European Banks Outlook 2011 PAN-EUROPEAN BANKS North/south divide persists We favour French, Scandi and UK commercial banks in 2011 December 16, 2010 Sector view Remains Bullish EU banks: Attractive valuation, but high volatility We believe the sector valuation is low both in absolute (1.3x TBV/7.5x 2012E) and particularly relative terms after recent macro-related underperformance and new capital regulations (which we expect to be imminently further relaxed) can and will be met through retained earnings. While we ultimately believe politicians will conclude that saving the euro is less costly than sacrificing it, we expect uncertainty to generate high sector volatility, which should prove to be a good buying opportunity. Underweight investment banks, which should stay de-rated With investment banks suffering the biggest negative impact from Basel 3, market structure changes and further taxation, we think the outlook for pro forma ROEs appears not much better than the COE, particularly for banks in tough regulatory regimes such as Switzerland and the UK. As a result, unless comp costs significantly reduce (and there is no sign of this in 2011), it appears right that these stocks should trade around 1x TBV. North/south divide for commercial banks We believe peripheral euro area concerns are genuine for some southern European banks, as the impact of austerity on growth and credit quality, as well as the cost and availability of funding, generates greater earnings risk. However, for many northern European banks whose exposure is primarily through government bonds and second-order exposures such as interbank loans, the risks are over-discounted, in our view. With many good northern European franchises traded at a little over 1x TBV, we have a preference for northern over southern European commercial banks. • French banks: We see an attractive risk/reward, with BNP Paribas our top pick. We upgrade Credit Agricole from Reduce to Neutral. • Investment banks: We are underweight versus commercial banks, favouring UBS over Credit Suisse, which we downgrade to Neutral from Buy. • Italian banks: While the least risky of southern European economies, we see few catalysts, preferring Intesa over UniCredit. • Nordic banks: We remain overweight the region on better growth and capital, with DNBNOR and Swedbank our top picks. • Spanish banks: We remain underweight as more capital is needed, but we believe trading opportunities could arise for Santander. • UK banks: We believe Lloyds offers good upside potential, but we cannot justify the valuation for RBS. We are positive on Asia in the longer term but fear a near-term correction. We prefer HSBC over Standard Chartered. • CEE banks: We prefer Russia and Poland over Turkey. Our top picks are Sberbank, PKO BP and Bank Pekao. We rate Garanti a Reduce. Research analysts European Banks Jon Peace j[email protected]+44 20 7102 4452 Robert Law [email protected]+44 20 7102 2715 Domenico Santoro [email protected]+44 20 7102 2375 Maciej Szczesny, CFA [email protected]+44 20 7102 2504 Daragh Quinn [email protected]+44 20 7102 8333 Raul Sinha [email protected]+44 20 7102 9136 Chintan Joshi [email protected]+44 20 7102 6597 Prathmesh Dave [email protected]+44 20 7102 8530 Tathagat Kumar [email protected]+44 20 7102 9177 Moreno Fasolo [email protected]+44 20 7102 1435 Nomura International plc See Appendix A-1 for analyst certification and important disclosures. Analysts employed by non-US affiliates are not registered or qualified as research analysts with FINRA in the US. EQUITY RESEARCH EMEA Relative rating: For details of Nomura’s relative rating system see text at the end of this publication
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European Banks Outlook 2011
PAN-EUROPEAN BANKS
North/south divide persists
We favour French, Scandi and UK commercial banks in 2011
December 16, 2010
Sector view Remains Bullish
EU banks: Attractive valuation, but high volatility We believe the sector valuation is low both in absolute (1.3x TBV/7.5x 2012E) and particularly relative terms after recent macro-related underperformance and new capital regulations (which we expect to be imminently further relaxed) can and will be met through retained earnings. While we ultimately believe politicians will conclude that saving the euro is less costly than sacrificing it, we expect uncertainty to generate high sector volatility, which should prove to be a good buying opportunity.
Underweight investment banks, which should stay de-rated With investment banks suffering the biggest negative impact from Basel 3, market structure changes and further taxation, we think the outlook for pro forma ROEs appears not much better than the COE, particularly for banks in tough regulatory regimes such as Switzerland and the UK. As a result, unless comp costs significantly reduce (and there is no sign of this in 2011), it appears right that these stocks should trade around 1x TBV.
North/south divide for commercial banks We believe peripheral euro area concerns are genuine for some southern European banks, as the impact of austerity on growth and credit quality, as well as the cost and availability of funding, generates greater earnings risk. However, for many northern European banks whose exposure is primarily through government bonds and second-order exposures such as interbank loans, the risks are over-discounted, in our view. With many good northern European franchises traded at a little over 1x TBV, we have a preference for northern over southern European commercial banks.
• French banks: We see an attractive risk/reward, with BNP Paribas our top pick. We upgrade Credit Agricole from Reduce to Neutral.
• Investment banks: We are underweight versus commercial banks, favouring UBS over Credit Suisse, which we downgrade to Neutral from Buy.
• Italian banks: While the least risky of southern European economies, we see few catalysts, preferring Intesa over UniCredit.
• Nordic banks: We remain overweight the region on better growth and capital, with DNBNOR and Swedbank our top picks.
• Spanish banks: We remain underweight as more capital is needed, but we believe trading opportunities could arise for Santander.
• UK banks: We believe Lloyds offers good upside potential, but we cannot justify the valuation for RBS. We are positive on Asia in the longer term but fear a near-term correction. We prefer HSBC over Standard Chartered.
• CEE banks: We prefer Russia and Poland over Turkey. Our top picks are Sberbank, PKO BP and Bank Pekao. We rate Garanti a Reduce.
See Appendix A-1 for analyst certification and important disclosures. Analysts employed by non-US affiliates are not registered or qualified as research analysts with FINRA in the US.
EQUITY RESEARCH
EMEA
Relative rating: For details of Nomura’s relative rating system see text at the end of this publication
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Table of contents
Executive summary 3
EU banks: Low valuation, high volatility 5
Politicians will ultimately save the euro 9
Banks will not dilute to meet Basel 3 12
Investment banks to stay de-rated 14
Credit quality a peripheral earnings risk 16
Funding a key differentiator for 2011 18
European recommendations for 2011 21
French banks: Attractive risk reward led by BNP Paribas 23
Underweight IBs vs commercial banks: we favour UBS over CS, BARC over DBK 30
Italian banks: We prefer Intesa over UniCredit 40
Nordic banks: Overweight the region, DNB and SWED our top picks 46
Spanish banks: How much additional capital could be required in Spain 55
Spanish banks: Santander still a macro call on Spain 59
UK domestic banks: We favour Lloyds over RBS 64
UK/Asian banks: We prefer HSBC over Standard Chartered 69
CEE banks: Prefer Russia and Poland over Turkey 76
The Revenue Book 79
Note: The revenue book is a compilation of national banking data.
Appendix A-1 145
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Executive summary Rating changes in this note We downgrade Credit Suisse from Buy to Neutral, reducing our price target from CHF 56 to CHF 48 owing to a cautious outlook for investment banks, particularly those in more aggressive regulatory regimes. We upgrade Credit Agricole to Neutral, from Reduce, with an unchanged price target of EUR 13 after recent underperformance, as we see a good risk/reward in French stocks. We view the valuation of Credit Agricole as an adequate offset for the more leveraged capital position.
EU banks: Low valuation, high volatility We believe that the sector valuation is low both in absolute (1.3x TBV/7.5x 2012E) and particularly relative terms after recent macro-related underperformance. We believe banks will meet the demands of new Basel 3 capital regulation through retained earnings rather than rights issues, meaning this valuation is ‘real’ rather than ‘pre-dilution’. Our underlying macro premise for 2011 is that politicians will ultimately act to save the euro as the cost of preserving it is less than the cost of a break-up. As politicians act slower than the market and initially resist radical steps, we expect this to lead to significant sector volatility, which should create attractive buying opportunities (although calling the turning points in real time will be a challenge). We believe peripheral euro area concerns are genuine for some southern European banks, as the impact of austerity on growth and credit quality generates earnings risk. However, for many northern European banks whose exposure is primarily through government bonds, the risks are currently over-discounted; hence, we retain a Bullish stance with a bias for northern European banks. We further acknowledge that with absolute valuation upside capped by weak growth, global investors may prefer US or emerging market banks.
Politicians will ultimately save the euro The solution to the euro area’s problems are not clear, but in the same way that we argued in 2010 that regulators would favour economic growth over diluting the banking sector, in 2011 we believe politicians will ultimately conclude that saving the euro and bailing out the periphery (through increasing the European Financial Stability Facility, significantly increased ECB bond buying or the introduction of pan-European bonds) is less costly than default or a euro area break-up given the unpredictable “network effects”. This is possible because aggregate EU15 debt/GDP as well as the fiscal deficit is lower than the US, and necessary because European banks are too interconnected to fail, with cross-border exposures a multiple of shareholders’ equity. The slow speed and uncertain nature of political response creates high sector volatility and buying opportunities for lower-risk northern European names. Among southern states, we see Italy as the best placed.
Banks will not dilute to meet Basel 3 We do not predict a flood of equity issuance to comply with Basel 3, although some banks may chose to raise capital for specific reasons (eg, to repay government debt or to finance an acquisition). We believe almost all listed banks can meet required capital levels by 1 January 2013 (well ahead of the 2019 deadline) through retained earnings (at the cost of minimal dividends). This task should be made easier if the Basel Committee revises lower its RWA calculations as expected (potentially before year-end). Book value multiples are therefore ‘real’ (ie, not pre-dilution), which is supportive of the valuation case for the sector. We believe the Systematically Important Financial Institutions – SIFI (or institutions deemed “too big to fail”) – issue will be dealt with via a menu of options (more common equity, contingent convertible instruments (cocos) or bail-in debt) such that many countries will not demand more equity than the 7% minimum (although banks will wish to have their own buffer). Despite G20 aims, this creates clear regulatory arbitrage, particularly for investment banks operating in more stringent countries. While regulators will decide whether banks are required to issue equity through setting the national minimum capital standards, we continue to believe the market will form its own view of the appropriate level of capital based on an individual bank’s business mix (investment banks requiring more). We expect more leveraged banks continuing to trade at a discount to less leveraged stocks, but we believe this discount will narrow through 2011 as investors become more comfortable with higher capital levels.
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Investment banks to stay de-rated Not only do investment banks suffer the biggest negative impacts under Basel 3 (with often a doubling in RWAs), they also suffer the greatest challenges from changes to market structure (eg, swaps clearing and prop trading restrictions) and further taxation (wholesale liability taxes). These impacts are hard to quantify, but simplistically, unless investment banks are successful in significantly increasing margins or business mix, or pushing compensation costs lower (unlikely in 2011), pro forma ROEs appear to be not much more than the COE. As a result, it would appear right that these stocks should trade in a range around tangible book. Regulatory arbitrage potentially produces a significant headwind for Swiss and, to a lesser extent, UK investment banks, and a benefit for German and French investment banks. Swiss banks could also remain under pressure until the depth and the pricing of the coco market is established.
Credit quality a peripheral earnings risk NPL and provision trends show that credit quality concerns are easing except in economies where we think there is a high risk of double dip (eg, Greece, Ireland, Portugal and Spain). The costs of austerity and cleaning up the banking systems in these economies generates higher earnings risk and, as a result, our EPS forecasts tend to be more below consensus in southern European economies than northern European ones.
Funding a key differentiator for 2011 Funding is arguably a bigger issue than credit quality for the sector in 2011. The ECB wants to withdraw excess liquidity and have member states guarantee bank debt if necessary (adding to the burden of debt/GDP). The divergence perceptions of the liquidity and solvency of northern and southern European sovereigns is having a similar effect on the issuance and cost of debt of their banks. Those banks operating in lower-risk countries (eg, Germany) and with lower funding costs (eg, Nordics) have a clear advantage both in terms of net interest margin and valuation (discount rate). We note that a recovery in bank debt issuance in June 2010 was a catalyst for the end of the first phase of the sovereign crisis, and we believe investors will closely watch this in 2011.
The north/south divide remains a key theme for 2011 The north/south divide was a key theme of ours for 2010, and we believe it will remain a dominant theme not just in 2011 but for many years to come given the lengthy periods of adjustments necessary to bring debt back down to stable levels. Our thesis is that banks in more leveraged southern European economies will see slower loan growth (given private sector deleveraging), weaker margins (owing to a higher cost of funds) and weaker credit quality trends (either a slower normalisation, or in the worst case a double dip). As a result, we believe their earnings will continue to underperform those of their northern European counterparts. At some stage, we believe this may be more adequately reflected in valuations, but as of today we think the differences are insufficient. We would use macro-related volatility in 2011 to buy northern European banks such as BNP Paribas, Lloyds, DNBNOR and Swedbank.
• •French banks: We see an attractive risk/reward, with BNP Paribas our top pick. We upgrade Credit Agricole from Reduce to Neutral.
• •Investment banks: We would be underweight versus commercial banks, favouring UBS over Credit Suisse (CS), which we downgrade to Neutral from Buy.
• •Italian banks: While, in our view, Italy is the least risky of the southern European economies, we see few catalysts, preferring Intesa over UniCredit.
• •Nordic banks: We remain overweight the region on better growth and capital, with DNBNOR and Swedbank our top picks.
• •Spanish banks: We remain underweight as more capital is needed, but we believe trading opportunities could arise for Santander.
• •UK banks: We believe Lloyds offers good upside potential, but we cannot justify the valuation for RBS. We are positive on Asia in the longer term but fear a near-term correction. We prefer HSBC over Standard Chartered (STAN).
• •CEE banks: We prefer Russia and Poland over Turkey. Our top picks are Sberbank, PKO BP and Bank Pekao. We rate Garanti bank a Reduce.
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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EU banks: Low valuation, high volatility
Summary
We believe the sector valuation is low both in absolute (1.3x TBV/7.5x 2012E) and particularly relative terms after recent macro-related underperformance. We believe banks will meet the demands of new Basel 3 capital regulation through retained earnings rather than rights issues, meaning this valuation is ‘real’ rather than ‘pre-dilution’. Our underlying macro premise for 2011 is that politicians will ultimately act to save the euro as the cost of preserving it is less than the cost of a break-up. As politicians act slower than the market and initially resist radical steps, we expect this to lead to significant sector volatility, which will create attractive buying opportunities with hindsight (although calling the turning points in real time we acknowledge is a challenge). We believe peripheral euro area concerns are genuine for some southern European banks, as the impact of austerity on growth and credit quality generates earnings risk. However, for many northern European banks whose exposure is primarily through government bonds and second-order exposures such as inter-bank loans, the risks are currently over-discounted; hence, we retain a Bullish stance with a preference for northern European banks. We further acknowledge that with absolute valuation upside capped by weak growth, global investors may prefer US or emerging market banks.
The absolute and relative valuation of EU banks is low
In the chart below, we plot the absolute price/tangible book value of EU banks, the iTraxx senior financials (inverted) and the performance of the banks sector relative to the market year to date. In absolute terms, the sector has remained very range bound in 2010 between 1.1x and 1.5x TBV as regulatory and macro concerns have offset an undemanding valuation. Approaching tangible book, valuation has offered some support in aggregate for the sector. However, with a forecast normalised ROTE of just 14.2% in 2012, very weak medium-term growth in western Europe and a historical cost of equity of 10%, investors have rightly, in our opinion, been unwilling to pay significantly more than 1.5x for the sector in aggregate.
Fig. 1: EU banks P/TBV, relative performance and iTraxx EU banks made new relative (not absolute) lows in late November
Source: Datastream, Nomura estimates
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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The three lines had tracked fairly closely until end-August when the absolute and relative performances strongly diverged. Initially, this was because of concerns about dilution following a number of large rights issues (eg, Deutsche Bank, Standard Chartered) plus heavy RWA increases from investment banks under new Basel 3 disclosure. Subsequently, a second round of sovereign concerns further undermined the relative performance of the sector, even as the broader market maintained its rally. Today European banks trade at 1.3x TBV or 0.9x stated book value (55% of the market multiple compared with a 20-year average of 85%) and a normalised (2012) P/E of 7.5x (73% of the market multiple, compared with a 20-year average of 84%). As we discuss in subsequent sections of this report, we believe banks will address the demands of new Basel 3 capital regulations from retained earnings rather than capital increases and, given this, we see valuations as real and, therefore, attractive, rather than pre-dilution. As the final Basel revisions (eg, on risk-weighted assets) are revealed, we expect the market to become more comfortable with capital levels and for the dilution discount to unwind.
We believe peripheral euro area concerns, however, will persist. Our underlying macro premise for 2011 is that politicians will ultimately act to save the euro as the cost of preserving it is less than the cost of a break-up. As politicians act slower than the market and initially resist radical steps, we expect this to lead to significant sector volatility, which should create attractive buying opportunities with hindsight (although calling the turning points in real time, we acknowledge is a challenge). We believe peripheral euro area concerns are genuine for some southern European banks, as the impact of austerity on growth and credit quality generates earnings risk. This could last for many years given the timeframes needed to stabilise and reduce debt/GDP to sustainable levels.
However, for many northern European banks whose exposure is primarily through government bonds and second-order exposures such as inter-bank loans, we believe the risks are currently over-discounted. As a result, we would maintain a bullish stance overall on the banks sector with a clear preference for northern European banks over southern European banks (although we are prepared to trade the sector volatility). As we see investors gradually placing more weight on normalised P/E valuations in 2011 and less on price/TBV as capital positions stabilise, we would highlight the attractive valuation of French banks compared with domestic Spanish banks.
Fig. 2: European banks 2012E P/Es (market cap weighted average) Insufficient differentiation, in our view, between northern and southern Europe
Source: Nomura estimates
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Bank styles: De-geared P/E may gain favour versus P/TBV
In bear markets (shaded) low P/B stocks and banks with low earnings momentum tend to underperform high P/B stocks and those with high earnings momentum (ie, quality franchises win). In more normalising markets, investors tend to go for “value” and tend to place more of a weight on P/E than on price/book.
Fig. 3: Correlation of bank P/B and earnings momentum with equity markets Quality stocks outperform in bear markets, value stocks in more normal markets
Note: Chart compares performance of top quartile metric versus bottom quartile metric for FTSE300 banks
Source: Datastream
Looking into 2011, as credit costs in most economies continue to normalise and as investors become more comfortable with Basel 3, we believe investors will again look to place more emphasis on P/E. However, with banks showing very different capital positions under Basel 3, we believe some attention will still be paid to gearing, even if this decreases with time. In the chart below, we show both normalised (ie, 2012E) and de-geared P/E (adjusting for pro forma Basel 3 core Tier 1 levels at 3Q10A). We would highlight the attractive position of the French banks after the sovereign crisis, the valuation of UBS versus CS, and how the large-cap Spanish banks present investors with a dilemma over risk and reward.
Fig. 4: Normalised (2012E) and de-geared P/E ratios
Note: De-geared using 8% target CT1 for European banks and 10% for UK, Swiss and Scandi banks Source: Nomura estimates
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Investors may, however, prefer global banks
For investors who can look outside Europe, we recognise that other regions may prove more attractive: for example, in 2010 Asian banks rose by 15% led by Indonesia (up 56%), while European banks fell 10% led by Ireland (down 54%). US banks still only trade on a small P/E multiple premium to European banks despite being arguably further through the credit/capital cycle.
In our 2011 ‘Global Strategy Outlook’ (5 December 2010), we highlighted that while we were overweight Financials globally, our preference was with banks in countries where policy will continue to be supportive and where valuations are lowest – the US and Japan.
At an individual country level, we are bullish on the banks in Japan, China, Singapore, Malaysia and in the US (brokers and asset gatherers). Individual country outlooks are available for interested readers.
Fig. 5: Global banks 2010 YTD performance Local currency
Source: Datastream
Fig. 6: Global banks Price/book Stated (not tangible)
Source: Datastream
Fig. 7: Global banks P/E Based on current mid-cycle earnings
Source: Datastream
Fig. 8: European versus US normalised P/E Based on 2012 forecast earnings
Source: Nomura estimates
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Politicians will ultimately save the euro Summary
The solution to the euro area’s problems are not clear, but in the same way we argued in 2010 that regulators would favour economic growth over diluting the banking sector, in 2011 we believe politicians will ultimately conclude that saving the euro and bailing out the periphery (through increasing the European Financial Stability Facility, significantly increased ECB bond buying or the introduction of pan-European bonds) is less costly than default or a euro area break-up given the unpredictable “network effects”. This is possible because aggregate EU15 debt/GDP as well as the fiscal deficit are lower than in the US, and necessary because European banks are too interconnected to fail, with cross-border exposures a multiple of shareholders’ equity. The slow speed and uncertain nature of political response creates high sector volatility and buying opportunities for lower-risk northern European names. Among southern states, we see Italy as the best placed.
Euro area: good in parts; too interconnected to fail
Aggregate EU15 debt/GDP as well as the fiscal deficit are lower than in the US. The problem lies with the distribution of debt and discipline within the euro area, which like the proverbial curate’s egg is good in parts. If the political will is there for the core to subsidise the periphery, we believe the market should see the euro area as solvent.
