UK bank analyst Jonathon Pierce believes the banks have moved too far too fast. 7 continuing risks make bank stocks unattractive at the current levels:
1. The terms surrounding APS (asset protection scheme) accession are far from certain;
Both LBG and RBS stressed that they were working towards completion of APS but made clear that there were sticking points. One of the issues is the fee, as demonstrated by the fact RBS now has to give up both its 2008 and 2007 deferred tax asset as part of the cost of APS. This adds £500m to the starting point. Another issue, as we suspected, is how APS loans that are restructured, refinanced or rolled over are treated. Do they continue to be covered by APS? If so, would the EC object to the massive competitive advantage that incumbent banks with capped cost of risk would have in competing for these refinanced loans?
2. There is speculation in the press APS won’t even happen;
3. Net interest income is weakening markedly;
We were worried about net interest income coming into these figures, and our concerns were realised. Combined net interest income across the domestic sector was £18.8bn, down 14% on H2 2008.
4. Aggregate deposit growth is very weak;We calculate that deposit balances across the sector fell by about 7% in the first half of the year. Part of this fall was due to FX, particularly at RBS, but UK based deposits also fell by about 3% on our numbers.
5. Non-interest income is under pressure;It was not only net interest income that weakened in H1 2009. Non-interest income, excluding investment banking operations, was also relatively poor.
6. NPL formation will increasingly be biased to non-APS loans;After an increase of 52% in the first six months of 2009, there is now almost £100bn of impaired loans on the UK domestic banks’ balance sheets. The figure would have been higher were it not for the write-off of certain NPL’s in the period.
7. Tangible NAV impacted by FX.One of the main features of H1 numbers was the weakness in tangible equity versus our forecasts. We have shown “reported” tangible NAV (adjusted for APS scheme) for simplicity in Figure 14, although our preferred measure strips out the APS fee.
Overall, banks have rallied hard in recent weeks, but at current valuations prices are suggesting a return to normality in the not too distant future, in our view. We think this is optimistic and remain fundamentally cautious.
Source: Credit Suisse
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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