Aug. 4 (Bloomberg) -- HSBC Holdings Plc, Europe's biggest bank by market value, reported the steepest earnings decline since 2001 on record subprime mortgage defaults in the U.S. and said profit growth from emerging markets will fall.

Net income for the six months ended June 30 dropped 29 percent to $7.7 billion, or 65 cents a share, from $10.9 billion, or 94 cents, a year earlier, the company said today in a statement. HSBC fell 1.1 percent in London trading after Chairman Stephen Green said the outlook is ``highly challenging.''

HSBC, the first European bank to take losses on U.S. subprime mortgages, set aside an additional $10.1 billion this year, bringing total costs since 2006 to $38 billion. While profit at the London-based bank rose in Europe, Latin America and most of Asia, Green said emerging markets will have ``less momentum'' after contributing two thirds of income this year.

``There's some pretty negative news,'' said Alan Beaney, investment head at Principal Asset Management Ltd. in Sevenoaks, England, which manages $2 billion including HSBC stock. ``Asia is slowing as was to be expected, and the U.S. took a hit.''

HSBC fell 9 pence at 828 pence today in London, valuing the bank at 99.5 billion pounds ($195 billion). The stock is down 1.7 percent this year, the best-performance in the 71-member Bloomberg Europe Banks & Financial Services index, which fell 33 percent.

HSBC's first-half profit beat the $7.3 billion average estimate of 11 analysts surveyed by Bloomberg. The bank reported a loss in the North American unit and declining profit in Hong Kong. Pretax profit rose in the rest of Asia, Latin America and Europe.

Monitoring the U.K.

``We are monitoring the mortgage market carefully'' in the U.K., Chief Executive Officer Michael Geoghegan, 54, told analysts in London. While the British economy is weakening, credit quality didn't deteriorate in the first half, and HSBC increased mortgage lending as U.K. competitors pulled back, Geoghegan said.

The bank said emerging markets will ``hold up reasonably well, albeit with less momentum, than in the recent past.'' HSBC pointed to rising inflation and the drag of the U.S. slowdown.

``Compared with the buoyant conditions of last year, it is apparent that corporate activity in some sectors is slowing and demand for equity-related and wealth products has reduced as equity markets have declined,'' Green, 59, said in the statement.

HSBC's profit in Hong Kong was hurt by ``significant falls'' in share prices, which reduced the value of the bank's investments, it said in the half-year report.

Hang Seng Bank Ltd., the Hong Kong lender that is 62 percent owned by HSBC, said first-half profit rose 2 percent, beating the median estimate of five analysts surveyed by Bloomberg.

Cooling in Hong Kong

Hang Seng increased lending and expanded in wealth management to overcome a cooling economy and accelerating global inflation. ``Hong Kong is not totally decoupled from what's going on in the rest of the world,'' Geohegan told analysts in London.

Pretax profit in China fell 41 percent to $907 million as year-earlier stake sales were not repeated, HSBC said. Profit rose 24 percent in India and 63 percent in the Middle East, helped by gains in United Arab Emirates.

The bank is in talks to cut the purchase price for a 51 percent stake in Korean Exchange Bank, two people familiar with the matter said yesterday. Asian stocks have fallen 18 percent since Lone Star Funds agreed to sell the stake in Korean Exchange Bank, led by CEO Richard Wacker, for $6 billion last September.

HSBC said yesterday it is negotiating with Lone Star after a second deadline for regulatory approval of the purchase expired July 31. HSBC and Lone Star, led by managing partner John Grayken, had rights under an April agreement to terminate the deal if regulators hadn't cleared it before the deadline.

Biggest Subprime Lender

HSBC became the biggest subprime mortgage lender in the U.S. after it bought Prospect Heights, Illinois-based Household International Inc. for $15.5 billion in 2003. Subprime loan-loss provisions were $17.2 billion in 2007 and $10.6 billion in 2006.

The bank, which said last year it would take three years to deal with bad loans in the U.S., is now less reliant on American profit than peers such as Edinburgh-based Royal Bank of Scotland Group Plc. HSBC ousted managers, closed operations and reduced lending in the wake of the subprime mortgage collapse as it refocused on faster growing markets in Asia and Latin America.

The pretax loss in North America was $2.9 billion, compared with a profit of $2.4 billion in the year-ago first half. U.S. consumer bad loan charges and other provisions rose 85 percent to $6.8 billion as the bank reduced its number of branches by 10 percent to 900 and said it would ``run off'' its $13 billion vehicle-finance operation.

Angry Investor

Writedowns and credit-related losses in North America exceed $32 billion since the start of 2006, ``more than all the profits earned in emerging markets and Hong Kong over the same period,'' Knight Vinke Asset Management LLC head Eric Knight said in an e- mailed statement today. The New York-based investment firm, which holds less than 1 percent of HSBC, wants an independent review of the bank's strategy and a U.S. spinoff.

One in six U.S. subprime mortgages had payments 90 days or more overdue in the first quarter, an all-time high, according to Mortgage Bankers Association in Washington. Those so-called seriously delinquent mortgages were either in foreclosure or about to start the process to transfers ownership to the lender.

One in five subprime home loans had late payments in the quarter, and one in 10 were already in foreclosure, according to Jay Brinkmann, an economist with the bankers' trade group. All were record highs in a series that goes back to 1998, he said.

HSBC Finance Director Douglas Flint said further writedowns will depend on the U.S. economy. ``The rate of deterioration has definitely slowed,'' he said on a call with reporters.

HSBC wrote down $3.9 billion in credit assets against first- half earnings. The markdowns included buyout loans, asset-backed securities and bond insurance. That compares with writedowns of $2.1 billion in the second half of last year.

Better Vintages

The bank also marked down $6.5 billion this year against reserves on asset-backed securities it intends to hold until maturity. HSBC doesn't expect a surge in defaults on the loans bundled in the securities because ``the vintages are better than others,'' Flint told analysts. ``We have done this incredibly conservatively.''

Banks and financial companies worldwide have posted about $481 billion of loan losses and writedowns in the past year amid the worst U.S. housing market since the Great Depression, data compiled by Bloomberg show. Mortgage-related writedowns totaled $54.6 billion at Citigroup and $38.2 billion at UBS since the start of 2007, according to Bloomberg data.

European profit, including the U.K., rose 28 percent to $5.2 billion. The bank completed the sale last month of seven regional banking units in France to Banque Federale des Banques Populaires for 2.1 billion euros ($3.3 billion).

HSBC's so-called core Tier 1 capital -- a measure of financial strength that shows a bank's ability to withstand losses -- fell to 8.8 percent as on June 30. Capital stood at 9.3 percent at the end of 2007, compared with 7.3 percent at Edinburgh-based Royal Bank of Scotland Group Plc, company reports show.

HSBC increased its first-half dividend by 6 percent to 36 cents a share.

To contact the reporter on this story: Jon Menon in London at jmenon1@bloomberg.net

Last Updated: August 4, 2008 12:25 EDT