Fig. 9: Government debt/GDP and fiscal deficits Bubble size is determined by CDS (Finland = 32, Greece = 872)
Source: Datastream
The solutions to the euro area’s problems are not clear. Options include a bail-out of the periphery by the core (either through direct subsidy from the EFSF or monetisation of debt through ECB purchases) or a managed government default and/or exit from the euro. Despite opposition from core electorates, we believe that ultimately politicians will favour a bail-out over a default because the euro area is “too interconnected to fail”. Domestic banks tend to hold a multiple of their own shareholders’ equity in government bonds. Any material government default or devaluation tends to bankrupt the banking system as asset values tumble while liabilities stay unchanged. Limiting the collapse to a single country is prevented by the high cross-border exposure of European banks. In the following table, we show European banks’ cross-border assets as a percentage of tangible shareholders’ equity (based on BIS and OECD data). Much like national bonds, the exposures sum to a multiple of shareholders’ equity. Bailing out the peripheral euro area is in the interest of core euro area banks. Even US banks have more than 100% of their shareholders’ equity invested in Europe. It is no surprise that the US recently expressed its strong support for the IMF providing more money to the EFSF.
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
10
Fig. 10: European bank cross-border exposure as a percentage of shareholders’ equity Shaded boxes represent countries where exposure is over 25% of shareholders' equity
Source: BIS, OECD
Peripheral risks: A long-term concern; Italy best positioned
An additional challenge we see in Europe is the weak state of some national banking systems. Despite the “reassuring” result of the July 2010 stress tests, the Irish banks needed bailing out before the end of the year (prompting the CEBS to state that it would rerun the stress tests including with liquidity tests early in 2011). Where banking markets are under-capitalised with respect to the bad assets still on their balance sheets and debt markets are unwilling to finance the risk (with even the ECB looking to reduce liquidity), governments may have to step in to guarantee the bank debt, as in Ireland, which can add significantly to debt/GDP. This is why the performance of bank stocks has shown such high correlation with debt markets in 2010.
Fig. 11: Government debt/GDP if bank liabilities are assumed Guaranteeing the bank sector can bankrupt the government, as seen in Ireland
Source: Datastream
While we are optimistic that a solution will be found for the peripheral euro area, without significant haircuts being imposed on the private sector (at least for all but the smallest states) the form today is unclear. It could include a significant increase in the size of the EFSF/ESM such that even a country as large as Spain could rely on it for funding for several years (currently the EFSF would only finance Spanish bond issuance through to mid-2012, which is far from long enough to stabilise debt/GDP levels). Alternatively, the ECB could significantly increase its peripheral bond buying, monetising the debt, or Europe could issue E-bonds, where the joint guarantee should lower financing costs.
Govt debt / GDP Bank wholesale liabilities / GDP Bank retail deposits / GDP
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
11
Whatever the solution though, it will involve a subsidy from the core to the periphery of the euro area, which will be unpopular with electorates. For this reason, politicians will act slower than the market wishes in the hope of avoiding the inevitable, creating high volatility as bond markets force governments into action. With hindsight, we believe these will prove strong buying opportunities, particularly for northern European banks where earnings risk is lower, but we acknowledge that at the time calling the turning point will be difficult with valuation only a limited guide.
We believe the peripheral euro area will be a long-term concern for the market. Even if the austerity packages are successfully passed and financing costs reduced, it will take some years before debt/GDP levels are stabilised and many more years to reduce these to more manageable levels. Periods of stress and relief tend to focus around government bond auctions. Greece and Ireland have the highest level of short-term debt but already have support packages in place. Spain has significant refinancing needs in April, while Italy has a fairly constant level of issuance throughout the year.
Fig. 12: Government debt maturity profile Greece and Ireland have already negotiated support packages
Source: Eurostat
Fig. 13: Sovereign issuance 2011 (coupon + redemption) April is a key month for Spanish bond redemptions
Source: Eurostat
While banks in the southern European states of Portugal, Ireland, Italy, Greece and Spain tend to trade together, we would emphasise that it is the smaller states that are perceived as the highest risk. Spain has comparatively low public sector debt/GDP, but high private sector debt and a weak banking market make for a large contingent liability. Italy also has a relatively high amount of public and private sector debt that is domestically held, which helps the financing. Italy also has a smaller fiscal deficit, a relatively stronger growth outlook and lower financing costs (spread over bunds this is currently 1.5% versus 2.4% for Spain, 3.2% for Portugal, 4.9% for Ireland and 8.8% for Greece). We therefore see Italy as the least risky among southern European states, although we do not see valuations or the interest rate environment as supportive of Italian banks.
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
12
Banks will not dilute to meet Basel 3
Summary
We do not predict a flood of equity issuance to comply with Basel 3, although some banks may chose to raise capital for specific reasons (eg, to repay government debt or to finance an acquisition). We believe that almost all listed banks can meet required capital levels by 1 January 2013 (well ahead of the 2019 deadline) through retained earnings (at the cost of minimal dividends). This task should be made easier if the Basel Committee revises lower its RWA calculations as expected (potentially before year-end). Book value multiples are therefore real (ie, not pre-dilution), which is supportive of the valuation case for the sector. We believe the SIFI (too big to fail) issue will be dealt with via a menu of options (more common equity or cocos or bail-in debt) such that many countries will not demand more equity than the 7% minimum (although banks will wish to have their own buffer). Despite G20 aims, this creates clear regulatory arbitrage, particularly for investment banks operating in more stringent countries. While regulators will decide whether banks are required to issue equity through setting the national minimum capital standards, we continue to believe the market will form its own view of the appropriate level of capital based on an individual bank’s business mix (investment banks requiring more). We predict more leveraged banks continuing to trade at a discount to less leveraged stocks, but we believe this discount will narrow through 2011 as investors become more comfortable with higher capital levels.
Basel 3 impact: favours retail over investment banks
In the chart below, we illustrate the change in core Tier 1 ratio moving from Basel 2 to Basel 3. This incorporates the pre-mitigation increases in RWAs, as well as the fully phased capital deductions (for securitisations, deferred tax assets, minority interests among others). Although mitigation strategies and utilisation of deferred tax assets (DTAs) should improve the impact with time, investment banks fare much worse than retail banks (by virtue of a near doubling in RWAs), with a negative impact of up to 8% for UBS compared with less than 1% for many retail banks.
Fig. 14: Fully phased change in core Tier 1 ratio from Basel 2 to Basel 3 Note US banks still operate under Basel 1
Source: Company reports
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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In the chart below, we show the pro forma Basel 3 core Tier 1 at 3Q10 (fully phased for deductions). In addition, we show the benefit claimed by investment banks from mitigation strategies, eg, from selling toxic assets or securitisation tranches, and the benefit of just over two years of retained earnings to the end of 2012.
Fig. 15: Pro forma Basel 3 capital ratios Fully phased at 1 January 2013
Source: Company reports
We observe that with the exception of Credit Agricole (which will need to rely on the promised support of the regional banks through what the company described as a “creative solution”, all these banks will exceed the global minimum standard of 7.0% by 1 January 2013 even on a fully phased basis (the deduction in practice phasing in over five years to 2019).
This supports our assertion that the sector can meet new capital regulations through retained earnings rather than through a flood of rights issues. Current bank book value multiples are therefore real (ie, not pre-dilution), which is supportive of the valuation case for the sector.
Inevitably, banks will wish to maintain a small buffer over the minimum in order to avoid any unexpected loss eating into the ability to pay dividends or compensation. Furthermore, countries where bank assets are very large compared with GDP (see Figure 9) are likely to demand additional measures; however, one outcome of the November 2010 G-20 meetings was that the SIFI issue (too big to fail) will be dealt with via a menu of options (more common equity or cocos or bail-in debt). Precise details are expected in late 2011.
This means that while some countries such as Switzerland and, likely in our view, the UK are targeting a minimum 10% core Tier 1 for their banks, many others such as France, Germany and Italy may target not more than 7%. As we discuss in a subsequent section, despite G20 aims, this creates clear regulatory arbitrage, particularly for investment banks operating in the more stringent countries.
While regulators will decide whether banks are required to issue equity through setting the national minimum capital standards, we continue to believe the market will form its own view of the appropriate level of capital based on an individual bank’s business mix (investment banks requiring more). We predict more leveraged banks will continue to trade at a discount to less leveraged stocks, but we believe this discount will narrow through 2011 as investors become more comfortable with higher capital levels.
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
14
Investment banks to stay de-rated
Summary
Not only do investment banks suffer the biggest negative impact under Basel 3 (with often a doubling in RWAs), they also suffer the greatest challenges from changes to market structure (eg, swaps clearing and prop trading restrictions) and further taxation (wholesale liability taxes). These effects are hard to quantify, but simplistically unless investment banks are successful in significantly increasing margins or business mix, or pushing compensation costs lower (unlikely in 2011), pro forma ROEs appear to be not much more than the COE. As a result, it would appear right that these stocks should trade in a range around tangible book. Regulatory arbitrage potentially produces a significant headwind for Swiss and, to a lesser extent, UK investment banks, and a benefit for German and French investment banks. Swiss banks could also remain under pressure until the depth and the pricing of the coco market is established.
Pro forma ROEs under Basel 3
Fig. 16: Investment bank pro forma ROE under Basel 3
Source: Company reports, Nomura estimates
In the table above, we have illustrated the potential impact on ROTE of Basel 3. In 2006 (on what was probably at the time an unrealistically light economic capital allocation), the wholesale divisions of the investment banks above claimed an average ROTE of 30%.
Based on our 2012 forecasts (which in aggregate we believe are not very different from consensus), and on the assumptions that (1) each 5% mitigation of RWAs costs 1% of pre-tax profit (a questionable assumption, but one for which we have received little guidance); and (2) capital is allocated at 8-10% of RWAs depending on geography, we estimate a pro forma ROTE in 2012 of a little over 13%, arguably not much more than the cost of equity for these divisions.
While some costs of new regulation in some businesses have been passed on to customers through wider margins, high competition has limited the effect. Shareholders have absorbed the vast majority of the cost of the new regulation as price/tangible book multiples have tumbled.
The challenge for investment banks is to try to shift the business mix into higher RoRWA flow businesses without competing away the returns, or to share more of the burden of the regulatory costs with employees in order to lift the ROTEs into the 15-20% range, which investors would find more acceptable. For 2011, this latter development looks unlikely as numerous banks have commented that competition for talent is intense. Furthermore, the deferment of compensation into 2012 and beyond through changes to payment mix will weigh on the ability to reduce these costs significantly in future years.
Overall, therefore, the fact that many of the global pure investment banks trade at around 1x tangible book value should not be a surprise. Banks that currently deliver a higher RoRWA (eg, BNP, GS) or which benefit from regulatory arbitrage (eg, DBK) have a better chance of delivering a better headline ROTE.
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
15
The costs of regulatory arbitrage (bear case for Swiss banks)
Despite the stated intentions of the G20, there is bound to be strong regulatory arbitrage under Basel 3 given the inability to agree common standards for SIFIs (or institutions deemed “too big to fail”). Countries such as Switzerland and the UK, where banking assets to GDP are very large, prefer banks to carry additional common equity, targeting a minimum core Tier 1 of at least 10% in the case of Switzerland (and we assume the UK will set a similar target). Others such as Germany and France have indicated that they prefer to deal with SIFIs through better supervision, contingent convertibles and/or bail-in debt, meaning their banks can operate much closer to the global minimum core Tier 1 requirement of 7%. As a result, a bank operating in a 10% core Tier 1 regime must earn a net profit more than 40% higher than an identical bank operating in a 7% core Tier 1 regime in order to deliver the same ROE.
The Swiss banks benefit from a lower corporation tax rate and, furthermore, Switzerland has not proposed a wholesale liability tax as many other European countries have agreed to implement. This goes some way to offsetting the reduced ROE from a higher capital requirement. However, as we show in the illustration below, we believe the higher capital requirement more than offsets these advantages and the advantage of a higher ROA from the synergies of running an integrated investment/private bank.
Fig. 17: Illustration of ROEs based on different capital allocations Swiss tax and synergy benefits more than offset by higher capital requirements
Source: Nomura research
Swiss banks also need to issue up to 9% of RWAs in contingent convertible instruments (cocos), a market that barely exists today. If such a market does not appear in the next decade, even more common equity must be held, which would not make it economic to domicile an investment bank in Switzerland. Until the market becomes deeper, some investors could be more cautious on the Swiss banks.
The costs of these cocos are difficult to determine today. Credit Suisse believes the 3% of high-trigger cocos that convert to common equity at a 7% core Tier 1 should not cost much more than the current hybrid, which yield a very high 750bp over senior debt as much of it was issued at the peak of the crisis. Credit Suisse adds that the 6% of low-trigger cocos that convert to common equity at a 5% core Tier 1 will replace Tier 2 capital (yielding 100-350bp over senior debt) and that the future cost of senior debt should be lower than in the past given the greater equity buffer. While the price of other coco issues such as Lloyds suggests this belief might be a little optimistic, the fact that staff are likely to receive these instruments in lieu of share-based payments should help limit the overall cost.
Switzerland Germany
Assets 1,000,000 1,000,000
Wholesale funding 40% 40%
RWAs 400,000 400,000
Core Tier 1 ratio 10% 7%
Required tangible equity 40,000 28,000
Pretax ROA - ordinary 1.00% 1.00%
Pretax ROA - synergy 0.10% 0.00%
Pretax profit 11,000 10,000
Tax - ordinary 22% 34%
Tax - wholesale 0.00% 0.05%
ROE 21% 23%
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
16
Credit quality a peripheral earnings risk
Summary
NPL and provision trends show that credit quality concerns are easing except in economies where there is a high risk of a double dip (eg, Greece, Ireland, Portugal and Spain). The costs of austerity and cleaning up the banking systems in these economies generate higher earnings risk and, as a result, our EPS forecasts tend to be more below consensus in southern European economies than northern European ones.
Macro outlook
In the charts below, we show GDP and unemployment forecasts by country, each a key leading indicator for future credit quality. Across Europe, there is a wide range of GDP forecasts for 2011, from strong growth in some Scandi and CEE countries (which is already leading to interest rate rises) through to a double-dip recession in Greece and Portugal. Growth in some southern European countries, such as Portugal and Spain, is sufficiently close to zero that the impact of increased austerity measures could conceivably see these countries also dip back into recession. This outlook is mirrored in the outlook for unemployment, which in general is expected to be persistently high in southern European economies compared with northern European economies.
Fig. 18: GDP forecasts by country Sorted by cumulative GDP growth 2010-11
Source: Datastream
Fig. 19: Unemployment forecasts by country Sorted by unemployment in 2011
Source: Datastream
NPL and provision trends
As shown in the following charts, after a strong acceleration in NPLs as a percentage of loans during 2H08 and 2009, the rate of increase has levelled into 2010, particularly for northern European economies. As a result, we believe provisions for the sector will continue to trend downwards in 2011-12, with northern European banks seeing a quicker normalisation than southern European banks.
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
17
Fig. 20: NPLs/total loans Inflows moderating, especially in N Europe
Source: Company reports
Fig. 21: Forecast provisions N Europe expected to normalise faster than S Europe
Source: Nomura estimates
Earnings risk
The costs of austerity and cleaning up the banking systems in southern Europe generates higher earnings risk and, as a result, our EPS forecasts tend to be more below consensus in southern European economies than northern European ones.
Fig. 22: Nomura 2011 EPS forecasts versus consensus Compared with IBES consensus
Note: For Lloyds, we believe our 2012 earnings estimate of 9.6p is a more relevant measure given the trend of normalising credit costs.
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
18
Funding a key differentiator for 2011
Summary
Funding is arguably a bigger issue than credit quality for the sector in 2011. The ECB wants to withdraw excess liquidity and have member states guarantee bank debt if necessary (adding to the burden of debt/GDP). The divergent perceptions of the liquidity and solvency of northern and southern European sovereigns are having a similar effect on the issuance and cost of debt of their banks. Those banks operating in lower-risk countries (eg, Germany) and with lower funding costs (eg, Nordics) have an advantage both in terms of net interest margin and valuation (discount rate). We note that a recovery in bank debt issuance in June 2010 was a catalyst for the end of the first phase of the sovereign crisis, and we believe investors will closely watch this in 2011.
North/south divide in funding
Fig. 23: EU bank bond redemptions (EUR bn equivalent) EUR 1.4trn of refinancing need in 2011-12
Source: Dealogic, Nomura research
Fig. 24: EU bank bond supply (EUR bn equivalent) EUR 720bn supply in 2010E versus EUR 760bn redemptions
Source: Dealogic, Nomura research
Unlike their corporate counterparts, European banks have persistently high refinancing requirements, with an estimated EUR 1.4trn of redemptions in the next two years. Supply in 2010 (across all instruments and currencies) of EUR 720bn compared with EUR 760bn of redemptions, with some peripheral issuers (Ireland/Portugal/Greece) unable to tap the public capital markets all year. The market is wary of a funding cliff of maturing government-guaranteed bank debt, which peaks at EUR 131bn in 1Q12 with EUR 80bn also due in 2Q12.
Fig. 25: M/M change in banks’ use of ECB repo operations
Source: ECB, Nomura research
Fig. 26: Periphery bank reliance on ECB funding
Source: ECB, Nomura research
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
19
ECB repo operations are thus still vital to funding periphery bank balance sheets, particularly for Greek and Irish banks. Smaller Spanish and Italian banks have had some notable capital market success in the covered bond space in 2010, helped by decent relative value and regulatory developments (covered bonds are the only bank debt eligible for liquidity ratios under Basel 3 and covered bonds favourable to AAA corporate bonds for insurance companies under Solvency II).
For some of the peripheral issuers (Spanish and Italian), this has been the only capital market open to them for much of 2010 and in the view of our credit analysts, this is likely to be the only market for some time, although much depends on sovereign developments in 2011. In the chart below, we compare the volume issuance of northern versus southern European banks, and an (imperfect) indication of the relative cost shown by a market-cap-weighted CDS.
Fig. 27: North/south divide in debt issuance Renewed issuance in June catalysed sector recovery
Source: Dealogic
Fig. 28: North/south divide in funding costs Market-cap-weighted CDS
Source: Datastream
North/south divide in funding
Taking this to a bank-specific level, in the following chart we illustrate CDS as an (imperfect) measure of relative funding cost, as well as the relative position of each bank’s CDS within the 52-week range (a low score therefore indicating an improved perception of risk).
We would highlight the high correlation between the sovereign and banking CDS with Nordic and Swiss banks among the lowest, and Spanish and Italian banks among the highest (Greek, Portuguese and Irish banks are well off the scale, with CDS much in excess of 800). This underpins our relative preference for northern over southern European banks in general.
We would also highlight the improved risk perception of Swedish, UK and investment banks compared with peers, a function of their relatively stable sovereigns. Of note, we believe is how much Deutsche Bank benefits from the perception of a stable sovereign and indeed a sovereign guarantee despite its low headline capital ratios.
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
20
Fig. 29: Individual bank funding cost and 52-week range
Source: Datastream
Modelling the differences in funding cost and availability is challenging as CDS are an imperfect proxy for funding costs, and lower cost options such as covered bonds may be available as a cheaper alternative, eg, for Nordic banks. However, we think banks with high loan/deposit ratios (indicative of greater wholesale funding) and a high CDS are more likely to see margin-related earnings risk, and the stock prices are certainly more correlated with developments in debt markets.
Fig. 30: Loan/deposit ratio 2010E and CDS Italian banks adjusted for retail bonds
Source: Datastream, Nomura estimates
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
21
European recommendations for 2011
Summary
The north/south divide was a key theme of ours for 2010, and we believe it will remain a dominant theme not just in 2011, but for many years to come given the lengthy periods of adjustments necessary to bring debt back down to stable levels. Our thesis is that banks in more leveraged southern European economies will see slower loan growth (given private sector deleveraging), weaker margins (owing to a higher cost of funds) and weaker credit quality trends (either a slower normalisation, or in the worst case a double dip). As a result, we believe their earnings will continue to underperform those of their northern European counterparts. At some stage, we believe this may be more adequately reflected in valuations, but as of today we believe the differences are insufficient. We would use macro-related volatility in 2011 to buy northern European banks such as BNP Paribas, Lloyds, DNBNOR and Swedbank.
Key theme: The north/south divide
There is a distinct north/south divide in Europe in the health of economies and banking systems. The former can be measured by indicators such as public or private debt/GDP (ie, leverage), external financing (where a high figure puts a country at the mercy of foreign creditors), fiscal deficits (which require austerity programmes to reduce them), GDP growth, unemployment and bond financing costs. The latter can be measured by lending growth (lacklustre across all Europe), funding capability and cost, non-performing loans (NPLs) and Tier 1 capital ratios. Yet despite some differentiation in share price YTD, on a market-cap-weighted basis, we find northern European banks (in Norway, Sweden, the UK, Germany, France and Switzerland) trade on only a small price/tangible book premium versus southern European banks (Spain, Portugal, Italy, Greece and including Ireland). Over time, we expect earnings and valuations to continue to diverge.
