DBRS Morningstar Changes Trend on Bank of China (Canada) to Negative following Sovereign Action; Confirms Rating of A (low)

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

KEY RATING CONSIDERATIONSs
The change in the trend to Negative on BOCC’s long-term ratings is driven by the change in the trend on the ratings of the PRC made by DBRS Morningstar on November 10, 2022. 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 ratings in tandem with the PRC’s ratings.

The 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.

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

Conversely, ratings would be downgraded following a downgrade of the PRC’s sovereign rating. Furthermore, ratings would come under pressure 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.

RATING RATIONALE
Franchise Strength
BOCC derives its franchise strength from its position as a financial intermediary facilitating transactional flows between the PRC and Canada, both for corporate and retail banking clients. Furthermore, BOCC also benefits from access to its Parent’s global network. In DBRS Morningstar’s assessment, BOCC remains well positioned to strengthen its franchise, although a sustained deterioration in the relationship between China and Canada could dampen growth prospects over the intermediate term.

Earnings Power
BOCC experienced some headwinds to earnings in 2021 with net income declining 3.8% year over year to $30.2 million largely because of increased operating and provisioning expenses as well as lower noninterest income. The Bank incurred provision for credit losses of $0.5 million, which formed a very manageable 1.33% of income before provisions and taxes. BOCC generates solid recurring earnings, with noninterest income forming 17.3% of total revenue, which is largely composed of fee and commission income. BOCC’s operating efficiency is top tier compared with those of its peers as it had an efficiency ratio of 41.9% in F2021.

Risk Profile
Asset quality has historically been sound given that the Bank maintains a strong risk management framework and conservative underwriting standards. As of F2021, gross impaired loans represented less than one basis point of gross loans. DBRS Morningstar remains cautious about BOCC’s significant exposures to commercial real estate and construction loans, which formed about one-third of gross loans at the end of F2021 and could result in higher asset impairment and losses in a sustained economic downturn.

Funding & 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. On balance, almost one-third of the Bank’s funding comes from relatively granular retail deposits, and BOCC can also access deposits from related entities within the BOC group, which somewhat mitigates this concentration risk. In addition, BOCC can readily source emergency liquidity from the Parent’s branches in New York and London, which helps support the SA1 designation.

Capitalization
DBRS Morningstar considers BOCC’s capital cushion, including a CET1 ratio of 23.7%, to be very strong, especially considering its largely collateralized loan exposures and the Bank’s strong 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
Rating actions on the PRC are likely to have an impact on this 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.

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/396929 (May 17, 2022).

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 23, 2022; https://www.dbrsmorningstar.com/research/381742). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929 (May 17, 2022) in its consideration of ESG factors.

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.

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 ratings are under regular surveillance.

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

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