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HSBC: Could do better

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Brokers give their response to HSBC's recent market update.

Garry White, Charles Stanley

HSBC’s first-half profits came in slightly below expectations. However, the bank is transforming in the hope of generating more sustainable returns. In the first half of 2014, pre-tax profits fell 12% year-on-year to £12.34bn, compared with market expectations of $12.9bn. However, despite the fact that this was a slight earnings miss, it was an improvement on the first quarter of the year when profits slid by 20%.

The first quarter fall was mainly down to a strong comparable performance in the first three months of 2013, when the numbers were flattered by a series of asset sales. This means the fall is not really as steep as it first appears. On an “underlying” basis when such things are stripped out, profits in the first six month were only 4% lower.

Stuart Gulliver, HSBC’s chief executive, is in the second phase of his strategic repositioning, which aims to reduce complexity in the organisation. So far, this has seen a reduction in headcount of about 40,000 and the closure or sale of 60 separate businesses. These changes are eventually expected to results in cost savings of about $5bn.

The bank’s reorganisation involves focusing on markets where it has a meaningful market share or has a business with good growth prospects. It is these changes that are mainly responsible for the group’s subdued profitability. HSBC is different to other banks that have reported recently because of its Asian exposure and its relative lack of investment banking exposure. Indeed, the company generates 20% of its revenue in Hong Kong and 17% from the rest of Asia.

Management also warned that new regulations were taking their toll, with the bank now spending an extra $800m on compliance-related matters. “The demands now being placed on the human capital of the firm and on our operational and systems capabilities are unprecedented,” HSBC said. “The cumulative workload arising from a regulatory reform programme that is unfortunately increasingly fragmented, often extra-territorial, still evolving and still adding definition is hugely consumptive of resources that would otherwise be customer facing.”

Revenues are down because of the disposals, with its Latin American and European business also relatively subdued. Extra spending on compliance meant costs rose by 3% in the period, despite the cost-saving measures the bank has introduced. It also means that return on equity, an important measure of profitability, fell 1.3 percentage points to 10.7%, below management’s target for a figure above 12%.

These pressures on its business have resulted in HSBC chairman Douglas Flint writing a letter to Chancellor George Osborne and Bank of England Governor Mark Carney seeking a delay in the 2019 timetable for the implementation of the Vickers reform. The proposals seek to protect high street banking businesses by ringfencing a bank’s riskier investment banking arms, as suggested by Sir John Vickers in 2011. HSBC is in the process of shrinking to grow. There will be growing pains along the way, with the first-half profit fall part of that process. The aim is to produce a more robust bank, focusing on its core markets. The aim is to produce returns for shareholders over the medium term. However, the cost of new regulations is a real risk for HSBC and other industry players.

Justin Cooper, Capita Asset Services,

“Hot on the heels of a cut in the sterling dividend investors will get from Shell, comes another bigger cut from HSBC. With pre-tax profits down 12%, the bank has held its dividend flat in USD, meaning UK investors will see their cheque shrink by around 8% when it lands on the doormat in October. Income investors have several more months of pain to endure before the effect of the strong pound begins to dissipate.”

Gary Greenwood, Shore Capital

HSBC has reported a small (1%) statutory pre-tax profit miss relative to consensus market expectations (source: Company) within its interim results (6m to end Jun). This was owing to higher than anticipated costs, which were largely offset by higher than expected associate income and lower than expected impairments.

Statutory pre-tax profits fell by 12% to $12,340m (consensus: $12,459m) with underlying pre-tax profits (company definition) down by 4% to $12,560m. Excluding significant exceptional items, underlying adjusted PBT increased by 3% to $13,262m. The underlying adjusted performance was driven by flat revenue, a 4% increase in costs and a 38% reduction in impairments. Negative cost / income jaws have been a key feature of HSBC’s results in recent periods and remain an area of concern to us.

The Chairman’s statement contains some very strong words in respect of the current regulatory environment and the impact this is having on the business. Indeed, it is the increase in investment in compliance and regulatory readiness that is the key driver behind the higher than anticipated cost inflation, in our view. We pick out a few of the Chairman’s comments as follows:

“The demands now being placed on the human capital of the firm and on our operational systems are unprecedented” “We are committed and resourced to deliver … but there is extremely limited spare capacity” “I don’t think we have ever had to ask so much of so many” “We face growing fatigue within critical functions as well as increased market competition for trained staff”

That said, the outlook statement contains some more positive commentary around the broader economic backdrop and the prospect of the group benefiting from a rise in US interest rates through the generation of higher revenues on its surplus deposits. In addition, management highlighted the strength of HSBC’s global network, how well this positions the group to leverage the world’s trade corridors and how difficult this is to replicate.

Management also refers to the underlying capital generation of the business and the ability of this to support a progressive dividend policy. We note that the second interim dividend per share was held flat at $0.10, as expected, giving a half year DPS of $0.20. We currently expect the full year dividend per share to be increased by 6% to $0.52 (versus consensus at $0.51).

We do not expect consensus earnings estimates to move significantly on the back of these numbers while our earnings estimates may need to edge down a little. For reference, consensus is currently looking for statutory pre-tax profits of $22,225m (EPS of $0.82) versus our estimate of $23,778m (EPS of $0.88). We re-iterate our neutral stance. HOLD

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