Pan-European Banks

CORPORATE CAPITAL PAN-EUROPEAN BANKS THE BASEL III GAME CHANGER • We initiate on the 10 largest European ‘lending’ banks: BBVA, DNBNOR, Handelsbanken, HSBC, Intesa, Lloyds, Nordea, Santander, Standard Chartered and Unicredit. • The Basel Committee proposals (which we tentatively call ‘Basel III’) are likely to be a game changer for the banks. This is a key part of our report. We see Lloyds and HSBC’s Core Tier 1 ratios falling substantially, to 4.4% and 6.0% respectively. We see other banks as adequately capitalised, with the three Nordic banks having considerable excess capital. • We are positive on the group as a whole. Economic growth is likely to surprise on the upside and we foresee the yield curve remaining steep for a prolonged time. Research Andrew Lim +44 20 3206 7347 [email protected] 19TH JANUARY 2010 THE BASEL III GAME CHANGER We believe that changes in bank capital regulations are going to be a ‘game changer’ for the sector. In our initiation report on large cap European lending banks, we undertake a detailed analysis of what would happen to banks’ capital ratios. We reach some startling conclusions, most notably that Lloyds’ Core Tier 1 ratio falls to 4.4% and HSBC’s falls to 6.0%. Other banks are seen to be adequately capitalised, with Nordic banks in particular having excess capital. • We initiate coverage on the large cap European • In our Sector and Economic Overview, we retail and corporate lending banks (which we broadly conclude that the lending banks are operating in a term ‘lending’ banks) for whom the vast proportion of very attractive economic environment which is likely operating earnings is derived from plain-vanilla to last until at least Q4 2010. We show, looking at lending activity (i.e. it is mainly net interest income, past recessions, that economic growth is likely to be it from retail or wholesale lending). This group surprise on the upside. We believe the yield curve comprises the Spanish banks BBVA and Santander, will remain steep for a prolonged period, with the the Italian banks Intesa Sanpaolo and Unicredit, the short end depressed by the magnitude of the output Nordic banks DNBNOR, Handelsbanken and gap and the long end remaining at a high level as Nordea and the UK banks HSBC, Lloyds, and governments seek to attract investors to the Standard Chartered. Our analysis of this group is significant volume of new debt issuance. split into three key components: Basel III Capital • We rate as BUY: DNBNOR (Recovering Norwegian Analysis, Sector and Economic Overview and economy, normalizing loan losses, very strong Basel lastly, Dupont Analysis of Earnings. III capitalization, cheap); Handelsbanken (Best • Basel III Capital Analysis. We believe that changes quality bank, to be appreciated more when the in bank capital regulations are going to be a ‘game extent of Basel III excess capital is realized); Nordea changer’ for the sector. The proposals from the (Solid Basel III capitalization, well run bank with Basel Committee, published in December 2009, will good earnings momentum, cheap). increase the quantum of capital in the system, • We rate as HOLD: BBVA (Very high ROE, improve its quality, force out complexity from attractive Latam footprint, near term concerns balance sheets and ultimately drive down ROE. We regarding Spanish loan losses); HSBC (Deposit undertake a detailed analysis of what happens to the surplus is a strong competitive advantage, attractive banks’ capital in an attempt to replicate as closely as Asian footprint, weak Basel III capitalization); Intesa possible the anticipated findings of the Basel Sanpaolo (Well run, defensive bank, but with a Committee’s own impact study, due H2 2010. The structurally low ROE); Santander (Well managed for results are very interesting. The UK banks Lloyds growth and stability, but near term concerns on and HSBC are significantly impacted by the Spanish loan losses); Standard Chartered proposals. We see Lloyds, in particular, having a (Attractive Asian footprint, large deposit surplus, not new Core Tier ratio of only 4.4% by the end of 2012. expensive but not cheap either). We also see HSBC’s Core Tier 1 ratio falling to 6.0%, significantly below peers. The other banks are • We rate as REDUCE: Lloyds (Large Basel III capital reasonably capitalised, with the Nordic banks in shortfall, earnings growth constrained by LTD ratio particular having substantial excess capital. of 170%, expensive); Unicredit (Structurally low ROE bank, not cheap). Research Andrew Lim +44 20 3206 7347 [email protected] Matrix Corporate Capital LLP is authorised and regulated in the United Kingdom by the Financial Services Authority. This document must be treated as a marketing communication as it has not been prepared in accordance with legal requirements designed to promote the independence of investment research. 