HSBC Holdings Plc's 2006 earnings were hurt significantly by its U.S. subprime mortgage business, and company executives and analysts seem hopeful that the business will return to profitability in the future, but for now the banking behemoth is less likely to pursue major U.S. acquisitions.
HSBC on March 5 
reported net operating income from its North American operations for the second half of 2006 of $6.15 billion, which includes a $4.62 billion loss from loan impairment charges and other credit risk. In comparison, net operating income for the second half of 2005 was $7.12 billion, which included a $2.89 billion loss from loan impairment charges and other credit risk. On a pretax basis, its U.S. personal businesses profits dropped by $725 million due to the poor performance of a portfolio of subprime mortgages purchased by unit HSBC Mortgage Services Inc.
Certainly, the news of a poor performance out of the subprime mortgage business was not shocking even if the magnitude of the losses was a surprise, particularly given the company's early February announcement that 2006 loan impairment charges and other credit risk provisions in unit HSBC Finance Corp. would be 20%, or $1.76 billion, higher than the consensus estimate of $8.8 billion. The bank said that the impairment particularly related to certain loans acquired in 2005 and 2006.
That news was followed a few weeks later by the announcement that HSBC would change up management of its North American operations with the resignation of then-CEO of HSBC North America Holdings Inc. and Chairman of HSBC Finance Bobby Mehta. Mehta was replaced by recently elevated HSBC Finance COO Brendan McDonagh.
HSBC also said that it named Paul Lawrence president and CEO of HSBC Bank USA NA and HSBC USA Inc.
In a March 5 conference call, Group CEO Michael Geoghegan attempted to clarify for listeners the types of subprime clients HSBC has served in the United States. He said that the average household income of the typical customer is $83,000, and the typical profile is a 41-year-old with two children and a house valued at $190,000. "The customer base is in line with the demographics of the USA," he said. "This is 'Main Street America.'"
Geoghegan added that "while trailer park lending makes for good headlines, frankly, it's not the customer base of HSBC Finance."
The executive also noted that HSBC is actively working to improve its U.S. subprime mortgage portfolios. Among other things, Geoghegan said that HSBC is stepping up its collections activity, strengthening credit oversight and curtailing the production of correspondent mortgage loans. He added that even though it may take two to three years to work out all of the problems, the company is committed to refocusing its business in the U.S.
Morningstar analyst Ganesh Rathnam told SNL Financial that he has no doubt HSBC will do what it takes to shore up its U.S. mortgage business, adding that the recent management shake-up of U.S. operations sends a signal to the investment community that HSBC considers fixing the segment a high priority.
And despite the headaches that no doubt lie before the company, Rathnam does not think HSBC would consider divesting the business. "Making mortgages, especially subprime mortgages, is a darn good business," he said.
In fact, Rathnam said that he expects profits within the bank's U.S. mortgage operations to bounce back to more historically consistent levels in 2007.
Still, Peter Shimkus, an analyst with Fitch Ratings who covers unit HSBC Finance, said that although the problems within the business were not a surprise, the magnitude of the losses was a bit unexpected, and he does not think HSBC is immune to the many challenges now facing the entire subprime industry.
"What HSBC has, though, is the ability to have a mix between subprime, nonprime, and close-to-prime mortgages to hopefully help balance their asset quality in the future," he told SNL.
The analyst was fairly sanguine about the company's future as it works out the problems, tightening underwriting and collection activity and, in time, improving the overall health of its mortgage book. "They've always been pretty good in terms of adjusting their underwriting and collection activities," he said. "But with this type of portfolio it will probably take a good year to year-and-a-half to work through."
With managers focused on fixing the mortgage business, HSBC may well be uninterested in U.S. acquisitions for the foreseeable future, people familiar with the bank's strategy told The Wall Street Journal. Citing someone close to the matter, the Journal said March 6 that HSBC had looked at a number of larger acquisitions in the United States during the past year but that its appetite has now changed.
Citing Finance Director Douglas Flint, the Journal reported that HSBC executives will be too busy with the mortgage problems to deal with the time commitment of a large-scale acquisition.
"If there was an opportunity that made enormous sense and we had unique capabilities to deliver on it, we would be foolish not to look at it," Flint said, according to the Journal. "But I have to say at the moment it would take a very, very special opportunity to want to allocate more scarce management resource to the U.S. when group resource and the U.S. resource is focused on dealing with the issues that we've got."
Chairman Stephen Green made similar comments during the bank's earnings conference call, speaking specifically to American bank deals. "As far as the U.S is concerned, I think it does follow from what we are saying that you shouldn't expect to see us doing a big bank acquisition in general banking in the U.S. market," he said.
