Changes in the HSBCs Capital Structure and Financial Sources - Assignment Example

A critical review of the following aspect of the HSBC business in the past three to five years: Changes in the capital structure of the company and the major sources of finance utilised. HSBC – the world’s local bank – is one of the largest international banking and financial services providing organisation. The bank’s network consists of 9,500 branches in 86 countries throughout the Asia Pacific region, Europe, the Americas, the Middle East and Africa. The HSBC Group is named after its founding member, the Hong Kong and Shanghai Banking Corporation Limited. It was set up in 1865 to materialize financial transactions between China and Europe. Listed on a number of stock exchanges that include London, Hong Kong, Paris, Bermuda and New York, shares of HSBC Holdings plc are traded on the New York Stock Exchange by about 200,000 shareholders from 100 countries. From the very start it has been HSBC’s policy to have a solid capital base so that business expansion activities remain uninterrupted. An intelligent balance among different segments of capital and investment needs of associate companies is maintained. Subsidiaries manage their capital requirements as per the approved annual plans for business and regulatory compliance. Excessive capital generation by subsidiaries is cycled back to the HSBC Holdings plc to strengthen its capital position. As the HSBC Holdings provides equity capital to its subsidiaries for profit purpose, therefore its subsidiaries generate their own non-equity tier 1 capital. Benefits of utilising capital and maintaining strong capital position in return are leveraged for better returns in equity. Keeping in mind the future capital planning, the bank has set up a benchmark ratio of 8.25% for tier 1 capital. To understand the capital structure of the HSBC Holdings plc, it is important to know what is tier 1 capital and tier 2 capital. Tier 1 capital includes shareholders’ funds, securities and minority interests. It is derived after making readjustments in shareholders’ fund for sufficient capital and after subtracting goodwill and intangible assets in book values to arrive at tier 1 capital. Tier 2 capital consists of additional capital formation from revaluation of properties, eligible next-in-line loan capital, impairment allowances, minority and other interests. Profits from equity valuation are also part of tier 2 capital. Capital structure -- last five years from 2004 to 2008 Starting from the year 2004 when HSBC Holdings plc had Tier 1 capital ratio of 8.9%, this reached to 9.0 in the year 2005 while total capital ratio was 12.0 in the year 2004 and 12.8 in the next year i.e. 2005. Capital resources reached to 105, 44990 million US dollars in the year 2005 from 78074 million dollars in the year 2004. In January 2005, movement in tier 1 capital in US$m was 67,259 from 54,863 in the year 2004. Movement in risk weighted assets was quite big – from 210 million dollars in the year 2004 to 759 million dollars in the year 2005. It indicates strength in capital base of HSBC Holdings plc due to increase in the values of shareholders’ funds, securities and minorities interests, which comprise the basis of tier 1capital. Shareholders’ fund, the regulatory capital, increased to 92,432 in the year 2005 from 86,623 in the year 2004. The increase was registered in Minority interests, and preference shares and innovative securities as well in tier 1 capital. In computing the figures, the HSBC Holdings plc followed the EU Banking Consolidation Directive and the FSA policy statement PS05/05, thus registering an increase of 7.1 billion US dollar but then exchange differences of 4.2 billion US dollars minimised the impact of increase in tier 1capital. The increase in tier 2 capital was 8 billion US dollars. The risk weighted assets recorded an increase of 9% to 68 billion US dollars. Thus, in the year 2005, tier 1 capital ratio was 9.0% while total capital ratio was 12.8% as on 31 December 2005. The abnormal increase in liquidity in private equity market offered the HSBC Holdings plc the opportunity to cash-in on the profit in historical investments and fulfill the investment needs of such companies that had costly capital structure. Capital structure was further strengthened by selling of interests, which was not part of main business of the HSBC Holdings plc. Fleet management business’ support functions were sold off in the UK and acquiring of Asian Merchant as joint venture added to the capital base. Total gain in disposals in the year 2005 was US$ 652 million. This trend continued till the 1st half of 2006, gaining from such sales to US$174 million. Capital was generated by the sale of 21.16% interests in Laiki Group for 235 million US dollars and 7.19% interests in UTI Bank for 142 million US dollars. The year 2006 again was strong with tier 1 capital ratio 9.4% and total capital ratio to 13.5%. Total assets on 31 December 2006 reached to 1,861 billion US dollars. This was an increase of 24% over the previous year i.e. 2005 in US$ to 359 billion since 31 December 2005. An important feature of the HSBC Holdings plc was sponsoring of cross-border distribution of debt market capital and equity capital market dealings. Such cross-border distribution included America Movil's 8 billion Mexican peso bond; Khazanah Nasional of Malaysia's US$750 million Islamic exchangeable 'Sukuk'; Emaar Economic City's US$680 million IPO in Saudi Arabia; and Shui On Land's