DBRS Morningstar Downgrades Long-Term Credit Ratings on Bank of China (Canada) to BBB (high) following Sovereign Action

DBRS Limited (DBRS Morningstar) downgraded the long-term credit ratings of Bank of China (Canada) (BOCC or the Bank), including its Long-Term Issuer Rating, to BBB (high) from A (low). The trends on all long-term credit ratings have been changed to Stable from Negative. At the same time, DBRS Morningstar confirmed the short-term credit ratings on the Bank, including its Short-Term Issuer Rating, at R-1 (low). The trends on all short-term credit ratings remain Stable. The Support Assessment (SA) for BOCC is SA1, reflecting the expectation of timely support from its parent, Bank of China Limited (BOC or the Parent), which is approximately 68% owned by the People’s Republic of China (the PRC or China; rated “A” with a Stable trend by DBRS Morningstar).

KEY CREDIT RATING CONSIDERATIONS
The downgrade of BOCC’s long-term credit ratings is driven by the downgrade to the credit ratings of the PRC made by DBRS Morningstar on November 9, 2023. The two-notch rating differential between BOCC and the PRC includes one notch for the PRC’s less-than-100% ownership of BOC, a global systemically important bank, and one notch for BOCC’s status as a fully owned foreign subsidiary in a low cross-border-risk country. Given BOCC’s SA1 designation, DBRS Morningstar would likely move the Bank’s credit ratings in tandem with the PRC’s credit ratings.

The credit ratings of BOCC, a wholly owned subsidiary of BOC, reflect its important strategic position as an extension of its Parent’s global platform, providing banking services to corporations and individuals of Chinese origin in Canada as well as Canadian-domiciled retail and corporate customers. BOCC’s strategic importance to its Parent is also demonstrated through the Bank’s close links with the Parent’s management and reporting systems. Given the international scope of BOC and its global systemic importance, as well as its being majority owned by the PRC, DBRS Morningstar expects the Parent to receive timely, systemic support from the PRC, if needed.

CREDIT RATING DRIVERS
Given BOCC’s strategic importance to the Parent, the credit ratings would be upgraded if the PRC’s sovereign credit ratings were upgraded.

Conversely, the credit ratings would be downgraded following a downgrade of the PRC’s sovereign credit rating. Furthermore, the credit ratings would be downgraded should there be a significant reduction in the ownership stake of the Chinese government in the Parent or if there is a reduction in BOCC’s strategic importance to the Parent.

CREDIT RATING RATIONALE

Franchise Strength
BOCC derives its franchise strength from its position as a financial intermediary facilitating transactional flows between the PRC and Canada for corporate and retail banking clients. Furthermore, BOCC also benefits from access to its Parent’s global network. BOCC is focused on further expanding its franchise across Canada, although a sustained deterioration in the relationship between China and Canada could dampen growth prospects over the intermediate term.

Earnings Power
BOCC experienced good earnings growth in F2022 with net income increasing 7.3% year over year (YOY) to $32.4 million, driven by strong growth in net interest income, partially offset by higher operating expenses and provision for credit losses (PCL). The Bank incurred PCL of $22.7 million, up from $0.5 million in F2021, with increases in both the personal and commercial segments. Operating expenses rose 4.0% YOY on higher personnel costs, and BOCC continues to deliver a top-tier efficiency ratio compared with its peers, improving to 30.9% in F2022. Net income for H1 2023 was up 71.6% YOY, resulting from continued net interest income growth and lower PCL, partially offset by higher operating expenses.

Risk Profile
Asset quality has historically been sound given that BOCC maintains a strong risk management framework and conservative underwriting standards. Gross impaired loans as a percentage of gross loans increased in F2022 from the prior year; however, the current impairment level remains manageable and in line with peers. Net write-offs were negligible for the year. DBRS Morningstar remains cautious about the Bank’s significant exposures to commercial real estate and construction loans, which formed about one-third of gross loans at the end of F2022 and could result in higher asset impairment and losses in a sustained economic downturn. DBRS Morningstar expects BOCC’s credit quality metrics to modestly deteriorate in F2023 amid a more challenging macroeconomic environment.

Funding and Liquidity
DBRS Morningstar assesses BOCC’s funding position as stable and its liquidity position as robust. Furthermore, funding sources are generally well aligned with the Bank’s lending activities. BOCC is exposed to some concentration risk within its funding profile given its reliance on corporate deposits, some of which could be large or non-relationship-based deposits. The Bank’s proportion of retail deposits declined in F2022, and it has become more reliant on funding from the BOC group. BOCC can readily source emergency liquidity from the Parent’s branches in New York, London, and Hong Kong, which helps support the SA1 designation.

Capitalisation
DBRS Morningstar considers BOCC’s capital cushion, including a CET1 ratio of 23.3% at June 30, 2023, as strong, especially considering its largely collateralized loan exposures and the Bank’s solid internal capital generation. BOCC also has the ability to access capital from its Parent, if needed, as demonstrated by an equity capital injection into the Bank in 2016.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Credit rating actions on the PRC are likely to have an impact on this credit rating. ESG factors that have a significant or relevant effect on the credit analysis of the PRC are discussed separately at https://www.dbrsmorningstar.com/issuers/20329.

Environmental (E) Factors
There were no additional Environmental factor(s) that had a relevant or significant effect on the credit analysis.

Social (S) Factors
There were no additional Social factor(s) that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
There were no additional Governance factor(s) that had a relevant or significant effect on the credit analysis.

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 (July 4, 2023) https://www.dbrsmorningstar.com/research/416784.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 22, 2023; https://www.dbrsmorningstar.com/research/415978). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (July 4, 2023; https://www.dbrsmorningstar.com/research/416784) in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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 credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

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

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

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