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HSBC - the pivot to Asia continues

Nicholas Hyett, Equity Analyst | 18 February 2020 | A A A
HSBC - the pivot to Asia continues

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HSBC Holdings plc Ordinary USD0.50

Sell: 369.65 | Buy: 369.75 | Change -14.25 (-3.71%)
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Underlying revenue rose 5.9% to $55.4bn in 2019, with underlying profit before tax up 4.9% to $22.2bn.

However, reported profits fell 32.9% as the bank took $7.3bn of writedowns relating to the economic climate and ahead of a major restructure. The bank announced plans to reduce its exposure to the US and European markets, particularly in relation to investment banking.

The dividend remains unchanged at $0.51 per share for the year as a whole.

The shares fell 4% in early trading.

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Our view

HSBC's exposure to rapidly developing economies with growing populations, is fundamentally attractive. Unfortunately, poor returns in more established markets and macroeconomic headwinds mean there are several unwanted distractions.

Top of the list of concerns are probably the trade dispute between China and the US and coronavirus outbreak. Asia accounts for almost all profits and HSBC's significant position in trade finance means it's particularly vulnerable. It doesn't help that within Asia, Hong Kong is a crucial market, and political turmoil there isn't good for business.

However, recently appointed interim CEO Noel Quinn is looking beyond those short term headwinds - in what seems to be an unusually extended, on the job, job interview. Focus and capital is set to shift from underperforming investment banking operations in Europe and the US to the better performing retail and commercial banks, and towards emerging Asian and Middle Eastern economies. A renewed focus on cost savings from digitisation, and integration of private banking into the wider retail banking business should boost efficacy.

All that change isn't coming cheap though. The group has set the price tag at $7.2bn across 2020 and 2021, and the share buyback programme has been suspended as a result. It doesn't help that cutting costs is expensive in the short term (investment bankers are expensive to keep but pricey to fire too) and increased investment in digital capabilities is demanding significant quantities of cash.

'Rebalancing capital to higher growth, higher return markets' is all well and good in theory. But the bank will need to find profitable uses for the capital once it's been extricated from the less exciting European and North American businesses. The Asian private bank could be one such opportunity, but it's not going to double in size overnight.

Unlike the investment bank, the UK high street operation is also attracting extra investment despite lingering uncertainty related to Brexit. So far the group's weathered the storm better than many rivals, with loan growth offsetting margin compression in a competitive market. However, bad loans are creeping up - mostly in business lending at the moment and certainty not to danger levels, but something to keep an eye on nonetheless.

Underpinning a generally unfavourable environment for banks is a less upbeat outlook for interest rates in the US. Banks have tended to do better when rates are rising, and with the Federal Reserve now far more likely to cut than raise rates, that's likely to mean the squeeze on interest margins continues for some time.

Still, HSBC has consistently stood firm behind its 6.7% prospective yield and enjoys a healthy level of capitalisation together with longer-term growth potential. Given the economic environment though, investors should be prepared to weather some ups and downs in the months and years ahead.

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Full Year Results

Retail Banking and Wealth Management (RBWM) saw revenue rise 9.5% to $23.4bn, driven by increased loans to customers and higher net interest income as a results. Underlying profit before tax in the division rose 14.7% to $8.0bn despite an increase in bad loans.

Revenues in Commercial Banking (CMB) rose 5.7% to $15.3bn, with underlying profits before tax down 2.3% to $7.3bn due to a significant increase in bad loans.

Global Banking and Markets (GBM) revenues fell 0.7% year-on-year to $14.9bn, combined with higher operating costs that meant underlying profit before tax fell 9.2% to $5.3bn.

A 5.2% rise in Global Private Banking (GPB) revenue, which came in at $1.8bn, with steady costs drove an 18.6% increase in divisional underlying profits before tax to $402m.

The Corporate Centre reported an underlying profit before tax of $1.1bn, compared to $461m last year.

Overall loans to customers rose 4.3% to over $1trn, with growth across the RBWM, CMB and GPB divisions. Overall net interest margins fell 0.08 percentage points to 1.58%.

On an underlying basis the bank's cost:income ratio improved slightly to 59.2% (excluding cost related to the restructuring).

The bank finished the year with a CET1 ratio of 14.7%, a slight improvement on last year. The group intends to stay between 14-15% going forwards and expects to be towards the top end of this by the end of 2021. However, the bank will suspend buybacks for this year and next, and as a result the scrip dividend (where dividends are paid in new shares rather than cash) will be dilutive.

HSBC's return on tangible equity deteriorated slightly during the year to 8.4%, while the bank is targeting 10-12% in 2022.

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