DBRS Comments on HSBC Holdings plc 1H12 Results, Senior at AA (high), Under Review - Negative

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 the six months ending 30 June 2012 (1H12). The ratings remain Under Review with Negative Implications where they were placed on 20 July 2012.

Despite indications of slowing in the global economy and ongoing uncertainties regarding the crisis in the Eurozone, HSBC reported underlying profit before tax (PBT), which excludes foreign currency movements, acquisition and disposals of businesses, and marks related to movements in the fair value of own debt, of $10.6 billion, a significant 83% improvement from 2H11. Importantly, HSBC achieved these results despite incurring $1.3 billion of provisions related to U.K. customer redress and $700 million of provisions for certain U.S. law enforcement and regulatory matters. DBRS notes that the historic missteps, related to these provisions were contributing factors in DBRS recently placing HSBC’s ratings Under Review with Negative Implications. In DBRS’s view, while these events are generally in the past, they continue to have consequences for the Group and highlight the difficulties of managing large globally active, complex financial institutions in this challenging environment. Nevertheless, DBRS views HSBC’s 1H12 results as demonstrating the benefits of the Group’s diverse global franchise, which underpins the resiliency of its underlying earnings.

Total underlying revenues at $34.8 billion, were 13% higher on a half-year linked basis. Revenue growth was underpinned by 8.5% growth in faster growing markets such as Hong Kong, Rest of Asia Pacific and Latin America. Despite growth in average interest-earning assets, net interest income declined 5% from the prior half-year to $19.4 billion. The decline reflects growth in lower yielding term lending in Commercial Banking and the Group’s focus in Retail Banking and Wealth Management (RBWM) of shifting the loan book composition towards high-quality secured lending and away from high-yielding unsecured lending. Net interest margin (NIM) at 2.37% at 30 June 2012 was 10 basis points lower than 2H11. This decline reflected lower yields on the Group’s excess liquidity and customer lending, as the Group focused on secured lending, which was partially offset by high customer balances in non-interest bearing accounts. Net trading income improved to $4.5 billion compared to $1.7 billion in 2H11 primarily due to higher client flows in foreign exchange and lower adverse fair value movements on economic and non-qualifying hedges.

Positively, underlying loan impairment charges were 26% lower from 2H11 at $4.8 billion. Impairments were lower in all business groups and regions except Latin America and Rest of Asia Pacific. Impairments were higher in Latin America primarily in Brazil reflecting higher volumes and delinquency rates while in Rest of Asia Pacific the increase was related to specific corporate items in Australia. Importantly, North America reported a 41% decrease in impairments driven by the reduction in lending balances in the run-off Consumer and Mortgage Lending portfolio.

Underlying operating expenses were 4% higher compared to 2H11 due to notable items, which include restructuring costs, U.K. customer redress and U.S. law enforcement and regulatory provisions. On an underlying basis, the cost efficiency ratio was 61.0% compared to 66.0% in 2H11. DBRS notes that notable items accounted for 7.9% of the 1H12 efficiency ratio.

By customer group, all segments reported double digit growth in underlying profit before tax on a half-year linked basis. For 1H12, RBWM generated an underlying PBT of $2.6 billion, a substantial increase from $657 million in 2H11. Lower impairment charges due to asset disposals and the run-down of the consumer and mortgage lending book in the U.S. and improving revenue generation in faster growing regions more than offset headwinds from Europe and costs associated with customer redress in the U.K. and other notable items. Within Commercial Banking, revenue growth in high growth markets reflects good lending growth, as well as the benefits of its international network and its leading position in trade finance. These factors combined with lower credit costs drove a 13% improvement in underlying PBT for this segment from 2H11 to $4.2 billion. Underlying PBT in Global Banking & Markets (GBM) rose substantially in 1H12 to $5.0 billion from $2.2 billion in 2H11. Results in GBM were positively impacted by higher revenues from foreign exchange due to strong client activity and market volatility, growth in payments and cash management particularly in Asia and rates reflecting good geographic diversification of the book. Global Private Banking results were 15% higher at $460 million; higher revenues and dramatically lower impairment charges were key drivers of these improved results. DBRS expects these segments to benefit from the Group’s focus on faster growing markets in 2012, although they could be impacted if the economic slowdown spreads to these markets.

HSBC continues to advance its initiative put forward in May 2011 to simplify and restructure the Group. 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. Indicating progress on these objectives, revenues increased 11% YoY in faster growing markets; and Hong Kong and Rest of Asia Pacific markets now account for over 66% of Group PBT. Regarding capital allocation, since the beginning of 2012, the Group has announced 19 disposals, bringing the total since the beginning of 2011 to 36. These actions have resulted in the release of $55 billion of risk-weighted assets, facilitating the redeployment of capital. On efficiency, the Group has achieved $1.7 billion in sustainable cost savings since May 2011.

From DBRS’s perspective, 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 anchor of the funding profile. At 30 June 2012, deposits totaled $1.3 trillion up 2% from year-end. As a result, despite growth in the loan book, HSBC’s loan-to-deposit ratio remains a sound 76.3%. In 1H12, the Group generated organic capital of $7.0 billion. This retention of earnings combined with a 4% reduction in risk-weighted assets resulted in HSBC’s Basel 2.5 Core Tier 1 ratio strengthening 50 bps from year-end 2011 to 11.3%. HSBC estimates its pro-forma Basel 3 Core Tier 1 ratio on 30 June 2012 to be 10.3% assuming no business growth and no capital generation. There is still considerable uncertainty about the scope and pace of regulatory changes around the globe. Given HSBC’s capital generation ability that it sustained throughout the crisis, DBRS sees HSBC as well-positioned to meet regulatory changes impacting capital and liquidity.

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 rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Roger Lister
Approver: Alan G. Reid
Initial Rating Date: 16 May 2001
Most Recent Rating Update: 20 July 2012

For additional information on this rating, please refer to the linking document under Related Research.