2016 hasn’t been all that bad for shares in HSBC (LSE: HSBA). The bank started off the year with a series of disappointing earnings as revenues fell and restructuring costs began to weigh on its bottom line. But after a tough start, the bank’s shares perked up in the second half of the year, helped in part by its sizeable exposure to foreign income and steady progress in its restructuring efforts.
Falling earnings
On the surface, HSBC’s financial performance doesn’t look too bad. Adjusted pre-tax profits in the first nine months of 2016 fell by just 6% to $16.7bn. But when we include non-recurring items, such as restructuring costs and a loss from the sale of its Brazilian unit, pre-tax profits fell by a staggering 46% to $10.6bn.
There were also a few worrying trends as adjusted loan impairment charges (LICs) rose 66% to $2.2bn in the first nine months of the year and revenues fell for its fifth consecutive year. But, there were some positives too — the bank achieved some $2.8bn of annualised cost savings this year, and following the sale of its Brazilian operations, HSBC is on target to reduce its risk-weighted assets by $290bn by 2018.
Falling dividend cover
The tough earnings environment triggered concerns over the sustainability of its dividends. With earnings forecast to fall short of its dividends this year, management is under pressure to improve its underlying profitability. However, the bank will likely struggle to deliver results in short order, as management recently abandoned its medium-term return on equity target of “above 10%”, citing economic uncertainty and slowing growth in its core markets of Britain and Hong Kong.
However, we can’t ignore the fact that HSBC may be able to pay its dividends out of capital for some time, thanks to the recent change in the regulatory treatment of its investment in China’s Bank of Communications. Following this, the bank’s core capital ratio (a key measure of financial strength), rose to 13.9%. That’s a huge improvement from the 12.1% figure reported in June.
Brexit and the weaker pound
The Brexit vote was undoubtedly the most significant event for HSBC shareholders this year, and that’s because of the impact that had on the value of the pound. Given that HSBC earns nearly all of its profits from outside the UK, British investors will no doubt benefit from the much improved sterling translation of these mainly dollar-denominated earnings.
And because HSBC already has a fully licensed subsidiary in France, it’s less exposed to the risk of losing access to the European single market. HSBC should be more concerned about the status of EU nationals working in the UK, given that of the 42,000 staff it has in the UK, about 2,000 are from the EU.
What to watch out for in 2017
Reviewing 2016, I expect the key themes behind 2016 will remain the dominant factors to watch out for next year. After all, Brexit hasn’t even happened yet, and despite recent restructuring progress, HSBC’s earnings outlook remains weak. The bank will likely struggle to meet its cost of capital as it expands in China and the rest of Asia at a time when growth in the region is slowing — and this means HSBC’s dividend concerns aren’t going away any time soon.
