Earnings Call Transcript - HSBC Q2 2023

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the Investor and Analyst Conference Call for HSBC Holdings plc's Interim Results for 2023. For your information, this conference is being recorded. At this time, I will hand the call over to your host, Mr. Noel Quinn, Group Chief Executive.

Noel Quinn, Group Chief Executive

Thank you, Richard, and good afternoon to everyone in the room here in Hong Kong. Thank you for joining us, and great to see you again. And good morning to everyone watching from London and elsewhere. Before Georges takes you through the second quarter numbers, I'll start with a summary of the first half performance and progress. First, I show this slide every quarter. It's critical in that it summarizes our strategy, and our strategy remains unchanged. It is summarized by the 4 pillars at the bottom of the slide. Let me take you through the latest outcomes of that strategy. We had a good first 6 months. I'm pleased with the broad-based profit and revenue generated by our global businesses and geographies. I'm also pleased with our strong capital generation and returns. We delivered an annualized return on tangible equity of 22.4%, including the 2 material notable items reported in the first quarter or 18.5% if you exclude those notable items. And we've announced a second interim dividend of $0.10 per share and a second share buyback of up to $2 billion. Today, we're also upgrading our guidance. Now we expect to achieve a return on tangible equity in the mid-teens for 2023 and 2024. Prior to 2023, we were very focused on transforming the business. Now while still continuing to improve operational efficiency, we are very focused on driving growth, diversifying revenue and creating incremental value. We have a plan built around 6 areas. I will take you through some of these over the next few slides. Starting with our international connectivity. We grew wholesale cross-border client business in the first half by around 50%, with growth across all regions, driven by higher rates. Our international proposition in Wealth and Personal Banking continues to gain traction. We now have 6.3 million international WPB customers, and that is up 500,000 or 8% over the last 12 months. That's significant because these international customers generate around 2.5 times the average customer revenue. Finally, we drove strong revenue growth in Transaction Banking, which was up 63%. There were good performances in foreign exchange and in global payment solutions. Trade was slightly down year-on-year, in line with global trade volumes, but trade balances stabilized in the second quarter, particularly in Asia. And HSBC was named Best Bank for Trade Finance by Euromoney for the second year in a row as well as Best Bank in Asia. The next slide sets out our latest progress on another area of focus, the redeployment of capital from less strategic or low connectivity businesses into higher-growth international opportunities. I'm pleased that we agreed new terms for the sale of our French retail banking operations in the quarter. The deal is subject to regulatory approval, and we now have a lot of work to do to complete migration in early 2024. The sale of our banking operations in Canada remains on track to complete in early 2024, with a special dividend of $0.21 per share planned thereafter. We completed the disposal of our Greek business last weekend, and we've announced the disposal of our Russian operations. We are changing the nature of our business in Oman, and we will wind down our WPB operations in New Zealand. Crucially, this is allowing us to target growth opportunities, some of which are set out on the right-hand side. The first is the continued development of our wealth business across the whole of Asia. Our digitally enabled wealth and insurance business in Mainland China now has 1,400 wealth planners and is driving good new business growth. We launched Global Private Banking in India last month. In June, we launched HSBC Innovation Banking, a strengthened globally connected proposition on the back of our purchase of SVB U.K. We will nurture the specialism that we acquired, back it with HSBC's balance sheet strength and global network and build further Innovation Banking businesses in the U.S., here in Hong Kong and Israel. The process is already well underway and will enable us to support our clients in the technology and life sciences sectors to achieve their global ambitions. Finally, we've announced today that we are also increasing our shareholding in trade shifts and have agreed to launch a jointly owned business in early 2024 to provide embedded financing solutions within their trade ecosystem. We believe this will help us to grow our client base in commercial banking, giving us a new avenue for growth outside of traditional relationship banking. The next slide looks at how we are diversifying revenue by growing fee income and collaboration. As I've said, our wealth strategy continues to gather momentum, especially in Asia. Net new invested assets were down in the rest of the world due to lower third-party asset management liquidity products, mainly in the U.S., but they were up in Asia by 21% to $27 billion. Over the last 12 months, we took in a total of $75 billion of net new invested assets and grew our invested assets by 8% globally. This all underlines the growth potential of our Wealth business. Fee income in Commercial Banking was up 6% in the first half and collaboration revenues between our Global businesses were up 5%. Collaboration revenue is particularly important in a relatively low growth economic environment because we can drive growth from within the organization. The next slide focuses on the tight cost discipline we've maintained and how it enables us to invest in the bank of the future. We remain committed to disciplined cost management and have continued to use cost savings to increase investment in digitization. We increased spending on technology by 12.8% in the first half and this spending now accounts for 23% of our target base operating expenses. This investment has translated into faster services, reduced friction and more competitive products, all of which will improve the customer experience and our operational efficiency. We made good progress in increasing digital penetration amongst personal and business customers while increasing our product release frequency. Investing in technology is also enhancing our capabilities. We now have a range of test and learn use cases for generative AI across HSBC and are in the process of scaling up a small number of those. Last month, we became the first bank to join BT and Toshiba's quantum-secured Metro network. This uses quantum technology for secure transmission of data, which should mitigate the risk of future cyber threats. And we are pleased to be working with the Hong Kong military authority on 2 pilots to test the Hong Kong dollar in a new payments ecosystem and to trial tokenized deposits. My last slide shows how we've continued to build on our position as an enabler of the net-zero transition. In the first half, we provided and facilitated $45 billion of sustainable finance and investments as we continue to work closely with our clients on their transition plans. This consisted of capital markets financing and on-balance-sheet lending to clients and included a number of key deals in Asia and the Middle East. We were recently named Best Bank for Sustainable Finance in Asia by Euromoney for the sixth consecutive year. I'll now hand over to Georges to take you through the Q2 numbers.

