HSBC’s Lukewarm Q2 Results Demonstrate Progress On Reorganization Plan
Earlier this week, HSBC (NYSE:HSBC) reported its performance figures for the second quarter of the year, marking the global banking giant’s first earnings update since it detailed a reorganization plan in June (see A Detailed Look At HSBC’s Large-Scale Reorganization Plan). ((2Q 2015 Earnings Release, HSBC Investor News, Aug 2 2015)) And from the looks of it, the bank has started work at earnest on delivering the targets it set. The quarter wasn’t great for HSBC in terms of revenues due to continuing headwinds from unfavorable currency movements as well as the low interest rate environment, but the bank managed to mitigate the impact on the bottom line by reporting a year-on-year reduction in operating expenses (adjusted for one-time items).
While it is too early to gauge the benefits of the reorganization plan on HSBC’s business model and key metrics, there are a few aspects that have clearly begun to show signs of improvement. To begin with, the size of HSBC’s risk-weighed assets (RWAs) shrunk to under $1.2 trillion at the end of Q2 2015 from $1.25 trillion a year ago primarily due to cuts in the investment banking division – the pace of which was evidently faster in Q2. This, coupled with the bank’s decision to sell its Turkish operations to ING and its Brazilian operations to Banco Bradesco, represent notable steps towards achieving long-term RWA targets. ((HSBC to sell Brazil business to Bradesco, HSBC Press Releases, Aug 3 2015)) HSBC also made progress on the capital requirement front, with its common equity tier-1 ratio reaching 11.4% at the end of Q2 2015 from 11.1% at the end of 2014. At the same time, the sharp improvement in results from Chinese operations support the bank’s plans to increase focus in the region over coming years.
We maintain a $53 price estimate for HSBC’s shares, which is roughly 15% ahead of the current market price.
See our complete analysis of HSBC here
Retail Banking Division Rides High On Strong Asia Results
HSBC’s global retail banking and wealth management (RBWM) business reported a reduction in net interest income for the third consecutive quarter, but more than made up for it by churning out strong wealth management revenues. Total revenues (adjusted for one-time items) improved 4% from $6.1 billion in Q1 2015 to $6.3 billion now. Although adjusted revenues are 6.5% lower than the figure for the year-ago period, it should be noted that the bank has shrunk the size of risk-weighed assets (RWAs) by almost 10% over the last four quarters – indicating that operating performance has been quite strong this time around. The operations in Asia remained the largest contributor to the top line – being responsible for 38% for the total RBWM revenues and more than 15.5% of HSBC’s total revenues.
HSBC’s wealth products include investment distribution, life insurance distribution, and asset management, which together generated just under $2 billion in revenues over Q2 2015. This compares to $1.63 billion in Q1 2015 and $1.53 billion in Q2 2014.
The bottom line was negatively impacted, though, by a $350 million increase in legal provisions related to its unit in North America. While 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 still maintains a sizable retail banking network. One of the key targets for HSBC in its reorganization plan was higher operating efficiency for its U.S. operations by focusing on wealth management, mortgages and deposit services. While we expect costs to remain elevated for a few more quarters as HSBC implements its growth strategy in the region, margins should improve by the end of next year. The impact of higher operating expenses for HSBC’s operations in the Americas on its share value can be understood by making changes to the chart below.
Investment Banking Division Shrinks In Size, But Revenues Jump Year-on-Year
HSBC reports the performance of its investment banking operations along with its treasury and securities services operations as a part of its Global Banking & Markets business division. This division reported revenues of $5 billion in Q2 2015 – 8% above the figure for Q2 2014, but 4% lower sequentially. This trend was largely expected, though, as the seasonal investment banking industry sees highest revenues in the first quarter. Things were also made worse in Q2 2015 by the marked reduction in global debt trading activity over May and June. Thankfully, the impact of lower debt trading revenues on the top line was mitigated to a large extent by strong foreign exchange and equities trading revenues.
The equities trading desk churned out $629 million in revenues for Q2 2015 – a 32% increase compared to the $478 million figure for Q1 2015 and a good 180% higher than the $224 million generated in Q2 2014. In fact, this was the best ever quarterly performance for HSBC’s equities trading unit – a result of high volatility in China’s equity market over Q2. While a large part of HSBC’s goal of reducing its balance sheet assets focuses on its trading book, we believe that the bank will leave its equity trading operations largely untouched because of its strong position in the Asian market.
There was some bad news for the division on the cost front, though, as total operating expenses swelled to almost $3.4 billion from under $2.6 billion a year ago due to a one-time legal charge of $794 million. The adjusted figure was $2.5 billion for both periods, and is slightly higher than the $2.4 billion reported in Q1 2015. Considering the fact that expenses are highest in the first quarter, operating costs have gone up for the bank over Q2. HSBC had warned about this trend a few months ago, due to the expected increase in headcount for regulatory and compliance-related operations. As the bank works through its low-profit units over coming months, we expect margins to improve steadily in the future.
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