Don't let worries over bad debts put you off banks - they are a steal right now, and here's why.
A successful business friend of mine once told me that you are not really in business unless you have some bad debts in your profit and loss account. He reckons that doing business necessitates taking some risk. Consequently, if you are risk-averse then don't ever go into business!
In recent months however, some investors have become increasingly concerned by the huge jump in bad debt provisions made by the major banks. But just how serious is this problem?
The table below shows the profits make by Britain's big five high street banks:
| Company |
Interim
profits
2006
£bn |
Interim
profits
2005
£bn |
Change |
|
HSBC
(LSE: HSBA)
|
6.7 |
5.7 |
+17% |
Royal Bank of
Scotland
(LSE: RBS)
|
4.5 |
3.7 |
+22% |
|
Barclays
(LSE: BARC)
|
3.7 |
2.7 |
+36% |
|
HBOS
(LSE: HBOS)
|
2.6 |
2.3 |
+13% |
|
Lloyds TSB
(LSE: LLOY)
|
1.8 |
1.6 |
+7% |
Collectively, the big five banks made almost £20bn profit in the first six months of this year. HSBC topped the league but Barclays' 36% increase is worthy of note, too. This was thanks to a buoyant performance from its investment banking arm.
But the increase in profits in Britain's Big Five banks has been at the expense of greater risk-taking. In the next table, the provisions for bad debts for the five banks are shown:
| Company |
Bad debts
2006
£bn |
Bad debts
2005
£bn |
Change |
| HSBC |
2.1 |
1.7 |
+18% |
Royal Bank
of Scotland |
0.9 |
0.8 |
+5% |
| Barclays |
1.1 |
0.7 |
+45% |
| HBOS |
0.9 |
0.7 |
+15% |
| Lloyds TSB |
0.8 |
0.6 |
+20% |
Barclays said bad debts charges increased by a half to £1.1bn. This has been attributed to UK customers struggling to pay back loans to the bank's Barclaycard unit. Lloyds TSB is another bank that has seen a deterioration in unsecured lending. It blamed changes to personal bankruptcy laws that make it easier for borrowers to default on loans through Individual Voluntary Arrangements.
Bad debts are clearly a factor to consider, but how bad are they compared to a year ago? In the final table, the ratio of bad debts to profits is shown for the current period and for last year.
| Company |
Bad Debt /
Profit
2006 |
Bad Debt/
Profit
2005 |
| HSBC |
31% |
31% |
Royal Bank
of Scotland |
20% |
23% |
| Barclays |
29% |
27% |
| HBOS |
33% |
33% |
| Lloyds TSB |
46% |
40% |
By and large, bad debts have kept pace with profit growth, though Lloyds TSB's ratio of bad debt to profit ratio looks worryingly high. The bank is Britain's biggest unsecured lender, and has been hit hardest by the changes to the UK bankruptcy laws. By comparison, Royal Bank of Scotland has the lowest bad debt to profit ratio.
As I see it, it is right to be concerned with bad debts, but it is also important to get things into perspective. Just recently, Royal Bank of Scotland boss Fred Goodwin reckoned that his bank may be near to the peak of the bad debt cycle. If that is true then the UK's banks, which are all valued at around 10 times earnings, look a real steal. The yields, which are clustered around 4.5%, are not bad either.
David owns shares in Barclays.
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