That’s not the view of FT Alphaville but the banking team at Morgan Stanley who have published a detailed report on HSBC on Wednesday. And it really does not pull any punches.
Having lifted the lid on HSBC’s balance sheet, analysts Michael Helsby in London and Anil Agarwal in the far east, conclude that it is not as strong as the market thinks.
With $12bn of surplus capital carried at the group level has almost gone, HSBC’s Asian franchise is not as well capitalised as they previously assumed and $10bn of losses coming from HSBC’s US business and Available For Sale (AFS) portfolio, they reckon a cash call is inevitable.Our analysis suggests a ‘Minimum’ $27bn capital requirement
Adding together the items for our Minimum’ capital requirement, we include the equity required to rebuild the capital cushion at the top ($11bn), to strengthen the Asian franchise in anticipation of the local regulator “lifting the bar” ($5.8bn) and the equity required to pay for the expected cumulative losses in HSBC’s US business ($5bn). We also put in an estimate for the impairment of assets currently held in the AFS reserve ($5bn), giving a minimum capital requirement of ~$27bn.
All of which has predictable repercussions for the dividend…
In 2007 HSBC paid out $10bn in dividend. Since 1992 investors have on average elected to take 26% of the dividend in scrip. Analysing the history suggests investors become more risk adverse in times of distress, and in our view it would be imprudent for the management team to assume an average take up in 2009 and 2010. If we combine this with our estimate of the capital requirement discussed above, a sharp reduction in attributable profits in 2009 and 2010 as structural and cyclical headwinds take hold (2009: $6.6bn, 2010: $6.2bn), it suggests to us that HSBC will cut its dividend in 2009.
And Helsby and Agarwal have pushed through some pretty aggressive downgrades because of lower margins in Asia, higher bad debts and currency movements.
We have reduced our 2009 PBT forecast by 34%, which equates to a 39% drop in EPS and flows through to a 32% fall in 2010. We now forecast 2009 EPS of US55¢ and 2010 of US50¢; 46% and 60% below FactSet consensus, respectively. We have reduced our price target to 455p from 550p previously.Turning to capital ratios, the analysts see HSBC ending 2008 with an apparently healthy equity tier 1 ratio of 7.3 per cent. However, they reckon that figure is an illusion as it includes:
(1) – An estimated $15bn (130 basis points) of unrealised losses in the AFS reserve which are added back to its capital ratio.
This is extremely high relative to other UK banks and is typically not allowed by other US/European and Asian banks. HSBC says that the quality of the assets within the reserve is sound. However, our review of the risk positions within the AFS reserve suggests that a very large proportion of the disclosed position is within assets that most investors would not perceive to be ‘good quality’.
(2) – 50bp of insurance capital, which by 2012 will not be allowed to be included within Tier 1.
They also say investors need to consider $34bn of Fair Value deficit that exists within the loan books of HSBC’s Finance business.
While we would not deduct this from capital ratios…if HSBC had to impair these assets this would take a further 200bp from capital.
On a look through basis then, Helsby and Agarwal contend that HSBC’s core equity tier 1 ratio drops to 3.6%. This is well below HSBC’s rivals and explains why they believe a dividend cut and rights issue are on the way.
Post a $20bn capital increase and a 50% dividend cut, we calculate HSBC would carry a clean Core Equity tier 1 of 7.2% (stripping out the AFS and insurance double counting), which looks reasonable given historical HSBC capital ratios and broadly in line with the recapped Santander, which has 7.1%. [Note Santander is not allowed to add back its €3.8bn AFS reserve, which equates to 80bp of capital].
Related Link:
HSBC’s subprime risk – FT.com