The UK’s home-grown banks, Lloyds (LSE: LLOY) (NYSE: LYG.US), Royal Bank of Scotland (LSE: RBS) and Barclays (LSE: BARC) (NYSE: BCS.US) could see their share prices double from current levels, if things go to plan.
But it’s unlikely that this will happen any time soon, as there are just too many headwinds facing the banking industry right now.
Multiple headwinds
The most pressing threat these three banks are currently facing is the rising threat of regulation. Indeed, regulators are currently demanding that these banks split their wholesale and retail operations, a process called ringfencing, in order to reduce risks.
Unfortunately, ringfencing will be a costly process as the new wholesale arms will require new IT systems, a new management team and infrastructure entirely separate from existing retail operations.
Not only will these demands incur large one-off costs but they will also increase every day operating costs. RBS, Lloyds and Barclays have all been working hard to reduce operating costs over the past few years, and additional regulation will undo much of this.
What’s more, these three banks are currently being subject to rigorous stress tests. Specifically, both the ECB and Bank of England are currently testing these banks to see if they have enough capital to withstand a record fall in house prices and a stock market crash.
Additionally, the ECB is dredging through historic loans on the balance sheets of the banks under examination. This process is intended to uncover any risky assets that have previously gone unnoticed.
If Barclays, RBS or Lloyds fail these tests, there could be serious repercussions.
Results misleading
Aside from regulatory and capital issues, it is becoming hard to decipher how much profit these banks are reporting. As a result, valuations can be misleading and often difficult to compute.
For example, Lloyds reported an impressive start to the year, revealing adjusted profits of £3.8bn. However, the bank only reported statutory profits of £863m, a full 77% lower than reported profits.
Barclays’ results make even less sense. The bank reported adjusted profit before tax of £3.3bn, down 7%, although statutory profit before tax was £2.1bn, while adjusted group profit attributable to shareholders came in at £1.8bn.
Mixed-up analysts
With several different profit figures being reported and regulatory pressures ahead, it’s becoming difficult to place a price target on the shares of RBS, Lloyds and Barclays.
And it seems as if the City cannot make up its mind, either. Over the space of the past 12 months, City analysts have frequently changed their outlooks on bank shares.
Take RBS, for example. At the beginning of this year, the City expected RBS to report earnings per share of 22.7p for 2014. Now, analysts believe that the company will report earnings per share of 27.9p for 2014.
Elsewhere, City analysts covering Barclays have revised their 2014 earnings estimates lower for the bank almost every month this year. The figure has fallen from 30.6p, reported at the beginning of this year, to 21.5p at present.