ab Global Equity Research
Europe Including UK UBS Investment Research
European Banks Banks
Market Comment
Euroviews – that vertiginous feeling The rally increases the probability of equity issuance… Financials have rallied strongly, reflecting recognition that policymakers will do 30 April 2009
what it takes to reflate the global economy and that nationalisation is a very last www.ubs.com/investmentresearch resort. However, this does not mean that dilution risk from equity issuance is no longer a concern, and we believe a number of European banks need new equity – John-Paul Crutchley either for loss absorption capacity or to support market risk within their businesses. Analyst [email protected] …but timing is back in the banks’ control +44-20-7568 5037 Governments (ex UK) have avoided dilutive recapitalisation of banks through the Alastair Ryan creation of “buffer” core Tier 1 – an instrument that satisfies regulators and more Analyst senior creditors – but this capital does not ultimately bear losses. “Buffer” capital is [email protected] useful where a bank is suffering from cyclical capital stress and may buy time – +44 20 7568 3238 giving a bank the opportunity to raise equity on more advantageous terms as the Daniele Brupbacher cycle improves. The alternative is a “zombie” work-out with operating profits Analyst utilised in absorbing losses and rebuilding capital for years to come. [email protected] +41-44-239 1493 Buying recapitalised banks… Nick Davey Through choice, we are taking money off the table following the market rally. Our Analyst preference is for banks with strong business models whose capital strength is close [email protected] to undoubted, such as HSBC, Lloyds and Intesa. Generically, we want to avoid +44 20 756 84409 banks with uncertain business models or where there is heightened risk of a Omar Fall protracted work-out process, such as domestic Germany, Ireland or Spain. Analyst [email protected] …and playing relative value ideas +44 20 7568 2131 We prefer HSBC over Standard Chartered – playing the better capitalised, more Alexander Kyrtsis attractively valued emerging markets story. SocGen remains our preferred French Analyst bank, with a better earnings momentum story than our least preferred bank, CASA. [email protected] Looking to purer domestic banks, we are happy owning Lloyds post its fourth +44-20 7568 1689 recapitalisation and the creation of a bad bank outright, and note the contrast with Matteo Ramenghi Sabadell, which arguably has it all to come. Similarly, we would rather own Analyst Intesa over Santander, as Italy is less exposed to structural economic weakness [email protected] than Spain. Finally, in emerging Europe, we would own Erste over OTP, +39-02-7210 0286 reflecting the former’s more attractive franchise and valuation. Ignacio Sanz, CFA Analyst [email protected] +34-91-436 9624 Philipp Zieschang Analyst [email protected] +41-44-239 7414
This report has been prepared by UBS Limited ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 34. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Customers of UBS in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at www.ubs.com/independentresearch or may call +1 877-208-5700 to request a copy of this research.
European Banks 30 April 2009
Contents page John-Paul Crutchley Analyst Euroviews 3 [email protected] +44-20-7568 5037 Economic outlook 4 Alastair Ryan — Main messages...... 4 Analyst — Things to watch...... 4 [email protected] From dogmatism to pragmatism 7 +44 20 7568 3238 Daniele Brupbacher — From zombie to Lazarus...... 8 Analyst — The point of “buffer” core capital...... 10 [email protected] — The impact of conversion ...... 12 +41-44-239 1493 Key stock calls 13 Nick Davey Analyst — Erste Bank – Buy, PT €18...... 13 [email protected] — HSBC – Buy, PT 530p...... 14 +44 20 756 84409 — Intesa – Buy, PT €2.3...... 15 Omar Fall Analyst — Lloyds – Buy, PT 120p ...... 16 [email protected] — Societe Generale – Buy, PT €45 ...... 17 +44 20 7568 2131 — CASA – Sell, PT €5.4...... 18 Alexander Kyrtsis Analyst — OTP – Sell, PT HUF 1,750 ...... 19 [email protected] — Sabadell – Sell, PT €3.7...... 20 +44-20 7568 1689 — Santander – Sell, PT €4.3 ...... 21 Matteo Ramenghi — Standard Chartered – Sell, PT 780p...... 22 Analyst [email protected] Country views 24 +39-02-7210 0286 — France ...... 24 Ignacio Sanz, CFA — Germany...... 24 Analyst [email protected] — Greece...... 25 +34-91-436 9624 — Italy...... 26 Philipp Zieschang — Spain and Ireland...... 27 Analyst [email protected] — UK...... 31 +41-44-239 7414
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European Banks 30 April 2009
Euroviews The adoption of quantitative easing provides further evidence of the “whatever it takes” stance being pursued by authorities to reflate the global economy. The Bank of England is already taking similar action to the Federal Reserve, but it may take some time for the European Central Bank (ECB) to follow. The moves to intervene in credit markets and stabilise the economic outlook have provided a positive backdrop for the sector, and stocks have reacted accordingly. The European bank sector has rallied 80% from its lows, as actions by policymakers have helped reduce perceived risk premia. At the same time, the broader macroeconomic picture remains difficult. Our expectation is that this rally, like others that have preceded it, will fade as the reality of the difficult earnings cycle reasserts itself. It is right to discriminate: expectations remain heightened among capital market names, leaving greater upside potential for those credit-sensitive names that afford minimal dilution risk. Our preferred stocks are relatively defensively positioned with strong business models or franchises and little need to raise additional capital beyond what has already been announced. Four themes are prevalent in our views of European banks: (1) Our Buy-rated names are linked through a broadly defensive focus and minimal dilution risk. We would rather buy a recapitalised stock post- dilution, rather than one where the risk of such still remains. (2) We remain very cautious on banks in economies with severe structural problems, such as Spain and Ireland. (3) The market has moved from pessimism to over optimism in capital market banks, recognising that these are generally less exposed to banking credit risks. However, it is not absent, as the exposure of Barclays and Deutsche to monolines shows. Moreover, the momentum of the first quarter is expected to fade. (4) It is right to be differentiated in respect of banks with exposure to emerging markets in the east. We remain much more comfortable with exposure to the CEE-4 rather than to more peripheral states, including Ukraine and the Baltics.
Table 1: Key stock calls
Stock Rationale
Most favoured Erste (Buy, €18 PT) Attractive risk/reward, strong franchise
HSBC (Buy, 530 PT) Undervalued, yield support
Lloyds (Buy, 120p PT) Recapitalised and cleaned up
Intesa (Buy, €2.3 PT) Defensive, well capitalised
Societe Generale (Buy, €45 PT) Diversified, well capitalised
Least favoured Credit Agricole (Sell, €5.4 PT) Expensive, capital less strong than perceived
OTP (Sell, HUF 1,750 PT) Expensive, dilution risk
Sabadell (Sell, €3.70 PT) Expensive, Spanish exposure
Santander (Sell, €4.3 PT) Expensive, Spanish exposure
Standard Chartered (Sell, 780p PT) Expensive, consumer business headwinds
Source: UBS
UBS 3
European Banks 30 April 2009 Economic outlook Our economists have dramatically revised down GDP forecasts for virtually all We thank our European economist, regions in Europe. As a result, in most cases the 2009 number that we now Stephane Deo, for contributing anticipate is the weakest since World War II. this section
Table 2: UBS and consensus GDP forecasts
New forecasts Consensus % 2008 2009 2010 2008 2009 2010 Euro area 0.7 -3.5 0.3 0.7 -2.6 0.5 Germany 1.0 -5.3 -0.6 1.3 -3.2 0.7 France 0.7 -2.5 0.8 0.7 -2.0 0.6 Italy -1.0 -3.0 0.7 -1.0 -2.8 0.3 Spain 1.2 -4.0 -0.8 1.2 -2.5 -0.1 Netherlands 2.1 -3.9 0.3 2.0 -2.4 0.2 UK 0.7 -3.8 0.6 0.7 -3.0 0.5 Sweden -0.5 -4.8 1.3 -0.5 -2.2 1.0 Norway (mainland) 2.4 -1.6 1.3 2.4 -1.0 1.0 Source: UBS estimates; Consensus Economics 9 March 2009 survey Main messages
Q Extreme weakness at the turn of the year: We have revised down our forecasts: Euro area (EA) growth is now expected to be -3.5% in 2009, while we were looking for “only” -2.0% previously. This is essentially the result of an extremely weak Q1: we had been looking for -0.7% qoq, but are now pencilling in an impressive -1.8%. This revision is on the back of the latest high frequency data, notably industrial production. Thus, the downward revision is almost exclusively backward looking, and a consequence of extreme weakness in Q4 last year and Q1 this year.
Q H2 should improve: We have revised, albeit slightly, our growth numbers for H2 this year. For the first time in years, we believe that risks are on the upside in H2. This is validated by recent moves in leading indicators: readers know that, since the end of last year, we have forecast a turning point in Q1, and this seems to be materialising with the more forward-looking indicators coming in more robust than we had expected. The inventory cycle is also often mentioned as a source of excessive GDP volatility. However, we would add to the list some extreme numbers in international trade and consumption, which could be corrected later this year.