Fig. 31: The north / south divide We believe northern European banks should enjoy more of a premium
Note: North macro data are a simple average of Norway, Sweden, Switzerland, Germany, France and the UK. South data are a simple average of Italy, Spain, Ireland, Portugal and Greece. Debt/GDP comprises public forecast for 2011 plus private debt for 2008. Fiscal deficit and GDP growth are 2010/11 cumulative. Unemployment is 2010 forecast and CDS is as of 8 December 2010. Banks data are market-cap-weighted average. NPLs are as at end-2009 and Tier 1 is 2010 forecast. Price/TBV is as of 9 December, 2010. The northern population is the average of Norway, Sweden, Switzerland, Germany, France and the UK. The southern population is an average of Italy, Spain, Portugal, Ireland and Greece. Source: Datastream, OECD, Central banks, Nomura research
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Recommendations
• French banks: We see an attractive risk/reward, with BNP Paribas our top pick. We upgrade Credit Agricole from Reduce to Neutral.
• •Investment banks: We would be underweight versus commercial banks, favouring UBS over Credit Suisse (CS), which we downgrade to Neutral from Buy.
• •Italian banks: While, in our view, Italy is the least risky of the southern European economies, we see few catalysts, preferring Intesa over UniCredit.
• •Nordic banks: We remain overweight the region on better growth and capital, with DNBNOR and Swedbank our top picks.
• •Spanish banks: We remain underweight as more capital is needed, but we believe trading opportunities could arise for Santander.
• •UK domestic banks: We believe Lloyds offers good upside potential, but we cannot justify the valuation for RBS. We are positive on Asia in the longer term but fear a near-term correction. We prefer HSBC over Standard Chartered (STAN).
Fig. 32: European bank valuations CEE banks: we prefer Russia and Poland over Turkey. Our top picks are Sberbank, PKO BP and Bank Pekao; we rate Garanti Bank Reduce
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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French banks: Attractive risk/reward led by BNP Paribas Jon Peace [email protected] +44 20 7102 4452
Summary
As large liquid holders of European government bonds, the French banks have traded as a group with a high correlation to southern European banks despite generally having a small direct retail exposure outside of Italy (the exception is Credit Agricole, which has retail operations in Greece and bank stakes in Spain and Portugal). With our thesis that European government bonds will be bailed out at the cost of greater austerity for over-leveraged states (hence, weaker profits for local retail banking operations), we believe French banks offer some of the best risk/reward trade-off in the sector for 2011, trading at around 1x TBV for mid-teen normalised ROTEs. With valuations having shown a significant compression, our preferred stock is BNP Paribas, which benefits from good risk management, strong capital and hidden value from the Fortis acquisition. We also rate Société Générale as a Buy given its low valuation, improving risk profile and undervalued exposure to the CEE region. In this report, we upgrade Credit Agricole from Reduce to Neutral with an unchanged price target, having underperformed the sector by over 10% in the past six weeks on capital and sovereign concerns. We believe that even on a de-geared basis, the shares now offer reasonable value and that with creative solutions from the regional banks, an equity capital raising could be avoided.
Investment theses
BNP Paribas BNP Paribas is primarily a retail bank operating in the core euro area countries, giving it more limited exposure to sovereign risk than the peripheral euro area economies. Following the acquisition of Fortis, BNP ranks as the largest deposit taker in the euro area, which gives it a funding advantage evidenced by one of the lowest CDS in the sector. While investment banking has been an important near-term contributor, at just 20% of normalised earnings (excluding financing), the risk from normalising FICC trading and increased regulation is manageable, in our view.
BNP trades on 5.7x our normalised 2012 earnings estimate of EUR 9.00, a sharp discount to the sector average of 7.5x. As we estimate a Basel 3 pro forma core Tier 1 on 1 January 2013 of 10.6% (excluding organic RWA growth and dividends), we believe that BNP should benefit from a re-rating as the leverage discount reduces. Our 2012 EPS forecast is some 7% ahead of consensus, in part because we believe analysts continue to underestimate the earnings power of the core businesses within the corporate centre. The shares trade on a price/tangible book of 1.0x (inclusive of up to EUR 5 of hidden value from Fortis) versus a sector average of 1.3x. We believe this is good value versus a target normalised ROE of around 15% (hence, ROTE of around 18%).
Société Générale
Société Générale (SocGen) similarly is primarily a retail bank with operations in the core euro area countries, with some additional exposure to higher-growth CEE countries (16% of normalised earnings, particularly in the Czech Republic, Romania and Russia). While SocGen does have a subsidiary in Greece, the EUR 4bn loan book is small and well provisioned. Losses on toxic assets caused significant P&L volatility in 2009, but in 2010, SocGen has seen a sharp rebound in profitability, which should continue into 2011 as credit costs continue to normalise. The hiring of Blackrock to perform an independent audit on the marks of the toxic assets in June 2010 was seen as a turning point in the risk profile of the stock.
SocGen trades on just 5.4x normalised 2012E earnings and 1.0x TBV compared with sector averages of 7.5x and 1.3x, respectively. Given that we believe SocGen can deliver a ROTE of 14.9% in 2012, this represents a good entry point. Although SocGen is not as well capitalised as BNP, we see recent market concerns about the risk of
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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raising additional capital as misplaced given good core profitability and the ability to make strategic disposals (such as the custody business). In addition, France remains a ‘soft touch’ regulator, which should not ask for a SIFI/“too big to fail” premium through additional common equity requirements.
Credit Agricole Credit Agricole SA is the listed minority (44% float/employee held) of Credit Agricole group, the largest retail bank by market share in France. Versus its largest domestic peers, it is overweight in French retail and asset gathering (each 30% of normalised profit) and underweight in corporate and investment banking (17% of normalised profit) and international retail (7% of normalised profit, including branches in Italy and Greece, and stakes in Bankinter in Spain and BES in Portugal). Agricole has been affected by its above-average exposure to Greece (troubled subsidiary Emporiki has generated large losses on its c.EUR 30bn balance sheet) and under new management impairments could again be taken, but, in our view, investors now have a better idea of potential losses in their forecasts.
The bank has always and continues to trade at a modest discount to the domestic peer group (4.8x 2012E earnings versus France 5.6x and the Banks sector 7.5x and 1.0x TBV versus France 1.1x and sector 1.3x). This reflects primarily the high leverage of the business, with a pro forma Basel 3 core Tier 1 on 1 January 2013 of just 6.9% even with a moderately favourable RWA treatment for the regional banks. However, Agricole will be able to rely on creative solutions from the regional banks (eg, RWA reinsurance) in order to meet its Basel 3 capital requirements without necessarily resorting to a capital increase (although we could not totally rule one out) and the guarantee from the regional banks allows Agricole to fund at one of the lowest rates in the sector despite its high leverage. After recent underperformance saw its de-geared 2012E P/E drop to 7.3x, a discount to the sector, we upgrade the shares to Neutral (from Reduce) ahead of the investor day from the new CEO in March 2011.
France a northern European economy
The north/south divide has been a key theme of ours in 2010, and given diverging economic trends and current valuations, we believe this will also be an important theme in 2011. While France’s public sector debt, fiscal deficit and unemployment are towards the higher end of northern European economies, its key measures are better than southern European averages. A comparatively low level of private sector debt and an absence of significant stress in funding markets have led to healthy loan demand, on a par with the Scandinavian banks.
Fig. 33: N Europe domestic lending growth France on a par with Scandinavia
Source: ECB
Fig. 34: S Europe domestic lending growth Italy the best but growth still weak
Source: ECB
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Southern European government bond exposures moderate
French banks have shown a high correlation with southern European banks in 2010 despite, in our view, being lower risk because their exposure is primarily through government bonds. With our thesis that European government bonds will be bailed out at the cost of greater austerity for over-leveraged states (hence, weaker profits for local retail banking operations), we believe French banks offer some of the best risk/reward trade-off in the sector for 2011.
According to CEBS data, total exposure to peripheral government debt as a percentage of tangible shareholders’ equity stands at c.70% for Credit Agricole, 65% for BNP Paribas and 40% for SocGen, less than many large-cap peers, with the majority of exposure relating to the relatively lower-risk Italy.
Fig. 35: Peripheral sovereign bond exposure as percentage of tangible shareholders’ equity French bank exposures moderate, particularly outside of Italy
Source: CEBS, Nomura estimates
In terms of direct retail operations, Agricole has the highest-risk exposure through its stake in Emporiki with a balance sheet of around EUR 30bn. While heavy provisions have already been booked and losses are expected to continue until 2012, we believe that forecasts are now more realistic. Agricole also has exposure to Italy, having bought retail networks from Intesa, and holds stakes in Bankinter in Spain (currently with an unrealised loss) and BES in Portugal.
BNP Paribas also has around EUR 160bn of exposure to Italy by way of its acquisition of BNL. With the Italian economy arguably in the best shape among southern European states, credit costs have stabilised, and we expect these to decline in 2011. BNP also has some exposure to Spain through consumer finance operations, which also have led to an elevated cost of risk, although in a group context, again we see this as manageable.
SocGen has a small exposure to Greece through its Geniki subsidiary, although the EUR 4bn balance sheet is a fraction of the size of Credit Agricole’s exposure. Other direct-lending exposures are small.
Leverage over-discounted in multiples, particularly for BNP
Although France is a ‘soft’ regulator, which emphasises better regulation and risk management over more common equity, the French banks have traditionally traded at a modest discount to the sector, which reflects their higher leverage (lower core Tier 1 ratios). Over the 20 years pre-crisis to June 2008, the French banks traded on average at 83% of the Bank sector multiple.
Today the discount is wider, with the French banks trading on 5.6x 2012E normalised earnings, or 75% of the market multiple. We believe this is too wide for the sector both in a historical context and relative to current capital levels. As we illustrate below, on a de-geared basis (target 8% core Tier 1 for European banks and 10% for UK, Swiss and Scandi banks), we believe the French banks offer good relative value.
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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We believe this is particularly the case for BNP Paribas, which reported a particularly good pro forma Basel 3 core Tier 1 at 7.3% at 3Q10A, improving to 10.6% on 1 January 2013 (ex organic RWA growth and dividends). On this basis, we believe there is a good argument for a re-rating of the stock.
Fig. 36: French banks P/E relative to Banks sector 20-year average is 83% of the sector multiple, current 75%
Source: Datastream
Fig. 37: De-geared 2012 P/E ratios Based on 8% target CT1 for euro banks and 10% for UK/Swiss/Scandi
Source: Nomura research
Earnings catalysts for individual stocks
Looking beyond the above-average correlation with southern European and regulatory developments, we would identify the following stock-specific catalysts for the French:
BNP Paribas (earnings upgrades): BNP is one of the stocks where we are most ahead of consensus. We believe the market underestimates the persistency of the market share gains in investment banking and is underestimating the core earnings in the corporate centre. Furthermore, BNP bought Fortis at around half book value. While some of the purchase-accounting adjustments are visibly accreted back, and others are unlikely to return (goodwill), there is the potential for further write-ups on other loans and securities, which in total could sum to almost EUR 5bn, or EUR 4 per share.
Société Générale (strategic M&A): Following the merger of its asset management business with Amundi, Société Générale has hinted at a number of potential strategic disposals including its custody business and its futures brokerage JV NewEdge. These high-multiple disposals could be used to finance high-multiple acquisitions. In particular, expanding the 16% of normalised earnings from CEE could help improve the stock rating given the high investor appetite for emerging market franchises.
Credit Agricole (restructuring and intra-group subsidy): Under a new CEO in 2010, Agricole plans to follow a mid-December business plan for the mutual group with a more detailed plan for the listed subsidiary in March 2011. The most important development for the stock will be disclosure of the capital subsidies to be provided from the regional banks to Credit Agricole SA to support its Basel 3 capital ratios. However, this is also an opportunity to restructure some of the group’s stakes, perhaps rationalising minority holdings in Iberia and the Middle East in order to focus more on Italy.
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
Corporate Centre (1,335) (1,450) (1,684) 11.4% 10.3 (15,710) (6.54)
Excess capital (8,847) (3.68)
Total 2,351 4,220 5,312 31,236 13.01
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Underweight IBs vs commercial banks; we favour UBS over CS, BARC over DBK Jon Peace [email protected] +44 20 7102 4452 Robert Law [email protected] +44 20 7102 2715
Summary
Basel 3 will weigh heavily on pro forma profitability of the investment banks, cutting the ROEs by more than half from peak levels to around 13% in 2012. Other market structure changes, such as derivative trading/clearing and wholesale liability taxes, will also weigh disproportionately on the investment banks. Until greater visibility is seen, valuations for pure investment banks of around 1x TBV might not be inappropriate, and we believe investors could prefer commercial banks near term. As a result, we downgrade Credit Suisse to Neutral from Buy (reduced PT CHF 48, from CHF 56), and we prefer UBS over CS owing to the hidden value of tax loss carry-forwards. We prefer BARC over DBK given the relative valuation even adjusting for tougher UK regulation. After a difficult two quarters characterised by significant volatility and weak client volumes, the fourth quarter still looks to be a little mixed given a return of sovereign risk, though we see 2011 revenues as a little better than 2010, as a cyclical rebound in M&A and ECM activity and a better performance in equities offset a continued normalisation in FICC.
Investment theses
Barclays We believe Barclays may be confined to a trading range and that a genuine re-rating is unlikely, until current industry profitability issues are resolved. Nevertheless, at the current price of 273p, we think the shares seem near the bottom of the likely range and see some limited recovery potential. At this level, the shares trade on 0.8x end-2010 diluted TBV and 8.5x our estimate of normalised EPS.
Barclays faces the same challenges as the investment banking industry as a whole, in achieving an attractive group RoE, given the regulatory pressure on the industry and the relative size of BarCap in a group context. Even post mitigating actions, BarCap will represent 60% of group RWAs. Assuming a similar Q4 to Q3, BarCap is currently generating top-line revenue of £13bn a year. Using a 33% pre-tax margin, this would be equivalent to profits of £4.2bn, or an RoE as low as 9%, assuming a 10% CT1, loading the UK levy on to the division and apportioning central costs. This will limit the overall group RoE, unless the company can improve the returns at its core business. We estimate that BarCap PBT would have to be raised by at least £2.5bn to achieve a 15% RoE on regulatory capital. Assuming BarCap profits near its 2010 level, we estimate normalised EPS of 32p for Barclays as a whole. This would represent a 10% RoE on a tangible basis.
With a new CEO about to take over, and given the strategic challenges facing the group, there are real uncertainties over future direction, we would argue more so than at other UK banks. Comments the new CEO makes with the full-year figures in early 2011 could be an important indication for the shares. Press reports note that the group is interested in growing its wealth businesses and to view Africa as an important opportunity; however, neither of these can be regarded as likely to be transformational in the short term at least. The market needs to be convinced that the group will seek to extract greater value out of the resources allocated to BarCap and has a convincing plan.
Overall group capital appears less of a concern than appeared to be the case earlier in the year. The pro forma Basel III CT1 ratio of c.8% is similar to most other global investment banking groups, if lower than other UK banks. Although the ratio is likely to have to be increased, we believe Barclays can achieve this organically, as other peers will seek to do. One further issue is the ongoing Lehman Brothers-related litigation. This has the potential for negative sentiment and ongoing uncertainty for an extended period, until it is ultimately resolved.
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Deutsche Bank We recognise that Deutsche Bank’s leading investment bank is performing well versus peers in Q4, but overall performance in 2010 was in line with peers so we believe this will be just a moderate short-term catalyst. The retail and asset-gathering businesses delivered 9M 2010 profits at just a fraction of 2011 targets, leaving the targets vulnerable to any potential further deterioration in the capital markets environment. With hindsight, Deutsche Bank paid a high price to secure the acquisition of Postbank. The market remains rightly sceptical as to whether the claimed level of synergies can be achieved given the challenges in reducing the Postbank staff and branches. We see limited reasons why the franchise might re-rate to offset the dilution considering the size and the quality of the franchise acquired, as well as the fact that Deutsche Bank already enjoys a low cost of funding.
For Deutsche Bank, the stated P/E of 6.7x 2012E (sector 7.5x) and price/TBV of 1.1x (sector 1.3x) appear interesting relative to a normalised (2012E) ROTE of almost 15%. However, when considering the business mix and the capital levels (pro forma fully phased Basel 3 core Tier 1 of 3.9% at 3Q10A), we do not see the valuation as compelling. Even allowing for the fact that German regulators should allow Deutsche Bank to run with a lower target level of capital than peers, and that we expect leverage discounts to decline in 2011 (particularly as Deutsche Bank can fund cheaply relative to peers), on a de-geared basis, we see better valuation elsewhere in the global sector. Particularly for European value investors, even after adjusting for a tougher domestic regulator, we believe Barclays looks more attractive at 0.8x book (for an 8.5% fully phased Basel 3 CT1 at 3Q10A).
Credit Suisse Credit Suisse (CS) underperformed peers in 2010 as trading revenues, private banking margins and book value growth proved weaker than expected. Looking to 2011, we believe each of these should show some improvement, but that valuation and capital could cap upside especially relative to domestic peer, UBS.
In new disclosure, we estimate a pro forma fully phased core Tier 1 of just 5.0% for CS in 3Q10, rising to 9.5% in 2012 (assuming no dividend and no organic RWA growth). By contrast, we estimate figures of 8.2% and 14.7% for UBS, respectively (figures that could be improved upon by more aggressive recognition of deferred tax assets). The market also remains concerned by the appetite for and cost of contingent convertible instruments (cocos), which must form 9% of core capital by 2019. Although we expect some issuance in 2011 (to specialist hedge funds and to staff), we believe it will take some time before the market is fully comfortable with this instrument.
The long-term valuation is reasonably attractive for CS, with a de-geared P/E in line with the sector average despite an attractive business mix and with a P/TBV of 1.8x justified by a high ROTE. However, we argue in this report that in recovering markets, investors may prefer lower P/TBV stocks, especially as it will take CS some time to build capital levels in line with Swiss regulatory demands. As a result, we downgrade the stock to Neutral with a CHF 48 target.
UBS In an environment of weak revenue growth, we believe restructuring stories should deliver superior earnings momentum. The UBS business plan calls for EPS of CHF 3.00 in 2012, against current consensus of CHF 2.12. We believe FICC trading, wealth management gross margins, and cost control and asset gathering profitability are areas where analysts could be too cautious in the long run.
UBS has the strongest Basel 2 core Tier 1 and capital generation in the European sector, and we estimate a Basel 3 fully phased pro forma core Tier 1 of over 14% by 1 January 2013, which puts it in a favourable position versus CS and versus tough domestic banking regulation. We do not believe the stated aim of not paying dividends "for some time to come" will weigh on the shares given a lack of payout elsewhere in the sector.
UBS is one of the lowest-rated banks in the sector on a P/E basis. While the stated price/TBV of 1.6x is a premium to the sector on 1.3x, we believe this is justified by the business mix, which should deliver a high-teen ROTE. Furthermore, we believe there is
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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substantial hidden value in the unrecognised DTAs, which at CHF 21bn are worth CHF 5.5 per share or more than half the tangible book value. Even if we recognise the benefit over 20 years at a 10% discount rate, we estimate this is worth CHF 2.4 per share or around one-quarter of the tangible book, taking the adjusted P/TBV from a sector premium to a sector discount.
We believe Basel 3 will hurt profitability…
In the table below, we have illustrated the potential impact on ROTE of Basel 3. In 2006 (on what was probably at the time an unrealistically light economic capital allocation), the wholesale divisions of the investment banks above claimed an average ROTE of 30%.
Based on our 2012 forecasts (which in aggregate we believe are not very different from consensus), and on the assumptions that: (1) each 5% mitigation of RWAs costs 1% of pre-tax profit (a questionable assumption, but one for which we have received little guidance); and (2) capital is allocated at 8-10% of RWAs depending on geography, we estimate a pro forma ROTE in 2012 of a little over 13%, arguably not much more than the cost of equity for these divisions.
Fig. 44: Investment bank pro forma ROE under Basel 3 Pro forma ROE of 13% little more than the cost of equity
Source: Nomura estimates
… and other market structure changes also weigh on IBs…
Not only do investment banks suffer the biggest negative impact under Basel 3 (with often a doubling in RWAs), they also suffer the greatest challenges from changes to market structure (eg, swaps clearing and prop trading restrictions) and further taxation (wholesale liability taxes).
These effects are hard to quantify as the regulations both in terms of Dodd-Frank in the US and in terms of MIFID 2 in Europe are still evolving, and again we expect regulatory arbitrage globally on a number of issues. Exchange trading and centralised clearing of OTC derivatives are likely to have the biggest impact on the sector globally, with the largest operators estimating around a 10% decline in FICC trading revenues. Barclays and Deutsche Bank proportionately have the biggest rates operations in Europe.
Wholesale liability taxes have been proposed in a number of geographies and at a number of rates in order to provide restitution for the past financial crisis and/or to make a reserve against future crises. These necessarily tax the business models of investment banks. While we would not be surprised to see greater standardisation in Europe, current rates differ greatly, with the UK targeting taxes of GBP 2.5bn from its banks, while Switzerland does not have a comparable mechanism.
Taken together, unless investment banks are successful in significantly increasing margins or business mix, or pushing compensation costs lower (unlikely in 2011), pro forma ROEs appear to be not much more than the COE.
