Trading and Spread Betting on the Banking Sector
Where Can I Trade the Banking Sector?
You can currently spread bet on the banking sector with:
You may be able to trade the banking sector with other firms.
Banking Sector Constituents
As of 4 July 2013, the following banks make up the FTSE 350 Banking Sector:
To check which banks are currently in the sector see FTSE 350 banking sector.
For more detail on a particular bank, just click on the relevant link above.
In most cases we have added the latest broker recommendations, live charts and prices as well as details on how to speculate on the individual bank.
For more on Sectors, also see our guide to trading and spread betting on Sectors.
Pricing and Valuing Bank Shares
Below, an interesting article on how to value a bank by Anthony Grech, IG Index, 7-Oct-2008.
Share prices react to news and information, but price alone is not always an accurate reflection of a company’s value in the short-term.
Information gaps, market sentiment and rumours can cause the price to deviate from a company’s intrinsic value. In the long term, share price and value should align, at least in theory.
Value is a direct function of risk and return. Market participants have a different risk/return profile, which means that a company’s equity may not be attractive to everyone at certain price levels.
In a downturn, however, strong support may start to appear as the risk/return trade-off of a particular security or sector starts to appeal to a greater number of investors.
Therefore, identifying a period of strong fundamental support may help traders identify the bottom of a cycle.
One way of looking at support is by identifying fundamental ratios and comparing them with the previous 2000-2002 banking sector downturn.
Two ways of looking at banking share fundamentals are from a price to earnings (P/E) and price to book (P/B) ratio perspective.
For the sake of brevity this analysis does not observe other fundamental data such as cost to income, advances to deposits and liquidity ratios and does not consider holdings of mortgage backed securities.
The P/E multiple:
This compares a bank’s share price with its latest annual earnings per share.
A high ratio may mean that a company is overvalued or could reflect investors’ willingness to pay a premium on every unit of earnings, whereas a low P/E may indicate that a company is relatively undervalued.
However, a low P/E does not necessarily mean that a stock is a good buying opportunity; it may in some circumstances suggest that a company is close to bankruptcy.
In the case for banks, low P/E’s reflect the reduced earnings prospects originating from further writedowns and credits losses.
The P/B multiple:
This compares a company’s share price with its book value of equity, also referred to as ‘shareholders funds’ (total assets less total liabilities).
A high P/B ratio may mean that a company is overvalued or that investors are willing to pay a premium over a company’s ‘accounting book value’.
Unlike the P/E (which reflects a company’s ability to generate profits), the P/B multiple reflects a company’s ability to grow its net asset base and generate higher returns on equity.
A P/B ratio below 1 indicates that the market believes that a company is not worth the value of its net assets (as is the case with most banks at the moment).
Banks are predominantly trading at low P/B multiples because investors are concerned with the quality of their loan books.
The sub-prime crisis and slowdown in the real estate market have exposed banks to rising bad debts. Banks also hold structured securities, which are extremely complex to value (hence they are classed as off-balance sheet items) and carry an element of leverage.
Because of the leverage, small adverse movements (depending on exposure levels) could result in huge chunks of a bank’s book value being eroded and could even cause collapse.
Investors are aware of these potential dangers and this is the reason why most banks are trading at significant discounts to their book value.
Below, we have listed a series of articles which speculate on the banking sector.
Most of the markets will have moved on since the analysis was written and the fundamental arguments may no longer apply.
However we feel the analysis is still useful if you are new to trading this sector because it talks through many of the factors that positively and negatively impact the UK banks.
Banking Sector in Focus After Relaxation of Basel 3 Rules
Below, a banking vs regulation article by Michael Hewson, CMC Markets, 24-Jan-2013.
The gains seen in the banking sector over the past few weeks and months have been driven largely by reduced tensions in Europe with respect to fragmentation of the European banking system.
ECB President Draghi's dramatic intervention last summer to do "whatever it takes" to save the euro along with the introduction of the OMT program has assuaged investor concerns that the European banking sector could have fallen apart.
This financial back stop has helped banks recover strongly, while pledges from central banks and governments across the globe to keep monetary policy loose and pump liquidity into the system has helped banks rebuild their balance sheets.