19 JANUARY 2010 PAN-EUROPEAN BANKS CONTENTS Summary 3 Stock Ratings 5 Sector and Economic Overview 8 Basel III Capital Analysis 19 Dupont Methodology For Banks 36 Dupont Analysis of Earnings 39 Valuation 65 Company Summaries 67 BBVA 68 DNBNOR 70 Handelsbanken 72 HSBC 74 Intesa Sanpaolo 76 Lloyds 78 Nordea 80 Santander 82 Standard Chartered 84 Unicredit 86 Appendix 88 19 JANUARY 2010 2 PAN-EUROPEAN BANKS SUMMARY We initiate on the large cap European retail and corporate lending banks (which we broadly term ‘lending’ banks) where the vast proportion of the earnings stream is derived from plain-vanilla lending activity (i.e. it is mainly net interest income, be it from retail or wholesale lending). This group comprises the Spanish banks BBVA and Santander, the Italian banks Intesa Sanpaolo and Unicredit, the Nordic banks Danske Bank, DNBNOR, and Handelsbanken, and the UK banks HSBC, Lloyds, and Standard Chartered. Our analysis of this group is split into three key components: Basel III Capital Analysis, Sector and Economic Overview and lastly, Dupont Analysis of Earnings. Overall, we are BUYERS of lending banks, as per our Sector and Economic Overview. BASEL III CAPITAL ANALYSIS – Page 19 We believe that changes in regulations for bank capital are a ‘game changer’ for the sector. The proposals from the Basel Committee published in December 2009 will increase the quantum of capital in the system, improve its quality, force out complexity from balance sheets and ultimately drive down ROE. We undertake a thorough analysis of what happens to the banks’ capital in an attempt to replicate as closely as possible the anticipated findings of the Basel Committee’s own impact study, due H2 2010. The results are very interesting. The UK banks Lloyds and HSBC are significantly impacted by the proposals. We see Lloyds, in particular, having a new Core Tier ratio of only 4.4% by the end of 2012. The fall is mainly due to the full deduction from common equity of investments in other financial institutions of £10bn (mainly insurance), which under the present FSA transition rules, is only deducted at the total capital level (not 50:50 from Tier 1 and Tier 2 capital as for most other banks). Basel III is essentially crystallising the problem that Lloyds has been able to get away with for years of double counting the capital in other financial entities on the group balance sheet. We also see HSBC’s Core Tier 1 ratio falling to 6.0%, significantly below peers and in line with what we would deem to be an appropriate regulatory minimum. The reasons for the substantial fall in the Core Tier 1 ratio are more varied than for Lloyds and arise mainly from the deduction of negative AFS reserves, the deduction of minorities, the increase in market risk weights and the deduction of investments in other financial entities. For the last point, HSBC has, like Lloyds, taken advantage of the FSA transition rules currently in force and opted to deduct investments in financial entities at the total capital level rather than 50:50 from Tier 1 and Tier 2 capital. We believe that management may ultimately desire to raise more common equity to obtain a capital buffer and regain parity with peers. The other banks are reasonably above the 6.0% level that we would deem a minimum, but some more so than others. The Italian and Spanish banks, together with Standard Chartered, have ratios 1–2% higher than the 6% level. The Nordic banks, however, have substantial excess capital. We see DNBNOR and Handelsbanken in particular as having Core Tier 1 ratios roughly 4% above the minimum, with Nordea about 3% higher. SECTOR and ECONOMIC OVERVIEW – Page 9 Our view of the economy is closely intertwined with our view of how lending banks will perform. The conclusion is that we should be BUYERS of lending banks, based on the following: 1. There is a strong historical relationship between the severity of a recession and the strength of the rebound. Given the severity of the recession just 19 JANUARY 2010 3 PAN-EUROPEAN BANKS past, the strength of the economic rebound is very likely to have been under-estimated by consensus. 2. Looking at previous recessions, the economic recovery plays the largest part in restoring health to the banking sector, once the necessary actions to stabilise the financial sector have been undertaken (usually with substantial government intervention and public money). Better than expected economic growth (as per point 1) should therefore translate into a better than expected improvement in credit quality and robust loan growth for the banking system. 3. There is scepticism that there is enough liquidity in the system to fund an increase in demand for credit as the economy recovers. Looking at the enormous rise in bank reserves placed with central banks, it would seem this scepticism is misplaced. The US Federal Reserve now has approximately $1tn of reserves in excess of the required minimum, whilst the BOE has reserves seven times the level that prevailed before the crisis.

Load more