HSBC profits dip as investment ploughed into UK and China

HSBC announced a $2bn share buyback as it reported a 4% fall in first-quarter profit as costs rose from increased investment in growth and digital banking.

The banking behemoth generated revenue of $13.7bn in the first three months of the year, up 6% compared to a year ago, or 3% at the underlying level if excluding currency translation and movements in significant items. Reported profit before tax of $4.8bn was 4% lower, well short of the $5.8bn average of analysts’ estimates, and down 3% to $6.0bn on an underlying basis.

The share buyback is expected to begin soon and HSBC said that because of the growth opportunities seen in the market, investment in the business is seen as the best use of cash, so this is expected to be the only share buy-back announced this year. A flat quarterly dividend of $0.10 was proposed, as expected.

Turnover was boosted by growth in deposit margins and balances in the core retail banking and wealth management business, while wider deposit spread were enjoyed in commercial banking, especially in Hong Kong and mainland China. Net interest margin, banks' key difference between interest paid on deposits and that charged for loans, improved to 1.67 from 1.63 at the end of December and 1.64 a year ago.

Hitting profits was a 13% jump in operating expenses to $9.4bn in the quarter as directors, led by new chief executive John Flint, upped investment in the retail banking businesses in HSBC's core markets of UK and China. This continues the plan launched by his previous CEO Stuart Gulliver to ‘pivot’ to Asia, and China in particular.

The increased investment led to negative cost-to-income ‘jaws’, being the difference between the rate of revenue growth and that of cost growth. Flint, the HSBC lifer who took the reins from Gulliver last month, guided towards the intention remained to deliver positive jaws for 2018 as a whole, with the market expecting full year income growth of 6.9% and cost growth of 5.4% to result in positive jaws of 1.5%.

"Our global businesses performed well in the first quarter, maintaining momentum from the end of 2017.

"We continue to benefit from interest rate rises and economic growth, particularly in Asia. Our primary focus is to grow the businesses safely, and we have increased investment to deliver that aim."

Shares in HSBC, which rose more than 9% in April but are still down for the year to date, fell 3% in the first hour on Friday morning to 701.34p.

Citi analysts said the results overall were in-line with consensus earnings expectation, but this was delivered via combination of a costs being 6% worse than estimates but beating on loan losses. "The revised 2018 cost guidance is about $1bn below current cons or circa 5% off underlying profits, albeit much of this could be offset in 2018 forecasts by hard to forecast lower loan losses."

Citi said a lot of the questions on the analyst earnings call were "not surprisingly about costs – and this will continue to be a focus", but added that investing in the business, especially for a new CEO, "makes strategic sense albeit may lead to small near term cons EPS downgrades". The decision to invest comes as HSBC uses the higher revenues the bank is benefitting from in recent quarters and they will continue to do so to capture growth opportunities, especially in Hong Kong, Pearl River Delta region.

"We believe there is an element of ‘catch up’ with best in class peers and new emerging competitors, especially on the digital spend," said Citi, noting that the CFO had pointed out that "run-the-bank costs" are down quarter-on-quarter while "change-the-bank costs" are up.

Richard Hunter, analyst at Interactive Investor, said that given the strength of its competitors’ numbers in this reporting season, investors might have expected HSBC to round off events in some style, but profits were not just hit by the rise in expenses as other weaker metrics provided a further drag.

"Regionally, Europe and North America fell to a loss, whilst the spectre of US litigation fines looms large, as it has done for others. The return of equity figure remains significantly shy of the 10% target the bank has set itself and currency swings have not worked in its favour," he said.

Shore Capital noted that return on equity of 7.5% was well below management’s target for this to exceed 10% over the medium-term.

ShoreCap said operational performance at HSBC is clearly improving, driven by a combination of a supportive economic backdrop, particularly in Asia, rising interest rates in the US and Hong Kong and management's simplification of the business and increase in underlying operational efficiency, but "we believe that an improvement in returns well beyond our own and consensus expectations is required to justify the current share price".