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Banks dropping ahead of Brexit

Daniel Lane

Daniel Lane - Fidelity Personal Investing

It’s been a tough year so far for the banks. Brexit, lower for longer interest rates, unpredictable mortgage application volumes and various fines have all weighed on the sector’s leaders. So, investors attracted to the nation’s lenders will have been watching this week as results from some of the UK’s big hitters put numbers to the rhetoric.

RBS

Today’s update from RBS showed just how big an impact Brexit uncertainty continues to have on the sector.

The bank reported a second quarter profit of £1.3bn and vowed to return £1.7bn to investors through a 2p dividend and 12p special dividend. And despite its confidence that 2019 expectations are within reach, and could be boosted with foreign currency movements, RBS is much less certain on 2020. Shares are down 6% at the time of writing, with the bank pointing to a backdrop of economic and political uncertainty, as well as the contraction of the yield curve.

Today’s results noted: “It is very unlikely that we will achieve our target return on tangible equity of more than 12% and cost:income ratio of less than 50% in 2020.”

And it isn’t just RBS highlighting the Brexit effect. Earlier this week, Lloyds boss Antonio Horta-Osorio said the “continuing uncertainty is having an impact and leading to some softening in business confidence as well as in international economic indicators.”

Pre-tax profits at Lloyds dropped 1% to £4.2bn in the six months to June 30, with shares down as a result. However, a surge of claims related to the PPI scandal ahead of the August deadline forced the group to bolster its reserves, bringing pre-tax profits down 7%.

Brexit aside, investors will be keen to see a line drawn under the issue after the summer to get a better picture of the day to day balance sheet without the constant compensation payments.

Another of the big players updating the market this week was Barclays. The bank reported a net profit of £1.03bn in the second quarter, nearly 4% behind forecasts and 16% lower than this time last year.

However, chief executive Jes Staley insisted full-year profitability targets were achievable, in part through aggressively cutting costs in the business.

Staley pointed to lay-offs, reduced bonuses and lower investment spending as necessary measures to bring the bank’s annual expenses below £13.6bn - the lower end of the range previously reported.

Despite the less than rosy results, Barclays lifted its interim dividend by 20% to 3p - a welcome announcement for investors who have seen regulatory fines hinder dividend progression in recent years.

With a week full of results like these it’s easy to write off the sector from an investment point of view but there are those whose interest is piqued by the word ‘uncertainty’. Contrarian fund managers with an eye on the eventual normalisation of interest rates and the end of compensation payments are making the case for investing in banks and the wider financials sector.

One of those investors is Alex Wright, manager of the Fidelity Special Situations Fund.

A look at the current top 10 names in the Select 50 fund gives a good indication of the contrarian nature of the manager’s approach, with holdings in companies and industries many fund managers have avoided completely in recent years, including RBS.

The manager has consistently had over a third of the fund in financials but, noting that competition in the UK banking space is thinning out margins among high street banks, he explains his other holdings in the sector: “Life insurance is something we’ve held in the fund for a while. I think the interesting thing is they have UK-based earnings but actually their models aren’t very tied to the UK economy because they invest in international assets. Unlike the banks who are finding it hard to grow but are producing good dividends, we’re seeing really good dividends from the life insurers as well as growth, and they’re cheap, which is quite an unusual combination.”

Five year performance

(%)
As at 1 Aug
2014-2015 2015-2016 2016-2017 2017-2018 2018-2019
RBS -2.3 -44.7 32.5 1.4 -10.1

Past performance is not a reliable indicator of future returns

Source: FE, as at 1.8.19, in local currency terms with income reinvested 

Important information The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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