Georges Elhedery, CFO

Thank you, Noel. And a warm welcome to everyone in the room with us today. It is great to be back here in Hong Kong to deliver our interim results. And for those of you watching today from London and across the globe, a very good morning, and thank you for joining us. We've announced a good set of second quarter results. Reported profits before tax were at $8.8 billion, up 89% on last year's second quarter. Revenue was up 38% at $16.7 billion. This was driven by first, NII of $9.3 billion, which was up $2.5 billion or 38% year-on-year. And second, non-NII of $7.4 billion, which was up $2.1 billion or 39% year-on-year. We booked expected credit losses of $0.9 billion in the quarter. Despite the inflationary environment, cost growth in the quarter was restricted to 1% compared to last year's second quarter, including $0.2 billion of severance costs. These severance costs were expected, and we are on track to meet our 2023 cost target to limit cost growth to around 3% on our target cost basis. Compared to the first quarter, lending and deposits were both down 1% due to subdued loan demand, deposit outflows in global banking and markets in Europe and the reclassification of our portfolio in Oman to held for sale. Our CET1 ratio remained strong at 14.7%. As Noel said, we announced a second interim dividend of $0.10 per share and the second share buyback of up to $2 billion, which we intend to complete in around 3 months. TNAV per share was down $0.24 due primarily to the final interim dividend for 2022 and the first interim dividend for 2023. The next slide shows another strong quarterly revenue performance, with overall growth of 38% compared to the second quarter of '22. Three further points on this. As Noel mentioned, revenue was up in all 3 global businesses. Wealth was up 19% due to higher rates and a strong insurance performance mainly here in Hong Kong. Across Commercial Banking and Global Banking and Markets, Global Payment Services reported revenues of around $4.2 billion, an increase of 115% on the second quarter of '22. On the next slide, reported net interest income was $9.3 billion, up $0.3 billion or 4% on the first quarter. We've introduced banking NII as a new disclosure this quarter. It is derived by adjusting reported NII for the centrally allocated cost of funding trading activities and the NII generated by the Insurance business. At $11.6 billion, banking NII was up $1.3 billion on the first quarter and up $4.5 billion on last year's second quarter. The $2.4 billion centrally allocated cost of funding trading activities within Global Banking and Markets and the second quarter included a $0.4 billion year-to-date impact of methodology changes. As a reminder, the related income associated with these funding costs is reported with non-NII. The net interest margin was 172 basis points, up 3 basis points on the first quarter of '23 and up 43 basis points on the second quarter of '22. We continue our structural hedging activity. Our NII sensitivity is $2.6 billion for a 100 basis point drop in rates against the previous year-end sensitivity of $4 billion. At this point, we are adjusting our NII guidance. We now expect NII of at least $35 billion in '23. Within this, we expect the centrally allocated cost of funding trading activities within Global Banking and Markets to be in excess of $7 billion with associated income reported in non-NII. We continue to reiterate that we expect to see higher pass-through rates and continued migration to time deposits. And we remain cautious on loan growth over the next 6 to 12 months, but we do expect it to start picking up sometime in 2024. I know that many of you will have questions about banking NII, in particular, which I'll be very happy to address as we move into Q&A later on. Moving on. Non-NII of $7.4 billion was down on the first quarter, which benefited from $3.7 billion of notable items and FX translation. However, it was up $2.1 billion or 39% in the second quarter of '22. A couple of things to mention here. One, there was a strong wealth performance, up $0.3 billion or 19% on the second quarter of last year, $0.2 billion of which came from increased life insurance income, primarily in Hong Kong. And two, Markets & Security Services was down due to lower client activity and the methodology change that I just mentioned earlier. Fees were up $0.1 billion in the second quarter of '22 due to higher personal banking and commercial banking fees. Turning now to credit. Our second quarter ECL charge was $0.9 billion, which was $0.5 billion up on the second quarter last year. It includes $0.3 billion for our mainland China commercial real estate exposure booked in Hong Kong and a $0.3 billion charge for the U.K. To remind you, this is a more normalized level of charge that we expect for this year and is a sign that our main credit indicators are holding up. On the basis of what we have seen so far in 2023 and ongoing macroeconomic headwinds, we continue to expect a 2023 ECL charge of around 40 basis points of average gross customer lending, including held-for-sale balances. The next slide is our 6-month update on our Mainland China commercial real estate portfolio. And before, our principal area of focus remains the portfolio booked in Hong Kong. At the full year, our exposure was $9.4 billion. It now stands at $8.1 billion, due primarily to repayments. The proportion of substandard and credit impaired exposures is around 65% of the portfolio marginally up from the full year. Of these $5.2 billion of exposures that we rate as substandard or credit impaired, $1.1 billion is secured with minimal ECL due to the security held. Against the remaining $4.1 billion, we have increased our provisions from $1.7 billion at the full year to $1.9 billion today. Within this, our coverage ratio against the unsecured credit impaired exposures has increased from around 55% to nearly 70%. At the end of 2022, we calculated a plausible downside scenario of $1 billion on this portfolio. As you can see, we have now crystallized some of that downside into the P&L. We remain comfortable with our coverage level. On Slide 17, despite the inflationary environment, cost growth was restricted to 1% on a constant currency basis, versus the second quarter last year. As you can see, a large share of this growth was technology-related. There was also a higher performance-related pay accrual and the expected severance costs, which were offset by a write-back of software and lease impairments. We remain committed to limiting cost growth to around 3% in 2023 on our cost target basis. On this target basis, second-quarter costs were up 6% year-on-year, of which around half was the $0.2 billion of expected severance costs. As a reminder, our cost target basis excludes notable items from constant currency operating expenses. It also excludes the impact of retranslating hyperinflationary economies at constant currency. And finally, it excludes the acquired cost base and additional investments in HSBC Innovation Banking, which are expected to result in incremental growth of around 1% above our targeted basis. The full cost target basis reconciliation will be on Slide 26 of this deck. Our CET1 ratio was 14.7%, which was stable on the previous quarter. Profit generation was offset by the dividend accrual of $6.9 billion during the first half and the share buyback of $2 billion that has now completed. So in summary, this was another good quarter. There were good profit and net interest income performances. Credit remains resilient. We are on track to limit cost growth in '23 to 3% on our cost target basis. We now expect NII of at least $35 billion in '23. And as Noel said, we now expect a mid-teens return on tangible equity in '23 and '24 excluding the upcoming sale of Canada. Finally, we are returning capital to shareholders by way of increased dividends and share buybacks. And with that, I'll ask Richard we can open it up for questions. Richard, please. Thank you.

