DBRS Confirms HSBC Holdings plc at AA (high), Trend Revised to Negative

DBRS has today confirmed the ratings of HSBC Holdings plc (HSBC or the Company), including its AA (high) Issuer and Long-Term debt ratings and its R-1 (high) Short-Term rating. DBRS has revised the Trend on all long-term ratings to Negative from Stable. The Trend on the Short-Term rating remains Stable.

This rating action follows the release of HSBC’s 2008 earnings. The rating confirmation reflects DBRS’s opinion that HSBC’s overall 2008 performance was respectable, given the unprecedented market turbulence and a rapid deterioration in the global economy. For the year, HSBC reported a pre-tax profit of US$9.3 billion, which was down 62% from 2007. The decline in pre-tax profit/earnings was driven by a US$10.6 billion goodwill impairment attributable to the acquisition of Household Finance and US$1.0 billion of charges related to the Madoff scandal. Excluding the sizeable goodwill impairment charge, pre-tax profit for 2008 was down 18% to US$19.9 billion. However, DBRS notes that the Group’s earnings were bolstered by an increase in the fair value of its own debt that added US$6.6 billion in pre-tax gains in 2008 and a pretax gain of US$2.4 billion on the 2008 sale of its French regional banks. Absent these one-time gains and the goodwill impairment, underlying profit remained acceptable. This strong earnings generation capability enhances the Company’s ability to absorb potential future losses associated with the current difficult operating environment.

HSBC’s diverse earnings power can be further illustrated by the profit recorded in all customer groups, except for Personal Financial Services. Moreover, all geographic regions remained profitable with the exception of North America. HSBC reported strong underlying pretax profit growth in China, India and the Middle East. DBRS views this performance during unprecedented global economic turmoil as evidence of the earnings power of HSBC’s globally diversified franchise. However, given the weak outlook for the global economy as well as DBRS’s expectations of continued global capital markets volatility, DBRS sees reduced underlying performance from the Company’s various regions for the near-term. This weakness is factored into the Negative trend on the Long-Term ratings.

Credit costs continued to pressure earnings, as the global economic downturn, particularly in the second half of the year, impacted credit performance. The rapid deterioration in the U.S. economy resulted in loan impairment charges in Personal Financial Services in the U.S. to rise to US$16.1 billion in 2008, a US$4.2 billion year on year increase. Credit losses in the U.S. were largely driven by the weaker HSBC Finance portfolio, which recorded higher provisions for credit losses in the Consumer Lending real estate secured portfolio and the credit card portfolio. With continuing house price deflation, rising unemployment and increasing individual bankruptcy filings, DBRS expects continued elevated credit costs in 2009.

Concurrent with its earnings announcement, HSBC announced that it was discontinuing most new lending, except some credit card origination, through its HSBC Finance Corporation (HSBC Finance) subsidiary. DBRS views the announcement as a long-term positive as this segment was the cause for significant earnings pressure. For the last two years, HSBC Finance’s earnings were drastically reduced by rising loan impairments and loan provisioning and DBRS expects that HSBC Finance will continue to record elevated credit losses, thereby pressuring HSBC’s earnings for the near-term. HSBC has supported HSBC Finance and has indicated that it will continue to provide all the support necessary to allow HSBC Finance to run-off in a measured way and fulfil all its commitments. HSBC’s statements and actions of support remain a key factor underpinning the ratings of HSBC Finance. Notwithstanding, DBRS no longer considers HSBC Finance as a core business to the Group, as such, HSBC Finance’s ratings have been lowered, removing some of the ratings lift gained from the core nature of the business.

DBRS views HSBC’s capital position as sound. Despite a difficult operating environment HSBC continued to generate capital during 2008. At year end, the Company’s Tier 1 capital ratio stood at 8.3%. Capital will be further bolstered by the recently announced US$17.7 billion rights issue. Upon the rights issue, which is subject to shareholder approval, HSBC’s pro-forma core equity Tier 1 ratio and Tier 1 ratios will be strengthened to 8.5% and 9.8%, respectively. DBRS views the rights issue as prudent given the current environment and believes the increased capital base should provide HSBC with ample cushion to withstand the increased losses that will arise from the current economic conditions in the Company’s core operating markets. Liquidity remained solid throughout 2008, as HSBC benefited from its extensive banking franchise. Indeed, customer accounts increased 16% to US$1.1 trillion from US$958 billion at year end 2007.

Ongoing market illiquidity and forced asset sales by other institutions led to further declines in observed prices for asset-backed securities. This resulted in an additional US$16.5 billion of reserves for movement in fair value of asset-backed securities held in the ‘available-for-sale’ securities portfolio in 2008. While this decline was reflected in reserves, with no impact on the income statement or the Group’s regulatory capital position, DBRS recognizes that a portion of the available for sale reserves may become impaired and therefore may be realized through the income statement in the future.

The Negative trend reflects DBRS’s concern that further economic weakening in HSBC’s markets will result in continued elevated credit costs, which will pressure earnings. Moreover, the Negative trend reflects DBRS’s expectation that the global economic slowdown may pressure revenue generation ability. While DBRS considers the Group’s solid earnings power a fundamental strength and a significant factor supporting HSBC’s rating, the unprecedented weakness and the global recessionary environment may result in a weakening of HSBC’s sizeable pre-provisioning earnings generation ability and lead to earnings pressure.

Notes:
All figures are in US$ unless otherwise noted.

The applicable methodology is Analytical Background and Methodology for European Bank Ratings, Second Edition, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.