Or Is It Just In Dire Financial Straits?

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

Global banking behemoth HSBC is not having a good 2015, despite celebrating its 150th anniversary. It has been implicated in even more scandals than usual, faces a 5% increase in dividend costs in its adopted home country, the UK, and has decided to lay off another 25,000 workers worldwide. It’s also selling off its Brazil and Turkey units and is even threatening to up sticks from the City of London and move its headquarters back to Hong Kong.

Which begs the question: why such drastic restructuring? More to the point, why now?

Back to the Past

According to HSBC, the move is aimed primarily at restoring investor confidence. Its decision to sell its operations in Turkey and Brazil forms part of a strategic reorientation toward East Asian markets, where HSBC originally cut its teeth 150 years ago (laundering the proceeds from the British East Indian company’s opium trade, as I documented here), and where margins are currently much higher than in Brazil and Turkey.

HSBC’s loss of interest in the Brazilian and Turkish markets is down to two main factors, according to Foreign Policy magazine: first, both markets are slowing down at an alarming rate; and second, they don’t offer the same get-richer-quicker opportunities available in the more unequal markets of the East:

In Brazil, assiduous redistribution by the governments of Luiz Inácio Lula da Silva and Dilma Rousseff has, for all their faults, evened out the income distribution to a historic degree. In Turkey, income inequality is also lower than it was when HSBC made its big acquisitions.

In both of these countries, there are more potential customers for HSBC than ever before. The problem is that they’re not the most lucrative customers. People just starting to climb the economic ladder don’t need a lot of special services, and their savings are so small that their accounts are relatively expensive for a bank to maintain; most banks would rather manage one account worth $100,000 than 100 accounts worth $1,000.

HSBC is no exception. In the Far East, even as China braces for a potentially bumpy landing, the opportunities are far greater. In Hong Kong, China, Singapore, and Malaysia, growth is steady, interest rates are low and inequality is high – and still rising. Big companies are getting bigger, as are the services they need and the fees they pay. In other words, it’s a banker’s paradise.

Chinese Pivot

The nexus of HSBC’s Chinese operations is the Pearl River Delta, an area just north of Hong Kong whose blistering growth over the last 15 years has helped it leapfrog Tokyo to become the world’s most populous urban area, with an estimated 42 million inhabitants in 2010. According to the IMF, the region has an annual gross domestic product of $857bn, which would rank it 17th in the world if it were a country, just below Indonesia.

The Pearl River Delta already accounts for half of HSBC’s total China revenue. As Reuters reports, despite the potential risks posed by a dramatic slowdown in China, the bank plans to quadruple its headcount in the Pearl River Delta and step up its lending to mid-sized companies in the infrastructure and real estate sectors.

In other words, HSBC is banking on the mother of all Chinese pivots, as was all but confirmed by news out Friday that the UK-based bank (for now!) had decided to end its sponsorship of Markit’s EM PMIs. According to some insiders, the bank’s decision to disassociate itself from the least government-controlled and hence most accurate market index in China was almost certainly a political one.

As one unnamed source told The Australian Financial Review, “If you are a sizeable bank that wants to do more business in China, you don’t want to make parts of the Chinese government angry. Sponsoring the survey is likely to affect your future business expansion in China.”

Signs of Desperation?

As HSBC pins its future on a slowing China and does all it can to keep the country’s neo-communist government happy, one can’t help but ponder its motives. Is it acting out of pure desperation? Are financial pressures building below the surface? Has the world’s local bank exceeded the limits of geographic expansion, not to mention the boundaries of acceptable financial criminality?

According to a 2014 report by Hong Kong-based research group Forensic Asia, HSBC could indeed be suffering from serious balance sheet woes. Titled “HSBC Holdings: End of the Charade,” the report alleges that the bank larded its balance sheet with “questionable assets” in the range of $63.6 billion to $92.3 billion; meaning, it would have to raise between $58 billion and $111 billion by 2019 to meet the new capital requirements.

That’s a hell of a lot of money, especially given that in the coming years HSBC faces billions of dollars in additional fines for a whole litany of crimes. They include helping tens of thousands of global businesses and individuals avoid/evade taxes, for which the bank faces criminal investigations in a number of countries including France, Belgium, Switzerland and Argentina.

So, could the once-almighty HSBC be teetering on the edge? Is it dumping its assets en masse in a frantic attempt to stave off collapse, or more likely the mother of all bail-in/bail-out combos? It’s not out of the question. Let’s face it, the world’s biggest, “most systemic” banks are too-big-to-fail for a reason.

However, while things may not look good on the surface and probably look a whole lot worse below it, the balance sheet reality of TBTF banks like HSBC has mattered little during this post-crisis period. Thanks to the unfathomable complexity of modern finance and the wonders of mark-to-model accounting, the so-called “reality” of a bank’s financial health is a purely subjective phenomenon.

As such, perhaps something else altogether lies behind the bank’s recent actions.

A Tactical Withdrawal

Retreat is often the trickiest of military maneuvers. This is particularly true of banks that have poured billions of dollars into fast growing markets only to see the dream turn sour – as appears to be happening right now with Brazil [Brazil Just Getting Worse and Worse] and Turkey. Both countries are slowing down economically and heating up politically, just as the world’s hot money begins to get seriously cold feet.

If the Federal Reserve does the unthinkable and raises interest rates this autumn, what began as a steady outpour of investors from emerging markets could quickly become a tsunami, just as happened in Mexico’s Tequila Crisis. The dollar’s surge, like rising interest rates, makes it more difficult for emerging nations and businesses to pay down their dollar-denominated debts. In the meantime emerging economies’ main engine of growth – commodities like oil, copper and soy – has fallen off a cliff. It’s a triple whammy.

As such, perhaps HSBC is acting less out of fear than out of a mixture of heightened caution and opportunism, banking on the continued long-term rise of the Chinese economy as well as increasingly turbulent conditions in other emerging markets. If so, the bank’s recent actions merit much greater scrutiny. After all, the bank did not get to where it is today – i.e. at the top of its game 150 years after its founding – merely by bending the laws of just about every jurisdiction on the planet. Institutionally speaking, it remains both flexible and astute and can read the ebb and flow of international markets better than just about any other player.

Contrast that with the financial institutions that are doubling down on their bets in high-risk emerging markets, many of whom are relative upstarts on the global scene. They include Spain’s BBVA and Santander (here and here, in Spanish), which are intent on expanding their already massive exposure to Turkey and Brazil, perhaps even by acquiring HSBC’s operations there. It seems HSBC is worrying about something that these banks don’t. By Don Quijones, Raging Bull-Shit.

Even now, the collective madness grows. Read…  The Five Horsemen (and One Horsewoman) of Europe’s Monetary Apocalypse

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