In October, global banking giant HSBC Holdings (HSBC) announced it was considering selling its Canadian subsidiary; those operations make it the seventh largest bank in Canada with $134 billion in assets, notes Gavin Graham, contributing editor to Internet Wealth Builder.

The announcement set off a contest amongst the Big Six Canadian chartered banks to acquire the operation. With approximately 2% of the country’s banking assets, HSBC Canada represented the last and best opportunity to grow market share domestically on a big enough scale to make a difference.

Royal Bank of Canada (RY) — known as RBC — went big; by agreeing to pay $13.5 billion for HSBC Canada, the deal is the largest ever Canadian bank merger. RBC has paid a generous price at 2.5 times HSBC’s tangible book value, but in the opinion of CEO Dave McKay “It really does represent a once in a generation opportunity.”

RBC estimates it can strip out 55% of HSBC’s costs, around $740 million annually, within two years. While the deal will reduce RBC’s equity capital Tier 1 ratio, as it will all be paid in cash, it will still leave the ratio above 12%, the minimum considered prudent by the authorities and the industry.

It’s ironic that the government’s decision to ban financial institutions from implementing dividend increases and buying back shares during the pandemic helped enable RBC to make the deal. The spending prohibition allowed RBC to generate lots of additional capital, thus enabling it to pay such a high price for HSBC Canada.

RBC will rely on cost cutting in the short term to make the deal immediately profitable. RBC estimates it will earn about $1.4 billion annually in additional profit in 2024, about a 10% increase on its 2021-22 annual earnings. This doesn’t take account of any cross-selling of its products to its new clients, approximately 40% of whom are regarded as affluent.

The deal still must be approved by the Ministry of Finance and the Office of the Superintendent of Financial Institutions (OSFI). Assuming that permission will be granted, the deal is expected to close late in 2023.

The combined organization will control approximately 23-24% of the Canadian banking market. The purchase will enable RBC to increase its dominance in the highly profitable Canadian banking market and the additional market share shouldn’t be an issue with the authorities.

The bank announced an increase of four cents a share in the quarterly dividend, to $1.32 ($5.28 a year), for a recent yield of 3.9%. Royal Bank of Canada remains a buy for its attractive valuation, increasing profits from a widening net interest margin (NIM) from rising interest rates, and a rising dividend.

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