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Ten years after banks hit their lows, sentiment towards the sector has once again turned sharply negative. Most bank shares are now at a 40%+ discount to broader equity markets which is significantly larger than their historic levels. This is despite the huge amount of work, led by regulators and legislators over this period, making the banking sector far stronger, more stable and therefore more attractive to investors today. So, is the current pessimism misplaced or still valid?
The crisis led to a concerted effort by governments and regulators worldwide to ensure individual banks were run as financially stronger businesses. Today, however, expectations for interest rates to be cut from their already low levels, against a background of relatively lacklustre economic growth, has resulted in markets expecting a weaker outlook for the sector. Therefore, at best share prices have lagged the underlying equity market, or at worst fallen in absolute terms.
Nevertheless, we believe investors are hugely overestimating the risks. Years of very little loan growth, much tougher regulation and stronger balance sheets all suggest a banking system that is well placed to weather a downturn. The amount of capital a bank is obliged to hold to compensate for the risk of individuals or companies defaulting on loans is now at multi-year highs. Lloyd’s Bank, for example, now holds twice as much capital as it did in 2008.
Another change we have seen in the past decade is a huge shift to digital banking, with many commentators talking about the risk the sector suffers in the same way as retailers have thanks to technology-led disruption, in this case from fintech companies. Investors, however, are underestimating the ability of traditional banks to compete in this area, their ability to outspend new entrants and cut costs alongside the fact that the regulatory advantage start-ups are likely to have will be eroded as they grow.
Ten years on, a duller, more boring banking sector is what makes the financial sector overall a much more attractive proposition today. It is made more attractive when coupled with the high level of capital return via dividends and buybacks that they offer. Maybe we will have to go through another downturn for investors to finally believe that risks have reduced, and that any slowdown may well be the catalyst for a recovery in the sector.
As John Maynard Keynes said: “When the facts change, I change my mind. What do you do, sir?”
Nick Brind and John Yakas
Co-Managers, Polar Capital Global Financials Trust
September 2019
Disclaimer
Polar Capital is a limited liability partnership with registered number OC314700, which is authorised and regulated by the UK Financial Conduct Authority ('FCA') and is registered as an investment advisor with the US Securities & Exchange Commission ('SEC'). A list of members is open to inspection at the registered office, 16 Palace Street, London, SW1E 5JD.
All opinions and estimates in this report constitute the best judgement of Polar Capital as of the date hereof, but are subject to change without notice, and do not necessarily represent the views of Polar Capital. Polar Capital is not rendering legal or accounting advice through this material; readers should contact their legal and accounting professionals for such information. This is not a prospectus, offer, invitation or solicitation to buy or sell securities and is not intended to provide the sole basis for any evaluation of the securities or any other instruments, which may be discussed. This is not a financial promotion. This is not a personal recommendation and you should consider whether you can rely upon any opinion or statement contained in this document without seeking further advice tailored for your own circumstances. The law restricts distribution of this document in certain jurisdictions; therefore, persons into whose possession this document comes should inform themselves about and to observe, all applicable laws and regulations of any relevant jurisdiction.
