HSBC Holdings PLC (HBC) is one of the largest global banks. Effectively it has two home markets: Hong Kong and UK. The bank has a long-standing presence across the Asian region and most recently it has expanded into the Americas. HSBC's operating segments are organized into six geographical regions namely: Europe, Hong Kong, Rest of Asia-Pacific, Middle East and North Africa (MENA), North America and Latin America. The bank operates across all major lines and further segments its business by the range of products and services it offers to customers, which are: Retail Banking and Wealth Management (RBWM), Commercial Banking (CMB), Global Banking and Markets (GB&M), Global Private Banking (GPB). The bank moved its Global Asset Management business from Global Banking and Markets to Retail Banking and Wealth Management, with effect from March 2011.
In terms of customer accounts ($m), Europe with 39% accounts for largest share of any region followed by Hong Kong which accounts for 25% of all customer accounts, whereas North America has a share of 13%. In terms of products and services Commercial Banking with 36% accounted for highest profit before tax (2011) followed by Global Banking and Markets, which contributed 32% of total profits before tax. Similarly in terms of risk-weighted assets Global Banking and Markets has the biggest share (35%), followed by Commercial Banking (32%) and Retail Banking and Wealth Management (29%).
Source: Company Documents, Price Point Research
Why We Like HSBC
We like the London-based bank for the following reasons:
- Strong funding
- Asian growth
- Attractive valuations
- Strong balance sheet
- Dividend yield
HSBC has a good loan-to-deposit (LTD) ratio of below 80%; in fact it is the only bank out of the five big British banks to hold more deposits than loans. The ratio is commonly used to assess a bank's liquidity. If the ratio is too high, it means that the bank might not have enough liquidity to cover any unforeseen fund requirements; on the other hand if the ratio is too low, the bank may not be earning as much as it could be. HBC is a deposit-led bank. The bank's Honk Kong franchise has an LTD of below 50%, moreover the Retail Banking and Wealth Management segment of the Asian franchise of the bank has an LTD of below 40%. In fact the London based bank has low LTD's across all its regional operations, with the exception of North America.
HSBC's strategy is to refocus on its strengths in the emerging markets, especially Asia. HSBC's strong Hong Kong franchise made a profit (before tax) of $5.8 billion or 26.6% of bank's total profits in 2011. This percentage has increased to 31% YTD. Although it doesn't have as strong position as it has in HK, HSBC has a strong network in the rest of Asia. The bank reported $2 billion in PBT from mainland China in 1H12. The second biggest economy in the world is the second largest profit generator for HSBC after HK. With its strategic investment valued at $23 billion, as of October 2012, HSBC China is the largest foreign bank in China. We believe HSBC's Asian growth momentum is underappreciated and we expect the bank to continue to consolidate its position in this region and post good results for its shareholders.
Source: Company Documents, Price Point Research
Financial and Credit Analysis
HSBC is trading at a forward P/E of 7.85, whereas it has a TTM P/E ratio of 12.7 compared to 15.1 of S&P 500. The bank has an earnings yield of 7.9 compared to 6.6 of S&P 500. It has P/B ratio of 1.1 against 5 years average of 1.3 and S&P 500 P/B of 2.1. Bank's P/CF ratio of 2.4 is also better than S&P 500 (9.2) and HSBC 3Y average of 10.4. The bank has a very healthy 7% long term consensus growth rate and a decent PEG ratio of 1.8. The stock has gained 37% in value YTD.
Source: Google Finance
HSBC is rated high by all three big rating agencies (Moody's: AA3, Standard & Poor's: A+, Fitch: AA). All of HSBC's debt is of high quality. The bank has debt/equity ratio of 0.66 against industry average of 3.08, debt/assets ratio of 0.04 against industry average of 0.15, EBITDA/Interest ratio of 2.89 against industry average of 1.22, debt/EBITDA ratio of 3.59 against industry average of 14.74, and finally CFO/total debt ratio of 0.70 which is way better than the industry average. These ratios tell us how well the bank has been managing its leverage.
We also like HSBC for its dividend yield and above average history of dividends. The bank has one of the best dividend yields (3.5%) among its peers (Barclays (BCS) 1.60%, Credit Suisse Group (CS) 3.20%, Citigroup (C) 0.10%, Royal Bank of Scotland Group (RBS) 0%, Lloyds Banking Group (LYG) 0%).
In its most recent (3Q) Interim Management Statement (IMS) the bank reported better than expected numbers on the back of lower provisions (particularly in U.S.) and slightly better revenues throughout. The London based bank reported adjusted profit before tax (PBT) of $6.1 billion vs. consensus estimates of $5.2 billion, beating consensus estimates by more than 17%. The reported PBT of $3.5 billion was adjusted for several one timers such as $172 million in disposal gains, $1.7 billion in own credit charge, $800 million in US litigation charges, $353 million PPI charge, $97 million in restructuring charges, $100 million gain on NQH, and $58 million in bank levy. Underlying revenues of $16.1 billion (vs. consensus estimates of $16 billion) increased 2% YoY and declined 5% sequentially, whereas, underlying costs of $9 billion were in-line with 2Q12.
