UPDATE: Scotiabank Fills Gap In Its Caribbean Business

Bank of Nova Scotia (BNS, BNS.T) will add billions in capital to its expanded Puerto Rican banking business after pushing aside a small local bank in the bidding war for a failed bank.

Scotiabank de Puerto Rico, the Toronto bank's subsidiary, bought R&G Financial Corp.'s (RGFC) R-G Premier Bank of San Juan on April 30, one of three failed island banks the Federal Deposit Insurance Corp. auctioned that day.

Bank of Nova Scotia is known to be thrifty when it comes to acquisitions, so the vigor with which it pursued its target became a surprise in the saga of island's ailing banking industry.

Popular Inc. (BPOP), Puerto Rico's biggest bank, bought failed W Holding Co.'s (WHI) Westernbank, the island's third largest. Oriental Financial Group Inc. (OFG) bought EuroBancshares Inc.'s (EUBK) Eurobank, which also collapsed.

Scotiabank's bid looked more aggressive to competitors that it did to the company. The bank's Puerto Rican head, Troy Wright, said in an interview, "We won in this case because we were smart in terms of the valuation of the business," basing the bid on potential revenue synergies other banks may not be able to extract and Scotiabank's ability to tie its Puerto Rico bank into its Caribbean business.

The Toronto bank had amassed considerable market share on other Caribbean islands, including the Dominican Republic. Puerto Rico was the missing link in a strategy to facilitate trade between the islands and service a group of pan-Caribbean businesses and their owners.

For the last century, Scotiabank de Puerto Rico was small--the island's smallest bank, in fact. "We didn't like that," Wright said. With R-G Premier, it now ranks third or fourth with about a 9% deposit market share, depending on how the island's consolidation ultimately shakes out.

Buried under a substantial share of brokered deposits--those collected from institutional investors such as pension funds rather than bank customers--and a pile of soured real estate loans were an attractive number of "core" consumer customers.

Scotiabank's Puerto Rican unit is a business bank with 17 branches. With R-G Premier, it got a retail-banking business with 29 branches. The purchase adds $5.6 billion in assets to Scotiabank's just under $2 billion, and $2.2 billion in deposits to its $1.4 billion. Scotiabank might add wealth management to R-G Premier, and perhaps a business around mostly low-income customers with no banking relationship at all.

The deal is a mere blip to Bank of Nova Scotia's financials, but it delivered a blow to Doral Financial Corp. (DRL) of San Juan, which was widely expected to have the most competitive bid for R-G Premier. The discount to R-G Premier's assets offered in Scotiabank's bid to the FDIC was substantially smaller than what Doral offered, according to a person familiar with the matter. An FDIC official revealed later that the agency was "in shock" when it saw how attractive Scotiabank's offer was, this person said.

An FDIC spokesman would say only that Scotiabank's offer was the least-expensive solution for the agency.

The consolidation added almost $7 billion in capital to Puerto Rico's banking industry: $5.28 billion through loss-sharing agreements between the FDIC and the acquiring banks, $1.63 billion of combined capital raises by three Puerto Rican banks.

Scotiabank will add several billion to that, Wright said, expressing confidence in the eventual recovery of the island's deeply troubled economy. Governor Luis Fortuno's efforts to lower the Commonwealth's deficit and control expenses "was a key factor making the bet to inject a significant amount of additional capital into our bank in Puerto Rico," Wright said. He expects the economy to grow between 1% and 3% a year over the next decade, but Scotiabank to grow revenue at least 5% and perhaps as much as 15%.

Other than with the Dominican Republic, Puerto Rico isn't doing much trade with the rest of the Caribbean, according to data by the Government Development Bank for Puerto Rico. The island "has for decades paid lip service to Caribbean trade and integration but has never really done it," said Miguel Soto-Class, director of the Center for the New Economy, a Puerto Rican think tank. He said he is "happy to hear Scotia has this strategy. If they can pull it off, it will be very important" for Puerto Rico.

-By Matthias Rieker, Dow Jones Newswires; 212-416-2471; matthias.rieker@dowjones.com

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