Is it time to reinvest in banking stocks?

A majority of big lenders offer generous dividends and their shares remain below their pre-financial crisis highs

For more than a decade, everybody hated the big banks after their bonus-fuelled speculation triggered the global financial crisis in 2008 and subsequent Great Recession.

The collapse of Lehman Brothers in September 2008 remains the largest bankruptcy in US history, involving more than $600 billion in assets.

Most banks only survived due to multibillion-dollar taxpayer bailouts yet carried on as before, lavishing senior staff with generous pay settlements and yet more bonuses.

So, a strange thing happened when the next big global crisis came along, in the shape of the coronavirus pandemic.

The banks weren’t to blame! Stranger still, this time they didn’t need billions in bailouts or government support, either.

The hard work that regulators had put in since the financial crisis had left the sector in a relatively good state, with solid balance sheets and a healthy cushion of capital.

Yet investors still don’t trust them. Bad memories linger and many banking stocks remain well below their pre-financial crisis highs.

Take UK bank Lloyds Banking Group, which was subject to a £20.3bn ($28.3bn) bailout in 2008. In 2007, just before the credit crunch, its share price peaked at 591 pence. Today, it trades at just 47p.

The banks have lost investors a lot of money. Yet many sense an opportunity today as the global economy recovers in the wake of the Covid-19 pandemic. Is it time to forgive the banks and buy their shares?

The big US banks have just been through their reporting season and the results have been stunning. The big four – Wells Fargo, Bank of America, Citigroup and JP Morgan Chase – posted a combined $33bn in profits, thrashing analyst estimates of about $24bn, Reuters reports.

This is up from $6bn a year ago, when the pandemic was squeezing the life out of the economy.

US investment banks also cashed in. Goldman Sachs' profit doubled to $5.35bn while Morgan Stanley’s revenue hit $2.83bn, about $400 million higher than expected.

UK banks are now reporting and it looks like the same story, with Barclays posting a record first-half rebound on Tuesday. Pre-tax profits for the year to June 30 topped £5bn, almost quadruple last year’s £1.3bn.

On Thursday, Lloyds Banking Group posted pre-tax profit of £3.9bn, against a first-half loss of £602m last year.

During the first lockdown, both banks set aside billions to cover potential bad debts as businesses and jobs crumbled during Covid-19-induced movement restrictions. But thanks to job furlough programmes, the impairments haven’t happened.

Barclays and Lloyds have now restarted dividends, which the British government had ordered them to stop a year ago.

Despite these stunning figures, conditions are not ideal for the banking industry right now as the pandemic has made consumers and businesses cautious, Nicholas Hyett, equity analyst at Hargreaves Lansdown, says.

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The recession, while sudden and steep, was short. Loan losses are much lower than feared
Glyn Owen, investment director, Momentum Global Investment Management

Rather than loading up on debt, they are paying it down. “That trend is slowing as the economy reopens, but it’s a headache for the banks, nonetheless,” he says.

Global banking stocks fell by about 45 per cent at the start of the pandemic, according to MSCI, much faster than shares generally, Glyn Owen, investment director at fund manager Momentum Global Investment Management, says.

Yet, to many people’s surprise, the banks have emerged from Covid-19 in “excellent financial health”. “The recession, while sudden and steep, was short. Loan losses are much lower than feared,” Mr Owen says.

The recovery is largely priced into their shares, with the banking sector having doubled from the lows of March 2020.

For example, Wells Fargo's share price is up 87 per cent in the past 12 months while Bank of America and JPMorgan Chase are both up about 60 per cent and Citigroup has grown by 36 per cent.

In the UK, Lloyds' share price is up 60 per cent in a year, just ahead of Barclays at 55 per cent.

The quick gains have already been made, but Mr Owen says this can still be a rewarding sector, thanks to loose monetary policy, big fiscal spending programmes and pent-up customer demand.

