HSBC's rights issue: Ruffled feathers

HSBC plans to raise $17.7 billion of equity—a sign of weakness or strength?

APOLOGIES are all the rage in banking now. As well as a general grovel on behalf of the industry, on Monday March 2nd HSBC said sorry for its original sin in 2003: buying Household, an American consumer-credit company that has since blown up. “With the benefit of hindsight, this is an acquisition we wish we had not undertaken,” the bank’s chairman said. Europe’s biggest lender by market value now hopes to draw a line under the affair by winding up the bulk of its American consumer-credit book. For good measure it also plans to raise $17.7 billion, in Britain’s biggest-ever rights issue and slash its dividend, after 15 years of consecutive double-digit growth.

That may all sound like a disaster but, depressingly, HSBC is one of the best-performing banks in the western world right now. Its 2008 results were riddled with one-off items, but the bank still made an annual pre-tax profit of over $9 billion in a year when most peers made losses. Bad debts are rising outside America, but at a moderate rather than seriously alarming pace. HSBC’s share price has roughly halved in the past year--less catastrophic than many competitors, a few of whom have just entered the deadly embrace of their governments. Its deposits still exceed loans made, making it relatively less dependent on the whims of wholesale markets for funding.

One interpretation of HSBC’s capital raising is that it is keen to make the gap between it and unhealthy banks even wider. Its ratio of equity to tier-one capital will rise from 7% to 8.5% if the rights issue is completed. That is far above the level of America’s mega-banks (JP Morgan Chase sits at 6.4%) and exceeds Europe’s other big beast (Santander’s ratio is 7.2%). Extra capital will allow HSBC to grow as other cash-starved competitors are forced to shrink their businesses.

Acquisitions might even be on the cards as weak banks with global operations are broken up, as is already happening to Royal Bank of Scotland and seems likely to be Citigroup’s fate. Yet is HSBC’s capital position quite as it seems? The bank has a large portfolio of available-for-sale securities (mainly asset-backed instruments). Deducting the marked-to-market losses on this would reduce the tier-one ratio back below 7%.

On top of that HSBC faces continued losses in America as its winds down its consumer business there. The bank has quite rightly rejected calls to let this division, which it does not legally guarantee, default. But the ongoing financial burden could be heavy. This unit produced an underlying pre-tax loss of $7 billion in 2008--a couple more years like that would knock a sixth or so off HSBC’s core capital.

All of which suggests that HSBC is undertaking a balancing act. Although it hopes further realised losses in America and on its asset-backed securities will be limited, a rights issue leaves it prepared for the very worst. That is not a position of strength, at least in absolute terms. But very few other banks are even capable of raising equity from external investors right now: their only response to the worst-case scenario is to cross their fingers. HSBC does not look in a great state, but remains fit enough to be able to admit its weaknesses.

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