Banks still have work to do

Britain’s high street banks are looking healthier, but they still haven’t recovered from their post-crisis hangovers. Investors should think about the risks ahead. Alice Gråhns reports.

Barclays chief executive Jes Staley made a deal with shareholders in 2016. He cut the dividend in half to free up money to overhaul the bank, promising to restore it later. Last week Staley doubled down, saying he would double the dividend in 2018 – or rather return it to 2015 levels – and could even buy back some shares to return more cash to shareholders, notes Lionel Laurent on Bloomberg Gadfly. Investors were encouraged: the shares jumped by 5%. However, betting on this promise being kept “still requires a fair amount of faith”. Staley has delivered on asset sales, job cuts and a clean-up of the balance sheet, while Barclays’ capital cushion has recovered. But “targeted profits are years away”.

One problem is that “too much revenue is being eaten up by costs” in the investment bank. Barclays hopes to reduce expenses to 60% of revenue; last year, they reached 73%. It hardly helps, adds Jim Armitage in the Evening Standard, that past misdemeanours “still haunt” Barclays, with the “looming megafine from US regulators over its selling subprime mortgage rubbish being the biggie”.

More sins of the past

Meanwhile, after nine years of losses, state-controlled Royal Bank of Scotland (RBS) has delivered its first net profit. This brings “deliverance, in the form of dividend payments, tantalisingly near”, says Christopher Thompson on Breakingviews. Its shares are up around 8% over the past year, largely because the bank has around £6bn of capital more than it needs to meet its target common equity tier 1 capital ratio (the ratio of a bank’s core equity capital to its total risk-weighted assets) of 13%.

Yet, as with Barclays, legal trouble looms. RBS has set aside $4.4bn for US fines relating to mis-selling pre-crisis mortgage-backed securities. But analysts reckon the episode could ultimately cost up to $9bn, wiping out RBS’s capital surplus. The bank’s “lost decade” may be over, “but final salvation is still a step away”.

As for Lloyds Banking Group, chief executive António Horta-Osório is still trying to keep the business “simple and boring”, notes Matthew Vincent in the Financial Times. He wants to grow retail banking, commercial lending, and insurance and pensions. If all goes to plan, profitability should rise, enabling repeats of the £1bn share buyback Horta-Osório announced last week on top of a 20% dividend hike – moves that followed a 24% jump in pre-tax profits.

The big unknowns are interest rates and customer acquisition, which may not “remain boring much longer”. Interest rate rises will bolster margins but will also change behaviour, creditworthiness and property values. The pensions market has become more competitive. Fintech start-ups also pose a threat, adds Laurent, especially since Lloyds has yet to put the payment-protection insurance scandal behind it. The problem is not the cost of redress, but the reputational damage it did to banks’ ability to sell other products to clients. “The future looks anything but boring… Lloyds will need to do better than simply doing more of the same.”

Britain’s ten most-hated shares

Company Sector Short interest on 27 Feb (%) Short interest on 23 Jan (%)
Melrose Industries Industrials 14.841 NEW ENTRY
Carillion Construction 14.8 15.02
Debenhams General retailers 13.82 15.85
Provident Financial Financial services 13.38 15.03
AA Motor insurance 12.03 NEW ENTRY
Pets at Home Pet retailers 11.47 NEW ENTRY
Aggreko Power supplies 10.88 10.91
Wm Morrision Supermarkets 10.199 11.04
GVC Holdings Gaming operators 10.189 NEW ENTRY
Marks & Spencer General retailers 10.18 12.29

These are the ten most unpopular firms in the UK, based on the percentage of stock being shorted (the “short interest”). Short sellers aim to profit from falling prices, so it can be useful to see what they’re betting against. The list can also highlight stocks that might bounce on unexpectedly good news when short sellers are forced out of their positions (a “short squeeze”). There were an unsually large number of new entries this week. Melrose is locked in a takeover battle with engineer GKN, while GVC is merging with Ladbrokes Coral.AA and Pets At Home are both highly indebted and have recently issued profits warnings.

City talk

Don’t underestimate Martin Gilbert, says Jim Armitage in the Evening Standard. Last week the Standard Life Aberdeen (SLA) co-CEO was “getting brickbats” for losing a contract to manage £109bn of funds for Lloyds’ Scottish Widows insurance arm because Lloyds didn’t like SLA being a competitor in insurance. Now we learn that, all along, “he had a bigger play elsewhere”. SLA is selling most of its insurance business to Phoenix for £3.2bn, which brings “a clean exit” plus a guarantee that Standard will keep managing £200bn of funds for Phoenix funds for years to come. “Standard emerges as a pure, zero conflict-of-interest fund manager.” It may now “even win back some of the Scottish Widows’ money. Clever.”

“Comcast boss Brian Roberts is driving a Sky-shaped wedge between Walt Disney and 21st Century Fox,” says Liam Proud on Breakingviews. The US cable group has made a £22bn offer (£12.50 a share compared with Fox’s £10.75 a share) for the UK pay-TV firm. The deal will go ahead if more than 50% of Sky shareholders accept, meaning Fox boss Rupert Murdoch cannot use his 39% stake to block it. So Murdoch must start a bidding war for Sky, or re-think his deal to sell Fox’s entertainment assets to Disney. Sky’s shares now trade above the value of Comcast’s offer. “Investors have placed their bets.”

Centrica boss Iain Conn has “avoided the indignity” of having to cut the utility firm’s dividend for a second time in three years “and has probably saved his job”, says Nils Pratley in The Guardian. But 4,000 staff will lose theirs as the firm cuts costs. Conn found himself “issuing regrets” to those affected. Perhaps axeing his £759,000 bonus would a better apology.