There's plenty more pain to come for British banks
By
Associate Editor
David Stevenson Nov 11, 2009
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It's been a while since Britain's banking bosses have sounded cheerful, and understandably so.
But with HSBC and Barclays' recent results, you could detect the faintest hints of optimism shining through. Dodgy debt write-offs may have been pretty hefty, but there's hope that this might be the peak, and that future loan losses will fall.
So should you be piling into the banking sector? No. We don't share the banks' cautious optimism. Here's why...
The state of the big four UK banks
Bankers don't do losses. When they lend money to people who can't repay it, they call the damage 'impairments'. And there have been plenty of those over the last year.
Last week Lloyds (LSE: LLOY) said its impairment charge should drop in 2009's second half, which sounds OK, until you look at what's already happened. The merged Lloyds TSB/HBOS was forced to make a massive £13bn write-down between January and March this year. That's equal to more than half the current market cap, and was one reason why we taxpayers had to bail it out by buying a 43% stake.
Yet this pales into insignificance compared with the disaster that is RBS (LSE: RBS). Almost £21bn of write-offs to date, including last week's extra £3.3bn in the third quarter, would have put the NatWest owner right out of business but for government backing costing as much as £53.5bn.
Against such horror stories, yesterday's news from the UK banks that have avoided taking the King's shilling almost looked good. Barclays (LSE: BARC) made a £1.56bn third quarter pre-tax profit. And although this was down from £2.8bn a year ago, due to more of those impairment charges, the full-year write-offs aren't likely to be any worse than the bank's August forecast.
Meanwhile HSBC (LSE: HSBA), which is now Europe's biggest bank, was quite upbeat. Here the talk was of third-quarter pre-tax profits being "significantly" higher than a year ago, as impairments fell to their lowest levels since the first half of 2008. And HSBC boss Michael Geoghegan was confident enough to say that he "believes the biggest jolt has now passed through the global economy".
So is it back to the races for the banks?
Nowhere near.
There's much more pain to come for British banks
Geoghegan's still hedging his bets, saying that "it's too early to claim victory, especially while unemployment is still rising in the West".
That's an understatement. The UK's economic outlook is pretty dire. Our government is spending, borrowing - and printing, as we explained in Monday's Money Morning: Protect your wealth from the Bank's money printing madness - far too much money. This may be a last-gasp attempt to bolster the economy in the short-term and buy votes ahead of next year's general election, but it's no long-run solution to our economic woes at all.
"Britain's wildly expansionary fiscal and monetary policy will do little to spur recovery and ultimately will be hugely damaging", says Liam Halligan in The Telegraph. "I fear we've reached the end of the beginning of an extremely difficult period in our history when living standards plunge, our public finances deteriorate and enterprise stagnates". In other words, the country's in a right mess. And the unemployment figures worrying Mr Geoghegan will keep rising as state spending is slashed.
So even if Britain's banks were in good shape, they'd be looking at a large chunk of their loan books going sour as the defaults rack up.
But the banks aren't in good shape. Their balance sheets already need some more heavy-duty repair.
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As MoneyWeek's resident uber-bear, Pali International's chief strategist James Ferguson points out in his Model Investor newsletter, "unfortunately the nature of post-bank crisis resolution periods is that as banks try to tidy up their bad assets, they take losses, which further erodes capital. That forces them to postpone realising further losses and clearing out further non-performing loans until capital has been rebuilt". It's a vicious downward spiral, and all the time that it's going on, banks are reluctant to lend, because they realise they'll need as much money as they can to cushion against future losses.
Ferguson reckons it could get a lot worse. Much of the damage so far has been on soured securities bought by the banks – such as those packages of US sub-prime loans whose implosion started the credit crunch. Yet if past crises are anything to go by, plenty of other dodgy debts have yet to emerge. The average loan loss write-off across the big four UK banks so far is just 2.8%. The International Monetary Fund sees this hitting 7.4% by the end of 2010, i.e. up by around 165%. So the banks will have to make many more 'impairments' – particularly if Halligan is right – and will be in desperate need of more capital.
And that's going to get harder to raise. Moody's points out that in the bull market, banks round the world borrowed more, over shorter periods, than ever before. Now those banks need to refinance maturing debt totalling $7,000bn (hard to envisage, isn't it?) by the end of 2012. As they compete with each other to find investors willing to fund these huge sums, they'll have to pay through the nose to borrow what they'll now need.
In short, this means that many banks will soon have problems both with their assets (the loans they've written for other people) and with their liabilities (the money they've borrowed from other people). Ouch!
Are any of the banks worth buying?
So are any of the UK banks worth buying?
HSBC clearly looks the soundest from a business perspective, particularly with its exposure to Asia. But at 730p, on a current year p/e of over 26 and yield of less than 3%, I won't be rushing out to get on board.
While the government can still find the cash, it will keep RBS and Lloyds afloat. But shareholders of both will be asked to stump up plenty more money too. This will mean grillions more shares sloshing around – which would hit share prices. Don't touch with a barge pole.
That leaves Barclays, which we reckoned at the start of the year (Which banks will survive the slump?) would probably be the best of a bad bunch. And it has since dumped a huge chunk of its dodgy securities assets. In addition, it does have its investment banking arm, Barclays Capital, to cash in on any financial market booms. But it won't be able to sidestep another serious UK economic slowdown. If you were smart enough to buy in much lower down, now looks a good time to take your profit.
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