HSBC Prepares to Face U.S. Money Laundering Charges

HSBC Chief Executive Officer Stuart Gulliver
HSBC Holdings Plc Chief Executive Officer Stuart Gulliver’s attempts to reduce costs at the bank are being hobbled by the U.S. probes and compensation claims from U.K. clients. Photographer: Jerome Favre/Bloomberg

HSBC Holdings Plc said it’s likely to face criminal charges from U.S. anti-money-laundering probes and the cost of a settlement may “significantly” exceed the $1.5 billion the bank has set aside.

The lender made an additional $800 million provision in the third quarter to cover a potential settlement, adding to the $700 million it had already earmarked. HSBC also put aside $357 million in the period to compensate U.K. clients wrongly sold payment-protection insurance on loans as it posted an increase in pretax profit that missed analysts’ estimates.

“The final amount of the financial penalties could be higher, possibly significantly higher,” HSBC said in a statement today. “The resolution of at least some of these matters is likely to involve the filing of corporate criminal as well as civil charges.”

Chief Executive Officer Stuart Gulliver’s attempts to reduce costs at the bank are being hobbled by the U.S. probes and compensation claims from U.K. clients. A Senate committee said in July that failures in HSBC money-laundering controls allowed terrorists and drug cartels access to the U.S. financial system. Standard Chartered Plc, which like HSBC makes most of its profit in Asia, paid $340 million in August to settle a regulator’s claim it broke Iranian sanctions rules.

“The size of the provision is a shock,” said Simon Maughan, a financial industry strategist at Olivetree Securities Ltd. in London. “There was a huge fuss made about Standard Chartered’s fine, but this far exceeds that.”

Shares Fall

HSBC fell 1.3 percent in London trading to 618 pence, the steepest decline in more than five weeks. The stock has climbed 26 percent this year for a market value of about 114 billion pounds ($182 billion).

Underlying pretax profit, which excludes acquisitions and disposals as well as accounting losses on the fair value of the lender’s own debt, rose to $5.04 billion in the third quarter from $2.24 billion in the year-earlier period, missing the $5.6 billion median estimate of eight analysts surveyed by Bloomberg. Underlying income, at $16.1 billion, missed the $16.5 billion estimate of Gary Greenwood, a banking analyst at Shore Capital Ltd. in Liverpool, England.

Gulliver, who became CEO in January 2011, is seeking to cut costs by $2.5 billion to $3.5 billion and revive profit by selling assets to focus on emerging economies in which the bank has a greater market share. The savings are likely to exceed that range and be met by the end of 2013, HSBC said today.

Cost Burden

Costs as a proportion of revenue, excluding the fair value of HSBC’s own debt, decreased to 64 percent from 66 percent in the year-earlier period as revenue from continuing operations increased. That’s still higher than Gulliver’s target range of 48 percent to 52 percent.

“Today’s cost performance is very disappointing,” Maughan said. “It raises a question mark about how rapidly these efficiencies can be made by Gulliver and his team.”

HSBC has cut about 21,000 workers in the last nine months, Finance Director Iain Mackay said on the call, cutting total employment to about 266,700 workers. Gulliver said today that the bank may eliminate more jobs.

“We are going to continue to manage the cost base of the firm very tightly, and we are probably likely to see the headcount reduce further from where we are at this moment at time,” Gulliver said.

U.S. Regulators

HSBC has been in talks with U.S. regulators over allegations it laundered funds of sanctioned nations including Iran and Sudan. The probes prompted Standard & Poor’s to question whether the lender, Europe’s largest by market value, is too big to be managed effectively.

A settlement of $1.5 billion would be the biggest reached in the U.S. over such allegations, topping the $619 million in penalties paid in June by ING Groep NV, the biggest Dutch financial-services company.

The provision “is based on the discussions we’ve had with the various departments of the U.S. government” since June, Gulliver told reporters on a conference call today. He said it was up to the U.S. as to when the matter would be settled, and declined to comment further.

HSBC is most likely to resolve U.S. claims with a deferred-prosecution agreement, said Bruce Zagaris, a partner at Berliner Corcoran & Rowe LLP in Washington specializing in money-laundering cases. Such a deal would levy a “very substantial” fine, and “they will be required to have very intrusive monitoring going forward for the next couple of years.”

Investment Bank

Other countries also may pursue claims, said Zagaris, who isn’t representing HSBC in the matter.

The provision for PPI brings to $2.1 billion the amount HSBC has set aside after regulators ordered banks to compensate clients who were forced to buy, or didn’t know they had bought insurance to cover their repayments on mortgages, credit cards and other loans. Of that, HSBC had paid out $1 billion in claims by the end of the third quarter.

HSBC has set aside the fourth most among British banks hit by a rise in claims from customers claiming they were mis-sold the insurance. Barclays Plc last month set aside 700 million pounds more for claims while Lloyds Banking Group Plc, Britain’s biggest mortgage lender, made an additional provision of 1 billion pounds, bringing the industry total to about 11 billion pounds.

Consumer, Asia

HSBC said pretax profit at the global banking and markets business, its name for its securities unit, more than doubled to $2.25 billion from $1 billion. Both the rates and credit divisions reported quarterly profits after losses in the year-earlier period. Credit had net operating income of $285 million, compared with a loss of $219 million. The measure at rates climbed to $363 million from a $241 million loss.

The unit posted $4.32 billion of revenue, compared with $4.54 billion in the second quarter. That performance was “slightly disappointing,” said Cormac Leech, an analyst at Liberum Capital in London who estimated sales would be $4.5 billion.

Securities firms in the U.S. and Europe have posted gains in revenue since European Central Bank President Mario Draghi’s July pledge to defend the euro with “whatever it takes” sparked a rally in bond markets. Deutsche Bank AG last week posted a third-quarter profit gain as revenue from trading bonds and other products jumped 67 percent. Goldman Sachs Group Inc.’s fixed-income, currencies and commodities revenue climbed 28 percent from a year earlier.

Asia Profit

Pretax profit at the bank’s consumer unit rose to $1.5 billion from $224 million as loan impairments in the U.S. fell. At the commercial bank, profit rose 15 percent to $2.25 billion from $1.95 billion. In Europe, the bank posted a $217 million loss, compared with $2.96 billion in pretax profit for the year before, as the lender booked a charge of $1.4 billion on the value of its own debt.

In Asia excluding Hong Kong, profit fell 5.1 percent to $1.9 from $2 billion. In the U.S., loan impairments fell to $695 million from $2.39 billion after the lender disposed of its credit card business to Capital One Financial Corp., a deal it completed in May.

Third-quarter net income fell to $2.5 billion. That’s a 52 percent decline from the year earlier, when HSBC had gains from the revaluation of its own debt.

So-called credit valuation adjustments require banks to book losses when the value of their debt rises, and gains when it declines, on the theory that a loss, or profit, would be realized were the bank to repurchase that debt.

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