DBRS Confirms HSBC Finance at AA (low) and R-1 (middle)

DBRS has today confirmed the ratings of HSBC Finance Corporation (HSBCF or the Company) and its subsidiary, HSBC Financial Corporation Limited, including the Company’s Senior Debt rating at AA (low). The ratings are based on HSBCF’s strong franchise as one of the oldest finance companies in the United States, its established history of managing credit risk, its solid liquidity profile and its well-managed balance sheet. Despite the recent weakness in earnings, DBRS views HSBCF’s solid earnings power as a significant ratings driver. Also underpinning the rating is the implied support of its ultimate parent, HSBC Group Inc. (the Group) and DBRS’s view that HSBCF is a core component of the Group’s businesses.

HSBCF’s Consumer Lending business, which is one of the largest originators of first-lien debt consolidation loans in the United States, underpins the Company’s solid franchise. DBRS views the Company’s long history of successfully operating this business as a key strength. Despite reduced earnings in 2006, DBRS considers the Company’s earnings and profitability strong. DBRS expects that profitability will improve as 2007 progresses; however, earnings will likely be pressured by weakness in the Company’s Mortgage Services segment. DBRS expects earnings to normalize in 2008 as this portfolio runs off.

Offsetting factors include reduced 2006 earnings as a result of recent credit losses within the Mortgage Services segment, which are expected to continue to pressure earnings in 2007. While the Company has a strong history of managing a sub-prime portfolio, navigating through the current environment will likely continue to be a challenge for HSBCF, given the deficiencies of the loans within the Mortgage Services segment and the current stress in the sub-prime mortgage industry. Further, the Company’s business lines, which include card, mortgage, auto finance and unsecured consumer lending products, remain exposed to the weaker segments of the U.S. consumer market and as such may experience operating difficulties during times of economic stress. That said, credit performance in these business lines remains largely within expectations.

HSBCF’s extensive history of managing credit risk weighs into DBRS ratings. However, the Company, like the whole sub-prime industry, experienced asset-quality deterioration in its Mortgage Services unit, owed primarily to lower-than-expected performance of purchased 2005 and 2006 vintage loans, causing large provisions and asset writedowns. Nonetheless, as indicated, profitability was still respectable, and credit weakness has been largely isolated to this segment as asset quality in the other business units was within expectations.

HSBCF has taken measured steps to reduce its exposure to the more-criticized asset classes. Moreover, the Company’s tightened underwriting standards, change in the management of the Mortgage Services segment and strengthened risk management policies and practices will likely lead to improved asset quality. Furthermore, HSBCF has eliminated a significant number of the products that were the cause of the deterioration, which should improve asset-quality measures going forward. However, although projected to run off, the more distressed loans will likely remain on the balance sheet for the near term.

The company is sufficiently capitalized. Total equity has grown to $20.1 billion; however, the large levels of intangibles reduce tangible equity to $11 billion, or 6.9% of assets. Liquidity is considered strong. While HSBC Group does not explicitly guarantee HSBCF debt, HSBCF receives significant funding advantages from its parent through direct funding as well as the benefits of issuing debt as a Group subsidiary. HSBCF guarantees the debt of HSBC Financial Corporation Limited, its Canadian subsidiary.

DBRS considers HSBCF to be a core element of HSBC Group because it complements the parent’s banking, capital markets and other businesses. Besides generating strong earnings in the United States with its extensive franchise, HSBCF generates credit card assets and other consumer-finance growth opportunities for the Group globally. Reflecting its position in the Group, HSBCF benefits significantly from access to funding from other businesses within the Group, which has increased to approximately $45 billion. Moreover, this position in the Group enables HSBCF to benefit from improved liquidity, shared funding and reduced funding costs. Evidence of HSBC Group’s support is the occasional capital infusions to maintain the Company’s capital targets.

The Stable trend reflects DBRS’s expectations that HSBCF will effectively manage its portfolio through the current stressed environment and that the asset-quality issues experienced in the Mortgage Services unit will be contained within that segment and gradually improve as the portfolio runs off and the impact of the remediation steps are realized.

Note:
All figures are in U.S. dollars unless otherwise noted.