Ever since the financial crisis, banking has been the incredible shrinking sector. In 2007, HSBC Holdings(LSE: HSBA) was posting global profits of $20.46bn. Last year, those profits had been downsized to $15.1bn. Earnings per share (EPS) growth has been negative for three out of the last four years - four out of five if you include 2016 forecasts.
This week markets were informed that HSBC's third-quarter earnings fell by a whopping 86%. It suffered a $1.7bn loss on a Brazilian disposal, incurred $1bn of restructuring costs and forked out $456m in PPI claims, plus another seven ugly one-off items. Despite all this, the share price ended the day 4.62% higher. There were some positive numbers in there, notably a 7% rise in adjusted pre-tax profits, but as broker AJ Bell puts it: "The share price is rising because HSBC may be shrinking its way back to health."
Not everything is shrinking. HSBC's common equity tier 1 capital ratio improved by almost two percentage points to 13.9%. Allied with $2.8bn of cost-cutting there are hopes this will support the dividend and fund future share buybacks. The forecast dividend of 6.4% is down from the recent vertiginous 8%, although cover remains thin at 1.1. All eyes are now on the Chinese economy, to which HSBC has outsize exposure. That will determine whether it shrinks or expands next year.
HSBC is shrinking itself to share price success so can Lloyds Banking Group(LSE: LLOY) pull off the same trick? It has also been suffering shrinkage, with revenues of nearly £39bn in 2012 forecast to slump to £13.7bn this year. The share price is down by almost a quarter over the past 12 months. The company has narrowed its focus to primarily the UK domestic market in a move designed to recreate the glory days when Lloyds was a low-risk income machine rather than a hungry growth monster.
However, this apparently sound move has met unforeseen circumstances, leaving the bank highly exposed to the Brexit shock. The share price hit a high of 72p just before the referendum, then crashed and unlike many stocks has failed to recover. Today it languishes at around 47p.
Q3 profit of £1.9bn was reduced by £1bn of PPI mis-selling costs. Also like HSBC, Lloyds had a healthy capital ratio of 13.4% at the end of Q3, up 0.4 percentage points on Q2. It's also cutting costs, closing 200 branches and lopping 3,000 off the staff headcount, as it pursues its digital first policy. The one thing that's rising is the yield, currently a solid 4% and forecast to hit 5.7% by the end of this year, and 6.6% by December 2017.
If HSBC's results are any guide, downsizing will eventually pay off for Lloyds too. Size no longer matters in the way it did before, profitability does. Investors accept this and that's good news for Lloyds as it looks to produce a leaner, meaner operation. The problem is that both stocks remain exposed to external shocks, in China and the UK respectively, and no amount of shrinkage can shield them from that.
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Harvey Jones 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.