What to do with CI after Scotia-DundeeWealth

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What lies in CI Financial's future? It's the burning question so many people have speculated on since Bank of Nova Scotia announced its deal with DundeeWealth in November.

Different scenarios have been flying around -- some plausible, some not -- but CIBC's research team has taken the time to put some thought into it and speculates on what it thinks is the inevitable outcome: a Canadian bank other than Scotia buying CI.

Before his reasoning, some context. Last fall analyst Rob Sedran at CIBC argued that Scotia should buy the 62 per cent of CI it does not already own because it had a "chronic underexposure" to wealth management. His belief was based on the assumption that DundeeWealth was not up for sale.

At its core, Mr. Sedran's argument really has not changed, it's just that DundeeWealth supplanted the need to bid for CI. Once the asset manager is brought into Scotia's fold, the bank will rank fourth in mutual fund assets in Canada, just ahead of TD, according to data from the Investment Funds Institute of Canada.

Because Scotia will soon have a sizeable wealth management presence (the deal deadline has been extended to February 1), CIBC doesn't think there's much reason to buy the rest of CI. Much of that has to do with capital usage. "A transaction with CI would be more than twice the size of the DW deal, and CI has relatively little by way of tangible common equity, which implies a material - and bigger - impact on capital ratios if that deal were to occur," they wrote in a note to clients. The DundeeWealth deal will have a 75- to 80-basis-point hit on Scotia's common equity.

Plus, Scotia has a big international presence, and it wants to keep growing, as proven by recent purchases in Panama and Uruguay. "Devoting so much capital to the domestic wealth management space would necessarily limit its appetite for international acquisitions for a time," CIBC noted.

Then there's the people issue. Combining CI with BNS/DW is a merger of almost equals, he says, and could create a tough integration problem. Moreover, asset managers' principal asset is people.

So if BNS isn't buying, then who? There are a few potential scenarios. The only independent fund manager that could probably handle CI's $6.2-billion market capitalization is IGM, which has the backing of Power Corp. CIBC rules this out because it doesn't provide CI with good enough distribution and the cultures may not integrate.

Then there's the foreign takeover angle.CIBC doesn't see much potential there because CI is expensive, making it hard for foreign acquirers to make the deal accretive. It also wouldn't increase CI's Canadian distribution.

That leaves Canadian life insurance companies and banks. Sun Life isn't a buyer, considering it originally sold its CI stake to Scotia in 2008, and Manulife will take a long time to recover. After analyzing the different Canadian banks, CIBC settled on its own bank because a foreign acquisition is still too risky, given CIBC's rocky history in the U.S., plus buying a wealth manager allows the bank to generate more revenue with little capital at risk.