Group Chief Financial Officer's review

The Group delivered a strong performance in the first quarter of 2022

Summary of financial performance

1      Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2      Change is the basis points (bps) difference between the two periods rather than the percentage change

3      Not meaningful

Statutory financial performance summary

1      Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2      Change is the basis points (bps) difference between the two periods rather than the percentage change

3      Not meaningful

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Group Chief Financial Officer's review continued

The Group delivered a strong performance in the first quarter of 2022, in volatile and challenging market conditions, with underlying profit before tax increasing 5 per cent on a constant currency basis. Income grew 9 per cent on a constant currency basis excluding positive movements in Debit Valuation Adjustment (DVA), with a record performance in Financial Markets, particularly in Macro Trading, partly offset by lower Wealth Management, reflecting less favourable market conditions compared to a record performance last year. Rising interest rates and increased hedging balances within Treasury led to the net interest margin increasing 10 basis points in the quarter, while RWA optimisation actions were the primary driver of a 1 per cent quarter-on-quarter reduction in loans and advances to customers. Expenses increased 8 per cent at constant currency, mainly due to inflation and performance related pay accruals, with underlying cost efficiencies funding increased investment spend. Credit impairment charges were equivalent to an annualised loan loss rate of 24 basis points. The Group remains well capitalised and highly liquid with a CET1 ratio of 13.9 per cent, at the top end of the 13 to 14 per cent target range, an advances-to-deposits ratio of 60 per cent and a liquidity coverage ratio of 140 per cent.

All commentary that follows is on an underlying basis and comparisons are made to the equivalent period in 2021 on a reported currency basis, unless otherwise stated.

•  Operating income increased 9 per cent, or 11 per cent on a constant currency basis, and was up 9 per cent on a constant currency basis and excluding an $85 million increase in DVA. A record Financial Markets performance and an expansion in the net interest margin was partly offset by lower Wealth Management income

•  Net interest income increased 8 per cent, with the net interest margin increasing 6 per cent or 7 basis points, due to rising interest rates and increased hedging balances within Treasury, and a 2 per cent increase in average interest earning assets

•  Other income increased 10 per cent, but was up 6 per cent excluding the positive impact of movements in DVA, with a strong Financial Markets performance including record Macro Trading income partially offset by lower Wealth Management income and reduced realisation gains within Treasury

•  Operating expenses were up 6 per cent or up 8 per cent on a constant currency basis, reflecting both an increase in and a normalisation of the phasing of performance-related pay accruals. Increased investment spend into transformational digital initiatives including Ventures was primarily funded by cost efficiency actions. The Group generated 1 per cent positive income-to-cost jaws at constant currency excluding DVA while the cost-to-income ratio excluding DVA and the UK bank levy was flat at 63 per cent

•  Credit impairment increased by $180 million to $200 million and was broadly in-line with charges in the prior quarter. There was an $81 million release in Stage 1 and 2 impairments reflecting the impact of a $104 million release in management overlays, primarily relating to COVID-19. Impairment of Stage 3 assets was a $281 million charge including a $107 million impact from a sovereign ratings downgrade of Sri Lanka into stage 3, and a $160 million charge on China Commercial Real Estate exposures

•  Other impairment was a $1 million charge, a $15 million reduction with the non-repeat of impairments relating to the aviation lease portfolio

•  Profit from associates and joint ventures increased 34 per cent to $63 million due to increased profits at China Bohai Bank

•  Charges relating to restructuring and other items decreased $25 million to $8 million

•  Taxation was $313 million on a statutory basis, with an underlying year-to-date effective tax rate of 21.1 per cent compared to the prior year rate of 22.2 per cent reflecting a change in the geographic mix of profits

•  Underlying return on tangible equity increased by 30 basis points to 11.1 per cent due to higher profits and lower tangible equity reflecting shareholder distributions including share buy-backs, and adverse movements in reserves due to movements in interest rates and FX

