The Lloyds (LSE: LLOY) share price is dropping. The banking sector is weighing down the FTSE 100. Several banks are suspending dividends and share buybacks, as demanded by the Bank of England (BoE). Lloyds Banking Group is among them.
The BoE is working under the assumption that the dividend cuts will help to provide debt relief. The thinking is the cash will help individuals and businesses that unable to make interest payments over the next few months.
However, investors aren’t impressed. Many are selling their Lloyds shares. Is now a good time to snap them up? Or is there a better banking sector option?
To answer this, I think it’s useful to compare two different banking business models: Lloyds and HSBC (LSE: HSBA).
Lloyds share price vs. HSBC share price
Lloyds bank shares never recovered from the financial crisis. They are now trading around 30p, where they were in 2012.
Admittedly, most investors hold banking sector shares for income, not growth. But with Lloyds having to suspend dividend payments, there’s no return there either. Certainly not in the short term.
HSBC has also stopped providing returns to investors. Like Lloyds, it acted on BoE ‘advice’. Currently, the bank is trading around 417p, compared with a low of 358p in 2008. It boasts a price-to-earnings ratio of 16.8. Contrast this with Lloyds P/E of 8.8. The market clearly expects more of HSBC.
The difference in share price is likely due to HSBC’s more geographically diverse business model. About 75% of its pre-tax profits come from Asia. In comparison, 95% of Lloyds bank’s assets are based in the UK. Consequently, Lloyds is strongly tied to the UK economy.
This means Lloyds’ pretax profit may be more volatile than HSBC. But, HSBC needs more capital to sustain its position.
Banks need capital to lend against
It’s the need for capital that could be difficult for a FTSE 100 bank. And for HSBC especially.
A bank’s assets are the value of the loans it makes. Its liabilities are the value of deposits and other borrowings it needs to finance itself.
At present, shareholders are withdrawing capital by selling banking shares. HSBC’s Hong Kong shareholders are particularly upset. And extremely low interest rates are discouraging retail customers from making deposits. HSBC and Lloyds may have to find other ways of financing.
At the same time, UK banks are required to loan to businesses and individuals. Unfortunately, a government guarantee doesn’t stop inflating balance sheets. This will affect the banks’ capitalisation ratios. And if it comes to it, I think the BoE is more likely to prioritise Lloyds for any capital needs.
HSBC earnings per share have fallen around 5% per year over the last five years. In contrast, Lloyds has improved its EPS considerably. Even with the payouts from the PPI scandal, Lloyds’ 2019 EPS was 75% higher than in 2015.
Last year HSBC paid out around 80% of its profits as dividends. Even without the current crisis, this looks unsustainable. Lloyds is relatively profitable and well capitalised.
Overall, I think Lloyds is better placed to withstand the current economic headwinds and is undervalued. I’d buy it. But as for HSBC, I’m waiting to see how it responds to short-term pressures before I consider it again.
