HSBC: 'Shrink and simplify'

A year after HSBC unveiled its $14bn acquisition of US subprime lender Household in 2002, Sir John Bond, the bank's then chairman, penned an irritated memo to some of the group's top managers.

"The message was clear," recalls one of those managers. "He was telling us not to mess with Household. He didn't want us going out there trying to impose our way of doing things on a business we didn't understand."

For HSBC, this was a radical departure. The bank had done a few acquisitions in the past - most notably the UK's Midland Bank a decade earlier. But the model had always been: do the deal; parachute in new management; fix any problems.

Sir John not only increased the number and scale of HSBC's acquisitions. He also changed tack, diversifying into subprime lending (Household), previously unexplored markets (Mexico's Bital) and Swiss private banking (Republic/Safra).

But the model of buying businesses outside HSBC's core areas of expertise - and then leaving them to their own devices - has caught up with it in a catastrophic way.

Those three deals alone have landed HSBC with tens of billions of dollars of losses from US subprime mortgages, a $1.9bn fine for financing Mexican drug cartels and, most recently, an admission of facilitating tax evasion and aggressive tax avoidanceon an industrial scale for clients of its Swiss operation.

The result? Stuart Gulliver, HSBC's chief executive since 2011, is under attack on multiple fronts. Politicians and regulators are furious about the string of scandals. At the same time he faces growing pressure from investors to reverse declining profitability and boost an underperforming share price. Some have called for heads to roll. All in all, the bank's annual shareholder meeting tomorrow seems certain to be fiery.

The challenge, says a person close to the HSBC leadership, is twofold. "We have to persuade everyone we're not too big to manage. But we've also got to convince everyone we're not a bunch of crooks."

Exiting emerging markets

Back in 2006, when Sir John retired, he was widely lauded for having transformed HSBC from a predominantly Asian lender into a truly global group, trebling its staff numbers to almost 300,000, expanding into 82 countriesand increasing assets fivefold to $1.9tn. But where once HSBC's size was seen as a source of strength, it now looks more like a handicap.

So much so that Mr Gulliver is preparing to announce a retreat from some of the big emerging markets that Sir John took the group into, including Brazil and Turkey. He has told colleagues he will redouble efforts to make Europe's biggest bank "simpler and smaller".

After HSBC's creation as a single branch on the Hong Kong waterfront 150 years ago, it is shrinking back to its roots. Accelerating the cutbacks of the past four years, Mr Gulliver's fresh strategy will focus on paring back its retail and investment banking operations in Latin America, Europe and the Americas, where increasing costs have been a drag on the group's highly profitable Asian business. Hopes are also pinned on a long-awaited rise in central bank interest rates - a boost to profits for most banks, and particularly HSBC, which is awash with currently unproductive deposits.

Mr Gulliver, who has been stung by personal attacks from politicians over his non-domicile tax status and his use of offshore structures in Panama and Switzerland, is set to announce details of his strategic plan on June 9.

Interviews by the Financial Times with six of HSBC's top 20 shareholders reveal that, while most support the general direction of Mr Gulliver's strategy, several say the bank would benefit from a more radical approach, and an injection of new blood in the boardroom.

"There are long-term problems that have been brought into focus by recent events," says Jessica Ground, global head of stewardship at Schroders, a top 20 investor in HSBC. "I do think Stuart Gulliver gets what the problems are and he's trying to sell businesses and simplify it . . . but it does take time."

A recurring criticism is that HSBC's conservative culture - based on the Scottish Presbyterianism of its founders - has been undermined by the acquisition spree overseen by Sir John and his successor as chief executive and chairman, Lord Stephen Green.

For much of its history, the bank functioned like a financial offshoot of the UK diplomatic service. Country managers - mostly white British men - were drawn from an "international officer" training programme, sent out east and given autonomy over local operations.

Mr Gulliver, himself a product of that scheme, has apologised for the Swiss tax evasion affair, admitting it is a "source of shame". But he also complained that banks were being held to a higher standard than the military or the church and argued it was impossible to know what all his staff were doing, while trumpeting his own overhaul of the bank's culture and controls.

"I have completely restructured it," he told the UK Treasury select committee in February. "We used to be run as 88 separate countries, reporting into the CEO. We used to be run basically with individual country fiefdoms."

Becoming chief executive was the realisation of a 30-year dream for Mr Gulliver, who was born in Derby, educated at a state school in Plymouth and joined HSBC, aged 22, straight from reading law at Oxford university. By 2003 he was running the group's expanding investment banking unit and had become one of the best paid bankers in the world.

Yet even as he assumed the CEO role, his long-held hopes of taking HSBC to the next level and sealing a landmark acquisition were fading as the bank's past misdemeanours came back to haunt him.

Mr Gulliver's response in 2011 was to attack HSBC's bloated cost base. Five performance filters were used to decide which business lines were worth retaining. After the Mexican debacle, a sixth was added to weed out operations that could be reputationally or ethically problematic. It all added up on paper. In practice it has not. Pre-tax profit last year was an impressive sounding $18.7bn, but that has dipped since Mr Gulliver took over. Shares in the bank have fallen 8 per cent during the 56-year-old's time in charge, underperforming the MSCI world banks index by more than a fifth.

