Strong earnings and improving credit quality in U.S. consumer finance lifted HSBC Holdings PLC's first-half results, but the London company is not counting on that trend to continue.
During a presentation to analysts after the $1.5 trillion-asset HSBC released its first-half results, chief executive Stephen Green said its expectation for a slowing U.S. economy is one of the reasons for the "repositioning" that is under way.
"We're more comfortable in that kind of environment with nearer-prime business" and shifting away from the subprime loans that Household International Inc. was doing before HSBC bought it in 2003, he said. (Household was renamed HSBC Finance Corp. last year.)
The percentage of first-half earnings from North America - the region that already produced the largest share of HSBC's earnings - increased to 34.9%, from 33.8% in the same period last year. Pretax earnings from that region rose 8.8%, to $3.7 billion, while those from Europe, which produced the second-largest share, fell 3.3%, to $2.9 billion.
After-tax profits, which rose 9.5%, to $7.6 billion, were driven by strong results in retail banking. Pretax profits from private client services rose 21%, to $5.5 billion.
HSBC does not break out quarterly results for comparison purposes at the holding company level, but it did provide some details on the period for its U.S. businesses in a filing with the Securities and Exchange Commission.
Second-quarter net income at HSBC Finance rose 9% from a year earlier but fell 24.6% from the first quarter, to $472 million, according to the filing. Managed receivables rose 4.5% from a year earlier and 3.3% from the first quarter, to $127.7 billion, despite the sale of private-label credit card loans to HSBC Bank USA.
Among the consumer lending lines, auto loans posted the strongest quarterly growth: 5.2%, to $10.8 billion.
"In the U.S., our consumer finance business benefited from both good volume growth and lower credit costs" in the first half, Mr. Green said. "On top of an improved economy, the benefits of an improved mix, higher-quality originations, and a focus on collections all contributed to declining chargeoffs."
The reserve for losses in the managed portfolio fell 28.2% from a year earlier and 1% from the first quarter, to $4.2 billion.
"The improving trends reflect a number of factors - a general improvement in the U.S. economy with increasing employment; a general shift in our portfolio towards real estate-secured lending and, within that, an increased emphasis in near-prime business; and a move towards near-prime business in auto lending," he said.
But the shift toward lower-risk loans took its toll, and so did rising interest rates. HSBC Finance's net interest margin contracted 124 basis points from a year earlier and 2 basis points from the first quarter, to 7.04%.
"There's been further compression on net interest margin, but the risk-adjusted return has stabilized and, indeed, is slightly up," Mr. Green said.
Responding to analysts' questions about stiffer competition in higher-quality loans, he said, "We think there is still plenty to go for in terms of growing that business. It is not a market that has gone ex-growth, as I say."
HSBC's overall commercial loan growth was strong, but a jump in the provision for commercial loan losses blurred the result, Mr. Green said. Pretax profits from commercial banking rose 9% - and only 3% organically. However, "underlying profit growth was much stronger than these figures indicate," he said. "Pre-provision operating profit in commercial banking increased by 17%."
The provision was particularly low in the first half of last year because of a record number of loan recoveries, which allowed HSBC to reduce the reserve by $94 million, he said. The company added $204 million to the provision this year.
Consumer credit quality in the United Kingdom continued to worsen, but less so than in previous reporting periods, Mr. Green said. In the United States, the trend was the opposite, and a continued emphasis on lower-risk loans reduced the need for provisioning, he said.
HSBC's provision for consumer loans rose 5.3%, to $3.2 billion, but in North America, the provision fell 13.1%, to $2.1 billion. In commercial lending, HSBC even reduced its North American reserve by $40 million.
It also touted strong profit gains in emerging markets, particularly in Latin America.
Mark Thomas, an analyst with Keefe, Bruyette & Woods Inc.'s London office, wrote in a research note that he expects HSBC's second-half results to come in weaker, but that the company "is well diversified, with issues in one particular region or customer group typically compensated for elsewhere."
HSBC Bank's income fell 35.4%, to $213 million. HSBC shifted expenses between the consumer finance company and the bank, and increased expenses related to the overall U.S. expansion affected the bank's results.
The $144.4 billion-asset bank's loan book rose 40.3% from a year earlier, in part because it took on loans from HSBC Finance, and 1.9% from the first quarter, to $87.8 billion. Deposits rose 14% from a year earlier and 2.5% from the first quarter, to $85.1 billion.
