19th February 2019

HSBC – Solid as a rock | Bank Capital Insights

Equity investors may be disappointed

HSBC reported Q4 and FY 18 earnings report on Tuesday morning that missed consensus estimates.   Most of the weakness stemmed from a slowdown in the global banking and markets division. The bank’s stock was down about 4% post the earnings announcement reflecting the earnings miss and slightly negative outlook for 2019.   The stock price reaction seems to be a natural reaction but for credit investors, it should not matter much.


Strength in diversification

HSBC benefits from strong geographic and revenue diversification.  The bank’s Asia pivot means that it is well positioned to benefit from future growth prospects and well-cushioned from a potential global downturn given its diversified business model.  Asia generates almost 60% of revenues followed by Europe at 30%.  And recurrent commercial banking type business generates almost 80% of revenues.

The bank generated a ROTE of 8.6% close to its COE, which leaves room for further improvement. The bank needs to further streamline its business lines and reduce operating costs and that would be management’s priority to improve overall returns.


Strong credit metrics

The bank’s credit strengths are further amplified by the fact that credit costs continue to be very low (at 16 bps for 2018) and non-performing exposures of just 1.3%.  These exceptional asset quality metrics are likely to slightly deteriorate in future periods in the event of a growth slowdown, especially in China.

Funding and liquidity metrics continue to be robust with a reported loan-to-deposit ratio of 72%, Liquidity Coverage ratio of 154% and High Quality Liquid Assets of $ 567 billion.  These are very strong numbers reflecting balance sheet robustness.

Overall capital metrics are solid but have a weakened a smidge.  Reported CET1 ratio is at 14% (down about 50 bps on the year) and Leverage ratio is now at 5.5%.  The bank has generates about $12 billion of net income that has allowed it to distribute excess capital.


Conclusion

All in all, the bank’s credit profile remains solid as a rock.  It appears that the bank will have limited or low issuance in AT1s this year and, to that extent, the existing issues should be supported very well and are prime candidates for adding risk on any weakness.

It is expected that the bank will continue with its MREL/TLAC issuance at the HoldCo level but given the strength of its balance sheet, it should not be a problem. The question is at what spread level do these new issues get absorbed?


GJ Prasad

A senior European bank research specialist with significant breadth/in-depth sector knowledge, GJ has researched bank capital instruments extensively - having covered the asset class for more than 15 years as an analyst and 7 years as a risk taker in buy-side roles. His specialisation includes carrying out detailed financial modelling work on the European banks focusing on asset quality, earnings and capital adequacy metrics. His deep-dive work focuses on single name selection and extensive risk analysis on capital securities, especially on structural features, issuer credit profile and equity/AT1 valuation.