Dividend cut at HSBC would only make sense under one scenario, Berenberg says

HSBC had shown it had a tight grip on costs over the last two quarters and with management as focused as ever on risks the dividend was sustainable, Berenberg said.

As risks continued to be re-priced, the lender’s focus on risk should become more appreciated, with the dividend yield providing support as the year progressed.

“If HSBC was viewed as a corporate bond fund it would be trading at an 18% discount to par value, while paying an 8% coupon.

“[…] This is the ideal territory where we want to buy a bank with the opportunity for the bank to trade back to par ie TBV while getting paid an 8% yield waiting for it to happen. This promises a circa 40% two-year return, assuming the re-rating back to par takes 24 months,” analyst James Chappell said in a research note sent to clients and dated 13 May.

Dividends or share buy-backs?

The analyst expected HSBC would report a common equity tier 1 capital ratio of 12.9% at the end of 2016, near the top end of its 12% to 13% target range.

There was only one scenario under which a dividend cut would make sense, if it was used for share buybacks instead.

That would keep the capital return to shareholders constant, reduce the scrip dividend dilution and cut the dividend pay-out ratio to 50% on a per share basis.

Such a move would be 5% accretive to earnings per share and tangible book value in 2018.

It would also boost the bank’s CET1 ratio to 13.8%.

In the same note Berenberg also cut its earnings estimates for 2017-2018 to reflect a higher tax rate in the UK, which was now seen at 25% versus 21% before.

Chappell reiterated his ‘buy’ recommendation and 600p target price.