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Bank of Nova Scotia has agreed to buy 14.9 per cent of Cleveland-based KeyCorp for about $3.9 billion as it looks to boost its focus on developed economies and strengthen its North American footprint.

The investment will be completed in two stages, subject to regulatory approvals, the bank said in a statement on Monday. The initial investment of 4.9 per cent is expected to close by year-end, while the remaining 10 per cent will close next year. The deal will also allow two Scotiabank officials to serve on KeyCorp’s board.

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“Moving capital from developing markets to developed markets is a huge part of building out this North American corridor,” Scotiabank chief executive Scott Thomson said on a conference call. “We went through a very intensive process … and saw which (banks) were attractive and which ones were a good fit. Key went to the top of that list.”

Scotiabank announced a new strategy in December that would increasingly allocate more capital towards “stable, high-return markets” in North America. The bank’s “immediate focus” would be to allocate a greater share of capital to Canada as well as “recycling capital” from its Latin American businesses to its corporate business in the United States.

Scotiabank has the largest international footprint among its Canadian peers, but its businesses in Latin America have too many clients using only one banking product, Thomson said in December.

He also said that although the bank has done plenty of work to reposition itself, the returns on the capital deployed haven’t “measured up” in the past decade, so Scotiabank’s total shareholder return has underperformed.

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If the new deal goes through, the U.S. will become Scotiabank’s second-largest market from an earnings perspective, with approximately 75 per cent of the bank’s total earnings coming from Canada, the U.S. and Mexico, Thomson said on Monday.

KeyCorp operates across 15 states with US$187 billion in assets and about 1,000 branches offering commercial and retail banking.

Investing in it would result in a “low-risk, low-cost optionality” in the U.S., Thomson said, and would also provide returns in excess of 20 per cent for Scotiabank’s shareholders, which he said was “attractive.” He added that there was a “strong cultural” fit.

“We view this investment as an important early step toward (the) longer-term vision, but also one that is accretive to our near-term profitability,” he said.

Jefferies Financial Group Inc. analyst John Aiken said the deal could be a positive for Scotiabank, but the market will need “tangible proof” before supporting it.

“What will be critical for investors will be to see whether the proposed strategic benefits can accrue to both parties, or if this is simply an investment,” he said in a note on Monday.

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Aiken said there might be market speculation about the possibility of Scotiabank eventually going for an “ultimate take-out or a controlling interest” in KeyCorp since this fits the “modus operandi” of how it expanded in Latin America.

“While we do not deny that this is a possibility, given the standstill agreement, this is only possible five years out (post the close of the transaction) and gives Scotiabank time to examine the lay of the land in the U.S. businesses it does not currently operate, in addition to assessing KeyCorp.’s operations,” he said.

National Bank of Canada analyst Gabriel Dechaine said the deal “surprised” the market in the morning. He said the transaction is expected to be financially accretive, but most investors were anticipating Scotiabank to be “less acquisitive than it has been historically.

“Scotiabank could be perceived as being in capital-conservation mode over the next few years, which will likely curb alternative capital deployment strategies, e.g., buybacks,” he said in a note on Monday.

But Veritas Investment Research Corp. analyst Nigel D’Souza said the transaction didn’t make any “strategic or financial sense” and is a “suboptimal utilization of capital” that could lower Scotiabank’s risk-adjusted returns.

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“Strategically, it is not clear why purchasing a minority interest in a U.S. regional bank at a premium to book value is a better utilization of capital than acquiring U.S. banking assets at a discount as the industry consolidates or through receivership or better than acquiring a standalone U.S. capital markets or wealth franchise,” he said in a note.

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