Investors should buy UK banks now while they are cheap as their share prices will rise significantly over the next two years, a report published by Societe Generale said; but other analysts contradicted this view because of the gloomy economic outlook.
Even if the UK banking sector was almost over the worst as the report suggested, there are still too many unknown factors which would continue to create volatility in the markets, Chris Wheeler, a banking analyst at Mediobanca, told CNBC.com.
“The problem [for the banks] is the whole macro outlook is still very vey worrying," Wheeler said.
"There are regulation issues, we still haven’t got Basel III nailed down, liquidity issues and what is going to be brought in on liquidity is still an issue for them, we have the stress tests coming up which could be bad news for the sector, we still have the sovereign debt risk which is not going to go away, we could still well have write downs and then finally we have the ICB final report,” he added.
Societe Generale, which focused on the UK’s five biggest banks, Royal Bank of Scotland (RBS), Lloyds Banking Group, Barclays Bank, Standard Chartered and HSBC, argued the UK banking sector was in a far more healthy state than is commonly perceived by most investors and the public.
The report came just two weeks after Moody’s warned 14 banks including RBS and Lloyds that it was reviewing their credit ratings lowering its outlook to negative for the UK banking sector on the belief the taxpayer would not support a further bailout of individual banks.
Societe Generalesaid while liquidity concerns persisted as a result of the financial crisis of 2008, conditions among the banks had improved much more quickly than had been anticipated.
It said the banking sector could see as much as 8 billion pounds in additional revenues by 2013 as interest rates rise over the next two years pushing deposit spreads higher.
And the report argued Britain’s banks would have core tier 1 capital ratios above 10 percent on a fully phased Basel III basis by 2013, meaning more serious capital distribution would be available from the following year onwards.
However, dividends would remain “small while share buybacks were very unlikely any time soon.”
Societe General said UK banks had taken significant steps to improve their balance sheets, but the issue of liquidity still weighed on their share price because 2011 was “a big year for funding maturities,” including much of the financial support the banks received from the government.
However, it predicted, the banks will have completed their full year targets by the end of the third quarter based on the fact they had already achieved between 40 and 50 percent of full year term issuance targets in the first quarter of 201.
Lloyds Banking Group was worst-placed of the UK banks in terms of liquidity, added the report, but had recently stepped up the pace of repairing its balance sheet and had now repaid 87 billion pounds of government funding, leaving a residual £70 billion.
“Because 2011 is the hump for maturities, it also represents the tipping point, we believe. If, as we expect, banks can manage their way through, 2012 and beyond looks much easier," the report said.
"We expect that at their Q311 trading statements, the banks should be able to say that they have reached their term funding targets for the year, and that the peak of the challenge has passed,” it said.
Are Banks Oversold?
The Independent Commission on Banking (ICB) publishes its final report in September and Societe Generale said its biggest concern was that would lead to significantly tougher competition within the sector, which would be negative for future returns for the largest banks.
But, it added, on the positive side while big banks funding was nearly fixed, wholesale funding was no longer available to smaller more aggressive players as it was pre-crisis.
However, Wheeler said the ICB's final report posed the most risk to the banking sector suggesting one member of the ICB had told him the openness of the report had been a deliberate move and that the cost of any new regulation, potential ring-fencing of retail deposit books and money transmission activities were all “preventing the banks from taking off.”
Societe Generale suggested Royal Bank of Scotland would see its share price rise by as much as 61 percent setting a target price of 65p per share from a current share price of 40p per share, while Lloyds would see an increase to its share price of 41 percent to 70p, Barclays a 51 percent increase to 400p, HSBC a 32 percent increase to 825p and Standard Charted an increase of 4 percent to 1635p.
Steven Mayne, director of Mayne Financial told CNBC.com the banking sector had been put under “quite a lot of pressure from traders.”
“In general the banks are very oversold and if you’re looking at the state owned banks particularly they are coming down to levels they historically bounce off because people are looking at them and saying there’s probably fair value here," Mayne said.
"You are getting that on Barclays, you’re seeing that on Lloyds you’re seeing that on RBS and you’re going to hopefully see some bounce upwards," he added.
But, Mayne said, the macroeconomic outlook is so uncertain that volatility in the stock market would remain for the rest of the year and even if banks did trade higher they would not be able to support the FTSE 100 and other markets.
“At these levels there is far more downward pressure on the markets. In the FTSE 100 it will be the banks and the mining companies that drag us higher. Because they’re oversold … It has amazed me the market has rallied given we have had so much bad news and acts of god since December. The volume has been dropping off the stock market probably for the last 12 months, definitely for the last six, and you can’t have a rally that continues on low volume,” he added.