Spread Betting on Banks
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If banks continue to maintain or even raise their already high dividends is that a ‘weak signal’? The banks have sources of income other than sub prime mortgages. Whilst growth may be difficult to come by for the next year or so, the other areas are doing very well indeed. Barclays have indicated that, even after writing off all their dodgy debt (they may well get a lot of it back), they should match last years numbers. World growth (not the UK or US) is still robust and the big players earn a huge slice of total revenue away from these shores.
As Simon Denom of Capital Spreads put it “The reason for the extreme weakness of operators such as Bradford and Bingley is that they have too many of their eggs in one basket (aka Northern Rock). They are heavily reliant on UK growth. Their forays abroad, a surprise anyway for many investors, seem to have brought nothing but pain which will naturally create a tortoise like retreat into the questionable ‘safe haven’ of the UK market just as it looks to be contracting”.
For those who think that shortage of land is a protection against price falls, the lessons of Japan (an even more ‘green belt’ protective nation than the UK) are educational. It was the travails of the banks over there which precipitated the huge falls in real estate values. At one time property fell some 70% from the peaks and we can only hope that the same does not happen here.
The news has seemed so unremittingly bad that sometimes you have to step back and wonder ‘are we just getting too negative’ for our own good. Yes ‘the sub-prime’ problems leading onto the ‘credit crunch’ problems giving rise to ‘growth’ worries etc etc are real issues but how big and how important.
The entire issue started with some unusual waiving of the normal criteria for awarding mortgages in the poor credit segment of the US consumer sector. But how big is this sector and how did, what appears to be a small percentage of overall lending, have such a major impact on banks many of which, on the face of it, are not really in the American mortgage lending arena. For some readers it may seem very strange that banks are now forced to issue large swathes of new capital at knockdown prices over such a relatively small issue. The problem is that banks make their money in the margins. If a bank lends you money at 7.5% this does not mean that they have made 7.5%. The bank itself must borrow the money from somewhere else (at say 6%) and it then makes a profit of the difference. If the bank is good at its job it will make this margin many times over but will always have the capital risk on the money it lends as it must always be able to repay the money it borrows. On this basis it can be seen that a relatively small level of bad debt can quickly get a bank into trouble. A 100% loss on a loan takes up quite a few 1.5%s. That goes a long way to explain why banks seem to always trade on very attractive returns to investors. Even in boom times major banks will seldom get over 12 to 13 times earnings because the big investors know that a slowdown can appear just around the corner.
And as one leading spread betting professional recently put it “The US is suffering because house prices became a get rich quick route in a country that has one major product in abundance ‘Land’. In the UK (although there are a few 100% plus mortgages) most loans are well covered and the value of the asset, the house, will almost certainly cover most of the debt anyway. So the risk to the bank is just the interest. In the States, with so much available building land, the potential for wild swings in house valuations is that much greater. If the lenders are handed back the keys on too many properties, that are worth just 75 to 80% of the initial loan, then crisis waits in the wings”.
"Spread Betting on Banks" written by RThomas, last updated 19-Sep-2008
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