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Group Chief Financial Officer's review

Back to growth and improving returns

Summary of financial performance

The Group delivered a strong performance in 2022 generating a 120 basis point uplift in underlying return on tangible equity to 8.0 per cent with underlying profit before tax increasing 15 per cent on constant currency basis. Income at $16.3 billion, grew 15 per cent on a constant currency basis excluding DVA, and is at its highest level since 2014, with a record performance in Financial Markets and strong expansion in the net interest margin. Loans and advances to customers grew an underlying 3 per cent despite the rising interest rate environment. Expenses increased 9 per cent at constant currency, due to continued investment in the business, salary inflation, and increased performance-related pay on the back of business performance. Credit impairment charges increased to $838 million including further charges relating to the China commercial real estate sector and the impact of sovereign-related downgrades. However, the loan-loss rate of 21 basis points remains well below our historic through-the-cycle loan loss range. The Group remains well capitalised and highly liquid with a CET1 ratio of 14.0 per cent at the top end of its target range enabling the Board to announce a 50 per cent increase in the full-year dividend and a further $1 billion share buyback programme to start imminently.

All commentary that follows is on an underlying basis and comparisons are made to the equivalent period in 2021 on a reported currency basis, unless otherwise stated.

•  Operating income increased 10 per cent, or 15 per cent on a constant currency basis, normalising for a $27 million positive movement in DVA. About half of the growth in income was from strong, sustained business momentum, through a combination of balance sheet growth and increased fee and trading income, with the remaining increase reflecting the benefit of a higher interest rate environment

•  Net interest income increased 12 per cent or 18 per cent on a constant currency basis. The net interest margin averaged 141 basis points and is 20 basis points higher year-on-year aided by rising interest rates despite a 4-basis point negative impact from short-term and structural hedges

•  Other income increased 9 per cent, with a record performance in Financial Markets partly offset by lower Wealth Management income impacted by subdued market conditions

•  Operating expenses excluding the UK bank levy increased 4 per cent and were up 7 per cent on a constant currency basis after adjusting for the increase in performance-related pay driven by the strong business performance. The underlying expense growth reflects the impact of a high-inflation environment including the impact on salary increases, additional investment into transformational digital capabilities and headcount. The cost-to-income ratio decreased 4 percentage points to 66 per cent excluding DVA and UK bank levy and the Group generated 6 per cent positive income-to-cost jaws at constant currency excluding DVA

•  Credit impairment was $838 million, an increase of $575 million. The impairment charge includes $582 million in relation to China commercial real estate sector and $283 million in relation to sovereign downgrades partly offset by releases in the management overlay relating to COVID-19. Total credit impairment of $838 million represents a loan-loss rate of 21 basis points, a year-on-year increase of 14 basis points in the cost of risk, but still well below the historic through-the-cycle loan loss range of 30 to 35 basis points.

•  Other impairment increased by $24 million to $79 million. The $300 million impairment charge recorded in 2021 relating to the Group's investment in its associate China Bohai Bank (Bohai) has been reclassified out of underlying performance and into goodwill and other impairments. The remaining other impairment primarily relates to the aviation leasing portfolio

•  Profit from associates and joint ventures decreased 5 per cent to $167 million reflecting a lower profit share from Bohai

•  Charges relating to restructuring, other items and goodwill and other impairment reduced by $373 million to $476 million, with $333 million lower restructuring costs, principally a non-repeat of the prior-year retirement programme in Korea. Goodwill and other impairment of $322 million is $22 million higher year-on-year following a $14 million write off of the goodwill relating to Bangladesh. Furthermore, there has been a $308 million impairment relating to Bohai, primarily a result of industry challenges and uncertainties that may impact credit losses and profitability.

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Group Chief Financial Officer's review continued

•  Taxation was $1,384 million on a statutory basis, with a statutory effective tax rate of 32 per cent. Taxation on underlying profits was at an effective rate of 30 per cent, an increase of 3 percentage points compared to 2021 primarily driven by lower prior year credits and higher taxes in UK, Pakistan and US.

