Earnings Call Transcript - HSBC Q4 2023

Operator, Operator

Good morning, good afternoon, good evening, ladies and gentlemen, and welcome to the Investor and Analyst Webinar for HSBC Holdings plc’s 2023 Annual Results. For your information, this webinar is being recorded. At this time, I will hand over to Noel Quinn, Group Chief Executive.

Noel Quinn, Group Chief Executive

Good afternoon for those in Hong Kong, and great to see you all. Good morning to those watching in London and around the world. Before Georges takes you through the Q4 numbers, I'll make some opening comments. First, I'm really pleased with the performance that the team delivered in 2023. We reported $30 billion of PBT for the first time ever, and we delivered a return on tangible equity of 14.6% or 15.6% excluding material notable items. Second, there were some items in the fourth quarter which make it harder to understand the underlying performance. Georges will take you through them in detail. But I want to stress there was still good underlying growth in the fourth quarter. Excluding the impact of notable items and Argentina hyperinflation, our profit before tax was $7.3 billion. Third, we distributed $19 billion of capital returns to our shareholders in respect of 2023. This included a full-year dividend of $0.61 per share, the highest since 2008, and $7 billion of share buybacks, which reduced the share count by over 4% at completion of the current buyback. Fourth, we still expect to have substantial distribution capacity going forward. We've announced a further share buyback of up to $2 billion. We're committed to considering a special dividend of $0.21 per share as a priority use of the Canada proceeds, subject to the completion of the transaction. We finished the year with a strong CET 1 ratio of 14.8%, which will be further boosted by the Canada deal. Fifth, we remain committed to cost discipline. We have a flow-through impact of 2023 inflation on our costs this year but expect a downward trend in inflationary pressures in 2025 and beyond. We continue to invest in growth opportunities and the digitization of our business to drive incremental efficiencies. We are very focused on funding much of that investment through cost-saving initiatives. Finally, we expect to have further opportunities to grow revenue even in a lower rate environment. Georges will take you through how we're reducing our sensitivity to rate movements, and we do acknowledge the downside risks to NII, but we're confident that we have the levers for growth that allow us to deliver mid-teen returns in 2024. I'll take you through some of these levers later, but let me now hand over to Georges.

