Banking Sector Trends

Interesting to note that Standard Chartered, perhaps one of the most unscathed internatioanl banks in the sector from the recent crisis, has announced a share placing to raise about 1 billion pounds ($1.7 billion). Unlike most banks in the sector, this isn't to fund massive losses from speculative lending, but instead to support ORGANIC expansion in key markets in Asia, Africa and the Middle East. The placing comes six months after Standard Chartered raised $2.68 billion from a rights issue.

http://www.stockopedia.co.uk/news/announcement/STAN/090804stan001118.htm

From the WSJ (http://online.wsj.com/article/SB124941021893305415.html):

Some investors may grumble at the modest dilution to earnings and return on equity arising from this 4% increase in the issued share capital. But Standard Chartered has always been prepared to sacrifice some short-term gains for longer-term success, as reflected in its mid-to-high-teens return on equity target. That's low perhaps given the markets it operates in, but a function of heavy investment in its franchise and infrastructure across Asia. Standard Chartered has earned the benefit of the doubt.

Interesting to see that RBS have brought the UK bank reporting season to a close this morning with an overall loss of £1bn....this compared with prior expectations of a "small profit".

HSBC and Barclays each reported profits of £3bn, LLOY reported a loss of £4bn and Northern Rock also reported a loss of £700mn+.

So what can we conclude from this (IMO !!):

a) It was a great half-year for investment banking, especially trading activities in debt capital markets. This is no surprise at all given the massive volatility coupled with the cheap funding and the enormously wide market spreads in the early part of the year.

b) Conventional bank lending profits remain under presssure from heavy loan losses. It is a matter of debate whether the worst of this has now been seen.

c) Lending volumes generally remain subdued. Banks would probably argue that there are a lack of good lending opportunities....whereas the government might take the view that they aren't trying hard enough.

So what of the outlook for the sector in H2?:

1) I think that the enormous revenue boost from investment bank trading activities will be much reduced in the second half but

2) I also think that loan losses are likely to be lower in H2 than in H1....so

3) Overall profitability will continue to present a mixed picture....though I'd think that this time LLOY will do rather better in relative terms than the other three major banks which have more significant trading activities...providing that......

4) House prices and the property market merely tread water, rather than resuming their fall and prompting further write-downs. I do think house prices still have further to fall - but I suspect that will be in 2010/2011 rather than in 2009. By that time the unemployment pressures and the burdens on the real economy will start to become a more evident dead weight than they will appear to be in the rest of 2009.

In aggregate I think that bank share prices have got somewhat ahead of themselves in recent months and, though they have provided extremely good returns over the last 5 months, they will do no better than the market average for some while yet. So...if I had gone overweight (which unfortunately I didn't), I'd now be cutting back.

As ever, it is possible that STAN (given their emerging market business mix) may be a very different proposition.

FWIW

ee

There was an interesting CBI Access to Finance survey released which indicates that companies are finding it easier to borrow money.

• The CBI's survey found that among firms which sought new credit lines over the past quarter, 27pc found that availability had improved, while 10pc said it had worsened. The resulting rounded balance of 18pc is a marked improvement from May's balance of -20pc.
• Apparently, the jump had been largely down to reports from the firms with more than 5,000 employees, which saw a strong improvement in credit availability but the credit crunch is apparently not abating for small and medium sized enterprises (SMEs) who are still struggling to get new loans or extend existing credit lines...

The news will be taken as an encouraging early sign that the various measures taken by the Bank of England and Treasury to fight the credit crunch are starting to take root. It comes the week after the Bank extended its Quantitative Easing programme by a further £50bn, warning that although the economy may now be past the worst, businesses and households are still finding it difficult to attain finance.

http://www.bloomberg.com/apps/news?pid=20601085&sid=aFwz6cs_TGyk

http://www.telegraph.co.uk/finance/economics/6001003/Credit-squeeze-is-starting-to-ease-for-UK-companies-CBI-survery-finds.html

There was an interesting article in the Saturday Telegraph debating whether the credit crisis was "over" - see: http://bit.ly/1ac2nU. The basic bull argument expressed was that the risk stemming from liquidity drying up and toxic financial instruments with values spiralling downwards is largely over, and we are left with the unpleasant but far more recognisable issues of bad debt as the recession impacts companies and households.

Simon Maughan, banking analyst at MF Global, says: "We are still going to get some significant losses and even the guys guiding on their own provisions are saying we are yet to see the peak in retail, commercial and corporate bad debts. But banks are back in control of the P&L and it's now about bad debts, cost cutting and their ability to earn their way out of it. If banks were taken off life support tomorrow would we be in a mess? Yes, but it isn't going to happen."

