HSBC : Post Results Equity Analyst Call Q3 2022 Results

Transcript

Post Results Equity Analyst Call

Q3 2022 Results

4 November 2022, 8.00am GMT

RICHARD O'CONNOR, GLOBAL HEAD OF INVESTOR RELATIONS: Good morning. Good afternoon, everyone. Thank you for joining us today. I'll hand over to Ewen for a few introductory comments. We'll do Q&A first of all in the room in London, then, Mark and team, you direct it in Hong Kong; and then we've got a number of guests on Zoom. If you can do the 'raise hand' function, and we'll rotate that around two or three times to make sure all your questions are answered. With that, I'll hand over to Ewen.

EWEN STEVENSON, GROUP CHIEF FINANCIAL OFFICER: Thanks, Richard. Good morning to everyone here in London and good afternoon for those of you in Hong Kong. Thanks a lot for coming in and joining today. In addition to me here in London, I've got Carlo Pellerani- Carlo's our Group Treasurer - Jon Bingham, who is our Global Financial Controller; and Richard and his IR team, who you all know. And, in Hong Kong, even though you can't see them on the screen, we've got Georges Elhedery - Georges is going to be our new Group CFO from 1 January - Ming Lau, Asia CFO; Kathleen Gan, Global Head of Finance; and Martin Haythorne, our Asia Chief Risk Officer.

I took away from last week that there were three areas that we should particularly focus on today: firstly, our net interest income and flip guidance for 2023; secondly, our China real estate exposure, particularly the offshore book in Hong Kong; and, thirdly, our operating cost guidance, the 2% growth for 2023 - but obviously happy to take questions on whatever other topics you want during Q&A.

Before we kick off on Q&A, a few points from me on our NII guidance for 2023. To reiterate what I said last week, we upgraded our like-for-like 2023 net interest income guidance by $1.5 billion after taking into account two factors. Firstly, FX: relative to when we spoke to you at second quarter results, there's a net interest income headwind of about $1.2 billion if you were to use September average rates. Obviously, this will also have a beneficial impact in lowering our dollar operating costs. As I said last week, at the same September average rates, 2021 operating costs would have been around $29 billion.

Secondly, the impact of funding our trading book assets with banking book liabilities - this is expected to be at least $1.3 billion of additional net interest income drag in 2023. This is because, as rates rise, the cost of funding net trading assets increases, which depresses net interest income, with an equal and offsetting amount reported as trading income. This is a pure offset between net interest income and non-interest income, and the corresponding part of the trading book income has all the characteristics of net interest income.

Are we still interest rate sensitive in 2023? Yes, but we do think it's right to be conservative at this point in the cycle. We are seeing, as you know, unprecedented speed and magnitude of rate increases and high volatility in market expectations. The market now expects interest rates in the UK, US and Hong Kong to peak in the next six to 12 months at levels not seen since at least the global financial crisis.

Our published NII sensitivity assumes a 50% deposit beta. We've been lower than that so far, but we do expect that to move substantially higher from here during this rates cycle. It also assumes a static balance sheet, which is particularly important in the context of our Hong Kong deposit book. Given the yield pickup available on the market, we assume a further material shift from NIBCAs into time deposits. Just as an example, we currently offer a 3.7% rate for new money at HSBC Premier for a one-year term deposit.

If you look at the market as the whole in Hong Kong, the proportion of time deposits was around 36% going into 2022. That's risen to over 45% by September, and we expect it to increase to above the 2018-19 cycle, which peaked at around 50%. Do note that our time deposit percentage is currently around half the market level, but we do expect it to continue to increase from here, and we think we've been fairly conservative in our assumptions on peak migration, which we expect to occur during 2023.

As we said last week, we'll revisit and refine 2023 assumptions during the fourth quarter, and Georges looks forward to updating you at our full-year results in February. So, to repeat the 2023 guidance, at least $36 billion of net interest income, which includes the $1.2 billion impact from FX and second-quarter reporting and an extra $1.3 billion of non-interest income from net interest income flipping into non-interest income to fund the trading book. So, relative to our second quarter guidance for net interest income of $37 billion, we've upgraded our revenues by $1.5 billion.

And finally, before I open up for questions, a few words on our 2023 operating costs. I know there was some concern last Tuesday that my departure will see a lessening in our commitment to cost delivery. Georges and I have been through our 2023 cost plans in some detail over the last few weeks. He and I are totally aligned on what is required to deliver to that 2% cost target this coming year, and we've got clear bottom-up plans that are being executed that are consistent with the guidance that we've given.

