Is it a good time to invest in UK banking stocks?

UK banking stocks have taken a beating in recent weeks following the collapse of US specialist lender Silicon Valley Bank.

The government’s intervention to facilitate the takeover of HSBC did little to address concerns that there were greater vulnerabilities within the banking system.

And as central banks continue to raise interest rates, there are concerns about mounting losses, bad loans and the impact on bond portfolios.

Despite fears of further collapses and possible bank runs, contagion in the UK banking sector has been contained. While investor sentiment has taken a hit, banks listed on the FTSE 100 are embarking on a tentative recovery.

Is this a good entry point for investors seeking exposure to the market, or are there broader issues at play across sectors? We look at some of the issues facing the industry and the key things to look out for when it comes to investing in bank stocks.

How have banks performed?

Silicon Valley Bank’s bankruptcy broke global markets last month, with investors dumping bank stocks and analysts adjusting interest rate forecasts.

UK banking stocks faced a reckoning in the market as investors feared the fallout from Silicon Valley Bank’s collapse would spread to domestic lenders.

Even with the subsequent collapse of Credit Suisse, UK banks are largely shielded from the worst, although investors still turned their backs on the sector.

The FTSE 350 banking index is down -5.26 percent over the past three months. The sale has been haphazard, with even the best capitalized and liquid banks suffering.

Until the second week of March, banks had a very strong start to the year, with equities rising to deliver a year-to-date total return of more than 19.9 percent, well above the 7.3 percent of the FTSE 100 in the same period. period of time. period of time.

In the remaining three weeks there was a sharp turnaround in fortunes, with the FTSE All Share/Banks index falling 15.6 percent in terms of total return.

Banks are considered a good defensive stock in times of economic uncertainty, and investors have flocked to lenders amid high inflation and recession fears.

Rising interest rates could, in theory, help ensure banks’ profitability as net interest income — the spread between the interest banks earn on loans and the interest they pay to borrow — widens.

However, what the Silicon Valley Bank and Credit Suisse saga has shown is that banks are under severe pressure from the adverse risk outlook, regulatory environment and rising operating costs.

How much pressure can UK lenders handle in the face of stubborn inflation and the growing likelihood of further rate hikes?

Bestinvest managing director Jason Hollands says: “While concerns of a systemic crisis have since subsided thanks to swift action by regulators to bolster support, UK bank stocks are still 7% below their early March highs.

And while talk of a financial crisis 2.0 has died down — and was in reality exaggerated in March — a certain caution remains about bank stocks in the markets, with banks expected to slam the shutters and cut lending in the rest. keeping time in check. of the year.’

Is now a good time to invest in UK banks?

UK bank share prices have started to recover in recent weeks, although like most of the UK market they remain very cheap.

It’s not a good idea to time the market, especially since the impact of the Silicon Valley Bank collapse may still be lingering in the system.

Instead, see if bank stocks fit into your portfolio and overall investment strategy. Bank stocks can be a great long-term investment opportunity for those willing to take on some risk.

The risk associated with banks depends hugely on the company itself, and we explore what to look for in a bank below.

They are cyclical stocks, meaning they are sensitive to recessions and there is a risk of credit losses for banks.

There are broader structural issues, regardless of the economic climate, such as the looming threat from challenger banks such as Starling, Monzo and Revolut, which have quietly built a loyal customer base.

However, Ian Lance, portfolio manager of the Temple Bar Investment Trust, thinks the threat from fintechs is exaggerated.

While many fintechs have launched to much fanfare over the past decade, the core banking landscape in most countries, and certainly the UK, hasn’t changed much: NatWest, a large UK retail bank owned by the trust, had 19 million UK customers by 2022 , the same number as in 2016. The story is the same with the other major UK banks, with little evidence of massive customer churn.”

With the current volatility, with inflation so stubborn and the Bank of England likely to raise rates again, it is difficult to know how bank stocks will behave for the rest of the year.

“In general, banks will never turn off the lights when it comes to providing exceptional levels of growth, they will tend to ebb and flow in line with the economy,” said Laith Khalaf, chief of investment analysis at AJ Bell.

“Banks are good for dividends, though, and this is probably the main attraction of investing in the sector, besides a bit of portfolio diversification.”

Hollands adds: ‘I am currently fairly neutral on bank shares. On the one hand, higher interest rates have increased the margins they can make on their lending and stock prices are cheap.

“But on the other hand, with the potential for a mild recession looming, this is likely to lead to rising bad loans that will eventually have to be written off.”

James Yardley, senior research analyst at Chelsea Financial Services, takes a more pessimistic tone when it comes to investing in banks.

‘I’m not a fan of banks at the moment. As far as I’m concerned, the quarrel between SVB and Credit Suisse is not over yet.

‘Banks have less gearing, better interest rate hedging, less exposure to commercial real estate and it is less easy to switch to money market funds or short-term government bonds.

‘Retail banks are simpler and less likely to run into problems than investment banks. Nevertheless, their profitability is also likely to be compromised as they have to offer higher interest rates on deposits. Credit growth is likely to be weak.

Frankly, I’d much rather invest in companies that aren’t 10 to 1 on their way to a well-broadcast recession. There are plenty of other good companies that don’t need such excessive leverage to generate a decent return on equity.”

Which banks are the most attractive investments?

There are five major banks in the UK stock market: HSBC, Lloyds, Barclays, NatWest and Standard Chartered. Each fulfills a different role within the domestic credit market.

HSBC is a major global bank with a huge presence, although most of its revenue comes from the Far East, meaning its fortunes are tied to the Chinese economy.

Lloyds and NatWest are merchant and retail banks doing business in the UK, although NatWest also has some exposure to investment banking. All three pay a decent dividend.

Barclays and Standard Chartered differ slightly in that they combine traditional banking with investment banking and asset management.

Both have an international presence, with Standard Chartered focusing primarily on Asia, while Barclays is transatlantic.

Khalaf says, “The advantage of having an investment bank is that you have another source of income in addition to the traditional banking business, which can boost income during times of heavy trading or M&A.

‘But it can also be annoying if the market wheels stand still for a while. If you’re managing a portfolio there’s nothing wrong with a little bit of each, or most of these, to get a little bit of diversification across the UK banking sector.”

Hollands’ favorite picks are NatWest, Barclays and Standard Chartered, which he says are “well capitalized, highly liquid and trading at low P/E ratios that reflect current uncertainties.”

He continues: “Of these, NatWest, as a retail-focused bank, has arguably the least risky model of the major UK banks as it has simplified operations following the global financial crisis.

However, I should point out that it has significant exposure to the UK economy through its mortgage lending, which should dampen enthusiasm given the headwinds the UK is facing from falling real wages and higher taxes.

Barclays, on the other hand, has a larger international footprint and also has greater exposure to investment banking, where it just announced another round of job cuts due to a drought of deals and IPOs in the city.

“While the outlook for investment banking remains difficult, Barclays would be well positioned if things change, and they will eventually.”