A few years ago, the clouds seemed to be abating for British banks like Lloyds Banking Group (LSE: LLOY), Barclays (LSE: BARC), HSBC (LSE: HSBA), and even beleaguered Royal Bank of Scotland (LSE: RBS).
The extremes of the financial crisis had passed. Post-crisis regulation was tougher, but it seemed possible investors would welcome the extra scrutiny and be more confident about owning banks. The Eurozone crisis had been and gone.
Sure, Payment Protection Insurance (PPI) claims were taking a toll on profits – but that surely couldn’t last much longer? Soon stronger balance sheets would enable the banks to grow their dividends, and even buy back shares.
I’d watched a similar recovery already in US bank stocks. It seemed only a matter of time before the same thing happened here. I even recommended banks in our Motley Fool Share Advisor service.
Sadly, those were far from my best recommendations!
Fate had other ideas for investors in UK banks.
The banking blues
Starting in late 2015 it seemed one headwind after another thwarted any advance in bank share prices. Some of these reflected real business issues, but others were about sentiment. Either way, the recovery stalled.
There was Brexit, for starters. Starting with the Referendum campaign, the four-year saga stoked uncertainty and dampened economic activity – Britain went from the fastest-growing G7 nation to the slowest, and property wobbled. There’s also been angst about future financial regulation and market access. None of this is good for banks.
Then there are the UK’s persistently low interest rates. These depress the net interest margin for banks, making it harder to cream a profit from matching borrowings with savings. A few years ago we seemed closer to the end of the low interest rate era. But if you have cash savings you’ll know how that went!
Individual banks have their own issues, too. Barclays and HSBC were hit by scandals and fines over historical money laundering and tax evasion. Lloyds found it had inherited a fraud problem when it picked up Bank of Scotland in the HBOS merger. Royal Bank of Scotland had to pay billions of dollars to US regulators over financial crisis misconduct.
And the PPI bills kept coming. Lloyds had expected a £1bn provision taken in 2016 to be the last “big” addition to the total it had set aside for customer, capping its bill at £17bn. Yet Lloyds has now set aside nearly £22bn to meet PPI claims. That’s £5bn more out the door to disgruntled customers rather than being reinvested, or returned to shareholders via dividends or buybacks.
Nor did UK banks doing business overseas provide much relief. Emerging market specialist Standard Chartered (LSE: STAN) had to undertake a $5bn rights issue in late 2015, and it has been a slog to rebuild profitability since. Even HSBC – the least woeful of the UK’s big banks – has faced surging costs and a sluggish top-line, causing it to miss its return targets. Alongside Standard Chartered it’s also faced months of unrest in its home market of Hong Kong.
The icing on this unappealing cake for many investors was the prospect of a Labour government under Jeremy Corbyn, with potentially bank-unfriendly regulation to follow. I’m not making a political point here – you only need to see how bank shares surged following the Conservative win to appreciate political risk had been in the price.
Banking on a recovery
Still reading? Congratulations! If you got through that litany of woe without running away screaming then you might have the constitution to be an investor in UK banks.
Of course you might ask why you’d want to. Setting fire to money will at least heat and light your home…
Well, the reason to consider bank stocks is most of those headwinds are easing, if not becoming tailwinds:
- The PPI drama is near a close. Yes, we’ve heard this before, but we’re months past the final deadline for claims. The banks are running out of people to wheelbarrow cash to.
- The new Tory government under Boris Johnson with its big majority breaks the Brexit deadlock. The supposed danger of a Corbyn-led government has passed, too. I expect things to continue to be bumpy, but at least we have a functioning government. If consumer and business sentiment improves in turn, the economy should get its mojo back. That’s great for banks.
- A strengthening economy would bring the prospect of higher interest rates back onto the table. I wouldn’t expect big moves, but even small advances could help boost Net Interest Margin from today’s depressed levels.
- Finally (or perhaps that should be fine-ly?) the big misconduct charges for legacy misdeeds by the UK banks appear to be in the rearview mirror. I don’t doubt there’s a new scandal brewing somewhere, but hopefully the increased scrutiny and regulation will (for now) curb their misadventures.
It’s also important to note there’s been underlying progress at the banks over the past few years, even if that hasn’t yet shown up yet in their share prices.
Costs have been slashed and in some cases less attractive territories and units have been jettisoned. Dividends have been restored. Most of the big banks have been buying back their shares cheap, which is the one upside of the low prices we’ve seen.
True, if following the banks over the past five years has taught me anything, it’s their capacity to disappoint. Still, with the possible exception of property, I’m not sure there’s a sector better poised to benefit from recent changes in the outlook for the UK – and property doesn’t have the end of those crippling PPI provisions to cheer, either.
Banks seem to me cheap, and the outlook better than for several years. 2020 vision may usually mean looking backwards, but maybe bank investors can finally look ahead.
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Owain Bennallack owns shares in Barclays and Lloyds Banking Group. The Motley Fool UK has recommended Barclays, HSBC Holdings, Lloyds Banking Group, and Standard Chartered.