Banking is not pretty

Mint – Blain’s Morning Porridge

Sure, we don’t trust our government, but we don’t trust the population either

Yesterday HSBC disappoints. This morning Lloyds delights. But, I think folk are missing the fundamental truths about banking – and it's not pretty.

Lloyds – which I said was worth buying about two years ago – gets the nod for improving costs, lower impairments and rising capital cover, and the street likes the cost/income ratio falling to pre-crisis levels – reflecting its success as a bank doing banking. Yee-haa. 

On the other side, the analysts are calling for HSBC to change its senior management process, take more risk, take less risk, get into China and get out of China, etc etc. The bank finds itself on the receiving end of yet another regulatory breach – money laundering. Yet, for all the disappointment yesterday, HSBC is one of the top performing names. And what makes HSBC, well HSBC, is its uniqueness, which includes its incestuous but functional management structure and the absence of overpaid chief executive officer drama. Promoting internally might not suit the management theory purists, but you can’t deny HSBC has culture… (Well certainly more culture than a pot of yoghurt...but that’s another story.) 

I probably think about banks too much. I became a banker because I thought they were successful businesses at the nexus of the economy based upon their monopoly of financial services, banking infrastructure and relationships – the classic banking model. But guess what…banking, like everything else has changed…changed utterly...a terrible beauty is being born.

In terms of monopoly – forget it. The evolution of crowdfunding, direct lending by institutions and the failure of the high street banks to adapt to survive are all critical. Have you tried to open an account at a high street bank recently? She-who-is-Mrs-Blain has been battling for over two months to get a new business account opened facing issues like “provide a wedding certificate”, but then the bank refusing to accept it unless authenticated…“it’s the rules madam”.

Then there is infrastructure; financial technology has mechanised much of what made banking unique, and opened up finance to direct lenders. Big data allows new entrepreneurial solutions to finance staples such as trade finance, forfaiting, secured lending and dare I say personal lending. Finance can be done more efficiently done by three men and a computer in Solihull than a Canary Wharf full of bank clerks. 

And then there are relationships. Please? Does anyone really believe banks rely on relationships any more? You are just numbers. Even private banks divide down their clientele by the numbers, only the very pinnacle of the mega-wealthy get any real service – and the smart ones amongst them own their own family offices to run their wealth.

And it’s not much different in investment banking – the successful names want to cut client lists to the 10% of their “relationships” that generate 90% of their profits.

Which is why I struggle to work out what banks really are today, and how long before they go the way of the steam engine. I’m enthusiastic about a new future of smaller, nimbler names… but in the meantime..

Which brings me to CoCos (contingent convertible bonds)…The Financial Times this morning says “European Coco Bond Investors Harvest Big Gains”. It's been many years since I first described CoCos as “The Frankenstein Incestuous Spawn of Deranged Regulators and Desperate Bankers”. It's true that no mainstream bank has actually triggered a CoCo and investors have been rewarded with decent returns as long as they’ve avoided dodgy Italian, Austrian, Dutch, Spanish, Portugese, and German names. The FT reports the Markit index for Cocos (must have missed that…) shows a close to 30% return.

I suspect most of that return comes from banks the market was betting would flounder – like Deutsche – staging something of a recovery in recent months. Deutsche’s apparent recovery doesn’t change the fundamentals – when the crunch comes to European banking….and it surely must...the CoCo sector will massively overreact as the renewed threat of wipe-out comes due. Yet the whole of a bank’s liabilities are liable to bail-in...so do CoCos actually offer value somewhere on the capital strucuture? Well they might...at the right price...which is probably after the next sell-off!

Sorry for irregular Porridge in recent weeks, but lots of client meetings and such. For the next few days I’ll be more concerned with the steepness of ski slopes than credit curves, but full service will resume shortly.

Bill Blain

Head of Capital Markets/Alternative Assets

Mint Partners