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OPINION

Stevenson defends his legacy at HSBC

HSBC’s outgoing CFO, Ewen Stevenson, has mounted a robust case for the bank’s cost performance in an intriguing call with analysts that also featured an appearance by his replacement, Georges Elhedery. As he prepares to leave the bank, Stevenson defended his legacy by taking on the firm’s arch-critic, Ping An.

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Nearly two weeks after HSBC announced the departure of chief financial officer Ewen Stevenson alongside its third-quarter earnings on October 25, it held a second, less-noticed call with analysts.

It is something some banks do to give analysts an opportunity to dig into more detail after the dust has settled on the conventional earnings call – and with a bigger roster of finance staff on hand to tackle the questions.

But for HSBC-watchers, the November 4 call was of more interest than usual since it not only marked the final time Stevenson would be chairing it before he leaves on January 1, but his designated replacement, global banking and markets (GBM) co-head Georges Elhedery, was also sitting in, which raised the prospect of a glimpse of how he might look at the role.

My colleague Chris Wright has written about Stevenson’s departure, and there has been speculation in the market about what lay behind the move. In the bank’s formal earnings call, chief executive Noel Quinn described the changes explicitly as succession planning. Announcing that Elhedery would take over, and that Greg Guyett would take sole leadership of GBM, Quinn added: “Ewen will therefore step down as group CFO”.

That doesn’t exactly scream willingness – it certainly sounds different to, say, UBS announcing this month that chief risk officer Christian Bluhm was quitting to embrace his love of photography. That said, it is also a world away from going to bed worth zero and waking up to find that the world had finally realised it, like Sam Bankman-Fried.

Of course, Quinn went on to thank Stevenson profusely, but credited him with so much transformation and reshaping and innovation and disciplined cost management that it seemed remarkable that he could bear to be separated from him at all.

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Ewen Stevenson

Some talk has also centred on the involvement of Ping An, HSBC’s largest shareholder and an agitator for more aggressive cost-cutting at the bank and a separation of its UK and Asian businesses. Did Ping An also agitate for a change of CFO?

If it did, it might now be disappointed with the fact that Elhedery will still be based in London rather than Hong Kong.

The likeliest-sounding theory doing the rounds is that Stevenson wanted very much to stay at HSBC but wanted Quinn’s job sooner than Quinn was prepared to give it up. When he pitched the promotion of Elhedery as succession planning, Quinn also made it clear he had no plans to quit any time soon.

Stevenson is credited with having been instrumental in helping HSBC deliver the cost discipline that it has seen so far, to the extent that analysts wanted reassurance from Quinn on the earnings call that Stevenson's leaving didn’t mean that the bank was changing its commitment to cost reductions.

“I can respond to that very categorically: there will be no easing at all in our cost discipline,” said Quinn.

And in the November 4 call, Stevenson again addressed the issue. Given that he’s leaving, you would assume he is going to be less worried about how costs work out in 2023 and beyond than he would have been a few months ago. But the way he tells it, he wants to ensure his legacy is safe.

He and Elhedery have been through the 2023 plans “in some detail over the last few weeks”, he said, and are “totally aligned” on what is required to deliver the 2% cost growth target for the year. And there were other happy-family references too to “the underlying philosophy that Georges and I and Noel have talked about”.

Hitting targets

But on to the numbers. Adjusting for currency movements and all sorts of non-operating items like restructuring costs and the planned disposal of its French retail business, HSBC announced year-to-date revenue up 11%, costs up 1%, but pre-tax profit up just 1% as provisions swung from a release of $1.2 billion to a charge of $2.2 billion. Strip those out, however, and profit growth was a rather healthier 22%.

Right now, the focus on costs in the year ahead is a big deal for HSBC, and hitting its targets is not going to be easy. No wonder that Stevenson had identified costs as one of the three areas that he had concluded needed more discussion on the call, alongside the other perennials such as net interest income and China real estate exposure.

Stevenson said that the bank had been hard at work ever since the earnings call in finding ways to deliver the bank’s 2% cost growth target for 2023 despite inflationary pressures and the fact that HSBC’s cost base, at $30 billion, is “a bit of a super-tanker”.

Exclude the $1 billion cost savings that the bank is projecting for the full year 2022, and underlying costs are rising at well above the target, giving a sense of just how much there is to do

It also doesn’t help that about half that figure is fixed pay, very much tied to inflationary trends. In 2021, fixed pay rose 1.6%. So far this year it is up 3.6%. Next year, that could be a couple of percentage points higher, said Stevenson.

Despite all that, he said that confidence in delivering the target was growing all the time, and that “we are down to a gap of less than 1% in terms of delivery against that number”. But it’s still going to be an almighty challenge, as Stevenson readily acknowledges.

The problem the bank has is that inflationary trends are, obviously, well above 2% around the world. Everything is being picked through to maximise what Stevenson calls “the efficiency of the spending”. Practically no part of the bank is being spared.

Exclude the $1 billion cost savings that the bank is projecting for the full year 2022, and underlying costs are rising at well above the target, giving a sense of just how much there is to do.

“Underlying cost growth at the moment is materially higher than 5% for 2023 … which would imply that the cost savings we need to deliver are materially higher than the $1 billion that we’ve talked about so far,” said Stevenson. “It’s that incremental set of cost actions that we’re continuing to work through.”

Good works

Let’s see what they end up achieving, but in the meantime a somewhat mischievous Manus Costello at Autonomous invited Elhedery to say if he agreed with Ping An’s view that HSBC should be much more aggressive with costs, as well as noting that GBM’s cost-to-income ratio and return on risk-weighted assets had improved in the time that Elhedery had been running it alongside Guyett since early 2020.