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Operating income by product

1      Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2      Following a reorganisation, there has been a reclassification of balances from Lending & Portfolio Management into Trade & Working capital including prior period numbers. Prior periods have been re-presented and there is no change in the total income

3      Income related to Group Special Asset Management, the Group's specialist recovery unit previously reported in Other products has been allocated to the relevant products. Prior periods have been re-presented and there is no change in total income

4      Not meaningful

Transaction Banking income increased 4 per cent. Trade & Working Capital increased 4 per cent due to double-digit growth in balances partly offset by margin compression. The margin compression reflects greater distribution activities and a shift in product mix towards lower margin but more RWA efficient products. Cash Management income increased 3 per cent with strong balance sheet and fee income growth partly offset by margin compression.

Financial Markets income increased 32 per cent and was up 25 per cent excluding positive movements in DVA. Macro Trading enjoyed a record quarter with Commodity income more than doubling, benefitting particularly from volatility in energy prices. FX and Rates income also delivered double-digit growth on the back of increased client flows. Credit Markets income increased 7 per cent with Financing Solutions & Issuance benefitting from strong performance in Project & Export Finance and Leveraged Structured Solutions partly offset by subdued activity in Capital Markets while Credit Trading was down 16 per cent, negatively impacted by widening credit spreads. Structured Finance income declined 6 per cent due to lower Aviation Finance income, while Financing & Security Services income increased 35 per cent including $94 million of gains on mark-to-market liabilities which are expected to reverse once funding spreads normalise.

Lending and Portfolio Management income decreased 16 per cent as RWA optimisation actions led to loan sale losses and lower balances.

Wealth Management income declined 18 per cent in comparison to a record performance in the first quarter of 2021, as market conditions became more volatile reducing transaction volumes, as well as from the impact of COVID-19 restrictions in particular in Hong Kong and China, resulting in a number of branch closures which negatively impacted face-to-face sales. Bancassurance income was up 9 per cent on the back of strong growth in Singapore. Excluding Bancassurance, Wealth Management income was down 26 per cent with reduced income from Managed Investments and Treasury products.

Retail Products income was flat on a reported basis and increased 3 per cent on a constant currency basis. Deposit income increased 6 per cent and 10 per cent on a constant currency basis due to higher margins, increased volumes and improved liability mix. On a constant currency basis, Mortgages & Auto income grew 3 per cent on the back of increased volumes. Credit Cards & Personal Loans income decreased 5 per cent reflecting lower fee income in Hong Kong.

Treasury income increased 23 per cent with net interest income more than doubling, benefitting from an increase in hedged balances and an increased return on assets as interest rates rose in several markets, partly offset by a $68 million reduction in realisation gains.

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Profit before tax by client segment and geographic region

1      Following the increased strategic importance and reporting of Ventures to management, this has been established as a separate operating segment in 2022. Prior periods have been restated

2      Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

3      Not meaningful

As part of the ongoing execution of its refreshed strategy, the Group has expanded and reorganised its reporting structure with the creation of a third client segment, Ventures, effective on 1 January 2022. Ventures is a consolidation of SC Ventures and its related entities as well as the Group's two majority-owned digital banks Mox in Hong Kong and Trust in Singapore, reported alongside the current client segments; Corporate, Commercial & Institutional Banking (CCIB) serving larger companies and institutions and Consumer, Private & Business Banking (CPBB) serving individual and business banking clients. There is no change to the regional reporting structure.

Corporate, Commercial & Institutional Banking income increased 19 per cent, or 15 per cent excluding DVA, with Financial Markets income up 32 per cent. Profits grew 24 per cent with increased income partly offset by 3 per cent higher expenses and $175 million increase in credit impairment charges.

Consumer, Private & Business Banking profit declined 26 per cent, with income down 7 per cent due to an 18 per cent reduction in Wealth Management as well as a 3 per cent increase in Expenses, while credit impairments were 28 per cent lower.

Ventures loss doubled to $77 million, reflecting the Group's continued investment in transformational digital initiatives with a doubling of expenses.

