Interactive Investor

UK bank sector results season: these are the likely winners

19th July 2022 13:33

Graeme Evans from interactive investor

Despite a decent trading performance, there’s been little to excite bank stocks in recent months. But some experts continue to see attractively valued recovery potential here.

The potential for a long-awaited re-rating of NatWest (LSE:NWG), Lloyds Banking Group (LSE:LLOY) and other UK lenders will be raised next week by another round of robust earnings figures.

Margin expansion, the confirmation of cost guidance and a lack of credit quality deterioration are forecast as second-quarter results show the sector’s attractive recovery potential.

UBS has “buy” recommendations on all the major banks, including Lloyds and NatWest, but thinks even a series of profit beats will be insufficient to shake off investor caution caused by the Ukraine war and the deteriorating economic outlook.

Jason Napier, UBS’s banking analyst, points to the market’s reaction to April’s first-quarter results, when 87% of European banks beat their consensus net interest income forecasts.

Despite pre-provision profits 17% above hopes and much higher interest rates on the way, revisions to earnings expectations for 2022 and 2023 were a paltry 1% and 3% respectively.

Napier expects a re-run for the UK banks in the current quarter reporting season, which begins on Wednesday 27 July with Lloyds before Barclays (LSE:BARC) the following day.

As well as stronger margins caused by higher interest rates and an improved lending mix, Napier thinks banks will retain near-term cost guidance despite inflationary pressures.

However, some of the pre-provision profit upgrades are likely to be absorbed by precautionary increases in loan loss expectations for 2023 in particular.

Napier thinks the market is being too cautious on the credit risk downside and the upside for net interest income, given that the sector is now at 0.7 times net asset value and 6.8 times forecast earnings. This is even weaker than European banks on 10 times 2023 earnings.

He said: “While we do not expect investors to re-rate the sector over the summer break - unless a surprising geopolitical breakthrough takes place - we do see attractively valued recovery potential here.”

Napier’s top domestic banking pick is NatWest, with a 33% capital upside to 290p and a forecast 2022 dividend yield of 5.1%. The lender is well placed in a period for tighter monetary policy as every quarter point move in the rates curve is worth £329 million.

The bank has given 22,000 staff a pay rise of £1,000 in response to inflation pressures, meaning the cost outlook will be an obvious area of focus in the results on Friday 29 July.

Household credit quality will be another closely watched metric, although boss Alison Rose told The Sunday Times last weekend that defaults remain low and there’s been no noticeable rise in the number of people falling behind on payments.

This reflects the continued strength of the UK jobs market, with today’s unemployment rate for May remaining at 3.8%.

Napier expects NatWest to add another £1 billion to its ongoing share buyback programme in a move that will reassure the market that the bank can absorb the impact of the government selling down the rest of its shareholding.

NatWest is expected to report a CET1 capital buffer of more than 15%, but has an end-of-year target to reduce this closer to other lenders at around 14%.

Napier has a 60p target price on Lloyds, believing that its strong record of capital generation and potential for returns to shareholders via buybacks will be a key plank of a re-rating story once macroeconomic concerns reduce.

The lender’s mortgage spreads have been below plan but Napier sees this changing as the rates curve steepens. On costs, Lloyds is forecast to reiterate operating expenditure of £8.8 billion for 2022 despite increased domestic inflation and £1,000 one-off payments to staff.

Results from Barclays are likely to be “noisy” due to the continued fall-out from March’s disclosure that its structured products business had issued $15 billion (£12.5 billion) more securities than permitted by Wall Street regulators.

A provision of £540 million was taken across 2021 and first-quarter results, but a further hit from the debacle is possible as Barclays has been forced to buy back the securities in a quarter when the S&P 500 fell by 16%.

While Barclays has previously said that a 5% fall in the S&P 500 is worth £300 million in additional costs, it has a market hedge in place to substantially offset those risks.

Despite the over-issuance, the board pressed ahead with a £1 billion share buyback at the end of May and the purchase of Kensington Mortgage last month. But with the CET1 due to fall to 13.4%, UBS does not expect a further buyback announcement next week.

It has a “buy” recommendation and 250p target price, which reflects evidence of underlying strength in sales and trading and good net interest income rate gearing. On the international banks HSBC (LSE:HSBA) and Standard Chartered (LSE:STAN), Napier has price targets of 635p and 850p.

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