The UK banking sector has proven an unforgiving place for investors so far into 2016. With concerns over the global economy, regulatory capital and balance sheet exposure to commodities driving a steep sell off during January and February, UK bank shares are now down by an average of -16.5% year to date.
After having covered many of the sector’s key constituents in February, now seems an appropriate time to take a quick look at Royal Bank of Scotland (LSE: RBS) and Lloyds Banking Group (LSE: LLOY), before results begin to emerge for the first quarter.
Worth holding onto
February’s results day will not have been the first time that RBS investors were caught on the wrong side of a collapse in the bank’s share price. The group has disappointed the market before and it still has a long way to go before it can close the book on a litany of issues stemming from the pre-crisis years.
Most notably, investigations into the securitization and sale of US mortgages could still cost shareholders billions, while the sale of PPI, interest rate swaps and the bank’s treatment of distressed customers in the UK could also add significantly to the final bill for past conduct.
However, looking past this, the majority of analysts agree that underneath everything else, RBS still has a pretty valuable personal and business banking franchise. Analysts at Berenberg estimate that this could be worth 19p-21p earnings per share annually.
Moreover, the eagerly awaited sale of Citizens Financial Group and Williams & Glyn, if either ever happens, will free up regulatory capital and enable management to focus more on the above core activities, which will be key to an eventual recovery of the shares.
In the meantime, expectations are about as low as they can get while the shares trade at just 0.67x tangible book value and 11x adjusted earnings per share, which is broadly in line with sector averages.
While it could still be some time before the shares stage a meaningful recovery, the aforementioned suggests that further downside could be limited from here and therefore, the shares may be worth clinging onto.
A watchful eye
Lloyds is another bank that has radically reorganised itself in recent years, shedding international exposure, in order to refocus itself on the domestic UK market for retail and business banking.
While a return to dividend payments was widely expected, management surprised everybody in February when they announced a higher than expected payout of 2.25p per share for the full year, in addition to a special distribution of 0.5p.
However, statutory earnings were just 0.8p for the period, thanks in large part to an increase in conduct related provisions. This means much of the dividend was paid from reserves, leaving the shares sat at an inflection point.
Investor expectations for dividend growth have risen since the results announcement but the bank will needs to reduce conduct costs and keep income steady if it is to even sustain the recent payout. If conduct costs show signs of rising again as the year progresses, either due to the approaching claims deadline for PPI or if the Plevin Case becomes a point of interest among ambulance chasers, investors could soon begin to doubt the bank’s ability to deliver.
As a result, conduct related news will require a watchful eye as the year elapses because developments here risk leaving investors disappointed. Nevertheless, most observers still seem upbeat in their outlook for the shares, while the average broker recommendation remains a Buy.
James Skinner has no position in any shares mentioned. 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.