Interim Report - 12 of 25

Economic background

Growth in Latin America slowed in the first half of 2012, with a common feature being the slowdown in demand from eurozone economies.

Brazilianeconomic activity slowed markedly; the annual pace of GDP growth fell to 0.8% in the first quarter. In contrast to the other economies of the region, the loss of momentum in Brazil appeared to be mainly the result of weak domestic investment spending. Inflation moderated, allowing the Central Bank of Brazil to cut the Selic policy rate by 400bps from the peak reached in August 2011.

Mexico produced the strongest performance in the region with the annual pace of GDP growth accelerating to 4.6% in the first quarter of 2012. Despite the weakness of global growth, exports remained a key driver of Mexican activity. Domestic demand was also robust. Inflation remained moderate despite strong fluctuations in the currency and, accordingly, Banco de Mexico left the monetary policy rate unchanged at 4.5% during the period.

In Argentina, economic activity decelerated markedly during the first half of 2012. Annualised GDP growth fell from 8.9% in 2011 to 3% in the first five months of 2012. Inflation remained high, and the currency depreciated at an annualised rate of 10%. To counter the deterioration in the current and financial account balances, the government required official authorisation of most transactions involving the acquisition of foreign currency.

Review of performance

In Latin America, our operations reported a profit before tax of US$1.1bn for the first half of 2012, broadly unchanged compared with the first half of 2011 and an increase of 11% on a constant currency basis. This included a gain of US$102m following the completion of the sale of our general insurance manufacturing business in Argentina, and a loss of US$135m recognised following the reclassification of our non-strategic businesses to held for sale.

On an underlying basis, which excludes the above US$102m gain, pre-tax profits increased by 3%, mainly due to increased revenue in our CMB and RBWM businesses in Brazil and Argentina following growth in average lending balances, primarily during 2011, higher Balance Sheet Management and Rates and Foreign Exchange revenues in Brazil as interest rates declined, and lower operating expenses resulting from lower restructuring costs and cost saving initiatives. This was partly offset by the loss of US$135m described above. Performance in Brazil was affected by higher

Profit/(loss) before tax by country within global businesses

loan impairment charges, following balance sheet growth in RBWM and CMB during previous periods, which benefited from strong customer sentiment in the buoyant economic conditions. Subsequently, as the economy has slowed, delinquency rates have risen.

In line with the Group's strategy, we applied the five filters to our Latin American businesses and decided on a number of disposals. In the first half of 2012, we announced the sale of our businesses in Costa Rica, El Salvador and Honduras, which is expected to be completed in the second half of 2012. We also announced the sale of our businesses in Colombia, Peru, Uruguay and Paraguay, with completion expected in 2013. We will continue to offer full branch services to customers during the transition.

Following a review of our general insurance business, we completed the sale of our general insurance manufacturing business in Argentina and in Mexico, we agreed to sell a portfolio of general insurance assets and liabilities. Under the terms of these agreements, the purchasers will provide general insurance to HSBC's retail customers in the two countries. This long-term collaboration will broaden and strengthen the suite of general insurance products available to these customers.

In our RBWM business, we continued with our strategy of generating strong long-term relationships and high risk-adjusted returns, capturing wealth creation opportunities from mass-market customers as a feeder to capitalise on upward social mobility. We grew our Wealth Management revenues across the region by 14%. We also continued to manage down certain vehicle finance and payroll loan portfolios in Brazil where there is no relationship-building capacity.

In CMB, we worked closely with GB&M to ensure our clients have access to relevant GB&M products. This collaboration resulted in revenue growth of 3% as more CMB customers started using Global Markets products. Our relationships with CMB payroll customers enabled us to increase personal lending to their employees, who became our RBWM customers.

In GB&M, we continued to target global corporate customers throughout Latin America. We maintained a strong presence in the foreign exchange and derivatives markets. We were also awarded first place in International Debt Capital Markets by the Brazilian Financial and Capital Markets Association.

