Expected losses of $3 billion on its loan book, the highest figure since Q3 2011, means that HSBC’s first-quarter pre-tax profit slumped 48% to $3.2 billion, the bank’s worst start to a year in over a decade,” says Russ Mould, AJ Bell Investment Director.
“HSBC now believes the annual total for bad loan losses could come to somewhere between $7 billion and $11 billion, a figure which perhaps goes some way to justifying the Prudential Regulatory Authority’s request that the bank hold back dividend payments and scrap its buyback scheme.
“HSBC has left itself some wiggle room on its dividend, since the bank has only stated it will pay no dividends in 2020. This does leave it the option of declaring a distribution alongside its Q4 results and then paying that after its Annual General Meeting in spring 2021,
“Although HSBC has confirmed that it will not run a share buyback scheme in either 2020 or 2021 and whether regulators or economic circumstances will permit dividend payments remains open to question, with the effects of the COVID-19 outbreak, the shape of any economic recovery and the oil price all key variables. For the record, analysts still think HSBC could pay a dividend of 26.4p a share for fiscal 2020, enough for a 6.3% yield on the shares.
“HSBC flagged the weaker economy and oil’s collapse as the major reasons for the $2.4 billion year-on-year jump in loan provisions that weighed so heavily on its Q1 profit, which came in at the lowest level since the bank began quarterly reporting at the start of the last decade.
“Banks tend to reassess their credit books – and get stuck into any kitchen-sinking of problem loans – at the end of a year, so the fact that HSBC felt the need to join the big four Main Street banks in the US in taking a cautious view so early on shows how difficult 2020 is likely to be.
“HSBC flagged a large loan loss in Singapore – potentially the oil trader Hin Leong – as well as a number of smaller losses at its investment bank. Overall, COVID-19 added $1.5 billion to loan loss provisions, split $630 million across retail exposures and the rest across wholesale markets.
“But it is not just COVID-19 and creaking oil markets that are to blame for HSBC’s profit plunge. Net interest margins remain under pressure, as central banks cut interest rates worldwide and launch Quantitative Easing programmes to keep them, and bond yields, low. As a result, HSBC’s net interest margin on its loan book sagged again, down to 1.54% from 1.59% a year ago.
“A change of five basis points (five one-hundredths of a percent) might not sound a lot but HSBC has $1 trillion in loans on its balance sheet so every little change will make a big difference.
“Throw in global Governments’ desire for banks to offer more credit and potentially not pull the rug on lenders during these difficult times and this is a very difficult environment for banks. This is reflected in HSBC’s lowly 4.2% return on tangible equity (RoTE) in Q1, a figure which is clearly influencing how investors are valuing the bank.
“That meagre RoTE, added to an increase in loan losses to 1.18% of the loan book and the sliding net interest margin mean that HSBC trades at just 0.7 times its tangible book, or net asset, value of $7.44 (or around 600p) a share.
“Investors are therefore saying that HSBC’s returns on equity are going to remain depressed for a very long time, even once the COVID-19 outbreak is hopefully behind us and the global economy is back on the up. That reflects wider fears about global indebtedness, record low interest rates and the sluggish trend growth, all issues which were nagging away at shareholders before the viral crisis, as they worried whether the West was in danger of ‘turning Japanese,’ thanks to excess debt and a growing reliance on either Government fiscal stimulus or ever-more extreme central bank intervention to keep the show on the road.
“Those investors who think such fears are overdone may find HSBC’s current valuation rather tempting, especially if the bank starts paying dividends again at some stage. Those who do fear that the experiences of Japan since 1989 are going to seep westward will steer clear, in the knowledge that the Topix banks index is down some 93% from its all-time high, some 31 years after it was reached.”