The UK's Q4 2023 banking crisis.

[Phil]

1 minute ago, Phil said:

Co-Op For sale. Do I transfer to Barclays?. Ffs. That's all I need.

https://news.sky.com/story/co-operative-bank-exploring-potential-sale-12857313

[sancho panza]

3 hours ago, Democorruptcy said:

Another to watch is The West Brom? I've been looking at corporate offerings today. The West Brom have a 6.15% PIB priced at about £60 so the running yield is around 10%. Obviously the 6.15% is below inflation currently but the price seems to imply a lack of confidence?

https://www.hl.co.uk/shares/shares-search-results/w/west-bromwich-building-society-6.15-pibs

I dont really udnerstand what they are DM but I'd be very careful getting nvolved in anything with a BS in thsi environemtn that isnt savings deposited and therfore protected by FSCS.

SOme BS issue bonds and again I'd be cautious with thsoe as to whetehr they're protected in a bankruptcy or whetehr you get lined up with other creditors.

In fact as you allude,I think you need to eb careful with any BS offering high IRs to savers in this environemtn

 

West Brom year end is Mar 31st,had a quick look at their interims and stage 2 was circa 10% at sept 31st.So willliekly be much wrose.It's a £6bn balance sheet so HMG won't give a flying toss I suspect with the other problems they'll have.

 

Edited April 14, 2023 by sancho panza

[sancho panza]

decent explantion of stage 1/2/3 is here

Stage 1 Assets - Open Risk Manual

 

Definition

Stage 1 Assets, in the context of IFRS 9 are financial instruments that either have not deteriorated significantly in credit quality since initial recognition or have low credit risk.

The term Stage 1 is not formally defined in the standard^[1] but has become part of the common description of the IFRS 9 methodology, including regulatory documentation.

The IFRS 9 standard formally defines the conditions that constitute a Significant Increase in Credit Risk, which necessitated the migration of an asset from stage 1 to stage 2 (and vice versa in case of a decrease)

 

Definition

Stage 2 Assets, in the context of IFRS 9 are financial instruments that have deteriorated significantly in credit quality since initial recognition but offer no objective evidence of a credit loss event. The term Stage 2 is not formally defined in the standard^[1] but has become part of the common description of the IFRS 9 methodology.

The standard formally defines the conditions that constitute a Significant Increase in Credit Risk, which necessitated the migration of an asset from stage 1 to stage 2 (and vice versa in case of a decrease). As a practical expedient, entities may assume that credit risk has not increased significantly if the credit risk of the instrument is determined to be low at the reporting date

 

Definition

Stage 3 Assets, in the context of IFRS 9 are financial instruments that offer objective evidence of a credit loss event.

The term Stage 3 is not formally defined in the standard^[1] but has become part of the common description of the IFRS 9 methodology.

In broad terms Stage 3 Assets are the ones for which the older IAS 39 standard considered impairment allowance.

[Democorruptcy]

13 hours ago, sancho panza said:

I dont really udnerstand what they are DM but I'd be very careful getting nvolved in anything with a BS in thsi environemtn that isnt savings deposited and therfore protected by FSCS.

SOme BS issue bonds and again I'd be cautious with thsoe as to whetehr they're protected in a bankruptcy or whetehr you get lined up with other creditors.

In fact as you allude,I think you need to eb careful with any BS offering high IRs to savers in this environemtn

 

West Brom year end is Mar 31st,had a quick look at their interims and stage 2 was circa 10% at sept 31st.So willliekly be much wrose.It's a £6bn balance sheet so HMG won't give a flying toss I suspect with the other problems they'll have.

 

WHOAAAAA boy.....!!

I wasn't suggesting I was getting involved with that offering. I was just looking at HL's corporate bonds etc and in the full list that £60 price for WBS stood out as being low.

 

[sancho panza]

11 minutes ago, Democorruptcy said:

WHOAAAAA boy.....!!

I wasn't suggesting I was getting involved with that offering. I was just looking at HL's corporate bonds etc and in the full list that £60 price for WBS stood out as being low.

 

It does make you wonder if we're the only ones sniffing weakness inbthe BS sector now generally. Would corporates buy that sort of thing or is it for retail?

Feel free to explain it in really simple terms.this is sector I'm not familiar with

Edited April 15, 2023 by sancho panza

[Democorruptcy]

1 hour ago, sancho panza said:

It does make you wonder if we're the only ones sniffing weakness inbthe BS sector now generally. Would corporates buy that sort of thing or is it for retail?

