DBRS Comments on HSBC Holdings plc 1H11 Interim Results, Senior Unchanged at AA (high), Trend Stable

DBRS Inc. (DBRS) has today commented that the ratings of HSBC Holdings plc (HSBC or the Group), including its AA (high) Issuer and Long-Term Debt rating and its R-1 (high) Short-Term rating, remain unchanged following the release of the Group’s results for the half year to 30 June 2011. The trend on all ratings is Stable. For 1H11, HSBC reported a pre-tax profit of $11.5 billion, increasing 3% from 1H10 and 45% from 2H10.

HSBC’s sound results reflect the benefits of the Group’s diverse global franchise with all customer groups and regions reporting a profit before tax. Moreover, the results evidenced the strong earnings generation power of the franchise, especially now that credit costs have abated with improving credit performance. For the six months to 30 June 2011, HSBC’s underlying profit before tax, which excludes foreign currency movements, acquisition and disposals of businesses, and marks related to movements in the fair value of its own debt, improved 28% on a half-year linked basis to $11.4 billion. Positively, while top line revenues increased, results were primarily bolstered by the continued positive trajectory in credit performance. Specifically, loan impairment charges and other credit risk provisions declined 19% on a half-year linked basis to $5.3 billion and are the lowest since 1H06. While DBRS sees the positive aspects of the improved credit performance, given uncertainties regarding the strength and sustainability of the global economic recovery and the already reduced level of provisions, DBRS expects moderation in the benefits to earnings from improving credit performance.

Importantly, underlying revenues grew 4% to $35.6 billion benefitting from double digit growth in faster growing economies, particularly Asia and Latin America, offset by the revenue constraints from the wind-down of the Group’s exit portfolios. Underlying operating expenses increased 2% from 2H10 to $20.5 billion. The increase was largely attributable to certain nonrecurring items such as $477 million in restructuring costs, a $611 million provision for UK customer redress programmes related to personal protection insurance (PPI) partially offset by a credit of $587 million due to a pension curtailment gain. Even with higher operating expenses, HSBC’s cost efficiency ratio improved to 57.5% from 59.9% in 2H10 from stronger revenue growth. Moreover, the cost efficiency ratio was 54.4% in 2Q11, the lowest level in three quarters, reflecting early actions towards cost savings and controlling discretionary spending. However, this remains outside of HSBC’s target efficiency ratio of 48% to 52% by 2013. Given the significant cost savings objectives management is enacting, DBRS expects solid improvement in cost measures.

While early in the process, HSBC’s results indicate good initial advancement towards the strategic goals the Group put forth in May 2011. The three major objectives of this plan include deploying capital more efficiently, improving cost efficiency (as touched on above) and targeting growth in selected markets within the Group’s footprint. To that end, revenues in target markets increased while funds under management in Global Asset Management reached a record level at the end of June 2011. Regarding capital allocation, HSBC has announced the closure of its retail businesses in Russia and Poland, as well as the disposal of three insurance businesses. More importantly, in the U.S., the Group has announced the sale of 195 non-strategic branches, largely in upstate New York. Nonetheless, DBRS views HSBC’s ability to ultimately realise the full benefits of successfully enacting the strategic plan as a longer-term process.

By customer group, results evidenced good momentum across the franchise with all segments reporting improved profit before tax (PBT) on a half-year linked basis. Retail Banking and Wealth Management (RBWM) reported an underlying PBT of $3.1 billon in 1H11, a 24% increase from 2H10. Improving credit performance across all regions and an increase in revenue generation in Asia and Europe more than offset lower revenue generation from HSBC Finance reflecting the ongoing decline in its run-off portfolio and lower card fees. Within Commercial Banking, improving asset quality and good growth in lending and trade volumes from Asia and Latin America drove a noteworthy 45% improvement from 2H10 in underlying PBT to $4.2 billion. Furthermore, Commercial Banking results benefitted from the Group’s geographic footprint and its positioning in faster growing markets, which led to a 9% increase in customer lending balances and increasing fee income from remittances, trade and investments. Underlying PBT in GBM grew 37% from 2H10 to $4.8 billion, driven by a 42% increase in Global Markets revenues. Global Markets revenues grew on higher client demand in Rates, an increasing share of client flows in Equities, solid balance growth and higher spreads in Securities Services. Global Private Banking results improved by 11% to an underlying PBT of $552 million on higher net fee income resulting from an increase in transaction volumes and growth in client’s assets under management, as well as higher net interest income from the continuing recovery in demand for lending. Given the positive trajectory of results across the franchise, positive trends in asset quality, as well as improving economic conditions in most of HSBC’s global footprint, DBRS expects solid improvement in credit and earnings through 2011.

DBRS views the Group’s financial profile as strong, anchored by a well-managed funding and liquidity profile, as well as, a solid capital base. Funding is underpinned by its substantial and geographically diverse deposit base. In the period, total deposits grew a solid 7% to $1.3 trillion demonstrating the strength of the franchise as competition for deposits continues to be intense. As a result, even with solid loan growth, HSBC’s loan-to-deposit ratio remains a sound 78.7% . Although HSBC’s balance sheet grew 10%, RWAs increased only 6%, evidencing the conservative risk appetite of the Group. Good profit retention and foreign currency translation offset the increase in RWAs resulting in a 30 basis point improvement in HSBC’s Core Tier 1 ratio to 10.8%. Given the strength of HSBC’s capital generation ability and its solid capital position, DBRS sees HSBC as well-positioned to meet regulatory changes impacting capital and liquidity. This was demonstrated by the European Banking Authority’s (EBA) recent “stress test”. In the most adverse scenario, HSBC’s estimated Core Tier 1 would be 8.5% in 2012, which easily exceeds the minimum 5% Core Tier 1 ratio established by the EBA to pass the test.

Note:
All figures are in USD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the issuer. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Steve Picarillo
Approver: Alan G. Reid
Initial Rating Date: 16 May 2001
Most Recent Rating Update: 28 January 2011

For additional information on this rating, please refer to the linking document below.