My inbox was bombarded by emails from stock brokers on 4 September when the European Central Bank announced that it would deploy capital to banks in alternative ways in order to shore up the banking system in Europe. I wont bore you with the details of the plan; essentially, lots of unwanted assets will end up on the ECBs balance sheet. Refinancing rates were cut to the lowest level on record, too. This should be enough.
But what is the lesson for the British banks and their shareholders?
The shares of British banks rallied on the day, but the rally was short-lived. In fact, the shares of Barclays (LSE: BARC)(NYSE: BCS.US), Lloyds (LSE: LLOY) and Royal Bank of Scotland (LSE: RBS) have given up all of their gains in the last couple of days of trading. HSBC (LSE: HSBA) stock has held up relatively well, which didnt come unexpected.
Id love to find a reason to recommend Barclays stock, but I struggle to find any at this price. The stock pulled back to 224p on Monday after surging to 231p in the wake of the ECBs announcement. It has recouped only about 3% of the value it had lost on the day Dark Pool allegations emerged. Time and again, I have pointed out that several risks weigh on the banks valuation, such as: litigation risk, reputation risk, execution risk, dilution risk and so forth. Admittedly, Barclays is shedding assets that dont make their cost of equity, but as it shrinks, it must be quicker to cut its workforce around the globe. More assets must be sold. A reshuffle in the management team would be good news, too. Only then, Barclays stock may comfortably trade above 260p.
RBS & Lloyds
Barclays is a different restructuring story from RBS and Lloyds.
RBS announced on Monday that it planned to raise $3.5bn by listing 25% of Citizens Bank. This IPO will be the largest US bank float since the credit crunch. The move fits with the banks broader strategy, but I am not convinced is in the best interest of shareholders seeking long-term value. RBS will continue to de-risk its balance sheet. Can it preserve competitiveness and performance? Management dont have an easy task.
At this price, RBS stock is a decent buy, although the banks risk profile is less attractive than that of rivals. Lloyds is a stronger financial institution, which is reflected in the valuation of its shares. Still, I think Lloyds stock is overbought right now. HSBC remains the safest option in the UK banking sector, in my view.
Following the ECBs announcement, a few analysts, both in Europe and in the the UK, really wanted me to buy the shares of the banks they work for. I need more evidence to be convinced that banks are serious about addressing their problematic corporate structures before taking a bullish stance on the sector. I also believe that this business cycle poses a serious threat to the banking world in the UK. Structural changes are taking place, while governments and central banks have limited tools at their disposal.
The ECBs latest move didnt strike me as being innovative, but even if Mario Draghi announced more radical measures, the equity valuations of the UK banks will only marginally benefit and only for a day, or two. Inevitably, the spotlight now is on the Bank of England, which is between a rock and a hard place, as I explained last week.
Of course, in this environment, opportunistic traders have a fantastic chance to make a fast buck overnight.
Banks aren’t the no-brainer investments they were previously believed to be, our analysts argue in anexclusive wealth report. Based on several metrics, however, the shares of two British banks, in particular, could offer plenty of upside into 2015. Mind you: you must have a bullish view on interest rates before investing in the banking sector.
Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.