DBRS Morningstar Changes Trend on HSBC Bank Canada’s Ratings to Stable from Negative; Confirms Ratings

DBRS Limited (DBRS Morningstar) changed the trend on all ratings of HSBC Bank Canada (HSBC Canada or the Bank) to Stable from Negative. DBRS Morningstar also confirmed its ratings on HSBC Canada, including its Long-Term Issuer Rating of A (high). This follows DBRS Morningstar’s confirmation and trend change on the Long-Term Issuer Rating of the Bank’s parent, HSBC Holdings plc (the Group; rated AA (low) by DBRS Morningstar), to Stable from Negative on December 14, 2021. HSBC Canada’s Support Assessment (SA) of SA1 reflects the implied strong and predictable support from the Group, if required.

KEY RATING CONSIDERATIONS
The Bank’s ratings typically move in tandem with the Group’s Long-Term Issuer Rating because it is a supported rating with an SA1 designation. DBRS Morningstar recognizes the Bank’s important position within its parent’s global franchise and expects continued support from the Group. As a result, HSBC Canada’s long-term ratings are one notch below the Group’s ratings, reflecting that it operates in a different jurisdiction than its parent. On an intrinsic basis, the Bank enjoys a strong and growing local franchise with well-established relationships.

The change in the Long-Term rating trend for the Group to Stable from Negative reflects the progress the Group is making towards de-risking and cost restructuring as well as a lower than initially anticipated impact on asset quality from the pandemic and Brexit.

RATING DRIVERS
An upgrade of the Bank’s ratings would be linked to improvement in the Group’s long-term ratings. Alternatively, a downgrade of the Group’s ratings would likely negatively affect HSBC Canada’s ratings. In addition, DBRS Morningstar’s SA could be affected if support from the Group is reduced or is not sufficiently reliable, which could potentially have a negative impact on HSBC Canada’s ratings.

RATING RATIONALE
HSBC Canada benefits from the support and brand recognition of its parent. Canada is a strategic priority market for the Group allowing the Bank to leverage broad-based international capabilities versus some of its Canadian competitors. HSBC Canada is Canada’s seventh-largest bank (and the largest Schedule II bank) with assets of $121 billion as at September 30, 2021. The Bank maintains a special focus on its Commercial Banking (CMB) and its Global Banking and Markets (GBM) segments, partly because of its ability to use the Group’s broader network to bank multinationals and local affiliates of global companies. Meanwhile, the Bank’s third segment, Wealth and Personal Banking (WPB), which continues to cater to globally affluent clients or clients with international businesses, has grown at a strong pace over the last few years. WPB has successfully attracted new clients across the country, particularly in Ontario and eastern Canada, through various initiatives including the introduction of products and technologies that are competitive with those of the large banks.

HSBC Canada enjoys a steady base of non-interest income, mainly consisting of fee and trading incomes from its CMB and GBM segments, which typically account for more than 40% of revenue. In addition, the Bank has the advantage of using the Group’s scale and capabilities to effectively manage its costs, which translates into an efficiency ratio commensurate with the large Canadian banks. Despite broad economic challenges caused by the Coronavirus Disease (COVID-19) pandemic, including a low interest rate environment that is pressuring margins for most Canadian banks, HSBC Canada’s operating income has reverted to pre-pandemic levels totalling $1.6 billion for 9M 2021. Furthermore, HSBC Canada released the majority of the provisions for credit losses (PCL) it had taken on performing loans during the pandemic. This all has translated into a 190% year-over-year (YOY) increase in net income to $530 million for 9M 2021.

The Bank entered the pandemic with a solid track record of strong asset quality, resulting in low impairments and loan losses. Gross impaired loans to gross loans and advances to customers have reverted to 2019 levels reaching 0.53% in Q3 2021 versus 0.71% in Q3 2020. Meanwhile the Bank’s exposure to commercial real estate remains proportionately high relative to the larger Canadian banks, which could pose a risk in the event of a real estate market correction. Of the $67.2 billion in loans and advances to customers at Q3 2021, 16% was to the commercial real estate and construction sectors versus averages of between 9% and 10% for the large Canadian banks.

HSBC Canada saw an influx of deposits in 2020, which was due to the Bank’s success in capturing market share in the WPB segment and corporate clients curbing working capital and holding excess liquidity. As the lockdowns and government stimulus programs ceased and consumer spending resumed in 2021, deposits have regressed to a more normalized level that still shows a strong contribution from WPB. Consequently, customer deposit accounts totaled $71.2 billion as of September 30, 2021, down 3% from the previous year. In addition, the Bank achieved funding diversification through debt issuances, securitizations, and a Canadian registered covered bond program. Liquidity levels remain strong with a liquidity coverage ratio of 152% for Q3 2021, well above the minimum required by the Office of the Superintendent of Financial Institutions.

The Bank’s Common Equity Tier 1 ratio stood at 14.0% as of September 30, 2021, higher than the average for the large Canadian banks, and giving HSBC Canada a significant capital buffer of approximately $2.8 billion according to DBRS Morningstar’s calculations. The Bank resumed normal dividend payments to its parent in 2021. HSBC Canada has historically maintained a high dividend payout to its parent; however, HSBC Canada is able to call upon the Group for capital, as evidenced by the issuance of common shares on March 30, 2020, prudently augmenting capital at the onset of the pandemic.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (July 19, 2021; https://www.dbrsmorningstar.com/research/381742). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrsmorningstar.com

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577