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Why I’m holding HSBC and Standard Chartered, despite the financial crisis

With the price of bank shares being driven by fear, should we avoid them completely? Or if we do want to get specific exposure to banks, which banks look the best?

As a private investor, I can only tell you what I’m doing (and remind you an index tracking fund should underpin your portfolio, not individual stock picks).

My personal view is that bank shares will continue to oscillate wildly until house prices stop falling. Then banks should begin to strengthen.

Further falls in house prices in the UK (which I expect) will hit our banks further, though I suspect the scale is now manageable after their capital raising and/or government injections. Much will depend on the performance of their other debt, such as loans to companies struggling through a recession.

The positive spin is that absent a global economic meltdown causing 30-40% of homeowners to default, any bank that survives the credit crisis will at some point be worth a lot more than today. Assets such as mortgages that were previously written right down will then be revalued upwards. (See my post on Prodesse, the investor in US mortgages).

For UK banks, the case is even stronger than for American banks, since UK mortgage holders cannot hand over their keys and absolve themselves of their mortgage, unlike US homeowners.

The Government’s new insurance package may help this strengthening process, if it encourages an orderly, liquid market in currently shunned assets. This could help stem further bank writedowns.

Banking on revaluing their assets

Imagine a world where instead of huge writedowns, banks revised upwards their balance sheets by billions every six months.

Market capitalisations of any banks left standing would boom. But until then banks will be stressed and more will go bust.

It’s this boom-or-bust view of banks that informs my choice of bank shares: HSBC and Standard Chartered.

Previously, I have held several banks for their dividend, as part of a high-yield portfolio. At different points in 2007 and 2008 I owned shares in HSBC, Lloyds, HBOS, and Alliance and Leicester

I managed to get out of both of Lloyds and Alliance and Leicester at reasonable prices, considering how far the shares fell later – Lloyds for around a 25% loss (after years of enjoying a great dividend), and Alliance and Leicester at a good profit before it was taken over by Santander.

HBOS was more painful. These were the first shares I owned. I got them for free when the company demutualized, floated on the London market, and began its disastrous foray into ‘real’ banking.

I had cash savings with HBOS thanks to a modest legacy of £1,000 from a dear relative who couldn’t afford to leave me what she did. I was being totally illogical and emotional, but I didn’t think I’d ever sell those HBOS shares. I’m sure thousands of other people have similar HBOS stories, which makes its reckless expansion and subsequent collapse even more depressing.

For full disclosure, I also briefly held RBS and Barclays during 2008, trading both for a small profit. (We’re talking barely a couple of hundred quid).

I sold them when I finally sold my Lloyds and HBOS shares, and rolled the proceeds into more HSBC shares and the addition of Standard Chartered.

Why HSBC and Standard Chartered?

In the light of my comments yesterday on the cloudiness of bank earnings, you won’t be surprised to hear I’m not going to give a detailed evaluation on the performance of the two banks I’ve chosen to hold.

Frankly, I think such analysis is impossible at the moment, and certainly I have no analysis edge over the market when it comes to their earnings.

I can, however, tell you why I hold the two banks.

When this crisis is over, the banks left standing will operate in a very different competitive environment. There will be far less competition, both home and abroad. Suicidal rivals writing barely profitable loans like Northern Rock will be long gone, helping the margins of those left in business. Assets will be routinely revalued upwards, boosting share prices.

If HSBC and Standard Chartered can’t survive to see such a world, no bank will:

  • Neither company has yet been required to seek government aid.
  • Standard Chartered did raise money extra capital from the markets for safety, but it did it so swiftly and efficiently at the end of 2008, showing how trusted its books are.
  • HSBC was the largest bank in the world by market capitalisation in December 2008.
  • Standard Chartered is an old-fashioned bank with a huge footprint in South East Asia. HSBC is similarly huge in Asia. (HSBC stands for Hong Kong and Shanghaii Banking Corporation). Asian populations are much more solvent than we are. There is no Asian sub-prime crisis.
  • Standard Charterted’s chairman Mervyn Davies has just stepped down to become the UK government as trade minister. To have come through the credit crisis with his standing intact for me gives great confidence in the bank.

Woolly reasoning? Perhaps, but I think at times of crisis the normal ways of investing in shares don’t apply.

Risk versus reward in bank shares

I’m sure that if they survive, Barclays, Lloyds and RBS will provide far more spectacular returns over the next 10 years than my chosen shares. But will they survive?

My investment in HSBC and Standard Chartered is all about not losing money, rather than gaining it.

To be honest, the strategy isn’t going spectacularly well so far – both banks are down with this month’s travails, and have fallen previously on rights issues rumours. The big danger is they’re simply the next dominoes to fall (though HSBC was actually the first big bank to declare a sub-prime issue back in 2007).

As I write, HSBC is down 35% on my purchase price, and Standard Chartered down 30%.

You might ask why I’ve bought bank shares at all. Good question. The reason is I’m stubborn, and I want to profit from the market’s stupidity. Given time I think HSBC and Standard Chartered will outperform the market. But there’s every chance that I’m the patsy.

Remember, most private investors (including me) will likely do much better to invest in a passive index tracking fund. There’s no need to invest in individual shares to profit from a banking recovery. If bank shares rise you’ll still capture plenty of the gain in an index tracker. Equally, if they all go bust you’ll feel the pain.

Returning specifically to Barclays and its 72% gain on Monday, I was tempted at 50p last Friday and obviously wish I’d bought some, but I’d have sold yesterday at 95p. Last week the share price was driven down by manic depression, but a near 100% rally in two days looks like euphoria. I’d now wait for more clarity from the results on February 9th.

It’s all about risk vs return. While the fundamentals are so murky, investing in banks is about confidence, fear, and greed. And yes, maybe a touch of gambling.

Note: I am just a private investor writing a blog about shares, and certainly not a guru or an expert. Make your own decisions, and please read my disclaimer.

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