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Georges Elhedery

On a pre-tax profit basis, adjusted for non-operating items but not for currency moves, GBM’s return on average RWAs was 1.8% in 2019, 2.1% in 2021 and 2.5% in the first nine-months of 2022.

Reported GBM RWAs have now fallen about 13% since the end of 2019 after the bank cut the scope of its operations and client footprint, and put in place an RWA optimization unit to help make balance-sheet use more efficient.

Elhedery kindly left the Ping An question for Stevenson to tackle, but he was more than happy to talk about all the good work done in the investment bank. Yes, there had been a transformation on RWAs and costs since February 2020. And it had been achieved by withdrawing from unattractive and RWA-dense businesses such as long-term derivatives while also stopping serving customers who had only domestic needs where HSBC was less interested, like in the Americas or continental Europe.

He said that the division’s approach to costs had been focused on “driving efficiencies across all sorts of areas … starting all the way from the management structure, to how we execute programmes at the detailed end of the programme”.

In other words, nothing avoids scrutiny – and the bank can expect the same approach in the year ahead.

Driving returns

That was it for Elhedery, happy to leave the floor to Stevenson and delay for a while longer the moment when he needs to give analysts real insight into how he will approach the role. And as for Ping An, Stevenson kicked off with a somewhat disarming note: “We broadly agree with them. If you go back in time, the organization hasn’t been particularly cost efficient.”

But there the civilities ended.

“We fundamentally disagree with them on the extent of productivity improvement that can be driven from here,” he said. Moreover, Ping An’s criticism was dated, said Stevenson. In 2018 (Stevenson joined late in that year), costs grew 5.5%. If the bank hits its target of keeping costs flat this year, it will have done so for four years.

“Very few organizations of our size have come anything close to that,” he said, and noted that the bank’s commitment to no more than 2% cost growth in 2023 “is several percentage points of cost efficiency ahead of where most of our peers are”.

It seems bewildering while in the midst of an inflationary crisis, but already analysts are looking forward to possible cuts in interest rates in late 2023

That would drive returns; Stevenson was confident that return on tangible equity would be above 12% in 2023, compared with the 8.4% the bank earned in 2019, the last time it was able to enjoy a positive interest rate environment.

And things are moving in the right direction: the group adjusted cost-to-income ratio was about 62.5% in the first nine months of 2021; this year it is about 57%. In the third quarter, it was 51%.

What can disrupt progress? It seems bewildering while in the midst of an inflationary crisis, but already analysts are looking forward to possible cuts in interest rates in late 2023. Aman Rakkar at Barclays wondered what might happen if revenue growth stalled on lower rates while underlying cost growth remained in mid-single digits. Might negative jaws be a feature of 2024?

Stevenson noted that loan growth was forecast at mid-single digits too, and he thought the bank’s wealth business should perform better than that. In any case, lower policy rates would imply lower inflation expectations, helping to ease cost pressures.

The bank saw negative jaws in 2018 when markets dropped off a cliff; stuff happens. But he thought the core business should be able to make positive operating jaws “from 2024 and beyond”.

In any case, Stevenson would be forgiven for now thinking of this as someone else’s problem – Elhedery’s, for one. But he stayed loyal to the end.

“I think the underlying assumption that we’re going to have a stalled revenue position in 2024 sounds a bit too negative”.

Chinese CRE: the gift that keeps on giving


Ping An would like a more Asia-focused HSBC, although one assumes that would not include ramping up exposure to the troubled Chinese commercial real estate (CRE) sector, one of the topics that continues to exercise analysts.

The bank has only disclosed end-June China CRE exposures, which stood at about $20 billion, with about $16.7 billion drawn. Of that, some $11.7 billion is offshore exposure booked in Hong Kong, of which about $10 billion is drawn.

Of that, about $4 billion is classified as sub-standard or credit-impaired and carries provisions of about $1.3 billion. The worst slice, credit-impaired, jumped to 18% of the Hong Kong book in the first half of this year, up from 4% at the end of 2021.

That portion accounts for practically all of the below-satisfactory China CRE exposures, since it is the Hong Kong book that contains the riskier unsecured multi-bank syndicated lending piece. And as Asia CFO Martin Haythorne noted drily, “that is the piece that is overall exhibiting the most challenged conditions for our clients”.

In its third-quarter earnings, the bank said that the $900 million of provisions that the bank had taken at group level this year had been driven by Chinese CRE exposure, as well as a broader weakening economic outlook.

Ed Firth at KBW wanted to know why HSBC had this exposure at all. Commercial real estate in China had been overheating for years, he noted, before adding: “When you did the lending… what was it that gave you comfort at the time that we wouldn’t be in this situation?”

’Natural shape’

For Haythorne, the relevant point was that before this year’s meltdown the CRE sector was estimated to account for anything between a quarter and a third of China’s economy.

“That’s obviously a significant part of a material market for us," he said, "and so there is a part of that book that is just the natural shape of our portfolio.”

In other words, HSBC can’t be in China and not have substantial CRE exposure.

And then there’s the context: the offshore China CRE book is about $12 billion out of about $1 trillion of total loans at HSBC.

Firth wondered if that meant the situation was more a function of “keeping your flag flying in China, you felt you had to do a certain share of that business?”

For Stevenson, that wasn’t it at all. And it wasn’t like the bank had just been sitting around doing nothing. It had no material losses in connection with Evergrande, for instance, because several years ago it had started to reduce its exposure. And it had been selective: the bank’s lending is concentrated on tier-1 and tier-2 cities.

But when it came to the bank’s overall exposure to the sector, the situation had been altered by policy interventions that had combined with market conditions to accelerate the downturn, said Stevenson.

“We can all look super-smart in hindsight. Looking at it through today’s lens, would you have had the same degree of exposure? Probably not.”