In with the new

HSBC: Behold the old HSBC. The UK lender ended the first quarter of 2011 with costs too high, returns too low, and pre-tax profit down 10 per cent, year on year. This says little about what lies ahead: for that, investors will have to wait for new chief executive Stuart Gulliver to unveil his strategic plans on May 11. But the lacklustre numbers serve as a reminder of how much there is to do.

The first priority must be to cut costs. HSBC’s expenses gobbled up 55 per cent of its income in the first quarter. That’s roughly in line with the ratio in the previous three months — which Gulliver branded “unacceptable” — and far beyond the 48 per cent the bank managed in 2009.

Lower costs would help HSBC boost its return on equity. While faring better than the dismal 5 percent showing of 2008 and 2009, the

11.4 per cent ROE in the first quarter remains below its target of 12-15 per cent.

The bank can also boost returns by using its balance sheet better. HSBC’s loan to deposit ratio is a conservative 78 per cent. Lending out 90 per cent of deposits, as Gulliver indicated HSBC could, would allow the bank to extend the equivalent of its entire Hong Kong loan book. Gulliver should have some tailwinds helping him out. A 1 percentage point increase in global interest rates would add almost $3 billion — or 11 per cent — to expected 2011 pre-tax profit, according to Morgan Stanley.

Finally, there is capital, which HSBC could be using more smartly. Basel regulatory reforms will shave some three percentage points off HSBC’s current Tier 1 capital ratio of 10.7 per cent. The North American consumer business, whose passing few investors would mourn, takes up over 6 percent of group capital, according to Barclays Capital. Then there is the $11 billion minority stake in Chinese insurer Ping An, which soaks up capital yet confers no control. Ping An's shares are stuck where they were two years ago.

None of these will be quick to turn around. But at least Gulliver’s mandate is clear. And with the shares 13 per cent below February’s high, there is obvious room for HSBC to improve.