Are Lloyds and Natwest shares doomed investments?

Lloyds and Natwest are performing well in an economic climate tilted more towards challenging than booming.

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In a week when Nigel Farage’s bank account was a hot topic in the mainstream media, half-year results from the big FTSE 100 lenders were pushed down the headlines.
 
The shares of UK-focused banks Lloyds and Natwest, as well as Barclays (54% of income from the UK), all fell during the week, compared with a modest rise for the Footsie.
 
Meanwhile, HSBC and Standard Chartered, whose incomes come largely from outside the UK, not only rose, but also outperformed the index.
 
Given the latest ‘Scandal That Engulfed British Banking’ (Wall Street Journal) and cheerless market response to UK-focused banks, are the shares of Lloyds and Natwest doomed investments?

Farage furore

As a quick reminder, Natwest chief executive Dame Alison Rose tittle-tattled to a BBC journalist about Farage’s bank account with Coutts (part of the Natwest group).
 
Natwest’s board initially expressed “full confidence” in Rose, despite her “significant error of judgement.” However, after pressure from the UK government — still a major shareholder (39%) — the board announced Rose would be stepping down.
 
Farage told Sky News “the whole board needs to go.” Chairman Sir Howard Davies has responded by saying he won’t quit. Whatever the rights and wrongs, further instability at the top of the bank is the last thing shareholders need.

Summoned again

Amidst the Farage furore, the Treasury called lenders to a summit over concerns people are being denied access to banking because of their politics or perceived beliefs. The upshot? Banks will have to implement new rules to protect against it
 
I seem to be forever reading about UK bank bosses being “summoned” by one body or another to “discuss” some aspect of their business activities.
 
In July alone, the Commons Treasury committee said it’s been putting pressure on the UK’s four largest lenders all year, accusing them of “profiteering” and failing in their “social duty.”
 
The City Minister, MPs and Bank of England officials also summoned bankers in July to discuss government plans to shake up lending laws that would encourage banks to offer 40-year fully fixed mortgages to help first-time buyers.
 
And the Financial Conduct Authority hauled in bank bosses to grill them on savings rates ahead of new regulations coming into force at the end of the month.

Nannying

New rules and regulations generally mean higher costs. And higher costs are a friction for profits.
 
Compared with the regulatory capital and liquidity buffers, and enforced ring-fencing of UK retail banking operations, brought in after the 2008 financial crisis, July’s developments are relatively small-scale,
 
However, they’re symptomatic of the lasting price UK banks are paying a decade-and-a-half on from the crisis. Namely, intense government and regulatory scrutiny, oversight and nannying of risk and social purpose in the UK banking sector.

Investor disinterest

It’s an investing truism that lower risk equals lower reward. And the market seems to have embraced this with a vengeance in the case of UK-focused banks.
 
Last week’s drop in the shares of Lloyds and Natwest was just a continuation of much longer-term investor disinterest in the stocks.
 
Over the last 10 years, the FTSE 100 has returned an annualised 5.56% (including dividends). Lloyds and Natwest investors have suffered annualised losses of 0.65% and 0.99%, respectively.

Doomed?

After such miserable returns, is it even worth asking: are Lloyds and Natwest shares doomed investments?
 
Well, it’s always good to challenge a prevailing orthodoxy, even if you end up agreeing with it. And I can see a number of reasons why the banks’ investment returns could be better in the next 10 years than in the last 10.

VfM

Buyers of Lloyds and Natwest shares today are getting relatively good value for money. 10 years ago, investors had to pay £1.24 for every £1 of Lloyds’ assets. Today, they’re getting the same £1 of assets for just 98p. And in Natwest’s case, it’s 93p.

Unlike 10 years ago, both banks are also now paying dividends. And the yields — 5.6% for Lloyds and 6.3% for Natwest — are generous. What’s more, they’re generating sufficient excess cash to be able to buy back their own shares, increasing the intrinsic value of each share that remains in circulation.

And they’re achieving this in a period when the economic backdrop is tilted more towards challenging than booming.

Promising

The investment outlook today for Lloyds and Natwest appears promising. That’s providing the government and its watchdogs aren’t too aggressive in channelling shareholders’ profits into risk compliance costs and whatever social functions they think banks should be performing.

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.

HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. Graham has no position in any of the shares mentioned in this article. The Motley Fool UK has recommended Barclays Plc, HSBC Holdings, Lloyds Banking Group Plc, and Standard Chartered Plc. 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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