DBRS Confirms HSBC Holding ratings at AA, Trend Stable

DBRS Ratings Limited (DBRS) has today confirmed the ratings of HSBC Holdings plc (“HSBC” or “Group”) including its AA Long-Term issuer rating and R-1 (middle) Short-term issuer rating. The Trend on all ratings is Stable. The Intrinsic Assessment (IA) for HSBC is AA (low). DBRS views the Group as systemically important within the UK (categorising the Group as SA-2) and the final ratings incorporate a one notch uplift from the IA for systemic support.

The confirmation of the ratings reflects the strength and breadth of HSBC’s franchise across developed and emerging markets. HSBC continues to maintain strong underlying earnings, a solid capital base and robust liquidity and the Stable trend reflects DBRS’ expectation that these strengths position the Group well to cope with any renewed stress in the environment. However, the size and complexity of the Group also present challenges, leading to a high regulatory burden and cost base.

HSBC is one of the largest and most diversified banks globally, with home markets in the UK and Hong Kong, and international activities across Asia Pacific, Europe, North America, Middle East and North Africa and Latin America underpinned by its very strong trade and commercial banking franchise. The Group has made a number of adjustments to its franchise, announcing over 74 disposals or exits since 2011, but has maintained resilient underlying revenues.

The Group’s overall asset quality is sound, reflecting the nature of the Group’s franchise and its related solid risk profile. The Non-Performing loan ratio was 3.2% in 1H14 (compared to 4.0% in 1H13) and the impairment charge was USD 2.6 billion in 9M14, equivalent to 6% of net operating income (compared to impairment charges of 40% at the peak of the Group’s asset quality challenges in the US consumer business in 2009).

However, as with a number of other large international banks, fines and litigation have become a significant drag on the Group’s profitability. In 9M14 the Group had over USD 2.6 billion costs and revenue charges in relation to a number of regulatory and conduct issues: compliance with the Consumer Credit Act, a settlement with the Federal Housing Finance Agency, a provision in relation to the FCA’s investigation into foreign exchange (subsequently resulting in a USD 343 million fine for HSBC Bank, alongside 4 other banks, in November 2014), UK customer redress and a settlement with the US Commodity Futures Trading Commission.

The Group’s commitment to reducing the likelihood of further conduct lapses has driven a global programme to overhaul standards and controls. This process is important for underpinning the Group’s financial strength over the medium term, but has created challenges from a cost point of view. Additional investment in compliance added USD 700 million to operating expenses in 9M14.

HSBC cost management programme continues and the Group has reported that it has reached USD 5.8 billion in sustainable cost savings since 2011. However, even excluding restructuring costs and UK customer redress costs, underlying operating expenses were up 5% YoY in 9M14, reflecting increased risk, compliance and related regulatory costs. Consequently, HSBC’s cost efficiency ratio for 9M14 increased to 62.5% from 56.6% in 9M13 and the Group has moved away for the next few years from its target of a mid-50% cost efficiency ratio to high-50%. Given the low interest rate environment, the pressure on costs and higher capital requirements, DBRS considers it will also be hard for the Group to meet its shareholder return target of 12 – 15% (9M14 annualised return was 9.5%).

HSBC has a very strong funding profile, resulting from the Group’s discipline in ensuring loans are funded by customer deposits across its markets. The Group had a strong loan-deposit ratio of 73.7% at the end of 9M14 and the Group’s principal entities held around USD 584 billion unencumbered liquid assets at the end of 1H14.

HSBC continues to generate capital internally and post strong capital ratios. The Group’s end-point Common Equity Tier 1 ratio at the end-September 2014 was 11.4%. The Group’s leverage compares favourably to peers with an estimated end-point leverage ratio of 4.6%. However, regulatory capital will remain a constraint for the Group, given that the final requirements of UK regulators, including the impact of ring-fencing certain activities in the UK, still remain uncertain. The Financial Stability Board’s proposals from November 2014 on Total Loss Absorbing Capital (TLAC) for G-SIBs could also negatively affect HSBC, given the Group’s structural surplus of deposits and comparatively limited use of wholesale debt funding at a number of its subsidiaries, but further clarification is still required.

HSBC’s ratings are unlikely to see upward rating pressure given their already high level and the challenging regulatory environment. The ratings could come under downward pressure if an economic downturn affects a number of the Group’s key markets at the same time; if the Group increases its appetite for market risk in the Global Banking & Markets division and increases its focus on more volatile capital market activities; or if there is evidence of further significant weaknesses in controls and operational risk in its geographically dispersed franchise.

Notes:
All figures are in USD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2014). Other applicable methodologies include the DBRS Criteria: Support Assessment for Banks and Banking Organisations (January 2014) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (December 2013).These can be found can be found at: http://www.dbrs.com/about/methodologies

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

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Elisabeth Rudman
Rating Committee Chair: Roger Lister
Initial Rating Date: May 16, 2001
Most Recent Rating Update: January 27, 2014

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For additional information on this rating, please refer to the linking document located at: http://www.dbrs.com/research/236983/banks-and-banking-organisations-linking-document.pdf

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