The post-financial crisis landscape has not been favourable to UK banks, with a litany of legal investigations, business restructurings and tightening regulations only serving to exacerbate the damage inflicted by the 2008 economic downturn.
However, with the company overhauls enacted by various big banks having been enough to reignite the interest of income investors, for Davies, manager of the Jupiter UK Growth Fund, it also warrants the attention of recovery strategies.
“Right now, UK banks present the biggest recovery opportunity on the market,” he said.
Davies cited three key drivers behind the renewed attractiveness of UK banks which he believes can carry them back into investor favour – value, underlying profits and sating the regulators.
“Valuations are still very low,” he expanded. “I am not saying that we will be going back to the ridiculously low valuations that we saw in the late 90s, but we are getting back to a long-run average of around 1.5-2x book value.
“It is a good starting point, but these businesses also need to be more profitable and the good news is that underlying profit has been improving dramatically. They are getting better margins on loans and there is a lot of self-help on the cost side. Also, the recovery of the UK economy is helping, and the amount that banks are having to set aside for bad loans has fallen dramatically.
“Until recently, shareholders have not seen profits coming back in the form of dividends, but going out in the form of fines and PPI, and also being set aside to keep the regulators happy. While there is nothing wrong with that and we want banks to safe next time a downturn occurs, we are definitely at the point where enough is enough. For example, this time last year Lloyds had around 8% set aside, and is now at 13% while thinking that 12% is enough.”
Three of the UK’s ‘big four’ – Lloyds, Barclays and RBS – feature in Davies’ top 10 holdings, accounting for respective fund weightings of 7.3%, 5.7% and 4.6%, while the banking sector represents an overweight of 7.9% versus benchmark.
Davies believes that with profits going up, so will dividends, and he is confident that share prices – Lloyds in particular – are poised for an upside surprise.
“We should see more profit coming back to shareholders in the form of dividends. Lloyds started paying a dividend earlier this year and it should pick up substantially to around 6p, and the share price should eventually reach 120p. Those people that have seen the price tripling from its low point think it does not have much further to go, but this is where share prices come into their own.
“Another step for Lloyds is getting the government off the shareholder register. The government’s share is down to around 12%, and I am pretty sure that there will be a retail offer. From an administrative point of view it could be quite annoying, but might be sensible from a regulatory point of view – it is much harder for people to be overzealous on a regulatory standpoint if there are lots of taxpayers as shareholders.
“RBS has already started the process, and as excess capital builds some will come back as a dividends, but some will also be used to buy back government shares.”