Georges Elhedery, Chief Financial Officer

Thank you, Noel. Warm welcome to everyone here in Hong Kong. For those of you watching in London, good morning, and thank you for joining our full year 2023 results call. We delivered a good underlying business performance in the fourth quarter, but let me first start by clarifying that our reported profit before tax was impacted by $5.8 billion of notable items and a further $0.5 billion from Argentina hyperinflation, including the more than 50% devaluation of the peso in December. Let me unpack three of those notable items. First, we reinstated the impairment on the sale of our France retail business as signaled at the third quarter. Second, we booked $0.4 billion of Treasury disposal losses in the quarter, again in line with the guidance at the third quarter to extend the duration of hedges in anticipation of rate decreases. Finally, each quarter we conduct a value and use test on the carrying value of our investment in BoCom, described in detail in our annual report and accounts. Following the outcomes of that test in Q4, we took a charge of $3 billion in the quarter against our carrying value. The charge had an insignificant impact on CT1 capital and our CT1 ratio, and no impact on our dividends or share buyback. Just to be clear, this has no impact on our strategy in mainland China, our strategic relationship with BoCom, or on HSBC's or BoCom's operation, strategy, or outlook. So on a reported basis, our profit before tax was $1 billion in the fourth quarter, down $4 billion from the fourth quarter of 2022. Excluding the $6.3 billion impact of notable items and Argentina hyperinflation, our profit before tax was $7.3 billion, up $0.7 billion versus the fourth quarter of 2022, primarily due to growth in banking NII. On the next slide, fourth quarter revenue was down $1.6 billion compared to the same period last year, due to the impact of notable items and Argentina hyperinflation. Excluding these, our revenue was up $1.5 billion, primarily banking NII. The strength of our deposit franchise, our access to deep pools of liquidity in the U.K. and Hong Kong, and our enviable balance sheet made it possible for us to benefit from the more favorable rate environment. Fourth quarter NII and banking NII were again impacted by Argentina hyperinflation and a reclassification of cash flow hedge revenue between NII and non-NII. Excluding these, both NII and banking NII were broadly stable on the third quarter, and NIM was down three basis points, primarily due to higher time deposit costs and deposit migration in Hong Kong. Turning to the outlook, taking our fourth quarter banking NII and adjusting for Argentina hyperinflation and the reclassification of cash flow hedge revenue, and the disposal of our France retail and Canada businesses gives you an annualized run rate of just above $43 billion. That should be your starting point for modeling our 2024 banking NII. We expect four key variables to drive our banking NII from that starting point in 2024: changes in interest rates, the reinvestment of maturing structural hedge assets at higher yield, deposit migration, particularly in Hong Kong, and balance sheet movements. There is a degree of uncertainty inherent in all of these. We're guiding towards a banking NII of at least $41 billion in 2024. This is our current estimate of the bottom end of the range of reasonable outcomes and is intended to help you with your modeling. We will continue updating further as the year unfolds. Before turning to non-NII, I would like to direct your attention to the chart on the bottom right of this slide. Over the last 18 months, our banking NII sensitivity has reduced by around $3.5 billion. More than one-third of this reduction is due to increased structural interest rate hedging. Subject to market conditions, we expect to increase both the notional and the duration of our structural hedge in the coming quarters in order to reduce our banking NII sensitivity still further. Non-NII was down $0.9 billion compared to the same quarter last year due to notable items and Argentina hyperinflation. Again, excluding these, non-NII was up $1.7 billion versus the same quarter last year. This was primarily due to the revenue offset into non-NII from the central cost of funding global banking and markets trading activity, which is included in banking NII, and from the cash flow hedge income reclassification between NII and non-NII I referred to previously. Other non-NII was up modestly versus the same quarter last year, including an increase of $0.1 billion in net fee income, primarily in commercial banking and wealth and personal banking. Looking at non-NII from our two strategic activities of wholesale transaction banking and wealth. In wholesale transaction banking, non-NII was up 2% on the fourth quarter of 2022. There was good growth in global payment solutions, in trade, and in foreign exchange, reflecting the strength of our international network and transaction banking capabilities, as well as increased client activity and repricing initiatives. This was partly offset by a relatively small decrease in security services. In wealth, non-NII in both asset management and private banking grew by double digits versus the fourth quarter of last year, due to an increase in assets under management, partly driven by net new invested assets. However, total wealth non-NII was down $0.1 billion as a result of a $0.2 billion correction to historical valuation estimates in our insurance business. For the full year, non-NII in wholesale transaction banking was $10.6 billion, up 5% on 2022, and $6 billion in wealth, up 7%. Turning now to credit, our fourth quarter ECL charge was $1 billion, primarily in wholesale. This brought our full year ECL charge to $3.4 billion, which was 33 basis points of average customer loans, including those held for sale, or 36 basis points excluding those, and within our full year 2023 guidance. Due to ongoing macroeconomic uncertainty, we're guiding towards ECLs of around 40 basis points for 2024. We took an ECL charge of $0.2 billion for mainland China commercial real estate in the fourth quarter, as part of the $1 billion charge for the quarter referenced in the last slide. This brought the full year charge on this portfolio to $1 billion, crystallizing the plausible downside scenario that we set out last February. Our main area of focus remains the portfolio booked in Hong Kong. That exposure is now $6.3 billion, down $1.2 billion in the quarter, and down $3.1 billion compared to full year 2022. We continue to monitor the sector closely, and we are comfortable with our current level of provisions. Turning to costs, full year 2023 costs on a constant currency basis were down 1%. On a target basis, full year 2023 costs came in 1% higher than our Q3 guidance, driven by three items that unexpectedly landed in the fourth quarter. First, the FDIC special assessment, which we expected to be incurred over 2024 and 2025. Second, the U.K. bank levy was higher than forecast, primarily due to adjustments relating to prior years. And third, there was an offsetting benefit from Argentina hyperinflation in the quarter. Looking ahead, we are aiming to limit cost growth to around 5% in 2024 on a target basis, which excludes the reduction in 2024 costs from the France, retail, and Canada disposals. This will be driven by the flow-through impact of 2023 inflation to 2024 costs, investment and volume growth, and partly offset by cost-saving initiatives. On the next slide, customer lending and deposits were broadly stable versus the third quarter, once you exclude the sale of our France retail business. Without that, there was $35 billion of deposit growth, of which $27 billion was in Asia, with around half of this in Hong Kong. Deposit growth in Asia benefited from seasonality, and we would expect at least some of that growth to reverse in the course of Q1. Turning now to capital, our CT1 ratio at the end of 2023 was 14.8%, which was down 0.1 percentage points on the third quarter. There are three things I'd like to draw your attention to. First, as I said earlier, the BoCom charge had an insignificant impact on CT1 capital and our CT1 ratio due to the compensating reduction in regulatory capital threshold deductions, and it had no impact on dividends or share buybacks. Second, we expect the share buyback announced today to have an impact of around 25 basis points on our CT1 ratio in the first quarter of 2024. Finally, we expect the Canada sale to generate around 1.2 percentage points of CT1 in the first quarter of 2024. We remain committed to consider a $0.21 per share special dividend in the first half of 2024 as a priority use of the sale proceeds, which equates to around 0.5 percentage points of CT1. Before I hand back to Noel, I am pleased to share some enhancements that we have made with regard to our international disclosures. There are two sets of data, and Noel will also comment further on them. Starting with our wholesale business, let me walk you through the data on this slide. In 2023, we generated $33.5 billion of client revenue across commercial banking and global banking markets. Of this, $20.4 billion was generated from multi-jurisdictional clients. By this, we mean clients that bank with us in more than one market. The charts on the right show that two-thirds of the client revenue we generate from those clients comes from providing them with services and markets outside their home market where they also bank with us. It is also worth pointing out that two-thirds of multi-jurisdictional client revenue, or $13.4 billion, was generated from clients whose home market is in the West, with the remaining $7 billion from clients whose home market is in the East. Turning now to WPB international revenue, more than $10 billion, or 40% of our WPB revenue, comes from international customers, around two-thirds of which is generated in Asia. Summarized, both the wholesale and WPB client revenue data clearly demonstrates the strength of our international network and our unique capability to serve international clients. Our network and further investments into our international proposition position us to capture an even greater share of this vital, fast-growing sector. Let me now hand back to Noel.