Operator, Operator

Operator, can you please open the floor for questions? Let's take our first question from Manus Costello.

Manus Costello, Analyst

I wanted to ask about NII, please. A couple of questions. Firstly, I noted that the NIM was flat in Asia in quarter-on-quarter. Could you give us a bit more color on that about what you would expect in Q2? I appreciate the change in the costs have been somewhat allocated but please provide some benefits compared overall in stronger conditions. And then secondly, we've also talked about increasing hedging and the structural hedge in order to reduce the downtime risk from NII. Could you clarify what we've done and how to think about that in terms of potential benefits going forward into '24 and beyond?

Noel Quinn, Group Chief Executive

Thanks, Manus. Georges, do you want to pick up both of those points?

Georges Elhedery, CFO

Thank you, Manus. So on NIM NII, NIM in Asia was flat because most of the uplift from rates has translated into an uplift in the non-NII component of the trading book funding, about $0.3 billion uplift in that space. We've introduced banking NII. In due course, we will enhance our disclosure in the space to introduce banking NII sensitivity and banking NIM, which would reflect such an uplift. With regard to your second question, Manus, the hedging activity, so if you look at our NII sensitivity, downwards 100 basis points have reduced from $4 billion to $2.6 billion. About one-third of that reduction is due to our hedging structural hedging activity and another one-third of that reduction would be the effect of the change in the composition of our balance sheet. And then the last one-third is numerous other factors, including modeling enhancements. If you now look at our structural hedging activity, which we've conducted over the last 12 months, the overall impact on the reduction of banking NII sensitivity is to the tune of $1 billion.

Noel Quinn, Group Chief Executive

Thank you, Georges. Georges, do you just want to explain why there's been more of a move into the sort of the non-NII trading book, what the underlying cause of that is?

Georges Elhedery, CFO

Due to the somewhat subdued loan growth in Asia, the management has decided to allocate more funding to support some of the trading activities. Consequently, the overall funding of our trading books globally, which is heavily utilized in Asia, has increased from about $108 billion, which is roughly 6% of our deposit base, to around $130 billion, or about 8% to 9% of the deposit base. This additional lending has transitioned some funds from net interest income to non-net interest income. It remains sensitive to rates and benefits from improved levels of rates, especially in dollars.

Operator, Operator

Our next question is from Aman Rakkar from Barclays.