Honk Kong franchise performed exceptionally well with PBT of $1.8 billion, an increase of 39% YoY. Revenues for the region also increased YoY by 16%, driven by strong results in commercial banking and RBWM divisions.
HBC's core tier 1 ratio improved to 11.7% from 11.3% in 2Q12. The bank further expects satisfactory trading performance in 4Q12, however European risks remain.
Settlement With The Department Of Justice
For its alleged role in helping launder money belonging to drug cartels and countries under U.S. sanctions, HSBC Holdings PLC became the first ever bank to admit to both money launder lapses and U.S. sanctions violations. The London-based bank has agreed to pay U.S. Department of Justice $1.92 billion in deferred-prosecution agreement.
Stuart Gulliver, Group Chief Executive, said: "We accept responsibility for our past mistakes. We have said we are profoundly sorry for them, and we do so again. The HSBC of today is a fundamentally different organisation from the one that made those mistakes. Over the last two years, under new senior leadership, we have been taking concrete steps to put right what went wrong and to participate actively with government authorities in bringing to light and addressing these matters.
"While we welcome the clarity that these agreements bring, ensuring the highest standards wherever we do business is an ongoing process. We are committed to protecting the integrity of the global financial system. To this end we will continue to work closely with governments and regulators around the world."
The settlement with DOJ includes civil fines of more than $650 million and $1.25 billion forfeited by HSBC, the largest ever U.S. forfeiture for a bank.
The bank has already been taking steps to repair the damage, and show that it took the Justice Department's investigation serious.
The biggest European Bank said last week that it was separating financial crime compliance from other areas of compliance, and will set up a financial intelligence unit to carry out in-house investigations into potential regulatory breaches.
The London-based bank announced a new position - head of financial crime compliance - and appointed Robert Werner a former U.S. Treasury Department official and a specialist in sanction violations and money laundering. Werner previously worked as the head of the U.S. Treasury's Office of Foreign Assets Control, the department responsible for enforcing U.S. sanctions.
The appointment of Werner follows the appointment of Stuart Levey, another U.S. Treasury Department official, whom the bank appointed as chief legal officer in the beginning of 2012.
The bank has taken several other steps recently to ensure higher standards going forward, the details of those steps / measures can be found here.
The HSBC announcement follows settlement by another British bank, Standard Chartered Plc, which agreed to pay much smaller amount of $327 million in fines for sanctions violations.
HSBC Sells Entire Stake in Ping An Insurance
Earlier this month HSBC announced that it has agreed to sell its entire stake (15.57%) in Ping An Insurance, at a premium of 2.3% over pre-announcement (December 4) closing price, to wholly owned subsidiaries of the Charoen Pokphand Group for $9.4 billion in cash or at a share price of HK$59.
On a post-tax basis HSBC expects to gain $2.6bn from the sale (14.5% of 2011 net income). The sold company accounted for 5.3% of HSBC's pre-tax earnings in 2011; however, that share dropped to 4.2% in the most recent quarter due to market valuation losses on equity securities held by the insurance company, reflecting volatile HK equity market.
After the transaction, the London-based bank expects to strengthen its Tier 1 Capital Ratio by 0.5% and the Total Capital Ratio by 1%. As of September 2012, the group had the Tier 1 Capital Ratio of 11.7% and the Total Capital Ratio of 15.6%.
HSBC has sold many other global insurance operations in the past and the recent transaction is largely in line with the bank's strategy. What remains to be seen is how the bank will deploy $9.4 billion (4.7% of its market cap as of December 10) proceeds. To this front the bank has provided no details. However, we believe the bank could use the proceeds and one-off post tax gain to pay the settlement fines and set up more provisions for its ongoing legal issues or the bank could return the money back to shareholders in the long term via a higher payout ratio.
We believe the Department of Justice's investigation was proving to be a big distraction for the bank and was hurting the bank's attempts to improve profitability and reduce costs. But the recent settlement will now allow the bank to shift back the focus on its core operations.
The London-based bank had already set aside $1.5 billion to cover the costs of any fines or settlement, and the sale of Ping An Insurance should provide further cushion. The bank has attractive valuations, strong LTD ratio and balance sheet, its Asian operations have gained strength and it has an attractive dividend yield. The fundamentals remain strong; we have a buy rating on HSBC.
Worse than expected macro environment, regulation, and costs and credit quality present risks to our analysis on HSBC. The bank's Global Banking and Markets division, which accounted for a hefty 32% of 2011 pre-tax profits, is exposed to global financial markets volatility and which could present a risk to HSBC's earnings.