23rd September 2015 by The Value Perspective
When it comes to the banking sector, have investors become like the frog in the pan of slowly-heated water – only with, potentially, a much more upbeat ending? The thought has occurred in the wake of our article Robust Banking Story, in which we argued Lloyds and Royal Bank of Scotland are a lot further down the road to recovery than their current valuations would suggest.
This process of reaching a point where the two banks could start to be considered ‘normal’ businesses again has, as we said, taken a long time – longer, certainly, than we expected for a variety of reasons. But has that led investors to stop paying attention to the strides the pair have made since they were effectively part-nationalised in the depths of the financial crisis?
There have undoubtedly been times since then when you could have been forgiven for thinking the banking sector as a whole was deliberately looking for new ways to put investors off. Yet compare where these businesses were six or so years ago – in terms of capital, structure and so forth – and where they are now and the difference is like night and day.
Compare how the market valued the sector six years ago, however, and how it values it now and the difference is nowhere near as marked. In fact, valuations have not moved very much at all, which leads us to wonder to what extent this could be storing up an opportunity for the future.
Certainly we would have expected some change in sentiment by now – that moment, at least, when the market moves from pricing something pessimistically to starting to acknowledge that, way off in the distance, there could be a hint of blue sky. Yet, as we mentioned in Robust Banking Story, not even the resumption of dividends – potentially with RBS and actually with Lloyds – has achieved that.
This is particularly odd given the wider market’s recent love affair with large, well-known, well-capitalised global businesses with the potential to deliver a steady stream of income. Nobody ever talks about banks in that way – not, at any rate, since the financial crisis – and yet it is hard to think of any other sector that has so consistently strived to reduce risk over that same period.
Many other businesses embarked upon a programme of ‘de-risking’ over a period of perhaps two or three years following the crisis but, sooner or later, they have put their foot back on the accelerator. The banks never have – but then, of course, it is also hard to think of any other sector that has so consistently had the boot at its throat over the last six or so years.
If most investors were asked to rank sectors on their financial fragility and likelihood of letting them down come the next downturn, we suspect they would still mark the banks down pretty heavily. Yet would it not be hugely ironic, not to mention satisfyingly contrarian, if banks turned out to be one of the safest parts of the market – simply because they had de-risked so well and raised so much capital that they were now able to weather the tough times better than many more supposedly ‘stable’ sectors?