Feb. 8 (Bloomberg) -- HSBC Holdings Plc, Europe's biggest bank, said it's setting aside 20 percent more than analysts estimated for loan losses in 2006 because the company's U.S. mortgage business is deteriorating.

Home loans to risky borrowers in the U.S. are going bad faster than HSBC expected just two months ago, the bank said yesterday in an e-mailed statement. HSBC's London-traded shares fell as much as 2.5 percent today to 909 pence, their biggest drop in eight months, and traded down 21.5 pence to 909.5 pence at 9:45 a.m.

London-based HSBC, which paid $15.5 billion to buy Household International Inc. in 2003, initially got a boost in profit as U.S. house prices soared. Now earnings are eroding as defaults jump. Home loans to borrowers with poor credit ratings or large debt burdens are souring at a faster rate than during the U.S. recession six years ago, according to Friedman Billings Ramsey Group Inc.

``Household provided them with a reasonably strong earnings boost in the last few years but it's hurting them now,'' said Sunil Garg, an analyst at JPMorgan Chase & Co. in Hong Kong who today cut his rating on HSBC. ``It's a deterioration of the U.S. market and HSBC isn't isolated in this.''

HSBC said analysts had expected $8.8 billion in loan-loss provisions for 2006, based on the average of 11 estimates gathered by the bank. A 20 percent increase would bring provisions to $10.56 billion, more than the $8.7 billion HSBC earned in the first half.

Sub-Prime Rates

The stock has fallen 7.2 percent since Nov. 13, when HSBC first said bad debts in the U.S. were rising, making it the third- worst performer on Hong Kong's benchmark Hang Seng Index. All other banking stocks on the index rose in the period.

``There will be some doubt about whether this is the big provision or whether it's a sign of things to come,'' said Tathagata Guha Roy, who helps manage $1 billion for Alliance Trust Plc in Hong Kong.

Chief Executive Officer Michael Geoghegan and Chief Financial Officer Douglas Flint will host a conference call today at 10 a.m. London time to discuss the provisions.

Rising interest rates and falling house prices have made it harder for many Americans to repay their mortgages, leading to higher loan losses at HSBC and rivals including New Century Financial Corp. The U.S. Federal Reserve raised its benchmark rate to 5.25 percent last year from 1 percent in 2004.

New Century, HSBC's largest competitor for so-called sub-prime mortgages, said yesterday it expects a fourth-quarter loss in part because of a jump in defaults on new loans.

`Further Weakness'

``The impact of slowing house price growth is being reflected in accelerated delinquency trends across the U.S. sub-prime mortgage market,'' HSBC said in the statement. ``It is clear that the level of loan-impairment provisions to be accounted for as at the end of 2006 in respect of Mortgage Services operations will be higher than is reflected in current market estimates.''

Lenders typically charge 2 or 3 percentage points more on sub- prime mortgages than on those to the safest borrowers. Such loans made up about a fifth of all new mortgages last year, according to the Mortgage Bankers Association in Washington.

Two months ago, HSBC warned that earnings were at risk of ``further weakness'' in the U.S. because a slowdown in mortgage lending would ``constrain revenue growth.'' Today, the company said the rest of its businesses performed in line with its expectations on Dec. 5, the date of its last outlook. HSBC is scheduled to report earnings on March 5.

Household Purchase

The worsening prospects for U.S. mortgages are increasing pressure on HSBC Chairman Stephen Green to accelerate growth in Asia. HSBC gets almost half its profit from the U.S. and the U.K., where record household debt is forcing the bank to increase bad- loan provisions as well.

``HSBC has exposure to the U.S. market which is unique to banks listed in Asia,'' said Garg, who cut his HSBC rating to ``underweight'' from ``neutral.'' ``The pure Asia plays look better.''

HSBC, the world's No. 3 bank by market value after New York- based Citigroup Inc. and Charlotte, North Carolina-based Bank of America Corp., bought Household International for $15.5 billion in 2003. Acquiring the Prospect Heights, Illinois-based company, a lender to consumers with poor credit ratings, left HSBC more vulnerable to a housing slowdown.

Mortgage Bankruptcies

Irvine, California-based New Century also is restating earnings for the first nine months of 2006 and delaying the release of fourth-quarter results.

Mortgage Lenders Network USA Inc. of Middletown, Connecticut, filed for bankruptcy on Feb. 5 and Agoura Hills, California-based Ownit Mortgage Solutions sought protection from creditors in December.

During the five-year boom in housing prices, homeowners who fell behind on mortgage payments could sell their homes and pay off their loans or get better refinancing terms based on the higher value of their property. Federal Reserve Governor Susan Bies said in a Jan. 11 speech that regulators were concerned about sub-prime loans made with low down payments or limited proof of borrowers' incomes.

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net.

Last Updated: February 8, 2007 05:02 EST