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RBC’s C$13.5bn Acquisition of HSBC Canada

By Jack Lee, Jeremia Darmadi, Heather Leung, Sissi Zeng and Victor Leung (HKUST), Ayushman Mukherjee, Matthew Liu and Divy Dayal (University of Cambridge)

Photo: Kit Suman (Unsplash)

 

Overview of the deal


Acquirer: Royal Bank of Canada

Target: HSBC Canada

Total Transaction Size: C$13.5bn ($10.1bn, £8.4bn)

Announcement date: November 29, 2022

Closed date: Late 2023

Target advisor: J.P. Morgan Cazenove, HSBC Global Banking

Acquirer advisor: RBC Capital Markets (primary); Goldman Sachs (secondary); Blake, Cassels & Graydon; Allen & Overy; Wachtell, Lipton, Rose & Katz (legal)


The Royal Bank of Canada (RBC)’s acquisition of HSBC Bank’s Canadian operations (HSBC Canada) for C$13.5 billion consolidates its position at home – particularly among international clients with Canadian connections – at a time when many of its peers have pursued overseas acquisitions in an attempt to diversify earnings (such as BMO and TD Bank, which have been distracted negotiating large American deals). The deal was completed at 9.4x HSBC’s 2024 adjusted earnings. Whether this deal will stand up to regulatory scrutiny remains in the balance – as a deal of similar magnitude was proposed between RBC and BMO in 1998, having been scuppered by regulators. If the deal is successful, investors may be reassured by RBC’s track record of prudent acquisitions.


“The deal makes strategic sense for both parties, and RBC will take the business to the next level. We look forward to working closely with RBC’s leadership team to ensure a smooth transition for our clients and colleagues. Our Group strategy is unchanged, and closing this transaction will free up additional capital to invest in growing our core businesses and to return to shareholders.” - Noel Quinn, CEO (HSBC)

Company Details (Acquirer - Royal Bank of Canada)


Founded in 1864, Royal Bank of Canada (RBC) is a Canadian multinational bank. RBC serves 17 million clients globally across 27 countries. In Canada, RBC is the bank with the highest market capitalisation. The company operates in the following global segments: Personal & Commercial Banking, Wealth Management, Insurance, Investor & Treasury Services and Capital Markets.


Founded in 1864, headquartered in Toronto, Canada

CEO: Dave McKay

Number of employees: 91,000

Market Cap: C$185.7bn

LTM Revenue: C$48.5bn

LTM EBT: C$20.1bn

LTM P/E: 12.1x

LTM P/BV: 1.8x


Company Details (Target - HSBC Canada)


Formerly known as the Hongkong Bank of Canada (HBC), HSBC Bank Canada is the Canadian subsidiary of the renowned multinational bank HSBC Holdings plc. Being the seventh largest bank in Canada and the largest foreign-owned bank in the country, HSBC Bank Canada represents the more globalised side of the Canadian banking industry.


HSBC Bank Canada provides a variety of services, including commercial banking, global banking, markets and securities services, wealth and personal banking. Plans have also been set to prioritise sustainable financing and investment in order to support the transition to a net zero carbon economy.


Founded in 1981, headquartered in Vancouver, British Columbia

CEO: Linda Seymour

Number of employees: 5,700

LTM Revenue: C$2.3bn

LTM EBT: C$1.0bn


Projections and Assumptions


Short-term consequences


The acquisition of HSBC Canada puts RBC in a formidable position as it continues to tighten its grip over the Canadian banking sector, much to the worry of regulators. The C$13.5bn deal is surprising due to rising costs of borrowing and recessionary risks. Nonetheless, RBC CEO claims it will “add a complementary business and client base” and provide greater levels of services to its customers. RBC is already the largest bank in an oligopolistic sector (with six banks controlling 80% of the market) and we can expect RBC to develop in its weaker sectors. For example, this acquisition brings with it strong expertise in liquidity management, trade finance, international cash management and sustainable finance – disciplines that RBC sees as yielding bigger returns in the future. Perhaps this future growth is the reason why RBC acquired HSBC Canada, as experts claim this deal to be overvalued by 30%.