Noel Quinn, Group Chief Executive

Thanks, Georges. Thank you, Georges. You've just heard about good underlying performance in the fourth quarter, and Georges has introduced more detailed information about our international revenue. Our wholesale international business model is a mature and differentiated business model with substantial scale. In recent years, we have started to develop and invest in our WPB international business model. What Georges' slide showed is that already 40% of WPB revenue comes from international customers, and we believe we can take it much further. Let me now turn to how we will drive revenue growth, not just this year and next, but over the next three to four years. I will begin with our purpose, ambition, strategy, and values. These have helped to drive the good underlying business growth, which, alongside supportive interest rates, have given us strong momentum. In the short term, we're conscious of the potential downside risk to NII. The structural hedging we have put in place will help to protect that income. We have some clear focus areas under our four strategic pillars, which I will cover on the following slides. Starting with focus on our international wholesale business, which remains our biggest competitive advantage, and because of its scale, our biggest growth opportunity. In the past, our businesses in the West were primarily focused on domestic clients. Over the last four years, we have repositioned those businesses to align them with our international strategy, exiting low return and low growth domestic RWAs. The result is the differentiated model you see today. In commercial banking, we are unique in our ability to serve clients across multiple geographies, which is what HSBC was founded to do. The result was the $13.3 billion of profit before tax that commercial banking generated last year. In global banking and markets, I believe we are uniquely positioned to connect clients between West and East, which has been evident in our market-leading performances in regions like the Middle East and businesses like Global Foreign Exchange. We have clearly got a strong international franchise. As you can see, we facilitated more than $850 billion of trade last year, with the diversification of supply chains leading to revenue growth opportunities for HSBC. We are ranked second globally by revenue in our payments business and processed around $500 trillion of electronic payments. We have been number three globally by revenue in FX since 2021. However, I believe there is a significant amount of untapped opportunity still to go for, which can drive revenue growth in the face of declining interest rates. This potential revenue growth is not necessarily dependent on GDP, as that growth opportunity already exists within our client base and is often fee-based, influenced by opportunities inherent to the international nature of our client base. To provide some evidence of this growth potential, we grew wholesale multi-jurisdictional client revenue by 29% in 2023, and the revenue multiplier for multi-jurisdictional corporate clients in commercial banking was five times that of an average domestic-only customer. I am pleased that international isn't just a wholesale story; we are doing more with our WPB customers as well. Building our wealth business to meet the rising demand for wealth management services, especially in Asia, has been a strategic priority in recent years. I am glad that we attracted net new invested assets of $84 billion last year, compared to $80 billion in 2022 and $64 billion in 2021. This is a good indicator of future revenue opportunities, which again are often fee-income and should benefit in a lower interest rate environment as investors shift from cash reserves into invested asset classes. Another trend is the growing demand for seamless cross-border banking services. Innovation is key here, and we hadn't innovated enough in this space in the past, which meant we weren't offering our customers what they wanted, but we are now. Global Money has more than 1.3 million customers, up from 550,000 a year ago. We also launched a new, strengthened international banking proposition. Overall, we grew revenue from WPB international customers by 41% last year, from $7.2 billion to $10.2 billion. And while it may be assumed this was driven solely by higher rates, I am pleased to say there was a 43% jump in new-to-bank international WPB customers last year. Again, these are higher revenue generating customers, bringing in three times as much revenue as an average domestic-only customer. Next, I showed a slide to demonstrate how we've gone from a business that depended on our home markets for the vast majority of our profits, while the rest of the franchise underperformed, to one with broad-based profitability across markets. This slide shows the increasing profitability of these diversified growth opportunities. The number one rankings speak for themselves, and I especially want to call out the great work that the global banking and markets team are doing in the Middle East. They topped these rankings three years in a row in a region that presents significant growth opportunities moving forward. India, mainland China, excluding associates, and Singapore all contributed more than $1 billion of profits in 2023, with Singapore doing so for the first time. This underlines why HSBC was named best bank in Asia by Euromoney, but there was strong growth across all these markets. We have reshaped our portfolio to reinforce strengths while exiting areas of underperformance and/or lower strategic priority. Over the last 12 months, we've announced exits in several of our smaller markets. This is one way that we expect to take out further costs alongside our continued focus on improving the internal efficiency of the bank. And by making savings, we can invest in the areas that help us drive growth. Before I move on, I want to mention SVB UK. Everyone knows that HSBC is an international bank, but we also have a long history of supporting innovative entrepreneurs. The acquisition of SVB UK enabled us to build a bigger proposition that can help us become known as the go-to bank for innovation companies. It's encouraging that innovation banking had its best-ever quarter for customer onboarding in the fourth quarter of 2023. I'm also encouraged by how many of those innovative companies want to take their capabilities cross-border. The next slide sets out how we're investing in technology to make customer experiences better, sell processes more efficiently, and our cost of execution lower. I'm pleased to see more of our personal and corporate customers being mobile and digitally active. HSBC has traditionally grown by cross-selling products to our existing banking clients, but innovation also enables us to open up growth avenues that are outside of our traditional customer footprint. Zing is one such growth avenue as it offers cross-border payment capabilities, but critically, it is targeted at non-HSBC customers. Our embedded finance joint venture announced with Tradeshift last year is another such growth avenue. It's still early days for both, but they will allow us to break outside of the existing business model. I will also briefly cover our final two pillars. There isn't a conversation I have with a client where the net-zero transition doesn't come up. Our first net-zero transition plan shows how we intend to finance and support the transition to net-zero and collaborate globally to help enable change at scale. It will be a complex journey, but we have exactly the right geographic footprint where the need and opportunity are greatest. Lastly, over the last four years, we've increased the pace of execution across the organization. The management team is confident about the business, but it's even more important that our colleagues are confident because when they are, we stand a much greater chance of succeeding. I'm pleased that our 2023 staff survey showed the number of colleagues seeing the positive impact of our strategy was up 11 percentage points from 2020 to 73%. I'm also very excited by the quality new hires we've been able to bring into the organization over the last 12 months. It's also a vote of confidence in our strategy and the momentum we've built over the last four years. In summary, I'm really pleased with how we performed in 2023 and the contribution our people made. We reported $30 billion of PBT for the first time and a mid-teens RoTE. There was good underlying growth in the fourth quarter, excluding the impact of notable items and Argentina hyperinflation. Our profit before tax was $7.3 billion. We distributed $19 billion of capital returns to our shareholders in respect of 2023, including the best full-year dividend since 2008 and three share buybacks. We still expect to have substantial distribution capacity going forward. We remain committed to cost discipline, and we expect to have further opportunities to grow revenue even in a lower rates environment. We're confident we have the levers for growth that allow us to deliver mid-teens returns in 2024. With that, let me hand over to Noel for Q&A.

Operator, Operator

Okay, Gurpreet.

Gurpreet Sahi, Analyst

Thank you. Gurpreet Sahi from Goldman. Two questions if I may, please. The first one is on FY 2025 and beyond. We note the RoTE guidance for this year, but could there be any comments regarding the RoTE for 2025 and beyond? In particular, if the banking NII sensitivity for the next 100 basis points of rate cuts can be guided to us. The second one is around the gain, the implied improvement in the capital from the gain in Canadian operations, which remains at around $10 billion, of which $4 billion can be special dividend. So, of the $6 billion, have we decided on how much will go towards capital distribution to shareholders and how much will go towards business growth? Thank you.

Noel Quinn, Group Chief Executive

Thank you very much for your questions. I’ll ask Georges to cover both of those, please.

Georges Elhedery, Chief Financial Officer

Thank you, Noel. Thanks, Gurpreet. We have not at this stage given guidance for full year 2025. I point you to the guidance we've given for full year 2024 of at least $41 billion in banking NII and mid-teens return on tangible equity. In terms of banking NII sensitivity, we do have a slide at the back end of the deck, which I can point you to, which shows for the further 100 basis points and for future years what's the impact. What I can point you to is, number one, we continue to intend to increase subject to market conditions, but as of today, to increase the structural hedge. Second, the volume of the structural hedge, and third, we continue to intend to increase the weighted average life of the structural hedge, having now reached 2.8 years and with the intent to take it to about three years, both of which should give you a sense of how we're mitigating rate impacts into 2024 and 2025 from the structural hedging activity. Regarding Canada, so $10 billion proceeds, $4 billion will be considered, well we committed to consider as a priority use for a special dividend. The residual $6 billion will constitute about 0.8%, 0.9% additional CET1, which may, which very likely will be at the Q1 outcome. We will continue looking at opportunities, but it remains our intent, subject to market conditions, our capital position, regulatory position; it remains our intent to continue a rolling series of share buybacks beyond this one.

