Earnings Call Transcript - HSBC Q2 2020

Operator, Operator

Good morning ladies and gentlemen and welcome to the Investment Analyst Conference Call for HSBC Holdings plc's Interim Results 2020. 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, Sharon. Good morning in London and good afternoon in Hong Kong and thank you for joining us. I've got Ewen with me today and he will present the numbers in detail before we then go to Q&A. Let me start by saying that it's been another difficult quarter for our customers, colleagues, and communities, but I've been pleased with how HSBC has responded. This is still a hugely unpredictable environment. We are conscious of that on both a human and a financial level. And we are doing all we can to support our customers and colleagues through this very difficult period. Against that backdrop, we are satisfied with our first half performance. Our Asia business held up well and our fixed income businesses delivered strong revenue growth. This compensated for challenges in parts of the world that have been harder hit by the impact of COVID-19. The businesses that perform less well are those we are already changing. We will be accelerating our transformation in the second half of the year and making other necessary changes in light of the new circumstances since February. There's still a lot of uncertainty around, not least from the ebb and flow of COVID-19 and the steps needed to contain it. Our improved capital position and excellent funding and liquidity are the hallmarks of our strength and resilience, helping us to be there for our customers, while also building the future of the firm. Our focus remains on helping our customers through this immediate period, while making the changes necessary to serve them better over the long-term. The current geopolitical environment is clearly complex. Tensions between China and the U.S. inevitably create challenging situations for an organization with our footprint. But our businesses in Asia have shown good resilience and we will face any political challenges that arise with a focus on the long-term needs of our customers and the best interest of our investors. Turning to our second quarter performance. Our Asia businesses continue to show good resilience, contributing $3.6 billion of reported pretax profit and Global Markets grew adjusted revenue by 55%. Our profitability was most challenged in the businesses at the center of our transformation; Europe, the U.S., and the non-ring-fenced bank which were severely impacted by high expected credit losses. Overall, pretax profits of $1.1 billion were down 82% and adjusted profits were down 57% on last year's second quarter. ECLs of $3.8 billion were up on the first quarter, reflecting updated forward economic guidance in the U.K. in particular. We've updated our 2020 range for ECLs which Ewen will talk about later. The interest rate cuts made earlier in the year began to impact our revenue from March onwards. We responded by pulling the cost levers available to us, reducing operating expenses by 7% compared with last year's second quarter. We continue to attract significant deposits in the quarter. I'm pleased to say that our capital ratio increased to 15%, providing a strong and resilient platform from which to serve our customers and manage the economic environment. Turning to slide three, the resilience of our Asia franchise continues to underpin our financial performance. This was due to the quality and strength of our business and client list and to the speed and decisiveness of the COVID response which allowed many economies to restart sooner than others. The activity underpinning our Asia performance remains robust. We've increased our trade finance market share. Client FX volumes are lower but relatively resilient and retail car transaction volumes recovered in June following a dip during the pandemic. Adjusted revenues in individual markets have been broadly stable despite the economic slowdown. And Asia lending is up 1% and deposit is up 7% in the last 12 months. First half expected credit losses of $1.8 billion in Asia included a large single name provision in Singapore in the first quarter. Looking to the second half, parts of Asia and Hong Kong, in particular, have tightened COVID restrictions in recent days. This is something that we're all getting used to as cases rise and fall and we are hopeful that the quick response of the authorities will contain any new outbreak and minimize the impact. Looking at slide 4. We remain focused on helping our customers, colleagues and communities through the pandemic, with high operational resilience in the face of unprecedented volumes and customer interaction. Around 94% of our branches are currently open and all our customer