Results from the local banks start pouring in from Thursday, and analysts are swinging behind the sector in increasing numbers. Here’s what to expect from the Big Four.
The steady improvement for shares in Lloyds Banking Group (LSE:LLOY) and other UK lenders over recent weeks, means the backdrop for investors is as positive as it has been for some time ahead of Barclays (LSE:BARC) kicking off the industry's earnings season on Thursday.
The prospect of UK interest rates rising before Christmas has given a significant lift to sector sentiment over the past month, with the potential boost to net income growth helping Lloyds shares to rise by 15% and Barclays by 14% since mid-September.
Buying comes amid confidence that higher borrowing costs shouldn't derail the UK recovery or lead to a surge in loan defaults, given that the jobs market is still robust and many households are likely to have built up a savings buffer during lockdowns.
- Lloyds Bank and BT shares: buy or sell?
- Lloyds Bank shares: better times ahead?
- How to prepare your finances for an interest rate rise
- Subscribe to the ii YouTube channel for interviews with popular investors
There's also the expectation that lenders in this rates cycle will be less encumbered by a build-up of high-risk lending.
Analysts at Bank of America said in a note today: “Given the historically significant build in deposits relative to loans since 2007, we are confident that the gains banks are set to experience from higher rates will not be consumed in impairments.”
Banks are also much better capitalised to support borrowing as well as returns to shareholders, with UK lenders now free from regulatory control over special dividends and buybacks.
This means that, after a long post-Brexit period in which UK banks have been in the shadow of European counterparts, analysts are swinging behind the sector in increasing numbers.
Deutsche Bank wrote recently that UK banks should benefit considerably from rate rises over the next few years, but that the market was still under-appreciating the potential. Its favoured stock is Lloyds, which it said had increased sensitivity to rate rises over the past two years through the accumulation of current accounts and active structural hedge management.
Lloyds shares are now back close to June's 2021 high of 50p, an improvement from 33p in February and 57p before the pandemic. UBS's banking analyst Jason Napier is backing a return to 55p after pointing out last week that Lloyds is “attractively valued” at 7.3 times 2022 earnings per share, representing a 23% discount to the European average.
Napier is not expecting third-quarter results on 28 October to contain any big corporate announcements, but what will be interesting is how Britain's biggest lender thinks UK consumers will cope with rising interest rates and higher energy costs.
- Find out why there's 'considerable upside' for UK bank shares
- ii view: Citigroup aided by investment banking
- Take control of your retirement planning with our award-winning, low-cost Self-Invested Personal Pension (SIPP)
UBS also has a “buy” recommendation on Barclays, whose investment banking operations mean there's more in common with Wall Street lenders after their better-than-expected results last week. A surge in dealmaking helped the likes of Morgan Stanley (NYSE:MS) and Bank of America (NYSE:BAC) to bolster revenues by more than expected, lifting Barclays shares ahead of its own update on Thursday.
The results will be an opportunity for Barclays to highlight its confidence in 2022 prospects, with UBS noting that shares are currently at a 27% discount to European rivals based on a valuation of 6.9 times projected earnings.
Napier added: “Though Barclays has a more international component to its card balances and substantial investment banking revenues, we see both businesses as likely to produce longer-term growth and available at a discounted valuation.”
HSBC is enjoying a particularly strong revival in fortunes, with shares up 19% in the past month, as prospects for earlier-than-expected hikes in UK and US interest rates help to end a long run of underperformance for the global banking giant.
Bank of America has a price target of 520p but warns there's still the threat of China's property jitters spilling into the rest of Asia. Napier, who had a target price of 485p, last week noted the potential for a $2.5 billion buyback based on a big capital buffer disclosed at the half-year stage.
- Richard Beddard: a new hot stock for the portfolio?
- The great investment strategies: growth investing
On NatWest shares, Bank of America has a price target of 260p compared with 233.35p seen today and 207p less than a month ago. It said the rates outlook was particularly positive for banks with high-quality deposits such as NatWest.
The bank added last week: “NatWest's focus on growth, cost cutting and capital distributions is undervalued, we believe, with its gearing to higher rates a further positive.”
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.