DBRS Confirms HSBC Finance Corporation’s Senior Debt at A (low), Trend Stable

DBRS, Inc. (DBRS) has today confirmed the Senior Debt rating of HSBC Finance Corporation (HSBC Finance or the Company) at A (low). The trend on the rating is Stable. The rating action follows DBRS’s confirmation of the ratings of HSBC Holdings plc (HSBC or the Group), HSBC Finance’s ultimate parent.

The rating of HSBC Finance reflects the ownership structure and the continuing operational and financial support provided by the Company’s ultimate parent, HSBC. Importantly to the ratings, the Group continues to publicly state that it has the capacity and willingness to provide all necessary support to the Company as it runs-off its legacy mortgage portfolio and repays maturing debt. From DBRS’s perspective, the benefits of the positioning within the HSBC family allows for significant uplift to the final ratings of HSBC Finance. Nonetheless, DBRS places the ratings below those of the parent, reflecting the absence of an explicit guarantee of HSBC Finance’s obligations by HSBC. As a result of DBRS’s view that the Group would support the Company, if needed, DBRS continues to assign an SA1 designation to HSBC Finance. As a supported rating with an SA1 designation, the ratings of HSBC Finance will likely move in tandem with HSBC Holdings’ rating.

The Stable trend reflects that of the Group. The trend also considers DBRS’s expectations that the ongoing recovery in the U.S. housing market will continue to benefit HSBC Finance as it seeks to accelerate the wind-down of the legacy mortgage portfolio through loan sales. The ratings of HSBC Finance would likely move higher if HSBC’s ratings were to be raised, or an explicit guarantee of the Company’s debt by HSBC was put in place. Conversely, while not expected, a lowering of the Group’s rating would likely result in a downgrade of the Company’s rating.

In confirming the rating, DBRS recognizes the substantial progress HSBC Finance has made to date in running down the troubled legacy mortgage portfolio, and the reduced overall burden to HSBC that HSBC Finance represents. Indeed, at December 31, 2015, total legacy mortgages, excluding held for sale, totaled $9.0 billion, and compared to $87.3 billion at year-end 2008.

The ratings also consider the Company’s strengthened balance sheet. Liquidity continues to be managed appropriately, while funding requirements continue to diminish as the balance sheet runs-down. That said, HSBC Finance has substantial debt maturities over the next 24 months, including $5.0 billion in 2016, and $1.45 billion in 2017, excluding debt held by HSBC affiliates. In DBRS’s view, there is likely to be a mismatch in the timing of the cash flows from the natural amortization of the loan portfolio and debt maturities post-2016. As such, DBRS expects that HSBC Finance will likely have to execute additional portfolio sales or seek additional borrowings from HSBC Group to cover the potential gap.

Capital remains appropriate given the efforts to de-risk the balance sheet. Tangible common equity to tangible assets strengthened to 20.87% at December 31, 2015, up from 17.33%, a year ago. Importantly, the Company has received no capital support from parent entities of the Company since 2011.

While HSBC Finance has made noteworthy progress running down the balance sheet, DBRS views the Company’s earnings generation ability as remaining constrained by the ongoing run-off of the legacy mortgage loan book. To this end, following two consecutive years of profitability, HSBC Finance returned to a loss position in 2015 reporting a net loss (U.S. GAAP basis) of $431 million, compared to net income of $523 million in 2014. Earnings were impacted by the Company’s acceleration of its sales of legacy mortgage portfolios, litigation related charges, and the continuing run-off of the mortgage portfolio. However, DBRS does not expect a number of the charges incurred in 2015 to reoccur. On an adjusted performance basis, excluding severance costs, litigation related charges, and the change in the fair value of debt and related derivatives, the Company generated an underlying loss before tax from continuing operations, of $25 million in 2015. DBRS views this adjusted loss as providing a better indication of the Company’s operating performance and the challenges around profitability that the Company must manage as the mortgage portfolio winds-down.

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

The principal applicable methodology is the Global Methodology for Rating Finance Companies (October 2015). Other applicable methodologies include the Global Methodology for Rating Banks and Banking Organisations (December 2015) and DBRS Criteria – Support Assessments for Banks and Banking Organisations (December 2015). These can be found at: http://www.dbrs.com/about/methodologies.

The primary 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: David Laterza
Rating Committee Chair: William Schwartz
Initial Rating Date: 16 May 2001
Most Recent Rating Update: 29 September 2015

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