Jeremy Warner's Outlook: Asian boom saves HSBC from US woes

Porsche is ill-advised to take on VW
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The Independent Online

The banking season drew to an ignominious conclusion yesterday with news of an eye-popping $17.2bn bad debt provision from HSBC for last year – far and away an all-time record for a UK bank. The shock of this truly humongous impairment charge is scarcely reduced by the fact that it had been well anticipated by banking analysts.

Yet just as remarkable is the parent company's ability to sail through these sub-prime storms with its earnings and top-line growth apparently unscathed. Pre-tax profits too were at record levels, even after absorbing a write-off which reduced American profits to virtually zero. In previous banking cycles, bad debt provisions of such size would have wiped out the entire company, making a rescue rights issue an absolute certainty.

This time around, HSBC emerges with its key capital ratios stronger than they were a year ago. Balance sheet growth remains at astonishingly high levels, with the bank in apparently rude health almost everywhere other than the US.

The story here is Asia, whose continued growth is more than compensating for the damage being inflicted by high exposure to the US mortgage market. Stephen Green, the chairman, would like these results to be seen as a vindication of the group's diversity and its deliberate targeting in recent years of emerging markets.

An equally valid way of looking at them, however, is that they illustrate just how ill-judged the acquisition of Household, the US sub-prime lender, really was. Even at the time, it looked to everyone else like a mistake. HSBC insisted it was a bargain, apparently oblivious to the old truism that when something is being sold on the cheap, there is usually a very good reason for it.

In any case, without the strength of HSBC's balance sheet behind it, Household would today be another Countrywide or even Northern Rock, and, without Household, HSBC would be up there with Standard Chartered as one of the undisputed stars of the banking scene. There would be no activist investors agitating for strategic and management change, and Mr Green would be fêted as a hero, rather than chided as a miscreant.

US woes are still far from over. Gone are the days when banks were allowed to make general provisions for ill-defined future bad-debt experience. Yesterday's write-offs were only for bad debts already sustained. Experience this year is likely to be equally bad, if not even worse.

The only redeeming feature is that, perhaps curiously, HSBC's exposure to the mortgage-backed securities which have created such havoc with other banks is relatively modest. HSBC managed to avoid that one. Instead, it is directly exposed to a large amount of sub-prime mortgage lending.

Still, to repeat that overused New Labour cliché, we are where we are, and there is not much HSBC can now do about Household other than attempt to manage it through. The idea floated by Eric Knight, the shareholder activist, that HSBC could cut and run is simply barmy. HSBC would be inundated with litigation if it attempted to hang bondholders out to dry in this way. It would also be demonised in international capital markets in a manner which made its continued ability to operate as a major global bank extremely difficult.

For better or worse, Household is there to stay. Eventually, when US consumer lending markets stabilise once more, it may even be worth a bob or two. In the meantime, HSBC must continue to fund its gigantic carrying costs – a microcosm, if you like, of what's been going on in the wider, global economy, with the developing markets of Asia and the Middle East funding the profligate spending of the US.

As a sop to the activists, HSBC has set itself a number of new targets, yet even in the present maelstrom of banking difficulties they hardly look stretching. Return on shareholders' equity is targeted across the economic cycle at between 15 and 19 per cent.

With the return last year, even after such massive write-offs, at nearly 16 per cent, this doesn't exactly look challenging. Nor too does the cost-to-income ratio range of 48 to 52 per cent. HSBC is already within that range, which is much higher than UK peers such as Royal Bank of Scotland, HBOS and Barclays.

As for the minimum capital target, that's actually been lowered from 8.25 per cent for tier one capital at present to 7.5 per cent. At a time when other banks are looking to strengthen their capital ratios, HSBC seems deliberately to be going the other way.

The purpose is said to be so as to give the flexibility for balance sheet growth, rather than to absorb further bad debt provisions. Even so. Capital strength was meant to be one of HSBC's key attractions. To be lowering the target in the midst of a banking crisis is a faintly odd message to be sending out, especially after such a spectacular bad debt provision.

Porsche is ill-advised to take on VW

The flurry of deals announced yesterday in the European auto industry makes some sense in terms of the rationalisation it ought to bring about among truckmakers, yet none whatsoever when it comes to Porsche increasing its stake in Volkswagen to a controlling position.

Every time a well-run, well-capitalised auto manufacturer buys a dog, the dog nearly always ends up eating or fatally wounding the company that's attempted to tame it.

The most notable example of this was BMW's acquisition of Rover. The "English patient", as the Germans stoically referred to their troublesome charge, brought BMW to its knees. In the end, it had to pay to get the plundering Phoenix Four to take the company off its hands. The same could be said about Daimler's acquisition of Chrysler. The merger was a disaster, and eventually had to be expensively unwound.

With the Porsche-VW deal, at least the two boards speak the same language, which ought to mean the cultural differences aren't quite so daunting. What's more, Porsche and VW are already deeply entwined. Ferdinand Piëch, the chairman of VW, is the grandson of the founder of Porsche, and retains a big stake in the company.

The two companies are also linked by history – Porsche designed the original VW Beetle under the Third Reich – and, even today, VW produces the platform which underpins Porsche's Cayenne SUV, one of its most profitable models.

Yet to dream of creating a new German champion of the global auto industry is a far cry from actually engineering one. Porsche is the world's most profitable luxury carmaker. VW is one of the world's least profitable volume car makers, and its brand, once a byword for reliability and excellence, is no longer what it was.

Competition from the Far East is going to make VW's task increasingly difficult. Porsche's management skills may in time bring about a necessary rationalisation of the European auto industry, yet, if the history of such marriages is anything to go by, it will almost certainly be at a very considerable cost to its own shareholders.

Luxury and volume cars are simply not the same business. That's one of the reasons Ford is getting rid of its expensively acquired premium marques. Only Tata, which is expected to complete any day now on the acquisition of Land-Rover and Jaguar, seems to share Porsche's view that it is possible to combine the two under common ownership. In Tata's case, it is only really pride and hubris which drives the ambition.

If you take in trucks as well, as the Porsche-VW alliance intends, then the potential for mismanagement grows greater still. There are echoes of the British car industry of 30 to 40 years ago in what Porsche and VW are trying to do. If they don't watch it, they'll end up in the same place – on the scrapheap.

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