Gurpreet Sahi, Analyst

Thank you.

Operator, Operator

Any others in the room? Okay, so we'll take our first question from Andrew Coombs from Citi.

Andrew Coombs, Analyst

Hi. Good morning from London, good afternoon to yourselves. Two questions, please. Firstly, I just want to clarify the messaging on the banking NII outlook. If I rewind 12 months ago, I think you gave guidance for greater than $36 billion of reported NII, but then this time a year ago, you said you weren't seeking to move consensus, which at the time was actually higher, it was at $37. If I fast forward to today, you're guiding to greater than $41. If I look at consensus NII, I adjust the trading book funding costs, it looks like consensus banking NII is around $44. So are you seeking to rebase consensus banking NII or should we put greater emphasis on your greater than within that $41 target? That's my first question. I just want to clarify that messaging. My second question is around the hedge. Thank you for the extra disclosure on the $478 billion nominal and the 2.8 years average life. Can you give us an idea of both the average yield on that book and also where it's currently rolling off and what you're aiming to roll it back on if you are extending the duration now? Thank you.

Noel Quinn, Group Chief Executive

Georges will answer both of those.

Georges Elhedery, Chief Financial Officer

Thank you, Andrew. So obviously today we cannot see consensus banking NII; basically, I'll use this opportunity to ask you collectively if you can start giving us your banking NII so we can see the NII forecasts and then the funding costs of the Trading Book gets lumped together with the non-NII and it's, to be fair, difficult for us to unpack it. Although $44 billion does sound high if we try to do the math ourselves. Let me take a step back and walk you through how we're thinking about NII and just bear with me for two minutes, but I think that explanation will probably help guide you. So we start from a Q4 10.7 billion banking NII. We would adjust for the parts related to Argentina hyperinflation and the reclassification of cash flow hedges between NII and non-NII. We'll adjust for the part that does not pertain to Q4, which is a full year correction. That's about an additional $0.5 billion you could use on the Q4 10.7 number. So that takes you to an 11.2 adjusted quarterly run rate. Annualized, taking into account day counts, you get to 44.4. From that 44.4, remember you have to deduct the full year French NII, France retail NII, as well as three quarters from the Canada NII, which combined come to about $1.3 billion. So $44.4 minus $1.3 takes you to just above $43 billion. That would be our starting position in terms of an annualization of a run rate, factoring in structural hedges, etc. Now from that $43 billion, there are various tailwinds and headwinds. We have the tailwind of reinvestment of all structural hedges from lower rates into the current rate environment. We do have some tailwinds, probably cautious on H1, but tailwinds beyond H1 in terms of volume growth and loan growth. We do have headwinds, including the rate cycle if we start seeing decreases in the second half of the year. We obviously have the headwinds, which we've observed specifically in Hong Kong around deposit migration to term deposits. Baking all of that into account, we're getting to the guidance of at least $41 billion, and we're comfortable sharing that today. Regarding the structural hedge, we have shared with you the volume, the weighted average life, and banking NII sensitivity. We have not yet shared and have not found the level of standard we would need to share the yield. What I can tell you about the yield is that both the yield of the maturing hedges being replaced at current rates, as well as the additional hedges we're doing with inverted curves, are all baked into our at least $41 billion banking NII guidance.

Noel Quinn, Group Chief Executive

If I could just add a couple of comments. One reason we're not giving a statement regarding consensus is, as Georges said, we think consensus is a mixture of updated thinking that has adjusted for some of these annualization effects of disposals and other things, and some consensus hasn't adjusted for that at the moment. Therefore, there's a little bit of apples and pears in today's consensus position. What Georges is clearly articulating for you is to take Q4, adjust for the known items, get to a new starting position of $43 billion, and he’s underpinned that starting position of $43 billion with at least $41. Thus, the range of modeling is going to be somewhere between $41 and $43, depending on the assumptions you might make on the headwinds and tailwinds. Given that lack of consistency on consensus, the uncertainty in the market, that's probably the best way to guide you on banking NII. There's a very clear repositioning of the starting position to get us back on an apples to apples basis, and the other thing, that was it. That's what I wanted to say. Those two comments. Thank you.

Operator, Operator

Thank you. Next question. We'll take one from the room.

Katherine Lei, Analyst

Katherine Lee from JPMorgan. So I have two questions here. The first question I want to clarify is that the mid-teen RoTE guidance is based on normalized lot. This means that the RoTE excludes the Canada disposal gain. So I want to clarify that because if this is the case in mid-teen RoTE, then if you look at the company compiler consensus, I think the RoTE is 17.4%. Then I just calculated this on a top-down basis, excluding the disposal gain, and the consensus RoTE is roughly about mid-teens as well. But I think that means that the HSBC guidance and consensus are quite in line in terms of normalized RoTE. However, I think on NII and cost, I think in the previous questions, there may be a bit of reset in expectation. I think cost, the 5% cost is a bit higher than where consensus was indicating. Then does that mean you are quite optimistic on non-NII growth, i.e., fee growth, or maybe you have a different view on asset quality and the ECL charges? I think this is the first part of the big question. The second part is on BoCom. May I know what triggered the $3 billion impairment charges? As China's yield is declining, like they just announced a 25 basis point cut on 5-year LPL cuts and all those. Should we be expecting more impairments on the BoCom investment? So basically, I want to see if there's any one-time events that trigger this impairment or if it is going to be a normalized part of the business. I believe this is related to the $14 billion capital deduction, which you have already made on associate. I think that is primarily BoCom. But can you explain a bit of that mechanism? Today's share price reaction is partly factoring in the kind of concern that if there is ongoing impairment on BoCom, that will affect the company's ability to deliver shareholder returns.

