Banking Profitability Bounces Back!

cityThe developing picture of the UK’s banks is of gradual recovery. After the once-in-a-generation shock of the Credit Crunch, the shares of Barclays (LSE: BARC), Lloyds (LSE: LLOY) and Royal Bank of Scotland (LSE: RBS) were trashed. The path to recovery has been slow and bumpy, but there are increasing signs that the banks are turning the corner.

The difficulty has always been how we can quantify their progress. Bank results are a flurry of numbers, from core tier 1 ratios, to net impairment provisions and adjusted operating expenses.

It is the bottom line that counts

But, at the end of the day, what determines how successful the banks are is their profitability. It shows that the business makes money, and it determines the share price. And it’s here where we are seeing the improvement.

At the time of the Credit Crunch, the banks found themselves hit from all sides. First of all, they found themselves saddled with a mountain of bad debt. Then the economy fell into recession, leading to thousands of company bankruptcies. Record low interest rates reduced one of the banks’ main sources of income. And intense scrutiny and regulatory pressure led to a never-ending series of fines and litigation, from payment protection insurance to Libor rigging and now exchange-rate rigging. And that’s not to mention a wave of technological change that means that most people nowadays check their accounts via their smart phones and computers.

But through the flames of creative destruction, the banks are emerging from the other side.

A broadly positive picture

Royal Bank of Scotland’s Q3 2014 results show pre-tax profits of £1.27bn, compared to £1.01bn in Q2. Impairment losses has fallen sharply compared to last year, and the tier 1 capital ratio has increased to 10.8%. So the company is losing much less money to debt impairment, it has spun out Direct Line and Citizens, and there are signs of growth. The main downside is that it is still setting aside substantial sums of money to pay fines and litigation costs.

Lloyds’ Q3 2014 results showed an underlying pre-tax profit of £2.2bn, up 41% compared to last year. The company is benefitting from growth in the UK economy and housing market, but it is taking a continuing hit from the PPI scandal, with an astonishing £11.32bn set aside so far.

Barclays’ results were also generally positive, with adjusted pre-tax profits of £1.59bn, beating consensus estimates. Retail banking and Barclaycard impressed, but investment banking disappointed.

The overall picture is of a banking sector that has returned to profitability, which is reducing debt impairment, but is still being hit by fines and litigation. It is a picture of share prices which are recovering, and will recover further, and of an industry which is slowly, but surely, waving goodbye to the Credit Crunch era, and looking ahead to the future.

There are both positives and negatives to investing in the banks. If you think that the banks have turned the corner, and are thinking of buying into their recovery, but find the numbers and metrics too complex and confusing, then our experts at the Fool have written a free report which guides you through all the complexities of investing in banks.

Want to learn more? Well, just click on this link to read "The Motley Fool's guide to banks".

Prabhat Sakya owns shares in Barclays, Lloyds and RBS. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.