DBRS Morningstar Confirms HSBC Holdings at AA (low), Trend Remains 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 ratings has been maintained at Negative. The Intrinsic Assessment (IA) for HSBC remains AA (low), whilst the support assessment is SA3.

KEY RATING CONSIDERATIONS

HSBC’s Long-Term Issuer rating reflects the strength of the Group’s global franchise and leading position in its home markets in the UK and Hong Kong, the solid capital base, robust funding and liquidity position and sound asset quality, despite some signs of deterioration partly driven by the challenging operating environment. The confirmation of the Negative Trend reflects the additional profitability and asset quality challenges the Group faces under the uncertain environment driven by COVID-19, which is translating into weaker revenues and a higher cost of risk. HSBC is making good progress against some of the key initiatives announced in its February 2020 restructuring plan, and the Group has managed to reduce risk weighted assets and adjusted operating costs. However, DBRS Morningstar expects that additional cost restructuring will be needed to partly offset the ongoing revenue pressure from the lower interest rate environment, particularly in Hong Kong, the main contributor to the Group’s revenues. Moreover, DBRS Morningstar considers that in addition to the challenges caused by the pandemic, the Group’s profitability and asset quality could also be affected by the outcome of the negotiations relating to the UK’s new trade relationship with the EU, as well as the ongoing geopolitical tensions.

RATING DRIVERS

Given the Negative Trend, an upgrade of the Long-Term ratings is unlikely in the near to medium term. However, the Trend would revert to Stable if the Group's asset quality and profitability is not materially affected by the challenging operating environment driven by COVID-19 and Brexit, and the restructuring continues to be successfully implemented.

A downgrade of the Long-Term ratings would arise from a severe deterioration in the Group’s core profitability and asset quality, negatively affecting capital. Any signs of franchise deterioration in Hong Kong and/or China would also be likely to have a negative impact on the ratings.

RATING RATIONALE

HSBC is one of the largest and most diversified banks globally. 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’s profitability is supported by its well-established retail and wholesale franchises across Asia, the Middle East and the UK. However, the COVID-19 operating environment has had a material impact on the Group’s profitability in 2020. In 9M 2020, HSBC’s reported profit before tax (PBT) declined by 62% to USD 5.2 billion due to significant loan impairment charges and weaker revenues, largely driven by interest rate cuts in its main markets of Hong Kong, the UK and the US. The impact of lower rates was only partly compensated by the strong performance of sales and trading revenues from Foreign Exchange, Rates and Credit, which benefited from the widening of spreads caused by COVID-19 environment. Similar to what was seen in domestic and international peers, HSBC’s 9M 2020 bottom line profitability was impacted by elevated loan loss provisions, largely related to the update of credit models incorporating the negative global economic outlook driven by the pandemic, but also by the increase in provisions for stage 2 and stage 3 loans. Restructuring expenses were USD 1 billion, but excluding these, the Group showed good progress on adjusted operating costs, which reduced by 5.7% YoY in 9M 2020.

The Group has a conservative risk profile which partly benefits from the good geographical diversification. Under the challenging global economic environment, HSBC's asset quality has remained strong despite some signs of deterioration. Stage 3 exposures (including POCI loans which are loans purchased or originated credit impaired) increased 36% at end-9M 2020 from end-2019 to total USD 18,680 billion, largely reflecting the negative economic consequences of the pandemic for corporate and commercial borrowers, primarily in the UK. In addition, the deterioration in the operating environment driven by the pandemic has contributed to an increase in the share of Stage 2 exposures (classified as those that have experienced a significant increase of credit risk but are not defaulted) in the book. Total stage 2 loans accounted for 15% of gross loans at end-Q3 2020 compared to 8% at end-2019. DBRS Morningstar will continue to monitor these exposures as they could potentially turn into stage 3 loans, particularly after the various moratoria expire.

In DBRS Morningstar’s view, the geopolitical tensions, as well as the US-China trade relationship, exposes the Group to political and reputational risks. In addition, and similar to most international peers, the Group is also subject to litigation risks associated with a number of outstanding cases related to regulatory matters and legal proceedings. At end-June 2020, the Group’s provisions for customer remediation were USD 1.1 billion (of which around USD 613 million were allocated to PPI in the UK) and provisions for legal proceeding and regulatory matters were USD 0.5 billion.

DBRS Morningstar considers HSBC’s funding and liquidity profile as a core strength of the Group, supported by the Group’s strong position in retail savings in Asia and in the UK. The Group’s loan-to-deposit ratio was a low 68% at end-9M 2020 reflecting the Group’s discipline to ensure loans are funded by customer deposits in each subsidiary. In addition, HSBC has a very strong liquidity position with HQLA assets of USD 659 billion at end-9M 2020 and the Liquidity Coverage Ratio was 147% at the same date.

HSBC has a strong capital position supported by solid internal capital generation and access to capital markets. At end-9M 2020, HSBC’s Common Equity Tier 1 (CET1) ratio was 15.6%, up from 14.7% at end-2019, largely supported by retained earnings. In the medium-term, HSBC aims to maintain its CET1 ratio in a range of 14-14.5%. DBRS Morningstar also considers that the Group is well placed to meet the future loss-absorption requirements. At end-H1 2020, the Group’s eligible capital and HoldCo senior debt resources were equivalent to 29.9% of RWAs, comfortably meeting the 2020 minimum regulatory requirement of 25.1%, representing the indicative sum of the Group’s local subsidiaries MREL/TLAC requirements.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

Notes:
All figures are in USD unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (8 June 2020)
https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The sources of information used for this rating include Company Documents, HSBC 2015-2019 Annual Reports, HSBC H1 2020 & 9M 2020 Interim Reports, HSBC H1 2020 & 9M 2020 Press Releases 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.

With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

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 12-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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/371594.

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

Lead Analyst: Maria Rivas, Senior Vice President, Global FIG
Rating Committee Chair: Ross Abercromby, Managing Director, Global FIG
Initial Rating Date: May 16, 2001
Last Rating Date: February 27, 2020

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