Of all the falling knives in the market at the moment, UK banks pose arguably the most complicated risks.
Not only is there the prospect of enforced ring-fencing of the retail banks from the investment banking divisions, as a result of the Independent Commission on Banking, there is also the small matter of a possible Eurozone meltdown.
In its morning note today Goldman Sachs nevertheless has a go at trying to make the case for grabbing UK bank stocks at the current lows.
Noting a "substantial share price sell-off" since first half results came out, it says:
The sell-off since then has not correlated closely with our interpretation of reported micro trends, as macro factors appear to have become the dominant driver of share prices. Following an average share price decline of 19% over the last month, we see value in the UK banks overall, although we are mindful of the multiple risks currently facing the sector, most notably related to sovereign debt, economic growth, funding conditions and UK regulation.
We view as remote risks related to a credit event for one of the larger European economies or an inability of a major UK bank to access funding. However, we raise our impairment estimates and target capital ratios to reflect the recent slowdown in global growth and risks related to ring-fencing of basic banking operations in the UK.
In recognition of the risks facing the UK banks, we look for the following features in recommending stocks within the space: 1) stocks where consensus expectations may have fallen too far (i.e. stocks for which our estimates are above consensus); 2) stocks where we see discrepancies between current valuation and steady-state returns; 3) stocks with manageable regulatory risk.
HSBC (Conviction Buy): Results showed solid operational trends and progress on the group's realignment.
We expect ROE to continue to trend upwards over coming periods, driving a re-rating in the stock. Our GS
EPS estimates are 0%-13% above Datastream consensus through 2013.
Lloyds Banking Group (Buy): Results highlighted further de-risking alongside solid core trends. We view market expectations as pessimistic (our GS EPS estimates are 5%-13% above consensus through 2013), expect steady-state ROTE to be among the highest in the sector and consider the stock's risk/reward characteristics compelling.
At 12:35 the FTSE 100 is up 61 points, with the banks, oil and gas stocks pushing the index along.
Lloyds Banking Group is up 5% to 29p, one of the top risers in the FTSE 100.
