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HSBC Holdings Plc’s 2 Greatest Weaknesses

When I think of banking and financial services company HSBC Holdings (LSE: HSBA) (NYSE: HSBC.US), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.

1) Regulatory uncertainty

In recent years, the British government has proved that light-touch regulation in the banking industry is about as effective at controlling excesses as dousing a candle with gasoline is at fire prevention. That’s why regulatory and governance requirements are rising in the banking industry, and HSBC is dancing to the new tune along with its London-listed peers.

According to HSBC’s chairman, in 2013, the British Government increased the rate of the bank levy imposed on the consolidated balance sheets of UK-domiciled banks and expanded the scope of the levy. That move cost the firm US$321 million, taking the levy for the year to US$904 million, of which US$484 million related to non-UK banking activity.

 Then there are the seemingly ever-escalating requirements for capital on banks’ balance sheets.

HSBC’s core tier 1 capital now stands at around US$149 billion or 13.6%. That might not seem like a big percentage of tied-up funds, but it’s up from about 7% in 2008, which represents a good few billion now unavailable to finance growth or to reward investors. It seems that regulation is changing the terms of business for banks, perhaps forever.

hsbcWith all the focus that society, governments and regulators are applying to the banking industry it’s understandable that banks in general are running scared. In order to ratchet up the resilience of systems, practices and governance, belt-and-braces reform often follows root and branch review. That expensive process raises on-going costs, perhaps forever.

 2) Cyclical operations

The general backdrop to the banking business is that profits rise and fall along with macro-economic cycles. In the case of HSBC, another dynamic is the long-term rise of the Asia region, which in 2013 provided 70% of the firm’s profits. So, investors must weigh the growth expected in emerging markets such as China against the cyclical behaviour of the shares.

Right now, HSBC’s forward dividend yield is running at about 5.7% for 2015 and the forward P/E rating is about 10. That looks attractive, but I’d expect the P/E rating to contract and the dividend yield to grow as the macro-economic cycle plays out. Judging whether earnings’ growth will be sufficient to overcome such drag on the share price to provide a decent investor total return from here is difficult.

What now?

HSBC Holdings’ dividend looks attractive but we should consider it against the backdrop of the firm’s cyclicality. 

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Kevin does not own shares in HSBC Holdings.