Is it time to bank on a rebound?
THE wheels that set the banking sector on a collision course with disaster were already well and truly in motion in summer 2007. Yet casino capitalism was about to reach its giddy climax in the UK, with Royal Bank of Scotland taking over Dutch bank ABN AMRO for the princely sum of £49bn.
Eight years and one financial crisis later, things are a bit different. RBS is engaged in the banking sector’s version of a car-boot sale.
Items on the pop-up table have i ncluded traditional f i nancial assets such as Citizens Bank and the international arm of Coutts, as well as quirkier objects such as the Grosvenor Hotel in London and the Priory Group, best known as the healthcare specialist of choice for overwrought celebrities.
The dramatic change in direction is totemic of the journey the banking sector has been on, and with it UK investors in these institutions.
Back in 2007 more than half of UK fund managers held Royal Bank of Scotland in their portfolio; today fewer than one in five do.
Before the financial crisis, banking stocks were favoured by Steady Eddie income managers. Today only HSBC can really claim to be a staple in income portfolios.
The staunchest backers of the banking sector now tend to be managers of specialist recovery funds who are looking for companies which have been down in the dumps and are in the process of turning themselves around.
Fund managers, as a whole, though, are wary of the sector.
Banks make up around 6pc of the typical UK fund compared to around 11pc of the UK stock mar- ket, with 20pc of managers choosing not to hold any banks at all. Private investors are so far even less convinced by the banking renaissance.
Only a quarter of share investors with Hargreaves Lansdown accounts hold any exposure to the banking sector. Lloyds is a clear favourite, with private investors numbering twice those of Barclays, its nearest contender in terms of popularity.
There i s some sense i n this. Lloyds is leading the pack with its recovery story. It has strong market positions in profitable areas from mortgages to current accounts. Its capital ratios are also strong, which means more cash can be paid out to shareholders in future rather than building up reserves.
Indeed, the dividend tap has started to dribble for the first time in more than six years, and could soon be gushing more freely.
Analyst expectations are for a dividend of between 3p and 5.5p next year. Based on the current price that would mean a yield of between 3.6pc and 6.6pc.
What’s more, the Government’s stake is becoming a diminishing limitation on the share price; the taxpayer owns less than 14pc of the bank. Chancellor George Osborne has promised a public sale of shares within 12 months, with some bonus shares attached.
Given how popular Lloyds already is with private investors, we can expect high levels of demand when this offer eventually comes to market. The domestically focused banks also have the tailwinds of an improving economy and the prospect of interest rate rises, which should improve margins.
There are, of course, still skeletons coming out of the closet.
Lloyds recently set aside a further £1.8bn for cleaning up after PPI and other misdemeanours. RBS has lost £1.3bn to litigation and conduct costs in 2015.
But the market is familiar, even comfortable, with this narrative by now, and again it is one which should be diminishing the further we get from the scene of the crime.
The attitude of fund managers could also provide a fillip for bank performance. If the sector starts to attract more income managers and mainstream growth funds, a wall of money could be headed towards banking stocks. UK fund managers control over £200bn of assets.
If they were to collectively halve their current underweight position, that would create around £5bn of buying demand for the bank shares.
The banks undoubtedly still face challenges in restructuring their businesses, but there is more than a little light at the end of tunnel.