Lloyds, RBS, Barclays, and HSBC: Britain's Big Four Banks Face A Big Breakup Threat

Breaking up Britain's long-standing "big four" banks has become a political hot-button issue heading into the May election. What this could mean, who is most at risk, and why it could be good news for some investors.

Jul 22, 2014 at 4:46PM

They hold 77 percent of personal banking accounts in the United Kingdom. They also hold 85 percent of business accounts and make 90 percent of the business loans.

They are Britain's Big Four banks, and as election season begins they've become a political issue.

Collectively, they are Royal Bank of Scotland (NYSE:RBS), Lloyds Banking Group (NYSE:LYG), Barclays (NYSE:BCS), and HSBC Holdings (NYSE:HSBC), and there are growing discussions about breaking them up.

The political issue
The British government's Competition and Markets Authority is complaining that the oligopoly in Britain's banking sector is making things tough for individual account-holders, and for small businesses, both of which are struggling to get equitable treatment as the Big Four scramble for business from big players.

Being a small business is hard anywhere, but the struggle to get banking services is becoming a rising political issue throughout Britain. Ed Balls, Labour's Shadow Finance Minister, is calling for an industrywide investigation and market share caps, amounting to a de facto breakup.

He's not alone. The European Union is already forcing Lloyds Banking and Royal Bank of Scotland to sell some 900 branches to limit their dominance in certain markets. The Cameron government also seems to be moving toward investigations, though unlike Labour's call for swift action, it could take until 2016 before any action was imposed.

As next May's general election gets tighter, expect both sides to push for bigger and more dramatic action on the banks, and expect the ruling Conservatives to try to push through a smaller breakup in some particularly important segment, like Scotland (where as you might imagine Royal Bank of Scotland dominates) to deflect complaints from Labour that they aren't doing enough.

What this could mean
Don't expect a massive move to happen overnight, but don't be surprised if the British government starts moving for regional breakups to try to "enhance competition."

This could have two potentially major effects of which investors should be aware. The first is that regional breakups mean the Big Four won't be treated equally. Looking at the Scotland example above, Royal Bank of Scotland and Lloyds Group would be the likely targets, while Barclays and HSBC, which don't have major shares there in the first place, would not. This could give the ones that remain whole a chance to  increase market share at the expense of their divided rivals.

On the other hand, if the breakup fever gets more widespread, we could easily be looking at wholesale breakup on the scale of the 1982 Bell System breakup in a few years. That could allow some of these big, complex companies to unlock more shareholder value as they split into smaller, more focused companies.

Big Four by the numbers
The easiest way to compare the four is to ask two key questions. First we must consider if these stocks are worth owning right now, irrespective of breakup speculation.

In that regard, Barclays and Lloyds Banking appear strongest. Both sport very low forward P/E ratios, 8.01 for Barclays and 8.61 for Lloyds Banking. Barclays has a slightly lower PEG ratio of 0.60, and a much lower price book value at 0.61. Lloyds Banking has a 0.67 PEG ratio and is at 1.29 times book.

HSBC must also be in the mix for paying the highest dividend yield of 3.9%, and for having the best profit margins. Barclays also pays a respectable 1.7% dividend.

The second question is which companies might benefit most from a split-up unlocking shareholder value. In this regard, Royal Bank of Scotland looks very strong, as one of the biggest of the Big Four and also dominant in Scotland, a market likely to be targeted for breakups early. They also trade at a low 0.60 times book value, which could suggest there is some major value to be unlocked here.

Barclays is also no slouch, though as one of the smaller Big Four players they are the least liable to face much forced division. They also have that low 0.61 price book, and as one of the least represented in Scotland, might be able to gain market share if the dominant player struggles with becoming several smaller companies.

It must not be forgotten how long these sort of forced breakups can take. The 1982 Bell Systems example, remember, started in 1974 at the Justice Department. There may be political pressure right now in Britain to do something faster, but that something is likely to be some tests in certain markets, like Scotland, before wholesale breakups are seriously considered.

Whatever ultimately happens, my favorite of the pack is Barclays, which is priced quite cheaply if one totally ignores the breakup speculation, but which also has some potentially lucrative spin-off prospects, if something like Barclaycard gets floated as a separate offering.

The other three are all reasonable choices, though Royal Bank of Scotland is a heavier bet on a breakup unlocking value, and Lloyds Banking is primarily a bet on its continuing growth. HSBC is primarily of interest as an income stock with its nice dividend.

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