Interactive Investor

Lloyds Banking causes City divide

18th May 2015 14:15

Lee Wild from interactive investor

Banks continue to divide opinion in the City. Deutsche Bank recently said the European sector was "about fair value" whereas JP Morgan announced Monday that investors should be 'overweight' banks. Of course, these two heavyweights, like most investment houses, have their favourites - we reported last week that JPM prefers Lloyds Banking Group over Royal Bank of Scotland. And it's no different at Investec Securities, which, just five weeks after advising against buying any further UK bank shares, has had a change of heart.

In March, Investec's respected banks analyst Ian Gordon upgraded Royal Bank of Scotland from 'sell' to 'hold' on valuation grounds following a slump in the share price. Now, they're slightly cheaper - down 13% in three months - despite a post-election bounce, and Gordon reckons the "notably improved entry level" makes the shares a 'buy'.

"RBS is the least exposed FTSE100 bank to the UK bank levy and, perhaps counterintuitively given 79% Government ownership, we think it now carries a lower level of political risk than peers," he writes. "Sensitivity to rising interest rates may yet become relevant and distribution of an emerging capital surplus now feels like a real issue."

For now, Investec ignores the market overhang created by the government's purchase of a £45.8 billion stake in 2009 at a huge premium to the market price. Instead, it reckons more than halving risk-weighted assets to an estimated £225 billion by 2016 implies a Common Equity Tier 1 (CET1) ratio above 17%. "We now assume that the £10 billion implied capital surplus will be used to repurchase Government-held shares in 2016," says Gordon.

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What's more, RBS is by far the most positively exposed UK domestic bank to a first hike in interest rates - Investec pencils in a 25 basis-point hike early next year. A 1% rate move is worth about £400 million to RBS at the pre-tax level.

RBS trades on 0.9 times tangible net asset value (tNAV) (384p at Q1), which prompts the broker to upgrade not only its rating, but its price target from 375p to 395p. "As such, (a little to our own surprise), RBS now emerges as our top pick, and our only 'buy' in the sector."

But, while Lloyds Banking Group has acquired quite a fan club after recent first quarter results and the election, Investec is not impressed. In fact, following a downgrade from 'buy' early last month, the broker now says 'sell' after the shares raced past its 84p target price to a six-and-a-half-year high.

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"We regard its Q1 performance as robust (but broadly in line with our formerly above-consensus forecasts)," writes Gordon. "As such, while consensus may have seen some catch-up, we are not upgrading our numbers (at all). Moreover, on a 12-month view we expect a combination of statutory downgrades and share indigestion to curtail further progress. Now, with modest implied downside, we cut to 'sell'."

Lloyds trades on 1.6 times tNAV of 55.8p and is still tipped by Investec to pay a dividend worth 5p a share in 2017, giving a prospective dividend yield of 5.6%.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.