UK Bank Stocks: Can Lloyds, Barclays and NatWest Keep Rallying?
· Members
Five years ago, £100 put into Standard Chartered shares would now be worth £435, before dividends. The same £100 in NatWest would be worth £273, in Barclays £214 and in Lloyds £204. The FTSE 100, the index of London's 100 largest listed companies, turned £100 into £144. Banks that spent a decade after the financial crisis as the market's walking wounded have been its best large-cap trade, and the share prices on Yahoo Finance show it hasn't been a one-stock story.
Watch it play outEvery big UK bank beat the market over five years
Put £100 into each of five holdings five years ago. Each coin is that starting stake.
The FTSE 100 grew it to £144. Coin areas match the values.
The banks grew faster: Lloyds to £204, Barclays to £214, NatWest to £273.
Standard Chartered more than quadrupled, to £435. That is share price alone, before dividends.
Lay the FTSE's £144 over each bank. Every one of them outgrew the market.
Source: Yahoo Finance month-end closing prices; Yield Theory calculations
This piece explains what drove the rerating and whether it has further to run: the structural hedge, margins, the government's NatWest exit, the motor finance scandal, bank tax risk, cash returns and valuations. Our view: the easy money has been made, but the domestic banks still have a few years of earnings growth the market can see coming, and Barclays is the one still priced as if it won't arrive. Dollar figures use about $1.32 to the pound.
The single biggest reason for the rally is a piece of plumbing most investors never look at. Banks take in billions in current-account balances that pay customers little or nothing. They don't leave that money in cash. They lock a stable slice of it into fixed-rate interest rate swaps, a kind of derivative that works like a five-year bond, staggered so a portion matures every month. This is the structural hedge. At Lloyds it is £246bn, with an average life of about 3.75 years, according to its half-year results.
Watch it play outThe hedge rolls slowly, so old low-rate swaps keep getting replaced
Lloyds locks a stable slice of current-account money into fixed-rate swaps: a £246bn structural hedge.
It is staggered so a portion matures every month, with an average life of about 3.75 years.
The oldest slice, written when rates were near zero, matures. The money rolls round to be reinvested.
Lloyds' hedge yielded about 2.8% in the second quarter. NatWest assumes it reinvests at about 3.9%.
Every roll onto a higher rate adds income. Lloyds expects hedge income of more than £8bn next year.
Source: Lloyds and NatWest half-year results
So hedge income lags interest rates by years. Swaps written during the pandemic, when the Bank of England's base rate was near zero, are still being replaced at much higher yields, and bank income keeps rising even as the Bank cuts. Investors spent a decade valuing UK banks as if rates would never normalise. Now the swaps lock in normal rates for years.
The other symbol of normality came last year, when the Treasury sold its last NatWest shares. The bank, then called RBS, took a £45.5bn rescue during the financial crisis, and the state owned 84.4% of it at the peak. Coverage of the exit reports that about £35bn came back through share sales, dividends and fees, roughly £10.5bn less than went in.
Watch it play outThe NatWest rescue came back short by about £10.5bn
During the financial crisis the state put £45.5bn into RBS, now NatWest, and ended up owning 84.4%.
Share sales, dividends and fees flowed back over the years that followed.
About £35bn returned. The faint ring is what full repayment would have looked like.
The last shares were sold last year. NatWest is fully private again, £10.5bn short of the original rescue.
Source: HM Treasury and UKGI statements, as reported
Before the numbers, test your instincts.
Check the claimThree things people believe about UK banks
How much have UK bank shares risen?
A lot, and mostly in the last three years. The rerating began when it became clear interest rates weren't going back to zero, then sped up last year as profits caught up. Over three years, NatWest's share price is up 265% and Barclays' 228%, against 43% for the FTSE 100. The two international banks, HSBC and Standard Chartered, which earn most of their money in Asia, led over five years and did best over the past year as well.
