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This document is a marketing communication and is not independent research prepared in accordance with legal requirements
designed to promote the independence of investment research and is not subject to a prohibition on dealing ahead of the
dissemination of investment research.
For Reg-AC certification, see the end of the text. Liberum Capital does and seeks to do business with companies covered in this
communication. 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.
8 June 2012 European Equity Research
UK Banks InitiationBack to the FutureBARC LN | LLOY LN | RBS LN | HSBA LN | STAN LN
With GREXIT seemingly inevitable and the remaining Euro-periphery in the balance, Barclays, Lloyds and
RBS are ‘high risk’ given a potential capital deficit of £66bn. However post €-crisis-resolution, analysis of 9
historical deleveraging cycles, since 1930, points to avg. annual bank TSR of 20% as the UK executes a
‘beautiful deleveraging’ from its 408% debt/GDP level. At current prices HSBC (BUY) and STAN (BUY) are
good value and investable due to low Euro-zone asset exposure, Basel 3 liquidity levels, and geographic
footprints with debt/GDP of only 319% and 270%. Lloyds (speculative BUY): discounts an excessive 70%
chance of Euro-breakup. Finally, Peer to Peer lending at a 70% CAGR is likely to disrupt banking by 2025E.
Eurozone crisis: The binary nature of the crisis makes BARC, LLOY and RBS un-investable. If all 5 of the
PIIGS leave the Euro, we estimate these 3 UK banks would have an aggregate capital deficit of £66bn relative
to a 10% Basel III equity target due to i) FX losses ii) loan losses iii) higher funding costs iv) lower IB revenues.
After potential rights issues of c106% of market cap, we get significant share price downsides: RBS: 40%,
Barclays 30% and Lloyds 27%. By contrast, Standard Chartered & HSBC would still have upside: 16% and 8%.
UK debt deleveraging: Post resolution of the Eurozone-crisis, we believe investors’ focus will shift to the
sector’s TSR prospects as the UK economy reduces total debt/GDP over the next 5-10 years. The prognosis is
positive, with a likely annual TSR of 20%, based on banks’ performance in 9 previous cycles since 1930. The
key success factor: maintaining a positive gap between nominal GDP growth and government borrowing costs
(currently +2.0% in the UK). For deleveragings with negative gaps the avg. annual TSR for banks is minus 47%.
We initiate on UK banks with buys on both Standard Chartered (24% upside) and HSBC (20% upside) where
prices have de-rated by 21% and 13% since February, offering good entry points on high quality franchises with
respective PIIGS exposure of only 6% and 21% of market cap (vs. Barclays 306%; RBS: 173%; Lloyds: 129%).
Elsewhere, Lloyds (speculative BUY) offers an attractive risk/reward (despite being un-investable due to £23bn
of Eurozone exposure). For Lloyds, we see downside of 27% in our stress case vs. base case upside of 60%.
Figure 1: Summary valuation and recommendations
Target price & ratings 1) As reported 2013E 2) U/L Reg&Cap adjusted 2013E6
Rec PriceTarget
Price%
Upside EPS PEx TCE p/TCE RoTCE Div YldCap
surplus4
Cap surp5
%mkt cap EPS PEx7 TCE p/TCE7 RoTCE
STAN1 $ Buy 1292p 1600p 24% 234 8.4 1658 1.20 14.8% 4.2% $4bn 8% 237 7.7 1618 1.12 14.6%
HSBA1 $ Buy 503p 606p 20% 101 7.7 823 0.94 12.8% 5.3% $4bn 3% 103 6.7 822 0.84 12.5%
LLOY £ Buy2 26p 29p 12% 3.5 7.4 62.3 0.41 5.8% 0.0% -£3bn -18% 4.5 5.3 44.6 0.58 10.2%
BARC £ Hold 174p 187p 8% 37.0 4.7 417 0.42 9.2% 3.5% -£2bn -10% 29.6 5.6 380 0.43 7.8%
RBS £ Hold 200p 213p 7% 26.5 7.5 492 0.41 5.3% 0.0% £1bn 4% 36.3 5.3 471 0.38 7.7%
Avg 14% 7.2 0.67 9.6% 2.6% -3% 6.1 0.67 10.6%
1. HSBC and STAN all in USD except price in £ ; 2. Speculative Buy (not investable due to Euro-zone crisis); 3. TCE=Tangible Common Equity per share ; 4. ‘Surplus’ = Common equi ty
capital surplus under fully loaded Basel III vs. 10% target ; 5. surplus as % of market cap ; 6. 2013E Reg&CapAdj numbers are excluding 1-offs, ex non core divisions, ex planned disposals, after normalising loan losses and after issuing or buying back shares to eliminate capital surplus/deficit ; 7. ratios calculated after deducting 2012-13E dividends to increase comparability. 8. dividend yields are 2012E. Share price data COB 5th June2012. Source: Liberum Capital, Bloomberg
Cormac Leech CFA
+44 (0)20 3100 [email protected]
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ContentsExecutive Summary 3
Back to the Future 9
1) Probability and impact of Euro-zone break-up 10
2) Implications of macro debt deleveraging 18
3) Balance sheet repair since 2008 26
4) P2P lending- disruptive threat 30
5) EPS forecasts vs. consensus 35
6) Capital, valuations and recommendations 36
HSBC 43
Standard Chartered 49
Lloyds Banking Group 56
Royal Bank of Scotland 58
Barclays 60
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Executive SummaryWhile bank equity investors are justifiably fixated on GREXIT and the Eurozone
crisis more broadly, we see three other important factors shaping the bank
valuations over the next 6-12 months. This report discusses the following 5 areas:
Potential capital destruction from the peripheral countries leaving the Euro
The UK’s ability to de-lever from the highest debt/GDP ratio, 408% (total debt),
since at least 1900.
