Puerto Rico's crippling debt load is sending the commonwealth into a financial tailspin, creating uncertainty for Bank of Nova Scotia.
Canada's third-largest lender has operated in Puerto Rico for more than a century and, in 2010, the bank doubled down, buying R-G Premier Bank after it was taken into receivership by the U.S. Federal Deposit Insurance Corp. The deal provided Scotiabank with 29 extra branches and added 1,200 new employees, as well as $5.6-billion (U.S.) worth of assets.
Five years later, the acquisition, and Scotiabank's commitment to Puerto Rico, is raising questions. The commonwealth is in its eight consecutive year of recession and the governor recently said the commonwealth's $72-billion in debts are "not payable."
However, the financial trauma isn't disastrous for Scotiabank. The Canadian lender made $34-million in Puerto Rico in 2014, according to the FDIC. This profit isn't an aberration, either: competitor Banco Popular de Puerto Rico made $229-million in 2014 on roughly $29-billion in assets.
"While the growth trajectory isn't what it was historically or what we were expecting, it does generate a reasonable return for our shareholders," Scotiabank said in a statement.
Puerto Rico's persistent debt woes have weighed on profitability – Scotiabank made $94-million there in 2011, or almost three times what it did last year – and could eventually lead to significant losses. Already some lenders have struggled – in February, Doral Bank was closed by regulators and sold to Banco Popular, causing the FDIC to lose $749-million.
Puerto Rico's debt burden stems from heavy government borrowing, with more municipal debt per capita than any American state. Although this leverage isn't directly tied to banks, a debt restructuring could force the government to cut pensions and jobs, hurting personal finances. The prolonged economic downturn could also lead to hefty commercial loan losses.
Should the economic environment materially deteriorate, Scotiabank has some protection. When the lender acquired R-G Premier in 2010, increasing its exposure to Puerto Rico, the FDIC absorbed much of the risk. Although the deal brought Puerto Rico to 1.3 per cent of Scotiabank's total assets, $5.3-billion of the acquired loans were covered by a loss-sharing agreement with the FDIC, through which the regulator would take the hit for 80 per cent of any losses.
The FDIC guarantee largely covers retail assets. "In our commercial portfolio, we have limited sovereign exposure and have been proactive in managing our corporate exposure," Scotiabank said in a statement. Much of the Caribbean has struggled economically since the Great Recession, but while Canadian Imperial Bank of Commerce and Royal Bank of Canada – the other large Canadian lenders in the region – only recently started acknowledging loan losses, Scotiabank started reworking its operations in some Caribbean countries five years ago.
Last fall, there were reports that Scotiabank was looking to sell its Puerto Rican operations, but no deal materialized. Despite speculation that private equity buyers may be interested in acquiring Caribbean banks, none have inked an acquisition, likely worried about the extent of the economic downturn.
"We will continue to monitor developments and take appropriate actions if needed," Scotiabank said in a statement.
Unlike Caribbean countries such as Barbados and the Cayman Islands, which are heavily dependent on tourist dollars that remain lower than their pre-financial crisis levels, Puerto Rico isn't as heavily dependent on this industry. However, that hasn't protected the commonwealth from its financial nightmare. The current governor has tried to implement austerity programs as well as borrow more but that hasn't solved the problem.
Credit rating agencies have downgraded Puerto Rico's bonds to junk and residents keep leaving for the mainland.