Aman Rakkar, Analyst

I have three questions, please. Regarding net interest income, it appears that you are exceeding $35 billion. The NII guidance suggests an increase in the net interest income run rate for the third and fourth quarters. I assume you would highlight the figure above $35 billion, implying some conservatism. Can you discuss the pressures and sources of support for the net interest income run rate until the end of the year? I believe the market would appreciate knowing whether this net interest income level is sustainable beyond this year. Any insights on the situation in the U.K., which has performed well, would also be helpful for understanding the sustainability of net interest income there. The second question pertains to distributions, specifically your dividend. You're reaffirming your 50% payout ratio guidance for this year. With strong earnings projected this year and potentially next year, consensus expects an underlying EPS of around $1.20, corresponding to an ordinary dividend of $0.60. This seems significant compared to the $0.51 stated previously and last year. How confident are you in maintaining a substantial ordinary dividend this year, considering it may be challenging to sustain in the future if rates decrease and earnings decline? Are you concerned about paying $0.60 this year and potentially lowering that number next year or thereafter?

Noel Quinn, Group Chief Executive

Georges, do you want to take the NII one first and just clarify our position on that, and then we'll come to distributions?

Georges Elhedery, CFO

Thank you, Amandeep. To address your points, we want to emphasize that this is a floor, and our guidance is now greater than $35 billion. We're updating this floor as we are becoming more confident with the results from the first half of the year. While we aim to stay cautious given the challenges in forecasting, we believe our guidance reflects that caution. Regarding our outlook for the remainder of the year, we are not planning to alter the consensus for second-half net interest income, as we are comfortable with the current consensus. We're experiencing some supportive factors, particularly with anticipated rate hikes in major currencies such as the dollar, pound, and euro. We've also noted tailwinds from the normalization of HIBOR, which has improved by about 1% quarter-on-quarter, and further normalization is expected, with HIBOR now around 5%. This will likely fully normalize by the end of July, providing us with some advantages as we move into the second half. However, we continue to face the same headwinds we've previously mentioned, which will persist into the second half. The first headwind remains subdued balance sheet growth and loan growth due to current activities. While we may see some recovery in 2024, for now, it will likely remain a challenge. The second headwind is the unpredictable nature of deposit costs, including pass-through rates and the effects of delayed migration to time deposits. In Hong Kong, we continue to assume a 1% migration per month, but forecasting this accurately is challenging, which contributes to our cautious outlook. Looking ahead, we are not providing guidance for net interest income in 2024. However, keep in mind a few factors for your analysis: exclude Canada and France upon completing their respective transactions, which we expect for Canada in the first quarter of 2024; anticipate some recovery in balance sheet growth in 2024, which will support net interest income; consider the structured hedging that will help stabilize the net interest income outlook; and assess the interest rate assumptions and pass-through rates you'll be using. Finally, we are investing significantly in our non-net interest income generating businesses, which we expect to contribute to growth. That's the current state of our net interest income.

Noel Quinn, Group Chief Executive

Carry on with dividends as well, please.

Georges Elhedery, CFO

We are planning to implement a 50% dividend payout ratio, excluding notable items. Based on your calculations, I believe you have already excluded these notable items. I won't comment on the specific size of the dividend, but to maintain our dividends, we are focusing on several key areas. First, we are considering share buybacks, which help reduce our share count. As long as we continue to generate capital, which we anticipate, adjustments to our share count will be necessary. Second, we are taking actions to stabilize net interest income, providing some protection against potential rate cycle reversals. Additionally, we will uphold our cost discipline, even though we are not yet revealing specific figures. Lastly, we are investing in fee-generating areas, such as investment and wealth management, to support our earnings and potentially our dividends beyond 2024.

Noel Quinn, Group Chief Executive

Georges, Excellent. A very comprehensive answer to both questions. So thank you. Thanks Aman. Next question, please?

Operator, Operator

Our next question is from Raul Sinha from JPMorgan.

Raul Sinha, Analyst

Maybe can I ask 2 things. The first one, just being on distribution perhaps driven by Georges' thoughts on potential for buybacks in the second half of the year and looking at your capital ratio. Obviously, we will probably have to make a couple of adjustments that are about 25 basis points, and we've got the buyback that we've announced today, that's 50 basis points on the level. Just thinking about your guidance, perhaps slightly less capital generative in the second half. So just wondering if you can scope for us Georges on what is your outlook from here? And then the second one, just for Noel on the management of credit. If I look at the performance of management revenue this quarter, it seems just sort of stable on Q1. I am wondering if that understates some of the momentum that you are building within the business. So if you could help us understand how you expect that margin to evolve.

Noel Quinn, Group Chief Executive

Yes, happy to do that. I'll let Georges take the buyback question first.