The considerable self-help progress the banks have made in rehabilitating their
balance sheets since 2008
The potential for the internet (for instance Peer to Peer lending) to make banks
redundant over the next couple of decades.
Finally we look at earnings vs. consensus, capital positions and calculatescenario-weighted target prices.
1) How likely is a ‘fragmentation of the Euro-zone’ andwhat is the estimated valuation impact for UK banks?“I don’t know if the euro will be here in 5 years”, Warren Buffett May 2012. The Euro-zone is clearly unstable:
The implied probability of default on peripheral bonds ranges from c97% for Greece
to a still non-negligible 17% for France.
It’s now uncontroversial to expect Greece to exit the Eurozone. The INTRADEmarket prediction website puts the probability by December 2014 at 65%. If a Dec
2015 or Dec 2016 contract were available on INTRADE we believe the implied
probabilities would be considerably higher.
Figure 2: Market implied probability of partial Eurozone fragmentation
Source: INTRADE, last updated 4 th June12.
The key question is post GREXIT, how likely is the rest of the Eurozone to remain
intact? Expert opinion is divided: Neil Record (short-listed for the Wolfson prize)
envisages a rapid domino effect to full breakup, while PIMCO has argued Spain and
Italy could remain in the Euro-zone. The key uncertainty is to what extent GREXIT
prompts policymakers to transition towards Eurobonds and fiscal integration.
Market prediction price implies
65% probability of at least 1
country leaving Euro by end 2014E
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In this report for the purposes of valuation we use a probability of 55% for the
probability of all the peripheral countries (Greece, Portugal, Ireland, Spain and
Italy) exiting the Euro for valuation purposes, labelled our ‘stress scenario’.
How much would bank equity capital decline in the Euro-breakup scenario?We assume that the Euro breakup takes place in 2012 and then calculate the
cumulative impact on Basel 3 equity tier 1 by the end of 2013 compared to our base
case forecasts (as an aside our base case earnings forecasts are on average 11%
below 2013E consensus).
In the stress scenario we estimate the cumulative impact of i) foreign exchange
losses on assets in exiting countries, ii) loan losses 130% higher than the base case
run-rate for 2 years, reflecting a global negative economic shock, notwithstanding
likely policy responses from governments (QE etc), iii) lower investment banking
revenues due to losses on inventory as well as net lower customer activity, iv) higher
wholesale funding costs. Our estimates are shown in Figure 3.
Figure 3: Total cumulative impact of Euro-exit bear case on core equity capital vs.base case, by end 2013E
Reporting ccy, billions BARC LLOY RBS HSBC STAN£ bn £ bn £ bn $ bn $ bn
FX losses -17.5 -8.6 -16.7 -10.0 -1.1Extra loan losses -8.8 -15.2 -14.4 -23.5 -3.9Higher funding costs -0.7 -1.1 -1.1 -0.2 -0.1Lower IB revenues -5.9 -0.2 -2.9 -5.5 -4.2Total pre tax impact -32.8 -25.2 -35.1 -39.2 -9.3Tax 8.5 6.4 8.8 8.5 2.5Impact net of tax -24.3 -18.7 -26.3 -30.7 -6.7
Source: Liberum Capital
What are the banks 2013E stress capital positions and fair values/share?In the stress scenario, capital deficits would range from 110% of market cap for
Lloyds to only 5% for Standard Chartered (see figures 20-24 in main section for
detail). For valuation purposes, we assume that these deficits are addressed via
rights issues (probably government underwritten). We assume the rights issues are
preceded by 30% share price declines and are then executed at market prices (to
avoid confusing TERP adjustments). On that basis we derive adjusted tangible
common equity per share as shown in Figure 4. The UK domestic banks (Barclays,
Lloyds and RBS) would have downside to fair value of 27-40% while Standard
Chartered and HSBC would still have upside to fair value per share on our estimates
(see valuation section for detail).
Figure 4: Bear case- summary fair values per share
BARC LLOY RBS HSBC STAN Avg£ £ £ $ $
Bear case TCE/share capi tal adjusted 1.63 0.20 1.74 6.35 13.8Current price 1.74 0.26 2.00 7.74 19.9Bear case p/TCE 1.1 1.3 1.1 1.2 1.4 1.2Bear case fair value per share 1.22 0.19 1.21 8 .34 2 3.0Implied % upside/downside (+/-) -30% -27% -40% 8% 16% -15%
Source: Liberum Capital
If all 5 peripheral countries were to
leave the Eurozone in 2012E, we
estimate a decline in 2013 core
equity of up to £26.3bn for RBS;
Standard Chartered is least
impacted $6.7bn; sector total
£93.6bn
We assume new equity capital
raised after 30% share price
declines and at market prices to
avoid TERP adjustments.
