The falls that domestically focused UK banks have suffered at the hands of Brexit show few signs of reversing and suggest the outlook is unlikely to improve from here, according to CMC Markets UK's Michael Hewson.
The chief market analyst says these stocks are already under pressure given the current low interest rate environment, not to mention their continual restructuring costs and ongoing litigation fines.
In fact, he points out that banks such as HSBC and Standard Chartered – which have fared better recently as they’re more global-facing – have still struggled to bounce back from performance peaks in 2013.
Performance of stocks over 5yrs
Source: FE Analytics
“Last week’s numbers from the major US banks have continued the recent divergence between their performance, and the performance of the European and UK banking sector over the course of this year,” Hewson said. 
“We’d already seen some evidence in July that US banks were seeing a pick-up in profits on the back of better than expected trading activity in terms of bond trading, as well as loan growth on a slowly improving US economy. However in Europe the outlook for banks is nowhere near as optimistic, as bad loans and negative rates hollow out the prospects of any sort of profitability.
“The sharp fall in the share prices of the UK banks in the aftermath of the Brexit vote has shown little signs of being reversed and the outlook probably won’t have improved too much given the cut in UK interest rates that followed in August, which flattened the UK yield curve even further.”
The chief market analyst isn’t the only investor to be cautious on UK banks. Following the financial crisis of 2008, many have shied away from the sector due to susceptibility to fines, opaque business models and vulnerability to ultra-loose monetary policy.
However, in an article published in September FE Alpha Manager Alex Wright explained that the likes of UK banks are currently very cheap at a time when market valuations appear stretched.
He said: “People are steering clear of the stocks that are often hard to analyse where things have maybe not been going so well recently and people are shying away from them. I think within those sectors there are some definite value opportunities – I’ve been taking advantage of some of those and own a number of companies across those types of stocks.”
In the below article, Hewson talks through the ‘big three’ domestic UK banks and what their upcoming trading updates could entail.
Lloyds Banking Group
“The kneejerk reaction in any profits downturn is to look to cut costs, and in this regard the last few months have seen a familiar theme play out with Lloyds Banking Group announcing a further 1,300 job cuts as the management continue their strategic overhaul of the business,” Hewson said.
“In total, the bank intends to cut 12,000 jobs by the end of next year as the bank looks to reposition itself into a more digital operation.”
That said, he points out the government will be selling its remaining 9 per cent stake in the bank, albeit with no offer of discounted shares as some investors anticipated.
The analyst says this is understandable given the fall in its share price over recent months. Since the referendum results were announced, the stock has plummeted by 22.64 per cent while the FTSE 100 is up 11.49 per cent.
Performance of stock vs index since EU referendum results
Source: FE Analytics
“With the share price currently trading just above three-year year lows it remains quite cheap, and with a dividend yield of over 4 per cent, it does appear that the worst of its problems are likely to be behind it, though we need to pay particular attention to its net interest margin, (its ability to make a return in the current low interest rate environment), which in July showed an improvement to 2.74 per cent from 2.62 per cent in 2015,” Hewson added.
Royal Bank of Scotland Group
Hewson says the prospects for RBS are somewhat more muted, with the UK government devaluing its stake in the bank for the second time this year from £21.5bn in March to £14.8bn.
“That sale of £2.1bn worth of shares at 330p a share back in August 2015 seems a long time ago now,” he said.
“While the bank has put on hold its plans to spin off its Williams and Glyns branches, which it was informed it had to sell as a result of its 2008 bailout, thus saving a significant amount of money there, at least £50m a month, it still faces a number of regulatory hurdles that it needs to overcome.”
The first of these hurdles, according to the analyst, is the ongoing investigation from the US Department of Justice regarding the mis-selling of mortgage back securities.
While Deutsche Bank has indeed been in the limelight following its recent $14bn fine, he says RBS also need to arrive at a settlement. Not only this, he says there is controversy surrounding its corporate restructuring group and the part it played in shutting a number of small businesses in 2008.
“The bank has yet to post an annual profit since being bailed out in 2008 with total losses in excess of £50bn already, and the likelihood is that we will see further provisions set aside in lieu of further litigation in this week’s numbers,” Hewson continued.
“In recent quarters the underlying retail business has been doing ok, posting profits in Q1 and Q2. Unfortunately however, the bank can’t escape the anchor of its legacy issues, and this week’s update looks likely to continue that trend.”
Performance of stock vs index since 2008
Source: FE Analytics
Barclays
As with the aforementioned banks, Barclays is being restructured while enduring the same challenges its peers are facing.
That said, Hewson believes its impending trading update could bring good news, given its fixed income business performed well in its last trading update in July. Following last week’s positive US banks update, he says that there could well be a decent outcome for Barclays.
Performance of stock vs index in 2016
Source: FE Analytics
“New CEO Jes Staley will need to prove he is on target to outperform given that he cut the dividend in half earlier this year in an attempt to speed up the move away from its non-core operations, including the disposal of its Africa business,” he said.
That said, the big three banks face clouds over their future given the UK's vote to leave the European Union as a significant chunk of their business comes from operations on the continent. However, this does not necessarily mean investors should flee from them.
“All three banks also need to consider the impact of the potential loss of passporting rights after the Brexit vote to leave the EU in the event that Article 50 gets triggered next year, though Lloyds is likely to be least affected by that due to its primarily domestic exposure,” Hewson explained.
“Given the current and future regulatory environment in this low interest rate world, expectations surrounding overall performance are already quite low, which suggests that with the shares already near significant multi-year lows and significant underperformers, therefore any disappointment on the profits front could well be already priced in?"