DBRS: HSBC 1H14 Results Demonstrate Strong Balance Sheet; Cost Challenges

Summary:
• Net profit of USD 9.7 billion, down 5% YoY; underlying profits are resilient, but face challenges.
• Further strengthening of balance sheet: strong capital, leverage and asset quality.
• DBRS rates HSBC Holdings plc Senior Unsecured Long-Term Debt at AA with a Stable trend.

DBRS Ratings Limited (DBRS) considers the 1H14 results of HSBC Holdings (HSBC or the Group) illustrate the benefits of the Group’s global franchise, with its diverse operations contributing to resilient underlying earnings. In 1H14, HSBC reported profit before tax (PBT) on an underlying basis (excluding fair value of own debt, the impact of acquisitions, disposals and FX) of USD 12.6 billion, a 4% decrease year-on-year (YoY). DBRS considers that profits were resilient taking into account various significant items in 1H13 and 1H14.

Weakness in Global Banking & Markets (GBM) was partially offset by strong underlying returns in Commercial Banking and across most geographies. The Commercial Banking (CMB) division, for example, reported a 16% YoY increase in underlying PBT and a 7% YoY increase in loan balances (on a constant currency basis) . GBM reported an 11% decrease in underlying PBT, principally reflecting lower revenue in Markets and Balance Sheet Management, as a result of lower market volatility and reduced client flows.

HSBC continues to benefit from reduced impairment charges, with improvements across most geographies resulting in a decrease in underlying impairments of 38% YoY, to USD 1.8 billion. The greatest improvement was experienced in Europe, North America and Latin America, as a result of improved portfolio quality, reduced levels of delinquencies and changes in impairment model assumptions. Asset quality trends remained solid, with impaired loans down 7%, to USD 33.9 billion, representing 3.2% of customer loans and advances.

Costs remain a challenge for HSBC, with a reported cost efficiency ratio of 58.6% (53.5% in 1H13) in 1H14 against a target of mid-50s. Underlying expenses, excluding significant items and business disposals, increased 4% YoY following increased investment in Risk and Global Standards of USD 326 million. DBRS notes, however, that HSBC managed to generate USD 500 million sustainable costs savings in 1H14, bringing the annualised savings total to USD 5.4 billion since 2011.

HSBC, in line with peers, continues to face investigations (including foreign exchange setting and LIBOR), and ongoing litigation issues, which have the potential to impact the Group’s reputational and financial position. In 1H14 the Group took additional charges for UK customer redress of USD 234 million and provisions in relation to the Consumer Credit Act in the UK of USD 367 million.

HSBC continues to improve its capital position significantly. At end-1H14, HSBC’s estimated end-point CRD IV Common Equity Tier 1 (CET1) ratio was at the top end of global peers at 11.3%, up 40 basis points from end-2013. The estimated leverage ratio (end-point basis) was 4.3%.

1H14 saw the commencement of the next stage of HSBC’s strategic restructuring. This stage, which is expected to run until 2016, is targeting growth of the business and dividends; implementation of Global Standards; and a continued focus on costs/ streamlining processes and procedures.

DBRS rates HSBC Holdings plc Senior Unsecured Long-Term Debt at AA with a Stable trend.

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