Since the depths of the financial crisis, there have been two main ways to invest in a banking recovery. One is to buy shares in the big banks themselves, now that their balance sheets are a lot stronger.
The other is to go for a challenger bank, which I think offers greater short-term growth prospects. I see more risk too, mind, and those who went for Metro Bank are probably regretting it. The Metro share price is down 95% in two years after a catalogue of horrors.
If you’d invested in Virgin Money at the wrong time, you’d have been hit by the PPI scandal. The final cost turned out to be less than expected, but it was enough to result in a £232m pre-tax loss for the year to September 2019. But with that out of the way, analysts are predicting healthy profits for the current year. And forecast earnings would put the shares at a price-to-earnings ratio of only 7.6.
The dividend would yield around 1.9%, but that would grow to 4% on 2021 forecasts.
A Q1 update Tuesday shows no obvious problems I can see. The bank did, however, point out that “the UK banking market continues to face competitive pressures and uncertainty over the final Brexit settlement.” Oh, Boris, if only you hadn’t set that December deadline, we could be enjoying a return to economic optimism right now.
Virgin saw a modest 1.6% growth in customer deposits, which seems fine. Mortgages did drop 0.8%, but it’s a tough market right now, and I’m not unduly concerned. Business lending grew 2.5% to £8.1bn for the quarter, and personal lending was up 3.7% to £5.2bn. I’m impressed by both of those figures.
On the liquidity front, the bank’s common tier one equity did drop a little, but at 13.1% it’s still very healthy.
I see a straightforward, well-managed retail bank here, with strong business and personal prospects. On today’s share price, I rate Virgin Money a buy.
Turning to the big banks, shares in Royal Bank of Scotland (LSE: RBS) spiked up immediately after the election. But like Lloyds and Barclays, they turned tail again after that post-election Brexit twist. Over the past five years, RBS shares are down 43%, for the biggest fall of the three.
Results for 2019 are due on 14 February, and the forecast 75% rise in earnings per share puts the bank’s shares on a P/E of 9.3. That’s relatively healthy compared to the banking sector in recent years. But it still looks very low to me if RBS really is out of the woods.
The share price fall has boosted the RBS dividend yield too. There’s a special on the cards for 2019, and forecasts for 2020 put the ordinary yield at 6.5%. It’s taken RBS a few years longer than Lloyds to get back to paying dividends. But from the initial 2.5% delivered in 2018, I see that as impressive progress.
Is there any risk to the dividend? Well, predicted 2020 cover looks to be about 1.7 times. I think that’s fine, provided we don’t crash out of Europe without a good trade deal. But while that threat remains, the dividend must be at some continued risk.
But overall, I see RBS as a buy with exciting growth and dividend potential. And I don’t think it will remain this cheap for much longer.
Alan Oscroft owns shares of Lloyds Banking Group. The Motley Fool UK has recommended Barclays and Lloyds Banking Group. 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.