HSBC overstated assets by more than £50bn?

Article from UK-based Telegraph:

HSBC could have overstated its assets by more than £50bn and ultimately need a capital injection of close to £70bn before the end of this decade, according to an incendiary report published by a Hong Kong-based research firm.

Forensic Asia on Tuesday began its coverage of Britain’s largest banking group with a ‘sell’ recommendation, warning the lender had between $63.6bn (£38.7bn) and $92.3bn of “questionable assets” on its balance sheet, ranging from loan loss reserves and accrued interest to deferred tax assets, defined benefit pension schemes and opaque Level 3 assets.


The original article can be found here:

HSBC Holdings: End of the Charade

When it comes to HSBC, the Street cannot come up with enough disingenuous excuses for the group’s glaring problems – notably at the subsidiary level. In our view, HSBC has not made the necessary adjustments during the quantitative easing reprieve. Rather, it has allowed legacy problems to linger as new ones in emerging markets gather pace. The result has been extreme earnings overstatement, causing HSBC to become one of the largest practitioners of capital forbearance globally. This charade appears to be ending, given how few earnings levers remain besides selling off core elements of the franchise and the stringencies of Basel III compliance. We expect EPS pressures and dilution from capital increases to be high. A dividend cut may even be on the cards. SELL.

SIGNIFICANT ASSET RISK AND EXTREME CAPITAL NEEDS
HSBC Holdings (5 HK; HSBC or the Group) has overstated assets at the major subsidiary level to the tune of US$63.6bn-US$92.3bn, by our calculation, amounting to between five and seven years of results. Given this unaccounted-for level of balance sheet risk and the enormous increase in the Group’s Basel III/CRD IV capital requirements, we believe HSBC needs to raise between US$58bn and US$111bn in capital (depending on the implementation of a counter-cyclical buffer), representing 32-61% of current stated equity. Given how much new equity HSBC appears to need, a dividend cut or suspension is quite plausible.

12%-15% CORE ROE TARGET IS PURE FALLACY
It is a wonder how Group management can say to shareholders with a straight face that HSBC will achieve perennial operating ROEs of 12-15%. Here are our problems with Group CEO Stuart Gulliver’s target: (a) the numerous franchise disposals and accounting change should cause the Group’s 2012 mainland Chinese 15.1% bottom-line contribution to decline by 39% in US$ terms; (b) HSBC’s emerging market franchises are not faring well either, since not only has HSBC failed to take advantage of QE judiciously, allowing many of its legacy developed market problems to linger, but newly created ones in emerging markets are now building up; (c) if we are correct, the Group is likely to raise substantial capital and/or hive off parts of its core franchise; (d) we think HSBC faces up to US$10bn of additional legal and regulatory penalties; (e) high reliance (52% of pre-tax income) on low-quality and volatile trading seems unsustainable.

INITIATING COVERAGE WITH A SELL RATING
We formally launch coverage of HSBC with a Sell rating and set a price target of HK$63 per share, implying 25% downside. At face value, HSBC’s shares trade on a P/BV of 1.6x and a consensus P/E of 10.6x. HSBC also trades on a P/TBV of 1.4x. If our analysis is correct, HSBC now trades on a P/ATBV (adjusted tangible book value) ratio of 2.3x. Our price target implies a P/ATBV of 1.7x.