It’s been quite a week for the banks, although as ever you have to swallow the bad news along with the good. However, it does seem that the balance is shifting in favour of the latter.
Laugh out Lloyds
Lloyds Banking Group (LSE: LLOY) and HSBC Holdings (LSE: HSBA) have both reported in recent days, but Lloyds enjoyed the warmer welcome after posting full-year profits of £4.4bn for 2018, up from £3.5bn the year before. It further delighted investors by hiking its dividend 5% to 3.21p, and announcing a share buyback of up to £1.75bn.
The bank now pays more dividends than before the financial crisis, and currently offers a forward yield of 5.8%, with cover of 2.1. This is expected to hit 6.3% by 2020. It looks like a dividend machine once more and is also the UK’s most profitable bank.
PPI deadline looms
Lloyds was hit hardest of all by the PPI mis-selling scandal, paying out around £19bn compensation since 2011. However, payouts were ‘just’ £750m last year, down from £1.65bn in 2017. The final deadline for claims expires on 29 August, and although people expect a last-minute flurry, it can then draw a line under the dismal affair.
I’ve been tipping the Lloyds share price for some time but to little avail, it is down 14% over one year and 27% over five. However, with the stock trading at just 7.9 times earnings and a price-to-book (P/B) ratio of 0.9, it still looks like a good opportunity to me, especially since City analysts forecast earnings will grow 35% next year.
The most immediate worry is Brexit, given Lloyds’ domestic focus, and no-deal could lead to a surge in loan impairments, currently negligible. It may struggle to grow in the mature, highly regulated UK market that is swarming with challenger banks but I still reckon it’s a fine long-term income play.
HSBC currently offers the most generous bank dividend with a forecast yield of 6.4%, but cover is relatively thin at 1.5. It is also the most expensive of the big FTSE 100 banks, as measured by its P/E of 11.28 times, according to research from Hargreaves Lansdown. Its P/B ratio is benign at 0.8, though.
While Lloyds has fallen 27% over the past five years, HSBC is down just 3% in that time although the last 12 months have been rocky when it dropped like a stone. It was caught out by difficult trading conditions in the final quarter of last year, with profits of $3.70bn coming in 17% below market expectations and 40% below the previous quarter’s result.
HSBC’s much-heralded strength is its massive exposure to fast-growing Asian markets, but the US-China trade war has turned that into a liability for now. It nonetheless reported underlying annual profits of almost $22bn while earnings grew, costs were kept in check and it boosted its return on equity.
The banking sector faces a host of uncertainties, from Brexit, to the pace of interest rate hikes, to concerns over the slowing global economy and the likely impact on impairments. If we get a Brexit fix I would buy Lloyds first, but I’d also seriously consider HSBC.
Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended HSBC Holdings and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.