Morningstar DBRS Confirms Credit Ratings on Bank of China (Canada) at BBB (high) With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed Bank of China (Canada)'s (BOCC or the Bank) credit ratings, including the Bank's Long-Term Issuer Rating at BBB (high) and Short-Term Issuer Rating at R-1 (low). The trend on all credit ratings is 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).

KEY CREDIT RATING CONSIDERATIONS
The two-notch credit 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, Morningstar DBRS 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 position as an extension of the 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 connection to its Parent is also demonstrated through the Bank's close links with BOC's management and reporting systems. Given the international scope of BOC and its global systemic importance, as well as it being majority owned by the PRC, Morningstar DBRS expects the Parent to receive timely, systemic support from the PRC, if needed.

CREDIT RATING DRIVERS
Morningstar DBRS would upgrade BOCC's credit ratings if the PRC's sovereign credit rating were upgraded.

Conversely, Morningstar DBRS would downgrade the credit ratings 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 Morningstar DBRS' expectation of support from the Parent.

CREDIT RATING RATIONALE
Franchise Strength
BOCC's franchise strength, which Morningstar DBRS views as limited, is derived from its position as a financial intermediary facilitating transactional flows between the PRC and Canada for corporate and retail banking clients. The Bank also benefits from access to its Parent's global network. BOCC's loan balance has fallen in 2023 and into 2024, partially driven by a challenging macroeconomic environment, as well as its decision to pause origination of new residential mortgages and commercial real estate loans in a focus on reducing real estate exposure. Going forward, BOCC will concentrate its efforts on other corporate and commercial loans, particularly renewable and infrastructure financing, and cross-border transactional banking, although a sustained deterioration in the relationship between China and Canada could dampen growth prospects over the intermediate term.

Earnings Power
BOCC saw strong earnings growth in 2023 with net income increasing 42% year-over-year (YOY) to $46.0 million, primarily driven by lower provision for credit losses (PCL), alongside growth in net interest income, partially offset by higher operating expenses. The Bank had a PCL recovery of $0.3 million in 2023, compared with a PCL expense of $22.7 million in 2022. Operating expenses increased 25% YOY in 2023, resulting in a deterioration of the efficiency ratio to 36.9% from 30.9% in 2022. In H1 2024, net income declined 81% YOY as PCL rose significantly to $26.9 million, revenue was flat, and operating expenses increased.

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 2023 from the prior year; however, impairments remain manageable and in line with peers, and there were no write-offs for the year. Morningstar DBRS remains cautious about the Bank's significant exposures to commercial real estate and construction loans, which formed about 38% of gross loans at the end of 2023 and could result in higher asset impairment and losses in a sustained economic downturn. Morningstar DBRS expects BOCC's credit quality metrics to deteriorate in 2024 as the macroeconomic environment remains challenging.

Funding and Liquidity
Morningstar DBRS views 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. The Bank's total deposits declined in 2023 and into 2024, alongside a shrinking loan portfolio. The proportion of retail deposits increased in 2023, and while BOCC remains reliant on the BOC group for a portion of its funding, this reliance has reduced YOY. The Bank can readily source emergency liquidity from the Parent, which helps support the SA1 designation.

Capitalisation
BOCC maintains strong capital levels, including a CET1 ratio of 26.8% at June 30, 2024, which has increased because of internal capital generation and lower risk-weighted assets. BOCC can also access capital from its Parent, if needed, as demonstrated by an equity capital injection into the Bank in 2016.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE (ESG) 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://dbrs.morningstar.com/issuers/20329.

There were no additional Environmental, Social, or Governance factors that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 4, 2024) https://dbrs.morningstar.com/research/433881. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.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 https://dbrs.morningstar.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.

Morningstar DBRS 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. Morningstar DBRS' trends and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit https://dbrs.morningstar.com.

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