We continued to implement measures to improve operational efficiency. As a result, we incurred restructuring costs in the first half of 2012 of US$72m and a 4% net reduction of 2,300 staff numbers during the first half of 2012. We also achieved a total of US$140m of additional sustainable savings.

The following commentary is on a constant currency basis.

Net interest income increased by 12% compared with the first half of 2011, driven by strong growth in our RBWM and CMB businesses.

In RBWM, net interest income increased in Brazil, mainly due to a change in the composition of the lending book as we increased our balances of higher-yielding assets and managed down our exposure in certain vehicle finance and payroll loan portfolios as described earlier. Additionally, in Mexico we increased average lending balances, mainly in payroll and personal loans. In CMB, average lending balances in Brazil were higher than the comparative period, mainly in trade and working capital products.

In Brazil, spreads widened across most lending products in RBWM and CMB as interest rates declined, resulting in lower cost of funds while in Argentina lending spreads in CMB were wider on overdrafts.

In Balance Sheet Management, net interest income increased notably in Brazil as we benefited from the downward movements in interest rates which lowered the cost of funding assets in this portfolio.

Net fee incomeincreased by 4% to US$843m, mainly in Brazil due to higher current accounts and Payments and Cash Management revenues, which benefited from repricing initiatives.

Net trading income of US$597m was 15% higher than in the first half of 2011, primarily in Brazil due to higher GB&M revenues which reflected increased revenues in Rates, resulting from tightening spreads on long bond positions, and also in Foreign Exchange products as a result of increased collaboration with CMB clients.

Net income from financial instruments designated at fair value increased by 38%, reflecting the growth of policyholder assets in Brazil. An offsetting increase was recorded in 'Net insurance claims incurred and movement in liabilities to policyholders'. 

Gains less losses from financial investments of US$89m was 33% higher than in the first half of 2011, primarily in Mexico and Brazil due to disposals of government bonds in GB&M in the first half of 2012, partly offset by the non-recurrence of a gain in GB&M on the sale of shares in a Mexican listed company in the first half of 2011.

Net earned insurance premiums increased by 12% to US$1.3bn, driven by increased sales in Brazil of unit-linked pension products, term life insurance and credit protection products. Premiums also rose in Mexico, mainly due to growth in sales of the endowment product, partly offset by a decrease in Argentina, driven by the sale of the general insurance business reflecting two months less of operations in the first half of 2012.

Other operating income decreased by US$103m, primarily due to the loss recognised following the reclassification of certain businesses to held-for-sale and the non-recurrence of the gain on sale and leaseback of branches in Mexico in the first half of 2011. This was partly offset by the gain on sale of the insurance business in Argentina of US$102m.

Loan impairment charges and other credit risk provisions increased by 57%, mainly in Brazil. This resulted from increased delinquency rates in RBWM in Brazil, following strong balance sheet growth in previous periods which was driven by increased marketing and acquisitions, and strong consumer demand in buoyant economic conditions which subsequently weakened. In CMB, loan impairment charges almost doubled, mainly in Brazil following increased delinquency and a rise in individually assessed loan impairment charges booked in the first half of 2012. We took a number of steps to address the increase in delinquencies in RBWM and CMB including improving our collections capabilities, reducing third-party originations and lowering credit limits where appropriate.

Operating expenses decreased by 1% compared with the first half of 2011. Restructuring costs declined by US$56m as the equivalent period in 2011 included costs associated with the consolidation of the branch network and the reorganisation of regional and country support functions. The success of these restructuring initiatives and our continued efforts to exercise strict cost control and progress with our organisational effectiveness programmes contributed to about US$140m of additional sustainable cost savings and a net 7% reduction in staff numbers of almost 4,000 compared with the end of June 2011. These savings were partly offset by inflationary pressures, union-agreed wage increases in Brazil and Argentina, and a provision relating to anti-money laundering in Mexico.

Profit/(loss) before tax and balance sheet data - Latin America

Profit/(loss) before tax and balance sheet data - Latin America (continued)

For footnotes, see page 100.