Is it Still Relevant to own Banking Sector Stocks like Lloyds & NatWest Group?

Summary

• The financial sector has been under pressure with most of the economic activities getting halted due to the unprecedented crisis
• FTSE 100 listed UK lenders are in a much stronger position than they were during the financial crisis of 2008
• LLOY and NWG despite remaining resilient are expecting higher impairment charges in the second half of 2020

As international trade evolved, banks grew in demand. During the unprecedented crisis, the financial sector has been up and running. The stimulus packages announced by the British government such as Bounce Back Loans and other schemes have been facilitated through the existing banking system. Banking, Insurance, and non-banking entities constitute the financial services sector. The concept of banking has been in existence from centuries.

If we talk about the banks, their primary revenue comes from the interest payment made by the borrowers. The banks generate secondary revenue from fee-based ancillary services. Banks control the flow of credit in an economy. The Bank of England (BoE) has already slashed the interest rates to an all-time low. Usually, this should result in increased credit levels, but that is not happening. With most of the economic activities getting halted, the consumers had few options to spend on. Since they were left with more money in the pocket, they chose to clear their dues. Similarly, even if they had taken loans, there would be very little opportunities to spend or invest.

Due to the economic impact of the outbreak of Covid-19, the borrowings have certainly declined during the lockdown. Due to the unprecedented economic crisis caused by the pandemic and Brexit uncertainties, the demand for credit has plummeted substantially. In addition, banks are finding it difficult to complete their documentation and underwriting with respect to loan disbursement in these turbulent times.

If the weak demand was not all, Britain’s regulator for financial markets, the Financial Conduct Authority (FCA) announced a moratorium on consumer credit products such as credit cards, personal loans, and overdrafts. The consumers are required to make minimum payments for their credit card bills and might even request to a lender for a deferral.

With consumer credit decreasing, lesser interest rates prevalent in the economy, along with moratorium imposed by the FCA, the different revenue streams of the banks are under immense pressure. Also, there has been a significant decline in cross-selling of ancillary products & services of the banks during lockdown, which resulted into a double whammy for the banks. In addition, UK lenders have made provisions to cover up for loans in case they turn bad. The government must intervene to ensure that these assets should not convert into non-performing assets or bad assets else it could trigger another financial crisis.

Recently, BGF (Business Growth Fund), a private investor, announced, that it is chalking out strategies to buy debts from the businesses to reduce pressure on the financial system. The idea is to convert debt into equity and help bail out thousands of businesses, which are struggling to remain afloat in these pressing times.

Also read: Are UK Banks Seeking New Avenues to Overcome the Business Falloff?

Moreover, UK lenders are likely to face stiff competition from the emerging peer-to-peer (P2P) lenders in the realm of consumer credit. P2P lender, Zopa Group was recently given full banking license. Metro Bank (LON:MTRO) recently acquired RateSetter (P2P lender) to venture into the emerging landscape of the financial sector.

The traditional banks have been existent for long; therefore, they are far more experienced in handling pressure situations such as the coronavirus crisis. In this article, we would like to put a lens through some banking stocks which are fundamentally sound and have resilient business models.

• Lloyds Banking Group Plc

FTSE 100 listed, Lloyds Banking Group Plc (LON: LLOY) provides a host of banking and financial services across the UK. The Group witnessed a recovery sign, mainly in the housing market and consumer spending. Though, the impact of economic fragility and lower rates will continue for at least the rest of the year. In 2020, the net interest margin is expected to remain broadly stable, operating costs are likely to be below £7.6 billion, and the impairment charges are expected to be around £5.5 billion.

Despite the uncertain environment, the Group’s business model and financial strength will ensure that it can continue to help Britain recover and would be supporting the customers. The balance sheet of the bank stayed resilient, with a CET1 ratio of 14.6 per cent. The Group has shown impressive growth in the last four years, which indicates the financial resilience and sound business model of the Group.

The stock was hovering above GBX 60 in early January. While writing on 20 August 2020 at 12:42 PM+1, the stock was trading at GBX 28.24. The stock has witnessed a steep correction of more than 55 per cent in its price year to date. The stock price has though stabilised at this level, showing less volatility.

Also read: Performance Review of Two Banking Stocks: HSBC Holdings PLC & Barclays PLC

• NatWest Group Plc

NatWest Group Plc (LON: NWG) formally known as Royal Bank of Scotland Group Plc, is a provider of banking and financial services. The Group’s performance in the first half of the year has been significantly impacted by the challenges and uncertainty posed by the coronavirus pandemic and Brexit. However, the lender has resilient, capital generative and a well-diversified business model along with a sound financial position. The company is well poised to withstand Covid-19 related impacts through its prudent approach to risk and robust capital position. The company is committed to achieving a £250 million cost reduction in 2020.

Due to the contraction of the yield curve, the bank’s net interest margin (NIM) slipped 22 basis points to 1.67 per cent, which was lower than the first quarter of 2020. The Group expects the level of risk-weighted assets to stay between £185 to £190 billion range. The bank is committed to reducing NatWest markets RWAs.

The stock was hovering above GBX 200 in early January. While writing on 20 August 2020 at 12:57 PM+1, the stock was trading at GBX 112.70. The stock has witnessed a correction of around 5 per cent in its price year to date.

Overall, the FTSE 100 listed UK lenders are in a much stronger position than they were during the financial crisis of 2008, where they had to be bailed out. If these lenders can preserve their capital and continue lending to small businesses with a prudent approach, then they would remain afloat. However, in the near term, many small businesses are likely to collapse due to a weak demand scenario, which could dent the revenue streams of the banks and may turn some of their assets bad.