HSBC's Asia Push Is Bearing Fruit for CEO Gulliver, at a Cost

(Bloomberg) -- HSBC Holdings Plc’s $100 billion bet on Asia is bearing fruit, but it has come at a cost.

Asia posted the biggest revenue gain among of the bank’s five regions, helping it report a third consecutive quarter of revenue growth just months before Chief Executive Officer Stuart Gulliver hands the reins to John Flint. However, operating expenses came in 6 percent higher than analysts expected as executives used $500 million of cost savings to grow the business and increase payouts to staff, rather than reward shareholders.

“What we saw was good: continued revenue growth coming through the Asia and U.K. businesses, the vast majority of our markets saw balance sheet and revenue growth,” Finance Director Iain Mackay said in an interview. The firm paid out $300 million extra in performance-related pay after hitting targets, and reinvested another $200 million to improve the bank’s digital systems for consumers, he said.

The shares fell 1.4 percent to 737.6 pence at 12:37 p.m. in London, and was the second-biggest decliner on the FTSE 100 Index. In Hong Kong, where the bank is also listed, the stock initially rose before ending the day 0.7 percent down.

In February, 28-year company veteran Flint will inherit a bank back in expansion mode after five years of declining revenues and belt-tightening. Gulliver spent much of his tenure shrinking and imposing central control over HSBC’s sprawling global network, exiting almost 100 businesses and 18 countries while dealing with several costly misconduct scandals.

In June 2015, HSBC said it would redeploy billions of dollars of assets to Asia, betting on higher returns as China’s economy expanded at a faster pace than Europe or the U.S. Just as the bank was putting an increased emphasis on China, the stock market imploded, but Gulliver stuck to his guns, saying the meltdown didn’t alter the country’s strong fundamentals.

“Our pivot to Asia is driving higher returns and lending growth, particularly in Hong Kong and the Pearl River Delta,” Gulliver said in Monday’s statement. During the quarter, HSBC added $1.1 billion of loans in Guangdong, the southern Chinese province where the lender has targeted expansion.

Costly Miss

HSBC generated $13 billion of revenue, adjusted for “significant” one-off items, which beat the average $12.7 billion estimate of 15 analysts compiled by the firm. Adjusted pretax profit for the third quarter fell 1 percent to $5.44 billion, compared with a projection of $5.41 billion. Dampening sentiment, operating costs rose 7 percent to $7.8 billion, missing the $7.3 billion analysts expected.

“Overall the cost miss is likely to disappoint some, although the reiteration of 2017 cost guidance should limit the impact,” Keefe, Bruyette & Woods analysts Richard Smith and Edward Firth said in a note. The miss “implies small earnings reductions near term.”

Revenue rose slower than costs -- a measure the bank calls jaws -- which management has identified as a strategic issue to address. Adjusted jaws was a negative 4.9 percent. The bank still expects jaws to be positive for the full year, Mackay said.

Much of the $200 million reinvested in the business was spent on technology, specifically the retail bank’s mobile-banking applications, he said. In September, analysts at Autonomous Research criticized HSBC’s app and called the lender a “laggard” in innovation. Backing up that critique, the firm’s British online services were interrupted on Friday last week and again on Monday.

At the securities unit, the bank’s traders fared better in the third quarter than others in the City of London. Fixed-income and currency trading revenue dropped only 5 percent, compared with the 34 percent plunge in the same business Barclays Plc reported last week. HSBC said it increased its market share in European rates and credit trading.

Buyback Boost

“We’d already apologized earlier for doubting HSBC’s ability to grow its massive global franchises, and we’re happy to apologize again on the back of these strong quarterly results,” Cenkos Securities Plc analyst Sandy Chen said in note. “HSBC’s premium rating already reflects the market’s confidence that this growth is sustainable, and these expectations could accelerate further if rate hikes spread globally.”

The shares have been rising this year after the bank unveiled plans to repurchase $5.5 billion of stock, with executives hinting they’re prepared to do more as the firm’s capital buffer grows. The firm’s common equity Tier 1 ratio retreated to 14.6 percent from 14.7 percent at the end of June, above its target range of 12 percent to 13 percent.

Mackay has previously said as much as $8 billion could be repatriated from its U.S. operations and a portion of this would be allocated to buybacks. HSBC’s North American unit passed a Federal Reserve stress test in June, clearing the way for more than $3 billion of capital to be returned to shareholders, analysts said at the time.

Hard Brexit

Despite making progress, Gulliver has still left his successor with work to do. Return on equity was below the bank’s target of more than 10 percent, coming in at 7.1 percent. Mackay said the bank wouldn’t exceed the goal this year.

Incoming CEO Flint will also have to navigate the bank through the U.K.’s divorce from the European Union. Executives said Monday they will wait as "as long as we possibly can" before moving up to 1,000 investment bankers to Paris, but still expect costs to be as high as $300 million as the bank is planning for a “pretty hard Brexit,” Mackay said.

To contact the reporters on this story: Stephen Morris in London at smorris39@bloomberg.net, Alfred Liu in Hong Kong at aliu226@bloomberg.net.

To contact the editors responsible for this story: Ambereen Choudhury at achoudhury@bloomberg.net, Jon Menon

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