•  Underlying return on tangible equity increased 120 basis points to 8.0 per cent due to the increase in profits and lower tangible equity, reflecting shareholder distributions and adverse movements in reserves due to movements in interest rates and currency translation. The reclassification of the 2021 Bohai impairment out from underlying performance increased the 2021 underlying return on tangible equity by 80 basis points to 6.8 per cent and has made the treatment of Bohai impairment consistent across both the 2021 and 2022 computation of underlying return on tangible equity

•  Underlying basic earnings per share (EPS) increased 18 per cent to 101.1 cents and statutory EPS of 85.9 cents increased by 40 per cent

•  A final ordinary dividend per share of 14 cents has been proposed taking the full-year total to 18 cents, a 50 per cent increase along with a new share buyback programme of $1 billion, taking total shareholder distributions announced since the start of 2022 to $2.8 billion

Summary of financial performance

1  Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2  Change is the basis points (bps) difference between the two periods rather than the percentage change

3  Goodwill and Other impairment include $308 million impairment charge relating to the Group's investment in its associate China Bohai Bank (Bohai). The 2021 comparative has been restated for consistency to reclassify the $300 million impairment from Other impairment within Underlying profit to Goodwill and other impairment. The 2021 Underlying earnings per ordinary share (cents) has been correspondingly restated to reflect this reclassification

4  Not meaningful

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Group Chief Financial Officer's review continued

Statutory financial performance summary

1 Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2 Change is the basis points (bps) difference between the two periods rather than the percentage change

3 Not meaningful

Operating income by product

1 Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2 Following a reorganisation of certain clients, there has been a reclassification of balances across products

3 Not meaningful

The operating income by product commentary that follows is on an underlying basis and comparisons are made to the equivalent period in 2021 on a constant currency basis, unless otherwise stated.

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Group Chief Financial Officer's review continued

Transaction Banking income increased 42 per cent. Cash Management income increased 85 per cent reflecting strong pricing discipline to take advantage of a rising interest rate environment. Trade & Working Capital decreased 1 per cent, with balance sheet growth offset by margin compression. The margin compression reflects a shift towards investment credit grade clients and a shift in product mix towards lower margin but more RWA-efficient products.

Financial Markets income increased 21 per cent and was a record performance. Macro trading increased 40 per cent with FX income delivering strong double-digit growth as macro events led to increased client demand and elevated volatility, widening bid-offer spreads. Commodities also delivered strong double-digit growth, including a record first quarter, when it benefited from volatility in energy prices, while Rates also provided strong double-digit increase in income on the back of policy rates increases. Credit Markets income decreased 3 per cent driven by subdued market conditions in spite of a strong performance in Credit Trading. Structured Finance declined 17 per cent with lower fee income within Aviation Finance. Financing & Securities Services income increased 67 per cent, including $184 million of gains on mark-to-market liabilities and benefiting from improved margins in Securities Services.

Lending and Portfolio Management income decreased 22 per cent due to increased cost of funds and the impact of risk-weighted asset optimisation actions.

Wealth Management income declined 17 per cent as customer sentiment became more risk-averse in volatile market conditions leading to lower transaction volumes. There was a negative impact from COVID-19 restrictions, in particular in North Asia, resulting in a number of branch closures and lower footfall which negatively impacted face-to-face sales. Managed Investments income was down 39 per cent, there was a 6 per cent decline in Treasury Products income while Bancassurance income declined 6 per cent. Wealth Management secured lending income fell by a third on the back of client deleveraging. Net new sales remained positive albeit at a lower level than 2021 but assets under management volumes reduced on the back of negative market movements.

Retail Products income increased 29 per cent. Deposit income increased 157 per cent due to active passthrough rate management in a rising interest rate environment, partly offset by migration from CASA to time deposits. Mortgages & Auto income decreased 35 per cent reflecting margin compression with the majority of mortgages in Hong Kong reaching the Best Lending Rate cap. Credit Cards & Personal Loans income increased 1 per cent reflecting a growth in credit card balances, particularly in our digital banks Mox and Trust Bank.

Treasury income declined 47 per cent, reflecting the losses from structural and short-term hedges in a rising interest rate environment which offset increased yields on the remainder of the Treasury portfolio.

