Half-year Report - 2022 Interim Report - Part 2

Net interest income ('NII') for 1H22 was $14.5bn, an increase of $1.4bn or 10.3% compared with 1H21. This reflected higher average market interest rates across the major currencies compared with 1H21.

Excluding the unfavourable impacts of significant items and foreign currency translation differences, NII increased by $1.9bn or 15.3%.

NII for 2Q22 was $7.5bn, up 13.2% year-on-year, and 6.5% compared with the previous quarter. This was driven by the impact of higher market interest rates across major currencies, particularly in Europe and North America. The increase was driven by higher asset yields, particularly on customer term lending, short-term funds and loans and advances to banks, as well as on reverse repurchase agreements. This was partly offset by higher funding costs, in particular for customer deposits, debt securities and repurchase agreements.

Net interest margin ('NIM') of 1.30% was 9 basis points ('bps') higher compared with 1H21, as the rise in the yield on AIEA of 23bps was partly offset by the rise in the funding cost of average interest-bearing liabilities of 17bps. The increase in NIM in 1H22 included the unfavourable impacts of significant items and foreign currency translation differences. Excluding this, NIM increased by 11bps.

NIM for 2Q22 was 1.35%, up 15bps year-on-year, and up 9bps compared with the previous quarter, predominantly driven by the impact of higher market interest rates.

Interest income of $20.9bn increased by $2.9bn or 16%, primarily due to higher average interest rates compared with 1H21, as the yield on AIEA increased by 23bps. This was caused by the increase in market interest rates, partly offset by unfavourable changes in balance sheet mix, as balances of low-yielding assets, particularly short-term funds and loans and advances to banks, increased by $37bn and reverse repurchase agreements increased by $27bn, while the balances of high-yielding assets, particularly customer term lending in the loans and advances to customer category, declined by $24bn. The change in interest income included $32.1m in relation to the unfavourable impact of significant items and $743m from the adverse effects of foreign currency translation. Excluding these, interest income increased by $3.7bn.

Interest income of $11.2bn in 2Q22 was up $2.2bn year-on-year, and up $1.5bn from the previous quarter. This was predominantly driven by the impact of higher market interest rates, partly offset by an unfavourable change in the balance sheet mix as balances in low-yielding assets increased, while balances in high-yielding assets declined. Compared with the previous year, balances in low-yielding reverse repurchase agreements increased by $34bn, whereas higher-yielding customer term lending balances declined by $23bn.

Interest expense of $6.4bn increased by $1.5bn or 32% compared with 1H21. This reflected the increase in funding costs by 17bps, mainly arising from higher interest rates paid on interest-bearing customer accounts, repurchase agreements and debt securities in issue. This was partly offset by a reduction in interest expense attributable to reduced balances of high-costing subordinated debt, which declined by $12bn. The change in interest expense included the favourable effects of foreign currency translation differences of $0.2bn. Excluding this, interest expense increased by $1.7bn.

Interest expense of $3.7bn in 2Q22 was up $1.3bn year-on-year, and up $1.1bn compared with the previous quarter. This was predominantly driven by the impact of higher market interest rates.

Net fee income of $6.1bn was $0.6bn lower than in 1H21, and included a $0.2bn adverse impact from currency translation. The fall in net fee income was in WPB and GBM, although it rose in CMB.

In WPB, the reduction in fee income was mainly in Wealth, particularly in broking and unit trusts in Hong Kong, reflecting weaker equity markets due to muted customer sentiment. Covid-19-related restrictions in Hong Kong in 1Q22 also resulted in temporary branch network closures. These reductions were partly offset by higher cards income, notably in the UK, as customer spending increased. The growth in cards activity resulted in a rise in fee expense.

In GBM, a reduction in fee income was driven by lower underwriting fees, as market activity fell due to the effects of the Russia-Ukraine war and wider macroeconomic uncertainty. This compared with a strong 1H21 when corporates raised finance as initial Covid-19 restrictions were eased.

