HSBC Holdings

HSBC's second-quarter pretax profit, excluding notable items, rose 13% year on year, supported by stronger banking net interest income and wealth fee income. Annualized return on tangible equity reached 19.5%. HSBC also announced a USD 1 billion share buyback.

Why it matters: HSBC fine-tuned its guidance to reflect modestly stronger banking NII and larger reorganization savings, but its medium-term growth targets remain unchanged. We updated our assumptions to reflect the latest results, but the impact on our earnings forecasts is immaterial. We now expect a more favorable rate environment for HSBC, as we believe the US Federal Reserve will delay rate cuts until 2027. Our updated forecasts also incorporate modestly stronger loan growth after lending activity in Hong Kong rebounded from several quarters of weak demand. We expect HSBC, one of Asia's leading wealth managers, to benefit from the region's structural wealth growth. We forecast average revenue growth of 6% over 2026-30, supported by growth in assets under management and improving product penetration.

The bottom line: We maintain our fair value estimate of GBX 1,490/HKD 158/USD 101 for narrow-moat HSBC, as the updated guidance and the USD 300 million gain from the sale of its Egypt retail banking business, scheduled to be completed in the second half of 2027, have limited impact on our valuation. We think shares are fairly valued. However, there could be upside if HSBC exceeds its 2028 revenue growth target of 5% (excluding notable items) as it accelerates planned investments from 2027 to support stronger long-term growth. In this bull-case scenario, we expect higher costs in 2027 as investment spending increases, partly offset by additional cost savings from ongoing restructuring initiatives. Management noted that investments will focus on core business pillars and are expected to generate returns relatively quickly.

HSBC's common equity tier 1 ratio increased by 100 basis points during the quarter, and management intends to deploy the excess toward dividends and organic growth. The resumption of a USD 1 billion buyback following the Hang Seng Bank privatization pause was in line with expectations and will reduce the CET 1 ratio by around 10 basis points in the third quarter. We forecast HSBC will reduce its share count by around 2% annually during 2026-30 through buybacks.

While investors have expressed concerns that tighter mainland China capital controls could slow wealth growth, management said recent account-opening activity has not been affected by the additional declaration requirements.

Second quarter annualized credit costs fell to 41 basis points from 52 basis points in the first quarter, as no additional provisions were taken for Middle East conflicts. Expected credit loss charges were mainly related to Hong Kong commercial real estate exposures. Management noted that conditions in the sector have stabilized, although charges continue to reflect valuation declines within the existing impaired portfolio. Full-year credit cost guidance remains at 45 basis points.

Following 15 announced exits since 2025, HSBC has launched a strategic review of its retail and domestic-focused small and mid-sized corporate banking operations in Turkiye, while its international wholesale banking franchise remains unaffected. We view this as consistent with HSBC's strategy of reallocating resources away from noncore businesses.

Our fair value estimate of USD 101 per ADR represents a 2026 price/book ratio of 1.9 times. We assume a cost of equity of 9.5%.

We assume reported net interest margins to remain under pressure through 2027, with a 4-basis-point decline in 2026 and 2027, before stabilizing thereafter. We expect this to partly offset average annual loan growth of 4%. Noninterest income is expected to grow at 9% on average, supported by a strong wealth management business. We assume credit costs to increase to 45 basis points of loans in 2026, partly due to preemptive overlays for the Middle East conflicts, before normalizing to 40 basis points from 2027. We assume that HSBC pays out around 50% of its core earnings as dividends and buys back 2% of its shares per year on average.

We assign HSBC a Morningstar Economic Moat Rating of narrow. We believe HSBC has a cost advantage based on funding costs in both its Hong Kong and UK operations, supporting a midcycle return on common equity of 16%, exceeding its cost of equity of 9.5%.

We previously assigned HSBC a no-moat rating, given concerns that operations outside Hong Kong would drag overall performance. We think recent organizational changes have lifted the group’s overall return on tangible equity and should alleviate such concerns. In October 2024, CEO Georges Elhedery announced the reorganization of operations into four business units: Hong Kong—which HSBC has pledged to make its top priority—the UK, corporate and institutional banking, and international wealth and premier banking. The restructuring aims to remove duplicated processes in the group and improve operating efficiency. HSBC aims to deliver USD 1.5 billion in cost savings through these initiatives, redeploying costs from low-returning activities toward HSBC’s strategic priorities. Separately, the bank has reviewed its global operations and made a number of exits in recent years. These include the underperforming ECM and M&A business in the US, the UK, and Europe, as well as some other lower-returning businesses in Europe. The group announced 11 exits in 2025 and is also reviewing some of its smaller retail operations, but will likely keep its existing wholesale footprint to maintain a global network to serve corporate customers’ cross-border needs.

We think the group’s Hong Kong operations enjoy a narrow moat, with a competitive advantage underpinned by its leading market position. HSBC, including Hang Seng Bank, accounts for 37% of Hong Kong's deposit share, compared with 15% for BOC Hong Kong, the second-largest bank in Hong Kong. The low-cost deposits contribute more than half of HSBC’s total funding base. This has enabled HSBC Hong Kong to consistently achieve an average cost of liabilities that is below that of smaller peers, translating into higher net interest income, boosting profitability. A strong deposit base would also translate into lower customer acquisition costs for the wealth management business, as it enables HSBC to capture wealth product cross-selling opportunities. The wealth management business tends to provide strong returns on equity, given its asset-light nature. We believe HSBC’s diverse product offerings in both the retail and wholesale markets also make it difficult for customers to switch the main bank relationship. This contributes to deposit and customer loyalty, which helps market leaders like HSBC to support its scale over time. As such, HSBC’s Hong Kong segment has seen a strong ROTE of over 30%.

The UK segment comprises HSBC’s ring-fenced bank, which we think also enjoys a narrow moat based on cost advantage. HSBC is one of the Big Four banks in the UK, which together hold the majority of the UK’s retail current account deposits. This allows the Big Four banks to enjoy below-peer cost of funding and to earn a spread on net interest income despite a generally competitive environment for household and corporate lending. HSBC’s UK operations have underperformed in the past decade, but we think that is related to the higher operating and regulatory costs in the UK system, such as the ring-fencing arrangement, UK banking surcharge, and bank levy. That said, we think conditions have improved, with the reduction of the UK banking surcharge to 3% from 8% in 2023 and the gradual decline in bank levy from 2016 to 2021. Alongside other cost-cutting initiatives, this has led to a meaningful improvement in the UK entity’s cost/income ratio. The UK segment ROTE has also improved to more than 20%.

The corporate and institutional banking and international wealth and premier banking segments consist of the group’s operations outside Hong Kong and the UK. In these geographies, we don’t see HSBC enjoying a funding cost-based advantage, as the bank does not possess the scale it has in Hong Kong and the UK. We also don’t think HSBC has an edge on operating costs, but the cost/income ratio is healthy at around 51%, supported by cost savings from the restructuring plan.

HSBC has cost advantages and significant intangible assets in its core market of Hong Kong that help it generate strong earnings there through economic cycles.

HSBC benefits from growing trade linkages between Greater China and Southeast Asia.

Wealth management offers a strong growth opportunity for HSBC in Asia.

HSBC has operations in many jurisdictions around the world, including some where it is a secondary player and doesn't enjoy the same advantages that it does in core markets like Hong Kong.

Given HSBC’s global reach, the bank is classified as a globally systemically important bank and is required to hold an extra 2% capital buffer, which could drag returns on equity, compared with smaller peers.

Geopolitical tensions and a trend toward derisking may make the combination of HSBC's Asian operations and its European ones less cohesive than in the past.