Tuesday, December 20, 2016

A current AIM International Fund holding: HSBC Holdings plc (HSBC, $41.94) by Nick Christman. "HSBC is the best European bulge-bracket bank play"


HSBC Holdings plc (HSBC, $41.94): “Own HSBC for a Steady Dividend and Global Banking Presence”
By: Nicholas Christman, AIM Student at Marquette University

Image result for hsbc logo
Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

 Summary
HSBC Holdings plc (NYSE:HSBC) is the holding company for the HSBC Group. HSBC is an international financial services conglomerate, providing their services across 6,000 locations and 70 different countries. Their largest business line is their retail banking and wealth management (RBWM) division, which accounted for 43% of total revenue in 2015.

• Underlying business trends remain strong on an adj. basis with PBT up 7% in Q3 16’ YoY.
• Loss of $1.7B on sale of HSBC Brazil as CEO continues to exit unprofitable countries.
• Accounting change in recording stake of Bank of Communication, located in China, caused a $121B in RWAs and $5.6B reduction in capital improving their CET1 ratio 104bps.  
• HSBC is positioned to benefit from an increase in interest rates with their advances to deposits ratio at 68%. A 25bps parallel shift down in rates globally would cause a $2B loss in net interest income, thus highlighting the importance of rising rates.

Key points: HSBC like the other global investment banks has struggled to find consistent returns as the uncertain regulatory and political environment has taken away the historical advantage of economies of scale within banking. However, HSBC has protected capital much better than their European counterparts as their strong US and Asian franchises earned 54% of their total revenue in 2015.

HSBC has continued to take opportunistic and aggressive steps to bring their RWAs down to manageable levels under the Basel III capital adequacy framework. While unloading these assets have led to losses, HSBC has made progress much faster than their peer G-SIBs. As of the end of Q3 16’, HSBC had reduced RWAs $229B since the reductions began in Dec 14’, which is 82% of their total goal. Their CET1 ratio of 13.92% leads the peer average of 12.55% and gives HSBC significant opportunity to return capital to shareholders. As of Q3 16’, 59% of HSBC’s $2.5B buyback has been completed.

HSBC has been making significant improvements in their operating costs through multiple initiatives. One such cost cutting program has been cutting redundant branches (271 in Q3 16’) and enhancing digital capabilities through self-service banking. Another focus has been cutting unnecessary employees meanwhile improving IT infrastructure and re-engineering operations to make the company more efficient. 9M16 operating expenses fell $.8B to 22.3B vs. $23.1B 9M15 operating expenses.  

HSBC still must settle multiple outstanding lawsuits including the RMBS suit with the DoJ. The market will have more clarity on the expected penalty when other major European banks finally come to a settlement with the DoJ on their respective cases. HSBC’s underlying ROE for 9M16 has exceeded 8% thus showing their leading profitability from a competitive standpoint out of Europe. If HSBC can wind down one time charges and benefit from a better interest margin environment, the company should be able to drive strong returns into the foreseeable future.

What has the stock done lately?
HSBC has returned 4.71% in the last month outperforming the European financials ETF (EUFN) by 151bps. The stock jumped 4% on the day it reported earnings, as underlying adjusted PBT was 10% higher than expectations. The overall improvement in rates and steepening yield curve has brought the entire banking sector higher. HSBC trades at a lower P/TBV multiple than its US competitors at .89x vs. 1.31x US peer average, and could see potential upside if Asia and EM exposure drive additional revenues.

Past Year Performance: HSBC stock has risen 9.59% over the past year, rebounding nicely from the lows following the Brexit induced selloff. HSBC has a 6.14% dividend yield, and this can be expected to be paid out going forward based off the company’s strong capital ratios and underlying profitability trends. The stock has performed better than European peers because HSBC is much more geographically diversified. This will protect the stock from any one macroeconomic change within a given region.


 Source: FactSet


My Takeaway
Along with JPMorgan, HSBC has the highest CET1 capital buffer, which leaves solvency as one of the biggest strengths for the business. The ability to focus on profitable growth globally will put their business ahead of their competitors. HSBC could look to use their higher capital position to accumulate assets in Asia, which will be cheap as European peers scale back. This flexibility and growth potential makes  Therefore, it is recommended that the AIM International Equity Portfolio continue to hold HSBC despite the regulatory and political risks that the company faces. 



Source: FactSet

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