HSBC's (HSBA) earnings were up in the first quarter as the bank enjoyed the benefit of favourable trends across the industry, but the 0.4% year-over-year and 4.0% linked-quarter increases in adjusted profit before tax were modest compared with the earnings increases reported by other global banks.
Still, HSBC's first quarter was nothing to sneeze at; return on average equity was 11%, above its ‘greater than 10%’ target, loan impairments fell seven basis points year over year to 0.24% of loans, and adjusted profit before tax grew in the largest three of HSBC's four primary business segments. We plan to maintain our fair value estimate for the narrow-moat bank.
HSBC continues to struggle to control costs, and its adjusted jaws (a measure of how much income growth exceeds expense growth) were negative 1.5% year over year despite the improvement in revenue.
HSBC noted wage inflation and regulatory compliance costs as the two biggest drivers of its expense increase, with investment in growth coming in a close third. This underscores our view that it will be difficult for the bank to reach the 46% cost/income ratio it reported precrisis, even once the interest rate environment improves.
Management has been particularly vocal on the topic of regulatory costs, suggesting that it may move its headquarters out of the United Kingdom and further stating that it could spin off its U.K. branch network if the ring-fencing rules prevent it from being an active shareholder. We think moving headquarters could be an attractive option, but it's no panacea. It would clearly help with the U.K. bank levy – some $1.1 billion in 2014, but regulatory costs have increased for all global banks in the wake of the financial crisis, and HSBC has had some particularly embarrassing lapses.
We're more intrigued by the idea of HSBC spinning off its U.K. retail network and becoming more of a pure-play Asian bank. On one hand, the U.K. retail business is an attractive one, but on the other, there are no clear synergies between it and the remainder of HSBC's businesses, and further simplification of the business could make it easier for management to run well.
