While most banks are struggling to find the capital to meet tougher regulatory requirements, HSBC Holdings (HSBA) is in the fortunate position of generating more than it can use. Moreover, loan growth prospects - while solid - just aren't robust enough to absorb it all. Returning capital to shareholders therefore looks increasingly likely, leaving the shares with some of the best income characteristics in the global banking sector. Add that to a modest share price rating and HSBC shares are a buy.
- Copious capital generation
- Superior dividend prospects
- Rapidly improving credit quality
- Exposed to higher-growth emerging markets
- Muted shorter-term growth prospects
- Sentiment hit by business conduct issues
The bank's capital strength is certainly impressive, with its core tier one capital ratio reached 12.7 per cent in the first quarter compared with 10.1 per cent at end-December 2011. Not only is that rather healthier than that of its UK rivals, but it already leaves HSBC compliant with the Basel III regulatory capital regime that’s due to begin in 2019. Not many other banks can claim that yet. Broker Espirito Santo reckons its Basel III core tier one ratio at end-March was 10.1 per cent, compared with the 9.5 per cent regulatory minimum.
Such copious capital generation reflects $4bn of cost-savings since 2011, and a further $2bn-$3bn (£1.27bn-£1.91bn) of savings are expected between 2014 and 2016. A restructuring programme has seen 52 non-core and underperforming businesses sold or closed. Rapidly falling bad debt provisions have also helped. Significantly, the North American business, where HSBC’s US consumer finance arm (in run-off) has been longstandingng bad debt headache, saw its impairment charge fall to $447m in the first quarter from $1.1bn a year earlier. The group's first quarter bad debt charge dropped 51 per cent year-on-year to $1.17bn, compared with a loan book of $959bn. Reasonable earnings growth in recent years, when some rivals have made losses, also helped bolster capital.
There’s plenty more to come, too, and Espirito Santo estimates that HSBC will generate $56bn of excess capital, above its Basel III ratio requirement, by 2015. But the bank is unlikely to grow quickly enough, organically, to absorb it. Espirito expects "muted loan growth" in the near teramidst less than buoyant global economic conditions. Blowing cash on acquisitions isn't thought likely, either, with analyst Ian Gordon of broker Investec Securities pointing out that management appears to have ruled out "any further major value-destructive acquisitions".
HSBC HOLDINGS (HSBA) | ||||
|---|---|---|---|---|
| ORD PRICE: | 680p | MARKET VALUE: | £127bn | |
| TOUCH: | 679-680p | 12-MONTH HIGH/LOW: | 773p | 509p |
| FWD DIVIDEND YIELD: | 6.4% | FWD PE RATIO: | 9 | |
| NET ASSET VALUE: | 941¢ | |||
| Year to 31 Dec | Pre-tax profit ($bn) | Earnings per share (¢) | Dividend per share (¢) |
|---|---|---|---|
| 2010 | 19.0 | 73.0 | 34.0 |
| 2011 | 21.9 | 92.0 | 39.0 |
| 2012 | 20.6 | 74.0 | 41.0 |
| 2013* | 29.6 | 109 | 54.0 |
| 2014* | 30.2 | 113 | 68.0 |
| % change | +2 | +4 | +26 |
Normal market size: 3,000 Matched bargain trading Beta:1.16 *Espirito Santo Investment Bank estimates $1=£1.57 | |||
That really only leaves one option: to return surplus capital to shareholders. Chief executive Stuart Gulliver appeared to signal as much last month after saying that he will "keep under review the capital we hold". But with HSBC's appetite for share buybacks looking "somewhat limited", according to Mr Gordon, then expect the dividend payout to soar. Espirito Santo expects the payout to reach 68¢ in 2014 followed by 76¢ the year after - implying a prospective 2015 yield of 7.1 per cent (see table). Not only does that beat anything on offer from the other UK banks - Standard Chartered (STAN) is next best, with a prospective 2015 yield of 5 per cent - but it’s hard to find a global bank peer with such attractive income characteristics.
HSBC's trading performance looks good, too. True, shorter-term loan growth won't be spectacular, but unlike most UK peers, the bank is focused on markets with decent longer-term prospects. For example, the faster growth markets of Hong Kong and Asia Pacific generated a combined 65 per cent of group pre-tax profit in the first quarter. There’s also a modest presence in Latin America, another emerging market with prospects. Even the lacklustre European operation, which made a $3.4bn loss last year, managed a $1.8bn profit in the first quarter driven significantly by falling loan impairments.
| COMPARING THE UK BANKS | |||||
| Prospective yield* | P/NTA 2013* | Core tier one capital ratio† | |||
| Name | 2013 | 2014 | 2015 | ||
| Barclays | 2.5% | 3.4% | 4.7% | 0.84 | 11.0% |
| HSBC | 5.1%** | 6.4%** | 7.1%** | 1.3** | 12.7% |
| Lloyds | nil | 1.6% | 3.2% | 1.1 | 12.5% |
| RBS | nil | nil | 3.2% | 0.67 | 10.8% |
| Standard Chartered | 4.1% | 4.5% | 5.0% | 1.4 | 11.7% |
*Investec Securities estimates **Espirito Santo estimates †Latest reported | |||||
Still, sentiment has been hit by various business conduct issues. Specifically, HSBC was fined $1.9bn by US authorities last year for inadequate compliance with money laundering rules, and it was also forced to put aside $1.4bn to cover UK payment protection insurance mis-selling claims. A $598m provision has also been made to cover claims for mis-sold interest rate products and that figure could well grow.
