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Bad times ahead for HSBC

Expect HSBC's shares to come under pressure as growth in Asia slows and the eurozone crisis gathers pace
December 8, 2011

With banks being told to prepare for the worst amidst a worsening crisis in the eurozone, it's certainly a bleak time to be a banker. Olli Rehn, the EU’s economic and monetary affairs commissioner, reckons there are just days left to save the euro. While Sir Mervyn King, governor of the Bank of England, warned UK banks of the "exceptionally threatening environment" posed by the eurozone crisis and advised them to "give consideration to building up capital further in the coming months", which may include tapping shareholders or axing dividends. Even HSBC, despite its global scale, is vulnerable to these threats.

IC TIP: Sell at 511p
Tip style
Sell
Risk rating
High
Timescale
Long Term
Bull points
  • Delivering cost savings
  • Attractive dividend yield
Bear points
  • Sentiment sliding as banking crisis deepens
  • Core Asian markets under pressure
  • Regulatory uncertainty
  • Shares highly rated for a UK bank

True, co-ordinated central bank action just days ago has helped sentiment - in an attempt to avoid a 2008-style credit crunch, central bankers have made it easier for banks to borrow dollars. But it’s the scale of the losses facing lenders in the event of a default on eurozone sovereign debt that's the biggest worry. Until that happens, however, it’s impossible to really know the scale of the likely capital shortfall, which is why Sir Mervyn is so keen for banks to boost their capital. And even though HSBC's exposure to the sovereign debt of weak eurozone countries isn't excessive - $5.5bn (£3.5bn) at end-September - that doesn't reflect how exposed it could be to those eurozone banks that do face hefty sovereign-debt problems. It's why HSBC's ratio of tier-one capital (basically equity) to risk-weighted assets of 10.8 per cent, may not actually be as healthy as it looks.

The weakening global economy is also hurting HSBC, and in precisely those markets where growth looked at its healthiest just months earlier - Asia. With the group's third-quarter figures last month, the Hong Kong operation reported that profits had fallen $0.1bn year-on-year. The bank also warned that near-term growth from the region is set to be curtailed amidst falling loan demand. Combined, the Hong Kong and rest-of-Asia-Pacific divisions generate over half of group pre-tax profit and difficulties here carry big implications for future growth prospects. "HSBC's slowing growth in Hong Kong and Asia is proving increasingly inadequate to fill the hole left by both the run-off of the Household [personal finance business] disaster in the US and incremental disposals," says analyst Ian Gordon of broker Evolution Securities.

HSBC (HSBA)

ORD PRICE:511pMARKET VALUE:£91.5bn
TOUCH:511-512p12-MONTH HIGH/LOW:740p456p
DIVIDEND YIELD:5.0%PE RATIO:8
NET ASSET VALUE:571p  

Year to 31 DecPre-tax profit ($bn)Earnings per share (¢)Dividend per share (¢)
200724.214487
20089.34193
20097.13434
201019.07334
2011*22.59540
% change+18+18

*Evolution Securities' estimates (EPS not comparable with historic figures)

Normal market size: 7,000

Matched bargain trading

Beta: 0.9

£1=$1.57

In fact, problems at the bank's US operation are behind a deterioration in overall credit quality, even though bad debts are generally falling at most other lenders. A rise in bad debts at the US business meant that HSBC's third-quarter impairment charge rose $744m on the year and US impairments now account for nearly 60 per cent of the group's total impairment charge. Moreover, as the global economy continues to weaken during 2012, further increases in loan impairments can't be ruled out.

Amidst wider financial market turmoil, the bank's investment banking arm is struggling, too - its pre-tax profit in the first nine months of the year slumped 23 per cent year-on-year to $5.8bn. Such a large investment banking unit leaves HSBC at the mercy of regulatory reform as well. Specifically, the UK's Independent Commission on Banking proposes that investment banking business should be ring-fenced from retail banking and that higher capital requirements should possibly be applied. That could mean significant extra costs, which may then constrain lending capacity and profits growth.

Still, HSBC is responding with a tough cost-cutting programme - at the half-year stage management announced plans to slice $2.5bn-$3.5bn from the cost base by 2013. And the shares, based on Evolution's estimates, offer a dividend yield of about 5 per cent, pretty good considering two of the UK's big-four banks don't pay dividends.