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FTSE 350: Banks braced for geopolitical tumult

The valuations of major lenders and their challengers belies solid progress on capital levels and income potential
January 24, 2019

Is now the time for investors to pick up some bargains among the UK’s banking stocks? Shares in major lenders and their challengers ended 2018 trading at their lowest levels in more than two years and have recovered little since. More than a decade on from the financial crisis and it is not lenders' own mis-steps that have turned investors away, but geopolitical tumult. Concerns around UK borrowers defaulting on their loans in the event of a Brexit-induced economic downturn has hurt sentiment towards domestic lenders. Emerging-market-focused lending giants HSBC (HSBA) and Standard Chartered (STAN) have not fared any better, due to a maelstrom of trade wars, slowing Chinese growth and fears the country’s high debt pile could turn toxic.

This year will be pivotal in determining whether banking shares re-rate or have further volatility in store. Continuing geopolitical tumult and slowing economic growth naturally increase the risk profile of banking stocks, although calling the eventual outcome of political events such as Brexit – and whether those rising impairments materialise – is almost impossible for private investors. What investors can assess is the underlying health of the businesses – and on that front the major lenders have made solid progress on improving performance.

Regulatory capital levels for all five major banking groups are ahead of internal targets, while litigation risks that had hindered Barclays (BARC) and Royal Bank of Scotland (RBS) have also receded. The latter’s $4.9bn settlement with the US Department of Justice over alleged historic mis-selling of residential mortgage-backed securities precipitated management to declare its first dividend since the group was bailed out more than a decade ago. Together with Standard Chartered’s decision to recommence payments in the form of a 2017 final dividend, that meant that all five majors had an income element.

But challenges remain – a benign credit environment may mean impairments are running at low levels, but boosting returns on equity is still proving difficult for some. Standard Chartered and HSBC are balancing expansion across Asia to take advantage of the growth opportunities in the wealth and savings markets, while keeping a handle on operating costs. Increased investment in strategic initiatives at StanChart meant its cost-to-income ratio jumped to 90 per cent, from 66.9 per cent in the prior year, although management has guided towards flat operating expenses for the second half.

For domestically focused lenders, competition within the mortgage market has proved a bigger impediment to boosting profits – that shows no sign of abating, with RBS, Lloyds (LLOY) and Barclays reporting pressure on margins as the market has become increasingly hot, with lenders fighting for new business. Buy-to-let lending yields are holding up for lenders including Paragon Banking (PAG) and OneSavings Bank (OSB), although alternative lenders have been forced to continue to limit their exposure to other specialist lending lines, including asset finance, a move that has borne fruit for margins.

2019 could provide little relief to lending margins, with rate rise expectations moderating, as analysts expect inflation to dip below the Bank of England’s 2 per cent target in January. Almost three-quarters of traders surveyed by Bloomberg are predicting that rates would remain at 0.75 per cent following June’s monetary policy committee meeting and just 16 per cent are confident of more than one increase in rates for the year. That is compared with market predictions in early November of at least one rate rise in 2019.

 

NamePrice (p)Market cap (£m)12-month change (%)Trailing PEForward PEDividend Yield (%)Last IC View
Bank Of Georgia1551.8763.01-36.045.84.94.89n/a
Barclays160.3827477.6-19.217.26.92.81Buy, 188p, 2 Aug 2018
Close Brothers15492343.783.9611.110.84.07Buy, 1,490p, 29 Nov 2018
CYBG186.32661.59-42.717.46.81.66Hold, 223p, 20 Nov 2018
HSBC 638.9128007.2-19.4111.310.95.9Buy, 640p, 15 Nov 2018
Lloyds Banking 56.1339944-20.37.27.25.56Buy, 63.8p, 1 Aug 2018
Metro Bank20742020.46-43.4344.923.90Sell, 2,708p,13 Sep 2018
Onesavings Bank373.8913.89-6.366.96.53.64Buy, 347p, 22 Nov 2018
Paragon Banking 412.21075.1-15.2587.24.71Buy, 420p, 21 Nov 2018
Royal Bank Of Scotland23728555.18-19.618.58.50.84Hold, 258p, 3 Aug 2018
Standard Chartered60319952.94-26.4210.89.62.13Buy, 687p, 31 Jul 2018
TBC Bank Group1484804.99-14.226.55.63.15n/a