Georges Elhedery, CFO

So in terms of the buyback, obviously, the fact that today we announced a $2 billion buyback will today have an impact on our Q3 CET1 ratio of 25 basis points. But you do expect us to continue generating profitability, which will build capital, 50% of which will be provisioned for dividends based on the 50% dividend payout ratio anticipation. And therefore, that buyback will take into the additional capital generation. So I wouldn't look at Q3 25 basis points as being a challenge. This is obviously just upfronting if you want the profit generation that we would be doing in the quarter. Beyond that, again, at this stage, what I can say is we believe we remain capital generative for the foreseeable future. And as long as we're capital generative, we continue to ambition a rolling series of share buybacks. But obviously, we would review this on a quarter-by-quarter basis based on a number of factors, including our capital adequacy ratio. I just want to also highlight and probably answering your question, Raul, that the Canada sale expected in Q1 '24 will provide us additional capital. The priority use of the first part of it is for a $0.21 dividend, which we will be in a position to distribute expected in H1 '24. And then the residual part of it, we will utilize to supplement or complement or top up any capital buyback we're planning to do.

Noel Quinn, Group Chief Executive

Thank you. And I think it's a fair comment on your second question that what we're talking about here is very much growth in lead indicators. The $27 billion of net new invested assets here in Asia in the first half, up 21%. Globally, net new invested assets growth of $75 billion over the past 12 months. A growth in our aggregate invested assets of 7% globally. They're strong lead indicators, an additional 0.5 million international customers in the past 12 months. For me, they are the lead indicators. I think you're absolutely right, there will be a lag effect as you turn customer acquisition and asset acquisition into revenue. But that's why we're talking about building businesses and new growth opportunities that can supplement our revenue going forward and give us some cushion on offset to any downside rate effect that may emerge post '23 and post '24. So we think it's the right thing to do. And you're right, the revenue will be a lag indicator on those early success criteria that we're sharing with you. If you remember, our growth in our Wealth business in Mainland China, we started with 0 wealth managers just over 2 years ago. We've now about 1,400. Our ambition is to get to 3,000 over the relatively near term over the next couple of years or so. Again, that will be revenue generative as an offset because most of that is fee-based as an offset to any downside pressure that may be on interest rates. So I think your second comment is a fair comment, but I turn that into the positive rather than the negative.

Operator, Operator

And Raul just to add, as you're aware, Q1 will be seasonally a bit stronger and IFRS 17 means you build revenue from a pretty low base, but it will increase rapidly. We'll take one more question from the lines and then we'll turn to the live audience in Hong Kong, please.

Andrew Coombs, Analyst

Two questions, please. Just firstly on Chinese commercial real estate, there have been the charges in Q1 and more additional charges in Q2. Those additional charges. And then when you talk about this downside scenario on Slide 16, I think previously you indicated $1 billion and you are now saying lower, should we just take off the $0.3 billion or can you provide some framework around what would be the downside scenario nowadays? And then my second question, perhaps I could just invite you to make some comments on the FCA's 14-point plan on cash savings that was released yesterday, and any implications you think that might have to the U.K. business.

Noel Quinn, Group Chief Executive

Okay. I'll take the second. But Georges, do you want to take the first?

Georges Elhedery, CFO

Thank you, Andrew. So we have put in more charges in Q2. The total charges was $0.3 billion or some of Q1 and Q2. Q1 being very benign is $0.3 billion. Most of these charges are on stage 3. These are more technical adjustments of the names that have defaulted. So where we stand now in terms of charges is we are comfortable with the charges we have against this portfolio in China CRE. Now with regards to the plausible downside scenario, we indicated $1 billion at the year-end as a plausible downside. We have indeed crystallized $0.3 billion of it. So without being precise on the math here, it is indeed a residual circa $0.7 billion that remains a plausible downside which may or may not materialize over the coming few quarters.

Noel Quinn, Group Chief Executive

Thank you for your question regarding the FCA and their work on savings accounts. We believe we are offering a diverse range of products in both our mortgage and savings deposit books, providing our clients with choices. In the savings area, we have a competitive selection of fixed-rate deposit accounts available, and we also have reasonable pricing for instant access savings accounts. We will engage with the FCA on any reviews they conduct. Currently, our 2-year fixed-rate savings account in the U.K. offers savers a yield of 5.1%. In comparison, our 2-year fixed mortgage product is approximately 5.53% for a 60% loan-to-value ratio, and about 6.1% for new-to-bank customers. We believe our deposit and mortgage books are structured appropriately. It's important to note that there is a price difference between term products and instant access products due to maturity and liquidity risks. We have aimed to price our products fairly, keeping in mind the pressures faced by U.K. customers during this challenging time of high interest rates and inflation. We strive to remain competitive and assist our customers. While we cannot force customers into term savings, we want to ensure they are aware of our term savings offerings if they meet their needs. I hope this answers your question.

Operator, Operator

Questions from the floor in Hong Kong. We'll take 2, Katherine and Nick, and then I'll come back to you some a bit later. Okay.