Feel free to explain it in really simple terms.this is sector I'm not familiar with

It's corporate debt, so I suppose anybody could buy it. It's not something I've ever done but I check the list now and again. There are some thread darlings in there!

[reformed nice guy]

3 hours ago, Democorruptcy said:

It's corporate debt, so I suppose anybody could buy it. It's not something I've ever done but I check the list now and again. There are some thread darlings in there!

Is there any website that tracks the various etfs, funds, ITs etc that hold these companies corporate bonds?

I imagine the ones dedicated to corporate bonds must do it MBS style and do tranches of shit mix mixed with "safer" corporate bonds

[Calcutta]

7 hours ago, Democorruptcy said:

WHOAAAAA boy.....!!

I wasn't suggesting I was getting involved with that offering. I was just looking at HL's corporate bonds etc and in the full list that £60 price for WBS stood out as being low.

 

Now I'm not going to sit here and say I'm never confused...

But fuck me wtf is going on there.

Prices seem to be around 100, some of them with a decent interest rate, some with a shit 1%, running for a year or two or UpTo 2037 or whatever. Makes no sense at all.

Makes me wish I'd gone to school.

[sancho panza]

22 hours ago, Democorruptcy said:

It's corporate debt, so I suppose anybody could buy it. It's not something I've ever done but I check the list now and again. There are some thread darlings in there!

Just having a dduckduck at this as I need to learn more about their funding structures

Interesting stuff.AS I thought,you're bottom of the chain in a bankruptcy

I wonder if you can short these ?

https://www.bsa.org.uk/information/consumer-factsheets/general/what-are-pibs

Permanent Interest Bearing Shares (PIBS) are securities previously issued by building societies, usually at fixed interest rates, and quoted on the stock market. Occasionally, a building society issued floating rate PIBS, where the interest rate changed in line with other rates of interest.

They are essentially a form of risk capital, ranking lower than subordinated debt, and were previously issued by building societies, which cannot raise risk capital by issuing ordinary shares on the stock market like a bank.
 

All PIBS are permanent and have no maturity date. A particular issue of PIBS may allow the society to “call” ie redeem the PIBS early – on a specified date. But there can be no certainty that this will happen: either the society may decide it is no longer advantageous to do so or the PRA might refuse consent. So it is important to be clear that the holder has no right to repayment on the call date.

What are the risks?

PIBS cannot be withdrawn like savings, or sold back to the society, but can be bought and sold on the stock exchange, which means the price varies. Like other fixed interest securities, if interest rates generally go up, their value goes down; conversely, if rates generally fall, their value rises. So there is a risk that you will not get back your investment if the general level of interest rates changes.

PIBS provided risk-bearing capital to the issuing society. For that reason, in the unlikely event of the building society getting into financial trouble, it can miss paying interest on PIBS (see below) and, if the society became insolvent, the PIBS holders would be last in the queue to get their money back. All the other investors would be paid first, and only if there was sufficient left would the PIBS holders be repaid. Also, unlike other building society investors, PIBS holders are not covered by the Financial Services Compensation Scheme.

The other risk is that the market in PIBS is not very liquid, so investors may not be able to sell their PIBS when they want to - it depends on there also being buyers in the market at the same time. For all these reasons PIBS are riskier than other building society investments, and, accordingly, attract a higher return.

Interest payments

Gross interest payments on PIBS are usually made twice yearly, but payments cannot be made if it would mean that the society would breach its capital adequacy guidelines. Although additional PIBS can be issued in lieu of a cashpayment, interest payments are non-cumulative, so in the event that a society fails to make a payment, no obligation is carried forward. The terms and conditions of PIBS clearly permit the issuing society to pass interest payments if necessary.

Taxation

PIBS are traded without interest, so any accrued interest has to be settled separately. Income tax is due on the income, but you can negate this by nesting them in an ISA or a SIPP. PIBS are subject to special tax provisions, so a gain or loss accruing on the disposal of PIBS is not a chargeable gain or loss for capital gains tax purposes.

Membership

Holders of PIBS are members of the issuing building society, just like savers and borrowers are, and are consequently entitled to voting rights.

[sancho panza]

18 hours ago, reformed nice guy said:

Is there any website that tracks the various etfs, funds, ITs etc that hold these companies corporate bonds?

