Why You Should Buy Lloyds Banking Group PLC And Sell HSBC Holdings plc

LloydsLloyds  (LSE: LLOY) (NYSE: LYG.US) and HSBC (LSE: HSBA) (NYSE: HSBC.US) are two very different beasts. After working hard to recover from mistakes made during the financial crisis, Lloyds is now rapidly returning to health after selling off non-core assets and streamlining operations.

Meanwhile, HSBC remains a sprawling giant of the banking world, with an international network of more than 6,200 offices in 74 countries. However, HSBC’s size and operating structure could be its Achilles heel as regulators become increasingly sceptical of big banks and levy hefty fines on the sector.

Back to basics

Lloyds’ restructuring has seen the bank go back to basics, simplifying to the old, unofficial 3-6-3 banking business model. Simply put, this rule describes how bankers would give 3% interest on depositors’ accounts, lend the depositors money at 6% interest and then be playing golf at 3pm – a straightforward way of doing business. 

A part of this return to basics, Lloyds has now exited, or announced the exit from over 20 countries so far, agreed to sell its asset management business, Scottish Widows to Aberdeen Asset Management and sold its stake in Sainsbury’s Bank. The group is on track to reduce its portfolio of businesses by approximately £10bn during 2014.

All in all, simplification means that Lloyds is now easier to understand and there are fewer things that can go wrong for the bank. Additionally, management has reduced the bank’s risk. Risk weighted assets fell to £263.9bn at the end of 2013, down from £310.3bn reported during 2012. Over the same period, total credit risk exposure also fell to £724.9bn at the end of 2013, down from £759bn. Lloyd should report a further reduction in risky assets this year. 

Bigger is not always better

On the other hand, HSBC is an extremely complicated company to understand.  For example, while management has been trying to sell non-core assets and simplify the business, HSBC still has approximately $2trn of assets on its balance sheet — an astronomical sum. 

Further, HSBC is suffering from an increasing regulatory burden as regulators around the world try and make an example of banks for mistakes made in the past. HSBC is now spending hundreds of millions every year trying to ensure that it complies with complex regulations. Unfortunately, this regulatory burden is putting a strain on HSBC’s operations and impacting profitability. 

Indeed, the bank now spends $750m to$800m a year on its compliance and risk programme, an increase of $150m to$200m from last year. Costs are expected to increase by a similar amount again next year and of course, these costs exclude one-off charges as a result of fines.

All in all, rising compliance costs pushed HSBC’s operating expenses up by a total of 4% to $18.2bn during the first half of this year. As a result, the bank’s cost efficiency ratio ticked up to 58.6% from 55.3%, above management’s targeted mid-50s level.

Easy to understand 

So, Lloyds' slimmed-down structure makes the bank look like a more attractive investment compared to larger, more complex peer HSBC. However, I strongly recommend that you do your own research before making any trading decision.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.