These six UK bank shares look cheap

After a better-than-expected results season, earnings forecasts for 2022 have been upgraded and share prices are playing catch-up.

Barclays (LSE:BARC), HSBC (LSE:HSBA) and Lloyds Banking Group (LSE:LLOY) are among six UK-based lenders whose shares have been labelled good value in the wake of a “bumper” third-quarter earnings season.

UBS's banking analyst Jason Napier said several positive cyclical factors were not reflected in current valuations, such as higher interest rates, the potential for write-backs of previous loan loss provisions and the greater clarity on dividends and share buybacks.

Shares in the sector have risen 20% so far this year, led by Lloyds and Barclays, but Napier notes the sector has effectively de-rated because earnings forecasts have risen 30% for 2022.

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This has left UK banks trading at 7.8 times next year's earnings per share, representing a 15% discount to European counterparts, 22% to the FTSE 100 and 50% short of the Stoxx600.

He said: “Notwithstanding present uncertainties around Article 16/Northern Ireland, we see this as an opportunity worth grasping and would be buying here.”

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HSBC (LSE:HSBA) is his top pick based on expectations for a 13% upside to 500p, while Barclays is the leading domestic bank with a target price of 250p and a 27% upside.

Lloyds continues to have a 60p target while there are also “buy” recommendations for Paragon (LSE:PAG), Standard Chartered (LSE:STAN) and Virgin Money UK (LSE:VMUK) with estimates of 615p, 530p and 220p respectively. NatWest (LSE:NWG) and Close Brothers (LSE:CBG) complete UBS's coverage with “neutral” ratings.

The upbeat assessment follows a third-quarter results season in which underlying profits beat consensus by 25%, with income 2% ahead and costs 1% better than hoped for.

Loan losses were low, a situation UBS expects to be sustained given that banks have substantially over-provisioned during the pandemic, and as the bank's economists believe the UK is better placed than Europe in terms of the outlook for GDP growth and unemployment.

The UK is also ahead of the interest rates curve, with the Bank of England set to act as early as December as part of 110 basis points of increases forecast in the City for the next 12 months.

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These rises are expected to provide a significant potential tailwind, particularly in the mortgage market where spreads continue to be at multi-year lows.

Strong capital generation also highlights the appeal of UK banking stocks after it emerged lenders are sitting on between 13% and 30% of their market capitalisation in excess of management targets.

Napier said this surplus looked more distributable than it did a month ago, given strong post-furlough scheme unemployment statistics and confirmation from the Bank of England that new Basel bank capital rules will not be effective in January 2023.

He noted that banks would require on average a year of trading at 15% average daily volumes just to get back to their regulatory capital ratio targets.