I imagine the ones dedicated to corporate bonds must do it MBS style and do tranches of shit mix mixed with "safer" corporate bonds

Dread to think who the patsy is here but likely either taxpayer or some pension fund whose underperformance will impoverish the poo .

Nest would be a candidate and they have some form for being the mechanism by which big insto's pick up cheap stock from unwitting investors in the past.

22 hours ago, Democorruptcy said:

It's corporate debt, so I suppose anybody could buy it. It's not something I've ever done but I check the list now and again. There are some thread darlings in there!

Can you psot some info on where and how you can see the wider lsit of these things please DM? I'd be itnrigued to follow the pricing over the coming months.

[Democorruptcy]

5 hours ago, sancho panza said:

Dread to think who the patsy is here but likely either taxpayer or some pension fund whose underperformance will impoverish the poo .

Nest would be a candidate and they have some form for being the mechanism by which big insto's pick up cheap stock from unwitting investors in the past.

Can you psot some info on where and how you can see the wider lsit of these things please DM? I'd be itnrigued to follow the pricing over the coming months.

The only list I occasionally check are the HL offerings but that's just a small snapshot of what must be available overall. For example VOD and BAT have just 2 in that list but as we know they have lots of debt at various prices.

PIBS are risky but in theory you get an higher yield than a savings account with FSCS protection. Like West Brom now 10% on a PIBS but you could lose the lot if they go bust instead of a reduced rate on savings backed by the FSCS. Like I said I've never bought anything in the list but check more to see what might be dog poo and the West Brom was closest this time.

Don't forget some of the offerings were issued years ago, the Halifax 13.625% must be GFC? Running yield currently 7.17% because the price was bid up since.

 

[Democorruptcy]

22 hours ago, Calcutta said:

Now I'm not going to sit here and say I'm never confused...

But fuck me wtf is going on there.

Prices seem to be around 100, some of them with a decent interest rate, some with a shit 1%, running for a year or two or UpTo 2037 or whatever. Makes no sense at all.

Makes me wish I'd gone to school.

I think most of them do make sense if you consider the rate on offer, the duration and how safe the company is thought to be at the time of issue and now. They aren't new issues, some in the list are years old and have a long time to run yet. To be clear I'm not tipping any up as a buy and have never purchased any, I more look at them as a clue to what's not liked at the moment. In most cases it would seem better to me to just buy the company share (if available), then you get a dividend and share price appreciation over time, instead of just the yield on offer. Obviously if you think the market in general or a share price might drop, the debt on offer might appeal more but I'm not sure how much liquidity is available, for when you might want to exit, the spread on the prices seems very wide.

 

[sancho panza]

US depositors yanking deposits at State Street Bank-----I'll get my coat

 

[montecristo]

On 14/04/2023 at 20:30, sancho panza said:

Just adding to earlier psot ref the Skipton

Page 7 PRA sniffing around and forcing risk eighting changes.

 

Page 19

page 110

BTL 40% of their laons are in stage 2+3 £1905.8mn/£4645.3mn comapred to 2021 when £69mn/£4546mn=1.5% in 2021

So what you are saying here in a nutshell is if you have any savings with Skipton (I do).  Withdraw asap?

[sancho panza]

15 hours ago, montecristo said:

So what you are saying here in a nutshell is if you have any savings with Skipton (I do).  Withdraw asap?

I'm not a financial advisor.

after 2008,they're pretty well practised at merging failing BS's into bad banks.If it was me,I wouldn't worry too much tooif I was under the FSCS limit but you really need to do your own research on it.Sorry to sound like a cop out but it's beyond my skillset/experience to comment further.

[sancho panza]

Going to have a look at a much smaller BS,Hinckley & Rugby.Balance sheet sub £1bn, a BS that created £40mn new mortgage volume in 2022(?market peak) to £648mn.

The big take home for me here isn't what's in the report but rather what's not.Unlike the other bigger BS's,

1 there's no attempt to outline the proportion of loans in stage2 either BTL or OO

2 besides the geographical breakdown of loans,there's no data on BTL by region(given it's 27% of it's loan book I think that's inappropriate)

3 no break down on BTL by LTV

Myabe there's an exemption for small BS's?