contact centers have been fully operational throughout. We have now granted around $30 billion of debt relief for our personal lending customers through more than 700,000 payment holidays, on loans, credit cards, and mortgages. More than 172,000 wholesale customers have received more than $52 billion of lending support, $33 billion of that, through government schemes and $19 billion through HSBC-backed lending. We arranged more than $1.1 trillion of loan, debt and equity financing for wholesale customers in the first half, including more than $48 billion of social and COVID bonds. We also retained our number one ranking for sustainable finance bonds in a rapidly expanding market. We've invested heavily in technology driving digital transformation to connect more customers remotely and increase digital engagement during lockdown. Downloads of our HSBCnet mobile app for business were up 157% on last year's first half. The value of mobile payments in the second quarter was up more than 200% on the same period last year. And digital wealth sales rose significantly year-on-year up 44% in Singapore, 38% in Hong Kong and 29% in Mainland China. The strength of our COVID response contributed to a sharp increase in customer satisfaction with double-digit increases in several retail markets record satisfaction scores in Trade and Global Liquidity and Cash Management, and Global Banking and Markets being voted number one standout FX dealer for global corporates in the recent Greenwich Buy-Side Study. Throughout all this, we maintained exceptional balance sheet strength and strong funding and liquidity with a CET1 ratio of 15% and $133 billion of first half deposit growth. Turning to our transformation program. While we slowed progress in some areas, in response to the pandemic, we laid good groundwork for the rest of the year, and we'll be accelerating our plans in the second half. We lifted the pause on redundancies in June and we'll be moving forward with those plans, thoughtfully but purposefully. We've already seen around $300 million of cost savings in the first half, with a further $500 million estimated in the second half from our transformation activities. This is slightly below the $1 billion of transformation savings we promised for this year, because of the pause on redundancies, but we expect to make up the difference in 2021. In the meantime, we've taken additional action on discretionary costs and we expect to make many of those savings permanent. On the rest of our transformation, we've completed the combination of RBWM and Global Private Banking and we're making strong progress in the back-office integration of Commercial Banking and Global Banking. As you've seen the areas of weakness in the second quarter were the areas that we're already committed to changing. We're confident that the actions we've identified in February are the right actions to take. But we're obviously looking at what more we need to do given the changed economic and monetary environment. We've created the structures to reduce RWAs in Global Banking and Markets and made a gross RWA reduction of $21 billion in GB&M in the first half of the year. In the U.S., lower interest rates posed a challenge to our U.S. retail strategy, and that's something we're looking at. But the U.S. business has already closed 80 branches and we're on track to reduce U.S. Global Markets, RWAs by around 45% by the year-end. In Europe, we simplified our management structure and have a new team in place to push through the transformation. I want to finish by talking about one of the most exciting growth businesses and that's wealth. In 2018, we set out a plan to capture the growing global wealth opportunity centered on Asia. And we've been investing to grow that business ever since. In the last 12 months, we've grown our Jade and Premier customer numbers by 6% and our wealth balances by 3% with around half of this growth coming in Asia. In our Asset Management business, we've grown assets under management by 5% and private bank client assets by 4% over the same period. In June, we launched Pinnacle, which is a new platform to significantly step up our wealth business in Mainland China. This allows customers to access a full suite of wealth services including insurance in one place which is unique for any Chinese wealth platform. We're investing to bring our wealth capabilities to new customers in China and we intend to grow the number of wealth planners in phases over the next four years. The Greater Bay Area, Wealth Management Connect program which was announced in June only enhances the wealth opportunity. And we're excited at the chance this gives us to serve more people in the region. With that, I'll pass over to Ewen to go through the numbers.