Noel Quinn, Group Chief Executive

Two excellent questions, and you're going to get two excellent answers from Georges.

Georges Elhedery, Chief Financial Officer

Thank you, Katherine. Taking them in the order you said, the first mid-teen RoTE is excluding notable items, therefore, it is excluding the gain on Canada. So your calculation is correct. In terms of NII and cost, there's a couple of things to share. We recognize the cost assessment. In terms of banking NII, we have given the guidance here. I mentioned in my earlier speech, but I just want to point out that our banking NII sensitivity has reduced by more than half from the full year 2022 due, among other parameters, to our structured lending activity. Therefore, the rate impact on our banking NII has reduced commensurately. Equally, we do have some anticipation of volume growth if and when rates start increasing, which is now planned for H2, and this is why we have some positive outlook for H2. If the rate decreases, volume could pick up, subject to economic conditions, etc. But that's the assessment we have made today. Regarding the non-rate sensitive earnings, I've called out transaction banking earlier. Between them, they constitute about 80% of our non-rate sensitive earnings. One has grown 5%, 23 to 22, and the other one has grown 7%. Therefore, we do feel there is momentum in both these areas for continued growth. I didn't talk about the residual 20%, but in the residue 20% capital market activities, for instance, are included. Again, in a different rate environment, we have grounds to believe this can also pick up. So yes, we are comfortable with the momentum we have in the revenue. Can I point you to one thing about cost? We called it out 5% for 2024 has a flow-through impact from inflation in 2023. 2023 experienced high inflation. There is some flow-through, some adjustments, including wage inflation, which we anticipate to see in 2024. Based on the current outlook of inflation, that parameter is easing as we look forward beyond 2024 without giving you any guidance for 2025. The inflationary component flow-through into 2025 does look like easing from where we stand today, looking at 2024's outlook for inflation. If I move on to your second question about BoCom, we talk about the value-in-use model. It's following Hong Kong accounting standards, international accounting standards. Without boring you with the accounting details, the ARNA has many pages that explain it. It feeds into parameters all in the public domain including macro data, other factors, including analyst comments, fed into the model. It is very difficult to predict what the model will give us in Q1. We'll take into account the information we receive over the course of Q1 and run the model as we do every quarter and consistently apply the outcome. Lastly, captive deduction. I think this is a very important point. Your math, Katherine is correct. There is about $14 billion sitting today in our regulatory capital deductions because they sit above our threshold. Therefore, you could legitimately assume that there is that much of a buffer against any impairments we may face in our financial holdings, BoCom being one of them. The other one is insurance. That's essentially the two. Therefore, you can legitimately assume that the compensation we have hypothesized in future impairments will be commensurate given the size of our threshold deductions at this stage.

Noel Quinn, Group Chief Executive

So he did give you two excellent answers. Thank you. Thanks, Georges. Next question, please?

Operator, Operator

Our next question comes from Joseph Dickerson at Jefferies.

Joseph Dickerson, Analyst

Can you hear me now? Sorry about that. Just cutting to the chase on some of the questions that have come through on the NII guide. I think you can probably get a sense that there's some reasonable confusion about what the message is for the 2024 baseline. If we work back from your kind of clean mid-teens ROE, you've given us some guidance on cost. You've also given us some guidance on credit. It's kind of getting into a baseline revenue number of about $64 billion in consensus, which is $63.5 billion or thereabouts. Are you comfortable with that consensus number? Are you seeking to change that with this guide? So that's question number one. Question number two is why the focus on banking NII versus total NII because it's going to be as rates come down a lot of moving parts on the trading book funding cost dynamic because, indeed, if I look at your annual report, you've actually got a benefit coming through in the USD bucket from rates falling in terms of the aggregate NII. So I guess why are you trying to distinguish between those two conceptually for us because, again, it's creating a fair amount of confusion with investors.

Noel Quinn, Group Chief Executive

Georges?

Georges Elhedery, Chief Financial Officer

Thank you Joe, yes, I recognize your arithmetics. Yes, I agree with your arithmetics. This being said, I cannot give you guidance on total revenue. Otherwise, I'll be giving you guidance on our full profitability. We recognize your arithmetics. A couple of things just to highlight for your consideration. The first one is our guidance for banking NII is not $41 billion; it's at least $41 billion, factoring in elements of uncertainty that I called out earlier. You have the building blocks for cost and for ECL, and the residual part, if you want, of our earnings story is the non-NII component, excluding the gains from Canada. As I said earlier, about 80% of it is generated from transaction banking and wealth, both of which do have momentum. Both of which are areas where we continue investing both in terms of digital capabilities and client servicing, as well as net new invested assets. We are excited about the potential of these two businesses, and we believe our meets RoTE is not based on unreasonable growth in these areas, but is based on momentum growth in these areas. I can point you to our net new invested assets, $84 billion for the year, up from $80 billion last year, and up from $64 billion the year before. Clearly, we're acquiring new assets. But equally, as you've seen, Asset Management and Private Banking grew double-digit percentage points. That's also partly due to valuation because our AUM is also increasing because the underlying valuation is improving, which is therefore a generator of fees commensurately, subject to market conditions as we go forward.

Noel Quinn, Group Chief Executive

I think if there are any more questions, maybe we get the IR team to just work with you after the call.

Georges Elhedery, Chief Financial Officer

Regarding your second point, we would like to provide guidance on banking net interest income (NII). Last year, we transitioned from solely focusing on NII to offering dual guidance that includes both NII and the funding cost of the trading book. We believe it's simpler to assess our overall rate-sensitive earnings through the lens of banking NII. The transition between these two aspects is essentially a zero-sum game. Therefore, changes between them represent our business choices about how much funding we allocate to the trading book, influenced by various factors such as trading opportunities and loan growth prospects. We feel that managing both separately would create unnecessary complexity.

Noel Quinn, Group Chief Executive

Thank you. Next question, please.

Operator, Operator

Our next question comes from Benjamin Toms at RBC.

Benjamin Toms, Analyst

Good morning, both. Thank you for taking my questions. Firstly, on cost of risk. In relation to your guidance of 40 basis points, is there still a plausible downside to this guidance? Or does the 40 basis points encapsulate that plausible downside? Then secondly, on loan growth, I know you're cautious on loan growth in the first half of 2024. Do you expect growth to pick up in the second half of 2024? Can you just confirm that you expect net growth in the balance sheet? It sounds like you do because you earlier described volumes and a potential tailwind to NII. Could you narrow down how much lending we should expect for growth for this year? Thank you.

