Banks face higher loan losses

(Reuters) - UK banks in 2009 will struggle to reverse a long period of underperformance with key operating economies deep in recession and as the banks face sharply higher loan losses, said analysts at Deutsche Bank, who cut the price target on four companies in the sector.

"We remain uncertain that capital levels are sufficient to prompt banks to lend without government support leading to higher unemployment and impairment charges and credible risks of another round of bank recapitalisations," analysts Jason Napier and Andrew Hill, who are bearish on UK banks, said.

But the analysts expect to turn more positive on the sector if there are signs of stabilising house prices and confidence, restoration of lending volumes and if the government undertakes suitable measures to assist in funding and counterparty risk mitigation.

"We expect all of the above conditions will be fulfilled sometime in late 2009 or early 2010," the analysts said.

They however said substantial short-term damage to the economy as well as to UK banks' balance sheets and profit and loss accounts will constrain bank confidence at best and force another round of bank recapitalisations at worst.

Within the UK bank sector, the analysts favour Barclays (BARC.L) the most, while "sell"-rated Lloyds TSB Group (LLOY.L) is the least-favoured.

The analysts also highlighted significant risks over the credit outlook for Royal Bank of Scotland Group (RBS.L) and HSBC Holdings (HSBA.L).

"Given our current concerns over credit quality and capital adequacy... we believe that any significant rally in the first quarter of 2009 in particular is an opportunity to reduce exposure to banks with weaker credit risk profiles such as Lloyds TSB, HSBC and RBS in particular," the analysts said.

Shares of Lloyds TSB, RBS and HSBC were all trading down about 2 percent each on the London Stock Exchange by 9:51 a.m. British time.

(Reporting by Tenzin Pema in Bangalore; Editing by Pratish Narayanan)