Banks are once again one of the market’s most unloved sectors as it’s becoming increasingly clear that very little has changed in the industry since the financial crisis. Indeed, this week speculation that German lender Deutsche Bank is struggling has sent shockwaves through the sector, adding to the negative sentiment that has stalked the industry for many years.
UK banks are arguably stronger than their European peers, but they’re not without their own problems. HSBC is struggling to drive growth in Asia as it retreats from what management has deemed to be non-core markets. Meanwhile, both Barclays and RBS are struggling with restructurings, and Standard Chartered is suffering a hangover from the commodities boom. On top of this, challenger banks’ business models are being disrupted by higher taxes and costs, which have put the brakes on growth.
Wrestling through the gloom
The one UK bank that is wrestling through the gloom is Lloyds (LSE: LLOY). Like almost all of its large peers, Lloyds has effectively finished its post-financial crisis restructuring. The bank’s balance sheet is one of the strongest in Europe and costs are on a steady downward trend. Lloyds’ return on equity, a key measure of bank profitability is around 15% if you exclude the one-off costs such as compensation for mis-selling payment protection insurance. If you want to use a single number to compare Lloyds to its larger peers, this is the one.
Lloyds’ return on equity is one of the highest among banks in Europe. HSBC and Deutsche are arguably two of the largest and most influential European banks, and both are struggling to achieve a return on equity of more than 5% consistently. City analysts forecast HSBC’s return on equity will come in at 5.3% this year while Deutsche’s return on equity stood at just 0.7% during the first half and normalises to just 4% for the past decade.
Sector leading profitability has helped Lloyds win favour with investors during the previous two years as the bank has been able to initiate and increase its dividend payout at a time when many of the company’s peers are cutting distributions to shareholders.
Risks ahead?
Having said all of the above, it remains to be seen how much longer Lloyds will be able to achieve these impressive returns.
The bank is the UK’s largest mortgage lender and profits are fixed to the fortunes of the UK economy and housing market. The City is forecasting a 14% decline in Lloyds’ earnings per share for this year, followed by a decline of 13% for 2017. Analysts at Goldman Sachs recently slapped the bank’s shares with a sell rating citing lower interest rates and increasing competition.
Overall, Lloyds may look to be one of the best investments in the UK banking sector, but there are risks ahead for the group.
Still, analysts have pencilled-in a dividend yield of 5.4% for this year, so if you’re put off by Lloyds’ deterioration growth outlook, shares in the bank are appealing from an income perspective.