Noel Quinn, Group Chief Executive

Thank you. Georges, do you want to take both of those?

Georges Elhedery, Chief Financial Officer

Thank you, Benjamin. Our cost of risk of 40 basis points reflects our current outlook on the balance sheet. We haven't indicated any further potential downside on the China commercial real estate portfolio in Hong Kong because we believe we are sufficiently provisioned for this portfolio after last year's provisioning. Additionally, we feel less concern about our residual exposure in that portfolio, which is now at $6.2 billion, a reduction of $3.1 billion from full year 2022. Therefore, our levels of concern have diminished. I can explain our ECL positioning in this portfolio further if needed, but we are comfortable and have no new concerns beyond what we noted last year. Regarding loan growth, we expect that as the economy improves and the interest rate environment becomes more favorable, loan growth should follow. We continue to project a medium-term mid-single-digit percentage point growth in both loans and the balance sheet. It's challenging to predict the second half of the year, but that forms part of our outlook.

Noel Quinn, Group Chief Executive

I think our view is, given the shift in the interest rate cycle and the shift in inflation, we'll start to see more economic confidence or business confidence and consumer confidence in the second half. We're not expecting significant growth in the balance sheet in the first half. If you start to see that kicking in the second half, you're unlikely to see full year mid-single-digit growth in 2024. You're going to see a proportion of that starting to kick in the second half of the year, and then you'll see it kicking in more strongly in 2025 and beyond. So I think in your modeling, you're probably looking at limited growth in the first half, with growth starting to come back in the second half.

Benjamin Toms, Analyst

Thank you.

Noel Quinn, Group Chief Executive

Thank you.

Operator, Operator

Our next question comes from Robert Noble at Deutsche.

Robert Noble, Analyst

Can you hear me?

Noel Quinn, Group Chief Executive

Yes.

Robert Noble, Analyst

Thanks for taking my questions. What was the size of the hedge last year? So how much is it that ramped up this year? And can you give us an idea of what the currency mix of the hedge is and whether there's any duration differences between those currencies as well? Secondly, what exactly is in the quarter, the cash flow hedge reclassification, the impact it had from transferring from NII to non-NII? Lastly, the timing of the special dividend of the Canada sale; will it come with Q1 results if the deal is announced prior to release? Or is it not linked to the results?

Noel Quinn, Group Chief Executive

Okay, Georges?

Georges Elhedery, Chief Financial Officer

Thanks, Noel. Robert, we've added about $80 billion, or north of $80 billion to our hedge this year in terms of bond notional, a little bit more in terms of other derivative notional. That's on top of $80 billion we've added over Q4 and starting in Q3 in 2022. That should give you an idea of what is the quantum we could reasonably do in 2024 if the market conditions remain supportive for the hedge. In terms of duration, the obvious one to call out is we can certainly hedge on our weighted average life for slightly longer currencies such as the pound, the U.S. dollar, and to some extent, the euro. We have an inability to hedge in any reasonable size or shape, primarily due to structural market conditions regarding our Hong Kong dollar exposure. Thus, our Hong Kong dollar exposure hedge would remain much lower, making our exposure in Hong Kong dollar more sensitive to the rate outlook compared to the other currencies. In terms of the Canada sale, you could expect in Q1, subject to completion, which is now planned to be on track to be by the end of Q1. We expect to see a jump of 1.2% to 1.3% in our CET1 ratio. The special dividend, which we're committed to consider, would happen afterwards. Our best estimate is H1, but frankly, afterwards, as soon as we can, subject to all necessary approvals. That will drop the CET1 by about 0.5, resulting in a net of around 0.8 in our CET1 after the dividend. We'll update you at the Q1 results about the special dividend considerations.

Noel Quinn, Group Chief Executive

Yes, it's probably not possible to close at the end of March and declare in the same quarter just for accounting reasons. So it's likely to be closed at the end of Q1 and probably declare Q2 and then pay following that. That's the likely accounting requirement just to get the books closed for Q1 and then declare Q2; it's the most likely outcome.

Robert Noble, Analyst

Sorry, declare in Q2, not with Q2 results?

Noel Quinn, Group Chief Executive

Probably with Q2 results.

Robert Noble, Analyst

Right. So pay in Q3?

Georges Elhedery, Chief Financial Officer

It's our intent to do it as soon as we can. I can take you through the process, but there is a process we have to go through, and the timelines will need to flow through. We will confirm the timing at the 1Q results.

Robert Noble, Analyst

Alright. That was just one little question of what the cash flow had customers in the quarter.

Georges Elhedery, Chief Financial Officer

The reclassification pertains to an issue in our reporting linked to a specific geography where some cash flow hedges were incorrectly recorded between net interest income and non-net interest income. We have corrected this, and it impacts one jurisdiction only. The adjustment reflects a full year's amount, with the $0.3 billion charge accounting for the full-year correction, of which approximately one-fourth is associated with the fourth quarter, while the remainder serves as a catch-up for the first three quarters of the year.

Robert Noble, Analyst

Alright, thanks very much.

Georges Elhedery, Chief Financial Officer

Sorry, just to be clear, Robert, the total income is not affected. This is just a reclassification of income from one line item to another line item.

Noel Quinn, Group Chief Executive

Thank you. Next question, please.

Operator, Operator

Alastair?

Alastair Warr, Analyst

Alastair Warr from Autonomous. Just a quick question on the ECL charges and things have subsided a bit on the China property side. Obviously, it's nice for you guys to see, but a few cracks popping up in Mexico. Is that something you characterize as the cycle stuff that might be going somewhere from here, or is it something a little more one-off?

Georges Elhedery, Chief Financial Officer

Thank you, Alastair. The Mexico ECL is related to an increase in our activity, specifically in unsecured lending. It's a feature of that jurisdiction where margins are very healthy, but the ECL coverage or charge tends to be a bit higher. It will depend on our activity, but we expect to run at slightly higher activity in unsecured lending among others in Mexico than we were before. I wouldn't look at it as a one-off, but obviously, it will depend on the cycle.

