Seconds out, round two.
furious row debate over Wednesday’s controverisal note from the Morgan Stanley banking team on HSBC rumbles on.
Having seen his work criticised by rivals and belittled by HSBC’s PR company, Morgan Stanley analyst Michael Helsby has hit back with this own fresh note to clients.
MORGAN STANLEY & CO — HSBC: A few clarifications – Reiterate U/W
HSBA LN, 588p, U/W, 455p PT
It appears that almost as much has been written by other sell side firms about our HSBC note than we wrote ourselves. Within the comments we have seen, there has been some gross mis-statements, which we feel we need to clarify. We would suggest investors read the report and stick firmly by the conclusions in it – that HSBC will halve the dividend in 09 and potentially raise $20bn of capital.
1) We are NOT saying that HSBC needs to raise capital to plug a hole created by marking the loan book of Household to market. Our reference to the $34bn FV gap in Household was mainly for comparison purposes, i.e. as an investor you cannot ignore that it is there, as it limits materially the options that HSBC has in the US and the way it must think about its capital position
2) We are NOT saying that the accounting rules are going to change so that HSBC has to realise the $15bn AFS hit within its capital ratios or that the $5bn insurance deduction will be brought forward from 2012. What we are saying is that for comparison purposes when you look at the core capital ratio of HSBC you need to be aware that you are not comparing apples and apples with other large banks in the UK, Europe or Asia. HSBC’s 130bp AFS reserve is huge relative to other UK banks (STAN next closest at ~18bp) or other Euro bank. (Note AFS is not added back in Spain, Italy, etc. In Europe, banks do not benefit from the insurance double counting either. We gave an example that when you compare the core capital ratio of HSBC it is really 5.5% versus a rebuilt Santander of ~7.1% on a like-for-basis.)
3) While we are NOT saying the AFS treatment reverses, we are saying that HSBC is likely to suffer a $5bn impairment within the assets held in the AFS book. At the end of 1H08, there was $73bn of assets held “net” in the AFS book. Of this $20.3bn were Gov sponsored/GSEs, which are marked at 99c in the $ (i.e. not a material element of the AFS reserve). The remaining AFS assets of note were: $6.9bn subprime RMBS, $10.3bn Alt A, $5.6bn other RMBS, $10.4bn CMBS, $5.6bn leverage loans, $6.2bn US student loan ABS and $7.4bn other ABS/ABS CDOs. For more detail on the marks see page 35 of the note. We conclude there is still more risk from credit assets but only adjust 1/3 of the $15bn AFS reserve for impairment.
To conclude we stick by our analysis.
First, HSBC has moved $11bn of capital from the holding company to the US and UK reducing its average surplus capital at the top from 120bp to 25bp. We think at this stage of the cycle a prudent management team would want a buffer, of at least average proportions. Moving from 25bp to 120bp costs $11bn.
Second, given US capital ratios will likely need replenishing dollar for dollar to match losses, we pencil in $5bn of capital to pay for the losses over the next 2yrs – NOT $34bn as some people seem to think.
Third, as discussed above we think expecting a $5bn impairment in the AFS reserve is the least we should expect, given the mix of assets.
Finally, we point to the weak core capital position in Hong Kong and Rest of Asia. In HK, the core capital ratio is 6.8%, which on a Basel 2 group measurement basis for RWA’s falls to 5.5%, the second weakest in Asia. We appreciate that HSBC has lots of liquidity, but so does Hang Seng and BOC and they both have core capital ratios materially in excess of HSBC (>10%). To take the equity tier 1 to 9% we pencil in $5.8bn of capital injection into HK. This gives a total of $27bn, which we reduce to $20bn to account for the dividend cut.
Of the capital discussed above, we acknowledge that the HK capital requirement probably carries the weaker argument (as the regulator has been happy so far) however, we will continue to highlight it as a risk.
To get from $20bn to $30bn of capital we highlight the insurance double counting and the further regulatory arbitrage in the AFS. Allowing for this would be a more extreme case, but one thing we have learnt over the last few months is that just because something is extreme, it does not mean it is not going to happen. Nevertheless, we will continue to focus on the $20bn as the most likely outcome.
Hope this clarifies the points. We reiterate the Underweight with 455p PT.
Over to you HSBC.
Why we think HSBC needs $20-30bn of capital and to halve its dividend – FT Alphaville
HSBC does not comment on broker notes – Long Room
MOST on HSBC – Long Room