HSBC charges into the U.S.: the London bank sees the U.S. as one of the world's ripest targets.

At a recent HSBC board meeting, Sir John Bond stood up in front of the bank's directors to deliver a detailed report on a subject of considerable importance: the group's record on acquisitions. The HSBC chairman's conclusion was generally positive. The bank's biggest purchases, which include Hong Kong's Hang Seng Bank in 1965 and Britain's Midland Bank in 1992, as well as Republic National Bank of New York five years ago, had been a success. Though there had been some mistakes, they were long ago.

For Bond, 63, the internal inquiry is an example of the bank's ability to learn from mistakes through what he calls "intelligent self-criticism." For a bank that analysts estimate has acquired more than 50 businesses at a cost of more than $50 billion over the past 12 years, its ability to identify and integrate acquisitions is crucial to its future growth. The conclusion that HSBC's record is improving is therefore encouraging. "The board should fire me if we're not [improving]," says Bond, who started his career at the bank in 1961. "We're paid to get better."

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Bond argues that, over the next 25 years, most of the growth in the global economy will be concentrated around the twin poles of North America and China. The logical conclusion is that HSBC must get bigger in both territories, particularly in the United States. "America is the largest financial market in the world and it happens to be accessible," Bond says, adding that it is relatively fragmented compared with most European markets, and is generally more profitable. "You will see the financial institutions in America, over the cycle, make better returns on shareholders' funds than you will in some of the major economies in Europe."

While HSBC has had a presence in Asia for almost 140 years, it is a relative newcomer in the U.S. The bank established a foothold by taking control of Marine Midland in the 1980s, but its business today is largely the result of two large deals: the purchase of Republic National Bank of New York in 1999 for $10 billion and the acquisition in 2002 of Household, the consumer finance group, for about $15 billion, HSBC's largest purchase.

These deals have alerted American bankers to HSBC's ambitions in their home market. While Citigroup has a larger market capitalization, HSBC trades on a higher multiple of earnings. The premium reflects what some investors see as the group's superior growth prospects, as well as its ability to avoid the regulatory mishaps that have damaged Citigroup's reputation.

Now that Chuck Prince, Citigroup's chief executive, has ruled out large acquisitions for the foreseeable future, and JPMorgan Chase and Bank of America are still digesting recent mergers, HSBC is regularly mentioned as the most likely buyer of U.S. banks.

Bond is keen to stress that the bank's first priority is to concentrate on developing the businesses it already has. He says that acquisitions are inherently risky and that sometimes a well-crafted marketing campaign can achieve the same as a more costly acquisition.

However, he is not ruling out deals. "The management team and the board believe that we're going through an unprecedented period of change in financial services," Sir John says. "Our shareholders would expect us to look at things we can make sense of, provided we're disciplined and we've got the capability to execute."

There are some who are skeptical about HSBC's record. In a report published this year, analysts at Citigroup Smith Barney, who examined HSBC's history since 1992, concluded that some deals, including the acquisitions of Republic and French bank CCF were unlikely to have earned a reasonable return on capital. Furthermore, they argued that HSBC's underlying growth was no better than the economic growth of the countries in which it operated.

A broader question is whether financial institutions are becoming so large as to be unmanageable. Over the past year, Citigroup's woes have prompted some investors to question whether the group's size and diversity have made it prone to regulatory lapses and failures of management oversight.

So far, HSBC has avoided these questions. The bank was not a significant player on Wall Street during the stock market bubble and avoided the regulatory embarrassments and legal settlements that have blighted some of its rivals. But it remains to be seen whether it will continue to be as surefooted now that it is beefing up its investment banking business.

Investors also praise HSBC's management culture. Although unusual among the world's largest banks, its top management is dominated by executives who are veterans of the bank. Credit decisions are made not by committees but by individuals, with approvals rising up the chain of command according to the size of the loan.

The bank is famously frugal, a culture that dates to 1865 when Thomas Sutherland, the Hong Kong superintendent of a shipping company, produced a prospectus for a bank based on "Scottish banking principles." Bond, who travels in economy class on European flights and uses public transport in London, personifies this approach. He acknowledges that, as the bank gets bigger, it becomes harder to expand at the same rate. Yet he remains a passionate advocate of the benefits of scale, arguing that the largest financial services groups see better returns. He has made growth the bank's main target. Indeed, Bond argues that the company's continuing appeal to its shareholders, customers and employees depends on its ability to keep expanding. "Our main role in life, as I perceive it, for all of our major constituencies, is to grow this business," he says.

But HSBC's investors are concerned that Household does not appear to be growing as quickly as expected. Household's earnings for the three months that ended in September showed its net interest income was roughly flat as rising interest rates and an expansion into less risky parts of the consumer finance market eroded margins. At the same time, costs are creeping up as sub-prime lenders face increased scrutiny from regulators. "They timed the acquisition [of Household] very nicely, but operationally it has been disappointing," says Simon Samuels, banking analyst at Citigroup Smith Barney.

