2015 is already shaping up to be an expensive year forHSBC Holdings(LSE: HSBA) (NYSE: HSBC.US). After setting aside billions last year for the payment of fines and misconduct charges from regulators last year, this year the bank is facing yet more fines and the additional cost of ring-fencing. All in all, these costs will hold back the banks growth.
Ring-fence costs
UKs new ring-fencing regime is designed to protecttaxpayers from future financial crises and requires that large, systematically important banks, such as HSBC andBarclays, separate theirhigh-street branch operations from investment banking activities by 2019.
The separated operations must have different boards of directors, different IT systems and not reliant on each other for vital services. Essentially the rules require banks withmore than 25bn of deposits to spin-off retail operations.
According to the Treasury, these reforms will costall banks involved 1.8bn to 3.9bn each year, with an additional one-off cost of 500mto3bn. The bulk of these costs will fall on the UKs five main banks, HSBC, Barclays, RBS, Santander and Lloyds, although Lloyds is now applying for an exemption to the rules. HSBCs management has stated that ring-fencing will cost the bank 1bn to 2bn.
Even though 2019 is still four years away the ring-fencing will take time and plans are already being drawn up. The BoE has asked banks to submit plans for ring-fencing by today.
Yet more costs
Unfortunately, the cost of ring-fencing is just one of the many factors that is set to hold HSBC back during the second half of this decade.
Indeed, the bank missed third-quarter earnings expectations last year after being forced to set asidemore than $1.6bn to cover the cost of legal settlements and customer compensation. These costs facing the bank are only set to increase over the next few months.
Specifically, alongside third-quarter results Stuart Gulliver, HSBCs chief executive, noted that the banks costs would remain elevated for the foreseeable future.Additionally, Gulliver told analysts that HSBC was now walking away from its target to have a cost-income ratio mid-50s by 2016. Instead he said the ratio would be in the high 50s. This unravels much of the work HSBC has done over the past few years to lower costs and boost profits.
For example,since taking the position three years ago, Stuart Gulliver has sold or closed around 60 of HSBCs businesses, 40,000 jobs have been axed and over $5bn was wiped of HSBCs operating cost bill during 2013 alone.
But now, costs are now increasing within the compliance and legal division at a rate of around 25% per annum. Undoing much of the hard work thats been accomplished throughout the rest of the bank.
Low valuation
HSBC will struggle to boost profits with costs rising during 2015, however, the banks valuation is attractive. At present the bank trades at a forward P/E of 10.2, below the FTSE 100 average P/E of around 15.
Still, when compared to its global peers such asBank of AmericaandCitigroup, HSBC appears to be reasonably priced.Bank of America and Citigroup currently trade at forward P/Es of 11.8 and 9.7respectively. Both of these international banking behemoths are currently facing the same regulatory pressures as HSBC.
Overall, rising costs and a fairly average valuation lead me to conclude that HSBCs shares will stagnate during 2015. That being said, HSBCs impressive dividend yield of 5.3% is hard to pass up, although this payout could be cut if costs continue to rise.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
