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Income Investor: should you buy UK bank shares?

Despite PPI mis-selling, Libor manipulation and money-laundering fines, our banks still have plenty to offer, says Income Investor.

Income Investor: should you buy UK bank shares?

For investors, the UK banking sector is widely seen as a bombed-out disaster area: one to avoid.

It seems that every day brings more scandal and failure relating to the UK's big retail banks. Barclays (BARC.L), Lloyds (LLOY.L), HSBC (HSBA.L) and Standard Chartered (STAN.L) have all hit the headlines for the wrong reasons. PPI mis-selling, Libor fines, money-laundering fines, operating losses – the list of bad news seems to never end.

What to do with bank shares?

Many income investors – like me – are probably sitting on holdings of shares in banks that used to be great dividend plays but were decimated when the UK government had to step in and save the banking sector from failure.

As part of the deal, dividends were stopped, and some fixed-interest securities were modified. Many will have lost money on the fall from grace of RBS (RBS.L).

But among the carnage there are some opportunities.

As I pointed out in a previous article, preference shares and corporate bonds issued by UK banks have provided high yields and substantial capital appreciation for the brave (or reckless?) investor who was prepared to buy them following the banking crash. Even today, yields on bank securities are still some of the best on offer.

And the value of bank shares has been shooting up this year: for example, Lloyds has doubled in value, even though it is not yet paying any dividend. Barclays is up (although by not as much) and is paying dividends again with a forecast yield of 2.7%. Even RBS has picked itself up off the floor.

Where the markets are heading

The fear of a total collapse of the international banking system is now receding. The continuing euro crisis continues to play out, but a solution seems to be emerging from the political mist. So we have two main price trends:

  1. Fixed-income bank securities have increased in price (reducing their yield), primarily owing to the huge amounts of government money being pumped into gilts, dragging down the rest of the fixed-income market.
  2. Bank shares have been rising strongly, despite continued bad news.

Now, I’m not a ‘value investor', but even I can see which way the market is moving.

So what to do now?

  • If you are an income seeker and not already invested in the banks, you may want to buy some high-yield fixed-income securities. But be aware that, although you will retain your purchase yield, you will see a capital loss unless you buy below par and are prepared to hold it to redemption or ‘call’.
  • If you are a ‘buy-and-hold’ income investor and are still holding bank shares, keep holding.
  • If you have a ‘value’ part to your portfolio, consider buying bank shares.
  • If you hold fixed-income securities from banks, you may have the chance to lock in capital gains by selling in the not-too-distant future, as it looks like QE may be coming to an end.                              

Finally, there is perhaps one potential further opportunity. My guess is that if unrest grows in Greece, the ‘least-worst’ solution may be for Greece to temporarily leave the euro for it to recalibrate its economy.

If this happens, there is likely to be a buying opportunity for bank shares and securities. So make sure you have some cash available.

If you've enjoyed this article, why not visit DIY Income Investor's blog? The views in this article are the author's own, and do not constitute advice.

5 comments so far. Why not have your say?

Rob Walker

Nov 07, 2012 at 14:00

I am surprised that the Greek exit from the Euro should be flagged as a buying opportunity and not the potential US fiscal cliff. Even if the US kicks the can down the road again, the period leading up to any conclusion on this is likely to have some days of extreme pessimism - that's when I will be buying, not wait for the possibility of a Greek exit which may not ever happen.

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Ken Adams

Nov 07, 2012 at 17:33

Apart from the dangers of having a business run by an irresponsible mob of yahoos, and the dangers emmanating from European indebtedness which could easily bring down a bank, and the dangers from the american fiscal cliff.

I agree they would be an excellent investment.

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Mark Lance

Nov 07, 2012 at 22:19

I am curious as to why everyone is jumping on the buy bank shares wagon when lloyds are around 45p when most experts were saying they were a posioned chalice earlier in the yearwhen they were sub 30p?

I sold all my lloyds shares at a good profit for 41p the other week and although slightly annoyed at this further rise , especially when they have had to set aside more money ( when will they stop having to come clean, are they still lying? are they finally telling the truth? ) I am not convinced that banks like lloyds are out of the miss selling woods. Lloyds aren't responding to Fos on many contested ppi claims, they are often proved to tell people they were never sold ppi when the person has a statement showing they did. Watchdog did a piece on them a week ago.

I for one think their is more bad news fines and pr issues for these banks, so would say leave them alone for at least 6 months to make sure all those skeletons are out on show and the closet doors remain closed!

Or does everyone think their share price has nearly doubled so its suddenly a great time to buy

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Nov 08, 2012 at 18:34

I agree with Mark Lance, I think there are skeletons yet to be exposed, to some extent I can sympathise with the banks reluctance to come clean, it could easily trigger a run and no High st bank is in any state to risk that so the bad news trickles will continue for sometime yet. remember, a banks assets are mainly other peoples loans and they are only worth what borrowers are prepared to pay back.

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Lawrence Sautter, Chartered MCSI

Nov 11, 2012 at 15:56

Stick to or keep on buying high quality dividend stocks, but not banks. Market confidence for banks is not back yet and this low interest environment is not healthy for banks. Banks are not attractive considering they have to rebuild confidence and proof that they have done their homework. This takes time, it is not a quick fix, I'm afraid. For stock ideas follow me on Twitter: sautterlas65

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