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HSBC’s Canadian bank has been very profitable, churning out $717-million in net income last year and its 13.3-per-cent return on equity makes it globally competitive.Fred Lum/The Globe and Mail

The dream scenario Big Six bank chiefs used to salivate over has come true: HSBC Bank Canada, the country’s seventh-largest lender, is up for sale. Yet with the auction already in motion, pulling off the country’s most expensive bank deal in decades is shaping up to be a challenging exercise.

HSBC’s Canadian bank is, by all accounts, a lucrative business. Unlike other global divisions that parent company HSBC Holdings PLC HSBC-N has sold off in recent years, including its American and French retail banking arms in 2021, the Canadian business is very profitable, churning out $717-million in net income last year. Its 13.3-per-cent return on equity, a crucial banking metric, makes it globally competitive.

Yet the timing of the deal, coupled with a fraught political landscape, is making any sale much trickier than it otherwise might have been, according to 10 banking industry sources familiar with the business and the auction. The Globe and Mail is not identifying the sources because they were not authorized to speak publicly on the matter.

A sale of HSBC Canada could be the largest deal for a domestic bank in more than two decades, with a price tag that could reach $10-billion. In simple terms, that would be the highest price ever paid for a Canadian bank, though Toronto-Dominion Bank’s $8-billion deal for Canada Trust in 2000 would be worth more after adjusting for inflation.

Although Canadian banks have made many big-ticket acquisitions abroad – most of them in the United States – the last major domestic deal was Bank of Nova Scotia’s BNS-T purchase of ING Direct, since renamed Tangerine, for $3.1-billion in 2012. In Canada’s highly consolidated market, major banking assets rarely come up for sale, especially since the federal government blocked proposed mergers of the largest banks in 1999. Acquiring HSBC Canada, then, presents a generational opportunity for its rivals, but one that is laden with strategic complexities.

Highly coveted banks tend to sell for 1.5 times to two times their book value, and HSBC Bank Canada’s book amounted to $5.7-billion as of Aug. 31. Earlier this month, when HSBC first revealed it was seeking buyers, analysts estimated that a price tag could surpass $10-billion. But that valuation may prove to be overly ambitious, because uncertainty over federal competition concerns and limits on the potential to cut costs could dent the amount bidders are ultimately willing to pay.

As it stands, each of the Big Six banks has expressed interest in bidding, and each has separately had a preliminary meeting with HSBC, according to two sources with knowledge of the process.

The auction is expected to last two rounds, with first-round bids expected in short order, according to two sources familiar with the process. Banks that are invited to the final round will get in-depth detail on HSBC’s books and customer accounts. HSBC Canada publicly reports its results as a standalone unit, which is rare for a foreign division of a global bank. But what is available for the public to read only scratches the surface of what a final-round bidder would need to see.

Hurdles are expected to materialize as the process proceeds. To start, the timing of the attempted sale, as well as the sheer size of any deal, has already given some Canadian banks an advantage – and put others in precarious positions.

Royal Bank of Canada RY-T, the country’s largest bank by profit, is widely seen as a leading contender for several reasons. Crucially, it has the highest pro-forma capital ratio of all the banks, which means it has excess cash to spend on an acquisition.

Since the 2008-09 global financial crisis, the country’s largest lenders have been required to hold higher capital buffers – effectively, more cash – to serve as a shock absorber against severe losses in an economic downturn. And, in the acute phase of the COVID-19 pandemic, Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), prohibited those banks from raising dividends or buying back shares, forcing them to conserve cash and stockpile capital even as they remained highly profitable. Unlike some rivals, RBC has yet to spend the war chest it accumulated.

By contrast, Toronto-Dominion Bank TD-T is spending US$14.7-billion this year on takeovers of two American institutions: retail bank First Horizon Corp. and investment bank Cowen Inc. And BMO BMO-T agreed to pay $17.1-billion for California-based Bank of the West in December, the largest U.S. deal in Canadian banking history.

Both banks are still working to close those deals, and both will have to spend years afterward integrating the new acquisitions with their existing operations. But it is too soon to rule out the possibility that they could come up with more money to buy HSBC Canada. TD in particular could sell some of its stake in Charles Schwab Corp. SCHW-N, worth US$15-billion – a resource the bank already tapped to buy Cowen.

The auction timing is also difficult for Bank of Nova Scotia. The Canadian arm of HSBC looks like a natural fit, because Scotiabank has expressed a desire to get stronger in British Columbia and Quebec, where HSBC is well established. Such an acquisition would also balance out the bank’s significant exposure to international markets – most notably in Latin America – which tend to be more volatile than Canada’s.

But Scotiabank has the lowest capital ratio among its peers, which limits the extra cash it has to spend. And the bank just named a new chief executive, Scott Thomson – an unconventional choice who has yet to formally join the company. His appointment has put some investors on edge.

