1Q 2013 Interim Management Statement

Financial performance commentary

·      Reported net operating income before loan impairment charges and other credit provisions ('revenue') was US$18.4bn in 1Q13, US$2.2bn higher than in 1Q12. This primarily reflected lower adverse movements of US$0.2bn on our own debt designated at fair value resulting from changes in credit spreads, compared with US$2.6bn in 1Q12. In addition, revenue included US$1.1bn of gains (net of losses) from disposals and reclassifications compared with US$0.2bn in 1Q12, including an accounting gain in 1Q13 arising from the reclassification of Industrial Bank Co., Limited ('Industrial Bank') as a financial investment following its issue of additional share capital to third parties. The resulting increase in revenue was partially offset by the absence of revenue in 1Q13 from businesses disposed of during 2012, notably Cards and Retail Services ('CRS') in the US, which was sold in May 2012.

·      Underlying revenue was US$17.6bn in 1Q13, US$0.8bn higher than in 1Q12. This included items totalling US$1.1bn, as follows:

-      a net gain recognised on completion of the sale of our remaining shareholding in Ping An Insurance (Group) Company of China, Limited ('Ping An') of US$0.6bn;

-      a favourable debit valuation adjustment of US$0.5bn in Global Banking and Markets ('GB&M') on derivative contracts reflecting a widening of spreads on HSBC credit default swaps and refinement of the calculation;

-      foreign exchange gains on sterling debt issued by HSBC Holdings of US$0.4bn;

-      a loss relating to the write-off of allocated goodwill recognised following the reclassification of a non-strategic business to 'Assets held for sale' in Global Private Banking ('GPB') of US$0.3bn; and

-      a loss of US$0.1bn on the sale of an HFC Bank UK secured loan portfolio.

Remaining Group revenue was broadly unchanged:

-      GB&M delivered a strong revenue performance in the quarter. However, this was lower than 1Q12 for two reasons: (i) 1Q12 benefited from the significant tightening of spreads on eurozone bonds following the European Central Bank's announcement of the Long-Term Refinancing Operation, although this reduction in revenue was partly offset by lower adverse fair value movements on structured liabilities; and (ii) Balance Sheet Management revenue decreased due to lower net interest income as proceeds from the sale and maturing of investments were reinvested at prevailing rates. In addition, there were lower gains on the disposal of available-for-sale debt securities in the UK. These factors were partly offset by increased revenue from Financing and Equity Capital Markets which was driven by higher lending spreads together with a rise in fees in our financing, advisory and underwriting businesses and the non-recurrence of losses on the sale of certain syndicated loans in 1Q12.

-      In Retail Banking and Wealth Management ('RBWM'), revenue decreased due to a decline in the US run-off portfolio which reflected a loss of US$0.2bn arising from the early termination of US$1.0bn of qualifying accounting hedges as a result of potential funding changes. Revenue in RBWM excluding the US CRS business and the US run-off portfolio increased, mainly driven by higher net interest income from an increase in average secured lending balances in Hong Kong and the UK.

-      In Commercial Banking ('CMB') revenue was in line with 1Q12. There was moderate growth in net fee income across most product groups, while net interest income was broadly unchanged as higher average lending and deposit balances, notably in the UK and Hong Kong, were largely offset by spread compression.

·      Loan impairment charges and other credit risk provisions ('LIC's) were lower in all regions than in 1Q12. The decrease was most significant in North America due to reduced lending balances and lower delinquency rates in our CML portfolio, as well as the sale of the CRS business in 2012. The Middle East and North Africa benefited from a net release of LICs raised in previous periods compared with significant impairment charges in 1Q12, reflecting the improvement in the financial position of certain customers. LICs also decreased in Europe, reflecting lower credit risk provisions due to net releases on available-for-sale asset-backed securities due to an improvement in underlying asset prices. This compared with charges in 1Q12. Also in Europe, notably in the UK, lower loan impairment charges in RBWM reflected a fall in delinquency rates.

