DBRS Comments on HSBC Finance’s 2Q10 Results, Senior at ‘A’, Trend Negative

DBRS has today commented that the ratings of HSBC Finance Corporation (HSBC Finance or the Company), including its Senior Debt rating of “A”, are unaffected by its 2Q10 earnings announcement. The trend on the long-term ratings is Negative and the trend on the short-term ratings is Stable.

Improving credit performance and reduced receivable balances resulted in HSBC Finance reporting a reduced loss before tax for the quarter. For the quarter ending June 30, 2010, the Company reported a loss of a narrowed $521 million compared to a $6.3 billion loss in the same quarter a year ago. HSBC Finance’s results evidence that the positive momentum in credit performance continued into 2Q10, while certain exceptional items, most notably a pretax $4.8 billion loss on debt designated at fair value and related derivatives, contributed to the outsized loss for the comparable period. Notwithstanding, DBRS sees the reduced loss as evidence of that the actions taken by the Company, beginning in early 2008, to remove risk from the balance sheet are positively impacting Company performance.

Loan loss provisions, on a dollar basis, declined both on a year-over-year and quarter-on-quarter basis. For 1Q10, provisions totaled $1.6 billion, declining 33% from 2Q09 and 15% from 1Q10. Importantly, for the second consecutive quarter, the improvement in provisioning was experienced across each business segment. Despite the decline in provisioning, coverage ratios remain prudent, with reserves as a percentage of non-performing assets of 100.2%. While the overall level of provisions continues to exceed pre-provision income, the continuing trend of reduced provision levels is viewed favorably by DBRS.

Lower net interest income and reduced lower other revenues somewhat offset the benefit from lower provisioning expense. Net interest margin (NIM) declined 76 basis points year-on-year to 4.94%, owed to continued mortgage modification efforts, which reduced receivables yield, an ongoing shift in loan book mix to mortgages from higher yielding credit cards, and the increased investment portfolio balance held in low yielding, high-quality securities.

HSBC Finance continues to make solid progress in its planned reduction of its run-off portfolio of consumer assets. At June 30, 2010, the run-off portfolio totaled $65.6 billion, a 6% reduction from the end of 1Q10. Furthermore, subsequent to quarter end, HSBC Finance agreed to sell approximately $2.9 billion of auto receivables to an unaffiliated third party and transfer $490 million of associated asset-backed debt. At quarter-end, the core retail credit card portfolio, maintained on HSBC Finance’s balance sheet, totaled $10.1 billion. During the quarter, the Company originated and sold $8.7 billion of credit card portfolios to HSBC Bank USA, an increase of 11.5% over the prior quarter, retaining the servicing on the portfolios for a fee. Lower provisioning and non-recurrence of a goodwill impairment charge resulted in the core Card and Retail Services segment recording a profit before tax of $259 million (IFRS Management basis) in 2Q10, compared to a $328 million loss a year ago. Moreover, evidencing the value of the expertise gained, the Company increased its direct marketing campaign and new originations for select segments of non-prime credit cards.

Liquidity remains well-managed, while funding needs are reduced as the non-core businesses run-off. HSBC Finance’s commercial paper program remains active, with $3.7 billion outstanding at June 30, 2010. Since year end, long-term debt has declined by 10% to $63 billion, reflecting the smaller balance sheet. Maturing debt is expected to continue to be repaid through the ample liquidity, asset sales, continued balance sheet attrition and cash generated from operations. HSBC Finance’s liquid investment portfolio totaled $5.2 billion flat to the prior quarter, but a sizeable increase of 79% from year end 2009.

Capitalization remains acceptable. Tangible common equity to tangible assets at 7.27% remains in excess of Company internal targets. During 2Q10, HSBC Finance received a $200 million capital contribution from HSBC (North America) to maintain capital at prudent levels given the still unsettled operating environment. Importantly, this was the first capital support of 2010 compared to total support of $2.3 billion in 1H09, illustrating the improving performance of the Company. Nevertheless, HSBC Finance’s ratings continue to be underpinned by DBRS’s opinion that the Group will support the Company (should support be required) to allow HSBC Finance to run-off its non-core portfolio in a measured way and fulfill all its commitments.

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

The applicable methodology is Rating Finance Companies Operating in the United States, available under methodologies on our website.

This is a Corporate (Financial Institutions) rating.