Analysts think the banks are fine (but investors don’t believe them), ten years after the Rock rolled over

"Ten years after Northern Rock customers queued outside the bank for their cash, analysts believe the five remaining FTSE 100 banks are in such good health that they are about to return to the profit levels of a decade ago – but it does not look as if investors believe them.

"Research from AJ Bell shows that aggregate pre-tax profit forecasts for 2018 for Barclays, HSBC, Lloyds, Royal Bank of Scotland and Standard Chartered come to £36.2 billion, a fraction above the £35.8 billion they made between them at the peak of the economic cycle in 2007, just before the Great Financial Crisis hit home," says AJ Bell Investment Director Russ Mould.

Big Five FTSE 100 banks aggregate pre-tax profit

Source: Company accounts, Digital Look, analysts' consensus estimates

“Analysts are forecasting healthy profits for the banks next year, yet stock market investors seem sceptical. Banks represent just 13% of the FTSE 100’s current total market capitalisation, compared to the 20%-plus seen in 2007, to suggest someone, somewhere is not so sure that banks are about to start booming again.

“This can also be seen in their valuations (not to mention how their share prices have rolled over this summer).

“Only Lloyds’ shares trade above one times net asset, or book, value – the net amount the banks would be worth in the (unlikely) event they were to cease trading and liquidate themselves, paying off all of their liabilities, selling their assets and returning the final proceeds to investors.

“This implies that investors remain concerned the banks are still sat on poor quality assets, may have to recognise more bad loan losses or pay out further customer recompense or regulatory penalties with regard to past business practices, with the result that actual profits may not live up to analysts’ expectations.

  Price/Book Value
Lloyds 1.23 x
HSBC 0.97 x
Royal Bank of Scotland 0.82 x
Standard Chartered 0.71 x
Barclays 0.65 x

Source: Thomson Reuters Datastream, company accounts. Based on historic NAV per share from the interim 2017 reports.

“A look at the accuracy of analysts’ estimates over the past three years shows that investors are right to be wary of forecasts that peak profits are just around the corner – because the number-crunchers have been forecasting a return to 2007’s glory days for every year since 2014 and they have been wrong (so far) every time.

Profit forecasts have consistently ebbed lower:

Profit forecasts have consistently ebbed lower:

Source: Company accounts, Digital Look, analysts' consensus estimates

“The good news is that 2018 forecasts are so far holding firm, but it remains to be seen whether the heady days of 2007 will return, as the Big Five Banks face three fundamental challenges:

  • The regulator continues to bear down on the banks, insisting that they hold more capital on their balance sheets, to protect themselves (and the broader economy) from any future economic downturn. This crimps their ability to lend and earn a return on their capital, especially as interest rates on cash and Government bonds yields remain at or near record lows. The regulatory backlash which followed the 2007-09 crisis also means that several profit streams which contributed to the peak profits of a decade ago are no longer available to the banks, amid allegations of mis-selling and malpractice.
  • Global debt levels are up by a third since 2007, surpassing the $200 trillion level. It is possible that only artificially low interest rates are keeping some borrowers afloat and saving the banks from bad debts. Moreover, the people, companies and Governments to whom banks would like to lend to may not wish to borrow (as their finances are still sound) while the banks may prefer to steer clear of those who are hungry for credit, as their balance sheets may already be weak.
  • The UK is a competitive market, as the big banks must confront the threat posed by challenger banks and online-only fintech start-up firms.

“In sum, banking is a mature, tightly regulated, competitive business, where profit growth will either come from cutting costs or taking more risk (either via cyclical investment banking businesses or lending more to customers with weaker credit histories).

“As such, the banks’ potential for earnings growth may be fairly limited, which is why it will be important for them to pay decent dividends and offer healthy yields, so they can offer returns which compensate investors for the risks associated with holding their stock. If they are to become mature, quasi-utilities, they need to offer a yield.

“Dividend payments are well up from their 2009 cyclical trough, helped by large increases at HSBC in particular, although the megabank’s dividend cover is now well below the ideal level of 2.0 times and growth is levelling off.

“Barclays cut its pay-out in 2016 but Lloyds has begun to rebuild its pay-out and investors are now waiting to see when both Royal Bank of Scotland and Standard Chartered reinitiate dividend payments, in what could be a genuine sign of management confidence in both the individual banks’ health and the overall economic cycle.”

Big five banks dividend cover

Source: Thomson Reuters Datastream, Digital Look, analysts' consensus estimates

  2017 E 2017 E   2018 E 2018 E
  Dividend yield (%) Dividend cover (x)   Dividend yield (%) Dividend cover (x)
Lloyds 6.20% 1.87 x   6.90% 1.62 x
HSBC 5.50% 1.29 x   5.50% 1.38 x
Barclays 1.70% 5.51 x   3.40% 3.51 x
Standard Chartered 1.30% 4.03 x   3.30% 2.31 x
Royal Bank of Scotland 0.20% 49.30 x   3.60% 2.87 x

Source: Thomson Reuters Datastream, Digital Look, analysts' consensus estimates