Ten years on, is the bank­ing sec­tor a wise in­vest­ment?

The Daily Telegraph - Business - - Business Comment - GARRY WHITE Garry White is the chief in­vest­ment com­men­ta­tor at wealth man­ager Charles Stan­ley

It was 10 years ago this week that large queues of peo­ple started to form out­side branches of North­ern Rock, the first vis­i­ble sign in the UK of the cri­sis that was to en­gulf mar­kets over the com­ing months. Poor credit as­sess­ment by banks and sloppy reg­u­la­tion on both sides of the At­lantic led to the worst bank­ing cri­sis since the de­pres­sion – re­sult­ing in mas­sive bailouts of fi­nan­cial in­sti­tu­tions and global eco­nomic grief. Now, one decade later, how are banks shap­ing up from an in­vestor’s point of view?

In the UK, the end of PPI pay­ments is now in sight. The Gov­ern­ment has re­turned Lloyds Bank­ing Group to pri­vate hands, and div­i­dends in the sec­tor are al­ready high and on the rise. So, can we now draw a line un­der the Great Fi­nan­cial Cri­sis and look for­ward to a con­fi­dent and prof­itable fu­ture for UK banks?

Well, not ex­actly. Although sub­stan­tial fines and com­pen­sa­tion have al­ready been paid, not all legacy is­sues are over. Bar­clays, RBS and HSBC have yet to set­tle with the US Depart­ment of Jus­tice over the sale of mort­gage-backed se­cu­ri­ties in the lead up to the credit crunch. The fines could eas­ily be $3bn (£2.25bn) – and even as much as $10bn judg­ing by those banks that have set­tled. This is a mas­sive amount for Bar­clays and RBS, po­ten­tially wip­ing out one year’s div­i­dend pay­ments. It should be eas­ier to swal­low at HSBC, which ap­pears to be the more at­trac­tive of the UK banks due to its sig­nif­i­cant op­er­a­tions else­where.

Bank prof­itabil­ity is prob­a­bly never go­ing to hit the heady heights of where it was be­fore the fi­nan­cial cri­sis, mainly be­cause of in­creased reg­u­la­tion. Be­fore things started to de­te­ri­o­rate, banks could as­pire to gen­er­ate re­turns on share­hold­ers’ eq­uity of at least 15pc. But cap­i­tal re­quire­ments fol­low­ing the cri­sis have more than dou­bled – and low in­ter­est rates have re­duced prof­its from the banks’ own as­sets. UK banks are, in gen­eral, now tar­get­ing a lower re­turn on eq­uity of 10pc, which most have so far failed to meet.

Growth in loans has also plum­meted, es­pe­cially for mort­gages. High house prices have re­duced af­ford­abil­ity for many younger cus­tomers, and banks have be­come wary of lend­ing to higher-risk cus­tomers. Home loan growth has gone from mid-teens per year pre­cri­sis to around 2pc to 3pc now. Low in­ter­est rates – which are likely to be around for some time in the UK – also crimp banks’ prof­itabil­ity. In­deed, earn­ings growth is un­likely to be­come in­ter­est­ing un­til in­ter­est rates are raised sub­stan­tially.

Lend­ing to busi­nesses has also been sub­dued. Some say this is be­cause the banks are un­nec­es­sar­ily re­stric­tive, while oth­ers say that busi­nesses do not want to bor­row be­cause they do not want to ex­pose them­selves to fund­ing risks. The only pos­i­tive re­cent macro trend for the banks has been the rise in con­sumer credit, but, for most, this is a small part of their ac­tiv­i­ties and can’t make up for de­clines else­where.

There are also com­pe­ti­tion is­sues that are likely to con­tinue to drag. Reg­u­la­tors are keen to en­cour­age chal­lenger banks, with the fo­cus of their at­ten­tion on cur­rent ac­counts, mort­gages and small busi­ness lend­ing. One of the most in­ter­est­ing and in­no­va­tive pro­posed reme­dies is the in­tro­duc­tion of “open bank­ing”. This would re­quire UK banks, with their cus­tomers’ ap­proval, to make cus­tomer data avail­able to other fi­nan­cial com­pa­nies who could then bid for the cus­tomers’ busi­ness. It is ex­pected that knowl­edge of a cus­tomer’s credit his­tory will im­prove com­pe­ti­tion in lend­ing to those cus­tomers, es­pe­cially to small and medium-sized en­ter­prises.

UK-listed chal­lenger banks such as Al­der­more, Shaw­brook, Metro Bank and Vir­gin Money have their own prob­lems. The big banks have sig­nif­i­cant economies of scale and are much more able to cope with reg­u­la­tory re­quire­ments than in­sti­tu­tions with smaller bal­ance sheets. This means that th­ese smaller play­ers are likely to be re­stricted to a nar­row part of the mar­ket that is un­der­served by the ma­jor banks, which could re­sult in riskier lend­ing port­fo­lios. If more com­pe­ti­tion is to be en­cour­aged, then reg­u­la­tors may need to take a look at the im­pact of new rules on th­ese up-and-com­ing lenders.

One un­der-dis­cussed risk for banks is dis­rup­tion from fintech com­pa­nies. Banks are in­creas­ingly us­ing dig­i­tal pro­cesses to lower costs and in­ter­act with their cus­tomers, but dig­i­tal ex­per­tise is not a tra­di­tional core skill of a UK bank and there is a sus­pi­cion that fintech com­pa­nies will be bet­ter able to ex­ploit the op­por­tu­ni­ties. Tra­di­tional banks are re­spond­ing by us­ing smart­phones and dig­i­tal tech­nol­ogy to dis­trib­ute and process busi­ness, but their fo­cus is more on low­er­ing costs than on rad­i­cally changing the way busi­ness is done.

UK banks may give good div­i­dend yields paid out of cur­rent prof­its, but in­vestors should be wary that bank prof­itabil­ity could fall sharply if mar­gins come un­der more pres­sure and loan losses start to pick up. This could put div­i­dends at risk, and the in­vest­ment also comes with an op­por­tu­nity cost – as more money could po­ten­tially be made in other sec­tors. In­deed, US fi­nan­cials look more at­trac­tive as in­ter­est rates are likely to be raised sooner, loan books are grow­ing, the econ­omy ap­pears to be in great shape and, fol­low­ing a re­cent pe­riod of dol­lar weak­ness, they are at­trac­tive in cur­rency terms too. In­vestors seek­ing bank­ing ex­po­sure may do bet­ter by head­ing west.

‘In­vest­ment in UK banks comes with an op­por­tu­nity cost – as more money could po­ten­tially be made in other sec­tors’

Newspapers in English

Newspapers from UK

© PressReader. All rights reserved.