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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… therefore valuations around 1x TBV might be appropriate
While some costs of new regulation in some businesses have been passed on to customers through wider margins, high competition has limited the effect. Shareholders have absorbed the vast majority of the cost of the new regulation as price/tangible book multiples have tumbled.
The challenge for investment banks is to try to shift the business mix into higher RoRWA flow businesses without competing away the returns, or to share more of the burden of the regulatory costs with employees in order to lift the ROTEs into the 15-20% range, which investors would find more acceptable. For 2011, this latter development looks unlikely as numerous banks have commented that the competition for talent is intense. Furthermore, the deferment of compensation into 2012 and beyond through changes to payment mix will weigh on the ability to reduce these costs significantly in future years.
Overall, therefore, the fact that many of the global pure investment banks trade at around 1x tangible book value should not be a surprise.
Fig. 45: Capital-adjusted valuations – P/TBV versus ROTE Normalised is 2012 earnings
Note: Degearing based on 10% CT1 for Swiss and UK, 8.5% for US, 8% for DBK Source: Nomura estimates
Fig. 46: Capital-adjusted valuations – P/E Normalised is 2012 earnings
Source: Nomura estimates
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
34
Q4 will be a little mixed…
After a difficult two quarters characterised by significant volatility and weak client volumes, the fourth quarter again looks to be a little mixed as a return of sovereign risk and high rates volatility weighs on client activity in FICC. While Q4 normally sees a lower comp cost accrual, this may be constrained by strong hiring and deferred comp.
Of note, we believe sovereign risk, muni concerns and yield curve volatility have constrained trading profits in FICC. Equity market prices are up Q/Q and Y/Y with volumes also better than prior quarter and volatility declining on both periods. ECM activity has shown the normal acceleration into year-end, although both M&A and DCM activity are down Q/Q and Y/Y.
Fig. 47: Capital markets data 4Q10 to date Q4 trends still a little mixed
Fig. 48: Capital markets revenue forecasts Figures adjusted for marks where disclosed
Source: Company reports, Nomura estimates
As shown in the table above, we also believe 2011 will be a better revenue year than 2010, with average revenues up 9% as a recovery in equity trading helps offset a continued normalisation in FICC from many operators.
QoQ YoY
Investment Banking Date Q/(Q-1) Q/(Q-4) Description
ECM volume 09-Dec 77% 9% Change in Dealogic quarterly volumes
DCM volume 09-Dec (24%) (6%) Change in Dealogic quarterly volumes
QoQ YoY
Equities Date Q/(Q-1) Q/(Q-4) Description
CashCash equity prices 09-Dec 6% 7% Change in end of period FTSE All World index price
Cash equity volumes 09-Dec 4% (4%) Change in quarterly average volumes on SPX & DJES (QTD)Derivative
Equity derivative volumes 30-Nov 9% 1% Change in quarterly volume traded on EUREX (QTD)
Equity volatility 09-Dec (3.3) (2.2) Absolute Change in avg quarterly level of VIX/VSTOXX indicesPrime / propHedge fund performance 09-Dec 2% 4% Change in HFR Index NAV
QoQ YoY
FICC trading Date Q/(Q-1) Q/(Q-4) Description
Rates
Interest rate 09-Dec 0 0 Absolute Change in Fed Funds in bps
Yield curve 09-Dec 52 -10 Absolute Change in bps in US 10Y-2Y spread in bps (QTD)
Rate volatility (proxy for margins) 09-Dec 28% 1% Change in MOVE index (QTD)Credit
Corporate bond volumes 09-Dec 4% 8% Change in 60 day average of FINRA TRACE
Credit spreads 09-Dec (15) 37 Abs chg in bps in Moodys BAA bond yield over 10 yr TsyFX & Commodities
FX derivative volume 09-Dec 15% 23% Change in spot FX avg daily volumes at ICAP (QTD)
FX volatility 09-Dec 1% (8%) Change in volatility index quarterly average
FX margins 09-Dec (17%) (39%) Change in quarterly average Bid/Ask spreadsCommodity prices 09-Dec 11% 16% Change in S&P GSCI Index (QTD)Commodity volatility 09-Dec 0.9% (1.3%) Change in 3M realised volatility of S&P GSCI Index
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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We prefer UBS over CS
We downgrade Credit Suisse to Neutral from Buy and reduce our price target to CHF 48, from CHF 56. In part, this reflects new disclosure around Basel 3 where we estimate a pro forma fully phased core Tier 1 of just 5.0% for Credit Suisse in 3Q10, rising to 9.5% in 2012 (assuming no dividend and no organic RWA growth). By contrast, we estimate figures of 8.2% and 14.7% for UBS, respectively (figures that could be improved upon by more aggressive recognition of deferred tax assets). The market also remains concerned around the market appetite for and cost of cocos, which must form 9% of core capital by 2019. Although we expect some issuance in 2011 (to specialist hedge funds and to staff), we believe it will take some time before the market is fully comfortable with this instrument.
In part, this also reflects relative valuation where on a de-geared basis (based on a 10% target Basel 3 CT1), we see UBS trading on a more attractive normalised (2012E) P/E and also with a more attractive de-geared ROTE versus P/TBV. We believe UBS should benefit from the hidden value of unrecognised deferred tax assets, which at CHF 21bn are worth CHF 5.5 per share undiscounted or around half the tangible book value. We also believe UBS could benefit from earnings upgrades as management’s 2012 targets are around 40% ahead of consensus.
We prefer BARC over DBK
We believe the more fixed-income-driven European investment banks are far from highly priced in absolute terms but do not offer significant upside potential in relative value terms.
Barclays appears to have similar challenges to Deutsche, which we regard as its most obvious European peer, but has a lower valuation and a stronger capital position. At 273p, the shares are near the bottom of their recent trading range, and we see some limited recovery potential. At this level, the shares trade on 0.8x end-2010 diluted TBV and 8.5x our estimate of normalised EPS. The pro forma Basel III CT1 ratio is 7.8% and the company has indicated it plans to continue to build capital organically.
For Deutsche Bank, the stated P/E of 6.7x 2012E (sector 7.5x) and price/TBV of 1.1x (sector 1.3x) appear interesting relative to a normalised (2012E) ROTE of almost 15%. However, when considering the business mix and the capital levels (pro forma fully phased Basel 3 core Tier 1 of 3.9% at 3Q10A), we do not see the valuation as compelling. Even allowing for the fact that German regulators should allow Deutsche Bank to run with a lower target level of capital than peers, on a de-geared basis, we see better valuation elsewhere in the global sector. Particularly for European value investors, even after adjusting for a tougher domestic regulator, we believe Barclays looks more attractive at 0.8x book (for an 8.5% fully phased Basel 3 CT1 at 3Q10A).
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Italian banks: We prefer Intesa over UniCredit Domenico Santoro [email protected] +44 20 7102 2375
Summary and investment theses
In the context of our cautious stance on Italian banks, we tend to prefer IntesaSP (Neutral, TP EUR 2.6) to Unicredit, which we recently downgraded from Buy to Neutral (TP EUR 1.9). Admittedly, this is based more on operational grounds rather than geographical ones (considering that Unicredit’s business mix is less Italian-centric given its greater exposure to CEE and Germany than IntesaSP). We believe IntesaSP’s solid balance sheet is better placed to capture any opportunities from improved macro conditions (via increasing volumes), while Unicredit’s sub-optimal capital allocation would need a few adjustments before the company can benefit from any business re-launch. Taking into account Unicredit’s capital evolution under Basel 3, we think Unicredit’s capital is a bit stretched (at end-2013). This might require an additional deleveraging effort of the less profitable business (CIB), with inevitable pressure on revenues. Capital at IntesaSP though looks fine. Furthermore, after the last events, the new CEO (Federico Ghizzoni) needs to gain the trust of investors, and this might take some time. When de-leveraging our valuation multiples for excess capital, we see IntesaSP trading at a 10% discount versus Unicredit on a 2012E P/E basis, which we would gain exposure to via IntesaSP’s saving shares (a conversion is likely, in our view). The main risk to our base case scenario is a quicker disposal of unprofitable Unicredit’s assets (in CEE), which would be positive for capital and sentiment.
Italy: not the worst... but not the best
As we wrote in our recently published report on Italian banks (‘In the name of capital: More constructive on Italy, less on Italian banks and their capital’, 15 December 2010), we tend to have a more constructive view on Italy versus other peripheral countries (Spain in particular).
Despite its high debt/GDP ratio (118%), Italy did not have to contend with booming domestic private debt, its budget remains broadly under control and households earmark a significant proportion of their savings for the purchase of sovereign bonds (50% of the total domestic debt is held internally versus 40% for Spain, 30% for Ireland and 15% for Portugal).
Despite earnings having generally bottomed out, we believe Italian banks will continue to struggle in a low-rate and challenging environment. Competition and increasing cost of funding are pushing down interest margin, while liquidity constraints limit the distribution capability of value-added products (with Italian banks favouring the placement of own bonds rather than AuM products on the retail network). Furthermore, despite the fact that credit quality is getting better, the considerable stock of watch-list loans might create additional NPLs inflow, keeping LLPs at a high level for a while. For these reasons, we see Italian banks struggling to reach their cost of capital in the next biennium (8% in 2011 and 10% in 2012 versus14% and 15%, respectively, for continental Europe); and consequently, we also see the persistence of the current discount to PTB (0.8x versus 1.2x for continental Europe).
In this context, we believe regulators will prefer to favour economic growth over diluting the banking sector. From a capital standpoint, however, even with the lower leverage and a much more traditional business model of Italian banks (versus European banks), we take the view that they do not look well placed in a pan-European context. In the absence of any capital action, especially for the small operators (BMPS in primis), we see their valuations continuing to reflect this risk; hence, we have a cautious stance on the sub-sector of small Italian banks.
IntesaSP remains the best-in-class in a European context when it comes to liquidity, restructuring track-record and balance sheet quality. Even recognising the virtues of the investment case, our Neutral rating is mainly based on valuation, which admittedly might cap
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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the shares performance (PTB 2010E 1.0x versus 9% ROTB). We see IntesaSP as the main beneficiary of rising rates in Italy, a scenario that needs to materialise to push the stock further up. A catalyst for the shares might be the upcoming industrial plan, which could re-emphasise the cost-cutting potential (consensus estimates for 2011-12 embeds growing costs versus management’s commitment to decreasing costs). On the negative side, the excessive exposure to Italy might prompt M&A deals, which might erode capital.
Our recent downgrade of Unicredit was mainly based on the group’s low profitability. We are of the opinion that an imperfect capital allocation across the group will continue to emphasise this issue even when net provisions (currently abnormally high for Unicredit) normalise a bit. Management presented in London on 2 December 2010. The new strategy put forward is that of reallocating capital, generated increasingly in CEE countries, while financing less profitable regions (Italy in primis) with dividends from CEE associates. Despite being the right long-term strategy, we think it is unlikely this effort will significantly improve profitability in the short term. In this respect, we are of the opinion that a more transformational reconfiguration of the group, mainly via downsizing the presence in unprofitable activities (retail in Germany, a number of CEE countries and CIB) would be better suited. It is our opinion that, after the resignation of a long-standing CEO (Alessandro Profumo), investors will continue to wonder about the shareholder foundation’s commitment to value creation and probably wait for better results before gaining faith again in Unicredit’s story.
IntesaSP/Unicredit: the difference in large print
Our preference for IntesaSP is both operational and capital related rather than based on geographical considerations. Admittedly, given Unicredit’s geographical business mix, its presence in Italy is a bit diluted when compared with that of IntesaSP. This is because of its greater exposure to fast-growing CEE countries (21% of total RWAs, 31% of total GOP), its presence in Germany (14% and 4%, RWAs and GOP, respectively) and Austria (14% and 5%, RWAs and GOP, respectively). On the other side, IntesaSP is more ‘Italian’, which might not be perceived positively by investors, especially in a period of increasing risk aversion toward peripheral countries. Italian government bonds represent 245% of the total TBV of IntesaSP versus 101% in the case of Unicredit. Furthermore, IntesaSP’s presence in CEE and the Mediterranean area (10% of total RWAs, 15% of GOP) is also biased toward less interesting countries (Hungary, Slovakia and Slovenia represent altogether 67% of its total ex-Italy RWAs), whereas fast-growing countries like Poland, Turkey, Russia and the Czech Republic represent 59% of total RWAs in CEE for Unicredit.
Fig. 56: IntesaSP Breakdown of GOP by division
Source: Nomura estimates
Fig. 57: Unicredit Breakdown of GOP by division
Source: Nomura estimates
We believe, however, that the difference is noticeable when it comes to capital. We consider the balance sheet structure of IntesaSP a bit more relaxed than Unicredit’s. In our opinion, this should allow the former to reap potential opportunities that any improved macro scenario should bring.
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
42
In terms of capital, assuming a pay-out for the next two years of 35% and 5% average RWA growth, we estimate a generation of 25bp pa for IntesaSP (our EPS estimates for IntesaSP are 5% below consensus in 2011 and 2% above for 2012). According to our dynamic model, the negative impact from Basel 3 is 40bp in 2011 and 50bp in 2012 (mainly from the insurance business and DTA deductions). Taking all this into consideration, core tier 1 should stand at 8.2% and 8.3%, respectively, in 2012 and 2013. This is in line with our estimated capital requirement for the company of 8.2% (a level of core tier 1 that we consider optimal for a bank with IntesaSP’s risk profile). It is worth remembering also that IntesaSP is still calculating RWAs under the Basel 2 foundation, and it will benefit by 25bp when the migration to Basel 2 advanced occurs.
Fig. 58: IntesaSP Capital required by division in 2012 (EUR m)
Source: Nomura estimates
Fig. 59: Unicredit Capital required by division in 2012 (EUR m)
Source: Nomura estimates
In terms of capital for Unicredit, accounting for 90bp of negative impact deriving from Basel 3 (mainly because of RWA inflation, ie, market risk and CRVA) and assuming a 35% pay-out ratio (5% average growth in RWAs), we estimate a core tier 1 of 8.0% and 8.2% in 2012 and 2013, respectively (our EPS estimates are 7% below consensus for 2011 and 2% for 2012). We are of the opinion that this level is a bit stretched for a bank like Unicredit (for which we estimate an optimal level close to 9%), thereby concluding on a capital shortfall of approximately EUR 4bn. A capital increase for Unicredit is unlikely, after having raised EUR 7bn over the past two years. Cutting dividends, or alternatively RWAs, might seem a more viable option. Considering the well-known Foundations’ constraints, we would be surprised by any dividend cut. Deleveraging RWAs in businesses like CIB, where the return is poor, seems a more likely option, again highlighting potential pressure on revenues.
Fig. 60: Evolution of core tier 1 under Basel 2 and Basel 3 EUR m unless otherwise stated
Source: Company data, Nomura estimates
IntesaSP RWAsOptimal
core tier 1Capital
requirement
Italian Retail 137,400 0.08 10,992
Eurizon capital 900 8.0% 72
CIB 132,400 8.5% 11,254
Public finance 17,800 7.0% 1,246
International subsidiari 34,400 9.0% 3,096
Banca Fideuram 4,200 8.0% 336
Corporate centre 27,800 7.0% 1,946
Total 354,900 8.2% 28,942
Unicredit RWAsOptimal
core tier 1Capital
requirement
Retail 71,401 8.0% 5,712
CIB 245,566 9.5% 23,206
Asset Management 1,913 8.0% 153
Private Banking 4,796 8.0% 384
CEE 98,578 9.0% 8,872
Corporate Centre 31,223 7.0% 2,186
Total 453,478 8.9% 40,512
2012e UCG ISP 2013e UCG ISP
Core tier capital 1 Basle II 43,994 32,602 Core tier capital 1 Basle II 47,090 35,445
RWAs Basle II 495,006 387,971 RWAs Basle II 519,756 403,490
Core tier 1 Basle II (%) 8.9% 8.4% Core tier 1 Basle II (%) 9.1% 8.8%
Core tier capital 1 Basle III 43,340 31,822 Core tier capital 1 Basle III 46,140 34,192
Impact from Basle III -654 -780 Impact from Basle III -950 -1,253
RWAs Basle III (including market risk) 540,006 398,671 RWAs Basle III (including market risk) 564,756 414,190
Impact (%) 8.3% 2.7% Impact (%) 8.0% 2.6%
Core tier 1 Basle III (%) 8.0% 8.0% Core tier 1 Basle III (%) 8.2% 8.3%
Total impact -0.9% -0.4% Total impact -0.9% -0.5%
Optimal common equity (%) 8.9% 8.2% Optimal common equity (%) 8.9% 8.2%
Capital deficit -4,720 -869 Capital deficit -4,123 228
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Turning to valuation, based on our estimates, we see Unicredit trading at a 16% premium on deleveraged P/E 2011E versus IntesaSP, and a 10% premium based on 2012E.
The current discount to PTB (ISP 1.0x and UCG 0.8x in 2012E) respective to their European counterparties is justified, in our view, by profitability prospects that in both cases do not look exciting. When considering deleveraged P/E ratios (see table below) the discount on IntesaSP appears too severe. This might be because of the current perception of IntesaSP being more exposed to Italian sovereign risk than Unicredit. We are of the opinion that if the pressure on Italian sovereign risk eases somewhat, IntesaSP should be the main beneficiary.
Fig. 61: Valuation matrix Book and earnings ratio
Source: Nomura estimates
Lastly, we would exploit any IntesaSP upside versus Unicredit via IntesaSP’s saving shares. The discount (versus the ordinary shares) has narrowed significantly, since the peak reached during the recession (35%). This is because savings shares (different from ordinary ones) have a guaranteed dividend. According to Basel 3, saving shares would not be counted as core capital by the regulator in the same way as ordinary shares are, and we estimate a negative impact of 25bp on IntesaSP’s core tier 1 when Basel 3 comes into force. Given this negative element associated with the saving shares, we think expectations regarding a conversion of the saving shares would help in continuing to close the gap between the two classes of shares. We see this as the best instrument to exploit IntesaSP at the moment.
Fig. 62: Saving shares versus ordinary discount Discount (%)
Source: Datastream
ISP UCG
ROTBV 11e 11.5% 8.5%
ROTBV 12e 13.6% 11.1%
PTB 11e 0.94 0.80
PTB 12e 0.86 0.73
P/E 2011e 8.2 9.4
P/E 2012e 6.3 6.6
P/E de-leveraged 2011e 8.6 10.2
P/E de-leveraged 2012e 6.4 7.1
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Italian bank models
Fig. 63: Unicredit estimates 2011-12 EUR m unless otherwise stated, priced at 13 December
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Nordic banks: Overweight the region, DNB and SWED our top picks Chintan Joshi [email protected] +44 20 7102 6597
Investment thesis
In a deleveraging Europe, we believe Swedish and Norwegian banks offer a positive outlook for 2011, with the possibility of growth outperformance, high capital ratios, mid-teen ROEs, high dividend yields and a potential return of excess capital down the line. Banks are leveraged investments versus economies and the Nordic economies are among the healthiest in Europe. We believe that given the growth and sovereign concerns in peripheral Europe, Nordic banks should be in an overweight position, although there may be near-term risk if we experience a “risk on” move owing to recent outperformance. We are more optimistic about the prospects of Sweden and Norway as opposed to Denmark and Finland, and our top picks in this subsector reflects this bias. We discussed the key macro drivers in our report “Still overweight in a European context”,15 October 2010.
We prefer DnBNOR for its exposure to a strong Norwegian economy, domestic and conservative focus, high dividend yield, gearing to a global recovery through its shipping book, potential return of capital and low re-geared (using a 10% CT1 benchmark under Basel 3 in 2012) valuations.
Similarly, we prefer Swedbank for its exposure to growth from the Swedish household and SME sectors, improving Baltic macro and banking outlook, potential to benefit from rate hikes, improvement in funding costs from refinancing expensive funding, convergence of funding costs relative to peers and low re-geared (using a 10% CT1 benchmark under Basel 3 in 2012) valuations.
Fig. 65: Nordic Banks valuation
Source: Company data, Datastream, Bloomberg, Nomura estimates
Market positioning seems to be on the long side
Speaking to investors recently, we believe positioning has been on the long side in these names and therefore there is a short-term risk of underperformance when the market is in a “risk-on” mode. However, we believe there are many investors who are not only underweight equities but also financials within equities, which would mean there is new money that could enter the Nordic banks, especially on any weakness.
With limited exposure to peripheral European countries, the Nordic banks’ performance has been positively correlated to peripheral European spreads through 2010. With sovereign concerns likely to be persistent at least in the initial part of 2011, we believe that Nordic banks can continue to hold their outperformance and extend gains in the face of the negative headline risks. Similarly, Nordic banks saw 2010 earnings estimates being upgraded by 30% relative to the top 16 large-cap banks in Europe, which again drove outperformance. We expect the more benign macroeconomic outlook relative to the sector and better growth prospects will continue to drive outperformance.