“Banks usually perform well in the early stages of an economic upswing as demand for loans grows and customer defaults fall,” Mr Owen says.

They should also benefit as the US Federal Reserve tightens policy and potentially increases interest rates, he says. This should improve net lending margins, which is the difference between what banks pay customers for deposits and earn from lending the money as mortgages and loans.

“Interest rate and bond yield rises are likely to be some way off and gradual, but will improve bank margins,” Mr Owen says.

Lenders with investment banking divisions should also benefit from buoyant capital markets, he says.

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They [banks] need to invest heavily in digitisation to fight back, while earnings growth could prove hard given record global debt levels
Russ Mould, investment director, AJ Bell

Banks have been liberated to reward shareholders with dividends and share buybacks.

“They are flush with excess capital and can start returning some of this to shareholders, offering the potential for above average dividend yields on top of capital appreciation,” Mr Owen says.

While some worry about the rise of app-based “challenger” banks and FinTech, Mr Owen reckons they have a long way to go to defeat the big banking beasts and may be overpriced.

“Revolut was valued at $33bn in its latest funding round, bigger than NatWest, yet its $361m revenues are dwarfed by NatWest’s $15bn,” he says.

The banking stock recovery has slowed lately, with the S&P Global 1200 Banks index down 10 per cent from its May peak, Russ Mould, investment director at AJ Bell, says.

“Fears of another Covid-19 wave and a slower-than-expected emergence from lockdowns have made investors more risk averse. Also, bond yields are falling rather than rising and central banks seem in little hurry to raise rates,” Mr Mould says.

Banks also face fundamental challenges, he says, including rock-bottom interest rates, low bond yields, tight margins and ongoing regulatory scrutiny.

“They need to invest heavily in digitisation to fight back, while earnings growth could prove hard given record global debt levels,” Mr Mould says.

The boom in new stock market flotations and mergers and acquisition activity is generating plentiful fees, but today’s low market volatility does not help investment bank traders, he says.

“There is also the nagging fear that a stock market accident of some kind is lurking after the stunning run of the last 12 years,” according to Mr Mould.

Regulatory stress tests suggest banks are well placed to withstand a global downturn, stock market crash and a housing market slump, Mr Mould says. “However, the collapse of Greensill Capital, a financial services company based in the UK and Australia, and New York-based hedge fund Archegos Capital Management shows that in this sector, nothing can be taken for granted.”

UK banks look relatively cheap on a price-to-book basis and offer generous dividend yields, Mr Mould says. Barclays is forecast to yield 3.7 per cent over the next year while Lloyds is expected to generate income of 4.7 per cent. These could climb to 5 per cent or 6 per cent over time.

European banks UBS and Credit Suisse have strong investment banking and wealth management arms, which guarantee them loyal customers and steady customer fees, he says.

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Banking stocks remain attractive for investors with a moderate risk appetite
Vijay Valecha, chief investment officer, Century Financial

“The US banks offer high returns on equity, exposure to the world’s largest economy and in the case of Citi, JP Morgan Chase and Bank of America, financial market exposure via their investment banking arms.”

The decision is down to you, Mr Mould says. “The banks will tempt optimists who think the pandemic is beaten, a strong recovery will follow and inflation will drive up interest rates. Pessimists who think the West is following Japan into a deflationary debt funk will avoid them at any price.”

Banking stocks remain attractive for investors with a moderate risk appetite, Vijay Valecha, chief investment officer at Century Financial in Dubai, says. “JP Morgan Chase and Bank of America are my top picks among US banks.”

Most private investors should spread their risk by investing in a low-cost, globally diversified exchange-traded fund (ETF) rather than individual stocks, and Mr Valecha tips the Financial Select Sector SPDR Fund.

Other popular banking ETFs include Fidelity MSCI Financials, Vanguard Financials ETF and the SPDR S&P Bank ETF.

Updated: August 2nd 2021, 11:27 AM
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