Leading analysts prefers Barclays and NatWest over Lloyds amid challenging UK bank outlook

JPMorgan analysts favor Barclays and NatWest over Lloyds, citing diverging performance driven by margin pressures and market dynamics; Barclays is considered the cheapest bank in Europe trading at 6.3x P/E with a projected 12.2% ROTE by 2026 while NatWest is valued at 7.6x P/E with a forecasted 17.7% ROTE. Lloyds faces headwinds due to its significant mortgage exposure (68% of its loan book) and potential litigation risks, leading to an "underweight" rating despite an expected ROTE of 15.5%; broader sector trends include squeezed asset margins, potential consolidation favoring larger banks, and anticipated regulatory easing.

Analysis

JPMorgan's latest assessment of the UK banking sector highlights a preference for Barclays PLC and NatWest Group PLC over Lloyds Banking Group PLC, driven by diverging performance outlooks amidst challenging market conditions. Barclays is positioned as an "overweight" recommendation and notably termed "the cheapest bank in Europe," trading at an attractive 6.3 times price-to-earnings (P/E) and 0.7 times price-to-tangible net asset value (PTNAV) for a projected 12.2% return on tangible equity (ROTE) by 2026. NatWest also receives an "overweight" rating, valued at 7.6 times P/E and 1.3 times PTNAV, with a strong forecasted ROTE of 17.7%. Conversely, Lloyds faces an "underweight" stance due to its higher valuation at 8.5 times P/E, significant vulnerability from its mortgage portfolio (68% of its loan book) under current margin pressures, and looming litigation risks associated with motor finance judgments. While the broader sector is expected to benefit from annual net interest income (NII) growth between 8% and 10% from 2024 to 2027, supported by resilient deposit growth and high household savings, asset margins, particularly in mortgages, are contracting significantly from approximately 70 basis points in early 2025 to 50 basis points by the second quarter. This compression specifically threatens banks with substantial mortgage exposure like Lloyds. Looking ahead, JPMorgan anticipates sector consolidation led by larger banks and potential long-term benefits from regulatory easing, which could lower the cost of equity from around 13.5% to 10%, further enhancing profitability for well-positioned institutions.

Key Decisions for Investors

• Investors should consider aligning portfolios with JPMorgan's preference for Barclays PLC and NatWest Group PLC over Lloyds Banking Group PLC, given their more attractive valuations and risk profiles in the current environment.
• Closely monitor the evolving UK mortgage margin landscape and upcoming motor finance litigation outcomes, as these represent significant headwinds, particularly for Lloyds Banking Group PLC.
• Factor in the potential for M&A activity driven by larger banks and the long-term implications of anticipated regulatory reforms, which could shift competitive dynamics and profitability within the UK banking sector.