Given the uncertain economic and regulatory backdrop, it would appear unwise to chase bank shares higher after such an explosive rally. But once the volatility dies down and the economic outlook becomes clearer, some of the listed lenders will be better placed than others to successfully move forward.
THE CRIPPLES
Initially, UK-retail focused Lloyds looked like it could emerge from the banking crisis in one piece. But that was before it snapped up HBOS, which was being overwhelmed by expensive wholesale funding. The merger was enthusiastically promoted by the government as the best way to avoid HBOS' collapse, while Lloyds saw the opportunity to circumvent normal competition rules and emerge as a superbank with, for example, a 30 per cent share of the mortgage market.
But it soon became clear that HBOS' loan quality was far weaker than anticipated and Lloyds, which took taxpayers funds as part of October's sector-wide recapitalisation scheme, has needed to set aside huge quantities of capital to cover HBOS' bad debts. Moreover, the competition issues raised by the deal, but which were ignored by the government in order to push the deal through, have caught the eye of the European Commission. It wants Lloyds (as well as RBS) to make disposals as the price of receiving so much state aid.
It looks like Lloyds is also beginning to smart at the £15.6bn of fees associated with joining the government's asset protection scheme and is thought to be considering a plan to raise up to £15bn in capital from private investors as a way of avoiding that. Entrance into the scheme will also give the government majority control of Lloyds. So, not only is Lloyds struggling with the prospects of long-term state control, but there's no dividend and even the benefits of the HBOS deal - increased market share - could undermined by the EU. With the recession still hurting there's little to attract investors for a long time to come. Fairly priced.
How are the mighty fallen! There was a time - not long ago - when RBS appeared to be all-conquering. After all, a string of big deals, including the acquisition of NatWest, had turned RBS from a Scottish-focused lender into a global baking giant. But buying ABN Amro at the end of 2007 proved to be a deal too far. That hiked the lender's exposure to toxic assets and, as the writedowns mounted during 2008, the lender was forced to take state capital to keep going. The bank is now 70 per cent owned by the state and, like Lloyds, its involvement in the asset protections scheme has left RBS obliged to lend more to recession-hit customers.
As with Lloyds, don't expect a dividend for years to come and, also like Lloyds, it faces pressure from the European Commission to sell assets as the price for receiving such generous state support. As the recession continues to bite, bad debts look set to go on rising - bad news for capital and earnings. The shares have enjoyed a fabulous rally from their 10p low point in January, but for the long-term investor, there's little ahead for a considerable time to drive the rerating. Fairly priced.
Price | Mkt value | H1 profit | Fwd PE | Fwd yield | Core T1 capital | Bad debts as % of loans | State holding | |
|---|---|---|---|---|---|---|---|---|
| Barclays | 365p | £40.3bn | £2.75bn | 18 | 0.7% | 7.1%* | 1.1% | none |
| HSBC | 652p | £113bn | £3.38bn | 27 | 3.2% | 8.8% | 1.5% | none |
| Lloyds | 100p | £27.2bn | -£3.96bn | na | nil | 6.3% | 2.1% | 43% |
| RBS | 46p | £26.4bn | -£244m | na | nil | 6.4% | 1.1% | 70% |
| Standard Chartered | 1,420p | £27.5bn | £1.71bn | 14 | 2.7% | 7.6% | 0/6% | none |
*Excludes the proceeds from the planned sale of Barclays Global Investors
All data sourced from www.investorschronicle.co.uk, company statements.
THE HIGH RISK PLAY
Credit where credit's due, Barclays has played its cards very well indeed. Barclays avoided the government's recapitalisation plan, choosing instead to raise £7bn of capital from a group of Middle East investors in November, on very expensive terms. But that has proven to be a smart move. That's because it enabled Barclays to avoid state control, leaving it free to restart dividend payments (expected by end-2009) and to avoid requirements to lend to recession-hit borrowers.