Q Tepid recovery in 2010: This is probably the most consensual view, and we do not disagree. The legacy of the current crisis will be long and slow to absorb, generating a lower potential GDP and a very gradual convergence to that potential. The ongoing deleveraging of the financial sector, the weakness of the Euro area’s main trading partner (Eastern Europe), the destruction of production capacity and an aging population are among the most often quoted reasons for this tepid outlook. Things to watch
Q Eastern Europe: We have repeatedly mentioned Eastern Europe (EE) as posing the main risk to the Euro area. The expected slowdown is
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European Banks 30 April 2009
materialising, and this will constitute an ongoing drag on the Euro area. However, the risk of a crisis, like the one in Thailand, seems slight to us. The latest move by the G20, which enhanced the IMF’s firing power, is clearly not enough to boost these economies back to pre-crisis performance rates, but it certainly lowers the probability of an extreme scenario.
Q Credit event in sovereign land: We do not think that a credit default will happen in Europe, as we believe that other countries have a strong interest in helping the country in trouble. However, we would certainly not fully exclude a credit event involving debt rescheduling or some liquidity issue (such as a default on a coupon or difficulties issuing new debt), which could lift the risk premium again.
Q Bank issue: While the Irish case is well known, other banks in Europe could be in serious trouble as well. We note in this sector that a big question mark hangs over Spain, but the risks could come from other parts of the Euro area, with exposure to Eastern Europe remaining a key source of risk.
Non-conventional measures everywhere At the time of writing, the Bank of England and Swiss National Bank already Everybody at or close to ZIRP have or are close to a zero interest rate policy (ZIRP). The ECB is not there yet, but is very close, with the refi at 1.25%, and ECB President Trichet has already said that another cut is coming. Money market rates are anyway already very close to zero. Similarly, Sweden’s Riksbank will likely ease to just 0-0.25% from an already low 1.0%. Only Norway’s Norges Bank appears an outlier, courtesy of a more resilient economy, but we nevertheless expect the bank to follow the ECB and cut to 1.0% in Q3.
ZIRP is not enough, however. The recession will be the worst since World War ZIRP is not enough II for most of these zones, bringing the output gap to unprecedented levels. Moreover, inflation will be very low, and even in negative territory for several months in a number of regions. Consequently, Taylor rules in most of these regions are dipping into negative territory. Although we have only limited confidence in Taylor rules, we take this as a sign that ZIRP is not enough and that more needs to be done. Non-conventional measures are now key.
Table 5: UBS European and US rate forecasts
Current 09 Q1F 09 Q2F 09 Q3F 09 Q4F 10 Q1F 10 Q2F 10 Q3F 10 Q4F Euro area ECB refi rate 1.25 1.50 1.00 1.00 1.00 1.00 1.00 1.00 1.00 UK MPC repo rate 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75 Sweden Riksbank repo rate 1.00 1.00 0.25 0.25 0.25 0.25 0.25 0.25 0.75 Norway Norges Bank deposit rate 2.00 2.00 1.25 1.00 1.00 1.00 1.00 1.00 1.00 Switzerland 3M Libor target rate 0.25 0.30 0.30 0.25 0.25 0.25 0.25 0.25 0.25 US Fed funds rate 0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0.50 0.75 1.00 Euro area 10 years 3.22 4.15 2.50 2.70 2.80 3.00 3.20 3.30 3.40 UK 10 years 3.42 3.31 2.50 2.25 2.25 2.50 2.75 3.00 3.50 Sweden 10 years 3.25 2.99 1.90 1.70 1.80 2.00 2.30 2.50 2.70 Norway 10 years 3.97 3.78 3.60 3.30 3.40 3.60 3.60 3.80 4.00 Switzerland 10 years 2.18 1.90 1.90 2.00 2.00 2.00 2.10 2.25 2.25 US 10 years 2.87 2.40 2.60 2.80 3.20 3.50 3.70 3.90 4.00
Source: Bloomberg, UBS estimates
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European Banks 30 April 2009
ECB At the time of writing the ECB has cut rates to 1.25%, but President Trichet has Going to non-conventional signalled that another 25bp cut will be forthcoming. Therefore, we expect the refi rate to fall to 1.00%, with the deposit rate remaining at 0.25%. During the last press conference, Trichet stated clearly that the ECB would announce more non-conventional measures in May. We see a strong likelihood that this will comprise a package of measures involving more intervention in the money market. This is probably the best decision, as the transfer mechanism (i.e. the ability of banks to lend to the economy) is fundamental to the Euro area. That said, we obviously do not know for certain what will be implemented, and will have to wait before we assess the decision.
Bank of England The Bank of England is already at ZIRP and has implemented the most QE for a long period commented on quantitative easing strategy. This is likely to remain for a long period. Based on past behaviour, the Monetary Policy Committee (MPC) has waited for the composite PMI balance to reach c55.0 before starting to raise interest rates. In fact, that figure is the long-run average of the series and is consistent with GDP growth of 0.6-0.7% q/q. Activity is likely to only barely reach these levels towards the end of next year, so if our forecast is correct, interest rates will probably start to rise then.
Riksbank We expect the Riksbank to ease to close to zero anytime soon. Thereafter, we The Riksbank will ease to just 0.25% expect the implementation of a programme of asset purchases, which should further help ease credit conditions and support the recovery. Please see our recent Nordic Economic Focus: Swedish quantitative musings: UBS cross-asset view, published 20 March 2009. Note that we also expect the Riksbank to start hiking rates in late 2010, as the signs of a recovery are confirmed.
Norges Bank We expect the Norges Bank to cut to 1% in early Q3, which is broadly in line We expect Norges Bank to with Norges Bank projections. The Norges Bank expects a sharp recovery in the cut to 1% in Q3 economy in 2010 and rates to start increasing again in second quarter 2010. In our view, these projections are optimistic, as we believe rates will stay lower for longer.
SNB We expect the SNB to remain unconventional for longer. With the likelihood SNB to stay unconventional for longer that negative inflation will remain into 2010 and beyond, our prime concern is with negative nominal wage gains for the Swiss economy. Accordingly, we expect the SNB to remain active for longer. The widespread mix of unconventional measures applies to money markets, capital markets and FX markets, with the SNB directly influencing relative prices. That said, the SNB is unlikely to set quantitative targets for its direct market interventions. Indeed, the SNB has made it clear that it will rigorously combat any further CHF appreciation, primarily versus the EUR. The risks are that the ongoing re- positioning out of CHF funding positions by investors, primarily in Eastern Europe, pushes the EURCHF above the 1.50 level, which is against the explicit will of the SNB.
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European Banks 30 April 2009 From dogmatism to pragmatism The policy response to the financial crisis has moved away from regulatory purity to the pragmatic need to ensure bank survival in the near term and then allow an appropriately considered response in the longer term. Nowhere is this more apparent than the recent introduction of new government supported, so called, core Tier 1 capital instruments in a number of jurisdictions. Whether it is “B” shares in the UK, preference shares in Ireland or participation capital in Austria and Germany, the end result is similar, to create a core Tier 1 instrument from a regulatory perspective to help manage to bank capital to the level demanded by the market during difficult times.
In our view these instruments do not provide loss absorbing capital to deal with expected losses at individual banks but, arguably, such instruments may a role where an institution is solvent but suffering from cyclical capital stress. Given that this capital meets the regulatory definition of core capital but is not loss absorbing, we regard it as a form of “buffer” core Tier 1; fine for temporary use but not much good as permanent operational capital. To this end, we note the comments in the recently announced US capital stress test programme which observed “the traditional role of capital, especially equity, is to absorb unexpected losses” and the likelihood of the realisation of substantial “unexpected” losses from legacy positions implies a need for greater levels of equity capitalisation.
To analyse the role of buffer capital, we first consider the role of capital within the banking sector. In our view there are four ways of considering the viability of both individual banks and, at an aggregate level, the banking system.
Q Does it meet regulatory capital requirements? This is effectively a test of whether a bank meets the tests set by its regulators and/or those demanded by the market to maintain confidence and allow the bank to keep operating.
Q Is it solvent from an accounting perspective? This is a test of whether a banks net assets, with appropriate valuation applied to its assets are in excess of its liabilities.
Q Does the value of the banks future income offset the present value of its liabilities? In our view, it is possible that a bank could fail both of the above tests and still have positive economic value. Such a bank could be regarded as having “zombie” status but provided it can retain market confidence and remain liquid, there is a potential path back to viability.
Q Finally does the bank have positive value if put into liquidation, ie if we realised the value of a banks assets today on a forced sale basis, would their value exceed that of the banks liabilities.
On this latter point, we think the answer is simple, for all banks, no. If you were to liquidate any bank globally we have no doubt there would be a significant shortfall between the realisable value of its assets and the face value of its liabilities. The reasons are simple enough; first think of the discounts at which a significant number of AFS securities trade relative to what banks consider to be the fair value and likely realisable value if these securities are held to maturity. This discount largely represents a liquidity discount and largely reflects the fact
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European Banks 30 April 2009 that there are no buyers for these assets at anything close to the original yield to maturity valuation. Now consider what discount would be needed for an even less liquid collection of bank loans. The required haircut would be substantial, even if funding could be obtained, because the required yield to maturity that would be needed to achieve an acceptable return is well in excess of what the loans yield when priced at par. Lehman Brothers paints a concrete example – Tier 1 ratio above 10% on Friday, 12 September 2008, senior debt virtually worthless on Monday, 15 September.