Profit before tax by client segment and geographic region

1 Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2 Following the increased strategic importance and reporting of Ventures to management, this has been established as a separate operating segment from 1 January 2022. Prior period has been restated

3 Not meaningful

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Group Chief Financial Officer's review continued

As part of the ongoing execution of its refreshed strategy, the Group has expanded and reorganised its reporting structure with the creation of a third client segment, Ventures, effective from 1 January 2022. Ventures is a consolidation of SC Ventures and its related entities as well as the Group's two majority-owned digital banks Mox in Hong Kong and Trust Bank in Singapore, reported alongside the current client segments; Corporate, Commercial & Institutional Banking (CCIB) serving larger companies and institutions and Consumer, Private & Business Banking (CPBB) serving individual and business banking clients. There was no change to the regional reporting structure.

Corporate, Commercial & Institutional Banking profit increased 31 per cent as robust Financial Markets and Cash Management performance drove 19 per cent income growth excluding positive movements in DVA. This was partly offset by a 4 per cent increase in expenses and a $469 million increase in impairments reflecting further charges in relation to the China commercial real estate sector and lower releases on the remaining portfolio.

Consumer, Private & Business Banking profit increased 30 per cent and was 35 per cent higher on a constant currency basis. Income grew 10 per cent on a constant currency basis with increased Deposit income partly offset by subdued Wealth Management and the impact of the Best Lending Rate cap on Hong Kong mortgage income. On a constant currency basis, expenses grew 3 per cent and impairments decreased $10 million.

Ventures loss increased to $363 million. Income totalled $29 million for the year, with an increasing customer base at Mox and Trust Bank. Expenses increased by a third reflecting further investment into the segment and increased operational costs to support the significant increase in customer onboarding and transactional volumes within the new digital banks. Other impairment of $24 million was taken in relation to the value of one of the Group's investments within the Ventures portfolio.

Central & other items (segment) recorded a loss of $571 million as income declined 71 per cent reflecting the losses from structural and short-term hedges booked within Treasury. Expenses increased 26 per cent while credit impairments were $112 million higher as a result of the ratings downgrades of select sovereigns.

Asia profits increased 8 per cent on the back of a 7 per cent increase in income. This was partly offset by 1 per cent expense growth and an 82 per cent increase in impairments reflecting increased charges relating to the China commercial real estate sector.

Africa & Middle East profits decreased 4 per cent but grew 4 per cent on a constant currency basis. Income increased 14 per cent while expenses grew 9 per cent, both on a constant currency basis. Impairments went from a net release in the prior year to a $118 million charge, partly due to the sovereign ratings downgrades of Pakistan and Ghana.

Europe & Americas profit increased by a third with a 17 per cent increase in income on the back of a strong Financial Markets and Cash Management performance. Expenses increased 5 per cent while the net release in credit impairment halved to $77 million.

Central & other items (region) loss decreased by $112 million to $608 million due to a 30 per cent increase in expenses. Income increased 145 per cent, while impairments reduced by 16 per cent.

Adjusted net interest income and margin

1 Variance is better/(worse) other than assets and liabilities which is increase/(decrease)

2 Adjusted net interest income is statutory net interest income excluding funding costs for the trading book and including financial guarantee fees on interest-earning assets

3 Change is the basis points (bps) difference between the two periods rather than the percentage change

4 Adjusted net interest income divided by average interest-earning assets, annualised

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Group Chief Financial Officer's review continued

Adjusted net interest income increased 17 per cent driven by a 17 per cent increase in the net interest margin, which averaged 141 basis points in the year, a 20 basis points year-on-year uplift benefiting from a rapid increase in policy interest rates across many of our markets :

•  Average interest-earning assets grew 1 per cent, or 7 per cent excluding the impact of currency translation and risk-weighted asset optimisation actions, reflecting an increase in investment securities held by Treasury Markets. Gross yields increased 87 basis points compared with the average in the prior year

•  Average interest-bearing liabilities increased 2 per cent, or 5 per cent excluding the impact of currency translation, reflecting an increase in customer accounts while the rate paid on liabilities increased 71 basis points compared with the average in the prior year

