“RBS’s journey from a Bust Bank to a Normal Bank is largely done” – Stephen Hester outgoing boss of RBS on Friday
This week marked a turning point in the health of the British banking industry. There were three big moments.
- The new boss of Barclays accepted the bank hadn’t enough capital and announced plans to sell new shares to raise equity. The old boss, Bob Diamond, never admitted Barclays was under capitalised but without an acknowledgment of the problem a solution can never be found. Thus the equity issuance is a positive development.
- Lloyds blew the City out of the water with much better than expected results which lead to big upgrades. That drove the share price 9% higher Thursday, well above the government’s breakeven price. A partial sale of the state’s 20% holding is now expected very soon.
- RBS returned to the black after five consecutive years of annual red ink (although the underlying numbers did slightly disappoint).
The normalisation of the British banking industry is well underway. And this is important for the UK economy because without a healthy and sound banking system, UK growth will remain sluggish at best. Over the last five years, we have experienced the economic devastation from a collapsing banking sector. A strong economy requires a strong banking industry and there are signs of vigour in both.
Even in Europe, which is behind the UK in terms of economic recovery, there is some improvement. Commerzbank kicked off the year with an equity issuance to repair its ravaged balance sheet. Deutsche Bank did not resort to new equity this week, but did continue to plan for a significantly smaller balance sheet – €250bn less by 2015 (about 15% of total exposure).
Reading through this week’s equity research, signs of strength in UK and European banks do emerge. In particular, the upgrades to Lloyds forecasts are especially large. JPMorgan analysts increased their price target significantly from 65p to 77p a share. And they upped Lloyds’ earnings forecasts a massive 25% for this year and 23% for 2014. Barclays’ research team increased their earnings estimates 32% for this year and 15% for next and upgraded Lloyds to a Buy from a Hold. Both sets of analysts think Lloyds is financially strong enough to start paying a relatively generous dividend in 2014 and 2015. That is an almighty step forward for a bank that had to accept a taxpayer bailout.
Societe Generale also reported results this week which lead to small upgrades. JPMorgan’s analysts like the French bank as it cheap – 0.7 X Book Value – and post 2Q results, they upped 2013 EPS forecasts by 6%. Analysts at Credit Suisse also like Societe Generale – it is deleveraging, has a solid capital ratio and is well exposed to French growth.
Swiss giant UBS also had numbers this week which had been pre-announced leaving little possibility of an earnings surprise. Although Nomura research team did note “The ability to report a figure close to the original consensus while still absorbing CHF865mn of largely regulatory charges was due to much stronger cost control in the Investment Bank and non-core unit”. Nomura analysts also noted that capital was “well ahead of target…. with positive implications for earnings expectations”.
In fact positivity surrounding Europe’s banks abounds. JPMorgan is positive on Danske Bank, thanks to a “earlier and larger than expected loan loss improvement” leading to earnings upgrades of 8% and 6%. Like Danske, the improvement in credit quality is the main story for Europe’s banks. A reduction in loan losses, accompanied by a strengthening capital position and potential for dividends. These are the positives for Europe’s banks.
dj Estoxx banks index weekly
To avoid Confirmation Bias (only looking at evidence that confirms a view), I will also look at the negatives. Some banks have disappointed this week. Deutsche Bank results were described by UBS as “unconvincing” and the analysts reduced both earnings forecasts (down 3% for 2013 and 7% for 2014) and price target (down 7%). Barclay’s numbers did not impress either – UBS analysts reduced EPS forecasts by 7% for 2013 and 4.5% for 2014 and reduced the price target from 360p to 320p. In the last six months, French banks on average have seen their earnings forecasts reduced by about 8-9%. And although Spanish banks are “enjoying their moment in the sun” according to Nomura’s research, with an improvement in margin in the 2Q, risks remain. Most notably, the ongoing provisioning for bad loans which continue to rise.
However, strategists are becoming more positive on European equities and financials. It is on the back of relative under-performance to the US and UK stock markets, better EZ economic data, and a relaxation of fiscal austerity. UBS has upgraded European equities from underweight to neutral this week, and it is not the only one. On July 15 JPMorgan strategists went overweight on European equities, favouring financials. If these strategists are right and European equities outperform, then high Beta names, with good exposure to Europe’s economies, should do well. Banks fit that description perfectly.
Next week sees another group of Europe’s banks report 2Q results including the global giant, HSBC, the emerging market bank, Standard Chartered, French bank Credit Agricole, Dutch bank insurance group ING and Italian bank Unicredit. That will offer yet more data for analysts to peruse. But it is becoming apparent that Europe is not Japan. Banks have recapitalised, admittedly slowly and from retained earnings and deleveraging. Losses in property portfolios are now being accounted for. Progress would have been a lot quicker with large taxpayer recapitalisations but that was politically unacceptable. Hidden help, mainly from the ECB and European funds was the method chosen. Progress may be slow but it is occurring.
Of course, there are still concerns about banks, mainly in troubled Southern Europe. In the UK, the sustainability of a housing recovery based on politics and not fundamental affordability still worries. Fears about zombie companies and consumers persist although better GDP will help thanks to higher wages, more jobs and higher company revenue. British Building Societies are not as far down the path to recovery as the quoted banks – the Co-operative has only just acknowledged its capital shortfall. And of course the great test, interest rate normalisation, has yet to come.
FTSE350 UK Banks index
But most important for all banks is economic growth and the latest data has been more optimistic both in the UK and in the EZ. Bank profits are highly sensitive to GDP. At the start I noted that a strong economy needs a strong banking system. Well a strong economy helps to create strong banks. And banks are highly operationally leveraged. On the way down markets and analysts under estimated the losses but on way back up, will under estimate the profit rebound too. Just look at the scale of the earnings upgrades for Lloyds.
Stephen Hester’s quote is applicable not just to RBS but also to other European banks. It is a significant that Lloyds can now be sold back into private hands. This is an important sign of progress (as well as helping George Osborne sleep at night). There are still trouble spots and challenges remain. But this week’s developments confirm that for UK banks particularly, the great threats of the past are now mostly over.
