HSBC Holdings PLC ADR Earnings Call Nuggets: Latin America Details and Interest Rate Sensitivity

HSBC Holdings PLC ADR (NYSE:HBC) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Latin America Details

Chirantan Barua – Sanford Bernstein: I have two questions. One is, Stuart, obviously on LatAm, when I read through your numbers, you were saying that you see an improvement in delinquency patterns raise, actually different asset classes work in Mexico and Brazil, impairments have gone up either from underlying model changes or as coverage. It’d be great, if you can give us some details not only on what are the underlying movements in this new geographies and trends going forward? The second one is on risk-weighted assets and capital, one is Hong Kong risk weighted assets are up 19% in the first half, is it the beginning of a trend or should we see the stalling at this level and your core tier 1 ratio at 10.1%, is this fully loaded with mitigation right now or you have some mitigation plan on top of it?

Stuart Gulliver – Group Chief Executive: Going to detail on Latin America then I’ll after he’s done, I’ll talk a little bit about the business in Latin America and some detail on the loan impairment charges.

Iain MacKay – Group Finance Director: So in loan impairment charges in Latin America really three factors here, we’ll talk about Brazil first. You’ll recall that in late 2011 we saw some deterioration in credit quality in Brazil and principally in Business Banking and over the course of fourth quarter ’11 and through ’12, we took actions around the tightening of credit standards improving the operational, management and collections capability within that business and as a consequence of which we do see underlying credit quality improving. However, within the second quarter of this year, we took a look at our loan loss coverage for restructured loans, looking at portfolio of about a $1 billion of such accounts and strength in coverage (indiscernible) the tune of some $250 million which took coverage on those restructured loans about 66%. That’s a key driver within that and that’s really the model methodology changes that we referred to within Brazil. So, I had a total book of business in Brazil of $27 billion, we’re talking about $1 billion restructured accounts portfolio with loan loss coverage now at 66%. So that was a purposeful step on our part to bring alignment to run cost policy and methodology on those types of accounts. Beyond that it’s exactly as we say in report, the underlying credit quality we see improving within the Brazilian business. Stepping onto Mexico, specific driver here, there was a change in government policy as it’s related to shall we call low cost housing where the government moved from what was called the horizontal strategy. So, more remote and away from city centers building larger communities of single story, second story properties to what they called a vertical strategy, which building newer city centers and high risers. That’s had across the construction industry an impact on cash flows and asset values and will record a provision of slightly less than $90 million for exposures to (city funds) in the construction business that we had in Mexico. That was the principal driver of step-up in loan impairment charges in Mexico, so taking underwriting together, overall loan impairment charges in Latin America increased by some $360 million, and $250 million, as I mentioned, strengthening for restructured accounts in Brazil and about $90 million in Mexico for the construction industry. Iain?

Iain MacKay – Group Finance Director: Going to your next question about RWAs in Hong Kong and jump in RWAs in Hong Kong, that’s mostly actually calls by the implementation of 45% flow loss given default on sovereign exposures and so that actually accounts for a chunk of it. If you think about it, Hong Kong has got significant deposit base, significant commercial surplus, that tends to get place in the government and once you start applying a 45% LGD on those government bonds, you can see there is a big jump in RWAs. In fact $19 billion of jump in RWAs at Group level is caused by the introduction of 45% LGD on sovereign bonds, which was a U.K. PRA, an initiative in the first half and that actually explains a large chunk as to why the core tier 1 fell back from 10.3% to 10.1%. Then in terms of, does the 10.1% contains all management actions.

Douglas Flint – Group Chairman: All management actions so far it certainly does which is not an insignificant number of whether it’s a distribution of Ping An, whether it’s running down in the U.S. portfolio, as to any number of actions included within that. Clearly, there is an ongoing effort, so when one thinks about the run-off of the U.S. CML portfolio, which is particularly intensive from our RWA perspective, the run-down of that portfolio through the decision of the non-real-estate portfolio are now embarking on the disposition of the defaulted accounts, our ongoing management actions in that particular area and then if one considers also the work that Samir and his team have been doing in managing down the legacy ABS portfolio so in Global Banking and Markets. Again, there has been a significant reduction in RWAs there and that effort continues. So significant progress, but everything that we’ve taken in terms of actions up to this point is reflected that 10.1%, but there is certainly a (whole bit) of continuing efforts available to us which we’re doing.

Stuart Gulliver – Group Chief Executive: The jump in (LGK), 45% LGD shows up in Hong Kong and in Global Banking and Markets by business lines.


Interest Rate Sensitivity

Raul Sinha – JPMorgan: Can I just have maybe one on your interest rate sensitivity disclosure on Page 172, where it looks like the sensitivity to your higher rates has come down again by $1.2 billion now from $1.4 billion. I just sort of wondered your comments around this? Should we sort of assume that this is because you are hedging your near-term position on interest rates? Or is it also reflective of the longer-term sensitivity towards interest rates for HSBC?

Stuart Gulliver – Group Chief Executive: I mean in essence it’s going to certainly turnaround maturing positions as they run-off in balance sheet management and the trading book. You shouldn’t read anything more sort of significant interest, the facts to the matter is, if curve steepen we’ll make more money in balance sheet management, as well as the curve because that – the balance sheet management will make money if the curve is steep. So either the long-end sells off or the short-end rallies and I would expect under QE tapering is the long-end will sell off somewhat. So that will benefit balance sheet management. If and in due course QE is reversed and net interest rates start to go up, it’s the second order impact of the U.S. reversing the policy that’s put in place. Then we will see a significant pickup in the net interest income of the Commercial Banking business and Retail Banking and Wealth Management as the deposit base suddenly starts to have value to it. What you are effectively seeing in page 170 is, it’s a sensitivity of 25 basis point per quarter, a 100 basis points in the year, but doing a quarter, quarter, quarter, not a step jump, we’d need to buy an extra 1.2 billion, that’s really the CMB and RBWM number, because that assumes that we didn’t do anything with the book, which of course with BSM we will be doing an awful lot with the book. So, we are not consciously reducing our ability to make money if rates go back up, not at all.

Raul Sinha – JPMorgan: Would it be fair to conclude then this table probably understates your sensitivity to high interest rates?

Stuart Gulliver – Group Chief Executive: I think that looking at my accounting colleagues frowning at me across the table, no, it’s what’s in the table.

Raul Sinha – JPMorgan: The second one, if I can just go back quickly to the Latin America provisions, I – obviously thanks for the additional disclosure you provided on the previous question, but I just wanted to get a sense of how much the rise in provision, especially on the collective side was just you’re taking a more cautious view on the economic outlook in Latin America and then how can we read across, if at all, into Asia, given Asia seems to have little or no restructured loans at all, does that mean that at some point over the next few quarters, you might do the same in Asia or is that not possible at all?

Iain MacKay – Group Finance Director: Well ,to my point, when you look at the increase in Latin America of $366 million, $250 million of that related specifically to increase in coverage, see some updating the model of $250 million and the underlying credit quality within remainder of that Brazilian book is something that we’ve been working on for the past 18 months now and the improvements in credit quality is coming across. You look across every other region that we’ve got and we’ve got a very, very stable credit picture. There is clearly markets in which there is heightened level of scrutiny and attention and as we manage some of the risks in it and you wouldn’t need to be a genius to figure out what some of those markets are, because they tend to be in the news on daily basis because of political unrest in some of those markets, but the credit quality of this book has been progressively repositioned where we’ve seen those risks emerge and it remains very stable.