What a year it has been on the political front! Now that the general election is behind us, average investors can better concentrate on their 2020 portfolios.
Especially since the Brexit referendum of June 2016, the volatility in the price of most bank stocks has made shareholders rather nervous. Yet many investors still include banks in their portfolios due to their relatively high dividends.
Today, I’d like to discuss several factors that I believe may drive the price of bank stocks, so that interested readers may make better-informed decisions for their portfolios.
Types of banks and their incomes
For centuries, commercial banking activities, namely deposit-taking and granting of loans, have been their most important operations.
For such commercial banks, their liabilities are largely in the form of deposits, which are available to their creditors or depositors on demand. On the other hand, their assets often take the form of loans that have longer maturities.
Such banks earn income on loans and other interest-earning assets. They pay interest on deposits and other interest-bearing liabilities. As we evaluate its balance sheet, we can arrive at a bank’s net interest income (NII) by deducting interest paid from the total interest earned.
Today, many banks have a hybrid model that allows them to generate about half of their revenue from non-interest bearing activities. These include fees from investment and brokerage services, banking-related service charges, credit card-related fees, trading profit and losses, mortgage-related activities and increasingly fees from mobile banking operations.
In other words, for many banks, the income is divided into net interest income and non-interest income.
Industry fundamentals
There are several fundamental factors that affect the industry. They include:
- Economy (both national and global), such as interest rates, currency exchange rate fluctuations, business cycles and property prices.
- Politics, for example trade wars between nations and government responses to referendums, such as Brexit.
- Regulation, such as mis-sold payment protection insurance (PPI) claims.
- Technology, such as the increased use of mobile banking online.
- Societal developments, such as demographic changes.
Of these factors, most analysts would rate the economy as the most important one. And among the economic factors for banks, the first one to discuss is interest rates.
After the economic recession and financial crisis of 2008, central banks in the UK, eurozone and US have stimulated economic growth by cutting interest rates to near zero, and thereby reducing the cost of borrowing for households and businesses.
Because banks do a large amount of the lending to those borrowers, their profitability is negatively affected by low rates, as they reduce their margins.
Strong economic growth is crucial for the performance of banks. The City agrees that since late 2016, the UK’s economic activity has been impacted by the uncertainty around Brexit.
However, 2020 is likely to be the year the UK leaves EU with some sort of a trade deal that works for both sides. And that would be good news for our economy.
FTSE 100 banks
The FTSE 100 includes several banks that may may be appropriate for long-term portfolios. They include Barclays, HSBC, Lloyds Banking Group, Royal Bank of Scotland Group, and Standard Chartered.
In addition to these banks, the FTSE 100 is home to several other important financial services companies in insurance, private equity, venture capital, investment and asset management, stock exchange, and financial information.
