FTSE-listed banking stocks followed their US and European financial counterparts down in recent weeks. At the time, many investors didn’t know what to make of it. But two weeks later, the market is starting to realise that banking stocks, on the whole, are much steadier than many had anticipated.
But, most importantly, this correction has created opportunities. Let’s take a closer look at why.
Unrealised bond losses
Much of the panic centred around the concept of unrealised bond losses. That’s because Silicon Valley Bank (SVB) which was under pressure to sure up its finances, was forced to sell bonds at losses.
This occurred because, as interest rates rose, the value of lower-yielding bonds fell. Bond prices and yields are inversely related.
But other banks aren’t like SVB. Especially in the UK. Big banks have more diverse bond holdings, more diverse depositors and greater liquidity. In these circumstances, unrealised bond losses aren’t important because the bonds will likely be held through to maturity.
It’s also worth highlighting that bad debt in Europe is down considerably in recent years — falling across the EU from €1bn eight years ago to €350bn last year.
Broadly speaking, banks haven’t been so healthy for a long time.
Headwinds and tailwinds
I’ve said this before, but it’s a good one. Higher interest rates are good for banks until they’re not — Jonathan Ferro says that a lot on Bloomberg.
Essentially, this means higher interest rates at first are positive. It allows Net Interest Margins (NIMs) to grow and that means higher Net Interest Income (NII). In most banks, NII forms a large part of total revenue. Especially for banks like Lloyds that don’t have an investment arm.
However, when rates get too high, problems appear. And we’re probably getting into the ‘too high’ category now.
Good debt turns bad as borrowers can’t afford their repayments, and new business falls as higher rates cause people and businesses to postpone borrowing, or find other forms of financing.
In the UK, we’re near the terminal rate. That was signalled a few times this week.
And this is positive because we’re expecting to see Bank of England rates fall close to the 2-3% sweet spot over the coming years. At such a level, banks have substantial NIMs without the negatives associated with very high rates.
Banks buying their stocks
I’m buying more banking stocks. In fact, I’ve topped up on all of the major UK banks and added Standard Chartered to my portfolio.
It’s a great opportunity for me as an investor. These banks are trading at discounts for no real reason. Barclays actually trades with a price-to-earnings of just 4.6. That’s way below the index average, around 12-13.
But I’m not the only one benefiting as share prices fall. Banks are too. For example, Standard Chartered bought 200,000 of its own shares from Goldman Sachs this week as part of its share buyback commitment.
What’s interesting is that when the buyback programme was announced, the share price was 780p, but this deal went through with a weighted price of 592p per share. That’s a considerable saving.
