Is this the beginning of the end for HSBC Holdings plc?
HSBC's (LSE: HSBA) first-quarter results, released at the beginning of this week, were widely expected to be the bank's worse since the great financial crisis and they didn't disappoint (or maybe they did, depending on your viewpoint). The bank reported a year-on-year decline in adjusted profit before tax of 18% to $5.4bn or £3.7bn, while reported profit before tax dropped 14% to $6.1bn, down from $7.1bn in the prior year. Adjusted revenue for the quarter fell 4% to $13.9bn.
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After the publication of the results, many City analysts tried to put a positive spin on HSBC's first quarter figures as they came in ahead of expectations. However, HSBC had been set a low bar to jump over, and it looks as if the only way is down for HSBC's income for the foreseeable future.
A changing bank
HSBC is in the process of a massive transformation. The bank is shrinking itself, pulling out of risky markets and trying to expand in markets where it has a competitive advantage over peers. Last year, HSBC announced that it was planning to strip $280bn of risk-weighted assets out of its balance sheet, and would redeploy around half of these assets to faster-growth markets, such as Asia. According to management, at the end of the first quarter, HSBC had divested around 50% of the targeted $280bn of risk-weighted assets it plans to sell. It was also announced that the bank was on track to complete the agreed sale of its Brazilian business by the end of June.
Unless HSBC redeploys its risk-weighted assets into significantly higher-return assets, it's reasonable to assume that the bank's earnings will fall going forward as the asset base used to generate sales shrinks. Moreover, as regulators clamp down on banks, they're being forced to reign in their risk-taking, and as higher returns usually come with high-risk assets, HSBC is stuck between a rock and a hard place.
Simply put, HSBC is shrinking itself, and in a low-return world, this tactic could only accelerate the bank's sales declines. Indeed, during the past few months, interest rates have started to fall into negative territory for the first time ever -- a disastrous development for banks. With interest rates below zero, it'll cost banks more to hold cash on their balance sheets (a requirement of regulators) and banks will be forced to issue loans with low-interest rates to customers, squeezing income.
Additionally, HSBC had to issue $10.5bn of total loss-absorbing capacity securities (debt that regulators can convert into equity in a crisis) during the first three months of this year, which the bank has called "surplus to requirements" but will put pressure on profit margins by pushing up its cost of funding.
The bottom line
Overall, HSBC's revenues and profit margins are under pressure as the bank retreats from markets, grapples with negative interest rates and has to foot the bill for higher funding costs. These factors will all weigh on its earnings going forward and as a result, it's unlikely HSBC will ever be able to return to its former glory.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
