Recent share price rises suggest the worst may be over for many lenders, but there could still be big losers

Published on Saturday 21 November 2009 14:16

LLOYDS Banking Group shareholders will gather in Birmingham on Thursday to decide whether to give it the green light for a further capital raising exercise and approve a £13.5 billion rights issue.

Banking shares are among the stock most widely held by small investors, particularly in Scotland. Millions received free shares with the demutualisations of Halifax, Northern Rock, Leeds, Bradford & Bingley, Woolwich and other building societies. Other investors invested heavily in the reputedly "safe" Scottish banks.

Beyond that many thousands of not particularly well-paid staff trusted all their savings to their companies via share-save and other incentive schemes. They were wiped out when the banks imploded, and many now also face losing their jobs.

Yet since March, the recovery story in the sector has been spectacular. As a group, UK banking shares have grown an astonishing 150 per cent, compared with an equally impressive 52 per cent rise in the FTSE index of the top 100 companies.

Yet the bounce back came from a woefully low base, and the challenges ahead for many of the banks remain formidable.

On Wednesday, the Supreme Court is expected to issue its landmark ruling on overdraft charges, which could rip to shreds current account profits. And the European Commission is agitating over lack of competition and may call for further disposals.

Either way, banks face significantly increased regulation, which will push up costs and constrain recovery. Ultimately, their break-up cannot be ruled out.

So, overall, banking remains a pitiful story, although it is a tale with many sub-plots, some of which look set for relatively happy endings. The credit crunch largely sidestepped the Australian and Canadian banks, which are in good shape, admittedly because recent banking collapses have ensured they learned about the dangers of excessive risk-taking.

HSBC's share price back to its pre-crunch levels, currently trading around 731p, having dived to 304p earlier this year. Its exposure to the Far East, where economies are growing, augurs well.

By contrast, Halifax shares, which had reached 12, collapsed to little more than 30p. Following Lloyds takeover, the group's shares now top 90p.

Similarly, the demise of Royal Bank of Scotland shares to around 50p from 6, will have churned the stomachs of many Scots who put their entire life savings into what they considered a rock-solid investment.

The jury is out on Barclays, which avoided taking direct taxpayer support, but gained a large Arab shareholder instead. Its share price has recovered to around 312p, having dropped from 8 to around 50p. It has retained its autonomy, and its investment bank, Barclays Capital, is storming ahead. Yet it faces many of the same challenges that floored Lloyds and RBS.

So what are the prospects for UK banks? Much will depend on the economies on which they rely, and how they recover. With the exception of HSBC, most UK banks are heavily exposed to the domestic economy and vulnerable to a weak recovery. Furthermore, there are concerns that more toxic loans will emerge with a new avalanche of company failures next year.

SVM's Colin McLean warns: "We don't normally see all bad debts coming through until after the recovery has taken place. In Scotland, we have already seen the collapse of the Kenmore property group, which wasn't expected, and I think we can expect more of these to come from some of the aggressive lending carried out by Bank of Scotland."

Seven Investment's Justin Urquhart Stewart added: "You have to ask yourself, where is the growth? Banks need economic growth to thrive, and here in the UK that could be very sclerotic. "

For Bryan Johnston of Brewin Dolphin, government interference is a worry. He said: "Lloyds and RBS are no longer masters of their own destiny. They are in hock to the state and arguably being forced to sell off their engines of recovery. Now the bureaucrats are in charge, which has to be of concern."

Rights and wrongs of taking stock in a turbulent sector

SOME banking shares are unbelievably cheap, and contain fundamentally sound businesses. In five or ten years, those who hold on to their shares may not regret their leap of faith.

But that does not necessarily mean you should risk more. Small investors can be forgiven for being bewildered by all these developments, and not knowing whether to hold their existing stock, sell or buy more, or whether the subscribe to the upcoming Lloyds issue.

Here Scotland on Sunday tries to answer your questions:

Q: What is a rights issue?

A: Existing shareholders are given the right to buy new shares at a discount.

Q: Should I take up the Lloyds offer?

A: We don't know yet. It will come down to the price, which will not be announced until after the meeting on Thursday.

Q: What is the point of voting then?

A: The ballot is to approve the capital raising exercise in principle.

Q: Must I attend the Birmingham meeting to vote on the Lloyds rights issue?

A: No: you can vote either by post or electronically, but this must arrive by 11am on Tuesday.

Q: Why are they holding the issue?

A: The bank wants to bolster its capital, to allow it to lend more freely, but it also wants to avoid having to pay the government the nearly 16 billion it is demanding to join its credit insurance scheme. With more capital, it won't need to join the scheme.

Q: Is it sensible to put more money into Lloyds?

A: SVM's Colin McLean says if you want to invest in the stock market there are better uses for your money, not least because the prospect of receiving dividends for a couple of years yet looks remote. McLean says: "One of the main attractions for investing is to receive a regular income. If you are not getting one, where is the value?"

Killik & Co's Jonathan Jackson says: "Lloyds is essentially a bet on the UK economy. If you think the prospects are good then it will be good for Lloyds. Most people believe we have a difficult few years ahead. That said, Lloyds is very cheap."

Which is where it can be attractive for the punters. Those who subscribed to its smaller placing earlier this year did well. They bought at 38p, so have more than doubled their money.

Q: When will RBS shares return to their previous highs?

A: You are in for a long wait. RBS was the biggest loser in the credit crunch and has few competitive advantages. In time it may be sold back to the private sector via a big privatisation exercise, but you may have to wait for decades. There is no prospect of a dividend for some time to come.

Q: Will HSBC continue to outperform the other high street banks?

A: It is well placed. It restricted its lending largely to the amount of cash it hand in the bank and did not become embroiled in the toxic loans which did such damage elsewhere. But it is its exposure to emerging markets which should drive strong growth.

Q: Should I sell my Barclays stock?

A: Killik's Jackson is bullish about Barclays, which even managed to pay a small bonus, and believes you should hang on or consider buying.

Others are concerned about the uncertainty of the Arab owner and its ultimate intentions.