“Welcome to the world of ‘Bullism’ where sooner or later everything at some point will be a buy!”
That’s an unusually hefty dose of cynicism from a City analyst. Marc Smart at Citigroup was reacting to yesterday’s surge in global stock markets.
On the one hand, a weaker-than-expected reading on Chinese manufacturing was taken as good news. Why? Because it means the Chinese will stop tightening monetary policy.
Meanwhile, US manufacturing growth slowed down too. But it slowed by less than expected. So that was good news too.
And then there was the good news from HSBC…
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HSBC has come through for the bulls
HSBC is one of the very few banks that can still hold its head up in public. It’s ironic. A profit warning from HSBC in early 2007 – the first in its history – was one of the first major red flags of the pending subprime crisis. The shock warning was down to the badly-timed purchase of US consumer credit business Household.
The bank took a real pasting from critics at the time. But within a very short space of time, HSBC’s subprime mistakes looked positively irrelevant compared to the idiocy of its rivals.
It probably helps that its chairman Stephen Green had a good crisis. An ordained minister, he’s managed to walk the tightrope between God and Mammon with impressive skill. He hasn’t exactly played to anti-banker sentiment, but he has been publicly on the right side of the debate when it comes to talking of a general need to change the financial system.
In any case, HSBC came through for the bulls again yesterday. Pre-tax profit for the first half doubled to $11.1bn. That was ahead of analysts’ forecasts.
But as the FT’s Lex column points out: “falling bad loan provisions did most of the hard work in HSBC’s first half.” Overall revenues actually fell a little – Andrew Lim of Matrix Corporate Capital went so far as to describe the results as “poor quality”. The main boost to profits was the fact that impairment charges for loans not being repaid on time almost halved, falling by $6.5bn on last year.
And in any case, the business formerly known as Household “remains a deadweight. North America still accounts for almost three-quarters of total impairment charges in HSBC’s global retail banking book.”
Why things are just ‘less bad’, not good
It’s a similar story to that told by the US manufacturing figures. Things have got ‘less bad’ rather than improving dramatically.
Actually generating growth is going to be a lot harder. HSBC is a nice big safe bank. On the one hand, that’s a good selling point to nervy customers. But on the other, it’s not great for profitability.
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One problem that HSBC has is that interest rates are so low. The reason the bank is seen as so ‘safe’ is that it has a high ratio of deposits to loans. In other words, it makes sure it gets enough savings deposits in the door, before it lends money out to those who want to borrow.
But it doesn’t lend all that money out – the loan-to-deposit ratio is below 80%. While it’s hanging on to capital that could be deployed elsewhere, low deposit rates mean it’s not earning much of a return.
That said, the bank isn’t keen to adopt some arbitrary lending target – certainly not at the behest of the British government. As chief executive Michael Geoghegan put it: “Lending targets might give short-term comfort but they can create long-term problems.”
It makes sense for banks not to lend during such uncertain times, as my colleague Merryn Somerset Webb recently pointed out: Banks deserve criticism for bad service – but not for refusing to lend.
And there’s plenty of evidence to suggest that sound businesses would rather pay down debt than take more on. As Allister Heath points out in City AM this morning, “small firms hold a record £56bn on deposit. HSBC’s corporate overdraft utilisation rate has fallen to 42% from 44%.” In other words, people aren’t taking advantage of existing facilities.
We’re in a “classic bear market”
And it’s hard to see what’s going to change this in the near future. The economic outlook is still extremely uncertain. As Geoghegan himself points out to the FT, we’re in what he calls “a classic bear market”, which will have “this ‘Oh my God’ sense’” for some time.
In Britain, the lingering post-election optimism has to be tempered by concerns over the impact of government spending cuts. Meanwhile, the US economy is still suffering from rampant unemployment and the likelihood of a double-dip in the housing market.
We’ll no doubt see more solid-looking figures this week as banks stop fretting quite so much about dodgy debts. But of course, if the wider economy takes another turn down, then those impairments could well start to pick up again.
We’ll have more on the banks’ results in the next issue of MoneyWeek out on Friday. And in the current issue, you can read James Ferguson’s take on why the European banking system in particular will have difficulty boosting lending for a long time to come: Bank stress tests: everyone wins, everyone loses (if you’re not already a subscriber, subscribe to MoneyWeek magazine.)
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