Every bank beat the FTSE 100 over three and five years
Share price change
1 yr
3 yrs
5 yrs
Stock
Lloyds
15%
156%
104%
NatWest
11%
265%
173%
Barclays
6%
228%
114%
HSBC
32%
138%
219%
StanChart
38%
241%
335%
FTSE 100
8%
43%
45%
StanChart, five years
Price change to the latest close from month-end closes, rounded. Excludes dividends.Source: Yahoo Finance; Yield Theory calculations
The past year has been rougher for the domestic three. The Iran war knocked bank shares earlier this year, and a ceasefire set off a sharp rebound, City AM reported. Since their midyear highs, worry about a bank tax in the coming Budget has pulled them back again. From the end of the first half to the latest close, Barclays has fallen 15.1%, Lloyds 10.8% and NatWest 7.9%, against a 3.8% dip in the FTSE 100.
Tax fears have hit Barclays hardest since midyear
Barclays−15.1%
Lloyds−10.8%
HSBC−10.7%
NatWest−7.9%
FTSE 100−3.8%
StanChart−1.7%
Share price change from the close at the end of the first half to the latest close.
Source: Yahoo Finance; Yield Theory calculations
What is the structural hedge, and why does it keep lifting income?
Go back to the swaps. A bank's current accounts behave like very long, very cheap funding. Customers rarely move all of them at once. If a bank left those balances earning the overnight rate, its income would swing with every Bank of England decision. So it fixes most of them, spreading maturities over roughly five years.
That smoothing works both ways. When rates shot up after the pandemic, the hedge held income back, because most swaps were still locked in at low rates. Now the catch-up is running in reverse. Lloyds' hedge earned £4.2bn two years ago and £5.5bn last year, according to its full-year results. It earned £3.4bn in the first half of this year, up from £2.6bn a year earlier.
Lloyds' hedge income is on track to nearly double in three years
246£8bn0
£4.2bn
£5.5bn
£7.0bn
£8.0bn
2 yrs agoLast yrThis yrNext yr
This year and next are Lloyds' guidance of more than £7.0bn and more than £8.0bn.Source: Lloyds full-year and half-year results
The arithmetic is simple. Each 0.1 percentage point on the yield of a £246bn hedge is worth about £246m a year. Lloyds' chief financial officer said the yield was about 2.8% in the second quarter and should reach about 2.9% over the rest of the year. NatWest, in its interim results, assumes it reinvests at about 3.9% on its deposit hedge this year, and plans on a 3.5% five-year swap rate after that. As long as new swaps earn more than old ones, every roll adds income. NatWest expects total hedge income to rise by more than £1.5bn this year and by more than £1.0bn next year.
At Barclays the hedge made up about 45% of group net interest income in the second quarter. More than 95% of the hedge income it expects through two years from now is already locked in, according to its half-year presentation. That visibility is rare in banking, and investors now pay for it.
Make a guess
Spot on.Close, a little low.Close, a little high.Way off, too low.Way off, too high. It was £18.3bn.
£18.3bn, including £6.8bn for this year alone, as of the first quarter. It's income from swaps already on the books, not a forecast.
Source: Barclays first-half results presentation
Why do net interest margins differ so much between UK banks?
Net interest margin (NIM) is the gap between what a bank earns on loans and investments and what it pays on deposits and borrowing, as a share of its interest-earning assets. Lloyds' banking NIM was 3.19% in the first half, up 0.15 points on a year earlier, and 3.22% in the second quarter. NatWest's was 2.48%. HSBC's was 1.61%, according to its interim results.
Lloyds earns twice HSBC's margin on every pound of assets
Lloyds3.19%
NatWest2.48%
HSBC1.61%
First-half net interest margin. Lloyds reports a banking NIM. Barclays and Standard Chartered are left out because their large markets businesses make the figure hard to compare.
