Breakingviews – HSBC fires on a shaky single cylinder

The HSBC bank logo is seen at their offices in the Canary Wharf financial district in London, Britain March 3, 2016.

LONDON (Reuters Breakingviews) – HSBC chief executive Noel Quinn is trying to revive the struggling $90 billion lender, but the ground continues to shift beneath his feet. With low interest rates undermining revenue across all divisions except investment banking, the London-based bank’s cost cuts will need to go much further than originally planned to bring yields down to a level respectable.

Monday’s second-quarter results showed that the investment banking sector is the only real growth sector. Revenue from fixed income, currencies and commodities trading jumped 79% year-on-year to $2.1 billion. Yet even this exceptional performance could not offset a fall in retail and commercial banking income, where lower central bank interest rates led to lower net interest income. Group-wide revenue fell 4% year-on-year, after adjusting for one-time items such as currency fluctuations.

Quinn’s problem is now twofold. First, investment banking is hardly a reliable source of income: HSBC traders benefited from a spike in volatility and wider bid-ask spreads in the second quarter, which have since narrowed. Other businesses, including its main Hong Kong unit, seem unlikely to pick up the slack given the territory’s deep economic contraction and political unrest. Second, the anticipation of bad debt is eating away at earnings to a much greater extent than originally expected. Quinn recorded a charge of $3.8 billion for expected credit losses in the second quarter. That was $1.2 billion more than analysts had expected and 30% more than the equivalent charge for the first three months of the year.

The upshot is that Quinn’s restructuring program, unveiled in February and which targeted a 10% to 12% return on tangible equity in 2022, will have to be bigger. Analysts expect HSBC to have about $158 billion in tangible equity that year. To hit the bottom end of the return target, Quinn would need $15.8 billion in revenue. Using a 21% tax rate, consensus bad debt estimates and its target cost base of $31 billion, this would require $55 billion in revenue – roughly equivalent to what HSBC has made last year. Repeating this will be a boost.

The only leverage Quinn has is cost. It is certainly making progress on its initial restructuring plan: adjusted expenses were down 7% year-on-year in the second quarter. But to realize its ambition for longer-term returns, it will need a lot more.

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