$10.6 billion hit

HSBC Holdings (HSBA.L) on Monday said its 2006 profits rose 5 percent, just short of analysts’ expectations, as Europe’s biggest bank took a $10.6 billion hit for bad debts after problems in its U.S. mortgage lending.

HSBC (0005.HK) reported a record 2006 pretax profit of $22.1 billion, up from $21 billion in 2005, but below an average forecast of $22.4 billion in a poll of analysts by Reuters Estimates.

Headquartered in London with about 125 million customers worldwide, HSBC said there had been no further deterioration at its troubled U.S. mortgage lending since it warned about the deepening problem a month ago, and it was confident the problems would not spread to other areas.

By midday HSBC shares were up 0.3 percent at 889 pence, valuing the bank at 103 billion pounds ($200.9 billion), against a 1.65 percent drop in the FTSE (^FTSE - news) index.

The bank reported strong growth in Asia, Mexico and its emerging markets, and in its private banking and investment banking arms, but what it called a "major setback" in U.S. mortgage lending cast a shadow across the group.

HSBC had already warned on February 7 that problems had deepened in its lending to higher risk U.S. home borrowers, prompting it to oust the head of its North America operations and restructure the business.

"It has not deteriorated (since then)," Douglas Flint, finance director, told reporters on a conference call.

He said the level of bad debts this year will be sensitive to economic conditions, the housing market, interest rates levels and the availability of refinancing options for sub-prime borrowers.

A downturn in the U.S. housing market has hit many lenders in recent months and HSBC said it was acting conservatively to include provisions for mortgages it expects to lose money on in the future.

Mortgages are frequently bought and sold in the U.S. mortgage market, and in recent years HSBC became a big buyer of sub-prime loans originated by other lenders.

It focused on buying second-lien loans, also known as "piggyback loans," which borrowers, who are unable to afford a 20 percent down payment, assume in addition to the primary mortgage.

Flint said its U.S. Mortgage Services arm had stopped lending higher risk products and no longer offered second-liens.

Michael Geoghegan, chief executive, also dismissed criticism that HSBC’s acquisition of Household International for $14.8 billion in 2003 had exposed the bank to too much risky lending. The business has been renamed HSBC Finance.

"This is not trailer park lending. The average household income of a typical HSBC Finance customer is $83,000. The typical profile is a 41-year-old with two children and a home worth $190,000 — the customer base is in line with the demographics of the USA," he told analysts at a presentation.

"This is Main Street America."

Mark Durling, banking analyst at Brewin Dolphin, said last month’s warning cushioned the impact and HSBC is seen as conservative in terms of impairments.

"There is some more (bad debt) pain to come, but not as bad as what the market has factored into the share price," he said.

North American bad debt soared to $6.8 billion in 2006 from $4.9 billion, representing 64 percent of the group’s total, even though the region only accounts for 21 percent of profits.

Bad debts in Europe, which are mostly in the UK, rose 12 percent on the year to $2.2 billion. Underlying bad debts in the UK were up 8 percent from 2005, in line with its lending growth, and bad debts in the UK retail bank were near flat on the year.

Flint said UK impairments from higher bankruptcies and individual voluntary arrangements were offset by its tighter lending on unsecured loans in the last two years.

CIBM GROWTH SLOWS

HSBC’s investment bank arm, CIBM, posted a 12 percent rise in profits to $5.8 billion, aided by buoyant capital markets, although the unit’s profit growth slowed from 37 percent in the first half.

"In the third quarter there was a significant slowdown in flow from client revenues," Flint said. "The fourth quarter bounced back, so we had three good quarters and one weak quarter."

HSBC said its income rose 14 percent to $70.1 billion, matched by a 14 percent rise in cost growth.

Its costs as a ratio of income nudged to 51.3 percent from 51.2 percent in 2005.

It raised its full-year dividend by 11 percent to 81 cents per share, just above analysts’ expectations.

It said Asia, Middle East, Latin America and other emerging markets were contributing faster growth to the group and it would concentrate future investment mainly in those markets.

In mature markets it will enforce tight cost control and dispose of businesses that dilute its return on capital or do not fit strategy, it said.