In Article of faith, we noted how banks are, to our minds, decent businesses even if – with the sector by some distance the cheapest in the UK market – this is not an opinion shared by too many other investors. We have been bullish on banks for a while now so what is it we see that other investors, who have either shunned the sector or perhaps dipped a toe only to quickly withdraw it, do not?
It is seven years ago to the month that the run on Northern Rock fired the starting pistol for the credit crisis – and a lot can happen in seven years. We would imagine there have been some big changes in your life since September 2007 – certainly there have, both personally and professionally, for us here on The Value Perspective – and things have changed significantly for the banks as well.
Today, the balance sheets and capital ratios of UK banks are night-and-day different to what they were seven years ago – to offer just one example, after an £800bn reduction in assets, the balance sheet of Royal Bank of Scotland is half the size it was in 2007. Furthermore, the lending undertaken by UK banks these days is significantly more profitable than it was seven years ago.
All in all, these are wholly different businesses to the ones they were in 2007 and yet companies that, over time, have tended to trade at a premium to their book value are now on a discount to it – to all intents and purposes on valuations that suggest their management should be seriously considering switching off the lights, bolting the doors and just giving up and going home.
To our eyes that seems unfair and unreasonable but it is certainly not surprising. The banking sector’s current status as ‘public enemy number one’ is part of a consistent historical pattern to which no investor is immune – a cycle of human emotion that begins when any market darling shows signs of stumbling.
Initially, investors are so in love with the business they deny there is a problem but, as the problem becomes more tangible, denial turns to fear then to desperation and eventually to capitulation and despair. That is the point at which investors cannot perceive any way that things are ever going to improve for the businesses – but then things do start to improve …
Here on The Value Perspective, this is about where we would say we are with the UK’s banks – for example, Lloyds is on the verge of once again paying a dividend. For the great majority of the market, however, it is a case of ‘once bitten, twice shy’ and investors are ignoring Lloyds and other banks because they feel they cannot trust them.
It has been our experience that the more deeply rooted the problems a company has suffered, the longer the rehabilitation process will take. We know it will take the market time to work through the rest of the emotional cycle – through the current despair or at least apathy and onwards through reluctance to excitement and then euphoria (before, at some point, the whole process starts again).
It is a pattern we have witnessed over the past decade with all sorts of UK businesses, including housebuilders, tobacco, utilities and real estate companies. Yes, the issues with banks have been bigger and, as such, their rehabilitation is taking longer but it is our firm belief that, over the next three to five years, these businesses will again be recognised for the good, solid, oligopolistic profit-generators they once were and, to our eyes, still remain.