My comments in Italics

https://www.hrbs.co.uk/wp-content/uploads/2023/02/Annual-Report-and-Accounts-2022.pdf

My comment: The first thing that leaps out is the cost to income ratio at 90%,(Cov BS by comparison is 43%).Admittedly a small lender,fioxed csots will be proportionately higher but gross profit was £1.32mn on Total Assets of £812mn

Page 10

My comment: Decent size increase in new lending jsut as the hosuing market looks to have peaked.Worth noting they admit to BTL lending here.Relevant for later on.27% BTL/71% Owner occupied

Page 39

My comment: note admin expenses up £1mn yoy.

 

Page 40

My comment: gross profit then another bar get put into pension fund,

 

Page 41: uplift in mortgage book to £648mn from £618mn at what look like the market peak.

 

Page 49

My comment: It's clear there is a strategy for reassessing mortgages for chnges in default risk

Page 51

My comment:Wages costs up £1mn

Page 52

 

 

Page 55

My comment: Here's the circa £40mn uplift in enw ledning just as market peaks,fair amoutn of duration risk given their funding model is mainly retail deposits

 

 

Page 59

My comment: Seen here worth comparing that loan book with £528mn due over 5 years to the details of their wholesale borrowing which is £77mn all due under 5 years

 

Page 64 :

My comment: an incredible 45% of their loan book is exposed to London and South East.An area where their members likely have little interest and where the Bopard likely have little experience of lending.Especially in light of the £40mn increase in loans in 2022.Absolutely staggering tbh that they've increased lending in that region by £27mn in 2022.

This is supposedly a mutual run for the benefit of the membership.

Page 67

My comment: Here's the rub for the mortgage book that is £528mn due over 5 years(see page 55 above) in that liabilities are skewed under 5 years.They may have hedged some of that but looking at the derivatives data,doesn't look that large.

Page 68

 

Page 71

My comment:£44mn/£273mn= common equity tier one capital / risk weighted assets (unaudited)=16.2%

[sancho panza]

Problems appear to be spreading

Edited April 25, 2023 by sancho panza

[sancho panza]

Looks like Nat West will be immune to the coming crisis.

people in glass hosues etc

https://uk.finance.yahoo.com/news/natwest-blames-svb-credit-suisse-103010528.html

NatWest Group has said “poor risk management” and “long-standing” challenges were to blame for the failures of Silicon Valley Bank (SVB) and Credit Suisse which sparked concerns over the strength of the global banking industry.

The British bank is strong and resilient in contrast, chairman Howard Davies told shareholders at its annual general meeting (AGM) in Edinburgh.

Mr Davies said the nation has seen the impact that economic uncertainty and rising interest rates can have on the banking sector, following the collapse of SVB and other US lenders, and the rescue takeover of Credit Suisse by rival UBS.

 

“Ultimately, poor risk management and long-standing, idiosyncratic challenges were largely to blame for those failures,” he told the audience.

“NatWest Group, by contrast, has built a robust and resilient balance sheet with strong capital and liquidity, a largely secured retail loan book and well-diversified commercial lending.”

The banking giant acknowledged the impact of cost-of-living pressures on households and its customers.

Mr Davies added: “While there are some grounds for cautious optimism, with employment remaining high, the economic environment will remain challenging for some time to come, with expected further tightening of consumer spending and real incomes, which will put pressure on household budgets.

“The UK may or may not experience a technical recession in 2023 – economic forecasters differ on that point – but the economy is unlikely to grow significantly.”

Edited April 25, 2023 by sancho panza

[PatronizingGit]

On 17/04/2023 at 19:26, sancho panza said:

US depositors yanking deposits at State Street Bank-----I'll get my coat

 

Wonder how many boomers are finally waking up. My folks cashed in some of their pensions two years back & have since had close to six figures sitting in current accounts (seriously) 

 

I said I can at least get you 4 or 5% easy access on that money with the big banks. They said 'oh yes' then I say you'll have to download the app or sign up for internet banking. Response - I don't trust the apps or the internet, so i'll just keep it in the current accounts (getting 0%) dear. 

 

 how many boomers are exactly the same? they'll whine & moan about the crooks in London, but dont even want to do something as simple as that to get a *little* return, even if it is below inflation. 

[spygirl]

ECB quizzes lenders over risk of Silicon Valley Bank-style losses

Chief supervisor says unrealised losses on bond holdings are ‘point of attention’ after sharp rise in interest rates

https://www.ft.com/content/e70e13df-2395-4044-bb37-8cff079cad01

 

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Upton

 

19 HOURS AGO

 

"The information collected by the ECB on unrealised bond losses"

 

Always enjoy satire!

