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Asia-focused HSBC faces threat from Brexit worries, weakening pound

Daniel Tabbush hascovered banks in Asia for 20 years, most recently as head of Asian bankresearch at CLSA. The following does not constitute investment advice, and theviews and opinions expressed are those of the author and do not necessarily representthe views of S&P Global Market Intelligence.

For all the talk about its Asia focus, still has asubstantial exposure to the U.K. and remains vulnerable to risks there,especially with the considerable weakening of the British pound in recent weeks.

As of Oct. 10, the pound was at US$1.24. The rate has notbeen this low since 1985. The swift weakening of the British pound is a sign ofconcern about the U.K. economy generally and means there is renewed defaultrisk for U.K. companies as well as personal borrowers. This is important forbanks active in the U.K. HSBC is the fourth-largest bank in the U.K. by branchcount, behind Lloyds Banking GroupPlc, Royal Bank ofScotland Group Plc and Barclays Plc.

HSBC has been touting its "pivot to Asia," andindeed, two-thirds of its adjusted profit before tax now comes from Asia,amounting to US$7.2 billion. But the bank still has a significant exposure tothe U.K. HSBC reported US$284.68 billion of gross loans and advances from theU.K. as of June 30, 31.75% of the global total. HSBC's next biggest market,Hong Kong, made up 23.90% of gross loans and advances as of the end of June.

The rapid decline of the British pound in recent weeks willmean a heightened concern for HSBC Europe, whose growth has been flagging. Thisregion has been a drag on HSBC even before Brexit concerns began in earnest.During the first half, HSBC Europe reported US$1.58 billion in profit beforetax, down 28.39% year over year. HSBC Europe could see an even greater profitdecline, not only because of less core income as loan demand weakens, but alsobecause of higher credit costs.

HSBC Europe saw credit costs of just US$398 million in thefirst half, compared with net loans and advances of US$365.33 billion. Thattranslates into a credit cost-to-loan ratio of 0.22% on an annualized basis.

Credit costs for HSBC Europe dropped from US$1.53 billion in2013 but the ascent from here may be sharp, as U.K. companies face worseningbusiness conditions and some may not be able to fully repay debt. This couldalso occur at the consumer level, especially if companies begin to cut back onlabor.

The bank has touted a focus on operations in the ASEANregion and the Pearl River Delta in southern China, but the reality appearsquite different. HSBC Europe and HSBC North America account for US$493.29billion of group loans, or 55.02% of total loans and advances. These areregions where economic growth rates are not high, where low interest rates willweigh on profit, and where higher credit costs are likely. As noted in itsinterim report, the global slowdown has delayed HSBC's strategy to redistributecapital into high-growth Asian markets.

Weakness in China and Hong Kong will also add to HSBC's woes, ascredit costs for banks in these regions are rising fast and not likely to abateany time soon. HSBC's Hong Kong-based units, Hang Seng Bank Ltd. and , reported bad loans up almost 30% year over year in the first sixmonths of this year. So while some consider Hong Kong or China as a relativebright spot, these hopes may be dimming fast.

A far weaker British pound and an inherently weaker economymean a greater likelihood of rising credit costs for HSBC. At the same time,HSBC remains highly exposed to other slow-growth, low-rate regions. What alsowon't help is that NPLs are growing and credit costs are rising in Hong Kongand China.