HSBC (LSE: HSBA) (NYSE: HSBC.US) supports one of the most attractive dividend yields in the FTSE 100. At current levels, the bank supports a dividend yield of 4.6% and the City has a yield of 4.8% pencilled in for next year.
Nevertheless, this hefty payout is not gold plated and the bank has been forced to cut its payout before. So the question is, can you really trust HSBC’s dividend?
Falling earnings 
HSBC has been working hard to transform itself over the past few years. The bank is currently in the second phase of a turnaround plan that began during 2011, designed to make the bank less complex and more efficient. As part of this plan, management has axed more than 40,000 jobs and sold or closed 60 businesses, producing annual cost savings of more than $5bn.
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Unfortunately, despite HSBC’s best efforts to cut some costs, other costs are rising. For example, during the first half of this year HSBC’s management reported that the bank was now spending $700m to $800m per annum on compliance and risk management, an increase of around 20% compared to last year.
As a result, underlying operating expenses ticked higher by 4%, to $18.2bn, pushing the bank’s cost efficiency ratio up to 58.6%, from 53.5% as reported last year. Management is targeting at mid-50s cost efficiency ratio.
At the same time HSBC’s sales are falling, as the bank pulls out of some markets. Second-quarter underlying revenues fell 4%, to $31.4bn, from $32.7bn a year earlier.
So, with costs rising and revenues falling HSBC’s earnings are sliding. Second quarter pre-tax profit fell to $12.3bn, 12% lower than the $14.1bn it earned in the corresponding period in 2013. HSBC’s first-half earnings per share dropped nearly 10% from $0.54 last year, to $0.50 this year.
No threat
Still, during the first half HSBC paid out approximately $0.20 per share in dividends, easily covered by earnings per share of $0.50 but risks remain. Indeed, the bank’s management revealed during the first quarter of this year that it is not possible to tell how much capital the HSBC should be holding in reserve. The bank could be required to boost its capital position at short notice.
That said, HSBC does have a solid financial cushion. The tier one capital ratio stood at 11.3% at the end of the second quarter. However, with a balance sheet in excess of $2trn, HSBC is extremely exposed to sudden shocks. If the bank were to need more capital, the dividend would be the first thing to go.
Safe for now
For the time being at least HSBC’s dividend looks to be safe, although I would strongly recommend that you do your own research before making any trading decision.
To some, the banking sector may appear daunting. Indeed, the complex numbers and formulas used to value banks can be daunting for even the most experienced analyst.