Katherine Lei, Analyst

My name is Katherine Lei from JPMorgan and I have two questions. One is more long-term and the other is more short-term. For the long-term question, could management provide insight on the potential impact of the Basel III reform? I believe one of the key supports for share prices is buybacks and shareholder returns. The regulatory changes could affect how we model future returns on capital. I would like to understand this better, especially after the recent U.S. regulatory release regarding the Basel III End Game and how it might change our current forecasts. For the short-term question, I noted that management mentioned potential additional ECL charges on China's CRE of $0.7 billion. Additionally, our guidance for full-year credit costs is 40 basis points, but the first half is slightly under 30 basis points on an annualized basis. Does the $0.7 billion get included in that 40 basis points guidance, or is it separate?

Noel Quinn, Group Chief Executive

I will address the second question first and then ask Georges to take on the more technical question about bolstering. Regarding the expected credit loss (ECL), we have decided to keep our guidance at 40 basis points due to significant economic uncertainty, particularly concerning China's commercial real estate sector and the broader global economy. While our first half performance on ECL showed $1.3 billion, which is below the expected run rate of 40 basis points, we believe we can absorb some of the risks tied to the commercial real estate in China. However, it's important to note that the situation depends on global developments, so I wouldn't want to suggest that our forecasts are foolproof. At this moment, we believe it's prudent to maintain a conservative ECL guidance of 40 basis points. Additionally, we are positioned to handle potential shocks in the second half, considering our first half performance. Georges, would you like to discuss Basel III?

Georges Elhedery, CFO

Yes, to conclude on the ECL point, it's important to analyze the first half of the year. In Q2, we see a more normalized level at $0.9 billion. Q1 was unusually low, which is why the first half may appear lower than expected. Regarding Basel III, the initial step is to understand the final rules, which are still in draft form and subject to change. According to the current draft rules and as per our PRA standards for group holdings, we anticipate a minor initial improvement in our RWAs. However, as the output floor is implemented five years from now, there’s a chance it could affect us significantly, though we view it as likely immaterial. It's also worth noting that the U.S. issued draft rules recently that came out more stringent than anticipated, impacting our U.S. operations. We expect marginal effects, with a single-digit RWA increase against potential downward adjustments beforehand. These rules will affect our local reporting for the U.S. entity but won't change our group-level reporting, so we'll need to manage both aspects simultaneously.

Operator, Operator

Thank you. Over to Nick.

Nicholas Lord, Analyst

It's Nick Lord from Morgan Stanley. Again, a couple of questions, if I may, please. I think Georges has given a very thorough description of how you might sustain earnings sort of post return in rates. But obviously, a lot of our fee generation is going to come at a cost. So I just wonder if I could invite you to talk about how you think of balancing that fee generation of costs over the next sort of 2 to 3 years? And then secondly, a little bit more specific, but you're now sort of 3 or 4 months into having bought SVB. You've spoken a little bit about it here. I just wonder if you could give us a little bit more detail on how your plans have evolved in that business.

Noel Quinn, Group Chief Executive

Yes. Thanks, Nick. And by cost, I'm assuming you mean investment costs to get to it?

Nicholas Lord, Analyst

How you manage investment costs to get to operate.

Noel Quinn, Group Chief Executive

Listen, you're absolutely right. We're keeping a strong and tight cost discipline in the bank. But what we're doing is we're reallocating cost from . And what we're typically reallocating is from what I call bad cost, costs that are associated with low return in portfolios, low return in business activities in certain markets or costs that are associated with manual processes that should be digitized. So if you look at our cost performance, I think we increased our investment in IT costs by 12% so far this year, first half to first half. We increased some of our investment costs in our global businesses, and we reduced costs elsewhere, and that's what's getting us back to the 3%. So we're investing and saving at the same time. And that is a phenomenon that probably historically HSBC has not been. It's typically been cost management or cost investment. And it's been a cycle, you manage costs tight and then you invest. We're definitely trying to do both at the same time, and there's a lot of self-funding going on to try and mitigate the overall cost base. And that's how we're building out the 1,400 people in Mainland China because we're saving costs through other country exits or the market exits, reducing our support costs in some of the manual processes in our global processing centers, that's allowing that investment to take place. And that's been the journey for the past 3 years. On the SVB, the integration is going well. The business, we've had no nasty surprises since the day we bought the business. It was profitable the day we bought it. It is still profitable. We're going through systems migration at the moment. One statistic, which is probably an important guide for the future; in the 3 months post acquisition, we talk to bank customers at a higher rate than the 3 months prior to acquisition. So in the transition of ownership from the previous owners to us, we've seen an uptick in the momentum of customers wanting to bank with SVB in that first 3 months period. This acquisition has also given us the knowledge, the platform, the connections and frankly, the positive brand and reputation globally that has allowed us to go and recruit a team in the U.S. We've recruited a team here in Hong Kong, and we've recruited a team in Israel. So my view is that there are strong growth prospects in that business, not just for the next 2 or 3 years. I'm doing this because I think this will be an important business for us in the 5- to 10- to 15-year timeframe. This is an important sector of the economy, and we're willing to invest in it. So I'm very pleased with how it's going. We probably do owe you, as an investment community, more detail on so how material, what are the numbers. And I think we'll come back to you at the end of the year with if you add this all together, the investment and the current bought business, what could that potentially look like going forward and how material is that. But that is something, if it's okay, we'll give you more towards the end of this year with the full year results.

