A strong run in 2016 madeHSBC (LSE: HSBA) the banking sectors top performing stock for the year its shares were up 22% against a rise of 9% for the sector. Despite its weak earnings trend and growing dividend concerns, investors warmed up to the banks shares following the Brexit vote and the associated fall in the value of the pound.
Looking forward, here are the factors to watch out for in 2017.
HSBCs restructuring efforts will continue to be high on the agenda in 2017. Given macroeconomic headwinds in its core home markets of Britain and Hong Kong, HSBC needs to make significant cost savings to deliver a turnaround in its earnings trend and offset the impact of rising loan losses and slowing revenue growth.
Green shoots of success are already beginning to show from the banks cost saving programmes with a 4% fall in operating costs reported for the third quarter of 2016, but significant further improvement is needed if the bank is to succeed in lifting its return on equity to exceed its cost.
The bank intends to achieve $4.5bn to $5bn in annual cost savings by exitingunprofitable markets and plans to reduce its risk-weighted assets to the tune of$290bn by 2018. It has so far already successfully completed the sale of its Brazilian retail operations and achieved close to $3bn of annualised cost savings last year, but its difficult to see where further cuts are going to come from. Room for further cuts seems limited and itmay find itself stuck with a choice between losing customers or withdrawing from more markets.
2016 FY Results
On an adjusted basis, revenue growth in 2016 is likely to have outpaced cost growth to produce a positive jaws ratio for the first time in many years. However, profits for the full year will likely come below the previous years figure and so earnings will likely have declined for the fourth consecutive year. Thats because, despite improvement on the cost front, loan losses have been steadily rising while profits from associates and joint ventures have been on the decline.
This trend of declining earnings is of particular concernbecause the macroeconomic environment could become more challenging this year. The overhanging economic uncertainty over the UKs future relationship with the EU will likely continue to act as a drag on GDP growth and cause a whole range of problems for the bank, including interest rates staying lower for longer, slower loan growth, and higher credit losses.
Ill be carefully watching out for the trend in loan losses as things already dont look pretty. Adjusted loan impairment charges (LICs) were up 66% to $2.2bn in the first nine months of 2016, and they dont seem to have peaked.
Whats more, the tough earnings environment doesnt bode well for its dividend sustainability. Dividend cover is currently at very dangerous levels (less than 0.7 times), meaning the banks shareholders will likely continue to worry about HSBCs dividend outlook.
With a relatively strong capital position, HSBC may continue to pay its dividends out of capital for some time. But over the longer term, these dividendconcernsarent going anywhere unless the bank delivers on aquick turnaround in profitability.
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Jack Tang 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.