Solid earnings are only the beginning for banking stocks

AFTER what has been a difficult few months, the European banking sector couldn’t have asked for a better start to a week that is jam-packed with their first-half earnings announcements. Both London-listed HSBC and Paris-quoted BNP Paribas posted better than expected profits and revealed that their bad debts have fallen sharply to pre-crisis levels.

Traders put the stress test jitters and regulatory uncertainty behind them yesterday and pushed up HSBC’s share price by 5.28 per cent and BNP Paribas’ by 5.27 per cent, lifting the overall European banking sector by 3.93 per cent. It was a promising start to what had been an eagerly anticipated week and will put the pressure on the other banks scheduled to report later this week.

Joshua Raymond, market strategist at City Index, says: “The UK banking sector has rallied over 21 per cent since the start of July to a new three-month high yesterday morning and this has firmly been on the back of earnings optimism.”

He adds: “The FTSE 100 remains locked in a trading range, but there is every hope that should US labour data impress along with earnings from banks such as Barclays and Lloyds Banking Group, the FTSE could make another attack on the 5,435 level.” City Index yesterday saw a high number of clients betting on this happening by picking up shares in other banks.

Lloyds, which is 41 per cent owned by the state, is expected to bounce back into the black with analysts forecasting £800m of profits in the six months to June compared with a £4bn loss in the same period of 2009.

Analysts at Keefe Bruyette Woods (KBW) are more optimistic, predicting pre-tax profits of £897m. Barclays, which has been one of the better-performing London-listed banks, is also tipped to increase its profits to £3.5bn despite a slowdown in investment banking revenues.

Nonetheless, City Index’s Raymond sounds a note of caution that contracts for difference (CFD) traders should take heed of: “There is every chance that having rallied so much so quickly, much of the good news is starting to be priced in and should any of the major UK banks slightly disappoint in one aspect of their earnings, this could trigger some profit taking.”

But looking beyond this week, what does the future hold for the British banks and what positions should CFD traders be placing? In terms of strength, the standout performers should continue to be both HSBC and Standard Chartered. Both have significant Asian exposure and are relatively well-capitalised.

However, analysts warn of limited upside to Standard Chartered, which closed up yesterday 1.06 per cent. Consequently, Standard Chartered is probably not worth buying if you don’t already own it.

Barclays is also seen as worth a buy by a number of analysts, including Deutsche Bank’s Jason Napier: “We like the long-term growth potential of the Barclays businesses. At 5.3 times 2012 earnings per share we see the stock as attractive and remain with a buy recommendation.” However, he has cut the target price to 400p from 415p as a result of the slower investment banking conditions.

It has been a frustrating and volatile time for the stocks of the two state-owned banks, RBS and Lloyds Banking Group, which have been trading sideways since late April. But they should benefit from the watering down of the Basel proposals and, in the event of strong figures this week, they could break out of their ranges. Evolution Securities rates RBS as a short-term buy and includes Lloyds in its core buy portfolio.

This week should be a promising start in what appears to be the next step in the sector’s recovery. CFD traders should either buy the sector or pick a few choice banks with three- to six-month views.