UPDATE 2-UK fund star Woodford dumps HSBC on banking fine inflation fears

Mon Sep 1, 2014 11:21am EDT

* Says Libor, FX probes could expose HSBC

* Fears a substantial fine could hamper dividend growth

* Sells his fund's entire stake in HSBC (Adds detail on other sellers of HSBC, context)

By Sudip Kar-Gupta, Nishant Kumar and Simon Jessop

LONDON, Sept 1 (Reuters) - Star British fund manager Neil Woodford sold his fund's stake in HSBC last month, citing concerns about the impact of potential fines from several industry-wide investigations on the banking group.

Banks in Europe and the United States have been fined for a variety of transgressions as regulators increase their scrutiny of financial institutions.

Two of the most high-profile and wide-reaching of the investigations concern the setting of interest rates between banks, specifically the London Interbank Offered Rate (Libor), and the fixing of currency rates.

"I am worried that the ongoing investigation into the historic manipulation of Libor and foreign exchange markets could expose HSBC to significant financial penalties," Woodford said in a blog posting on his fund's website.

"Not only are these potentially serious offences in the eyes of the regulator, but HSBC is very able to pay a substantial fine," said Woodford, who built a near cult-like status during more than 25 years at Invesco Perpetual. He left in April to set up Woodford Investment Management.

Asked about Woodford's share sale, HSBC said it had no comment to make on the matter.

While Woodford is not the first to advise caution on the sector after a flat start to the year for the STOXX Europe 600 Bank sector following a gain of nearly 70 percent over the previous two years, investors pay close attention to the bets of such high-profile fund managers.

Sell-side analysts retain a consensus "buy" recommendation on HSBC stock, which currently trades at 1.1 times book value, above the 0.9 times sector average, data from Thomson Reuters StarMine showed.

For Woodford, who began building a stake in the UK's biggest lender in 2013 after avoiding the sector since 2002, HSBC was "a different beast" to its peers, many of which still had problems over the quality of their loan books, capital adequacy and high leverage ratios.

In spite of the fact he considered HSBC a "conservatively-managed, well-capitalised business with a good spread of international assets", Woodford said he had become concerned in recent weeks about the threat of "fine inflation".

From the $1.9 billion paid by HSBC in 2012 over money laundering to the $16.7 billion set to be paid by Bank of America over its role in selling toxic mortgages, fines were increasing, Woodford said, and looked to be based on a company's ability to pay "rather than the scale of the transgression".

UNQUANTIFIABLE

With the size of any potential fine "unquantifiable", Woodford said he was concerned about HSBC's dividend payouts. The stock currently yields 4.8 percent, against a FTSE 100 average of 3.8 percent.

"A substantial fine could hamper HSBC's ability to grow its dividend, in my view. I have therefore sold the fund's position in HSBC, reinvesting the proceeds into parts of the portfolio in which I have greater conviction," he said.

Woodford generated a return of more than 2,200 percent for the Invesco Perpetual High Income Fund, while the FTSE All-Share Total Return index rose 868 percent during the same period.

CF Woodford Equity Income Fund had 2.68 percent of its 2.4 billion pounds of assets in HSBC shares at the end of July, according to the fund's factsheet. That meant the stake was worth 64.3 million pounds ($107 million) at the end of July and was the fund's biggest financial sector holding.

HSBC shares, which opened down 0.2 percent, extended their fall to 1.4 percent after Woodford's blog post. The shares were trading down 1.1 percent at 1357 GMT on Monday. By comparison, Britain's FTSE 100 was down 0.1 percent.

Woodford had invested 17 percent of his fund's assets in the broader financial sector at the end of July, far below the roughly 25 percent weight of such stocks in his benchmark FTSE All Share Index.

As well as HSBC, which was his second-biggest financial sector holding, he had positions in companies including insurers Legal & General, Hiscox and Catlin, and doorstep lender Provident Financial.

(1 US dollar = 0.6018 British pound) (Additional reporting by Matt Scuffham; Editing by David Clarke/Ruth Pitchford)

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