The coronavirus pandemic has led to bank shares looking particularly cheap, analysts at Berenberg said, but warded off investors as the apparent value “is illusory”.
“Banks have rarely appeared so cheap – although uncertainty has rarely been so high,” analysts at the bank said in a note to clients where price targets for Lloyds Banking Group PLC (LON:LLOY) and its peers were cut by 33% on average.
Revising down earnings forecast by 30% to reflect the slowdown in activity and lower interest rates, the analysts said the crucial sensitivity for the banking sector is the level of potential losses, with the combination of a highly likely shock of uncertain size and new loan loss rules, “likely to create material loan losses” during this year and beyond.
Having previously calculated that the whole sector would see around 110-170 basis points of loan losses in the 2020 financial year, the various new policies have since been announced to ease this effect that “are likely to dampen (although not avoid) front-loading of provisions”.
As a result, the analysts expect circa 40% of loan losses for the three years to 2022 to occur during 2020, versus roughly 65% in the previous analysis.
The level of aggregate loan losses is also estimated to be less than initially expected, although they are still forecast to rise by 70% in 2020 and 25% in 2021 for European banks.
“As expectations adapt and policies change, loan losses will remain a key uncertainty.”
While costs are one area of mitigation within banks’ control, this requires upfront costs, and capacity for reductions may be constrained and not sufficient to offset lower expected revenues.
Looking at the apparent value of the sector, trading on 5.5 consensus one-year forward earnings, the analysts changes now put the sector at 8.9 times of 2021 earnings per share.
“This 6% discount to historical multiples is not compelling, in our view.”
Barclays PLC (LON:BARC) is one of the shares where the analysts believe there is “material upside” as it cut the price target to 150p from 220p, while at the other end, “top shorts” include HSBC PLC (LON:HSBA), with the target cut to 430p from 490p.