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Banking Sector Outlook: The Morningstar View

VIDEO: Can banks be relied upon for steady dividends or are they still struggling under the weight of PPI claims? Morningstar analyst Niklas Kammer explains

Holly Black 7 November, 2019 | 10:33AM

 

 

Holly Black: Welcome to the Morningstar sector review. I'm Holly Black. With me is Niklas Kammer. He is equity analyst at Morningstar in Amsterdam. Hello.

Niklas Kammer: Hi, Holly.

Black: So, you cover the banking sector. UK banks have been reporting over the past couple of weeks. Who have been the winners and losers in the most recent earnings season?

Kammer: Yeah, looking at the last quarter, Barclays was the clear winner. Barclays had a good quarter in the investment bank, which surprised us and the market as well. It was a positive surprise mainly because other European investment banks are currently struggling in that environment, especially competing with global US investment banks. Lloyd's and RBS, on the other hand, are more geared towards the UK macroeconomic environment. And there are really two overriding factors that drive performance there. Number one, ring-fencing regulations in the U.K., which came into force forced UK banks to redeploy excess liquidity into the market, depressing mortgage margins. And then, secondly, credit demand from corporates remains low due to the prolonged uncertainty around Brexit. And then, lastly, PPI provisions were a big factor for all three banks.

Black: I think PPI is a key thing we think of around the UK banks at the moment. Now, the deadline on that has passed but banks are obviously still processing claims. So, I mean, how big a weight has that been on profitability in recent years?

Kammer: It has been quite substantial. There are some differences between the banks, but for example, Lloyd's, Lloyd's in cumulative over the whole time span of this PPI saga has put aside about £22 billion to cover these claims. Those three banks in total together had to put aside about £39 billion. And just to put this into perspective, this covers about 40% of their total market capitalisation collectively.

Black: So, I think banks for investors have historically been a good income investment. They've been reliable dividend payers. Is that still the case? I mean, how safe are those dividends now?

Kammer: Yes, that's a good question. Just today we published an overview of our European banking coverage, just focused on dividend safety. And especially, we're focusing on relative dividends safety. And we build this piece basically around two main questions. Number one, if you're an investor and you already own bank shares for the dividends, how safe is the dividend? So, how safe is it for you to continue to expect this income stream in the future? And we think that the UK banks score pretty well here. And it's mainly due to they're good capitalisation, and especially, the good profitability in the case of Lloyd's and their earnings growth outlook due to, for example, PPI falling away.

And then on the second dimension we looked at, if you're an investor looking to step onto this train, and you want to pick up a bank for its yield, then, out of the UK banks, we would highlight Lloyd's. Lloyd's is the only moaty bank in our UK banking coverage due to its strong retail deposit franchise, and we think the bank is likely to resume its share repurchase program next year. And then, lastly, I would like to stress that even though as you alluded to in the question that dividends for banks have historically been viewed as rather safe, that banks are typically more leveraged than nonfinancial businesses, are cyclical businesses and are more prone to liquidity crisis. So, there is some caution there to be had by investors, and we would tell investors to look beyond just a pure juicy dividend yield.

Black: Niklas, thank you so much for your time.

Kammer: Thank you very much.

Black: And thanks for joining us.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Holly Black  is Senior Editor, Morningstar.co.uk

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