HSBC yesterday reported a 10% improvement in pretax profit year-on-year to $14.1 billion in the first half this year, driven by the sizeable cost cuts the bank has made during the past couple of years and lower loan impairment charges.
The underlying profit before tax, which is adjusted for changes in exchange rates, changes in the cost of the bank’s own debt and net gains on the sale of assets, was up 47% to $13.1 billion. The return on average shareholders’ equity increased to 12% from 10.5%.
The bottom line was below the average analyst estimates of $14.6 billion, compiled by HSBC itself, and the bank’s share price fell 4.4% in London trading and 4.5% in New York. (The results were released after the close of trading in Hong Kong yesterday, suggesting a further sell-down is likely to happen here today.)
However, investors appeared to be disappointed not so much about the slight miss in profits, as the 7% decline in revenues to $34.4 billion. CEO Stuart Gulliver attributed this partly to the slowdown in economic growth, particularly in emerging markets.
But it also highlights the challenge that the bank faces after disposing of 54 businesses and generating $4.1 billion of annualised sustainable cost savings since the start of 2011: Cost cuts will only go so far when it comes to improving returns — in the long run, revenues will have to increase as well. This is particularly true since new regulatory requirements continue to eat into returns as well.
The bank also noted that the cost of settling a US lawsuit related to the sale of mortgage-backed securities in the lead up to the financial crisis could amount to as much as $1.6 billion — almost twice the amount paid by UBS in the settlement of a similar suit last month.
The US Federal Housing Finance Agency alleges that HSBC, UBS and 16 other banks misrepresented the quality of the underlying loans of residential mortgage-backed securities (RMBS) that they sold between 2005 and 2008. Aside from UBS, Citi and GE Capital have also settled, although the latter two have not disclosed the costs involved.
“Based upon the information currently available, it is possible that these damages could be as high as $1.6 billion,” HSBC said.
This is the first time the bank has put a number of the cost of litigation, although it has previously said that the financial impact could be significant. According to media reports, analysts had estimated the potential cost at about $900 million.
The revelation that the settlement could be significantly larger than that drew attention to the fact that even as it has taken big steps to reshape the bank, HSBC may continue to suffer from legacy issues. The section dealing with legal proceedings and regulatory matters spanned 11 pages in the 61-page earnings release.
The bank also set aside another $367 million to compensate customers in the UK for insurance sold against loan defaults, taking its provision for that issue to $2.8 billion.
On the more positive side, Gulliver noted in a written statement that the steps taken to reshape HSBC since 2011 have released around $80 billion of risk-weighted assets to date, with a potential to release another $15 billion going forward.
Alongside internal capital generation, this will add further support to investments in organic growth opportunities that are a strategic fit, he said.
“These include priority areas such as transaction banking and trade finance, where we are already recognised as a market leader globally and ... opportunities such as the development of equities in Hong Kong and our debt capital markets platforms in faster-growing markets, where our well-established presence and strong relationships give us a highly competitive position.”
The bank has achieved $800 million of additional sustainable cost savings since the beginning of this year, taking its total cost cuts in the past two-and-a-half years to $4.1 billion. The cost efficiency ratio improved to 53.5% in the first half from 57.5% a year earlier and was at the low end of the “mid-50s” target that the bank has given itself for the next couple of years.
In the first half, total operating expenses fell by 13% from a year earlier to $18.4 billion. On an underlying basis, the decline was 8%.
In May, HSBC said that it intends to trim costs by a further $2 billion to $3 billion in 2014 to 2016. Part of that will be achieved by additional job cuts, from about 261,000 at the end of last year, to between 240,000 to 250,000 by the end of 2016.
However, after paying $1.9 billion to US authorities related to inadequate compliance with anti-money laundering rules and the bank secrecy act last year, HSBC has increased the resources in its regulatory and financial crime compliance units by more than 1,600 people in the past six months. It is also delivering mandatory training to all of its employees on critical compliance subjects on a continuing basis, chairman Douglas Flint said.
The bank announced the sale of a further 11 businesses in the first half and also a $3.7 billion non-real estate loan portfolio in April, accelerating the run-off of the consumer and mortgage lending portfolio in the US. The latter resulted in a loss of $300 million, which the bank said was “considerably lower than initially expected.”
It will sell more such loans, but the rate of the business disposals will slow as the initial three-year phase of the restructuring programme draws to a close, Gulliver said.
As of the end of June, the group’s total assets were $2,645 trillion, which represented a decrease of $47 billion, or 2%, since December 31, 2012.
Loan impairment charges of $3.1 billion were 35% lower than in the first half 2012. The bank said it saw declines in the majority of its regions, but most notably in North America where the decrease reflected improvements in housing market conditions, the continued run-off of the US consumer and mortgage lending portfolio and lower delinquency levels. This was partly offset by an increase in impairment charges in Latin America.
Underlying revenues did increase by 4% to $33.3 billion, supported by growth in several key business areas. The commercial banking unit saw an increase in net fee income. Global banking and markets, which includes investment and transactional banking, saw revenues increase in financing, equity capital markets and credit. And the retail banking and wealth management divisions recorded growth in mortgage balances as well as wider spreads in HSBC’s home markets in the UK and Hong Kong, the bank said. A greater collaboration between its global businesses also helped, it added.
That said, net interest income fell 8% to $17.8 billion.
The Hong Kong business posted a pretax profit of $4.2 billion, up 11.8% from the first half 2012, while the rest of Asia-Pacific saw its pretax profit grow by 15.7% to $5.1 billion. These two regions generated 65.8% of the profit. Europe accounted for 19.7% and North America for 4.7%.
Global banking and markets was the largest single business division in the first half, accounting for 40.7% of pre-tax profit after earnings increased by 13.4% to $5.7 billion. Retail banking and wealth management posted a 49% decline in profits to $3.3 billion and its contribution to the total earnings fell from 50.3% to 23.2%. The contribution from the commercial banking division also fell, from 34.8% to 29.4%, as the pretax profit declined by 6.7%.
