Should You Buy HSBC Holdings plc, Lloyds Banking Group PLC Or Barclays PLC… Or Is The Sector Rotten To Its Core?

The banking sector has taken a real beating in recent years. HSBC (LSE: HSBA), Lloyds (LSE: LLOY) and Barclays (LSE: BARC), along with most British banks, have been the targets of a not undeserved and relentless bashing from the national press.

As a long-term investor, I try to buy when there is blood on the streets and these once-admired operations still trade below their 2008 prices.

The public have certainly been baying for the heads of our fat-cat bankers of late, but are any of these companies worth buying?

The bad news is all out… isn’t it?

PPI, Libor rigging, money laundering.. I’m sure you’re familiar with the many scandals the big banks have been involved in recently. As the sector slowly recovers, surely it’s all finally over, isn’t it?

It would seem not.

A group of banks, including the above three, were fined hundreds of millions each, totalling £2.7bn, after traders inside the organisations were found guilty of rigging the currency markets.  

These traders were not only manipulating the exchange rates in order to profit, but had the audacity to nickname themselves “The Three Musketeers,” and “The A-Team.”

Well, I’m sure it will turn out to be every man for themselves and none for all when these criminals are questioned, and I’m equally sure that no one’s going to pity these fools when they lose everything.

As a Fool with a capital “F,” however, I’m personally very worried by the culture in these banks. Such juvenile and criminal activity could pave the way for further moral failures, and down that path lays crippling fines and poor shareholder returns.  

As a long-term investor, I try to buy businesses that nurture growth through sensible, forward looking cultures. But do any of these reformed banks fit our Foolish values, and are they worth investing in?

Barclays: Project Transform

Barclays did not fare well in the ’08 financial crisis, barely avoiding government intervention by raising £6.5bn through private investors. It also cut its dividend and has since held a rights issue. Management had greedily overstretched, not a trait I’m comfortable with as a long-term investor.  

Furthermore, Barclays has been accused of many misdemeanours including PPI, Libor rigging and the more recent exchange rate rigging, and was fined a whopping £7.89bn between 2009 and 2013!  

To counter this it has introduced Project Transform, which aims to rebuild the culture of the organisation, but the question remains: can Barclays clean up its act and become an investible bank?

Its chances don’t look good at the moment. It recently set aside £500m for the aforementioned currency-rigging fine.  

However, with a 40% pay-out ratio currently targeted for the dividend and earnings forecast to grow over the next couple of years looks to be significant slack for the company to grow the 2.6% dividend.

Lloyds: Resurging Giant

Lloyds seriously struggled in 2008, and had to be bailed out by the government to the tune of £5.5bn. It has made significant progress with its recovery and is expected to deliver more than £7bn in pre-tax profit this year. This would leave the shares trading on a PE of 9.8 for the year, sneaking into single-figure “value territory.”

Furthermore, resumption of the dividend looks more and more likely after the company passed the Bank of England’s stress test. Analysts at Barclays have predicted an initial 1.7p dividend rising to 6 in 2017. That equates to yields of 2.1% and 7.4% respectively. Although I wouldn’t necessarily trust such a long-term forecast, it does give a snippet of what Lloyds could be capable of if its recovery continues unobstructed. 

For me, the main risk with Lloyds lies not in its culture, but in its recovery being derailed.  

HSBC: Survivor

The self-proclaimed “world’s local bank” HSBC didn’t suffer in 2008 as much as the other banks mentioned today, indicating a more conservative approach to risk. However, HSBC is certainly not immune to dodgy dealings and was fined £1.1bn in 2012 after failing to detect Mexican drug cartels using their accounts for money laundering.

In total, HSBC paid £7.21bn in fines between 2009 and 2013 — not all that far off of Barclays.

The valuation looks attractive here, too. The company trades on a PE of 12 and yields 4.6%, well covered by earnings and cash flow.

The World’s Safest Local Bank?

In my opinion, HSBC, the sole survivor of 2008, is easily the most attractive investment. HSBC seems the least likely to fall afoul of bad culture and overreaching management in the future, while paying a great dividend.

So there you have it — various reasons why, in current conditions with fine-happy regulators and dirty company culture, I would invest in HSBC over the other UK banks.

It is said that no one man can understand the workings of these mega-banks, not even the CEOs.

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Zach Coffell 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.