The banks have published their impairment losses, resulting from coronavirus and Brexit. RBS (LSE:RBS) estimates £0.8bn, Lloyds (LSE:LLOY) £1.4bn and Barclays (LSE:BARC) £2.1bn. This sparked lots of volatility in their respective shares, but in the long term could they lead the stock market rebound? I think this will depend on three key factors.
Leading the stock market rebound
I look at a bank’s Common Equity Tier 1 Ratio (CET1) in order to judge its ability to withstand a financial crisis. This assesses how much capital the bank has to cover potential losses from its assets (predominantly loans it has made).
RBS is best capitalised of the three. It has £78bn worth of cash and its CET1 stands at 16.2%, the highest of any of ‘the big five’ banks. Barclays and Lloyds both have a CET1 of 13.8%. All are comfortably above the 7% level set by Basel III. This is reflective of the improvements made since the 2008 banking crisis, and should stand them in good stead to lead a stock market rebound. Indeed, as a whole, the UK banking sector’s CET1 ratio is currently three times the 2008 level.
However, it is worth noting that these ratios were calculated in financially strong times. If assets become more impaired, this ratio decreases. This is something the Bank of England tests in its stress tests. All three banks passed the latest test with CET1 ratios above the 7.2% hurdle rate.
Therefore, I think all three banks should have sufficient resources to survive a significant downturn.
Competitive advantage
Of course, having a lot of capital on its own doesn’t make a good investment. The ability of these banks to drive the stock market rebound depends on its ability to generate long-term profits.
A big threat to the big five has been the challenger banks. However, the big banks appear to be winning the war. Increased digitalisation and better ability to absorb regulation costs has been driving this. Indeed, the top six banks now hold 87% of personal accounts, up from 80% in 2000.
Low interest rates are definitely a threat in this industry. Barclays estimates this will cost it £250m. Regulation is also a threat. Again, Barclays estimates the clampdown on fees and overdrafts will cost it £150m. However, I actually think this will help the big banks keep their market share, as it’s an extremely tough and capital-intensive market to enter.
In conclusion, I believe these three banks should be able to weather the storm and lead the stock market rebound after its gone. At respective price-to-earnings ratios of 7.4 (Barclays), 9.2 (Lloyds) and 4.25 (RBS), they all appear to present good value picks. Additionally, at price-to-book ratios of 0.3 (Barclays and RBS) and 0.4 (Lloyds), they are all cheaper than the industry average 0.75.
