DBRS Comments on HSBC Finance’s 2Q12 Results, Senior Unaffected at ‘A’, Under Review Negative

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 2Q12. The Company’s long-term ratings remain Under Review with Negative Implications, where they were placed on 20 July 2012. The trend on all short-term ratings is Stable.

Although still loss making, DBRS views HSBC Finance’s results as demonstrating the continuing progress of the Company in managing the run-down of the loan book while minimizing the overall cost of this process to HSBC Holdings plc, the Company’s ultimate parent. On a U.S. GAAP basis, HSBC Finance reported a net loss of $258 million for the quarter. The loss primarily reflects a $1.5 billion charge to write down to fair value a portfolio of loans which were transferred to held for sale as the Company intends to sell these loans to a third-party. Further, results were impacted by a $112 million charge to provision expense for the credit related component of the fair value mark of the personal non-credit card portfolio transferred to held for sale. Offsetting these charges was a $1.4 billion after-tax gain on the sale of the Company’s U.S. Card and Retail Services business to Capital One Financial Corporation on May 1, 2012. On an underlying basis, which excludes fair value movements on the Company’s own debt and the initial lower of amortize cost or fair value adjustment on receivables transferred to held for sale, the Company’s pre-tax loss from continuing operations was 52% wider YoY at $884 million for 2Q12.

Revenues, excluding movement on own debt and the mark-to-market value adjustment on loans transferred to held for sale, declined 55% YoY to $448 million reflecting lower net interest income and a decline in other income on reduced derivative income. For 2Q12, net interest income declined 23% to $391 million reflecting the lower receivable book and reduced overall receivable yield partially offset by lower interest expense due to a decline in borrowing balances and lower average rates. Additionally, DBRS notes that net interest income in the year ago period benefitted from an increase in the Company’s estimate of interest receivable on income tax receivables. Net interest margin (NIM) was 29 bps lower than 2Q11 at 2.93%. However, excluding the impact of the income tax related item, NIM was higher by 25 bps in 2Q12 compared to 2Q11. DBRS expects revenues to decline further given the run-off of the loan portfolio.

Earnings were reduced by higher credit provisions reflecting the impact of higher reserve requirements on trouble debt restructurings (TDR) loans primarily due to higher TDR loan levels and updates in certain assumptions in valuation models as well as the adoption of new accounting guidance in 3Q11 for TDR loans. For 2Q12, provisions for credit losses were $738 million, a 26% increase from a year ago. DBRS notes that $112 million of the mark to fair value of the personal non-credit card portfolio transferred to held for sale was related to credit and included in provision expense. Positively, operating expenses were 38% lower YoY at $239 million, partially mitigating earnings pressure from elevated credit costs and declining revenue. Operating expenses were lower reflecting the absence of a $150 million increase in legal reserves in 2Q11 related to certain litigation matters. Excluding this item from both periods, operating expenses were 3% higher, or $6 million in 2Q12 reflecting higher consulting and compliance related expenses somewhat offset by lower REO expenses.

HSBC Finance continues to make good progress in the planned reduction of its run-off portfolio of consumer assets. During 1H12, the run-off portfolio, excluding loans held for sale, was reduced to $35.0 billion. The Company expects the pace of run-off to moderate as charge-offs decline and the impact of loan modifications and the lack of re-financing alternatives keep the remaining loan book on the balance sheet longer.

Liquidity continues to be well-managed. Funding needs continue to decline as the run-off portfolio is further reduced. Long-term debt was 16% lower than at year-end 2011 at $33.6 billion. HSBC Finance has approximately $8 to $11 billion of funding needs for the remainder of 2012, which the Company expects to be met through the sale of the Card and Retail Services business, cash generated from operations, asset sales from portfolios transferred to held for sale and borrowings from HSBC or its subsidiaries. HSBC Finance is currently winding-down its commercial paper program and ceased new commercial paper issuances in 2Q12. At June 30, 2012, commercial paper outstanding totaled $302 million. The Company expects the wind-down of the commercial paper program to be largely complete by year-end 2012. HSBC Finance maintained $2.0 billion of third-party back-up lines of credit and also has a $2.0 billion committed credit facility with HSBC Bank USA Inc. and credit facilities totaling $2.0 billion with HSBC affiliates to support the commercial paper program.

DBRS views capitalization as acceptable. Specifically, tangible common equity to tangible assets was 9.52% at quarter-end, up significantly from 7.11% at year-end 2011 and above Company targets. Capital strengthened following the sale of the U.S. Card and Retail Services business for an after-tax gain of $1.4 billion. DBRS notes that during 1H12, the Company did not receive any capital contributions from HSBC (North America). Nonetheless, HSBC Finance’s ratings are underpinned by DBRS’s expectation that parental support would remain forthcoming should it be required.

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

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

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