UK bank shares like the FTSE 100’s Lloyds Banking Group (LSE:LLOY) are among the most economically-sensitive out there. When times are good, their profits can boom. But during tough periods, they can struggle to grow revenues and often endure colossal loan impairments.
The risk these companies pose to investors are higher than normal then, as the British economy struggles. But the threat posed by rising competition is a bigger concern to me than temporary economic trouble. It’s one that casts a significant long-term danger to high street banks.
This is why, despite Lloyds’ cheap share price, I’m not tempted to buy its shares right now. Today, ‘The Black Horse Bank’ trades on a forward price-to-earnings (P/E) ratio of 6.1 times.
It also carries a market-beating 6% dividend yield. But this doesn’t mean I’m avoiding all banking shares right now…
Competitive dangers
A stream of interest rate hikes have raised the profits the high street banks have made since late 2021. In a nutshell, higher rates increase the difference between the interest these companies charge borrowers and what they offer to savers. This is known as the net interest margin (NIM).
Banks have been reluctant to pass on the full extent of rate rises to their customers, resulting in that big earnings boost. But this has prompted a tsunami of savers rushing out to find better rates elsewhere.
According to challenger Atom Bank, a mammoth £22bn was pulled out of Lloyds, Barclays, NatWest, Santander and HSBC (LSE:HSBA) by depositors during the first three months of 2023. And Lloyds et al may struggle to win these switchers back.
Customer satisfaction scores of digital and challenger banks are (largely speaking) miles ahead of those of traditional high street banks. Meanwhile higher operating costs are hampering established banks’ ability to offer competitive products.
One I like
This doesn’t mean that all UK-listed banks should be off-limits for investors though. FTSE 100-listed HSBC is one I think could deliver exceptional long-term capital gains and dividend income.
That Atom Bank data shows that the business is another big casualty of the competitive landscape. What’s more, the pressures from rivals are especially high in HSBC’s core Asian marketplace. Consumers here are far more receptive to new financial sector entrants and so the digital and challenger banks here are growing especially strongly.
Yet the pace at which populations and wealth levels here are growing still provides established banks with enormous opportunities. Low banking penetration gives the business enormous scope to grow earnings, certainly compared with operators in mature markets like the UK.
HSBC is investing heavily to supercharge revenues growth as well. For instance, it plans to spend $6bn over the next few years to expand in China, Hong Kong and Singapore.
Today, HSBC trades on a forward P/E ratio of 5.8 times. It boasts a FTSE-beating 7.4% dividend yield for 2023 too. I think it could be one of the best banking stocks to buy right now.
