/Scotiabank’s strategic foray into Latin America hits a snag with unrest in Chile

Scotiabank’s strategic foray into Latin America hits a snag with unrest in Chile

A message was spray painted on a boarded-up window of a Bank of Nova Scotia branch in Santiago last week: “Tienen el poder y lo van a perder.”

The message obviously had a literal meaning — “they have the power and they will lose it” — but it had a figurative meaning as well, a sign that one of Canada’s biggest banks had not gone unscathed by the protests that have rocked Chile for a month.

More than 20 people have died and thousands have been injured over that time. Protests continue, but the government, reeling from the sudden burst of opposition, has agreed to a variety of reforms, as well as to a vote in April over whether Chile should rewrite a dictatorship-era constitution.

Compared with all that, some spray paint is small thing. Still, Scotiabank is more than a year removed from closing an acquisition that turned it into one of the South American country’s biggest banks, as part of a broader strategy aimed at four Pacific Alliance markets: Chile, Colombia, Mexico and Peru.

That plan has paid dividends for Scotiabank, whose international operations have recently produced greater earnings growth than that of its domestic retail unit, but all four of those countries have run into various issues over the past year, including threats of civil war resuming in Colombia and gang-related violence in Mexico.

Scotiabank’s strategy is similar to that of the other Big Five Canadian banks in that they have all had to look outside their home market for future growth engines. Where Scotiabank differs, however, is that it has been buying businesses in Latin America, while its peers have invested in the more familiar — and safer — environs of the United States.

As a result, Scotiabank officials could face questions from analysts about the impact of the Chile protests during a conference call on Nov. 26, when the lender kicks off another earnings season for Canada’s big banks.

People demonstrate with a giant Chilean national flag in Santiago on Nov. 8, 2019.

Martin Bernetti/AFP via Getty Images files

“I think (the protests) are definitely front of mind for a lot of investors,” said Meny Grauman, an analyst at Cormark Securities. “Clearly, there are questions about what the protests mean in the short term for Scotia’s business in Chile specifically. And I think longer term, it definitely does raise some important questions about stability in the region.”

A spokesperson for Scotiabank said the bank has adopted flexible work hours when needed because of transportation disruptions, but that the Chilean operations “are stable with 98 per cent of our branches operating normally.” The bank also said protesting had declined since the agreement was struck between the major political parties for a referendum on a new constitution.

Scotiabank, which calls itself “Canada’s international bank,” has basically been doing business in Chile since the country’s return to democracy. Dictator Augusto Pinochet gave up the presidency in March 1990; the same year, Scotiabank bought a 25-per-cent stake in the local Banco Sud Americano, a stake that grew to near-total ownership and was followed by subsequent acquisitions in the country of around 18 million people.

A Scotiabank branch in Santiago, Chile in 2014.

Ronald Patrick/Bloomberg files

Furthermore, Scotiabank in November 2017 announced an approximately $2.9-billion deal to buy a majority stake in BBVA Chile from Banco Bilbao Vizcaya Argentaria SA. The deal closed in July 2018, turning Scotiabank into one of the country’s biggest private lenders, with around 7,000 employees and 170 branches.

Scotiabank chief executive Brian Porter in August reminded analysts of an upcoming October investor day in Santiago where the bank, the third largest in Canada, had hoped to show off the value of its investment.

“Our operations in Chile have experienced higher combined market share, an improved productivity ratio and strong earnings growth,” he said at the time. “The integration of our operations in Chile will be completed by the end of this year.”

But that was before transit fares were hiked in Santiago.

The October increase on the cost of subway tickets was relatively small — about a nickel or so in Canadian currency — but it was an increase too far for Chileans.

Protests followed and the unrest mushroomed from objections over the since-cancelled fare hike to broader and much bigger demonstrations against the status quo. Protesters and police clashed and businesses were vandalized and looted as Chile exploded with outrage.

People with looted goods in Valparaiso, Chile, October 24, 2019.

Rodrigo Garrido/Reuters files

Scotiabank decided to postpone its investor day until next year, while major trade and climate conferences scheduled in Santiago were cancelled.

Chile had been one of the more stable members of the Pacific Alliance bloc of countries that Scotiabank has focused on, but the recent protests have shown there is an undercurrent of inequality beneath that steady image.

For example, take Chile’s trade organization for private-sector banks. On Oct. 14, it published a report that noted Chile has made great strides in offering financial services, but that lower-income households were still considerably less likely to have a bank account than their richer counterparts.

Six days later, the trade organization issued a statement urging respect for the rule of law and warning its members would decide on a case-by-case basis whether to open branches amid the massive wave of protests.

A demonstrator with her arms reading “We are not in war, we are united” poses in Santiago, on October 25, 2019.

Pablo Vera/AFP via Getty Images files

Chile is not the only country in Latin America that has faced recent unrest either. Bolivia’s president was forced to leave the country and seek asylum in Mexico after the military turned on him following a disputed election. Ecuador’s government relocated from the capital after the country was rocked by protests over the scrapping of fuel subsidies.

There has been a “veritable explosion” in Latin America, according to Jorge Heine, a former Chilean cabinet minister and diplomat.

“I’ve lived in India, I’ve lived in China, I’ve lived in South Africa, and yet the inequality is higher in Latin America, which a lot of people do not realize,” said Heine, who is currently a research professor at Boston University. “We have a real problem and we have to address it.”

A transit fare hike was just the tip of the iceberg for Chile’s unrest.

I’ve lived in India, I’ve lived in China, I’ve lived in South Africa, and yet the inequality is higher in Latin America, which a lot of people do not realize

Jorge Heine, a former Chilean cabinet minister and diplomat

The country has been a bastion of laissez-faire capitalism, which was ushered in under Pinochet with an assist from the Chicago Boys, a group of economists trained by renowned free-market capitalist Milton Friedman. Policies stoked privatization and deregulation, and Chile’s economic growth blew past that of the rest of Latin America.

