HSBC’s Capital Cloud Lifts but Returns Remain Dark

HSBC just got an early Christmas present. The UK-based global bank said on Nov. 7 that its closely-watched core Tier 1 capital ratio had jumped by almost 2 percentage points to 13.9 percent in the space of three months. The main reason was the UK regulator’s obliging stance towards HSBC’s shareholding in China’s Bank of Communications.

HSBC’s treatment of its 20-percent stake in the expanding Chinese lender has a significant impact on its capital calculations. HSBC previously added its share of BoComm’s risk-weighted assets and equity in its own totals. But a conveniently-timed Oct. 20 “clarification” from the UK’s Prudential Regulation Authority reminded financial institutions that they can – if the PRA allows – just deduct the equity tied up in minority shareholdings from capital. In that case they no longer need to consolidate the associated risk-weighted assets.

The upshot for HSBC, which has long argued for the shift, is that it can exclude $121 billion of risk-weighted assets associated with BoComm, while deducting $5.6 billion from its equity total. The shift boosted its reported capital ratio by more than a percentage point. Given that HSBC wants a ratio between 12.5 and 13 percent, it gains some breathing space.

The brighter mood does not extend to HSBC’s return on equity (ROE), which turned negative in the third quarter due to the costs of offloading its Brazilian unit, as well as adverse debt and currency moves. Even discounting these, the lender’s ROE in the first nine months of 2016 was only 8 percent, below the level demanded by shareholders. This year HSBC may have to dip into reserves to pay its dividend. That, and the risk of unexpectedly tighter capital rules under impending reforms, may eat into the extra capital.

If it does have cash to spare, HSBC should invest it in areas where its market share is strong, like Asia and the United Kingdom. The lender has 13 percent of UK current accounts but only 6 percent of mortgage loans, for example, according to Citi. Returns in regions like North and South America still lag those of local peers. But focusing on more profitable business might drag HSBC’s returns closer to respectability.

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