HSBC: An Underperformer - Analyst Blog

We are initiating our coverage on HSBC Holdings plc (HBC) with an Underperform recommendation. Our primary concern is the harsh impact from the deepening Euro-zone crisis. Moreover, the company is suffering from weak revenue growth in its mature markets due to the ongoing low interest rates and regulatory restrictions.

Revenue growth remained restrained in recent years as a continued low interest rate environment stained revenue generation from several corners. Reducing loan balances, lower trading income in Global Banking and Markets due to lesser client activity and a reduced contribution from Balance Sheet Management are among the factors that have kept overall revenue under pressure.

As growth remains muted in HSBC’s more mature markets (Europe, the U.K., and the U.S.), revenue growth is expected to remain under pressure in the upcoming quarters as well. Moreover, new regulations are expected to restrict fee income growth.

We are also concerned about the performance of Global Banking and Markets as pressures from European sovereign debt crisis have dim chances of easing soon. The lack of loan growth in Commercial Banking, particularly in Hong Kong and Asia, also remains a major concern. Commercial Banking loan growth has been the key performance driver in the recent past, but the slowing economy is forcing the company to reduce its appetite in this arena.

The company’s core operating performance remains unsatisfactory. While the company has reported steady operating income primarily based on reducing loan impairment charges and other credit risk provisions in the last few quarters, its core business performance indicators such as net interest income, net fee income and net trading income failed to impress.

As the slowing economy coupled with a low interest rate environment are expected to put pressure on the core business drivers in the upcoming quarters, it would be difficult for HSBC to improve operating results based only on uncertain benefits like lower impairment charges.

On the flip side, HSBC’s product and service leadership in alternative investments, foreign exchange, credit, investment advice and many other cross-border banking services help it in spreading its customer base better than peers. Moreover, the company has more than half of its operations in fast-growing emerging markets that are expected to outperform the developed western economies.

Despite the uncertain macro environment, HSBC remains strong with respect to its balance sheet and capital position, which is definitely a competitive advantage over other banks. The company continued to grow its capital base and strengthen its capital ratios. At the end of 2010, core tier 1 ratio increased to 10.5% from 9.4% in the previous year. This was well above the minimum regulatory requirement plus the capital conservation buffer.

We expect this capital strength to allow HSBC to enhance its profitable market share. Also, as a consequence of capital strength, unlike many of its peers, HSBC continued to pay dividends over the last couple of years, though at a reduced rate. The company continued the same trend in 2011 as well.

HSBC has been also progressing well with respect to its long-term strategy to reduce costs up to $3.5 billion by 2013. In August, HSBC announced its plan to restructure the business and trim its workforce by 30,000 in the next two years.

Also, the company is in the process of selling its profitable U.S. credit card business to Capital One Financial Corporation (COF) to slash its non-core business and reduce costs. The primary intention is to focus more on the fast-growing emerging markets. The deal, which is expected to be completed by the second quarter of 2012, will likely enable HSBC to gain share in all its key Asian markets where demand is very high.

Though cost containment measures will help the company deal with the economic pressures to a great extent, we expect high inflation in some key Asian markets, slothful loan growth, insufficient core operating performance and high wage inflation to restrict the company’s growth, at least in the near term.

HSBC currently retains a Zacks # 5 Rank, which translates into a short-term Strong Sell rating.

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