OREANDA-NEWS. HSBC Holdings' (AA-/Stable/F1+) capital retention in the first three months of 2016 is just sufficient to balance expansion and credit migration with progress on winding down legacy assets and other initiatives to reduce risk-weighted assets (RWA), allowing it to maintain a high dividend, says Fitch Ratings.

Retained earnings net of USD2.1bn dividends generated only 7bp of RWA in 1Q16 (31bp in 2015), which follows a steady path of declining capital contributions - and is the lowest level since 2004, as calculated and tracked by Fitch. HSBC's regulatory end-point common equity Tier 1 ratio has consequently remained unchanged at 11.9% against known regulatory requirements of 11.2%. This figure remains below the 12%-13% target range, but we expect that it will move inside the range once the sale of HSBC's operations in Brazil is completed in 2Q16. The Fitch Core Capital ratio remains sound at 12.7% (2015: 12.5%).

Fitch expects RWA to continue to rise moderately as HSBC deploys liquidity and seeks revenue growth. RWA rose by 1% during 1Q as market movements and growth - the latter particularly in the US, the UK and Mexico - drove a USD16bn increase, which was balanced by USD15bn reductions. Downgrades on commodity exposures increased RWA by USD9bn.

HSBC's financial metrics remain in line with its ratings, as the bank benefits from diversification across geographies and business lines as well as from reliable revenue from payments and cash management, foreign exchange transactions, global trade and receivables finance and securities services. This revenue contributed USD3.9bn or 28% to the adjusted group total, albeit down slightly in percentage terms from 27% in 2015 (USD15.7bn).

Performance was resilient overall from commercial banking and global banking and markets, and the impact from reduced client activity amid high market volatility was generally contained. Retail banking and wealth management was dragged down by lower fees, a reduction in insurance revenue and losses in Brazil. Hong Kong contributed 38% to adjusted pre-tax profit in the quarter, the rest of Asia-Pacific 25%, UK 16% and the rest of Europe 3%.

Fitch considers loan impairments as not excessive relative to HSBC's overall book at 11bp of gross loans in 1Q (2015: 36bp). More than half of its USD1.2bn impairment charges (2015: USD3.7bn) relate to North America and Brazil, and a significant portion is related to commodities. HSBC's large loan books in the UK and Hong Kong remain clean, while the rest of Europe and Asia overall has also performed satisfactorily. The key concentrations to watch remain exposures related to China and commodities.

Impairments weigh, however, on HSBC's profitability, and highlight the persistent revenue headwinds that HSBC faces from lower cross-border trade, subdued retail brokerage, sluggish markets-related activity, and costs associated with maintaining high liquidity. Implementing total loss absorbing capacity (TLAC) requirements will present a further challenge to HSBC's profitability. The bank issued USD10.5bn in TLAC securities from its top holding company in 1Q16, which it will invest across its operating subsidiaries as these will have to earn their cost.

ROE of 9% in 1Q16 (2015: 7.2%) continues to fall short against HSBC's own benchmark of above 10%, and the bank will face significant challenges well into 2016 - and likely in 2017 - in achieving revenue growth which outpaces cost growth. The decline in adjusted costs in 1Q16 (1%) lags the decline in adjusted revenue (3.8%). This resulted in the gap, known as "jaws" in the banking industry, remaining negative at -2.8% (2015: -3.7%).

The reported USD6.1bn pre-tax profit reflects USD1.2bn in fair-value gains on own debt. Pre-tax profit was USD5.4bn in 1Q16, when adjusted for these and USD390m non-recurring expenses - largely costs associated with the implementation of its refined strategy. Pre-tax profit was 18% lower than in 1Q15 but significantly above its weak USD1.9bn in 4Q15. There were no significant charges related to conduct, legal or redress, nor any extraordinary disposal gains.