Central & other items (segment) profit increased 6 per cent to $106 million with income increasing 17 per cent reflecting higher Treasury income and an increased profit share from China Bohai Bank. This was partly offset by a 20 per cent increase in expenses and a $15 million net increase in impairments due to the sovereign ratings downgrade of Sri Lanka.

Asia profits decreased 26 per cent with credit impairments increasing by $227 million and a 6 per cent increase in expenses. Income was down 1 per cent but up 1 per cent on a constant currency basis excluding movements in DVA, with higher Financial Markets income offset by lower Wealth Management and a non-repeat of realisation gains in Treasury.

Africa & Middle East profits increased 59 per cent as income increased 12 per cent or 16 per cent on a constant currency basis. Expenses increased 5 per cent on a constant currency basis while impairments were a $46 million net release in the quarter.

Europe & Americas profit more than doubled as income grew 56 per cent, or 47 per cent excluding positive movements in DVA, due to strong Financial Markets and Treasury performance. Expenses increased 4 per cent while there was a lower credit impairment release.

Central & other items (region) recorded a loss of $221 million, with expenses 11 per cent higher and a non-repeat of prior year other impairment relating to the aviation lease portfolio.

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Adjusted net interest income and margin

1      Variance is better/(worse) other than assets and liabilities which is increase/(decrease)

2      Adjusted net interest income is statutory net interest income less funding costs for the trading book and financial guarantee fees on interest-earning assets

3      Change is the basis points (bps) difference between the two periods rather than the percentage change

4      Adjusted net interest income divided by average interest-earning assets, annualised

Adjusted net interest income increased 8 per cent driven by a 6 per cent increase in the net interest margin which averaged 129 basis points in the quarter, increasing 7 basis points year-on-year and 10 basis points compared to 4Q'21:

•  Average interest-earning assets increased 1 per cent in the quarter. Gross yields increased 14 basis points compared with the prior quarter due to an increase in hedged balances within Treasury and the impact of rising interest rates on customer loan pricing and on Treasury portfolio yields

•  Average interest-bearing liabilities increased 1 per cent in the quarter. The rate paid on liabilities increased 3 basis points compared with the average in the prior quarter reflecting the impact of interest rate movements and a slight change in the liability mix

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Credit risk summary

Income Statement

1      Variance is increase/(decrease) comparing current reporting period to prior reporting periods

Balance sheet

1      Variance is increase/(decrease) comparing current reporting period to prior reporting periods

2      Includes reverse repurchase agreements and other similar secured lending held at amortised cost of $12,571 million at 31 March 2022, $7,331 million at 31 December 2021 and $3,197 million at 31 March 2021

3      Change is the percentage points difference between the two points rather than the percentage change

Asset quality remained resilient in the first quarter, with an improvement in a number of underlying credit metrics. However, the Group continues to remain alert to the challenging external environment including the continued impact of COVID-19 in key markets, idiosyncratic pressures in the China commercial real estate sector, commodity price volatility and the impact of the Russia/Ukraine military conflict which in part contributed to both commodity price volatility and the accelerated trajectory of inflation and interest rate rises across our footprint.

Credit impairment was a $200 million charge in the quarter, a $180 million increase and represents an annualised loan loss rate of 24 basis points which is below the Group's medium-term guidance of 30-35 basis points.

The $81 million release in stage 1 and 2 impairment reflects a $104 million release from management overlays, $4 million of which was is in stage 3, primarily relating to a reduction in the COVID-19 element of the overlay. Management overlay totals $239 million as at 31 March 2022, with the COVID-19 element totalling $153 million and $86 million relating to the China Commercial Real Estate sector.

Stage 3 impairments of $281 million includes $160 million relating to China Commercial Real Estate exposures and $107 million relating to the sovereign ratings downgrade of Sri Lanka, partly offset by lower charge-offs in Consumer, Private and Business Banking.