Be that as it may, banks still remain reluctant to lend given pressure for them to rebuild their capital buffers which is why the recent relaxation of Basel 3 capital rules has helped in giving the sector an extra boost.
This decision has prompted a widespread reassessment of the UK banking sector in general. A raft of upgrades on the sector have helped push the share price values of Lloyds Banking Group, Royal Bank of Scotland and Barclays to their highest levels in months.
The end of the month will see the latest earnings releases for UK banks. However, the main question being asked by spread betting investors is how much upside is left given that the share prices of each of the banks up over 70% on a six month time frame.
Concerns are rising that with interest rates as low as they are, the scope for better bank profitability is likely to remain difficult, especially given the outlook for growth remains difficult. In fact Barclays is up 84%, Lloyds Banking Group, up 82% and RBS up 77%.
The key levels to observe are the 2011 highs which sit at 339.45p for Barclays, 69.85p for Lloyds and 49.5p for Royal Bank of Scotland.
Banking Sector Set to Remain Risky
Below, an article highlighting the risks of trading the sector by Michael Hewson, CMC Markets, 3-Jul-2012.
Many commentators are saying now is the time to buy into banking stocks.
In the following article, Michael Hewson from CMC Markets believes the charts do not support this ‘buy’ message and urges investors to consider the uncertainty that will remain in the banking sector moving forward.
Concerns about Europe and exposure to the amount of bad debt on European banks balance sheets are quite enough for the banking sector to think about.
The current furore surrounding the LIBOR fixing scandal isn’t likely to change public perception of mistrust with respect to the problems facing a sector that has endured a torrid five years.
In mid-2007 the UK banking sector had a combined market value of over 11,000. It now trades at a mere 33% of that at 3,800.
Since the lows seen in 2009 at 1,877 the sector managed to recover to highs of 5,400 in 2010 and the beginning of 2011.
However, since then, the sector has remained under pressure largely as a result of events in Europe and the sectors exposure to potential sovereign insolvencies and insolvent banks in Europe.
Banking sector: 5 year chart
Public perception about the banking sector had already been fairly low after the events of the last few years, which in turn has prompted calls for much tougher regulation of the banking industry and the ‘too big to fail’ culture.
Certainly there has been a lot of criticism of the Vickers Report on banking with the watering down of some of the more controversial aspects of the report, including the separation of the investment banking and retail arms.
Recent events with respect to the behaviour of banks in the UK over PPI mis-selling, interest rate swap mis-selling and now LIBOR fixing is likely to increase calls for much more regulatory oversight from regulators.
Calls would not only be for here in the UK, but also worldwide as public anger demands action from politicians anxious not to be seen to be pandering to banks vested interests and big business.
If you add to that, the controversy over the JP Morgan ‘London Whale’ trading losses which are expected to exceed $5bn, then you have a very toxic operating environment for banks in general.
This increases the risks of the sector being used as a political football by politicians anxious to deflect attention from their own shortcomings, inadequacies and policy failings.
You only have to look at Europe’s politicians and the proposed implementation of a financial transaction tax to see how much in denial these policymakers are with respect to their roles in the current European crisis.
Tuesday’s resignation of Barclay’s CEO Bob Diamond, while likely to draw a line under his role in the Libor fixing saga, is unlikely to be the end of the story for the banking sector.
There also remains the question of how much central bankers knew of what was going on and whether a blind eye was turned to the practice.
Regulators globally are now likely to focus their attention to the involvement of other banks and the likelihood of litigation as a result of any findings is likely to increase.
Any increased regulatory oversight is likely to increase the costs to the business models of banks and could also prompt much tougher steps to separate the business units of bigger banks, and even break some business units up altogether.
Barclays - Where to from Here?
Barclays spread betting market has certainly shown some resilience after its sharp falls last week and while some analysts are starting to break cover and tip the shares to move higher, the charts don’t support that view in the short term.
Barclays: 1 year chart
Since April, the price action has been firmly to the downside and while it remains in the downward channel from the March highs as well as the 200 day MA, the trend remains lower.
