When will it be safe to buy into the banks?

Royston Wild takes a look at the problems washing over the British banking sector.

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The global banking sector was again dragged through the mud last week after US regulators decided to get tough with Deutsche Bank, one of Europe’s biggest financial institutions.

The Department of Justice slapped a colossal $14bn fine on it for the sale of bad mortgage securities almost a decade ago. The sum will be subject to a much-reduced counter-offer from Deutsche Bank, of course, although a hefty hit fine is widely anticipated.

Some pundits have suggested the move was motivated by the EU’s decision to make Apple pay up to €13bn in back taxes earlier this month. Still, the decision further illustrates that regulators are rapidly running out of patience with banking’s major culprits.

Washington woes

Indeed, Bloomberg reported that US law enforcers are considering backpeddling on a deferred-prosecution agreement made with HSBC in 2012. The bank was fined $1.9bn for money laundering on condition that it improved internal controls and submitted to an outside monitor. But the deal could be scuppered should current investigations into currency market manipulation result in criminal charges.

Barclays and Royal Bank of Scotland are also sweating over severe regulatory action in the States too. Like Deutsche Bank, both firms are being investigated there for the wrongful sale of residential mortgage-backed securities in the run-up to the 2008/09 financial collapse.

And closer to home, the long-running saga of mis-sold PPI protection is yet to come to a head. The Financial Conduct Authority has already put back a proposed claims cut-off date, and a deadline of 2019 is now in mind. Lloyds is the biggest culprit here, the firm having set aside £16bn to cover costs already.

Sales struggles

But these aren’t the only problems to test the nerves of banking investors, naturally. An environment of low interest rates continues to whack profitability, and this looks set to continue as insipid global economic data continues to roll in — indeed, fresh stimulus in Europe and Japan in particular is being touted in the months ahead as economic turbulence continues.

Protracted cooling in Asia looks likely to keep sales under pressure at Standard Chartered and HSBC, while growing turmoil in Latin America is putting the earnings outlook at Santander under intensifying pressure. These firms also face further hefty losses from their commodity market trading activities.

And back in the UK, the full implications of Brexit on everything from credit demand and mortgage applications to business loans is likely to hammer those operators dependant on a strong domestic economy. Lloyds and RBS look particularly vulnerable given their small international footprints.

Risk vs reward

Could any of the firms be considered attractive ‘contrarian’ buys at the moment?

Hmmm. Standard Chartered offers stonkingly-poor value, in my opinion. A forward P/E rating of 31.4 times is indicative of a firm with white-hot growth prospects, rather than one in the early throes of huge restructuring and ongoing revenues woes.

Barclays’ multiple of 15.6 times and RBS’s reading of 15.7 times, like HSBC’s ratio of 13.2 times, are a vast improvement in terms of valuation, but still trade above the yardstick of 10 times indicative of high-risk stocks.

In this regard I believe Santander and Lloyds are more fairly priced, the banks dealing on prospective ratings of 9.7 times and 7.8 times respectively.

While these figures may tempt many hardy bargain hunters, I for one would resist taking the plunge given the scale their problems in the near term and beyond.

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.

Royston Wild has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool UK has recommended Barclays and HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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