View on UK banks
Newton Private Investment Management
January 2010 (update)
Our investment process is driven by themes. These themes seek to identify changes in the real world that can be exploited in portfolios in order to grow and protect the real wealth of our clients over time. Our debt and credit theme was based on the fact that developed economies had levels of indebtedness that were high by historical standards, and that banks were unlikely to be able to continue their growth without taking on higher levels of risk. In recent years we have maintained only a limited exposure to UK banks. The UK listed banks we have preferred are those with significant overseas operations such as HSBC and Standard Chartered.
Although our debt and credit theme has been in place for some time, significant banking share price falls have only taken place in the last few years. Since the start of 2007, a number of groups have disappeared as independent companies - Northern Rock, HBOS, Alliance & Leicester and Bradford & Bingley among them. The UK government is now a significant shareholder of Lloyds and RBS as a result of these banks' need for new capital. From the beginning of 2007, the FTSE banks sector fell 80% to its trough in March of 2009 (this figure includes dividends reinvested). The wider market fell by approximately half this amount.
Since March 2009, the banks sector has risen sharply outperforming the wider market until August. Last year, UK bank shares were at half the level they were at the start of 2007.
Looking ahead, our choice to retain a limited exposure to western banks is driven by our view on the future profitability of those banks and their ability to pay dividends.
The Bank of England's June 2009 Financial Stability Report highlighted that, in the past five years, UK bank profits have been driven more by increases in leverage than by returns on assets. The more recent December report discusses the fact that this leverage is now declining and this will lower banks' profitability. It also states that incremental costs of improving the industry's funding structure could pose a material headwind to profit generation and that banks would benefit from distributions being materially lower than in the past. In short, a bleak outlook for both profits and dividends - a view held by Newton's bank analysts for some time. In addition, there is the aspect of greater Government interference, whether by increased regulation or as a large shareholder.
However, there are winners in any scenario; banks with strong capital ratios and good credit underwriting skills will benefit from their competitors weaknesses. The return to more traditional forms of banking is also likely to generate a more stable profit profile in the longer term.
Finally, banks with significant exposure to Asia and some other faster growing emerging markets may represent more attractive investments.
Philip Collins
Investment Director
Newton Investment Management Limited
Telephone: 0800 917 6594
e-mail:
www.newton.co.uk/privateclients
This is a financial promotion and is not intended as investment advice. Past performance is not a guide to future performance. The value of investments, and income from them, is not guaranteed and can fall as well as rise due to stock market and currency movements. When you sell your investment, you may get back less than you originally invested. Issued by Newton Investment Management Limited. Registered office: The Bank of New York Mellon Centre, 160 Queen Victoria Street, London EC4V 4LA. Registered in England No.1371973. Authorised and regulated by the Financial Services Authority.
1057 January 2010
