A Detailed Look At HSBC’s Large-Scale Reorganization Plan
Earlier this week, HSBC (NYSE:HSBC) announced sweeping organization-wide changes aimed at aligning its business model towards more profitable opportunities while also adapting itself to the stricter global regulatory environment. [1] The move has been anticipated for a while now, as the bank has struggled to improve returns over recent years even as a string of high-profile lawsuits and regulatory probes hurt investor confidence considerably. The newly announced plan focuses on reducing the size of HSBC’s risk-weighed assets (RWAs), cutting costs and increasing investments in Asia with the long-term goal of improving shareholder payout. The key goals of the shake-up are to attain a return of equity figure of 10%, to reduce annual recurring costs by as much as $5 billion and to ensure a faster growth in revenues compared to expenses by the end of 2017.
Notably, the proposed disposals and cost reduction schemes could reduce HSBC’s total headcount by as much as 50,000 over the next two years – just under 20% of the bank’s global workforce of 266,000 at the end of 2014. The bank will, however, add more jobs over the period to improve regulatory oversight as well as to grow its business in specific regions. In this article, we detail the changes HSBC intends to implement as a part of this reorganization plan and how each of its proposed actions will impact the bank’s share value.
We are currently in the process of updating our $53 price estimate for HSBC’s stock to factor in the impact of the recently announced changes.
See our full analysis for HSBC
Reduction in Group RWAs
The largest aspect of HSBC’s reorganization plan is a reduction in its total risk-weighed assets by at least 25% compared to the figure at the end of 2014 – a total reduction of $290 billion. Almost half of this target will be achieved by shrinking less profitable units under the bank’s Global Banking and Markets (GB&M) division, which includes its investment banking operations. The proposed $140 billion reduction in GB&M assets will slash the division’s RWAs to less than one-third of the group’s total RWAs. HSBC will achieve the remaining asset reduction by running-off its U.S. Consumer and Mortgage Lending (CML) division and by selling its operations in Brazil and Turkey.
The reduction in GB&M assets will have a negative impact on the revenues. HSBC reported $516 billion in RWAs for its GB&M division at the end of 2014. Now, shrinking this figure by $140 billion implies a 27% reduction. As HSBC will target the low-profit units, we believe the actual reduction in revenues for the division will likely be around 15%, with most of the cuts being implemented in the FICC (fixed-income, currencies and commodities) trading unit.
Optimization of Global Network
One of the biggest competitive advantages HSBC enjoys over other global banking giants is the extent of its geographical diversification. But the complexity arising from the extensive global network has been a cause for concern since the economic downturn of 2008 – especially since it has not been accretive to the bank’s returns. This is why the bank shrunk its global presence from 87 countries in 2011 to 73 at the end of 2014. HSBC intends to continue to exit low-profit regions over coming years, beginning with Brazil and Turkey. The bank’s gross outstanding loan portfolio at the end of 2014 was $25.5 billion in Brazil and slightly less than $8.6 billion in Turkey.
It must be mentioned here that the bank has a sizable share of Brazil’s retail banking market, and is ranked 6 among banks in the country in terms of assets. Talks with potential buyers for the Brazil unit are at advanced stages, with the country’s 4th largest bank – Banco Bradesco – seen as the most likely buyer. [2] A sale will bring in between $3-4 billion in cash to HSBC and will shrink its employee strength by almost 21,000 – almost 8% of the bank’s global workforce.
Improve Profitability In Mexico and the U.S
HSBC intends to strengthen its position in Mexico so that it can leverage the country’s economic growth. Mexico’s attractiveness comes from its export-focused economy as well as from its being a part of the NAFTA (North American Free Trade Agreement) with the U.S. and Canada. HSBC is currently the fifth largest bank in Mexico, and has a sizable share of the nation’s trade, equity underwriting and debt origination markets. Over the next two years, the bank will look to improve operating efficiency in Mexico to boost pre-tax incomes from less than $100 million now to more than $600 million by the end of 2017.
Also, HSBC has reduced its retail banking footprint in the U.S. over recent years by getting rid of its credit card operations in the country. The bank will now look to improve the efficiency of its existing retail branch network by focusing on wealth management along with providing mortgages and deposit services. Furthermore, it intends to boost revenues by pursuing growth in transaction banking and capital financing.
Prioritize Growth In Asia
The importance of HSBC’s operations to its business model becomes quite clear from the fact that the region contributed around 64% of the banking group’s total pre-tax incomes for 2014 (as adjusted). Notably, this represents a sharp increase from the region’s 33% share of the pre-tax income in 2004. The bank expects this figure to grow considerably, based on estimates that Asia will contribute nearly 50% of the world’s total banking revenue pool by 2025 – up from 30% in 2010.
HSBC is particularly interested in growing its business in the Pearl River Delta region of China and the ASEAN-affiliated nations of Malaysia, Singapore and Indonesia. This is likely to have a tangible impact in the rate of growth of HSBC’s loan portfolio in the region over coming years.
Ring-Fence U.K. Operations
HSBC is required to ring-fence its retail banking operations from the riskier investment banking operations in the U.K. as a part of the directive issued by the British government to the country’s largest banks in 2012. The ring-fencing needs to be in place by 2019, and will see HSBC set-up a separate banking entity based out of Birmingham to house its retail, private and commercial banking units in the U.K. The remaining units will remain under the current London-based subsidiary. The process of ring-fencing and the associated funding requirements for the two separate banking subsidiaries will result in an increase in operating expenses for HSBC’s European operations in the future.
Also, the bank is currently reviewing the possibility of moving its headquarters out of the U.K. to avoid the heavy bank levy being imposed on the largest U.K.-based banks. The review will be completed by the end of the year, and a decision to shift the headquarters out of London could result in a one-time cost of a couple of billion dollars over coming years.
Cut Annual Recurring Costs By $4.5-5 Billion
HSBC’s profitability goals hinge on its ability to cut annual recurring costs by up to $5 billion over the next two years. The savings will be achieved through six actionable items, and the bank will spend between $4-4.5 billion to be able to realize these benefits. HSBC will shrink its workforce by between 22,000-25,000 as a part of this cost cutting program. The plan involves:
- Enhancing digital capabilities, reducing administrative roles and cutting down the number and size of branches.
- Streamlining and automating operations, and also shifting operating roles to low-cost locations
- Simplifying the software development process and optimizing the IT infrastructure
- Moving finance as well as risk-related roles out of high-cost regions
- Reducing external spending by consolidating suppliers
- Simplifying organizational structure and removing dual reporting lines
The benefits of these expense management measures will be seen across divisions. The partial impact on HSBC’s share price can be understood by making changes to the chart below which captures the non-interest expenses for the bank’s commercial banking division.
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- Investor Update 2015, HSBC Website, Jun 9 2015 [↩]
- Bradesco Said to Be Most Likely Buyer of HSBC’s Brazil Unit, Bloomberg, Jun 8 2015 [↩]