Europe ex Swiss/Asia 6.6 7.6 12.3 (4.7) 1.07 1.08 0.88 12.7% 1.38 25%
Note: For re-gearing excess capital is 10% Core Tier 1 under Basel 3 in 2012
Note: Implied P/TBV is based on a COE/g of 10%/3%
Note: Excess capital is reduced from capital in Degeared ROTE calculation and reduces the degeared share count
10-Dec-10
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Fig. 66: Nordic banks’ 2010 performance Compared with S European spreads and 2010 consensus earnings – all indexed to 100
Source: Datastream, Nomura estimates
Superior credit growth outlook
Europe is currently gripped by strong deleveraging trends. With Spain, Italy and, arguably, the UK showing lacklustre prospects for credit growth, and Germany continuing its decade-long deleveraging cycle, we think the large Nordic countries (barring Denmark) stand out in terms of their potential to increase leverage – a key driver of banks’ performance over the next few years, in our opinion. We see a strong correlation between credit growth and macroeconomic growth. Similarly, we see a strong correlation between low initial private sector debt and prospective credit growth, and therefore prefer to own banks in those countries where private sector leverage is below average. In this regard, Sweden, Norway and Finland are well placed, in our view, with average or below-average private sector leverage, while Denmark appears to be poorly placed with the highest level of private sector leverage as of 2008, as per IMF data. For further discussion, see our report “Still overweight in a European context”.
Return of excess capital not before 2012 and likely in 2013
Given the magnitude of the crisis that the global economy has faced, we would expect regulators to be extremely conservative when it comes to returning excess capital. We would not expect a return of capital until we have seen an exit from loose fiscal and monetary policies in Europe and the US, and thereafter some stabilisation of global growth prospects. We do not expect this until 2012 and, therefore, depending on the speed of the global recovery, expect that return of capital would be allowed only after 2012.
However, we do believe Nordic banks are over-capitalised and while there is a short-term risk that regulators may be hawkish, in the medium term we would expect Nordic banks either to return the capital or utilise the excess capital to boost earnings. Under Basel 3, we see core Tier 1 (CT1) ratios averaging c.10.7%, compared with other large-cap banks at c.6.7%.
We expect the Nordic regulators to enforce a near-10% CT1 requirement, as there is a need for counter-cyclical buffers given the divergence of GDP growth and lending growth in most Nordic countries. In the short run, regulators can delay return of capital by extending the transition rules, which would most affect banks that have the highest levels of excess capital. We also see a risk of higher risk weightings for the Nordic mortgage businesses. However, we see this having a limited impact on excess capital – for instance, double risk weightings for mortgages at Swedbank would reduce the CT1 ratio by c.1% but still leave excess capital of 3.5% for 2012E RWAs.
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140.0Nordic Banks vs. SX7P2010E Cons. Earnings - Nordic vs. Large-Cap BanksPIIGS GDP wt. spread to Bunds - RHS
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Fig. 67: European banks’ capital ratios
Note: Assumes no dividends and no organic RWA growth for comparability; Takes management guidance for mitigation (at no assumed cost); Standard Chartered, HSBC, Lloyds and Citi (net) have not disclosed mitigation expectations; RBS mitigation is understated as management largely provided post mitigation numbers; Standard Chartered and Lloyds numbers start from 1H2010 (not 3Q 2010) Source: Company data, Nomura estimates
Re-geared valuations reveals further upside potential
While optically valuations for Nordic banks look high, if we adjust for the excess capital that is evident at the Nordic banks, we find implied price-to-book valuations (based on ROE-G/COE-G) reveal upsides that are in line with the sector assuming common 10% COE and 3% growth estimates for all the large-cap banks. As the table above shows, Nordic banks are trading on a re-geared normalised 2012E P/E of c.8x, which is broadly in line with the sector (held to a 10% CT1 benchmark in 2012 under Basel 3).
However, we would argue that given the better growth prospects of the Nordic banks and the lower sovereign/macro risks, COE should be slightly lower and growth should be slightly higher than at other European banks. This would imply that there is still further outperformance in terms of re-geared valuations. We expect this implied upside will be reflected in market prices as and when we see continued outperformance in Sweden and Norway, and as Nordic banks announce tangible plans around their excess capital. The first steps towards repaying excess capital would be to repay all free cash flows to shareholders.
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Swedbank
We see potential upside driven by strength in the Swedish economy and an improving Baltics market.
Preferred Swedish bank
We find Swedbank the most attractive Swedish bank mainly because of its more attractive de-geared valuations. If we hold Nordic banks to a 10% CT1 benchmark in 2012 under Basel 3 and use the excess capital to re-gear the earnings, we find that Swedbank trades on a P/E ratio of a little over 7x. While the re-geared 2010E P/TB is c1.5x, we find implied P/TB valuations provide upside potential of over 30%. This is broadly in line with DnBNOR, our other preferred name among the Nordic banks.
Net interest income rebound stronger
The latest SME consensus figures reveal an 18% or SEK c.2.9bn growth in NII from the 3Q10 annualised NII level up to 2012; however, we find this underestimates some of the moving parts up to 2012, and we predict stronger NII growth of 24% in this period. This is mainly driven by:
• Volumes: Swedbank has been fairly conservative in volume growth over the past four to six quarters and understandably so as it dealt with the Baltic crisis. It gave up new mortgage lending market share in Sweden and its over-group-level loan book actually shrank since peaking in 4Q09. We expect some amount of conservative volume growth up to 2012 as stronger volume growth in retail and LCI is offset by volume contraction in the Baltics. We estimate overall loan growth of a little over 6% by 2012 (compared with the Nordic average of c.9.2%). Assuming constant margins, we estimate this would contribute SEK c.700m.
• Positive refinancing effect: Swedbank currently has state-guaranteed funding of SEK 163bn, 82% of which matures within the next three years. This was issued at expensive levels during the crisis. Refinancing at current market rates would create a positive refinancing effect of 60-80bp as per company guidance. This implies an improvement of SEK 800m to SEK 1,050m by end-2012.
• Rates/margin effect: Of the SEK c.2.9bn increase, SEK 1.5bn-1.7bn can be explained by the above two factors, which means consensus estimates SEK 1.2bn-1.4bn from rates/margins. This compares with Swedbank’s rate-sensitivity guidance of SEK c.1.7bn for a 100bp increase in rates. Currently, the Riksbank estimates policy rates will increase by c.2.25% by the end of 2012 from the current level of 1%. This would imply consensus is grossly underestimating the margin impact if company guidance is to be believed. To put this in perspective, a 2.25% hike in interest rate would result in SEK c.1.8bn higher NII just from interest on free equity. Given that Swedbank has the largest share of retail deposits, we are more optimistic on margin developments. The key risk here is that incoming regulation would have an impact on margins; however, given new regulations will be phased in by 2018, we feel confident that margins are likely to expand to account for the new regulations.
High levels of excess capital
We forecast a CT1 ratio under Basel 2 of c.15% by end-2012. Swedbank had guided to a Basel 3 impact of c.35bp, which would imply that capital ratios would be close to 14.5% by our estimates, despite assuming a 50% pay-out ratio. While it is unclear what benchmark the Swedish regulator will set for Swedbank, we expect a near-10% minimum CT1 ratio. As we outlined earlier, we do not expect the regulator to allow a return of capital in 2011 and see this as more likely in 2013. Also, there is a risk that the regulator may choose to increase the risk weighting of mortgage loans, which is currently c.6%; however, even if we were to double risk weightings in Swedish mortgages, it would reduce the CT1 ratio by c.1%. This would still leave excess capital of c.3.5% under Basel 3, which is SEK c.21.5bn, or 20% of market value.
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Geared to a Baltic recovery
Swedbank has the highest market share in the Baltics among the Nordic banks. With the Baltics experiencing a sharp ‘V-shaped’ recovery, the prospect of an improvement in earnings for the Baltic division looks likely. While we do not expect pre-provision profits to return to 2008 levels, given that performing loan volumes and activity levels are much lower today, we would expect continued improvement over the coming quarters if the macroeconomic recovery continues on track.
Also, as we see improvements in the economy, asset quality could continue to improve as non-performing loans turn performing and loss-given default improves. With coverage ratios in the Baltic at c.61% for Swedbank (SEB c.65%), we can expect write-backs driven by these factors, which could create some upside on the cost of risk line, although the magnitude of surprise is likely to be much smaller than in the recent past. More likely, in our view, is the potential improvement in pre-provision profits, which is currently 25% below 2008 levels.
Fig. 68: Baltic performance Q409=100
Source: Company data
Fig. 69: Baltic business confidence
Source: Datastream
Changes to estimates and valuations
We upgrade our estimates, which are marginally driven by upgrades to the top line and lower cost of risk. The main revenue item we have upgraded is net interest income. Across the sector, we model 2012 with a normalised cost of risk. However, we would expect Nordic banks to experience credit losses lower than the normalised level, especially if current macroeconomic expectations pan out. Our increase in earnings has driven a SEK 3 increase in our price target, which is now SEK 117.
Fig. 70: Swedbank sum-of-the-parts valuation We upgrade our price targets by SEK 3 to SEK 117
Source: Company data, Nomura estimates
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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DnBNOR
Solid macro outlook, domestic focus, high dividend yield and strong capital position.
Second-lowest-rated Nordic bank
We see DnBNOR as the lowest-rated Nordic bank and the one that has the most upside potential in terms of implied price-to-book multiples. DnBNOR is one of the better-value names in the sector, in our view, and is exposed to superior macroeconomic conditions in a European context, on both current and normalised valuations, especially if you account for the higher capital buffers that the bank currently has.
While DnBNOR now trades on 8.5x 2012E earnings, if we hold it to a 10% CT1 ratio (which compares with an average of c.9% for the sector) and re-gear the earnings multiple, it trades at c.7.1x 2012E earnings compared with the sector on c.8x. We are not arguing for a release of capital anytime soon and believe any release will happen only after we see four to six quarters of consistent economic growth.
However, if we compare DnBNOR or other well-capitalised Nordic banks with European peers, there has to be a reflection of the excess capital in valuations to make it a more like-for-like comparison. In terms of 2010E P/TB multiples, DnBNOR trades in line with the sector average. Its 2010-12 dividend yield ranges from c.4% in 2010E to c.5.5% in 2012E on consensus estimates (ref price NOK 78). This compares with the current dividend yield of c.3% for SX7P Index. While we think current valuations look attractive, the medium- to longer-term investment case for DnBNOR is its exposure to a much better placed Norwegian economy. With superior private and public debt dynamics, debt is not a burden on economic growth but rather a driver.
2012 outlook
DnBNOR is targeting at least a 13% return on equity by 2012 and pre-provision profits in the range of NOK 22bn-25bn. Loan growth assumptions behind 2012 guidance are for c.5% pa growth up to 2012 to achieve the lower end of the NOK 22bn-25bn range and c.7% pa growth to achieve the upper end of this range. This compares with a 9M 2010 annualised growth rate of c.4.4% or c.4.0% if adjusted for currency movements, with the corporate loan growth picking up in the recent quarter.
Leading indicators for growth in 3Q10 and 2011 are positive, but if the lower growth expectations from the US affect Europe, then DnBNOR may struggle to reach the lower end of its target growth range. However, we believe that if Norway struggles with credit growth, then few countries in Europe will outperform Norway in that environment, so we do not necessarily think it will be negative on a relative basis. Also, if we see an improving growth expectation, then that should be positive for earnings momentum at DnBNOR.
Fig. 73: 2012 guidance and current consensus
Source: SME, Nomura estimates
NOK in Mn 2010 2011 2012 Target-Low Target-High
Net Interest Income 23,322 24,805 26,300
Non-Interest Income 15,136 14,523 15,096
Total Income 38,436 39,328 41,396 40,741 46,296
Total Costs -18,593 -18,842 -19,369 -18,741 -21,296
PPP 19,843 20,486 22,027 22,000 25,000
Loan Losses -3,084 -2,292 -2,043 -2,043 -2,043
Profit before tax 16,759 18,194 19,984 19,957 22,957
PAT (attributable) 12,414 13,572 15,085 15,167 17,447
Equity (ex-MI) 105,834 115,712 123,956
ROE (ex-MI, Avg) 12.1% 12.3% 12.6% 12.7% 14.6%Note: We have assumed 24% tax-rate for 2012 and consensus credit losses to work out bottomline targets; Revenue and costs estimated using 46% CI ratio target;Consensus equity is calculated based on consensus earnings and 50% payout ratio.
Fig. 72: GDP outlook Norway/Sweden to outperform
Source: Datastream, Consensus Economics
Real GDP Grow th EIU
13-Dec-10 2010 2011 2012-25
Sweden 4.3% 2.9% 2.6%
Norway 1.5% 2.6% 2.5%
Denmark 1.9% 1.9% 2.3%
Finland 2.3% 2.0% 2.4%
Average 2.5% 2.3% 2.5 %
Germany 3.4% 2.1% 1.6%
France 1.6% 1.5% 1.8%
Ireland -0.7% 1.5% 3.4%
UK 1.7% 2.0% 1.9%
Euro Area 1.1% 1.5 % na
USA 2.7% 2.4% 2.7%
Estonia 2.0% 3.8% 3.5%
Latvia -1.3% 2.9% 3.7%
Lituania 0.4% 2.9% 3.4%
Ukraine 4.3% 4.6% 1.9%
Russia 4.0% 4.3% 3.0%
Poland 3.4% 3.8% 3.0%
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Strong operating performance and a Norwegian focus
We see a number of strengths in DnBNOR’s operations, which we think continue to be attractive especially when compared with European banks.
Pre-provision profitability DnBNOR has the highest pre-provision profitability among Nordic banks at c1.8% when measured as a percentage of loans. This compares with the Nordic average of c.1.4% and the European average of a little over 2%. With the 2012 cost of risk in the range of c.20-25bp for most Nordic banks, this implies a greater ability to absorb unexpected losses and, hence, lower operational leverage.
Focus on domestic operations DnBNOR realises that global macroeconomic uncertainty means it is not focused on pursuing opportunities outside its domestic markets. With material excess capital, we see this domestic focus as a positive to the eventual return of capital. Also, with GDP growth in Norway and other countries that DnBNOR operates in being fairly robust, we would expect it to show the loan growth that it is currently targeting. In addition, with the takeover of the DnBNORD joint venture, the bank can be more opportunistic with growth in the Baltic/Polish markets.
Cost effectiveness DnBNOR’s target of 46% cost-income ratio looks achievable to us, especially since the cost-income ratio of the marginal/incremental profit is below 35% by our estimates. This would put DnBNOR in line with the best-in-class Swedish bank. We are not too far away from DnBNOR’s targets in our 2012 forecasts and are broadly in line with consensus.
Asset quality risks look manageable We believe asset quality risks in an improving Norwegian and global macro environment are manageable. With the Baltics recovering, we see the key areas of concerns as shipping and leveraged buy-out loan books. The LBO portfolio of a little under NOK 40bn is geared to a macroeconomic recovery and could result in losses if we see the stalling of Norwegian/global growth prospects.
The shipping exposure of under NOK 140bn has performed better than expected. With 20% of the capacity being phased out because of new OECD rules and new capacity coming in quite slowly, the tanker segment has performed better than expected. Dry cargo was another segment where the return of global trade from the troughs of 2008 has helped the segment. However, the container segment continues to be a concern, mainly because of the supply that is coming into this segment and the under-utilisation of current capacity; nevertheless, this is only 9% of the total exposure.
Net interest income We flagged in our post-3Q10 results note that consensus is underestimating NII running into 2012. In the adjacent figure, we try to estimate the NII for 2011-12 under certain assumptions. We have seen deposit margins in retail increase from 23bp to 53bp in the past four quarters driven by a 75bp hike in policy rates. Consensus expects a 100bp hike by end-2011 and a 175bp hike by end-2012. We estimate deposit margins would increase by 30bp by end-2011 and by 40bp cumulatively by end-2012.
We conservatively expect mortgage margins to fall by another 7.5bp and LC&I lending margins to go up by 5bp. Assuming a higher impact from both these factors is unreasonable, in our opinion, given the overall product margins. We find current consensus is underestimating the impact from the various moving parts if we assume that any increase in future funding costs can be passed on to the end consumer. We would argue for a c.1% upgrade on 2011 NII consensus and a c.6.5% upgrade on 2012 NII consensus.
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Valuation In our sum-of-the-parts estimates, we value DnBNOR at SEK 101, which is 1.4x 2012E tangible book. We benchmark DnBNOR to a 10% CT1 under Basel 3 in 2012 and see excess capital to the tune of NOK 13.8bn after discounting it for 2.5 years in our sum-of-the-parts valuations.
Fig. 77: Sum-of-the-parts model
Source: Company data, Nomura estimates
Fig. 78: DnBNOR summary financials
Source: Company data, Nomura estimates
DNB (NOK Mn) Term. Term. Term. DCF DCF val
Division 2009A 2010E 2011E 2012E ROE CoE P/ B mult. val per share
Corpora te Ba nk ing 3,616 4,160 4,426 4,916 9.5% 10.1% 0.9 10.0 38,112 26.0
Reta il Bank ing 4,343 4,700 5,093 6,511 20.2% 10.1% 2.3 11.8 66,653 45.5
DnBN OR M arkets 3,357 2,505 2,562 2,848 26.8% 11.3% 2.8 10.6 25,935 17.7
Life & Asset M anagement 843 1,081 828 882 7.1% 10.1% 0.6 8.8 7,990 5.5
Loan to Deposit Ratio 180% 200% 189% 190% 190% 187% 186%
RW A (Norway Rules - full IRB Estimates) 759,476 919,678 839,385 823,120 860,477 903,090 951,548
* Capital ratios calculated under Norwegian rules pro-forma for full IRB
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Spanish banks: How much additional capital could be required in Spain? Daragh Quinn [email protected] +44 20 7102 8333
Summary
The funding pressures being felt by Spanish banks remain driven, in our view, by continued concerns over solvency. This is a result of the high level of private sector debt, the bursting of the housing market bubble and the outlook for low growth. Given the continued losses in Ireland and the level of recapitalisation that the banks have seen, there are reasonable concerns about the effectiveness of the European-wide stress test held during the summer (which the Irish banks passed). Given the potential losses being faced in Spain and existing capital/profitability levels, we believe there are additional capital requirements. Importantly, however, these additional capital needs are not evenly spread across the system.
We estimate a potential capital requirement for Spanish banks of between EUR 43bn and EUR 80bn, depending on the severity of losses. However, if the largest savings banks could raise equity directly in the markets (which given the recent reforms is now a possibility), we think the Spanish government would need to inject as little as EUR 24bn (or just 2% of GDP, in addition to the c. EUR 15bn that has already been injected into the system).
Skeletons in the closet – Spanish savings banks and real estate losses
We believe the savings banks remain a key risk for Spain. Although the stress test in Spain only estimated a relatively small capital requirement, we believe this stress test was useful, given the detailed bottom-up estimate of credit losses. In our view, the level of losses and the key assumptions to estimate these, by the Bank of Spain, are reasonably conservative. Where we would have more doubts is the level of cushion that was calculated to absorb these losses and that for some banks, the adverse scenario could be closer to the base-case scenario. In this case, we would not view as probable the market’s willingness to fund these banks over two years, while they run down capital/ profits (the level of operating profit the Bank of Spain estimated the banks could use to offset losses and lower Tier I to 6%) but rather a pre-emptive capital raise would be required.
Fig. 79: Spanish banks stress-test results Credit losses and buffer estimated by the Bank of Spain (July 2010 stress test)
Source: Nomura research, Bank of Spain
-4%-2%1%3%5%7%9%
11%13%15%17%
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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However, not all Spanish banks are the same, and we believe it is important to make this distinction in determining the potential capital requirements of the sector. We estimate that the additional capital requirement for Spain could be in the range of EUR 43bn to EUR 80bn. This represents c.4-8% of GDP, which coupled with the money already injected would raise the total cost to c.10% of GDP.
Fig. 80: Adjusting for banks that might not rely on the government Adjusting system-wide risk-weighted assets
Source: Nomura research, Bank of Spain * BBVA, SAN, La Caixa **POP,SAB,BKT,BBK
EUR 80bn – high end of losses: To calculate the EUR 80bn, we have excluded BBVA, Santander and LaCaixa from the calculation. This leaves risk-weighted assets (RWA) of EUR 900bn. Using the highest losses in Spain from the stress test, estimated at 15.8% of RWA, this would generate a loss of EUR 142bn for the sector. To offset this, we would deduct EUR 34bn of provisions the banks have already made, one year of operating profit (EUR 13bn) and the EUR 15bn provided by the FROB/deposit guarantee fund.
Fig. 81: Capital required – EUR 80bn Assuming high loss rate (15.8% RWA)
Source: Nomura estimates, Bank of Spain
EUR 43bn – average losses: To calculate the capital requirement of EUR 43bn, we excluded the other listed banks (SAB, POP and BKT, assuming they can raise capital in the markets) and the savings bank, BBK (high level of capital – Tier I 15%). This leaves RWA of EUR 700bn. Using the average loss ratio for the remaining banks (13.2% of RWA) generates losses of EUR 92bn. To offset this, we deduct EUR 27bn in provisions already made by the remaining banks, EUR 7bn (one year of operating profit) and the EUR 15bn from the FROB.
