Butterfield Bank is likely to have its long-term credit ratings cut by one notch if its $1.8 billion acquisition of CIBC Caribbean Bank Ltd goes ahead as planned, according to ratings agency KBRA.

KBRA has changed the status of Butterfield’s A+ senior unsecured debt and deposit ratings, and its A subordinated debt rating, to “watch downgrade” from “watch developing”.

The agency affirmed Butterfield’s short-term debt and deposit ratings at K1.

The move reflects the scale of an acquisition that would effectively double the size of the Bermudian-headquartered bank and significantly change its balance sheet, including increasing its exposure to lending and commercial real estate.

KBRA said: “If the acquisition of CIBC Caribbean closes as expected, NTB’s long-term ratings will likely be lowered by one notch, with the outlook revised to stable.”

Butterfield announced in May that it had agreed to acquire Canadian Imperial Bank of Commerce’s 91.7 per cent stake in CIBC Caribbean for about $1.8 billion.

The consideration comprises $1.09 billion in cash and $703 million in newly issued Butterfield common shares, while Butterfield also plans to issue about $700 million of subordinated Tier 2 debt as part of the financing.

The deal, expected to close in the first half of next year, would create a bank with about $29 billion in assets while retaining its headquarters in Bermuda.

KBRA said the potential downgrade was principally driven by “the scale of the transaction, relative to NTB stand-alone”.

It said the acquisition would increase the size of the loan portfolio and risk-weighted assets, while also lowering capital ratios — modestly reducing Butterfield’s historically strong liquidity profile.

Those have been important factors supporting the bank’s ratings.

The transaction would also change the composition of Butterfield’s loan book, expanding it into new geographic markets. CIBC Caribbean is a major player in new markets for Butterfield, including Barbados and the Bahamas. The bank will significantly increase its exposure to commercial and commercial real estate lending, KBRA said.

However, the agency said it did not expect Butterfield to change its approach to limiting credit risk within its investment portfolio, which is expected to continue to account for a sizeable share of the enlarged bank’s assets.

Liquidity would also remain comparatively strong despite declining from present levels.

KBRA estimated that cash, short-term investments and the investment portfolio would together represent more than 50 per cent of the combined bank’s assets, compared with about 66 per cent of Butterfield’s stand-alone assets at the end of the second quarter.

The agency said the level of cash and short-term investments would remain meaningful relative to deposits, “a key consideration given the absence of central bank support and the modest deposit insurance schemes across the deposit footprint”.

Despite the increased risk profile, KBRA was broadly positive about the earnings prospects of the combined group.

It said: “Based on KBRA’s analysis, the earnings profile of the combined banks will remain in the range of NTB’s historically solid performance.”

The addition of CIBC Caribbean’s “rich and relatively low cost deposit base” and expected cost savings from the merger should provide benefits.

Those would be partly offset by higher interest expense associated with the planned subordinated debt issuance, amortisation costs and the accelerated impact of Bermuda’s income tax regime, KBRA said.

The latter will occur because the increase in Butterfield’s group-wide revenue resulting from the acquisition is expected to bring it within the scope of Bermuda’s corporate income tax.

“Risk-adjusted earnings will remain substantial,” KBRA said.

The acquisition would also change Butterfield’s revenue mix. Non-interest income would account for a smaller proportion of revenue, while net interest income would increase as the bank takes on a substantially larger loan portfolio.

KBRA expressed confidence in Butterfield’s ability to manage a larger geographic footprint.

It said: “While the transaction would extend NTB’s market presence into new geographies, KBRA believes NTB is positioned to manage the expanded reach, given the breadth of the current franchise including its long-term operating presence in the Caribbean.”

The transaction will deepen Butterfield’s presence in the Cayman Islands while taking it into additional Caribbean territories.

After completion, existing Butterfield shareholders are expected to own about 76 per cent of the combined group, with CIBC holding 22 per cent and CIBC Caribbean minority shareholders about 2 per cent.

Butterfield intends to launch a mandatory takeover offer for those remaining shares with the aim of ultimately owning all of CIBC Caribbean.