Income funds turn sights on UK banks as end of PPI saga draws closer

By Tricia Wright

LONDON (Reuters) - Huge payouts to customers mis-sold mortgage and credit card payment protection insurance (PPI) have cost British banks dearly for years, but the end may be in sight and income fund managers are starting to show renewed interest in the sector.

Millions of borrowers were sold unsuitable PPI policies, but a deadline for customer compensation claims has been set for August 2019 and investors are already becoming more bullish about the prospects of capital returns from the banks through dividends or buybacks.

"What we're anticipating ... is actually that PPI hindrance goes away and we can get significant yield growth from these companies," said Ed Meier, who runs the Old Mutual UK Equity Income Fund.

Meier increased his position in Lloyds Banking Group (LLOY.L) in February and Barclays (BARC.L) in December.

British banks have spent heavily on conduct, litigation and restructuring since the global financial crisis, but the biggest single sum was for PPI mis-selling.

A total of 30 billion pounds has been paid in compensation to mis-sold customers since January 2011, according to the Financial Conduct Authority.

Lloyds had by far the biggest exposure to the scandal, with total PPI provisioning of almost 19 billion pounds, dwarfing shareholder returns of 7.9 billion pounds over the same period.

Having halted dividends after its government bailout during the financial crisis, the bank resumed payouts in 2014 and launched a 1 billion pound share buyback last month.

Graphic: Lloyds PPI - https://reut.rs/2FddG39

For the first time since 2014 Britain's banks all avoided having to increase their capital reserves after annual stress tests last November, with the Bank of England saying they could cope with a "disorderly" Brexit without curbing lending or being bailed out by taxpayers.

The banks are now free, therefore, to decide how to spend their profits, with the return of cash to shareholders among options that also include M&A activity and investment in their businesses.

Barclays has said it could launch a share buyback after it reached a settlement with the U.S. Department of Justice (DoJ) over alleged mis-selling of mortgage-backed bonds. It has already reinstated its dividend.

Royal Bank of Scotland (RBS.L) has said it will move quickly to resume dividends once its own case with the DoJ is settled.

Banks in Britain have so far set aside more than 44 billion pounds to cover such claims and it is likely more of them will have to disclose increased provisions.

Mid-sized bank CYBG (CYBGC.L) recently said it has increased PPI provisions.

Lloyds is set to issue a first-quarter trading update early on Wednesday, with Barclays and RBS reporting first-quarter results later in the week.

Eric Moore, who runs Miton's Income Fund, has been gradually building holdings in the banks. He says that dividend yields at both Lloyds and HSBC (HSBA.L) look reasonably good at 4.6 percent and 5.2 percent respectively.

He bought shares in Lloyds from 2015-2017 and in HSBC from 2016-2018. He also hold Barclays stock.

(Reporting by Tricia Wright; Editing by David Goodman)