Once the cornerstone of any income portfolio, financial stocks tumbled from favour during the global recession.
Banks could no longer be relied upon to pay regular dividends, depleting the pot for those reliant on yield. But over the past five years due diligence, government bailouts and more stringent operating guidelines have meant banks are returning to the dividend table.
Investors should be aware they may have missed the first bounce back however. That happened in 2012, when Barclays share price bounced 31% and hedge fund manager Crispin Odey - among others - reaped the rewards.
Below, we've rounded up Morningstar analysts' ratings on the key financial stocks.
Lloyds Banking Group reported net income of £1.6 billion for the first half of the year after absorbing £768 million of exceptional charges. These included £500 million of additional charges for the mis-selling of PPI, and £786 million of restructuring expenses, which were partially offset by exceptional gains like the £433 million gain on the sale of shares of St. James Place.
By a number of measures, Lloyds' results showed that the bank's operations are improving.
We're happy to see that the bank is making solid progress on costs too, pushing underlying costs down 6% sequentially and thereby decreasing the bank's cost/income ratio, as we calculate it, to 50% from 55% in the second half of 2012. For a retail and commercial bank like Lloyds, we typically see a 50% cost/income ratio as a marker of an especially well-run institution.
We're also pleased to see that Lloyds' legacy risks are shrinking. Moreover, the bank's share price has risen above the government's bail-out price, which means that it may soon sell its stake.
ROYAL BANK OF SCOTLAND (RBS) - ***
Royal Bank of Scotland reported net income of £142 million in the second quarter, down 64% sequentially, but reversing the £466 million loss reported in the year-ago quarter.
It also announced that Ross McEwan, currently head of the U.K. retail operations, will take over for Stephen Hester as CEO in October. Reported profits were hurt by net £383 million of unusual items including £185 million of fresh PPI provisions.
We're pleased enough with the choice of McEwan as chief executive - we've heard good things about his leadership skills, and we're glad to see a retail banker appointed instead of an investment banker--but we think that RBS likely had a very shallow pool of candidates to choose from because of the overhang of government interference.
McEwan accepted a salary of £1 million, and no bonus in 2013 or 2014. We're all for reining in banker pay and returning more of it to shareholders, but this compensation is too low to be competitive and clearly limited RBS' options.
We think this, and other types of government interference, remain a key risk for the bank until the government stake is disgorged.
Despite the financial crisis and the now-changed banking landscape, Barclays has continued to focus on high-profile but risky businesses such as investment banking through Barclays Capital (about half of pretax profits in 2011 and 2012, but 80% in 2010) and international retail and commercial banking.
As a result, it has struggled to bring compensation costs in line with revenue and has suffered embarrassing risk management lapses. We're hopeful that the recent Libor rate-rigging scandal will have a silver lining by prodding the bank to pull back from its riskiest activities.
Already, the scandal has resulted in new management, with Antony Jenkins and David Walker now in place as CEO and chairman, respectively. We think their past work in retail banking and banking ethics portends a new road ahead for Barclays.
We are lowering our fair value estimate by 40p to 320p, closer to the current share price of 280p. The share has a Morningstar rating of three stars, which means it is considered fairly valued.
Although concerns about Barclays' viability have eased, questions about write-downs and long-term profitability remain. Loan losses, while still above historical levels, have eased but could rise sharply if turmoil deepens in Europe.
Regulators almost certainly will require Barclays to hold more capital in the future, which will reduce shareholder returns and may require the bank to raise even more capital. Tougher regulations and client risk aversion may mean investment banking profits never return to historical levels, and Barclays will need to do a better job controlling compensation costs if shareholder returns are to increase.
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