DBRS Confirms HSBC Bank Canada at AA and R-1 (high), Negative Trend

DBRS has today confirmed the ratings of HSBC Bank Canada (HSBC or the Bank) and its related entity, including the Bank’s non-guaranteed long-term deposits and senior debt at AA and the short-term instruments at R-1 (high). All trends remain Negative.

DBRS ratings of HSBC are based on the relationship the Bank has with its ultimate parent, HSBC Holdings plc (the Group); DBRS’s long-term issuer rating for the Group is AA (high) with a Negative trend. Under DBRS’s bank rating methodology, HSBC’s support assessment is SA1, reflecting a strong expectation of timely support from the Group. Given the strategic nature of the relationship between HSBC and the Group but lack of an explicit guarantee, the non-guaranteed long-term deposit and senior debt, the subordinated debt, innovative instruments and preferred shares have been assigned a rating one notch below the equivalent or implied ratings of the Group. The short-term ratings are derived through the long-term ratings (please see DBRS’s website under Rating Policies for more information). In the event of a downgrade of the Group’s ratings, the Bank’s ratings would be downgraded in tandem.

The benefits of HSBC’s relationship with the Group include branding, added revenue generation opportunities using the Group’s global distribution network and client contacts, cost efficiencies, risk-management expertise and the potential as an alternative funding source. HSBC itself has good intrinsic strengths, including its low cost-to-income ratio (partially due to the business mix and Group relationship) and its superior customer service model.

HSBC continued to generate respectable returns on equity (ROEs) of 16.6% in 2008 and 11.6% in the first half of 2009, although earnings have been under pressure as a result of higher credit costs. DBRS notes that the 2007 year was restated to include full-year results of HSBC Financial Corporation Limited (now the Consumer Finance segment), which was acquired on November 30, 2008, from an affiliate.

The Bank continues to have significantly higher loan concentrations than its Canadian bank peers in business lending (commercial real estate in particular), geographic concentration in British Columbia and single-name exposures.

Loan loss provisions increased materially in both 2008 and the first half of 2009, with the bulk of the increase attributed to the business (primarily) and government portfolio, although it has also deteriorated. Loan loss provisions in the Consumer Finance unit remain high. Gross impaired loans in the Consumer Finance portfolio increased to 5.5% of the portfolio at the end of Q2 2009 from 2.9% at the end of 2007, while in the business (primarily) and government portfolio, gross impaired loans increased to 4.0% of the portfolio from 1.1% at the end of 2007. While net charge-offs have increased, they remain at an acceptable annualized level of 27 basis points in the first half of 2009 and are expected to remain manageable.

Although the scale of the Consumer Finance segment makes it manageable, it is a highly cyclical business that generated a $20 million loss in the first half of 2009. Actions were taken in 2008 to address the problems, including the sale of its auto loan portfolio, a reduction in its branch network to 93 from 109, the tightening of underwriting criteria for all products and the closure of the centralized sales channel. An additional 16 offices have been closed in 2009.

The Bank’s financial risk profile remains reasonable, with ample flexibility given the levels of regulatory and tangible capital ratios, stable funding base, the availability of Group support and relatively low market risk levels.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodologies are Rating Banks in Canada, Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments and Rating Bank Preferred Shares and Equivalent Hybrids, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.