Proactive Investors - Barclays (LON:BARC) Capital has upgraded its rating for Virgin Money UK PLC (LON:VMUK) to 'overweight' from 'equal weight', signalling a positive shift in its outlook despite growing recession risks.
The move reflects Barclays' assessment of an attractive risk-reward balance for VMUK, amidst a backdrop of economic uncertainty impacting UK banks.
It also comes as Barclays analysts evaluate the potential effects of a recession on the banking sector, considering factors such as fluctuating interest rates and rising unemployment.
One key scenario considered involves a reduction in UK interest rates by 1% by 2024, coupled with an unemployment rise to 6% from the current 3.7%.
Such conditions could lead to a significant decrease in earnings per share (EPS) for major banks such as HSBC Holdings PLC (LSE:LON:HSBA), Lloyds Banking Group PLC (LSE:LON:LLOY), and NatWest Group PLC (LSE:LON:NWG), ranging from 25-40% compared to Barclays' central case.
Despite these potential challenges, Barclays sees an overall positive outlook for the sector.
The analysis suggests an average of 40% implied upside potential across the banks covered, or even 60% if the more optimistic central scenario plays out. This implies that bank stocks could offer substantial returns if the economic conditions align more favourably than expected.
The report also delves into the relationship between unemployment rates and loan losses. Historically, a 1% annual increase in UK unemployment has led to a rise in loan losses for banks, impacting their financial stability. This aspect is particularly relevant in the current economic climate, where job security is uncertain.
In terms of net interest income (NII) - the difference between the revenue generated from a bank's assets and the expenses associated with paying out its liabilities - Barclays anticipates up to 8% higher NII than the consensus for 2023/24.
This is especially true for NatWest and HSBC, indicating that these banks could see greater profitability from interest-earning activities.
Barclays maintains a favourable view of other UK banks as well. NatWest and OneSavings Bank (OSB) are rated 'overweight', with Barclays highlighting their strong potential returns and resilience in various economic scenarios.
HSBC, despite some near-term challenges related to capital and adverse foreign exchange movements, is also seen as a resilient player with long-term value, retaining its 'overweight' rating.