UBS issues reality check to global banks but likes Lloyds, RBS

UBS had a reality check for global banks in 2016, warning that another year of fundamental headwinds such as oil and central bank policy will likely weigh on earnings expectations.

Strategist Philip Finch said sentiment towards the banking sector had become more balanced, although skewed slightly negatively given concerns about a China-fueled global growth slowdown and oil credit risks, though he felt the sector was reasonably well placed to absorb the latter.

Based on bottom-up estimates, Finch forecasts overall non-performing loans (NPL) coverage for global banks at 117% in 2016, down from 125% in 2015.

"Last week's surprise Japanese deposit rate cut into negative territory, alongside talks of further easing by the ECB (which sent bond yields to new lows), suggest further downside risk to bank margins in Japan and Europe respectively.

"In contrast, the hawkish stance by the Fed has provided a more favourable platform for net interest income growth for US banks even assuming no further rate hikes."

Top US banking picks are Morgan Stanley, BAC and Citizens, while in the UK, UBS analysts have an overweight position within the European coverage universe, with Lloyd’s Banking Group and Royal Bank of Scotland top picks.

Both banks are felt to have attractive capital-generating business mixes as well as surplus capital and both are forecast to return over half of their market cap in dividends and buybacks over the next five years.

"We’re also calling for the closure of half of UK bank branches over the next 10 years. We all know that digital banking is becoming an increasingly popular method of servicing customers. What that’s meaning in the UK is that every year footfall in branches falls around 10%."