Interestingly, it quoted Kenneth Rogoff, professor of economics at Harvard University, who famously warned that "a whopper" of a bank would fail just three weeks before Lehman imploded!

His view: "We are definitely past the panic phase and the possibility that the economy will fall off a cliff, because governments around the world have guaranteed everything that moves or breathes... We are still in a slow-burn phase of the crisis where there is no imminent crash but we are on a course towards larger and larger government and intervention in the financial system and it is hard to get back on your feet. The Great Depression Two has been wiped off the table but we could be heading for a repeat of the 1970s."

So, a return to early 1990s style misery rather than armageddon, or are there more surprises in store for us?

In reply to emptyend (post #2)

The one additional point I would make is the potential for both £BARC and £HSBA to take signficant share from the other two weaker players who are really on their knees. I see £HSBA in particlar as being in a very strong position (as discussed on the stock forum/wiki). For example, its announcement last December of a US$5 billion SME fund was genius, although clearly a global initiative, not just a UK one. Under normal circumstances, to try to play the relative operational peformance, I would be tempted to buy one of the stronger players and short either £RBS or £LLOY . However, given the depressed share prices of the latter two, I suspect that could go really horribly wrong if RBS bounces back from 40p.

In reply to Betasurfer (post #5)

The one additional point I would make is the potential for both Barclays and Hsbc Hldgs to take signficant share from the other two weaker players who are really on their knees. I see Hsbc Hldgs in particlar as being in a very strong position

I've worked for two of the four and did loads of business with the other two. I've also met the present CEOs of all but LLOY.

If (and its a fairly big if, in an election year) the government can be induced not to interfere in RBS and LLOY, then I think both have very capable management that should not be underestimated, at least in the UK context. Where I have no doubt that HSBC/BARC will indeed take share is in the international market, with Barclays leveraging their Lehman fire-power in debt capital markets and HSBC being seen as a safe haven for major corporate clients (and retail) in more traditional banking.

The question of which banks should be preferred therefore comes down to how valuable one thinks the international business will be. Pre-crisis, I was much keener on BARC than on the others (mainly due to quality of management). At current prices, I think all except perhaps HSBC are looking expensive in the short term - but I'd expect all of them to look OK further out....and if I was looking for the "big recovery bet", that would probably (at some point) mean buying LLOY - but not yet. BARC and HSBC should do OK - but quite a bit of it is now in the price, IMO.

rgds

ee

I hold some LLPC preference shares, which seem to be coming off a bit after a fairly strong recovery. This is undoubtedly on the back of the Crock recently passing some coupons and this downgrade: http://ftalphaville.ft.com/blog/2009/08/24/68276/hybrid-security-or-not/  [though, AIUI, this applies to more complex securities than the prefs].

First there was news that Northern Rock would be deferring payment of its suboordinated debt coupons. Then then there was a mass-downgrade of the hybrid debt of banks including Lloyds and RBS, from ratings agency Fitch. In short, things are happening in the market — and they haven’t been all that good.

So far, so bad. However:

...'To be honest this has long been in the price of these type of bonds, the EU clarification just  gave Fitch and the other ratings agencies the opportunity to confirm that this type of debt  will be treated as the lowest of the low (i.e. highest in risk terms).'...

 

...'A deferral need not be permanent, but it could make it harder for the UK government to offload its stakes in the two lenders [RBS and Lloyds]. An outstanding or missed coupon looks ugly and can prevent a bank from paying dividends. If RBS and Lloyds do have to defer, the government would likely have to come to terms with bondholders before it can sell down any of its stakes.'

In the case of LLPC, ordinary dividends cannot be paid ahead of preferred dividends (but as they're not cumulative, missed dividends will not be made up, nor does govt have to "come to terms" with preferred stock holders). Nevertheless, ISTM that the relatively small cost of paying the preferred dividends may be rather less that the cost of missing them in terms of the government's ability to eventually offload it's own stock.

I'm inclined to see how far LLPC pulls back and maybe consider a top-up. An 11%+ yield is awfully tempting.

Any further thoughts on this?

Regards,

Mark

Mark,

I think another reason for LLPC coming off a bit is the fear that the EU may try and block the payment of preference share dividends by state-aided banks. There is a good thread on this on the Fool - sorry no link, but it is on the Banking Sector board. I have just (today) bought some NWBD to add to my holding of LLPC as it staggers the income receipts a bit and also offers some risk mitigation through the different institutions as opposed to just holding Lloyds prefs.

