Over the past couple of quarters we have been inundated with questions regarding the banking sector, and in particular how it will perform should the current economic cycle deteriorate.
We agree that the banking sector probably still has to ‘prove’ its credentials during the next downturn before it can fully regain investor confidence, and for that reason we can expect the sector to attract its fair share of volatility in the event of a sharper than expected slowdown.
However, we continue to see the sector as a source of relative value, and we think any volatility should be viewed as a potential buying opportunity for the right names, particularly at the shorter end of the curve.
A good illustration of this point was the release of Barclays’ full-year results for 2018 this morning. We all know UK banks have the additional headwind of Brexit uncertainty to contend with, and thus it is no surprise that investors have focused their concerns on the country’s domestic players. It was therefore encouraging to see that for the year just passed, Barclays reported income unchanged at £21.1bn alongside a reduction in costs and impairments, which helped increase profit-before-tax by around 20%.
More importantly for subordinated debt holders, the key CET1 capital ratio was reported to be 13.2% at year-end. This was slightly down from the 2017 number (13.3%), primarily due to litigation and conduct costing the bank 71bp, but still healthily above the regulatory minimum of 11.7% set following the 2018 stress test.
We fully appreciate there are headwinds for the banking sector along with the rest of the economy. Indeed, HSBC and RBS have both recently sounded caution in their near-term assessment, with HSBC taking an increase in its impairment charges in anticipation of economic uncertainty. However, on the flip side, Lloyds CEO Antonio Horta-Osorio on Wednesday declared “absolute confidence” in the UK’s economic prospects, reporting “no change or deterioration in any key segments” of the business, with a £1.75bn buyback endorsing his view.
For us, though, our real comfort in this sector arises from the maintenance of surplus capital by the large banks, giving them a robust buffer against any material downturn in the economy. Sure, there may be some mark-to-market volatility as investors become cautious in periods of economic stress, but while capital ratios are maintained well above regulatory minimums we continue to see investment opportunities in the banking sector, particularly at the shorter end of the credit curve.