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Fig. 82: Capital required – EUR 43bn Assuming average loss ratio (13.2% RWA)
Source: Nomura estimates, Bank of Spain
A closer look – bank by bank
Given the detailed analysis given by the Bank of Spain, we have also estimated the potential shortfall for each bank, assuming the loss ratio calculated by the Bank of Spain is correct. However, to offset these losses, we use a lower buffer than the Bank of Spain. We use, as a buffer to absorb losses, existing provisions, funds already petitioned from the FROB, one year of operating profit and that Tier I capital must be maintained at 8% (and also 10%). This compares with the two years of operating profit, tax and other revaluation gains, and lowering Tier I capital to 6% used by the Spanish central bank.
In the following figure, we highlight the capital deficit for each individual bank under both capital scenarios. The stress test losses for BBVA and SAN were calculated on a global basis, whereas we would only really be concerned with potential additional losses in Spain, therefore we have excluded these banks from this analysis (in any case, we assume any capital requirement could be raised in the market or by cutting dividends). For the remainder of the system, this would imply an additional capital requirement of EUR 52bn for Spanish banks (EUR 73bn if a Tier I of 10% is to be reached). If the listed banks could raise this from shareholders/the market, this would mean the FROB/ Spanish government would have to inject an additional EUR 42bn (or EUR 59bn with Tier I at 10%). The merger between Caja Madrid and Bancaja (provisionally named Jupiter by the Bank of Spain) would account for 27% of this amount, or some EUR 11.5bn.
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Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Fig. 83: Capital deficits
Source: Nomura research
We believe this highlights the importance of the new merged bank of Caja Madrid and Bancaja (and five additional savings banks). If this new financial group, with assets of EUR 348bn, can raise equity from the market, this would significantly lower the amount of additional capital the Spanish government would need to inject into the system. La Caixa also generates a relatively high absolute capital requirement (16% of the total), but given the 80% ownership in its subsidiary, Criteria, we believe it continues to have significant resources available before it would have to raise capital from the government. Excluding La Caixa from the amount of capital required would see the number fall to EUR 36bn. If, in addition, Caja Madrid was able to raise equity from the market, this would reduce the amount needed from the government to just an additional EUR 24bn (or 2% of GDP), on our estimates.
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Gap: Tier I @ 10% Gap: Tier I @ 8%
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Spanish banks: Santander still a macro call on Spain Daragh Quinn [email protected] +44 20 7102 8333
Summary and investment thesis
We expect Santander’s stock performance to continue to be affected by the outlook for sovereign risk in Spain. However, given the underlying profitability of the group and ability to absorb losses, we expect this volatility to present buying opportunities. We estimate the international businesses of Santander (LatAm, UK, US and Portugal) to be worth EUR 9.0 per share. Valuing the remainder of the Spanish/core business at the same earnings multiple as the Greek banks would be equal to EUR 1.4 per share, or a total group value of EUR 9.4 per share. Valuing these earnings at the same level as domestic Spanish banks would raise the total value to EUR 11 per share. Although we do not use a formal sum-of-the-parts in our valuation methodology, this is the same value we estimate using a group ROE and Gordon Growth Model. We maintain our Neutral rating and price target of EUR 11 per share.
Key issues
Valuation and Spanish sovereign risk Economic conditions in Spain and concerns over peripheral Europe and sovereign risk have been key drivers for Santander’s stock performance for much of the year. Until there is a more robust policy response from the Spanish government and central bank, we believe this will continue to be the case over the coming months. Below, we show the relative performance of Santander versus European banks versus the Spanish 10-year bond and also the relative P/B valuation of Santander relative to the sector. Although Santander has a strong diversified presence outside Spain, the Spanish balance sheet still accounted for 32% of the group total and total Spanish earnings 34% of the group total (as of 9M 2010, although down from 45% for the same period last year). With Santander accounting for c.20% of the Spanish stock market (Ibex-35), we see the outlook for Spain and the perception of sovereign risk as a key driver for relative performance.
Fig. 84: SAN performance versus ES bond yields Spanish 10-year bond yields (%) versus relative performance
Source: Datastream, Nomura research
Fig. 85: Santander performance and relative valuation Relative P/B (100=multiple = the sector) and relative stock performance
Source: Datastream, Nomura research
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Sum-of-the-parts and the risks in Spain While we recently downgraded Santander to a Neutral rating (see our report published 4 October 2010, ‘Deleveragin/M&A; downgrading SAN’), there have been windows of opportunity where we think the valuation has been attractive. As we expect to see continued volatility in Santander’s performance, we would see these as potential opportunities given the group’s underlying profitability.
In Figure 49, we highlight some of our key assumptions in the outlook for profitability in Latin America, the US, Portugal and the UK. We estimate these areas will generate c.EUR 8.7bn in net income in 2011, distributing the results of the corporate centre, we estimate this would drop to EUR 7.9bn (for the group we estimate total net income of EUR 10.4bn in 2011). Based on peer multiples across these markets (and the valuation of Santander’s listed subsidiaries – Chile and Brazil), we estimate an approximate valuation of EUR 78bn or EUR 9.0 per share within the group (Santander is trading at EUR 8.32 per share – as at close 13 December 2010).
Fig. 49: Value of international business Earnings based valuation (peer valuation and value of local subsidiaries)
Note: 1: adjusting for corporate centre 2: NAV = locally reported NAV 3: based on current market cap Source: Nomura estimates, company data
At levels below EUR 9.0 per share, we believe this implies negative equity or dilution to equity from the remainder of the group (essentially the Spanish/core business). What are the risks in Spain and what would be the capacity of the group to offset any additional potential losses? We estimate this business generates a pre-provision profit of c.EUR 9bn on a loan book of EUR 320bn.
We estimate net income of EUR 2.9bn in 2011 for the remainder of the group (adjusting for the distribution of the corporate centre profits, as some of losses in the corporate centre are the result of currency hedging for the LatAm/non-euro earnings). These earnings are equivalent to c.EUR 0.3 per share. Valuing these earnings on the same P/E multiple as the Greek banks would equate to EUR 1.4 per share, or up to EUR 2.0 per share valued on the same P/E for domestic Spanish banks (2012E P/E).
Fig. 50: What is the value of the rest of the group? Earnings based valuation
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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How bad could the losses be in Spain? To be on the conservative side and using the loss estimated by the Bank of Spain for savings banks in the recent stress test (9.5% of credit risk), we would expect to see significantly higher losses relative to Santander. This would indicate potential losses of up to EUR 31bn for Santander. Against this, Santander has already made some EUR 11bn in provisions (including generic and provisions against real estate) and generated some EUR 9bn in pre-provision profits, indicating that Santander would be able to write off c.9% of this loan book (using two years of operating profit) before having to use capital or profits from other units.
How I learned to love a potential UK listing and stop worrying about capital Given the recent acquisitions from Santander and the impact of Basel 3, we believe Santander will look to strengthen its capital base. We expect this to be achieved by two of the interim dividends being paid in shares, organic capital generation and also a partial listing of Santander’s UK subsidiary. However, market conditions and the departure of the head of the UK business have seen Santander postpone a potential UK listing into the second half of 2011. Delays to this listing, which could raise between GBP 3bn and GBP 5bn, increase the risk that Santander could consider raising capital at group level; however, were Santander to complete this listing successfully, we believe it would lower significantly the risks of capital being raised at group level.
Fig. 86: Mitigating the impact of Basel 3/acquisitions – 2011 Starting from Q3 Basel 2 capital ratio to end-2011E all in Basel 3 ratio
Source: Company data, Nomura estimates
Is there enough capital in Spain? While we believe Santander is adequately capitalised at group level, there could be some debate on how capital is distributed within the group. The capital levels of the individual subsidiaries suggest the remaining capital at group level is low. However, this does not account for how these subsidiaries are consolidated at group level, ie, accounting and regulatory differences and also the distribution of goodwill/revaluation reserves across the group. Santander has stated that making adjustments for accounting and regulatory difference, the capital assigned to the Spanish business is in excess of 10%. We believe this must also be a number with which the Bank of Spain is comfortable.
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Fig. 87: Capital – subsidiaries versus group Based on 2009 FY numbers
Source: Company data, Nomura research
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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Santander model
Fig. 88: Santander model
Source: Nomura estimates
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
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UK domestic banks: we favour Lloyds over RBS Robert Law [email protected] +44 20 7102 2715
Summary and investment thesis
In our view, Lloyds’ current pre-impairment profitability already justifies upside in the shares, when impairments normalise, whereas we believe RBS needs to see improvements in pre-impairment profits, in addition to a normalisation in impairments.
Lloyds and RBS have almost identical market capitalisations, Lloyds £47bn and RBS £45bn. However, we would argue that their sustainable level of profitability is very different and that the implied P/E multiple for Lloyds is therefore significantly lower on a normalised basis.
The nine-month pre-impairment profit for RBS was £9.0bn, ex own debt, and we estimate £11.5bn for the full year. By contrast, the first half pre-impairment profit at Lloyds was £7.0bn, and we estimate £13.6bn at the full-year stage. This shows that the Lloyds market cap to pre-impairment profit multiple for Lloyds stands at a 12% discount to RBS. This would be geared by impairments. Lloyds has a loan book of £612bn, compared with £528bn at RBS; however, Lloyds has a significantly higher proportion of residential mortgages in its portfolio. We therefore assume a higher level of impairments on a normalised basis at RBS of £3.7bn (75bp of loans), compared with £3.3bn (58bp) at Lloyds. This would widen the P/E differential to 20%. We estimate a Lloyds normalised P/E of 7.4x our assumption of 9.3p of normalised EPS. By contrast, we estimate an RBS normalised P/E of 9.3x our assumption of 4.4p of normalised EPS.
Our normalised EPS estimates are equivalent to a 15% RoE at Lloyds and 9% at RBS.
RBS is targeting a 15% RoE by 2014. This would require EPS of c.7.5p a 50%+ improvement in the normalised earnings that we currently see. If the group is successful in achieving this pre-impairment growth, we believe there could be similar improvement in the Lloyds earnings, arguably more if the improvement is concentrated in the commercial banking areas, which are the dominant part of the Lloyds group.
In our view, the different pre-impairment returns and RoEs are a function of the different business mixes at RBS and Lloyds, and therefore justify different (and wider) price to book valuations.
Business mix
Lloyds and RBS have very different business mixes, which in our view are likely to lead to different long-term RoEs.
Lloyds is predominantly a traditional commercial banking operation, particularly heavily concentrated in mortgages and savings. Its capital markets activities are relatively small.
By contrast, 34% of the current RBS RWAs are in the GBM division, and we estimate this will rise to 43% under Basel 3. We estimate the effective RoE on the increased capital requirements of the GBM businesses on a normalised basis is currently c.9%. GBM faces the industry challenges in raising its RoE, in addition to the challenges it faces as a government-owned entity.
Assuming that GBM is unable to increase its returns, or that they lag those of the traditional businesses, RBS would need to increase its commercial banking returns above 15% to achieve its overall 15% group RoE target. We would argue that if the traditional banking industry is able to sustain these higher returns, Lloyds with its greater traditional banking mix, would achieve even higher returns.
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Capital
We believe the recapitalisation measures taken by the UK industry and the authorities have lifted UK bank ratios to among the strongest in Europe and internationally. There is still uncertainty over the levels that the UK authorities will ultimately require, eg, for systemically important banks; however, we believe it is highly unlikely that the industry will require further recapitalisation. As the sector is already satisfying the FSA stress-test requirements, it would be illogical for any new capital targets to be even more onerous in the short term and force capital raising. We believe companies will be able to satisfy increased capital requirements through retentions, rather than having to raise additional capital.
However, we also argue that those expecting capital return are over-optimistic. Capital projections are uncertain and this very uncertainty suggests caution, particularly given the UK and global macro uncertainties and the high leverage levels in many markets. As we discuss below, both Lloyds and RBS have substantial wholesale funding requirements and reducing capital until these have been brought down would seem premature. We believe that no management or regulator is likely to seek/allow capital reduction until these uncertainties have been substantially reduced. Over the longer term, a banking sector that is profitable and an environment of deleveraging will naturally result in free cash flow for banks; however, we view this as a medium-term issue, which we are unwilling to factor into valuations.
Potential negatives
Slowing in the recovery in UK banking profitability The key bull case for the domestic UK banks is that the industry will achieve attractive returns in the future and that valuations are near book value, Lloyds 1.1x TBV and RBS 0.8x. The industry has made attractive returns in the past, except during times of high credit losses. The leading banks are all targeting c.15% RoEs and have strong shares; c.90% of new mortgage origination is in the hands of the largest six banks. After falling during the era of cheap wholesale funding, overall margins have started to recover. The loss-making banks have returned to profitability in 2010, earlier than originally expected.
While we believe this case is likely to be valid in the longer term, there is potential for the pace of recovery to slow and disappoint, particularly after the progress made in 2010. The government’s fiscal tightening (particularly after a period of stimulus) creates real uncertainty for 2011. We continue to have impairments falling, but there must be question marks about this, particularly in the personal sector, if unemployment starts to rise again. The biggest factor for impairments, in our view, remains the trend in CRE, which again is uncertain. Margins have begun to improve, however, both RBS and Lloyds have indicated that the asset spread improvement is slowing and increases in official rates are needed for liability spreads to take up the running. We believe a major factor behind margin improvement in 2010 was the normalisation in short-term wholesale funding spreads for banks; this was a one-time effect. Further margin gain in 2011 is likely to be materially slower and could prompt disappointment.
The combination of margin gain and normalisation of impairments implies there is considerable variation in expectations for the pace of profit recovery and there is scope for downgrades of more optimistic expectations, even if recovery continues.
We would regard both Lloyds and RBS as affected by expectations of the pace of recovery, rather than distinguishing between them.
Funding Both Lloyds and RBS entered the credit crisis with large wholesale funding requirements, which were exposed. Both have medium-term plans to restructure their balance sheets, one objective of which is to reduce the reliance on wholesale funding, particularly the short-term element. During 2010, both made progress in line with and even ahead of plan. The perception is that RBS may have been more aggressive in its actions during 2010, although this is difficult to substantiate from outside.
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However, these plans are both five-year targets. Both remain vulnerable to an extended seizure in wholesale markets in the meantime. Furthermore, it remains to be seen whether the process of restructuring problem assets becomes more difficult in the later years.
The market perception is that Lloyds is more vulnerable to this issue. It had a loans/deposits ratio of 163% at the H1 stage, compared with 126% for RBS. We would accept that pure funding issues would be likely to affect Lloyds proportionately more. However, in the event that any market dislocation involved the wholesale markets generally, which we believe is likely, we would argue that RBS too would be likely to be affected (and Barclays for that matter), owing to the wholesale businesses.
Independent banking commission The outcome of the commission’s investigation and the government’s response to it are both unknowns. We believe the most likely outcome is increased restrictions and requirements on the industry, which hamper it, but do not transform its prospects or value; however, this must be uncertain. Furthermore, until the report is published in September, market speculation is likely to be negative for the banks, rather than positive, as has been the case, so far.
Market attention has switched to competition in UK banking, over the separation of traditional and investment banking businesses. As the market leader in mortgages, with a near 30% share and having acquired HBoS in a controversial transaction, Lloyds is potentially the most affected by any decision to reduce industry concentration.
We would argue that the six or so large providers of banking services are sufficient to foster competition, particularly by comparison with other industries, and that little would be gained by adding another one or two. More contentious, in our view, is the concentration implied by the share of the leading supplier in some products, Lloyds in mortgages and RBS in SME, both shares ultimately reached by acquisitions that the authorities allowed; however, it was precisely to address this that the EU required the disposal of branches and assets. In the Lloyds case, we estimate the eventual branch sale will reduce its mortgage share to 25%. Of course, the commission could advise this is still too high.
In our view, any ultimate damage to Lloyds’ valuation is unlikely to remove the potential upside in the shares represented by a current normalised P/E multiple we estimate at 7.4x.
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UK models
Fig. 89: Lloyds model
Source: Nomura estimates
Lloyds Banking Group financial information and forecasts Co. guid'ce£m H1 2009A FY2009 H1 2010A YoY FY 2010E FY 2011E FY 2012E FY 2014ENet interest income 6,442 12,726 6,911 7% 13,985 14,279 13,908Non-interest income 5,791 11,875 5,831 1% 10,930 10,211 10,265Total income 12,233 24,601 12,742 4% 24,915 24,491 24,174Insurance claims 294 637 261 511 526 542
Total income net of claims 11,939 23,964 12,481 24,404 23,964 23,631 27,715Expenses 5,718 11,609 5,435 -5% 10,816 10,334 10,355 11,086
(which includes synergies of) 107 534 650 1,387 2,000 2,000
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UK/Asian banks: Prefer HSBC over Standard Chartered Raul Sinha [email protected] +44 20 7102 9136
Summary and investment thesis
We are positive on Asian and emerging markets economic growth over the longer term, which, in our view, is likely to outstrip developed markets and provides an attractive backdrop for banking sector returns. Private sector leverage in most Asian and emerging markets economies is lower relative to developed markets, along with high savings rates that allow low banking sector loans-to-deposits ratios. Accordingly, Asian and emerging markets banks remain less geared to the negative effects of deleveraging across developed markets. Relative to the rest of the European banks sector, we see better long-term growth prospects at HSBC and Standard Chartered. However, in the near term, we have tempered our positive view given relative valuations as well as the prospect of higher inflation, which we believe could be a negative for local peer bank valuations.
Between the two, we prefer HSBC which trades at a discount to Standard Chartered and has defensive attractions in our view. HSBC’s shares command a valuation of 1.7x TBV and 11.6x our estimate of 2011 EPS of the ongoing businesses. The group has a strong balance sheet and now derives the majority of its profits from emerging markets. It looks likely to continue to be defensive in bear markets. However, we would also see only modest upside in more positive markets.
Standard Chartered remains well positioned for the long term, given its unique franchise across Asia, Africa and the Middle Eastern markets. However, we are more cautious in the near term given the backdrop of inflation and tightening in some of its key markets, valuations that reflect its many positives and earnings downgrades. Following the recent trading statement, we see potential downside risk to consensus expectations for 2010 and 2011 and believe ROTE is unlikely to exceed c15% until 2012. Standard Chartered shares trade at 13.6x our 2011 earnings estimate and 2.3x PTBV
Fig. 91: HSBC and Standard Chartered – PE relative to Banks DJ Stoxx
Source: Nomura research, Datastream
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Comparing current profitability trends
Standard Chartered Management’s through-the-cycle target is a mid-to high-teens Return on equity which the group has largely exceeded through the current cycle, even in the last two years where peers have struggled to generate positive returns. However, following on from the rights issue, we see the return on tangible equity at c15% in 2011, down from 19% in 2009, which we believe may constrain a valuation-based re-rating of the shares. A higher return on tangible equity may be possible through even lower impairments, which are running at c40bp. Pre-provision profits growth, which is weighed down by the strong rate of cost growth and investment is unlikely to exceed the low teens in 2011 in our view, after remaining flat in 2010.
Over the longer term, we see the group attractively placed to deliver its target return on equity, as higher interest rates and pay-back of current investments allow stronger revenue growth. In the consumer bank, management has previously indicated an aspiration to achieve revenues of $10bn by 2013, up from c$6.1bn in 2010, which would be driven by a recovery in interest rates and local currencies, particularly the Korean won. In the wholesale bank, management believes that revenues pools are likely to grow 2 to 2.5x GDP growth before market share gains. Given the group’s activities are entirely in faster growth markets in Asia, Africa and the Middle East, we agree with management’s view of sustainable income growth rate of mid to high teens through the cycle. In the near term however, the volatile nature of wholesale revenue growth may imply an outturn at the bottom of this range.
HSBC HSBC has a current ROE target range of 15-19%. This is on stated book and as goodwill represents 20% of reported book, the target effectively represents 19-24% on a tangible basis. We believe that current year PBT in the ongoing businesses appears to be some USD 23bn, EPS of c92. This would be an ROE of 15.4% on a tangible basis. However, using the H2 BSM division revenue this would fall by USD 1.25bn, or earnings of c6 to c86 of EPS, and a tangible ROE of 14.4%. We regard these figures as more reasonable levels of sustainable returns, unless long yields return to mid single digit levels and therefore margins improve. To achieve the minimum level of targeted ROE, HSBC would need to achieve attributable profits of at least USD 20bn in 2010 terms. We estimate this would represent PBT of at least USD 27bn. To achieve its ROE targets, the group needs to improve its core business returns by the equivalent of at least USD 4bn of PBT, or 15-20%. The key area for this upside may come from better revenue growth and higher margins, which are dependent on the interest rate outlook.
HSBC’s revenues have been under pressure from falling asset yields. This has squeezed the margins in the customer business through lower liability spreads. We venture this effect could have reduced revenues by as much as USD 5bn in the traditional banking businesses. At the group level the revenue impact has been delayed by BSM. However, BSM revenues themselves are now falling and the full effects of lower rates are likely to show through in 2011/12.
Consequently, if BSM revenues are normalised for current three-year bond yields, rather than the actual yield on the portfolio, revenues and margins would fall even further – we estimate by USD 2.5bn. This effect would depress reported revenue growth next year. Similarly, if short rates rose, but long rates did not, the BSM revenues would also continue to fall.
