Let’s be honest, the elephant in the room is another major financial crisis in 2015. Investors are worried that stocks exposed to such a crisis will be hammered by the market. It’s why, for example, I have been advocating buying more defensive plays next year like healthcare stocks.
To highlight just how worried the authorities are about another credit crunch, two separate stress tests have been completed (one European, the other British) to sort the ‘good’ banks from the bad ones. I want to now highlight one bank that passed these tests with flying colours, and another bank that’s showing very promising signs for the medium term.
A chance for HSBC to flex its muscles
I imagine the very idea of a stress test for most people conjures up… well… stress! For those already strong enough to take even the hardest of hits though, it’s a bit of a chance to show off. That’s precisely what HSBC Holdings (LSE: HSBA) (NYSE: HSBC.US) has done this month.
Think of the stress test like a weights session at the gym. Each bank is asked to carry some pretty heavy weights — things like “a property market collapse”, or “a spike in the unemployment rate”. It’s designed to find out if, under all these economic stresses, the bank buckles under the pressure. As it turns out, HSBC was one of five banks that didn’t have any “capital inadequacies”.
To the contrary, HSBC is ‘strong’. It has a profit margin of 22%, earnings per share growth of 78%, a price-to-earnings ratio of around 10 and a dividend yield of over 5%. The bank’s main weakness at present is its net interest margin — currently sitting around 1.95%. However, Goldman Sachs says HSBC could add $1.3 billion in net interest income next year if interest rates rise even by just 25 basis points.
Another strength of HSBC is its global presence. It’s set up in 70 countries with tens of millions of customers worldwide. It has a significant position in China and is Hong Kong’s largest bank. Despite its dominance in the Asia Pacific region, the bank has warned of slowing growth in the region’s emerging economies. This isn’t regarded yet as a serious problem but it will no doubt be watched closely by analysts.
Can Santander rise above the pack?
Then there’s this year’s “dark horse”. Like many banks, Banco Santander (LSE: BNC) (NYSE: SAN.US) is expected to see an improvement in its interest margin in 2015 to 2.8% or greater. It’s profit margin is already north of 17%, while the Spanish bank boasts a dividend yield of 7%. Banco Santander’s earnings for the first nine months of 2014 rose by 32% to €4.36 billion and, given further improvements to the Spanish economy (expected to grow at 2%), the bank should be well place for some modest growth next year.
Three key risks for Banco Santander are the UK property market, the health of some of the major economies in the Eurozone, and deflation. For now, the government — predictably so — is reassuring investors that the economy is improving.
So there you go, HSBC and Banco Santander are separated from the pack based on their valuations, earnings potential and dividend offerings. I also favour them over Lloyds Banking Group, Barclays and Royal Bank of Scotland. Why? Well, Barclays is currently in my ‘bad books’ because its latest interim results show a significant recent reduction in the bank’s investment banking business and a 4% drop in overall income to £18.6 billion. As far as Lloyds is concerned, I’m not overly impressed… earlier this year it announced 9,000 job losses and said it was closing 150 branches over the next three years. In addition, the latest stress tests revealed the group was still at risk or vulnerable in the event of a “severe economic downturn”.
Finally, I want to touch on the fact that none of the banks seem to be looking after one of their major stakeholders very well. A recent Survey by Which? shows satisfaction rates among customers are low. In fact most banks barely pass: Santander scored 64%, Lloyds 58%, Barclays 57%, HSBC 55%, and RBS came in at 53%.
It seems even the most successful of City banks has its work cut out next year making everyone happy.
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David Taylor has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.