Dividend policy: Four dividends paid quarterly. Management has committed to maintaining the dividend this year at 51¢ a share.
Yield: 6.2 per cent
Last cut: 2009
HSBC (HSBA) is an oddity within the post-financial crisis UK banking sector. While all its UK-listed peers have been forced to cut – or completely do away with – dividends to shareholders following the crisis, HSBC has managed to at the very least maintain its payment since it was last cut in 2009.
However, unlike some of the other income majors in this series, the banking group’s dividends are not backed by a steady earnings stream. Like other banking groups, misconduct charges, bad loans and restructuring charges have taken a chunk out of profits at various points during the aftermath of the financial crisis. Basic earnings per share declined a huge 89 per cent last year to just 7¢, following a $3.2bn (£2.5bn) write-down in goodwill associated with its European private banking business and the sale of its Brazilian operations. Like fellow income stalwart Royal Dutch Shell (RDSB), part of the reason HSBC yields so highly is because of the risk associated with the volatility of its earnings.
Up goes the leverage, bang goes the dividend
Banks are among the most cyclical companies listed on the public markets, benefiting from the economic confidence that drives an appetite for credit. The problem in recent years for most UK-listed banks has been the low interest rates in the UK and US, as central bankers have propped up economic activity. This squeezes the margin between what banks can charge on lending and what they have to pay on customer deposits. HSBC has not been immune to the impact of this. Last August management announced that tough economic conditions in some of its core emerging markets and expectations of enduringly low interest rates meant it was removing its timetable for hitting its target 10 per cent return on equity by the end of this year. During the first three months of the year it managed 8 per cent.
Given this volatility in the bank’s earnings, it is unsurprising that earnings coverage of the dividend has fluctuated during the past eight years. Even on an adjusted basis, only a slither of the 2016 dividend was covered by earnings. However, this is expected to recover this year, with Bloomberg consensus forecasts projecting adjusted EPS of 61.4¢, equating to 1.2 times coverage. Dividend cover is then expected to rise to 1.3 times and 1.4 times in 2018 and 2019, respectively.
That’s because the quality of revenue is expected to improve. HSBC has been benefiting from its ‘Asia pivot’. The region’s rising middle class and a maturing savings and wealth management market are the long-term growth trends HSBC hopes will drive earnings. That’s not to mention the favourable impact of higher US interest rates, given that its earnings are dollar-denominated. Although its bias towards Asia also means the bank’s fortunes are more exposed than most of its UK-listed peers to emerging market sentiment, as well as commodities cycles.
Crucial to maintaining the dividend is the bank’s ability to strengthen its balance sheet and improve its capital position. On that front, HSBC is making progress. In 2015 chief executive Stuart Gulliver set a target of reducing the bank’s risk-weighted assets (RWAs) by around a quarter – or $290bn. Last year alone it cut risk-weighted assets by $143bn. At the end of the first quarter risk-weighted assets stood at $858bn, meaning the bank had exceeded the 2015 target.
This has largely been achieved by selling down its investment bank’s legacy credit and long-dated rates book, reducing its capital financing activities and redeploying capital away from Turkey and Brazil. This has boosted its ability to return capital to shareholders. Last year it bought back $2.5bn in shares, and a further $1bn at the start of this year.
A less top-heavy balance sheet (see chart) bodes well for the security of the bank’s income: the major lesson of the financial crisis for private investors. At the end of March, HSBC’s core tier one equity ratio – core equity as a proportion of RWAs – stood at 14.3 per cent. This is comfortably above management’s 12 per cent to 13 per cent target range. At the end of the year its CET1 ratio is forecast to be 14 per cent, rising to 14.1 per cent the following year.
