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Analysis & opinionJanuary 3 2012

HSBC refuses to rest on its laurels

HSBC has not suffered in the global financial crisis as badly as many of its UK counterparts, and it is already well established in the high-growth emerging markets likely to dominate world trade in the coming decades. However, the bank's new chief executive still believes it could be offering better value to HSBC investors.
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HSBC refuses to rest on its laurels

By HSBC’s own estimates the emerging markets will account for 54% of global economic output by 2050 – up from 27% in 2010. In a list of the 30 largest economies by then, 19 are ones currently described as 'emerging markets' and in which HSBC already has a strong presence. In other words, the bank is ideally positioned for the global economy of the 21st century.

HSBC is also well known for having eschewed the more racy parts of capital markets trading and for baulking at super-sized bonuses since long before the crisis. This means its transition to the new regulatory environment may also be smoother than for its rivals.

New broom sweeps clean

Under this scenario it might be expected that the new chief executive Stuart Gulliver would conclude that his best approach was to keep the motor running, the course unchanged and be thankful not to be at the helm of a more challenged institution.

In fact, Mr Gulliver has opted instead to conduct a complete overhaul of the bank, subjecting each part of the business to a rigorous test of its viability and suitability within the group. The broad course will remain unchanged, but in pursuit of that every piece needs to measure up. Alongside this there is a huge focus on costs in a bid to make HSBC a much more attractive share for investors.

“What I am trying to do is create a cohesive logical argument as to why you should own HSBC as an investor, “ says Mr Gulliver in an interview in late 2011. The Banker picked HSBC as its Global Bank of the Year 2011 and Best Bank in Asia-Pacific in recognition of the progress already made towards this goal.

Mr Gulliver says: “It starts with the observation that we sit across a couple of the massive trends that are taking place in the world. I believe that the centres of the world economy have already moved from West to East and from North to South and we are sitting in those geographies and we have been there for a long time.

“If you believe in those big macro trends of trade and capital flows to, from and between emerging markets, then the way our businesses pick them up is [first] through the commercial banking and global banking and markets [businesses], which is the network, and then [second] the wealth creation – that takes place because of that massive gross domestic product growth -- is picked up effectively through retail banking and wealth management and the private banking piece [retail banking and wealth management, or RBWM].” 

Better communication

But to achieve maximum returns from this business model the bank does need to be streamlined, and to see this reflected in the share price it needs to communicate its strategy better to investors. With this aim, HSBC held its first ever full-blown investor day in May last year and intends to make this a regular feature from now on. In his presentation at the event, Mr Gulliver admitted that the "share price has gone broadly sideways for 11 years". He added that while the reasons for holding HSBC stock in a crisis were obvious [diversification and high capitalisation] "in recovery… we now risk losing ground to more agile competitors".

Mr Gulliver says that during his 32 years with the bank – he joined the firm straight out of university – there has never been a comprehensive review of the businesses. Now every business is being put through what HSBC calls its "five filters" process. These are its international connectivity with other countries in the HSBC network, whether it is in a country that will be part of the global growth story, its return on equity, cost-efficiency ratio and whether it funds the group. Following this exercise, 14 businesses have been sold off with a number of large transactions in the pipeline, but as yet unannounced.

Mr Gulliver explains in his interview with The Banker: “What has happened over the years is that we have acquired all sorts of [businesses] that don’t necessarily fit to that logic. What I am doing is a portfolio optimisation. It’s the first time this has been done in the 32 years I have been with the firm.

“That investor day [in May] was the first ever full investor day. We did a two-hour one when [activist shareholder] Knight Vinke attacked us [in 2007], but having an annual investor day, moving to quarterly reporting, that’s all fresh.

We have sold the retail business in Russia, closed the one in Poland, closed the one in Georgia, closed Ukraine, exited retail banking in Kuwait, pulled out of domestic private banking in the United Arab Emirates… people can see progress and there are about another 40 transactions of various sizes still to come through

Stuart Gulliver

“So in a way it’s no wonder that we haven’t always achieved full valuation in our share price because we haven’t gone out of our way to try to make the case to investors and we haven’t conducted a portfolio review to ask ‘does every business have a logical relationship with every other business?’.“

“Let me give you an extreme example of a historical misfit. On the one hand we have Household [HSBC’s US subprime lender bought in 2003] where we lend to people with low Fico [credit] scores to buy properties in the US which has a high delinquency rate. On the other hand we do private banking in Asia for some of the wealthiest tycoons in the world – what’s the connection between those businesses? There is none. I want to get rid of that lack of continuity.”

Streamlining exercise

Businesses so far sold in pursuit of this aim include – as highlighted in November’s interim management statement – the US cards business, 195 branches mainly in upstate New York, the Canadian investment advisory business, the Chilean retail banking business, the UK motor insurance business, private equity businesses in the US and Canada, and Hungarian consumer finance.

Mr Gulliver says: “We have demonstrated since May our intention to carry out that strategy and we have done 14 transactions already releasing $40bn of risk-weighted assets, involving about 14,000 people leaving the firm – 13,000 going to acquirers and about 1000 jobs being eliminated. This has released capital of the order of about $8bn or $9bn of which some will go against the US subprime book but some will get released to be redeployed.”