For HSBC, this is a timely sell-off. With impending recessions, HSBC has set up a safety net through this deal, generating a pre-tax gain of US$5.7bn. The board of HSBC are now considering whether they should grow organically or restore control through share buybacks. Either way, HSBC are insulating themselves from the cold economic outlook. The Canadian division was generating relatively low profits (<5% LTM EBT of parent, HSBC Holdings) and held a mere 2% domestic market share, hence losing it shouldn’t trouble the London-based firm. In fact, we can expect an injection of the capital into HSBC’s more established markets, diversifying, growing and pleasing shareholders.


Some industry experts insist that this forms a monopoly in an already highly concentrated market, however, with HSBC Canada holding such a miniscule market share, RBC should be looking to welcome their first major acquisition under David McKay. Critics claim that this will significantly reduce Canadians’ access to a competitive and diverse market at home, however this can only be determined once regulators finalise reviewing the transaction.


Long-term Upsides


RBC expects the acquisition to be c. 6% EPS-accretive and to achieve c. C$740mn in cost synergies from significant overlap in footprint and operations. Qualitatively, the deal will strengthen RBC’s foothold in its home soil and extend RBC’s market share lead over its competitors. This deal will expand RBC’s customer base by c. 4.5% for which RBC has identified cross-selling opportunities that would bring organic growth to RBC’s top line. The boost to RBC’s bottom line will also aid RBC’s future expansion plans and deliver greater returns to RBC’s shareholders.

On the other hand, this divestment is likely a part of HSBC’s restructuring campaign to re-focus itself on its more profitable Asian operations and exit the North American and French retail banking markets. HSBC expects to record a pretax gain of c. US$5.7bn and a CET1 ratio improvement by 130 bps from the deal – putting the cash on the table to develop its pillar markets. The additional cash generated from the deal will be redistributed to shareholders via special dividends and/or buybacks – particularly important after some disappointed shareholders, including Chinese insurer Ping An, HSBC’s largest shareholder, formed a bloc calling for the bank to raise its payout.


Risks and Uncertainties


While execution and retention risks plague most deals, the most immediate concern faced by RBC is the Canadian government’s hardened antitrust stance. At present, 80% of the country’s banking assets lie under the control of its top 6 lenders, the largest being RBC in assets, revenue, and market capitalization - a stark contrast to the 40% held by the 5 major US banks. Nevertheless, considering that the transaction lies far below the Competition Bureau’s size threshold and implies only a 2% increase in RBC’s domestic market share, the transaction should pass regulatory review.


Should the deal get blocked, RBC may need to undergo divestment to satisfy regulators, and thus forgo a portion of the projected C$740 million (55%) annual expense synergy savings. Consequently, this would weaken RBC’s investment case - a rationale largely dependent on the assumption of fully realised cost savings and optimistic target valuation.


The 9.4x multiple of HSBC’s 2024 adjusted earnings has also been deemed steep due the large proportion of variable rate mortgages held by HSBC relative to its entire loan portfolio holdings. Given the sharp downturn of Canada’s housing market (a key revenue driver for RBC, forecasted to decline further) amidst other recessionary signals, taking on HSBC’s loan portfolio would subject RBC to further default risk posed by interest rate hikes.


"HSBC Canada offers the opportunity to add a complementary business and client base in the market we know best and position us to be the bank of choice for commercial clients with international needs, newcomers to Canada and affluent clients who need global banking and wealth management capabilities. The earnings accretion that comes from HSBC is very, very significant for us and overall drives a mix of very strong, consistent earnings that drive high dividend pay-out ability.” - Dave McKay, President & CEO (Royal Bank of Canada)

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