2016 was meant to be the year in which UK banks finally made good on their promise of recovery. Yet so far this year, banks have massively underperformed the wider market.
The progress made in strengthening banks balance sheets hasnt been reflected in their share price performance, as these figures show:
Stock |
YTD change |
Standard Chartered |
-32% |
Barclays |
-31% |
Royal Bank of Scotland |
-26% |
Lloyds Banking Group |
-23% |
HSBC Holdings |
-21% |
FTSE 100 |
-11% |
Almost all of these stocks now trade at a big discount to their book values, suggesting that investors have serious concerns about banks future returns.
So whats driving this sell-off fear or fact?
Potential problems
The big worry seems to be that a surge in bad debts will hammer banks balance sheets. This would threaten banks regulatory capital strength and could leave them forced to raise fresh cash from shareholders.
The prices of bonds issued by banks have fallen in value to reflect these fears, and this has helped drive banks share prices lower.
There are certainly some areas of serious concern in the corporate bond market. Bonds issued by many US oil and gas companies are trading at distressed levels. These arent just small, junk-rated companies. Some substantial firms with investment-grade credit ratings are at risk.
Theres also a fear that as Chinas property boom unwinds and the countrys economic growth slows, bad debt levels could rise dramatically. This is seen as a particular risk for HSBC and Standard Chartered.
Thats not all
Investors are concerned that banks arent sufficiently well-funded to withstand another 2009-style downturn. Theres uncertainty over the impact of regulatory changes.
The outlook for earnings growth also seems to be worsening. For example, consensus forecasts for Barclays 2015 earnings per share have fallen by nearly 20% over the last year.
In the UK at least, theres the nagging fear that banks will face yet more misconduct fines. These have proved to be costly and have damaged investors confidence in banks ability to deliver reform and growth.
So are the banks a sell?
2009 doesnt seem that long ago and investors are understandably concerned about the potential for another banking meltdown.
Yet this risk may be overstated. Banks balance sheets are much stronger than in 2009. All the big UK banks passed the Bank of Englands latest round of stress tests in December, without being required to raise fresh capital.
These tests include the simulation of a major downturn in China, and the banks ability to deal with misconduct fines of up to 40bn!
A contrarian buy?
The banks arent absolutely bulletproof. But my view is that the outlook is probably not as bad as current valuations suggest.
I believe that theres some value in the banking sector, and that most of the major UK banks are worth considering as value buys on a three-to-five-year timescale.
Barclays, HSBC and Lloyds all trade on eight times forecast earnings or less. All offer a forecast dividend yield of 4% or more. A lot of bad news is already reflected in the share prices of these banks.
Now could be the right time for contrarian investors to take a closer look.
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Roland Head owns shares of Barclays, HSBC Holdings and Standard Chartered. The Motley Fool UK has recommended Barclays and HSBC Holdings. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.