With that, I'll open up for questions. Just as a reminder, we've got Martin Haythorne, Asia CRO, here to answer any questions you've got on the China commercial real estate book. And we've got mics here in London, and I think in Hong Kong, if you could please speak into the mics so that everyone can hear. Thank you.

RICHARD O'CONNOR: If you give your name and institution as well, just for the transcript. Thank you very much. So we'll start with a few from London.

RAUL SINHA, JP MORGAN: Just maybe starting off on China CRE, one of your competitors gives a breakdown of the secured/unsecured bit within the Hong Kong offshore exposures, and I was wondering if you could give us a little bit more colour around those exposures and how you think about the stress or the risk in terms of credit loss on that.

And then, secondly, just to follow up on your comments on costs, Ewen, I think previously you have hinted about the fact that you needed to do some additional cost saves to hit your target. Can you talk to us a little bit about where those cost saves might be coming in and a little bit more colour in terms of which areas within the bank there's still scope to take cost out? Thank you.

MARTIN HAYTHORNE, ASIA CHIEF RISK OFFICER: Thank you. Thanks very much, and good afternoon, everyone. Thanks for the question, Raul. Perhaps just to start on the China CRE positions secured/unsecured question, the China CRE exposure that we set out in our disclosures is obviously a portfolio of assets for us. I should start with the nature of that lending. That lending is just over 60% relating to residential. The remainder is a mix of commercial and industrial assets. The commercial, it's important just to note, is a mix of our support for clients who are in development stage, but also includes a mature portfolio of income-yielding assets, so all of those constituent parts are in the numbers in our disclosure.

I think, secondly, it's worth pointing out that, of the exposure - and, again, the credit quality is set out in the disclosure - the split is roughly 70% to privately owned enterprises in the mainland and 30% to state-owned enterprises. And then, as you would imagine for a portfolio of assets of that kind of order, it's a real mix of both secured and unsecured, the secured pieces being project and asset-specific security as well as an unsecured book. The largest element of the unsecured book is typically in the format of multi-bank syndicated lending done from offshore in the Hong Kong book, and that is the piece that is overall exhibiting the most challenged conditions for our clients.

Specifically, what we say is that we have $9.8 billion of loans and advances in the Hong Kong offshore book, and roughly around $8 billion of that is in the higher-risk format that I've just described.

RICHARD O'CONNOR: Just to add to that the disclosures show that the exposure as at June less than satisfactory, good or strong is about $4 billion out of - call it the $10 billion offshore book. And, as at the end of September, we had about a $1.3 billion provision on that exposure. And that's that offshore, Martin, syndicated loan book which you described earlier.

MARTIN HAYTHORNE: Correct.

RAUL SINHA: That's as of first half - has it changed?

MARTIN HAYTHORNE: I didn't hear the question. I wonder if you could repeat it.

RICHARD O'CONNOR: What's been the change in Q3 since that disclosure we made at the end of June in terms of the substantive and credit-impaired part of that exposure?

MARTIN HAYTHORNE: Well, the operating conditions for the client-set continues to remain challenging. I think that the main developments for the client-set in Q3 have been the ones that you will all be aware of. Clearly, we've seen a continuation in the fall of home sales year-on- year in China, which is the top line for that client-set. You'll also know that there's very limited new offshore funding being made available to the clients through the bond markets as well as the banks, and, of course, that client-set continues to be challenged by the higher US dollar borrowing costs that are that are filtering through for them. So there continues to be a challenging set of circumstances for that client-set.

EWEN STEVENSON: On costs, we've been doing a substantial amount of additional work over the last few weeks, including this week. I would say confidence in delivery against that 2% target continues to grow based on that work. We are down to a gap of less than 1% in terms of delivery against that number. Obviously, remember it is a bit of a super-tanker. It is a $30 billion cost base, so we are prone to both positive and negative surprises month in, month out. I would say it is pretty broad.

If you think about the underlying inflationary trends in the market at the moment, they are comfortably above that 2%, so I would say very few parts of the Bank are immune from having to think about tight cost control next year, but we have been looking hard into areas like consultancy spend. We have got a new Head of Procurement who is going through everything on the supply side, tightening up on third-party contractors, looking at the efficiency of how we deliver change, slowing down the pace of some change that we are delivering, looking hard at the efficiency of all of the regulatory spend, which is quite substantial at the moment, and how we improve the efficiency of that spend. Overall, I think we continue to commit to that number, so you should take confidence on that that we have got the underlying support to continue to make those statements.

