HSBC value belies income potential

As arguably the last remaining universal bank (commercial and investment banking as well as a gamut of other financial services) within the UK-listed sector, HSBC has benefited from the diversification of its operations. However, management is looking to Asia for profit growth, with the region accounting for three-quarters of adjusted pre-tax profits during the first nine months of the year. Management is aiming to grow its businesses, particularly in China's Pearl River Delta and Southeast Asia, taking advantage of growing middle classes, demand for savings products and increased trade within these regions. Adjusted pre-tax profits for Asia grew an impressive 13 per cent during the first nine months of the year.

At its retail banking and wealth management division, higher revenue from current accounts, savings and deposits – thanks to wider spreads and balance growth in Hong Kong, as well as the UK and Mexico – drove a 10 per cent rise in net operating income during the first three quarters. Commercial banking also benefited from wider deposit margins – particularly in Hong Kong – and a strong global liquidity and cash management business, with net operating income up 13 per cent at $11.2bn.

The challenge for management is balancing Asian expansion while keeping control of costs. However, recently appointed chief executive John Flint seems to have got a handle on operating expenses. Admittedly, the banking group reported negative adjusted ‘jaws’ – the difference between the rates of change in revenue and costs – of 1.6 per cent for the first nine months of the year. However, the rate of cost growth is slowing. Operating expenses rose 2 per cent during the third quarter, compared with 7 per cent during the first half, improving ahead of market expectations. In fact, adjusted pre-tax profits rose 16 per cent to $6.2bn during the third quarter compared with the same time last year, beating company-compiled consensus by 8 per cent. ‘Jaws’ turned positive during the third quarter and management has guided towards positive ‘jaws’ for the full year.

The lender’s high exposure to emerging markets means it suffered significant impairments following the downturn in commodity prices in 2015. However, the quality of the loan book has improved considerably since then. In fact, loan impairment charges of $914m at the end of September were 16 per cent lower than at the same time last year and represented just 0.1 per cent of overall loans and advances.

The banking giant is also benefiting from the gradual increase in US interest rates. That has aided the net interest margin – the difference between the amount the group makes on loans and interest paid on deposits – which had expanded to 1.67 per cent at the end of September, from 1.63 per cent at the end of last year. What’s more, the lender is closing in on its return on tangible equity (ROTE) target of 11 per cent by 2020, with an annualised ROTE of 10.1 per cent at the end of September.