In our view, there are very few banks in Europe able to meet the first test if their assets were appropriately marked to market. However, this, in our view, is not necessarily surprising. The purpose of regulatory capital is to provide a “buffer” to allow banks to remain solvent and continue to operate through distressed times rather than being a standard that should be applied at all times.
If the market and/or regulators do not allow capital levels to decline in downturns below a certain predefined market standard then in reality a buffer above this level is required to provide the headroom to be utilised during a downturn, ie if 7% is the minimum in a downturn, then you probably need in excess of 9% in the good times to make sure you do not breach 7% in the bad.
Solvency on an accounting basis is a less challenging hurdle for the sector to meet. The question is not whether an arbitrary capital ratio is met but whether the capital that the bank has is positive. If a bank is allowed to have regulatory buffers, it appears to us that such should be used during the downswing of a cycle. Forbearance is, in our view, an acceptable policy provided it is for a limited period of time and that ratios are rebuilt to a more acceptable level once the crisis has passed.
In our view, most European banks are solvent on this, weaker, measure. At a broader level, the test for positive economic value is a measure of a banks ability to operate, repay its debts and generate/rebuild capital for future use. For a banking system to operate, it must be able to fund itself and thus remain liquid – this highlights the crucial role that governments and central banks now undertake through the provision of liquidity into the system. From zombie to Lazarus Like Japan in the 1990s, we have a situation where a number of European banks do not presently have adequate capital to absorb their expected losses and meet “well capitalised” market expectations. The question is whether it is possible to work our way back to a normal functioning banking system from here. There has been much debate on the risk of creating “zombie” banks, banks that are functioning but are technically insolvent. If managed appropriately, the creation of a zombie banking system is the first step towards a banking system that like Lazarus comes back from the dead. This is what Japan did in the 1990s and we discuss the mechanics in more detail below.
Even if a bank is technically insolvent, we believe that with a supportive regulatory and policy framework, it is possible for a bank to rehabilitate itself and eventually regain solvency, albeit that there may not be much to interest equity investors for a significant period. Let us take a hypothetical bank with assets of 1 trillion, liabilities of 900bn and hence a net worth of 100bn. Let us
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European Banks 30 April 2009 also suppose that a portion of the banks assets, say 200bn, comprise essentially worthless ABS, CDOs and property development lending. The bank is effectively insolvent. On a mark to market basis, its net worth is negative 100bn.
However, on an economic basis, the bank may not necessarily be worthless. Let us assume that the bank can generate a spread of 3% and with current interest rates it is paying ½% on its liabilities and earning 3½% on its assets.
In this scenario in a normal environment (where it did not have 200bn of worthless assets), the bank would earn 35bn on its assets and pay 4.5bn on its liabilities. If we assume other income, costs and normal impairment broadly offset for the sake of simplicity, the bank would generate pre tax profit of 30.5bn.
If we now consider the example of the impaired bank, its real income generating assets are only 800bn on which it generates 28bn of income but still has to pay 4.5bn on its liabilities, thus in this scenario it generates pre tax profit of 23.5bn. On this basis the bank would be solvent within about four years and be fully recapitalised within eight years. On this basis, the bank has a positive economic value; a zombie bank would, like Lazarus, walk again.
We also note that the structure of interest rates has a very significant impact on the ability to recapitalise this way. For example, consider the above example of a bank with 1000 of assets of which 200 are impaired and a margin of 2% under three scenarios; the first, as above, where the cost of funds is ½% and then when the cost of funds is 5% and 10%:
Table 3: Recapitalising banks is easier when rates are low
Policy rates ½% 5% 10%
Interest income on performing assets (800bn) 28 64 104
Interest expense on liabilities (4.5) (45) (90)
Operating income 23.5 19 14
Source: UBS
Another way of looking at this is the observation that funding NPLs is easier in a low interest rate environment than a higher interest rate environment. Either way, the conclusion is that banks that have a robust annuity stream can eventually manage through moderate insolvency or periods of weak capitalisation to become viable institutions once more. Clearly the process is more suited to commercial /retail banks with annuity driven revenue streams as opposed to wholesale funded investment banks where the cost of liabilities is more likely to be determined by market forces (eg CDS spreads) rather than policy interest rates.
The determinants of whether the process can work will be the level of impaired assets, the level of annuity income at each bank and the ability to maintain confidence/liquidity. If the bad assets are sufficiently large then the institution has gone beyond the point at which its cash flow will be sufficient to recapitalise it within a reasonable timeframe. Alternatively, if a bank is in a position where is capital base is under strain for cyclical reasons, then the provision of short term “buffer” capital by authorities may be an appropriate response to avoid contributing to a more systemic failure.
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European Banks 30 April 2009
The point of “buffer” core capital So when it comes to rescuing the financial system, the type and amount of capital required is largely dependent upon the financial position of each bank. A bank that is at risk of fundamental insolvency is likely to need a substantial infusion of pure equity unless it has no other alternative than to operate as a zombie bank for an extended period while it gradually tries to transform itself back into a viable entity through the "Lazarus" process.
Success here will be dependent upon the institution being able to take sufficient time to work through its problems and market forbearance. More realistically, we think there is a point to "buffer" core Tier 1 capital when an institution is fundamentally solvent but capital ratios are cyclically depressed and because of this, there is unwillingness by the market to fund capital injections into the bank to restore the core Tier 1 ratio to an appropriate level.
In our view, instruments such as “B” shares in the UK, preference share in Ireland or participation capital in Austria, are essentially “buffer” capital in that they allow core Tier 1 to be reported at a level acceptable to debt markets and senior creditors to ensure the business is able to retain confidence, continue to operate and remain liquid while allowing the true equity account to bear the cyclical impairments associated with the downturn. To this end, if a bank is able to absorb losses and rebuild its core equity (excluding the “buffer” core Tier 1) to acceptable levels, then the business has a viable future. We regard it as axiomatic that for a bank to be regarded as “normal” and be in a position to pay dividends to shareholders, the core equity Tier 1, excluding “buffer” core capital has to be at a satisfactory level.
To this end, we see a fundamental difference between RBS and Lloyds respective capital positions. RBS has a high dependence on UK government “B” share capital. Without the benefit of this capital, RBS’s core equity Tier 1 ratio would be below 2% by 2010e. As a consequence of this, we see little alternative than for the “B” capital to be converted to common equity. We suspect that it will be a considerable time before RBS can consider paying a normal dividend to ordinary shareholders.
Chart 1: RBS – shareholder involvement is highly leveraged
14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 2008 2009E 2010E 2011E 2012E 2013E
Tier 1 ratio Core equity Tier 1 ratio Core Tier 1 ex "B" Shares
Source: UBS estimates
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European Banks 30 April 2009
Conversely, Lloyds is in a more robust position. Even without the benefit of the UK government “B” shares, the core Tier 1 ratio would be above 5%, although, as a marginal offset, we note that Lloyds benefits from a higher level of insurance capital within its core Tier 1 than is the case at RBS. The attraction to us of Lloyds is not only has it been recapitalised beyond what is needed to absorb expected latent losses within the balance sheet but those losses have also been economically capped which removes tail risk to shareholders.
Chart 2: Lloyds – better positioned for earlier dividend resumption
25.0%
20.0%
15.0%
10.0%
5.0%
0.0% 2008 2009E 2010E 2011E 2012E 2013E
Tier 1 Core Tier 1 Core Tier 1 ex "B" Shares
Source: UBS estimates
In Austria, the same is true for Erste Bank. We estimate a true core Tier 1 ratio 2009E of 5%, significantly below the 7.1% "buffer" core Tier 1 ratio and the 8.1% Basel II Tier 1 ratio including market and operational risks. The relevant capital ratio under Austrian regulation is the Tier 1 ratio only including the banking book which we think will even stand at 9.2% at year-end 2009.
Chart 3: Erste Bank – true core Tier 1 rebuilds healthily
10.0%
8.0%
6.0%
4.0%
2.0%
0.0% 2008 2009E 2010E 2011E 2012E 2013E
Tier one Ratio Core Tier 1 ratio Core tier 1 ratio ex Participation Capital
Source: UBS estimates
The situation in France is more complex; last year the French government set aside a €40bn package of which €10.5bn was given to biggest banks in the form of subordinated debt. The second tranche of the same amount was always planned for this quarter. What is new is that banks will now have the choice to take the new tranche either as subordinated debt or as core securities. The core
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European Banks 30 April 2009 securities are non-voting, not redeemable by the subscriber and not convertible. They sit in the share premium and are therefore pari passu with equity upon liquidation or after retained profits have been utilised to fund losses.
The difference between some of the other government packages therefore is that this is loss absorbing while the group is still a going concern (Unlike KBC for example, where it is only so at liquidation) and the common equity holder doesn't have to be 'zeroed' first. BNP Paribas has taken €5.1bn (including converting the first tranche of subordinated debt of €2.55bn), SocGen has yet to decide but will likely take €1.7bn while CASA is choosing not to take any, for now. Participation in the issue takes BNP’s core T1 to 6.4% (+70bp, post Fortis), and SocGen to 7.1% (+50bp and double this if they do like BNP Paribas and convert their first sub. debt tranche). The impact of conversion Table 4 summaries the impact of conversion of these “buffer” capital issues across the European banks sector. We put a high likelihood of this happening for Banco Popolare, Unicredit and MPS and significantly less likely for Intesa and BPM. In France, the figure for SocGen is our estimate of likely take-up.
