HSBC Holdings Plc’s earnings per share reached 74 cents in 2012, trailing the prior-year’s earnings of 91 cents by 18.7%. In 2012, net profit came in at $14.0 billion, plummeting 16.5% from $16.8 billion in 2011. The primary reason for the year-over-year fall in earnings was a $9.1 billion negative swing in the fair value of own debt as credit spreads tightened and a higher tax rate.
Results for 2012 also included payments of $1.9 billion made as part of the settlement of the investigations into past inadequate compliance with anti-money laundering and sanctions laws as well as extra provisions related to UK customer redress program of US$1.4 billion.
Further, results were adversely impacted by the loss in the Other segment. Yet, strong performances by all other divisions were a positive for the quarter.
The core results were negatively impacted by higher operating expenses. Nevertheless, improved top line and growth in total operating income were the positives.
HSBC made significant progress in executing the strategy to reshape itself and improve its returns. Since the beginning of 2011, the company announced the divestiture or closure of 47 of its non-core/unprofitable operations across the globe. Moreover, HSBC generated sustainable cost savings of $2.0 billion in 2012, giving an annualized total savings of $3.6 billion. This surpassed the company’s cumulative target range of $2.5–$3.5 billion of savings since 2011.
Performance in Detail
Underlying profit before tax was $16.4 billion in 2012, surging 18.2% year over year. The increase was driven by revenue growth, lower loan impairment charges and other credit risk provisions. These positives were partially offset by rise in operating expenses.
Total revenue (on an underlying basis) stood at $63.5 billion, climbing 7.0% from $59.3 billion in 2011. Improvement was largely driven by growth in revenues from Global Banking and Markets, Retail Banking and Wealth Management as well as Commercial Banking operations, partially offset by lower revenues in Global Private Banking.
Total operating income inched down 1.1% from the year-ago period to $82.5 billion. The dip was primarily attributable to reduced net interest income and fee income. These were partially offset by rise in net trading income, dividend income and other operating income. This also included gains on sale of US branch network, US cards business and Ping An Insurance (Group) Company of China, Limited.
Total operating expenses were $42.9 billion, increasing 3.3% from $41.5 billion in 2011. Expenses in the reported quarter included aforesaid payments and provisions.
The underlying cost efficiency ratio deteriorated to 66.0% from 63.4% in 2011, as a result of higher costs. The rise in efficiency ratio indicates lower profitability.
Performance by Business Line
Retail Banking and Wealth Management: The segment reported $9.6 billion in pre-tax profit, significantly up from $4.3 billion in 2011. The impressive rise was primarily due to lower loan impairment charges and strong revenue growth.
Commercial Banking: The segment continued to show improvements. Pre-tax profit of $8.5 billion was up 7.4% from $7.9 billion in 2011. Segment revenue continued to bolster, partially offset by increase in loan impairment charges.
Global Banking and Markets: Pre-tax profit for the segment was $8.5 billion, increasing 20.9% year over year. Segment results improved on the back of higher revenues, which were partly offset by rise in loan impairment charges.
Global Private Banking: Pre-tax profit for the segment was $1.0 billion, up 6.9% from the prior period. The marginal rise was driven by lower operating expenses and declines in loan impairment charges and other credit risk provisions, partly mitigated by fall in revenues.
Other: The segment recorded a pre-tax loss of $7.0 billion in 2012 against pre-tax profit of $1.7 billion in 2011. The main reason behind this was heightened adverse fair value movements arising from the effect of changes in credit spread on the fair value of the company’s long-term debt.
Profitability and Capital Ratios
Profitability ratios continued to deteriorate during 2012. Annualized return on equity fell to 8.4% from 10.9% in 2011. Moreover, pre-tax return on risk-weighted assets (annualized) fell to 1.8% from 1.9% in 2011.
HSBC continued to generate capital from its retained profits. The company’s core tier 1 ratio as of Dec 31, 2012 improved to 12.3% compared with 10.1% as of Dec 31, 2011. The rise was driven by capital generation and a reduction in risk-weighted assets as a result of business disposals. Total capital ratio also augmented from 14.1% recorded at the end of 2011 to 16.1% as of Dec 31, 2012.
Concurrent with the earnings release, the HSBC board announced fourth interim dividend of 18 cents per share. The dividend will be paid on May 8 to holders of record as on Mar 21. This represents a 28.5% rise in dividend compared with the final dividend in 2011.
Currently, the harsh impact of the deepening Euro-zone crisis is our primary concern. Moreover, HSBC is suffering from 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 greatly to deal with the economic pressures. However, 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 Rank #2 (Buy). However, other foreign banks like Banco Bilbao Vizcaya Argentaria, S.A. (BBVA - Snapshot Report), Shinhan Financial Group Company Limited (SHG) and Banco Macro S.A. (BMA - Snapshot Report) carry a Zacks Rank #1 (Strong Buy) and are worth considering.