12th September 2015 by The Value Perspective
by Andrew Lyddon
Believe it or not, there was once a time when you could make an upbeat comment about a UK bank and people would not bat an eye yet in recent years, of course, it is considered deeply unfashionable to do so. Mind you, such a charge is only ever going to encourage us here on The Value Perspective so let’s now be positive about a UK bank – in fact, let’s be positive about two.
The most notable aspect of the latest results from Royal Bank of Scotland (RBS), at least to our eyes, was not the now-familiar talk of regulation and the possibility of further fines but that the bank was, for the first time since effectively being part-nationalised during the financial crisis, able to talk confidently about the circumstances in which it might one day resume paying a dividend or buy back shares.
Admittedly that day will probably not come before 2017 and RBS still has plenty of work to do before then. But nevertheless, it now joins Lloyds in at least being able to nod in the direction of a dividend – Lloyds has already resumed payments to its shareholders – and both can do so because, slowly and steadily over time, their capital positions have recovered back to very robust levels.
RBS’s capital position has still to be boosted quite considerably by measures such as the disposal of the remainder of its stake in US bank Citizens but, essentially, it now stands perhaps a year or two away from a capital position comfortably in excess of the level demanded by the UK regulator. Lloyds is closer even than that. Furthermore, with the UK Government recently making its maiden sale of RBS shares, public-sector ownership at both banks is now falling.
In other words, both businesses have reached a position where, even in today’s much more onerous regulatory environment, capital is a long way towards being restored; dividends and shareholder returns are either now being enacted, in the case of Lloyds, or at least acknowledged, in the case of RBS; and the Government is in the process of exiting its stakes.
Five years ago, had you asked someone what needed to happen for those two banks to start being considered ‘normal’ businesses again, do you not think their reply would have looked a lot like that last paragraph? Yes, this process has taken a long time – longer, certainly, than we expected for a variety of reasons – but the point is it has happened.
Of course, five years ago, many people were doubtful that it would, or could, happen at all. Time and again, investors greatly underestimate the ability of companies to recover if given enough time to do so. Impressively, Lloyds and RBS have done so despite extra headwinds, such as provisions for PPI and other past misconduct, the scale of which few would have predicted at the time.
Here on The Value Perspective, we believe the main lesson to be taken from this episode therefore is that, if investors are willing to take a longer-term outlook, companies are very often able to turn themselves around – moving from being in an uncomfortably problematic position to one that offers a much more promising and financially secure future. If one can buy shares in these businesses at a cheap enough price, then there can be very good returns to be made, just by being patient.
A secondary point, however, stems from the fact the financial crisis put not two but three large UK banks in that uncomfortable position. Of this trio, most people would once have suggested it was Barclays that emerged in the best shape – after all, its losses were more modest and it managed not to end up with the government on its shareholder register.
Yet despite having seen, as it were, a ‘less low’ trough than its two competitors, it would be hard to argue Barclays is now in as strong a position as Lloyds and RBS – certainly in terms of capital and possibly also in terms of the amount of future restructuring required to knock the business into the shape it needs to be in order to thrive as a bank today.
From this, we would conclude that these trough periods of corporate life do often serve a purpose – forcing management to take the sort of drastic but important actions that, further down the line, can leave their business in a much stronger position, more quickly, than it might otherwise have been.