According to a recent report from Forensic Asia, HSBC Holdings plc (ADR) (NYSE:HSBC) could need new capital between $58.3 billion and $110.6 billion to comply with the 2019 Basel III milestone.

HSBC

Thomas J. Monaco and Andrew Haskins of Forensic Asia in their recent coverage assigned a Sell rating to HSBC.

Basel III milestone

According to the Forensic Asia analysts, the level of questionable assets on the HSBC Group’s balance sheet amounts to between $63.6 billion and $92.3 billion. They believe the HSBC Group is in even more of a quandary today as post-QE blues have added to HSBC’s legacy-problem assets. They believe the questionable balance sheet line items include loan loss reserves, accrued interest receivable, deferred tax assets, defined benefit pension plans, Level 3 assets and intangibles. The analysts point out that by applying moderate stress tests to the group’s major subsidiary balance sheets (90.4% of consolidated assets), the cumulative level of questionable assets ranges between $63.6 billion and $92.3 billion or even higher.

The following table highlights the impact on HSBC’s capital of asset overstatements:

HSBC Asset Overstatements

Recently, the Basel committee required banks to hold capital equivalent to at least 3% of their assets, without taking into account the riskiness of their investments. Banks will also be required to disclose how well they meet the rule from 2015.

The following table depicts HSBC’s capital increase timeline:

HSBC's capital increase timeline

The Forensic Asia analysts point out that the 2019 Basel III milestone implies a cumulative capital need for HSBC of between $58.3 billion and $110.6 billion representing 32.9 to 60.6% of current stated equity. The analysts believe the bulk of the new capital for HSBC is likely to come from dilutive equity issuances and the possible liquidation of its core franchises.

EPS, ROE and dividend to be affected

The Forensic Asia analysts point out that dilutive equity issuances and the liquidation of core franchises would not be positive for operating EPS, nor for core ROEs. Moreover, due to the substantial capital requirement, there is a real possibility the dividend will either be cut or temporarily suspended.

The analysts doubt whether HSBC would achieve perennial operation ROEs of 12 to 15%.

HSBC-Consensus forecasts

Thomas J. Monaco and Andrew Haskins of Forensic Asia in their recent report have thus initiated coverage on HSBC Holdings plc (ADR) (NYSE:HSBC)’s shares with a Sell rating and a price target of HK$63 a share, indicating 25% downside potential. The analysts believe instead of taking a European or Asian view, one should analyze the HSBC Group’s overall risk for an unbiased assessment.