HSBC Holdings (LSE: HSBA) has been described as being perilously exposed to China after the bank began its retreat from other emerging markets earlier this year.
And its not just HSBC thats exposed to Chinas slowing economy. In total, at the end of 2014 UK banks were exposed to over $198bn in Chinese assets and Chinese cross-border claims on its residents total $1trn. Simply put, if Chinas economy does suffer a hard landing, its unlikely any banks operating in the region will be able to avoid the knock-on effects.
Overweight
HSBC andStandard Charteredboth derive a significant portion of their revenue from China. For example, during the first-half of 2015, 69% of HSBCs group profit before tax came from Asian operations. HSBCs first-half profit jumped 10%, thanks to an investing frenzy in Hong Kong among individual customers.
With this being the case, HSBCs success is highly dependent upon Chinese economic prosperity. A 10% decline in pre-tax profit from HSBCs Asian arm will lead to a 7% fall in overall group pre-tax profit.
Carry trade
One part of the Chinese crisis that City analysts are becoming increasingly worried about is thecarry trade, a practice where wealthy individuals borrow money from banks in Hong Kong, to invest in China for a higher rate of interest. It is estimated that this market is worth up to $200bn and a rapid unwinding if markets fell could lead to a widespread Asian financial crisis.
According to City reports, concerns about the carry trade have pushed some hedge funds to place bets against HSBCs share price, as it becomes increasingly apparent that the bank wont be able to escape the Chinese crisis.
That said, City analysts still believe that HSBCs earnings per share will expand by a double-digit percentage this year. Current forecastssuggest that HSBCs earnings per share will jump by 15% to 52.2 for 2015, which means that the company is trading at a forward P/E of 9.6.
However, while City analysts are optimistic about HSBCs outlook, the market is telling a different story. Specifically, HSBCs low valuation and a dividendyield of 6.6% both indicate that the market is concerned about the banks outlook.
Until HSBC can prove that its not suffering from the Chinese economic slowdown, its difficult to justify paying a premium for the banks shares. Moreover, while HSBC reported a tier one capital ratio in excess of 11% earlier this year, with over $2trn of assets on its balance sheet, if the market moves against the bank then HSBCs capital reserves could disappear very quickly. Its more than likely that HSBC will cut its dividend payment to save cash in the near future. Indeed, it looks as if the market is already pricing in a cut.
Whats more, even after falling 16% during the past month, HSBCs shares still look expensive compared to the banks international peers.Citigroup Inc, HBSCs closest international peer, currently trades at a forward P/E of 8.5.
Dividend plays
HSBC could be forced to slash its dividend payout if China’s economic growth grinds to a halt.
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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.