Ewen Stevenson, CFO

Thanks, Noel and good morning or afternoon all. Given the impact of COVID-19, our second quarter was tough. We had an 82% fall in reported profit before tax and a 57% drop in adjusted profit before tax. There were a couple of bright spots, Fixed Income and Global Markets was a standout together with a resilient performance by Hong Kong and other parts of our Asian franchise. Overall, our results were heavily impacted by lower revenues from subdued customer activity in many parts of our business and the building effect of ultra-low interest rates, the second quarter in a row of very high ECLs and a $1.2 billion software intangible write-off largely as a result of the weak return outlook for our non-ring-fenced bank. Adjusted revenue was down 4%. This included a $507 million benefit from volatile items, which in part reduced reversed some of the negative impacts we saw from mark-to-market movements in the first quarter. ECLs were up on the first quarter at $3.8 billion or 148 basis points of gross loans with the largest impacts in the U.K. and Commercial Banking. We've continued to take action on cost to adjust for the weakened revenue environment. Our adjusted operating costs fell by 7% against the second quarter of last year. Despite the weak macro environment, our balance sheet metrics continue to improve. Our core Tier 1 ratio was up 40 basis points to 15% in the quarter and customer deposits grew by $85 billion. Our first half return on tangible equity was 3.8%. That's down from 11.2% for the same period last year. And our tangible net asset value per share of $7.34 was down $0.10 on the first quarter due to movements in own credit adjustments. Turning to slide 9. Looking across the three global businesses. In Wealth and Personal Banking revenues were down 12% with Retail Banking revenues falling by $809 million due largely to the impact of falling interest rates on liability spreads. At a headline level, Wealth Management revenues were broadly stable, but excluding positive market impacts and insurance manufacturing down 17% due to lower sales volumes. Commercial Banking revenues were 14% lower due mainly to the impact of lower margins on Global Liquidity and Cash Management and lower volumes in Trade Finance. In Global Banking and Markets revenues were up 24%. Global Markets grew by $755 million, which we achieved while keeping traded value at risk broadly stable. This included an excellent performance in our fixed income franchises up 79%. Principal investments revenue grew by $185 million primarily due to the material reversal of the mark-to-market losses we saw in the first quarter. In Corporate Centre revenues were $90 million lower with $157 million of adverse movements in valuation differences on our long-term debt and associated swaps. Just to remind you all, that the second half usually sees lower revenues from non-interest income in Global Banking and Markets and Wealth. And given the buoyant Global Markets revenues in the first half, we expect that seasonality to be more pronounced this year. On slide 10, net interest income was $6.9 billion down 9% against the first quarter. The net interest margin was 133 basis points down 21 basis points on the first quarter of which 20 basis points came from the fall in interest rates. While we're beginning to see some modest asset repricing, we still expect recent interest rate cuts to have a negative impact of more than $3 billion for 2020 with a further significant negative impact expected in 2021. Turning to slide 11. Adjusted operating costs were 7% lower than the second quarter in 2019 and down 5% in the first half relative to the first half of 2019. As a result of the operational impact of COVID-19, we're spending less on certain discretionary cost line items. We expect this to lead to some permanent benefits in our cost structure relative to previous planning assumptions. We're being disciplined on variable pay accrual in line with lower expected profits this year, and we've restarted the cost reduction program that we announced in February. At the end of June, headcount including contractors was down 8,300 in the last 12 months, and down 3,800 since the start of the year. As we signaled at our first quarter results, we're now planning for full year 2020 costs to be below 2019 run rate. As you do your modeling and operating cost for the second half, please don't use the first half run rate as a guide. Second quarter costs were low due to COVID-19 and we expect both a step-up in investment in technology spending and the high U.K. bank levy due to strong growth in our deposit base. On the next slide, we saw a further substantial ECL charge in the second quarter, some $3.8 billion or 148 basis points of gross loans, $3.3 billion of which were Stage 1 and Stage 2 charges. This reflected extra forward economic outlook charges across all global businesses and regions particularly in respect of the U.K. and Commercial Banking. U.K. expected credit losses were $1.1 billion higher than in the first quarter, reflecting the worsening economic outlook, of which $900 million of these related to our U.K. ring-fenced bank. Stage 3 ECL charges were broadly stable at around $1.5 billion in both the first and second quarters, although the first quarter did include a significant charge on a single name corporate exposure in Singapore. Recognizing the deterioration in the economic outlook in the second quarter, we've updated our range for full year group expected credit losses to $8 billion to $13 billion. Given the first half ECL charge of $6.9 billion, adding the current run rate of Stage 3 losses for the second half gives a full year ECL charge of around $10 billion. The range either side of this broadly reflects our disclosed economic sensitivities. The lower end reflects a path closer to our consensus Central economic scenario, reflecting a strong economic rebound in 2021 with some unwinding of the economic adjustments taken to date. The higher end of the range reflects a path closer to our downside economic scenario with a much more muted economic rebound in 2021 leading to further negative ECL adjustments for forward economic guidance in the second half. I would caution that there remains a wide range of potential outcomes including the risk that the upper end of the range may need to increase further. And in that respect I would encourage you to read our expected credit loss sensitivities in the interim report. On slide 13, our core Tier 1 ratio at the end of the second quarter was 15%. That's up 40 basis points in the quarter. Core Tier 1 capital increased by $3.2 billion. This reflected lower regulatory deductions for expected losses, FX movements, fair value gains through other comprehensive income and a reduced prudent valuation adjustment. On the next slide, risk weighted assets rose by $11.2 billion in the first half or $33.2 billion excluding FX movements. This was mainly due to a $23.3 billion asset side movement, mostly relating to first quarter lending growth and also a $16.8 billion increase from changes in asset quality due to credit rating migration. Our $100 billion gross risk-weighted asset reduction program is underway with $12 billion of additional savings from Global Banking and Markets in the second quarter. We continue to expect credit migration to cause RWA inflation in the second half, partially offset by progress against our gross RWA reduction program. So in summary, a difficult quarter overall, a few bright spots, Asia resilience and a strong quarter for fixed income. But overall many parts of the business were hit by very high ECLs and significant revenue pressures. As we look out to the second half, there remains considerable uncertainty; the continuing impact of COVID-19, the ongoing Brexit negotiations, and U.S.-China tensions and any impact this has on our Hong Kong franchise. As such, it's too early to discuss distribution policy or medium-term return targets and we don't expect to do so until our full year 2020 results in February. However, we're pleased that we face into this uncertainty with a strength in core Tier one ratio of 15%, an extra $85 billion in customer deposits, continued vigor in managing our cost base and the benefit of a diversified portfolio of franchises globally. Noel and I remain very committed to the plan we announced in February namely a material reduction in RWAs, particularly focused on the U.S., the non-ring-fenced bank and Global Banking and Markets with a reallocation of capital towards our strongly performing Asian franchise, a significant reduction in the operating cost base of the bank and a material reduction in the operating complexity of the bank.

