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Backing the banks: the best way to play the recovery?

Joanna Faith
Written By:
Joanna Faith
Posted:
Updated:
19/08/2013

UK banks may well be on the road to recovery following the trauma of the financial crisis, but is it time for investors to take a punt on the sector?

The UK economy is finally on the road to recovery. Exports have surged, the construction sector is growing and crucially house prices – which are a key indicator – have reached a six-year high.

For investors looking for a way to play this recovery, the banking sector – an effective geared investment on the economy – may provide the answer. But which of the FTSE 100-listed banks are best positioned?

Lloyds

Boosted by the Government’s Help to Buy scheme, the renaissance in the housing market is likely to benefit Lloyds Banking Group particularly thanks to its dominant position in the UK mortgage lending market.

Earlier this month, Lloyds reported that it was back in the black with a pre-tax profit of £2.1bn for the six months to the end of June. The bank said it had made substantial progress on strengthening its balance sheet, although “further work remains to be done”.

Star fund manager, Richard Buxton, is one professional investor backing Lloyds. The bank is his biggest holding accounting for just over 4% of his Old Mutual UK Alpha fund. He believes Lloyds’ recent results demonstrated further progress in reducing bad debts, improving returns and moving towards a position of being able to resume dividend payments.

“It has felt pretty lonely being a UK bank shareholder in recent years, but in the case of Lloyds, with the shares up over 50% this year, one feels less like a social pariah,” he says.

Neil Veitch, a fund manager at Edinburgh-based SVM Asset Management, also owns Lloyds shares: “It is slowly becoming that long-forgotten creature – a normal, domestic bank,” he says.

Experts predict Lloyds will start paying a dividend again as early as 2014. The bank has not paid a dividend to investors since 2008, when it was bailed out by the government and ordered to freeze pay-outs.

“It looks as if they will start with a small payment initially and work back over time towards a high pay-out ratio, perhaps up to 70% of profits. So the shares will become a new source of equity income,” says Fidelity’s Michael Clark.

HSBC

HSBC is in a strong position and, notably, is the only bank on stockbroker The Share Centre’s ‘buy’ list.

“As a truly global bank, it should be able to make the most of its international links to make strong returns for its shareholders”, says Fidelity portfolio manager, James Griffin.

HSBC reported $14.1bn in half-year net profits, up from $12.7bn last year. And despite this being below analysts’ forecasts as revenues dropped 12% on a slowdown in emerging markets, The Share Centre analyst, Helal Miah, recommends investors take advantage of any weakness in share price.

“The group is an attractive option in the sector, especially for income seekers,” he says.

Back in 2007, a total of seven banks paid out a dividend: Barclays, HBOS, HSBC, Lloyds, Northern Rock, Royal Bank of Scotland and Standard Chartered.

Compare this to last year and just HSBC, Barclays and Standard Chartered were still paying dividends.

Richard Hunter of Hargreaves Lansdown stockbrokers says HSBC’s dividend yield of 4.2% is an attraction to income investors in the current interest rate environment.

“HSBC is still the preferred play within the UK banking sector by some considerable margin,” he says.

“Investors are increasingly prepared to pay for this comfort, despite a share price which has added 40% over the last year as compared to a 15% gain in the wider FTSE 100. As such, the market consensus of the shares as a strong buy is likely to remain firmly intact.”

Standard Chartered

Standard Chartered is another global bank with large exposure to emerging markets.

However, the last year has been anything but plain sailing for the company. It was hit with a huge fine for breaking sanctions on Iran. Nevertheless, it still managed to increase profits last year by 1%, just short of analysts’ forecasts.

According to Chris White of Premier Asset Management, its growth has slowed and it is relying more on cost saving rather than revenue growth to meet profit expectations, however it currently looks cheap on an historical basis.

White says that while Europe shows signs of recovery in the short-term, on a 5-10 year view, Asia and Latin American will have more growth potential, something that will benefit Standard Chartered.

RBS

Royal Bank of Scotland (RBS) is the bank seemingly polarising professional investors the most.

It reported a return to profit in the first half of the year as the majority taxpayer-owned bank moves towards privatisation.

SVM’s Veitch says RBS is “too complex a beast” at this point in time.

“As a house we generally prefer our financials to have strong balance sheets, strong liquidity, to try and be at the simple end of the spectrum. Financials are inherently complex and we try to lessen the complexity by investing in the stronger ones. RBS is just too complex at this stage.”

However, Mike Felton of M&G Investments who spends his time finding unloved or misunderstood companies that will do better than the market expects, took a position in RBS earlier this year as he thought the market’s prognosis was too pessimistic. This is a position he still holds today.

Interestingly, Miah of The Share Centre suggests investors avoid RBS: “Investors looking to try and claw back a little of the losses by holding will have to be very patient. There are better opportunities to be had in the market.”

Barclays

Barclays is also dividing opinion. It reported a 17% drop in half-year adjusted profit of £3.59bn and announced a £5.8bn capital-raising rights issue.

At the time of reporting the results last month, Barclays said it had set aside another £1.35bn to settle payment protection insurance (PPI) bills taking its total PPI bill to £4bn, after revealing it was getting claims dating back to the 1980s.

Ben Yearsley of Charles Stanley Direct says: “I would stay away from Barclays until it has raised the £12bn it needs to shore up its balance sheet.”

“Once this has been done, it may well be an interesting prospect. Many fund managers I speak to think there could be a healthy dividend yield in the next year of two.”

Veitch is less certain: “I think Barclays is an interesting situation, one we’ll keep a close eye on through the rights issue period. There can quite often be technical opportunities to buy stock cheaply through a rights issue period, and Barclays isn’t an expensive share.

“However, the set of numbers that accompanied the announcement of a rights issue were not particularly stellar, there were issues across all lines of business. I wouldn’t rule it out but equally I’m not 100% certain we will participate.”