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Investing.com -- UK banks are in a holding pattern as investors await the November 26 budget, with UBS on Monday maintaining an overweight position on the sector despite limited appetite from long-term investors to increase domestic bank exposure.
According to UBS, hedge funds are showing more interest in UK banks due to their attractive valuations, high return on tangible equity (ROTE), accelerating loan growth, improving deposit mix, and structural hedge benefits.
These factors position UK domestic banks to deliver the fastest revenue growth among European banks over the next couple of years.
UBS has identified Barclays PLC (LON:BARC), NatWest Group PLC (LON:NWG), and Paragon Banking Group PLC (LON:PAGPA) as top picks among domestic banks, while maintaining a neutral stance on HSBC Holdings PLC (LON:HSBA) and a buy rating on Standard Chartered PLC (LON:STAN) heading into third-quarter earnings, which are expected to continue positive trends seen in the second quarter.
Investor sentiment remains cautious ahead of the budget, with uncertainty about how the UK government will address a fiscal gap estimated between £10 billion and £30 billion. UBS anticipates a modest increase in bank taxation, potentially raising the bank surcharge from 3% to 5%, which banks would likely pass on to customers.
The investment bank believes the government views a vibrant financial services sector as crucial for addressing sluggish growth and the country’s large financing gap, making wholesale changes to bank taxation unlikely.
However, UBS expects a slower mortgage market from September to November due to uncertainty around potential changes to stamp duty and landlord taxation.
Despite these challenges, UBS forecasts strong earnings growth for UK banks, with earnings per share projected to increase 4% to 19% in fiscal year 2025, 27% in 2026, and 6% to 17% in 2027. This growth will be driven by accelerating loan growth, improving deposit mix, hedge benefits, and operating leverage.
UBS projects average ROTEs of 14.7% to 15.0% over the next three years (excluding motor provisions), which should deliver an attractive distributed yield of 8.5% to 9.2% from fiscal year 2025 to 2027.
Valuation-wise, UK domestic banks are trading at 7.9x and 7.1x fiscal year 2026 and 2027 earnings per share, while international banks are at 9.3x and 8.6x, compared to the European bank sector average of 9.2x and 8.3x.