A move back above the 200p level could well stabilise in the short term.
As for the nationalised banks of Royal Bank of Scotland and Lloyds Banking Group, the risk remains that they too become embroiled in the LIBOR scandal with all the risks that entails for further share price gains.
The ironic thing is that any fines, if levied, will end up being paid for by the UK tax payer.
Future Profitability of the Banking Sector
The main downside to all of this is that any future profitability of these banks is likely to be mitigated by stronger regulation as the banks riskier activities get pared back.
It therefore seems unlikely that, given the current environment, tax payers will see any return on their investment in either of these banks.
Royal Bank of Scotland: 2 year chart
Royal Bank of Scotland’s share price needs to get back to 550p to even get close to break even, which is more than double its current value of 218p.
A break above the 300p level would certainly help in stabilising the share price, but for now the range seems to be 175p, the 2011 lows, and the multiple highs this year around 299p.
HSBC: 1 year chart
Even HSBC, which has found itself fairly insulated from the travails of the banking sector over the past few months, has struggled to make much in the way of gains above the highs seen this year at 588p.
If the current enquiries into other banks activities see the bank dragged into the LIBOR enquiry, further share price volatility in the sector seems likely.
The upshot is that the banking sector is likely to remain a fairly high risk sector going forward; with the likelihood of further regulation, possible litigation and further write downs of bad debt as economic conditions deteriorate in Europe.
According to BIS data, as of the end of 2011, UK bank exposure to Spain and Italy is estimated to be in the region of £90bn.
This raises the likelihood of significant losses especially if there is a restructuring of the Spanish banking sector further down the line, if economic conditions in the country continue to deteriorate.
Should We Buy into the Banking Sector?
Below, this could be read as part II of the above ‘Pricing and Valuing Bank Shares’ article by Anthony Grech, IG Index, 7-Oct-2008.
Banks are currently struggling due to turbulent economic conditions, but how does their current value compare to that of the 2000-2002 downturn? Should we be buying into the sector?
Looking at the lowest P/E and P/B ratios of the previous banking sector downturn which occurred between 2000-2002…most of the FTSE 100 listed banks are already trading at lower P/E and P/B multiples.
The fact that most of the banks are trading below comparable multiples shows an absence of fundamental support levels and indicates that investors are not giving as much weight to these multiples as they did in the past.
That is possibly because the market has been reacting negatively to any news concerning writedowns and a slowdown in the economy.
Investors may also be discounting these multiples on the basis that the systematic (sector wide) and unsystematic (company specific) risks inherent to this banking sector downturn are unique and much greater than the risks in previous downturns.
The latest credit market blowout and the introduction of securitised leveraged products have made it a more dangerous playground as the risks present in this downturn have become harder to quantify.
Liquidity constraints in the secondary market have raised doubts or concerns on a number of issues including the alternative valuation methods used to price complex securitised products, the level of write-offs incurred so far and the possibility of future write-downs.
In turn, this has also tainted the accuracy of future earnings forecasts.
All these factors may help explain why we are entering a period where P/E and P/B multiples are at historic lows.
Therefore, an absence of a fundamental support and the likelihood of increased systematic and unsystematic risks occurring as a result of a more pronounced downturn in the UK housing market, leads me to believe that the sector has not reached a bottom yet.
Balance sheet restructuring and risk management are among the most important functions for a bank at this juncture.
As a result, I believe that cost controls, the sale of non-core assets, a bank’s ability to attract funds and a reduction in the exposure of certain asset backed securities will all play an important role in helping liquidity and will be key issues going forward.
Time to Buy the Banks?
According to Anthony Grech’s 2008 Banking Report “those banks that successfully manage to survive this downturn will ultimately prove to be excellent investment opportunities within the next 5 years.
“Speculators interested in the sector’s upside prospects could start to allocate very small amounts of their wealth during dips.
“However, I must caution that I also believe that further sub-prime news and economic deterioration in the UK and US will drag on the sector and that better entry levels could be achieved at a later stage”.
For more also read our Diary of the 2008 UK Banking Crisis.
'Trading and Spread Betting on the Banking Sector' edited by SD, updated 18-Nov-13
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