Banks are faced with a seismic shift of epic proportions.
In order to invest in them these days, investors must believe that: a) interest rates in the developed world will rise faster than expected; b) loan losses, i.e. defaults, will rise at a modest pace in a less accommodative environment; c) big one-off charges have come to an end; d) the regulatory environment is set to become less challenging; and, e) trust is no longer an issue.
Barclays (LSE: BARC) (NYSE: BCS.US) and Lloyds (LSE: LLOY) (NYSE: LYG.US) make no exception. The former is dirt cheap, while the latter is too good an opportunity to pass up, many have argued. As for myself, I thought I’d look elsewhere for value.
Disintermediation Of Services
Disintermediation of services in banking is a crazy variable that investors ought to consider when assessing the risk associated to their banks’ shares.
If TransferWise were big enough and more diverse to be listed on the public stock market as a pure-play banking services provider, I’d be willing to bet on it. Other retail investors would take heed. Stocks are emotions, and emotions run high when it comes to investing.
The banks? Thanks, but no thanks.
Waiting For “TransferWise Bank”
“A couple of months back, European money transfer startup TransferWise hit a major (PR) milestone. Its platform had processed £1 billion of customers’ money, an eight-fold increase from the previous year. At the time, Executive Chairman and co-founder Taavet Hinrikus sounded as bullish as ever,” Techcrunch reported last month.
I’d love to see how these guys perform under the public market scrutiny. If their financials were simple to understand – and they should be straightforward indeed – TransferWise could pose a serious threat to the banking world. TransferWise cuts the middleman and the huge fees charged by banks in overseas transactions. But what if it became competitive in the loan market?
Bank Lending
Bank lending started to change forever from the early days of the credit crunch in July 2007. In the last seven years, investment-grade (IG) borrowers — generally speaking, companies with solid financials in most cases — not only have dictated their cost of funding, favoured by declining interest rates and spreads, but have also led fundraisings more often that at any given point in the past.
Since the credit crisis hit, “club loans” — or self-arranged syndicated loan facilities — have become predominant in the loan market.
Club Loans
In club loans, banks act as co-ordinators but have no real seniority in the banking syndicate (read: low fees), which is selected by the IG borrower. Still, when senior arrangers are appointed, fees are duly cut to show banks who is in charge now: the borrower.
For non-IG “credits”, meanwhile, debt can’t be arranged at all, due to the inherent risk profile of the borrower and the impact that it brings to the capital ratios of the banks. In short, for these borrowers, banks must set aside more capital — which in turn dilutes returns.
As IG borrowers continue to cut the number of key lenders they boast relationships with, traditional lenders find themselves between a rock and a hard place. Over time, they have lost fees from loan mandates as well as the precious ancillary business — such as mandates in investment banking – that comes with them. They’ll struggle for a long time, for their business model is broken and their bloated cost base has yet to be properly addressed, in my view.
TransferWise doesn’t lend money, but is exploiting amicable trends and a difficult regulatory environment for traditional lenders. Its impact must not be underestimated.
Barclays: Risks
Barclays has been slower than domestic rivals to address several issues in its assets portfolio. In order to bet on its shares, investors should take a bullish stance on several factors, including:
a) Litigation risk, which is impossible to quantify right now.
b) Reputation risk: Barclays hasn’t done itself a great favour in recent times.
c) Execution risk: its cost-cutting plan will be painful in months ahead.
d) Divestment risk: assets disposals in Europe must speed up.
e) Dilution risk: additional equity capital isn’t needed now but may be needed in future.
Is it really worth the pain?
Lloyds: My Bank Account
Elsewhere, Lloyds is the most attractive UK bank I’ve encountered in recent times — at least according to what most people have been telling me in the last year or so. Virtually anybody is upbeat about the bank’s prospects for revenues, earnings, profitability, dividends, capital ratios, market opportunities and so forth.
I beg to differ. Lloyds is a good bank, but it’s the same bank that moved my bank account to TSB with no notice. This is not to say that I spend much time reading all the bank statements I receive — but not even a single email in my inbox is a bit disappointing for this British darling.
Back to serious stuff: “Unless the Treasury gets its stake down, and quickly, Lloyds stock will enjoy minimal upside in the next six to 12 months. And even then, Lloyds stock will be under pressure,” I recently argued. There are other problems, though, and its valuation isn’t compelling as yet.
Finally
“Global banking regulators are considering new measures that would make it harder for banks to understate the riskiness of their assets, including potentially ending the long-standing treatment of all government bonds as automatically risk-free, according to people familiar with the discussions,” the Wall Street Journal reported on Sunday.
Is this a once-in-a-lifetime opportunity for TransferWise and the likes?
These players need to find a way to lend to the consumer at convenient rates, so their cost of funding is key in their business models. Retail investors may well provide the answer they need.