US$876 million IPO in Hong Kong. Outlook of financial market during this period was boosting the world economy except America. Emerging markets like China, India Brazil and Russia appeared quite promising, leading to competitive capital restructuring. It was very conducive to HSBC’s capital strength. New opportunities arose in developing and investing in infrastructure of emerging markets. Strong capital base and liquidity ratio boosted the confidence level of HSBC in dealing with any political risk or macro happenings, which were outside the control of the bank. Focus now in the year 2007 was using the strong capital base to internationalise the emerging and developed markets technologically to the benefit of HSBC’s shareholders in the long run by leveraging from the network of branches and scale of business. In the year 2007, HSBC’s tier 1 capital ratio was 9.3% and total capital ratio 13.6% as on 31 December 2007. HSBC’s total assets recorded an increase of 494 billion US$, which was 27% from the previous year i.e. 2006. Performance in the year 2007 was remarkable on all fronts – shareholders’ equity registered an increase of more than 15%, capital ratios were strong enough to boost long-term growth. As per the policy of the bank, whenever there is such a requirement in emerging markets, it deploys capital in such markets by divesting assets of greater value to where they are in shortage. Such activity has been going on in France where cash offers for seven regional banks were made that materialised in 2008. HSBC acquired French insurance business in the year 2007 to the tune of 50% shares of Erisa, not owned by HSBC. Targets had been set for the year 2008 to get a profit on equity above the investment cycle of 15 to 19%; reaching towards tier 1 capital under the Basel II structure of 7.5 to 9.0% . For the year 2008, the bank has been successful in retaining tier 1 ratio to 8.3% and total capital ratio to 11.4%. Rights issues fully underwritten had been introduced to solidify the capital structure of the organisation. After the shareholders’ affirmation by 19th March 2009, the Rights Issue will plus 150 basis points to the firm’s capital ratio. It will boost the tier 1 equity ratio to 8.5% and tier 1 ratio to 9.8% as decided. As a result, the bank’s responsiveness to sudden unfavourable trends will increase; acquisitions will further offer opportunities for expansion. As on 31 December 2008, increase in HSBC’s assets was 7% in comparison to the previous year i.e. 2007. Comparing the performance of last five years, capital resources at the year end for the year 2008 were 131,460 million dollars, coming down from 152, 640 million dollars in the year 2007 – a down of 21,180 million dollars in HSBC capital resources. Comparing the figures from 2004 to 2008 indicates a steady rise in capital resources till 2007. In 2004, it was to the tune of 90,780 million dollars, in 2005, it was to the tune of 105, 449 million dollars, in the year 2006, it reached to the figure of 127, 074, gaining by the year end 2007 by 152,640 million US dollars. The downfall came at the end of year 2008, as stated above to 131, 460 million dollars. In the words of Group Chairman, S.K. Green, in his statement “…our targets range for the tier 1 ratio so that the range will be from 7.5 per cent to 10 per cent. Planned internal capital generation remains strong and this capital raising will enhance our ability to deal with the impact of an uncertain economic environment and to respond to unforeseen events”. The impact and relevance of the Environment Report and/or Social Responsibility Report in the Financial Statements of the HSBC Holdings plc in the past three to five year. HSBC Holdings plc is a financial company that firmly believes in the socially responsible and environmentally conscious behaviour. It has behaved in the most desired responsible manner for the causes that help the society at large and communities where it does business. HSBC has invested its human and financial resources keeping in mind long-term effects of becoming a favourite of its customers, employees and investors. Being awarded the “Sustainable bank of the year” title for being a leader in interactively amalgamating social, environmental and business objectives by the Financial Times Sustainable Banking Awards speaks volumes on the HSBC’s initiatives in the communities it operates. Some of the major initiatives taken by the bank include Energy Sector Policy and Carbon Finance Strategy to create consciousness among employees and customers for practicing social and environment standards. Some other projects initiated by the bank include ’Future First’, a five year 10 million US dollars programme for poor children to become a part of the mainstream society. Another five year programme ‘Investing in Nature’ ended in 2006. These initiatives and many others are a proof that HSBC Holdings plc is sincerely attuned to these causes. Impact and relevance of the bank’s social and environment initiatives can be seen in its financial statements. It has impacted indirectly the society via the bank’s lending and investment activities. Reviewing the annual report 2005, one finds that the bank’s initiative of sanctioning micro-finances for a long term in countries like India, Mexico, the Philippines and Russia has been meant to serve the socially low profile people in consultation with local micro-finance organisations. A United Nations discussion forum was also organised to create consciousness for the poor who don’t