Lloyds downgraded on Exane's bleak outlook for sector

Exane BNP Paribas has downgraded Lloyds Banking Group from ‘neutral’ to ‘underperform’ and reiterated its ‘underperform’ rating for Barclays on a bleak operational outlook for UK banks.

In a note to investors on Wednesday, it said comments from the Department for Business, Innovation & Skills (BIS) and the Bank of England’s Financial Policy Committee (FPC) have led it to soften its view on capital.

That in turn has forced Exane BNP Paribas to expect lower than consensus dividends over the next three years.

On top of that, the investment bank believes the operational outlook for the sector is increasingly bleak.

“We cut 2017 EPS estimates by an average of 4% to reflect slightly lower margin and slightly higher impairment assumptions - driven by a more rapid reduction in releases and recoveries.”

It said Britain’s potential exit from the EU could also push up the sector’s risk premium ahead of the referendum.

Exane BNP Paribas’ concerns about Lloyds Banking Group’s margin and impairment have increased since it last downgraded the stock in September 2015.

“We also think the cost income target of 45% by 2018, set just one year ago, is now unachievable,” the note said.

“Distribution potential is also debatable, and we think the bank will be able to pay just 12p of dividends (or the equivalent in buybacks) over the next three years, well below some market estimates.”

The investment bank also believed Barclays should raise capital given how tight it is operating against end-point requirements.

“Even if this capital was not ultimately needed, we believe it could be used to significantly enhance earnings through a LME on its subordinated debt.”

It said if the bank did this, Exane BNP Paribas’ might look more positively on the stock.

Its target price on Barclays was dropped 14% to 215p, while it dropped the target price of Lloyds 5% to 74p but raised Standard Chartered’s target price 3% to 515.

The note also highlighted that RBS remains the investment bank's only ‘outperform’ rating.

Lloyds shares dropped marginally on the downgrade, down 0.26p (0.38%) to 69.04p, while Barclays was up 3.02p (1.49%) to 205.37p at 0908 GMT.