Are UK banks becoming investable again?

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With Chancellor George Osborne believing the time is right to sell the Government’s stake in Lloyds Banking Group, the investment potential of banks has once again been put under the microscope.

While still dividing opinion, banks have displayed enough positive signs of recovery for fund managers to start taking overweight positions in them. One such manager, James Griffin of the £686m Fidelity Moneybuilder Growth fund, is very bullish on the outlook for UK banks.

Griffin says: “For me, the banks remain mis-priced and I still think they are relatively under-owned. My view is that Lloyds will pay dividends this year.”

Griffin, who has been adding to his HSBC and Barclays positions, both among his top 10 holdings, believes there is an overhanging uncertainty with the privatisation of Lloyds. He wants more clarification is needed on how the process will work and who will be first in line for the shares.  

A recent newspaper article claimed Invesco Perpetual equity income manager Neil Woodford, famous for his bearish stance on banks, was gearing up to buy a chunk of the soon-to-be available Lloyds stock. However, Woodford released a statement refuting these claims, asserting that he had “absolutely no intention of buying a stake in Lloyds or any other UK-focused high-street bank at the present time and doesn’t expect to do so for some time”.

Woodford does concede that some banks have recovered to a point that makes them look “investable”, using HSBC with its heavy Asian exposure as an example.  

Guy de Blonay, manager of the £531m Jupiter Financial Opportunities fund, feels the time is right for Lloyds to be fully privatised but is sceptical about fellow taxpayer-backed bank, Royal Bank of Scotland.

He says: “There is this question on whether or not it should break up or not. I am not convinced this will be good for the shareholder.”

In particular, de Blonay indicates a selling off of RBS’s Irish exposure would “deprive” the bank of international exposure and links to any forthcoming Irish recovery. “The investment case becomes sterile,” says the fund manager.

Dividend flows have stuttered from the banking sector in the past few years, as the repairing of balance sheets has been prioritised. With equity investors hungry for yield in today’s climate, banks have not been as attractive as they once were, with dividends far from pre-crisis levels. Charles Stanley Direct investment director Douglas McNeill forecasts the return of healthy dividend flows as a long way off.

He says: “We are pretty cool on Lloyds at the moment. Lloyds is one of the banks were there is no dividend flow and traditionally it has largely been about that. RBS has recovered somewhat. But the prospect of dividends seems even more distant. It seems to us the reward for holding that stock does not cover the risks.”

The lack of yield from banks is an important factor for fund managers to consider and with Lloyds in particular, hesitation could arise when the newly re-issued shares become available. Graham Ashby, head of equities at Ignis Asset Management and manager of the £94m Ignis UK Equity Income fund, says he would shun the opportunity to invest in the bank’s equity and would prefer to do so via contingent convertibles.

With the Lloyds CoCo representing a 1.1 per cent holding in the Ignis UK Equity Income fund, Ashby says: “Lloyds has been our favoured domestic bank for some time, but it has not paid a cash dividend to shareholders since 2008 – making it difficult for UK equity investors to have a holding. This may change going forward – although the quantum and timing is still uncertain.”

Another big concern for investors is the huge swathes of new regulation hitting the sector and the dim view of banks held by politicians and regulators. McNeill says: “The sector has a lot of work to do to rebuild investor confidence. Their fall from grace was pretty spectacular and a jaundiced view of banks still persists.”

Chase de Vere head of communications Patrick Connolly believes the banks face a gradual process of recovery before becoming a decent investment option again. He says: “So far we have had a lot of words, from the authorities, and they need following through. Are the risks from banks still fully understood? I do not think we can put a timeframe on when we will see this recovery occur.”