Shares in banks are looking extremely attractive and directors are piling in. Should you follow suit? Tim Bennett investigates
It’s the question on every investor’s lips: is it time to buy the banks yet? The directors of some of the UK’s biggest banks certainly seem to think so. As Jessica Brown notes in The Times, bank directors were bigger buyers of shares in their own businesses during the past three months than any of their peers from other sectors.
For example, Stephen Green, group chairman of HSBC, recently picked up almost £145,000 of shares, even as the bank revealed subprime-related write-offs of $17.2bn. Angus Rigby of TD Waterhouse reports that “many private investors have been lured into the sector with hopes of juicy yields”. RBS, Lloyds TSB, Barclays and Alliance & Leicester are among the top buys as average bank dividend yields approach 6%, nearly twice that of the broader FTSE 100.
These undeniably attractive yields are partly down to banks’ share prices diving, but also because the bigger players have been raising their dividends in a bid to shore up confidence. RBS has seen its share price fall by more than 30% in the past six months, but recently hiked its dividend by 10%, pushing the yield up to 8.6% – comfortably more than the best deal available from any current account. Given that “the reporting season has helped to put aside some of the wilder fears about the impact of the credit crisis”, as Toby Thompson of New Star puts it, surely now is a prime time to snap up some bargains while yields are still this high?
Sadly, the answer is no. On conventional measures such as price/earnings ratios and dividend yields, banks appear cheap, but they’re not nearly cheap enough. We are entering what Bedlam Asset Management describes as “the world’s first ever global banking crisis” and due to uncertainty about the eventual scale of any subprime losses, shares in the sector “remain toxic”. Bedlam believes the MSCI World Financial index needs to fall by at least another 25% even to “start to analyse [banks] for value”.
Take those supposedly solid recent results, says Simon Watkins in The Mail on Sunday. Although the sector is expected to match – or even beat – last year’s combined £37bn profits figure, this may soon turn out to be “meaningless”. That’s because we are heading for a new wave of write offs on loans made to Alt-A borrowers in the US. These mortgages are “near-prime or near-sub-prime, depending on your point of view”, as one commentator put it.
Alt-A borrowers typically have sound credit ratings, but have borrowed without showing proof of income. It’s a recipe for potential fraud and given that US house prices fell 10% in the final quarter of 2007 alone, it’s unlikely the fallout will be confined to the poorest households for long. Barclays has admitted to about £5.5bn of such loans, while HBOS surprised investors by declaring more than £7bn. That’s before you consider exposure to the UK housing market, which is rapidly going the same way as the US.
And it’s not just high-risk home loans. The fees earned from deals are vanishing as mergers and acquisitions (M&A) dry up from lack of funding. Bloomberg reports that bankers at Bank of America, Lehman Brothers and JPMorganChase have all predicted a fall in M&A activity of at least 20% from 2007 as the market “lumbers through a…painful liquidity situation”, as former Goldman Sachs partner Roy Smith put it. Even 20% looks far too optimistic – leveraged buyout activity is already down 68% year on year. After the internet bubble burst in 2001, M&A fees fell by up to 49% (Citigroup) and underwriting fees by up to 36% (at both Morgan Stanley and Credit Suisse).
Worse, says Bedlam, investors are falling for the myth that bank shares are cheap once dividend yields exceed bank deposit rates. They shouldn’t. This downturn “is only 30 weeks old”, yet dividend cover (which shows how many times a single year’s earnings, or cash flow, covers the dividend) “is already low”. Banks that have raised dividends in a show of “machismo” are gambling on economic growth and their ability to keep paying. That’s unwise, given an estimated 12%-15% of US and EU Tier One capital “has been destroyed” since summer, leaving many banks struggling to maintain capital ratios at the traditional safety level of 8%.
Bedlam reckons bank shares won’t be close to the bottom until dividends are slashed so that “10% historic yields become more like 3%” and banks admit defeat by raising new capital to repair balance sheets. It’ll take time to “clean up what happened”, says Rick Leaman of UBS. We agree: steer clear of banks for now.
How the banks are faring
Bank, Share price, P/E, Dividend yield
, 8.2, 10.78%
203.25p, 5.1, 10.33%
367.25p, 4.7, 9.04%
543.5p, 5.1, 9.00%
440.25p, 7.6, 8.15%
456.75p, 6.6, 7.44%
769p, 9.3, 5.89%
1,617p, 16.2, 2.47%
Source: Digital Look (correct as of 04/03/08)
| Bank | Share price | P/E | Dividend Yield |
| Alliance & Leicester (AL) | 513p | 8.2 | 10.78% |
| Bradford & Bingley (BB), | 203.25p | 5.1 | 10.33% |
| Royal Bank of Scotland (RBS), | 367.25p | 4.7 | 9.04% |
| HBOS (HBOS), | 543.5p | 5.1 | 9.00% |
| Lloyds TSB (LLOY) | 440.25p | 7.6 | 8.15% |
| Barclays (BARC) | 456.75p | 6.6 | 7.44% |
| HSBC (HSBC), | 769p | 9.3 | 5.89% |
| Standard Chartered (STAN), | 1,617p | 16.2 | 2.47% |