By Sinead Cruise and Steve Slater
LONDON (Reuters) - No longer feared as "too big to fail", shareholders are weighing whether HSBC is now "too big to succeed", and want to know next week how the bank's bosses propose to increase profitability at a sprawling group beset by huge costs.
Investors believe CEO Stuart Gulliver and Chairman Douglas Flint need to announce bold moves to restore the London-based bank's flagging fortunes at a strategy day on June 9.
While shareholders accept not all their concerns will be answered at the meeting, they say no action can be too big to
debate, including a break-up of Europe's largest lender.
"This investor day is potentially a very significant event," said Chris White, head of UK equities at Premier Asset Management, which owns HSBC stock. "The world has moved against them and HSBC has to try to react to that. That is why we could end up seeing some quite radical surgery here."
HSBC largely had a less troubled global crisis than its peers, some of which were bailed out by governments fearing they could drag down the financial system due to their great size.
It needed no such help, partly thanks to its extensive global business which offset heavy losses in the United States and Europe. But it is the expense and difficulty of maintaining this global reach that is now worrying investors.
Tougher banking regulation imposed since the 2008-09 crisis has hurt HSBC deeply. Watchdogs have exposed weak supervisory links between some far-flung operations and the London central command of what once called itself "the world's local bank" to advertise its expertise in a wide range of countries.
HSBC has paid around $8.6 billion in fines for a series of compliance failures. These include allowing money laundering in Mexico and doing business with the likes of Iran, Libya and Sudan in violation of sanctions. Now it faces allegations that its Swiss private banking unit helped clients to dodge tax.
The bill for fines is modest compared with the $14 billion paid by Barclays or no less than $80 billion by Bank of America.
(For graphic, click http://graphics.thomsonreuters.com/15/bankfines/index.html )
But coupled with low interest rates, the soaring cost of ensuring compliance across more than 70 countries has put profitability and return targets under pressure and raised questions on whether such global reach is worth the expense.
VAST AND COMPLEX
HSBC's first-quarter pretax profit rose a better than expected 4 percent from a year earlier to $7.1 billion after a bounce in investment banking revenue offset the rising compliance costs.
HSBC doesn't publish a single separate figure for the cost of its regulatory programmes and compliance, which can include fines, legal advice and hiring staff to ensure it doesn't break the rules. However, it has said this was one of the reasons why adjusted group operating expenses rose 6.1 percent year-on-year in 2014 to $37.9 billion.
Analysts such as Thomas Stoegner and Ken Ang at Macquarie say the costs of running such a vast and complex global network have begun to overshadow any potential financial benefits.
"There is the risk that HSBC simply accepts to barely earn its CoE (cost of equity) just to keep the global empire together," they said, pointing out the high cost to investors and adding that it was "sleep walking towards a break-up".
At the Reuters Global Financial Regulation Summit last month Flint acknowledged the challenge to prove its worth.
"The challenge and the responsibility of management is to demonstrate that scale has benefits. You can make the case that it is good for customers but can you make the same case that it is for shareholders?" Flint said, accepting that investors were increasingly asking that question.
HSBC declined to comment for this article.
BOLD ACTION NEEDED
Gulliver has already pulled the bank out of 77 countries or businesses through sales or closures since becoming CEO just over four years ago. This has marked a notable departure from HSBC's long history of accelerating growth via acquisitions.
He has cut more than $5 billion in annual costs and Hugh Young, head of Aberdeen Asset Management Asia, a top 10 shareholder, said the bank needed to "go on tidying".
But others believe HSBC hasn't gone far or fast enough to shrink its $2.6 trillion balance sheet compared with Barclays or the bailed-out Royal Bank of Scotland.
"June 9th will be some of what the market wants but not all," said one of the bank's 30 largest investors, who declined to be named. "Rather, I would expect management to acknowledge an openness to further restructuring," he said, adding: "The range of views on the board means that nothing ever happens as quickly as the market would like."
HSBC is expected to update investors on progress in selling operations in Brazil and Turkey, and how it plans to overhaul its U.S. and Mexican businesses to pare back costs and improve returns.
But shareholders want to hear how Gulliver intends to wield the axe in global banking and markets (GB&M), the investment bank he ran for five years, particularly in its credit and rates teams, according to some analysts.
The bank declined to comment on a Sky News report on Monday that citing unidentified sources as saying it was planning between 10,000 and 20,000 job losses. It is unclear how many of those cuts have already been announced.
"THIS NO LONGER WORKS"
GB&M made $5.9 billion, or roughly a third of group profits last year, but it accounts for 42 percent of the bank's total assets on a risk-weighted basis. That gap is likely to widen as capital rules bite into trading activities, analysts said.
Moreover, GB&M's returns on risk-weighted assets (RoRWA) were just 1.2 percent last year and dragged group RoRWA to 1.5 percent, well below Gulliver's target of 2.2-2.6 percent.
Slashing the size of GB&M should reassure investors on the regulatory and compliance bill, which pushed group costs to 67 percent of revenues last year compared with a mid-50s target.
"The GB&M business was built for a prior regulatory environment. We have to have acknowledgement from HSBC that this no longer works and that something needs to be done about that," said Rob James, analyst in the UK equities team at Old Mutual Global Investors, another investor in the bank.
"Rather than the geographical split that has been mentioned, I think it is more reasonable to consider a functional split between wholesale and retail," he added.
Offloading uncompetitive regions and non-core businesses such as its principal investments portfolio should allow HSBC to devote greater resource to its strengths, namely its Asian and commercial banking business, investors said.
RoRWA in its Asian division have averaged 3.8 percent in the last three years.
Gulliver is also expected to address the question of whether HSBC should move its headquarters from to Asia, most likely Hong Kong, where it was based until 1993. Tax demands on British banks are rising while regulations will force them to separate their retail banking operations from 2019.
(Additional reporting by Lawrence White in Hong Kong and Matt Scuffham in London; editing by David Stamp)
