Earnings Call Transcript - HSBC Q2 2022

Mark Tucker, Chairman

Good morning or good afternoon, wherever you are in the world. I'm really delighted that we're in Hong Kong today for our interim results announcement for the first time since the COVID-19 virus struck the world. I'm here today with Noel and Ewen. They will take you through the presentation shortly, and Noel will then lead the Q&A. As well as today's results, we're also giving plenty of time to meeting with our customers and investors face to face. And I'm very much looking forward to meeting with our Hong Kong shareholders tomorrow. We have always greatly valued their feedback and engagement, and we look forward to seeing them in person. There have been reports in recent months about ideas for alternative structures for HSBC. The Board has been fully engaged in examining these ideas in depth, and we will continue that thorough examination. Noel will discuss this in more detail during the presentation. The Board firmly believes that as these results clearly demonstrate, HSBC's strategy is working and expect that it will deliver very good returns over the coming years. For 157 years, we have followed trade and investment flows to support our customers as they fulfill their financial ambitions. We have used our deep experience and strong global relationships to help our customers navigate the world. Today, we remain steadfastly focused on our core purpose of opening up a world of opportunity. Our model is increasingly relevant to individuals and to companies of all sizes and whose financial ambition spans multiple countries and regions. Our transformation has enabled us to emerge from the pandemic a stronger bank and well positioned to capitalize on the current interest rate cycle. Very few banks can rival our ability to connect capital, ideas, and people through a global network that facilitates the international collaboration required to succeed in today's world. The focus for the Board and the management team is on delivering our strategy precisely because it is the best way for us to support our customers and to improve returns. With that, let me hand over to Noel.

Noel Quinn, CEO

Thank you, Mark, and good afternoon to everyone in Hong Kong. It's great to be here to present our half year results. Good morning to everyone in London. Before I turn to progress against our strategy, a brief reminder of the context. As Mark said, our purpose as an organization is opening up a world of opportunity. These worlds are a product of extensive consultation with our customers and our colleagues about who we are and what we do. I strongly believe that our strength as a global institution comes from our ability to connect to major trading blocks of the world. I will come back to the value of our connectivity and strategy later on. The next slide sets out the key points that we're going to cover in our presentation today. First, we've had another strong performance in the second quarter. I'm pleased that reported revenue grew by 2% on last year's second quarter and was up 12% on an adjusted basis. Adjusted profits before tax were up 13% on the same period last year, and continued strong cost control led to positive adjusted jaws up 12%. Second, we've made good progress with our transformation program. If you look back a few years ago, we had loss-making businesses in the U.S. and Europe, and capital was being used inefficiently. We have structurally repositioned our portfolio, our businesses, and our operating model for higher returns. The two most material adjustments in our portfolio have been the exit and wind down of nonstrategic assets and clients in the U.S. and Europe, and the strong impetus behind organic and inorganic growth in Asia, especially in Wealth and Personal Banking. This reposition effect is starting to pay off in terms of growth and returns, as these results show. Third, it's the benefit of transformation and the tailwinds from higher interest rates that allow me to announce some ambitious new targets and underpinning guidance even against the challenging economic backdrop. After delivering an annualized return on tangible equity of 9.9% in the first half, we are confident of delivering at least 12% from 2023 onwards. This would represent our best financial performance for a decade. Finally, as a result, we are providing more specific guidance of a 50% dividend payout ratio for 2023 and 2024. We understand and appreciate the importance of dividends to all our shareholders, so we will aim to restore the dividend to pre-COVID levels as soon as possible. We also intend to revert to quarterly dividends in 2023. Let me now walk you through the progress we've made in the first half of this year in transforming the bank. In Asia Wealth, our investments over the past few years are gaining traction. We've made a series of bolt-on acquisitions to accelerate our progress. In the first half, we completed the acquisition of Axa Singapore, and we remain on track to complete the acquisition of L&T Investment Management in India. In Mainland China, we continue to build momentum on the back of 17 new licenses and regulatory approvals gained since the start of 2020, seven of which were in the first six months of this year. We have strong revenue momentum across all of our businesses with 4% of the adjusted revenue growth in the first half after turning the corner on revenue back in 2021...

