It’s been a difficult few years for UK banks as they grapple with an abundance of issues on multiple fronts, including much more onerous stress tests.
Increasing litigation, regulation and wholesale management changes have been the overriding narrative of 2015 as the banking sector has continued to be the whipping boy of choice for the legacy of problems from the financial crisis of 2008, while Asia focussed bank Standard Chartered (L:STAN), who managed to avoid the events of 2008 pretty much unscathed followed up its dismal performance in 2014, with another nightmare in 2015.
Having to contend with the political uncertainty surrounding a UK General Election at the beginning of this year wasn't exactly an incentive for investors to buy into banking shares with all the political uncertainty surrounding what might have been a possible Labour election victory.
While we have seen a continued recovery in the UK economy in 2015 this economic recovery has not translated into a positive performance for the UK banking sector, and it is notable that the bulk of this year’s declines came after the Conservative election victory in May.
These declines have been largely as a result of three distinctly different factors. Partly they may well have been in part down to disappointment at the outcome of the UK summer budget, as the Chancellor implemented an 8% profits tax, on top of the corporation tax the banks already pay, while slowly reducing the levy on the banks’ balance sheets.
The recent Autumn Statement didn’t help either with its measures to restrict the “buy to let” market hitting challenger banks, Aldermore (L:ALD) Bank, Onesavings (L:OSBO) and Paragon (L:PARA) disproportionately harder given their heavier reliance on the sector to generate returns.
We’ve also seen the deterioration in the prospects for the global economy which probably hasn’t helped either, as concerns about emerging markets have risen, while the slide in commodity prices has raised concerns about banks’ exposure to the highly leveraged basic resource sector.
This has been no better illustrated in the performance of Standard Chartered(L:STAN)’s share price where the declines have gone from bad to worse, down 29% in 2014 and down almost 40% so far year to date.
This year has been nothing short of a disaster for the Asia focussed bank as the new CEO Bill Winters cut the dividend in the summer and then followed it up with a surprise loss of $139m in Q3, which was in contrast to an expected $900m profit, well down on last year’s $1.5bn profit.
The bank also announced the loss of 15,000 jobs as well as announcing a $5bn rights issue, which will be a two for seven at a discounted 465p a share.
The recent volatility in Chinese markets in August this year, the continued weakness in commodity prices could well see bad loan impairments rise in the coming months, particularly in India, and that's even before you consider the effect this month’s US rate rise might have on the banks' exposure in the region.
While a rate rise in positive in some respects as it allows banks to improve their margins there is a risk that in so doing the rise in borrowing costs could tip some over leveraged companies over the edge, when it comes to rolling over their US dollar loans at higher rates.
While the performance of HSBC (L:HSBA) has been slightly better, with increased profits, it has still had its share of misfortune setting aside vast sums of money in respect of potential litigation over forex price fixing, helping clients with tax avoidance, and other potential legal issues. Its exposure to recent Asia market turmoil has also seen revenues in that region decline, but is well ahead of the curve in terms of its cost cutting program than its immediate peer Standard Chartered, who is way behind the curve in all of this.
Rising confidence in the resilience of the UK banking sector has certainly improved on where we were a few years ago as the continued improvement in the UK economy has helped in a significant reduction in the amount of non-performing loans on the respective banks books, which has helped boost profits as bad loan valuations decline.
Lloyds Banking Group (L:LLOY) hasn’t had a particularly great year but it has outperformed relative to the rest of the sector, which is reflected in the improvement in the underlying numbers, despite concerns about the growth in its dividend in the wake of the recent Bank of England stress tests.
The bank posted a 28% increase in profits before tax for Q3 to £958m on the same period a year ago, while operating costs fell 2% to £1.91bn. The bank also reported that its balance sheet had strengthened further with a common tier one ratio of 13.7%.
Provisions in respect of bad loans came in lower by 33% as a result of the continued improvement in the UK economy, while on the lending side, loans to small business increased by 5%, and mortgage lending rose by 1%, despite some softening in the UK economy over the third quarter.
Ultimately the bank remains a play on the UK economy, and while a global slowdown will ultimately affect its profitability, the limited global footprint of the bank should insulate it to some extent.
The bank still remains on course to make a pre-tax profit for the fiscal year of £8.2bn, well up from the £2bn in 2014, with the prospect that we could also see an increase in the dividend from the 1% seen in 2014.
This is ultimately what investors need to focus on, as the government continues to wind down its stake, though the prospects for the UK economy will also play a part.
