Suddenly, HSBC group chairman Stephen Green and Michael Geoghegan, chief executive, can do no right. Since a rapid credit deterioration emerged last December in US mortgages that the bank acquired in 2006, analysts have been picking apart the group’s strategy of the past five years, investors have been attacking the way the bank is run, and the valuation and stock price have fallen.
Is all this starting to smack of an over-reaction?
“HSBC walking blindfold in a mine field” was the title of the note Keefe, Bruyette & Woods put out last December to underline its concerns about losses on US mortgages originated just six months earlier. The markets quickly became gripped by the worry that the losses had revealed the 2002 acquisition of sub-prime lender Household to have been a colossal mistake, along with HSBC’s strategy of taking Household’s supposedly cutting-edge credit modelling and deploying it across the bank’s consumer finance businesses in emerging markets.
What if the models were fatally flawed?
In fact, the most surprising thing about the bank’s US mortgage woes is that investors were surprised by them. HSBC acquired these mortgages rapidly in the robust markets of 2005 and the first half of 2006 from a nationwide network of unaffiliated lenders. It seems likely that customers and perhaps staff at the originators were tempted to inflate the stated earnings of mortgage applicants to secure bigger loans that they expected to service partly out of rising home prices. When house prices faltered last year, the game was quickly up for many of these borrowers. It’s the kind of dubious behaviour that stretched and turning markets always reveal. HSBC simply suffered the first dire consequence of the weakening US housing market. Other banks might yet suffer similar setbacks on mortgages and unsecured consumer lending.
In January, a new strain entered the criticism of HSBC. Its revenues are likely to slow now that it is reining in lending in response to these credit losses. Maybe so, though Euromoney’s view has always been that when you realize that you are digging yourself into a hole, laying down the shovel is rather a good idea.
The loan book suffering from impairment is small – $20 billion of second-lien and revolving-line mortgages – and the losses are easy for HSBC to absorb. The difficulty for Green and Geoghegan is that this specific problem has revealed a more general and widespread dissatisfaction with the bank and some of the strategic steps it took under Green’s predecessor, the ironically still highly regarded John Bond.
HSBC used to offer a large dose of stability and conservatism spiced up by an exciting dash of emerging markets growth. Now, since the Household acquisition, which rebalanced its exposures away from the emerging markets towards the developed world, it offers precisely the reverse. Household’s business has shown itself to be highly volatile and uncertain, and the bank has provided less benefit from the spectacular performance of emerging markets in the past five years than, for example, Standard Chartered.
Analysts at Merrill Lynch compared HSBC shares with a portfolio made up of stocks in Royal Bank of Scotland, with its developed world exposure, and Standard Chartered. They found that recently RBS and Standard Chartered have outperformed. HSBC, for now, is suffering from a classic conglomerate discount. This is a stunning reverse from the days when its mix of Scottish conservatism and Asian growth meant that its shares traded at a premium. And while Green and Geoghegan will no doubt manage their way through the recent US problems, addressing that discount will be a much tougher and longer-lasting challenge.