·      Reported operating expenses in 1Q13 of US$9.3bn were 10% lower than in 1Q12. On an underlying basis, operating expenses fell by US$0.2bn, primarily due to lower charges relating to UK customer redress programmes of US$0.3bn and a US$0.2bn reduction in restructuring and related costs. Remaining operating expenses were US$0.3bn higher, mainly due to an operational risk provision in GPB, a customer remediation provision related to our former CRS business, the cost of transitional service agreements following the sale of the CRS business and an impairment of our interest in a joint venture, which in aggregate totalled US$0.4bn. Wage inflation also contributed to the increase in operating expenses. These factors were partly offset by sustainable cost savings and lower performance-related costs in GB&M.

·      We achieved an additional US$0.4bn of sustainable cost savings across all our regions, taking the annualised total to US$4.0bn as we continued with our organisational effectiveness programmes.

·      The reported cost efficiency ratio improved from 63.9% in 1Q12 to 50.8% in 1Q13 while, on an underlying basis, it improved from 56.9% to 53.2%.

·      The number of full-time equivalent staff at the end of the quarter was 260,400, broadly unchanged since 31 December 2012. This reflected a reduction from organisational effectiveness initiatives and business disposals which was largely offset by recruitment, notably in our Risk function (including Compliance) as we continued the implementation of global standards.

·      The effective tax rate for 1Q13 of 15.7% was lower than the UK corporation tax rate of 23.25%. This was driven by the benefits arising from the non-taxable gains on profits associated with the reclassification of Industrial Bank as a financial investment and the Ping An sale, and the geographical distribution of the Group's profit.

·      Profit attributable to ordinary shareholders for the first quarter was US$6.2bn, up by US$3.8bn on 1Q12, with the result that the annualised return on average ordinary shareholders' equity was 14.9% compared with 6.4% in 1Q12.

1Q13 compared with 4Q12

·      Reported revenue of US$18.4bn in 1Q13 was US$1.5bn higher than in 4Q12, despite significantly lower gains (net of losses) from disposals and reclassifications of US$1.1bn compared with US$3.3bn in 4Q12. 1Q13 included adverse movements on own debt designated at fair value resulting from changes in credit spreads of US$0.2bn compared with US$1.3bn in 4Q12.

·      On an underlying basis, revenue was US$3.0bn higher, driven by:

-      a charge in 4Q12 of US$0.9bn from the change in estimation methodology in respect of credit valuation adjustments on derivative contracts;

-      the net gain recognised on completion of our remaining shareholding in Ping An of US$0.6bn in 1Q13 which offset the adverse fair value movement on the forward contract included in our 4Q12 results; and

-      foreign exchange gains in 1Q13 on sterling debt issued by HSBC Holdings.

·      Remaining revenue increased, driven by GB&M. This was notably in Rates in Europe following muted customer activity in the fourth quarter, in our Credit business as the momentum achieved in 2012 within debt capital markets continued, and in Balance Sheet Management due to higher gains on the disposal of available-for-sale debt securities in North America and Europe in 1Q13.

·      LICs were lower than in 4Q12, mainly in Europe due to a higher level of individually assessed impairments in CMB in 4Q12 on UK, Spanish and Greek exposures. In addition, there were lower loan impairment charges in North America, primarily due to the non-recurrence of an adjustment made in 4Q12 of US$0.2bn to increase the estimated average time period from current status to write-off for real estate loans.

·      Reported operating expenses for 1Q13 were 18% lower than in 4Q12. On an underlying basis, operating expenses were also lower, as 4Q12 included charges related to the UK bank levy and fines and penalties paid as part of the settlement of investigations into past inadequate compliance with anti-money laundering and sanctions laws. In addition, in 1Q13 there were lower charges relating to UK customer redress programmes and restructuring and related costs. The remaining operating expenses were US$0.4bn (5%) lower, primarily reflecting the non-recurrence of asset write-offs and lease provisions, and a decline in litigation penalties and related costs.

