The raft of updates from the UK and European high street banks sector over the last fortnight has only served to further entrench our negative view of the sector.
These incumbent banks, which account for over 10 per cent of the FTSE All-Share index, have been a source of significant investor discomfort this summer having now dropped by over 13 per cent since the end of July (in total return terms), an underperformance of the UK market of over 9.5 per cent.
Performance of indices over 2yrs
Source: FE Analytics
The latest leg lower has been driven by disappointing updates from the likes of Lloyds, Barclays and RBS. The recent Q3 statement from Standard Chartered confirmed long-running rumours of a rights issue; whilst the accompanying cancellation of the final dividend and lack of clarity on subsequent payments, served only to underscore the business’ problems. 
Together, this paints a picture of a difficult UK operating environment, balance sheet opacity and demanding regulatory capital requirements.
Negative sentiment is likely to have been accentuated by European newsflow: the two-year suspension of dividends by Deutsche Bank and a $6.2bn capital raise from Credit Suisse show that the toxic burdens of the ‘Credit Crunch’ are being borne Europe-wide.
The nature of the incumbents’ issues drives our well-documented aversion to their shares.
As we have said before, the incumbent banks are beset by sizeable legacy issues. To our minds, these underline the poverty of their prospects relative to their ‘challenger bank’ counterparts.
Politically, the government is seeking to reduce the systemic risk of the incumbents and sate the public’s hunger for credit-crunch recriminations; financially and regulatorily, they are burdened by the imperative to rebuild capital buffers so as to satisfy regulatory capital requirements, whilst also preparing for the Prudential Regulation Authority’s autumn ringfencing proposal; and operationally, they are hamstrung by ad hoc and creaking IT infrastructure that speaks more broadly of an outmoded business model.
The updates of the last couple of weeks have shown further symptoms of these ongoing legacy issues.
Lloyds IMS of Wednesday 28 October, missed expectations due to a soft other revenues line (insurance, commercial banking), ongoing PPI provisions and weak mortgage issuance; and, more worryingly for income investors, omitted detailed guidance on future payouts.
Barclays disappointed the market, as its Q3 statement detailed higher than expected litigation charges, write-offs and ringfencing costs. Meanwhile, a lack of clarity on capital targets hinted at the outside possibility of a capital raise, or ongoing balance sheet shrinkage.
RBS’ Friday update revealed a Q3 bill of £967m for litigation, misconduct and restructuring costs; and warned investors that this may pale in significance against the scale of its US subprime misselling liabilities.
Standard Chartered’s emerging market profile previously gave it some protection from the Credit Crunch aftermath but is now becoming a millstone.
Performance of stocks versus index over 6 months
Source: FE Analytics
We maintain our zero weighting to the UK incumbent banks sector, and prefer to own a selection of smaller ‘challenger’ banks which we believe offer strong earnings growth based on modern technology platforms that permit scalability and tight cost control.
Jaime Clark is a member of Liontrust’s macro-thematic team along with FE Alpha Managers Jan Luthman and Stephen Bailey. Together, they run the Liontrust Macro Equity Income and Liontrust Macro UK Growth funds.
All the views expressed above are his own and should not be taken as investment advice.