These concerns are beginning to show in HSBC's share price. HSBC shares still command a premium to the sector, trading at about 13 times Citigroup Smith Barney's 2005 forecast for the bank, compared with an average of 11 times for European banks. But that premium has been eroded in the past year as HSBC's shares have underperformed the European banking sector by about 7 percent.

Bond remains bullish about the prospects for consumer finance. He points out that around 40 percent of U.S. adults are excluded from the banking system, either because they do not have property or a regular income or because there is a blot on their credit history. Businesses such as Household use computer modeling to decide whether to award a loan. And, unlike the regular banking market, there are only a handful of sizable players. He says that many of Household's customers are immigrants who need a loan to help them start their new lives. Like other consumer finance groups, Household has faced accusations of predatory lending from consumer groups but Bond attributes Household's problems to "one or two rogue branches."

The next challenge for HSBC is to see whether it can use Household's skills to develop consumer finance businesses in other parts of the world, particularly Asia. HSBC has started switching over its credit card operations to Household's computer systems. Ken Harvey, HSBC's head of information technology, was promoted from Household. The U.S. division's management has also been involved in the search for acquisitions in the consumer finance business in Asia, and HSBC has looked closely at several possible acquisitions in Japan.

Bond believes that there is a natural fit between consumer finance companies, which consume capital, and commercial banks, which tend to have surplus capital on their balance sheets. "It's better, more efficient financial intermediation if the depositors of the consumer society can lend directly to the borrowers," he says.

Much of HSBC's longer-term appeal to investors lies in its position in Hong Kong and the assumption by most investors that it can capitalize on the growth of China. Its operations on the mainland are restricted to working for foreign companies and trading foreign currency, but HSBC is positioning itself for the day when the market opens up. In 2002, it acquired a 10 percent stake in Ping An, a Chinese insurance company. This year, it paid $1.75 billion for 20 percent of Shanghai's Bank of Communications.

Ask banking executives for their views of HSBC as a competitor and most will offer glowing praise. An investment banker, however, will generally respond with head-shaking incomprehension. The reason is that since HSBC announced a shake-up of its corporate, investment banking and markets division, rivals have questioned its long-term appetite for the risks and pressures of running an investment banking business.

Over the past 18 months, Stuart Gulliver and John Studzinski, the new heads of HSBC's investment banking business, have overseen an effort to increase the fees that the bank earns from its largest corporate customers. About 1,000 employees have left, while HSBC has hired another 700 to try to build an advisory business on top of its lending, cash management and debt capital markets operations.

This surprised rivals because HSBC, which prides itself on a frugal approach, has generally been suspicious of the free-wheeling, bonus-driven culture of most investment banks. "They are a great company, but they are a nonfactor in investment banking," says one senior rival executive. "I don't get why they are in the business." The chairman of a rival financial group suggests HSBC's approach makes sense only as a prelude to buying a U.S. investment bank such as Merrill Lynch.

Bond bristles at the criticism, which he argues is based on a fundamental misunderstanding of the bank's strategy. He points out that although its wholesale business is already one of the largest in the world, its equities platform had been underperforming. "What we needed to do was make our equities business viable and relevant to our client base, and we needed to see if we could build an advisory business."

Executives argue that the move, which translates into a $400 million increase in the bank's annual costs, is low risk compared with a risky and costly acquisition. Although HSBC has long been rumored as a possible buyer of Merrill Lynch, insiders insist that an investment banking deal is out of the question.

The bank also has no intention of taking on Wall Street investment banks on their home turf. Instead, it is seeking to build on long-established links with the world's 3,000 largest companies. "We did a little test-marketing of our largest corporate clients around the world and we had a unanimous response," Bond says. "They said, 'You produce people of the right caliber and we would be very happy to have an alternative to the existing range.'"

Bond also dismisses concerns that the guaranteed contracts required to lure investment bankers will upset lower-paid employees in other divisions. "These people take different risks with their careers and have different aspirations," he says. "I haven't had one person walk through my door this year saying 'this is an absolute travesty.'"

However, Bond and his colleagues insist HSBC's investment bankers must share the company's client-focused ethos. Bond argues that, in an ideal world, investment banks would receive their fees in the form of their clients' shares, though he acknowledges that there are practical hurdles that make this impossible. Executives say it is far too early to judge the effects of the hiring spree. For now, however, rivals look set to carry on sniping.

Adapted with permission from the Financial Times.

RELATED ARTICLE: On the Acquisition Trail

HSBC has made 50 acquisitions over the past 13 years at a cost of more
than $50 billion. Here are some of the most recent:

1999  Republic
      National Bank
      $10 billion
2002  Household
      Formerly
      Household
      Finance
      $15 billion
2004  Shanghai's
      Bank of Communications
      20 percent
      $1.75 billion
2005  Merrill Lynch?
      Insiders deny any intention, but speculation persists.

Source: Financial Times/Chief Executive