Moody's Changes HSBC Holdings' Outlook To Negative

Moody's Investors Service has changed the outlook on the Aa2 long term senior debt ratings of HSBC Holdings plc (HSBC Holdings) to negative from stable. Moody's also downgraded the bank financial strength rating (BFSR) of HSBC Bank plc (HSBC Bank),

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Moody’s Investors Service has changed the outlook on the Aa2 long-term senior debt ratings of HSBC Holdings plc (HSBC Holdings) to negative from stable. Moody’s also downgraded the bank financial strength rating (BFSR) of HSBC Bank plc (HSBC Bank), the group’s European operations, to C+ from B and its debt and deposit ratings to Aa2 from Aa1; the outlook on these ratings is now also negative. The Prime-1 ratings on the short-term obligations on both entities were affirmed. Separate press releases will follow on other rated subsidiaries.

The change in outlook to negative on HSBC Holdings’ Aa2 long-term debt rating reflects Moody’s view of the increasing pressures on the profitability and capital of the group as the credit crunch develops into a global phenomenon, as well as ongoing charges in relation to the US consumer finance business, HSBC Finance, and remaining ABS exposures on the group’s balance sheet. The rating also takes into account the benefit of the group’s recently announced US$17.7bn rights issue.

The rating agency still considers HSBC Holdings to be one of the more resilient global banks, with the capacity to continue to generate capital over the medium term through earnings. Liquidity remains a core strength of HSBC, with a high level of customer deposits (the loan-to-deposit ratio was 84% at the end of 2008).

With regards to the ongoing pressure from the group’s US exposures, Moody’s recognises that the group was able to absorb large write-offs (US$16.3 billion) and provide substantial capital injections (almost US$4.5 billion) to HSBC Finance over the past two years. During that time, the US-based finance company generated core pre-provision profit of around US$16 billion. However, although the group has now established US$12.4 billion provisions for future charge-offs, it is clear that the closure of the branch network and future delinquencies will continue to absorb capital for another two to three years (which the group has factored into its capital budgeting process). The negative outlook on the group’s rating partly also reflects the uncertainties remaining over the impairment prospects of HSBC Finance.

The group’s 2008 pre-tax profits of US$9.3 billion (US$19.9 billion before a write-off of US$10.6 billion in goodwill in relation to the HSBC Finance acquisition) were supported by a number of one-off gains (including US$6.6 billion own debt gain, US$2.4 billion gain in relation to sale of French branches,) but were also affected by a number of large one-off negative items (including the US$10.6 billion write-off of goodwill, US$1 billion loss in relation to Madoff exposures and US$5.4 billion credit writedowns).

Despite a slowdown from high growth rates in Asia, we expect the group to continue to generate substantial pre-tax profits in Asia (US$11.9 billion from Hong Kong and the rest of Asia Pacific in 2008), as well as in Latin America (US$2.0 billion), alongside a weaker outlook for Europe (US$10.9 billion), and poor underlying profitability in the US (loss of US$15.5 billion). However, as the global recession gathers speed, the benefits from the group’s wide geographical diversification will lessen, and increasing impairment charges across the group could put additional pressure on capital.

In addition, although HSBC has never been one of the largest global investment banking players, its capital market activities and the conduits it established have left the bank with a legacy of a large gross notional position of approximately US$80 billion ABS (which excludes the US government agency ABS), held both in the trading book and as available-for-sale assets. Moody’s noted that US$3.5 billion that would also have affected the P&L in 2008 without the reclassification of US$16.6 billion assets under IAS39. The group has taken US$18.7 billion negative fair value adjustments against the available-for-sale securities. The bank intends to hold these securities to maturity, and expects a substantially lower realised loss than the unrealised fair value adjustments. However, Moody’s cautions that a higher level of impairments than assumed by the group in its own stress tests or a sale that crystallised losses would lead to a large jump in writedowns for the group.

Moody’s noted that some of the downward pressure on HSBC Holding’s Aa2 rating has been mitigated by the group’s fully underwritten US$17.7 billion rights issue and the reduction in dividend payments. The group estimates that the US$17.7 billion capital-raising, announced at the time of the 2008 results, will strengthen pro-forma core equity and Tier 1 ratios to 8.5% and 9.8%, respectively.

DOWNGRADE OF HSBC BANK RATINGS

The downgrade of HSBC Bank’s ratings to Aa2/C+ with a negative outlook, from Aa1/B, reflects the bank’s modest capital ratios, risks from large corporate and ABS exposures, and pressures on profits across HSBC’s European banking franchise. But the ratings also incorporate a high level of systemic support and support from the group for this core part of its operations.

With regard to the UK activities, which represent the majority of the consolidated bank’s lending, Moody’s considers the residential mortgage books and personal lending to be conservatively positioned relative to its peers, but expects higher provisions on the corporate loan books and further potential writedowns from Global Banking and Markets to reduce profitability through the recession.

A large proportion of the ABS positions, which were discussed above for HSBC Holdings, are situated on the balance sheet of HSBC Bank. Since the capital strength of HSBC Bank is weaker than that of HSBC Holdings, Moody’s regards them as representing a relatively higher risk for the standalone financial strength of HSBC Bank.

Other pressures for the consolidated entity HSBC Bank include weak profitability in Global Banking and Markets in the French operations and a weaker outlook for private banking revenues.

The capital ratios of HSBC Bank plc are relatively modest (6.8% Tier 1 ratio at the end of December, 2008), despite capital injections by the parent of GBP1.75 billion in 2008; and a further GBP527 million capital injection that was made on 30 January 2009. Given potential further writedowns and larger provisions in 2009, Moody’s considers that these capital levels did not support a BFSR in the B range, but were more adequate for a BFSR in the C range. As Moody’s took into consideration a certain flexibility in reallocating capital within the group — and the group’s consolidated stronger capitalisation levels, especially when taking into consideration the rights offering – the impact of such further writedowns and provisions is at least partially mitigated, underpinning the BFSR at the C+ level.

The C+ BFSR maps to a Baseline Credit Assessment of A2. The Aa2 debt ratings incorporate both a very high probability of UK systemic support, given the importance of the bank in the UK banking system, as well a very high probability of support from the overall HSBC group. The negative outlook on the debt ratings is in line with the negative outlook for HSBC Holdings. The ratings of the bank’s subordinated debt and hybrid instruments were downgraded in line with the downgrade of the senior debt ratings and maintain our usual notching practices.

D.C.

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