Credit risk summary

Income Statement

1   Variance is increase/(decrease) comparing current reporting period to prior reporting periods

2  Not meaningful

Balance sheet

1   Variance is increase/(decrease) comparing current reporting period to prior reporting periods

2   Includes reverse repurchase agreements and other similar secured lending held at amortised cost of $24,498 million at 31 December 2022, $$18,032 million at 30 September 2022, $7,894 million at 30 June 2022 and $7,331 million at 31 December 2021

3 Change is the percentage points difference between the two points rather than the percentage change

Asset quality remains stable, despite a year-on-year increase in the impairment charge, with an improvement in a number of underlying credit metrics. However, the Group continues to remain alert to an unpredictable and challenging external environment including pressures in the China commercial real estate sector, commodity price volatility and the impact of the Russia/Ukraine war. This war in part contributed to both commodity price volatility and the accelerated trajectory of inflation and interest rate rises across our footprint, which in turn have contributed to both an increased risk of global recession and the appreciation of the US dollar versus the majority of developed and emerging market currencies. These factors have contributed to increased sovereign credit stress in a handful of our markets which we continue to monitor closely and undertake mitigating actions where appropriate.

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Group Chief Financial Officer's review continued

Credit impairment totalled $838 million, an increase of $575 million, representing a loan loss rate of 21 basis points, still some way below the historic loan loss rate range. Impairment charges relating to the China commercial real estate sector totalled $582 million in the year, including a $78 million increase in the management overlay relating to the China commercial real estate sector, which now totals $173 million. Sri Lanka and Ghana had their sovereign ratings downgraded into stage 3 , while Pakistan sovereign ratings were downgraded into credit grade 12. These sovereign ratings downgrades incurred a $283 million impairment charge in the year. The CPBB normalised run-rate charge increased by 9 per cent while recoveries in CCIB declined by a third. The above were partly offset by a $228 million decrease in the COVID-19 related management overlay, which now totals $21 million.

Gross stage 3 loans and advances to customers of $7.8 billion were 3 per cent lower, primarily as repayments, client upgrades and write-offs more than offset new inflows, including those relating to the sovereign ratings downgrade of Ghana and Sri Lanka and the China commercial real estate sector. Credit-impaired loans represented 2.5 per cent of gross loans and advances, a decrease of 18 basis points.

The stage 3 cover ratio of 57 per cent was lower by 1 percentage point, while the cover ratio post collateral at 76 per cent increased by 1 percentage point.

Credit grade 12 balances have decreased by 9 per cent to $1.6 billion as the sovereign ratings downgrade of Pakistan was more than offset by downgrades into stage 3 primarily as a result of Sri Lanka and Ghana sovereign ratings downgrade.

Early Alert accounts of $5.0 billion have reduced by 10 per cent, reflecting the net impact of regularisations of accounts back into non-high-risk categories, net impact of downgrades into credit grade 12 and exposure reductions partly offset by new inflows. The Group is continuing to carefully monitor its exposures in vulnerable sectors and select markets, given the unusual stresses caused by the currently challenging macro-economic environment.

The proportion of investment grade corporate exposures has increased by 7 percentage points to 76 per cent, reflecting the increase in reverse repurchase agreements held to collect.

The above balance sheet disclosure relates to loans and advances to customers. The movement in high risk assets (gross stage 3 loans and advances, credit grade 12 balances and early alert accounts) does not fully reflect the impact of the sovereign ratings downgrade of Ghana, Pakistan and Sri Lanka as it does not capture the impact of these downgrades on the Group's investment and securities portfolio.

Restructuring, goodwill impairment and other items

1 Goodwill and other impairment include $308 million impairment charge relating to the Group's investment in its associate China Bohai Bank (Bohai). The 2021 comparative has been restated for consistency to reclassify the $300 million impairment from other impairment within Underlying profit to Goodwill and other impairment

The Group's statutory performance is adjusted for profits or losses of a capital nature, amounts consequent to investment transactions driven by strategic intent, other infrequent and/ or exceptional transactions that are significant or material in the context of the Group's normal business earnings for the period and items which management and investors would ordinarily identify separately when assessing underlying performance period-by period. A reconciliation of restructuring, goodwill impairment and other items excluded from underlying results is set on pages 41-45.

