JPMorgan has reiterated its preference for Barclays PLC (LSE:BARC) and NatWest Group PLC (LSE:NWG) over Lloyds Banking Group PLC (LSE:LLOY), highlighting key divergences in performance driven by shifting margins and evolving market dynamics.
The investment bank underscores Barclays and NatWest as "overweight" recommendations, with Barclays notably termed "the cheapest bank in Europe".
Pointed out is the fact that Barclays is trading at an attractive valuation of 6.3 times price-to-earnings (P/E) and 0.7 times price-to-tangible net asset value (PTNAV) for a projected return on tangible equity (ROTE) of 12.2% by 2026.
NatWest also holds appeal, valued at 7.6 times P/E, 1.3 times PTNAV, and forecasted to achieve a ROTE of 17.7%.
In contrast, Lloyds faces more significant headwinds, trading at a higher valuation, 8.5 times P/E, 1.2 times PTNAV, with an expected ROTE of 15.5%.
JPM highlights Lloyds’ significant exposure to mortgages, representing 68% of its loan book, as a major vulnerability given current margin pressures. Additionally, litigation risk from upcoming motor finance judgments could negatively impact Lloyds, justifying JPMorgan's relative "underweight" stance.
Deposit margins have become central to banks' profitability, supported by structural hedges and a high household savings ratio, currently at 12%, above the historical average of 8%.
The investment bank forecasts an annual net interest income (NII) growth of between 8% to 10% from 2024 to 2027, buoyed by resilient deposit growth despite economic uncertainties.
Asset margins, particularly in mortgages, are increasingly squeezed, dropping from approximately 70 basis points in early 2025 to 50 basis points by the second quarter.
This trend raises concerns about structurally lower profitability from mortgage lending, especially impacting banks with larger exposure.
JPM also anticipates further consolidation within the sector. Larger banks with funding advantages are expected to pursue acquisitions, targeting attractive mortgage portfolios and optimising their lending operations, notably in business segments like buy-to-let and SME lending, areas where smaller or challenger banks may struggle.
Longer-term, analysts expect regulatory easing, including potential reforms to ring-fencing rules and adjustments to leverage ratios, to lower the sector’s cost of equity from around 13.5% to 10%.
Such reforms could improve profitability further, particularly benefiting larger banks positioned to leverage these changes.
Overall, while UK banks offer attractive investment opportunities due to their solid returns and relatively undervalued positions compared to European peers, JPMorgan emphasises selectivity.
Investors are advised to favour Barclays and NatWest for their stronger risk-reward profiles and lower exposure to specific challenges, notably in the mortgage and litigation landscapes currently troubling Lloyds.