UK banks: valuations disappoint despite rising profits

Receive free Lex updates

We’ll send you a myFT Daily Digest email rounding up the latest Lex news every morning.

UK bank shares are putting in a depressing performance this year. Profits have climbed and share prices have outrun the broader market. But banks are cheaper on a price-to-tangible book basis. The expected boost from hawkish central bank decisions has fizzled out.

The Bank of England’s decision to leave the base rate alone on Thursday will not change matters. Investors had already bought into the sector as lenders entered the sweet spot of higher loan pricing and lagging deposit rates. The FTSE All-Share Banks index has climbed about 19 per cent in the year to date, well ahead of the broader index.

Despite this rise, almost all UK banks’ price-to-tangible book values have retreated. Only HSBC’s has gained. Smaller lenders such as Virgin Money, OSB and Paragon have watched their valuations deflate by up to 40 per cent, according to data from S&P Capital.

The valuation dip coincides with median net interest income climbing. For the six largest banks, it is expected to rise about 10 per cent this year, according to Visible Alpha analyst estimates.

However, investors seem to have tempered their optimism about the sector when customers withdrew deposits more quickly than many UK banks had anticipated. High rates for local fixed-rate mortgages could lead to diminishing loan demand from customers too. Two-year fixed rates rose from about 5.25 per cent to almost 7 per cent between April and August.

For privately held banks, this is a particular problem. Hopes of listing or selling stakes in banks such as Co-operative Bank or Aldermore dwindle with lower valuations. The implied cost of equity on UK banks is almost 16 per cent, says UBS’s Jason Napier based on his profit estimates. Europe, excluding the UK, is at 14 per cent. That makes the sale of bank equity less appealing for owners.

UK banks may look cheap when compared with the historical average. But the market is right to have doubts about the sustainability of earnings.