Gross stage 3 loans and advances to customers of $7.2 billion were 11 per cent lower compared to 31 December 2021 primarily due to repayments, loan sales, client upgrades and write-offs partly offset by the sovereign ratings downgrade of Sri Lankan exposures as Sri Lanka suspended external debt payments. These credit-impaired loans represented 2.4 per cent of gross loans and advances, a decrease of 26 basis points compared to 31 December 2021.

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The Stage 3 cover ratio of 61 per cent increased 3 percentage points compared with the position as at 31 December 2021, and the cover ratio post collateral of 78 per cent also increased by 3 percentage points, with both ratios increasing due to loan sales, increased repayments and additional stage 3 provisions.

Credit grade 12 balances have decreased 43 per cent since 31 December 2021 reflecting the impact of the sovereign ratings downgrade of Sri Lanka into stage 3 and client upgrades out of credit grade 12.

Early Alert accounts of $6.7 billion have increased by $1.1 billion since 31 December 2021, primarily in the China Commercial Real Estate and Commodity Traders sectors. The Group is continuing to monitor its exposures in the Commercial Real Estate, Commodity Traders, Metals & Mining and Oil & Gas sectors particularly carefully, given the unusual stresses caused by the effects of COVID-19 and commodity price volatility. Rising commodity prices have, however, eased credit pressure for certain other sectors.

The proportion of investment grade corporate exposures has remained stable since 31 December 2021 at 69 per cent.

Restructuring, goodwill impairment and other items

The Group's statutory performance is adjusted for profits or losses of a capital nature, amounts consequent to investment transactions driven by strategic intent, other infrequent and/or exceptional transactions that are significant or material in the context of the Group's normal business earnings for the period and items which management and investors would ordinarily identify separately when assessing underlying performance period-by period.

Restructuring charges of $8 million primarily reflect expenses relating to redundancies partly offset by income from the Principal Finance and Ship Leasing portfolios.

The Group has announced the exit of seven markets in the AME region and will focus solely on the CCIB segment in two more. The results from the markets and businesses being exited will be reported in restructuring from 2Q'22 onwards.

Balance sheet and liquidity

1      Variance is increase/(decrease)comparing current reporting period to prior reporting periods

2      The Group now excludes $11,970 million held with central banks (31.12.21: $15,168 million, 31.03.21: $15,996 million) that has been confirmed as repayable at the point of stress

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The Group's balance sheet remains strong, liquid and well diversified:

•  Loans and advances to banks were 20 per cent or $9 billion lower from 31 December 2021 to $36 billion due to a reduction in Treasury loans and Financial Institutions Trade loans

•  Loans and advances to customers decreased 1 per cent from 31 December 2021 to $296 billion reflecting the risk-weighted asset optimisation actions undertaken by CCIB in the quarter. Excluding the impact of these actions and adverse foreign exchange movements, loans and advances increased by $4 billion in the quarter, primarily from an increase in Trade balances 

•  Customer accounts of $456 billion decreased 4 per cent from 31 December 2021 due to client activities and management action resulting in the rolling off of certain non-operational deposits

•  Other assets increased 5 per cent in the first quarter of 2022 with increased derivative balances, unsettled trade balances and investment securities. Other liabilities increased 12 per cent from increased derivative liabilities, cash collateral liabilities and unsettled trade liabilities

The advances-to-deposits ratio increased to 60.0 per cent from 59.1 per cent at 31 December 2021 reflecting the outflow of customer accounts in the quarter. The point-in-time liquidity coverage ratio decreased 3 percentage points to 140 per cent and remains well above the minimum regulatory requirement of 100 per cent.

