Stuart Gulliver’s good intentions have collided with the reality of the markets. In May, the HSBC boss set out his plan to sculpt a leaner, more profitable bank – one with return on equity of 12-15 percent, and a cost base equivalent to 48-52 percent of income. Based on the bank’s third-quarter showing, the punchy end of those targets is no longer realistic.
What happened in the meantime was Europe. As a primary dealer in European bonds, HSBC is in the unfortunate position of having to go long in all the wrong places. Its credit and rates businesses, which a year ago made over $3 billion, ended up $460 million in the red in period. Asian markets, for now, are uninfected – though Gulliver has fretted publicly that if European banks pull credit, they could be.
That left the bank with $3 billion of underlying profit before tax, just half the second-quarter figure. Adding back the $1.3 billion loss on certain hedges, which should wash out with time, the number still missed consensus expectations of $5.2 billion. HSBC’s European business crept into a loss. But even in the emerging markets, where HSBC pins its future, loan impairments and wages are rising, putting further pressure on margins.
The setback doesn’t undermine the wisdom of Gulliver’s strategy. HSBC has unshackled misfit businesses, from U.S. credit cards to UK car insurance and Hungarian consumer finance. Some 13,000 employees have gone with them, and $40 billion of risk-weighted balance sheet capacity has been freed up. And while operating costs reached a gruesome 67 percent of revenue, in absolute terms, HSBC managed to keep its expenses from rising.
Whether or not markets sour further, it’s likely HSBC will come out in better shape. In the short run, getting the model right may make things worse, as higher margin business are sold and restructuring costs, of which almost $700 million have already surfaced in 2011, work through. And a poor underlying return on equity of 9.8 percent in the quarter shows how fast the world has changed since May. Gulliver’s targets may need a rethink.