ALASTAIR RYAN, BANK OF AMERICA: Sorry, I am going to follow up on the question before, please. That was a really non-specific answer on the China commercial real estate. It's a talking point, as you rightly highlighted, Ewen, so can we work back then? You have given us a Group loan loss expectation, so although this portfolio is material and it's very hard for us to judge credit losses, which could in theory be high because these developers are going to cease to exist, but that is embedded within your Group guidance for next year, so the ongoing deterioration is somehow captured at a Group level, even if it feels like the loss content of that book could be higher.

EWEN STEVENSON: Again, to repeat the numbers, offshore book is about $12 billion. We have got just over a billion dollars of provisions against that book today. We have been running at a few hundred million of loan loss provisions each quarter for the first three quarters of this year. I think it's going to take more than 2023 before you're going to begin to see a recovery in the China commercial real estate markets, so the guidance we've given at the top end of our 30 to 40 basis point range would imply $4 billion plus or minus of loan loss charges next year. I think it's comfortably within that.

Having said that, I think where we've seen sensitivity is particularly the sensitivities around the larger names, and if we see idiosyncratic default risk around those names. The China government is clearly introducing a broad set of policy measures to try to help mitigate some of the adverse impacts that we're seeing in the real estate markets, and those policy impacts

are continuing to be rolled out. But I take the point, and I'll leave it with Richard, on us providing you more disclosure, I guess, at full year on the nature of that portfolio and some of the security that sits behind it.

RICHARD O'CONNOR: Martin, correct me if I'm wrong. It's $12 billion, of which $2 billion are guarantees, so it's $10 billion drawn, and, at the end of June, about $4 billion of that was below satisfactory, and that's the bar which we are providing for at the moment. There have been a couple of names - one in September and one post-September - which have gone into - let's call it restructuring, and we've taken provisions on those particular names, so it is on a name- by-name,bottom-up basis.

EWEN STEVENSON: In addition, of that four billion that's sitting in sub-standard or impaired, it's only a percentage of that that's currently sitting in the work-out unit. The provisioning level against that is decent, but the question is what else rolls into that work-out unit.

MAGDALENA STOKLOSA, MORGAN STANLEY: Just a couple of follow-ups on the potential for provisioning in the corporate book. Of course, we have talked about the Chinese portfolio, but where else, particularly on a six to nine-month view, are you seeing a potential for deterioration across your global book - because, effectively, you are one of the largest corporate lenders globally. Where do you see early signs of, one, what are you watching? And, two, remember during Covid, right at the beginning, we did have a conversation about risk- weighted assets migration. It never materialised. How do you look at it today in different circumstances, different behaviour of the credit market?

EWEN STEVENSON: In capital forecasts, there is an element of credit rating migration. It's relatively modest at the current time, but, if you look at the statements we have made around returning to the low end of a 14% to 14.5% range by mid-year, in that is an element of offset for migration. The market that we are spending most time on at the moment is the UK, which is both corporate and non-corporate. Frankly, around the world at the moment, outside of the China commercial real estate book, we are seeing very few signs of emerging credit impairment. We are all anticipating that it will come, but we are not seeing it at the moment. And I would say we don't have a big book in Europe, but, if we did, I guess we'd be paying attention to that, but it's really the UK.

YAFEI TIAN, CITIGROUP: Thank you. I have a follow-up question on the interest margin here in Hong Kong. I think Ewen mentioned on the call that you're expecting Hong Kong margin to peak around fourth quarter, but can you give us some colour around the current deposit beta you're seeing in Hong Kong? And what is the assumption you baked into that peak margin guidance in Hong Kong? I'm just wondering, with the additional potential higher Fed rates to 5% as the terminal rate, does that guidance of peak NIM in Hong Kong stand?

MING LAU, CHIEF FINANCIAL OFFICER, HSBC APAC: So you would have seen, I guess, Yafei, through the third quarter, net interest margin for HBAP overall actually increased quite significantly. So we saw about a 33 basis point increase in NIM for the third quarter. The exit rate, actually, for the third quarter was quite a bit higher than the 179, but not yet to the peak which we saw between 2018 and 2019 of roughly about 205 basis points. So, just looking at the fourth quarter alone, I would expect the fourth quarter net interest margin to continue to rise.