qualify for loans through prevalent financial bodies of their countries. The bank has taken the environmental causes like applying low carbon technologies, creating water infrastructure and durable forestry. HSBC was one of the major banks to become carbon neutral and achieved the set deadline three months in advance in the year 2005. Efforts were made to follow carbon reducing practices, investing in renewable technologies and buying low-cost energy saving and environment-friendly goods. Efforts made by the bank were all-inclusive and not limited to just a few initiatives. Buildings from where the bank ran its operations were mapped as per the developed environment design guidelines. A travel management database was built to map the carbon emissions by travellers to feel responsible for the quantity of carbon emitted due to their travel, in the environment. All carbon reducing initiatives were subjected to review in the country of their origin. The bank is using Forest Stewardship Council (FSC) approved paper for its letterheads and compliments slips. By organising annual review of its social and environment initiatives, as reviewed in the year 2005, the bank prioritised its initiatives in education and environment. Some of the highlights in education include Global Teachers’ Programme sponsored by HSBC Education Trust. In the year 2005, it collaborated with the Ministry of Education of the Peoples Republic of China to jointly promote the cause of education. Other programmes include Financial Literacy Programme, in collaboration with SIFE – Students in Free Enterprise, in 1000 universities of 40 countries (hsbc2005ar0.pdf). Other than that, throughout the world 540 central banks and regulatory bodies supervised social and environment obligations like anti-money laundering and anti-terrorist initiatives of the bank. It regularly monitored risks besides in the monetary areas as well in the social and environment risks areas also. Sustainable development of social and environment projects dear to the ethical principles laid down in the relevant policies is measured to be negative if related economic advantages of a project are lesser than its social and environment advantages. Managing such risks requires making sustainability risk policies on Equator Principles for project finance lending, sector-specific policies impacting forestry, fresh water infrastructure, and energy, metal & mining. Defence lending where sustainability risks are higher, are reviewed by the operating companies. System-based processes are applied to measure the cost of running such policies and minimise it too. Effects of such policy processes on the bank’s lending and investment activities are regularly identified with the set standards and regulations (Annual Report 2007). The sustainability strategy of HSBC is based on four themes in the background of its response to United Nations Millennium Development Goals against climate change, water availability, for biodiversity and eradication of poverty. Through displaying responsible social and environment behavior, the bank has reached to 4th position from 7th in the Accountability Rating. In Carbon Disclosure Project, it has got a score of 95 and a triple-A rating in the index of FT-500 Corporations. A Climate Change Centre of Excellence was created in the year 2007 by the bank to find out the impact of climate change. In the year 2007, the bank also employed Lord Stern, the noted scholar and World Bank chief economist to advise the Chairman on climate change. To mitigate the challenge of extremism, the bank conducts regular security reviews for the safety of its staff, properties and information. Charitable donation to the tune of 101 million US dollars was made in the year 2007, which is comparatively higher than donations made in the year 2006 to the tune of 86.3 million US dollars (hsbc2007ara0). The corporate sustainability committee of the HSBC Holdings board guides the board, its committees and executive management on sustainability policies concerning environment, social and ethical issues. Regular monitoring of such issues is exercised by mainly the Group Human Resources, Group Risk and Group Corporate Sustainability. Mr. W K L Fung was appointed its chairman on 30 May 2008. As climate change affects the employees of HSBC, Lord Stern’s services and guidance was handy in relevant initiatives on climate change in the year 2008 too. Climate Principles are being followed earnestly. HSBC also participated in the Prince of Wales’ Accounting for Sustainability project in developing such systems that assist organisations -public or private in perfect accounting of overall social and environmental expenditure on such activities. In this context, charitable donations in the year 2008 reached a new high of 102 million US dollars, 1 million more than made in 2007. Half of the annual donations were made for educational programmes and 25% on environment programmes. External auditor Price Waterhouse Coopers has been appointed by the HSBC Holdings plc to cross-check the sustainability and management structure of HSBC. It will report on the content, neutrality status of carbon and following of Equator Principles (Hsbc 2008ara0.pdf). Evaluation of the additional statements of HSBC with two additional statements included by AstraZeneca PLC in its annual reports or financial statements; the effectiveness of these additional statements in meeting Corporate Governance requirements and/or needs of the stakeholder groups. “Legislation (such