Are banks back?

A decade on from the run on Northern Rock, are banks a better investment opportunity? Darius McDermott, managing director of Chelsea Financial Services, gives his view.

Are banks back?

The Bank of Mum and Dad has been back in the news this week. According to new research*, if it actually existed, the Bank of Mum and Dad would be ninth largest mortgage lender in the UK and on a par with the Yorkshire Building Society!

However, it would surely make a very bad investment. While low or no interest rates and long or infinite repayment periods may be attractive to the borrowers, the Bank of Mum and Dad has few if any deposits, no way of making a profit and a possible pending liquidity issue with funding: money doesn’t grow on trees and Mum and Dad might actually want some of their equity or savings to spend on themselves in their retirement.

Do real banks offer better opportunities?

Views on banks that do exist are generally quite polarised among fund managers. Some tend to steer clear of them completely. Neil Woodford famously invested in a bank for the first time in a decade in May 2014 in the Woodford Equity Income fund, only to sell it the following September. Liontrust Special Situations’ investment process, which looks for firms with intellectual capital like strong distribution networks, recurring revenue stream and products with no obvious substitutes, means banks are automatically excluded.

By and large, the stance has been a sensible one in the past decade. The FTSE All Share Banking sector fell by a huge 78% in the financial crisis before it bottomed and remains more than 40% below its 2007 level today**.

Others see banks as good investments at the moment however, and a sector that will benefit from rising interest rates should we ever see them. R&M UK Equity Long Term Recovery has a few in its top ten, as does Schroder Recovery. Both are funds with a strategy of buying companies that are unloved and cheap but the managers feel will surprise investors positively.

Banks’ balance sheets are certainly a lot healthier than they were at the start of the financial crisis, but stock prices have not recovered to the same extent. Since July last year, when value stocks started to outperform growth, the FTSE All Share banking sector is up 44%***.

Of course, anyone investing in a FTSE 100 tracker fund will have 13%**** of their money invested in banks whether they think they are a good investment or not.

Or should we lend to the lenders?

According to TwentyFour Asset Management there are also several banks that look good from a fixed income perspective right now.

Highly supportive markets have facilitated the stronger banks to generate capital organically, while also enabling even the weaker banks to raise equity capital, such as Deutsche Bank and Unicredito. TwentyFour Dynamic Bond fund has almost 23% invested in the bonds of banks.

GAM Star Credit Opportunities is another bond fund I like that has an even higher weighting to bank fixed income as the manager can find some very high yields in this area. For example, he recently purchased euro denominated HSBC contingent convertible notes with a coupon reset in 2023 and a yield in euro terms of 5%. Hedged back to sterling this resulted in a yield of over 6%*****.

A return to ‘normalisation’

Believe it or not it is almost 10 years since the global financial crisis really began to take hold in the UK and we experienced our first run on a bank (Northern Rock) in 150 years.

Overall the banks are in much better shape and the final 2% of Lloyds Bank owned by the tax payer after its own bailout is rumoured to be going on sale imminently.

Interest rates are still at ’emergency’ levels and growth dipped slightly in the first quarter of the year as Brexit uncertainty took its toll. This situation is likely to continue for some months. But, as and when interest rates do rise again, so could bank profitability.

*Conducted by Legal & General and the Centre for Economics and Business Research consultancy

**Source: FE Analytics, 5th May 2007 to 11th March 2009 and 10 years to 5th May 2017, total returns in sterling.

***Source: FE Analytics, 4th July 2016 to 5th May 2017, total returns in sterling.

****FTSE Russell, 28th April 2017

*****Source: GAM Star Credit Opportunities fund fact sheet, April 2017

 

Past performance is not a reliable guide to future returns and tax rules can change over time. Darius’s views are his own and do not constitute financial advice. Please remember, no news or research item is a recommendation or advice to buy. Every Investor is not responsible for accuracy and may not share the author’s views. If you are unsure of the suitability of any investment for your circumstances please contact an adviser. All investments can fall as well as rise in value so you could get back less than you invest. 

 

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