OREANDA-NEWS. Fitch Ratings has affirmed HSBC Mexico, S. A.'s (HSBC Mexico) Long-Term Local and Foreign Currency Issuer Default Ratings (IDRs) at 'A'. Fitch has also downgraded HSBC Mexico's Viability Rating (VR) to 'bbb-' from 'bbb'. IDR ratings are driven by the perceived support from its parent due to the strategic importance of the Mexican subsidiary, and, therefore, not affected by the downgrade of the bank's VR.

Simultaneously, Fitch has affirmed the national scale ratings of HSBC Mexico and HSBC Casa de Bolsa, S. A. de C. V. (HSBCCB) at 'AAA(mex)' and 'F1+(mex)'.

The Rating Outlook is Stable. A full list of rating actions follows at the end of this press release.

The VR is negatively affected by HSBC Mexico's overall financial performance, which is no longer commensurate with the bank's risk profile and other Latin American banks rated at 'bbb'. The VR downgrade primarily reflects the bank's continued low earnings and pressured asset quality and the agency's view that these factors will remain under stress, due to an accelerated loan growth, increasing loan loss reserves, and still high operational expenses relative to revenues. Fitch believes HSBC Mexico will be materially challenged to sustain its capital metrics purely through retained earnings and does not rule out further required capital injections from its parent in the future. The VR downgrade also reflects the bank's current higher risk appetite for growth relative to peers.

KEY RATING DRIVERS

HSBC Mexico's IDRs, SUPPORT RATING AND NATIONAL RATINGS

Local and foreign currency IDRs, national ratings, as well as its Support Rating (SR) are driven by the strong ability and propensity of its ultimate parent; HSBC Holdings plc (HSBC, rated 'AA-'/Stable Outlook by Fitch; VR at 'aa-') to provide support to HSBC Mexico, if it would be required.

Since mid-2015, HSBC redefined the strategy for its Mexican subsidiary and confirmed that Mexico is a priority market due to the ample business scale of the bank in the country. In Fitch's opinion, HSBC Mexico continues as a strategically important subsidiary as it is highly integrated to HSBC's core businesses and maintains strong and positive operational synergies. HSBC Mexico is rated two-notches below from HSBC's IDR, because the bank rating criteria usually limits potential uplift from a relatively strong foreign owner to no more than two notches above the sovereign's rating (Mexico IDRs are currently 'BBB+'/Stable Outlook).

VR

HSBC Mexico's operating profits to RWAs have been historically weak. Since 2013 net income started to shrink mainly affected by increasing loan impairment charges related to its homebuilder exposure and reduced revenues from trading activities. During FY2015, the bank reported losses. Operating profitability has been improving during the first six months of 2016 up from its lowest level; however, it remains weak relative to the industry average. In Fitch's view, earnings and profitability will likely continue lagging as compared to its closest peers and will remain a rating weakness over the following two years.

The bank's asset quality is weaker than other large Mexican banks. In 2013, the bank had a large exposure to homebuilders which deteriorated loan quality indicators. Non-performing loans (NPLs) have continued under pressure over the past three years, with average impairment ratios of 5.4%. NPL ratio improved to 4.2% at end-Jun 2016, driven by a partial sale of the homebuilders' portfolio. The bank charge-off ratio to average gross loans of 4.4% at end-June 2016 was the highest over the past four years.

Fitch expects HSBC Mexico's asset quality metrics (NPL ratios and charge-offs) to slightly improve as the bank finishes writing-off or selling its legacy impaired loans and as the recent actions to tighten its underwriting standards start to bear results. Fitch considers the entity's main challenge is to contain additional loan deterioration that could arise from rapid growth. The cushion of loan reserves is reasonable, with coverage of 120% of impaired loans as of mid-2016.

HSBC Mexico's good franchise has remained somehow resilient, in spite of the de-risking process that it has gone through over the past four years. In Fitch's view, vulnerability to franchise erosion in the foreseeable future is low, due to the core business strategy focused in client and portfolio growth. The bank remains as the fifth largest bank in Mexico by total assets, loans and deposits.

Since 2015, HSBC Mexico gradually resumed the pace of lending. Over the past 12 months loans have been rapidly growing (almost 19%), mainly driven by consumer (payroll and personal) and commercial lending. Due to the bank's low profitability, growth has overpassed internal capital generation over the past two years.

HSBC Mexico's Fitch Core Capital (FCC) to Risk weighted Assets (RWAs) ratios have been stable and remained at adequate levels over the past years. There have been ample capital infusions to HSBC Mexico in the past. As of June 2016, the bank's FCC to RWAs ratio stood at adequate 10.9%.

