if you could own a bank with a yield of 6.1%? What if it was conservatively run, had a strong core business, and was a reliable dividend payer? You’d probably jump at the chance to own such a high-yielding bank. No problem — you can Bank of Nova Scotia (NYSE: BNS)So now is a good time to take the plunge.
Why is Bank of Nova Scotia’s yield so high?
Bank of Nova Scotia, better known as Scotiabank, has lagged behind other banks. A large part of the reason for this is that it has taken a different strategic direction than its Canadian banking peers. Most of the major Canadian banks have opted to expand south into the U.S. market. Scotiabank skipped the U.S. and began building a business in Central and South America.
The logic is sound, as the US is a highly competitive market that is also fully developed. The markets that Scotiabank went to were developing and less competitive, suggesting the potential for more growth in the long run. While that may have been true, and may still be true, these less developed markets were not as profitable as hoped. Scotiabank has lagged its peers on key metrics such as earnings growth, return on equity, and return on risk-adjusted assets.
So despite being one of the largest banks in Canada (with an established position in the sector thanks to Canada’s strict banking regulations), Scotiabank offers a dividend yield of 6.1%, more than twice the yield of the average bank. The bank has paid dividends every year since 1833, has a generally conservative ethos (another hallmark of a Canadian bank), and has an investment grade balance sheet. The risk here does indeed seem quite modest for the high yield reward.
What is Scotiabank doing about its underperformance?
The problem for investors, of course, is that Scotiabank is not doing particularly well relative to its peers. But management is not ignoring the problem. In fact, it has addressed it head-on and is moving in a new direction. It is exiting weaker markets (such as Colombia) and putting more effort into expanding into better markets (such as Mexico). The company is also following its peers by building a larger presence in the United States.
That last part is important to Scotiabank’s approach, because it wants to create a dominant North American bank that stretches from Mexico to Canada and across the United States. That way, it can serve a regional trading bloc with a geographically integrated product. This is where Scotiabank just took a giant leap forward.
Rather than try to build a company from the ground up, it has agreed to buy just under 15% of the company’s shares. KeyCorp (NYSE: KEY). The move will be done in two transactions and is expected to be immediately accretive to Scotiabank’s earnings. It also provides a lifeline for KeyCorp, which needed to shore up its own finances. In principle, this is a win-win. However, the real benefit is likely to be long-term.
At this point, Scotiabank’s investment is just that, an investment in another bank. However, it hopes to find ways to work with KeyCorp to offer products and services. KeyCorp is more consumer-focused, while Scotiabank is more business-focused, so the two banks won’t be stepping on each other’s toes. Any partnership would complement both banks’ businesses.
There’s a five-year standstill clause in the deal, so KeyCorp can’t do much more than that for now. However, it’s hard not to imagine Scotiabank at least considering an acquisition of KeyCorp at some point in the future — a move that would give it an immediate presence in the U.S. market.
The future will look very different for Scotiabank
Investors should never put too much stock in an investment like Scotiabank’s. But it’s a clear statement that management plans to shift gears dramatically and quickly as it seeks to close the performance gap with its peers. It will certainly be a multi-year effort. But with such a powerful push from a financially strong high-yield bank, investors who think in decades, not days, may want to get in now. That fat dividend yield may not last as long as you think if Scotiabank’s business starts to improve amid an aggressive push to improve performance.
Should You Invest $1,000 In Bank Of Nova Scotia Now?
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Reuben Gregg Brewer has positions in Bank Of Nova Scotia. The Motley Fool recommends Bank Of Nova Scotia. The Motley Fool has a disclosure policy.
Did This High-Yield Stock Just Change the Playing Field? was originally published by The Motley Fool