as the Companies Act 1985 in the UK) requires that additional information in the Annual Report such as a Director’s report. As well as statutory information many companies choose to give additional information such as Operating Reviews, Chairperson’s statements or Business Summaries. Around the world the names and formats of additional information do vary, but the actual information included is of similar nature.” Source: Elliott B &Elliott J., (2006) Financial Accounting, Reporting & Analysis, International Edition, 2nd Edition, p.78 HSBC, AstraZeneca Plc or any other listed company selling its products and services on global scale, provide additional information about the company’s performance, future initiatives, statements of accounts and a list of other additional information, which is the right of its stakeholders to know about. Companies are bound by law also such as the legislation on Companies Act 1985 and other such legal requisites that bound companies to provide annual business reports on all aspects. The purpose behind making the activities of a firm transparent is to win the confidence of its stakeholders that all reports are independently audited and there is nothing unscrupulous happening away from the stakeholders’ eyes. These stakeholders are mainly shareholders, who need all this information to make future investments and are earning partners of the company. Other than shareholders, customers and employees also form an important part of the company and have right to know as per legislation in the origin country as well as other countries where companies have to follow the practices prevalent according to their rules and regulations. HSBC being a company dealing in financial products, its comparison with AstraZeneca plc – an international pharmaceutical company, the content of their annual statements will definitely vary as statistics play an important role in forecasting how a financial company will perform in future. HSBC Chairman’s statement in this regard for the year 2008 is quite comprehensive, touching all decisive parameters and taking into consideration the global business view in the context of current economic meltdown as finance sector is one of the most affected business sector bearing the negative after-effects of worldwide recession. The HSBC bank has set high corporate governance standards that comply with Combined Code as well as NYSE corporate governance standards. HSBC Chairman’s statement touches all important activities and provides significant data besides forecasting on future performance. Chairman’s Statement At the outset the Chairman, S.K. Green, talks about the strong foundation of HSBC that has successfully braved the storm of worldwide recession. The company’s faith in the understanding that the fast growing economies will speed the transfer of central point of “economic gravity from west to east” has been verified in the current economic situation. Recounting the brand recognition met to the bank by Brand Finance as the number one brand, the Chairman provides detail of the ‘profit from broad-based earnings platform’ in North America, where losses were reported in the Personal Financial Services. His statement shows the far-sightedness of the company in identifying the economic crisis in America as early as 2006 and it scaled back as a result in 2007. The company resisted from practicing direct models of lending that depends on wholesale market. HSBC in the light of new economic circumstance would focus more on corporate and commercial business as well as in private and premier banking. In performance overview and strategic activity, the Chairman, Green, discussed all stats on capital structure and acquisitions and disposals made worldwide. In the fast changing recessionary scenario, he gave all credit to the bank’s employees for standing out and remaining distinct in satisfying customers. Next, he provided details of dividend declaration and the progressive dividend policy for the year 2009, comparing interim dividends for 2008 and 2007 as well. It seems that the Chairman’s purpose behind has been to win the confidence of shareholders by introducing the Rights Issue so that regulatory capital framework remains unaffected. Other important details of Chairman’s statement were related to maintaining the company’s strong financial position, discussing the bank’s culture & compensation and finally, learning its lessons from the current economic meltdown. Last but not least, he has summed up the total effect of all operational activity, creating hope for the future. AstraZeneca, on the other hand, is a pharmaceutical company. Its Chairman Louis Schweitzer has from the very beginning of his statement showed concern for Astra’s patients, shareholders and society by rigorous R & D initiatives, business performance and operations efficiency in his 2008 statement. In his statement he has discussed company’s business performance through its increasing profit line, satisfying its shareholders with a dividend of 10% for the year 2008, providing figures of cash distribution to shareholders through dividend and share repurchase. To satisfy the primary stakeholders i.e. the company’s shareholders He has compared the company’s London-listed share price with FTSE 100 index that decreased by 31% in the year 2008 while that of Astra plc increased to 31%. Chairman Schweitzer has further hinted on his investment strategy by doing R & D work in problem areas where disease has spread and healthcare industry has been deficient