Morgan Stanley research suggesting the U.K. bank should raise up to $40 billion may be alarmist. But having weathered the first stage of the crisis thanks to low leverage, diversified assets and strong liquidity, HSBC will be hit hard as the global downturn gathers pace. Morgan Stanley argues HSBC's capital position is weaker than it seems. Leverage looks reasonable at 28 times tangible assets, in line with J.P. Morgan Chase, while the Tier 1 capital ratio, an indicator of financial strength, is a solid 8.6%. But HSBC has significant exposure to toxic assets, including U.S. subprime mortgages that aren't marked to market, either because they are held directly on its loan book or because the U.K. regulator allows unrealized losses on certain assets to be written back for capital purposes. Morgan Stanley estimates HSBC's true leverage is closer to 50 times and Tier 1 is 4.6%, making it one of the most highly leveraged banks in the world. Associated Press This isn't entirely fair. Morgan Stanley notes that HSBC's U.S. consumer-lending exposure would need a $34 billion write-down to reflect market prices. But no bank marks its loan book to market. Meanwhile, its direct loans should prove higher quality than those in securitizations, and rock-bottom market prices partly reflect illiquidity. More fundamentally, Morgan Stanley's case is built partly on second-guessing what arbitrary capital-ratio targets regulators will demand. But a bank like HSBC with a loan-to-deposit ratio of just 88%, and a diversified asset base, can operate off lower capital levels than less-liquid rivals. Insisting on surplus capital well above that needed to absorb a pessimistic case for losses simply makes the bank less profitable. That said, HSBC should build a bigger cushion. As things stand, the bank should make gross operating profit of around $38 billion this year, enough to absorb the $27 billion of losses Morgan Stanley predicts on the assumption of a nasty recession. But that doesn't leave a large buffer against a doomsday scenario.
$41.33 (01/17/09)
