Five reasons to own Lloyds and UK bank shares in 2023
23rd November 2022 15:52
by Graeme Evans from interactive investor
Share on
Higher interest rates aren’t being factored into bank sector valuations, and upgrades could follow alongside annual results, argues this top analyst.
![Lloyds Bank logo and UK flag 600](https://media-prod.ii.co.uk/s3fs-public/2022-10/horse_0.jpg)
Lloyds Banking Group (LSE:LLOY) has been backed to lead a re-rating of the UK bank sector after a City firm flagged five reasons for optimism heading into 2023.
UBS believes third-quarter results have exposed some attractive valuations in a sector that trades on 5.5 times forecast earnings due to fears over continued economic turbulence.
Lloyds is the top pick after UBS flagged a yield of 5% and potential for a buyback of £2.25 billion at February’s annual results worth an additional 7% of market value.
- Read about how to: Open a Trading Account | How to start Trading Stocks | Top UK shares
The City firm has a price target on Lloyds of 70p, which compares with 45.5p seen today, as the Halifax mortgage lender remains trapped in a range between 40p and 50p. Its other “buy” recommendations include Barclays (LSE:BARC) with a target of 262p and NatWest Group (LSE:NWG) at 330p.
Five reasons for optimism
UBS analyst Jason Napier said: “We are positive on UK banks for attractively valued rate-driven payouts. The next six months are key to our re-rating thesis.”
His optimism is built on a robust third-quarter earnings season after the sector’s pre-provision profit beat the City consensus by 14%. This was driven by net interest income up 14% quarter-on-quarter as the sector benefits from rising interest rates.
The quarterly figures drove upgrades to consensus forecasts, but Napier indicated this week that these remain too cautious after hiking his own numbers for 2023.
- Lloyds Bank: a strong quarter reflects strength and prudent planning
- ii view: Lloyds Bank in good shape to cope with economic decline
- City comes out in support of these big bank stocks
He expects the annual results season will see the banks upgrade their 2023 guidance on net interest income and pre-provision profits, while he also sees the potential for significant capital returns and reassuring updates on their credit performances.
Confirmation of an uninterrupted UK energy supply and increased seasonal appetite for bank risk by investors are the final two favourable factors in Napier’s assessment for 2023.
No margin for error
But Napier warns that if the sector still fails to re-rate it will be hard to do so once rate cuts start moving into view in the second half of 2023 and early 2024.
For now, he believes the market is failing to account for the impact of much higher Bank of England interest rates.
The margins of the big three banks rose by 23 basis points (bps) quarter-on-quarter in the recent results, but current guidance has a 4-9 bps minimum uplift in this quarter.
Napier said: “The biggest driver of rate leverage comes from base rate changes. Why then, does it make sense for Q4 margins to increase by a quarter of that of Q3 when average BoE rates will be up 125 bps over the quarter versus 67 bps in Q3? It doesn't.”
- World Cup winners: 10 shares investors might pick for their team
- Insider: chiefs load up on shares tipped to double
With big lenders showing discipline in their mortgage and deposit pricing, UBS believes the City consensus will eventually catch up in terms of net interest income forecasts.
Napier’s analysis also highlights that banks are fundamentally different from a lending risk perspective than in past cycles. However, he says they continue to bear “real scars” from the 2007 financial crisis, when they were found to be illiquid and undercapitalised.
Subsequent regulation has forced a quadrupling of regulatory capital levels per unit of risk, while borrowers have learned to run businesses with much less bank leverage.
NatWest’s guidance for loan losses in 2023 is in line with through-the-cycle averages, with UBS seeing similar expectations by the rest of the sector when the results season returns in February. Napier added: “We think downside risks to credit losses are much lower than are priced by the stocks.”
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.