Thursday, 2 February 2012

Backing up the banks again

The Banking sector has suffered more over the last five years, than any other sector, falling by more than two thirds and underperforming the FT All Share by a considerable margin. As Warren Buffet is keen to remind us, “we should be fearful when others (not just bankers) are greedy and greedy when others are fearful” later reinforcing his argument by investing in the U.S. Banking sector. So is now the time for the contrarian investor in the UK to be buying back into banks, on this side of the Atlantic?

As the situation continues to evolve in Europe, the sector is likely to remain very volatile. In particular, the events of the last few years have crystallised a desire from all parties to see a better capitalised banking system, capable of withstanding systemic shocks. This, in turn, will mean that banks will have to raise their capital levels substantially over the next few years. Why is this important to investors? Primarily because capital that would, in the past, have been distributed to shareholders in the form of dividends will now be retained to strengthen balance sheets. Thus we anticipate any recovery in the banking sector to be a protracted rehabilitation rather than a dramatic return to rude health.

What, then, should investors look to do in this environment? One stock to consider is Standard Chartered Bank, where the lack of exposure to the eurozone has seen them fare well through the crisis. Expensive in relation to the rest of the banking sector, certainly, but exposure to the faster growing regions of the world coupled with a dividend yield of around 3.5% - comfortably above deposit rates – makes Standard Chartered a consideration.
Standard Chartered five year chart. Past performance is not a guide to future performance. 
HSBC offers some recovery potential and a current yield of 5.0%. As a global bank, HSBC has exposure to Europe, but was not at any stage forced into the arms of governments or sovereign wealth funds and has been able to retain its full independence. Clearly they are not immune to wider issues within the sector, but HSBC do offer some attractive defensive exposure to a recovery in the wider financial system.

We would remain cautious about the other banks in the UK. The furore surrounding Stephen Hester’s bonus at Royal Bank of Scotland – without getting too drawn into the rights and wrongs of the situation – highlight the degree of political pressure that a bank majority owned by the state will face. Lloyds Banking Group, with Mr Horta-Os├írio back at the helm, faces something of a management hiatus at present. Barclay’s progress is beholden to Barclays Capital and, while it has been able to restore a dividend, progress here is likely to be constrained by the industry wide problems discussed above.

RBS, Lloyds and Barclays. Past performance is not a guide to future performance. 
In summary, regulatory tightening will continue for the foreseeable future and the industry will de-gear, constraining the profitability of; Lloyds, RBS and Barclays to modest historic levels. Against this background, the Asian focussed businesses of Standard Chartered and HSBC may be stocks to consider.


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