Bank stocks have caught my attention lately because the Bank of England has just lifted restrictions on bank dividends that were put in place in March 2020. The restrictions were to ensure banks held enough capital to weather the coronavirus storm. I think this new move makes bank stocks more attractive, partly because it suggests that our central bank is confident about the future economic situation.
I don’t currently have a UK bank stock as part of my portfolio. A key element of my attitude to risk is diversification rather than concentration. This means purchasing different stocks across different sectors. Ideally, I’d like to add a bank stock, but only if the benefit of diversification outweighs any risks.
Bank stock paying dividends?
HSBC (LSE: HSBA) has a 2.7% dividend yield. It’s twice the size of its nearest UK competitor Banco Santander. But it’s not just UK-focused. Internationally, the bank is expanding across Asia, with a $100bn plan to become the market leader for high net worth individuals. Analysts believe that Asia holds the biggest opportunity for retail banking growth.
Its share price was 401p at Friday’s close, up from a low of 283p in September 2020 and up nearly 14% since this time last year. I think there’s room for more growth too. For a start, it was 791p in January 2018. And its price-to earnings (P/E) ratio of 18 is about average for a bank stock. It has cash reserves of $870.5bn, a 33% increase on last year, with long-term debt of only $96bn. These numbers are positive indicators for me.
Don’t bank on it
But bank stocks have struggled since the financial crash in 2008, and this has been one of the worst performing FTSE 100 sectors over the past decade. When the pandemic struck, most UK banks were still dealing with the implications of Brexit and the Covid crisis didn’t help their appeal. HSBC, Barclays, Lloyds, Natwest and Banco Santander all lost roughly 50% of their value in less than six months. That was no surprise. After all, HSBC’s profits fell 34% in 2020 to £6.2bn, and it has slashed its financial targets for this year.
I think that bank stocks like HSBC are particularly susceptible to weak confidence in the economy. There’s still too much uncertainty and rising coronavirus cases spurred on by the Delta variant have the potential to place the UK back into another lockdown.
But what about banks’ prospects looking ahead? Banks make much of their money from loans. With the end of the Stamp Duty holiday, I believe there will be less demand for mortgages. The UK inflation rate has risen to 2.5%, and further increases could have an impact on demand for credit. Interest rates are at record lows across the Western world, with the UK base rate a meagre 0.1%. Not only does this mean less profit can be made on loans, it also makes banks less resistant to inflation. In addition, if there’s sustained economic damage, I think businesses may struggle to pay back loans.
Externally, there are new challenges. FinTech companies are an issue. Last week Revolut became the UK’s most valuable private technology company at £24bn. It recently applied for a full UK banking licence. Challenger banks Monzo and Starling are also chipping away at HSBC’s customer base.
It all makes HSBC bank stock too risky for me. I’m staying away.
Charles Archer has no position in any of the shares mentioned. The Motley Fool UK has recommended HSBC Holdings. 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.