DBRS Confirms HSBC Holdings Long-Term Issuer Rating at AA (low), Stable Trend

DBRS Ratings Limited (DBRS) 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 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.

KEY RATING CONSIDERATIONS
HSBC’s ratings and Stable trend 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 the robust funding and liquidity. DBRS views the Group’s underlying profitability as a key factor underpinning the ratings. While the group has made solid progress towards resolving a number of legacy issues, there are still some outstanding and, in DBRS’s opinion, these could remain a drag on earnings in the near to medium term.

RATING DRIVERS
Upward pressure on the ratings could result from further substantial progress in addressing legacy conduct issues, combined with a material improvement in underlying 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 substantial 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. Significant adverse economic effects of the UK’s exit from the EU on the Group’s risk profile could also exert downward pressure on the ratings.

RATING RATIONALE
HSBC is one of the largest and most diversified banks globally, although its profitability is heavily weighted towards Asia, which represented around half of the Group’s revenue and close to 90% of statutory pre-tax profit in 2018. 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.

Following several leadership changes, HSBC announced an update of the Group’s strategy in June 2018 which includes updated financial targets for 2020. Following a long restructuring period, the focus of the Group has shifted towards growth. Strategic priorities include growth acceleration in Asia and in the international network, market share gains by the UK ring-fenced bank, a turnaround of the US business, as well as an improvement in capital efficiency. Over the course of 2018 the Group has made good progress towards some of the 2020 targets.

The Group completed the ring-fencing of its UK retail banking activities in July 2018. The reorganisation of the Group’s legal entity structure and business model was required as part of the UK’s ring-fencing requirements and led to the splitting of the Group’s UK activities between ring-fenced and non ring-fenced entities. HSBC created a separate ring-fenced entity, HSBC UK Bank plc (HSBC UK), which includes the Group’s personal and commercial customers in the UK, as well as private bank clients.

The Group has continued to generate solid underlying earnings, supported by its well diversified franchise. In 2018 adjusted profit before tax (PBT) was USD 21.7 billion, up 3% YoY, driven by revenue growth. On a statutory basis, PBT was up 16% YoY, to USD 19.9 billion. HSBC’s revenue generation has been consistent in recent years despite challenges evident within the operating environment. The Group’s adjusted revenues in 2018 were USD 53.9 billion, up 4% YoY, with improved revenues across all divisions, notably Retail Banking and Wealth Management and Commercial Banking, in part offset by negative results in the Corporate Centre. Under the recently announced 2020 strategy, cost control remains critical and HSBC expects to maintain positive jaws on an adjusted basis, despite an expected USD 15–17 billion of investments aligned to strategic priorities.

HSBC’s risk profile benefits from conservative underwriting standards and good geographical diversification. Asset quality remains strong with Stage 3 exposures (assets which have defaulted or are otherwise considered to be credit impaired ) accounting for a low 1.3% of customer loans at end-2018 and the cost of risk representing 18bps of average gross loans. Risk costs have been supported by resilient economic performance in the Group’s core markets and HSBC expects their normalisation going forward. DBRS notes that an adverse outcome of the negotiations concerning the UK’s exit from the EU and the escalation of tensions related to tariffs in global trade could lead to asset quality deterioration. However, DBRS would expect the impact of these potential outcomes to be mitigated by the Group’s conservative underwriting and balance sheet strength.

Since the global financial crisis HSBC has suffered a significant financial and reputational impact from conduct risk issues across a broad number of areas. As a result, HSBC has, in recent years, undertaken measures to reinforce its compliance capabilities within the entire organisation. DBRS notes that in 2018 operating expenses related to customer redress programmes were USD 0.1 billion, down from USD 0.7 billion in 2017 and USD 1.2 billion in 2016. However, settlements and provisions in connection with legal and regulatory matters increased to USD 0.8 billion (2017: net release of USD 0.2 billion). Despite resolving a number of legacy matters, some remain outstanding and, in DBRS’s opinion, could result in potentially substantial additional costs.

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 some increase in 2018, reflecting solid lending momentum across major markets, the Group’s loan-to-deposit ratio was a low 72% at end-2018. The Group’s liquidity profile is also strong with HQLA assets of USD 567 billion and a Liquidity Coverage Ratio of 154% at end-2018.

Despite some decline during 2018 HSBC’s capital ratios remain strong. The Group reported an end-point CRDIV Common Equity Tier 1 (CET1) ratio of 14.0% at end-FY18, down 50 bps YoY, driven by dividends, RWA growth, FX movements and other factors. Under the 2020 strategy, HSBC expects to maintain its CET1 ratio above 14%. The end-2018 CRD IV end-point leverage ratio was a strong 5.5%. HSBC’s performance in recent regulatory stress tests confirms the Group’s solid capital position.

Over the last three years HSBC has made solid progress towards meeting MREL requirements. At end-2018 the Group’s regulatory capital and eligible HoldCo Senior debt was 26.6% of RWAs, comfortably meeting the 2019 minimum requirement for own funds and eligible liabilities (MREL). Given the Group’s MPE resolution strategy, HSBC expects that from 2022 the sum of the requirements relating to Group entities will be the binding constraint at the Group level and expects the requirement to be in the mid- to high-twenties when expressed as a percentage of consolidated RWAs. While some of the some of the local requirements await finalisation, DBRS 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; 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 (July 2018). This can be found 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: Ross Abercromby, Managing Director, Global FIG
Initial Rating Date: May 16, 2001
Last Rating Date: July 11, 2018

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