HSBC (HBC) Needs Capital

At least, that's what Morgan Stanley thinks. Yesterday (1/14/09), they came out with a pretty big research note on HSBC (HBC), saying they think HBC will need up to $30 billion in equity and will need to halve its dividend. The note comes a day after our post highlighting interesting record options activity in HSBC, where we mentioned HSBC's lack of equity raises amidst the current crisis. Also worth noting per UK regulatory disclosures, hedge fund Eton Park Capital ran by Eric Mindich has had a short position in HSBC for many months. We recently covered Eton Park in our hedge fund portfolio tracking series where we examined their long holdings here.

With 57% of their loans in the US and UK, HSBC is definitely exposed to trouble, despite being a true international bank. Morgan Stanley thinks HSBC has one of the weaker capital ratios in Europe and the second weakest in Asia, and will face problems for the next two years.

An excerpt from Morgan Stanley's report,

"We have reduced our 2009 PBT forecast by 34%, which equates to a 39% drop in EPS and flows through to a 32% fall in 2010. We now forecast 2009 EPS of US55¢ and 2010 of US50¢; 46% and 60% below FactSet consensus, respectively. We have reduced our price target to 455p from 550p previously.
...
In 2007 HSBC paid out $10bn in dividend. Since 1992 investors have on average elected to take 26% of the dividend in scrip. Analysing the history suggests investors become more risk adverse in times of distress, and in our view it would be imprudent for the management team to assume an average take up in 2009 and 2010. If we combine this with our estimate of the capital requirement discussed above, a sharp reduction in attributable profits in 2009 and 2010 as structural and cyclical headwinds take hold (2009: $6.6bn, 2010: $6.2bn), it suggests to us that HSBC will cut its dividend in 2009.
...
Post a $20bn capital increase and a 50% dividend cut, we calculate HSBC would carry a clean Core Equity tier 1 of 7.2% (stripping out the AFS and insurance double counting), which looks reasonable given historical HSBC capital ratios and broadly in line with the recapped Santander, which has 7.1%. [Note Santander is not allowed to add back its €3.8bn AFS reserve, which equates to 80bp of capital]."

While HSBC might have weathered the subprime thunder relatively speaking, it seems as if they are still not out of the storm. As we highlighted in our January 13th post on HSBC, they have the oh-so-fun mix of leverage, large writedowns, and low capital raised. Add record options activity on top of that and things start to get interesting. We also highlighted the $45 level as a "make or break" level for HSBC on technicals. Wednesday at the open it gapped down below it. While a re-test of $45 from the underside is probable, things could get ugly for HBC shares.

Full disclosure: At the time of publication, MarketFolly was short HBC via puts
Links: Marketwatch, FT Alphaville

HSBC (HBC) Interesting Options Activity

While we usually leave all the options coverage for some of our other favorite blogs, we simply had to point out this interesting activity in HSBC (HBC). Optionmonster has highlighted the fact that as of yesterday (1/12), HBC "traded 173,000 puts versus average of 7,700 puts over the past 30 days. Crazy busy, and 94 percent trading out in March." Activity was mainly in the March contracts at the 50, 45, and 40 strikes. If it continues to escalate, they said the activity would remind them of that once seen in Lehman Brothers and Bear Stearns. They also noted that it was the largest put activity in that name, ever.

And, today (1/13), the put activity continues, as the March 25's are starting to see volume. As you can see from the chart below, HSBC (HBC) is in a strong downtrend and is trading around $45 currently, a level of recent support. If it breaks this level, then look out below.

(click to enlarge)

We have highlighted HSBC (HBC) as a short on the blog numerous times. Back in August, we noted that delinquencies were rising across the board and the best way to play it would be to short institutions with lots of leverage, derivative exposure, or residential and commercial mortgage exposure. Our post on August 31st, 2008 suggested shorting C.B. Richard Ellis (CBG), General Growth Properties (GGP), Capital One (COF), Discover Financial (DFS), HSBC (HBC), and Washington Mutual (WM). Obviously, shorting all of those names has paid us off handsomely.

GGP and WM both collapsed rather quickly. However, all along, HSBC (HBC) has been meandering along, trading sideways. In our post on September 16th, 2008, we looked at writedowns, losses, and capital raised for various institutions. At that time, we noted that,

"One institution in particular I want to point out is HSBC (HBC): $27.4 billion in writedowns and losses, but only $3.9 billion raised. They by far have one of the more lopsided ratios. Now, we obviously know that this simple chart does not tell the whole story, but I thought it was worth highlighting."

Then, in October, signs of weakness started to appear as the market turmoil continued. Our post on October 8th, 2008 highlighted various Leverage Ratios of financial institutions. In that post, we saw that HSBC's leverage ratio (total assets/equity) was 20.1 as of June 30th 2008, an increase from their ratio of 18.4 in 2007. At the time, we saw that HSBC (HBC) loosely had this deadly mix: use of leverage, large writedowns, and low capital raised.

HSBC has been in a downward spiral ever since. And now we see news of interesting options activity in the name. While we by no means think HSBC is in as bad of shape as a Lehman or Bear, we do think rough waters are in store and that is why we've highlighted them as a short numerous times in the past. Proceed with caution, as the $45 support level is more important now than ever.


Full disclosure: At the time of publication, MarketFolly was short HBC via puts

Writedowns, Losses, and Capital Raised

Amid all the financial chaos, I thought it would be a good idea to post up a simple chart breaking down the financial landscape in terms of writedowns, losses, and capital raised. From Bloomberg, you'll see how institutions are looking in terms of raw numbers: writedowns/losses versus capital raised. One institution in particular I want to point out is HSBC (HBC): $27.4 billion in writedowns and losses, but only $3.9 billion raised. They by far have one of the more lopsided ratios. Now, we obviously know that this simple chart does not tell the whole story, but I thought it was worth highlighting.

(click to enlarge)

Full disclosure: At the time of publication, MarketFolly was short HBC via puts