Balance sheet commentary

·      Reported loans and advances to customers declined by US$39.0bn during 1Q13. This resulted from foreign exchange differences of US$25.4bn, a US$1.2bn reduction in reverse repo balances and a decrease in customer lending of US$12.5bn. The latter was driven by the reclassification of customer lending balances relating to the planned disposals of non-strategic businesses in Latin America and Europe to 'Assets held for sale'. Apart from this, loans and advances to customers remained broadly unchanged from 31 December 2012. Term and trade-related lending to CMB customers in Hong Kong rose as cross-border trade between Hong Kong and mainland China increased. In addition, residential mortgage balances rose in a number of countries across Rest of Asia-Pacific, including mainland China which benefited from an active property market. Residential mortgage balances continued to grow in Hong Kong, albeit at a slower rate than in 2012, while competitive campaigns led to a rise in the UK. This was partly offset by the continued decline in residential mortgage balances in the US run-off portfolio. In addition, overdraft balances in the UK which did not meet the accounting netting criteria fell.

·      Reported customer accounts declined by US$32.1bn compared with 31 December 2012. This resulted from foreign exchange movements of US$29.8bn, and a fall in customer deposits of US$9.7bn in 1Q13. The latter was driven by declines in Latin America and Europe which reflected the reclassification to 'Liabilities of disposal groups held for sale' of customer account balances relating to the planned disposals of non-strategic operations. A US$7.4bn rise in repo balances partly offset these declines. The fall in customer account balances was broadly in line with 31 December 2012 levels, as a decline in current accounts in the UK relating to the reduction in overdraft balances which did not meet the accounting netting criteria and lower customer deposit balances in North America was largely offset by growth in all global businesses in the Middle East and North Africa and higher RBWM balances in Hong Kong, Rest of Asia-Pacific and the UK.

·      Other significant balance sheet movements in the quarter included an increase in trading assets and liabilities, reflecting a rise in customer activity and a resultant increase in settlement account balances. Loans to banks also rose, largely in Europe, as liquidity was deployed into reverse repos, and in Hong Kong and Rest of Asia-Pacific, where there was a rise in interbank placements.

Capital and risk-weighted assets

The core tier 1 capital ratio strengthened to 12.7% from 12.3% at 31 December 2012 as a result of the completion of management actions and profit generation offset by the effect of regulatory changes.

Internal capital generation contributed US$3.0bn to core tier 1 capital, being profits attributable to shareholders of the parent company after a regulatory adjustment for own credit spread and net of dividends. This was largely offset by foreign currency translation differences resulting from the strengthening of the US dollar.

Risk-weighted assets ('RWA's) reduced by US$26.2bn, of which US$9.8bn was due to foreign exchange movements. Credit risk RWAs decreased by US$38.1bn from the reclassification of Industrial Bank as a financial investment and its consequent exclusion from the regulatory consolidation of RWAs. This was partially offset by an increase in credit risk RWAs of US$19.0bn due to the introduction of a new PRA regulatory floor in the calculation of credit risk RWAs on sovereign exposures under the advanced internal ratings-based ('IRB') approach.

The estimated CRD IV CET1 ratio strengthened to 9.7% from 9.0% at 31 December 2012 due to the sale of our remaining shareholding in Ping An and to the factors described above. After taking into account planned management actions mitigating the effect of immaterial holdings, the CET1 ratio is estimated to be 10.1%.

Net interest margin

Net interest margin was lower than in 1Q12 as a result of significantly lower yields on customer lending, including balances within 'Assets held for sale'. This was driven by the effect of disposals during 2012, notably the higher yielding CRS portfolio in the US, coupled with a downward trend in interest rates in a number of countries. Yields on our surplus liquidity also fell, notably in Latin American and Europe, as proceeds from maturing investments and disposals were reinvested at lower prevailing rates. The fall in yield was partly offset by a reduction in the cost of funds on customer accounts in the low rate environment and on debt issued by the Group, notably in the US where lower funding requirements following the business disposals led to debt at higher effective rates maturing and not being replaced. The decline in net interest margin compared with 4Q12 similarly reflected the change in the composition of our balance sheet as a result of disposals, together with lower yields on our surplus liquidity. This was partly offset by a reduction in our cost of funds, notably on debt issued by the Group, together with lower rates paid on customer account balances.

Trading conditions and outlook for 2013

Although broad macroeconomic challenges persist, we expect the mainland Chinese economy to accelerate after a slower than expected start to the year. We forecast that the US will continue to outperform its peers, though the pace of growth will be slow compared with past experience. We expect that the eurozone will contract, that emerging markets will grow at around 5%, and that global growth will be around 2% in 2013.

Our performance in April continued the trend we saw in the first quarter.