North America Financial Bond: Bank of Nova Scotia’s US$600m 60-year limited recourse capital notes

IFR Awards 2021
2 min read
David Bell

Less taxing

Bank of Nova Scotia printed a novel Additional Tier 1 transaction in September that marked the first tax-deductible limited recourse capital notes from a Canadian bank in the US dollar market and paves the way for other banks in the country to broaden their capital funding.

Canadian regulators approved limited recourse capital notes to qualify as Additional Tier 1 capital in July 2020, giving Canadian banks a structure that allowed them to make tax-deductible interest payments while still counting for capital treatment. Investors have recourse against debt-based AT1 securities that are placed into a trust.

Several Canadian borrowers have issued the structure in Canadian dollars, but until Bank of Nova Scotia’s US$600m 60-year non-call five offering, none had issued in US dollars.

“The holy grail of tax-deductible capital that can be sold outside of Canada had proven elusive,” said Temmy Lizarzabal, co-head of North America financial institutions DCM at Citigroup.

The limited recourse capital notes offering, rated Baa3/BBB–, set itself apart from other bonds issued to raise AT1 capital by having a fixed maturity instead of a perpetual structure, which means the LRCN's interest payments are tax-deductible unlike most AT1 subordinated notes where payment amounts are deducted from net income.

Bookrunners Scotiabank, BNP Paribas, Citigroup, Goldman Sachs and JP Morgan priced the notes at 3.625% on September 29, in line with guidance.

There was support from regulators behind the new security as it was felt Canadian banks, which rely heavily on a domestic retail investor base to support AT1 issuances, were at a disadvantage compared with other jurisdictions where banks could issue tax-deductible AT1 securities.

“Reducing systemic risk in Canada was a huge factor,” said Lizarzabal. “Regulators felt if they gave Canadian banks the ability to issue securities that were tax-deductible and could be sold globally to institutional investors, they could shift the systemic risk of having a lot of this capital sold to retail investors in Canada.”

BNS's LRCN also differentiates itself with an issuer-friendly option to call the bond on any quarterly interest payment date starting from October 2026, when the interest rate is first reset over five-year Treasuries. The bank's existing US dollar 2020 4.90% AT1 notes could only be called at reset dates.

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