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UK bank stocks are looking cheap

The building of FTSE 100 bank HSBC in Singapore
Image: HSBC

We’re bang in the middle of the big banks’ third-quarter earnings season.
 
Of the FTSE 100‘s top four names,  Barclays and HSBC have already reported, and Lloyds and Natwest will have done so by the end of the week (Thursday and Friday respectively).
 
What have we learnt so far about how the banks are performing? And about the outlook for the sector and the wider economy?

Strong profit recoveries

Barclays and HSBC both posted impressive, forecast-beating Q3 profits.
 
Barclays’ pre-tax profit almost doubled to £2bn versus a City consensus expectation of £1.6bn. This took its year-to-date profit to £6.9bn — its highest on record for the nine-month period.
 
Similarly, HSBC’s $5.4bn in Q3 was up 76% and smashed a consensus forecast of $3.8bn. For the year to date, profit is running at $16.2bn.
 
Both companies’ profits benefitted from releasing hundreds of millions of cash they’d set aside last year for bad debts. Debts that haven’t materialised.
 
Barclays’ surplus cash buffer (CET1 ratio) at the quarter-end stood at 15.4% and HSBC’s at 15.9%. These ratios are not only well above the regulatory minimum, but also comfortably in excess of the banks’ internal target ranges of 13-14% (Barclays) and 14-14.5% (HSBC).

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Home and away

On the international stage, Barclays’ transatlantic investment banking business performed strongly, helped by fat fees from booming merger and acquisition activity. Meanwhile, HSBC reassured on potential exposure to bad property debt in its key China market.
 
But with domestically focused Lloyds and Natwest yet to report, what did Barclays and HSBC have to say about the UK?
 
The two banks continued to experienced strong UK mortgage and deposit volumes. Barclays also highlighted evidence of a consumer recovery, seeing positive trends in consumer spending and in payments volumes since the easing of lockdown restrictions.

UK outlook

Barclays upgraded its economic forecasts for UK GDP, saying it expects GDP to reach pre-pandemic levels by early next year. HSBC also highlighted a firming-up of the macroeconomic outlook for the UK.
 
Following on from the aforementioned reversals of bad debt provisions, Barclays said it expects the impairment run-rate to remain below historical levels in coming quarters.
 
The banks are also fairly relaxed about UK inflation (provided it doesn’t rise too far, too fast). According to Reuters, Barclays’ boss Jes Staley told reporters that annual price rises of up to 4% could be positive for the bank, if supported by economic growth.
 
Both banks noted that potential earlier-than-anticipated increases in Bank of England base rates would be positive for them.

Cautious optimism and confidence

While the macroeconomic outlook has improved, and Barclays and HSBC believe the worst is behind them, they acknowledge that the level of uncertainty in the external risk environment is relatively high.
 
For example, the impact of the tapering down of the unprecedented financial support given to individuals and businesses by governments isn’t exactly predictable.
 
Having said that — and having read the banks’ Q3 results, studied their presentations and listened to their conference calls with analysts — the overriding impression I got from management was one of cautious optimism and confidence.
 
Furthermore, if actions speak louder than words, Barclays’ current value-enhancing share buyback programme of up to £500m, and a buyback programme of up to $2bn announced by HSBC with its Q3 results, shout ‘confidence’ from the rooftops.

Bank stocks look cheap

The market doesn’t appear to have bought into the banking recovery story wholeheartedly. Barclays’ and HSBC’s share prices have nudged up a little, but they — along with the other big UK banks — remain cheaply rated on several common valuation measures.
 
For one thing, their shares are priced below the value of their net assets. For every £1 of net assets, buyers of the shares are currently paying less than a quid — in Barclays case, 70p.
 
For companies with stacks of surplus cash and management teams expecting to deliver sustainable annual returns on equity of 10%+, share-price discounts to net asset values appear anomalous.
 
In addition, the stocks look cheap based on ratings of less than 10 times forecast 2022 earnings. And prospective dividend yields in the 4-5% region are not only very healthy, but also look capable of being supplemented by special dividends and/or further share buybacks.

Next up

I’ll likely return on a future occasion with a deeper look at the aforementioned risk environment for banks. And a consideration of the relative merits of the individual bank stocks.
 
For the moment, Q3 results, presentations and conference calls from Lloyds and Natwest beckon!

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Graham doesn't own any shares mentioned in this article. The Motley Fool UK has recommended Barclays, HSBC Holdings, and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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