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UK banks worth buying for discount to wider market, potential for dividends - UBS

UK domestic banks trade at a 14% discount to the European banks sector, which itself trades at a 42% discount to the European market

Lloyds Banking Group -

Lloyds Banking Group PLC (LON:LLOY), Barclays PLC (LON:BARC) and Virgin Money UK PLC (LON:WMUK) shares are all ‘buys’ for UBS as the European banking sector, particularly the UK’s, is seen as significantly undervalued compared to the rest of the market.

UK domestic banks trade at a 14% discount to the European banks sector, which itself trades at a 42% discount to the European stock market, UBS pointed out.

There seems to be no reason for this, the UBS analysts said: London-listed lenders have “just as much excess capital (15% of mkt cap), higher provision levels, lower troubled assets, a regulator we expect to sanction excess capital returns in July, and a central bank which should, we think, be considering tapering QE and hiking rates within the investing horizon”.

With the economy outperforming expectations and seeing relative valuations as attractive, UBS said it was retaining its UK domestic banking ‘overweight’ recommendation.

Barclays is the top large cap pick and Virgin Money the top mid-cap picks, but Lloyds and Paragon Banking Group PLC (LON:PAG) also ‘buy’ rated.

HSBC was removed from the European preferred list last month, while NatWest Group PLC (LON:NWG) and Standard Chartered PLC (LON:STAN) both remain ‘neutral’ rated.

The analysts noted that the most significant P&L outperformance for European banks in Q1 2021 was in trading income and loan losses, with a 60/40 beat/miss ratio in net interest income “confirming the challenges of a low rate world”.

But the UBS team said that even if those two factors attract low P/Es from investors, “outperformance on earnings and bad asset formation is delivering an increasingly strong capital return profile”, with data for May and June suggesting further growth in balance sheet strength.

These factors are “key” ahead of the updates on dividend guidance from the Bank of England's Prudential Regulation Authority and the European Central Bank due in July.

UBS expect these dividend updates from the regulators to “return control to bank boards, a positive step for the sector, in our view”.

Looking at the mortgage market, where house prices are up 11.3% and mortgage volumes are up 34% year on year, while mortgage spreads for the lenders fell again in June, the analysts said “the green shoots of spending-led growth in higher-margin card activity are also to be seen in this month's data.

“It will take time for this to be material to top-line momentum, but is a dependable and attractive part of the thesis, we think.”

Quick facts: Lloyds Banking Group PLC

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Price: 43.605 GBX

Market Cap: £30.91 billion

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