UK bank shares to buy where valuations are ‘exceptionally low’

Energy costs and rising mortgage rates are putting pressure on household finances, but one expert thinks a series of events will offset a large part of the pain. That makes these bank shares a buy.

Mortgage rates near 6% may not be as bleak for household finances as the current “exceptionally low” valuations of UK lenders appear to suggest, a City bank has said.

Shares in Lloyds Banking Group (LSE:LLOY), NatWest Group (LSE:NWG) and other UK banks have fallen by around 14% since Kwasi Kwarteng’s tax-cutting mini-budget caused rates on home loans to spike towards their highest levels since the financial crisis.

But Deutsche Bank’s banking analyst Robert Noble believes there are reasons to think the household impact of this rapid repricing will not be as severe as many investors fear.

• Read about how to: Open a Trading Account | How to start Trading Stocks | Top UK shares

He reckons the benefit from higher savings rates, lower taxes and energy support measures will offset a large part of the pain for mortgage holders.

Noble said that wage growth of 3.4% a year is needed to offset the energy and mortgage repricing drag. Currently UK wage growth is running at around 5% a year.

He added: “The outlook for household finances is not as bleak as latest mortgage rates suggest.

“Mortgage holders could even see stable disposable income going forward assuming modest wage growth - which would not have been the case without the mini-budget. We believe a large house price correction in the UK is a low probability event.”

Assuming that the weaker outlook for consumer disposable income has caused the recent average 14% decline in UK bank share prices, he said this would suggest that valuations in the sector of 4.7 times 2024 earnings are now “exceptionally low”.

• How do rising interest rates affect your investments?
• Share Sleuth: the undervalued pandemic winner I’ve been buying

Noble has “buy” recommendations on Lloyds and NatWest, with price targets of 64p and 380p respectively, and also sees big upsides for Virgin Money UK (LSE:VMUK) and Standard Chartered (LSE:STAN).

Shares in Lloyds were 49p and on a recovery path in advance of the mini-budget, fuelled by the margin-enhancing prospect of a steady pace of interest rate rises.

But the owner of the UK’s largest mortgage lender, Halifax, now stands closer to 43p, after the surge in interest rate expectations raised fears of a hard landing for the property market and prompted lenders to withdraw many of their high loan-to-value (LTV) offers.

The current average five-year mortgage rate in the UK is now 5.2-5.4%, which is 140 basis points higher than in September. Yesterday, data provider Moneyfacts revealed that the average rate on a two-year fix had hit 6.07%, resulting in a £225 increase in the monthly repayment on a 30-year £200,000 mortgage in just over a month.

• Greggs shares: what the City thinks
• 10 dividend shares to protect your portfolio from the weak pound

Deutsche Bank said industry spreads on mortgages remain relatively stable, although Noble added that these are currently below banks' planning assumptions.

He adds that the loan loss sensitivity of UK banks to falling house prices is now much lower, as the distribution of banks' LTVs have fallen considerably. Noble added that recent regulatory changes also meant that risk weighted assets are much less sensitive to house price changes.