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Banks pass the stress-tests. Is now the time to invest?

The positive results of the latest round of Bank of England stress-tests are further evidence bank-shy investors are running out of excuses not to buy into the sector

30/11/2017

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

Say you were to emerge blinking from your bunker in the wake of interest rates up to 4%, the value of the pound down more than a quarter, unemployment up almost 10%, residential property prices down by a third, commercial real estate prices down by two-fifths and world and UK GDP down 2.4% and 4.7% respectively – how many UK banks would you expect still to be standing?

The answer, if the latest round of ‘stress-tests’ carried out by the Bank of England are anything to go by, is all of them – or at least all those that were tested.

Written off as almost uninvestable by much of the market, none of the listed UK banks failed the annual test of their financial resilience. This test is a kind of balance sheet war-gaming that also takes virtual lumps out of their investments.

Thus, in the latest scenario, the banks’ balance sheets were expected to cope with the FTSE 100 and the oil price plummeting respectively 45% and 52% in a year and the foreign exchange and bond markets similarly hit.

In terms of imposing stress, the regulator wasn't holding back. 

Not holding back

And, as we mentioned, all the UK banks passed.

In the spirit of complete openness, Barclays and Royal Bank of Scotland (RBS) should perhaps have an asterisk by their names as they would not have passed based on the strength of their balance sheets at the end of December last year, which was when this round of stress-testing officially started.

Nevertheless, if you take into consideration the remedial actions those two banks have taken since – the capital generation and the disposals made – then the UK banking sector boasts a 100% pass rate.

All of them were judged to have enough capital on their balance sheets to withstand what was on paper, as it were, a pretty apocalyptic set of circumstances.

Banking bears

Should you be one of the legion of banking bears, of course, you might argue it is not possible to model such complex and dynamic systems on a spreadsheet, the world is a more complex place than that and the Bank of England, in common with everyone else, has no idea what will happen in the future.

And, here on The Value Perspective, we would completely agree with all those points.

But we would also point out the cumulative effect of the stress-tests the UK banks have just faced is almost twice as bad as 2008 and 2009 combined.

Over those two years, which sat at the heart of the financial crisis, the UK banking sector lost a total of £28.6bn at the pre-tax profit level whereas the stress-test they have just been through envisaged them losing £48.7bn in aggregate.

Whether you take the stress-tests detail by detail or as a whole, therefore, the banks passed.

Time to look at banks again?

In recent years, Barclays, RBS and Standard Chartered have all had to take some kind of action to shore up their finances but these latest results are arguably the cue for Standard Chartered to start paying a dividend again – RBS too, once it sorts out its litigation issues with the US Department of Justice.

It is, in other words, the green light for the UK’s banking system to return to normality and yet, as a sector, the banks are valued at 0.8x price to book – that is, as being worth 80% of their assets minus their liabilities.

As such, here on The Value Perspective, we cannot help but feel anyone who now chooses to disagree with the Bank of England’s verdict – continuing to avoid banks on the basis their balance sheets are too weak – are now really just looking for excuses.

Author

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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