Of the five FTSE 100 banks, domestic lenders are preferred to their Asia-focused peers by analyst Jonathan Pierce at Deutsche Numis Research, with Lloyds Banking Group PLC his top pick in the sector.
In a note to clients today as he assumes coverage for the London's five blue-chip banks, Pierce says: "The outlook for bank earnings, capital generation and book value, particularly in the context of future reductions in short rates, is a critical part of any investment thesis right now."
Profits at the trio of domestic banks, Lloyds, NatWest and Barclays, are depressed by 60% by the so-called 'structural hedge', a risk management tool used by banks to manage and reduce their exposure to changes in interest rates in order to stabilise earnings, compared to 25% for HSBC and 15% for Standard Chartered.
"All banks will benefit from the unwind of these costs. But the aggregate tailwind from hedge repricing at the domestic banks could lift profit by 80% over time versus 15% at HSBC and 9% at Standard," said Pierce, adding that it will also buffer 80% of the impact of policy rate cuts versus 50% at HSBC and 10% at Standard.
"The ballast provided to earnings and book value from the hedge is not reflected in the implied [cost of equity] at the domestic banks versus the Asian banks, in our view."
He notes that cash-flow yields are forecast to average 18% for the domestic banks in 2026 versus 15% at HSBC and 13% at Standard Chartered, while distribution yield forecasts are also slightly higher at Barclays (18%), Lloyds (17%) and NatWest (15%) versus HSBC (14%) and Standard (13%).
"Certainly, UK domestic banks are exposed to idiosyncratic risks that are less relevant to the Asians, but the same applies in reverse."
Notwithstanding the exposure that Lloyds has to the FCA motor market review, the black horse lender is his preference, expressed with a 'buy' rating and a 3p hike in the share price target to 64p.
He hiked his target price for Barclays to 280p from 270p and for NatWest to 350p from 345p.
Between the two Asian bank, the analyst says his "clear preference" is for HSBC Holdings PLC (LSE:HSBA), rating it a 'buy' and Standard Chartered at 'hold' "despite the latter's P/E and PTNAV being notionally more appealing".
HSBC's target price was cut to 825p from 1000p and Stan Chart's is cut to 825p from 900p.