Table 4: EPS and NAV impact from conversion of buffer capital at current share price
Local currency Capital New 09E EPS % chng New 09E BVPS % chng New 09E PER New 09E PBR
Greece
NBG 1252 1.35 -13% 8.98 10% 10.7 1.6
Eurobank EFG 1025 0.37 -20% 5.58 0% 15.2 1.0
Alpha Bank 967 0.29 -17% 4.55 10% 22.3 1.4
Piraeus Bank 724 0.23 -22% 6.75 -2% 27.0 0.9
ATE Bank 427 (0.03) -28% 1.03 7% (37.0) 1.2
Italy
Intesa Sanpaolo 4000 0.19 -12% 2.46 -1% 12.4 0.9
BPM 500 0.31 -22% 7.07 -11% 13.1 0.6
Unicredit 4000 0.13 -13% 2.54 -4% 13.9 0.7
Banco Popolare 1450 0.37 -31% 8.52 -16% 13.1 0.6
MPS 1900 0.10 -18% 1.33 -2% 12.7 0.9
France
BNP Paribas 5100 3.12 -13% 42.61 -1% 12.3 0.9
SocGen 1700 3.09 -7% 50.12 -2% 12.4 0.8
Ireland
Allied Irish 5000 (0.08) -87% 2.10 -80% (10.1) 0.4
Bank of Ireland 3500 0.10 -84% 1.64 -76% 6.4 0.4
Other
Erste Group 2700 0.57 -35% 14.68 3% 27.3 1.1
Commerzbank 17150 (0.66) -74% 6.15 -33% (7.7) 0.8
Source: UBS estimates
UBS 12
European Banks 30 April 2009 Key stock calls Erste Bank – Buy, PT €18 Further upside to our price target, despite recent rally Erste Bank’s share price is up almost 140% from its trough at the end of February. Erste now trades at 0.6x stated P/NAV or 1.1x tangible P/NAV. With the ROTE (return on tangible equity) soon likely to be again in the mid-teens, we see some upside potential to our €18 price target. While we cannot exclude the possibility of some short-term profit taking, we feel very comfortable with a Buy rating on Erste Bank on a 12-month time horizon.
Erste Bank will receive some government money Erste signed an agreement with the Austrian government, and will receive €2.7bn of participation capital and potentially some hybrid capital. The participation capital is non-voting, non dilutive, non-cumulative and ranks pari- passu with equity capital, and is not convertible into ordinary shares. The conditions of the package are, in our view, a positive. Given our assumption that Erste will likely still produce a small profit in 2009, we think a 2009 Tier 1 ratio of 9.2% or 8.1% including market and operational risks is high enough. We do not expect further capital measures and think that Erste’s cumulative earnings over the coming years would be enough to pay back the Partizipationskapital. That said, we cannot ignore Erste deciding to replace some of the Partizipationskapital with a capital increase.
A lower risk profile We upgraded Erste Bank to a Buy rating in February, as we think the following points are overlooked and distinguish it from its peers: (1) Erste’s CEE loan-to- deposit ratio is less than 100%; (2) it is likely to receive shareholder-friendly government capital; (3) its 2009 funding is safe; (4) the loan book is almost entirely exposed to EU countries; (5) risk absorption capacity is significant; and (6) FX loans represent ‘only’ 35% of the total CEE loan book compared with an industry average of c50%.
NPLs will increase significantly; still profitable We expect CEE non-performing loans (NPLs) to increase from c3% in Q3 2008 to 8% in 2009 and 10% in 2010. The corresponding risk charge would more than triple from 91bp in nine-month 2008 to 336bp in 2009 and 242bp in 2010. A pre-provision profit of almost €3 billion and a pre-provision margin of c4% in CEE represent a significant buffer for a CEE loan book totalling c€48 billion.
Valuation Our price target is based on a Gordon growth model, and uses a 9.5% sustainable ROE (8.5% previously), and the average of our 2011 and 2012 ROE forecasts (a cost of equity of 12% and a perpetual growth rate of 4%). We think the market will be ready to partly factor in this higher ROE level again, whereas our previous price target assumed that the market would price in a depressed ROE level. We do not preclude Erste Bank from being able to deliver a ROE of more than 13% in future years, but we regard the level in our valuation model as a realistic blended average number for short-term pressure on ROEs followed by a medium-/long-term recovery.
UBS 13
European Banks 30 April 2009
HSBC – Buy, PT 530p Investment case HSBC is now in the group of European banks that can be said to be done with their recapitalisations. Many others may manage to avoid issuing stock but we believe this conclusion is a far from certain one, outside of Standard Chartered, Lloyds and RBS. In our view, HSBC raised equity to be able to take a reasoned view on its ‘stress’ positions – Household and the Available-for-Sale (AfS) book. And provide it with the luxury of having time to manage these positions out in order to maximise the potential return to shareholders through to maturity.
We believe we are still early in the credit cycle. HSBC ex Household is less credit intensive than most banks, with higher margins, less dependence on credit as a proportion of income, and a diversified, relatively short-dated and secured loan book. This emphasises why it is likely to remain highly resilient to credit impairments – lending is a low proportion of income, even before considering the relatively low-risk nature of its loan book, which is short-dated or highly secured.
Successful Treasury positioning will likely keep the deposit-squeeze wolf from the door this year, though the Treasury benefits would fade if rates remain permanently low
While we recognise that Household remains a drag, further downside from the 24% losses we already discount on the runoff book seems moderate as the US stimulus package kicks in.
Valuation We believe HSBC is well positioned to meet its goal of a US$0.08 quarterly dividend through this year and to grow it robustly thereafter. A prospective yield over 4% in a zero rate environment should provide strong support to the stock.
Completion of the rights issue led us to reduce our cost of capital for the group to 11.5%, from 13%. Together with the dilution resulting from the issue, these inputs drive our one-stage Gordon growth-derived price target, taking our PT from 450p to 530p.
UBS 14
European Banks 30 April 2009
Intesa – Buy, PT €2.3 Investment case We see Intesa as one of the banks best placed to face the current challenging economic environment, given its strong capital and liquidity position, sound asset quality and potential to further reduce its cost base.
Q Well positioned: Intesa is mainly a domestic play in the Italian market, which has avoided credit excesses and is – so far – seeing a relatively contained rate of NPL increases. We expect further efficiency gains to come (costs -3% y/y), as the full integration and restructuring plan is rolled out onto the network.
Q Well equipped: Core Tier 1 is 6.4% at year-end, moving to more than 7% as a result of the €4bn government capital to be received over the next few months. We do not see meaningful dilution risk in the case of Intesa, given the government capital is meant to provide a form of ‘equity bridge financing’ through the crisis and the forthcoming disposals (assets with a book value of €9bn and implying core Tier 1 deductions of €5bn). Intesa is liquidity rich: net positive inter-bank position of €5bn, loan-to-deposits below 1x and €56bn of eligible assets for the Central Bank, which provides a further buffer.
Risks to our view The key risk to our view is a much worse than currently expected macroeconomic deterioration in Italy and in the CEE countries where Intesa operates (main exposure is Hungary, 2.4% of group’s loans).
Valuation We believe a 0.9x tangible book to be very attractive for a bank that does not carry dilution risk, has a strong liquidity position and should generate returns close to its cost of equity both this and next year.
Potential catalysts Intesa will report its Q1 results on 14 May and will present a new industrial plan by the autumn. Disposals of non-core assets are possible this year, in our view.
UBS 15
European Banks 30 April 2009
Lloyds – Buy, PT 120p Investment case In our view, post four recapitalisations and the creation of an effective bad bank structure through the Asset Protection Scheme, we see the ongoing Lloyds as one of the lowest risk banks in Europe.
While Lloyds will be required to absorb the first £25bn of losses on the £250bn of assets placed in the APS, the company has been suitably capitalised to absorb this cost while maintaining a core Tier 1 ratio in the high single digits. As a consequence, we have a high degree of confidence in Lloyds not needing to come back to the market for additional equity capital which reduces the risk of further dilution to shareholders.
As well as a degree of certainty over share count and valuation, we also see the following attractions to Lloyds:
Q First, it offers a cost story. In an uncertain environment for European banks earnings, we find the potential cost savings from a domestic in-market merger to be highly attractive;
Q Secondly, we see scope for Lloyds to be a revenue growth story relative to peers. Not only will a significant amount of legacy HBOS business that was written on a loss-leader basis be repriced over time but we see significant attractions to being invested in an asset intensive balance sheet which has a net £100bn of exposure to mortgages at a time when UK mortgages are probably the fastest repricing asset class globally.
Valuation Lloyds is currently trading on 0.7x trough tangible book and c.4½x normalised earnings which we expect the company to deliver by 2011/2012e.
We have a 120p price target on Lloyds. Given that dilution risks are now minimal and that we expect Lloyds to be able to deliver a mid-teens RoE into the upswing of the next cycle, we think a floor on the stock of close to tangible book is warranted.