Cheers,

Steve.

In reply to marben100 (post #7)

Some more meat on this http://ftalphaville.ft.com/blog/2009/09/23/73506/lloyds-as-leverage-leader/.

What is your take on the preference shares now. I am thinking of buying few in my ISA.

There hasn't been much discussion here but over at the other place TMF, WShak and avidya have made some excellent posts on some interesting threads.

I have bought the RBS series 3 euro prefs and the series 1 sterling prefs. Both are amongst the most attractive of the bank prefs available, but are deemed to be more risky of being deferred by some. I don't think either Lloyds or RBS will defer one single pref, FWIW, unless we have a serious second dip to this recession. If that happens well they'll probably defer all of them so buying the highest yielders and keeping an eye on the call dates is the way to go here, imv.

The sterling prefs had a 37% p.a. after tax yield, at the price I paid last  week (46%) mainly because there is no CGT, where I live in Belgium and assuming, of course,  that the coupons are paid through to the 10/12 call date and they are called then.

The euro prefs are interesting for me for income which was yielding around 20% on the price I paid and in euros so no currency risk on that slice of income until 10/2017.

There is much discussion of further EU intervention at the mo' over on TMF. I can see the EU trying to prevent certain coupons being paid, including the two that I have bought, but expect this to be reversed along the lines of what happened to KBC recently. It looks to me that Lloyds will try to avoid government support via a fund raising and converting some hybrid debt; This luxury isn't available to RBS but I do expect a tender for some prefs sometime before the year end and there is talk of raising another £3-5bn or so being raised via  new equity. I don't think I'll be selling my holdings though.

Both businesses will, I think, be forced by the EU to sell off bits of the UK business, and this is where the EU will bite. However this has next to no effect on the case for holding the prefs, or not.

The biggest danger for these prefs is that there is a severe double dip recession. If that happens would either be allowed to fail? I would suggest probably not and for RBS we got as close as we're ever going to get to that a year ago.

All IMHO, DYOR starting unfortunately over at the other place.

repobear

In reply to puneetk (post #9)

What is your take on the preference shares now.

 

I wouldn't recommend following my take - I am no expert on these! However, I have added some NWBD to my porty since my post, in additon to the LLPCs and am very pleased to hold these. The risk/reward seems attractive to me. I note that in Figure 19 in the article you link to "Preference" is distinguished from "Hybrid T1" capital, so presumably the hybrid exchange referred to in the article would apply to the latter and not the former. However, it would make sense for the banks to buy back their current preference capital at a price somewhat above the current market price, if they could so by raising cheaper funds. Whereas a rights issue is a threat to ordinary equity holders, it is a boon to preference stock holders as it increases the robustness of the business, at the expense of diltuing ordinary shareholders.

My biggest concern currently is inflation. I suspect/fear that at some point these yields won't look so attractive - but ISTM that that point is long way off and there is plenty of time for the market valuation of these preferreds to recover in the interim.

repobear, thanks for that. Could you provide some links to the relevant TMF threads? I know that the discussion has occurred on a few threads and I'm not quite up-to-date with it. It was through studying those threads that I decided to add some NWBD.

TIA,

Mark

Hi Mark,

My big regret this year is that I didn't catch this one earlier, but I'm still pretty happy with my position here. After  a shaky couple of opening rounds WShak has had a pretty masterful 'crunch''. His problem, like all of us, is that he doesn't know whether he is in round 5 or round 10 of a 15 round contest.

The best threads can be found where he is most active

http://boards.fool.co.uk/Messages.asp?mid=11471602&bid=50033&sort=username

Anyone who spends 4-5 hours reading some of these threads might realise that the risk/reward is still interesting. Those who had the balls to get in near the bottom have been well rewarded already, The euro prefs were around 10% at one stage thus yielding over 70% !. The really smart money went in at more than double these prices when the risks were clearly much lower. I got in later.

Avidya is well informed poster well worth reading and not known to many here. One of his better recced posts is below

http://boards.fool.co.uk/Message.asp?mid=11679978&sort=username

Anyone wanting further food for thought can look here

http://boards.fool.co.uk/Messages.asp?mid=11598071&bid=50033&sort=username

I hope this helps. Time for the gym for me,-)

repobear

Surpised to have seen little comment on King's pronouncement yesterday evening. Seems to me that he's advocating something along the lines of Glass-Steagall - which sounds like a darn good idea to me, in the light of the events of the last 2-3 years.

With hindsight, the repeal of Glass-Steagall in the US looks like a big mistake. Something must be done to get rid of the "too big too fail" concept, whilst protecting "innocent depositors".