HSBC Mexico is mainly funded by deposits which accounted for nearly 73% of the core banking funding sources as of June 2016. There are no major concentrations in HSBC Mexico's depositor base; as of June 2016 the 20 largest depositors accounted for less than 10% of total deposits.

Since January 2016, relevant changes in senior management have occurred. HSBC Mexico appointed a new CEO and the new management strategy considers enhancing seniority of the managerial team that has been driving some additional team member changes. Fitch highlights the bank's challenges to sustain the continuity and stability toward the parent's ambitious business and financial targets regarding the Mexican subsidiary for 2017.

Fitch considers HSBC Mexico's funding profile as comfortable with a loan to deposit ratio of 91.8% (2012-2014: 73% average), though gradually deteriorating, since loans have continued to grow while deposits were declining over the past 18 months (influenced by term deposits) due to the management strategy to moderately reduce negative carry from excess liquid resources. The bank's liquidity coverage ratio (LCR, under Mexican regulation) was 149.9% as of June 2016. Despite deposits reduction, the entity remains as the fifth retail deposit taker of the country. The bank's funding and liquidity profile is one of its main strengths, although it currently has a low importance on its VR, since Fitch's considers that increasing risk appetite and weak earnings are the main drivers of this rating.

HSBC MEXICO'S SENIOR AND SUBORDINATED DEBT

The national scale ratings of HSBC Mexico's subordinated debt reflect Fitch's opinion that support from HSBC, if needed, would extend to any outstanding debt in the local market, in order to prevent reputational risk effects and overall funding costs. Coupled with the relatively high IDR of HSBC, the subordinated debt ratings are equal to the senior unsecured debt ratings.

HSBCCB'S NATIONAL RATINGS

HSBCCB's national scale ratings were also affirmed since it is perceived by Fitch as a strategically important affiliate of HCBC Mexico and fully integrated into its operations and franchise. Also, the local holding company of both operating entities, Grupo Financiero HSBC, is legally enforced to provide support to its subsidiaries. Therefore, the national scale ratings of the brokerage unit are aligned with the respective bank's ratings.

RATING SENSITIVITIES

IDRS AND SUPPORT RATING

There is limited upside potential on HSBC Mexico's IDRs, since these are already two-notches above the sovereign's IDR. The local currency IDR could only be upgraded by an increase in the sovereign rating. The foreign currency IDR could improve also if the sovereign rating is upgraded and if there is an increase in Mexico's country ceiling. Any change on Fitch's perception towards the strategic importance of HSBC Mexico to its parent may trigger a review of its Support rating and IDRs. If HSBC's ratings are downgraded by more than one notch, HSBC Mexico? s IDRs could also be downgraded.

VR

HSBC Mexico's VR could be upgraded if the bank achieves an orderly growth in the light of its ambitious targets. Specifically, this growth must be accompanied by improvements in asset quality (adjusted impairment ratio, NPLs plus last 12-month charge-offs, consistently below 6%) and profitability (operating profit to RWAs consistently above 1%), as well as maintaining its current franchise, liquidity profile and adequate capital metrics.

HSBC Mexico's VR could be negatively affected if the bank fails to improve its asset quality metrics, consistently reports financial losses and shows FCC ratios below 10%. Also, a deterioration of the liquidity profile could negatively affect the VR.

NATIONAL RATINGS AND SENIOR DEBT

HSBC Mexico and HSBCCB's national scale ratings could only be negatively affected by a multi-notch downgrade of HSBC's IDRs, or a change in its propensity to support these Mexican affiliates.

Given Fitch's criteria for ranking bank hybrids and non-performance risk of these securities, the subordinated debt could be affected by a downgrade of the parent's (HSBC) VR, even before such downgrade could affect the national scale issuer and senior unsecured debt ratings and the IDRs of HSBC Mexico.

Fitch has affirmed the ratings as follows:

HSBC Mexico

--Foreign and local currency long-term IDR at 'A'; Outlook Stable;

--Foreign and local currency short-term IDR at 'F1';

--Support Rating at '1';

--Long-term national scale rating at 'AAA(mex)'; Outlook Stable;

--Short-term national scale rating at 'F1+(mex)';

--Long-term national scale rating for local senior debt issuances at 'AAA(mex)';

--Long-term national scale rating for local subordinated debt issuances at 'AAA(mex)'.

HSBCCB

--Long-term national scale rating at 'AAA(mex)'; Outlook Stable;

--Short-term national scale rating at 'F1+(mex)'.

Fitch has downgraded the following rating:

HSBC Mexico

--Viability Rating to 'bbb-'from 'bbb'.