Lloyds and NatWest shares set to struggle ahead of Q3 earnings

• Lloyds and NatWest Group set to unveil third quarter (Q3) earnings on Thursday 29 October
• Analysts from JP Morgan see an opportunity for investors in UK banks in 2021
• UK stocks set to slump in winter as growth in Covid-19 cases threaten prolonged lockdowns

Lloyds and NatWest Group will unveil their third quarter (Q3) results on Thursday 29 October, with investors expecting more disappointment and uncertainty from UK lenders this earnings season.

But despite the challenging trading environment for UK banks, analysts from JP Morgan believe the sector could deliver capital returns for investors in 2021.

‘We believe it's hard to overstate the importance of [a successful Brexit deal] (despite lower economic impact) for UK bank share prices as well as potential capital return,’ analysts at JP Morgan said in a research note.

JP Morgan goes on to tell its clients that a successful Brexit deal could significantly mpact the Prudential Regulatory Authority’s guidelines on capital resiliency and capital returns for UK domestic focused banks, which could see the like of Lloyds and NatWest start paying dividends again.

Lloyds closed at 28p per share on Tuesday, with the stock down 55% year-to-date, while NatWest Group ended the session at 119p, with its share price down 51% since the start of the year.

Lloyds and NatWest 2020 outlook

Despite Lloyds seeing some early signs of recovery in its core markets, such as consumer spending and mortgage lending, the overall outlook for the domestically-focused bank remains highly uncertain amid the low interest rate environment and a fragile UK economy.

This lacklustre outlook is reflected in Lloyds updated 2020 guidance, with the bank’s net interest margin expected to remain broadly stable on the second quarter level at circa 240 basis points, resulting in a full year margin of circa 250 basis points.

Lloyds operating costs are forecast to fall below £7.6 billion in an effort to bolster its balance sheet, with the bank expecting impairments for the financial year to be anywhere between £4.5 billion - £5.5 billion amid rising bad loans due to the economic fallout from Covid-19 pandemic.

Meanwhile, at NatWest the outlook is marginally better, with the lender looking to achieve a £250 million cost reduction in 2020 and strategic costs to fall within its £800 million - £1 billion guidance range.

It too expects impairment charges, albeit lower than Lloyds, within a range of £3.5 billion - £4.5 billion. However, the bank admits that its guidance is likely to change due to the impacts of Covid-19 on the economy and because the mitigating benefits of the UK government’s support schemes remain uncertain.

Bank of England mulls further stimulus and negative interest rates

In order to provide additional support to the UK economy from the impact of Covid-19, the Bank of England’s Gertjan Vlieghe considered the possibility of adopting negative interest rates and additional stimulus.

‘GDP and labour market indicators stand at levels that are below what has historically been the trough of a recession,’ Vlieghe said.

‘Given that virus prevalence has been increasingly again recently, it is likely to weigh more heavily on economic activity,’ he added. ‘Indeed, it appears that the downside risks to the economic outlook at starting to materialise.’

In a speech on the health of the UK economy earlier this week he warned of a ‘tremendous challenge ahead’ amid rising coronavirus cases that have led the government to impose tighter restrictions across the country.

‘My own view is that the risk that negative rates end up being counterproductive to the aims of monetary policy is low,’ Vlieghe said. ‘Since it has not been tried in the UK, there is uncertainty about this, and the MPC is not at a point yet when it can reach a conclusion on this issue.’

‘But given how short term and long term interest rates already are, headroom for monetary policy is limited and we must consider ways to extend that headroom,’ he added.

The BoE and other central banks around the world have dramatically reduced interest rates and offered economic stimulus to stimulate activity and stabilise their economies amid the fallout from Covid-19.

However, historically low interest rates are taking their toll on financial institutions, eroding lenders net interest margins and hurting profitability which will make it difficult for the likes of Lloyds and NatWest to generate returns for investors over the next five years.

But over the long-term many bank stocks trading at record low levels, making them relatively cheap for investors and capable of offering signifcant returns as markets slowly begin to stabilise.

FTSE 100 likely to weaken further after rally into resistance

The FTSE 100 is weakening after the latest rally into the 200-hour SMA and standard deviation channel resistance, according to Josh Mahony, senior market analyst at IG.

‘The downtrend evident since June remains in play here, with fears over the growth in coronavirus lockdowns likely to continue hurting market sentiment,’ he added. ‘As such, further weakness looks likely unless we see a break through the 5886 swing-high.’

How to trade stocks with IG

Looking to trade Lloyds and other stocks? Open a live or demo account with IG and buy (long) or sell (short) shares using derivatives like CFDs and spread bets in a few easy steps:

1. Create an IG trading account or log in to your existing account
2. Enter ‘Lloyds Banking Group PLC’ in the search bar and select it
3. Choose your position size
4. Click on ‘buy’ or ‘sell’ in the deal ticket
5. Confirm the trade