The valuation of Lloyds also has the additional benefit of having the right to subscribe for further shares proportionate to existing holdings at a price of 38.43p/share. The value of this right is approximately 26p/share currently.
UBS 16
European Banks 30 April 2009
Societe Generale – Buy, PT €45 Capital raising a possibility post the rally, but size matters It is possible that SocGen may use the recent rally to neutralise any capital raising arguments in the market by bypassing an injection of government core securities and raising common equity. The key with SocGen however is that the quantum of required capital is relatively modest. A capital raising to get to 8% core Tier 1 from these levels would leave the stock trading on a 1.1x tangible and some 8x ‘sustainable’ earnings, well below the long term average.
CIB strength is a welcome monoline offset We would not extrapolate the blow-out Q1 in CIB, however it should be a welcome buffer for monoline marks. Beyond that, regulatory pressure could hamper SocGen’s 17-20% RoE target for the division. However our simple sensitivity shows there is plenty to play for even if we do not get that far.
2009 to stay profitable, as CEE risk offset by French franchise We are comfortable with our loan loss estimates for the key Russian and Romanian units at 900bp and 600bp respectively for 2 years, well ahead of management stress tests. At the same time, we believe French retail banking remains one of the most resistant and cash generative in Europe and should be protected by negative swings in bond yields by falls in the Livret A rate.
Buy SocGen, Sell CASA We reiterate our Buy, and have increased our price target to €45 from €37 as we think the market is ready to factor in a higher sustainable RoE again of 10% (9% previously). While we cannot exclude some short term profit taking, we would buy SocGen against CASA which we feel is overvalued at 1.2x tangible book against SocGen’s 1x.
UBS 17
European Banks 30 April 2009
CASA – Sell, PT €5.4 Capital arbitrage deserves a discount, not a premium CASA’s share price has been one of the best performers in the sector year to date on the back of perceived capital strength. However we think the reported core Tier 1 of 8% in Q4 does not tell the whole story. Apart from the ‘advance’ from the Caisses Regionales of €3.6bn which will be turned into prefs, CASA is not deducting the part of its minority stake in the Caisses Regionales from its core Tier 1 calculation, as it must do in its regulatory Tier 1. At best, we think CASA is on 6.9%, a worst case on closer to 4.6%.
Emporiki will continue to weigh With loan losses at 526bp for the quarter, Emporiki is at more than double the level of Greek peers despite less SEE exposure. We understand that there are legacy issues, however given the years of CASA interest in the group, this suggests a more recent material deterioration in the €23bn loan book over and above broad asset qualities challenges in Greece. We see 300bp of provisions in 2009-10.
CASA CIB cannot just be seen ex the ‘bad stuff’ The focus of CASA’s CIB business had been on it being shielded from peers’ woes in investment banking thanks to its restructuring midway through last year. However, the group continues to make sizeable losses on ‘discontinued operations’ given residual assets and positions in both credit and equity derivatives, while it has sizeable monoline exposure.
Premium valuation not warranted CASA trades on 1.2x tangible book, a 20% premium to the other two listed majors. We are at Sell with a target of €5.4.
UBS 18
European Banks 30 April 2009
OTP – Sell, PT HUF 1,750 Downgrade to Sell after share price rally as concerns remain We recently downgraded OTP to Sell following the recent 80% rally in the share price. We regard a certain return of risk appetite for risky (CEE) assets as justified, but think OTP’s share price has gone too far. This is particularly true bearing in mind our unchanged fundamental concerns in areas such as capital base, NPL and LLP trends, funding structure, FX lending and regional exposures. We reduced our 2009, 2010 and 2011 EPS estimates by 4% as a result of OTP re-issuing treasury shares.
Our fundamental concerns on OTP have not changed. We discussed them in detail in our research (see A wide range of potential outcomes, published 26 November 2009, Downgrade to Sell, 17 February 2009, and Upgrade to Neutral – concerns remain, 19 March 2009).
Re-issuing treasury shares improves local capital ratios – nothing else OTP entered an innovative swap construction with MOL, which increases the local, unconsolidated capital ratio by 125bp, basically compensating for the negative effects in Q1 2009 arising from the capital injection in Ukraine, a weakening HUF as well as the share buyback. However, Basel II capital ratios under IFRS rules will remain virtually the same – in our view, a better reflection of the economic reality. Also, we treat this re-issuance of treasury shares as an ex-right capital increase, which is almost 4% EPS dilutive and, therefore, we adjust our EPS numbers.
HUF3,292 in a best case, HUF700 in a worst case Following the goodwill impairment in Q4, we think the market will focus on tangible NAV per share (we actually expect more goodwill impairments), which stands at cHUF3,292.
Our price target can be viewed as the weighted average of the tangible NAV per share (HUF3,292) scenario and the negative recapitalisation (HUF700) scenario.
Valuation We derive our price target of HUF1,750 using a one-stage Gordon growth model. We apply a 5.5% perpetual growth rate (quite generous, in our view, in a recessionary world), a 14% cost of equity (above the 12% level we apply for Erste Bank due to the higher risk geographical mix of OTP’s operation) and a 9% ROE level – a touch above our forecast 2010 level, but, more importantly, a reflection of the potential dilution risk.
While we do not deny the possibility that OTP could again generate ROEs above 10% at some point in the future, we think the market will implicitly factor in depressed ROE levels for now on the back of the current difficult operating conditions as well as the inherent dilution risk.
UBS 19
European Banks 30 April 2009
Sabadell – Sell, PT €3.7 1Q09 P&L – a lagging indicator of B/S risk We still expect Banco Sabadell to release a solid P&L account, driven by 8% NII growth (in our view, SAB has more flexibility to re-price assets than its peers, given the short average duration and also, unlike Popular, it has an ALM portfolio that partly hedged the IR risk), total revenues that are expected to remain flat YoY and gross operating profit of €298m (+2.4% YoY). Net profit will be affected by a more than 150% increase in NPL provisions and will decrease by 26%, down to €162m.
Credit quality expected to continue deteriorating sharply We forecast NPLs to be 3% and coverage to fall to 85%, as we expect Sabadell to release c€30m in generic provisions this quarter. Following the disposal of some RE assets, we expect the core capital to continue improving, up to c7% in 1Q09
The capital debate on Spanish banks has just started SAB’s core Tier 1 under Basel II stands above that of its Spanish peers, However, our estimates for NPLs (5.2% in 2009, 9% in 2010), assuming a 50% cov ratio and the use of generic provisions in 2009, could put some pressure on capital in 1H10 and onwards.
Valuation: Remain underweight; SAB still a key Sell Our price target reflects P/BV. Despite Sabadell underperforming the EU banking sector by 20% YTD, it still has outperformed the sector by 15% over the past year. In addition, it trades on 1.3x NAV 2009E – a c20% premium to EU banks, which we do not think is justified, given our expectations of a very weak macro outlook for Spain.
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European Banks 30 April 2009
Santander – Sell, PT €4.3 Investment case We consider Santander a very well managed bank but we think that its premium relative to the sector is excessive and will progressively fall, given the macro challenges the bank is expected to face – particularly in its home market.
Our economists have reduced their GDP forecasts for 2009 for Spain from -2.7% to -4% – now expecting a severe recession. Recent macro and sector data, notably unemployment and NPL formation, have surprised us and most investors negatively. We expect NPL to more than double in the course of 2009 and the coverage to fall further to close to 50%, which we see as the lowest threshold before incorporating adjustments in the valuation.
With a core Tier 1 (c7%), NPL coverage (91%) in line with most European peers and the crisis fast moving from capital markets into the real economy, we believe that the premium to sector will be progressively challenged and will eventually be reduced.
Further challenges for Santander include the integrations in the UK (30% of group’s loans) and the restructuring of Sovereign in the US (6% of loans), two geographical areas which have also been significantly hit in the current crisis.
Risks to our view We think that the main upside risk to our very cautious view on Spanish banks and Santander lies in better than expected results in the first part of 2009 owing to the release of generic provisions and to the mortgages re-pricing process in the context of falling inter-bank rates. These would be however non recurrent items that would not change the medium term picture for Spanish banks.
Valuation Santander trades at 1.5x tangible equity, which compares to the European sector on c1x. Our price target has been set in line with its tangible equity of €4.3.
Potential catalysts Beside the release of Q1-09 results over the next few days, we think that the main catalysts and data points for the Spanish banks will be the ongoing restructuring of the savings banks sector and its implications for the listed banks and the monthly disclosure by Bank of Spain of sector and asset quality data.
UBS 21
European Banks 30 April 2009
Standard Chartered – Sell, PT 780p We rate StanChart as a Sell. The very rapid appreciation in the stock price over the last six weeks has left the stock ahead of itself in our view.
Consumer struggling A higher multiple means that more details matter and the Consumer Bank is seeing a sharp deterioration in profitability. H2 08 divisional PBT was back to 2001 levels. With revenues continuing to fall in H1 09 and no significant cost programme, we expect a further fall in PBT in H1 09E. This year could see 85% of group PBT delivered by Wholesale.
