Why are Barclays plc and HSBC Holdings plc priced at half their value?
The woes of Barclays (LSE: BARC) during the Financial Crisis are no secret, but why are shares of this global giant still trading at a mere 0.42 times the company's book value? The main reason comes down to one number: £51bn. This is the amount of non-core risk-weighted assets still on the bank's books that it's trying to dispose of. Progress is being made, as £3bn worth was sold in Q1 and a further £3.4bn is expected to find a new home later this year. However, the £603m quarterly loss from these non-core assets was more than enough to take the shine off the £950m profit from core operations last quarter.
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A second anchor on share prices is the large investment bank that's still weighing down stellar retail banking operations. The investment bank brought in £701m in pre-tax profits for the quarter, about the same as the retail bank's £704m contribution. Yet the retail bank contributed more profits with a fraction of the investment bank's resources. This led to return on tangible equity (RoTE) of 7.3% for the investment bank compared to a whopping 20.5% for the UK retail bank.
A third issue is the persistent high costs, restructuring charges and litigation expenses from which the bank has still yet to escape. Barclays' cost-to-income ratio for the first quarter, while a minor improvement year-on-year, was still a staggering 76%. This is significantly worse than competitor Lloyds' 47.4%, for example. Barclays still hasn't been able to escape the spectre of regulatory fines either as litigation and conduct fines topped £4.3bn in 2015 alone. Although these issues combined with the highly cyclical nature of banking leave me pessimistic that Barclays' shares will be living up to the bank's book value anytime soon.
Emerging markets and operating costs
Shares of HSBC (LSE: HSBA) aren't much better, trading at 0.43 times the lender's book value. Like Barclays, HSBC is also attempting to rid itself of a massive amount of under-performing assets, in this case assets built up during the boom years in emerging markets. The target for HSBC is reducing £290bn of risk-weighted assets, about half of which has already been accomplished. The plan has long been to redeploy a majority of these assets to the bank's core Asian operations, but the continued slowdown in China means this capital could be returned to shareholders instead.
The second reason the bank's shares trade at a subdued valuation is high operating costs. Management is aiming to cut $4.5bn to $5bn in costs annually. This will entail slashing as many as 50,000 jobs and will come alongside selling non-core assets such as Brazilian operations. Bringing out-of-control costs down will be critical as RoTE in Q1 fell from 13.1% to 10.3% year-on-year.
HSBC's strength in emerging markets is also weighing on the company now that plummeting commodity prices are harming economies from Argentina to South Africa. This has filtered through to HSBC's balance sheet in the form of loan impairments, which more than doubled year-on-year to $1.1bn. All of these issues together will impinge on HSBC's growth in the years to come. But if high costs can be wrangled down and the bank can refocus on its Asian breadbasket, I see more hope for HSBC shares to live up to their book value than Barclays.
Of course, the fact that these banks have disappointed shareholders even as the UK's economy has improved over the past eight years doesn't bode well for share prices when the economy reverses course. Thankfully, not all of the FTSE's blue chips are as cyclical as banks, including the slew of more recession-resistant companies in the Motley Fool's latest free report, Five Shares To Retire On.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Barclays and 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.
