LONDON HSBC posted lower than expected earnings on Monday and said it might have to pay $1.6 billion (1 billion pounds) in damages over a U.S. lawsuit, reviving concerns over legacy issues and growth prospects at Europe's biggest bank.
Its shares fell more than 4 percent, after a slowdown in emerging markets contributed to a steeper than expected 12 percent drop in revenues in the first half of the year.
The London-based bank also said it may face a $1.6 billion settlement with a U.S. regulator over allegations it mis-sold mortgage-backed bonds during the housing bubble.
The Federal Housing Finance Agency (FHFA), the conservator of Fannie Mae and Freddie Mac, has alleged 18 banks misrepresented the quality of the collateral backing securities they sold between 2005 and 2008.
"Based upon the information currently available, it is possible that these damages could be as high as $1.6 billion," HSBC said.
HSBC had previously said the financial impact of any litigation could be significant but had never estimated the scale. Analysts said it might be about $900 million.
Swiss bank UBS paid $885 million in a settlement with the FHFA last month and two other lenders have settled for undisclosed sums. Other banks have set aside money for potential settlements.
HSBC Chief Executive Stuart Gulliver is attempting to repair the bank's reputation in the United States after authorities there last year fined it $1.9 billion for compliance failings in Mexico.
That settlement included a deferred prosecution agreement, which meant HSBC avoided being criminally charged but agreed to have a monitor evaluate its improvement in compliance.
The bank said it had added 1,600 compliance and regulatory staff in the first half of this year, despite axing thousands of jobs elsewhere.
HSBC's pretax profit rose 10 percent in the first half year as the bank's three-year cost-cutting plan paid off and losses on bad debts declined.
Gulliver is two and a half years into a restructuring plan and has sold, or exited, 54 businesses. He has cut $4.1 billion in annual costs and is making progress on returns.
But some analysts said growth will be a challenge given a tough global economy and tighter regulations.
"For all the worthy progress in terms of strategic repositioning ... weak revenues driven by anaemic loan growth and a declining margin constrain financial progress and returns," said Ian Gordon, analyst at Investec.
Pretax profit rose to $14.1 billion from $12.7 billion a year ago. But the outcome fell short of the average $14.6 billion expected by analysts polled by the company.
"There has been a slowdown in faster-growing markets in recent quarters, even emerging markets go through business cycles," Gulliver said. "But the reality is those markets continue to grow relatively quickly."
Profits from Latin America more than halved to $466 million as losses from bad loans jumped in Brazil and Mexico, continuing its troubled run in the region.
The bank also set aside another $367 million to compensate customers in Britain who were mis-sold insurance against loan defaults, taking its provision for that issue - which has affected British banks across the board - to $2.8 billion.
Shares in HSBC closed down 4.4 percent in London at 718 pence, the weakest stock in the European banking index, having spiked to a more than two-month high on Friday.
Gulliver said he expected China's GDP growth to slow to 7.4 percent this year and next as the country shifts away from economic stimulus toward reform measures, but said slower expansion should provide the basis for more sustainable long-term growth.
China's annual economic growth was still more than its total GDP was 18 years ago, he noted.
The bank continued to expand in mainland China and had 169 outlets there at the end of June, up from 124 two years ago.
Hong Kong and the rest of Asia accounted for $8.1 billion of first-half profit, or 62 percent of the group total.
Gulliver is increasing focus on those regions and also wants to cut complexity within the organisation.
HSBC has slashed its number of customers to 55 million from 89 million two years ago and the CEO has cut more than 35,000 staff - a trend which could continue, reducing headcount to 240,000 by 2016 from 259,400 at the end of June.
Gulliver said the biggest restructuring changes had occurred and the pace of deals is likely to slow, although he expects to sell more U.S. loans to accelerate the run-off of its consumer loan book there. It sold two portfolios of U.S. loans for $3.2 billion in March, leaving it with a $36 billion loan book at the end of June, down $10 billion from a year ago.
HSBC Chairman Douglas Flint said the bank could bump up salaries to counter European Union plans to cap bonuses at one or two times salary, which he said could have a "highly damaging impact on our competitive position".
Flint said he would consult with shareholders on how best to pay competitively while keeping a remuneration framework he agreed with shareholders two years ago, which allowed for bonus awards of several times salaries.
(Editing by David Holmes and David Cowell)