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HSBC Offers a Peek At Subprime

The size of the bank's expected writedown Wednesday could be a clue about the credit markets.

Investors concerned about how bad the subprime crisis is -- and how long it may continue to destabilize world markets -- may begin to get an answer on Wednesday when HSBC (HBC) reports third-quarter earnings, say market participants.

But opinions differ widely, with some forecasting an easing of the effects of the subprime debacle when HSBC announces, while others see it as only halfway through.

Last week, the U.K.'s

Sunday Telegraph

reported that the bank will announce $1 billion in additional writedowns from its U.S. mortgage business when it announces third-quarter results. Earlier in the year, HSBC announced additional provisions of $2 billion for losses related to subprime loan debt.

Others say the writedowns may be larger still, with those at the most bearish end citing figures up to an additional $2 billion. Exactly how big that number is will be a sneak preview of how bad things may get in the U.S. mortgage market going into 2008.

"I cannot see any good news out of this," says John Wadle, Asian regional banks analyst for UBS in Hong Kong. "On Wednesday, the question is just how bad it's going to be."

But Wadle says that if the writedown is within the expected range of a further $1 billion, the market will take this as a signal that the subprime woes are finally manageable for both HSBC and other banks.

"My suspicion is it will only be $1 billion dollars," he says. "If it's $1 billion, people will say banks will muddle through, but if it's $2 billion then the market will have to conclude it's a very, very painful cycle."

On Monday, Morgan Stanly downgraded shares of the global banking giant to "underweight," putting a price target of 800 pence on its U.K. shares. In the U.S., HSBC ADRs have fallen 9.6% since the beginning of the month, to $87.47.

And HSBC has increased provisions for bad loans by 63% so far this year, to around $6.4 billion in the first two quarters alone, according to



This has some money managers forecasting further losses for HSBC, and in turn, more pain for U.S. banks in general.

"You saw provisions of $2 billion earlier, and I think it's very likely you will see an increase of that," says Jeroen Knol, a global fund manager for ABN Amro in London. "You have seen


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also taking charges -- it's actually a moving scale because it's still ongoing."

Knol does not own HSBC shares, but looked at investing in the bank last year and decided against it. He cited "uncertainty over U.S. exposure, which was a big chunk of the business mix."

Subprime mortgages make up an estimated 12% of the $10 trillion U.S. mortgage market, with losses on the risky mortgage loans about halfway into the credit cycle, according to ABN Amro.

Many money managers say that while U.S. banks have tended to over-provision for those future losses, in Europe there remains an under-provisioning that could still spill into global equities.

In the U.K. in particular, rumors have been circulating on the floors of hedge funds that building societies -- financial institutions in the U.K. that offer banking and mortgage lending -- may be more laden with outstanding loans than previously thought.

Another aspect to HSBC's results investors will be scrutinizing is just how much the bank is exposed to the U.S. mortgage market. This is significant, say analysts, because one potential plus for U.S. equity markets might depend on to what degree businesses in Asia can offset domestic stateside housing pressures.

The more HSBC is exposed, the more likely it is that the spread of knock-on effects of subprime losses will be felt globally, in unaffected markets.

UBS's Wadle says that the key questions for investors in HSBC will boil down to whether it can make provisions without eating into dividends. He predicts shares in the bank to fall by 5% in the near-term, and that any further declines of up to 5% in the stock would only be caused by a further $2 billion writedown.

But that type of scenario is not so unrealistic, adds ABN's Knol. He points out that a lot of business for HSBC is generated through the "agent channel, which is harder to control."


$1 billion is a bit on the low end. If you know HSBC management, they are quite conservative -- they will probably have to take a bigger charge," he says.

Daniel M. Harrison is a business journalist specialising in European and emerging markets, in particular Asia. He has an MBA from BI, Norway and a blog at

. He lives in New York.