The trouble is that this recession is proving painful for all lenders and the bank's capital resources - amongst the thinnest in the non-state influenced segment of the sector - are under pressure from rising bad debts. In response, Barclays has been selling the family silver to raise cash - its highly profitable asset management arm, Barclays Global Investors, is being sold to US fund manager, BlackRock, for £7.8bn. And while that will provide much needed capital, the deal will also leave Barclays focused on volatile investment banking earnings and the sickly retail banking market.
That's hardly a recipe for long-term growth. Moreover, the funds raised by the disposal could yet be consumed if bad debts go on rising. So a punt on Barclays looks like a gamble that economic recovery will come to the bank's rescue before its capital can be further depleted. There's no certainty of that, and, after the shares soared from just 51p in January to 360p now, it looks a risky gamble. High enough.
THE LONG-TERM WINNERS
As with all banks, Standard Chartered hasn't avoided the global recession. But its Asian focus - a market which is traditionally fast growth in good times and which recovers faster than more mature western markets in bad times - leaves it in a different category. Indeed, while the lender's bad debt charge more than doubled in the year to end-June, it still represents just 0.6 per of the group's loan book. That's tiny compared to, say, Lloyds, with a bad debt charge that stands at 2.1 per cent of its book. The lender is still paying dividends, too.
Capital also looks solid - it already boasts a reasonable capital ratio, with more funds on the way from a planned £1bn placing. And there's been no need to turn to the state for help. Certainly, trading on about 14 times forecast consensus earnings for 2009, the shares look no better than fairly priced for now. But, as conditions improve, Standard is one to watch.
Sentiment toward HSBC continues to be affected by the grim situation at its US sub-prime operation, and while that's now in run-off, it still accounts for most of the bank's bad debt charge. But that's not a lethal problem. The fact remains that, as with Standard Chartered, HSBC' earnings stream is largely focused on Asia where prospects should improve quicker than elsewhere. Also like Standard, it hasn't needed state aid and the bank boasts one of the healthiest capital cushions in the global banking market. There's still a reasonable dividend, too. True, after more than doubling since early March, HSBC's shares thoroughly reflect those defensive characteristics for now - leaving them fairly priced. But once recovery gets underway in Asia, it shouldn't take long for HSBC's earnings to pick up.
THE FORGOTTEN VICTIMS
Not all shareholders have benefited from the spectacular re-rating of the banking sector. While investors in Barclays and RBS have enjoyed stellar price gains since the start of this year, those who held shares in Northern Rock and Bradford & Bingley received nothing when the banks were nationalised – and any recompense they do get looks like it will be a long time coming.
The Banking (Special Provisions) Act of 2008 provides for a compensation scheme for shareholders. The trouble is, an independent valuer will assess what level of compensation that might be paid – and many suspect that the terms of reference for the valuer have been set in order to ensure that the compensation 'calculated' will be very little. In particular, it's taken as given that Northern Rock was unable to continue as a going concern and was in administration.
The UK Shareholders Association (UKSA) asserts that, at the time of nationalisation, neither of these statements was true. The company was certainly not in administration; whether it was a going concern hinges on whether it could have continued without access to emergency funding from the Bank of England. The arguments in respect of Bradford & Bingley (B&B), nationalised in September 2008, are likely to be similar.
Nor have ordinary shareholders been the only ones to feel the pain. Investors in B&B's perpetual subordinated bonds (equivalent to permanent interest-bearing shares, or Pibs) have also received rough justice.
Earlier this year, B&B announced it would not make the semi-annual interest payment on the PSBs, the first time a UK building society has failed to meet an obligation as it fell due. The interest on this instrument does accrue but, given the backdrop, there would appear to be little chance of investors getting their money in anything but the long term.
B&B's move seems to have emboldened other banks to start fiddling with the terms of their subordinated debt. West Bromwich Building Society was not nationalised, but did have to undertake a financial restructuring in order to strengthen its capital. Many feel that it has used this as an pretext to vary the terms of the interest payments on its Pibs, to the detriment of the holders.
UKSA has campaigns underway in respect of Northern Rock, Bradford & Bingley, Lloyds Banking Group and West Bromwich BS. See www.uksa.org.uk.
