DBRS Morningstar Confirms HSBC Holdings at AA (low), Trend Revised to Negative

DBRS Ratings Limited (DBRS Morningstar) has confirmed the ratings of HSBC Holdings plc (HSBC or the Group) including its AA (low) Long-Term Issuer Rating and R-1 (middle) Short-Term Issuer Rating. The trend on the Group’s long-term rating has been revised to Negative from Stable. The Intrinsic Assessment (IA) for HSBC remains AA (low), whilst the support assessment is SA3. As a result, the Group’s final ratings are positioned in line with its IA.

KEY RATING CONSIDERATIONS

HSBC’s ratings reflect the strength of the Group’s global franchise, its leading positions in its home markets in the UK and Hong Kong, the solid capital base, sound asset quality, and robust funding and liquidity.

The revision of the Trend to Negative reflects a notable deterioration in the operating environment in Hong Kong, the largest contributor to the Group’s earnings. The region’s economy entered an economic slowdown in 2019, due to the social protests and a deterioration in exports reflecting global trade tensions. While these factors had a limited impact on the Group’s performance in 2019, DBRS Morningstar expects the economic downturn to continue in 2020, and its adverse impact to be magnified by the recent outbreak of the coronavirus Covid-19 in mainland China, which has strong trade and business links with the region. Although the full economic impact of Covid-19 is still uncertain, we anticipate the Group’s profitability and risk profile will weaken in 2020. DBRS Morningstar also expects the Group’s profitability over the next two years to be challenged by the large restructuring expenses envisaged under the recently announced turnaround plan.

RATING DRIVERS
Given the Negative Trend, upward pressure on the ratings is unlikely in the near to medium term. However, the Trend could revert to Stable, if the Group’s credit profile were to remain more resilient than currently anticipated in the face of a deterioration in the operating environment in Hong Kong and mainland China, combined with evidence of successful implementation of the new restructuring plan.

The ratings could come under downward pressure in case the Hong Kong and China economies suffer extended economic weakness, resulting in a severe deterioration in the Group’s profitability and asset quality metrics. The emergence of major hurdles in the execution of the restructuring plan could also pressure the ratings.

RATING RATIONALE

HSBC is one of the largest and most diversified banks globally, although its profitability in recent years has been increasingly weighted towards Asia, which represented around 49% of the Group’s adjusted revenue and 84% of the adjusted pre-tax profit in 2019. 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.

With its full year 2019 results, HSBC announced a plan focused on improving the Group’s profitability through the redeployment of capital from underperforming businesses to those with stronger return and growth prospects, mainly in the Retail Banking and Wealth Management and Asia. Under the plan, HSBC seeks also to simplify its corporate structure and strengthen operational efficiency. In DBRS Morningstar’s view, a significant delay in the appointment of the CEO or a prolonged deterioration in the operating environment in Hong Kong, could represent a challenge to the implementation of the plan.

HSBC’s profitability is supported by its well-established retail and wholesale franchises across Asia, Middle East and the UK, which generate strong earnings and have contributed to growth in recent years. The recently announced plan to improve the underperforming businesses should lead to an improvement in the Group’s efficiency in the long term. However, the plan has already had an adverse impact on the 2019 statutory earnings and is expected to generate additional significant restructuring expenses and asset disposal losses over the next three years. In 2019 HSBC’s reported profit before tax (PBT) declined by 33% to USD 13.3 billion, due to significant exceptional charges. These included USD 7.3 billion of goodwill impairment in relation to a revision of long term prospects and the planned restructuring of the Group’s wholesale businesses, USD 1.3 billion charges related to customer redress, mainly PPI, and USD 0.8 billion of restructuring costs. DBRS Morningstar notes that, despite the challenging operating environment, the franchise in Hong Kong continued to perform well in 2019. The adjusted PBT of the Group increased by 5% to USD 22.2 billion, confirming the resilience of its business model.