Ewen Stevenson, CFO

Thanks, Noel, and good morning or afternoon all. As Noel and Mark have said, it's really great to be in Hong Kong for these results. We had another strong quarter, reported pretax profits of $5 billion. While down 1% on last year's second quarter, this marks a strong core operating performance. Compared to the second quarter of last year, adjusted revenues were up 12%, including net interest income up 20% with operating expenses flat. We had 12% positive jaws. Adjusted pretax profits were up 13%, and profits attributable to ordinary shareholders were up 62%. Credit conditions remained benign in the quarter. ECLs were $448 million net charge compared with the net release last year. We benefited from a $1.8 billion deferred tax asset credit in the quarter, reflecting a recognition of brought forward tax losses in the UK given the improved profitability outlook. We now expect a 2022 effective tax rate of around 10%, reverting to a more normalized effective tax rate of around 20% in 2023. To remind you, for 2022 dividend modeling purposes, please exclude the DTA gain and the French loss on disposal being noncash significant items, but include the $3.4 billion of cost to achieve we expect to spend this year and other significant items. Our core Tier 1 ratio was 13.6%. Tangible net asset value per share was $7.48, down $0.32 on the first quarter, mainly due to FX impacts, but also to the fourth quarter 2021 dividend payment. And we've announced an interim dividend of $0.09 per share, up $0.02 on the first half of 2021.

Richard O'Connor, Moderator

Thank you, operator. We'll take most questions from the audio lines today. We have a few analysts and investors in Hong Kong. We’re off to four or five from the lines, I see even raise their hands, and we've got a microphone to come around and hopefully get some questions from Hong Kong. Can I just ask everybody to limit themselves to normal two questions? But with that, operator, we'll go straight to the first question, please.

Raul Sinha, Analyst

This is Raul Sinha, JPMorgan. I’ve got two, one on capital and one on strategy, please. On capital, when we look at the second half of the year, it looks like a step up in the capital ratio and obviously the French loss. And historically I think we've seen based on your guidance, it looks like the second half might be less capital dilutive than what we normally expect. So I'm just wondering if you can talk about the moving parts or the actions you could take, just flagging to get the capital ratio by about there, perhaps a little bit more color there. And then related to that, when do you think you might be in a position to buy back stock again from a timing perspective? And then the second one on strategy, just going back to platform.

Ewen Stevenson, CFO

Yes, Raul, the line wasn't perfectly clear. So I'll do my best. On capital, I think the first part of it was sort of understanding the moving parts on the rebuild of capital. Yes, from first half, 13.6, obviously, we've given you the M&A impacts that we expect in Q3. In addition to that, we are taking probably about 20 basis points to 30 basis points of incremental capital actions that we previously haven't talked about with the market, which you should expect to come through in the second half of this year. We also remember that under Bank of England DRA rules, we have to accrue dividends at the top end of our 40% to 55% payout ratio. So in the first half, effectively the core Tier 1 ratio is understated because of that accrual and there's a catch-up that you'll see in Q4. So we do think that we'll trough next quarter a bit below where we are. We'll be back close to 14%. By full year, we'll be back within range of 14% to 14.5% during the first half of next year. And then your question on buybacks links into that, which is you should not expect us to be doing buybacks until we're back within our core Tier 1 range of 14% to 14.5%, which, yes, you can imply from that will be more back-end loaded next year as a result.

Noel Quinn, CEO

Before I delve into the specifics you mentioned, I want to address the alternative structure options. It's important to consider a combination of factors. We have identified a negative impact on the revenue synergies discussed in the report. There is also a negative effect on certain funding and capital synergies within the diverse group. Additionally, there is a negative impact from one-off execution costs. Furthermore, a split into two less diversified groups would lead to higher ongoing funding costs compared to a diversified group. There will also be ongoing operational costs to consider. In reviewing all these elements, you need to assess them collectively rather than isolating one. There are numerous judgment calls involved in this evaluation. We believe that by carefully weighing these factors, the safest and quickest path to increase dividends and returns is the strategy we are currently following. We have provided schedules in the materials and appendix to help clarify these considerations. I believe no single cost item stands out as more significant than the others. Additionally, there is a significant execution risk since a project of this complexity might take three to five years with uncertain outcomes regarding regulatory and investor approvals.

