2023 marked a tumultuous period for banks globally, after the US suffered a regional banking crisis sparked by the collapse of Silicon Valley Bank, an event which coincided with the demise of Credit Suisse in Europe.
As financial markets attempted to determine if this could be a repeat of 2008, governor of the Bank of England Andrew Bailey was questioned extensively about the health of UK banks, stating that no additional stress was experienced in the UK banking sector as a result of events in the US and Europe.
Guy de Blonay, portfolio manager of the Jupiter Financial Opportunities fund, said the challenge for UK banks in particular was the “sudden shift by depositors away from current accounts towards high-rate fixed term savings accounts”, which has started to “hit net interest margins harder than expected”.
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This, combined with an “uncomfortable environment” of persistently higher wage inflation, political instability and soaring government debt, has not helped the narrative surrounding the UK economy, de Blonay added.
“The result has been a poor share price performance in the last twelve months for UK domestic banks against the wider banking sector,” he said.
“Fast forward and more recent UK economic indicators at both macro and micro level are starting to suggest that the situation is not quite as bad as the valuation of UK banks implies.”
Juliet Schooling Latter, research director at FundCalibre, added: “I am sure everyone has heard the disclaimer that ‘past performance is not a guide to future returns’, but in the case of the banking sector there is an argument this holds up for the better”.
She said that after a couple of “challenging” decades for the sector, banks today were “safer and more stable” after the Global Financial Crisis thanks to a regulatory overhaul.
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The higher interest rate environment, while detrimental to many other equities, was very beneficial to the sector, as banks achieve better margins in higher interest rate environments, she explained.
While the Bank of England has signalled that it is not attempting to cut interest rates too soon, there is a general expectation in the markets that developed market central banks, collectively, will begin cutting rates this year.
“If interest rates do not go back to zero and the economy holds up, banks could do better going forward,” Schooling Latter said.
Alex Crooke, fund manager of the Janus Henderson Bankers investment trust, said it was “often not appreciated that the UK banks hedge forward their interest earning deposit, and so the benefit of higher interest rates does take longer to come through”.
“Just as investors were disappointed to not see the profit upgrades they expected last year, this year should surprise more positively, as the interest income reported by banks does not collapse as rates fall and is supported by forward hedges,” Crooke said.
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Overall, the Janus Henderson manager said he was “much less bearish “and sees “opportunities to purchase shares in the UK banks for the coming year” but understands investors’ lingering trepidation towards the sector.
“The UK banking sector was tipped to perform well in 2023, principally on the back of higher interest rates benefiting the interest income they earn on client deposits,” Crooke said.
“However, the year proved to be far more challenging…[and] the optimism of last year has turned sour for the coming year, reflecting a worry about bad debts mounting, a sluggish housing market and interest rates being cut.”
Schooling Latter noted the highly cyclical nature of UK banks was something “we cannot ignore”, and also pointed to the potential issue of systemic risk, given banks can suffer because of the poor performance and risk management capabilities of their peers.
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Still, reverting to the ‘past performance’ disclaimer, Schooling Latter said the recent negative sentiment towards banks made valuations cheap, while dividend yields were “generous” at around 5%, “despite the additional stability and safety measures which have been put in place”.
In the UK, banks served as a major dividend provider, she said. Along with oil, the sector was one the largest dividend contributors in the third quarter of 2023, accounting for roughly 20% of all dividends, according to the latest Link Group UK Dividend Monitor.
Schooling Latter said banks would “remain an integral part of any UK income investors’ portfolio, and now is arguably as good a time as any to hold them”.