The Group maintains a low risk profile, benefiting from conservative underwriting and risk management and good geographical diversification. During 2019 asset quality remained strong with the share of Stage 3 exposures (assets which have defaulted or are otherwise considered to be credit impaired ) in gross loans and advances to customers remaining flat at 1.3%. Despite some increase in the cost of risk, in part reflecting provision charges in relation to the
deterioration in Hong Kong’ economic outlook, the cost of risk remained a low 27 basis points (2018: 17 basis points). In DBRS Morningstar’s opinion, the continuation of the economic downturn in Hong Kong, magnified by the impact of the coronavirus is likely to lead to a deterioration in the Group’s asset quality in 2020. Furthermore, an adverse outcome of the negotiations relating to the UK’s new trade relationship with the EU could have an adverse effect.

DBRS Morningstar notes that HSBC has, in recent years, undertaken measures to reinforce its compliance capabilities within the entire organisation and has made good progress in resolving some of the outstanding legacy matters. Following USD 0.8 billion charge in 2018, mainly related to the legacy RMBS activities, settlements and legal and regulatory matters had no significant impact on earnings in 2019. However, charges related to customer redress programmes increased substantially to USD 1.3 billion from USD 0.1 billion in 2018, mainly due to the surge in the volume of PPI-related claims in 2019.

DBRS Morningstar considers HSBC’s funding and liquidity profile as a core strength of the Group, reflecting its strong position in retail savings in Asia and the UK. The Group’s loan-to-deposit ratio was a low 72% at YE2019, reflecting the discipline in ensuring loans are funded by customer deposits. Despite the challenging situation in Hong Kong, customer deposits in the region (35% of the Group’s overall customer deposits), remained stable. The Group’s liquidity profile is very strong with HQLA assets of USD 601 billion and a Liquidity Coverage Ratio of 150% at YE2019. All of the Group’s material operating entities were well above their respective regulatory minimum LCR and NSFR requirements.

DBRS Morningstar views the Group’s capital position as strong. During 2019 HSBC’s Equity Tier 1 (CET1) ratio increased to 14.7% from 14% at YE2018, reflecting solid underlying earnings and the reduction in RWAs, in part offset by the dividend, share buy-backs and other factors. With its 2019 results, HSBC announced that it expects to maintain its CET1 ratio in the upper end of the target 14-15% range. The YE2019 Basel 3 end-point leverage ratio was also a strong 5.3%. HSBC’s performance in recent regulatory stress tests confirms the Group’s solid capital position. DBRS Morningstar expects, however, the Group’s internal capital generation in the near to medium term to be adversely affected by the significant charges resulting from the execution of the restructuring plan and the effects of the economic slowdown in Asia.

In 2019, HSBC continued to issue externally senior debt out of its HoldCo strengthening loss absorbing capacity. Proceeds of external debt are predominantly used to acquire capital and internal MREL/TLAC instruments issued by its subsidiaries. At YE2019 the Group’s eligible capital and HoldCo senior debt resources were equivalent to 30.1% of RWAs, comfortably meeting the 2020 minimum regulatory requirement, representing the indicative sum of the Group’s local subsidiaries MREL/TLAC requirements. While some of the some of the local requirements await finalisation, DBRS Morningstar considers the Group to be well placed to meet the future loss-absorption requirements.

The Grid Summary Grades for HSBC are as follows: Franchise Strength – Very Strong/Strong; Earnings – Strong; Risk Profile – Strong/Good; Funding & Liquidity – Very Strong; Capitalisation –Strong.

Notes:
All figures are in USD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2019). This can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include Company Documents and S&P Global Market Intelligence. DBRS Morningstar 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 Morningstar had no access to relevant internal documents for the rated entity or a related third party.

DBRS Morningstar 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 Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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 and US regulations only.

Lead Analyst: Tomasz Walkowicz, Vice President, Global FIG
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions Group and Sovereign Ratings
Initial Rating Date: May 16, 2001
Last Rating Date: March 1, 2019

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