Lloyds upgraded, though NatWest will remain more profitable for next few years - broker

Keefe, Bruyette and Woods (KBW) upgraded Lloyds Banking Group to 'outperform' from 'market perform', raising its price target to 90p, and increased NatWest Group's target to 600p. While NatWest is expected to maintain a higher return on tangible equity (ROTE) through 2026, having surpassed Lloyds in 2024 for the first time in over a decade, KBW forecasts ROTE convergence around 17% by 2027. Lloyds is projected to generate slightly higher returns from 2028 onwards, driven by its retail banking exposure and potential capital efficiency gains from IFRS17 changes, leading KBW to conclude that the historical valuation discount applied to Lloyds is no longer justified.

Analysis

Keefe, Bruyette and Woods has issued a positive reappraisal of UK lenders, upgrading Lloyds Banking Group to 'outperform' from 'market perform' with a price target increase to 90p, while lifting its target for the already 'outperform' rated NatWest Group to 600p. The core of the analysis hinges on the future trajectory of return on tangible equity (ROTE). While NatWest surpassed Lloyds on this metric in 2024 and is forecast to maintain its lead through 2026, KBW projects a convergence with both banks achieving approximately 17% ROTE by 2027. The long-term outlook favors Lloyds, which is expected to generate slightly higher returns from 2028 onwards. This is attributed to its greater exposure to retail banking and, critically, the potential to enhance capital efficiency in its insurance division following the implementation of IFRS17 accounting standards. Consequently, KBW has increased its estimate for normalised ROTE to 16% for both institutions and asserts that the historical valuation discount applied to Lloyds versus NatWest is no longer justified.

Key Decisions for Investors

• Given the upgrade and the argument that its valuation discount is no longer warranted, investors could consider the case for Lloyds, particularly focusing on its long-term return profile post-2027.
• For those with a shorter investment horizon (through 2026), NatWest remains the favored holding based on projected near-term ROTE superiority, but the narrowing valuation gap suggests the relative trade is becoming less distinct.
• Investors should closely monitor future earnings reports for evidence of the forecasted ROTE convergence and, specifically, any commentary from Lloyds' management on capital efficiency gains realized from the IFRS17 changes in its insurance business.