Royal Bank of Scotland Group Plc, Lloyds Banking Group Plc and Barclays Plc have all garnered recent headlines related to legal cases pending, and still have billions of pounds set aside to cover possible fines, legal fees and compensation. Between them, they reported £16.85 billion in conduct- and litigation-related provisions as of Dec. 31, 2017, although this was down from £21.84 billion at Jan. 1, 2017, S&P Global Market Intelligence data shows.
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Crisis-era litigation
Much of the litigation concerns crisis-era behavior. Barclays is facing charges brought by the U.K.'s Serious Fraud Office, or SFO, over a controversial capital raise that it carried out in Qatar at the height of the financial crisis in 2008 in a last-ditch attempt to avoid a government bailout. RBS is involved in an ongoing case with U.S. authorities over the mis-selling of residential mortgage-backed securities in the run-up to the crisis. Lloyds is facing a lawsuit brought by shareholders who say they were misled about the financial health of HBOS Plc, which Lloyds acquired in 2008.
But, amid the prospect of rising interest rates and better returns at banks, investors appear to have been taking the latest developments on the chin.
Barclays' share price dropped only fractionally Feb. 12, when the SFO said it would expand the Qatar charges to include subsidiary Barclays Bank Plc. Furthermore, shareholders reacted positively to Barclays' 2017 annual results Feb. 22, despite the fact that the bank made a loss of £1.92 billion. Analysts noted that the promise of higher dividends in the future likely gave the share price a boost.
Taxpayer-owned RBS agreed a $500 million settlement with the state of New York on March 6 over RMBS mis-selling, but shares ticked up on the day. The bank is still awaiting a decision on a further, probably much larger, fine from the U.S. Department of Justice, though. According to Sky News, it could face a penalty much higher than the $3.5 billion it has put aside for the purpose.
RBS also faces a backlash related to the alleged abuse of small businesses in its now-defunct turnaround unit, the Global Restructuring Group, or GRG. A leaked commissioned by the U.K. Financial Conduct Authority into GRG revealed a catalog of inappropriate behaviors, including unnecessary fees and fines levied on struggling businesses.
And Lloyds must contend with a range of business owners who are planning legal action against the bank for alleged misconduct. One high-profile case involves television personality Noel Edmonds, who claims a scam at HBOS destroyed his Unique Group business.
Long-term value
However, according to analysts, the major U.K. banks demonstrate potential for longer-term shareholder value.
Analysts at UBS have Barclays stock at a "buy" rating, thanks to "attractive valuation and improving return profile." Investec also rated Barclays a "buy" thanks to "encouraging signals" regarding future dividends and the prospect of stronger future revenues. It also has Lloyds as "buy," citing the promise of improving distribution to shareholders.
The fines and historical conduct issues present "a real risk" for big British banks, but people should consider what their long-term earnings power could be if interest rates stabilize at a higher level, Mark Rogers, head of U.K. investing at personal investment platform Motley Fool, told S&P Global Market Intelligence. Following years of ultra-low interest rates, the Bank of England increased its base rate in November 2017.
He added that fines and restructurings over the last few years have been "painful medicine," but that the banks could emerge "arguably undervalued, with the tailwind of rising interest rates, and much better capitalized than before." Expectations of future litigation charges have to a certain extent been baked into valuations, he said.
"After a decade of downbeat general sentiment, if the tide is turning, shareholders today could stand to benefit," he said.
RBS received a more mixed response from analysts. UBS kept RBS' stock at "neutral," citing anticipated higher spending on restructuring in the near term. Laith Khalaf, a senior analyst at stockbroker Hargreaves Lansdown, said the core U.K. business of RBS was "going great guns" but that uncertainty around the U.S. RMBS litigation remained a concern, and that government moves to sell off the taxpayer stake would put downward pressure on the share price.
Investec analyst Ian Gordon said RBS is unlikely to be hit with any financial penalties that it will not be able to handle from the ongoing GRG controversy, for which it has provisioned.
Gordon said his working assumption is that GRG-related payouts would probably be in the low hundreds of millions rather than the billions.
The industry norm
Jukka Rintamaki, a research fellow at Cass Business School's Department of Management, said it was possible that investors are prepared to overlook scandals and conduct issues at banks because they do not expect a negative reaction from customers.
People may think that "transgressive" behavior is simply the industry norm, or that it will not impact the areas that are important to them, Rintamaki said.
"As such, they are not really considered when making purchasing decisions," he said.
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