There is a perception that HSBC would benefit from higher yields. If there is a general rise in yields and the short end remains positive, we would expect this to be the case. However, if the yield curve flattened at the same time as higher official short rates, the positive effect of higher deposit revenues in the core businesses would be offset by lower BSM. Effectively, the BSM activity is doing its job in protecting the revenue line from lower rates, but it can only defer the impact for so long; current revenues are therefore supported by this effect.
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If yields rise to near the 3% figure implied by current 10-year bonds, we would expect these two factors to roughly offset each other. This implies the current c14% ROE on a tangible basis in the core businesses is a reasonable indication of long-term earnings power, but that in the short term there is downside pressure as the BSM contribution falls, unless official rates rise.
It would take still higher rates to some 5% or so, for the net impact of higher rates and lower BSM to be markedly positive, compared with the 2010 run rate in our view.
Capital strength, consumption and dividends
Standard Chartered Standard Chartered’s rights issue in October 2010 came as a surprise to us and the market, with the group indicating that this was a pre-emptive measure to preserve organic RWA growth in an environment where regulators might accelerate the implementation of higher capital requirements.
The capital raise improved the group’s CT1 ratio to 11% pro forma from an earlier 8.8% as of the H1 2010 stage. On a pro forma Basel 3 basis, we estimate that this implies Standard Chartered’s 2012 CT 1 ratio would be c.10.5%, similar to our estimate on the same basis for HSBC of 10.7%. The group indicated a 100bp cost to CT1 from Basel 3 prudential filters. This includes mid-single-digit billion increases in RWA for market risk and CVA, which comprises roughly 50% of the reduction, with the rest accounted for by risk asset growth.
Given the pace of balance sheet expansion has now accelerated to the high teens in terms of risk-weighted asset growth, capital consumption at Standard Chartered is likely to remain in focus. With a payout ratio of c33% and an ROTE in the mid teens, the group may not be able to sustain high teens risk-weighted asset growth without the help of the scrip take-up within the dividend. Management believes that balance sheet expansion is likely to slow at least to the mid teens, which would alleviate the pressure on capital. However, there are also regulation-related increases to RWAs, including mid-single-digit billion increases in RWA for market risk and CVA, which will further constrain organic capital generation in our view.
HSBC We believe HSBC’s capital position is relatively strong, and that this can support a relatively normal level of dividend distribution even in the short term, in contrast to many large banks, but we would not accept that the group has surplus capital. The core Tier 1 ratio was 10.5% at the end of the third quarter of 2010 on a Basel II basis.
We expect the group CT1 ratio will stay near its current level of somewhat over 10% on a Basel III basis and project a ratio of 10.7% for end-2012 on this basis. We believe a near 10% figure is where the group is aiming towards and is a level regulators are likely to require ultimately. On a pro forma basis currently, we believe the CT1 ratio on a Basel 3 basis would be 9.1%. This would be at the upper end of the range of international competitors, if not yet quite at the level the group may ultimately seek to maintain.
HSBC has not yet provided guidance concerning the potential impact of Basel 3. We estimate that RWAs could increase by some USD 80bn, or 7%, post mitigation. However, HSBC also has RWAs in its run-off portfolios, notably in HSBC Finance, but also in the legacy capital markets books. The Finance Director has indicated these represent 15-20% of current RWAs, ie, some USD 200bn. We estimate the RWAs in the HSBC Finance run-off books are c.USD 100bn, effectively a 150% risk weighting, which would imply a similar figure for the legacy wholesale RWAs. Finally, we expect organic RWA growth to reflect relatively robust volume in the emerging markets businesses and limited growth in the west. We also expect the net effect of these factors will be to add 15- 20% to group RWAs by the end of 2012.
Offsetting the RWA growth are retentions, including the scrip element of the dividend and any proceeds from the proposed China listing. As HSBC’s has remained profitable through the crisis, despite the HSBC Finance losses, it has maintained a more normal level of distribution, even though the pay-out was rebased in 2009. The tangible ROE
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bottomed at 7% in 2009. We expect 12% in 2010, rising to 14% by 2012. The company paid a DPS of c34 in 2009, a near 100% pay-out. As earnings recover, the pay-out ratio should fall; our 2010 DPS estimate of c36 would be a 50% pay-out, but 39% of our estimate of EPS from the ongoing businesses.
Assuming a 14% ROE, high single-digit capital growth would require a pay-out ratio approaching 45%. We therefore see scope for pay-outs to be lifted above our estimates, but only by c10%. It is only when factoring in the management’s effective minimum target tangible ROE of 17-18% and that would justify a materially higher pay-out. However, we do not believe HSBC is likely to discount this level of return in its dividend payments, until interest rate rises have begun to occur. Nevertheless, HSBC is already distributing a meaningful level of DPS, which is covered by earnings, in contrast to many other banks.
Standard Chartered – We remain cautious within a backdrop of downgrades and tightening At its recent pre close trading statement, Standard Chartered indicated a strong trading performance for the year with record income and profits in line with our expectations. However, compared to its last IMS statement, operating trends have weakened in our view. While we believe that Standard Chartered remains well positioned for the long term, we are more cautious in the near term given the background of inflation and tightening in some of its key markets and valuations which reflect its many positives. We also believe that consensus expectations for 2010 and 2011 have potential downside.
Income growth has softened recently, driven by WB client income Income in the second half was indicated to be broadly flat on the first half. At the 3Q IMS statement, the group had indicated that the income run rate was above the run rate of the first half. This appears to be driven primarily by Wholesale, where client income growth has slowed from the high teens at the 3Q IMS to the mid teens now. The Consumer bank top line meanwhile continues to improve.
The group also indicated that net interest margins have fallen fractionally owing to moderate pressure on asset margins across several products and geographies.
Expenses higher than expected owing to investment, cost inflation, regulatory and compliance costs Costs were higher than our expectations, with the management indicating a continued deliberate high level of investment in both businesses as well as increased regulatory and compliance costs and competition for staff. We expect cost growth to exceed income growth for the full year by the same margin as in the first half of the year. Cost income jaws were 8% negative at the first half stage and we had expected this to narrow to c6% negative for FY as per earlier guidance, including the one-off gains in 2009. The statement implied costs are running c$200m higher than our previous expectations. We have now moved our estimate for costs higher for 2010 and 2011, as we expect wage inflation and the continuation of investment programmes to keep cost growth elevated. As a result, we have downgraded our estimates at the pre-provision profits level and now expect no growth in underlying pre-provision profits in 2010, with c12% in 2011.
Consumer bank continues to accelerate the top line Within the divisions, Consumer banking income growth was indicated to be broadly in line with the rate shown at the first half (8.5%), with expenses also significantly higher. The statement indicated that costs for the year would be up in double-digit percentage terms. We now expect 8% income growth and 11% cost growth in CB in 2010.
Wholesale held back by negative jaws, but low impairments could offset the impact on profits WB income was indicated to be in the mid single digits, in line with our expectations, with client income growing at a mid teens rate and contributing 80% of WB. At the 3Q IMS statement, the group had indicated that client income for nine months was up in the high teens implying a slight softening of the run rate. We expect own account income to be below H1 owing to weaker financial markets and ALM, offset by stronger principal finance gains. WB expenses were also ahead of our expectations, although less so than in CB. The group indicated double-digit cost growth for the year with significantly negative jaws. We expect 5% income growth and 12% cost growth for 2010 in WB.
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HSBC – Valuation premium reflects group strengths HSBC’s shares trade at 1.7x TBV and 11.6x our estimate of 2011 EPS of the ongoing businesses. The group has a strong balance sheet and now derives the majority of its profits from emerging markets. It looks likely to continue to be defensive in bear markets. However, we would also see only modest upside potential in more positive markets.
Revenue still constrained by falling yields Balance sheet management revenue has further to fall as the full effects of lower yields work through. Although HSBC is a beneficiary of higher official rates, it is also affected by the yield curve shape; we believe that wider deposit spreads from higher official rates would be offset by yield curve flattening. We think the company would benefit most from higher yields and a positive yield curve.
Sum-of-parts – 70% of the group’s value is in emerging markets Emerging markets represent 55%+ of profits and c45% of RWAs for the ongoing businesses. We would argue these franchises represent two-thirds of group value. Within emerging markets, Hong Kong represents over 20% of group profits, with the value of Chinese assets a further 16% of the group. Hong Kong is likely to grow more slowly than less developed markets, while arguably the stronger growth in China is reflected in using the market value of assets, rather than their share of PBT. Other emerging market presences, such as India, Mexico and Brazil, are much smaller in a group context. The developed market businesses are valued near TBV and some 10x earnings. Our HSBC Finance valuation assumption includes USD 6bn for the ongoing cards operations, offset by USD 6.5bn of negative value for the run-off portfolios.
Fig. 92: Sum-of-the-parts – 70% of the group’s value is in emerging markets
Source: Nomura estimates
USD million TBV %
FY2010 Attributable
profit % P/E P/B Val'n %
Emerging Markets
Hongkong Bank 21,182 20.3% 6,202 50.3% 16.5 x 4.8 x 102,328 51.8%
Hang Seng Bank 4,770 4.6% 1,087 8.8% 18.0 x 4.1 x 19,561 9.9%
HSBC Middle East 538 4.4% 13.0 x 6,996 3.5%
HSBC Mexico 3,745 3.6% 277 2.2% 13.0 x 1.0 x 3,598 1.8%
HSBC Brazil SA 3,650 3.5% 591 4.8% 13.0 x 2.1 x 7,679 3.9%
33,347 32.0% 8,694 70.6% 16.1 x 4.2 x 140,161 70.9%
Developed
HSBC France 6,831 6.6% 750 6.1% 9.1 x 1.0 x 6,831 3.5%
HSBC Bank Plc 23,886 22.9% 2,106 17.1% 10.2 x 0.9 x 21,497 10.9%
HSBC USA 12,942 12.4% 1,586 12.9% 12.2 x 1.5 x 19,413 9.8%
HSBC Finance Corp 5,431 5.2% -1,586 -12.9% 16.0 x -0.1 x -650 -0.3%
49,090 47.1% 2,856 23.2% 16.5 x 1.0 x 47,091 23.8%
Other entities / balancing 21,851 21.0% 768 6.2% 13.6 x 0.5 x 10,441 5.3%
GROUP 104,288 100.0% 12,318 100% 16.0 x 1.9 x 197,694 100%
GROUP per Share ( c ) 593 71.2 15.8 x 1.9 x 1,123
( p ) 377 45.3 716
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UK/Asian bank models
Fig. 93: HSBC model
Source: HSBC, Nomura estimates
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Fig. 94: Standard Chartered model
Source: Company data, Nomura estimates
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CEE banks: Prefer Russia and Poland over Turkey Maciej Szczsney [email protected] +44 20 7102 2504
Summary
We are negative on Turkish banks given a more pessimistic outlook on margins and loan losses. However, we are positive on Russian banks owing to strong volume growth at Sberbank and we are positive on Polish banks on improving volumes and margins. In the MENA region we would be positive on Qatari and Egyptian banks, Neutral on Saudi banks and conservative on UAE banks. For more details please see our recent EEMEA strategy note of 1 October 2010, Weaker volume growth for EEMEA banks lies ahead.
Fig. 95: Nomura rating versus consensus
Source: Nomura research, Bloomberg
Fig. 96: Nomura forecasts versus consensus
Source: Nomura research, Bloomberg
Turkish banks
We believe Turkish banks face a profitability headwind in 2H 10 and 2011. For most Turkish banks, our forecasts indicate the need for a rather material 10-15% downward adjustment to consensus estimates. We believe the market is overly optimistic on margin and loan-loss charges outlook.
On margin, we now see rather gradual TRL rate rises; hence, we think the negative impact of a duration mismatch will be a less important factor. However, even if margins in 2011 only stood at our 2H 10E level, there would already be a 20-30bp y/y compression. Further, we think additional spread erosion will emerge from competitive factors. We expect most spread competition in the TRL corporate segment. Strong lending growth in 1H 10 also shifted loans/deposits in the system past 80%, which coupled with the central bank's liquidity exit strategy (eg, a recent increase in the mandatory reserve requirement) is pushing up spread competition for deposit funding.
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Finally, we should point out that in 3Q 10 Akbank, Isbank and Garanti, in particular, are set to suffer from diminished returns on CPI-linked bonds.
On asset quality, 1H 10 was a fortunate combination of two trends – falling new NPL formation coupled with high collections of old NPLs. However, since dominant parts of collections are settled within 12-15 months from when a loan becomes non performing, we expect the level of collections to start to decrease. Normalisation of loan-loss charges in the case of Turkish banks will imply a higher cost of credit risk, in our opinion, starting from 2011.
On a stock-specific level we rate Halkbank as Buy. After its year-to-date underperformance, Halkbank's P/E is among the lowest in the Turkish banking system. We forecast earnings ahead of consensus expectations and expect Halkbank to maintain its superior ROE generation, thanks to its high cost efficiency. We also believe the bank will continue to gain market share. Halkbank has a high level of TRL liquidity and limited exposure to CPI-linked bonds.
We rate Garanti bank as Reduce. We think 2010E P/B at 2.2x is too high a multiple for the bank. We see 16% potential downside to 2011E consensus EPS owing to margin erosion and the cost of credit risk moving back to 80bp of gross loans. We are also concerned about the jump in the level of pre-NPL restructured loans in 2Q 10, for which the bank holds no specific provisions. Finally, in 3Q 10, Garanti is likely to be among the most affected banks by diminishing returns from CPI-linked bonds. The sale of GE's minority stake in the bank also remains unresolved.
Russian banks
We believe our Buy rating on Sberbank is the best counter-weight for our negative view on Turkish banks. Even though we are aware that it is very much a consensus call, Sberbank is our preferred way for investors to gain exposure to the fast growth in Russian banking volumes (CAGR 18% for loans and deposits) that we envisage for the next five years. In our view, the bank is over-provisioning. We also believe the strong margin compression we witnessed in 1H 10 is likely to calm as management has been repricing time deposits downward. As loan-loss charges drop and margins stabilise, Sberbank's ROE should quickly rise over 20%, which would make the current 2010E P/BV multiple of 2.0x not overly demanding, in our view. Long term, Sberbank also offers cost efficiency improvement potential. In the short run, we think approval of management's stock option programme and the potential launch of the GDR programme would act as positive catalysts for the stock.
Polish banks
We remain positive on Polish banks. We believe Polish banks will continue to deliver positive revenue momentum thanks to continuous margin recovery but also volume growth pick-up. First, we think Poland is likely to be one of the initial EEMEA countries to raise interest rates, which thanks to the floating-rate nature of Polish banks' balance sheets should result in margin boost. In addition, we expect corporate lending demand to recover, supported by EU structural-fund-related investments, the upcoming Euro 2012 football championships and overall low penetration of corporate lending (corporate loans/GDP of just 20%). Since new loans still carry spreads above pre-credit-crunch level, we expect stronger lending activity also to bring a positive margin effect of 20- 30bp. In addition, we believe asset quality is past its trough and loan-loss charges are likely to be on a declining trend. We highlight that Polish banks are very well provisioned, although this may not be evident at first glance as Polish NPL classifications are among the most rigorous in the region. While banks in other countries show loans overdue by 90 days as NPLs, in Poland the NPL ratio also includes many other cases (like corporate borrowers that are making losses). For example, of the 7.1% NPL ratio reported by PKO BP on unconsolidated basis in 1H 2010, only 3.3% are loans overdue by 90 days.
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
78
Consequently, reported NPL coverage of 43% rises to 92% if adjusted to make the methodology match that used in other countries. Overall, we do not believe Polish banks will have to go through a period of elevated loan-loss charges.
On a stock-specific level we rate PKO BP as Buy. While PKO BP's 2010E P/BV of 2.5x perhaps leaves limited room for re-rating, we are attracted by the bank's ability to generate total return through BVPS growth. After missing out on a potential merger with BZ WBK, we believe management focus will revert to organic volume growth. PKO BP should also see its margin expand, particularly in a rising interest rate environment. We also think loan-loss charges have peaked and there is potential upside to earnings from the lower cost of credit risk. Moreover, in December, PKO BP is likely to pay out its conditional dividend of PLN 1.90 per share.
We continue to like Bank Pekao (Buy) in Poland. We believe Pekao is as well positioned to see its margin expanding. It is also becoming more active in the lending market, and this could turn sentiment towards the name, which in the past has generally been perceived as a bank that constantly loses market share. The bank also offers an option on the revival of the mutual fund market in Poland. A high level of Tier 1 should translate into a prolonged period of high dividend payouts, an important component of the bank's total return. Our view on Pekao is non-consensus, given that no other Polish bank has as many 'sell' ratings from the market.
MENA banks
On our MENA universe, we remain positive on Qatari banks. We believe Qatari banks’ profitability is likely to recover faster than MENA peers. Given healthy volume growth and a noticeable asset-quality improvement. Qatari banks also benefit from relatively appealing valuations, with price multiples below Saudi and Egyptian peers. Finally, the high dividend yields that Qatari banks offer add to their attractiveness, we believe. CBQ and Doha Bank remain our preferred stocks in Qatar.
We continue to see value in CIB in Egypt and maintain our Buy rating: Consensus appears to believe the bank has reached its fair value and become expensive. We agree that CIB's valuation might look demanding. However, we believe it deserves largely to trade at such a premium. In our estimate, the stock should deliver superior profitability with ROEs at ~ 30% in the next few years. In addition, we believe CIB is geared to strong potential earnings growth driven by high volume growth and margin expansion. Lastly, we see CIB as the best proxy to the Egyptian economy.
We are Neutral on Saudi banks; Riyad Bank is our only Buy: We continue to believe the Saudi banks’ solid fundamentals and the benign economic environment in which they operate are likely to be supportive for high long-term returns (~15% five-year CAGR); however, in the mid-term, we do not see strong catalysts for stock price increases.
We remain conservative on UAE banks: We believe the strong recent rally triggered by the Dubai World announcement in September needs solid fundamentals to support current valuations. For us, UAE banks still have some challenges ahead. Profitability is likely to remain under pressure amid high loan-loss charges, which should accelerate in 3Q and 4Q this year.
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
79
The Revenue Book We highlight the country-level trends in important revenue drivers of the banking sector across Europe in our Revenue Book.
A two-track economic recovery in Europe has affected European banks in a similar manner. The divergent trajectories of northern and southern European banks are seen in lending growth and margin trends as well.
Among the countries showing good lending growth are Norway, Sweden and France, all in northern Europe. On the other hand the southern European countries of Greece and Spain, in which Ireland is also classified, have seen negative lending growth in recent months. We believe this north-south divide is likely to remain unchanged in 2011 southern Europe continues to remain in de-leveraging mode and their residents are having to further reduce their debt burden to deal with austerity measures initiated by their governments. Lending growth in northern Europe isn’t likely to be spectacular either. However, given the relatively better growth these economies are experiencing, consumers may moderately increase their borrowing. Corporates in northern Europe are also likely to borrow more, in keeping with the GDP growth momentum.
The revenue book for each country has volume charts and margin charts.
The volume charts show how lending growth has evolved in a country both in terms of outstanding amounts as well as the amount of new lending. Deposit growth is also shown in the volume charts section, again broken down by outstanding amounts and new business.
The margin charts show the trends in lending and deposit margins at the country level.
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
80
Euro area Macroeconomic data
Fig. 97: GDP growth percent y/y change
Source: ECB, Datastream, Nomura research
Fig. 98: Unemployment rate percent
Source: ECB, Datastream, Nomura research
Balance sheet structure (latest month)
Fig. 99: Lending mix – outstanding loans by customer
Source: ECB, Datastream, Nomura research
Fig. 100: Lending mix – outstanding loans by maturity
Source: ECB, Datastream, Nomura research
Fig. 101: Lending mix – new business by duration
Source: ECB, Datastream, Nomura research
Fig. 102: Deposit mix – excluding overdrafts
Source: ECB, Datastream, Nomura research
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
82
Spread drivers – euro area
Fig. 109: Household mortgage spreads bp over 10y bond
Source: ECB, Datastream, Nomura research
Fig. 110: Household mortgage spread, new by duration bp
Source: ECB, Datastream, Nomura research
Fig. 111: Corporate lending spread vs 12m Euribor
Source: ECB, Datastream, Nomura research
Fig. 112: Corporate spreads, new business by size vs 12m Euribor
Source: ECB, Datastream, Nomura research
Fig. 113: Deposits 3m Euribor , bp
Source: ECB, Datastream, Nomura research
Fig. 114: Total customer spread bp
Source: ECB, Datastream, Nomura research
-100
-50
0
50
100
150
200
Jul-0
4
Dec
-04
May
-05
Oct
-05
Mar
-06
Aug
-06
Jan-
07
Jun-
07
Nov
-07
Apr
-08
Sep-
08
Feb-
09
Jul-0
9
Dec
-09
May
-10
Oct
-10
Outstanding N ew
0
50
100
150
200
250
Jul-0
4
Dec
-04
May
-05
Oct
-05
Mar
-06
Aug
-06
Jan-
07
Jun-
07
Nov
-07
Apr
-08
Sep-
08
Feb-
09
Jul-0
9
Dec
-09
May
-10
Oct
-10
< 1yr vs 3m Euribor 1-5 yrs vs 12m Euribor> 10 yrs vs 10yr bond
0
50
100
150
200
250
300
Jul-0
4
Dec
-04
May
-05
Oct
-05
Mar
-06
Aug
-06
Jan-
07
Jun-
07
Nov
-07
Apr
-08
Sep-
08
Feb-
09
Jul-0
9
Dec
-09
May
-10
Oct
-10
Outstanding N ew
0
50
100
150
200
250
300
350
Jul-0
4
Dec
-04
May
-05
Oct
-05
Mar
-06
Aug
-06
Jan-
07
Jun-
07
Nov
-07
Apr
-08
Sep-
08
Feb-
09
Jul-0
9
Dec
-09
May
-10
Oct
-10
< EUR 1m (~ SME) > EUR 1m (~ large corporate)
-300
-200
-100
0
100
200
300
400
Jul-0
4
Dec
-04
May
-05
Oct
-05
Mar
-06
Aug
-06
Jan-
07
Jun-
07
Nov
-07
Apr
-08
Sep-
08
Feb-
09
Jul-0
9
Dec
-09
May
-10
Oct
-10
Sight Term
270
280
290
300
310
320
330
340
350
Jul-0
4
Dec
-04
May
-05
Oct
-05
Mar
-06
Aug
-06
Jan-
07
Jun-
07
Nov
-07
Apr
-08
Sep-
08
Feb-
09
Jul-0
9
Dec
-09
May
-10
Oct
-10
Total customer spread
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
83
Bank lending survey – euro area
Fig. 115: Change in credit standards
Source: ECB, Datastream, Nomura research
Fig. 116: Factors affecting credit standards
Source: ECB, Datastream, Nomura research
Fig. 117: Changes in demand
Source: ECB, Datastream, Nomura research
Fig. 118: Changes in pricing
Source: ECB, Datastream, Nomura research
Note: Net balance equals difference between % of loan officers saying tightened standards/see increased demand and those easing standards/seeing decreased demand. Average of corporate and households (mortgage and consumer credit).
