HSBC Holdings plc (NYSE:HSBC) is expected to report relatively weak earnings in Q2 2024 at the end of the month. Potential rate cuts ahead are negative for its revenue and earnings growth ahead, but its dividend yield is quite high and sustainable over the long term. HSBC is a bank that I’ve covered several times in the past, and Í was positive about its business prospects and share price from 2022 to mid-2023. However, in my last article on HSBC, I downgraded my recommendation to “Hold,” as interest rates were probably reaching a peak and further upside was, in my opinion, limited at the time. Since then, its shares are up by about 18% including dividends, but have underperformed the market by some margin during the same time frame, showing that HSBC’s upside was indeed somewhat limited.
As the bank is expected to release its Q2 2024 earnings in a few weeks, I think it’s now a good time to do an earnings preview and update its investment case. We will see whether HSBC offers value for long-term investors or not.
While HSBC is based in the U.K., it’s one of the few global banks. Its largest market is Hong Kong, which has a currency peg to the U.S. dollar, making HSBC quite exposed to U.S. interest rates. Moreover, HSBC also has a strong presence in trade finance and finances global commercial trade, which is usually done in USD, making it even more exposed to the greenback. Considering this profile, HSBC has benefited from high interest rates in the U.S. over the past couple of years, which has been reflected in a growing net interest income. While a few months ago, there were expectations for rate cuts during 2024, persistently high inflation reads and a resilient U.S. economy have led the Federal Reserve to maintain the Fed’s funds target rate in the range of 5.25%-5.5% since July 2023.
While higher rates have been a tailwind for HSBC’s interest income, customers are demanding higher rates on time deposits, leading to a more subdued NII growth in recent quarters. As shown in the next graph, HSBC’s NII has been about $11 billion in the past few quarters. This is expected to decline a bit in the near future because HSBC has recently announced an agreement to sell its Canadian operations to the Royal Bank of Canada (RY). In addition, it also reached an agreement to sell its Argentinian operations to Grupo Financiero Galicia S.A. (GGAL).
In Q2 2024, its NII is expected to decline a little bit and total revenues should be close to $16 billion, representing a decline of 4.5% YoY. Regarding other revenues, they are expected to be more stable, amounting to about nearly $7.9 billion in Q2 2024. This shows that HSBC’s rates tailwind is largely gone, and going forward its NII is likely to be on a downward path if the Fed eventually cut rates as currently expected by the market. Indeed, recent inflation figures were below expectations and inflation cooled down recently, increasing the probability of rate cuts ahead.
Current market estimates expect two rate cuts by the end of this year, with about four cuts expected during 2025. This will turn rates into a headwind for HSBC and jeopardize, in my opinion, its guidance for NII of about $41 billion in 2024. Nevertheless, even if the bank misses its NII guidance, it is not expected to be by a wide margin. The “higher for longer” interest rate environment has been supportive of its NII, and rate cuts take some time to be reflected in the bank’s asset yields.
Regarding costs, HSBC is reporting good cost control despite inflationary pressures and investments in digitalization, leading to total costs of about $9 billion in the quarter, up by 7% YoY. Its efficiency ratio is expected to be about 56% in Q2 2024, which is an acceptable level, but above the most efficient banks that have an efficiency ratio in the 40-45% range. Regarding asset quality, despite higher rates and some concerns about the commercial real estate (CRE) market, in which HSBC has some significant exposure, the bank’s credit costs have remained at moderate levels. There hasn’t been a spike in recent quarters, showing that HSBC’s credit quality remains good.
In Q2 2024, its loan loss provisions are expected to be about $930 million, which is relatively stable compared to Q2 2023, but a slight increase compared to the previous quarter. This increase in provisions is expected to be in the consumer and commercial banking units, being part of a “normalization” of loan losses, rather than HSBC being overly exposed to some problematic area, such as CRE. Due to lower revenues, higher costs, and stable loan loss provisions, its net income is expected to decline to about $5.5 billion in Q2 2024 (vs. $6.8 billion in Q2 2023, which also included some extraordinary gains due to asset sales), and its return on equity (ROE) ratio should be around 13%.
This profitability level is lower than reported in the past few quarters, but it’s still acceptable and within its medium-term goal, thus HSBC’s profitability is expected to remain strong. However, due to lower rates expected ahead and the negative impact this will have on the bank’s top-line, and that costs have been quite sticky historically, its ROE could decline to a level between 11-12% over the next couple of years. This is below the bank’s profitability target. This indicates that HSBC is likely to maintain its strategy of selling non-core units and operations where it earns below-average profitability levels, leading to a more streamlined geographical exposure over the long term.
Regarding its capital position, HSBC is expected to report a CET1 ratio of 15.2%, practically unchanged from the previous quarter, as the bank’s profit should be offset by higher risk-weighted assets, particularly related to credit risk. Nevertheless, this capital ratio is strong and above the bank’s own target of 14-14.5% in the medium term. This means HSBC has an excess capital position, a profile that is expected to be supported by its sale of operations in Argentina and Canada, allowing it to maintain its capital return policy in the near future.
Based only on “ordinary” dividends, HSBC is expected to distribute a dividend of more than $3 per share, leading to a dividend yield close to 7%. Its dividend payout ratio is expected to be maintained at about 50%, which is a very conservative ratio, thus despite its high-dividend yield, its dividend is clearly sustainable over the long term.
In conclusion, HSBC Holdings plc’s Q2 2024 earnings are expected to be relatively weak, as the bank’s tailwind of higher rates comes to an end. This means its earnings growth outlook in the coming quarters is not particularly impressive, making income the most attractive feature of its investment case.