Source: Company half-year results
The gap is business mix, not skill. Lloyds is almost a pure UK retail bank: mortgages, car loans, cards and cheap current accounts. HSBC's huge balance sheet of trade finance, securities and corporate deposits earns thinner spreads. Margins aren't rising everywhere, though. Lloyds said older mortgages are being replaced at lower spreads, and NatWest expects its margin to be flatter in the second half, with growth coming from lending volumes. The hedge is doing the lifting, while lending margins are being squeezed.
How did the government's exit from NatWest change the stock?
For years, the Treasury's stake hung over NatWest, because investors knew more government selling was coming. The stake was sold down through placings, a trading plan and directed buybacks, where the bank bought shares straight from the government. Selling shares raised £24.8bn: £13.2bn through the trading plan, £5.7bn through placings and £5.8bn through buybacks.
From rescue to fully private, and the scandal that nearly derailed the rally
Financial crisisRBS rescued£45.5bn of state money, 84.4% owned
9 yrs agoLloyds fully privateThe other big rescue ends
2 yrs agoCourt of AppealCar finance ruling sinks lenders
Last yrSupreme Court; NatWest exitLenders win most of the appeal; Treasury sells last shares
This yrFCA final rulesRedress scheme costs lenders a little over £9bn
Source: HM Treasury; UK Supreme Court; FCA
With the overhang gone, NatWest now runs like any other listed bank. Its return on tangible equity (RoTE, profit as a share of shareholders' equity minus goodwill and intangibles, the industry's main profitability measure) was 19.7% in the first half. It raised its full-year guidance to above 19% and said it expects to announce its next buyback six months earlier than planned. It has also bought the wealth manager Evelyn Partners, which cut its tangible net asset value by 37p a share. More on why that matters for valuation below.
What did the motor finance scandal cost the banks?
For two years, car finance was the biggest threat hanging over the sector. The issue was commission: lenders paid car dealers for arranging loans, often without telling customers how much, and sometimes let dealers raise the interest rate to earn more. Two years ago, the Court of Appeal ruled that dealers owed customers duties that made commissions paid without their informed consent unlawful. Close Brothers, a specialist lender, fell from 367p to 277p, about a quarter, around that ruling, and Lloyds lost 7.3%.
Last year the Supreme Court overturned most of that. It found dealers owed no fiduciary duty, so commission wasn't a bribe. But it upheld one claim under the Consumer Credit Act's "unfair relationship" test. In that case, the commission was 55% of the total cost of credit and the dealer had an undisclosed tie to the lender. On the next trading day, Close Brothers closed 23.5% higher and Lloyds 9.0% higher.
Find the detail
Tap the phrase you think is the tell.
Spotted it.Not that phrase. A 55% commission, with an undisclosed tie to the lender, is what the court found unfair. The FCA's scheme turns that into thresholds: full redress where commission was very high and ties were hidden.
“He bought a used car through a dealer” Millions did. Buying through a dealer wasn't the problem.
“the dealer was paid commission” The court said commission alone doesn't make a deal unfair.
“worth 55% of the total cost of credit” Size was central. That figure, plus the tie, made the relationship unfair.
“through a lender he chose himself” He didn't. An undisclosed tie gave the lender first refusal.
Source: UK Supreme Court judgment, as summarised by Kirkland & Ellis
The Financial Conduct Authority (FCA), the UK's conduct regulator, then built an industry-wide compensation scheme. Its final rules, published this year, cover about 12.1 million car loans, down from 14.2 million in the draft, with a total cost to lenders of a little over £9bn and about £7.5bn going to consumers, according to Norton Rose Fulbright's summary. The average payment rose to about £830 an agreement, Mayer Brown notes.
The final scheme covers fewer loans but pays more on each
Draft
14.2 million agreements
Commission threshold 35% of credit cost
Silence counted as acceptance
One scheme
vs
Final rules
About 12.1 million agreements
Threshold raised to 39%
Customers must accept redress
Two schemes, split by loan age
About £830 average payment
Source: FCA final rules, as summarised by Norton Rose Fulbright and Mayer Brown
Lloyds, which lends on cars through its Black Horse arm, has provisioned £1.95bn after adding £800m when the draft scheme came out. After reading the final rules, it kept that figure, Car Dealer Magazine reported, and its half-year results took no further charge. Close Brothers raised its provision to £320m, and Barclays has set aside £325m.
