Last week was one that most equity investors would like to forget.
The FTSE 100 took a 10% tumble between Monday morning and Friday evening. And the British banking sector led the way down.
To be fair to UK lenders, it was very bad luck to be reporting half-yearly results just as markets were having a freak out. And as those results contained a fair amount of pain, it’s no wonder the sector’s stock prices were panned.
But that’s in the past. What should investors do now – bite the bullet and buy bank shares? Or is there a better bet amongst UK financial stocks?
There’s a little good news – and a lot of bad news
We’ll start with the good news. HSBC, which kicked off last week’s UK bank reports, actually made more money than last year. Pre-tax profits rose by 4% to £11.5bn.
But that’s about the extent of the good news. Barclays said that it made a third less in the first half of 2011 than it did last year. Lloyds Banking Group, which includes HBOS and is now over 40% state-owned after the sector had to be bailed out in 2008, did even worse, with a £3.25bn pre-tax loss.
LBG shares then fell so fast that trading had to be suspended while London Stock Exchange staff checked the sharp drop wasn’t a mistake.
Then there was Royal Bank of Scotland. As you probably know, that really is ‘our’ bank. After the 2008 crisis, British taxpayers ended up owning almost the whole of RBS. So we all now have a genuine vested interest in how it fares. Sadly, though, it doesn’t look like we’ll be retiring just yet on the back of our ‘investment’.
RBS has just reported a £1.4bn net loss for this year’s first half, which compares with a £9m profit for the same period last year. And since that taxpayers’ cash went in, the bank’s shares have plunged by almost 45%.
There’s more on RBS here, with a chart of the bank’s performance over the last five years. As you’ll see, it’s been a horror story. Since early 2007, RBS shareholders have lost a shuddering 95% of the value of their investment. Indeed, the sector as a whole has undershot the overall market by fully 30% over the last two years.
Are banks a good contrarian bet now?
After that, it’s tempting – particularly for contrarian investors – to think that bank stocks might be nearing their low point. So could the sector be due a recovery?
If you’re prepared to wade through the endless half-yearly reports – RBS’ results extended to well over 200 pages – there are some signs of hope.
To cut a long story short, the banks got into trouble because they lent too much money to people who couldn’t repay it. But gradually, these ‘toxic’ loans are being written off. And other assets that aren’t seen as key – bankers like to call these ‘non-core’ – are being flogged off. Costs are being cut too (though on the shopfloor rather than in the bonus pool) with 1,000s of jobs slashed.
What’s more, UK bank shares have now fallen so far that they’re selling on big discounts to stated book value. In other words, with LBG for example, you can buy around £1-worth of assets for 50p.
So what should investors do now? Not much, if deputy PM Nick Clegg gets his way. He has suggested the government ought to dole out those state-owned British bank shares – for free – to the taxpayers who funded the bailouts in the first place.
That wouldn’t be simple, though it might work. In this week’s magazine, my colleague Matthew Lynn has an interesting take on it, which subscribers can read here: It’s time to sell off the banks.
Getting something back that’s already ours is one thing. But paying out more good money for bank shares is a different matter.
Why? Look at it this way. RBS has a current market cap of about £31bn – in other words, that’s what the market reckons its net assets are really worth.
But it’s just told us that the total value of its assets – funded by deposits, borrowings and the bank’s own capital – is almost £1.5 trillion. This means that just a 2% drop in that total asset value would wipe out the current market cap – i.e. the bank could effectively be worthless in the market’s eyes.
Clearly, that’s a back-of-the-envelope bit of analysis. But it spotlights the risks investors run by buying bank shares. And with all the question marks that are cropping up over global growth – in fact, with fears growing that the world’s economy could return to recession – would you want to bet against a 2% asset fall?
A financial stock that looks worth buying
In short, banking still looks a sector to avoid. But don’t just take my word for it. Hedge fund Crispin Odey, who’s got a great track record of getting bank calls right, “is among a group of London-based investors who [have] drastically reduced holdings in UK banks”, reports Helia Ebrahimi in The Telegraph. “There’s a long way down, especially for banks”, says Odey.
So does that apply to all financial stocks?
Actually, no. Another firm to report results this week was insurance company Aviva (AV) (formerly known as Norwich Union). Profits were up a better-than-expected 5%, as was the interim dividend.
Yet Aviva shares have dropped 60% below their 2007 highs as investors have lost patience with management’s ability to unlock the firm’s true value.
But on a 2011 forecast p/e below six, and a twice-covered near-8% yield, this is a stock that’s now so cheap it has to be worth buying. If the price is dragged down further by the market mayhem, so much the better.
Category: Market updates