UK bank results season: three shares to buy

With second-quarter results just two weeks away, one City analyst has named the bank shares they like best, and why upgrades are likely.

The potential for positive results-day surprises at Lloyds Banking Group (LSE:LLOY) and HSBC (LSE:HSBA) today prompted a City firm to name the lenders as short-term investment ideas.

Lloyds is due to report second-quarter figures on Wednesday 26 July, followed by Barclays (LSE:BARC) the next day, NatWest Group (LSE:NWG) and Standard Chartered (LSE:STAN) on Friday 28 July and HSBC on Tuesday 1 August.

In its preview note, Deutsche Bank said existing guidance is low enough to warrant upgrades to net interest income and return on tangible equity at Lloyds and HSBC.

The least preferred stock in advance of the results is NatWest, given that the current City consensus is above existing income guidance. The bank also warns of the potential for a miss on costs after the company forecast higher levels in the first half.

Overall, Deutsche Bank expects declining balance sheets to be the major focus of the season.

Banking analyst Robert Noble points out that deposits are falling quicker than loans in the UK, putting pressure on banks to adjust balance sheets to maintain liquidity levels.

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He adds that spreads on deposits are much higher than on loans, meaning that larger deposit declines are causing larger movements in net interest income.

The flip side is that lower balance sheet growth consumes less capital, which should benefit capital distributions to shareholders. At current prices, UK banks are yielding 15%, which includes dividends and share buybacks.

Noble said: “We do not expect any material surprises in distributions at the half-year stage and expect the capital position to build into H2, when we expect much larger distributions.”

On Lloyds, Deutsche Bank expects an interim dividend of 1p with the half-year results. It adds that a 40% dividend payout ratio and an expected £2 billion per annum in buybacks over the next three years equates to 16% average yearly yield.

Deutsche Bank’s estimates currently sit 4% higher than the City consensus on adjusted profits and 2% for the year as a whole.

Lloyds is likely to increase its net interest margin guidance, but 150 basis points of interest rate hikes since the first quarter are unlikely to have any further benefit. On impairments, the note expects a normalised charge and assumes no impact from economic model changes.

Lloyds shares are down by around 5% this year, and at 5.7 times 2024 earnings trade at a discount to the Stoxx 600’s multiple of 6.4 times. Deutsche Bank’s price target of 63p represents a 46% upside, one of three “buy” recommendations alongside NatWest and HSBC as a top pick among European banks with a price target of 1,000p.

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The Asia-focused lender has outperformed the market by rising 18% this year, but remains at a big discount to its own historical valuations on 5.8 times forecast earnings.

In terms of the results, Noble sees the potential for an upside surprise from higher non-interest income such as from wealth management and trading.

He estimates a 50% dividend payout ratio and $2 billion a quarter in buybacks, with 2024 set for a 21 cent special dividend and extra $3 billion buyback on the sale of HSBC Canada.

Noble added: “Over three years, we expect HSBC to return over $60billion in capital to shareholders. We estimate 15% average yield over the next three years.”

NatWest has a target price of 370p, while Barclays, Standard Chartered and Virgin Money UK (LSE:VMUK) have “hold” recommendations.

Shares across the sector were boosted yesterday when the Bank of England revealed that all the UK’s major lenders passed its annual cyclical scenario stress test.

The aggregate capital drawdown of 3.5% was lower than the 5.2% seen in the 2019 test, reflecting improved asset quality, higher deposit balances and net interest income increases.