HSBC's (NYSE:HSBC) business strategy appears to have collapsed over the last five years. The grand design of HSBC as a global bank in a Citi (NYSE:C) fashion, with significant presence on all four continents and major trade routes, serving multinationals on payment systems transactions, trade finance and investment banking activities on a global basis, and HNW individuals with sophisticated private banking services worldwide, has proved to be too difficult to implement.
The lack of penetration in certain areas - Latin America and Africa - the scandals in which the private bank has been involved - money laundering in Mexico, Swiss tax avoidance scheme, and Panama Papers - and the currently developing crisis in emerging markets with its epicentre in HSBC's operational core - China and Hong Kong - are the factors that have, in our view, put the worldwide strategy of the bank in jeopardy.
Finally, it is likely that the harsh cost-cutting and asset disposal programs around the world implemented by HSBC have created significant cultural problems within the organization and increased the potential for organizational malfunction.
Financial Risk And Geographic Equilibrium
In early 2016, HSBC's systemic stability lies in the dual design between its Asian leg - China, Hong Kong and nearby areas - and its Western holdings - UK, US and Continental Europe.
In a blueprint similar to that of Banco Santander (NYSE:SAN), but in different continents, when one of HSBC's geographic segments enters into a crisis - Asia nowadays - the other leg - Western World - is expected to be at least stable and generate enough revenues to keep profits and regulatory capital at a reasonable level.
This design gives stability to HSBC's balance sheet; for example, the Hong Kong-based bank should survive in a better condition after the Asian slump compared with Standard Chartered (OTCPK:SCBFF), a pure Asia and emerging markets player.
Nevertheless, the Asia/West counterweight has negative points: 1) It does not generate significant enough synergies between both units in opposite parts of the globe; 2) it might be argued that it responds more to the easiness of doing business and acquiring local bank bases on historical events - the geographical footprint of the British Empire - than to the business needs of institutions and individuals around the markets in which HSBC seeks to serve; and 3) as it has limited business continuity, some of the themes developed to justify the design - following trade flow "corridors" - have forced the bank to invest in areas in which it had little advantage and could not easily reach a leadership position.
Latin American Investment
During the last decade, HSBC had developed an important Latin American sub-strategy and built a sizeable network in the area: offshore services and the biggest bank of Panama, the fifth lender in Mexico, and a sizeable organization in Brazil. Overall, HSBC had more than 3,000 branches in Latin America at the start of 2012.
The whole design for the area has crashed: lack of competitive scale forced HSBC to sell its operations in Colombia, Peru, Uruguay and Paraguay during 2012; the financial scandals in which the bank has been involved in Mexico and Switzerland have probably triggered the disposal of its offshore business in Panama; and finally, the lack of clarity on the ultimate goals of a significant presence in Latin America without leading in any market, together with the China-induced economic crisis, has probably forced the sale of HSBC Brazil for $5.2bn to be completed by the end of 2016.
In other words, the HSBC strategy for Latin America seems to have been wrong for a long time.
Operations In The UK
HSBC's UK operations are significant; together with Barclays (NYSE:BCS), RBS (NYSE:RBS), Santander and Lloyds (NYSE:LYG), it is one of the top five banks of what is a profitable oligopoly. The bank has circa 1,100 branches in England, Wales and Scotland, and it holds 33% of its whole loan book in the UK.
The bank's UK footprint corresponds basically to the former Midland Bank, fully acquired by HSBC in 1992, in what was one of the largest banking acquisitions in UK history.
The HSBC UK profile has been traditionally conservatively profitable when compared to its peers. In terms of metrics and strategic positioning, HSBC is in a similar frame as key competitors Lloyds, Barclays, RBS and Santander.
HSBC will keep its UK operations for the long term because 1) they are profitable on their own and 2) they are a counterweight to the problems in Asia. The unit is disconnected to some extent from the rest of the geographic segments of the bank, so the potential for synergies is limited. Notwithstanding, it is probably one of the few parts of HSBC which is profitable and able to develop its business strategy autonomously.
Operations In Asia
Hong Kong and China are the operational core of HSBC. The bank itself was registered in Shanghai and Hong Kong in 1865 to finance trade between China, British India and the rest of the Empire. A branch in Yokohama was opened in 1866, and soon after, HSBC was managing most of the Chinese public loans. From its Hong Kong headquarters, HSBC engineered its global expansion with key acquisitions in the UK (Midland Bank), the US (Mariner Midland), Hong Kong (65% of Hang Seng Bank), Latin America and the Middle East.
At the end of 2015, Hong Kong represented 23% of the bank's loan book; the whole Asia region represented 39% of HSBC's global loan book. In terms of revenues, the weight of Asia is even bigger: 59% of all HSBC global revenues are generated in Asia, and 22% in Hong Kong only.
Asian operations are the weak spot of HSBC: if the China-led slowdown intensifies, the area will certainly drag down the bank's returns, capital position, and the stock price. So far, the full effect of this expected value destruction has not been felt by the balance sheet.
NPL charges and other credit provisions have remained stable during the last three years for the Asian region in the context of a slightly increasing trend, reaching the level of $693 million in 2015 compared with $647 million in 2014. In mainland China, the origin of instability, asset quality seems to be under control.
Total risk exposure at the end of 2015 was $143bn, of which $135bn was wholesale and $8bn was retail. Wholesale loans break down into 22% Chinese public debt, 51% Chinese corporates and SMEs, and 26% local bank loans. No significant increase of NPLs or NPL charges has been noticed so far.
In spite of this, it is likely that the financial risk of the mainland China loan book has significantly increased due to the asset bubbles generated in the coastal regions over the last decade and the slowdown that is quickly gaining traction across most of the country.
In terms of the financial fragility of the loan book of a bank, there is typically a delay of two to three years between the moment in which the NPL risk is generated and the point in time in which it is made explicit in the balance sheet and the P&L account.
Therefore, given the worsening situation of the Chinese economy, we should see a progressive increase of NPLs from the Chinese operations during the next two to three years.
What does all this mean in terms of stock price?
Investors have noticed this situation and the HSBC stock price has reacted accordingly. 1) The perceived lack of global strategy for the bank, 2) exposure to a potentially deep recessionary area and 3) the organizational impact of severe rounds of job and infrastructure cuts around the world have triggered the breach of the upside price trend during early 2013 at around 660p and the formation of a negative trend structure that reached a minimum of 410p in January 2016, amplified by the banking panic of early 2016.
The future of HSBC looks sketchy; the three negative factors that have triggered the fall in stock price will remain (organizational dysfunction, perceived lack of strategy) or increase (Asia slowdown). Thus, the stock price should continue its downward path.
There is only one minor bright point in this gloomy assessment: HSBC is big and not fully Asian. Therefore, the main target for the hedge fund shorts that wish to express their negative mood on Asia in banking terms will likely be a smaller, pure emerging markets lender such as Standard Chartered or a mature, overleveraged and risky commercial bank deeply invested in the commodities cycle such as Westpac (NYSE:WBK) or Commonwealth Bank of Australia (OTCPK:CMWAY).
In any case, under the dynamics analysed, HSBC looks like a clear short in 2016 and 2017.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.