HSBC’s capital search gives market shudders

When HSBC first told its shareholders about mounting losses on US mortgages early in 2007, few investors realised the bank had in effect provided an early warning of the credit crisis.

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After almost two years of extreme turmoil in global financial services, however, investors are paying close attention to HSBC’s pronouncements. So the bank’s decision to raise £12.5bn in fresh capital from its investors and cut its dividend for the first time any of its executives can remember was bound to send a shudder through the markets.

For those of a gloomy disposition, there are plenty of ominous signs in HSBC’s 2008 results. Though the bank managed to remain comfortably in the black last year with pre-tax profits of $9.3bn – despite writing off $10.5bn in goodwill on its US consumer finance operations – profits were less than half those of 2007.

There are also signs of global slowdown at the group that likes to call itself the world’s local bank. Every one of HSBC’s operating divisions made less money in the second half of 2008 than it did in the first. The same was true for each of HSBC’s regions except Europe, where profits in the second half were boosted by a $2.5bn (£1.7bn) exceptional profit from selling French operations.

As the developed world slides deeper into recession and emerging markets in Asia and Latin America suffer a sharp slowdown, there is every indication conditions will get worse. Yet despite the gloomy picture, HSBC says it does not need the additional capital to shore up its businesses. Executives argue the bank’s operations in Europe and Asia are continuing to generate excess capital despite lower business volumes and higher bad debt provisions.

They also insist this surplus capital will be sufficient to cover likely future losses in HSBC Finance Corporation, formerly known as Household, the ailing consumer finance operation that is being largely closed to new business.

The bank argues the funds are needed to re-establish HSBC as one of the world’s best-capitalised financial institutions, a position eroded in recent months by governments pumping capital into its ailing peers.

Though HSBC says it has seen no sign of depositors shifting funds to state-backed lenders, concerns about capital were beginning to weigh on the bank’s share price, raising the alarming prospect that the worries could become self-fulfilling.

In other words, if HSBC is to compete in a world of state-controlled banks, it has to stand above them. “The rights issue is designed to get us a bullet-proof balance sheet,” says Stuart Gulliver, chief executive of global banking and markets.

The rights issue will boost HSBC’s tier one capital ratio – a key measure of balance sheet strength – to almost 10 per cent and allow it to boost lending in emerging markets where many western banks are being forced by government shareholders to scale down operations.

“This gives us the capacity to take market share because those banks that now have amazingly strong balance sheets are not going to be allowed to deploy capital outside Germany, the UK and the US,” says Mr Gulliver. HSBC could also fund potential acquisitions, such as the Asian assets Royal Bank of Scotland put up for sale last week.

Some analysts on Monday appeared to accept HSBC’s confidence. “We do not believe the rights issue simply reflects expectations of higher losses,” writes Tom Rayner, an analyst at Citigroup. “With many competitors having already raised new capital, this looks a pragmatic decision. The combination of capital strength, liquidity and geographic reach should leave HSBC well positioned . . . to benefit from any recovery in global banking markets.”

However, the drop of nearly 20 per cent in HSBC’s share price on Monday underscores nervousness about the global economic outlook and the bank’s exposure to the downturn.

Stephen Green, HSBC’s chairman, on Monday admitted the world had changed in the past six months and it was far from clear how the global financial system would look once the turmoil had ended. “This is not the sort of crisis we are going to bounce back from,” he says.