HSBC

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

HSBC is one of the world’s largest banking and financial services organizations, aiming to be the preferred international financial partner for its clients.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

HSBC operates across a broad range of banking and financial services, primarily organized into three global businesses: Wealth and Personal Banking (WPB), Commercial Banking (CMB), and Global Banking and Markets (GBM). They also have a corporate center which includes centralized treasury, stewardship costs and consolidation adjustments.

  • Wealth and Personal Banking (WPB): This division focuses on providing financial solutions to retail customers and high net worth individuals, including day-to-day banking, investment, and insurance services.

A key component of this business is relationship management, as well as digital services for ease of access. WPB aims to provide a suite of products and services that are both simple and convenient while leveraging its global connections.

  • Commercial Banking (CMB): CMB provides a range of financial products and services to businesses, from SMEs to large companies, including lending, trade finance, and cash management. Their focus is on international connectivity and industry-leading expertise to provide financial solutions for their customers.
  • Global Banking and Markets (GBM): This segment caters to multinational corporations, financial institutions, and institutional clients, and encompasses a spectrum of financial and capital market products. This includes investment banking, proprietary trading, and fixed income and equity trading.

GBM is characterized by a significant concentration in Asia, particularly in Hong Kong, but also includes strategic partnerships in the UK and Europe. They are the primary facilitators of trade and finance flows across the global economy.

Revenue Distribution: While WPB and CMB generate significant revenue, GBM operations tend to have a higher exposure to market volatility and have been impacted more by the current interest rate environment than other segments. The most recent annual report shows that Wealth and Personal Banking and Commercial Banking have been strong contributors to operating profit, and the bank seeks to further increase profitability in these businesses by shifting capital allocation to areas of greater return.

  • Net interest income is a key driver of profits for banks, and most notably for CMB. WPB contributes less to NII than Commercial Banking.
  • Non-interest income is an important component of profit, coming mainly from fees and commissions derived from various financial operations. Wealth and Personal Banking has the most reliance on fee and commission based income, with GBM providing significant contributions as well.

Industry Trends:

  • Digitalization: The banking industry is rapidly evolving with the rise of digital technologies and the increasing prevalence of online banking, mobile payment systems, and AI-powered financial advice. Companies are having to invest to improve the tech stack of their existing and new products.
  • Sustainability: There is an increased focus on sustainable investments and environmentally friendly operations, with banks facing pressure from stakeholders to play a role in ESG initiatives.
  • Economic Slowdown: The global economy has been impacted by high inflation, geopolitical instability and the rising interest rates, that is negatively affecting business revenues.

Competitive Landscape

  • HSBC, being one of the largest global banks faces competition across all its business units from multiple competitors. They face competitors in every market segment they operate in, including local players in each market.
  • In Wealth and Personal banking, they face competition from local retail banks, online brokers, financial advisors, and insurance companies, making this a very competitive landscape.
  • In Commercial Banking they compete against a host of other global banks, regional banks and other financial service providers, with focus on industry and customer-level specializations.
  • GBM faces competition from other global banks with strong investment banking and trading activities. The industry is also seeing new fintech competitors that use technology to bring increased efficiencies and lower costs.
  • Intangibles A key source of competitive advantage for banks is their regulatory approvals, network of branches and proprietary data. Having access to these resources creates strong barriers to entry for potential competitors.

What Makes HSBC Different?

  • Global Network: HSBC’s extensive international network, especially its long presence in Asian and Middle Eastern markets, is a significant differentiator from other large banks.
  • Strategic Focus: While the group is focused on building long-term relationships with its stakeholders, it has taken steps in recent years to simplify the group and focus investments on the most attractive geographies.

Financials Analysis

The following commentary is mainly based on the 2023 Full Year Financial Results that were published February 21, 2024 and other publicly available information.

Income Statement

  • Net Interest Income (NII): NII increased substantially year-on-year due to higher interest rates that have affected the global economy, but is expected to decrease going forward.
  • Net Fee Income: There were reductions in net fee income from wealth management, but increases in other areas.
  • Credit Impairments: There was a significant impairment charge in the fourth quarter of 2023, mainly due to the sale of its French retail operations and provisions for commercial real estate.
  • Operating Expenses: They increased in 2023, and is projected to stay elevated going forward.
  • Profit Before Tax (PBT): Profit before tax increased substantially for 2023 due to the previously mentioned effects in Net Interest Income and other items, and the absence of 2022’s $10bn loss.
  • Profit after tax: Profit after tax rose to $21.3 billion, an extremely positive outcome for the year.

Balance Sheet:

  • Strong Liquidity: There is ample liquidity and well-managed funding profiles, that enables the company to manage its operational and financial risks.
  • Conservative Capital: They have strong capital ratios, which are above regulatory requirements. The Common Equity Tier 1 ratio was 14.2%.
  • Risk Weighted Assets (RWA): There was a large increase in Risk Weighted Assets in 2023 because of an increase in credit risk, market risk, and operational risk.

