They are expensive, risky and pay no dividend. Why on earth would anyone want to own banking shares?
This article is the bear case for our Duelling Fools feature on "Banking Shares". You can also read the bull case or cast your vote in our banking shares poll.
1. UK Economy -- Truly Dire
More than any other type of company, bank profitability is highly dependent on the health of the economy.
And that's where things quickly start to look sticky for those banking bulls. Just last week, the Office For National Statistics (ONS) released some truly dire gross domestic product numbers.
How dire? The UK economy shrank by 5.6% per cent in the year to June 2009. That was far worse than just about any economist had predicted.
"These figures reinforce our view that the road out of recession will be long and slow," said Ian McCafferty, the CBI's chief economic adviser in The Times. He went on to say "While the figures on credit constraints appear encouraging, they should not be taken as a sign that bank lending is flowing freely again."
In The Telegraph, Michael Saunders, UK economist at Citigroup, said "As well as a deep recession, we expect a slow recovery, held back by high private debts and (with inadequate bank capital) poor credit availability…It will be many years before the UK returns to a well-balanced and sustainable mix of low unemployment, low fiscal deficit and low public debts, decent economic growth and low inflation."
I really could go on forever about the poor state of the economy, and how recovery is going to take years, not months. But I think you get the picture. In such an environment, banks are going to be struggling just to make a profit. You can forget a return to the boom times of 2003 to 2007 until next decade.
2. Interest Rates -- Going Up, Up Up
Base interest rates are just 0.5%. It sounds like a pathetic deal for savers and a great deal for borrowers. But right now, home buyers are struggling to get a mortgage rate of less than 5%.
It doesn't get much better than this for banks. Right now, they can borrow money at around 1% and lend it out for 5% or more. They should be rolling in profits.
But they are not. Royal Bank Of Scotland (LSE: RBS) will make a loss this year, and is forecast to make a loss next year too. The same goes for Lloyds Banking Group (LSE: LLOY).
And what do you think is going to happen when interest rates inevitably rise from 0.5%? On the one hand it will be good news, because it will likely come when the economy gets stronger. But on the other hand, it's going to make it even harder for banks to make a decent profit on their lending book.
3. Government Intervention -- Higher costs, lower profits
The UK government is already a majority shareholder in RBS and Lloyds. Banks will simply not be allowed to make excessive profits, for fears of a public backlash. This problem for the banks is amplified as an election is due in less than a year. The government will tread very carefully.
On top of that, one huge upshot of the global financial crisis will be increased banking regulation. Their every move will be watched and monitored. It all adds up to higher costs and lower profits. Shareholders will be the ultimate losers.
4. Sell High, Buy Low -- The Time To Buy Was 6 Months Ago
People contemplating buying banking shares today have completely missed the boat. I pity them, for all the easy money has already been made. Take a look at how far the share prices have already jumped since their 2009 lows…
- Barclays (LSE: BARC) -- up 496%
- Royal Bank Of Scotland (LSE: RBS) -- up 327%
- Lloyds Banking Group -- up 176%
- HSBC (LSE: HSBA) -- up 88%
I've put my money where my mouth is by selling my entire holding in Barclays. If nothing else, I follow the simple investing principle of buying low and selling high. Buying now is not buying low.
5. Valuation -- Banks Are Expensive
People often make the mistake of investing based on the historical share price. They think along the lines of "If HSBC shares were over 800p in 2008, the shares today at 570p are cheaper."
Hogwash.
HSBC shares today, at around 570p, are expensive. They trade on a 2009 forecast P/E of 22 and a 2010 forecast P/E of 17.
Any bank analyst worth their salt will tell you that is incredibly expensive for a bank. In fact, in this market, it's incredibly expensive for any company. It's one of the reasons I included HSBC in my early June article titled 6 Stocks To Sell Today. Nothing has changed since then, except HSBC is even more expensive!
HSBC is the best of the British banks. I mentioned above how RBS and Lloyds are not even expected to make a profit in 2010, putting them on a P/E of around about infinity. Barclays forward P/E is a more modest 13, if you can believe the earnings forecasts (see point 1 above). I don't.
6. Dividends -- 0%
Dividends have already been slashed to zero for RBS and Lloyds, with Barclays likely to follow suit. A big attraction to bank shares has been their high dividend yield.
But that was all in the past, and in any case, the high dividend yields were a product of an unsustainable credit bubble.
How does a dividend yield of 0% strike you? I simply cannot understand why, especially given what's happened to banks in the recent past, and the dire outlook for the economy, why anyone would take the risk in buying bank shares.
7. The Alternatives -- Other Companies Are Much Cheaper
I'll make this one short and sweet…
| Company | Forward P/E | Forward Dividend Yield |
|---|
| GlaxoSmithKline (LSE: GSK) | 10 | 5.6% |
| Vodafone (LSE: VOD) | 8 | 7% |
| BP (LSE: BP) | 9 | 7.3% |
| Barclays | 13 | 2% |
| HSBC | 17 | 4% |
| RBS | Infinity | 0% |
| Lloyds | Infinity | 0% |
A picture tells a thousand words. Why would anyone in their right mind choose banks when you've got these other great options?
8. Indecipherable Accounts
Have you ever tried fully deciphering a bank's accounts? Typically they run to 60 odd pages, full of talk about equity tier 1 ratios, Mandatorily Convertible Notes, risk weighted assets, adjusted gross leverage, loss impairments, etc, etc. It's impossible to know and understand what these terms mean and how they might affect the bank's profitability.
Why bother? Look elsewhere.
9. Beware The New Sub-Prime
It's the next American financial crisis, and it could hit soon. It's bigger and badder than subprime. This time, we're talking prime mortgages. In short, many prime borrowers might just be subprimers with inflated credit scores. You can read all about the sorry tale here, or else take my word and believe there's a very real chance of more financial pain for the global banking system.
10. Neil Woodford
I'll leave the final word to investing great Neil Woodford. As recently quoted on Citywire, Woodford said:
"…I believe that further banking sector losses are yet to come. What we have seen so far, are the investment losses associated with excessive risk taking on treasury assets, what we have yet to see are the losses associated with recession, namely rising loan defaults."
If it's good enough for one of the most successful UK investors, it's good enough for me. It should be good enough for you too.
The choice is easy. Just say no to banks.
Where next?
> Not surprisingly, Bruce Jackson doesn't have an interest in any of the companies mentioned in this article.
