For most large UK banks, the attraction of share buybacks is palpable. The overarching reason for this – if we put aside the well-documented incentives for executive pay packets – is that the options for using surplus capital are limited. The battle for deposits is intense. Hunting a greater market share of dubious credit-worthy lending opportunities runs the risk of capital destruction. And, in any case, loan growth is constrained by intense competition, low interest rates and economic uncertainty. Added to this, regulators are intensely focused on major initiatives that would dampen capital ratios. It almost goes without saying that the days of banking mega-mergers are long gone.
Given this outlook, many shareholders would vote for management to maximise dividends. And for the past few years, that’s pretty much what HSBC(HSBA) has been doing. In 2016 and 2017, it stuck to its pattern of paying out 10¢ per share each quarter, and an extra 11¢ with full-year results, despite widely exceeding reported earnings per share.
Last year, strong outings from the group’s securities, cash management, retail banking and wealth management divisions offset lower-than-expected credit revenue, and meant profits rose enough for the dividend payout ratio to drop below 100 per cent. With this return to sustainable profits looming back into view, management opted to press go on a $2bn share buyback programme, rather than increasing the cash distribution. Investors can expect news on the next round of repurchases when the group unveils its half-year numbers on 5 August.
There’s a defensive logic to this. HSBC is perhaps the most geographically diverse bank in the world, and can therefore point to far more growth opportunities than its London-listed peers. But its core Asian markets face varying degrees of trade, political and macroeconomic uncertainty. Against this backdrop, net interest income growth isn’t guaranteed.
However, recent form has been encouraging. In the three months to March, revenue growth outstripped operating expense growth – the so-called 'adjusted jaws' ratio – by 6 per cent. But this sets a high bar for the rest of 2019, while HSBC juggles both a $15bn-$17bn investment programme and the cost-cutting needed to “meet risks to revenue growth”. Amid these shifting priorities, there’s little wonder the business wants as much flexibility on capital distributions as it can get. Directing investors’ focus towards buybacks also avoids creating a rod for its own back in the form of progressive dividends.
Buying back shares should also eventually mean that HSBC can neutralise its scrip dividend (that is, shares issued to investors in lieu of cash), thereby preventing share price dilution. It might seem counter-intuitive to issue and retire shares at the same time, although it’s worth noting that the scrip is the preferred option of shareholders who want to avoid dealing charges or stamp duty.
Lastly, share buybacks also mean HSBC can put its money where its mouth is, or rather its capital where its marketing is; if the lender’s investment banking arm wants to encourage corporate clients to start their own programmes (with all the fees attached), it helps that the group believes it’s a worthwhile use of capital.
