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If Royal Bank of Canada's plan to buy HSBC Bank Canada is approved, the deal would extend RBC’s lead over competitor banks by tens of billions of dollars in both loans and deposits.Duane Cole/The Globe and Mail

Royal Bank of Canada RY-T is buying HSBC Bank Canada for $13.5-billion, bolstering RBC’s position as the country’s largest bank with a deal that could reshape its competitive position against rivals as it looks to grab a greater share of new customers.

The transaction, which was announced Tuesday, is a prize that Canadian banks have been eyeing for years. HSBC Canada, a subsidiary of Britain-based giant HSBC Holdings PLC, has strengths in commercial lending and mortgages and has been consistently profitable. As the seventh-largest bank in the country by assets, it is the last domestic acquisition target for the Big Six banks that has enough market share in deposits and loans to make a real competitive difference.

If approved, the deal would extend RBC’s lead over competitor banks by tens of billions of dollars in both loans and deposits. And, by winning the bidding for HSBC Canada, RBC has snatched from its smaller rivals one of the few remaining chances for them to catch up in assets and scale through an acquisition.

HSBC Canada’s unique position in the market means the deal raises questions about competition and concentration. RBC needs approvals from the Competition Bureau, the Office of the Superintendent of Financial Institutions and the federal Finance Minister to close the transaction. If allowed, it would drive up RBC’s share of the domestic banking market by about 2 per cent at the outset, the bank said.

When HSBC signalled its exit from Canada in October after 41 years in business in the country, it attracted a flurry of interest from Canadian banks. HSBC is retreating from some markets under pressure from shareholders who want it to focus more on Asia, where it does the majority of its business, and as geopolitical tensions with China make it harder for Western companies to operate there.

All six major Canadian banks rushed to the negotiating table to consider bids for HSBC Canada. But some of them were knocked out of the bidding after larger banks, including RBC, drove the purchase price higher.

“It really does represent a once-in-a-generation opportunity,” RBC’s chief executive officer, Dave McKay, told reporters on Tuesday.

The deal could give RBC a meaningful advantage in Canada at a moment when rival banks have looked to the United States to make similarly huge acquisitions. Bank of Montreal paid $17.1-billion for California-based Bank of the West this past December, and Toronto-Dominion Bank struck a US$13.4-billion deal to buy Tennessee-based First Horizon Corp. in February.

That left RBC with the largest reserve of capital available to spend on HSBC Canada, stockpiled in large part while dividend increases and share buybacks were on hold through much of the COVID-19 pandemic.

RBC’s postacquisition share of domestic deposits, at 23 per cent or 24 per cent, would be comparable to the equivalent concentration created if two of the smaller Big Six banks were to merge – a prospect seen as a non-starter since the federal government blocked previous merger attempts in 1998, reasoning that the deals would unfairly reduce competition.

HSBC Canada “is still a relatively small bank by market share,” Mr. McKay told analysts on Tuesday. “We are not aware of any areas where the bureau is likely to have concerns with this type of transaction.”

A statement from the Finance Department said Finance Minister Chrystia Freeland must take into account “all matters she considers relevant,” which could include the rights and interests of customers as well as the impact on competition.

The two banks expect the deal to close late in 2023.

The purchase price RBC has offered is hefty: In simple dollar terms, it is the most a Canadian bank has ever paid for a domestic rival. At 2.5 times HSBC Canada’s tangible book value, it is at the high end of conventional valuations. But RBC expects to reap huge savings by stripping out 55 per cent of HSBC’s costs – about $740-million annually – within two years.

The deal also includes a “locked-box” provision, under which HSBC Canada’s profits from June 30, 2022, will accrue to RBC until the deal closes, a sum RBC estimated at $1-billion.

Why selling HSBC Canada, the country’s most lucrative bank deal in decades, is unusually challenging

While RBC will rely on cost-cutting to make the deal’s math work for shareholders in the near term, what made the deal attractive to the bank is that it represents a chance to acquire a new book of customers – and then to cross-sell everything from deposit accounts and credit cards to investment products and advisory services to those customers.

Acquiring new customers is gruelling work in Canada’s highly consolidated banking market. For years, RBC has been investing to get better at it. It is now betting that HSBC Canada will give it “connectivity to the next generation of immigrants” to Canada, in the form of a stronger pipeline of referrals, Mr. McKay said.

RBC estimates it could earn $1.4-billion in additional profit in 2024, after cost-cutting and taxes, but that projection that doesn’t include any cross-selling of products to new clients, leaving room to make the deal more profitable.

Buying HSBC Canada is “not an asset strategy,” Mr. McKay said. “This is a client strategy at the end of the day, and a client growth story.”

HSBC Canada had $134-billion of assets as of Sept. 30, split fairly evenly between loans and deposits. It also had about 130 branches serving 770,000 retail clients, with Vancouver and Toronto and their suburbs being its key markets. About 40 per cent of those clients are considered affluent.

But RBC will have to fight hard to keep them. The bank made projections for attrition and “a haircut on revenue” in its financial models for the deal, chief financial officer Nadine Ahn said. But executives declined to specify how many HSBC clients they expect to lose.

The bank will also draw scrutiny over how many jobs and bank branches it will need to shed to reach its aggressive cost-cutting goal. Personal and commercial banking head Neil McLaughlin said there is overlap between branches and offices, but he did not say how many closures RBC plans. An investor presentation ascribed 17 per cent of the projected cost savings to “retail and commercial distribution.”

Some jobs will be made redundant, Mr. McLaughlin said, but he would not say how many would be cut. He said many HSBC employees could find new roles in thousands of positions that are vacant at RBC, and that more will open up through natural attrition.

Shares in HSBC Group closed up 4.4 per cent on the London Stock Exchange on Tuesday. RBC shares rose 0.4 per cent on the Toronto Stock Exchange, to $133.77.