Proactive Investors - Short-sell Lloyds Banking Group PLC (LON:LLOY) and buy NatWest Group PLC (LON:NWG) is a short shelf-life ‘pair trading’ idea suggested by analysts at RBC, who see a valuation gap between the UK’s two mortgage-lending high street banks.
“LLOY and NWG valuations have historically been c.80% correlated; however, the Lloyds premium has opened up post results to c.0.11x 2yr forward price to tangible book value (P/TBV) - higher than the avg. premium of c.0.06x since 2020,” RBC analyst Benjamin Toms said in a note.
“Although Lloyds is carrying better momentum, its latest 2yr forward return on tangible equity (ROTE) expectation is only slightly above NatWest's (13.5% vs 12.8%), which does not fully justify the current valuation gap in our view.
“In the short term, we would recommend a pair of long-NWG; short-LLOY until the valuation gap closes.”
Toms, meanwhile, reckons over the medium term Lloyds shares should be preferred over NatWest because of the black-horse bank’s strategic investments and the analyst said highlighted a confidence in Lloyd’s asset quality.
Despite the short-term value gap, RBC is generally bullish on UK banks.
“UK banking net interest margin (NIM) may come down in 2024, but we believe the structural hedge should underpin solid returns and attractive dividend yields for a number of years,” Toms added.
“We remain comfortable around asset quality, which we expect will hold up through next year.
“Although net interest income (NII) momentum may have run out, we continue to believe that UK banks remain attractive at current valuations.”
RBC today downgraded its price target for Lloyds to 65p from 68p whilst retaining an ‘outperform’ rating, meanwhile, it retains a ‘sector perform’ rating for NatWest with a 290p target.
Elsewhere, RBC downgraded HSBC Holdings PLC (LON:HSBA) to ‘sector perform’ and told investors “now is a good time to take profits”.