DBRS Morningstar Confirms Ratings on HSBC Bank Canada at A (high)/R-1 (middle), Negative Trends

DBRS Limited (DBRS Morningstar) confirmed the ratings on HSBC Bank Canada (HSBC Canada or the Bank), including its Long-Term Issuer Rating at A (high) and its Short-Term Issuer Rating at R-1 (middle). All trends remain Negative. HSBC Canada’s Support Assessment (SA) of SA1 reflects the implied strong and predictable support from its parent, HSBC Holdings plc (HSBC or the Group), if required.

KEY RATING CONSIDERATIONS
As a supported rating with an SA1 designation, the Bank’s ratings typically move in tandem with the Group’s Long-Term Issuer Rating. DBRS Morningstar recognizes the Bank’s important position within HSBC’s global franchise and expects continued support from the Group, most recently demonstrated with capital infusion from the Group at the onset of the Coronavirus Disease (COVID-19) pandemic. 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, HSBC Canada’s local franchise has well-established relationships with multinationals, benefitting from both the capabilities and the geographic breadth of the Group; a predominantly affluent retail client base; and relatively good operating efficiency. These positive attributes are offset by the Bank’s historically high dividend payout to the Group. In addition, although improving, HSBC Canada traditionally has relatively higher exposure to Western Canada and sectors such as energy and commercial real estate compared with Canadian bank peers.

DBRS Morningstar could change the trend on the ratings to Stable if the Group’s asset quality and profitability are not materially affected by the challenging operating environment driven by the coronavirus pandemic and Brexit and if restructuring continues to be successfully implemented. Conversely, HSBC’s ratings could be downgraded if there were a severe deterioration in the Group’s core profitability and asset quality, negatively affecting capital. Additionally, any signs of franchise deterioration in Hong Kong and/or China would also be likely to have a negative impact on the ratings.

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 as Canada is a strategic priority market for the Group; this allows the Bank to leverage broad-based capabilities that are international in scope versus some of its Canadian peers. HSBC Canada is Canada’s seventh-largest bank (and the largest Schedule II bank) with assets of $124 billion as at September 30, 2020. 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 its parent’s broader network to bank multinationals and local affiliates of global companies. Meanwhile, the Bank’s third segment, Wealth and Personal Banking (WPB), which traditionally catered to globally affluent clients or clients with international businesses, has been growing at a strong pace over the last few years. WPB has been successfully attracting new clients in eastern Canada, particularly in Ontario, through various initiatives including the introduction of products and technologies that are competitive with those of the large Canadian banks.

Because of the challenged economic environment caused by the coronavirus pandemic that all banks are facing, HSBC Canada’s earnings have faced headwinds during most of 2020. For the first nine months of 2020 (9M 2020), revenue declined by 6.4% year over year (YOY) to $1.5 billion primarily reflecting net interest margin pressure as a result of interest rate cuts and holding increased levels of lower-yielding liquid assets. Additionally, earnings were affected by higher provisions for credit losses (PCL) of $328 million, which was a significantly higher amount than the $45 million PCL recorded in 9M 2019. DBRS Morningstar notes that the majority of the increase comprised PCL on performing loans, reflecting changes in forward-looking macroeconomic indicators related to the impact of the pandemic. Positively, HSBC Canada maintains a steady level of non-interest income, consisting mainly of fee and trading incomes from its CMB and GBM segments, which typically account for more than 40% of revenue and which have proven to be resilient in the current environment. Overall, the Bank reported 9M 2020 net income of $183 million, a YOY decline of 58%.

The Bank entered the current downturn with a solid track record of strong asset quality, resulting in low impairments and loan losses. However, HSBC Canada’s exposure to commercial real estate is higher relative to the larger Canadian banks and could potentially pose a greater risk in the event of a prolonged economic downturn. Of the $31.5 billion in wholesale loans and advances to customers at September 30, 2020, approximately 30% was to the commercial real estate and construction sectors. As with the rest of the banking sector, HSBC Canada did offer its clients loan payment deferrals that stood at $2.2 billion for personal mortgages and $1.1 billion for wholesale loans as at September 30, 2020. The outstanding balance on these deferred loans represents just 7.5% of total personal mortgages and 3.4% of total wholesale loans. Meanwhile, gross impaired loans-to-gross loans rose to 0.7% in Q3 2020 from 0.5% in Q3 2019 largely because of increased impaired loans in the mining and quarrying segment. DBRS Morningstar expects impaired loans are likely to trend higher as a result of the renewed business closures and uncertainty regarding the timing of the economic recovery.

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. Consequently, customer accounts reached $73.6 billion as of September 30, 2020, up 20% from the previous year. In addition, the Bank achieved funding diversification through debt issuances, securitizations, and a Canadian registered covered bond program. Meanwhile, the Bank itself also maintained higher levels of liquidity, reporting a robust liquidity coverage ratio of 201% for Q3 2020, well above the minimum required by the Office of the Superintendent of Financial Institutions and many Canadian bank peers.

The Bank’s Common Equity Tier 1 ratio stood at 13.1% as of September 30, 2020, in line with the large Canadian banks, and giving HSBC Canada a significant capital buffer of approximately $2.5 billion. Despite the cancellation of common dividends for Q2 2020 and Q3 2020, the Bank 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 and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 8, 2020, https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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.

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.

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.

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

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