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HSBC - dividend suspended, reported revenues expected to fall

Sophie Lund-Yates, Equity Analyst | 1 April 2020 | A A A
HSBC - dividend suspended, reported revenues expected to fall

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HSBC Holdings plc Ordinary USD0.50

Sell: 373.95 | Buy: 374.00 | Change -10.40 (-2.71%)
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Due to the disruption caused by coronavirus, the Bank of England has asked HSBC not to pay its fourth interim dividend. Similar requests have been made of other UK banks.

As a result HSBC has cancelled its final dividend payment of 2019 and will make no quarterly or interim payments or undertake any share buybacks until the end of 2020. The dividend policy will be reviewed once the full impact of the pandemic becomes clearer.

So far bad loans have remained relatively low. However the disruption means HSBC expects lower revenues in insurance, valuation adjustments in Global Banking & Markets, and an increase in defaults.

The shares fell 7.8% following the announcement.

View the latest HSBC share price and how to deal

Our view

COVID-19 is causing unparalleled economic disruption. That will inevitably have an impact on banks, and HSBC isn't immune.

The group expects defaults on loans to increase, which isn't surprising given the amount of pressure businesses are under as lockdowns take a hammer to revenues. Loan defaults equal lower profits for banks. Added to that, revenue from the insurance business will suffer too - record low interest rates mean investment returns from premiums will struggle to get off the ground.

And as will be the case for all the banks, lower rates means net interest margins (the difference between what the bank can make on loans and pays for funding) will be squeezed. That will significantly reduce the profitability of loans.

Investors in HSBC should be particularly mindful of the fact most profits come from Asia. With the region being particularly hard-hit by the pandemic - Hong Kong was in lockdown for over a month - there could be pressure on HSBC's capital. As businesses struggle and turn to borrowing to get through, loans increase. That leads to a decline in capital ratios - calculated by dividing available capital by 'risk weighted assets' (RWAs). Higher loans means RWAs increase.

Against that background it's not a huge surprise banks have been asked to scrap dividend plans. Paying out surplus capital to shareholders while things are so up in the air isn't the best idea.

That's particularly true for HSBC because as well as the issues bothering the entire sector, it's recently embarked on a costly restructuring programme. The aim is to focus more on emerging Asian and Middle Eastern economies, as well as integrating private banking into the wider retail banking business.

Not only will this shift take time and money ($7.2bn to be precise), we don't know how long emerging markets are going to take to recover from coronavirus. That could dull the shine of new CEO Noel Quinn's strategy for some time.

There are some brighter spots though.

HSBC has an investment banking arm, which should offer some short-term protection. This division makes money in a different way, so it's not exposed to lower interest income. Bumpy economic conditions also tends to mean a spike in trading and hedging activity, which is good news for revenue.

Investment banking isn't a cure all, but in the near-term it will help the group mitigate headwinds impacting the rest of the business.

The other thing to keep in mind is that the sector at large is in a much better capital position than before the financial crisis. A conservative capital position is a layer of protection to help weather the storm. But remember that doesn't mean the current disruption won't cause ups and downs, and that capital pile will likely come out of all this smaller than when it began.

The length of lockdowns and strength of the eventual recovery will determine the extent to which the bank has to wind down its capital reserves. There are more than enough demands on HSBC's capital at the moment, and replacing reserves takes time. We'll have a better idea of when dividends might be back on the table once there's a clearer picture of the damage caused by this pandemic.

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Full Year Results (18 February 2020)

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.

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.

Find out more about HSBC shares including how to invest

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