In CMB, fee income increased from account services and credit cards as customer activity increased, as well as from trade products, as global trade volumes recovered compared with 1H21.

Net income from financial instruments held for trading or managed on a fair value basis of $4.9bn was $0.7bn higher. The increase was driven by GBM, as higher market volatility supported a strong performance within Global Foreign Exchange.

This was partly offset by adverse fair value movements on non-qualifying hedges of $0.2bn.

Net expense from assets and liabilities of insurance businesses, including related derivatives, measured at fair value through profit or loss of $3.1bn compared with a net income of $2.8bn in 1H21. This decrease primarily reflected adverse equity market performances in Hong Kong and France.

This adverse movement resulted in a corresponding movement in liabilities to policyholders and the present value of in-force long-term insurance business ('PVIF') (see 'Other operating income' below). This reflected the extent to which the policyholders and shareholders respectively participate in the investment performance of the associated asset portfolios.

Changes in fair value of other financial instruments mandatorily measured at fair value through profit or loss of $0.1bn were $0.5bn lower compared with 1H21. This included lower revaluation gains in Principal Investments. It also included revaluation losses on other financial assets due to the increased macroeconomic uncertainty, in part due to the Russia-Ukraine war, as well as adverse movements on interest rate-linked instruments as yield curves steepened.

Gains less losses from financial investments of $21m were $0.4bn lower compared with 1H21, reflecting smaller gains on the disposal of debt securities.

Net insurance premium income of $7.6bn was $2.0bn higher than in 1H21, reflecting strong sales in Hong Kong.

Other operating income of $0.7bn increased by $0.6bn compared with 1H21, primarily due to $0.9bn higher net favourable changes in PVIF.

The changes in PVIF were mainly in Hong Kong and included a $0.2bn increase in the value of new business and a $0.3bn gain following a pricing update for our policyholders' funds held on deposit with us in Hong Kong to reflect the cost to provide this service. There was also an increase of $0.3bn primarily reflecting the effect of sharing lower investment returns with policyholders.

PVIF is presented in accordance with IFRS 4 'Insurance Contracts'. As set out in 'Future accounting developments' on page 29, IFRS 17 'Insurance Contracts' is effective from 1 January 2023. Under IFRS 17, there will be no PVIF asset recognised. Instead, the estimated future profit will be included in the measurement of the insurance contract liability as the contractual service margin and gradually recognised in revenue as services are provided over the duration of the insurance contract.

The increase in 'Other operating income' also included a $0.1bn provisional gain on completion of our acquisition of AXA Singapore in 1H22. The increases were partly offset by 1H22 losses associated with the planned sales of our branch operations in Greece and our operations in Russia.

Net insurance claims and benefits paid and movement in liabilities to policyholders of $5.4bn were $2.5bn lower, primarily due to lower returns on financial assets supporting contracts where the policyholder is subject to part or all of the investment risk, mainly in France and Hong Kong, together with the impact of higher sales volumes in Hong Kong.

Change in expected credit losses and other credit impairment charges ('ECL') were a charge of $1.1bn, compared with a net release of $0.7bn in 1H21.

The 1H22 charge primarily reflected stage 3 charges of $0.8bn, including charges related to the commercial real estate sector in mainland China, as well as against Russia exposures. We also recognised additional stage 1 and stage 2 allowances to reflect heightened levels of economic uncertainty and inflationary pressures, in part offset by the release of most of our remaining Covid-19-related allowances. This compared with a net release in 1H21 primarily relating to Covid-19-related allowances previously built up in 2020.

We continue to expect our ECL charges to normalise towards 30bps of average loans in 2022, recognising the possible risk of further deterioration in the consensus economic outlook. We also continue to monitor external developments in certain key vulnerable sectors, particularly offshore commercial financing of the real estate sector in mainland China.

For further details on the calculation of ECL, including the measurement uncertainties and significant judgements applied to such calculations, the impact of economic scenarios and management judgemental adjustments, see pages 67 to 75.