Operator, Operator

Thank you, Mr. Stevenson. Your first question this morning comes from Martin Leitgeb at Goldman Sachs. Please go ahead. Your line is open.

Martin Leitgeb, Analyst

Good morning and thank you for the presentation and your comments. My first question is regarding the challenging revenue outlook you've mentioned. What potential offsets do you see? Has your perspective on the smaller retail franchises changed? You also referenced a reassessment of the U.S. strategy. Are there other offsets you are considering, such as volume growth or a notable increase in volume in U.K. mortgages, or possibly adjustments in how you charge for accounts like current accounts or corporate deposits to address the revenue challenges? My second question is about capital. Concerning the core Tier one trajectory moving forward, should the majority of the credit migration you anticipate, with mid- to high single-digit RWA inflation this year, occur this year, or could it extend well into 2021? I’m looking at the numbers and guidance you’ve provided, as it seems that based on your impairment guidance, you are likely to remain comfortably within the mid to upper end of your core Tier one target range. Thank you.

Noel Quinn, Group Chief Executive

Okay. Martin, thank you. Let me deal with some of the revenue offsets first and then ask Ewen to comment on that and the capital position. With respect to our U.S. business, they actually had a very strong Q2 in the U.S. business. Their revenue in Q2 of this year was the highest quarterly revenue since Q4 of 2017. I'm also pleased with the way that Michael and the team have started to execute on the transformation plan. They've already closed around 80 retail branches on the East Coast of America, which is around about a 50% reduction. And they've been successful in retaining around about 85% of the deposit base even though they've gone through that reduction program. And they're also well on track on their cost reduction plans as well where they've already completed 50% of the planned 2020 staff exits and are on track to meet or exceed the goal we set them back in February of this year, so progress on the transformation. We clearly need to understand the full economic impact of the lower interest rate environment, but we're committed to transforming that business and improving the returns. On a broader basis on revenue, we're clearly looking at what other options we have to mitigate some of the revenue shortfall from lower interest rates. And we see wealth and growth in our Wealth business as an opportunity for that. And I'll ask Ewen to comment more on that in detail. But we're exploring all options to look at revenue mitigation.

Ewen Stevenson, CFO

Yes, Martin. Regarding net interest income, we are starting to notice some repricing on the asset side, especially in Asia. It's still in the early stages, but we believe there is potential. Additionally, in Hong Kong, we are seeing a shift back towards current accounts and away from term deposits, which is not surprising given the current rate environment and should help reduce some pressure on liability margins. For non-interest income, customer activity is currently very subdued, largely due to the impacts of COVID. Therefore, as we move into 2021, I think we can expect some recovery in customer activity. In terms of government-related lending in the U.K., we've increased our market share, capturing about 15% of bounce-back loans and 20% of other lending schemes, which exceeds our usual market share in commercial lending. I believe we will be cautious regarding U.K. mortgages, given the current economic outlook and the uncertainties surrounding Brexit. Moreover, we can mitigate revenue losses by improving cost management, and as you noticed this quarter, we've made some progress in that area. This quarter was unique due to COVID, as many of our head offices were largely closed. However, we anticipate that coming out of COVID will present opportunities to make some of these operational shifts permanent. On RWAs, similar to ECLs, they are expected to peak this year, leading to a reversal in ratings migration into 2021 and 2022. Although this will lag behind trends on ECLs, we anticipate additional ratings migration pressure in the second half of this year, which is why we are maintaining our RWA guidance of mid to high single-digit growth for this year. Regarding capital, we do not expect Global Markets to replicate their first-half performance of just over $4 billion; they generated $2.6 billion in the second half of last year. Additionally, considering the strong deposit growth, the U.K. bank levy may increase rather than decrease for us this year. Therefore, we believe that the combination of these factors and some RWA inflation will cause core Tier 1 to decline between now and the end of the year. Previously, we guided a capital range of 14% to 15%, aiming for the higher end during 2021. If we reassess that now, we would be comfortable in the 14% to 14.5% range instead of moving toward 15%.

