Bull and bear: Bank profits: exceptional items wipe out surging underlying profits - The Share Centre Blog

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Michael Baxter

Bull and bear: Bank profits: exceptional items wipe out surging underlying profits

Written by: Michael Baxter on March 26th 2013

Category: Bull & Bear, News

Bull and Bear – an optimistic and pessimistic view of investment news. Today’s stories include: Bank profits: exceptional items wipe out surging underlying profits. Sainsbury’s warns Tesco. Buffett says natural juices will save us. We need new structure, but which new structure? Companies in the news: Kentz, Diploma

Bank profits: exceptional items wipe out surging underlying profits

Core profits at the UK’s major banks rose 45 per cent in 2012 – impressive, time to celebrate perhaps?

But exceptional items, such as PPI, wiped out those gains and overall bank profits fell by 40 per cent. The celebration is off.

Total underlying profits accruing to the UK’s major banks (that’s Barclays, HSBC, Lloyds Banking Group, RBS and Standard Chartered) rose by £31.5 billion last year. But, throw into the mix regulatory fines, customer redress provisions and the accounting consequences of improved creditworthiness, and statutory profits were down 40 per cent on the previous year at £11.7 billion – or so says KMPG.

Bull:       The underlying message here though is that banks are coming back. KPMG said that “Impairment (bad loan) charges have continued to fall with continued low interest rates enabling the majority of customers to pay their mortgages and even reduce their credit exposures.”

Still on a bullish theme KPMG added that 2012 saw stronger investment banking results. It said that: “More positive sentiment surrounding the future of the Eurozone” has helped. Luckily for KPMG it announced its research after the Cypriot crisis hit the headlines so added: “Although, as events in Cyprus are showing, such sentiment can be short-lived.”

Bear:     KPMG warned that there are high risks associated with efforts by the banks to transform their business models. It said: “Banks are undertaking multi-year transformation programmes with significant up-front costs to core infrastructure, systems and processes. Such programmes are complex and involve significant levels of operational risk and many are yet to deliver.”

It also warned that: “The era of high margins and high returns is over” and many banking activities are beginning to resemble regulated utilities without the returns a regulated utility would expect.

Then there is the little matter of further scandals yet to be revealed at the banks. Who knows what is lurking in the metaphorical woodwork.

As for improved sentiment related to the Eurozone lifting bank profits, all one can really add is: “really?”

Conclusions:      KPMG said that it: “Believes that banks need to significantly reduce costs if they are to convince shareholders they can generate returns in excess of their considerably increased costs of capital, liquidity and operation.”

It is right, but opportunity awaits new banks.

Sainsbury’s warns Tesco

Trust. It’s a valuable commodity. It is hard to create, easy to destroy.

Take supermarkets. Have you noticed that some of those ‘buy one, get one half price’ offers are actually not very good deals at all. So you buy say 500 grams of a certain cereal for say £2.99, and buy another one for £1.50. Shop for a bit longer, and you may find a kilogram version of the product for sale for, say, £3.50.

Take another example. Have you ever picked up a product that was apparently part of a special offer, only to find out at the till that it was not in the deal at all; it was actually another product with a very similar name, not behind the label promoting the offer that was discounted?

The point of these examples is to illustrate that sometimes point of sale advertising in supermarkets can be misleading. Sometimes a supermarket may have made a mistake, but if it happens too often, trust starts to dissipate.

Now Sainsbury’s has accused Tesco of being – how can one put it… – economical with the truth. The row relates to own brand products. Tesco is never shy to tell customers when its own brand products are cheaper than Sainsbury’s own brand products. But is it really comparing like with like?

Sainsbury’s boss Justin King said: “How on earth do you compare non-brand products? We don’t think you can compare the strength of our own brand label with the cut price versions at Tesco and Asda.”  He added: “The horsemeat crisis has damaged trust in supply chains across the whole grocery industry and we should all sit up and take notice of what that tells us.”

He is right.

The supermarkets that regain trust from customers the quickest, and indeed can create even more trust, will be the winners in the supermarket game over the next few years.

Which supermarkets do you trust? Don’t be surprised if the trust factor shows up in the P&L in a year or two.

