“Like the British weather, it only ever seems to rain in the UK banking sector,” said analysts at HSBC as they trimmed share price targets on Lloyds Banking Group PLC (LON:LLOY) and its high street rivals.
With subdued mortgage volumes and contracting pricing already weighing on the sector, the analysts also cautioned that the previously positive story of deposit pricing was also likely to get more competitive as the system looks to replace £130bn of cheap Bank of England funding.
“We are concerned that we could be on the cusp of a shift here, not least because the banks will need to begin repaying the BoE shortly as facilities mature,” the analysts said in a note to clients on Thursday, adding that there are already some early signs of upwards pressure on deposit rates.
Moreover, the recent lowering and flattening of the yield curve “is problematic for UK domestic banks that invest along this curve,” known as the 'structural hedge' and which provided around £3.3bn of net interest income for Barclays PLC (LON:BARC), Royal Bank of Scotland Group PLC (LON:RBS) and Lloyds last year.
Without any change in interest rates and with the banks mechanically reinvesting maturing hedges, the HSBC analysts estimated this contribution will drop by 35% in the next two years.
“If the hedge is not reinvested, a likely outcome for Lloyds at current rates, we estimate the net contribution could fall by almost 50%.”
While revenue estimates were cut across the board, not helped by weaker retail fee income due to regualtory pressure on overdraft fees, feeding into lower target prices, banks' market valuations have also been depressed by macro sentiment, so HSBC's recommendations remained unchanged.
The target price for Lloyds was trimmed to 58p from 59p and the ‘hold’ rating maintained, while RBS and Barclays both remained at ‘buy’ with their targets cut to 260p and 220p respectively from 270p and 240p.
Challenger banks stuck in a rut
Life is seen as being even tougher for challenger banks, such as CYBG PLC (LON:CYBG) and Metro Bank PLC (LON:MTRO), which are more exposed to deposit wars, in part as they are heavier users of cheap BoE funding.
Equally concerning for the challengers, the analysts pointed to ever higher mortgage retention rates amongst the incumbents as fixed rates expire, reducing the pool of loans for which challengers can compete.
“Barriers to entry appear to be rising not falling with digitalisation – it wasn’t supposed to be that way.”