Bank Shares – still toxic in 2013

Back in the early 2000’s, bank shares were some of the best long bets you could take in the market.  They were viewed as de facto defensive utility stocks, when in reality they were leveraging up their balance sheet from 20x to 30x and even 50x in the case of those exotic Icelandic banks

Of course, we all know how this ended in 2007-8… The wheels not only came off, but the wreckage careered over the cliff as well and took the poor British tax payer with it! All bank shares were caught up, even the more restrained organisations such as HSBC and which managed to rack up £20 billion in losses on sub-prime mortgages and other exotic CDO and CLO products.

Since then, many banks such as RBS and Lloyds have been reduced to penny share status,  Government bailouts and the ignominy of share consolidations to restore prior share prices!

As well as the hangover from their own bad debts, the regulators have got to work bashing the banks for all their mistakes too and imposing regulation piles on regulation. There is the Vickers report, Basel III regulations and the retrospective changes to product laws havealso  really kicked in. In response, the banks are shrinking their investment banking divisions and putting aside huge provisions for mis-selling on everything from PPI to Derivatives.  We have not even mentioned the Euro Crisis…

Despite all of these headwinds, banks are of course a utility business for corporates and retail customers. As such they can turn out big profits every year even in hard times. During the crisis, they have been able to hugely reduce employee compensation and also sell off the non-core assets they acquired in the boom. This slimming down has started to make big improvements in their returns on equity.

So what will happen next? Every year it seems, bank shares have a run up in their share prices until their results come out, this pattern for long positioning has held steady for 3 years now. Looking at RBS its shares are up 40% in a few months.  However, be prepared for its usual denouement and this year will be no different I guess. Despite their efforts, the pain of mis-selling scandals and re-structuring is still ever present and this year won’t be the year that the big banks turn around their profitability. Also, they are still over exposed to the housing market and the euro-crisis and as either of these can turn nasty in 2013 there is still huge risk in the bank shares, more so when they have run up collectively to the degree that they have in the past few months.