Barclays (L:BARC) – while the performance of Barclays has been better than its peers this year its performance has been no less abject, as it drops back close to its 2014 lows.
The bank gives the impression of not knowing what it wants to be having called time on CEO Antony Jenkins turnaround plan in the summer.
Having dispensed with its CEO Antony Jenkins in July in a row over strategy the share price has slid sharply.
Mr Jenkins had been put into the role in 2012 to stabilise the bank in the wake of a perfect storm of fines, litigation and bad practice at senior management level he was tasked with streamlining the banks operations.
The direction of travel at the time suggested that the bank needed to be put it on a more retail footing, however it would appear that senior management have since had a change of heart and the appointment of Jes Staley, an ex JP Morgan investment bank from 1st December, would appear to suggest that senior management don’t want to dispense with the investment banking model completely.
He will need to do this against a backdrop of a rising regulatory burden and a certain amount of investor disquiet as to what the banks overall strategy is given that Mr Staley sought to play down the prospect of any wide scale changes to those that have already been embarked upon.
RBS (L:RBS) – at the end of 2014 the bailed out bank managed to post its first annual pre-tax profit since the financial crisis, signalling optimism that the bank was starting to see some light after travelling through a very long dark tunnel of corporate malpractice, fines, litigation and IT failures.
The sharp fall in Q3 profits a few weeks ago has cast a bit of a cloud over that optimism after the bank posted a surprise £134m loss in the quarter.
The bank continues to sell off assets, completing the sale of its remaining stake in US Citizens bank for £1.7bn, and is still under investigation in the US for allegations of the mis-selling of mortgage backed securities, which could see a fine in excess of $10bn if proven. There has also been resurrected talk that the bank may be in discussions to sell off its Williams and Glyn’s unit, with Santander (MC:SAN) or Virgin Money (L:VM) potentially interested.
The bank is also under investigation by UK regulators for the activities of its Global Restructuring Group turnaround unit, which could well see the bank incur more large fines.
While the government managed to sell off a small percentage of its stake in the summer at 330p a share, the taxpayer still owns 73% of the bank, and given the current direction of travel, further sales look unlikely at this point, as the shares trade just above the lows seen in 2014.
Conclusion
It’s been another poor year for the UK banking sector with the Asia focussed banks looking particularly vulnerable, while the domestic political environment hasn’t exactly helped either.
The willingness of a Conservative Chancellor to steal the Liberal Democrats clothes in implementing an 8% profits tax on all banks balance sheets has prompted a storm of criticism, not least from the challenger banks who rightly claim that it penalises them far more due to its very low threshold of £25m. The recent measures to rein back the UK property market have also hit the challenger banks harder than most given that the majority of their business on mortgage lending.
For a Chancellor who claims that he wants to encourage new entrants to the sector and champion challenger banks these various measures seem rather misguided, a fact that TSB boss Paul Pester highlighted earlier this year, and suggest a Chancellor who either doesn’t understand the banking sector, or is more interested in politics than fixing the problems of the UK economy.
There are also concerns that the sustained slide in commodity prices could see banks with large loan exposures to mining and oil production companies incur large scale losses as a result of defaults.
We got an indication of these concerns earlier this year as the catastrophic slide in the share prices of Glencore (L:GLEN), Anglo American (L:AAL) and Lonmin (L:LMI) will testify.
Concerns over loan exposure can only increase the longer oil prices remain near multi-year lows below $50 a barrel, while iron ore, copper, platinum and zinc prices have also slid to multi year lows recently.
So far this year we’ve averaged $55 a barrel over a rolling 12 month period on the Brent contract, with US crude below that at $50, as opposed to a rolling average of over $90 a barrel at the beginning of this year.
It has been estimated at the beginning of this year that the big UK banks had around $10bn-$15bn each worth of oil exposure so they will be hoping that the oil price doesn’t do what it did in 2008 and drop below $40 for an extended period of time.
The Asia focussed banks in particular have performed much worse, due to concerns about the slowdown in China and the rest of Asia.
In conclusion, the performance of the banking sector is likely to be a very tricky one to call in the coming months, and for the reasons outlined above is likely to be an investment for the brave, while the continued weakness in not only oil prices, but commodity prices in general has given bank CEO’s one more thing to worry about, as well as trying to pass the next set of stress tests, which are now likely to become an annual event.
In order to deal with these issues the banks are once again likely to find their capacity to lend money to the real economy somewhat limited in the coming months, which could well invite further criticism from politicians looking to score political points.
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