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Do we trust banks to make us money?

The fund managers looking after our ISAs and pensions are divided as to whether bank shares are on the road to recovery

 

by Gavin Lumsden on Feb 22, 2013 at 17:18

Do we trust banks to make us money?

Banks remain as hot a topic with fund managers as they do with everybody else as the UK economy continues to struggle in the aftermath of the financial crisis.

You might have thought that the highly-paid fund managers looking after our ISAs and pensions would see the bankers as some kind of soul-mates in the City.

Not at all. In fact most professional investors are as cross as the rest of us at the crazy, bonus culture that led banks to build up hugely dangerous risks in their businesses before the 2008 crash.

Woodford is out

Neil Woodford, the country’s most famous fund manager, has had nothing invested in banks since before the crisis. That’s quite something given he has over £20 billion in the Invesco Perpetual Income and Invesco Perpetual High Income funds.

Of course fund managers like Woodford are less emotive than many of us would be when discussing the banks. Their focus is on the bottom line and the big debate here is whether banks, which have started to report their 2012 results and whose shares have surged since last summer, have really recovered.

Woodford is firmly in the ‘No’ camp. This week he argued that bank profits were ‘unlikely and unsustainable’ as the sector dealt with a legacy of bad debts.

Citing the example of Santander, the Spanish bank that bought Alliance & Leicester and Bradford & Bingley, Woodford said its 2012 results had not been as good as they might have appeared. Profits rose 2% before provisions against bad debts that might not be repaid, but those provisions leaped 50% to €18.8 billion!

Profits under a cloud

Woodford latched on to a comment from Santander that the surge in provisions was thanks to ‘the strength of the bank’s earnings’ to proclaim that banks would be hobbled by their reckless past lending for some to come. Because they lacked sufficient reserves, every time they made a decent profit they had to use some of it to write off more toxic loans which they would never get back.

Woodford said Santander’s statement was ‘an explicit acknowledgement that the lack of capital in the banking system means that banks can only recognise existing losses if they have the profitability to do so.’

So although banks are no longer in danger of collapse like they were five years ago, the fact that regulators are forcing them to make their businesses more secure mean future profits remain under a cloud.

This is why Woodford is happy to shun banks, preferring instead the cash generative powers and resilience of tobacco and drugs companies.

But someone likes Lloyds

But like I said this is a debate. Among those on the other side is Mikahail Zverev, head of global equities (shares) at Standard Life Investments, who insists some investors are missing the point about Lloyds Banking Group’s recovery.

Lloyds had to be bailed out by the taxpayer after it was encouraged by the previous government to take over HBOS (Halifax Bank of Scotland) as it teetered on the verge of collapse.

Under chief executive Antonio Horta-Osorio, who used to work at Santander, Lloyds has slimmed down, netting around £1 billion in the past 12 months from selling unwanted businesses. Its shares have soared 60% in the past six months as investors have believed Horta-Osorio’s assertion that the bank is ‘stronger and safer’.

We’ll get an update on how Lloyds is progressing next Friday when it reports its full-year results. 

Zverev, who runs the Standard Life Investments Global Equity Unconstrained fund, argued Lloyds was the stand-out choice in the banking sector because of what it can do with the money it has raised. ‘The thing the market has missed is that when Lloyds releases that capital it gets redeployed to domestic lending, and that’s where it makes a difference.

‘The market is not trusting them to do this,’  Zverev added.

The lack of trust in Barclays was also evident when it released its full-year results this month. A 26% rise in adjusted pre-tax profits and a sweeping plan by new boss Antony Jenkins to cut costs and reduce its notorious investment bank took a while to sink in. The shares did nothing for the first 40 minutes of the day before soaring 9% as the City decided it was good news.

This delay enabled Guy de Blonay, manager of the Jupiter Financial Opportunities fund, to top up his holding in Barclays. Blonay has done well on Barclays, pouncing on the shares last summer when they were trampled in the dust at the height of the Libor rate fixing scandal, which saw Jenkins’ predecessor, Bob Diamond, ousted.

Blonay said: ‘In a nutshell, everything we wanted to hear from the management has come in the one day. Even though we had heard it in bits before, it came with a tone which meant you can believe with conviction Antony Jenkins can do it.’

It is clear others do not share this conviction in Barclays or its rivals. Watching which side is proved right will be fascinating. A lot of our money is riding on it.

3 comments so far. Why not have your say?

Dennis .

Feb 23, 2013 at 13:31

Banks will never be the same again as an income investment, they will be highly regulated and effectively under government control which for me says that there must be better opportunities elsewhere.

There are some sectors where you are "not supposed to make profits" for political reasons, eg health and education. I think you can now add banks to the list.

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mikest

Feb 23, 2013 at 15:28

I agree with you up to a point Dennis, but perhaps you’re forgetting that the govt. have a vested interest in getting the banks back into the black so that they can start selling off their holdings at a profit. This probably won’t happen until closer to election time but, having stuck with them through the rough stuff, I’m prepared to be patient for just a while longer.

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Dennis .

Feb 24, 2013 at 09:20

I think you might be right short term in that if the govt does a public offering (to sell us what we already own!) then it will probably be at a discount. However, I can then see them coming under political pressure to keep profits low. There is a similar process happening at present with National Grid and the utilities. The issue is that there are probably better investing opportunities elsewhere.

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