Are Lloyds Banking Group PLC, Barclays PLC, Banco Santander SA And Royal Bank of Scotland Group plc Recovery Buys?

Are Lloyds Banking Group PLC (LON:LLOY), Barclays PLC (LON:BARC), Banco Santander SA (LON:BNC) and Royal Bank of Scotland Group plc (LON:RBS) a good way to play the economic recovery?

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Piggy bankLeaving aside their tendency to manipulate key interest rates, and sell customers protection products they didn’t need, one of the things that banks were most widely criticised for during the financial crisis was their unwillingness to lend to UK businesses, especially the class of smaller businesses known as SMEs.

At the time, banks such as Lloyds Banking Group (LSE: LLOY), Barclays (LSE: BARC) (NYSE: BCS.US), Royal Bank of Scotland Group (LSE: RBS) and Banco Santander SA (LSE: BNC) said that they were just being prudent by strengthening their capital position against possible losses — but now that the UK economy is growing again, have things changed?

Are banks lending more to UK businesses, and as investors, does banks’ lending help us evaluate the investment case for each bank?

Are the banks lending more?

Four of the UK’s big high-street banks have reported results recently. Let’s take a look at what they said about business lending during the first half of 2014:

Bank Business lending up?
Lloyds Lending to SMEs up 5% over 12 months
‘Marginal growth’ in lending to mid-sized corporations
Barclays Reported 2% (£4.5bn) increase in ‘mortgages balances and UK corporate loans‘, including £0.9bn of new lending to small businesses with a turnover of less than £5m.
RBS 11% increase in SME loan applications and 31% increase in gross new lending
Santander (UK) Lending to companies up 10% in H1 2014, compared to same period last year

Source: Company reports

Although the banks don’t all provide detailed information about their lending, it seems that the trend in UK corporate lending is upwards, at least at these banks.

Will lending help profits?

A rise in good quality lending should help boost profits at these banks, especially when combined with falling rates of bad debt, and continued low funding costs. The bank’s recent results support this logic:

Bank H1 2014 net interest margin (H1 2013) H1 2014 change in impairment charges H1 2014 underlying profit growth
Lloyds 2.40% (2.01%) -58% +32%
Barclays 2.96% (2.88%) -33% -7%
RBS 2.17% (1.97%) -88% +93%
Santander (UK) 1.80% (1.46%) -28.8% +4.6%

Source: company reports

Any bank that is enjoying a rising net interest margin and falling impairment charges should be able to grow profits — or it’s doing something wrong. Unfortunately, of course, many of these banks have been doing things wrong, and are continuing to pay the price for it.

A good example is Barclays, which added a further £900m in PPI provisions during the first half of 2014, taking its total so far to an incredible £3.56bn.

Although interest rate rises could cause impairments to increase again, the continued combination of falling impairment rates, and wider economic growth, should mean that UK banks are able to increase their profits from business lending over the next few years.

Are the banks a buy?

I rate Lloyds, Barclays and Santander as a buy, but I think RBS looks too expensive following its recent gains: after all, no dividend payment is expected for at least another year, and the state-owned bank still has to persuade the government to sell its £48bn stake in the bank.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares in Barclays. The Motley Fool has no position in any of the shares mentioned.

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