M&A activity was relatively high in some sectors in 2013, but it was actually a relatively quiet year for mergers and acquisitions activity in the financial sector. That might be set to change in 2014 as the Fed taper begins to take hold and the the rumor of interest rate hikes gradually marches toward reality. Citi Research released a report last week focusing on the possibility of a merger between Standard Chartered PLC (LON:STAN) and The Bank of Nova Scotia (NYSE:BNS) (TSE:BNS).

Merger would create a new Canadian financial powerhouse

Citi analysts Ronit Ghose et al. suggest that a Standard Chartered PLC (LON:STAN) and The Bank of Nova Scotia (NYSE:BNS) (TSE:BNS) merger makes sense from a number of perspectives. The merger would create a Canadian-based, but truly international, financial institution. The Citi report describes the key advantages of such a merger. “The combined group would be an international bank spanning all key continents, with a cash cow Canadian operation generating capital that could organically fund international growth. BNS may not have significant cost savings but it would offer economies of scope. We estimate Scotia could pay a 20% premium and still make the transaction 10% EPS accretive.”

Standard Chartered underperforming

The analysts highlight the underperformance and structural problems at The Bank of Nova Scotia (NYSE:BNS) (TSE:BNS). “2013 was a poor year for Standard Chartered. The stock declined 14% in absolute terms versus European banks shares increasing on average 19%. More importantly, Standard Chartered PLC (LON:STAN) shares lagged bank stocks in its core markets in Asia, Africa and the Middle East. The headwind facing the stock has been both top-down (eg EM gearing in a tapering focused world) as well as bottom up (questions over capital adequacy, asset quality and more recently management change).”

Standard Chartered stock price

Standard Chartered PLC (LON:STAN) announced a major reorganization and management shake up a few weeks ago, including  CFO Richard Meddings and  Head of Consumer Banking Steve Bertamini moving on, and a new position for former Head of Wholesale Banking Mike Rees. A disappointing share price and the apparent structural issues in the business model have led to public pressure for more major changes, including calls for M&A activity. Several potential merger partners have been mentioned in the financial press, including JPMorgan Chase & Co. (NYSE:JPM) and Banco Santander, S.A. (ADR) (NYSE:SAN), but the Citi analysts say The Bank of Nova Scotia (NYSE:BNS) (TSE:BNS) seems like an ideal fit.

What Scotiabank brings to the table

The Bank of Nova Scotia (NYSE:BNS) (TSE:BNS) is one of the largest banks in the world, with a $75 billion market cap. It also enjoys a strong international network, with operations in over 55 countries and an especially strong presence in the Americas. The Citi analysts highlight the potential synergies in such a merger.

BNS Revenue Split

Standard Chartered Revenue split

“A Scotia/StanChart combination would create an international banking network spanning Asia, Africa and America – it would have greater international EM diversification and economies of scope than an HSBC.

A Toronto headquartered group could also generate operating cost, funding and capital synergies. In an all-share combination, we estimate that BNS could pay a 20% premium to STAN shareholders and with zero synergies the transaction would still be EPS neutral in the first full year. With moderate synergies — c2% pro-forma cost and revenue synergies — The Bank of Nova Scotia (NYSE:BNS) (TSE:BNS) could pay a20% premium and still derive c10% EPS accretion. There would also be cultural synergies between Canada, UK and Asia.”