JP Morgan, the American investment banking giant, has released a research note analysing the performance and potential of two leading UK banks, NatWest Group PLC (LSE:NWG) and Lloyds Banking Group PLC (LSE:LLOY).
The bank’s key takeaway: It favours NatWest over Lloyds following a reset in net interest margin (NIM) expectations. The NIM, a measure of the difference between the interest income a bank earns from its lending activities and the interest it pays out to its lenders, such as depositors, is a crucial indicator of a bank’s profitability.
Since the start of the year, JP Morgan’s view has held that net interest income (NII) gearing — the ratio of a bank’s net interest income to its total assets — is unlikely to assist the banks. Net interest income refers to the difference between the revenue that is generated from a bank’s assets and the expenses associated with paying its liabilities.
The last two quarters have seen UK domestic banks reporting NIM trends that haven’t lived up to optimistic market expectations.
JP Morgan asserts that both NatWest and Lloyds have adjusted the market’s expectations for NIM, which it believes were set too high. However, JP Morgan remains cautious about the outlook for NII in the medium term, citing potential risks such as deposit migration, rising betas, fluctuating lending volumes, and mortgage headwinds.
Despite the challenges, JP Morgan sees better risk and reward prospects for NatWest compared to Lloyds in the near term, especially as the UK base rate is expected to rise by another 50 basis points (bps).
JP Morgan’s outlook takes into account factors like asset quality resilience, the continuation of capital return, moving swap rates, and the upcoming second-quarter results. The bank has placed both NatWest and Lloyds on its “catalyst watch”, indicating events or conditions that could potentially affect the companies’ stocks.
While both stocks are rated ‘neutral’, NatWest is seen as the one with slightly more upside potential.
Barclays a better bet?
Although shares in NatWest and Lloyds appear inexpensive based on headline valuations with a price to tangible net asset value (P/TNAV) at 0.9 times and a price/earnings (PE) ratio between 5-6 times, JP Morgan sees a higher upside in Barclays PLC (LSE:BARC), another domestic UK bank.
The P/TNAV ratio is used to evaluate the market price of a company’s stock relative to its tangible assets, while the PE ratio measures the price paid for a share relative to the annual net income or profit earned by the firm per share.
Barclays, JP Morgan’s only ‘overweight’ pick in the UK domestic banking sector, is trading at 0.5 times P/TNAV and 4 times PE.