Operator, Operator

Back to lines and Tom Rayner and Sam will come back in about 5 minutes to you live, okay?

Tom Rayner, Analyst

Could you provide more clarity on your revised ROTE guidance for 2023 and 2024? I understand that there are significant notable items included. It seems the sale in Canada influences the consensus return. My concern is that this might obscure the true extent of the underlying upgrade you're expecting for return in 2024. I'm worried that the way you're now presenting the numbers, with notable items included, could complicate investors' understanding of the underlying business drivers and potentially affect your rating. I would appreciate your comments on this.

Noel Quinn, Group Chief Executive

Georges, do you want to pick that up, please?

Georges Elhedery, CFO

Our guidance for return on tangible equity in the mid-teens has been without considering notable items. This year, we had two significant items in the first quarter: a provisional gain of $1.5 billion from SVB and the reversal of a $2.1 billion impairment related to our French retail business. As we head toward year-end, we expect to reinstate this impairment in the second half, likely before the transaction closes on January 1. This notable item should balance out in our full-year expectations. For 2024, we anticipate the impact from Canada could add a couple of percentage points to our return on tangible equity. While this might stretch our mid-teens guidance slightly on both sides, we prefer to exclude it as it is still subject to further regulatory approvals. You can analyze the figures with or without that consideration.

Noel Quinn, Group Chief Executive

We are looking at a mid-teens ROTE, and in the first half, we reported a headline rate of 22.4% ROTE. After adjusting for two notable items, this adjusts to an 18.5% ROTE. Our guidance for mid-teens corresponds more closely to the 2018 numbers rather than those from 2022. Looking ahead to 2024, we expect to realize a profit from the sale of our Canadian operations, contingent upon the completion of that transaction, as well as a capital policy rider that includes dividends and buybacks. However, we are not factoring that profit into our guidance for mid-teens ROTE, as it falls outside our core business expectations. It’s important to clarify that our mid-teens guidance excludes significant one-time items, whether they are positive or negative. Our focus is on the fundamental aspects of the business as we provide this guidance.

Georges Elhedery, CFO

And just I think complementing that, we're not trying to change consensus at this stage where we see consensus for our ROTE for '23 and '24.

Perlie Mong, Analyst

I just got two questions. The first one is on parts of net interest income and especially in Asia. So if I look at your Asian entity for it look like revenues is truly is high quarter-on-quarter, but NII gone up a little bit. So that suggests me that there's fractionally down a little. Just wondering what you're seeing in front line, especially at the banks. And obviously, Hong Kong's GDP yesterday was quite a bit weaker than expected. So just what you have seen in contact and note of some expectations about the China business and to what extent you think that might help you. That's my first question. And then the second question is on the deposit migration in Hong Kong, as I just noted in Slide 41, it looks like the structure was very strong retail franchise, it looks like it was dissipating away. So does that suggest that the migration is maybe there in Hong Kong and may be eluding out.

Georges Elhedery, CFO

On the non-Net Interest Income related to wealth in Asia, the most significant increase is in insurance. Initially, when considering the impact of funding the trading book, which is reflected under non-NII and amounts to $1.2 billion, the growth primarily comes from insurance, especially in Hong Kong. Although insurance shows up in non-NII, it is not classified as fee income. This growth mirrors the 40% to 50% year-on-year increase we've experienced in the first quarter, influenced by the reopening of the border between China and Hong Kong, leading to an influx of new policies from Mainland Chinese clients. Currently, about 30% of new policies in Hong Kong originate from Mainland China. As anticipated, insurance is a fundamental element of our wealth management strategy here, and it is the primary factor driving this growth. However, we are noticing some weakness in Wealth related to equities trading, which aligns with overall market conditions. While Hong Kong's GDP significantly affects our loan portfolios and balance sheet growth, Wealth activity does not directly correlate with GDP; instead, it is influenced by investor behavior and market sentiment. Regarding your second question about deposit migration, at HSBC, we are observing a monthly migration rate of approximately 1%, although it slowed a bit in April. This pattern aligns with our forecasts. In contrast, Hang Seng, where term deposits hold a share in the mid-30s percent, is proactively managing highly rate-sensitive deposits. This strategy may result in some attrition from these rate-sensitive deposits, enabling them to maintain or slightly decrease their term deposit ratio. They benefit from a robust liquidity position and a strong deposit franchise, so they do not necessarily require highly rate-sensitive deposits at that margin.

Operator, Operator

Thank you. We've got a question from Sam. And then we've got one last question from the line. Sam, over to you.

Sam Alt, Analyst

Congrats on the strong results. Sam Alt from Jefferies. Just a very quick question on Hong Kong mortgage. Mortgage rate in Hong Kong right now is well below HIBOR. Many smaller banks are actually backing off from the mortgage market. So do you see mortgage pricing in Hong Kong going up and what would be the implications for that? So that's the first question. The second question is on China, there are a lot of macro concerns going on right now. So how would you navigate through the macro uncertainties as a bank?