-20
-10
0
10
20
30
40
50Q
1 2
00
3
Q3
20
03
Q1
20
04
Q3
20
04
Q1
20
05
Q3
20
05
Q1
20
06
Q3
20
06
Q1
20
07
Q3
20
07
Q1
20
08
Q3
20
08
Q1
20
09
Q3
20
09
Q1
20
10
Q3
20
10
Net
bal
ance
of b
anks
Realized Expected
-25
-15
-5
5
15
25
35
45
55
Q1
20
03
Q3
20
03
Q1
20
04
Q3
20
04
Q1
20
05
Q3
20
05
Q1
20
06
Q3
20
06
Q1
20
07
Q3
20
07
Q1
20
08
Q3
20
08
Q1
20
09
Q3
20
09
Q1
20
10
Q3
20
10
Net
bal
ance
of b
anks
Cost of funds or B/ S Competition Economic outlook
-50
-40
-30
-20
-10
0
10
20
30
40
Q1
20
03
Q3
20
03
Q1
20
04
Q3
20
04
Q1
20
05
Q3
20
05
Q1
20
06
Q3
20
06
Q1
20
07
Q3
20
07
Q1
20
08
Q3
20
08
Q1
20
09
Q3
20
09
Q1
20
10
Q3
20
10
Net
bal
ance
of b
anks
Realized Expected
-40
-20
0
20
40
60
80
Q1
20
03
Q3
20
03
Q1
20
04
Q3
20
04
Q1
20
05
Q3
20
05
Q1
20
06
Q3
20
06
Q1
20
07
Q3
20
07
Q1
20
08
Q3
20
08
Q1
20
09
Q3
20
09
Q1
20
10
Q3
20
10
Net
bal
ance
of b
anks
Realized Expected
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
84
Austria Macroeconomic data
Fig. 119: GDP growth percent y/y change
Source: Datastream, Nomura research
Fig. 120: Unemployment percent
Source: Datastream, Nomura research
Balance sheet structure (latest month)
Fig. 121: Lending mix – outstanding loans by customer
Source: OEB, Nomura research
Fig. 122: Lending mix – outstanding loans by maturity
Source: OEB, Nomura research
Fig. 123: Lending mix – new business by duration
Fig. 124: Deposit mix –excluding overdrafts
Source: OEB, Nomura research
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
Q1
2003
Q3
2003
Q1
2004
Q3
2004
Q1
2005
Q3
2005
Q1
2006
Q3
2006
Q1
2007
Q3
2007
Q1
2008
Q3
2008
Q1
2009
Q3
2009
Q1
2010
Q3
2010
3.5%
4.0%
4.5%
5.0%
5.5%
6.0%
Q1 2
00
3
Q3 2
00
3
Q1 2
00
4
Q3 2
00
4
Q1 2
00
5
Q3 2
00
5
Q1 2
00
6
Q3 2
00
6
Q1 2
00
7
Q3 2
00
7
Q1 2
00
8
Q3 2
00
8
Q1 2
00
9
Q3 2
00
9
Q1 2
01
0
Q3 2
01
0
26%
21%
47%
53%
0%
10%
20%
30%
40%
50%
60%
H/ hold -mortgages
H/ hold -other H/ hold - total Corporate
18%12%
69%
0%
10%
20%
30%
40%
50%
60%
70%
80%
<1 year 1-5 years > 5 years
[Data not available]
79%
21%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Household Corporate
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
102
Spread drivers – Germany
Fig. 205: Household mortgage spreads vs 10y bond
Source: Bundesbank, Nomura research
Fig. 206: Household mortgage spreads, new by duration bp
Source: Bundesbank, Nomura research
Fig. 207: Corporate lending spreads vs 12m Euribor
Source: Bundesbank, Nomura research
Fig. 208: Corporate spreads, new business by size vs 12m Euribor
Source: Bundesbank, Nomura research
Fig. 209: Deposit spreads vs 3m Euribor
Source: Bundesbank, Nomura research
Fig. 210: Total customer spread bp
Source: Bundesbank, Nomura research
0
50
100
150
200
250
300
Jan-
03
Jun-
03
Nov-
03
Apr-0
4
Sep-0
4
Feb-0
5
Jul-0
5
Dec-
05
May-
06
Oct
-06
Mar-0
7
Aug
-07
Jan-
08
Jun-
08
Nov-
08
Apr-0
9
Sep-0
9
Feb-1
0
Jul-1
0
Outstanding N ew
-50
0
50
100
150
200
250
300
350
Jan-
03
Jun-
03
Nov-
03
Apr-0
4
Sep-0
4
Feb-0
5
Jul-0
5
Dec-
05
May-
06
Oct
-06
Mar-0
7
Aug
-07
Jan-
08
Jun-
08
Nov-
08
Apr-0
9
Sep-0
9
Feb-1
0
Jul-1
0
<1 yr vs 3m Euribor 1-5yr vs 12m Euribor
>10yrs vs 10 yr bund
0
50
100
150
200
250
300
350
Jan-
03
Jun-
03
Nov-
03
Apr-0
4
Sep-0
4
Feb-0
5
Jul-0
5
Dec-
05
May-
06
Oct
-06
Mar-0
7
Aug
-07
Jan-
08
Jun-
08
Nov-
08
Apr-0
9
Sep-0
9
Feb-1
0
Jul-1
0
Outstanding N ew 3m Euribor
0
50
100
150
200
250
300
Jan-
03
Jun-
03
Nov-
03
Apr-0
4
Sep-0
4
Feb-0
5
Jul-0
5
Dec-
05
May-
06
Oct
-06
Mar-0
7
Aug
-07
Jan-
08
Jun-
08
Nov-
08
Apr-0
9
Sep-0
9
Feb-1
0
Jul-1
0
< EUR 1m (~ SME) > EUR 1m (~ large corporate)
-150
-100
-50
0
50
100
150
200
250
Jan-
03
Jun-
03
Nov-
03
Apr-0
4
Sep-0
4
Feb-0
5
Jul-0
5
Dec-
05
May-
06
Oct
-06
Mar-0
7
Aug
-07
Jan-
08
Jun-
08
Nov-
08
Apr-0
9
Sep-0
9
Feb-1
0
Jul-1
0
Household Corporate
275
295
315
335
355
375
395
Jul-0
4O
ct-0
4Ja
n-0
5A
pr-0
5Ju
l-05
Oct
-05
Jan-
06
Apr-0
6Ju
l-06
Oct
-06
Jan-
07
Apr-0
7Ju
l-07
Oct
-07
Jan-
08
Apr-0
8Ju
l-08
Oct
-08
Jan-
09
Apr-0
9Ju
l-09
Oct
-09
Jan-
10
Apr-1
0Ju
l-10
Total customer spread
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
103
Bank lending survey – Germany
Fig. 211: Change in credit standards
Source: Bundesbank, Nomura research
Fig. 212: Factors affecting credit standards
Source: Bundesbank, Nomura research
Fig. 213: Changes in demand
Source: Bundesbank, Nomura research
Fig. 214: Changes in pricing
Source: Bundesbank, Nomura research
Note: Net balance equals difference between % of loan officers saying tightened standards/see increased demand and those easing standards/seeing decreased demand. Average of corporate and households (mortgage and consumer credit).
-40
-30
-20
-10
0
10
20
30
40
50
60
70
200
3 Q
1
200
3 Q
3
200
4 Q
1
200
4 Q
3
200
5 Q
1
200
5 Q
3
200
6 Q
1
200
6 Q
3
200
7 Q
1
200
7 Q
3
200
8 Q
1
200
8 Q
3
200
9 Q
1
200
9 Q
3
201
0 Q
1
201
0 Q
3
Net
bala
nce
of b
an
ks
Realized Expected
-40
-30
-20
-10
0
10
20
30
40
50
60
20
03
Q1
20
03
Q3
20
04
Q1
20
04
Q3
20
05
Q1
20
05
Q3
20
06
Q1
20
06
Q3
20
07
Q1
20
07
Q3
20
08
Q1
20
08
Q3
20
09
Q1
20
09
Q3
20
10
Q1
20
10
Q3
Net
ba
lan
ce
of b
an
ks
Cost of funds Competition Risk perception
-60
-40
-20
0
20
40
60
80
20
03
Q1
20
03
Q3
20
04
Q1
20
04
Q3
20
05
Q1
20
05
Q3
20
06
Q1
20
06
Q3
20
07
Q1
20
07
Q3
20
08
Q1
20
08
Q3
20
09
Q1
20
09
Q3
20
10
Q1
20
10
Q3
Net b
ala
nce o
f b
an
ks
Realized Expected
-30
-20
-10
0
10
20
30
40
50
200
3 Q
1
200
3 Q
3
200
4 Q
1
200
4 Q
3
200
5 Q
1
200
5 Q
3
200
6 Q
1
200
6 Q
3
200
7 Q
1
200
7 Q
3
200
8 Q
1
200
8 Q
3
200
9 Q
1
200
9 Q
3
201
0 Q
1
201
0 Q
3
Ne
t b
ala
nc
e o
f b
an
ks
Realized Expected
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
141
Spread drivers – UK
Fig. 387: Household mortgage spreads bp over 10y bond
Source: BoE, Nomura research
Fig. 388: Household mortgage spread, new by duration bp
Source: BoE, Nomura research
Fig. 389: Corporate lending spread vs 12m Euribor
Source: BoE, Nomura research
Fig. 390: Corporate spreads, new business by size vs 12m Euribor
Source: BoE, Nomura research
Fig. 391: Deposits 3m Euribor , bp
Source: BoE, Nomura research
Fig. 392: Total customer spread bp
-50
0
50
100
150
200Ja
n-0
4M
ay-0
4Se
p-0
4Ja
n-0
5M
ay-0
5Se
p-0
5Ja
n-0
6M
ay-0
6Se
p-0
6Ja
n-0
7M
ay-0
7Se
p-0
7Ja
n-0
8M
ay-0
8Se
p-0
8Ja
n-0
9M
ay-0
9Se
p-0
9Ja
n-1
0M
ay-1
0Se
p-1
0
Outstanding N ew
-100-50
050
100150200250300350400450
Jan-
04
May
-04
Sep-
04
Jan-
05
May
-05
Sep-
05
Jan-
06
May
-06
Sep-
06
Jan-
07
May
-07
Sep-
07
Jan-
08
May
-08
Sep-
08
Jan-
09
Ma y
-09
Sep-
09
Jan-
10
May
-10
Sep-
10
Floating vs Base rate < 1 yr vs 3m LIBOR> 10 yrs vs 10yr bond
-50
0
50
100
150
200
Jan-
04
May
-04
Sep-
04
Jan-
05
May
-05
Sep-
05
Jan-
06
May
-06
Sep-
06
Jan-
07
May
-07
Sep-
07
Jan-
08
May
-08
Sep-
08
Jan-
09
May
-09
Sep-
09
Jan-
10
May
-10
Sep-
10
Outstanding N ew
-50
0
50
100
150
200
250
Jan-
04
May
-04
Sep-
04
Jan-
05
May
-05
Sep-
05
Jan-
06
May
-06
Sep-
06
Jan-
07
May
-07
Sep-
07
Jan-
08
May
-08
Sep-
08
Jan-
09
May
-09
Sep-
09
Jan-
10
May
-10
Sep-
10
< GBP 1m GBP 1-20m > GBP 20m
-200-150-100
-500
50100150200250300
Jan-
04
May
-04
Sep-
04
Jan-
05
May
-05
Sep-
05
Jan-
06
May
-06
Sep-
06
Jan-
07
May
-07
Sep-
07
Jan-
08
May
-08
Sep-
08
Jan-
09
May
-09
Sep-
09
Jan-
10
May
-10
Sep-
10
Sight Term
[Data not available]
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
142
Bank lending survey – UK
Fig. 393: Change in credit standards
Source: BoE, Nomura research
Fig. 394: Factors affecting credit standards
Source: BoE, Nomura research
Fig. 395: Changes in demand
Source: BoE, Nomura research
Fig. 396: Changes in pricing
Source: BoE, Nomura research
Note: Net balance equals difference between % of loan officers saying tightened standards/see increased demand and those easing standards/seeing decreased demand. Average of corporate and households (mortgage and consumer credit).
-35
-30
-25
-20
-15
-10
-5
0
5Q
2 2
007
Q3
200
7
Q4
200
7
Q1
200
8
Q2
200
8
Q3
200
8
Q4
200
8
Q1
200
9
Q2
200
9
Q3
200
9
Q4
200
9
Q1
201
0
Q2
201
0
Q3
201
0
Ne
t bal
ance
of
ban
ks
Realized Expected
-60
-40
-20
0
20
40
Q2
200
7
Q3
200
7
Q4
200
7
Q1
200
8
Q2
200
8
Q3
200
8
Q4
200
8
Q1
200
9
Q2
200
9
Q3
200
9
Q4
200
9
Q1
201
0
Q2
201
0
Q3
201
0
Net
ba
lan
ce
of b
ank
s
Changing economic outlookMarket share objectivesChanging appetite for riskChanging cost/availability of funds
-30
-25
-20
-15
-10
-5
0
5
10
15
20
Q2
2007
Q3
2007
Q4
2007
Q1
2008
Q2
2008
Q3
2008
Q4
2008
Q1
2009
Q2
2009
Q3
2009
Q4
2009
Q1
2010
Q2
2010
Q3
2010
Net
ba
lan
ce
of b
ank
s
Realized Expected
-50
-40
-30
-20
-10
0
10
20
30
Q2
200
7
Q3
200
7
Q4
200
7
Q1
200
8
Q2
200
8
Q3
200
8
Q4
200
8
Q1
200
9
Q2
200
9
Q3
200
9
Q4
200
9
Q1
201
0
Q2
201
0
Q3
201
0
Ne
t bal
ance
of
ba
nks
Realized Expected
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
144
Nomura | EMEA European Banks Outlook 2011 December 16, 2010
145
Appendix A-1
Analyst Certification
We, Jon Peace, Robert Law, Domenico Santoro, Maciej Szczesny, Daragh Quinn, Raul Sinha, Chintan Joshi, Prathmesh Dave, Tathagat Kumar and Moreno Fasolo, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.
Industry Specialists are senior employees within Nomura who are responsible for the sales and trading effort in the sector for which they have coverage.
Issuer Specific Regulatory Disclosures
Mentioned companies
All share prices mentioned are closing prices unless otherwise stated
Ticker Price Price date Stock rating Sector rating
CS Group CSGN VX CHF 39.00 December 14, 2010 Neutral Bullish
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Important Disclosures Conflict-of-interest disclosures Important disclosures may be accessed through the following website: http://www.nomura.com/research/pages/disclosures/disclosures.aspx . If you have difficulty with this site or you do not have a password, please contact your Nomura Securities International, Inc. salesperson (1-877-865-5752) or email [email protected] for assistance. Online availability of research and additional conflict-of-interest disclosures Nomura Japanese Equity Research is available electronically for clients in the US on NOMURA.COM, REUTERS, BLOOMBERG and THOMSON ONE ANALYTICS. For clients in Europe, Japan and elsewhere in Asia it is available on NOMURA.COM, REUTERS and BLOOMBERG. Important disclosures may be accessed through the left hand side of the Nomura Disclosure web page http://www.nomura.com/research or requested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please email [email protected] for technical assistance. The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Industry Specialists identified in some Nomura International plc research reports are employees within the Firm who are responsible for the sales and trading effort in the sector for which they have coverage. Industry Specialists do not contribute in any manner to the content of research report in which their names appear. Distribution of ratings (Global) Nomura Global Equity Research has 1878 companies under coverage. 48% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 41% of companies with this rating are investment banking clients of the Nomura Group*. 37% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 54% of companies with this rating are investment banking clients of the Nomura Group*. 13% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 16% of companies with this rating are investment banking clients of the Nomura Group*. As at 30 September 2010. *The Nomura Group as defined in the Disclaimer section at the end of this report. Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America for ratings published from 27 October 2008 The rating system is a relative system indicating expected performance against a specific benchmark identified for each individual stock. Analysts may also indicate absolute upside to price target defined as (fair value - current price)/current price, subject to limited management discretion. In most cases, the fair value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as discounted cash flow or multiple analysis, etc. STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'RS-Rating Suspended', indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the company. Benchmarks are as follows: United States/Europe: Please see valuation methodologies for explanations of relevant benchmarks for stocks (accessible through the left hand side of the Nomura Disclosure web page: http://www.nomura.com/research);Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published from 30 October 2008 and in Japan from 6 January 2009 STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Price Target - Current Price) / Current Price, subject to limited management discretion. In most cases, the Price Target will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'RS' or 'Rating Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive
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absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Explanation of Nomura's equity research rating system in Japan published prior to 6 January 2009 (and ratings in Europe, Middle East and Africa, US and Latin America published prior to 27 October 2008) STOCKS A rating of '1' or 'Strong buy', indicates that the analyst expects the stock to outperform the Benchmark by 15% or more over the next six months. A rating of '2' or 'Buy', indicates that the analyst expects the stock to outperform the Benchmark by 5% or more but less than 15% over the next six months. A rating of '3' or 'Neutral', indicates that the analyst expects the stock to either outperform or underperform the Benchmark by less than 5% over the next six months. A rating of '4' or 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark by 5% or more but less than 15% over the next six months. A rating of '5' or 'Sell', indicates that the analyst expects the stock to underperform the Benchmark by 15% or more over the next six months. Stocks labeled 'Not rated' or shown as 'No rating' are not in Nomura's regular research coverage. Nomura might not publish additional research reports concerning this company, and it undertakes no obligation to update the analysis, estimates, projections, conclusions or other information contained herein. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next six months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next six months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next six months. Benchmarks are as follows: Japan: TOPIX; United States: S&P 500, MSCI World Technology Hardware & Equipment; Europe, by sector - Hardware/Semiconductors: FTSE W Europe IT Hardware; Telecoms: FTSE W Europe Business Services; Business Services: FTSE W Europe; Auto & Components: FTSE W Europe Auto & Parts; Communications equipment: FTSE W Europe IT Hardware; Ecology Focus: Bloomberg World Energy Alternate Sources; Global Emerging Markets: MSCI Emerging Markets ex-Asia. Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published prior to 30 October 2008 STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Fair Value - Current Price)/Current Price, subject to limited management discretion. In most cases, the Fair Value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as Discounted Cash Flow or Multiple analysis etc. However, if the analyst doesn't think the market will revalue the stock over the specified time horizon due to a lack of events or catalysts, then the fair value may differ from the intrinsic fair value. In most cases, therefore, our recommendation is an assessment of the difference between current market price and our estimate of current intrinsic fair value. Recommendations are set with a 6-12 month horizon unless specified otherwise. Accordingly, within this horizon, price volatility may cause the actual upside or downside based on the prevailing market price to differ from the upside or downside implied by the recommendation. A 'Strong buy' recommendation indicates that upside is more than 20%. A 'Buy' recommendation indicates that upside is between 10% and 20%. A 'Neutral' recommendation indicates that upside or downside is less than 10%. A 'Reduce' recommendation indicates that downside is between 10% and 20%. A 'Sell' recommendation indicates that downside is more than 20%. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Price targets Price targets, if discussed, reflect in part the analyst's estimates for the company's earnings. The achievement of any price target may be impeded by general market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if the company's earnings differ from estimates.
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