Is the Fog Lifting for Financials?
The effects of the credit crisis have been significant and far reaching. The government and Bank of England have taken action to help sustain and stabilise the banking system. Most steps have been aimed at making credit more available and boosting the financial positions of some of the UK’s largest financial institutions. No one knows when the economy and credit markets will turn the corner, but financial institutions will likely experience continuing challenges and changes in the industry going forward. However, the fog may be beginning to lift for financials as asset values stabilise, financial positions are strengthened and actions by policy makers take effect.
How Bank Ownership has Changed
As the credit crisis unfolded, some banks merged, others were acquired, and a few were nationalised by the government. In this chart, you can see the changing ownership in several of the UK banks following government intervention.
Government ownership provides needed support to the banks but also results in restrictions and can limit opportunities in the future.
Future Challenges for Financials
We believe the share prices of financials over the near term will be driven by the economic environment and the availability and cost of lending. When the economic environment begins to improve, lending markets resume functioning as usual and losses from bad loans begin to slow, pressure on financial companies will ease. However, new regulations, lower levels of gearing and slower growth at riskier business units will likely pose some challenges for financial institutions in the future.
Investing in Financials in the Aftermath
We recommend investing in financial services companies with the following characteristics:
- Limited or no government ownership
- Limited amounts of further capital needed
- Reasonable loan quality
- Attractive valuation
Companies that we believe exhibit these characteristics and which we rate as a Buy include Barclays and HSBC.1-4, 6 We believe both of these companies are well-positioned to benefit as the fog lifts for financials.
Other financial services companies we follow include Aviva5,6 (Hold), Lloyds Banking Group6 (Sell), Royal Bank of Scotland6 (Hold), and Schroders (Hold). We believe each of these companies lacks at least one of the characteristics that we’re looking for when recommending financial services shares.
Valuation and Risks
We use a variety of methods when valuing financial services shares, including price-to-earnings ratios, price-to-book ratios and return on investment calculations. The primary risk to the financial services sector is a worse-than-expected economic downturn. This would likely lead to higher loan losses and further capital needs. Other risks include large fluctuations in interest rates, increased regulation and integration challenges.
If you’re considering investing in financial services companies, speak with your financial adviser about which shares may be appropriate for your portfolio.
Shannon Stemm
Financial Services Analyst
Important Disclosures:
1 Edward Jones has managed or co-managed an offering of this company’s securities within the past 12 months.
2 Edward Jones has received compensation from this company for investment banking services within the past 12 months.
3 Edward Jones expects to receive or intends to seek compensation for investment banking services within the next three months.
4 Edward Jones has provided investment banking services for this company within the past 12 months.
5 Edward Jones has provided non-investment banking securities-related services for this company within the past 12 months.
6 The equity is the subject of a current offer to the public and a prospectus has been published. Your financial adviser will inform you of where you can obtain a copy of the prospectus.
