Fund manager Guy Monson says unlikely at it seems now, ‘utility-style banks’ will become ‘reassuringly dull sources of regulated dividend flows’
More than seven years after the global credit crisis wiped out the equity base of most Western banks, the industry continues to be something of a millstone for global investors.
UK and international bank stocks are down more than 10pc this year to date after a poor 2015 – a decline that has already been enough to delay the planned offering of some of the UK government’s 9.9pc stake in Lloyds Banking Group. Such is the pessimism around the industry that a substantial number of Western banks are trading below book value, with UK banks now at an almost 25pc discount.
Intuitively this feels wrong; yes, banks are still facing a trail of fines and litigation costs (and in the UK’s case further provisions for the giant PPI mis-selling scandal), but surely overall conditions for domestic banking are improving? The economy is strengthening, unemployment is low and regulators are at last sounding more dovish.
The US has begun, albeit tentatively, to raise rates, offering the hope of improving lending margins in the future, while bank capital ratios have consistently surpassed market expectations despite the higher than expected “one-offs”. So are banks simply misunderstood, or will poor asset quality and meagre loan growth dog the sector for years to come?
• ‘Telegraph 25’: the definitive list of our favourite investment funds Our contention is that the best of the global banks are just starting to morph from the high beta, volatile recovery stories of the last few years into something that might one day resemble more of a regulated utility.
Think for a moment what the characteristics of a quoted utility are. Typically, they have low business risk, predictable but moderate revenue growth, low market beta and secure dividend flows. They are usually subject to government regulation, and in return offer more visible long-term income streams, even if capital growth is modest.
It may sound outlandish to those investors who have suffered so much, but perhaps one could imagine a day when the larger domestic banks are also seen as reassuringly dull sources of regulated dividend flows.
So what might a new “utility style” bank look like? First, the business model will be much simpler than the mishmash of investment banking, lending and leverage that we knew a decade ago. Domestic retail banking, with high barriers to entry, large deposit bases and add-on credit card and other wealth services will be at the core of their models.
To achieve this will require considerable spending on today’s antiquated IT systems, but on the plus side a smaller branch network (UBS research shows that the median UK bank branch is just 2.2 miles from another of the same brand). Second, operational complexity and risk will be reduced by limiting derivative exposure and minimising risk capital across their shrunken investment banking divisions.
Third, we will see the new “utility banks” limit their cross-border exposure as the risks involved in international operations will add to capital requirements for all “Systemically Important Banks”. Banks, in other words, will relish becoming boring, returning to their core mission and limiting capital intensity and operational complexity.
• The other ‘patient’ fund outperforming Neil Woodford offers another chance to invest
Under this scenario, the shareholder value destruction that has been the norm for more than a decade could soon be a thing of the past. The triggers will be a resumption in dividend payouts in the UK and Europe, share-buy-backs in the US, more prudent capital stewardship and greater visibility (particularly in distributable reserves and mark to market gains). If we are right that the sector offers the prospect of utility-like income flows, then the timing could be fortuitous.
With equity income funds in the UK (and globally) fretting about likely dividend cuts in the energy and mining sectors, the banks have an opportunity to reclaim the position they held for more than a decade pre-crisis as the reliable core of both UK and global dividend strategies.
This offers bank shareholders the prospect not just of a stable income stream, but also of a potential re-rating, as the stronger banks with surplus capital are slowly welcomed back as respected members of the blue-chip, dividend paying fold.
• Guy Monson is chief investment officer at Sarasin & Partners and a managing partner
Customer support service by UserEcho