Restructuring charges of $174 million for 2022 reflects the impact of actions to transform the organisation to improve productivity, primarily redundancy related charges.

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Group Chief Financial Officer's review continued

Goodwill and other impairment of $322 million includes $308 million in relation to a further reduction in the carrying value of the Group's investment in its associate China Bohai Bank (Bohai). To ensure consistency, the Group has retrospectively reclassified the $300 million impairment charge taken in 2021 on its investment in Bohai, from other impairment included in underlying operating profit, to goodwill and other impairment which is excluded from underlying operating performance. The remaining $14 million goodwill impairment relates to Bangladesh primarily due to lower economic growth forecasts and higher discount rates.

Other items include a $20 million fair-value gain relating to the sale of a property in Thailand.

The Group has announced that it is exploring strategic alternatives for its Aviation Finance business as well as the exit of seven markets in the AME region and will focus solely on the CCIB segment in two more. It is expected that the results from the markets and businesses being exited will be reported in restructuring from 1 January 2023 with prior periods retrospectively restated.

Balance sheet and liquidity

1 Variance is increase/(decrease)comparing current reporting period to prior reporting periods

2 The Group now excludes $20,798 million held with central banks (30.09.22: $21,683 million, 30.06.22: $16,918 million, 31.12.21: $15,168 million) that has been confirmed as repayable at the point of stress

The Group's balance sheet remains strong, liquid and well diversified.

•  Loans and advances to customers increased 4 per cent since 31 December 2021 to $311 billion. This includes a $24 billion increase in Treasury and securities backed loans held to collect partly offset by a $13 billion reduction from risk-weighted asset optimisation actions undertaken by CCIB and a $8 billion reduction from currency translation. Excluding the above, there was 3 per cent underlying loan growth, with growth in Trade partly offset by deleveraging in Wealth Management.

•  Customer accounts of $462 billion decreased 3 per cent since 31 December 2021 as a result of currency translation. Excluding the impact of currency translation, customer accounts were broadly flat in the year.

•  Other assets decreased 3 per cent since 31 December 2021 with a reduction in reverse repurchase agreements designated at fair value through profit or loss partly offset by an increase in investment securities held within Treasury Markets and increased derivative balances.

•  Other liabilities were 3 per cent higher since 31 December 2021 reflecting an increase in derivative balances.

The advances-to-deposits ratio decreased to 57.4 per cent from 59.1 per cent at 31 December 2021 reflecting a reduction in loans and advances to customers excluding reverse repurchase agreement as a result of risk-weighted asset optimisation actions. The point-in-time liquidity coverage ratio of 147 per cent increased 4 per cent and remains well above the minimum regulatory requirement.

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Group Chief Financial Officer's review continued

Risk-weighted assets

1 Variance is increase/(decrease) comparing current reporting period to prior reporting periods

Total risk-weighted assets (RWA) decreased 10 per cent or $26.5 billion from 31 December 2021 to $244.7 billion.

•  Credit risk RWA decreased $22.7 billion to $196.9 billion. There was a $13.9 billion reduction in the CCIB low-returning portfolio targeted for optimisation, a $11.1 billion decrease from other RWA efficiency actions and a $9.9 billion reduction from currency translation. This was partly offset by a $6.9 billion increase from regulatory changes, $3.5 billion inflation from credit migration and a $1.9 billion increase from a combination of asset growth and mix

•  Market risk RWA decreased by $3.9 billion to $20.7 billion primarily reflecting reduced standardised specific interest rate risk positions and changes in value at risk methodology

•  Operational risk RWA was broadly flat at $27.2 billion

Capital base and ratios

1 Variance is increase/(decrease) comparing current reporting period to prior reporting periods

2 Change is percentage points difference between two points rather than percentage change

The Group's CET1 ratio of 14.0 per cent was 19 basis points lower than at 31 December 2021, but approximately 50 basis points above the CET1 ratio at 1 January 2022 when regulatory changes, which reduced the Group's CET1 ratio, came into force. The underlying 50 basis points increase reflects the impact of RWA optimisation actions and profit accretion during the year despite funding $1,258 million of share buybacks and an increased ordinary dividend. The CET1 ratio is 3.6 percentage points above the Group's current regulatory minimum of 10.4 per cent and at the top end of the Group's 13-14 per cent medium-term target range.