Martin Leitgeb, Analyst

Perfect. Brilliant. Very clear. Thank you. Thank you very much.

Operator, Operator

Thank you. Your next question comes from the line of Tom Rayner, Numis. Please go ahead.

Tom Rayner, Analyst

Can you provide more details on the net interest income guidance? It's projected to be greater than $3 billion. Based on the sensitivity analysis on page 87, there has been a noticeable increase in rate sensitivity for both the first and second year impacts. Since rates have generally decreased, has there been any adjustment to that greater than $3 billion projection, perhaps moving from slightly greater to significantly greater? Looking ahead, how confident are you that 2021 will be the low point for net interest income? It may be challenging to forecast 2022, but do you believe that some recovery in volume and asset repricing could help counteract the negative effects of lower rates? Thank you.

Ewen Stevenson, CFO

Yes. So there's no change, I think, in terms of net interest income guidance for this year. You do have to adjust for the shift in dollars, FX movements. But my only caution around that is, obviously, HIBOR has come down a bit further in July relative to the end of Q2. That interest rate sensitivity is the interest rate sensitivity from here with lower interest rates, so it has gone up because of the flooring effect on some of the liability product, but that's if interest rates shift down from here. I think you will, in some books, obviously, see accumulating effect as you can see in those interest rate sensitivity table. So we do think there'll be another meaningful net interest income hit in 2021, as we currently sit. Yes, as you look out to 2022, when I checked a few days ago, consensus views on policy rates where they were broadly going to stay at current levels 2020, 2021, and 2022 and begin to rise in 2023. I would hope by the time we got into 2022, unless you were completely there that you would be seeing sustained economic recovery which means back to growing loan books again, asset side repricing coming through more powerfully and therefore, yeah the start of a recovery in net interest income.

Tom Rayner, Analyst

Thank you. I have a quick follow-up question. Can you provide any details on the scale of the capital benefits you mentioned that are expected in the second half, particularly related to the software and SME changes? They seem significant.

Ewen Stevenson, CFO

There's a lot happening in the second half. We anticipate core asset growth to be relatively subdued. There will be some advantages from the RWA rundown program, along with modest gains from regulatory changes, although we do face some offsets, such as TRIM in Europe. The main focus will likely be on ratings migration. However, all these factors are included in our guidance of mid-to-high single-digit RWA growth. Additionally, the software intangible likely contributes no more than 20 basis points to core Tier 1.

Tom Rayner, Analyst

Okay. Great. Thanks a lot.

Operator, Operator

Thank you. Your next question comes from the line of Ed Firth, KBW. Please go ahead.

Ewen Stevenson, CFO

Morning.

Ed Firth, Analyst

Hi everyone, I have two quick questions. First, regarding the NII, I want to clarify your statement. If I look at the implied second half based on the current run-rate, it seems your second half is annualizing around $25 billion. When you mention further pressure into 2021, does that mean additional pressure from the second half run-rate, or does it already account for the pressure you're experiencing? Should we expect more pressure moving forward, or are we currently at that point, with the annualizing effect only becoming relevant as we approach next year?

Ewen Stevenson, CFO

Yes you can get there various ways. But if you annualize the second half as you set out, I think you're sort of broadly, in the ballpark of where you need to be.

Noel Quinn, Group Chief Executive

On the U.S.-China pressures, as you can see from the first half results, we have experienced a very strong performance in our Asia business, particularly in China during the second quarter. Our profit in China for the second quarter increased by approximately 29%. We have also observed strong deposit growth in our Asia business. The deposit growth in Asia during the second half of the year was quite significant.

Ewen Stevenson, CFO

$27 billion.

Noel Quinn, Group Chief Executive

We are reporting $27 billion and have not observed any significant impact on our business performance from U.S.-China tensions in the second quarter or the first half of the year. Looking ahead, we remain dedicated to supporting our customers across all the regions they operate in. We believe there is an important role for an international bank in helping our clients with their international trading and expansion needs. While I can't predict what may happen regarding sanctions, I want to emphasize that our business in Asia has performed exceptionally well in the first half of this year.

Ed Firth, Analyst

Okay. Thanks so much.

Operator, Operator

Thank you. Your next question comes from the line of Guy Stebbings, Exane. Please go ahead. Your line is open.

