Say what you like about UK banks – and people generally do – there is a remarkable consistency in what their senior figures say in public. Take the following examples from the chairman’s statements contained in three consecutive annual reports from Barclays, the first of which includes the striking observation: “We have had to deal with 18 different government reviews over the past three years.”
The statement goes on to highlight “a seemingly endless stream of new accounting rules”, changes in the bank’s capital requirements, the emergence of price control, “increasingly tough ‘know your client’ rules” from the UK regulator and the creation of “a whole industry” in corporate governance – along with the “prospect of plenty more on its way”.
The following year’s chairman’s statement notes a recurring theme of “the significant amount of senior management time that continued to be committed to regulation, compliance and governance”. Accepting there would never be a single set of rules to fit “all companies in all countries in all circumstances”, Barclays sees “no signs of relief from the number of reviews, consultations and regulations that affect the banking industry”.
That year, the statement continues, the bank “responded to government consultations and questionnaires on capital adequacy, payment systems, credit cards, insurance, business crime, pensions, other investment products, corporate governance, company law, mortgage regulation and marketing of financial services as well as numerous employment and social issues”.
Skipping ahead a few lines and a few more domestic concerns, the statement goes on to note the UK regulator’s expectation that no fewer than 14 major sources of EU legislation would become mandatory for the financial sector over the next four years. Little of this, it adds wryly, “appears to be subject to a rigorous cost benefit assessment before it is promulgated and implemented”.
The extra cost, in both management time and actual expenditure, is also felt to be “high relative to associated benefits” – a view unlikely to have altered the following year when Barclays sees “no abatement in the volume and frequency of regulatory change”, with a host of initiatives in the UK, the US and especially the EU that are expected to cause “considerable resource stretch for even the largest financial services institutions”.
The interesting thing about these extracts and examples is not so much the ‘what’ but the ‘when’ – they are all taken from the chairman’s statements in Barclays’ annual reports from 2002, 2003 and 2004. So while, for much of the market, the current regulatory backdrop is a significant reason not to touch the UK banking sector, here on The Value Perspective, we hold a different view.
An ever-changing and increasingly tough regulatory environment has been a fact of life for UK banks for some years now but it has rarely prevented them from making good returns. What is more, for those who care to look, their core businesses continue to make good returns ahead of their cost of capital – it is just that this fact is obscured by non-core business and conduct fees, both of which we expect to decline over time.
Today, it is abundantly clear “the volume and frequency of regulatory change” highlighted by Barclays between 2002 and 2004 really did not do the job its architects presumably intended. Nevertheless, we would agree with John McFarlane, the bank’s latest chairman, who observed in his first statement: “Today the group is smaller, safer, more focused, less leveraged, better capitalised and highly liquid.”
Comparing 2015 with 2008, he added, saw the bank boasting £2.1 trillion of assets now versus £1.1 trillion “and declining” then; shareholders’ equity of £54.5bn now versus £36.6bn then; balance sheet leverage – that is, total assets to ordinary shareholders’ funds – of 20x “and comparable to more highly rated peers” now versus 56x then; and shareholders’ equity as a percentage of risk-weighted assets of 15.2% now versus 8.5% then.
As articles such as Sneaking up demonstrate, here on The Value Perspective, we have argued for some time now that UK banks are a lot further down the road to recovery than the wider market seems prepared to believe. Certainly we would agree with McFarlane’s assessment that banks are materially safer than they used to be and this, combined with some very attractive valuations, means they make up a significant part of our portfolios.