DBRS Confirms HSBC Finance Corporation at A (low); Maintains Stable Trend

DBRS, Inc. (DBRS) today has confirmed the Senior Debt rating of HSBC Finance Corporation (HSBC Finance or the Company) at A (low). At the same time, DBRS maintained the Stable trend on the rating. The rating confirmation followed DBRS’s confirmation of the ratings of HSBC Holdings plc (HSBC or the Group; rated AA (low) with a Stable trend), 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. In DBRS’s view, the benefits of the positioning within the HSBC family allows for substantial uplift to the final ratings of HSBC Finance. Nonetheless, DBRS places the rating below that 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 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’s rating.

The Stable trend reflects that of the Group. The trend also considers DBRS’s expectations that the gradual recovery in the U.S. housing market will moderate in 2017, as higher rates impact housing activity. Nonetheless, DBRS expects that conditions in the U.S. housing market will continue to be supportive of HSBC Finance’s efforts to accelerate and complete the wind-down of the legacy mortgage portfolio through loan sales in 2017.

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, 2016, total legacy mortgages, which was comprised solely of mortgages held for sale (HFS), totaled just $5.7 billion, 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 moderate as the balance sheet runs-down. HSBC Finance has approximately $1.45 billion of debt maturities in 2017, excluding debt held by HSBC affiliates, with the next notable debt maturity being $2.3 billion in 2021. In DBRS’s view, there continues to be a likely mismatch in the timing of the cash flows from the liquidation of the loan portfolio and debt maturities in future periods. As such, DBRS expects that HSBC Finance will likely have to seek additional borrowings from HSBC Group to cover the potential gap.

Capitalization is considered sound given the remaining mortgage exposure on the balance sheet. Tangible common equity-to-tangible assets strengthened to 28.5% at year-end 2016, up from 20.87%, at year-end 2015. Importantly, the Company has received no capital support from parent entities of the Group since 2011.

While HSBC Finance has made substantial progress in running down its balance sheet, DBRS views the Company’s earnings generation ability as remaining constrained. To this end, following two consecutive years of profitability, HSBC Finance has returned to a loss making position over the last seven quarters. Indeed, HSBC Finance reported a net loss (U.S. GAAP basis) of $529 million in 2016, compared to a net loss of $431 million in 2015. Earnings in 2016 were impacted by the Company’s acceleration of its sales of legacy mortgages, a charge related to the settlement of securities litigation, and transformation-related costs. However, DBRS does not expect a number of the charges incurred in 2016 to reoccur in 2017. On an adjusted performance basis, excluding transformation 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 $19 million in 2016, a slightly narrower loss than generated in 2015 ($25 million). 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 until the mortgage portfolio wind-down is completed.

RATING DRIVERS
Given the linkage, the ratings of HSBC Finance would likely move higher if the Group’s ratings were to be raised or an explicit guarantee of the Company’s remaining debt obligations by HSBC Group were 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. Further, should the Group signal to the market that it will not provide timely support to HSBC Finance, the SA1 designation would be in jeopardy, which would result in negative rating pressure.

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

The applicable methodologies are Global Methodology for Rating Finance Companies (October 2016), Global Methodology for Rating Banks and Banking Organisations (July 2016), and DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2016), which can be found on our website under 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.

Lead Analyst: David Laterza, Senior Vice President – Head of U.S. Non-Bank Financials, Global FIG
Rating Committee Chair: Michael Driscoll, Head of US FIG – Global FIG
Initial Rating Date: October 25, 2001
Last Rating Date: February 24, 2016

The rated entity or its related entities did participate in the rating process. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities.