HSBC's major move into the US pays off - for the time being

Doubters forced to rethink as controversial Household investment boosts bottom line

It is barely 12 months since HSBC, the high street bank, swerved off the steady course it shared with its major UK competitors, by swallowing a massive consumer finance business in the US which caters for people with poor credit histories.

Yet yesterday, HSBC revealed in its figures for 2003 that Household International, headquartered in Illinois, already appears to be injecting extra life into the group, contributing $2.2bn - or 15 per cent - of its $14.4bn of pre-tax profits excluding goodwill write-offs and doubling the bank's total customer base to more than 100 million worldwide.

Indeed, when Household and HSBC's other major acquisition, Mexico's Bital bank, are stripped out, its profits for the past 12 months rose by a far more muted 7 per cent.

Sir John Bond, the chairman of HSBC, whose preferred method of communication is measured understatement, declared himself pleased with the progress of the deal. Household had, he said, "achieved synergies and overall results ahead of our original business case".

HSBC, well-known in the City for its conservative business culture, stunned investors when it revealed in November 2002 that it wanted to hand over £9bn of shareholders' money for Household, which specialises in lending money to people on low incomes, often with histories of bad debts.

At the time, especially British analysts were not convinced by HSBC's argument that the deal provided a hefty footprint in the US, or that it could use its massive balance sheet and strong financial rating to raise capital cheaply, which it could then use to finance Household's high-margin loans, with the result being hefty profits.

Instead, analysts were open-mouthed in their surprise that the bank would choose to take on the risks of massive potential bad debts. There was also astonishment that HSBC would risk damaging its brand by attaching itself to a business which was being sued in several states for allegedly subjecting some customers to a life of debt because of rates of repayment that were so high.

The deal has not been without its embarrassments for HSBC. At the height of the row between companies and investors about "fat-cat" pay last year, Sir John was forced to defend the decision to grant William Aldinger, the chief executive of Household, a deal which could see him receive $37m over three years - plus free dental care for life for him and his wife. HSBC has also had to pay out more than £300m in court settlements over its lending policy.

But one year on, and Sir John appears to be winning many of the arguments with the investor community at least. Despite revealing yesterday that HSBC wrote off an unprecedented £3.25bn for bad debts in 2003 - most of which was on Household's riskier loan book - investors did not react with panic. Fox-Pitt Kelton wrote in a note that "bad debts were a little bit better" than its forecasts.

One banking analyst said: "When they first announced the Household deal, people were very nervous, but we have had a chance to look at the business now, and are more comfortable with it."

HSBC has always argued that while Household's typical customers in the US might not have much money, their behaviour is predictable, so it is easy to control the level of bad debts. Much easier, HSBC has pointed out, than trying to hedge against the multi-million dollar losses which can accrue the instant a corporate loan to the likes of Enron goes wrong.

One of the secrets of Household's success in the US - where it had grown to be one of the largest consumer finance businesses - has been its ability to predict how many loans will turn sour with a less than 5 per cent margin of error. What may make Household a truly transformational deal for HSBC is that it ought to provide numerous opportunities for leveraging off its customer base in other parts of the world.

The bank has, in the past few months, set the 150 or so people with maths PhDs at Household to apply their science to Brazil and Mexico, two countries where HSBC has invested heavily and where it believes the proportion of the population who want banking services will explode within a generation.

Moving into consumer finance makes particular sense for HSBC, which already makes 75 per cent of its profits outside the UK, as the emerging middle classes tend to start off by taking out loans for cars and household goods before moving on to mortgages and credit cards.

Another project HSBC has lined up for the coming year for Household, it revealed yesterday, is to move into "near prime" lending - the "white space" between the two sides' traditional markets.

Such a move would inevitably shave some of the margins off profits accruing from Household. At the same time, however sophisticated Household's modelling, the health of its business clearly depends on the ongoing robustness of US consumers.

So far, the outlook is clear. The bank reported that it did not see any strain in the behaviour of the vast majority of its customers, and economic data from the US suggests key indicators, such as the job market, look encouraging.

But, analysts pointed out, the picture could change - a move which could at least tarnish the shine of the Household's deal impact on HSBC's P&L.

Mark Thomas at Fox-Pitt said: "In the credit conditions of today, the market is very relaxed. But HSBC has a higher risk profile than other banks so if the view changes about credit quality, those lending it money will start to charge it more."

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