HSBC's new problem: Too much cash?

The bank will soon start to generate significant free cash flow. What to do with it?

By Jim J. Jubak Aug 6, 2010 1:13PM

Jim JubakWait! A bank with too much capital?

Hard to believe, but analysts at UBS calculate that's exactly the "problem" that HSBC (HBC) is likely to face over the next four years.

UBS forecast that the bank's Tier One capital ratio hit 10% by the middle of 2010 after it successfully used a rights offering to raise capital. That ratio could well hit 13% by 2013.

That certainly removes any need to raise capital. And it gives HSBC plenty of money to lend. The bank is underleveraged right now, UBS argues, with a loan-to-deposit ratio of about 77%.

And now that HSBC is running down its troubled U.S. mortgage business, the bank will start to generate free cash flow. Lots of it. UBS estimates that, after dividend payments, HSBC will generate $48 billion in free cash flow over the next four years.

What will the bank do with it?

After its disastrous history of acquisitions in the years just before the global financial crisis, the bank won't be looking to do a major deal, UBS suspects. And besides, there just aren't a whole lot of the deposit-rich acquisition candidates that every bank wants to buy right now. (This could be wishful thinking by UBS, since rumors say HSBC may be interested in acquiring UBS.)

Some of that cash flow will go to building up the bank's business in Asia and to add to its investment banking arm -- but those efforts won't do more than take a modest bite out of the cash supply.

After all, we're talking about cash flow that adds up to 30% of the company's current stock market value.

The most likely destination for much of that cash is shareholders' pockets. HSBC will wind up distributing a good chunk of that cash to shareholders by doubling its dividend over the next four years, UBS forecasts.

Right now the bank's American depositary receipts pay an annual dividend of $1.60 for a yield of 3.0%.

It's been a tough stock market for bank stocks -- even good ones -- and I don't think HSBC will hit my target of $67 a share by December 2010. I'm keeping that target price but extending the time line to June 2011.

At the time of this writing, Jim Jubak didn't own shares in his personal portfolio of any stock mentioned in this post. 

Tags: HSBC
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