Noel Quinn, Group Chief Executive

Guys hi.

Guy Stebbings, Analyst

Hi. Thanks for taking my question. Firstly, can I just ask on Wealth? It was quite a good quarter but included the insurance manufacturing. So if we adjust for that I think it was down around about sort of 10% in the second quarter. Just trying to think, how should we be thinking about that line going forward? Because it seems there's quite a lot of disruption in that business but I was hoping it maybe is improving versus the first quarter.

Noel Quinn, Group Chief Executive

I'll give you a first response on that is, clearly, new business activity will be down from normal levels of new business activity. So you would have seen a rebound in the financial performance because the manufacturing part of the business had a claw back on some of the mark-to-market adjustments that were experienced in Q1. But new business activity of selling Wealth products would have been impacted in April and May but we started to see a pickup in that activity in June. So I think that that's what you would have expected, to have seen given the impact of COVID.

Ewen Stevenson, CFO

Yes, we've noticed some changes facilitated by regulators allowing a transition from in-person business to selling Wealth products through digital channels. However, 2020 is expected to be a low point for Wealth, assuming an economic recovery takes place in 2021. Additionally, we should keep an eye on the reopening of the Mainland China border with Hong Kong, which will certainly provide support.

Guy Stebbings, Analyst

Okay. Thank you. And then the second question was just on costs in the context of the D&I headwinds, which we already talked through. And obviously, a very good quarter, down 7%. Suggest the run rate could be quite a lot more than the targeted 3% plus but you've called out that investments comes a bit low at Q2. I think Q2 2019 was particularly elevated. So just trying to gauge how much should we be tempering our enthusiasm relative to the 7% we saw in the second quarter? Thank you.

Ewen Stevenson, CFO

Yes there's a few things. I mean second quarter yes, effectively most of our workforce, roughly 200,000 out of the 235,000 employees were working from home. No one was traveling. Office costs, central office costs were very low. So I would just be cautious that using that as a guidance. In addition, marketing spend was materially down too because we took a very conscious decision to market less in the second quarter. I would think if you – and then offsetting that, I said we're planning to step up investment spend. But in the second half, we think bank levy is probably going to go up rather than down this year. So yes, probably 3% to 4% down for the full year feels better than what you saw in the second quarter.

Guy Stebbings, Analyst

Okay. Very helpful. Thanks.

Operator, Operator

Thank you. Your next question comes from the line of Manus Costello, Autonomous. Please go ahead.

Manus Costello, Analyst

Hi, I just had a question about the retail business. Your big improvement in NPS is very impressive. I wonder to what extent is the flip side of weaker returns for shareholders? Customers obviously feel like they're getting a good deal. And you mentioned this Noel, but I wonder if you could give a bit more detail. How might you think about addressing that balance between customers and shareholders in the retail business going forward such that you can boost shareholder returns and maybe spend some of the NPS improvement?

Noel Quinn, Group Chief Executive

Manus, thank you. I'm very pleased with the NPS performance in both retail and the bank as a whole. And I think we look at that very much as a positive. I attribute it to two things and that is the quality of the support our colleagues provided to customers in the first and the second quarter of this year. They really responded amazingly well. We've lots of outreach to our clients to make sure they understood where they stood and responded to their concerns. Plus we put in place some new digital support programs to make sure that we had regular dialogue with them and they were able to transact despite the fact that we couldn't serve them face-to-face. And I'd also point to the fact that we provided our customers, particularly in retail with circa $30 billion of payment holiday support and our commercial or wholesale customers with around about $52 billion of credit support in response to COVID. So I think those were the right things to do. And I believe supporting clients at a time of stress is a good thing for any bank to do. In terms of translating that into higher returns for the future, we're clearly looking to extend the use of digital and lower the cost to serve. We're looking to increase further our penetration of the wealth market, particularly in Asia and to diversify our revenue stream away from pure NIM or NIM and into NFI sources of revenue. And we believe that our opportunity to grow wealth in China is strong and our Wealth in the rest of Asia is strong and that can lead to higher returns. We're also looking to improve the returns in our retail business by taking down our cost base.

Ewen Stevenson, CFO

Yes. Manus I wouldn't think the two are inconsistent in the slightest. Improved NPS, where we have the highest NPS scores, they typically correlate with digital distribution. And digital distribution as you know is lower cost to serve than physical distribution. So actually I view that improvement in NPS as excellent and reflect a lot of work that Charlie Nunn and his team have been putting in to improving the quality of the digital offering we've got. And you saw in the slide that Noel put up earlier, one of the outcomes of COVID has been a very rapid acceleration in some cases by several years in terms of digital engagement from our customer base. Yes, that's both good for NPS, but it also should be good over the medium term for how we can adjust and accelerate our cost structure.

