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Trade war, low US profits, Huawei tensions among challenges for HSBC's next CEO

Trade tensions, sluggish profits in the U.S., Brexit and concerns about China are some of the key challenges awaiting the new CEO of HSBC Holdings PLC, after the surprise departure of CEO John Flint on Aug. 5.

The decision to let Flint go after less than 18 months in the top job was "mutual," according to HSBC chair Mark Tucker. Noel Quinn, previously CEO of global business banking at HSBC, will take over as interim CEO while the bank considers both internal and external candidates for the job.

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HSBC's interim CEO, Noel Quinn

Source: HSBC

The news came as a surprise to the market, with S&P Global Ratings saying the rationale for Flint's removal was not clear, and that it primarily indicated the "increased ruthlessness" of HSBC's board.

Nicholas Hyett, an equity analyst at Hargreaves Lansdown, said it was strange to be changing leadership again before Flint's reforms had a chance to bed in. The latter's strategy may not have been revolutionary but was "certainly not a disaster," and the bank had posted a strong set of earnings results for the first half, he wrote in a note.

But despite encouraging headline numbers, HSBC faces a raft of challenges as it looks to shore up a share price that lost close to 15% under Flint's tenure.

Trouble in the U.S.

One of the first problems that Quinn — and whoever is eventually appointed as CEO — will have to address is low profitability in the bank's U.S. business.

HSBC CFO Ewen Stevenson was explicit during the bank's first-half earnings call that low profitability in the U.S. had been, and would continue to be, a problem.

"We recognize that current returns in the U.S. are not acceptable, and it remains a firm priority of ours to improve these," he said.

The bank had set a target of increasing return on tangible equity in the U.S. business to 6% by 2020, but with the figure languishing at 2.5% at the end of the first half, it now acknowledges that it will miss this goal.

In light of the recent cut to interest rates in the U.S. — the Federal Reserve cut the overnight lending rate to 2% from 2.25% on Aug. 1, the first time in 11 years — HSBC's U.S. business will remain a "strategic challenge," Ian Gordon, an analyst covering banks at Investec, said in an interview.

Stevenson ruled out the divestiture of the U.S. business during the earnings call, and he also ruled out M&A. The U.S. is "critical" to HSBC's global business, and building scale through M&A would not solve any of the bank's challenges, he said.

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Trade tensions

The impact of ongoing global trade and tariff-related tensions is likely to be another headache for the new CEO.

"Trade tensions between U.S. and China are progressively impacting the growth outlook for both markets. We're responding to this changed revenue outlook with a tightened focus on cost," Stevenson said during the earnings call, adding that the bank was also slowing the pace of investments into those markets.

Given that HSBC has a particularly large trade finance business in China, continuing tensions could have a direct impact on profitability, Hyett said in an interview.

Cooling relations in China

On top of this, with HSBC reportedly on a list of foreign companies deemed "unreliable" by the Chinese government, doing business in one of the bank's most important Asian markets could also pose some challenges.

The bank allegedly gave information to U.S. prosecutors that helped them to build a case against Meng Wanzhou, finance director of Huawei Technologies Co. Ltd., who faces charges of wire fraud and breaking U.S. sanctions against Iran. Huawei has faced questions from countries concerned that its technology equipment might pose a national security threat.

"The nature of operating in emerging markets is that there is always a higher degree of political risk," Hyett said, adding that chilly relations with China's authorities could make it harder to do business in the country.

But while HSBC may be facing a political impasse, it has a very strong track record of doing business in the country to fall back on, Hyett noted. The bank, whose initials stand for "Hongkong and Shanghai Banking Corporation," has been present in China for more than 150 years.

It is also highly active in lending to the Belt and Road initiative, a flagship project of the Chinese government, Hyett noted.

Brexit woes

Meanwhile, "Brexit remains unresolved with skewed risk to the downside," Stevenson told analysts during the earnings call.

With the U.K. slated to leave the EU on Oct. 31, and the terms of the departure still unclear, Brexit will be another challenge for the new CEO.

HSBC is a global bank, but its U.K. mortgage activity is a very important part of the business, Hyett said. This could be a source of vulnerability if Brexit leads to a downturn in the housing market.

"If we see a damaging Brexit, then the value of these assets will be hit," he told S&P Global Market Intelligence. "It's a long-term headwind that the bank will have to manage effectively."

But Investec's Gordon said he did not think Brexit would be a game-changer for HSBC, noting that the gains from the mortgage business are still looking "very strong."

The bank's book of U.K. first-lien residential mortgages increased to $128 billion at June 30, 2019, compared with $124 billion at the end of 2018.