Our HSBC research report released September of 2016 has proven to be 110% correct. This is the first sentence of our report:
HSBC Common Equity Returns: Notwithstanding a possible boost from significant depreciation of the pound and their beating (already lowered) analysts’ expectations, it looks as if the market has not sufficiently discounted HSBC’s price given it’s extremely negative fundamental, credit and macro outlook.
This morning the company reports an 82% drop in year over year earnings. Bloomberg reports HSBC Plunges After Missing Profit Estimates on Revenue Drop
Net Interest income (US$ billion)
The bank had no less than 6 "one off" expenses and $6 billion worth of of writedowns where analysts were only expecting $1 billion. Of course, we clearly anticipated such, as you can see below.
“Pretax profit is a large miss versus consensus” with “weakness in revenues across all major line items,” Citigroup Inc.’s Ronit Ghose said in a note titled “Weak Revenues, Messy Quarter.” Ghose also noted “an unusually large amount of one-offs” in the period, including a multibillion-dollar writedown on the value of its scandal-hit European private bank.
Here are some snippets from our report. To access our full report (HSBC Research Q3 2016 Research Report - Subscriber Edition), and legacy reports (browse banking section of paid archives), please subscribe.
HSBC Holding PLC
Notably, GBP has depreciated against dollar by ~15% in the last month. This might have contributed to appreciation of HSBC stock price since July 7, 2016 till Aug 6, 2016.
Financial Results – 2Q2016:
HSBC Holdings PLC reported a decline of ~29% in their reported profit before tax. Reported PBT was totaled at USD9.7 billion in 2Q2016 versus US$13.6 billion in 2Q2015
Similarly the bank’s revenue also fell down 11% to US$29.5 billion in 2Q2016 compared to US$32.9 billion in 2Q2015
HSBC reported an increase of 64% in total loan impairment and other credit risk provisions to US$2.4 billion in 2Q2016 from US$1.4 billion in 2Q2015
As per the bank’s Group Chief Executive Stuart Gulliver HSBC is going to buy back up to $2.5bn of its shares this year and hopes for another buyback in 2017. This is an absolutely silly use of capital given the decline in fundamentals, worsening credit metrics and deteriorating macro environment! A move whose only possible justification is to place investor perception of per share metrics.
The bank also stepped back from its dividend policy which implied a payout ratio of 8%
Risk-weighted assets (RWA) reduced by $21bn or 2% to US$1,082 billion as of June 30, 2016 mainly because of targeted RWA initiatives and the effects of currency translation in 1H2016. RWA initiatives resulted in a reduction of $48bn and included asset sales in the GB&M legacy and US CML run-off portfolios, reduced exposures, refined calculations and process improvements
Net Interest Income (NIM):
The net Interest income of HSBC Holding PLC came down by 4% to US$15.7 billion in 1H2016 from US$16.4 billion in 1H2015. Besides, the Net interest margin also came down to 1.83% from 1.92%
Margins are under continued pressure while the revenue is shrinking. What this means that HSBC’s ability to withstand any potential loss due to global banking system is weakening every quarter of every year, year after year. Revenue is not increasing and profitability will be affected. Losses in value of assets and loans may seriously impact the bank’s ability to provide returns to shareholders.
Performance by Geography:
Profit before tax (US$ million):
Total PBT of bank’s Europe business declined to US$1.6 billion 2Q2016 versus US$2.2 billion in 2Q2015 (a decline of almost 25%). Among the countries in Europe, HSBC’s PBT in France declined. Other countries experienced a loss of almost US$663 million.
The performance of Global Private Banking division deteriorated in all countries
Overall PBT of Retail Banking and Wealth Management and Global Banking and Markets division of HSBC also declined in Europe
We have looked at HSBC derivatives again.
Please see the attached file. Notably, the notional value of derivative did witness a decrease in 2015 (over 2014 levels) due to decrease in notional value of interest rate derivatives. However, it again increased in 1H2016. The volatility in value of derivatives is worth noting. For example, in case of interest rate derivatives, the % of gross fair value of derivatives to notional value increased from 3.8% in 2015 to 4.8% in 1H2016 due to the fact that the yield curves in major currencies in Europe ( mostly in UK and to a lesser extent in France) have decreased in recent time because of the economic slowdown. This resulted in an increase in gross fair value of interest rate derivatives and corresponding offset amount. And this increase is the main factor behind increase in total net value of derivative assets
On an overall basis, the % of gross fair value of derivatives to notional value increased from 3.7% in 2015 to 4.5% in 1H2016
The point being highlighted here is that the fair value is very volatile and is dependent on factors external to the bank’s control. Any major turbulence will have non-measurable and unexpected change in value of derivatives and corresponding losses that can materially impact the financial position of the banks.
On a separate note, the bank has not mentioned change in valuation approach (unlike DB) as a reason for change in value of derivatives.