HSBC is raising equity through a rights issue (see my Basic Concepts post on rights issues).  At over $17 billion, it is the largest in the history of the UK stock market.  Given this size, the damage any rights issue can do to a stock’s price and management’s denial of the need for a capital raising last October, the issue must be of utmost importance to HSBC.  Why is the company raising this massive amount of new capital?

Cynics say that the true reason is that the damage from buying subprime consumer lender Household International (including Beneficial Finance, too) is far greater than the bank cares to disclose.  It’s worth looking at why the bank says it’s raising money, however, since their reasons would have important implications for the banking sector over the coming decade.

First, HSBC points out that the banks rescued by their home governments will likely end up with the strongest balance sheets in the industry.  They will, in theory at least, have a powerful competitive advantage over banks which have not needed rescuing, unless those banks also strengthen their capital–as HSBC is now doing. 

The second reason has, I think, a lot more implications for investors.  HSBC figures the governments which have ploughed huge amounts of money into their banks (this includes the US, UK, France and Germany) are not going to allow that capital to be used as the the foundation for loans outside the home country.  And they are going to armtwist the banks to lend, not just keep it parked on the balance sheet for just in case.  

Two implications:

The rescue markets may turn fiercely competitive, as newly-healed banks strive to keep out of the regulatory hot seat by making loans  (we’re already starting to see how ugly the US hot seat can be).  This will be great for non-financial enterprises in those countries.  Ready availability of credit at low prices will make the areas preferred destinations for any global business to set up manufacturing or service operations.  But it’s not so great for bank profit growth.

Also, assume we thought the major commercial banks that might have a history of and might want to lend overseas have roughly zero capital apart from what their governments have given them.  Therefore, those banks would have roughly zero ability to do so.  This leaves the field wide open in the developing world for banks like HSBC.  In fact, these markets may be more profitable than before because there will be less competition.

A professional investor will ask himself three questions in response to what HSBC is saying:

       1. Does the market believe this is true?

       2. Do I believe this is true?

       3. (Probably the most important!) Do I need to have an opinion about this?

I think the answer to #1 is no.  I think the market is still trying to sort out which banks will live and which will die.

#2?  I have no idea, although what HSBC is saying sounds plausible.

#3.  There are really two issues here.  Do I need to own a bank?  Maybe I can just avoid the industry or, if I’m a relative performance person, mimic the index, thereby eliminating stock-specific risk.  If I do have to own a bank, however, then, all other things being equal, I should own a bank in an emerging market.

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