China could be on the verge of a banking crisis, and crises of that nature are not good news for bank shares. HSBC (LON: HSBA) has massive exposure to China and Hong Kong; the circumstances don’t look good for HSBC shares. But then again, history shows that in times of a crisis, shares are often over-sold, creating opportunity. As a former Lord Rothschild is supposed to have said, “The time to buy is when there is blood on the streets, even if the blood is your own.”
On the other hand, remember 2007 and 2008. Throughout 2007 the news on banking was unremittingly bad, the credit crunch deepened, there was a run on Northern Rock, bank shares fell and fell some more. There was metaphorical blood on the streets, yet 2007 was not the time to buy. In 2008, the financial crisis got worse until October when a full-blown banking crisis rocked the global economy, and bank shares fell much further.
The HSBC dividend
Whether HSBC shares are a good buy boils down to the HSBC dividend and related possible share buy-backs. On August 2nd HSBC announced an interim dividend of 5.123p a share. The bank is expected to pay two dividends this year, and its previous dividend was 10.792p. So, assuming the bank matches that dividend next time, its annual dividend for this year will be a tad short of 16p.
HSBC shares have fallen 21 per cent since early May. At the current share price and assuming a 16p dividend for the year, the dividend yield is now 4.4 per cent. However, in each of the four years, 2015, 2016, 2017 and 2018, HSBC dividends were around 2.4 times greater than my projection for dividends this year.
On the assumption that post-Covid, HSBC shares return to normal, we get the enticing prospect of a dividend yield of around ten per cent, based on the current share price.
The bank has also recently hinted at the prospect of share-buy backs.
Evergrande is China’s second-largest property developer, and it appears to be close to collapse. If it were to collapse, as happened with Lehman Brothers in 2008, the resulting financial contagion could push the Chinese banking sector to its knees. I don’t need to tell you that such an event would be bad news for HSBC. The bank has a common equity tier 1 ratio (CET-1 ratio) of 15.6 per cent so that it can withstand a big shock to its balance sheet, but even so, a full-blown banking crisis in China will hit HSBC hard.
According to the FT, HSBC has actually increased its exposure to Evergrande bonds since February. According to Bloomberg data, HSBC holds $206.9m in Evergrande bonds. However, the bank has a market cap of £74 billion, its Q2 pre-tax profits were US$5.1 billion, so its direct exposure to Evergrande does not seem too onerous.
Of more concern is that 5.5 per cent of its US$119.5bn of gross corporate real estate lending relates to Hong Kong.
Lehman or LTCM
On paper, then, HSBC would not be seriously damaged by even an outright collapse in Evergrande, but if we learned nothing else from the 2008 crash, we learned that when one major player falls, it can create devastating contagion.
If China suffers a banking crisis, as the West did in 2008, it is extremely difficult to envisage a positive outcome for HSBC shares.
And there are reasons to be pessimistic about China’s debt exposure in the longer term. Private sector debt in China has increased from around 120 per cent of GDP 10 years or so ago to 180 per cent.
An alternative view is that the Evergrande crisis will not be like 2008, more like 1998 when crisis beset the giant hedge fund Long Term Capital Management. Under the leadership of Alan Greenspan, the US Federal Reserve orchestrated a bailout, and financial contagion was avoided.
You might disagree with their ideology, but there is no doubting that Chinese leaders are clever. They have observed the history of finance in the West and understand the implications of a full-blown banking crisis in China. Most analysts think a 1998 LTCM crisis type scenario is more likely than a 2008 Lehman crisis scenario. If that view is right, and I suspect it is, then I would say the HSBC dividend is likely to carry on rising over the next few years, creating a very attractive yield.
I am, however, concerned about the underlying challenges with the Chinese property market and I think HSBC’s exposure could be a problem in the long term.