2015 is already shaping up to be an expensive year for HSBC Holdings (LSE: HSBA) (NYSE: HSBC.US). After setting aside billions last year for the payment of fines and misconduct charges from regulators last year, this year the bank is facing yet more fines and the additional cost of ring-fencing. All in all, these costs will hold back the bank’s growth.
Ring-fence costs
UK’s new ring-fencing regime is designed to protect taxpayers from future financial crises and requires that large, systematically important banks, such as HSBC and Barclays, separate their high-street branch operations from investment banking activities by 2019.
The separated operations must have different boards of directors, different IT systems and not reliant on each other for vital services. Essentially the rules require banks with more than £25bn of deposits to spin-off retail operations.
According to the Treasury, these reforms will cost all banks involved £1.8bn to £3.9bn each year, with an additional one-off cost of £500m to £3bn. The bulk of these costs will fall on the UK’s five main banks, HSBC, Barclays, RBS, Santander and Lloyds, although Lloyds is now applying for an exemption to the rules. HSBC’s management has stated that ring-fencing will cost the bank £1bn to £2bn.
Even though 2019 is still four years away the ring-fencing will take time and plans are already being drawn up. The BoE has asked banks to submit plans for ring-fencing by today.
Yet more costs
Unfortunately, the cost of ring-fencing is just one of the many factors that is set to hold HSBC back during the second half of this decade.
Indeed, the bank missed third-quarter earnings expectations last year after being forced to set aside more than $1.6bn to cover the cost of legal settlements and customer compensation. These costs facing the bank are only set to increase over the next few months.
Specifically, alongside third-quarter results Stuart Gulliver, HSBC’s chief executive, noted that the bank’s costs would remain “elevated” for the foreseeable future. Additionally, Gulliver told analysts that HSBC was now “walking away” from its target to have a cost-income ratio mid-50s by 2016. Instead he said the ratio would be in the high 50s. This unravels much of the work HSBC has done over the past few years to lower costs and boost profits.
For example, since taking the position three years ago, Stuart Gulliver has sold or closed around 60 of HSBC’s businesses, 40,000 jobs have been axed and over $5bn was wiped of HSBC’s operating cost bill during 2013 alone.
But now, costs are now increasing within the compliance and legal division at a rate of around 25% per annum. Undoing much of the hard work that’s been accomplished throughout the rest of the bank.
Low valuation
HSBC will struggle to boost profits with costs rising during 2015, however, the bank’s valuation is attractive. At present the bank trades at a forward P/E of 10.2, below the FTSE 100 average P/E of around 15.
Still, when compared to its global peers such as Bank of America and Citigroup, HSBC appears to be reasonably priced. Bank of America and Citigroup currently trade at forward P/Es of 11.8 and 9.7 respectively. Both of these international banking behemoths are currently facing the same regulatory pressures as HSBC.
Overall, rising costs and a fairly average valuation lead me to conclude that HSBC’s shares will stagnate during 2015. That being said, HSBC’s impressive dividend yield of 5.3% is hard to pass up, although this payout could be cut if costs continue to rise.
