HSBC Holdings Plc reported full year 2011 earnings of 91 cents per share compared with 72 cents in 2010. The company’s net profit came in at $16.8 billion, up 28% from $13.2 billion in the year-ago period. Results in 2011 included favorable credit spread movements of $3.9 billion on the fair value of the company’s recognized debt.
The year-over-year improvement was primarily led by strong performance by the Commercial Banking and Retail Banking and Wealth Management segments and a significant improvement in the profit of the Other segment. However, performance of the two other businesses showed deterioration compared to 2010.
Moreover, increased net interest income and lower insurance claims were among the positives during the year. However, lower net trading and fee income and higher operating expenses were the dampeners.
Additionally, HSBC made significant progress in executing the strategy to reshape itself and improve its returns. In 2011, the company announced divestiture or closure of 16 of its non-core/unprofitable operations across the globe. Also, in 2012 it announced sale/closure of 3 of its businesses.
Underlying profit before tax in 2011 was $17.7 billion, declining 11% from $19.8 billion in the prior year. The decrease resulted from higher operating expenses, which were partially offset by improvement in loan impairment charges, strong revenue growth in key regions and other credit risk provisions.
Quarter in Detail
Total operating income grew 4% year over year to $83.5 billion in 2011. The increase was primarily driven by improved net interest income (up 3%), dividend income (up 33%), net earned insurance premiums (up 16%) and substantially higher income from financial instruments designated at fair value. However, these positives were partially mitigated by reduced fee income and net trading income.
In 2011, total operating expenses were $41.5 billion, up 10% from $37.7 billion in the prior year. The rise was due to higher compensation and benefit costs and general and administrative expenses. The increase was partially offset by $0.9 billion of cost savings in executing restructuring strategy.
The cost efficiency ratio for 2011 deteriorated to 57.5% from 55.2% in the prior year. The ratio was also below the target benchmark range of 48-52%.
Profitability ratios showed improvement during the year. Annualized return on equity improved to 10.9% from 9.5% in the prior year, reflecting the favorable movement on the fair value of debt. Moreover, pre-tax return on risk-weighted assets (annualized) increased to 1.9% from 1.7% in 2010.
HSBC continued to generate capital from its retained profits during the year. However, reflecting an increase in risk-weighted assets and growth in loan balances, the company’s core tier 1 ratio as of December 31, 2011 decreased to 10.1% from 10.5% as of December 31, 2010. Total capital ratio also declined to 14.1% from 15.2% at the end of the prior year.
By Business Line
Retail Banking and Wealth Management: This segment witnessed year-over-year growth in pre-tax profit primarily due to strong business and revenue growth in Rest of Asia-Pacific and Latin America regions. However, the increase in loan impairment charges associated with the company’s run-off consumer finance portfolio in North America negatively impacted the results.
Commercial Banking: This segment continued to show improvements. In 2011, pre-tax profit was better than the year-ago period. Despite increasing headwinds in several economies, primarily in Europe, revenue continued to grow buoyed by higher net interest income from customer loan growth and higher lending activities.
Global Banking and Markets: Pre-tax profit for this segment was lower than 2010. Results were hurt by the challenging trading environment, widening credit spreads and continued uncertainty related to the European debt. However, strong franchises in Global Banking, Foreign Exchange and Equities improved revenues significantly during the year, particularly in Rest of Asia-Pacific and Latin America.
Global Private Banking: In 2011, pre-tax profit for this segment came in lower than the prior year. Higher operating expenses and increased loan impairment charges were the main reasons behind the fall, partially offset by increase in revenue.
Other: This segment witnessed improved pre-tax profit over the prior-year period primarily due to gains arising from the effect of changes in credit spread on the fair value of the company’s long-term debt.
Concurrent with the earnings release, the HSBC board announced fourth interim dividend of 14 cents per share. The dividend will be payable on May 2, 2012 to holders of record as on March 15, 2012.
Our primary concern is the harsh impact from the deepening Euro-zone crisis. Moreover, HSBC is suffering from a weak revenue growth in its mature markets attributable to the ongoing low interest rates and regulatory restrictions. However, the company is poised to benefit from its extensive global network, strong capital position, business re-engineering efforts and strong asset growth.
Further, HSBC’s cost containment measures will help it to deal with the economic pressures to a great extent. But, we expect high inflation in some key Asian markets, sluggish loan growth, insufficient core operating performance and high wage inflation to restrict the company’s growth, at least in the near term.
HSBC currently retains a Zacks #1 Rank, which translates into a short-term ‘Strong Buy’ rating. However, the company’s closest peer – Barclays Plc. (BCS - Analyst Report) retains a Zacks #2 Rank (a short-term ‘Buy’ rating).