In the global banking playground, it is HSBC’s turn to be picked on. In the past three months, the bank’s shares have fallen 9 per cent, while the banking sector globally has gained 8 per cent. Troubles at Household, the US consumer finance group acquired in 2003, are the latest catalyst. Losses on Household’s US mortgage book in the third quarter were all the more galling given prior eulogising of the credit risk models built by its 120 PhD-holders.
Based on Household’s travails alone, though, HSBC’s weakness is overdone. Household generates a fifth of group profits and only one part of that business – second lien mortgages – has run into trouble. It is quite possible that broader problems are looming in the US. But UBS reckons that at HSBC’s current share price, the implied value of Household, forecast to generate $2.3bn of earnings in 2007, is less than zero.
Household’s problems have taken on a broader significance. First, doubts about HSBC’s expansion in consumer finance have been rekindled. Household has so far delivered a respectable 17 per cent annualised return on equity and, whatever its current problems, building up consumer finance seems a logical step for a well-capitalised bank with a strong deposit base. Second, conglomerates are out of fashion and HSBC is suffering for its status as one of only a few genuinely global financial groups. Citigroup, its closest peer, knows how this feels. It is true that financial conglomerates have done a rather mediocre job of demonstrating synergies from global operations. Still, while the impact of size on cost/income ratios is in general slightly negative, HSBC has a cost/income ratio of 50 per cent, below the sector average.
Lastly, Household has knocked the perception of HSBC as both a play on emerging markets and a defensive stock. With a 4.8 per cent expected dividend yield, in a potentially difficult year for retail banks, HSBC’s defensive characteristics are again looking rather attractive. UK investors tend to punish banks’ overseas missteps severely, but this is starting to look draconian.