in curing. In this regard, the company’s approach in the year 2008 has been in experimenting with medicines in the laboratory that give quick relief and reach fast to the patients. The focus has been on “delivering differentiated medicines that make a meaningful difference to patients”, who are the major beneficiaries of the company. If we compare the statements of both the Chairmen, one difference is stark and that is HSBC Holdings plc is a financial products and services company and stats and figures are very crucial for such a company to plan future business strategy. HSBC Chairman has discussed at length all the financial details and has succeeded in projecting a rosy picture of the company amidst the worldwide recessionary trends, as if HSBC is an exception to the rule. The Chairman has given credit for this to the farsightedness displayed by the management and employees also. Common to both Chairmen’s statement is their acknowledgement that shareholders of both the companies are the major stakeholders. They have made such statements that are meant to win the confidence of company shareholders. HSBC commitment to follow combined corporate governance rules and regulations is subservient to none. Same is the case with AstraZeneca plc, inclined to show strong will power to adhere to the guidelines of following codes. The Chairman of Astra Plc has stated how the company has been indirectly affected y the worldwide recessionary trends and its affects on the business. The Chairman has laid stress on leveraging from the current risks and new opportunities by making judiciously profitable investments from its intellectual property and involve stakeholders to the benefit of all – patients, shareholders and society. Another noticeable difference in the statements of both Chairmen is that other than catering to shareholders’ interest which is common in both organisations, acquisition and disposal activity is a major business strategy at HSBC Holdings plc while Astra Plc has stressed on R & D productivity, commercial success and operational efficiency. Both have discussed at length the details on the shareholders’ earnings. Here, their areas of interest of catering to the shareholders’ concerns – are same. Cautionary statement HSBC Holdings plc has used certain verbs like ‘expects’, ‘anticipates’, ‘intends’, ‘plans’, ‘believes’, ‘seeks’, ‘estimates’, ‘potential’ and ‘reasonably possible’ with variations on factors that can bring unexpected change in the financial condition, results of operations and business of HSBC in the Cautionary Statement. Such factors, in the case of HSBC, might be related to economic ups and downs in prevalent market conditions, where HSBC has its operations. Common among such factors could be recessionary trends, and sudden downward curves in employment, changes in market exchange rates and foreign exchange rates, sudden change in interest rates, turmoil in equity market, decreased liquidity ratio, affects of consumer-owned real estate markets, below-normal returns on investments of public and private sector pension funds, wrong actuarial assumptions or price competition in the business market catered by HSBC. Changes in government policy and regulation might include such changes as in the policies of central banks, interest rate besides the UK, the Hong Kong and the US related authorities and regulating bodies and other countries’ regulators where HSBC operates. HSBC has enlisted a number of other such relevant factors that can alter the results of the bank’s performance. Important such factors specific to HSBC have also been enumerated that can turn the tables in its favour, such as managing loan losses through hedging and successfully managing all challenges. AstraPlc, reference to “safe harbour” provisions of the US Private Securities Litigation Reforms Act 1995 is quite direct. It has not taken any obligation to update such statements, making it clear to all stakeholders that nothing can be guaranteed. Business risks of both the companies are different because of difference in the nature of their products and services. Primary stakeholders of Astra plc are its patients for whom developing new medicines and fighting for patents is crucial. Common to both the companies are issues like product competition, pricing pressures, partnerships, acquisitions, future disposals, regulatory approvals for new products, and litigation. HSBC’s cautionary statement is more focussed on economic factors that can alter the future performance and its acknowledgement that efforts made by the bank n right direction to not to flow with the flow of the wind can turn the tables in its favour. Confidence in management policy initiatives seems overflowing – a good step to win stakeholders’ confidence. Risk factors with Astra plc are product specific like the risk of expiry, risk of having a biologics and vaccines business, product counterfeiting, risk of inadequate insurance coverage, difficulty in getting and fulfilling regulatory compliance for new products and the risk that R & D initiatives are lacking. Other risks are related to its dependence on third parties for supplies and services and risk of not taking productivity initiatives and risk to company’s goodwill. One can see clearly that both the companies, as Elliotts’ say, have provided almost the same information, to convince the stakeholders that they are earnestly following the corporate governance rules in running their businesses. 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