COMMENT
Why You Should Invest In Banks

Year after year UK banks seem to churn out ever higher profits quite effortlessly. Last year was no exception either.

In January, Northern Rock (LSE: NRK) kicked off the bank-reporting season with record pre-tax profits of £431m, a 13% improvement on its performance the year before. Amongst the other mortgage specialists, Alliance & Leicester (LSE: AL.) said its pre-tax profit jumped 16% to £608m, while Bradford Bingley (LSE: BB.) reported a 6% rise to £280m.

The big lenders did quite well too. HSBC (LSE: HSBA) posted a 27% jump in full-year profits to £9.1b and Royal Bank of Scotland (LSE: RBS) said its profits gained 14% to £6.9b. Meanwhile, Barclays (LSE: BARC) saw its profits rise 20% to £4.6b and HBOS's (LSE: HBOS) profits leapt 22% to £4.6b. Only Lloyds TSB (LSE: LLOY) came in with reduced earnings. However, that reflected the sale of non-core businesses that included its New Zealand unit. At the underlying level, profits gained 10% to £3.4b.

Collectively, the banks have racked up pre-tax profits of almost £30b in the last twelve months, which is almost a quarter of total corporate profits. Yet despite their strong profit contributions, shares in banks are still valued at around 10 times forward earnings. By comparison, the UK stock market is valued at 16 times earnings.

Personally, I would much rather pay £10 than £16 for a pound of profit, but not everyone agrees. A P/E of 10, which is a 30% discount to the market, suggests that investors remain cautious about banks. This is not entirely surprising given that mortgage lending, which has been quite robust, is now showing signs of tiring.

It is also worth mentioning that banks have benefited from higher levels of unsecured consumer borrowing over the last few years. However, consumer borrowing can quickly wane if interest rates rise. Additionally, defaults on loans could result in higher levels of bad debts.

In my view these are short-term risks that long-term investors should ignore. Instead, it may be better  to focus on dividend yields, which are bunched around 4.5% (with the notable exceptions of Lloyds TSB, which is yielding 7 %. These yields are very attractive, and together with their low P/Es, make any of the banks enticing investments.

David owns shares in Barclays.