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

DBRS Ratings Limited (DBRS) 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 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 global franchise with leading positions in the Group’s home markets in the UK and Hong Kong, its solid capital base, sound quality of the loan book, and robust liquidity and funding. DBRS positively views a major improvement in the statutory profitability in 2017, driven by healthy underlying performance as well as the non-recurrence of some significant items from 2016. While the drag on earnings from legacy conduct issues reduced during 2017, these remain an important challenge facing HSBC. Despite significant progress made to date, the Group remains focused on strengthening its compliance controls.

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.

The Group has made progress in implementing its strategic plans, achieving eight out of ten of the strategic actions set out at its 2015 Investor Update. These include achieving a USD 338 billion gross reduction in risk-weighted assets (RWAs), annualised run-rate savings of USD 6.1 billion, and significant progress in strengthening compliance standards across the Group. The Group is also close to completing the ring-fencing of its UK operations prior to the 1 January 2019 deadline and the ring-fencing transfers are planned for 1 July 2018.

HSBC improved its earnings in 2017 with adjusted profit before tax (PBT), which excludes certain non-cash items, such as impairment of goodwill and own credit spreads, as well as cash items, such as restructuring and conduct costs, up 11% year-on-year (YoY) to USD 21 billion. This reflected resilient revenues and reduced loan impairment charges. On a statutory basis, PBT more than doubled YoY, to USD 17.2 billion, primarily as a result of one-off charges in 2016.

HSBC’s revenue generation has been resilient in recent years, despite the challenging operating environment. The Group’s adjusted revenues in 2017 improved by 5% YoY, reflecting progress across most divisions, and solid momentum in customer lending. DBRS notes that the Group is well positioned to benefit from a potential increase in interest rates in 2018, which should support the Group’s liability margins.

Cost reduction has been a significant component of HSBC’s recent strategic initiatives, with the Group targeting a 2017 exit rate equal to 2014 adjusted operating expenses. The Group achieved this target with an annual run-rate savings of USD 6.1 billion since the start of the programme in June 2015 and USD 2.1 billion of cost savings realised in 2017, and has concluded its “costs to achieve” transformation programme. Total adjusted operating costs were, however, up 4% YoY due to increased investment, notably in Retail Banking and Wealth Management (RBWM), and increased performance-related pay.

DBRS views the Group’s overall asset quality performance as sound, given its relatively low impaired loans ratio of 1.5% at end-2017, and adjusted loan impairment charges (LICs) of USD 1.8 billion, equivalent to only 19 basis points (bps) of gross loans. The sound asset quality reflects the Group’s conservative underwriting, the solid economic performance in Hong Kong and the UK and the benign global credit cycle. The substantial reduction in LICs in 2017 was driven by several factors, including the run-down of the US consumer and mortgage lending (CML) portfolio and improved credit quality in selected markets and sectors, notably oil and gas.

DBRS notes that the Group had USD 160 billion (around 15% of total loans and advances) of exposures to mainland China entities at end-2017. The exposure is predominantly wholesale. Although DBRS takes comfort from relatively low impairments and satisfactory industry diversification of HSBC’s mainland China exposure, it will continue to closely monitor its performance, given potential risks related to the Chinese economy.

Despite the progress made, the Group remains susceptible to legacy conduct risks. While in December 2017 the anti-money laundering deferred prosecution agreement expired, a number of major items remain outstanding, including US mortgage securitisation activity and litigation, Madoff, tax-related investigations and payment protection insurance (PPI). In January 2018, the Group entered into a three-year deferred prosecution agreement with the US Department of Justice regarding fraudulent conduct in connection with foreign exchange transactions dating back to 2010 and 2011.

DBRS considers HSBC’s funding and liquidity profile as a core strength of the Group, benefitting from the Group’s strong position in retail savings in Asia and the UK and its discipline in ensuring loans are funded by customer deposits. Despite a slight deterioration during 2017, reflecting solid lending momentum across major markets, the Group’s loan-to-deposit ratio remained low, at 70.6% at end-2017. The Group’s liquidity profile is also strong with high quality liquid assets (HQLA) of USD 536 billion at end-2017. The Group reported a Liquidity Coverage Ratio of 142% at end-2017.

HSBC’s capital ratios continued to strengthen in 2017. The Group reported an end-point CRDIV Common Equity Tier 1 (CET1) ratio of 14.5% at end-2017, up by 90 bps YoY, with the solid internal capital generation mitigating the impact of the most recent USD 2 billion share buy-back and recent changes in US tax legislation. At end-2017, the CRD IV end-point leverage ratio was 5.6%, up 20 bps YoY. The CET1 and leverage ratios are relatively high, comparing favourably with many of the Group’s UK and global peers.

At end-2017 the Group’s minimum requirement for own funds and eligible liabilities (MREL) was 23.3%, positioning the Group well to meets its 2022 requirements estimated at 23.1%. While HSBC has a Multiple Point of Entry resolution strategy, HSBC Holdings is expected to remain the principal issuing entity, down-streaming MREL, in compliance with local regulations.

RATING DRIVERS
Upward pressure on the ratings could result from a further substantial progress in addressing legacy conduct issues, followed by a satisfactory track record of low litigation and conduct-related expenses. The ratings could also move higher if the Group were to deliver a further material improvement in profitability while maintaining its strong credit profile.

The ratings could come under downward pressure in case of a major deterioration in asset quality. Emergence of new litigation or conduct issues could also pressure the ratings, especially if DBRS perceives these issues to be causing damage to the Group’s strong franchise.

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

Notes:
All figures are in USD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017). This 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 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: July 14, 2017

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