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UBS prefers Barclays, Lloyds and RBS despite worries about Brexit uncertainty

UBS said Barclays is its top pick of European banks

Barclays
UBS raised its target price on Barclays and reiterated a 'buy' rating on the stock

UBS said investors are pessimistic about UK lenders due to Brexit uncertainty but it still prefers Barclays PLC (LON:BARC), Lloyds Banking Group PLC (LON:LLOY) and Royal Bank of Scotland Group PLC (LON:RBS).

The third quarter earnings season for UK banks begins on Wednesday with figures from Barclays.

UBS expects the run-up to the results to be dominated by the “ebb and flow” around the political risk of Brexit, Italian budgets, Brazilian elections, Turkish central bank policy and broader equity market volatility.

Competition in mortgage lending for UK banks also remains a key focus for investors, UBS said.

UBS cuts target prices for HSBC and StantChart, lifts Barclays

For Asia-focused HSBC Holdings PLC (LON:HSBA) and Standard Chartered PLC (LON:STAN), UBS reckons current trading appears more difficult with lower expected market-related revenues in retail and the investment bank, emerging market foreign exchange weakness and prime rate hikes in Hong Kong all headwinds to revenue growth.

UBS maintained a ‘neutral’ rating on HSBC and StanChart. However, it cut its target price on HSBC to 650p from 750p and reduced its target price for StanChart to 600p from 735p.

“We expect both to recommit to flat costs in the second half (vs the first half) which means that our forecast revenue cuts drop to the bottom line, reducing HSBC earnings per share by 3% in each year and Stan by 9-14%,” UBS said.

“With UK domestic banks trading at a material price-earnings ratio and capital return discount to both HSBC and StanChart we retain a preference for Barclays, LBG and RBS, with Barclays our top pick into numbers. All are rated Buy.”

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UBS raised its target price on Barclays to 240p from 235p, supported by lower-than-expected litigation costs. For Lloyds and RBS the target prices were left unchanged at 80p and 300p, respectively.

Political pressures expected to ease

UBS sees a normalisation in valuations over the coming year as political pressures ease and investor confidence increases in the outlook for a rate-driven cyclical recovery in margins and returns for Eurozone banks.

An end to a planned transitional period of a year after the UK leaves the EU next March should also see lower fears of a near-term dislocation in UK domestic fortunes and a return to rate hikes, UBS added.

Higher interest rates will boost net interest margins – a measure of banks’ profitability.

UK bank stress test in focus

The UK banks’ results season comes ahead of the outcome of Prudential Regulation Authority’s bank stress test on December 5.

“There is no mechanical link between stress test results and bank capital requirements but, unfortunately, there's also a two-month gap between test result publications and banks being informed of their Pillar 2 capital requirements,” UBS said.

“We expect very significant capital drawdowns in this year's test, driven by the scenario and the 'perfect foresight' implementation of IFRS9 in the exam.”

READ: Lloyds and RBS back on their feet 10 years after government's bank rescue deal

The stress test will see whether banks have strong enough capital buffers to withstand any future financial stocks, including a decline in UK and world gross domestic product, a drop in UK house prices and an increase in UK unemployment.

Quick facts: Barclays Plc

Price: 165.78 GBX

LSE:BARC
Market: LSE
Market Cap: £28.63 billion
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