Ewen Stevenson, CFO

Yes, to provide more details about some of the numbers, as Noel mentioned, establishing a separate Asian subsidiary would incur one-time costs. You would need to show that you have independent IT systems, which could take three to five years to build and cost billions of dollars. Currently, there is a $40 billion MREL stack in our Asian subsidiary that is connected to the parent company. A three to five-year program would be needed to reissue this MREL to the public markets and manage the liabilities associated with the excess MREL at the group level. There could also be tax implications from triggering capital gain steps during the restructuring, alongside other one-time costs related to creating an independent business in Hong Kong, where I am now. Then there are ongoing dis-synergies; for instance, we've noted that 45% of our $20 billion wholesale revenues come from international customers. You can estimate how much of that $9 billion could be at risk, but it would be significant. We would need to duplicate corporate functions and IT running costs that currently provide us with global synergies. We would also lose the purchasing power benefits we enjoy today. Our Asian business would likely need to operate with a higher core Tier 1 ratio as a standalone entity, lacking the group support it benefits from now, which the HKMA considers. The rest of the group has about $100 billion in AT1, Tier 1, and Tier 2 capital. Breaking out the Asian subsidiary could pose a significant risk of a downgrade in the group’s ratings, potentially affecting that $100 billion by 25 to 50 basis points annually. Our UK holding company benefits from advantageous tax arrangements compared to Hong Kong and gains a tax shield on its UK headquarters costs. The execution complexity is also considerable; all timelines suggest a three to five-year framework. During that time, we would need to focus on the IT changes required for the separation rather than the core business. Regulatory approval is needed across about 25 jurisdictions, raising questions about indexation; we are currently fully indexed in both markets. U.S. dollar clearing may not be accessible to the Asian subsidiary, and obtaining a dollar clearing license could be challenging, as others have experienced. So, as Noel pointed out, when considering the costs, implementation complexity, and ongoing dis-synergies, we find it difficult to identify any viable value proposition to present to shareholders.

Noel Quinn, CEO

Manus, thank you. I believe we are already witnessing strong growth from our current strategy. We are focused on growth opportunities in Asia, as evidenced by our Commercial Banking business in Hong Kong, which has shown impressive growth. On a global scale, our trade business has increased by 20% in revenue. To be candid, Manus, we have already considered the strong growth opportunities in Asia and are allocating more capital to the region. Thus, we have incorporated that growth scenario into our current plan.

Ewen Stevenson, CFO

Yes, one could assume that we could increase growth in certain areas, but that would require a shift in our risk approach and consequently impact our capital, funding, and liquidity strategies that we are currently evaluating. However, we believe that the overall negative dis-synergies outweigh any potential positive synergies. It's also possible to consider that separating the Asian business could lead to a rerating, but we anticipate that the rest of the world would experience a downgrading. Therefore, when assessing both aspects together, we have not found compelling structural options that would result in a rerating for the entire group.

Omar Keenan, Analyst

Congratulations on a good set of numbers. That's good to see jaws coming through so strongly. I've got two questions, please. So my first question is on the analysis of the strategic options. And I wanted to ask you, is there anything that you've decided to do that is incremental to the strategy because of the process that you've gone through in the past couple of months? And what I can see is that cost efficiencies have moved to the upper end of the range, and you're talking about 20 basis points to 30 basis points of additional capital actions. So I was hoping you could add a little bit more color specifically on those two points and then you can give some color on how your thinking has evolved? And my second question is on deposit beta. So one of your peers said last week that they were starting to see some migration from current and savings accounts to time deposits. I was hoping you could give us some updates on how you're thinking about the competitive environment and deposits as we look forward?

Noel Quinn, CEO

On your first one, I'll just answer that, and I'll pass to Ewen to the second point. I mean we're very determined to improve the performance of the business, and we take all feedback that says the business hasn't performed well over the past 10 years. We take that at heart and have done, and are very committed to trying to drive our capital efficiency into the business. So we constantly look at parts of the portfolio that are strategically less important and are underperforming. We're determined to continue to drive our efficiency into the capital allocation of the business. On the specific point of the additional capital management actions we've taken, I think investing in response to the CET1 impact of the mark-to-market on the treasury book. That's in addition to mitigate the downturn in the CET1 as a consequence of that. But we're confident that the capital build coming from higher profitability will start to reboot CET1 towards the end of this year and into next year.

Ewen Stevenson, CFO

But those capital management actions are not in response to structural considerations. They're more in response to near-term capital management activities. Those actions are tactically important and right things to do, but they're not strategically damaging to the franchise of the bank. We're not having to turn off good strategic growth. We're able to take those actions whilst pursuing our strategy.

Noel Quinn, CEO

Yes. On NII guidance, a couple of things. A, you should assume that, yes, we've got a bit of fat in there when we're guiding to at least $37 billion. Secondly, I think remember, as interest rates rise, continue to rise, the positives will continue to rise. So if you don't get that final add on interest rates at the back end, then we're already modeling very high deposit leads at that time. So the implicit impact on the net interest income is a lot lower than what you may think. We've run various scenarios and are comfortable based on a range of scenarios that we'll be able to deliver $37 billion. But obviously, there's very material change in rates, so we'll reassess that.

