Bank shares will recover and their customers can pay for your retirement.
This article is the bull case for our Duelling Fools feature on "Banking Shares". You can also read the bear case and cast your vote in our banking shares poll.
If you're an investor with horizons longer term than a week on Friday -- as we all should be in my opinion -- then the banks are a good buy. But beware, they aren't all the same.
History has shown us that most blue chips recover. It's true, though, that some go under from time to time and the banks certainly aren't completely without risk due to their past profligacy, over confidence and general foolishness. It's amazing how often we human beings repeat the mistakes of the past.
Then and now
But we also have a habit of over-compensating in the opposite direction and share prices often do the same. Circa 2006 …"Credit? Sure have as much as you like, buy a few houses then borrow on any gain in equity to buy more. You'd be stupid not to really."
Circa now… "A mortgage? Yes indeedy. We'll need a 40% deposit, proof of your last five years' income, a reference from your employer saying you'll still be there in 2020 and the deeds to your Grandma's house."
What's past is past. Crucial to the banks' boom and bust -- and their long-term recovery, though, is securitisation. The banks were stupid with money because they were able to securitise the loans.
What this means is they could package the debt and sell it on, so the original lender didn't care too much whether the borrower could afford to make the repayments. Earnings looked fine on a "borrow from Peter to pay Paul" basis. Clearly, this was unsustainable.
Securitisation -- a dirty word
Things are very different now. Securitisation has become a dirty word, a lot of the companies buying the debt don't exist any more (surprise, surprise!) and the lending environment is a lot more sensible; we have this weird new concept where loans are based on the borrower's ability to actually pay it back. All these things have a way of working themselves out in the long run.
There's a lot of recovery already priced in, though, it has to be said.
Many of us bought Lloyds Banking Group (LSE: LLOY) shares under 40p not too long ago. They're now well north of 80p and are ex-rights. All the major banks have seen major price hikes. But the basic premise on which many of us bought bank shares late last year and earlier this year remains in place; extreme Bank of England policy and coordinated government action around the world to support the banks as the life-blood of economies.
Conservative approach
And there has been the kind of over-reaction there always seems to be. The required Tier 1 capital ratios of 4% are being exceeded by a long way by the major banks to help restore investors' confidence. This looks likely to continue even further for the time being; all of which is good news for investors.
The FSA may yet increase the minimal capital requirements but it will still be well below the major banks' current levels. So as we gradually begin to see the economic recovery that we always do, the banks will begin to buy back their own shares and/or pay divis as capital ratios are eased a little.
When will all this happen? Don't ask me -- but happen it will. There'll be some big blips along the way and if you're a really talented trader, you may be able to ride them up and down.
But for most of us mere mortals, the right thing to do is zoom out, take a wide-angled view of things and let the banks do the work for us on a long-term dividend reinvestment basis; when we start seeing the dividends again that is!
Don't try to be too clever
My own favourite is Lloyds. Hopefully, the Board will put their brief flirtation with racier investments firmly behind them and return to their previously conservative style which would have steered the old nag safely through the crunch without slipping into the red.
And, though the HBOS deal was an unmitigated disaster, Lloyds did buy a heck of a lot of tangible assets. According to the boss, "we acquired £18bn tangible assets for £8bn." Lloyds is now the biggest ever UK bank which controls around a third of all UK mortgages and a quarter of all savings.
It's all about future earnings and, in my opinion, buying Lloyds is an excellent way of putting yourself on the other side of the mortgage debt equation and raking in the cash on a very long term basis.
Overall, I'd say don't try to be too clever with the banks. Personally, I'll be doing a "Rip Van Winkle" with my bank shares from here on in and re-investing the dividends; please wake me up in 20 years' time when the UK's mortgagees will have paid for my retirement.
Where next?
> David owns shares in Lloyds Banking Group.