Poverty has fallen considerably over the past 19 years and Chile was the first country in South America to join the Organisation for Economic Co-operation and Development, a group of wealthy countries.

Chile, however, has high income inequality, with the protests highlighting that many feel left behind despite all the growth. Concerns of costly, inadequate or unequal education, health care and pensions have risen and are driving forces behind the unrest. The country is also still using a constitution that dates back to Pinochet’s dictatorship, under which more than 3,000 people were killed and thousands more tortured or jailed.

Chile President Sebastián Piñera (who initially declared a state of emergency and called out the military in response to the protests) vowed to boost the minimum wage and pensions, and to tax the rich more. There are also expectations that a new constitutional deal could smooth things over, at least in the short term.

Chilean President Sebastián Piñera is embraced by his wife Cecilia Morel after addressing the nation in Santiago, on November 17, 2019.

Claudio Reyes/AFP via Getty Images

Citi Research analyst Fernán Gonzalez said the deal should help restore peace, put a damper on protests and add political stability.

“That being said, investors will probably remain concerned about what an assembly can do to the constitution, what changes are to be made, what can be included or left out,” he said in a recent note. “Uncertainties are not going to go away overnight as this is probably going to be a lengthy process.”

Juan Pablo Luna, a professor of political science at the Instituto de Ciencia Política and the School of Government at the Pontifical Catholic University of Chile, said the Chilean government “really mismanaged the crisis at the beginning,” helping give momentum to a broader social movement.

The deal struck for a new constitution has already lost some legitimacy in the public’s eyes, he added, partly because it comes from the government.

“They don’t get that they are the problem and, therefore, they cannot be the solution,” Luna said. “I think we will continue to see instability and turmoil.”

Given Scotiabank’s unique geographic footprint, the economy, politics and general stability of Latin America more broadly are also more important to it than they are for Canada’s other big banks. Underscoring this is Scotiabank’s decision to exit a number of other international markets and specifically target the Pacific Alliance while others opted to make big buys in the U.S.

I think we will continue to see instability and turmoi

Juan Pablo Luna, political science professor

For instance, Royal Bank of Canada bought Los Angeles-based City National Bank in 2015 and Canadian Imperial Bank of Commerce acquired Chicago-based PrivateBancorp two years ago.

Meanwhile, Scotiabank in the past two years has bought Citigroup Inc.’s consumer and small and medium-sized business operations in Colombia and 51 per cent of the controlling interest of a bank in Peru. It made two major acquisitions in Canada as well, buying independent asset manager Jarislowsky Fraser Ltd. for $950 million and doctor-focused wealth firm MD Financial Management for $2.6 billion.

Behind the decision to expand in South America, at least in part, is demographics. The Latin American economies have had bigger economic growth in recent years than Canada and the U.S., and the population there is relatively younger and underserved by banks.

Scotiabank in August said the growth prospects for the Pacific Alliance economies “in general remain much more solid than those in advanced economies.” Third-quarter economic growth for Chile was 3.3 per cent year-over-year, although that was before the protests.

“Tremendous progress has been made” in Chile, former cabinet minister Heine said. “Having said that, half of our exports are still in copper.”

So far, Scotiabank’s Latin America strategy has paid off. For the three months ended July 31, the Pacific Alliance contributed $513 million in earnings that were attributable to the bank’s equity holders, or approximately a quarter of Scotiabank’s entire quarterly profit (Chile contributed 29 per cent, or almost $150 million, of that). Net income from Scotiabank’s international unit rose nearly 90 per cent year-over-year in the bank’s third quarter, compared to about three per cent for its Canadian banking business.

Scotiabank is also not alone among Canadian banks in going abroad to try to find new sources of growth. The Canadian economy has had relatively lacklustre expansion, consumers remain relatively largely indebted, and trying to pry clients loose from the competition can be a chore.

Scotiabank is also not alone among Canadian banks in going abroad to try to find new sources of growth.

Peter J. Thompson/National Post

Barclays analyst John Aiken said Scotiabank shares have performed “broadly in line” with the other banks over the past three months, after lagging some of their peers over the past five years amid the lender’s M&A activity. For Scotiabank, though, it’s a “long-term game,” Aiken added, and one where disruptions in emerging markets should be expected.

“When you take a look at what does investing in that region mean, of course you’re looking for stronger growth than you can get in a Canadian or U.S. context,” he said. “However, it’s not going to be anywhere near as linear as one should expect from a Canadian or U.S. perspective either. And so you’ll expect some disruptions, be it political unrest or greater volatility from credit or the leap-forward and the pull-back in terms of economic growth.”

The bank has been in the region for a long time and has earned a “comfort level” as a result, Cormark analyst Grauman said.

“They’ve convinced investors that they know what they’re doing in Latin America and that they are experts in that region,” he added.

They’ve convinced investors that they know what they’re doing in Latin America and that they are experts in that region

Meny Grauman, analyst

Scotiabank has not yet shown any outward signs of wavering in its dedication to Latin America. In Chile, specifically, its branches remain open and the company has already rescheduled its Santiago investor day for January, although it is continuing to monitor the situation.

“Our commitment to the Pacific Alliance region remains unchanged due to its strong fundamentals, including favourable demographics, strong governance, and a sound macroeconomic environment,” a bank spokesperson said.

There is also hope that more equitable prosperity can come from the recent protests.

“The notion that somehow you have to have this sort of extreme inequality to grow, I don’t quite buy,” Heine said. “It seems to me that if you have a system which is fair … you will have a better country, and in the end, a better-performing economy.”

Financial Post

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