Value investors should put the memories of the global financial crisis behind them and consider revisiting the UK banking sector, according to Schroders’ Andrew Evans.
More than 10 years since the onset of the financial crisis and the first run on a UK bank for 150 years in Northern Rock, the sector remains unloved by many investors.
Evans, a member of the global value team and co-manager on several European equity funds, said he understood investor reticence over returning to the sector.
He said: “A decade and a bit – or 3,669 days to be precise (including three 29 Februarys) – is a long time even in value investing terms and yet the wider market remains scarred by the experience in one key respect.
“Tempted back into most other parts of the stock market over the intervening years, the majority of investors still cannot bring themselves to buy UK banks to any meaningful degree.”
Evans added: “The months that followed Northern Rock’s fall produced a barrage of negative press about the financial sector that only grew worse after the collapse of Lehman Brothers 12 months later and, while specific headlines may have faded from memory, a general feeling of unease persists.”
The impact of the global financial crisis on the banking sector was severe and resulted in a loss of confidence by UK investors.
Performance of index since start of data
Source: FE Analytics
Indeed, it has taken years of government support, recapitalising and consolidation for the sector to stabilise. As the above chart shows, the FTSE All Share Banks sector has failed to recover from the crisis, losing 29.58 per cent since January 2006.
Evans added: “Within a matter of months of the fall of Lehman Brothers, therefore, we had reached a different view from the great majority of investors on the prospects of the UK banking sector – arguing they were not quite so dire as the lowly valuations of its leading players would suggest.”
The manager said the Schroders value team are constantly revisiting and testing its investment thinking on the sector and having considered the balance sheets of the ‘big four’ banks – Barclays, HSBC, Lloyds and RBS – Evans said there was a risk/reward trade-off for the sector that was attractive from a value investor perspective.
The manager said the team had compared total assets of the big four today with 2007, in attempt to gauge each bank’s exposure to potential losses and decide how much capital a bank needs to set aside to reduce the risk of going bust.
“Total assets and risk-weighted assets for the four actually peaked at £6.6trn and £2.1trn respectively but as you can see – and perhaps a little surprisingly – both figures are now broadly in line with where they were in 2007,” he said.
Total assets and risk-weighted assets of the UK's 'big four' banks
Source: Bloomberg
However, more importantly, Evans said the big four had “significantly fewer liabilities” or leverage than they had before the crisis.
“In common with other companies, banks rely on a mix of equity and debt to finance their business operations,” he said.
“The higher a bank’s leverage ratio – calculated as its total assets divided by its tangible equity (which ignores ‘intangibles’, such as goodwill) – the weaker its balance sheet and the more vulnerable it will be to shocks such as the financial crisis.”
He said the big four's leverage ratio in 2007 had stood at 46 times, but has since reduced to a “much healthier” 18 times today.
He further noted that tangible equity – another measure of a bank’s ability to deal with financial losses - has also doubled since 2007.
Yet, markets have yet to price in just how much risk has been taken off the banks’ balance sheets, otherwise “there would be less value in the share price”, said Evans.
Indeed, Evans said the big four market capitalisation was close to where it was in 2007.
He said: “In other words, Barclays, HSBC, Lloyds and RBS have all been through a period of significant ‘de-risking’ – now holding a lot more equity relative to the liabilities on their balance sheets and the size of their businesses – and yet the market is giving them absolutely no credit for that whatsoever.
“With this state of affairs largely unchanged from when we reappraised the sector back in March, we remain as comfortable with our banking exposure now as we did then.”
However, with the exception of HSBC, the big four have yet to return to pre-crisis levels.
Performance of ‘big four’ since 9 August 2007
Source: FE Analytics
HSBC, the UK's largest bank, has grown by 38.69 per cent since the onset of the global financial crisis, as the above chart shows.
The other members of the group have not fared as strongly, as they struggled to recapitalise and were forced to set aside money relating to the mis-selling of payment protection insurance (PPI). Lloyds Bank has lost 33.41 per cent over the period, Barclays is down 54.55 per cent and RBS has lost an eye-watering 94.06 per cent.
But Evans said if current risk levels were fully reflected in the share price “we would feel less comfortable about maintaining our positions”.
He added: “Still it would appear we need not worry just yet.”
HSBC represents a 4.4 per cent weighting in the offshore Schroders ISF European Value fund co-managed by Evans, it is also present in several other portfolios he co-manages. The €825.5m, four FE Crown-rated fund has returned 51.83 per cent over three years compared with a 43.74 per cent rise in the MSCI Europe benchmark.