HSBC Holdings Plc, Europe’s largest bank by market value, posted a decline in full-year profit after paying a record penalty for compliance failures and said costs rose for a third year, missing its target.

Pretax profit for 2012 dropped 5.6 percent to $20.65 billion, trailing the $23.49 billion estimate of 26 analysts surveyed by Bloomberg. Revenue fell 5.4 percent to $68.33 billion from $72.28 billion, HSBC said today in a statement. The shares declined as much as 3.5 percent in London trading.

Chief Executive Officer Stuart Gulliver is being thwarted in his plan to reduce costs to 48 percent to 52 percent of revenue as the London-based lender set aside $1.9 billion to settle U.S. money-laundering probes and boosted spending on compliance by $500 million. Expenses as a proportion of revenue climbed to 62.8 percent from 57.5 percent, and wage inflation in markets such as Latin America is increasing, HSBC said today.

HSBC’s surging costs “illustrate the size of the financial performance gap to be closed,” Ian Gordon, an analyst at Investec Plc in London who has an add recommendation on the shares, wrote in a note to clients today. “HSBC still has quite material challenges.”

The bank, which operates in more than 80 nations, is spending an extra $500 million a year on compliance and legal staff since the investigation into anti-money laundering infractions, Gulliver, 53, said on a conference call today.

Shares Drop

HSBC has also had to compensate Britons who were wrongly sold insurance on loan repayments as well as interest-rate swaps. In the fourth quarter, the bank provided about $300 million for the redress of U.K. customers mis-sold swaps and about the same amount regarding loan insurance, Finance Director Iain Mackay said.

“There’s some stuff we didn’t actually foresee, some stuff we didn’t see the degree of and some stuff we should have seen,” Gulliver said, referring to the bank’s costs and compliance issues since 2011. “We had not invested appropriately on compliance or our legal function.”

HSBC shares slid 2.9 percent to 706.8 pence at 11:20 a.m. in London trading, exceeding the 1.5 percent drop by the Stoxx 600’s index of European banking stocks. Before today, they had risen 28 percent over the past 12 months. HSBC said it would increase dividend payments to $8.3 billion, or 45 cents per share, a 10 percent boost from last year.

Return on Equity

The bank took a $5.2 billion charge for revaluing its own debt. So-called credit-valuation adjustments require banks to book losses when the value of their debt rises, and gains when it declines, on the theory that a loss, or profit, would be realized were the bank to repurchase that debt.

HSBC said return on equity fell to 8.4 percent from 10.9 percent a year earlier due to the debt revaluation. Gulliver’s target is 12 percent.

HSBC has so far provided $2.4 billion for payment protection insurance and has paid out $1.2 billion, Mackay said. The bank hasn’t yet made payments for interest-rate hedging products, as that program has not yet started.

London-based competitors Lloyds Banking Group Plc and Royal Bank of Scotland Group Plc posted net losses for the year last week as they set aside a combined 2.9 billion pounds related to the scandals. Barclays Plc last month posted its first loss in two decades last month and set aside an additional 1 billion pounds to compensate clients.

Money Laundering

HSBC agreed on Dec. 11 to settle U.S. charges that it helped Mexican and Colombian drug cartels launder millions of dollars in trafficking proceeds. The bank made an $800 million provision in the third quarter to cover a potential settlement, adding to $700 million it had already earmarked.

Gulliver has closed or sold 47 businesses since he took the top job in 2011, sacrificing revenue and targeting 30,000 job cuts. The company said today it has cut $3.6 billion of costs, above its $3.5 billion target.

“On the face of it, these numbers don’t look good, but they’re actually no worse than the others in terms of fines and charges, and we credit HSBC with not trying to hide them from view,” Sandy Chen, an analyst at Cenkos Securities Plc in London, wrote in a note to clients today. “Fundamentally, the global streamlining program is showing results.”

The company said today that it’s “unable to reliably measure” costs related to probes of the London interbank offered rate. RBS, Britain’s largest taxpayer-owned lender, was forced to pay regulators a $612 million fine last month for rigging benchmark interest rates such as Libor.

Investment Banking

HSBC paid $3.7 billion in staff bonuses to employees for 2012, or $2.9 billion net of tax.

Profit at HSBC’s investment bank, led by Samir Assaf, rose 20 percent to $8.5 billion. Operating income at the investment bank’s credit business more than doubled to $779 million for the full year, leading profits at the unit higher, according to the lender’s annual report, also published today. Operating income for equities fell to $679 million from $961 million.

Pretax profit from commercial banking increased 7 percent to $8.5 billion.

A 41 percent drop in loan-impairment charges at the consumer banking and wealth-management unit helped pretax profit at the unit more than double to $9.58 billion.

North America

Pretax profit in North America surged more than 20-fold to $2.3 billion from $100 million, helped by a 51 percent drop in loan impairments. The bank’s 2003 purchase of Household International Inc. required the bank to set aside more than $65 billion for souring loans in the region.

The company had a $3.4 billion loss in Europe, compared with a $4.67 billion profit a year earlier.

Profit in Hong Kong, HSBC’s biggest single Asian market, rose 30 percent to $7.58 billion from $5.82 billion, and increased 40 percent to $10.4 billion in the rest of Asia.

Last month, HSBC sold its stake in Shenzhen, China-based Ping An Insurance (Group) Co. for about $9.4 billion and also said it would sell its Panama unit for $2.1 billion. It completed the sale of its U.S. credit card unit to Capital One Financial Corp. for a premium of $2.5 billion in May, the same month it agreed to sell four units in Latin America for about $400 million to Colombia’s Banco GNB Sudameris SA.

(Source: Bloomberg)