DBRS Comments on HSBC Finance’s 2Q11 Results; Senior at ‘A’, Trend Stable

DBRS Inc. (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 the Company’s financial results for 2Q11. The trend on all ratings is Stable.

While still loss-making, DBRS views HSBC Finance’s results as reflecting the noteworthy progress the Company has achieved in lowering the risk profile of the balance sheet, running down the loan portfolio and managing the expense base, all of which supports the improvement in operating performance. For 2Q11, HSBC Finance reported a pre-tax loss from continuing operations, on a U.S. GAAP basis, of $137 million compared to a pre-tax loss from continuing operations of $866 million a year ago. Importantly, calculated on an underlying basis which excludes fair value movements on own debt and related derivatives, the Company’s pre-tax loss narrowed to $382 million from $1.3 billion in 2Q10. Revenues declined 10% year-on-year to $1.6 billion reflecting the lower receivables balance. Revenues are expected to continue to decline with the portfolio in run-off mode; however, improving credit performance is reducing credit provisions thereby relieving some of the earnings pressure. For the quarter, provisions for credit losses were $781 million, a 51% reduction from the comparable period a year ago. Loan loss provisions declined primarily due to lower receivables balances and positive underlying credit trends across all products.

Importantly, net interest income exceeded provision for credit losses for the second consecutive quarter illustrating the improving quality and seasoning of the receivables book. For the quarter, net interest income declined 1% year-on-year to $981 million, reflecting the lower receivable book partially offset by higher receivable yield. The improvement in yield on receivables reflects the improved credit quality of the card book and a lower level of non-accrual loans in the real estate secured and personal non-credit card portfolios. Excluding the impact of an estimated interest receivable related to income taxes receivable, net interest margin (NIM) improved 35 basis points year-on-year to 5.17%. Operating expenses were 27% higher in the quarter due to an increase in legal reserves related to certain litigation matters and an impairment charge related to certain previously capitalized software development costs.

During the quarter, HSBC Holdings plc (HSBC or the Group), HSBC Finance’s ultimate parent, announced that the credit card business of HSBC Finance is no longer a strategic focus of the Group and that HSBC will conduct a strategic review of the business evaluating all available options. The Card segment’s lending products include MasterCard, Visa, American Express and Discover cards as well as private label receivables. While potential options include a disposal of the business, which would remove the only profitable segment from HSBC Finance, DBRS sees no impact to the rating of HSBC Finance. The ratings of HSBC Finance reflect DBRS’s expectation that parental support would be forthcoming should it be required. Given the past actions and statements of support from HSBC, DBRS sees the announcement regarding the Credit Card business as not affecting this opinion. DBRS will monitor the strategic review process and provide further commentary comment as announcements warrant.

HSBC Finance continues to run-off its portfolio of consumer assets. At June 30, 2011, this portfolio totaled $51.5 billion, a 9% reduction from the end of 2010. Despite the aforementioned review process, the Card business remains active. For the three month period to June 30, 2011, the Company originated and sold on a daily basis $8.8 billion of credit card receivables to HSBC Bank USA. The Card and Retail Services segment continues to be profitable with the segment generating a profit before tax, on an IFRS Basis, of $187 million for the quarter, 26% higher than a year ago. Results were driven by the improving credit quality of the portfolio, which led to lower impairment charges and higher other operating income on lower fee charge-offs.

Liquidity is well-managed and funding requirements continue to decline as the loan portfolio runs off. Since year end 2010, long-term debt has declined by $6.8 billion, or 12%, to $47.8 billion reflecting the ongoing balance sheet reductions. HSBC Finance’s commercial paper program remains active, with $3.7 billion outstanding at the end of June 2011. HSBC Finance estimates its funding needs for the remainder of 2011 to be in the range of $4 billion to $8 billion, which the Company expects to be repaid through ongoing balance sheet attrition, cash generated from operations, selected issuance of retail notes and potential asset sales. At June 30, 2011, HSBC Finance’s liquid investment portfolio totaled $2.8 billion, or 35% lower than year-end, reflecting the higher debt maturities and calls during the quarter partially offset by the ongoing liquidation of the receivables portfolio, sale of REO properties and an increase in collateral required from counterparties under derivative agreements.

Capitalization strengthened from year-end 2010. Tangible common equity to tangible assets at 8.10% improved 73 basis points and remains in excess of the Company’s internal targets. Important to the rating, the Company did not require capital support during the quarter.

Notes:
All figures are in U.S. dollars 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: Steven Picarillo
Approver: Alan G. Reid
Initial Rating Date: May 16, 2001
Most Recent Rating Update: January 28, 2011

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