DBRS Confirms HSBC Holdings Ratings at AA (low), Trend Stable

DBRS Ratings Limited (DBRS) has today confirmed the ratings of HSBC Holdings plc (‘HSBC’ or ‘Group’) including its AA (low) 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), whilst the support assessment remains SA3. As a result, the Group’s final ratings are positioned in line with its IA.

HSBC’s ratings and Stable trend reflect the strength of HSBC’s franchise across developed and emerging markets, its solid capital base, sound quality of the loan book, and robust liquidity. The ratings and trend also incorporate the challenges HSBC has faced in meeting its profitability targets and in continuing to strengthen compliance.

HSBC is one of the largest and most diversified banks globally, although its profitability is heavily weighted towards Asia. The Group has a strong presence in the UK and Hong Kong, and an extensive global network, which represents a competitive advantage in servicing businesses and individuals with international needs. HSBC continued to make good progress against its strategic initiatives in 2016, with the sale of operations in Brazil helping the Group achieve 97% of its targeted USD 290 billion risk-weighted asset (RWA) reduction.

Progress in meeting certain profitability and revenue targets has, however, proved more challenging reflecting operating headwinds, including the slowdown of the mainland Chinese economy. Despite these challenges, HSBC’s 2016 results highlight the continued resiliency and impressive revenue generating capability of its diverse franchise, both of which are critical underpinnings of the Group’s ratings. On an adjusted basis, which excludes certain non-cash items, such as impairments of goodwill and own credit spreads, as well as cash items, such as restructuring and conduct costs, profit before tax remained broadly stable year-on-year (YoY), at USD 19.3 billion, reflecting both a resilient revenue performance, and the Group’s progress in reducing its cost base.

Cost reduction has been a significant component of HSBC’s recent strategic initiatives, with the Group targeting USD 6.0 billion of cost savings by 2017, revised up from an initial target of USD 4.5 – 5.0 billion. Progress against these targets has been solid, with run-rate savings of USD 3.7 billion achieved to date, USD 2.2 billion of which were realised in 2016. As a result of the progress, adjusted costs were down 4% YoY, resulting in positive adjusted jaws (income growth less expense growth) of 1.2%. However, given the persistent drag of litigation & regulatory related expenses, which totalled USD 4.6 billion in 2016, cost control remains critical for the Group.

DBRS views the Group’s overall asset quality performance as sound, given its relatively low impaired loans ratio of 2.1% at end-2016, and adjusted loan impairment charges of USD 2.7 billion, equivalent to only 31 basis points (bps) of gross loans. DBRS pays particular attention to the Group’s exposures in mainland China, which amounted to USD 146 billion at end-2016, and 94% of which was in the form of wholesale lending. Although DBRS takes comfort from the nature of HSBC’s Chinese exposure, with losses remaining low, it will continue to monitor the exposure given the stresses evident within the market. Operational risk, however, continues to be a key challenge, as evidenced by the latest opinion of the independent monitor appointed to produce annual assessment of the effectiveness of the Group’s anti-money laundering and sanctions compliance programme, which shows the Group still has significant work to do.

HSBC’s strong funding profile results from the Group’s strong position in retail savings in Asia and its discipline in ensuring loans are funded by customer deposits across its markets. Indeed, the Group’s already very strong loan-to-deposit ratio improved in 2016 to 67.7% at end-2016 from 71.7% a year earlier. Overall, the Group’s entities held around USD 560 billion of unencumbered liquid assets at the end of 2016.

HSBC continues to strengthen its capital position, through internal capital generation and a reduction in Group RWAs. In 2016, Group RWAs decreased 22% to USD 857 billion, driven in part by the continued implementation of RWA reduction initiatives, including the sale of operations in Brazil, as well as the change in the regulatory treatment of the Group’s investment in the Bank of Communications Co, Limited (BoCom). This contributed to an improvement in the Group’s end-point CRDIV Common Equity Tier 1 (CET1) ratio to 13.6% at end-2016, up 170 bps from end-2015, whilst the estimated end-point leverage ratio was up 40 bps YoY, at 5.4%. This leaves the Group well placed compared to domestic and global peers. The Group also looks well placed to meet certain future requirements, including minimum requirement for own funds and eligible liabilities (MREL). Having issued approximately USD 31 billion of MREL-eligible instruments in 2016, the Group reported a transitional capital and senior debt ratio of 23.8% at end-2016, in advance of both its expected January 2019 MREL requirement of 16%, and internally estimated January 2022 MREL requirement of 21.8%.

RATING DRIVERS
HSBC’s ratings are unlikely to see upward rating pressure given their already high rating level, as well as the challenging regulatory and operating 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. Moreover, an increase in risk profile due to expansion of capital markets activities could also have negative rating implications. Substantial litigation or reputational issues could also pressure the ratings, especially if DBRS perceives these issues to be causing damage to the Group’s strong franchise.

Notes:
All figures are in USD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2016). Other applicable methodologies include the DBRS Criteria – Support Assessments for Banks and Banking Organisations (March 2016) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2017). These can be found at: http://www.dbrs.com/about/methodologies

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

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

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

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 historical default rates published by the European Securities and Markets Authority (“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, Managing Director, Head of EU FIG, Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG, Global FIG
Initial Rating Date: May 16, 2001
Last Rating Date: February 25, 2016

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