Buffett says natural juices will save us

No, not fruit juice. Warren Buffett was not suggesting that if we drink more orange juice with bits in we will be healthier. He was making a point about the economy, and the juices he referred to were more psychological in nature

He said people tend to focus too much on what the government’s done, and to give them either credit or blame. He said: “The real credit belongs to our system.”

Interviewed on ‘Business Wire’, he said: “[In the US] we went from a wooded land to an incredible, absolute abundance of riches.” He said that the US has a system that can “unleash human potential… Never bet against what humans can accomplish if they’re operating in the right soil. And we have the right soil.”

As for natural juices, he added that the recovery in the US system “is coming back because of the natural juices of capitalism and not because of government.”

That may be true, but there are occasions – occasions that is, not all the time – when free markers and unbridled capitalism can work against their own collective interests. The US does have deep rooted problems – namely relating to demographics – and the way in which access to education and opportunity is becoming less equal.  And the government needs to play a role in counteracting these divisive factors.

There is another more subtle point. Growth is not automatic. There have been periods in history when it has not occurred. It is not automatic in nature either, sometimes evolution can become stuck and needs some kind of external event – such as a meteorite wiping out dinosaurs, or the formation of the Rift Valley – to create change. For a period of time, forces – most of which we have little understanding – combined to enable capitalism to create growth. Those forces may not always be present, or at least may need to be manipulated.

We need new structure, but which new structure?

The BRICS want to form a bank. As you may have spotted, sometimes we have the BRICs, and at other times we have the BRICS. If the s at the end is a capital letter, it means South Africa is included.

Leaders of the BRICS have been having a jolly good tete-a-tete.  They have been having an annual summit – this time at Durban.

On the agenda is the creation of a new BRICS specific bank, to rival the IMF or World Bank. Bloomberg quoted Martyn Davies, Chief Executive Officer of Johannesburg-based Frontier Advisory, who said: “The deepest rationale for the BRICS is almost certainly the creation of new Bretton Woods-type institutions that are inclined toward the developing world.”

But the question is: so what? So we get a BRICS version of the World Bank, but how will that affect us? More to the point, if the BRICS can sort their own issues out without recourse to the West, is that not a case of good for them?

Maybe it is. But it is pretty tragic that the IMF let down developing economies so badly in the 1990s.

But here is one question: will the IMF be able to afford to bail-out the Eurozone in a few years’ time if its membership is not drawn partially from the BRICS?

And does all this not create an us and them type of environment? There are the BRICS and there is the West and Japan. And never the twain shall meet.

Meanwhile, there is an interview with the former World Bank President Robert Zoellick in today’s ‘Spiegel’.

Zoellick was giving his views on a planned transatlantic trade pact between the US and Europe. He said: “An EU-US trade agreement, if completed, could be a great facilitator and set some good standards for the global economy. But both sides must stand together to achieve this.” And therein lies the problem. In order to stand together, both sides first need to reconcile their differences over agriculture subsidies.

Zoelick said: “The farm community in the United States is important in trade politics, because we have two senators per state, and we have a lot of farm states. And the American farm community has told me how frustrated they have become with the Europeans. According to them, the US negotiated to open up the European beef market, but then it was blocked by European concerns about hormones. The US negotiated to open up the poultry market, and that was blocked by debates about chickens disinfected with chlorine. The US negotiated to open up the grains market, and then this was blocked by discussions about genetic engineering.” See: Trans-Atlantic Trade: ‘We Need a New Structure for the Global System’ 

Companies in the news

Bull:       At the ‘Times’, Tempus took a look at Kentz Corporation (oil and gas engineering) this morning. The company has a backlog of orders. It has good geographic diversification, and Tempus said “good value”.

Bear:     Tempus was less sure about industrial and healthcare services group Diploma. Actually it likes the company, but frets about its valuation of 16 times earnings, and said “perhaps time to take some profits”.


These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Tags: Bank profits exceptional items, BRICS World Bank IMF, Diploma, Investing in banks, Kentz Corporation, , transatlantic trade, US Europe free trade agriculture subsidies, Warren Buffett natural juices, Warren Buffett on US economy

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