Adverse capital markets conditions experienced globally in the fourth quarter were a drag on HSBC’s (HSBA) results, resulting in lower trading income and net fee income against previous quarters.
The weaker trading income was consistent with European and US peers while banks in Asia posted a decline in net fee income on lower brokerage and sales from investment products.
For HSBC, the lower income in the fourth quarter resulted in negative jaws, or operating growth outpacing revenue growth, for the full year against management’s earlier positive jaw guidance. While the market is likely to interpret this as a negative, we note that operating expense was steady and the decline in income was attributable to market conditions.
Management is committed to maintaining a positive jaw in the medium term. For the full year, the underlying metrics for retail banking and commercial banking continue to perform well, in our view.
Asset quality was strong with nonperforming loans remaining benign at 1.3% of total loans. As previously noted, credit cost is expected to normalise to a range of 30 to 40 basis points on total loans. An uplift in expected credit loss in the fourth quarter was due to the probability change in the various scenarios in calculating the credit loss, including weaker outlook in the UK.
Our forecasts have previously assumed a steady increase in expected credit losses but we adjust our forecast to factor an acceleration in credit cost given the rising uncertainty in economic conditions. We also factor in slower increase in net interest margin in 2019 and 2020.
Our fair value estimate is reduced to £7.90 from £8.80. We continue to see HSBC as undervalued as we believe concerns over a deterioration in global trade are factored into current share price. Our new fair value represents a price/book ratio of 1.3 times with return on tangible equity increasing over our explicit forecast period.
HSBC: Business Strategy Overview
HSBC’s strengths are its positions in the UK and Hong Kong banking systems, as well as its overall leadership role in trade finance. With China, Hong Kong, and Singapore being important pools of wealth and growing trade corridors, the bank’s pivot toward Asia, about 75% of pretax income, makes sense. The focus is on deepening relationships with customers across its existing geographies, and leverage the bank’s international network in bringing in new clients.
HSBC’s banking network serves 90% of global trade and about 40% of the bank’s revenue. The broad geographic nature of its business model results in reduced pretax profit volatility versus peers, as evident during the global financial crisis, but comes with higher capital requirements. Due to its status as a global systematically important bank, or G-SIB, HSBC is one of three banks required to hold extra capital buffer of 2%.
Over the past few years, the bank has undertaken a largely successful restructuring and has exited unprofitable markets and low-returning portfolios, reducing total risk-weighted assets by about $296 billion.
A focus on reducing costs, a straightforward plan in a low-interest-rate environment, has stripped out about $6 billion in costs via headcount reductions, procurement efficiencies, and various digital initiatives. With US interest rates normalising and the bank focusing on increase income, the bank is now poised to reap the benefits of its leaner structure.
We also like the bank’s pivot toward Asia, as it takes advantage of HSBC’s strengths. The region is growing in terms of importance for global trade, increased urbanization, and a growing middle class. The bank’s strengths in Hong Kong position it well to take advantage of growth in the Pearl River Delta, and the leading international bank in China.
The latter is achieved through the bank’s long operational history and investments in China. As a result, HSBC is well positioned to capture economic growth in asset management, Chinese yuan internationalisation, and consumer and corporate lending.