Depositors/investors should be clear whether they are placing their money with a "protected institution", which is effectively government guaranteed, or an "investment institution" where "you're on your own, sonny". In exchange for the government guarantees, protected institutions would be very tightly regulated, have to hold high levels of reserves and have to be rigorous in their lending standards. Only protected institutions would be allowed to offer retail banking services.

I do appreciate that this isn't a complete solution: it addresses the needs of smaller businesses and individuals and thus limits the damage banking problems can do to "main street" but it doesn't address the needs of bigger businesses, who need to use investment banking services for their financing needs. OTOH, maybe it will cause those larger businesses to think longer term and arrange their finances using a spread of longer term instruments (i.e. equity or longer dated corporate bonds) which may be no bad thing either.

Do you agree/disagree/have a better idea?

Cheers,

Mark

In reply to marben100 (post #13)

I agree - speculation/trading and retail deposit taking don't match. Mervyn's right on the need for fundamental change. The problem is that the banks have captured the regulators and the government, and will lobby incredibly intensely against this kind of change. It will take massive pressure to make it happen. After all that's happened, I don't understand why there isn't more anger on the streets!

In reply to marben100 (post #13)

Depositors/investors should be clear whether they are placing their money with a "protected institution", which is effectively government guaranteed, or an "investment institution" where "you're on your own, sonny".

I've been working with some business school students recently and, in discussing a bankruptcy case from a few years ago, it was staggering how many of them recommended that equity should be bailed out.

The response, broadly, was: "If we don't protect investors, then they won't invest again..."

:(  

Who says we're not products of our environment?

SW10

Thanks SW10... interesting

I've been working with some business school students recently and, in discussing a bankruptcy case from a few years ago, it was staggering how many of them recommended that equity should be bailed out.

I wonder whether the blame for this attitude can, to some extent, be laid at the door of "modern portfolio theory"? A fundamental fallacy in that theory, IMO, is that it appears to equate risk with volatilty. I have had debates about that on TMF and I have seen posters here also focussing on volatility. In my eyes, risk is the chance of your investment being wiped out (or largely wiped out) - not the fact that Mr Market is a maniac and prices can be wild at times.

I guess that this idea is at odds with what those students are being taught?

No wonder they call economics the "dismal science"!

Best,

Mark

In reply to marben100 (post #13)

But Gordon and Alistair don't agree -

Gordon Brown and Alistair Darling today hit back at calls from Mervyn King, the Governor of the Bank of England, for banks to be split-up, stating such a move was "not right for the 21st century".

http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article6883910.ece

Excellent spreadsheet from OldBoyReturns

http://www.fixedincomeinvestments.org.uk/lbg-rbs-stocks-analysis It is built to price possible missed dividends following the clarification from RBS at close of play Tuesday.

http://www.investegate.co.uk/Article.aspx?id=200910201627011088B

The Royal Bank of Scotland Group plc, The Royal Bank of Scotland plc and National Westminster Bank plc - Clarification of Contractual Position Relating to Payments Under Preference Shares and Subordinated Securities The Royal Bank of Scotland Group plc ("RBSG"), The Royal Bank of Scotland plc ("RBS") and National Westminster Bank plc ("NatWest") have received various investor queries as to whether RBSG, RBS and/or NatWest have contractual rights to stop payments of dividends and interest on their preference shares and subordinated securities. In response to these queries, RBSG, RBS and NatWest are making this announcement to clarify the contractual position under such preference shares and subordinated securities. Nothing in this announcement should be taken as an indication by RBSG, RBS or NatWest as to whether or not they will or will not continue to make payments on the securities listed below.

Great work by OBR, but I can't see JPMorgan's logic in using a 10% discount rate to calculate NPVs - seems very high to me, considering current interest rates. It is possible that this high rate is used to factor in the risk of skipped coupons - in which case, using the same rate AND allowing for skipped coupons seems like double counting. Not having access to their note, I also wonder what ultimate value they assign to the shares at the end of the discounting period?

On the assumption that the issuing banks don't go bust or are nationalised without recourse for preference s/hs (an outcome I'd assign a low probability to), it seems reasonable to me to assume that these instruments will return to "normal valuations" once the current uncertainties (as perceived by the market) are removed.

Another significant point is that the risks of skipped coupons are distinctly different for different prefs. Some coupons are discretionary and hence higher risk. Others are cumulative or have clauses that mandate the issue of scrip to replace missed cash dividends. That implies to me that different discount rates should be used to reflect the varying risks. Call options, where they exist, are a further complication.

Cheers,

Mark