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State-owned banks lag their peers

BANKS were the star performers in the FTSE 100 last week, after Barclays reported its best ever profit of £11.6bn in 2009, an increase of 92 per cent in just 12 months. This week the focus shifts to RBS and Lloyds Banking Group, who will announce earnings on Thursday and Friday respectively.

After the turmoil suffered by both Lloyds and RBS – the former agreed to buy near-bankrupt HBOS, the latter found itself plunged into a deep sub-prime and corporate loans crisis, both were given copious amounts of government capital – neither bank is expected to have turned a profit last year.

Analysts expect RBS to post a loss of around £5bn-£6bn. Lloyds is expected to have made a loss of £4.5bn or so. Charles Stanley’s banking analyst Nic Clarke says that with results like these, “it will be a very long time before Lloyds and RBS can dig themselves out of the hole that is government ownership”.

But profits, or lack of them, are not the only thing to look for, says Clarke. The key variable will be Lloyds and RBS’s outlook for any further write-downs on bad debt. For both Lloyds and RBS the trend in debt impairments improved in the third quarter of last year. But this could be short lived. The number of bad debts will increase if unemployment continues to rise in the UK.

Their significant exposure to the UK retail banking sector is a major risk for both banks. Retail banking has come to the fore at RBS as the bank scales back its investment banking unit, blamed for losses during the financial crisis. Lloyds has always been a retail bank, though it has inherited many commercial loans from HBOS.

This is in contrast to Barclays, now primarily an investment bank. Barclays Capital drove last week’s stellar results, while profits in its UK retail banking division more than halved in 2009.

Clarke says that you can split the UK banking sector into three categories. At the top is HSBC and Standard Chartered, the best performers due to their exposure to the fast-growing Asian markets. Next is Barclays, the surprise performer due to the strength of its investment banking unit since its purchase of Lehman US. RBS and Lloyds lag behind their peers, though the latter could bounce back earlier than expected once it sorts out the problems at HBOS.

There is one other bright spot on the horizon for Lloyds and RBS, says Clarke. He does not expect the debt crisis affecting Greece to impact the banking sector in the UK.

However, if no solution is found to reduce Greece’s deficit, then contagion could spread to the other Club Med economies of Spain, Italy and Portugal. Clarke says this would impact UK banks, including LLoyds and RBS because the UK, along with France and Germany, are exposed to the bulk of the sovereign debt issued by these countries.

So although next week’s figures should show that the healing process continues for both RBS and Lloyds, clouds remain on the horizon. This makes it hard for spread betters to take a directional view on either Lloyds or RBS. However, if you want to get exposure to any upswing in their share prices after they announce their results later this week, then David Jones from IG Index recommends spread betting on a call option. These instruments allow you to profit from an increase in a stock’s price, while also capping your losses to the premium you pay on the option. Jones recommends buying it earlier rather than later, because any rumours that results will surprise to the upside will be quickly priced into both companies.