In a note on the big UK banks, JPMorgan analysts cut their rating on Lloyds to ‘neutral’ from the previous ‘overweight’ and trimmed their share price target to 70p from 80p after the shares had enjoyed a 15% total return so far in 2019.
Pricing of interest rate derivatives pointed to an earnings per share headwind of 8-12% by year-three for the big high street banks, assuming net yields remain close to zero.
If rates remain stable, the analysts see increasing capital requirements for large lenders likely to drive pricing, with Lloyds's highest group return on tangible equity in the UK at 15% versus 9-10% for Barclays, RBS and HSBC, "its returns hurdle rate is higher, resulting in less competitive pricing and limited mortgage growth".
Lloyds had been upgraded by Cazenove in late 2016 due to its “best in-class” capital generation, shareholder returns profile and the resilience of its net interest margin, “which may continue if the UK reaches an economically positive agreement on Brexit”.
But with JPMorgan economists predicting a 25% probability of a no-deal Brexit under a new prime minister, leading to likely rising pressure on banks’ finances from lower rates and higher impairment, and also potentially weighing on capital build and returns for all domestic UK banks.
If no-deal avoided
Royal Bank of Scotland Group PLC (LON:RBS) was also rated ‘neutral’ but it is in a “better position” to make an upfront capital return following one-time disposal gains, with the coming earnings season felt likely to see the announcement of a special dividend of around 8p per share.
In a scenario where a no deal Brexit is avoided, the analysts see RBS returning 33% of its market cap versus 28% from Lloyds.
“Although the special dividend improves the investment case and may appeal to tactical investors, we think RBS needs to start buying back shares in a way that reduces the UK government stake for the market to turn more positive.
“We think this could be achieved if the UK government started an automated drip feed sell-down of its RBS stake alongside an RBS buyback.”
Barclays PLC (LON:BARC) is now JPMorgan’s only ‘overweight’ in the sector, for its greater geographically diversity with only 52% revenue exposure to the UK
HBSC Holdings PLC (LON:HSBA), the only name in the sector rated ‘under-weight', is also facing risks from Brexit, the analysts said.
Shares in Lloyds fell around 2% to 57p in early trading on Tuesday but were erasing those losses later, while RBS, Barclays and HSBC were little moved.