Cube Midcap Report (28 Oct 2019) – Bank botheration #HSBC
Good morning! We have an entire week of midcap reports coming up for you.
Today, I’m going to take a look at HSBC.
- Share price: 593.7p (-4%)
- Market cap: £120.3 billion (c. $154 billion)
This banking giant, like many of its peers, has achieved little for investors in modern times beyond paying out a chunky dividend.
HSBC’s share price was higher than the current level in 1999.
Poor returns on bank assets have depressed valuations in the sector, and rightly so.
Barring the occasional crisis, bank shares have suited investors who want yield (e.g. pensioners wishing to live off the income from their portfolios), but they have been a poor source of capital gains.
My interest in the sector stems from my belief that they can tell us something useful about the state of the economy (the global economy, in HSBC’s case).
I also like to have exposure to the FTSE-100 index, from time to time, and HSBC accounts for over 7% of the index, according to the latest weightings. As many investors know, the FTSE is a bank-heavy index.
Finally, I do invest in small-cap financial stocks (including a small Challenger bank) and so it could be helpful to know how the financial giants are doing!
Without further ado, let’s summarise what happened at HSBC in Q3.
Net income attributable to HSBC shareholders fell to less than $3 billion, versus $4.4 billion in Q2 2019 and $3.9 billion in Q3 2018. The bank said that this reflected “challenging market conditions”.
Revenue was down versus those quarters, too, “due to lower client activity in Global Markets, compared with a strong 3Q18”. Global Markets is HSBC’s investment banking division.
It was a quarter to forget. Here’s what it means for year-to-date performance:
Year-to-date, therefore, we do have some progress in most key metrics. The exception is net interest margin, which materially declined – HSBC blamed customer redress programmes in the UK and hyperinflation in Argentina for the majority of the deterioration.
All of these points from the outlook our very important:
- “The revenue environment is more challenging than in the first half of 2019, and the outlook for revenue growth is softer than we anticipated at the half-year. As a result, we no longer expect to reach our RoTE target of more than 11% in 2020.
- We will act to rebalance our capital away from low-return businesses and adjust the cost base in line with the actions we take.
- These actions, or any continuing deterioration in the revenue environment, could result in significant charges in 4Q19 and subsequent periods, including the possible impairment of goodwill and additional restructuring charges.
- Addressing low-return businesses and reducing risk-weighted assets (‘RWAs’) will allow redeployment of capital and resources into higher growth and return opportunities.
- We intend to sustain the dividend and maintain a CET1 ratio of above 14%.”
HSBC looks “safe” at a CET1 ratio of 14.3% (with the disclaimer that understanding the true risk on its balance sheet is not really possible). Any CET1 ratio greater than 10% could informally be considered low-risk.
However, the combination of a “safe” balance sheet and poor returns on assets makes for a weak Return on Equity.
HSBC’s balance sheet includes total assets of some $2,700 billion.
Shareholders’ equity is $190 billion (vs. market cap $154 billion).
Generating an attractive return on this huge pile of equity capital without using too much leverage is a real challenge, particularly when dealing with uncertain economic conditions.
HSBC has now abandoned its target of achieving a return on tangible equity >11% by 2020. As the previous table showed, ROTE is currently running at around 9.5%.
Here’s the geographical breakdown:
I’ve highlighted Europe and Asia. You can see a huge fall in European profitability this year, while Asia continues to grow (despite the disruption in Hong Kong, which triggered a $90 million charge). Asia has accounted for more than 80% of HSBC’s profit this year.
The new CEO has decided that an overhaul is needed. Capital allocated to continental Europe, the UK and North America will be reduced, and the investment banking business (“Global Markets”) will be particularly vulnerable to cuts. Indeed, the entire organisation is to be “remodelled” to “simplify the bank” and “reduce costs associated with running the Group”.
I do think there is some utility in watching events in HSBC.
For example, the CFO has warned today that “the outlook for credit remains more uncertain than usual” and “expected credit losses remain sensitive to forward economic guidance”. Given the extent to which the global economy relies on credit, I like to hear about the outlook direct from the horse’s mouth, so to speak!
And if capital is being withdrawn from banking activities in the West, due to a lack of corporate activity, then clearly this is something else which investors might want to be aware of.
Existing forecasts for HSBC’s dividend suggest that it will remain flat at around 39p per annum, and management confirmed today that they want it to remain at this level.
If I was investing purely for income, I would be tempted. And from the point of view of the FTSE-100, I think that this share could act as an anchor for the index – it’s unlikely that the market is pricing this badly wrong, in my view. A modest discount to book value sounds about right.
That’s all for today. Hopefully we get some spicier announcements from mid-caps tomorrow!