The thing we need to keep in mind, and I think is one of the biggest factors in terms of why we're calling potential for peak net interest margin, is essentially the point around time deposit migration. Ewen has spoken to the fact that, if you look at the market in Hong Kong, we've already seen roughly about a 9 percentage point increase in time deposit migration in the market overall. Our assumption in terms of why we believe margins are going to start to peak is, essentially, we are seeing a pickup in terms of time deposit migration in the portfolio.

If you work through the impact of that, we roughly have about a $540 billion deposit book in Hong Kong. 60% of that is in the retail space. Roughly a 10% migration in time deposits in the retail portfolio - if you take a simple, roughly 300 basis point difference between your savings accounts and your time deposits, in terms of the price which you pay the client - that would give you a sensitivity of roughly $1 billion for every 10% shift in time deposit mixed in the retail book.

If you just look at what we're thinking through in terms of assumptions, you could argue the assumptions are conservative, but, just looking back on history through when interest rates were last roughly around 450 to 500 basis points, it was between 2004 and 2006, and, at that point in the market in Hong Kong, time deposit mix was in excess of 60%.

YAFEI TIAN: The second one is page 17 of the slide around the wealth balances. I just want to understand about the wealth deposit decline in particular. I understand the investment assets are very much impacted by market activities, so I just want to understand the current deposit dynamics in the geographies that you are operating in, particularly in Hong Kong. Are we seeing very slow deposit growth, and how does that impact your wealth?

MING LAU: If you look at what's happened recently on deposits, we did notice through September migration in terms of a bit of outflow on deposits to wealth, and that was particularly evident in Hong Kong with the government issuing the silver bond. But the other thing I would say on wealth balances overall - it's pretty evident it's been impacted by the drop in equity prices across the globe, but, when you actually look at net new money inflows, we still saw a pretty significant inflow of net new money into our Asia Wealth business.

RICHARD O'CONNOR: If you look in just WPB, it was impacted by the move of France deposits to held-for-sale, so in the quarter, deposits were down $6 billion due to that outflow, but net new money was year on year over $90 billion and over $30 billion in the quarter. So you can see that we are picking up balances, but there is some shift from deposits to the Wealth business happening in Hong Kong.

GURPREET SAHI, GOLDMAN SACHS: Just a small follow-up, again on Hong Kong, on the mortgage book, this time around we know LTVs - and maybe related to UK also - LTVs at around 50 per cent and very conservative, but property prices might already have peaked in both these geographies and are starting to come down. At what point do the risk managers really get concerned: at 10%, 20% or 30% price fall from the peak? Then, on the ground, are you seeing the level of competitiveness from the banks already withdrawing from the market - because we are seeing mortgage originations at a very low level.

MARTIN HAYTHORNE: As you rightly say, the book is pretty conservatively positioned at an LTV of 50%, and, as you'll know here, that's partially because of the regulatory caps that are in place with any mortgage over 60% being insured by the HK Mortgage Corp. There is a regulatory environment which actually pervades across the whole of Hong Kong, not just in the numbers we've talked about.

The portfolio remains strong and delinquencies are both low and stable today. We've seen, I think, by some measures, from peak to today, we're down about 11%. I think HSBC's analysis is down 8% for the year to date for 2022, so we have seen that kind of move. If you look in historic terms, what we have seen since - really you have to go back to the Asian financial crisis for this to be multi-year downs of significant order. Even the 2008 period was one year down Hong Kong.

The numbers that I've talked about - and you've talked about of the 50% LTV gives us obviously a significant space around valuation. The other element that is important for mortgage is, of course, affordability. We, and I'm sure other organisations, have been stressing the income ability to repay for some time now, assuming 200, 300 basis point rises in rates from where we are today for new business. We're confident in terms of the new business that we continue to write, and, of course, Hong Kong benefits from a quality legal system and a good credit bureau which helps in the quality of the book.

MARK PHIN, HEAD OF INVESTOR RELATIONS, ASIA-PACIFIC: The other thing I would add, Gurpreet, is to look at our downside two scenario, which includes Hong Kong house prices down, as I recall, 22%, 23%.

TOM RAYNER, NUMIS SECURITIES: Could I just come back on costs, Ewen? You've talked through your plans for next year with Georges. I think Georges is going to be helped by the flowthrough from some of the cost savings put in place this year. I think you indicated $1 billion, so, if we were to look at the underlying cost rate in 2023 excluding the benefits of those cost savings, you'd be closer to 5%, or maybe above 5%.