Noel Quinn, Group Chief Executive

So it'll be more a question of as you say the cost structure rather than thinking about changing fee structures or anything to help improve the top line? It will be about...

Ewen Stevenson, CFO

I think it's a combination. I think it's adjusting to the new revenue realities of today's world plus our continued focus on cost and continued focus on providing good quality service. It's a combination of those three things together.

Noel Quinn, Group Chief Executive

I mean, the thing that we are going to have to think about on revenue Manus is just in an environment of ultra-low interest rates where you are not earning a return on your liability product. Yes do – we need to think about adjusting some of the cost structure to a more fee-based cost structure, but we're sort of early into that thinking.

Fahed Kunwar, Analyst

Hi. Good morning. Thanks for taking my questions. Just a couple of questions. The first one just back on NII, I think I heard you say the first half 2020 run rate that the annualized net asset was broadly correct. So I understand, why that's the case because HIBOR looks like it's down probably about 100 basis points kind of first half versus where it is right now. So how does 2H 2020 NII hold up so well in the face of HIBOR coming down to that extent? And the second question, I had was just on the U.S.-China situation.

Noel Quinn, Group Chief Executive

Ewen, do you want to do with the NII?

Ewen Stevenson, CFO

Yeah. On the NII we had always assumed that HIBOR was going to normalize towards dollar interest rates in the second half so that might be the disconnect in your modeling. But yeah, I don't have the benefit of your model. But I think what we said is broadly true that in terms of the previous answer to the other question.

Noel Quinn, Group Chief Executive

I think on the second part...

Fahed Kunwar, Analyst

Sorry, as follow-up on that, I think your sensitivity is now about a 30% increase in terms of the year two impact on NII versus the year one impact. Is that a decent kind of way to think about the cumulative hit to year two NII? Or is there anything to mitigate that size of increase?

Ewen Stevenson, CFO

Yeah, but I think as you think about that interest rate sensitivity, it's interest rate sensitivity from here i.e. that we've already had the first half impact on rates. So it's not a clean read across, I think. So be careful about how you interpret that interest rate sensitivity, because it's from here rather than where it was at the start of the year.

Noel Quinn, Group Chief Executive

Thank you. On your second point, I think there are – I'm not going to get into speculating on what actions may or may not be taken between respective governments. It's not my role to do that. At the end of the day, I'm a banker not an economist or a politician. But clearly, there are potential impacts on general economic confidence from any form of trade tensions and that will have an impact on all financial institutions. There is clearly potential for changes in supply chains. Over the past 155 years, we have witnessed many shifts in supply chain activity, and we will continue to adapt to whatever comes our way in the future. We strongly believe in the strength of the PEG, so we do not view it as a significant risk. We consider the PEG to be solid and well-supported, and see no threat to it. There is also the possibility of sanctions against individuals or entities, but I will not speculate on whether they will occur or what impact they might have. It is not my role to do so. To be straightforward, if you evaluate the performance over the first six months, it has primarily been affected by COVID, rather than being significantly influenced by political tensions or geopolitics. Most of the impact in the first half of the year is related to COVID.

Rob Noble, Analyst

Morning all.

Noel Quinn, Group Chief Executive

Morning.

Rob Noble, Analyst

Just a clarification on whether there are any more excess expected losses within your capital. Was any excess expected loss deducted from capital? Is that all eliminated now? And do you need to rebuild that going forward into 2022, 2023, or whenever it is? Thanks.

Ewen Stevenson, CFO

Yes. We've got some disclosure I think at the back of the slide back on that. Sorry just trying to find it but it is in our slide pack. And if not I can get IR to follow-up with you.

Noel Quinn, Group Chief Executive

Okay. Next question.

Operator, Operator

Thank you. Our final question is from Joe Dickerson from Jefferies. Please go ahead.

Joe Dickerson, Analyst

Hi, just a quick one. So, you've taken this extra charge provision charge in the U.K. and noted the downside risks to the economy. And I think you made some similar comments at Q1 about the relative weakness in the U.K. Can you just help me square the circle? I mean, if I look at your mortgage balances they're up 6% year-on-year in the ring-fenced bank which is like 2 times the industry growth. Can you just help me square the circle between the two views and whether or not you feel like you're being appropriately paid for this risk given your caution around the U.K.? Thanks.

