HSBC shares unlikely to evade attraction of 545p

Updated 1335 GMT

HSBC earnings quality should be the biggest focus

HSBC’s 2014 results show that the quality of its earnings has taken a hit that’s just as significant as its declining income.

The market was already well attuned to this risk–embodied by 2014 return-on-equity (ROE) retreating to 7.3%, from 9.2% and cost efficiency ratio slipping to 67.3% vs. 59.6%–and that’s why the stock has been trending lower since 2013.

So the 17% drop in pre-tax profit for the year, not to mention damaging press allegations that the bank helped clients to evade taxes, are grim, but in fact in line with expectations.

It’s the risk that compliance costs could spiral higher in keeping with the widening regulatory horizon facing the bank around the world that is justifiably spooking investors more.

This has been underlined by HSBC guiding in its full-year report today that ROE would be “more than 10%”, having previously targeted ROE between 12% and 15%.

The market responded by wiping more than $9bn off the value of the bank’s equity, sending the shares almost 6% lower.

Flat revenues were the best news from 2014

On an adjusted basis, profit before tax was broadly unchanged, but HSBC is obliged to report pre-tax profit for the year at $18.68bn; leading to earnings per share of 69 cents.

The latter was light of consensus forecasts that foresaw EPS of $0.837, according to data provided by Thomson Reuters.

The dividend per share at 50 cents was closer to forecast but still short of the market’s $0.512 target.

Total revenues at $62bn, coming in just $148m higher than the year before turns out to be one of the few relative positives in these numbers.

Strategic contrition

Obviously, the bulk of public attention will be on allegations that the bank helped wealthy clients to evade taxes—but the most important aspect of this, from investors’ point of view, is the impact on HSBC’s operations.

HSBC said it would pay or set aside $1.187bn in “connection with foreign exchange investigations”.

For the year ahead, provisions for litigation costs and increased compliance related to alleged tax evasion in countries including US, France, Belgium and Argentina, can surely be expected to be of a similar order.

Regarding recent alleged wrongdoing HSBC said in its full-year statement Monday: “We deeply regret and apologise for the conduct and compliance failures highlighted which were in contravention of our own policies as well as expectations of us”.

This is in keeping with tone struck by the bank in comments and responses over the last month to several damaging press articles.

It suggests HSBC has decided to adopt a contrite stance to the newest regulatory challenges it faces, even though in legal terms, many of the allegations are unproven at best.

Many appear unlikely to reach the courts and those that do are likely to be trapped by legal process for at least a year.

HSBC’s wary eye on US DoJ

HSBC will of course be aware that the tax evasion allegations are prime territory covered by the powerful and far-reaching US legislation covering the financial behaviour of its citizens, enshrined in the Foreign Account Tax Compliance Act.

Obviously, the markedly apologetic tone HSBC has adopted won’t save it from US Department of Justice action, if the DoJ is minded to act.

But the bank’s attitude could help decide how much it is fined, if a fine becomes likely.

In a potential DoJ prosecution, a scenario likely to be far more embarrassing and operationally painful than legal action involving any other country, scrutiny on HSBC’s CEO, Stuart Gulliver would increase.

For the moment, whilst Gulliver has in the last 24 hours been personally drawn into taxation allegations, we do not anticipate pressure on his office has increased to a level that’s critical, given that the revelations are of practices that are entirely legal.

Still, HSBC share price loss of more than 5% compared to Friday’s close reflects not just the flaccid operational performance of the company under the weight of several factors that the market had assumed the bank had handled better.

It also probably reflects the market’s distaste for the distraction engendered by the tax allegations and the risk that they may bring further disruption.

With the shares having breached all viable support on a weekly basis, its long fall from 2013 highs is unlikely to be broken at current levels.

The closest region at which prices were last buttressed is around 545p, with the stock having battled around similar levels for much of 2012.

In the daily timeframe, trading in City Index’s Contract for Difference in HSBC now looks attenuted by the extent of the sell-off it reflects in the underlying equity.

However, the attached Slow Stochastic ‘reversal’ system, which was devised strictly around stochastic principles suggests there may even remain further room on the downside, albeit a moderate amount.

The system’s ‘slow’ (blue) moving average would need to cross back above the ‘fast’ yellow line whilst both are beyond the lower bound of the channel in order to give a signal for the trade to ‘bounce’.

That has not quite happened yet.