Is It Time to Buy Banks Again?

LONDON -- Don't let the moaners and groaners fool you. Despite all the negative press, banks have recently been a fantastic investment. These shares have all trounced the FTSE 100 (UKX) index. Bank shares continue to hit new highs.

I've looked into the prospects of the U.K.'s five largest banks: Royal Bank of Scotland (LSE: RBS  ) , Barclays (LSE: BARC  ) , Lloyds Banking Group (LSE: LLOY  ) , HSBC (LSE: HSBA  ) , and Standard Chartered (LSE: STAN  ) .

Company Price (pence) P/E (forecast, 2012) P/E (forecast, 2013) Yield (forecast, 2012) Yield (forecast, 2013) Market Cap (millions of pounds)
Barclays 246 7.0 6.6 2.6 2.9 30,140
HSBC 634 11.2 9.8 4.3 4.7 116,780
Lloyds Banking 46.5 18.6 12.3 0 0 32,705
Royal Bank of Scotland 295 17.1 10.7 0 0 17,762
Standard Chartered 1455 10.9 10.0 3.6 4.0 35,180

Data from Stockopedia.

1. Barclays
Barclays is the outstanding share in the group. It has suffered the most negative press in the year due to its role in the LIBOR scandal. Perhaps as a result, its shares now demonstrate great value.

The low price-to-earnings (P/E) ratio suggests that the investment community is worried about the bank's likely future earnings.

Prior to the LIBOR scandal, Barclays' Bob Diamond was one of the highest paid men in British banking. Much is made in the industry of the importance of high pay to retain key staff. Yet since the controversial Diamond left his role as chief executive, the shares are up almost 50%.

Ironically, I think a LIBOR fine would be good for Barclays' share price. This would help analysts quantify the precise cost of the scandal and get back to examining Barclays' underlying business.

2. HSBC
HSBC is often preferred as the most geographically diverse of the U.K.'s banks. In 2011, the bank made 21.3% of total profits in Europe and 26.6% in Hong Kong. 34.2% was made in the rest of the Asia-Pacific region, and 10.6% was made in Latin America.

This diverse income base helped HSBC weather the financial crisis better than many of its peers. The bank continued to pay a dividend throughout the downturn. Although that dividend was cut in 2008, and again in 2009, it has since been increasing. The dividend forecasts suggest that HSBC management is determined to increase the payout ahead of inflation. A 5.5% advanced is expected for the current year, followed by a 9.5% increase for 2013.

Given the bank's demonstrated resilience, the shares look like they could still be cheap. The average FTSE 100 share trades on a P/E of 14.9. Is HSBC's 33% discount deserved?

3. Lloyds Banking
Lloyds is the big winner this year with its shares doubling in the last 12 months. This has left the shares looking rather expensive. However, there is a case that the shares might still be cheap.

Due to the expense incurred meeting Payment Protection Insurance (PPI) claims, profits at Lloyds this year will be depressed. PPI will wipe over two billion pounds off profits this year, hence Lloyds' high 2012 P/E.

The other part of Lloyds' story is the rate of asset impairment. This is Lloyds' measure of losses on its assets and loans. In the bank's most recent trading statement, it reported 1.35 billion pounds of such losses. While this may sound a lot, it was 40% less than the cost one year previously.

4. Royal Bank of Scotland
Royal Bank of Scotland is majority-owned by the taxpayer. Of the five, RBS came closest to bankruptcy during the financial crisis.

RBS has the largest "beta" of the FTSE 100's banks. The beta is a measure of the volatility in a share price versus the volatility of the index. The result is that owning RBS shares can be a roller-coaster ride.

The three main risks specific to RBS are impairments, LIBOR, and PPI.

Impairments at RBS have also been falling. In its most recent quarterly statement, RBS reported an 11.9% fall in group impairments. Although that's a smaller decline than Lloyds announced, losses are heading in the right direction. While RBS may well cop a fine for LIBOR rigging, its involvement is likely less than Barclays'.

5. Standard Chartered
Standard Chartered is the bank that UK investors often forget. Over 90% of the bank's profits are generated in Asia, Africa and the Middle East. It is only the bank's sponsorship of Liverpool FC that makes them a household name in the UK.

Standard Chartered survived the financial crisis better than any other U.K.-listed bank. Although the dividend was cut 11% for 2008, it increased in every other year. The shareholder payout is now higher than it was before the credit crunch began.

Standard Chartered hasn't been without problems. Earlier this year, U.S. regulators fined the bank $340m over transactions Standard Chartered had processed for Iranian clients. This scandal has caused the bank's shares to lose almost 30% of their value.

Standard Chartered is expected to increase earnings 8.7% this year and 8.8% the next.

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