HSBC Holdings plc (HSBA) Ordinary USD0.50
HL comment (28 April 2020)
Underlying net operating income fell 5.8% to $13.3bn in the first quarter, as market movements negatively affected the life insurance and investment banking businesses. Despite lower operating costs profits before tax fell 51.3% to $3.0bn as the bank set aside $3.0bn for bad loans (credit impairments) related to the coronavirus outbreak and single large credit exposure in Singapore.
Given the ongoing impact of coronavirus management now expect profitability in 2020 to be materially lower than in 2019. Having suspended dividend payments at the regulator's request earlier this year, the bank confirmed that the dividend policy will be reviewed at or ahead of, full year results.
The shares fell 1.7% in early trading.
COVID-19 is causing unparalleled economic disruption. That will inevitably have an impact on banks, and HSBC isn't immune.
The group expects defaults to increase, not surprising given the pressure businesses are under as lockdowns obliterate revenues. But loan defaults weigh on profits that will already be struggling.
Lower interest rates mean lower net interest margins (NIM - the difference between what the bank can make on loans and pays for funding) making lending less profitable. The pain from a lower NIM will mount as fixed loans roll-off, and reduced economic activity is also likely to bite in the trade finance and commercial banking businesses.
If conditions get worse from here provisions for bad loans will increase, eating into capital reserves. Increased loans and credit downgrades of existing borrowers mean 'risk weighted assets' (RWAs) rise. Since capital ratios are calculated by dividing available capital by RWAs both parts of the equation are moving in the wrong direction.
Paying out surplus capital to shareholders in that scenario is perhaps not the best idea for short term stability and that's led regulators to ask for the suspension of all UK bank dividends. HSBC has duly complied, and investors should not expect a dividend before the end of the year.
There are some brighter spots though.
HSBC has a large investment banking arm, which should offer some good news in the short-term. This division makes a substantial chunk of revenue through fees rather than loan interest. Turbulent financial markets have tended to mean a spike in trading and hedging activity, which has been good news for revenue. In the near-term it will help the group mitigate headwinds impacting the rest of the business.
The bank is also heavily exposed to emerging Asian economies, particularly China, and there are some signs these markets are recovering reasonably well from the coronavirus shock. While we remain conscious of the risk of a second wave of infections, this could prove an advantage over more domestically focused rivals.
Investors and regulators alike will also be relieved banks generally are much better capitalised than before the financial crisis. A conservative capital position is a layer of protection to help weather the storm and the bank has traversed the first part of the crisis without a significant dent to reserves.
While HSBC has so far proved resilient, the length of lockdowns and strength of the eventual recovery will ultimately determine the damage the bank sustains. They are, as yet, unknowns. Prolonged disruption and a slow economic recovery will be a drag on capital and replacing those reserves takes time. Hopefully by the half year stage we'll have a clearer picture of potential damage and the timeframe of any renewed dividend payments.
First Quarter Results
Retail Banking & Wealth Management (RBWM) saw net operating income fall 17% to $4.9bn, driven primarily by a $994m decline in life insurance manufacturing. Underlying profit before tax fell 84% to $1.8bn, reflecting lower revenue, a $0.8bn credit impairment and slight increase in operating costs.
Net operating income in Commercial Banking (CB) fell 5% to $3.7bn, impacted by lower interest rates. Underlying profit before tax fell 69% to $1.4bn following a $1.1bn credit impairment.
HSBC's investment bank, Global Banking & Markets (GB&M), saw net operating income fall 8% to $3.7bn. Significant reductions in valuation in Principal Investments and the credit book more than offset increases in trading revenues. Underlying profits before tax in the division were 49% lower at $0.8bn, with a $0.5bn credit impairment.
Global Private Banking net operating income rose 13% to $511m, with growth in investment revenue and lending. Profit before tax rose 23% to $0.1bn.
The Corporate Centre reported a positive net operating income of $622m and underlying profit before tax of $1.1bn (up $0.8bn on last year).
Overall net interest income rose 1.9% in the quarter to $7.6bn. That reflects increased lending to customers, which more than offset a slightly lower net interest margin (the difference between what the bank charges on loans and pays for funding) of 1.54%.
Operating expenses were 2.9% lower in the first quarter of 2020 compared to a year earlier. That reflects lower performance related pay and cost-saving initiatives, and comes despite ongoing investment in digitisation.
The bank finished the quarter with a CET1 ratio of 14.6% (a key measure of banking capitalisation) compared to 14.7% last year. This includes the benefit of cancelling the 2019 fourth quarter dividend.
HSBC now expects further credit impairments in the rest of 2020, with reduced customer activity and lower interest rates to weigh on net operating income. The also expects its CET1 ratio to be negatively affected. Some parts of the planned transformation plan have been delayed, and as a result restructuring costs are expected to be lower than originally planned this year.
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