Further provisions made to cover potential compensation claims for payment protection insurance (PPI) mis-selling may have made most of the headlines when the UK’s high street banks published their latest quarterly numbers but the market’s reaction to those results confirmed investor sentiment towards the sector has improved in recent months.
Nevertheless, just as we were not unduly worried as negative sentiment impacted the share prices of Barclays, Lloyds and Royal Bank of Scotland over the last couple of years, we will not be growing overly excited now their share prices look to be moving in a more favourable direction.
Every quarter, when we review the banking sector’s results on The Value Perspective, we make the point that it is the fundamentals – the quantitative and qualitative information underpinning economies, sectors and companies – that is important. So has anything changed for the banks on a fundamental basis to justify the shift in their share price fortunes or is it simply down to market sentiment?
Regular visitors will know that, when analysing bank results, we prefer to focus on two particular aspects – tangible book value and capital. Tangible book value – a measure of a bank’s fair value – gives us an idea of the changing upside in the business, while capital ratios indicate how safe or otherwise it should be as an investment.
The latest round of results revealed no changes of note to either measure for any of the banks. The new PPI provisions have by and large been offset by the underlying profitability of the groups, exposures to bad debts remain low and book values are broadly flat. As such, while the market could arguably have been right to penalise the banks over the recent past or to reward them now, it cannot have been correct both times – that is just the inconsistency of sentiment.
The fundamentals are the key and, throughout the last 18 months or so, we believe they have been far stronger than most people have perceived. And, while it is encouraging to note UK banks’ share prices ticking upwards, we believe these rises have yet to account fully for the strong underlying profitability of the groups, or indeed the improving structural case that can be made for the sector more broadly.