DBRS Downgrades HSBC Finance Corporation, Senior at A (low), Trend Stable

DBRS, Inc. (DBRS) has today downgraded the ratings of HSBC Finance Corporation (HSBC Finance), including its Senior Debt rating to A (low) from ‘A’. Concurrently, DBRS has confirmed the Company’s R-1 (low) Commercial Paper rating. The trend on all ratings is Stable. Furthermore, the ratings have been removed from Under Review with Negative Implications, where they were placed on July 20, 2012. Today’s rating action follows DBRS’s downgrade of the ratings of HSBC Holdings plc (HSBC or the Group), HSBC Finance’s ultimate parent to AA from AA (high).

The downgrade takes into account HSBC’s recent fines and customer redress costs (including anti money laundering in the US and Payment Protection Insurance (PPI) in the UK), which demonstrate a weaker operational risk profile than is commensurate with the prior rating level. Moreover, DBRS expects the process for HSBC to raise compliance standards across the Group to be a lengthy and costly process. DBRS notes that HSBC already made major organisational changes to its structure in 2011, whereby control has been more centralised within the global businesses and functions rather than spread across multiple geographies, and that these changes should underpin the ongoing reforms. However, in DBRS’s view it is a significant challenge to successfully reform procedures and strengthen controls in large, complex banking organisations, such as HSBC.

HSBC appeared before the US Senate Permanent Committee on Investigations in July 2012 due to extensive failures in its compliance procedures for anti-money laundering and Office of Foreign Assets Control (OFAC) and subsequently agreed to make payments of $1.92 billion in December 2012. In the UK, the Group has set aside approximately $2.6 billion since the beginning of 2011 for customer redress primarily for PPI, and DBRS notes that HSBC is also part of the ongoing FSA review of SME interest rate hedging products.

In response to these failures, the Group has increased its spending on anti-money laundering, remedial measures, and an overhaul of controls and procedures, and intends to bring all controls globally to its highest global standard. DBRS considers that it is difficult to assess the full cost and revenue impact of meeting these higher standards, but expects it to be a drag on profitability. Moreover, the challenge of reforming the control culture of such a geographically widespread organisation as HSBC is significant.

Mitigating the above challenges, DBRS recognises that any further fines and provisions are unlikely to be large enough to undermine the Group’s financial stability. Moreover, HSBC remains one of DBRS’ highest rated banking groups and the Group’s AA ratings are underpinned by its strong diversity by geography and business line, as well as its solid financial position.

The rating outlook is stable reflecting the Group’s significant earnings and capital buffers, which have historically allowed it to absorb even problems as large as its exposure to US subprime. However, deterioration in franchise strength or asset quality across multiple jurisdictions could lead to negative ratings pressure. In addition, further evidence of its inability to meet global regulatory requirements could also lead to downward pressure on its ratings. Upward ratings pressure is unlikely given the high level of the current ratings.

The ratings of HSBC Finance are underpinned by the ownership structure and the support provided by the Company’s ultimate parent HSBC Holdings plc (HSBC Group). The benefits of the positioning within the HSBC family allows for significant ratings uplift. Yet, the ratings are placed below those of the parent, reflecting DBRS’s view that HSBC Finance is non-core with the business largely in run-off mode. Importantly, the ratings of HSBC Finance consider DBRS’s expectations that parental support would continue to be forthcoming, if needed.

Also, today DBRS has discontinued the ratings of HSBC Financial Corporation Limited as this entity was sold to HSBC Bank Canada and all outstanding debts have subsequently been repaid.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is Rating Finance Companies Operating in the United States. The other applicable methodology includes the DBRS Criteria – Intrinsic and Support Assessments. These can be found at: http://www.dbrs.com/about/methdologies

[Amended on June 17, 2014, to reflect actual methodologies used.]

The sources of information used for this rating include the 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: David Laterza
Rating Committee Chair: 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.