UK banks, including the Royal Bank of Scotland (LON:RBS) and Lloyds (LON:LLOY), have suffered badly in the recent pullback by markets though their big falls arguably have had less to do with their micro trends than their exposure to a severe economic downturn and regulatory changes. Goldman Sachs for one reckons their heavy retreat means there is value to be had in the sector.
The banks reported a decidedly mixed set of interim numbers recently, with revenues generally in line with or better than expected by Goldman; with costs ranging in line to worse. The results also revealed credit costs relating to, for instance bad loans, slightly disappointing relative to market expectations.
Yet the sell-off since then has not correlated closely with Goldman’s analysis of those interim numbers and their absolute implication for operational trends going forward.
Instead, macroeconomic and regulatory factors, or rather fears, appear to have become the dominant driver of their share prices in the recent sell off.
Goldman stresses it remains “mindful of the multiple risks currently facing the sector, most notably related to sovereign debt, economic growth, funding conditions and UK regulation”. However, following an average share price decline of 19% over the last month among the sector players, it believes there is now real value to be had in among the sector players.
In particular the broker is concerned about the impact of the recent slowdown in growth and risks related to ring fencing of banking operations in the UK – a move that looks likely to be recommended by the Independent Commission on Banking (ICB) when in publishes its report on the sector next month. In view of these concerns, Goldman has raised its impairment estimates and target capital ratios for the institutions.
Bearing in mind the risks facing the banks, Goldman analysts have looked for a number of key positive features across the players to support any positive recommendations.
Firstly they screened for bank stocks where consensus expectations may have fallen too far, that is, ones for which the broker’s own estimates are above consensus.
Secondly they looked for major discrepancies between current valuation and their “steady-state” returns.
Lastly the analysts considered the ability of each bank to manage regulatory risk, withstand any major changes that may emerge from the ICB’s report.
The filtering has resulted in the broker recommending HSBC (LON:HSBA) as a ‘conviction buy’. Goldman notes that bank’s recent interims showed “solid operational trends and progress on the group’s realignment”.
In its interim statement, HSBC announced a big cost cutting exercise, with a 25,000 reduction headcount, and much greater emphasis on fast growing Asian markets going forwards.
Goldman’s expects HSBC’s return on equity (ROE) to continue to trend upwards over the coming reporting periods, driving a re-rating in the stock. The broker’s current earnings per share estimates for the bank are around 0%-13% above Datastream consensus through the 2013 reporting periods.
The screening also favours Lloyds Banking Group, which Goldman rates as a ‘buy’.
Lloyds interim results highlighted further de-risking alongside solid core trends. The broker views current market expectations for the bank as “pessimistic” and notes that its earnings per share for the group are 5%-13% above consensus through 2013.
Meanwhile, Nomura has been looking at prospects for non-UK banks. The broker firstly points out that EU (and US) banks enter the current period of economic uncertainty “considerably stronger” than their 2008 lows in terms of leverage, asset quality and liquidity.
Yet European bank valuations, at just 0.5 times stated book value, imply more than a mild recession or even an extended Japanese-like period of low growth, but rather a much more serious asset and book value impairment, says Nomura.
The big discreprency between their operational metrics and fundamental valuations means the broker sees “a binary outlook” for the EU banking sector.
It says: “If large scale EU sovereign defaults can be avoided, given the improved metrics from 2008 lows, valuations appear to more than discount a moderate double dip.
“However, such is the stock of sovereign debt, further short-term downside risk exists if the European Central Bank and the European Financial Stability Facility cannot keep Spain and Italy’s liquidity problems from becoming a self-fulfilling solvency concern.
Source:proactiveinvestors