Investors remain wary despite buoyant results

THE recovery of the UK's banking sector is far from complete even after they unveiled better than expected half-year results this week, experts have warned.

Banking stocks plunged dramatically in 2008 but buoyant results published this week appear to have accelerated their recovery, thanks primarily to a dramatic reduction in bad debt levels.

However investors tempted to interpret the results as a signal to dive back into the sector have been advised to heed the lessons of the banking crisis.

On the face of it, investors with holdings in banks, or considering reinvesting in the sector, have plenty of reasons to be cheerful. Lloyds Banking Group, 41 per cent owned by the taxpayer, reported pre-tax profits of 1.6 billion in the first six months of the year, compared with a loss of 4bn in the same period last year, while RBS, 83 per cent taxpayer-owned, made profits of 1.1bn.

Barclays recorded a better than expected 44 per cent rise in pre-tax profits to 3.947bn for the first six months of the year, Northern Rock made a 350m profit in the first half of the year and HSBC posted 7bn profits for the same period.

Standard Chartered's profits for the six months to June were up 10 per cent while in Europe Societe Generale reported a threefold rise in profits in the second quarter and BNP Paribas reported quarterly profits were up by almost a third.

The results have exceeded analyst expectations and prompted a revision of the outlook for the sector.

Eric Daniels, chief executive of Lloyds, claimed the next few periods would be even better for the bank. However this week's figures could be deceptive.

The pre-tax profits reported by Lloyds and HSBC in particular owed more to reduced levels of bad debts than any increase in revenue, with investment banking down 11 per cent from a year ago.

The Barclays return also reflected a significant fall in bad debt costs and a trebling of profits at its investment division, Barclays Capital.

And Ken Taylor, director of Mackenzie Taylor Wealth Management, said that doing less badly should not be confused with positive growth.

"Of course as we all own a stake in the Scottish banks as taxpayers it must be viewed as positive that their trading position is improving, but it is certainly not business as usual and lending remains very challenging," said Taylor.

Bank performance could also be affected by the impact of continued low interest rates on the returns earned by their reserves, He added: "Personally I do not view investing in bank stocks generally as being the soundest strategy." Taylor was far from alone in exercising caution. Adrian Lowcock, senior investment adviser at Bestinvest, suggested investors should keep in mind the lessons of the 2008 banking crisis.

"One of the most surprising and deeply disturbing issues of the crisis was just how little people understood of the banking sector's finances and balance sheets. In many instances this included the bosses of the banks themselves. Whilst things have become a lot simpler, banking balance sheets remain complex and beyond the reach of most investors' expertise."

Haig Bathgate, investor director at Turcan Connell in Edinburgh, is similarly wary of investing in banks. He also points to the complexity of bank balance sheets, where it remains difficult to understand their underlying exposure.

"After the scale of the borrowing boom there is still likely to be a large number of problem areas in the domestic banks' balance sheets even though some of them have started to post seemingly healthy profits."

Bathgate is also deterred from investing in the sector by the prevailing economic uncertainty, with the potential for a double-dip recession to impact the banks from a bad debt perspective. "Even if that doesn't happen, with the austerity measures only starting to be implemented and unemployment set to increase further, there is a significant possibility that default rates will increase on loans and mortgages," he said.

Those who do want some exposure to the banks should invest through collective funds to help reduce the risk. Lowcock recommended the Jupiter Financial Opportunities fund, now co-managed by leading financial sector experts Philip Gibbs and Guy De Blonay.

"Whilst the outlook for banks continues to improve and the sector has offered up some opportunities, it is very difficult to determine when to buy," said Lowcock.

"The share prices continue to remain volatile and investors should avoid rushing in on the back of a wave of euphoria." Many investors also have dividends to worry about, particularly after the hammer blow of the suspension of the BP dividend for 2010. Both RBS and Lloyds are banned from paying a dividend to shareholders until January 2012, under the taxpayer aid agreement.

It's not only those investing in banks that are affected by this week's results.

Brian Steeples, managing director of Glasgow-based IFA the Turris Partnership, said the UK needs a robust and profitable banking sector to underpin economic growth and stability.

"The investment markets have reacted well to this week's bank results and that is healthy. Whilst the economic recovery remains weak, albeit positive, the base rate will remain artificially low. Once a more stable , stronger recovery is under way, the base rates will increase to more normal levels of around 3 per cent. That may be still be 12 months away."