Banks awash with cash whet investors' appetites

They've seldom had it so good - in real terms you would have to go back decades to find a similar performance, reports John Eisenhammer

Banks have not had it so good for ages. As the 1995 results season looms, City memories have to dig deep to recall such a period of sustained high profitability as the high street banks have been enjoying for the past two years.

The net return on equities from the banking sector overall averaged 20 per cent last year. Chris Ellerton, analyst at SBC Warburg, said: "This is a fantastically high return, and about the same as 1994."

Investors are looking towards full-year dividends being around 20 per cent higher on average, reflecting the fact that most of the banks are awash with money. The growth in operating profits before bad debts for the sector as a whole is expected to show a jump of 7 per cent, compared with a drop of 9 per cent in 1994. "This is good underlying growth, even if not as spectacular as the pre-tax figures suggest," noted Hugh Pye, analyst at BZW.

A happy coincidence of several factors has propelled the banks to these heights. Bad-debt provisions have reached their low point, while corporate insolvencies continue to run at a modest level.

The sustained bouts of cost-cutting, seen primarily in branch closures and staff lay-offs, continue to throw a healthy glow on the bottom line. Most importantly, net interest margins remain high and show no sign yet of being squeezed, as far more people are interested in stashing their money with banks and building societies than in borrowing to spend.

Lastly, the current low inflationary climate is excellent for bank health: bank stocks benefit from low bond rates, and bankers tend to be more cautious with their lending when there is little sign of asset price inflation to float them out of trouble.

"In real terms you have to go back decades rather than years to find a similar period of performance from the banks. This is the longest period of high profitability they have enjoyed for a long, long time," Mr Ellerton said.

But even in this robust bud there lurks a worm. The merest mention of the word Eurotunnel is enough to inject pain into the smiles of Lord Alexander, chairman of NatWest Group, and Sir William Purves, chairman of HSBC group. Their banks are facing the biggest hits from the long-running misery tale. On provisions aimed at covering between 30 and 50 per cent of the expected loss, NatWest could be in as deep as pounds 200m and HSBC/Midland up to pounds 150m, with Lloyds and Barclays only relieved to be following some way behind. If they have not already provided for Eurotunnel, the market expectation is that the second half of 1995 is when they will have finally had to bite the bullet. Mr Pye said: "They will almost certainly have made those provisions now. But, however unpleasant, they will not make much of a material impact on results. For a bank like NatWest you are talking about provision of between pounds 100 and pounds 200m when it is making pre-tax earnings of some pounds 1.8bn."

The biggest boon for clearers' profits has been the persistence of an artificial market in deposits, which has held up lucrative interest margins. Banks have been awash with liquidity thanks to the surplus of deposit growth over the flaccid increase in mortgage demand.

Even where banks have had to cut mortgage rates to keep up with the competition, they have been able to match this with a reduction in lending rates, due to the lack of bidding-up pressure in the market.

Apart from the general trend towards saving in the personal sector, an important element in this artificial market has been the de-mutualisation effect among building societies. Many people are keeping money locked away in building societies, either because they know they are planning to convert to banks and are therefore waiting for their windfall share payout, or because they are speculating on further societies joining the plc bandwagon.

With some of these large players not having to bid up for deposits, the pressure on the market is much reduced.

How long personal margins will hold up in this way is the big unknown. Corporate lending margins are already wafer-thin in a ferociously competitive market. Tim Clarke, analyst at Panmure Gordon, said: "I think there is a risk that personal margins will be squeezed. The ability to lower rates on deposits becomes more difficult the more interest rates come down."

But this may not be before the end of the year. The building society effect will last well into 1997, when Halifax/Leeds, Woolwich and Alliance & Leicester finally convert to plc status and members receive their windfalls.

With so much money pushing up bank capital ratios, the issue of share buy-backs is expected to resurface during the results season. Barclays is the prime candidate. It whetted market appetites with a modest pounds 180m hors d'oeuvre last year, and investors are hungrily awaiting a more substantial repurchase in 1996, perhaps in the order of pounds 400-pounds 600m.

NatWest Group, whose pockets are bulging since selling out of US commercial banking last year, also appears to be warming to the notion of a share buy-back, although its strategic preference remains for acquisition-driven growth in the retail and investment banking sectors.

The strong pace of cost-cutting has been giving way to a more steady cost control, as banks find fewer areas left for radical surgery. The big exception is Lloyds/TSB, with expectations of significant shake-out and savings once the reorganisation of the group gets under way. Staff numbers across the sector are, nevertheless, expected to continue to decline. They were already 20 per cent down at 290,000 at the beginning of last year from the peak of 350,000 in 1989, and there are suggestions from the likes of Sir Brian Pitman, Lloyds chairman, of another 20 per cent still to come.

But as he has demonstrated with Lloyds/TSB/Cheltenham & Gloucester, the real scope for taking out costs comes with mergers and acquisitions. This continues to drive takeover speculation, with the Royal Bank of Scotland and Standard Chartered in the spotlight.

Bank results: forecasts for 1995

pre-tax profit pounds earnings per net div

(% change) share (% change) (% change)

(pre-exceptional items)

Abbey Nat 1040m (+12) 52.3p (+13) 21.75p (+23)

Barclays 2070m (+11) 68.5p (+4) 25p (+19)

HSBC 3485m +10) 89.5p (+12) 31.25 (+16)

Lloyds TSB 1593m* (-12) 21.5p (+14) 11p (+15)

NatWest 1750m (+10) 65.1p (+5) 25p (+16)

Stan Chart 650m (+ 27) 43.9p (+35) 11.24p (+41)

*pounds 500m exceptional restructuring provision Source: SBC Warburg