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Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

<a href="https://www.smartkarma.com/entities/hsbc-holdings-plc-a723bd63-0890-486f-aaa0-3bb9ad2b95ce" target="_blank" data-smartkarma-citation="entities:21976:1" rel="noopener">HSBC Holdings' (HSBA LN)</a> capital ratios remain above regulatory minimums, even after adjusting COVID-19 forbearance loans at Stage 3 provisioning levels. However, the resulting theoretically slim real economic capital buffer would leave the bank sensitive to another downturn. The risk for AT1 and other credit investors is that HSBC's board misinterprets the “surplus” capital of the firm as being something manufactured by management, rather than artificially engineered by regulators.Having recently raised AT1 capital, HSBC will, undoubtedly, restart equity buy-backs as a show of strength. AT1 investors should be concerned by a large return of capital at this point in the economic. In fact, given the relief cohort composition from a product and geographic perspective, combined with limited personal loan reserve coverage, credit investors should prefer continued capital accretion rather than large “surplus” capital outflows.  Like most banks globally, HSBC’s credit costs were artificially engineered lower during 2020 via regulatory forbearance combined with legislated and bank provided Covid-19 relief. This helped the bank report better results and inflated HSBC’s capital ratios despite the ongoing health crisis. Zero-recovery rates on both the unprovided level of current non-performing assets and the Covid-19 relief portfolio would take HSBC’s CET1 capital buffer into uncomfortable territory. However, annual, normalized, pre-provision income is around 63% the capital buffer at risk from Covid-19 relief granted. This equates to an earn-out period of 1.6 years. This 18-month time-period should be sufficient for the Covid-19 relief portfolio to mature.We caution that it is premature to calculate real economic performance by the Covid-19 relief cohort. As of 30 June, HSBC estimated that over 96% of its Covid-19 relief measures were due to expire by year-end. However, since then, several countries where HSBC operates have extended the duration of legislated relief and others are experiencing another wave of Covid-19 lockdowns. In fact, the 50% reduction in relief that HSBC had forecast to expire by the end of September did not materialize. The question is where are the stress points in the relief cohort?Covid-19 relief was largest against corporate and commercial wholesale borrowers both in terms of the amount of relief provided and relative to the total amount of wholesale loans outstanding. At the same time, Covid-19 relief assistance to unsecured personal loan customers was materially lower despite higher default rates in personal loans. This is not to say that personal lending may not become problematic going forward as that is dependent on the speed, strength, and sustainability of the on-going economic recovery, particularly as it applies to employment levels. The limited assistance provided against personal lending may result in higher delinquencies within this portfolio over time.  In geographic terms, Covid-19 relief granted was largest in Hong Kong. In fact, Hong Kong exposure may be problematic for the firm, given the higher percentage of wholesale relief granted  combined with generally higher expected loss-given-defaults within this type of lending.Meanwhile, with one-month Hibor trading flat to one-month Libor, the easy money to be made from borrowing in USD and lending in HKD is over. The exceedingly low rate may be beneficial to Hong Kong based corporate borrowers, but it may not be so beneficial to HSBC’s net interest margin. Nonetheless, some margin pain may be the price to pay for lower Covid-19 related delinquencies amongst Hong Kong corporate borrowers. Another round of Coronavirus lockdowns, further unrest or another economic shock in Hong Kong, could result in rising non-performing loans.

HSBC Holdings' (HSBA LN) capital ratios remain above regulatory minimums, even after adjusting COVID-19 forbearance loans at Stage 3 provisioning levels. However, the resulting theoretically slim real economic capital buffer would leave the bank sensitive to another downturn. The risk for AT1 and other credit investors is that HSBC's board misinterprets the “surplus” capital of the firm as being something manufactured by management, rather than artificially engineered by regulators.Having recently raised AT1 capital, HSBC will, undoubtedly, restart equity buy-backs as a show of strength. AT1 investors should be concerned by a large return of capital at this point in the economic. In fact, given the relief cohort composition from a product and geographic perspective, combined with limited personal loan reserve coverage, credit investors should prefer continued capital accretion rather than large “surplus” capital outflows.  Like most banks globally, HSBC’s credit costs were artificially engineered lower during 2020 via regulatory forbearance combined with legislated and bank provided Covid-19 relief. This helped the bank report better results and inflated HSBC’s capital ratios despite the ongoing health crisis. Zero-recovery rates on both the unprovided level of current non-performing assets and the Covid-19 relief portfolio would take HSBC’s CET1 capital buffer into uncomfortable territory. However, annual, normalized, pre-provision income is around 63% the capital buffer at risk from Covid-19 relief granted. This equates to an earn-out period of 1.6 years. This 18-month time-period should be sufficient for the Covid-19 relief portfolio to mature.We caution that it is premature to calculate real economic performance by the Covid-19 relief cohort. As of 30 June, HSBC estimated that over 96% of its Covid-19 relief measures were due to expire by year-end. However, since then, several countries where HSBC operates have extended the duration of legislated relief and others are experiencing another wave of Covid-19 lockdowns. In fact, the 50% reduction in relief that HSBC had forecast to expire by the end of September did not materialize. The question is where are the stress points in the relief cohort?Covid-19 relief was largest against corporate and commercial wholesale borrowers both in terms of the amount of relief provided and relative to the total amount of wholesale loans outstanding. At the same time, Covid-19 relief assistance to unsecured personal loan customers was materially lower despite higher default rates in personal loans. This is not to say that personal lending may not become problematic going forward as that is dependent on the speed, strength, and sustainability of the on-going economic recovery, particularly as it applies to employment levels. The limited assistance provided against personal lending may result in higher delinquencies within this portfolio over time.  In geographic terms, Covid-19 relief granted was largest in Hong Kong. In fact, Hong Kong exposure may be problematic for the firm, given the higher percentage of wholesale relief granted  combined with generally higher expected loss-given-defaults within this type of lending.Meanwhile, with one-month Hibor trading flat to one-month Libor, the easy money to be made from borrowing in USD and lending in HKD is over. The exceedingly low rate may be beneficial to Hong Kong based corporate borrowers, but it may not be so beneficial to HSBC’s net interest margin. Nonetheless, some margin pain may be the price to pay for lower Covid-19 related delinquencies amongst Hong Kong corporate borrowers. Another round of Coronavirus lockdowns, further unrest or another economic shock in Hong Kong, could result in rising non-performing loans.

HSBC: Capital, Forbearance and Covid-19 Sensitivity