5 reasons not to buy the Footsie's biggest banks

Barclays Bank and Lloyds Bank signs
Barclays Bank and Lloyds Bank signs

The poor performance of the UK's largest banks since the end of the Financial Crisis needs little introduction for any investor who has been hoping and praying for a turnaround for more than seven years now. While things may not be as apocalyptic as they are across the Channel at the likes of Deutsche Bank, there's a litany of reasons that I'm still not touching the UK's biggest banks.

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1. New regulations

Since the financial crisis regulators across the world have cracked down on banks' riskier activities in order to forestall the need to once again tap the public for bailouts. This means significant capital is stuck in low-return vehicles such as cash or sovereign debt rather than being employed in higher-return activities like lending. This is best seen in the tier 1 capital ratios of the Footsies' biggest domestic-focused banks.

Barclays

Lloyds

RBS

2007

7.8%

9.5%

7.3%

2015

11.4%

13%

15.5%

2. Higher costs

Why have costs risen so dramatically across the industry? For one, compliance requirements are significantly higher than they once were, which means hiring more back office staff dedicated to ensuring the bank follows myriad jurisdictions' laws rather than generating revenue. Another factor is simply that profits have been falling, meaning a banks' cost-to-income ratio could be rising even if operating costs remain level. This is seen below in the adjusted cost-to-income ratio for our three banks.

Barclays

Lloyds

RBS

2007

57%

49%

43.9%

2015

69%

49.3%

72%

3. Low interest rates

Whether it be in America, Japan or the UK, interest rates are at historic lows as governments desperately attempt to engineer financial growth through monetary policy. This may be good news for house hunters needing a mortgage, but for the banks providing that mortgage it means lower net interest margin, or the difference between the rate at which banks borrow and lend money.

You need to look no further than the fall in the BoE's base rate from a peak of 5.75% in July of 2007 to the current 0.25% to understand why this would be a problem for banks. And with fears mounting that hard Brexit could lead to a recession, don't expect higher interest rates any time soon.

4. Low profitability

It doesn't take a CFA to figure out that higher capital reserves, higher costs, vastly lower trading profits and subdued net interest margin lead to lower profits for the big banks. To illustrate this, it's best to look at the big three banks' adjusted return on equity before the financial crisis and now.

Barclays

Lloyds

RBS

2007

20.3%

25.2%

18.8%

2015

4.9%

15%

11%

5. Low dividends

If the banks' bottom lines are significantly smaller than in 2007, it makes sense that shareholder returns have likewise gone into a tailspin. While Lloyds shares now offer a very good 4.3% yield, they're the exception rather than the rule as RBS has yet to return to dividend payouts and Barclays slashed returns by 50% last year.

So, with the prospects for growth dim, profits at record lows and dividends a fraction of their pre-crisis levels, I won't be buying any of the UK's biggest lenders any time soon.

With yields non-existent or a shadow of their pre-crisis level, income investors will find little joy in the UK banking sector. But there's no need to despair as the Motley Fool's top analysts have recently released their free report on one company that has boosted dividends by over 400% in the past four years.

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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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