Can you really profit by banking on the Big Four?

Britain’s Big Four banks are again at the centre of a compensation crisis. The lenders face the likelihood of being compelled to meet their share of a £44billion bill to cover consumer redress for the past selling of car finance.

Lloyds alone may have to pay out £3billion, leading its boss Charlie Nunn to argue the obligation to cough up for these liabilities calls into question the UK’s ‘investability’.

Yet shares in Lloyds have jumped more than 30 per cent since the start of the year, driven by the belief that its shares are a bargain or worth holding, regardless of this institution’s number one position in the car finance market.

The other members of the Big Four are also seen as a vehicle for growth, although the Supreme Court blocked an attempt by the Treasury to limit compensation for the scandal – which arose from a Financial Conduct Authority probe into ‘secret commissions’ given to auto dealers.

Shares in Barclays, HSBC and NatWest are up by around 15 per cent, 17 per cent and 19 per cent respectively since early January, continuing their feats of 2024.

NatWest soared by 82 per cent last year, becoming the best-performing blue-chip share, its progress unimpeded by the cancellation of a campaign to sell a large chunk of its shares to the public.

Jack Barrat, portfolio manager at Man Group, says: ‘Despite the recent strength, we remain enthused about the value opportunity in UK banks. In places, they remain at steep discounts to the book value of their assets.’

Barrat says that the banks are generating more cash, which is being returned to shareholders in the form of dividends and share buybacks. If lending picks up, shares in banks may be able to trade once more at a multiple of their book value.

This argument should serve as an alert to investors, especially in light of data about the so-called ‘Magnificent 47’.

These are the 47 European banks, including the continent’s Big Four, BNP Paribas, Deutsche Bank and Santander, that make up the Stoxx 600 banks index.

Together these institutions have provided a return of 100pc since January 2022.

This compares with the 90 per cent for the hugely better-known Magnificent Seven US tech companies.

Private investors have tended to shun the Big Four since the global financial crisis when Lloyds and NatWest (then known as Royal Bank of Scotland) were bailed out by taxpayers.

But Jason Hollands of Bestinvest says it may be time to change stance. He says: ‘Banks have been on roll.

‘Over the past year, the FTSE UK banks index has delivered a total return of 69.8 per cent, beating both the FTSE 100 [19.8 per cent] and the US S&P 500 [23.3 per cent].’

Hollands adds that these gains have been made off a low base. He says: ‘The Big Four’s shares were hit by the global mini-banking crisis sparked by the collapse of Silicon Valley Bank in early 2024.’ However, anyone contemplating taking a chance on the banks should be aware of the hazards facing the sector. Nigel Yates, portfolio manager at AXA Investment Managers, says that the ‘structural hedge’ represents a tailwind. Banks make most of their money from the net interest rate margin, that is the difference between loan rates and savings rates.

Banks offset the narrowing of this margin that results from falling interest rates by building portfolios of bonds designed to provide a strategic hedge.

But this buffer cannot afford full protection, even though banks’ losses on loans are currently forecast to remain benign.

Yates also warns that if the Big Four prosper, this may attract more competition, more regulation, or new taxes.

Bearing these risks in mind, here’s what you need to know on which of the Big Four are worth holding – and which are bargains worth snapping up now.

BARCLAYS

Earlier this month Barclays announced that profits for 2024 totalled £8.1billion, above market estimates of £8.07bn, aided in part by the takeover of Tesco’s banking division.

The figures contained a £90m provision against car loans compensation, although the bank withdrew from this business in 2019. There was also news of a £1billion share buyback, a manoeuvre that aims to boost a company’s share price.

Under boss CS Venkatakrishnan, known as Venkat, Barclays is carrying out a huge strategic overhaul designed to cut costs.

Such is the optimism inspired by progress to date that analysts are confident about the outlook for the bank, especially since the fees earned by its jewel-in-the-crown investment banking division are increasing.

Zoe Gillespie of Brewin Dolphin said Barclays was ‘beginning to deliver a reassuring level of consistency that it hadn’t necessarily been known for in the past’.

The bank’s shares are at 311.3p. Broker Peel Hunt has raised its target price to 359p. Jefferies’ target is 395p.

HSBC

HSBC is also in the throes of a major makeover, slimming down its global operations to focus on its Asian and UK divisions, although the £163billion institution is still Europe’s largest lender.

Chief executive Georges Elhedery plans $300m-worth of cuts this year to produce ‘a simple, more agile, focused bank built on our core strengths’.

Unlike Barclays, HSBC is cutting back its investment banking activities in Europe and the US. But analysts approve of Elhedery’s focus on its lucrative Asian wealth management arm – the Hong Kong subsidiary has attracted 800,000 new customers.

They also like the 6.5 per cent rise in 2024 profits to a record $32.3billion announced earlier this month and the $2bn of share buybacks and dividends. It is also less exposed to the car finance scandal.

Over the past 12 months, HSBC’s shares have moved to 933.6p. Last week Goldman Sachs raised its target price to 1056p. Most analysts consider the shares a ‘hold’.

LLOYDS

Shares in Lloyds have leapt nearly 55 per cent over the past year, underlining the market’s resolve to look beyond the car finance scandal and to concentrate instead on factors such as ‘loan quality’.

As Matt Britzman of Hargreaves Lansdown explains, fears that ‘borrowers would buckle under the pressure of persistent inflation’ were largely unfounded, good news since Lloyds is the UK’s number one mortgage lender.

The confidence in the overall prospects for Lloyds was also unshaken by the decline in 2024 pre-tax profits to £5.97billion, against £7.5billion in 2023. It seems the cost reductions (yes, Lloyds is also slimming down), extra capital generation and the promise of a ROTE – return on tangible equity, a key metric in the assessment of a bank’s profitability – of 13.5 per cent this year and 15 per cent next year was sufficient to calm nerves.

The £3.6billion distributed to shareholders in 2024.

This largesse is expected to continue this year, with a £1.7billion share buyback programme.

This week UBS raised its price target for the shares to 72p.Deutsche Bank’s target is 88p. Consensus among analysts is that Lloyds is a hold.

NATWEST

NatWest, a £38billion institution, owes its return to popularity to a series of factors, such as its rehabilitation following the Nigel Farage debanking affair. This transformation was led by the boss Paul Thwaite.

Analysts also like NatWest’s dividend and share buyback policy, and the recent acquisitions of the mortgage book of Metro Bank and most of Sainsbury’s Bank.

Keval Thakrar, equity analyst, at the Rathbone Income Fund, cites NatWest’s deft use of its strategic hedge, its ‘prudent risk management and its robust stability’.

Amid all this enthusiasm there is little mention of car finance payouts because NatWest’s involvement is said to be negligible.

NatWest’s profits for 2024 exceeded estimates at £6.2billion and analysts rate the shares a ‘buy’, apparently unbothered that the price has leapt by 102 per cent over the past 12 months to 479p. The average target price is 488p.

DIY INVESTING PLATFORMS

AJ Bell

AJ Bell

Easy investing and ready-made portfolios

Hargreaves Lansdown

Hargreaves Lansdown

Free fund dealing and investment ideas

interactive investor

interactive investor

Flat-fee investing from £4.99 per month

Saxo

Saxo

Get £200 back in trading fees

Trading 212

Trading 212

Free dealing and no account fee

Affiliate links: If you take out a product This is Money may earn a commission. These deals are chosen by our editorial team, as we think they are worth highlighting. This does not affect our editorial independence.

Compare the best investing account for you