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As I’m sure many are aware, HSBC (HBC) shuttered its Decision One subprime mortgage lending unit, in a move that was faintly reminiscent of Capital One’s decision to close down GreenPoint Mortgage. However, just like Capital One, HSBC’s subprime exposure doesn’t end with the closing of just one of its subprime businesses.

From Bloomberg:

HSBC Holdings Plc, the U.K. bank that was among the first to disclose soured U.S. home loans seven months ago, will shut its Decision One subprime mortgage unit and eliminate 750 jobs.

[…]

HSBC's provisions for bad loans, primarily to U.S. borrowers with poor credit histories, climbed 63 percent to almost $6.4 billion in the first half.

Decision One “is a small part of our business,'' HSBC Chief Executive Officer Michael Geoghegan said in the statement. ``It's no longer sustainable and not the right place to allocate capital in the future….

Staff Reductions

HSBC, which employs 56,000 people in North America, last month said it would shed 600 U.S. jobs with the closure of a mortgage office in Carmel, Indiana. The British bank, which bought Prospect Heights, Illinois-based Household International Inc. for $15.5 billion in 2003, has scaled back U.S. home-equity loans and ousted some of the unit's managers to cap defaults.

HSBC said it will continue to service the unit's existing loans, which currently total $349 million.

When you examine HSBC’s exposure to the subprime lending market in the U.S., you realize that the shuttering of Decision One is just the tip of the Iceberg. HSBC still has a sizeable portfolio of subprime auto loans, mortgages personal loans and credit cards through its Household Bank and Orchard Bank units. In fact, a report in the Boston Globe noted that HSBC doubled the number of credit offers it sent to subprime borrowers within the first half of this year.

In other words, despite the way this story has been reported in the Media, HSBC isn’t exiting the subprime lending business, they simply closed ONE of their subprime lending businesses.

The other aspect of HSBC’s exposure to the subprime lending market is that they’re one of the few major British Banks to target subprime borrowers in the UK, meaning, they have subprime exposure on both sides of the pond. Britain has its own subprime problems outside of ours, so it stands to reason that it’s just a matter of time before HSBC reports problems with subprime loans on its own shores. As a bank that originates subprime loans on both sides of the pond (as opposed to other banks that are originating on one side and perhaps investing on the other), HSBC is uniquely vulnerable to the subprime problem.

After paying $15.5 Billion to purchase Household Financial in 2003 and then writing off $11 Billion to cover losses within that unit for fiscal year 2006, it’s safe to say that the Household Finance purchase has been a disaster. Making things worse, is the fact that HSBC’s loan losses in 2007 are likely to be even greater than last year’s number. It’s quite possible that over the course of two years, HSBC will write off losses equal to nearly double what they paid for Household Financial. When does HSBC decide to stop the bleeding and dump the unit all together?

Moving forward, I think HSBC should do the following:

1) Dump Household Finance, do whatever it takes to get out of that business, whether that means closing it down or selling it. At this point, the losses are mounting and it doesn’t make sense for them to hang on to that business, especially when the losses are on the verge of exceeding the original purchase price.

2) Expand their business in the U.S., with respect to retail banking operations, lending and services that focus on affluent customers, which I think HSBC does a pretty good job of, especially within the European and Asian markets.

Moving forward, HSBC needs to focus on its core businesses and leave the subprime lending to someone else. I think HSBC’s strategy to build a global banking business focused on affluent customers is solid, but at the moment, their subprime exposure is not only a drag on earnings, but an unnecessary distraction for management. For 2006 HSBC netted the highest ever profit for a British bank, but that news was drowned out by the $11 billion worth of loan losses they had to write-off. If that’s not a hint to focus on the core and get out of subprime, I don’t know what is.

Sources:

- Bloomberg: HSBC to Close U.S. Subprime Mortgage Unit, Cut Jobs– September 21, 2007.

- London Times: “US triggers $11bn HSBC fall-out” – March 4, 2007

Disclosure: The Author doesn’t own shares in any of the companies mentioned in this article.

Source: HSBC's Closes Decision One: Just the Tip of Its Subprime Iceberg