HSBC Should Stay Put and Get Bigger, or Leave and Shrink --- UBS

HSBC Holdings PLC is once again assessing whether to shift its headquarters from the U.K. But one of the options -- moving bank to Hong Kong -- “is certainly the wrong answer,” according to analysts at UBS AG.

In a meaty 58-page report sent to clients this week, analysts at the Swiss bank are frank about the current debate around HSBC re-domiciling. UBS currently has HSBC at a neutral rating, after downgrading from a buy in February.

At present, executives at HSBC are lamenting the increasing cost of the U.K. banking levy, effectively a tax on balance sheet assets. HSBC is set to pay around £1.5 billion ($2.3 billion) for the 2015 levy, up from just over £1 billion in 2014. In early May, HSBC Chief Executive Stuart Gulliver warned the bank’s dividend policy would become “impossible” if the levy continued to rise.

However, moving to Hong Kong may bring a new set of problems.

“Over time, the financial flows between Hong Kong and China will continue to increase dramatically, the HK$ will almost certainly end up linked to the Renminbi rather than the US$ once the Chinese open up the capital account and the large Chinese banks will likely regard Hong Kong as just another large Chinese city in which to do business. The dominance of HSBC in Hong Kong is now in decline in our opinion,” says UBS.

If HSBC were to move to Asia, then UBS argues that it needs to be a different bank, and follow the lead of its U.K. rival Royal Bank of Scotland by shedding non-core elements of the group, such as its mid-level European investment banking business.

Rather than reviewing its headquarters, HSBC needs to review its strategy, UBS says. It is no secret that gets much of his profit from its Asian franchise. According to UBS estimates, it represents around 80% of the group's valuation.

UBS also notes that HSBC’s UK retail and commercial bank, plus its Canadian bank, are also highly profitable businesses.

If you strip out these three businesses, then you are left with estimates of only $0.5 billion of annual profit from around £87 billion of capital, most of which is tied up within its investment bank. The group made a profit of $18.7 billion in 2014.

The solution? Spinning off profitable units and shrinking the investment bank.

“Simply put, if the diversification from the journey of the last 30 years was the wrong strategy to have executed, does it make sense to take the accumulated baggage back home with you? We think not,” says UBS.

Or HSBC can remain in the U.K, but take a leaf out of J.P. Morgan's book by getting bigger and better. But to attain "such a status", HSBC might need to get out its wallet, either by acquiring a U.S. bank with capital markets and wealth management operations, or by merging with a European investment bank.

However, UBS notes that any bank M&A would meet with stiff regulatory scrutiny. HSBC is set to reveal its strategic review on June 9. HSBC declined to comment.