Concerns about the state of the global economy, plunging government bond yields and a rising number of corporate defaults around the world have sent tremors through the global financial sector over the past month. Investors have run for cover as concerns have built up and financial stocks have faced heavy selling pressure since the beginning of 2016.
Indeed, year-to-date shares in HSBC (LSE: HSBA) have fallen by 19.3%, underperforming the wider FTSE 100 by around 17%, excluding dividends. Shares in RBS have underperformed the index by 26%, Barclays has underperformed by 21.5%, and Lloyds has underperformed by around 8%. Once again, these figures are all excluding dividends.
The banking sector as a whole is down by 17% for the year, and the wider financials sector has lost around 11% year-to-date.
About to get worse?
Unfortunately, things could be about to get a lot worse for the financial sector and if, as some economists are predicting, the US Federal Reserve decides to backtrack on its pledge to raise interest rates, shares in HSBC could plunge to their lowest level since the financial crisis.
At the peak of that financial crisis, shares in HSBC traded as low as 360p and history could repeat itself again this year if global economic growth continues to slide.
If the Federal Reserve believes global economic growth isn’t healthy enough to sustain an interest rate hike, the bank could decide to lower its key interest rate again, which would have profound effects on the financial sector.
Banks rely on higher interest rates to generate higher returns from their lending to customers and after nearly a decade of near zero interest rates, interest margins have been squeezed to unsustainable levels. A further interest rate cut would hit HSBC’s income, and when you consider the fact that the bank has consistently struggled to grow its bottom line since the financial crisis, this could mean more trouble for the company.
Struggling to grow
Since 2011, HSBC’s earnings per share have consistently fallen year after year as the bank has failed to meet its promise to return to growth. For the year ending 31 December 2011, HSBC reported earnings per share of $0.92. For the year ending 31 December 2016, City analysts believe the bank will report earnings per share of $0.59 based on current exchange rates, a 10% year-on-year fall in earnings per share. Based on this forecast, HSBC’s shares are trading at a forward P/E of 10.5.
Unfortunately, while HSBC’s earnings per share have been contracting over the past five years, the company has been hiking its dividend payout and as a result, dividend cover has fallen. This means that the bank is now paying out the majority of its earnings per share to investors every year in dividends, leaving little room for error.
Next year HSBC’s dividend payout will only be covered 1.2 times by earnings per share. Any further declines in earnings could leave HSBC struggling to meet its dividend commitments.
