Investors in FTSE 100 banks face a choice between growth and yield

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Deadlines mean this document must be written just before Friday’s full-year results from RBS and Standard Chartered but the figures published from the other members of the Big Five FTSE 100 banks make for instructive reading and continue to move share prices.

Barclays and Lloyds appear to be in investors’ good books.

A higher dividend from Lloyds, lower compensation restructuring and compensation costs, improved profits and the faster-than-hoped liquidation of its ‘bad bank’ assets at Barclays mean their shares have traded higher.

By contrast HSBC appears to be in the doghouse, if a sharp fall in its shares following figures released on Wednesday 22nd is any guide.

The key difference lies with both the quantity and quality of their profits.

A matter of quality

In contrast to HSBC, Lloyds and Barclays produced a marked increase in stated profits, helped by a substantial decline in the ugly, (allegedly one-off) items which have dogged their profit and loss accounts since the first PPI compensation payments in 2011.

Barclays and Lloyds showed lower charges in their P&Ls, but HSBC’s were higher

£ billion Barclays Lloyds HSBC
2015 Stated pre-tax profit 1,146 1,644 12,578
Impairment charges  (2,114)  (568)  (2,473)
PPI compensation  (2,772)  (4,000)  (361)
Other conduct charges  (1,615)  (837)  (1,170)
Restructuring costs  (793)  (170)  (781)
Total   (7,294)  (5,575)  (4,784)
Adjusted pre-tax profit 7,295 8,100 13,019
2016 Stated pre-tax profit 3,220 4,238 5,243
Impairment charges  (2,373)  (645)  (2,456)
PPI compensation  (1,000)  (1,000)  (406)
Other conduct charges  (363)  (1,085)  (768)
Restructuring costs  (206)  (622)  (2,351)
Total  (3,942)  (3,352)  (5,981)
Adjusted pre-tax profit 6,966 7,900 14,228

Source: Company accounts. Does not feature all one-off items in the accounts. HSBC’s earnings translated from dollars into pounds at year-average exchange rates.

The sense that Barclays in particular may (finally) be through the worst is enhanced by chief executive Jes Staley’s announcement that the company’s ‘bad bank will be wound down by the end of June, six months earlier than planned.

In 2016, that operation lost £1.8 billion pre-tax as it ended the year with £32 billion of risk-weighted assets, some 9% of group total.

And although Barclays has cut its dividend for the second year in row, compared to increases at Lloyds and HSBC, the reduced pay-out of 3.0p compared to 6.5p met analysts’ forecasts and had already been flagged by the bank’s management team a year ago.

The relief at lower PPI, conduct and restructuring charges seems palpable as the shares move higher, and further reductions would go a long way to improving Barclays’ profitability, the quality of their earning and their dividend paying potential, not to mention polishing its tarnished reputation.

Growth doubts remain

The one cloud at Barclays, HSBC and Lloyds is the lack of underlying growth. Stripping out all of the bad stuff and funnies, underlying pre-tax income fell slightly year-on-year at Barclays, Lloyds and HSBC in reporting currency terms (the increase at HSBC comes from the pound’s drop against the dollar).

This reflects the key challenges which still face the banking industry, namely excess indebtedness in the West, fierce competition and tight regulation which means some profit sources from a decade ago (payment protection insurance, for example) are no long available avenues for earnings now.

As such underlying profit growth will be hard to come by. And if banks are to record higher profits they may have to take more risk to do so.

This could come from an increase in lending (and its expanding credit card operations in Lloyds’ case) or from investment banking at Barclays in particular, where rising stock markets are, for the moment, justifying boss Jes Staley’s firm commitment to this operation.

This is why analysts’ now expect aggregate 2018 earnings from the Big Five to come in below where they were at the height of the pre-crisis boom in 2007:

Big five profits from pre-2007

Source: Company accounts, Digital Look, consensus analysts’ forecasts. 2016 numbers for RBS and Standard Chartered are still estimates, pending Friday’s results.

Options to consider

Investors must therefore decide what they want from the banks and which one is best placed to deliver it (assuming they believe that they wish to seek direct exposure at all, although those who don’t should bear in mind that the Big Five represent 14% of the FTSE 100’s market cap, the single biggest sector in the index).

  • They can choose limited underlying growth, improved predictability (if one-off items decline) and falling risk (as the banks continue to shrink balance sheets), all of which are likely to mean modest share price gains but with the compensation of higher dividends. Lloyds may fit the bill here (allowing for the dangers of a UK property slowdown to its mortgage book and its push in credit card lending), while RBS has ambitions to go down this path too.
  • Or they can choose plans to target faster growth, improved predictability (if one-off items keep declining) and potentially the higher risks associated with that growth and slower progress on the dividend as a result. Barclays and HSBC seem to fit this profile, with Standard Chartered perhaps somewhere between the two.

This choice is also reflected in the valuations currently attributed to the five stocks. Lloyds is the most expensive on book value, perhaps as a reflection of its ‘safety’ premium and potentially fast-growing and juicy yield.

RBS is the cheapest, as a result its horrible string of losses and absence of a dividend, with the ongoing threat of further US conduct fines hanging over it.

If Barclays, Standard Chartered and RBS can continue to raise their game and tidy up their stated results, perhaps their shares could trade back towards one times book value, too, but the burden of proof clearly lies with them

At least the markets seems to think Barclays’ and Lloyds 2016 numbers are a step in the right direction on to the road to operational, reputational and share price redemption.

Valuation comparison for the FTSE 100’s Big Five banks

Price/book Price/earnings Dividend yield
2016 2017E 2018E 2016 2017E 2018E
Barclays 0.83x 11.9x 10.3x 1.2% 1.3% 3.3%
HSBC 1.19x 12.7x 11.7x 5.7% 6.0% 6.0%
Lloyds 1.26x 10.3x 10.7x 3.6% 5.0% 5.7%
RBS 0.74x 18.9x 15.1x 0.0% 0.2% 3.4%
Stan. Chart 0.62x 44.6x 19.2x 0.4% 1.9% 3.9%

Source: Company accounts, Digital Look, consensus analysts’ forecasts.
Price/NAV numbers are historic, based on last published net asset value per share figure – Q4 for Barclays, HSBC and Lloyds, Q3 for RBS and Q2 for Standard Chartered.
2016 dividend yields for Barclays, HSBC and Lloyds are historic based on published numbers. They are still forecasts for RBS and Standard Chartered, pending Friday’s numbers.

Russ Mould, AJ Bell Investment Director


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Written by:
Russ Mould

Russ Mould has 28 years' experience of the capital markets. He started at Scottish Equitable in 1991 as a fund manager and in 1993 he joined SG Warburg, now part of UBS investment bank, where he worked as equity analyst covering the technology sector for 12 years. Russ joined Shares in November 2005 as technology correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media by AJ Bell Group, he was appointed AJ Bell’s Investment Director in summer 2013.