Well, well, well, what’s this we’re seeing? Sell notes on banks? Apparently the move by regulators on both sides of the Atlantic to crack down on research analysts – who regularly put out puffs on companies that their employers are trying to tout for corporate finance business – has struck home, and in a big way.
Until now the banks were the sacred cows of the research departments.
Rubbish poor old Marks & Spencer or BT if you must, but hands off LloydsTSB, for sooner or later it will come right and deliver more value to shareholders.
So what does it mean when analysts at major international institutions like ING tell you to get rid of your LloydsTSB or Barclays shares?
Essentially, it means that the analyst is taking (and giving you) a realistic view of the banking sector. “LloydsTSB has little or no headroom, from a dividend perspective, to cope with falling profits in 2003 due to the #100m SME cost kicking in, reduced volume growth, increased competition, increased regulation and credit quality environment at a retail, SME and corporate level,” says ING analyst Michael Helsby.
Phew. But wait, there’s more. “We believe that things (at Barclays) will get worse in 2003, not better, as the #120m SME cost kicks in, volume growth slows, competition increases and credit quality deteriorates further,” warns the same analyst.
Taken at face value, banking trends point to gloomier times ahead for the UK economy, particularly for the corporate sector where spiralling bad debts, or the threat of credit deterioration, have prompted both these banks to issue profit warnings. This spate of bad news was preceded by Abbey National, which will this year report its first loss since converting from building society status in 1989. Morgan Stanley expects to see the bank’s earnings per share to take a 6.5% tumble next year and drop a further 3.5% in 2004.
Despite the warnings, it’s too early to write off the banks. The prospects of a double-dip recession coupled with a collapse in the housing market taking the banks down with it will depend on interest rates and unemployment.
For the moment, neither of these factors gives much cause for concern, unlike in the recession of the early 1990s when at one point rates shot up to 15% and the number of jobless was hovering around three million.
The rating agencies, at least, are not sounding any alarm bells. Fitch Ratings, for instance, has all the major players (with the exception of Abbey National) on a Stable outlook, with Royal Bank of Scotland’s successful integration of NatWest earning it a Positive.
“The current environment is more challenging than in the past ten years or so and clearly there’s pressure on UK banks, but they are still performing relatively well compared with their European peers,” says Fitch analyst Gerry Rawcliffe.
Shareholders may grumble about a cut in EPS over the next couple of years, but they have had a phenomenal run in the past ten years, thanks largely to consumers who have been keeping the wheels turning at the banks in which they invest their money. While the German banking sector is looking at a systemic crisis, their British peers can rely on a solid retail franchise that has sustained the sector through the economic cycle.
“The performance of the UK banking market in 2002 has been surprising,” says Morgan Stanley analyst Peter Toeman. “At the start of the year we anticipated a slowdown in volumes. However, in practice, consumer confidence has remained upbeat, unemployment continues to fall and as a result, volumes have boomed.”
Moreover the big UK players turned their backs on investment banking years ago and thus spared themselves the worst pain of collapsing equity markets. The one exception is Barclays through its investment banking arm Barclays Capital. But this business is focused on fixed income, not the equity and corporate finance activities that have led many large investment banks to lay off tens of thousands in the past couple of years.
So look for margin and credit quality pressure in the corporate sector, profits coming in at the lower end of expectations and more emphasis on cost-cutting when the banks begin reporting their 2002 results in late January. But there’s every reason to expect that buoyant consumer demand for mortgages and savings products will see the banks sailing through choppy waters ahead.