OREANDA-NEWS. HSBC Holdings plc (AA-/Stable/F1+) has executed well on cutting costs as well as reducing non-profitable, capital intensive activities, says Fitch Ratings. The bank will return USD2.5bn in capital to shareholders via a share buyback as it struggles to re-invest the proceeds from the sale of its operations in Brazil, given the outlook for muted growth and the ongoing reduction of risk-weighted assets (RWA). This follows a trend of steadily declining capital contributions over the last six quarters mainly due to greater payouts.

HSBC's pre-tax profit in 2Q16 was USD5.4bn, broadly similar to that in 1Q16, when adjusted for significant items including USD1.1bn in lower fair-value gains on own debt, USD0.6bn of disposal gains and the USD2.2bn in non-recurring goodwill writedowns, legal charges and costs associated with the implementation of its refined strategy. Hong Kong continued to account for the largest share of adjusted profit before tax at 40% in 2Q16, followed by the rest of Asia-Pacific with 30%. The UK's contribution dropped to 11% in 2Q16 from 16% a quarter earlier while North America's share was stable at 6%.

The outlook for revenue growth remains dim and HSBC expects that it will not be able to meet its ROE target of 10% by 2017 (1H16: 7.4%) if current operating conditions persist. In particular, growth from the bank's international franchise has been trailing GDP growth, its US businesses will continue to underperform and fail to meet their 2017 targets, and HSBC's revenues from Chinese yuan internationalisation remain well behind budget. Its business model in the US is geared towards supporting its global franchise as only 20% of revenues with US clients are booked in the US and 80% outside.

Financial metrics remain in line with the ratings, as the bank controls costs stringently and benefits from diversification across geographies and business lines as well as from reliable transaction banking revenue. This revenue accounted for USD7.7bn, or 26%, of the group total in 1H16, a 1% fall from 1H15. HSBC's total revenue decline in 2Q16 was 1.9pp slower than cost cuts. The bank moved towards its targeted reduction of the cost base to USD7.3bn per quarter by end-2017, with a quarterly run rate of USD7.5bn in 1H16, excluding the bank levy and Brazil operations.

HSBC's ratings are sensitive to its financial performance, including its ability to generate capital and expand its international franchise, and ongoing underperformance in key subsidiaries.

HSBC has held firm to its measured risk appetite and reduced growth for its pivot to Asia, which Fitch views positively. Its concentrations remain manageable: its China exposure remained unchanged at USD143bn at end-June 2016 and the same was true for other concentrations, including exposure to commodities.

Management expects a regulatory end-point common equity Tier 1 ratio to improve to 12.6% after the sale of its Brazil operations and the share buyback (end-2015: 11.9%). HSBC's reliable profit generation and expected relief from further RWA reductions allow it to return capital. Fitch's assessment of a potential substantial share buyback financed through an expected dividend from its US entities in 2017 will take into account HSBC's capital flexibility, growth strategy and earnings capacity at that time. The bank's Fitch Core Capital ratio is estimated to be above 13% after the Brazil sale and the share buyback compared with 12.5% at end-2015.

We expect HSBC to meet its RWA reduction target of USD281bn by end-2017, which would give it the flexibility to redeploy capital when market conditions improve. RWA initiatives contributed USD33bn to an overall 3% RWA decline during 2Q16, or by 7% post the disposal of its Brazil unit. Growth - particularly in the US, the UK and Mexico - drove a modest USD3bn increase (1Q16: USD16bn increase) in RWA, and credit quality downgrades increased RWA by USD6bn (1Q: USD9bn).

HSBC's loan-impairment charges and other credit-risk provisions are not excessive relative to its overall book at an un-annualised 23bp of gross loans in 1H16, or 16bp excluding the Brazil unit. Its USD2.4bn impairment charges (2015: USD3.7bn) include allowances for mainly commodity-related Global Banking and Markets loans in North America and Australia, certain Retail Banking and Wealth Management (RBWM) loans in the UK, Commercial Banking (CMB) cases in Spain, both RBWM and CMB in Brazil and also RBWM loans in Mexico.

Impairments will, in our view, continue to weigh on HSBC's profitability, and highlight the persistent revenue headwinds that HSBC faces from lower cross-border trade, subdued wealth management activities and retail brokerage, sluggish markets-related activity, and costs associated with maintaining high liquidity. Implementing total loss absorbing capacity (TLAC) requirements continues to present a further challenge to HSBC's profitability. The bank issued USD18.6bn in TLAC securities from its holding company in 1H16, which it will invest across its operating subsidiaries.