Banking on surprising the markets

THIS week sees the release of interim figures from a number of UK banks, and few are holding out hope for particularly strong results. A generally weak UK economy that grew an anaemic 0.2 per cent in the second quarter, coupled with concerns about the risk of UK bank exposure to possible European default, have brought share prices tumbling over the last quarter. Lloyds has fallen 30 per cent, Barclays is down 24 per cent and RBS has dropped 19 per cent. HSBC and Standard Chartered have come out on top of this ugly dog fight, down only 8 per cent and 4 per cent respectively. HSBC will announce today, and it is expected that it will post relatively healthy figures. According to Angus Campbell, head of sales for London Capital Group: “HSBC remains a favourite among analysts and its earnings are expected to show some decent volume growth, despite a decline in trading revenues, but this is down to seasonal factors.” Campbell adds: “Like Lloyds and RBS, Barclays has also been a real underperformer due to concerns over its sovereign exposures. So with the Asian focused banks seeing less share price weakness in recent weeks than the more European and domestic focused banks we should expect them to perform mildly better next week.”

Of the banks reporting this week, two came through the credit crisis largely intact – HSBC and Standard Chartered. Of course, you can point to HSBC’s global exposure and Standard Chartered benefiting from doing relatively little business in the UK, US or Europe. But they both also reported low return on equity numbers (RoE), which seems to contradict the idea that banks which report a higher RoE will trade at a higher premium to book value (see chart, below). “We are beginning to wonder if lower RoE targets are actually a reason for optimism in this sector,” says Bruce Packford, banking analyst for Seymour Pierce equity research. He asks “if 15 per cent RoE is better than a 20 per cent RoE – why not 12 per cent or even 10 per cent returns?” Packford welcomes lower and more realistic RoE targets among UK banks, saying that these suggest that some of the lessons of the past have been learnt.

Alongside the worries of UK bank exposure to European debt, a threat could come from the Independent Banking Commission. which has recommended separating riskier bank activities from the retail businesses. Though the implications of ringfencing are hazy, analysts predict Barclays and RBS would be most impacted, followed by HSBC and Lloyds.

It is set to be an interesting week for UK bank equities and traders should be on their toes in case of any surprises.