Lloyds carries most of the listed banks' car finance bill
Lloyds£1.95bn
Barclays£325m
Close Brothers£320m
Total motor finance provisions as last reported.
Source: Company statements, as reported by Car Dealer Magazine and LawPlus
The story isn't quite over. Four legal challenges to the scheme have been filed, and Lloyds says the Upper Tribunal hearing won't come before the end of this year. But the worst case has gone: £1.95bn is less than half of Lloyds' £4.3bn first-half pre-tax profit.
Will the Budget bring a new bank tax?
This is the live risk. John Healey, who replaced Rachel Reeves as chancellor, met the heads of the big banks ahead of his first Budget and told them he hadn't yet decided on taxes, according to Business Matters. Economists estimate he needs to find about £10bn in tax rises or spending cuts.
Banks already pay two extra taxes. The bank surcharge adds 3% to the 25% corporation tax rate on banking profits above £100m. The bank levy charges a fee on their balance sheets. These raised about £1bn and £1.3bn respectively two tax years ago. The TUC, the trade union federation, wants the surcharge raised to at least 8%. Last year the IPPR think tank proposed taxing the interest banks earn on reserves held at the Bank of England, which swelled under quantitative easing. Bank shares fell 4–5.5% the day that idea surfaced, but Reeves chose not to add a windfall tax or a reserves tax in her last Budget, Bloomberg reported.
London already taxes banks harder than its rivals
London46.5%
Frankfurt39.1%
New York27.9%
Total tax rate on a model bank: corporate taxes, levies and employment taxes as a share of profit.
Source: UK Finance, as reported by Business Matters
How much would a surcharge rise cost? Lloyds expects a 27% effective tax rate, made up of the 25% corporation tax plus the 3% surcharge. If the surcharge rose to 8%, its rate would rise by roughly 5 points, and after-tax profit would fall by about 5/73, or 7%. Hitting reserves income would be messier and harder to estimate, because it would cut directly into what the hedge earns. Either way, the effect is a single-digit cut to earnings, not a broken investment case. The bigger danger is the precedent: the UK becomes a place where bank profits get taxed whenever they rise.
How much cash are UK banks returning to shareholders?
This is where the rerating pays out. Each bank targets a CET1 ratio, the core capital buffer regulators require: about 13% at Lloyds and NatWest, 13–14% at Barclays and 14–14.5% at HSBC. Capital earned above that goes back to shareholders.
First-half payouts: dividends plus buybacks
£2.3bnBarclaysUp 61% on a year earlier
£1.9bnLloydsIts first interim buyback
$1.0bnHSBC buybackRestarted after a pause
$1.0bnStanChart buybackAfter $1.5bn earlier this year
Source: Company half-year results
Lloyds raised its interim dividend 30% to 1.58p and added a £1.0bn buyback on top of its £1.75bn programme. Its share count fell from 58,799m to 58,081m in six months. Barclays raised its interim dividend to 5.9p from 3.0p, and has returned £9.0bn of the at least £10bn it promised over three years ending this year. NatWest paid a 12p interim dividend, up 26%, and targets paying out about half its profit as dividends. HSBC has also restarted buybacks, and Standard Chartered raised its interim dividend 66%, according to its results.
One catch: a buyback only adds value if the price is below what the shares are worth. Lloyds bought back shares at an average 98.1p, about 1.7 times its tangible book value per share. A bank buying below book adds book value to every remaining share. Above book, a buyback still lifts earnings per share, but each pound retires fewer shares and tangible book per share shrinks (see our course chapter on dilution and buybacks).
Are UK bank shares still cheap?
