The surge in interest rate rises from central banks has generally been good news for banking stocks. Lenders make their money on the difference between the interest they pay out to depositors and the interest they earn from loans and investments. Higher rates mean a wider gap. But it isn’t that straightforward.
UK bank stocks have mostly fallen this year as lenders compete for deposits by offering savers higher rates of interest, with the cost of living crisis threatening defaults on loans.
UK lenders are facing a “pain game” as interest rate hikes hurt the outlook for both loans and deposits, Guy Stebbings, analyst at Exane BNP Paribas warned.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
“Back in the danger zone,” Stebbings said in a note to clients. “Higher rates lift bank earnings but at a certain level this equation breaks down.” He added that “we are well past this point.”
The Bank of England currently has its interest rate at 5.25%, a fresh 15-year high.
ARE UK BANKS AT ATTRACTIVE VALUATIONS?
With banks operating under pressure, is now a good entry point for investors looking for exposure in the market?
“The UK banks remain one of the cheapest sectors in the UK stock market, but despite the tailwinds from rising interest rates, it is difficult to find a near-term catalyst for the sector,” Owen Freshwater, investment manager at Evelyn Partners, tells MoneyWeek.
“The 5 major UK banks all trade below their tangible book value and on single-digit P/E multiples. With return on tangible equity rising to low-to-mid teens across the sector on the back of higher interest rates, banks are finally earning decent profits again and able to return profits to shareholders via dividends and share buybacks,” he adds.
Laith Khalaf, head of investment analysis at AJ Bell, agrees that UK banking stocks aren’t looking that attractive, unless you’re thinking about dividends.
“If you’re looking for growth, then there are probably better places to look than the UK banking sector,” he tells MoneyWeek. “What banks do offer though, is a pretty healthy dividend stream for income seekers. Lloyds has a dividend yield of around 6%, Barclays sits around 5.5%, NatWest is nudging up to 8% and HSBC around 7%,” he adds.
Analysts say that UK banking stocks’ valuations are at a low ebb, even by the banks’ own low standards, and that offers the potential for a jump in the share price if there is a reappraisal of UK value stocks but that is a big if.
“We’ve been waiting a long time for that turnaround, and investors shouldn’t hold their breath,” Khalaf says.
Bank shares have been overshadowed by the recent banking turmoil. Due largely to these external factors, the shares have seen a dip of around 9.5% over the last six months.
“Even so, this has not prevented the price having added 5% over the last year, which is largely in line with the wider FTSE 100 index which has risen by 5.3%. The second quarter slowdown has taken some of the shine from the bank’s recent progress, but the market consensus of the shares as a buy for the longer term is unlikely to be unduly affected,” Richard Hunter, head of markets at interactive investor, says.
ALL ABOUT THE DIVIDENDS
The UK banks have undergone a turbulent few months, with the collapse of European giant Credit Suisse and Silicon Valley Bank earlier this year sending shockwaves throughout the sector. But the dust appears to be settling, as the sector avoided a liquidity crisis and announced a raft of dividends and share buybacks.
“With return on tangible equity rising to low-to-mid teens across the sector on the back of higher interest rates, banks are finally earning decent profits again and able to return profits to shareholders via dividends and share buybacks,” Freshwater says.
UK banking dividends are covered by earnings and low valuations offer a margin of safety for investors, as there is limited scope for share prices to fall further, barring some global economic catastrophe.
“So at the very least, investors are being paid to wait for better times,” Khalaf says.
WHICH STOCKS ARE STILL WORTH A LOOK?
The risk associated with banks depends on the lender so here we are breaking down what to know about the five major lenders in the UK.
HSBC, Lloyds, Barclays, NatWest and Standard Chartered - the big UK-listed banks - share a lot of key features but there are some differences.
HSBC and Standard Chartered are increasingly global businesses with strong focuses on Asia, and as such, are more insulated to some of the domestic problems in the UK.
NatWest, Barclays and HSBC all have an investment arm which leaves their shares exposed to higher risk and potentially reward.
“Barclays has greater exposure to investment banking which for now remains muted. Lloyds has greater exposure to the UK mortgage market, and we anticipate a potential slowdown here,” Freshwater says.
UK banks breezed through the recent Bank of England stress tests, giving investors an encouraging sign. But in terms of share price performance, there is currently a divide between momentum and outlook.
“For the former, the primarily Asia facing banks, HSBC and Standard Chartered, have been beneficiaries of the reopening of the Chinese economy post-Covid 19, even though the current macro prospects for the region are less certain,” interactive investor’s Hunter says.
HSBC has outperformed the market this year with a 20% rise. Despite this, it still trades at a significant discount to its own historical valuations.
“In terms of outlook and the market consensus, NatWest is currently the preferred play in the sector, which could partly be the result of a solid and dependable, if a little unexciting, performance following the recent banking turmoil,” he adds.
Barclays is the only other bank to have outperformed the FTSE 100, with NatWest the weakest performer for the year so far.
Analysts at broker Berenger say that NatWest looks “particularly undervalued”.
NatWest’s chief executive Alison Rose was forced to resign after admitting she had leaked private banking information about Nigel Farage to the BBC. Following Alison’s exit, NatWest has had £800m wiped off its market value.
“At Barclays, the diversity of the group’s businesses is a boon through the various economic cycles and, to some extent, the three main units are all hitting something of a sweet spot. Unsurprisingly perhaps, the only recent words of caution relate to the US presence, from where the recent banking turmoil emanated,” Hunter says.
Overall, it is difficult to know how UK bank stocks will behave for the rest of the year but they can be a long-term investment opportunity for those who want to take on some risk. But diversification is key.
“If you want exposure to the UK banking sector for income I’d probably suggest owning a bit of each of the big four, just in case there’s a corporate slip up as we have seen with NatWest in the last few weeks. Diversifying in this way also means you aren’t too reliant on one bank for your income stream,” Khalaf says.
Similarly, Freshwater warns that not all UK banking stocks are the same but investors shouldn’t be too quick to dismiss them.
“The UK banks look good value, but a re-rating may be some way down the road (if ever!). When deciding which bank to buy, one must be cognisant of the geographical exposure of said bank (just because it is UK listed does not mean it has sizeable exposure to the UK economy). In the meantime, investors are provided an attractive dividend return, with buybacks further supporting the share price,” he says.
“A significant downturn in the UK economy would undoubtedly leave the sector worse off in terms of loan losses, but for the time being these remain relatively well-contained.”
Pedro Gonçalves is a finance reporter with experience covering investment, banks, fintech and wealth management. He has previously worked for Yahoo Finance UK, Investment Week, and national news publications in Portugal.
Bank of England holds interest rates at 5.25%
The Bank has kept rates at 5.25%, ending its run of 14 consecutive increases. We look at what it means for your money - and what the Bank’s next move could be
By Ruth Emery Published
The best packaged bank accounts
Advice Packaged bank accounts can offer great value with useful additional perks – but get it wrong and you could be out of pocket
By Tom Higgins Published