Noel Quinn, Group Chief Executive

Okay. Thanks, Sam. Do you want to handle the mortgage and take the first part? Yes.

Georges Elhedery, CFO

So, our mortgage activities are continuing, and the rates are quite appealing for borrowers. We have seen a slight increase in our mortgage book, although it is not substantial. This growth is occurring despite the sluggish property sales in Hong Kong. The pricing of our mortgages is capped and closely linked to the savings rate. For example, last week we raised the savings rate by about 12.5 basis points on the Hong Kong dollar, which automatically adjusts the cap and consequently increases the mortgage pricing by the same amount. I view this as a natural progression with rates rather than a specific strategy or dynamic regarding mortgage pricing.

Noel Quinn, Group Chief Executive

In terms of the macroeconomic situation in China, we previously discussed that the international banks hold approximately 2% of the corporate debt market in Mainland China collectively. Therefore, expanding your Corporate Banking business as an international bank—especially if your focus is on connecting Mainland China with the rest of the world in both directions—doesn't solely rely on GDP growth. Even though GDP is still over 5%, which is decent, you can still achieve growth since you're relatively niche in a large market. Similarly, in our Wealth business in Mainland China, we are focusing on helping internationally oriented and particularly domestic customers in the Greater Bay Area access wealth and insurance products for their protection and savings needs. This initiative targets the affluent and emerging affluent sectors rather than just high net worth individuals. Our core business in Hong Kong has benefited significantly from a similar approach, serving as a strong driver of growth and profitability for HSBC. We believe there is a substantial long-term growth opportunity in the Greater Bay Area due to the connection between it and Hong Kong. Unlike three to four years ago, we are now aiming for international wealth and insurance as our main offerings instead of merely becoming another mortgage or card provider in Guangdong province. While it’s essential to be aware of the macro environment, we remain optimistic about the conditions for growth in our Mainland China business.

Operator, Operator

Last question from Joe Dickson from the lines, please.

Joseph Dickerson, Analyst

This is a follow-up question from Jefferies during the Q&A. A quick question: most have been addressed. Regarding the dividend query that Aman raised, the response was a bit lengthy. If I understand correctly, you would prefer the ordinary dividend to be progressive? Additionally, could you elaborate on the Hong Kong business, specifically the NIM trend that remained flat quarter-on-quarter? How much did the U.S. dollar-denominated business influence that? Looking at your rate sensitivity disclosures, the USD segment appears liability neutral. How much of the NIM change, particularly any adverse expenses, can be attributed to the U.S. dollar business? Or was it due to other factors?

Noel Quinn, Group Chief Executive

Let me address the dividend first. Our guidance for 2023 and 2024 indicates a payout ratio of 50%. Additionally, we have announced that a portion of the proceeds from the sale in Canada will be used for a $0.21 special dividend. However, we are not providing guidance on whether the dividend will increase or remain flat; we are solely indicating the 50% payout based on profits. As a management team, we aspire to see our profits grow. Nonetheless, we are not committing to a progressive dividend policy at this time. Our policy remains a 50% payout ratio, which will depend on our earnings.

Georges Elhedery, CFO

Regarding the Hong Kong net interest margin, the net interest income increased by $0.1 billion, while the banking net interest margin increased by $0.4 billion due to the non-net interest income component of trading funding rising by $0.3 billion. The calculation for net interest margin only considers the net interest income component, which is why it appears flat. However, we will soon enhance our disclosures related to banking net interest margin, providing greater insight into the overall margin when factoring in trading book funding. In terms of sensitivity to the US dollar, there is a similar dynamic occurring within the trading book funding. The dollar serves as a primary currency for funding many of our operations. Therefore, while analyzing net interest income sensitivity, the dollar behaves oppositely to most other currencies as it is a funding currency. Ultimately, the dollar funds our trading book, and our estimates indicate that approximately $1.3 billion of sensitivity is tied to the dollar, leading to a negative sensitivity of our overall balance sheet for a decline of 100 basis points.

Noel Quinn, Group Chief Executive

Well, I just want to say thank you very much for all of your questions and your time today. I really appreciate you spending some time with us. Just to close with a couple of comments. We've had a good first 6 months. I'm pleased with how the business is performing. We delivered an annualized return on tangible equity of 22.4% or 18.5%, excluding those notable items. And we've increased dividends and buybacks. I'm also confident about the future. We still have opportunities to drive growth and to diversify revenue while retaining tight cost control, and we have upgraded our returns guidance for 2023 and 2024. Richard and the team are available to you if you have any further questions. But in the meantime, have a good rest of the day. Thank you very much.

Operator, Operator

Thank you, ladies and gentlemen. That concludes the call for HSBC Holdings plc Interim Results for 2023. You may now disconnect.