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

DBRS, Inc. (DBRS) has today confirmed the ratings of HSBC Finance Corporation (HSBC Finance), including its Senior Debt rating of A (low). Concurrently, DBRS has discontinued the Company’s Commercial Paper rating following the Company’s decision to not renew the CP program. The trend on the Senior Debt rating is Stable. Today’s rating action follows DBRS’s confirmation of the ratings of HSBC Holdings plc (HSBC Group or the Group), HSBC Finance’s ultimate parent at AA.

The rating confirmation reflects DBRS’s expectation that HSBC Group will continue to provide support both operationally and financially to HSBC Finance as it runs-down its legacy residential mortgage lending portfolio. The rating action also considers the improving earnings of HSBC Finance benefiting from improving asset quality, cost reduction initiatives, and the gradual strengthening of the U.S. housing market.

The trend on the Senior Debt rating is Stable reflecting that of HSBC Holdings. The Stable trend also takes into account DBRS’s view that the strengthening U.S. economy underpins further improvement in the U.S. housing market. As a result, DBRS expects HSBC Finance’s earnings to benefit from continuing improvement in asset quality and to further advance the liquidation of its run down portfolio via portfolio sales. The ratings of HSBC Finance would likely move higher if HSBC Group’s ratings were to be raised or an explicit guarantee of the Company’s debt by HSBC Group was put in place. Conversely, while not expected, a lowering of HSBC Group’s rating would likely result in a downgrade of the Company’s rating.

The ratings of HSBC Finance are underpinned by the ownership structure and the continuing operational and financial support provided by the Company’s ultimate parent HSBC Holdings plc. Since the onset of the financial crisis, HSBC parent entities have provided $8.0 billion of capital to the Company as well as funding support through affiliated borrowings. Importantly, HSBC 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 real estate secured receivables portfolio and repays its debt as it matures. The benefits of the positioning within the HSBC family allows for significant uplift to the final ratings of HSBC Finance. Nevertheless, the ratings are placed below those of the parent, reflecting the absence of an explicit guarantee of HSBC Finance’s obligations by HSBC Group, as well as DBRS’s view that HSBC Finance is non-core to Group with the business in run-off mode. As a result of DBRS’s view that Group would support the Company, if needed, DBRS continues to assign an SA-1 designation to HSBC Finance. As a supported rating with a SA-1 designation the ratings of HSBC Finance will likely move in tandem with HSBC Holdings rating.

Liquidity continues to be managed appropriately while funding requirements continue to diminish as the balance sheet runs-down. That said, HSBC Finance has significant debt maturities over the next 24 months including $5.7 billion in 2015 and $5.3 billion in 2016. In DBRS’s view the natural amortization of the loan portfolio is unlikely to generate sufficient cash flow to meet these levels of debt maturities. As such, HSBC Finance would have to execute additional portfolio sales or seek additional borrowings from HSBC Group to cover the difference.

DBRS considers the restoration of profitability at HSBC Finance as demonstrating the progress the Company has made in removing risk from the balance sheet, aligning operating costs with the reduced operating footprint, and the benefit of the improving U.S. housing market. For 9M14, HSBC Finance reported, on a U.S. GAAP basis, net income of $487 million. Results benefited from a reserve release of $238 million reflecting improving asset quality, the lower receivables balance, and recovering home prices. Earnings further benefited from a $404 million reversal of prior period fair value adjustments on receivables transferred to held for sale, reflecting the continuing improvement in the U.S. housing market. DBRS notes that these reversals were 60% lower than those recorded by the Company during 9M13 as the impact of rising house values moderated during 9M14. Looking to 2015, DBRS expects that house price appreciation will be modest, and as a result, HSBC Finance’s earnings will benefit less from additional reversals of fair value adjustments. Nevertheless, while DBRS expects revenues to continue to decline over time as the portfolio winds down, DBRS sees profitability remaining acceptable as credit performance improves, funding costs benefit from affiliated borrowing, and management continues to manage the operating cost structure appropriately.

The improved earnings of the Company along with solid capital retention has resulted in capital strengthening. Tangible common equity to tangible assets strengthened to 16.95% at September 30, 2014, up from 12.68% a year ago. Importantly, the Company has received no capital support from parent entities of the Company since 2011.

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

The principal applicable methodology is the Global Methodology for Rating Finance Companies (October 2014). Other applicable methodologies include the DBRS Criteria – Support Assessments for Banks and Banking Organisations (January 2014) and Global Methodology for Rating Banks and Banking Organisations (June 2014). These can be found at: http://www.dbrs.com/about/methodologies.

The 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: 28 January 2014

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