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‘Regulatory unknowns’ for HSBC as Woodford scraps holding

Neil Woodford’s recent U-turn on HSBC raised eyebrows but opinion on the UK’s largest bank remains mixed.

The equity income fund manager abandoned his 2.7 per cent holding in HSBC just months after buying in at the launch of his fund in June.

It was the first time the former Invesco Perpetual manager had owned a bank since 2002.

He cited the increased danger of regulatory penalties, especially the policy of handing out fines based on a company’s ability to pay rather than an amount related to the misconduct.

“I am worried the investigation into the historic manipulation of Libor and foreign exchange markets could expose HSBC to significant financial penalties,” he says.

“Not only are these potentially serious offences in the eyes of the regulator but HSBC is very able to pay a substantial fine.”

While Old Mutual Global Investors head of equities Richard Buxton’s largest position is HSBC, he holds Barclays and Lloyds Banking Group as well. 

He says: “Of course it is highly likely banks will be subject to further fines for historic behaviour but it is highly unlikely in the case of these banks that it would require raising of additional capital.

“It will defer a return to better levels of profitability and dividend payment but that does not take away from the underlying case for investing in them for the patient long-term investor.” 

IG Group markets analyst David Madden says HSBC has been “by far the best of a bad bunch” among UK and European banks.

The largest banking group in both the UK and Europe, HSBC is also less reliant than its peers on investment banking and has a strong base of deposits. 

That has helped lessen the fall of its share price as well as volatility compared with its more investment bank-leveraged peers.

“HSBC is not a particularly sexy stock; I can’t see some massive moves from it but it’s a reliable stock,” says Madden.

Like all banks, it is still asset stripping and slimming down its business. HSBC has sold or closed 68 business units in the three-and-a- half years since chief executive Stuart Gulliver was appointed.

“It is Asia-focused and, given that the Far East is where the real growth is, that has predominantly driven their profits,” says Madden. 

The British banking industry divided in the lead-up to the global financial crisis, he explains.

Some, such as HSBC and Standard Chartered, focused on spreading retail and commercial banking operations across the emerging markets.

Meanwhile, RBS, Barclays and Lloyds expanded loans to European and UK customers with the boom in house values.

European banking valuations have soared in the first half of 2014 while UK banks have slumped after disappointing results.

Investment banking units have been hit by low interest rates, dampened market volatility and cheaper sterling. Meanwhile, the risks posed by past actions has led ratings agency Moody’s to downgrade the UK banking sector outlook to negative from stable.

Despite this, Fidelity MoneyBuilder Dividend manager Michael Clark believes the tide may be turning for some British banks, HSBC included.

“While this suggests a rather grim outlook, there are some UK banks which could prove the bears wrong and do well over time – creating opportunities for bottom-up stockpickers such as myself,” he explains.

Clark says HSBC’s share price has recovered over the past six months but he still sees its 5 per cent yield as reasonable.

With roughly 60 per cent of its profits coming from Asia, HSBC is positioned well to gain from the region’s continued growth. Meanwhile, at home,  it has the best UK loan book in the business, he adds.

“Over the longer-term, the development of capital markets in China and the greater convertibility of renminbi should be major positives for HSBC. In mainland China, the bank is not involved in domestic property lending, which remains the main area of concern in that market.”

He is also happy with Barclays, despite lacklustre sentiment. The bank’s restructuring continues as it slims down to its high-quality businesses in UK, Africa and Barclaycard.

“The bank faces issues with US regulators and may well be given a significant fine although these issues are reflected in its share price,” he explains. Its renewed commitment to returning cash to shareholders was clearly highlighted in last year’s rights issue, and it should offer a good yield by 2015.”

Clark is less moved by Standard Chartered, which has slowing revenue growth combined with increasing loss provisions.

“Standard Chartered has increased its risk profile over the last years, with strong balance sheet growth, a shift towards unsecured lending and an increasing proportion of profits coming from investment banking activities,” he says. 

“While valuation metrics look attractive, there is further downside risk to earnings.”

Premier Asset Management UK equities head Chris White is “substantially” overweight HSBC in his Premier Income and Monthly Income funds relative to the average UK Equity Income fund, which holds a 3.5 per cent stake.

His 6 per cent holding is, however, roughly equal to the stock’s weighting in the FTSE All Share Index.

“Ignore the questions of fines for the time being and the business itself looks pretty interesting,” he says.

White thinks the restructuring, which has gathered pace since the appointment of Gulliver as chief executive, has “confused” investors.

“The top-line growth underlying the revenue, excluding all the changes, has been increasing year-on-year but it’s not getting through to the headline numbers because of businesses being sold and the general restructuring,” he explains.

White believes several trends are likely to help fill the bank’s sails in the next few years.

With a loan to deposit ratio of 74 per cent, HSBC has plenty of capacity to increase lending in the future once interest rates start to rise, he says.

The powerful pound of the last 18 months is expected to devalue British dividends paid in US dollars by £3.5bn this year, according to Capita Asset Services. 

However, White believes sterling’s ascension has finished and it will begin to fall relative to the dollar, boosting HSBC’s US-denominated dividends. He admits the amount of outstanding litigation for bank misconduct, including HSBC, is considerable and unquantifiable.

“There are some big unknowns out there. The fines imposed by regulators, particularly in the US, have been very large and punitive and clearly that is a potential negative.”

Despite that, the outlook for the business is too good to let those risks dissuade him. 

He is uncertain about Standard Chartered, which has a similar profile to HSBC. “I have a 1 per cent position, which is small for me. I feel I want to be more positive on Standard Chartered on valuation grounds and because the outlook in emerging markets looks better than it was six to 12 months ago, especially in places like India and China,” he explains.

“Standard Chartered is making the right moves and trying to get the bank back on the front foot, but it still seems a bit early to be taking a bigger position.”

IMA

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