My view of HSBC (HSBA) to date has largely been along the lines of “it’s not a great business, but it’s not as bad as the market implies either”. Admittedly, initiating coverage during the COVID sell-off made that a fairly easy call to make, with the stock slumping to very attractive discounts to tangible net asset value (“TNAV”) at its low points. There were good reasons for that, namely COVID and possibly politics too, but such is life as a bank. I was also positive on the restructuring plan. Granted, we’ve been here before with HSBC, and past efforts clearly haven’t worked out well enough, but exiting its US retail business is definitely the right decision, and I’m generally optimistic looking ahead.
The shares are down around 4% since my last update, underperforming the FTSE 100 and peers Lloyds, Barclays and NatWest. I called the stock fairly cheap back then, and I do still see upside from the current P/TNAV multiple. When (or whether) it gets all the way back to TNAV is a different question, with that depending on the recovery, restructuring plan and any political discount weighing on the shares. Although previously self-styled as the ‘world’s local bank’, HSBC makes most of its money from its Hong Kong retail activities. That’s the best part of its business by a mile, with the UK bank okay, but nothing special. Anyway, political unrest in Hong Kong has attracted a lot of attention, and anything that casts doubt on its economy is going to weigh here.
With the above in mind, I’m wary of treating this as if it were, say, a US bank. The case for a valuation around TNAV would be straightforward in that case, with more upside still if management were to hit its double-digit ROTE profitability target. Still, at 0.75x TNAV and circa 410 pence in London trading, I do think the balance of risk points to the good here, especially given the wider rally in bank stocks over the past few quarters.
Reserve Releases Boost Q2 Results
Credit quality has held up very well during the downturn, leading the industry to unwind some of the money set aside last year to cover potential bad debt. Indeed, reserve releases juicing bottom lines has generally been the story of the second quarter earnings thus far. HSBC is no exception in that sense, with the bank booking a positive $284m ECL contribution versus a circa $4,170m charge in the year-ago period. That boosted adjusted profit before tax (“PBT”) to $5,560m, up from $2,591m in the year-ago period. For the half-year period, positive ECL contributions totaled $719m versus $6,858m set aside in the first half of 2020. Adjusted PBT came in at $11,950m in the first half of 2021, up from $5,654m a year ago.
Results obviously look slightly less spectacular on a “core” basis. Half yearly revenue fell over 4% to $25,551m, with quarterly revenue down 3.2% sequentially and 10% year-on-year. Lower interest rates explain a chunk of that, while fee-based income in the investment banking arm was also significantly lower. That revenue tends to be more volatile in any case, plus the comparison is off a very high baseline. Pre-provision PBT was consequently down both year-on-year and quarter-on-quarter.
Loan Growth Picks Up
On the plus side, loan growth came in positive, with lending balances up 2% sequentially to $1,060bn. That was helped by solid growth in UK mortgages (up $3bn sequentially), with global mortgages up around $6bn. Total loans in the global retail segment increased 3% to just over $490bn. Also on the plus side, net interest margin (“NIM”) only fell another 1bps (to 120bps) sequentially. Combined with the uptick in loan growth, that led to fairly stable net interest income. Falling yields on interest-earning assets, primarily due to lower interest rates, was largely offset by a fall in funding costs. Deposits increased 1% quarter-on-quarter to $1,650bn. Return on tangible equity (“ROTE”) was 9.4% in the first half, with TNAV per share up a few cents sequentially to $7.81.
Management is guiding for annual loan growth in the mid-single-digit area, which broadly chimes with organic growth in Q2. Certainly areas like personal unsecured lending have plenty of scope to pick up as the economic recovery (hopefully) gathers pace. With NIM also hopefully stabilising, that should provide a bit of support to net interest income and the top line.
Capital returns to shareholders should pick up as well. An interim dividend of $0.07 per share was declared for H1, albeit well below net income of $0.36 per share. Now, management has indicated its intention to rebase the payout to 40-55% of annual net profit. Some quick maths implies an annualised payout in the $0.22 per share area, though lower ECL charges muddy the water a bit for 2021. In any case, we can expect a much larger payout in the second half of the year versus H1.
As I said in the introduction, I’m still expecting medium-term upside from the current valuation, with that coming from gradually improving ROTE. Between that, earnings growth and a tentative circa 4% forward dividend yield, double-digit annualised returns is still on the cards over the next few years.
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