HSBC Worth $50 Despite Subpar Q3 Performance
HSBC (NYSE:HSBC) reported mixed results for the third quarter of the year earlier this week, as slow economic conditions coupled with the bank’s efforts to refocus its business away from low profit areas resulted in a reduction in revenues for each of its operating divisions. [1] Notably, revenues for HSBC’s cornerstone retail banking and wealth management business (RBWM) slid 16% from last year – something that did not go down well with investors given the bank’s strategy of focusing primarily on RBWM operations to unlock value in the long run.
But things for HSBC were better than they appear at first glance. To begin with, it should be noted that a stronger U.S. dollar adversely affected HSBC’s results, as the geographically diversified bank reports its results in U.S. dollars. Factoring this in along with other one-time items, the reduction in revenues over Q3 2015 can be traced almost completely to a reduction in trading revenues and insurance-related fees. Given that the period was poor for these operations around the globe, the underwhelming Q3 showing does not take away from the strength of HSBC’s business model. The bank made headway on the cost front, with adjusted non-interest expenses nudging lower for the second consecutive quarter. Also, HSBC seems to have worked its way through a bulk of its legal backlog, as settlement and misconduct costs fell to $200 million in Q3 2015 from around $1.1 billion in Q2 2015 and Q3 2014. Finally, HSBC reported an improvement in its common equity tier 1 (CET1) ratio figure from 11.2% in Q2 to 11.4% at the end of Q3.
Considering all these factors, we maintain a $50 price estimate for HSBC’s shares, which is roughly 25% ahead of the current market price. We believe that fears of the bank shifting its headquarters out of the U.K. in the near future, and a seemingly poor performance for Q3 are responsible for the significant price gap.
See our complete analysis of HSBC here
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Retail Banking Results Dragged Down By Weak Conditions In Asia
HSBC’s retail banking and wealth management (RBWM) business witnessed sizable headwinds on two fronts over the first quarter of the year: the negative impact of a strengthening U.S. dollar, and the growing pressure on net interest margins from the low interest rates prevalent worldwide. Both factors depressed the total revenue figure for RBWM, which fell to below $5.5 billion for Q3 2015 – 16% lower than the figures for Q3 2014 and Q2 2015. However, adjusting revenues for currency translations and extraordinary items shows that things were not that bad, as the revenues for the quarter ($5.4 billion) were roughly 5% lower than those for Q3 2014 ($5.6 billion). The reduction can be attributed almost completely to a fall in life insurance revenues from $417 million in Q3 2014 to $207 million now, with all other revenue streams remaining largely unchanged.
The decline in retail banking profits for HSBC was particularly prominent in Asia-Pacific, where the pre-tax income was reduced to $901 million in Q3 2015 from $1.1 billion last year. While uncertain economic conditions in China contributed to a marked reduction in revenues for the division, higher regulatory and compliance costs hurt profit margins further. However, an improvement in operating performance for HSBC’s Europe RBWM mitigated the impact of the poor showing in Asia to a great extent.
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Investment Banking Division Fares Well Given The Tough Environment
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 $4.5 billion in Q3 2015 – 3% below the figure for Q3 2014, and 10% lower than what it reported for the previous quarter. This was largely expected, given the year-on-year reduction in trading revenues reported by all U.S. banking giants from a lower level of activity in the fixed income industry and the high volatility seen across global equity markets. HSBC’s trading desk generated less than $1.5 billion in revenues in Q3 2015, compared to $2.1 billion in Q2 2015 and $1.7 billion in Q3 2014.
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While an uptick in revenues from capital financing, as well as payments and cash management helped the division in Q3, the biggest push to operating margins came from the fact that one-time legal and restructuring costs were just $161 million this time around, compared to $812 million in Q2 2015 and $969 million in Q3 2014. This helped the cost-to-income ratio improve considerably from almost 80% a year ago and 67% in the previous quarter to 57% now. As HSBC clears its outstanding legal burden, and as its reorganization plan begins to yield results, we expect operating margins for the division to steadily improve as captured in the chart below.
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- 3Q 2015 Earnings Release, HSBC Investor News, Nov 2 2015 [↩]