Chart 4: Consumer PBT by half year since 2001 (US$ m)
1,000 900 800 700 600 500 400 300 200 100 0 1H01 2H01 1H02 2H02 1H 2H03 1H 2H H1 H2 H1 H2 H1 H2 H1 H2 03 04 04 05 05 06 06 07 07 08 08
Source: Company data
Even a robust Wholesale Bank can only take you so far We do not subscribe to the idea that StanChart’s Wholesale earnings are lower quality than Consumer. Indeed, with only one real competitor (HSBC) still standing, the FX, trade finance and rates businesses are amongst the highest quality earnings streams any bank enjoys. But without Consumer returning to growth – at best a 2010 prospect – we believe the group will struggle to grow its bottom line, as Wholesale margins are probably at peak levels. Wholesale bad debts remain modest but as the cycle progresses are set to rise.
Valuation: Close to historical averages; elevated in relative terms At 11.5x 12-month forward earnings, StanChart is still below its 13.1x average but as we see growth likely absent before 2011, compared with historical growth around 15%, this is still a relatively challenging level, as is the 1.9x tangible NAV multiple – well over twice that of the sector. Our price target is based on a one-stage Gordon growth model.
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European Banks 30 April 2009
Chart 5: Top/bottom 10 European banks – performance YTD
CS Group (54.9%)
Barclays (52.7%)
Bankinter (42.6%)
CASA (28.9%)
Raiffeisen Intl Bank (27.2%)
BNP Paribas (26.4%)
Vontobel (14.1%)
Mediobanca (13.9%)
NBG (8.7%)
HSBC (-19.1%)
MPS (-20.1%) Lloy ds Banking Group (- 20.2%) Bank of Ireland (-23.3%)
Commerzbank (-23.9%)
KBC (-25.9%)
EFG International (-27.5%)
RBS Group (-30.6%)
VP Bank (-42.9%)
AIB (-51.5%)
-60.0% -40.0% -20.0% 0.0% 20.0% 40.0% 60.0% 80.0% YTD performance
Source: Thomson Datastream
Chart 6: Top/bottom 10 European banks – performance from trough
Bank of Ireland (412.0%) Barclays (357.5%)
RBS Group (233.0%)
AIB (211.1%)
KBC (189.1%)
Banco Popolare (166.1%)
UniCredit (160.5%)
IL & P (160.3%)
Deutsche Bank (156.3%) Lloy ds Banking Group (149.4%)
Marfin Popular Bank (50.4%)
LLB (46.9%)
Banco de Sabadell (44.1%) Banco Espirito Santo (37.1%) BPI (34.8%)
Agricultural Bank (22.4%)
BCP (22.0%)
SGKB (21.2%)
Bank Sarasin (20.9%)
Banif SGPS (4.9%)
0.0% 50.0% 100.0% 150.0% 200.0% 250.0% 300.0% 350.0% 400.0% 450.0% Performance since trough
Source: Thomson Datastream
UBS 23
European Banks 30 April 2009 Country views France We consider the French banks to still be defensive on fundamentals within a pan-European context, but this – excluding SocGen – is already in the price. Exposure to capital markets earnings, asset management, and structured products gives rise to potential sources of negative surprise into 2009/10.
The French banks have gone from being perceived as relatively well capitalised midway through last year to less so this year following the raft of recaps across the sector. The banks have yet to receive common equity in the latest round of bank recapitalisations, partly due to the fact that they've navigated through the crisis in better shape than many peers and so are reluctant to run the risk of diluting existing shareholders.
Instead they took a first tranche of government subordinated debt last year and this year are either converting that into core government securities or issuing new government core securities. BNP is taking around €5bn and SocGen is expected to take around €1.7bn, we regard this as a classic case of the injection of “buffer” core Tier 1, although we would expect more of a move to build up capital than was demonstrated by the payment of cash dividends for 2008.
The French banks are now between 6.4% - 7.5% core Tier 1 with SocGen at the higher end and BNP at the lower end. Our sell case on CASA is based on the fact we think they have got several elements within their definition of core capital we would consider debatable.
In terms of need for common equity moving forward, we think the risk is highest for BNP as despite the French banks' diversification benefits, they still have sizeable volatile capital markets operations, which accounts for around a third of their equity allocation and earnings across the cycle so anything less than 7% core Tier seems challenging, especially taking into account a big acquisition like Fortis to digest. If the price of BNP moves significantly above book value, we suspect there will be significant risk of an opportunistic equity issue.
In our view a key for these banks moving forward in terms of whether and how much more capital they need is more a function of the outlook for risky assets and in particular the large monoline hedged notionals in corporate CDOs and CLOs, rather than the normalised credit cycle, given that the French have a high pre-provision profit buffer to withstand traditional loan losses ramping up substantially. Germany From an investment perspective, rather than a homogenous sector, we continue to see Germany as four individual cases; an investment bank; a real estate play which is in the process of nationalisation, a belated M&A story and a consolidation synergy play. To us, DBK remains a geared market proxy. We remain cautious on the stock and questions over the capital position of the bank will continue to linger while the company remains the only major investment bank not to have raised additional equity throughout the entire financial crisis
UBS 24
European Banks 30 April 2009 with the monoline exposures the most significant issue facing the company in the near-term.
Deutsche Bank has a Tier 1 of 10% of which hybrid capital contributes 3%, leaving the core Tier 1 at around 7%. Deutsche’s target is to maintain its Tier 1 capital levels at 10%, so capital preservation and hence maintaining profitability is a key issue. The biggest risk factor at the moment is, in our view, its exposure to monoline insurers where the credit adjustments are marked using credit agency ratings instead of against the CDS spreads. If they marked this exposure in the same way as more conservative peers, we believe it would require an additional €2-3bn charge in respect of CVA’s, although it should be noted that some of this exposure is of fairly short duration. Deutsche has exposure and in the event of a need for a substantial equity injection, we believe the company would have to turn to the government for funding.
Commerzbank recently reported combined numbers with Dresdner. These indicate that it has a 10% Tier 1 ratio based on 2008 pro-forma numbers, around 1.5% of this is normal Tier 1 hybrids, but a further 5-5.5% is silent participations, effectively “buffer” core Tier 1, loss bearing preference shares that need to be repaid at par. If you were to strip this out, the core Tier 1 would be 3.5%. Currently the participation capital is counted as core Tier 1, but the EU is close to agreeing that silent participations will no longer count as core capital in ten years time.
If Commerzbank were able to begin rebuilding capital, this would be less of a concern but the company has flagged that it expects to deliver a substantial loss for 2009, including restructuring charges that could easily reach E4-5bn. Thus the end-2008 Tier 1 ratio of 10% is likely to drop below 8% over the course of 2009. Excluding silent participation capital this would imply a c.2% core Tier 1. Absent moves to create a “bad bank” solution, for Commerzbank, is hard to regard the bank as having long-term zombie status.
Postbank is a similar story, in that it has a low Tier 1 ratio. It reports under Basel II deducting unrealised losses on AFS securities from Tier 1 capital – in that sense they are quite conservative. Postbank has roughly 6% core Tier 1 capital. Both Postbank and Commerzbank would be highly geared to any form of in- house bad bank that is currently under discussion by the government, perhaps allowing the banks to spread their losses on structured credit over 10 years or so. Greece Since accession to EU membership, conventional wisdom on Greece has suggested that funding of external balances such as an ongoing current account deficit would not be an issue of concern. Indeed as the IMF put it in a 2007 staff report:
In view of Greece's EMU membership, the availability of external financing is not a concern, but the correction of cumulating indebtedness could weigh appreciably on growth going forward. While the risk of transmitting vulnerabilities to the euro area is very small reflecting Greece’s small relative size, large persistent current account deficits would increase the vulnerabilities to a reversal in market sentiment, leading to a corrective retrenchment of private sector balance-sheets in the face of rising
UBS 25
European Banks 30 April 2009
indebtedness, and a possible appreciable rise in the cost of funding over time. These developments would have significant negative implications for growth.
Greece: 2007 Article IV Consultation - IMF Staff Report
Unfortunately, as the chart below of yield spreads of Greece and other high yield Euro-members shows, this supposedly axiomatic truth may well be in danger of failing. It is by no means certain that EMU membership provides certain low cost external financing. The countries that, like Greece, are seeing spread divergence with the core Euro-zone countries – Ireland, and Spain have borrowed excessively leading to high current account deficits creating concern over their ability to continue raising external funds with implications for implicit solvency of each nation-state.
Chart 7: Selected Euro government debt – spread over Germany
3.000 2.500 2.000 1.500 1.000 0.500 0.000 -0.500 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Sep-05 Sep-06 Sep-07 Sep-08 May-05 May-06 May-07 -1.000 May-08
Greece Italy Ireland Spain
Source: Bloomberg
Clearly, the nature of the Greek bank story has been changing with the growth story of the past 5-6 years giving way to a significant slowdown, high current account and budget deficits and concerns over CEE/SEE exposures. Although the Greek banks do not look particularly attractive on a Price/Tangible Book basis but expected RoE with little risk of dilution and the longer-term hope of consolidation provides better valuation support than elsewhere. In terms of PER and Price/GOPS they also look relatively attractive which supports a neutral/overweight call in a European context. Italy The outlook for Italian GDP has worsened considerably over the last quarter. The OECD recently revised their forecasts and now estimates that Italy's GDP will fall by 4.2% in 2009 and indicated that it thought that Italy would not come out of its recession until "sometime" in 2010 at the earliest. UBS expects a 3% Italian GDP contraction in 2009 to be followed by modest recovery with 0.7% growth in 2010; the 2009 contraction continues to be mainly the result of indirect impacts, Italy has avoided credit excesses seen in a number of other Eurozone countries. With few exceptions, banks have also avoided pitfalls of excessive leverage, extreme business models or excessive exposure to investment banking, albeit that the size of Unicredit’s balance sheet gives rise to some cause for concern.