 

The ECB is sitting on probably €1 trillion of unrealised bond losses itself, but of course keeps schtum about those. Technically insolvent on a mark-to-market basis.

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A new kind of thinking

 

19 HOURS AGO

 

reply In reply to Upton

No worries, the fiat machinery easily will take care of it by continuing printing money and bailing out whatever is needed to keep the fragile fiat ideology alive….

[King Penda]

2 hours ago, PatronizingGit said:

Wonder how many boomers are finally waking up. My folks cashed in some of their pensions two years back & have since had close to six figures sitting in current accounts (seriously) 

 

I said I can at least get you 4 or 5% easy access on that money with the big banks. They said 'oh yes' then I say you'll have to download the app or sign up for internet banking. Response - I don't trust the apps or the internet, so i'll just keep it in the current accounts (getting 0%) dear. 

 

 how many boomers are exactly the same? they'll whine & moan about the crooks in London, but dont even want to do something as simple as that to get a *little* return, even if it is below inflation. 

It’s insane my mum has over 110k she wants it in one place so it’s easy to find if she dies .I’ve explained only 85k is safe .it’s fucking pointless .she says I got 90 interest im like I could get you close to 430 a month intetest .no zero fucking interest .

[Virgil Caine]

Banks reporting jumps in profits today

https://www.thisismoney.co.uk/money/markets/article-12016313/Barclays-sees-profits-balloon-2-6bn-credit-card-use-rises.html

https://www.msn.com/en-us/money/markets/deutsche-bank-logs-11th-straight-quarterly-profit-reveals-job-cuts/ar-AA1apfqi

 

A lot of this is presumably down to higher interest rates

I note the comment about exposure Barclays to credit card lending and bad debt.

In always reminded of the fact that Lehman brothers reported 55 consecutive quarters of profit but was essentially undone by  2 quarters of losses prior to its collapse in 2008.

 

Edited April 27, 2023 by Virgil Caine

[sancho panza]

23 hours ago, spygirl said:

ECB quizzes lenders over risk of Silicon Valley Bank-style losses

Chief supervisor says unrealised losses on bond holdings are ‘point of attention’ after sharp rise in interest rates

https://www.ft.com/content/e70e13df-2395-4044-bb37-8cff079cad01

 

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remove

Upton

 

19 HOURS AGO

 

"The information collected by the ECB on unrealised bond losses"

 

Always enjoy satire!

 

The ECB is sitting on probably €1 trillion of unrealised bond losses itself, but of course keeps schtum about those. Technically insolvent on a mark-to-market basis.

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shareShare

 

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A new kind of thinking

 

19 HOURS AGO

 

reply In reply to Upton

No worries, the fiat machinery easily will take care of it by continuing printing money and bailing out whatever is needed to keep the fragile fiat ideology alive….

Interesting from Groundwater that it turns out that some of these banks learned absolutely nothing from the mess in 08.

I think more US banks are in toruble than we realsie if tehyve been pulling these sorts of stunts ref IO laons.

also from a UK perspective we've had a look at some of the marginal lenders and the torrid state of their laons books with huge chunks migrating from stage 1(performing ) to stge 2 (deterirorating) and it's absolutely incredible to read these sort of psots.

I know from my work that tlak in the crew room is sometimes of 35 year mrotgages....simply incredible that these are being allowed.This will end in tears and lots of spilt milk.

[sancho panza]

39 minutes ago, Virgil Caine said:

Banks reporting jumps in profits today

https://www.thisismoney.co.uk/money/markets/article-12016313/Barclays-sees-profits-balloon-2-6bn-credit-card-use-rises.html

https://www.msn.com/en-us/money/markets/deutsche-bank-logs-11th-straight-quarterly-profit-reveals-job-cuts/ar-AA1apfqi

 

A lot of this is presumably down to higher interest rates

I note the comment about exposure Barclays to credit card lending and bad debt.

In always reminded of the fact that Lehman brothers reported 55 consecutive quarters of profit but was essentially undone by  2 quarters of losses prior to its collapse in 2008.

 

Was hoping yesterday and today to catch up with one of the High St banks.Unfortuantely Mrs P has had to travel so it's put me back a week.But it seems trite to be celebrating Barclays results when they've had profits up on people spending more on the never never.Reality is that some people may be doing it to survive so it's not the sign of confidence some may think.

Reaf Lehman,couldn't agree more.Before I start looking it's worth reading this from the legend Terry Smith(Accounting for Growth),fund manager.Echoing my thoughts on bank shares.