Mr Gulliver refers to other transactions as examples of what is happening. “We have sold the retail business in Russia, closed the one in Poland, closed the one in Georgia, closed Ukraine, exited retail banking in Kuwait, pulled out of domestic private banking in the United Arab Emirates… people can see progress and there are about another 40 transactions of various sizes still to come through.”

Other major challenges are to get the cost base down (the target for the cost-efficiency ratio is between 48% and 52%), to create a common business model for commercial banking and RBWM, and to explain to analysts and investors that HSBC is not primarily a retail bank but a wholesale bank. 

On this latter point, Mr Gulliver explains: “What we have done mistakenly in the past is to [give the impression] that the network is [primarily] to do with retail banking. We have had this slogan the ‘world’s local bank’ which, of course, [everyone] really reads as the ‘world’s retail bank’. Analysts have assumed that to be the strategy but actually it’s not.”

Mr Gulliver says that in only two countries does HSBC have a full-scale retail banking operation – the UK and Hong Kong – and as most bank analysts covering the stock are based in those two places this may have contributed to the misunderstanding.

In fact, says Mr Gulliver, HSBC wants to be the world’s leading international bank using the network to take advantage of the changes in global trade and capital flows through the commercial banking and markets businesses. On the RBWM side it is much more of a mass affluent strategy than a pure retail one. The ‘world’s local bank’ slogan will remain, however, but the campaign will be redirected more towards trade flows between emerging markets. An example of this is a new advert showing a Chinese terracotta warrior wearing Brazilian flip-flops.

Reorganising the decks

Another goal is that commercial banking and RBWM (which used to be called personal financial services) will be run as a single global business in the way that global banking and markets (GBM) – the division that Mr Gulliver used to run before becoming CEO – has been operated for some time. For the first time RBWM now has a global head in Paul Thurston; global head of commercial banking is Alan Keir; Samir Assaf is chief executive of global banking and markets. 

“Previously we didn’t have a single head of retail banking and wealth management and no single head of commercial banking. That meant we ended up with many varieties of both businesses across the world. It depended on the interests of the particular [country] CEO. What that means is you end up with a significant cost base. You have multiple product propositions, multiple internet offerings – in the commercial bank there are 30 different middle-market internet offerings – so you can’t deliver a systems platform at a low-cost base and you can’t outsource.”

HSCB profits

With annual IT costs of $6bn, keeping this figure as low as possible is a high priority if the bank is to achieve its target of taking out $2.5bn to $3bn of costs over the next three years.

Another huge cost is people, and HSBC has announced that it will be cutting its headcount by 30,000, about 10% of the total, over two years. A big problem is that costs, and especially staff costs, are often higher in emerging markets than in Europe. These costs are being attacked by taking out layers of bureaucracy so that there are no more than eight layers between the CEO and a teller or a dealer – currently the firm has 17 layers in some places. In this delayering exercise, there will be a cull of some regional headquarters.

Cost worries

The focus on costs is also worrying HSBC in relation to the proposals of the UK’s Independent Commission on Banking to raise capital requirements, as reported in December’s issue of The Banker (See special report ‘Beyond the ring-fence’). The bank has said that the high cost of being headquartered in the UK could force it to move. This would obviously mean going back to Hong Kong from where it moved in 1992 after acquiring the UK bank Midland (since rebranded as HSBC) and amid fears over the transfer of sovereignty of Hong Kong from the UK to China in 1997.

The other side of realising profits targets is by increasing revenue, and in this HSBC has more opportunities than most players with its key franchises in such countries as Brazil and Mexico and, of course, China. Returns from the China investments and business now account for 10% of the total. HSBC has a 19% stake in Bank of Communications, a 15.57% stake in Ping An Insurance and an 8% stake in Bank of Shanghai. HSBC also has more than 100 of its own China branches.

We continue to open as many branches as the regulator will allow us, we have a good dealing room in Shanghai, we have as many licences as any foreign bank has to trade in bonds and be involved in the local derivatives markets and so on, and we are the biggest player in renminbi internationalisation

Stuart Gulliver

“We continue to open as many branches as the regulator will allow us, we have a good dealing room in Shanghai, we have as many licences as any foreign bank has to trade in bonds and be involved in the local derivatives markets and so on, and we are the biggest player in renminbi internationalisation. Then we have these China investments and we have said publicly that if Bank of Communications raises equity we will take up our rights. These equity investments are the only way we can be overweight China where the banking industry is protected. In fact, total foreign share of banking assets in China is now lower than before World Trade Organisation [membership].”

But, of course, in modernising HSBC, Mr Gulliver is keen to retain HSBC’s culture of good risk management and controls. “We are not trying to change the culture of the individuals,” says Mr Gulliver.

“There is a lot about this firm that is brilliant. We had a really glorious period when we traded at four times book but since we bought Household we have derated and we now trade at book. The industry isn’t held in high regard and we are held in no higher regard than anyone else. I would like to change the perception of the firm back to its golden era perception. We want to modernise but with the same values. 

“The firm can be much faster, much more responsive, much leaner by going through this five filter exercise and ending up with a cohesive logical set of businesses that have reference to one another, getting the cost base down and the bureaucracy stripped out, but inside an organised framework.”

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