Richard O'Connor, Moderator

We have one question from Hong Kong. If you wouldn’t mind, give your name and institution, please.

Gurpreet Singh Sahi, Analyst

This is Gurpreet with Goldman. Congratulations on a good set of numbers. I have two quick questions, please. First is on the prime rate in Hong Kong, and then the mortgage cap that should effectively be hitting all the mortgage borrowers starting next month, if I'm not mistaken. What could be the efforts to narrow that time minus and hence lift the effective gap for the mortgage borrowers? And how much of that can we do before we see kind of deposit migration as you have talked about?

Noel Quinn, CEO

I'll take that as a compliment. I believe being seen as traditionally conservative is a positive trait. Let me address the China commercial real estate situation, and then I'll hand over to Ewen to discuss the prime rate and the mortgage gap. The expected credit loss charge in the first half of the year is a favorable result. However, the economic situation remains uncertain. Therefore, I believe it would be imprudent for us to assume that first half performance will set a trend for the entire year at this point. It is appropriate to anticipate a higher charge in the second half due to the level of uncertainty. Currently, we expect that forward economic indicators may continue to decline, which means there will likely be more Stage 1 and Stage 2 provisions in the latter half of the year rather than just focusing on Stage 3.

Ewen Stevenson, CFO

On the prime rate, not everyone in the room here in Hong Kong understands this, but not everyone is in Hong Kong. The mortgage market here is typically priced off a one month HIBOR plus a spread. Borrowers also have the option to switch from that rate to what's known as the net lending rate minus the margin. Currently, those two rates are generally aligned, and I would say that most of our focus is leaning toward the latter, meaning that the best lending rate minus the margin offers a lower rate to customers than the one month HIBOR type of spread we are charging. That rate is set and calculated daily, and customers do not need to take any action; the switch from one rate to the other occurs automatically.

Thomas Rayner, Analyst

It seems you're feeling so charitable and you're giving specific guidance on net interest income cost of returns. I could possibly back out what you're thinking on noninterest income. But I just wondered if you could give us any color on what you're thinking in terms of the main drivers, COVID restrictions, trade, what's going on in capital markets, Chinese GDP, all those things that seems to be the early missing piece of the P&L, we don't have that.

Noel Quinn, CEO

What we've all got to factor into our future thinking is take here in Hong Kong, there should be, at some point, a rebound in wealth management activity that will drive higher fee income. There should be at some stage a rebound in capital market activity that should drive higher fees to GB&M, but it's too early at the moment to predict exactly how much of that will come back and when it will come back. But you could argue, if you look at the P&L of the retail bank and the WTB the first 6 months, they've got revenue growth. And what you found is that the retail banking has driven strong growth from NII, but has been subdued on its fee income. I'd like to end with a few slides before Q&A. When we began to accelerate our strategy in February 2021, one of our four strategic pillars was to focus on our strengths. As you have seen from the material today and throughout our history, we have no greater strength than our ability to bridge capital and trade flows between major economic blocks of the world. We're the world's leading trade bank, one of the largest payments providers globally and one of the largest FX houses in the world. And even as trade flows have changed and supply chains have shifted, we've taken market share in trade because our network means we can go wherever trade goes. We also command a 20% wallet share of wholesale banking client business from Europe, the Middle East and the Americas into Asia. Outside of revenue, our international model has also started delivering synergies in our cost base, particularly through digitization, where we can build the months to apply globally at much lower costs. And there are also capital and funding synergies through the greater diversification of our portfolio and the inter-connectivity within it. In the past, investors could not fully assess all that value because parts of our portfolio dragged down the overall returns below the cost of capital. So the work we have done over the past few years to tightly control costs, reduce capital allocated to low-return, domestic-oriented businesses, and increase investment in higher growth, higher return geographies in Asia and in businesses such as wealth will allow us to demonstrate the value of our international strategy much more clearly, as is evidenced in our forward guidance of at least 12% returns in 2023 and beyond. In summary, we've explained today how our strategy will generate significant value for our shareholders. We remain focused on our strengths, of which international connectivity is at the start. Our UK and Hong Kong franchises are performing very well, and we are shifting capital to areas with the strongest returns. We're managing costs tightly, and we expect at least $37 billion of net interest income next year as rates normalize. We are simplifying and digitizing the bank. We are engaging and will continue to engage with all our shareholders. We share the desire for improved returns and understand the importance of dividends to them. We think the best and safest way to improve returns is to focus on our strategy, which we are confident will deliver a return on tangible equity of at least 12% from 2023 and materially increased distribution.