The regulatory changes which came into force on 1 January 2022 included the cessation of software relief, the impact from the IRB model repair programme and the introduction of standardised rules for counterparty credit risk on derivatives and other instruments (SA-CCR). In aggregate, these regulatory changes resulted in a decrease in the CET1 ratio of approximately 70 basis points by reducing CET1 capital by $1.1 billion and increasing RWAs by $5.7 billion. In the fourth quarter, further regulatory changes including the IRB model repair programme increased RWAs by $1.3 billion, reducing the CET1 ratio by approximately 10 basis points

The CET1 ratio was reduced by approximately 70 basis points from a reduction in reserves mainly relating to a reversal of prior year unrealised gains on debt securities as a result of higher market yields and movements in currency translation reducing both the translation reserve and RWAs.

Profit accretion increased the CET1 ratio by approximately 110 basis points whilst lower RWAs as a result of efficiency and optimisation actions within CCIB and Treasury, provided an approximate 120 basis point uplift to the CET1 ratio.

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Group Chief Financial Officer's review continued

Ordinary shareholder distributions reduced the CET1 ratio by approximately 65 basis points. The Group spent $1,258 million purchasing 184 million ordinary shares of $0.50 each during the year, representing a volume-weighted average price per share of £5.48. These shares were subsequently cancelled, reducing the total issued share capital by 6 per cent and the CET1 ratio by approximately 45 basis points. The Board has recommended a final dividend of 14 cents per share resulting in a total 2021 ordinary dividend of 18 cents a share or $523 million, reducing the CET1 ratio by approximately 20 basis points . Payments due to AT1 and preference shareholders cost approximately 15 basis points.

The Board has announced a share buyback for up to a maximum consideration of $1 billion to further reduce the number of ordinary shares in issue by cancelling the repurchased shares. The terms of the buyback will be announced and the programme will start shortly and is expected to reduce the Group's CET1 ratio in the first quarter of 2023 by approximately 40 basis points.

The Group's leverage ratio of 4.8 per cent is approximately 10 basis points lower than the 4.9 per cent ratio as at 31 December 2021. This reflects lower Tier 1 capital partly offset by a decrease in leverage exposures largely driven by efficiency and optimisation initiatives. The Group's leverage ratio remains significantly above its current minimum requirement of 3.7 per cent.

Outlook

Our performance has been strong, and the pace of economic recovery in many of our footprint markets is encouraging.

Whilst recessionary and inflationary pressures will continue to impact many parts of the world, particularly in the first half of 2023, we expect most of the markets in which we operate to continue their recent momentum with GDP growth in the Asian economies at above 5 per cent over the next two years being pivotal to progressive global recovery.

The recent opening-up of China and the generally receding impacts of COVID-19 should help in that regard albeit we will continue to monitor closely the sovereign risks in markets that are most exposed to tightening liquidity.

Overall, the markets in which we operate, the further benefits of rising interest rates and the evidential improvement in many of our operating metrics cause us to be optimistic about the period ahead. For 2023 and 2024 our expectations are now:

•  Income to grow in the 8-10 per cent range excluding DVA and at constant currency

•  Full year average net interest margin of around 175 basis points in 2023 and above 180 basis points in 2024

•  Asset and RWA growth in the low single digit percentage range

•  Around 3 percentage point positive income-to-cost jaws in 2023 and in 2024, excluding DVA and UK bank levy and at constant currency

•  Credit impairment to continue to normalise towards the historic through the cycle loan-loss rate range of 30-35 basis points

•  To operate dynamically within the full 13-14 per cent CET1 target range

•  RoTE to be approaching 10 per cent in 2023

•  RoTE to exceed 11 per cent in 2024, with further growth thereafter

Andy Halford

Group Chief Financial Officer

16 February 2023