Canadian Imperial Bank of Commerce has the opposite challenge: It is already highly exposed to the Canadian market, especially in mortgages, which has attracted scrutiny and pressure from investors. They have pressed the bank to diversify more outside of Canada and to focus on investing in its existing business – two things CEO Victor Dodig has clearly signalled are his priorities.

Montreal-based National Bank of Canada is thought to be in an advantageous position – at least in theory. National Bank has long wanted to bolster its presence outside of Quebec, especially in retail and commercial banking, and its shares have outperformed rival Big Six banks over the past five years. A strong stock price makes it easier for National to sell new shares to help fund a deal.

The problem is that National is the smallest of the Big Six, with a market value around $30-billion, making it hard for it to pay the price on its own. The solution, some sources suggested, could include teaming up with a few pension funds or other institutional investors, similar to how Intact Financial Corp. raised $3.2-billion to fund its joint takeover of RSA Insurance Group PLC in 2020.

Foreign bidders for HSBC Canada still can’t be counted out, but the banking landscape has changed in recent years: For most banks, the days of global empire building are over. Citibank, which has some operations in Canada, has been in retreat around the world, as have many European banks, including ING and BNP Paribas, which sold Bank of the West to BMO last year. Other major U.S. banks have minimal retail banking presence in Canada. JP Morgan JPM-N is out of contention, as it is running the sale process.

While HSBC is profitable in Canada, there are limited opportunities for a foreign owner to grow the business. Scale matters, and with six larger rivals already established it likely isn’t worth it for a foreign bank to pay a premium for the seventh-largest player.

Because Big Six banks are expected to dominate the bidding, competition issues loom large. In a speech last October, Matthew Boswell, Canada’s competition commissioner, called out a common defence used to justify contentious mergers: the prospect of efficiencies. If a bidder can prove that its deal will generate lower total costs for the combined entity, a merger is often allowed to proceed.

“The consequences of increased concentration, higher prices and lower competition across sectors of the economy – all in the name of merger efficiencies – are very real for consumers and our economic performance as a country,” he said.

One way to avoid that issue, sources say, could be to split HSBC up – for instance, by selling its operations in Eastern Canada and Western Canada to different buyers. That’s what HSBC did with its U.S. retail banking business last year. But one source said HSBC is aiming to sell the bank as a single entity.

Another option: HSBC could keep some of the business, such as its capital markets division. It could also carve out accounts belonging to wealth management customers and keep them, particularly if they have ties to its core business in Asia, which is likely to become the bank’s main focus. It did just that in the U.S., where it kept 20 to 25 locations and turned them into international wealth centres.

Competition concerns aside, there are geopolitical factors that might cause Ottawa to favour a sale. HSBC is headquartered in London, but has deep roots in Hong Kong and makes most of its revenue in Asia. Its largest shareholder is Chinese insurer Ping An, which is pressing HSBC to concentrate on Asia. If China’s government continues to exert tighter control over Hong Kong, it could put HSBC’s Western operations in a sticky position.

There is one thing that seems clear: Should a Canadian rival buy the business, much of the value and the ability to earn back the takeover premium paid will come from slashing expenses on people and technology – which could result in deep cuts.

Historically, acquirers have sought to strip out 20 per cent to 40 per cent of a target bank’s costs by merging back offices, closing bank branches and streamlining technology spending. Though more of those cost savings now come from technology, as banking is increasingly done digitally, integrating digital systems isn’t simple. Straightforward tasks such as merging clients between banks can be painful, and different IT platforms may not be compatible. Something as simple as giving a client a new bank account number can become a lengthy chore, giving people reasons to move to other lenders.

Because of those difficulties, what bank executives must weigh is just how badly they want this business. Once HSBC Bank Canada is gone, domestic expansion is likely to be a slow grind. When TD bought Canada Trust, the price tag looked hefty. In retrospect, it allowed TD to leapfrog competitors and transformed its prospects in ways that were hard to predict using Excel spreadsheets.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 20/02/24 4:42pm EST.

SymbolName% changeLast
HSBC-N
HSBC Holdings Plc ADR
+1.31%40.85
BNS-T
Bank of Nova Scotia
+0.42%64.13
BNS-N
Bank of Nova Scotia
+0.15%47.43
RY-T
Royal Bank of Canada
+0.46%132.55
RY-N
Royal Bank of Canada
+0.19%98.02
TD-N
Toronto Dominion Bank
-0.48%59.65
TD-T
Toronto-Dominion Bank
-0.26%80.66
SCHW-N
The Charles Schwab Corp
-1.27%63.58
JPM-N
JP Morgan Chase & Company
+0.39%179.73

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