HSBC's Profit Rises but Regulators Weigh on Results

NEW YORK ( TheStreet) -- HSBC Holdings ( HBC) on Monday reported a significant increase in third-quarter profit, but also said its results were continuing to be weighed down by "ongoing regulatory uncertainty." Investors are responding positively to the company's news, lifting HSBC ADRs 2.7% to $56.68 at the opening of U.S. trading.

HSBC reported third-quarter profit before tax -- which excludes changes in fair value based on credit spreads, known as credit valuation adjustments (CVA) and debit valuation adjustments (DVA) in the United States -- of $4.53 billion, increasing 40% from $3.481 billion in the third quarter of 2012.

The company's third-quarter after-tax profit attributable to shareholders was $3.2 billion, or 16 cents a share, increasing from $2.498 billion, or 13 cents a share, a year earlier.

Operating expenses were down 4% from a year earlier, to $9.572 billion in the third quarter; however, HSBC said expenses excluding extraordinary items were up, "reflecting higher investment expenditure, wage inflation and litigation and regulatory-related costs."

Following other large international banks, HSBC said it was cooperating with investigations of foreign exchange trading by the British Financial Conduct Authority (FCA) and other regulators.

During the third quarter, the company paid $147 million to UK customers as part of an agreement with regulators to settle an investigation of its sale of payment protection insurance (PPI). Other "customer redress" items weighing on third-quarter results included $132 million to customers who purchased interest-rate hedging products, under a 2012 agreement with regulators, and $149 million to wealth management clients.

On a much brighter note, the company said it was making better-than-expected progress in cutting costs. HSBC CEO Charles Gulliver in the company's interim management statement said the firm generated "an additional US$0.4bn of sustainable savings over the quarter," bringing total annualized "sustainable savings achieved since the start of 2011 to US$4.5bn."

HSBC's cost efficiency ratio for the third quarter was 63.6%, improving from 70.6% for the third quarter of 2012. The efficiency ratio is, essentially, the number of pennies of overhead expenses incurred for each dollar of revenue. For the first three quarters of 2013, HSBC's cost efficiency ratio was 56.6%, improving from 61.2% a year earlier.

HSBC said its return on equity for the first three quarters of 2013 was 10.4%, improving from 8.9% a year earlier.

Gulliver said "Hong Kong performed well in the quarter, reflecting broad-based revenue growth," and that the territory "continues to benefit from its close economic relationship with mainland China." He also said the continued housing recovery in the United States and "increased investor appetite" could accelerate the run-down of HSBC's U.S. loan portfolios.

The company continued to build regulatory capital, with a core Tier 1 capital ratio of 13.3% as of Sept. 30, increasing from 12.7% in June. "Internal capital generation of US$2.6bn and favourable foreign exchange movements of US$2.4bn contributed to a total increase of US$4.8bn in core tier 1 capital," HSBC said.

Investors can look forward to an additional boost in capital during the fourth quarter, and a related decline in risk-weighted assets, through the sale of the company's operations in Panama during October, resulting in "an estimated gain of US$1.1bn."

HSBC's American depositary receipts trading on the New York Stock Exchange closed at $55.21 Friday, returning 9% this year. The ADRs trade for 13.1 times the consensus 2014 earnings estimate of $4.21 a share, among analysts polled by Thomson Reuters.

Based on a quarterly payout of 50 cents, the ADRs have a dividend yield of 3.62%.

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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