Noel Quinn, Group Chief Executive

Ewen, do you want to?

Ewen Stevenson, CFO

I mean, I think yeah, where we're concerned about credit in the U.K., I think it's more on the commercial side than the retail side. The mortgage book, if you look at the average LTV of new lending, you look at where their book is overall in terms of the average LTV. You look at the returns that we're still generating out of that business I think, we're getting adequately and more than adequately compensated for the downside risks. And mortgages, consumer debt, credit card spending has declined markedly over the last few months as a result of COVID. And I think folk have been using things like mortgage relief to pay down consumer debt. So, consumer balances have fallen as a result of that, and therefore, less for us to ECLs. It's really on the commercial side that I think we've got more sensitivity and you can see that. And you can see that in the overall level of commercial provisions, commercial ECLs, which are over $2 billion in the quarter relative to retail. I don't think the two views are inconsistent at all. Our sweet spot in mortgage lending is typically prime mortgage lending where we think we are running relatively low risk and getting adequately compensated. The other thing, I'd say, is you can look at the stress characteristics of our portfolios in the Bank of England, ACS results. What you see there is relatively strong outperformance in retail and still outperforming in wholesale versus U.K. peers.

Joe Dickerson, Analyst

That's very helpful. Thank you.

Operator, Operator

Thank you. Our final question comes from the line of Aman Rakkar, Barclays. Please go ahead.

Noel Quinn, Group Chief Executive

Hi, Aman.

Aman Rakkar, Analyst

Good morning. I have a couple of follow-up questions. I understand you cannot comment on the dividend, but could you clarify if you finished at the top end of your ECL guidance? Is there a possibility that you might make very little profit this year or even face losses? I’m curious if you believe that could affect your ability to resume dividend payments in February, should you be experiencing losses, or do you think your strong capital position will prevail?

Noel Quinn, Group Chief Executive

Let me deal with the second one first. I mean, we're clearly committed to delivering on the cost reduction program that we identified in February. We also need to reflect the fact or respond to the fact that the revenue is softer now than it was in February. I mean looking at what additional measures we need to take. So, you're right to say that we're looking at what other additional actions we can take on revenue or costs or capital to improve the returns. But, we'll got no details to talk through on that at this point in time. And we have to see how COVID develops over the next quarter or two quarters to determine how enduring this revenue position and cost position is going to be. But we committed to delivering that which we said in February and looking at additional actions as required.

Ewen Stevenson, CFO

Yes. So, there are a couple of other points regarding COVID, which certainly presents some opportunities, though we will need time to determine how lasting these changes will be. Earlier, we mentioned a significant increase in digital engagement from our customers. This will enable us to reassess our assumptions about the balance between physical and digital distribution in the medium term, as well as our approach to workforce dynamics, including implications for our commercial real estate portfolio and earlier travel assumptions. Overall, COVID has provided a unique chance for us to rethink our engagement and work as a team. However, as Noel mentioned, it's too soon to provide a detailed model on this. By the time we present full-year results, we expect to have more comprehensive insights to share on the matter.

Noel Quinn, Group Chief Executive

Regarding dividends, the two ends of the ECL range indicate different scenarios. The high end suggests that you are likely experiencing significant impacts from other factors due to a deeper economic recession and a slower recovery into 2021. This situation will lead to higher levels of RWA inflation, which means the impact on RWAs will also put considerable pressure on your core Tier 1. Conversely, at the lower end of the range, you would be looking at a more favorable and stronger recovery into 2021, with less RWA migration and a greater sense of confidence about the outlook for 2021 and 2022. So, it's somewhat uncertain at this time. We believe we'll gain significant insights over the next six months regarding COVID, particularly concerning the effects of the second and third waves on different economies globally and the prospects for an effective vaccine in 2021. We will have more information about our position regarding Brexit and another six months' worth of insights into geopolitics, which should help us develop a clearer understanding of any effect this may have on our business, especially in Hong Kong. That's why we've decided to delay discussions about dividends until we provide our full year results. We recognize the importance of this for our equity story and are eager to restart distributions as soon as possible. However, we prefer not to make definitive statements until we have a clearer perspective on the economic conditions we are facing.

Aman Rakkar, Analyst

That's fair. All right. Thank you very much both.

Operator, Operator

Thank you.

Noel Quinn, Group Chief Executive

So, thank you so much for joining us today and it was good talking to you.

Operator, Operator

Thank you ladies and gentlemen. That concludes the call for the HSBC Holdings plc interim results 2020. You may now disconnect.