Noel Quinn, Group Chief Executive

But it's a function of doing business and growing the business, as opposed to a function of a historical problem materializing. Next question, please.

Operator, Operator

Our next question comes from Perlie Mong at KBW.

Perlie Mong, Analyst

Thank you for taking my questions. I have a couple. Firstly, what can you do with costs in a falling rate environment? You've mentioned management actions. The reason for my inquiry is that this year, the overall cost is about 7% year-on-year. This figure includes several one-off items like levies this quarter and the situation with SVB earlier in the year. I'm noting that it has risen from around 2% year-on-year, which we discussed when addressing the 2023 guidance, to a final result of approximately 6% to 7%. What measures do you have to manage costs effectively if revenues were to fall short? My second question relates to the anticipated impact on revenues in different rate environments. I appreciate the information you provided regarding the structural hedge. Looking at the broader picture, could you clarify how you expect customer behavior to react in a falling rate environment? Specifically, regarding the shift in deposit mix, as seen in Hong Kong, where the transition to term deposits happened rapidly compared to the U.K. on the way up, and it is still progressing based on today's disclosures. If rates were to change, would you anticipate that adjustment to happen quickly? In a high-rate environment, would you expect the mix to persist? You mentioned that capital markets may perform well in a falling rate environment. Can you elaborate on that in the context of capital markets and loan growth? This also ties into underlying GDP, and there's still significant uncertainty ahead. Even if rates decrease, how soon do you think we can see the benefits materialize?

Noel Quinn, Group Chief Executive

Okay. We'll tackle the cost first and then maybe we come to the revenue second, and I'll do a few introductory comments on how I see revenues. Regarding costs, Georges, do you want to quickly analyze reported costs from 2023 versus 2022 on a target basis and then reported 2023 to 2024 target basis? I might just add a few comments at the end of that on cost levers the way I look at it. But Georges?

Georges Elhedery, Chief Financial Officer

Good. Yes. Thanks. On a reported basis, 2023 to 2022, we were down 1%. The growth against our target of 6% also reflects that a lot of the restructuring costs we've taken in 2022 did not repeat. We've guided how the costs have increased from our initial 3%, where we included severance, into the 6%. Obviously, the last percent this quarter was unexpected. The rules for the FDIC special assessment came in November. The earlier draft rules we had seen in September indicated we would incur that cost in 2024 and 2025. However, the rules that came in November had us to have a different accounting treatment and accelerate all that as did all other banks subject to the FDIC special assessment. So I want to call it out that this one was a particular event we also called out. Looking forward into 2024, we're looking at 5% on a target basis growth. This excludes the cost reduction we would see from exiting the French retail business and the Canada business. Between the two of them, we will be exiting on an annual basis an equivalent of $1 billion, just shy of that, which is around 3%. That would be a reduction of cost of 3% but is excluded from the way we're managing our target basis. Just explaining how we're coming up with this cost, and then Noel can talk you through the levers to manage our cost. So first, we have this flow-through inflation from 2023. There is some wage adjustments we need to take into account for 2024 based on the flow-through inflation from 2023. That component, we feel, is easing, and the outlook of inflation will ease as we go out of 2024 into the future. There is continued spend in technology and continued investment in some of the growth areas, organic growth areas. That's particularly true in wealth, and those spending are partly offset by a number of cost management actions, some of which we have taken already, such as the severance program, which will have a flow-through benefit into 2024, and other actions we're planning to take. Just before Noel talks to levers, we're looking at cost growth on a target basis in dollar numbers. We're not looking at our cost efficiency ratio basis. There may be fluctuation in our revenue, but frankly, in a year like 2023, our CER has dropped from 65% in 2022 to 48%. So we will tolerate some volatility on the CER as long as we're managing our cost in a spend dollar basis.

Noel Quinn, Group Chief Executive

Thank you, Georges. This is an important topic, and I want to emphasize that we are dedicated to maintaining cost discipline. The key question is how we are achieving this. We focus on finding efficiencies within our existing organization, investing in technology to improve processing costs, and continuing to pursue these initiatives. We are simplifying our portfolio, closing down businesses, and reducing costs organically. Additionally, we are also cutting costs through mergers and acquisitions. While we account for that in our target metrics, it's important to note that we will be exiting $1 billion in costs in 2024 due to M&A decisions that are strategically sound. Of that amount, $300 million comes from divesting our French retail business, which was unprofitable. We've eliminated those costs through the sale, and it will enhance our profitability since that business was not performing well. We’ve also reduced $800 million in costs in Canada through sales, and we aim to complete this by the end of Q1, without tempting fate. The rationale behind these actions is that the business in our hands was valued at around 1 times book, but we managed to achieve over 2.5 times book in the sale. We sold it as it was more valuable to another party. We're redistributing the proceeds back to our shareholders, believing that this decision is in their best interest. We are pursuing both internally and externally generated cost efficiencies for strong strategic reasons and will continue leveraging these approaches. Given our organization's growth opportunities, we should invest. Last year, we decided to increase costs from 4% to 5% by enhancing the variable pay pool by an extra percent, which we deemed appropriate for our employees. We believe this is a sound cost decision. We must acknowledge the impact of inflation. The additional 1% that raises us to the 6% figure you mentioned was unexpected. When we last spoke in Q3, we did not anticipate this final 1% related to FDIC and bank levies. This issue with the FDIC seems to be a timing matter; it was expected in 2024 or 2025 but unexpectedly materialized in the final quarter of the year. You have our assurance that we will remain vigilant regarding high costs. Now, regarding revenues, let me explain our outlook for revenue growth outside of net interest income or interest revenue. The impressive efforts by Georges and the team in hedging and establishing additional structural hedges will help mitigate potential downsides. I see two main components to our upside opportunities. First, our core unique selling proposition in International Banking. Within our franchise, we have clients operating in more countries than we currently service, whether they are personal or corporate clients. There remains a significant untapped potential to deepen our engagement with our client base. Each time we acquire a client in multiple jurisdictions, we see a revenue multiplier of five times in Wholesale Banking and three times in retail banking, representing an internally generated revenue opportunity that does not rely on GDP; it’s within our control. The second revenue opportunity you've highlighted is countercyclical. Having been in the industry for 37 years, I have witnessed various cycles. Typically, lower inflation results in lower interest rates, which then stimulates economic activity with some delay. I believe this uptick will positively affect capital market activities in our Global Banking and Markets division. It should also boost demand for corporate and personal lending in our wholesale and retail sectors, albeit with a delay. Consumers are likely to shift from cash to invested assets, presenting a substantial opportunity for our wealth management business. Our track record in attracting net new invested assets over the past three years has been impressive: $84 billion, $80 billion, $64 billion. Our management team is committed to delivering on this front. We understand the necessity of maintaining strict cost control and enhancing revenue diversification. In closing, I appreciate that we’ve undergone four years of transformation, which has brought us to a point where we can now focus on growth opportunities. The hard work from the last four years has provided us with a solid foundation for future growth. Thank you.

