HSBC's surprise: An $897M charge for toxic U.S. mortgages

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John Flint is off to a bumpy start at HSBC Holdings.

Costs at Europe’s largest bank rose at a quicker pace than revenue in the first quarter, and it took a surprise charge for past misconduct.

HSBC unexpectedly set aside $897 million related to a U.S. investigation into the historic sale of toxic U.S. mortgage bonds.

“We are engaged in active discussions with the Department of Justice with a view toward potential resolution of civil claims,” and had taken as a provision because negotiations had “developed” during the last quarter, the lender said in a news release Friday.

It also said a $2 billion share buyback would be the only one this year given the “growth opportunities” it currently sees, signaling HSBC plans to reinvest the excess capital it is generating rather than return it to investors. Some analysts had expected $4 billion or more to be repurchased.

Chief Executive Officer Flint, an HSBC lifer who took over in February, is preparing to unveil his strategic plan for the global behemoth in the coming months. While he inherited the Asia-focused lender back in expansion mode after years of restructuring, profitability has lagged rivals and the CEO must quickly show investors he can grow while containing costs.

“The reality is Asia is where the economic growth is: rates, demographic, GDP,” Flint said in an interview, when asked about HSBC’s increasing reliance on the region. “The wealth creation is happening in Asia. So is it a concern? I don’t think so.”

HSBC’s best regional performance came once again came from Asia, and Hong Kong in particular, where it’s redeploying as much as $100 billion of capital. First-quarter pretax profit there increased by 8% and now accounts for four-fifths of earnings, whereas profit in North America and Europe dropped by 16% and 72% respectively.

Among HSBC’s main four business lines, profit from retail, commercial and private banking rose, while earnings at the investment banking fell, largely because of a 10% drop in revenue from trading. Analysts had been expecting better after an average rise of 12% for U.S. peers and an 8% increase at London rival Barclays PLC.

While revenue and profit largely met expectations for the first three months of the year, costs rose 8% on an adjusted basis, compared with only a 2.5% rise in revenue.

One of Flint’s main concerns will be improving HSBC’s return on equity, which came in at 7.5% in the quarter, lower than its target of 10% and below the last-reported levels at its closest western rivals in size, JPMorgan Chase & Co. and BNP Paribas SA. Emerging-markets rival Standard Chartered PLC also posted a 7.6 percent ROE earlier this week.

The CEO said he believed he had the capacity to invest in new technology while keeping a lid on costs and could achieve positive jaws — the difference between the rates of revenue and cost growth — by the end of the year. However, achieving a 10% return for 2018 “looks difficult,” Finance Director Iain Mackay said on a call with reporters.

The chief reiterated he would unveil his strategic update “at or before” the bank’s next set of results, scheduled for August, and said he’d enjoyed his two months in charge so far, particularly the warm reception he’s had from Asian tycoons who have been doing business with HSBC for decades.

“The challenge is just the prioritization thing; I’m drinking from a proverbial fire hose,” Flint said. “I’ve been here forever, but this is a different job, and I’m just getting into that rhythm.”

Bloomberg News
Mortgages Credit quality Crime and misconduct Earnings Growth strategies HSBC DoJ