Moat Analysis

Moat Rating: 2 / 5 - Narrow Moat.

  • Intangible Assets (Brand): HSBC has a strong brand, particularly in Asia and the Middle East, but that has not translated into a huge pricing power in all markets that it operates. Their brand may be less of a moat in developed economies.
  • Switching Costs: The business banking and brokerage business have a moderate level of switching costs. Large corporates often get entrenched and will keep their bank if the service is solid.

The switching costs in wealth and retail banking, however, is low, with very little stickiness. It is easy to move from one bank to another for consumers, making the retail banking space difficult to have a moat.

  • Network Effect: Although HSBC has a global network, it’s not clear that the scale creates a network effect beyond a regional or local level. There is no indication of any direct or indirect network effects.
  • Cost Advantages: While a large scale operator, and thus has some cost advantages from economies of scale, they are not generally the lowest cost operators across all their segments due to the way they have to do their operations in many different countries under various regulatory requirements.

While HSBC has certain competitive advantages rooted in scale and established global operations, their overall moat is considered to be narrow because of a lack of structural advantages like strong network effects or long lasting tangible advantages and high switching costs.

Risks to the Moat and Business Resilience

It is very important to consider the different risks that can harm a company’s long term business and moat. Here are some of the main risks that may face HSBC:

  • Economic and Geopolitical Risks:
    • The global economy is volatile and sensitive to interest rate increases and economic downturns. This affects the general profitability of banks like HSBC, that are exposed to a variety of credit and market risks
    • Geopolitical events such as conflicts, sanctions, and changes in trade policy, can all have an adverse effect on revenue for the bank in respective regions.
  • Regulatory Changes: * The banking industry is highly regulated, and frequent changes in regulations may increase compliance costs and impact a bank’s business model. It is difficult to determine these risks and assess their long term impact.
  • Credit and Counterparty Risks
    • As a financial institution with heavy exposure to credit and debt markets, they have to contend with the likelihood of credit impairments from counterparty risks, sovereign defaults and from changes in the economic outlook.
  • Technology and Cybersecurity Risks:
    • Banks face increasing cybersecurity threats, due to the heavy reliance on digital technologies, which can affect operations and damage reputation. This is a significant concern for banks as a large scale breach could lead to severe consequences.
  • Erosion of Moat:
    • Their global brand and network, are facing more competition and a greater need for operational expenses to maintain it. It has become easier for smaller banks to create local network of branches, as well as, online-only banking.
  • Other risks:
    • Financial crime, model, and operational risks can cause large losses.

Business Resilience: Despite these risks, HSBC has a few factors working for it in terms of business resilience:

  • Strong Global Presence: It is diversified across multiple geographic regions and business sectors, which reduces the impact of any one issue.
  • Established Brand: It has brand recognition, particularly in Asia and the Middle East, that has helped it garner high net-worth individuals and companies as customers.
  • Effective Management: They are actively looking to improve areas of the company where they are not making optimum profits to improve shareholder returns.

Understandability Rating

Understandability Rating: 3 / 5.

  • HSBC’s operations are diverse and span across various geographical regions and business segments, making it moderately difficult to understand their core business model and key drivers of profitability.
  • While there are aspects that are relatively easy to grasp, some parts of it, specifically, operations in developing countries, as well as the numerous products they offer, can be confusing.
  • Although their annual report, financial statements and earnings calls provide a good deal of information, these are still rather difficult to fully absorb and make accurate conclusions.

Balance Sheet Health Rating

Balance Sheet Health Rating: 4 / 5.

  • HSBC has a strong capital structure with its key ratios well above regulatory minimums.
  • They have a huge cash reserve and an efficient system for deploying it.
  • While their Debt-to-equity ratio is on the higher side, their leverage is mostly due to their balance sheet being comprised of loans and deposits.
  • Overall, the company is well-capitalized and well-structured.

Additional Commentary

  • HSBC is currently undergoing a major transformation plan and wants to exit unprofitable regions of the business and focus more on Asia.

However, this plan comes at a cost, as has been observed in the most recent financial results, where they wrote off their French operations for a large loss. They also mentioned that there may be further restructuring charges going forward.

  • Also, the bank plans to aggressively grow in new businesses that may be more volatile, such as wealth and asset management.
  • The increasing trade tensions between China and the US, have a negative effect on the bank because of their operations in Asia, particularly in Hong Kong and mainland China. They have to navigate the increasing political instability, and any negative implications that this may cause.
  • Also, the increasing regulations that is being developed across the world for banks is a risk that needs to be watched carefully and the company’s risk management practices have to be implemented adequately.

Conclusion

HSBC is a very large international bank with a presence in multiple regions. They benefit from an established brand, a vast network of branches, and a long history. While it is very profitable, it has been facing headwinds from the current interest rate environment. There is also a lot of restructuring going on, that may cause their short-term profitability to fluctuate. For the long-term, while their moat isn’t strong, it should be able to generate profits for many years, with a strong brand and a global presence and is thus suitable for a long term, though not a particularly “compounding” investment.