RBS and Lloyds: Profits slump, but what does the future hold for investors in banks?

1st May 2012

Both banks have put in place major turnaround programmes aimed at returning them to profitability, but these plans are disrupted.

The loss for both banks totals a staggering £25billion and counting. And it appears there will be little respite with first quarter results expected to reveal severe difficulties ahead – after all, we've dipped back into recession, and unemployment and household debt is on the rise.

While both banks have plans to help themselves, the future is uncertain. Lloyds has Operation Verde, the name given to the plan to offload 632 branches for an estimated £1.5billion. Meanwhile, RBS has plans to throw off the trauma of the past four years and transform its share price in one fell swoop by slashing the number of shares it has in issue.

In a speech to the Manchester Business School on Wednesday, chief executive Stephen Hester admitted RBS is finding the going tough.

"Economic recovery is proving slower and more challenging and the market and regulatory environment has changed even more dramatically than we bargained for, requiring us to go much further in our safety and soundness agenda," he said.

A sign of things to come was provided earlier this week by Santander, the Spanish bank with a major High Street presence. Santander, the Spanish banking giant with 26.7million British customers, was hit by a credit rating downgrade from Standard & Poor's.

But what does the future hold for investors?

Despite the bad news, the question on the tip of many investors' lips is – Are banks a good investment?

David Kuo, from investment site www.fool.co.uk, said in the Independent: "It isn't hard to understand why many private investors have been drawn to banks."

He points towards anyone who picked up shares in Barclays when they fell to a low of 51p in 2009 – to see them gain 382% in three years. In other words, a £10,000 investment would have turned into £48,200.

These are the kind of exciting returns you would expect from speculative oil explorers, dicey miners and chancey prospectors – not from banks. But are there still gains to be made? Could RBS and Lloyds stage dramatic recoveries?

Certainly the experts didn't know which way the tide would flow this year. The profit forecasts for Lloyds Banking Group to see how confusing it can be. For instance, City analysts had thought the bank could either report a profit of £3bn or a loss of £890m this year.

So how on earth can anyone make a sensible investment decision when the forecasts range from a healthy profit to an unhealthy loss?

There are a number of issues for investors to consider.

The long-term total return from bank shares if an issue. The total return comprises capital appreciation, which is when shares rise over time, and reinvested dividends. Unfortunately for banks, the total returns show a divide between banks that have rewarded shareholders and those that have destroyed value.

RBS and Lloyds, for example, are much tied to the fortunes of the UK and Europe, while HSBC and Standard Chartered have proved good performers over time – but they are far more global in their reach, with a strong presence in Asia.

Over 11 years Standard Chartered delivered a return of 174%, which equates to an annual return of 9%. Put another way, a £10,000 investment in the bank in 2000 was worth around £27,400 11 years later. Meanwhile, Lloyds and RBS destroyed shareholder value.

Of course a key factor is prospects for the eurozone, as the entire European banking sector is interlinked, with banks holding slices of each other's debt and lending to each other on a daily basis to keep the wheels of finance oiled. Another eurozone crisis will be bad for banks, and news of Spain today adds fuel to this fire.

Less tangible and a more mindful method of considering the future for investing in banks is the issue of stewardship – or how bosses treat their shareholders.

Kuo says: "This should be transparent, and they should communicate with shareholders openly and aim to keep salaries and bonuses at reasonable levels. One measure of reasonableness is to only consider bonuses if shareholders have been rewarded with acceptable long-term total returns. In other words, bosses' rewards should be in line with shareholder rewards."

Ask yourself if you would entrust a particular bank with your money because as a shareholder you are a part-owner of the business. That should provide a useful clue as to whether a bank is worth investing in.


More on Mindful Money

After executive pay, where next for shareholder activism?

Bank of Japan announces more QE

S&P downgrades Spain's credit rating

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