HSBCÆs share price is continuing a freefall which saw it lose almost 15% during the course of last weekÆs trading, as fears mount that the financial situation at the bank is deteriorating. Sentiment across banking stocks has also been adversely affected by profit warnings from Deutsche Bank and Royal Bank of Scotland in Europe and worse than expected results from Citi and Bank of America in the US. But for HSBC specifically, its share price getting battered caps a week of bad news related to the UK-headquartered bank itself.
Activist investor Knight Vinke on Sunday agreed with recent research issued by Morgan Stanley and Goldman Sachs that HSBC ôhas a substantial and worsening capital shortfallö and that HSBC is poised to announce a substantial rights issue, perhaps the largest ever made in the United Kingdom. The underlying reason, cited by both Knight Vinke and the brokerage firms, is the worsening situation at Household International, HSBC's subprime lending business in the United States.
Knight Vinke also asked two London Business School professors of finance, professors Franks and Acharya, to comment on the issues it raised at HSBCÆs annual general meeting in May last year and attached the said comment to its January 18 statement. Among the observations made by Franks and Acharya is that HSBC rewards managers ôfor increases in return on equity and earnings per share without taking into account economic leverageö and that the risks this entails ôis unlikely to align management and shareholder interests and may cause them to divergeö. The academics go on to postulate that both ROE and EPS are short-term measures, they provide short-term horizons for decision-making and may encourage managers to destroy rather than create shareholder value.
While some might argue that Franks and Acharya are stating the obvious, it is now generally agreed that the structure and mechanism of compensation at investment banks is at least partly to blame for the balance sheet issues they all currently face.
Knight Vinke has been a critic of HSBCÆs bonus scheme and payouts since 2007.
On Friday, Goldman Sachs issued research on HSBC downgrading its shares to a sell, following a similar recommendation earlier in the week from Morgan Stanley research.
Goldman Sachs updated its financial forecasts for HSBC and is now predicting that profits for 2008 will be $13 billion, down 31% year-on-year. The research also estimates that HSBC will make a $1.5 billion loss in 2009. The downturn in performance is attributed to increased delinquency, mortgage/consumer credit loss assumptions and loss projections for Household International.
Goldman Sachs goes on to estimate that HSBC needs to recapitalise by $17 billion to improve its tier-1 capital to 7% in 2009, cushion forecast losses, enable it to continue paying dividends and remove the negative overhang on the shares.
But even the measures proposed by Goldman Sachs may not satisfy Knight Vinke. On Sunday, in advance of HSBCÆs statement yesterday, Knight Vinke made clear its disdain for HSBCÆs insistence that it is well-capitalised, saying: ôHSBCÆs capital structure is much weaker than would be suggested by the tier-1 ratio, a regulatory metric, which is all that its management ever talks about. As shareholders of Citi, UBS, Barclays and soon Deutsche Bank will know to their detriment, having a strong tier-1 ratio is absolutely no guarantee that additional capital will not be required.ö
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