As Banks Regroup, HSBC Shows Why Boring Isn't Bad
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Thrifty, Cautious Institution Weathers The Hard Times by Avoiding Hot Trends
By ERIK PORTANGER Staff Reporter of THE WALL STREET JOURNAL
LONDON -- Earlier this year, Krishna Patel, head of equities and corporate finance at HSBC Holdings PLC, summoned his top lieutenants to talk about bonuses for 2001.
It had been a tough year. The global stock-market slump had left HSBC's equities and corporate-finance units with a loss of $112 million. No one expected the bank to be overly generous. But Mr. Patel, who is 53, had some surprising news on that gray February morning: The bank wasn't giving cash bonuses to anyone in his division. Instead, the best-performing staff members would receive HSBC shares, which they couldn't sell for three years.
"I hope you're kidding," one staffer said. Mr. Patel wasn't, and in the next few weeks dozens of HSBC's best analysts and corporate financiers walked out the door.
For almost any other bank with a significant global corporate and investment-banking business, scrapping cash bonuses for the star performers would be unthinkable. But HSBC, the world's second-biggest bank by stock-market capitalization, after Citigroup, has thrived while flouting many of the industry's recent trends. It hasn't sought to pump up growth by acquiring investment banks. It has worked to keep a lid on costs and bad loans and conflicts of interest. It reports only one set of results, and they are the bottom line -- not the "pro forma" variety that excludes lots of "special" items. It doesn't cultivate star analysts or bankers. It doesn't pay stratospheric salaries.
The bank's corporate culture is still infused with the cautious principles -- mainly thrift, teamwork and lending conservatively -- of Thomas Sutherland, the Scotsman who founded the bank in Hong Kong in 1865. "We are cautious about businesses that rely too much on individuals," says Sir John Bond, HSBC's chairman. "They lead to ever-increasing demands from those people that they need more of the profits."
Once mocked as hopelessly old-fashioned, these days HSBC offers a persuasive argument for not running with the herd. The sour economy, accounting scandals and their own questionable practices have played havoc with many banks that pushed the envelope on both commercial and investment banking. Credit Suisse First Boston and J.P. Morgan Chase have had to deal with bad loans, soaring costs and regulatory scrutiny. Citigroup has been under a months-long investigation into activities at the parent company and its Salomon Smith Barney securities-firm unit. At issue is whether Salomon published overly optimistic research on telecom stocks during the market bubble of the late 1990s to win lucrative investment-banking contracts, misleading investors who bought these shares.
By contrast, the dull but probe-free and steadily profitable conservatism of HSBC looks pretty good. The London-based bank reported net income of $3.28 billion for the first half, down 7.3% from the year-earlier period mainly because of higher bad-debt provisions after two years of global economic weakness. Since the beginning of the year, HSBC's stock has fallen a relatively modest 6.7%. J.P. Morgan Chase's stock has plummeted 78.4%, and Citigroup's shares are down 31.9%.
HSBC isn't trouble-free. It still relies heavily on its old home base, Hong Kong, a small and currently depressed market that contributed 35% of this year's first-half pretax earnings of $5.06 billion. (Europe provided 40%, North America 12%, and Latin America and the rest of Asia made up the balance.) The bank has had to make substantial write-downs on corporate loans in Argentina, which has been in recession since mid-1998 and has defaulted on billions in debt.
And despite all the current woes of Citigroup and those who follow its model, the jury is out on whether that strategy is fatally flawed or is simply going through a tough patch. By one yardstick, Citigroup is doing well: In terms of return on equity, a measure of how profitably the bank uses shareholder equity, Citigroup shone at 19.9%, compared with 11.8% for HSBC.
Moreover, HSBC's refusal to coddle investment bankers could make it hard to hire good people when the market recovers. Similarly, its decision not to bulk up in equities and corporate finance means it can't hope to match the sophistication of such investment banks as Goldman Sachs Group Inc. and Morgan Stanley in those areas when the markets are healthier.
Reliable Flow
Still, HSBC's low-risk businesses pump a reliable flow of money to the bottom line. It has strong positions in such areas as currency trading (No. 3 globally behind Citigroup and Deutsche Bank) and underwriting of bond issues in Britain, France and Asia. Meanwhile, HSBC's corporate, investment-banking and markets division delivered pretax profit of $1.94 billion for the first half, or about a third of the group total.
"HSBC is boring but profitable," notes Simon Harris, head of corporate banking at financial consultant Oliver Wyman. "It's a pretty defendable strategy."
Founded as Hongkong Bank, it was the first Western bank to have its headquarters in Hong Kong, and it soon expanded rapidly throughout Asia. Until the late 1970s, by which time its name was the Hongkong & Shanghai Banking Corp., the bank was little-known outside East Asia. It was a quirky institution where for decades new recruits being groomed for management couldn't get married until after their first three-year posting -- known as "being on ice." Then it began building itself into a global bank by acquiring Marine Midland, a U.S. bank, in 1980, and later Britain's Midland Bank and France's Credit Commercial de France.
It also added some investment-banking interests. In 1986, it acquired James Capel, a British stockbroker known for sophisticated equity research. With Midland came Samuel Montagu, a midsize British investment bank.
But HSBC continued to resist the main trend of the 1990s, when rivals such as Citigroup, Deutsche Bank, Credit Suisse Group and J.P. Morgan Chase sought serious muscle in investment banking through mergers and acquisitions. The conventional wisdom was that commercial lenders couldn't rely solely on their traditional businesses and needed to scrap with the likes of Morgan Stanley and Goldman for fat investment-banking profits. The ability to provide big loans as well as offer first-rate advice on M&A deals, arrange initial public offerings and bond issues, among other services, was seen as a huge competitive advantage. The one-stop shop ruled.
