Updated: Feb 17
"All three banks have been written off for the last decade, but maybe now is the time to finally start looking at these long-forgotten UK financial stocks, It could be time! "
By: Allan R. Kirby
Historically, buying value stocks has helped Retail Investors improve performance over the long term. In fact, one of the best investors of our time Warren Buffett has followed someone by the name of Benjamin Graham. Graham taught us the long-term value investing strategy of purchasing stocks at a price below their intrinsic value; then holding them until their price reflects the real value of the company. Warren Buffet described Benjamin Graham’s book The Intelligent Investor as “by far the best book on investing ever written”.
The problem is investors have been rewarded with growth stocks especially during the pandemic. Luckily for me, I invested heavingly into technology such as Apple over the years and have been greatly rewarded. However, as I have mentioned on many occasions in other articles it's critically important to ensure investors continue to have a balanced approach and invest in value stocks along with growth.
Younger invester looking for success in investing should not only look at growth but also deep value stocks, even a small portion to help balance out when investing in single stocks.
Nobel Laureate Eugene Fama and researcher Kenneth French, former professors at the University of Chicago Booth School of Business have written that Investors with a long-term time horizon of 10-15 years or more will be rewarded for poor performance suffered in the short term. This is why I still look to financials as an area that could still hold potential long term gains to patient investors. I am not talking about PayPal and Square or many other fintech companies such as nCino. I am talking about the more traditional money center banks specifically UK financial institutions such as Lloyds Banking Group, Natwest Group (Formerly named Royal Bank of Scotland), and Barclays. All of these financial companies have been hit hard over the past year due to the pandemic, and the uncertainty that surrounded Brexit did not help either. Basically, it was a double hit just when things seemed to be going right for them.
Lloyds Banking Group, Natwest Group, and Barclays have been hit hard by the pandemic, and it was not surprising to see their stock prices take a hit. In March 2020 the banks canceled their dividends for the 2019 fiscal year, share buybacks and cash bonuses to senior staff were also suspended. With the country shut down and no dividend, there was simply no reason to hold on to the shares and they were all sold off. But what added to the risk was the fact that not only did the financial get hit due to the pandemic, Brexit came along and added to problems. It got so bad, that Lloyds share price at one point was as low as $1.17 USD, while Natwest was down to just $2.34 USD while Barclays crashed all the way to $3.41 USD.
Basically, no one knew how long the pandemic would last, how much damage it would cause to the economy and the financial systems. People were likely thinking this is 2008 all over again and decided the UK banks were just too toxic to own. With Brexit negotiations seemingly in complete disarray, it was hard-pressed to find anyone who wanted to invest in any UK stocks. Additionally, the banks were offering repayment holidays on loans to customers affected by the coronavirus outbreak as well as waiving any other banking fees in order to help customers survive through the pandemic. All necessary from a customer perspective but as an investor, there was a concern of how this would ultimately affect their bottom line.
What ended up happening
Fast forward just 8 months later, towards the end of 2020 and we found ourselves in a different situation. Covid-19 vaccines are now being rolled out and with Brexit uncertainty behind us, 2021 is shaping up to be much better than what we thought it would be a year ago. Although we continue to have lockdowns and there will be stress on the UK economy, the worst will soon be behind us. As a result, the second half of 2021 should see a strong economic rebound in the UK. When this happens I believe all three stocks will do well especially with Lloyds and NatWest they will both benefit from the economic boom that will occur.
What I love best is the fact that the pandemic along with Brexit showed me how solid these financial institutions were when faced with a crisis, the banks acted quickly and decisively. They are now sitting on a lot of capital as the banks set aside billions of pounds to protect against loan losses that have yet to materialize. Recent third-quarter reports from Lloyds Banking Group, Natwest Group, and Barclays now shows that the provisions for loan losses are back in line with pre-crisis levels. The news gets better because the banks are allowed to start returning some of their capital back to investors.
Now my expectations are tempered, I am not expecting a quick return to the pre covid 19 payouts, that would not bold well politically. I foresee a slow gradual improvement to a return of capital to shareholders over the next two years, possibly a little longer. Plus the UK regulator has set a dividend limit of 25% of a bank’s cumulative profits over the previous two years or 0.2% of its risk-weighted assets.
Time to Buy?
Lloyds Banking Group, Natwest Group, and Barclays are well off their 52-week lows but they still have a lot of room to appreciate. These banks will easily survive the pandemic and may in fact come out even stronger than before. Take a look, do your research, and decided for yourself if these are stocks to add to your portfolio.
The following provides how each bank did for the third quarter;
Barclays (NYSE: BCS)
In October 2020 third-quarter earnings Barclays posted a net profit of £611 million ($797.7 million). This was more than double what analysts had been expecting. This was due to a significant reduction in coronavirus-related impairment charges in fact cash set aside to accommodate bad loans amounted to just £608 million, while it was expected to be £1 billion.
Common equity tier one capital (CET1) ratio was 14.6%, up from 14.2% at the end of the first half.
Group income hit £5.2 billion, down from £5.54 billion in the third quarter of 2019.
Return on tangible equity (RoTE) was 5.1%.
Net interest margin (NIM) was 2.51%.
Lloyds Banking Group (NYSE: LYG)
In October 2020 third-quarter earnings Lloyds posted a net income of £3.4 billion, they return to profitability in Q3 with statutory profit before tax of £1.0bn and profit after tax of £0.7bn This was better than expected but that is not all:
Common equity tier one capital (CET1) ratio was 15.2%.
Other income £1.0 billion.
Return on tangible equity (RoTE) was 7.4%.
Net interest margin (NIM) was 2.42%.
NatWest (NYSE: NWG)
In October 2020 third-quarter earnings operating profit before tax of £355 million and an attributable profit to ordinary shareholders of £61 million including a £324 million loss on redemption of own debt.
Common equity tier one capital (CET1) ratio was 18.2%.
Return on tangible equity (RoTE) was -2.7%.
Net interest margin (NIM) was 1.65%.
All three banks are deep value stocks trading below book value, but they have been aggressively investing in technology to improve efficiency and reduce costs. These cost controls will help drive profits when Brexit and the pandemic are finally resolved. So we believe over the long term all three financial institutions are setting themselves up to become modern highly efficient banks that will be able to return capital to shareholders over the long term. The share price does reflect all the bad news and it will not take much for this stock to appreciate in value once the pandemic is over and Brexit is completely resolved.
Finally, we also expect the return on tangible equity (RoTE) will greatly improve over the next few quarters, RoTE is a critical way to measure the profitability of a bank, because its a way to measure how effective a bank is at generating profits from its equity, the money invested by its shareholders. We believe the banks need to get at least 10% and preferably up to 12% over the long term. However, this will mean continued cuts in staffing, closing branches, and continue investing in technology.
Disclosure: mysmallbank.com nor the author received any compensation from any security mentioned in this article. The article is our opinion only and is written to help readers learn more about the stock mentioned in this article. Consider this as basic information only and utilize professional services and additional sources before making an investment decision.
The author does have positions in all three stocks (LYG, NWG, BCS).