Better outlook for banks one year after Lehman

WHEN Lehman Brothers collapsed a year ago, it seemed that the world would never be the same. Global markets wobbled and once giant investment banks were crippled as sub-prime mortgages and credit default swaps unravelled and we braced ourselves for a worldwide recession. Wall Street had shrunk to less than a third of its pre-Lehman market capitalisation by March 2009 and banks were still teetering on the edge. <br /><br />But in the past six months, the markets &ndash; led by the financial sector &ndash; have staged a remarkable recovery. Wall Street is now worth 95 per cent of its value this time last year and analysts are increasingly optimistic about the future for banks that they had once written off.<br /><br />That is not to say that the banking crisis is over &ndash; as David Rosenberg at investment firm Gluskin Sheff points out, the closure of three more US banks last Friday brings the total number of bank failures in the US so far this year to 92, more than we have seen in the last 15 years combined.<br /><br /><strong>RELATIVELY UNDERVALUED</strong><br />But with banks still relatively undervalued &ndash; of the major American and European banks, only JPMorgan, Barclays and Goldman Sachs have regained their pre-Lehman stock price &ndash; now is an ideal time for contracts for difference (CFDs) traders to start considering buying into banking stocks with a medium-term view. The outlook for European banks in particular is good, and their price is up 28 per cent so far this quarter, outperforming the wider market by 9.6 per cent. (See chart.) <br /><br />Analysts at investment bank Keefe, Bruyette and Woods (KBW) &ndash; which is overweight on banks &ndash; believe that the outperformance of the sector has further to go because it continues to benefit from monetary and fiscal support.<br /><br />During the market rally, traders&rsquo; strategy had been to pick up very cheap financial stocks and bet on their relative recovery. But with stock markets looking toppy, KBW notes that quality names with good business models and competent management are relatively cheap versus the sector, and that while investors have focused on low price-earnings multiple stocks, this ignores the total value from investing in the higher-quality, dividend-paying names. CFD traders long on these stocks will also receive the dividend payments. <br /><br />&ldquo;We recommend investors take the summer bounce as an opportunity to reduce exposure to &lsquo;recovery&rsquo; names and revert back to the safer, quality names,&rdquo; its analysts say.<br /><br />These quality names include the likes of HSBC, Santander &ndash; which owns Abbey, Alliance &amp; Leicester and Bradford &amp; Bingley &ndash; Spanish bank BBVA and Greece&rsquo;s NBG. <br /><br />But to balance these credit-oriented names in their portfolio, the analysts say they are still very comfortable with more market-driven names that offer much better value &ndash; Deutsche Bank, BNP Paribas, Societe Generale and Barclays.<br /><br />Barclays has been one of the most successful British banks over the past year, along with HSBC and Standard Chartered, thanks to its ability to survive without government aid and its share price has rallied accordingly since its lows in the first quarter.<br /><br />Falcon Securities&rsquo; Ronnie Chopra says that with Barclays&rsquo; share price up from 50p to around 370p at the moment, those fortunate to have gone long in the middle of March and held on to those CFDs would now have gained more than 70 times their original capital with Barclays on a 10 per cent margin.<br /><br />But he adds that Barclays shares are looking a little toppy and might be worth a short-term short position. Some profit-taking will be inevitable as regulation tightens, which may hamper margins.<br /><br /><strong>SYSTEMATIC RISK</strong><br />As a result of proposed regulation, banks with high leverage, a low level of common equity Tier One capital and/or those of a sufficiently large domestic or international size that they pose a systematic risk, are likely to come under significant pressure to issue more common shareholders equity.<br /><br />Those UK banks still suffering are the usual suspects of RBS and Lloyds Banking Group. While RBS has been improving its position and visibility for profits, it has rallied strongly but at 7.6x adjusted expected 2012 over-the-counter earnings, though, the market has already gone a long way to capture the potential value of the stock. Therefore, further rallies from here should be seen as ideal short-term selling points for CFD traders already long of the bank. <br /><br />A year on from Lehman&rsquo;s collapse, the banking system in the UK and abroad is still far from healthy. But relatively cheap quality plays offer CFD traders a good, and less risky way to take a position on the financial sector, which is expected to lead the recovery.<br /><br />But traders should avoid the riskier stocks such as RBS, Lloyds Banking Group and Commerzbank, which all have a subdued couple of years ahead.<br />