Banks are valued against tangible book value: shareholders' equity minus goodwill and intangibles. A bank that earns exactly its cost of equity, the return investors demand, should trade at about 1.0 times tangible book. One earning more deserves a premium. Here are the latest share prices against tangible net assets per share at the half year. HSBC and Standard Chartered report in dollars, converted at $1.32.
Bank
Price
Tangible book per share
Price / tangible book
RoTE, first half
Official RoTE target
Lloyds
102.3p
57.0p
1.79x
17.1%
Over 16% this year, over 18% in two years, about 20% in four
Barclays still trades at book value; the rest are near two times
HSBC1.99x
NatWest1.81x
Lloyds1.79x
StanChart1.62x
Barclays1.02x
Latest share price over tangible net asset value per share at the half year. Dollar book values at $1.32 per pound.
Source: Company half-year results; Yahoo Finance; Yield Theory calculations
A simple rule of thumb links the two columns. Fair price to tangible book is roughly (RoTE minus growth) divided by (cost of equity minus growth). It's a version of the reverse DCF idea, working out what returns the price already assumes. Assume an 11% cost of equity and 3% long-run growth. Lloyds' 1.79x then implies a sustainable RoTE of about 17.3%. NatWest's implies 17.5%, HSBC's 18.9% and Standard Chartered's 16.0%. Barclays' 1.02x implies only 11.2%, below even this year's target.
What a bank's returns are worth in price-to-book terms
Pick a sustainable RoTE and the return investors demand
On this view, Lloyds and NatWest are priced about where their returns are now, not where their targets say they're going. If Lloyds reaches 18% in two years and holds it, the formula puts it near 1.9x at an 11% cost of equity. That's modest upside from here, plus the cash it pays out. Barclays is the outlier. Even meeting its target of more than 14% justifies about 1.4x, and Barclays UK, its domestic bank, already earned 20.1% in the first half. The discount reflects its investment bank, whose trading profits are lumpier and which investors have long been wary of. NatWest's multiple is also flattered by Evelyn Partners: buying the wealth manager shrank its tangible book, so the same share price now looks more expensive.
What could go wrong?
A bank tax. A surcharge rise or a levy on reserves income would cut earnings, and it would hit the hedge-heavy domestic banks hardest.
Falling swap rates. If five-year rates dropped well below the yield on maturing swaps, the hedge tailwind would fade.
Credit losses. Every bank here has been booking low impairments. A UK recession would change that quickly, which is why banks are cyclical stocks.
Motor finance litigation. Legal challenges to the FCA scheme could change its size or timing.
Our numbers. Returns exclude dividends; dollar book values use one exchange rate.
Our read
The rerating was earned. UK banks went from earning less than their cost of capital to earning well above it. The structural hedge means much of next year's income growth is already contracted. The two big overhangs, the NatWest stake and motor finance, have both been settled.
What's left is a slower kind of return. Lloyds and NatWest trade near 1.8 times tangible book, a fair price for 17–18% returns. From here, holders mostly earn dividends, buybacks and any beat against targets. Good, but not another doubling. HSBC at nearly two times book looks fully priced for a bank whose target is 17%.
Barclays is where the rally still has room. It trades at book value, its UK bank already earns 20%, and it has locked in £18.3bn of hedge income over three years. If it gets group returns to 14% in two years and investors start to trust the investment bank, that alone is worth a 30–40% rerating on our arithmetic.
The Budget is the near-term test. The pullback since midyear already prices in some tax. A modest surcharge rise would trim earnings by single digits and leave the case intact. A tax on reserves income would be worse, because it would cut directly into the hedge income driving this whole story.
Go deeper
Valuation and expectations: how to tell when a rerating has already priced in the good news, as it largely has at Lloyds and NatWest.
Capital allocation: why the same buyback creates value at 1x book and much less at 1.8x.
Cyclical companies: banks earn their returns over a full credit cycle, not at its best point.
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derivative that works like a five-year bond, staggered so a portion matures every month. This is the structural hedge. At Lloyds it is £246bn, with an average life of about 3.75 years, according to its