Risk-weighted assets  

1      Variance is increase/(decrease) comparing current reporting period to prior reporting periods

Total risk-weighted assets (RWAs) decreased 4 per cent or $10.4 billion from 31 December 2021 to $260.8 billion, including the impact of $5.8 billion incremental RWA from regulatory changes and adjustments and the cessation of software relief. Excluding the impact of regulatory changes, RWAs decreased by 6 per cent or $16.2 billion in the quarter:

•  Credit risk RWA decreased by $9.0 billion in the first quarter to $210.6 billion with the $5.8 billion increase from regulatory changes and underlying growth asset more than offset by a $6 billion reduction in the CCIB low-returning portfolio targeted for optimisation, $6.5 billion from other RWA efficiency actions, $4.9 billion positive credit migration and favourable movements in FX 

•  Operational risk RWA was flat at $27.1 billion

•  Market risk RWA decreased by $1.5 billion to $23 billion reflecting reduced standardised specific interest rate risk positions

Capital base and ratios    

1      Variance is increase/(decrease) comparing current reporting period to prior reporting periods

2      Change is percentage points difference between two points rather than percentage change

The Group's CET1 ratio of 13.9 per cent was 23 basis points lower than at 31 December 2021, but 48 basis points above the CET1 ratio at 1 January 2022 when regulatory changes which reduced the Group's CET1 ratio came into force. The underlying 47 basis points increase reflects approximately 115 basis points uplift from the impact of RWA optimisation actions and profit accretion during the quarter despite funding a $750 million share buyback. The CET1 ratio remains 3.8 percentage points above the Group's latest regulatory minimum of 10.1 per cent and at the top of the 13-14 per cent medium-term target range.

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The regulatory changes which came into force on 1 January 2022, include the cessation of software relief, the impact from the IRB model repair programme and the introduction of standardised rules for counterparty credit risk on derivatives and other instruments (SA-CCR). In aggregate, these regulatory changes resulted in a decrease in the CET1 ratio of 70 basis points by reducing CET1 capital by $1.1 billion and increasing RWAs by $5.8 billion.

The CET1 ratio was reduced by 30 basis points from a reduction in reserves mainly relating to a reversal of prior year unrealised gains on debt securities as a result of higher market yields and movements in FX reducing both the translation reserve and RWAs.

The Group is part way through the $750 million share buyback programme it announced on 17 February 2022, and by 31 March 2022 had spent $433 million purchasing 64 million ordinary shares, reducing the share count by approximately 2 per cent. Even though the share buyback was still ongoing on 31 March 2022, the entire $750 million is deducted from CET1 in the period, reducing the ratio by 27 basis points.

The Group is accruing a provisional interim 2022 ordinary share dividend over the first half of the year which is calculated formulaically at one third of the ordinary dividend paid in 2021 or 4 cents a share. Half of this amount was accrued in the first quarter and combined with payments due to AT1 and preference shareholders reduced the CET1 ratio by 6 basis points.

The above CET1 ratio headwinds were predominately offset by 69 basis points uplift from an underlying reduction in RWAs, including the benefit of CCIB and other RWA efficiency actions, and 43 basis points from profit accretion in the quarter.

The Group's UK leverage ratio of 4.4 per cent is 50 basis points lower than the 4.9 per cent ratio as at 31 December 2021. This reflects lower Tier 1 capital from the reduction in both CET1 capital and a call of $1 billion of AT1 balances as well as increased leverage exposures driven by asset growth. The Group's leverage ratio remains significantly above its minimum requirement of 3.7 per cent.

Outlook

The start to 2022 has been strong and recent geopolitical events have strengthened the outlook for rates albeit making the outlook for the pace of economic recovery less predictable. Consequently for FY'22:

•  Income growth to slightly exceed the previously guided 5-7% range

•  Operating expenses are expected to be slightly higher than the previously guided constant-currency $10.7bn as a consequence of the impact of the higher income growth expectations on performance related pay; we continue to expect to deliver positive income-to-cost jaws

•  Credit impairment is expected to start to normalise towards the medium-term loan-loss rate range of 30-35bps

•  We intend to operate dynamically within the full CET1 13-14% target range

We are on track to deliver 10% return on tangible equity by 2024, if not earlier.

Andy Halford

Group Chief Financial Officer

28 April 2022

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