DBRS Comments on HSBC Holdings plc 2011 Results, Senior 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 ratings and its R-1 (high) Short-Term rating, remain unchanged following the release of the Group’s results for full year 2011. The trend on all ratings is Stable.

HSBC’s full year results reflect the benefits of the Group’s diverse global franchise. Indeed, with the exception of North America, all customer groups and regions reported an underlying profit before tax (PBT). Overall, HSBC reported underlying PBT, which excludes foreign currency movements, acquisition and disposals of businesses, and marks related to movements in the fair value of own debt, of $17.7 billion for the year. While underlying PBT was down 6% year-on-year (y-o-y), given the current operating environment, DBRS views the results as demonstrating the Group’s significant and resilient earnings generation ability, its well-respected brand, and the diversity of its businesses across products and geographies.

Revenues at $68.1 billion were underpinned by 10% growth in faster growing markets, offset by revenue pressure emanating from headwinds in the Eurozone, which resulted in a reduction in loan demand and client activity as well as the continued reduction in the run-off portfolio in the U.S. Net interest margin (NIM), which at 2.51% at year-end, was 17 basis points lower than 2010. The tightening of the margin reflected lower gross asset yields attributed to the run-off of the U.S. consumer finance portfolio, and the repositioning of the Retail Bank and Wealth Management (RBWM) portfolio towards secured lending. Additionally, increased deposits costs and an increase in the cost of funds in mainland China, India, and Brazil owed to base rate increases contributed to the lower margin.

Positively, loan impairment charges were 14% lower y-o-y at $12.1 billion. Impairments were lower in all regions except Latin America and Hong Kong. DBRS notes that the higher impairments in these regions reflected loan growth, not credit deterioration. Moreover, the reduction in impairments was driven by HSBC Finance in North America, as the higher risk loan portfolio continues to run-off.

Operating expenses were 8% higher y-o-y due to restructuring costs, the U.K. bank levy and the previously announced PPI provision. However, excluding notable items and restructuring costs, underlying operating expenses were only 3% higher, driven by business expansion and wage inflation, primarily from the Group’s faster growing markets.

By customer group, almost all segments reported growth in PBT. However, Global Banking and Markets and Global Private Banking reported weaker results, reflecting the impact of difficult market conditions. For 2011, RBWM generated an underlying PBT of $4.2 billion, an increase of 6% from 2010. Lower impairment charges and improving revenue generation in Latin American, Rest of Asia Pacific and Hong Kong more than offset lower revenue generation from North America. Within Commercial Banking, record revenues from strong lending growth in Asia and Latin America outpaced the increase in operating expenses, and combined with lower credit costs, drove a noteworthy 30% (y-o-y) improvement in underlying PBT to $7.9 billion. Underlying PBT in GBM declined 23% to $7.1 billion due to reduced client activity in Credit and Rates and higher operating expenses from targeted investment and regulatory compliance. Nevertheless, revenue expanded in over half of the GBM’s business lines, including Global Banking, Foreign Exchange, and Equities supported by good demand in Rest of Asia Pacific and Latin America. Global Private Banking results were 11% lower at $944 million, reflecting higher operating expenses and higher compliance costs offsetting a 5% increase in revenue. Given the Group’s focus on, and investment in faster growing markets and the expectation of continued growth in these markets, DBRS expects solid results through 2012.

Importantly, the results evidenced good progress towards the strategic goals the Group put forward in May 2011. The three major objectives of this plan include deploying capital more efficiently, improving cost efficiency and targeting growth in selected markets within HSBC’s footprint. To that end, revenues increased 10% in faster growing markets and these markets now account for 49% of Group revenues, up from 44% in 2010. Regarding capital allocation, to date, the Group has announced 19 disposals which will result in a $50 billion reduction in RWA, allowing for the redeployment of capital. In 2011, the Group achieved $900 million in sustainable cost savings. However, higher operating expenses and muted revenue growth resulted in the increase of the efficiency ratio to 57.5%

The Group’s balance sheet remains solid, underpinned by a well-managed funding and liquidity profile, as well as a sound capital base. The substantial and geographically diverse deposit base is the foundation the funding profile. At year-end 2011, deposits totaled $1.25 trillion, up 2% y-o-y. As a result, despite growth in the loan book, HSBC’s loan-to-deposit ratio remains a sound 75.0%. HSBC continues to generate solid levels of organic capital, retaining $12.8 billion of earnings in 2011. This retention of earnings, combined with the introduction of Basel 2.5 and loan growth resulted in HSBC’s Core Tier 1 ratio standing 40 basis points lower than at year-end 2010 at 10.1%. While there is still a level of uncertainly given the scope and pace of regulatory changes around the globe, 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. To this end, HSBC estimates its pro-forma Basel 3 Core Tier 1 ratio at year-end 2013 to be 10.2%, assuming no business growth and no capital generation.

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 DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This commentary was disclosed to the issuer and no amendments were made following that disclosure.

This credit rating has been issued outside the European Union (EU) and may be used for regulatory purposes by financial institutions in the EU.

Lead Analyst: Steven 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 under Related Research.