Fwiw we did very well in HSBC and Standard thru to 08,took some hits in Northern Rock and RBS which got us out of the main two bank holdings near peak.Huge learning curve.Before 08 I consdiered bank shares as blue chip asyou could get.Haven't touched one since.

Here's the Terry Smith piece.I dont think we've had it yet(we may have)

https://www.fundsmith.co.uk/news/2014/2083-financial-times-why-i-don-t-own-bank-shares/

Financial Times - Why I don’t own bank shares

Back to news

31 October 2014 By Financial Times, Terry Smith

 

This seems like a good week to explain why I don’t own bank shares. Although it is seven years since the onset of the financial crisis, around 24-25 banks in Europe still have insufficient capital, according to the latest European Central Bank “stress tests”.

 

I’ve often been asked why I won’t invest in bank shares given that I was once the top-rated rated banking analyst in the City. The answer is that having an understanding of banks would make anyone more wary of investing in them.

 

One of my basic tenets is never to invest in a business which requires leverage or borrowing to make an adequate return on equity.

Most of the companies that we invest in at Fundsmith have some borrowing. But they do not require it in order to survive, and they make decent returns before the use of debt, rather than making small returns on their assets and then financing most of those assets with debt.

Banks rely on leverage to a greater extent than any other business. A 5 per cent equity to assets ratio for a bank is leverage of 19 in debt to 1 of equity.

The good news about such high leverage is that when something goes wrong, at least you go bust quickly.

 

Have a look at this very simplified bank balance sheet for Lloyds Banking Group at the end of 2013:

Lloyds Banking Group summary balance sheet

	Liabilities (£bn)	Liabilities (%)		Assets (£bn)	Assets (%)
Equity capital	40	5	Cash	50	6
Deposits and other liabilities	807	95	Loans and other assets	797	94
Total	847	100	Total	847	100

This is not unusual. It is the normal banking model. A bank makes a small return, typically 1-2 per cent, on its total assets, but as 95 per cent of the assets are funded by depositors and bondholders, the return on equity is much higher. A return of £1 on £100 of assets is a return of 20 per cent on the £5 of equity capital.

Which is all fine – until something goes wrong. Then a loss of just 5 per cent of the value of the assets means the shareholders’ equity is wiped out.

A more pernicious threat is a run on the bank. Investors had forgotten about the credit cycle until 2007, and when credit is withdrawn sometimes it is withdrawn from banks as well as their customers.

 

When I was analysing banks in the 1980s it was possible – by studying the bank’s accounts and regulatory returns – to gauge a bank’s exposure to bad debts or credit risk, interest rates and currencies. With the advent of over-the-counter derivatives in these products, which began with interest rate swaps in the 1980s, this is no longer possible.

Having an understanding of banks would make anyone more wary of investing in them

Someone working in the bank’s treasury department may have altered all those exposures with a phone call or the click of a mouse and there is no way for investors to know. Judging by the events of the financial crisis, it is clear that a fair few bank managements were in the dark too.

All of which leads me to suggest that if you are going to own any bank shares, they should be in retail banks which simply take deposits, lend money to their own customers and make payments for them.

 

Such banks do exist and if I had to invest in a bank, that would be where I would look. But even those institutions are not immune to the threat which can arise from so-called systemic risk. They can be brought down by a run caused not by their own misjudgements, but by those of other banks in the system.

The fragility of banks is illustrated by a story from the 1980s, when there was a wave of nervousness in Hong Kong following the signing of the joint declaration regarding the colony’s handover to China. Property prices began to collapse and banks ran up bad debts as result.

During this febrile period, a queue of people waited for a bus. It started to rain, and the queue moved across the pavement to shelter under the cover of a canopy on a building, which happened to house a branch of a local family-controlled bank. Passers-by, seeing the queue, concluded that there was a problem with the bank. Rumours of a run spread rapidly and by the following day the bank was besieged by depositors demanding to withdraw their savings.

Terry Smith is chief executive of Fundsmith LLP

 

[Virgil Caine]

58 minutes ago, sancho panza said:

Was hoping yesterday and today to catch up with one of the High St banks.Unfortuantely Mrs P has had to travel so it's put me back a week.But it seems trite to be celebrating Barclays results when they've had profits up on people spending more on the never never.Reality is that some people may be doing it to survive so it's not the sign of confidence some may think.

