18th August 2014
The UK’s banking sector has been vastly under-owned in recent years but with good reason. Almost six years on since US banking giant Lehman Brothers filed for bankruptcy, many investors despite the rally since the market low, remember and possibly still even feel the pain of the financial crisis.
When the 158-year-old US banking giant filed for bankruptcy, its downfall sent global markets into a tailspin. The UK’s FTSE All Share index plummeted by 35% falling from 2,757 on the Friday before Lehmans went bust, to a post-crash low of 1,781 on 3 March 2009.
Fast forward more than five years and the first half of 2014 witnessed the stockmarket value of many banks on the continent surge.
However experts point out that it has been a different story for their UK counterparts with the FTSE 100’s five UK banks delivering lacklustre performance, despite a backdrop of an improving UK economy.
Over the past 12 months, the FTSE Banks index is down 8%, shares in HSBC are off 5%, Lloyds Banking Group is 2% lower, the scandal hit Barclays has plummeted by 15% and the Asian focused Standard Chartered is a substantial 18% lighter. Only the still 81% taxpayer owned Royal Bank of Scotland has managed to make a gain, albeit by just 2%.*
Looking across the UK’s banking sector, Michael Clark, manager of the Fidelity Moneybuilder Dividend fund says: “Low interest rates, subdued market volatility and the strengthening of sterling have hit investment banking units, while continued exposure to conduct and litigation charges caused ratings agency Moody’s to downgrade its outlook for the UK banking sector from ‘stable’ to ‘negative’.”
While all this suggests a rather downbeat outlook, Clark however believes there are some UK banks which could prove the bears wrong and do well over time.
“The sector is home to some high quality companies which generate high cash flow sufficient to fund both future growth and increase dividend payments,” he adds.
Below Clark outlines his take on the UK’s FTSE 100 listed banks…
The share price relative to the market has fallen back to the very low levels seen during the Asian crisis of the late 90s and this creates an investment opportunity. HSBC has good exposure to fast growing markets in Asia, which accounts for around 60% of its profits and has the best banking book in the UK, with very low exposure to high risk property loans. Over the longer-term, the development of capital markets in China – and the greater convertibility of Renminbi – should be major positives for HSBC.
It is not involved in the Chinese domestic lending issues so my view is that it has good exposure to the right markets in the Far East. The bank is very conservatively run and is making good progress both externally – better compliance, regulation and capital – and internally, in terms of cost control and growth initiatives. Overall, I believe it is a steady ‘compounder’, with a good dividend yield of 5% and has a proven and successful business model with long-term viability.
Barclays is another relatively unloved stock. The bank is restructuring, running off non-core assets and focusing on higher return businesses such as its collection of quality franchises in UK banking, Africa and Barclaycard. The bank faces issues with US regulators – and may well be given a significant fine – although these issues are reflected in its share price. Its renewed commitment to returning cash to shareholders was clearly highlighted in last year’s rights issue, and it should offer a good yield by 2015.
Lloyds has confirmed that it is unable to pay a dividend for the time being. This was in line with my expectations, but disappointed a number of people in the market. Management has also given guidance on future dividend policy. The bank will pay 50% of earnings in the medium-term. If we assume this means two years from now, it suggests a dividend yield of 5.2% in 2016, which is disappointing. Many stocks yield more than that today so I see better value elsewhere in the market.
Royal Bank of Scotland
First quarter results were strong for RBS but as it contained several non-recurring items I don’t believe these results are a reliable indicator of future performance. RBS is woefully under-invested in systems which will remain a drag on operational capabilities for years to come. In fact, it could be 2016 before the company starts making decent profits and is allowed to pay a dividend to shareholders.
Standard Chartered is a good franchise with exposure to structurally growing markets in Asia and Africa. However, revenue growth is slowing and loan loss provisions are rising. Standard Chartered has increased its risk profile over the last years, with strong balance sheet growth, a shift towards unsecured lending and an increasing proportion of profits coming from investment banking activities. While valuation metrics look attractive, I believe there is further downside risk to earnings.
*(Source FE Analytics)