HSBC executives wondered if they were following the right investment-banking strategy. In 1995, the bank hired James O'Donnell, an American investment banker who had worked at Merrill Lynch & Co. and Drexel Burnham Lambert, to run its equities and corporate-finance activities.
"The feeling was, he's an American. He'll help us get rid of the English-gentlemanly way of doing things," says Mr. Patel, the current equities and corporate-finance chief.
But Mr. O'Donnell's suggestions, to buy either PaineWebber, or Donaldson Lufkin Jenrette, weren't well-received and he left the bank two years later. Sir John, the bank's chairman, says the main reason why HSBC didn't buy an investment bank was "because our shareholders have never asked us to recreate Morgan Stanley in HSBC. They can buy a share in Morgan Stanley if that's what they want." He was also wary about paying huge amounts of money for squads of star investment bankers.
In the late 1990s, as merger activity was reaching fever pitch among other major banks, HSBC executives continued to stand pat and took comfort in the profits that were then rolling in from the great bull market. "In a market as buoyant as that, it didn't pay us to strategize," Mr. Patel says.
In some small ways, HSBC did emulate its American rivals. "We introduced a 'can do, will do' culture rather than a 'might do, probably,' " Mr. Patel says. HSBC began monitoring the time spent with clients and measuring it against the revenue generated to determine which clients weren't repaying the bank's efforts. It also introduced a formula for calculating bonuses that allowed bankers to share all profits above a certain threshold.
Traditions of Thrift
But the traditions of thrift and conservatism continued to permeate the bank. Sir John received total compensation of $2.8 million last year; by comparison, Citigroup's chairman, Sanford I. Weill, pulled in $26.7 million, excluding stock options, according to filings with the Securities and Exchange Commission. Sir John rides the London Underground to work, makes a point of switching off the lights every time he leaves his office and flies economy class on short trips.
When HSBC formed an online-banking joint venture with Merrill Lynch in 2000, rumors flew that a merger could be imminent, but staffers say the two cultures never sat comfortably together. When Edward Goldberg, a senior Merrill executive who had played a key role in building the joint venture, returned to the U.S. in early 2001, HSBC staff threw a farewell party with white wine and potato chips. A spoof memo once made its way around the bank via e-mail. "When on overseas trips, there is no need to pay for laundry services when you can handwash clothes in the bathtub," the e-mail read, adding that "the weather is so hot in many countries that you can simply hang your washing out the window."
Teamwork is drummed into new recruits, fresh out of universities, when they visit Bricket Wood, a 53-acre estate in Hertfordshire, 20 miles north of London. HSBC bought the estate to be a training center in 1994 and now leases part of it to a farmer to help pay for the upkeep.
The graduates stay in themed dormitories that represent different stages of the bank's history. The walls of the Midland dorm are covered with old photos of the bank and its staff and with old banknotes issued by Midland. The other main dorm is called "Wayfoong," which is the Chinese name for Hongkong Bank and translates as "abundance of remittances."
Each small room has a single bed. Instead of a Gideon Bible, graduates can flick through a condensed history of the bank before drifting off to sleep. To learn to work together, they build bridges across a lake and construct an imaginary water pipeline from plastic tubing.
Ray Campsie, who runs the training program, harps on the message that HSBC doesn't want superstars. "Banking is a simple business. It's about keeping it simple," he says. "Customers aren't interested in your job title. They don't care if you're an investment banker or a commercial banker. They have a problem that they want you to solve."
Well before most other banks, HSBC took steps to counter the public perception that analysts are biased toward "buy" recommendations on shares because they hope to curry favor with corporate clients. Last year, HSBC set up a system that required its 300-plus analysts to divide shares in a sector evenly so that buy recommendations couldn't outnumber sells. For similar reasons, the bank banned analysts from encouraging investors to "hold" a stock, which was regarded as an alternative to "sell" and another way to avoid offending corporate clients. HSBC's relatively small M&A-advisory business means there is less risk of offending existing clients by recommending that investors dump their shares.
The bank also resisted the practice of making potentially unprofitable loans to companies in the hope of winning investment-banking fees from them. In 2001, HSBC's bad-loan provisions were just over one-third of those at Citigroup.
Todd Thomson, chief financial officer at Citigroup, says it's important to focus on long-term performance rather than short-term woes. "This business tends to be cyclical, but high-growth," Mr. Thomson says, adding, "If you are going to participate in this business, you need to be a significant global player. You can't dabble in it. The amount of return you get is exponentially better at greater levels of scale."
HSBC's cautious approach won plaudits from investors but didn't prevent its equities and corporate-finance operations from slipping into the red last year. The losses were more modest than at many rivals, however, and easily offset by the more than $1 billion in fees and commissions made from bond underwriting and other services and about $500 million from trading bonds, derivatives and other securities. For this reason, HSBC's securities salesmen, traders and analysts were counting on at least small cash bonuses.
When they failed to appear, rivals took advantage of the plunge in morale to poach some of HSBC's most experienced hands, including its head of global equities research, head of banking research, top equity strategist and most of its analysts covering mining, media companies and British investment funds. In all, about 90 members -- or 10% -- of the equities and corporate finance staff bolted.
While HSBC, which has a global staff of 180,000, lost some strong performers, the resignations also had the salutary effect of reducing the amount of severance pay needed as HSBC cut staff to reflect today's depressed markets. On top of those who left voluntarily, HSBC has cut a further 100 jobs in equities and corporate finance this year.
HSBC is unapologetic about its stance on bonuses. "These are the economics of the business," says Sir John, "and bonuses get paid out of profits."
Write to Erik Portanger at erik.portanger@wsj.com1
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