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European Banks 30 April 2009
The Italian banks have increased their core Tier 1 to of around 7% (2008 pro- forma) driven partly by the issue of €10bn of government capital in the form of “Tremonti bonds”. This has removed the short-term dilution risk, although we again largely consider the capital to be essentially “buffer” capital and repaying the capital introduces dilution risk in some banks.
In Italy, we segment the universe into three categories:
(1) Those who have not needed to take government money (UBI 7.1% core Tier 1, Mediobanca 10%);
(2) Those who have taken it but have a clear reimbursement plan (Intesa 6.4% pre government money with disposable assets with a book value of €9bn to finance repaying €4bn to the government; BPM with core tier 1 of 7% taking €500m from government, but issuing a convertible bond for the same amount);
(3) Those who have taken the money but do not know if and how they will reimburse it (Banco Popolare with a core tier 1 of c5.5%, excluding government bonds, took €1.45bn, Unicredit with a core tier 1, excluding government preferences, of 6.6% took €4bn, and MPS with a core Tier 1 of 4.6% took €1.9bn). For these banks we are or will factor in future dilution into our valuation.
Italian banks appear to be attractively valued (80% of tangible book on average). We expect their funding structure, the below average leverage of the Italian household and the above average cost cutting potential to continue to support Italian banks relative performance to the sector. Intesa remains our key pick which combines a solid capital base, a focus on retail, better than average asset quality and healthy funding. We also consider the valuation attractive, at less than 85% of tangible book. Spain and Ireland The gravity of the economic outlook is clear in Ireland and Spain is moving in the same direction. Both economies are guilty of having “over-converged”. Membership of the Euro fuelled a convergence process with higher levels of nominal inflation in lower income countries and deflationary pressures in higher income countries such as Germany and France. As a consequence, wage and CPI inflation in the convergence countries far outstripped that seen in Germany and France where job creation and wage growth has been much more muted.
We also note that household indebtedness also remain high in Spain and Ireland which contrasts with much more modest levels in the core Euro-zone. Spanish households are as indebted as US ones and Ireland consumers are even more indebted. We would not be surprised to see consumers in Ireland and Spain going through a period of very significant degearing which will be exacerbated by asset price declines. This is broadly the experience being felt by the US consumer, albeit that Spain and Ireland have to contend with the rather hawkish ECB who do not appear to want to adopt the very aggressive moves taken by the Fed to stabilise asset prices.
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European Banks 30 April 2009
Chart 8: Consumer indebtedness – household debt:disposable income
185% 165% 145% 125% 105% 85% 65% 45% 25% 2000 2001 2002 2003 2004 2005 2006 2007 2008 Spain Ireland US Germany Italy
Source: OECD
A similar theme has played out in the asset markets where there has been a debt fuelled growth in asset prices which together with higher wage costs has reduced Irelands and Spain’s competitiveness relative to key trading partners. With both countries running significant current account deficits, there is an implicit concern over sovereign solvency with this being reflected through the spread at which Irish and Spanish debt trades over German government bonds. The normal adjustment mechanism for a current account deficit is currency depreciation which should help stimulate exports while curtailing imports. Unfortunately, such an adjustment mechanism does not exist within a currency union so these imbalances can only be corrected through a sharp contraction in domestic demand through a tough recession which is a very painful adjustment process. Property prices have to fall further than elsewhere and people have to be paid less. The chart below compares the real effective exchange rate of Ireland, Spain and Germany over the last decade. This provides a measure of cost competitiveness of countries relative to each other.
Chart 9: Ireland, Spain and Germany – real effective exchange rates
120 115 110 105 100 95 90 85 80 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Spain Ireland Germany
Source: Eurostat
The analogy, in our view, is with Hong Kong at the time of the Asian crisis. Like Spain and Ireland today, Hong Kong enjoyed robust economic growth in the period up to the Asian crisis but then had to adopt painful economic
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European Banks 30 April 2009 retrenchment to structurally adjust to the competitive devaluations of neighbouring countries.
The Hong Kong Dollar was pegged to the US dollar, which, as with Spain and Ireland today, ruled out the devaluation option and similarly interest rates were, like Spain and Ireland today, too high. Little could be done about this in Hong Kong as rates were effectively set by the Fed and imported into Hong Kong through the peg, just as Eurozone interest rates are set by the ECB. Hong Kong adjusted, the hard way, property prices fell 70% peak to trough, wages fell in nominal terms as companies looked to adjust to the new economic reality.
Chart 10: UK, Irish and Spanish insolvencies, Q1 2007 = 100
500 400 300 200 100 0 Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09
UK Ireland Spain
Source: National Accounts
The same is true for Ireland and Spain today in our view. Property prices need to fall considerably further with the need for declines exacerbated by the structural excess capacity in the housing market that has been the direct result of the recent construction boom which now needs to unwind. The sharp rise in company failures over the last year (see above) attests to this.
The Irish banks are in the unfortunate position of having been overwhelmed by their problems. With Bank of Ireland having development lending of €13.1bn and investment lending of €23bn and tangible equity of €6bn versus €22bn and €24bn with €7½bn of tangible equity at AIB, the workout period will, in our view, be protracted.
While the recently announced announcement by the government to inject capital into the system is a welcome initial step, it is in our view too little too late to avoid a protracted workout situation through the proposed bad bank. We expect that future profits will be absorbed by ongoing impairment and traditional equity buffers will need to be rebuilt before ordinary shareholders can start to enjoy an expectation of normalised returns.
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Chart 11: Spanish banks versus Irish banks – the long and winding road
120
100
80
60
40
20
0 01 Jul 08 01 Oct 08 01 Apr 08 Apr 01 01 Jun 08 01 Jan 09 01 Jan 08 01 Feb 09 09 Mar 01 01 Feb 08 08 Mar 01 01 Nov 08 01 Dec 08 01 Aug 08 01 Sep 08 01 May 08 MSCI Spain Banks Rebased MSCI Ireland Banks Rebased
Source: Thomson Datastream
Spain’s outperformance relative to Ireland has, in our view, largely been a function of a better regulatory start point rather than any fundamental differences in the economy or the banking system. The Bank of Spain was wise enough to prevent the banks getting involved in SIVs, Conduits and other structured finance vehicles which caused stress to the banking sector the early part of the credit crisis.
The Bank of Spain was also astute enough to remember that banking is, above all, a cyclical business. Hence their insistence on the need to build generic provisions in the good times to provide a degree of protection in more difficult environments has ensured that the Spanish banking system has had a degree of insulation from the crisis that has not been available elsewhere as the broader macroeconomic trends have deteriorated. This has meant that most of the early deterioration in domestic Spanish bank lending has been dealt with through the balance sheet rather than through the P&L. We are not so sure that this position can be maintained given that the pace of asset deterioration in Spain which continues to accelerate.
Chart 12: Spanish NPL formation goes exponential
80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 Jul-08 Apr-08 Oct-08 Jan-08 Jun-08 Jan-09 Dec-07 Feb-08 Mar-08 Aug-08 Sep-08 Dec-08 Nov-08 May-08
Source: Bank of Spain
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At face value, the capital position of the banks does not particularly stretched with Santander having a core Tier 1 of 7% and BBVA 6.4% and the domestic banks somewhere between the two. Clearly, for banks that are operating in an economy that needs severe restructuring the nominal Tier 1 has only a limited meaning. Given that NPLs tripled in 2008 and we believe they will at least double again in 2009 and that this meant that banks’ generic provisions were consumed during 2008, leaving limited capital buffers to absorb future losses. We expect more capital raising across the board, by both the savings banks and the listed banks, including BBVA and Santander.
Table 5: Domestic Spanish banks – developer and construction exposure
ALBK BKIR POP BKT SAB BTO PAS
Loan book 4Q08 UBS 129,000 145,000 91,208.0 39,930.4 65,164.2 71,820.7 24,477.4
Exposure to RE developers, construction and land, UBSe 22,000 13,100 16,782.3 998.3 11,729.6 7,900.3 4,405.9
NAV 08, €m 7,500 6,000 6,555.6 2,301.4 5,018.0 5,236.4 1,689.6
Loans to RE developers & construction/NAV 08 2.9x 2.2x 2.6x 0.4x 2.3x 1.5x 2.6x
Exposure to RE developers, construction as % loan book 17.1% 9.0% 18.4% 2.5% 18.0% 11.0% 18.0%
Source: UBS
As such we maintain sell recommendations on Santander, BBVA and Sabadell.
