Is HSBC Holdings plc Set To Fall Another 20%?

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 it’s not just HSBC that’s exposed to China’s 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 China’s economy does suffer a hard landing, it’s unlikely any banks operating in the region will be able to avoid the knock-on effects. 

Overweight

HSBC and Standard Chartered both derive a significant portion of their revenue from China. For example, during the first-half of 2015, 69% of HSBC’s group profit before tax came from Asian operations. HSBC’s first-half profit jumped 10%, thanks to an investing frenzy in Hong Kong among individual customers. 

With this being the case, HSBC’s success is highly dependent upon Chinese economic prosperity. A 10% decline in pre-tax profit from HSBC’s 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 the carry 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 HSBC’s share price, as it becomes increasingly apparent that the bank won’t be able to escape the Chinese crisis. 

That said, City analysts still believe that HSBC’s earnings per share will expand by a double-digit percentage this year. Current forecasts suggest that HSBC’s 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 HSBC’s outlook, the market is telling a different story. Specifically, HSBC’s low valuation and a dividend yield of 6.6% both indicate that the market is concerned about the bank’s outlook. 

Until HSBC can prove that it’s not suffering from the Chinese economic slowdown, it’s difficult to justify paying a premium for the bank’s 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 HSBC’s capital reserves could disappear very quickly. It’s 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. 

What’s more, even after falling 16% during the past month, HSBC’s shares still look expensive compared to the bank’s international peers. Citigroup Inc, HBSC’s closest international peer, currently trades at a forward P/E of 8.5.