Operator, Operator

So we have time for one last question, and then I'll hand it back to you, Noel, if you want to make any concluding remarks. Our final question comes from Aman Rakkar at Barclays.

Aman Rakkar, Analyst

Thank you very much. Hi, Noel, hi Georges. I have two broad questions. The first one is kind of split into two. I’ve got a second question around GB&M and capital return. First broad question is around fee income. The first part of it is, I'm a bit confused by your banking NII sensitivity. You can see on Slide 34, $3.4 billion on 100 basis points rate cap. The majority of that comes from non-NII. So can you help me there because I just don't understand that? I thought banking NII stripped out the trading funding cost. Whatever color you can give us there? The related question is that your outlook for fee income more broadly; I get your messaging around wealth. Transaction banking is kind of demonstrating positive momentum. But can I ask you about the other big chunk of fee income, which is GB&M. There are various moving parts there. I suspect that you think cyclically, it's not earning its full amount. But I also note that Global FX has kind of been decent for a while. So can you give us your view on to what extent that business is operating at, below or ahead of capacity? That was a broad two-pronged question on fee income, believe it or not. The second question was around your distribution, your approach to distribution that you're potentially phasing down the barrel of slower volume growth in 2024. I'm interested in that you're arguably going to be more capital generative this year on still decent profits and not a lot of balance sheet growth. How do you approach that? Do you kind of give us additional buybacks through the course of this year? Or do you kind of hold that powder dry for a bigger rebound in 2025, say? Thank you very much.

Noel Quinn, Group Chief Executive

Okay, I think Georges can pick off those two points?

Georges Elhedery, Chief Financial Officer

Sure. Aman, so what historically we've been giving you is NII sensitivity, but there's a significant component that is rate-sensitive in our earnings, which doesn't sit in NII. It sits in non-NII under funding cost of the trading book. What we've been doing, and hopefully that slide was meant to clarify it, but I assume now we have to do more offline with you to go through it. What we've been doing is showing the sensitivity of both the NII to rates, as well as the sensitivity of the funding cost of trading book to rate; that gives a full representation of how sensitive our earnings are to rate and takes away the noise created by ongoing commercial decisions on how much funds we provide the trading activity or take away from the trading activity in year. It kind of cleanses that information out because it's just giving you the total that is relevant for our overall earnings. That sensitivity has reduced by more than half over the year, partly due to our structural hedging activity. On fee income, regarding GB&M, a couple of points to call out: First, the PBT of GB&M was more than 20% or 25% higher year-on-year, clearly indicating the business that is increasing its PBT. Its return on tangible equity has exceeded our cost of capital, reaching above 12%. To be fair to GB&M, its return on tangible equity only increased by about 10% because there are some corporate center-related adjustments, which have affected them. Otherwise, the return on tangible equity could have followed the trend of PBT growth. Thus, they could have seen close to 20%. Therefore, we are comfortable with how the business is continuing to transform itself, focusing on strengths and adjusting their footprint; that momentum continues. In terms of distribution, it remains our ambition to have a rolling series of share buybacks as long as our capital supports it, and the outlook for capital does support it. However, it remains subject to ongoing macroeconomic developments and regulatory approvals, etc. One thing to consider regarding our bolt-on acquisitions is that when we look at an acquisition, the first parameter is making sure it's strategically beneficial for our desired growth. The second parameter is to ensure it is more accretive compared to a share buyback. Thus, we are doing M&A that is both strategic and accretive. In terms of other parts of distribution, we have a 50% dividend payout ratio for 2024, which we reaffirmed. If you want to give a benchmark on where we would operate on a target basis, our CET1 ratio will be in the 14 to 14.5 range, which we reiterate, but we recognize we may not meet that target as we may be well above it for a few quarters, particularly thanks to Canada and our own capital generation.

Noel Quinn, Group Chief Executive

So if it is reasonable to expect that, it is reasonable to target year-on-year growth in GB&M, and the fee income businesses in GB&M are in those various moving parts as we think about growth.

Georges Elhedery, Chief Financial Officer

Yes, in the strategic area, certainly. The areas we've called out are foreign exchange, payments, and support for trade. We expect also growth. As Noel mentioned earlier, in capital market activity, if and when rates come down, we see progress in this area of the fee income space. Clearly, GB&M has focused itself, and the message is that in the areas where they're focusing strategically, yes. In the areas they've exited or are downsizing, these would be non-strategic areas that will continue to experience downsizing.

Aman Rakkar, Analyst

Okay, thanks so much.

Noel Quinn, Group Chief Executive

Listen, I just wanted to say thank you all for joining. I also want to say I'm really pleased that we've had a record profit year in 2023, with the best returns we’ve had in a decade. I'm happy we were able to reward our loyal shareholders with $19 billion of capital returns to our shareholders in respect to 2023. This included the best full-year dividend since 2008 and three share buybacks. We still expect to have substantial distribution capacity going forward. We are committed to cost discipline. I want you in no doubt on that. We expect to have further opportunities to grow revenue, and we’re very focused on it because we’ve come out of that four-year transformation phase with a very strong focus on growth. We continue to target a mid-teens RoTE in 2024. Thank you all for joining us. Neil and the team are available should you need them. I hope to see many of you here in Hong Kong in April when we hold our inaugural Global Investment Summit. Looking forward to being back here at the end of March and for the Investment Summit in early April. Thank you all very much.

Georges Elhedery, Chief Financial Officer

Thank you for coming.

Operator, Operator

Thank you, ladies and gentlemen. You may now disconnect the call.