Reaf Lehman,couldn't agree more.Before I start looking it's worth reading this from the legend Terry Smith(Accounting for Growth),fund manager.Echoing my thoughts on bank shares.

Fwiw we did very well in HSBC and Standard thru to 08,took some hits in Northern Rock and RBS which got us out of the main two bank holdings near peak.Huge learning curve.Before 08 I consdiered bank shares as blue chip asyou could get.Haven't touched one since.

Here's the Terry Smith piece.I dont think we've had it yet(we may have)

https://www.fundsmith.co.uk/news/2014/2083-financial-times-why-i-don-t-own-bank-shares/

Financial Times - Why I don’t own bank shares

Back to news

31 October 2014 By Financial Times, Terry Smith

 

This seems like a good week to explain why I don’t own bank shares. Although it is seven years since the onset of the financial crisis, around 24-25 banks in Europe still have insufficient capital, according to the latest European Central Bank “stress tests”.

 

I’ve often been asked why I won’t invest in bank shares given that I was once the top-rated rated banking analyst in the City. The answer is that having an understanding of banks would make anyone more wary of investing in them.

 

One of my basic tenets is never to invest in a business which requires leverage or borrowing to make an adequate return on equity.

Most of the companies that we invest in at Fundsmith have some borrowing. But they do not require it in order to survive, and they make decent returns before the use of debt, rather than making small returns on their assets and then financing most of those assets with debt.

Banks rely on leverage to a greater extent than any other business. A 5 per cent equity to assets ratio for a bank is leverage of 19 in debt to 1 of equity.

The good news about such high leverage is that when something goes wrong, at least you go bust quickly.

 

Have a look at this very simplified bank balance sheet for Lloyds Banking Group at the end of 2013:

Lloyds Banking Group summary balance sheet

	Liabilities (£bn)	Liabilities (%)		Assets (£bn)	Assets (%)
Equity capital	40	5	Cash	50	6
Deposits and other liabilities	807	95	Loans and other assets	797	94
Total	847	100	Total	847	100

This is not unusual. It is the normal banking model. A bank makes a small return, typically 1-2 per cent, on its total assets, but as 95 per cent of the assets are funded by depositors and bondholders, the return on equity is much higher. A return of £1 on £100 of assets is a return of 20 per cent on the £5 of equity capital.

Which is all fine – until something goes wrong. Then a loss of just 5 per cent of the value of the assets means the shareholders’ equity is wiped out.

A more pernicious threat is a run on the bank. Investors had forgotten about the credit cycle until 2007, and when credit is withdrawn sometimes it is withdrawn from banks as well as their customers.

 

When I was analysing banks in the 1980s it was possible – by studying the bank’s accounts and regulatory returns – to gauge a bank’s exposure to bad debts or credit risk, interest rates and currencies. With the advent of over-the-counter derivatives in these products, which began with interest rate swaps in the 1980s, this is no longer possible.

Having an understanding of banks would make anyone more wary of investing in them

Someone working in the bank’s treasury department may have altered all those exposures with a phone call or the click of a mouse and there is no way for investors to know. Judging by the events of the financial crisis, it is clear that a fair few bank managements were in the dark too.

All of which leads me to suggest that if you are going to own any bank shares, they should be in retail banks which simply take deposits, lend money to their own customers and make payments for them.

 

Such banks do exist and if I had to invest in a bank, that would be where I would look. But even those institutions are not immune to the threat which can arise from so-called systemic risk. They can be brought down by a run caused not by their own misjudgements, but by those of other banks in the system.

The fragility of banks is illustrated by a story from the 1980s, when there was a wave of nervousness in Hong Kong following the signing of the joint declaration regarding the colony’s handover to China. Property prices began to collapse and banks ran up bad debts as result.

During this febrile period, a queue of people waited for a bus. It started to rain, and the queue moved across the pavement to shelter under the cover of a canopy on a building, which happened to house a branch of a local family-controlled bank. Passers-by, seeing the queue, concluded that there was a problem with the bank. Rumours of a run spread rapidly and by the following day the bank was besieged by depositors demanding to withdraw their savings.

Terry Smith is chief executive of Fundsmith LLP

 

I have read that article before but it is well worth going through his arguments again. It more or less explains how banks can collapse quickly when they start making losses and suffering runs on deposits.  I would be very worried about any bank not increasing its profits substantially following a 5-6 fold increase in interest rates given that all SVR loans not in default should now be money spinners