Wrestling with complexity

Investors and policy makers complain that the bank is still too complex. Today the market favours simple domestically focused lenders, such as the UK's Lloyds Banking Group or Wells Fargo in the US.

"There is huge complexity at HSBC and massive costs, which puts the bank under a lot of pressure," says Vincent Vinatier, portfolio manager at Axa Investment Management, a top 20 investor in the bank. "With global international trade volumes down, you have to ask yourself is there enough volume in the system for HSBC to make things work."

Almost $8 in every $10 of pre-tax profit that HSBC made last year came from Asia and the lion's share of that came from its dominant Hong Kong business. Analysts say that outside the region only commercial banking, and the UK retail arm, really hold their own.

"HSBC makes a supernormal return on equity of something like 35 per cent in Hong Kong," says one investor. "Anything else is going to dilute that."

Decades of trying to keep up with the likes of arch rival Citigroup by planting flags across the world before the financial crisis hit in 2008 has left HSBC with big overheads. The bank still employs more than 260,000 people in more than 70 countries even after ditching its slogan of being the "world's local bank", cutting 50,000 jobs and retreating from some retail banking markets.

"Stuart Gulliver has never been a particular fan of retail banking outside of Hong Kong and the UK," says a former senior HSBC executive. "When you try to overlay a global model on to what is essentially a local business, it has proved to not be very profitable."

Mr Gulliver this year abandoned his target for bringing costs down to about half of net operating income before loan loss provisions - at the last count they were above two-thirds. He has complained that every year regulation and compliance add an extra $1bn to its $40bn-plus cost base.

"Banks have become too damn complicated," says James Laing, deputy head of UK and European equities at Aberdeen Asset Management, a top 10 shareholder in the bank. "They have become a mix between IT businesses, consumer protection agencies and policemen searching for money launderers, which puts a huge cost burden on them."

Big banks have had to invest billions of dollars to update their technology. They are racing to stay ahead of criminals, hackers and terrorists trying to infiltrate the financial system, while trying to meet customers' growing appetite for the latest mobile banking services.

"Stuart Gulliver certainly did the right thing when he took over to cut it down into a more manageable business," says Nigel Wilson, chief executive of Legal & General, another top 10 shareholder in HSBC. "As with all financial firms, technology and costs are two key areas that need attention - investors are expecting him to address those areas."

Douglas Flint, chairman, warned last year that the regulatory clampdown and large fines levied on banks were introducing "disproportionate risk aversion" among staff.

More than many rivals, HSBC also faces big bills and disruption to implement structural reforms required by regulators following the financial crisis. It has had a run-in with the Bank of England over pressure to fund itself through a central holding company rather than via subsidiaries around the world, as part of a drive to make big lenders more easy to wind up in a crisis. And it has complained that new ringfencing rules are forcing it to undertake a costly split of its UK retail banking and US operations into financially separate units.

Plotting a future path

At the same time, the UK government has introduced and repeatedly raised the rate of the "bank levy". The quirks of this balance sheet tax mean it hits HSBC hardest - last year the bank stumped up more than a third of the £2.2bn raised across the industry. Each increase further boosts the argument in favour of the bank quitting the UK to return to its previous headquarters in Hong Kong.

L&G's Mr Wilson says it would be dangerous for the UK to lose its last truly global bank - after drastic restructuring at Barclays and Royal Bank of Scotland . "The world in 20 years is going to be dominated by a few big banks and we should be encouraging HSBC as a big, successful, British bank to be among them," he says. "Making it smaller won't necessarily make it more successful - the problem is complexity."

Some of HSBC's less supportive shareholders bemoan what they see as a downbeat mood within what is still in many ways a thriving bank. One asset manager says the bank lacks the fighting spirit of US rival JPMorgan. The US bank's chairman and chief executive Jamie Dimon has told investors that its scale generates $15bn in cross-selling benefits and $3bn in cost synergies.

"Jamie Dimon makes a compelling case as to why scale matters and yet HSBC presents scale as a millstone," says the investor, who wonders whether Mr Gulliver's plan to announce more cuts in June is "just about addressing the embarrassment" of having missed his previous targets.

A combination of growing defensiveness at the bank and the political pressure following the scandals has made waves in the boardroom. Efforts have begun to hire a number of new non-executives and bolster governance structures though so far HSBC has managed to avoid the rivalrous warfare that preceded the accession of Mr Gulliver and Mr Flint in 2011.

Suggestions that Mr Flint might have to step down to placate angry politicians and investors have died down. Besides, investors wonder who could handle the complex demands of the role. "There are fewer people capable of chairing a systemically important bank like HSBC than are capable of landing on the moon," says Mr Laing at Aberdeen.

But the fate of HSBC's leadership, like the outlook for the bank's financial performance, now hangs on Mr Gulliver's June plan, and whether a bold new blueprint can turn round the flagging spirits of Europe's biggest bank.

Additional reporting by David Oakley, Henny Sender and Jennifer Hughes

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