Chart 13: Employment: Change since the start of the crisis
2% 1% 0% -1%
-2% UK -3% Spain -4% -5% -6% -7% Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09
Source: Bank of Spain UK We still expect a difficult operating environment for the UK banks in 2009/10. After a deep recession in 2009, we only expect anaemic recovery into 2010. However, we see increasingly defensive characteristic to the UK banks in a European context. First, the UK has used the flexibility afforded by an independent monetary authority to cut interest rates, albeit after a belated recognition of the need to do so, aggressively and begin applying quantitative easing techniques to the market.
At the same time, fiscal measures have been employed by reducing taxes and stepping up government spending. Also, the willingness to debase the currency has the impact of making the UK a more attractive investment destination,
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European Banks 30 April 2009 provides a benefit to exporters and, at the margin, should discourage UK citizens holidaying abroad over staying within the UK.
Another factor supporting an investment in UK banks is that the system has been aggressively recapitalised which provides the capacity for significant loss absorption. All UK based banks have raised equity capital since the beginning of the financial crisis. We estimate that an aggregate of c.$160bn has been raised by UK banks since the beginning of 2008, as summarised below.
Table 6: UK bank capital raising since January 2008
Number of rounds bn
Barclays 3 £9.4
Lloyds 4 £37.4
RBS 4 £51.5
HSBC 1 $17.7
StanChart 1 $2.5
Source: Company accounts, UBS estimates. Note Lloyds figure includes legacy HBOS capital raisings. Lloyds and RBS figures include “B” equity issued to the UK government of £15.6bn and £19bn respectively.
As we discuss above, we think the capital debate is resolved for Lloyds irrespective of whether the government “B” shares are converted to equity. The same is not true for RBS who needs the “B” shares to be converted to bring the overall core equity back to more normalised levels within a realistic timeframe. Barclays presents a more interesting case. The year-end pro forma core equity Tier 1 ratio looks low when one considers the need for additional capital to support the banks trading portfolios and the expectation of significant losses on monoline exposures. For this reason, we expect Barclays to be the most likely UK bank to raise additional capital.
A further factor supporting the UK is an improving supply side dynamic from a credit formation perspective. A major headwind during 2008 was the fact that the shrinkage of Northern Rock’s balance sheet was exacerbating the problem caused by the withdrawal of a number of participants from the market. This is highlighted in the chart below which shows the net equity withdrawal by UK households. 2008 saw a net repayment of housing debt by UK consumers as they sought to reduce borrowings in the face of lower credit availability.
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Chart 14: Quarterly UK mortgage equity withdrawal (£m) – payback time
20,000
15,000
10,000
5,000
0
4 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 200 2006 2008 -5,000
-10,000
Source: Bank of England
With the decision to allow Northern Rock to begin writing new business and stop its planned balance sheet shrinkage coupled with the new lending commitments from banks participating in the APS, the supply of credit should show considerable improvement in 2009 relative to 2008.
Notably, the recent Bank of England Q1 2009 Credit Conditions Survey highlighted the fact that spreads on secured credit to UK households was rising more quickly than expected and that over the next three months improvements in the cost and availability of funds were expected to support increased credit availability, albeit that demand was expected to remain muted.
Chart 15: UK banks change in credit availability – first expected increase since Q3 07
20.0
10.0
0.0
-10.0 07 7 07 8 08 8 08 08 - -0 r-08 t- c- un ug ct- ec-07 eb-0 p ug-0 c eb-09 J A O D F A Jun- A O De F Past three months -20.0 Next three months -30.0
-40.0
-50.0
-60.0
Source: Bank of England, Credit Conditions Survey
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Q Statement of Risk
The European banking sector is currently weathering the combined effects of the global credit crunch and a synchronised global economic downturn. If this persists for an extended period, there is a risk our earnings expectations are too high.
Q Analyst Certification
Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report.
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For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request.
UBS Investment Research: Global Equity Rating Allocations
UBS 12-Month Rating Rating Category Coverage1 IB Services2 Buy Buy 51% 36% Neutral Hold/Neutral 37% 31% Sell Sell 12% 22% UBS Short-Term Rating Rating Category Coverage3 IB Services4 Buy Buy less than 1% 43% Sell Sell less than 1% 36% 1:Percentage of companies under coverage globally within the 12-month rating category. 2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months. 3:Percentage of companies under coverage globally within the Short-Term rating category. 4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months.
Source: UBS. Rating allocations are as of 31 March 2009. UBS Investment Research: Global Equity Rating Definitions
UBS 12-Month Rating Definition Buy FSR is > 6% above the MRA. Neutral FSR is between -6% and 6% of the MRA. Sell FSR is > 6% below the MRA. UBS Short-Term Rating Definition Buy: Stock price expected to rise within three months from the time the rating was assigned Buy because of a specific catalyst or event. Sell: Stock price expected to fall within three months from the time the rating was assigned Sell because of a specific catalyst or event.
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KEY DEFINITIONS Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case.
EXCEPTIONS AND SPECIAL CASES UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.
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Company Disclosures
Company Name Reuters 12-mo rating Short-term rating Price Price date Banco de Sabadell2c SABE.MC Sell N/A €4.23 28 Apr 2009 Barclays2c, 4, 6, 16b BARC.L Neutral N/A 232p 28 Apr 2009 BBVA2c, 15, 16b, 22 BBVA.MC Sell N/A €7.76 28 Apr 2009 BNP Paribas2a, 3a, 4, 16b, 22 BNPP.PA Suspended N/A €36.77 28 Apr 2009 Crédit Agricole2a, 4, 5 CAGR.PA Sell N/A €10.10 28 Apr 2009 Deutsche Bank2a, 4, 15, 16b, 18, 22 DBKGn.DE Suspended N/A €40.26 28 Apr 2009 Erste Bank2c, 5 ERST.VI Buy N/A €15.11 28 Apr 2009 HSBC2a, 4, 5, 6, 16a, 16b, 22 HSBA.L Buy N/A 457p 28 Apr 2009 Intesa SanPaolo2b, 4, 5, 22 ISP.MI Buy N/A €2.25 28 Apr 2009 Lloyds Banking Group1, 2a, 3c, 4, 5, 12, 16b LLOY.L Buy N/A 96p 28 Apr 2009
OTP Bank2c, 4 OTPB.BU Sell N/A HUF2,601.00 28 Apr 2009 RBS Group2a, 3b, 4, 5, 8, 13, 14, 16b, 20 RBS.L Neutral (CBE) N/A 33p 28 Apr 2009 Santander2c, 16b, 22 SAN.MC Sell N/A €6.56 28 Apr 2009 Société Générale2c, 4, 5, 16b SOGN.PA Buy N/A €36.11 28 Apr 2009 Standard Chartered2a, 4, 5, 6, 14, 22 STAN.L Sell N/A 930p 28 Apr 2009 Source: UBS. All prices as of local market close. Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date
1. UBS Limited is acting as manager/co-manager, underwriter or placement agent in regard to an offering of securities of this company/entity or one of its affiliates. 2a. UBS AG, its affiliates or subsidiaries has acted as manager/co-manager in the underwriting or placement of securities of this company/entity or one of its affiliates within the past 12 months.
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2b. UBS AG, its affiliates or subsidiaries has acted as manager/co-manager in the underwriting or placement of securities of this company/entity or one of its affiliates within the past five years. 2c. UBS AG, its affiliates or subsidiaries has acted as manager/co-manager in the underwriting or placement of securities of this company/entity or one of its affiliates within the past three years. 3a. UBS Investment Bank is acting as financial advisor to the Belgian Federal Government on the renegotiation of the terms of the sale of Fortis Bank and Fortis Insurance Belgium to BNP Paribas. 3b. UBS Limited is acting as as financial adviser to RBS in relation to RBS`s participation in the Asset Protection Scheme. 3c. UBS Limited is acting as financial adviser in relation to Lloyds Banking Group Plc participation in the Asset Protection Scheme 4. Within the past 12 months, UBS AG, its affiliates or subsidiaries has received compensation for investment banking services from this company/entity. 5. UBS AG, its affiliates or subsidiaries expect to receive or intend to seek compensation for investment banking services from this company/entity within the next three months. 6. This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and investment banking services are being, or have been, provided. 8. The equity analyst covering this company, a member of his or her team, or one of their household members has a long common stock position in this company. 12. Directors or employees of UBS AG, its affiliates or subsidiaries are directors of this company. 13. UBS AG, its affiliates or subsidiaries beneficially owned 1% or more of a class of this company`s common equity securities as of last month`s end (or the prior month`s end if this report is dated less than 10 days after the most recent month`s end). 14. UBS Limited acts as broker to this company. 15. UBS AG, its affiliates or subsidiaries has issued a warrant the value of which is based on one or more of the financial instruments of this company. 16a. UBS Securities (Hong Kong) Limited is a market maker in the HK-listed securities of this company. 16b. UBS Securities LLC makes a market in the securities and/or ADRs of this company. 18. UBS AG, its affiliates or subsidiaries beneficially owned 5.26% of this company`s voting rights as of last month`s end. 20. Because UBS believes this security presents significantly higher-than-normal risk, its rating is deemed Buy if the FSR exceeds the MRA by 10% (compared with 6% under the normal rating system). 22. UBS AG, its affiliates or subsidiaries held other significant financial interests in this company/entity as of last month`s end (or the prior month`s end if this report is dated less than 10 working days after the most recent month`s end).
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