Could 2018 be the year that UK banks finally start to show signs of life, nearly 10 years on from the financial crisis?
It’s indeed starting to look like this is the case. Three of the UK’s top high street banks have reported results this week and all of them have shown dramatic year-on-year improvement in earnings. Lloyds kicked off the reporting season, followed by Barclays (LSE: BARC) and then RBS, which today reported a three-fold increase in profit for the first quarter, following its first full-year of profitability since the crisis last year.
Unfortunately, Barclays reported a loss for the period of £764m, due to the costs of settling a mortgage mis-selling probe in the US and charges related to the UK payment protection insurance scandal.
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Nevertheless on an underlying basis, the business continues to show an improving performance, a performance that indicates to me the bank could outperform the FTSE 100 this year.
Improving operations
It all comes down to Barclays’ return on tangible equity (RoTE) — a key measure of bank profitability.
Last year, the company reported a dismal RoTE of 1.1%, among the lowest of its peer group. But for the first quarter, excluding exceptional items, RoTE rose to 5.6% from last year’s print of 3.6%. Management believes the bank can achieve a pre-litigation expense RoTE of 9% 2019 and 10% in 2020 and beyond.
If Barclays can hit this target, the share price is set for a substantial re-rating.
Of the firm’s banking sector peers, those earning a RoTE of 10% or more are trading at a price-to-tangible book value (PTBV) of one. Barclays on the other hand, with it’s RoTE of 5.6%, is trading at a PTBV of around 0.75. With this being the case, as Barclays progresses towards its profitability target, I believe shares in the bank could rise by as much as 25% to the tangible book value of 251p per share.
Charging ahead
Another bank I’m positive on the outlook for is challenger OneSavings (LSE: OSB).
OneSavings’ valuation is currently assuming the worst case scenario. The stock trades at a forward P/E of 7.2 and supports a dividend yield of 3.9%. But despite this bargain-basement valuation, the group is growing rapidly and is showing no signs of slowing down anytime soon. Last year the bank’s loan book expanded by 23%, generating a 21% rise in underlying profit before tax. Underlying basic earnings per share climbed 23% to 51.1p.
Even though earnings growth is expected to slow this year, it’s not likely to evaporate altogether and analysts are still predicting an 11% increase in the dividend payout.
What’s more, OneSavings’ outlook could change significantly if the Bank of England begins to increase interest rates. That means it would benefit from a broader net interest margin — the difference between what a bank receives in income from its loan portfolio and pays out to depositors.
Overall then, considering OneSavings’ positive outlook, I believe the stock is deeply undervalued at current levels and could be a great buy for investors seeking both income and growth.