If the 5 peripheral countries exit
the Euro, we see RBS having 40%
downside to a fair value of 121p
and Barclays having 30%
downside to 122p
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2) Beyond the Eurozone crisis, what does the UK debtdeleveraging ahead mean for UK bank valuations?“It’s déjà vu all over again”, Yogi Berra
The UK economy has already started to de-lever from a peak of total debt to GDP of430% as of 1Q10. While at first glance this would appear a highly adverse
environment for the UK banks, the UK economy has deleveraged from this level
before, from 1947 to 1969, during which time the UK banks reported low loan losses
and positive TSR of 8% annually (albeit lagging the broader market TSR of 12%).
Debt deleveragings occur every 65-80 years. This infrequency means that the policy
makers and investors, with experience from the previous cycles, are deceased,
frequently resulting in errors responding to the crisis.
Deleveragings fall into 2 categories, 1) ‘beautiful deleveragings’ (as defined by
Bridgewater Associates) in which there is a orderly reduction in debt, GDP growth is
maintained, inflation remains stable, and bank share prices continue to rise, and 2)‘ugly deleveragings’ with either deflation or hyperinflation and sharp real declines
in bank share prices. It turns out that the key is to maintain a positive, but
single digit, gap between nominal GDP growth and government borrowing
yields, thereby achieving a gradual decrease in the debt/GDP ratio. The UK, since
1Q09, has maintained a positive gap of 0.8% and appears to be executing a
‘beautiful deleveraging’ with total debt now starting to decline (private debt and
financial debt declining, partially offset by some increase in public debt). By contrast
the Euro-zone periphery is experiencing an ugly deleveraging under this framework
(see figure 7).
Figure 5: UK total debt/GDP 1900-2011 Figure 6: UK total debt/GDP 2000-11
0%
50%
100%
150%
200%
250%
300%
350%
400%
450%
500%
1 9 0 1
1 9 1 1
1 9 2 1
1 9 3 1
1 9 4 1
1 9 5 1
1 9 6 1
1 9 7 1
1 9 8 1
1 9 9 1
2 0 0 1
2 0 1 1
debt/GDP
0%
50%
100%
150%
200%
250%
300%
350%
400%
450%
500%
0 0 Q 4
0 1 Q 4
0 2 Q 4
0 3 Q 4
0 4 Q 4
0 5 Q 4
0 6 Q 4
0 7 Q 4
0 8 Q 4
0 9 Q 4
1 0 Q 4
1 1 Q 4
Household Corporate Public Adj. Fin
408
114
83
109
102
430
130
70
120
110
Source: Liberum Capital; ONS; Bridgewater Associates, McKinsey; ONS Source: Liberum Capital; ONS; McKinsey Global Institute
So what does this mean for the UK banks?
As figure 7 details, the average TSR for banks under beautiful deleveragings is 20%
p.a. approximately in line with the overall market. Adjusted for beta, banks effectivelyunderperform vs. the broader market during beautiful deleveragings.
UK banks achieved 8% p.a. TSR
throughout the 1947-1969
deleveraging period.
Deleveragings occur only once a
generation
UK is currently executing a
‘beautiful deleveraging’
The UK’s debt/GDP is manageable
from the perspective of the UK
banks.
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So, arguments that the UK economy and its banks will collapse due to excessive
total debt are likely to be proven wrong, provided that the BoE continues to provide
enough QE to keep nominal growth GDP above borrowing costs (a configuration
some would call financial repression).
Figure 7: Banks TSR during ‘ugly’ / ‘beautiful’ historical deleveragings
Country/period Start date End dateStart
Debt/ GDPEnd Debt/
GDPDebt
change
Avg Govt.bondyield
AvgNominal
GDPgrowth
NGDPgrowth lessGovt bond
yield
Banksannual
TSR
Equitymarketannual
TSR
Banks vs.EquityMarket
annual TSR InflationReal Bank
TSR
Ugly deleveragings
US Depression 1930 1932 155% 252% 97% 3.40% -17.00% -20.40% -31% -30% -1% -8% -23%
Japan 1990 Present 403% 498% 95% 2.60% 0.60% -2.00% -11% -5% -6% -1% -10%
US Sep08 - Mar09 Sep-08 Feb-09 342% 368% 26% 3.40% -5.40% -8.80% -82% -52% -30% 2% -84%
Spain Sept '08 to now Sep-08 Present 348% 389% 41% 5.00% 0.50% -4.50% -23% -11% -12% 1% -23%
UK Sep08 - Feb09 Sep-08 Feb-09 388% 395% 7% 3.50% -5.70% -9.20% -92% -57% -35% 2% -94%
Average 327% 380% 53% -9.00% -47% -30% -17% -1% -46%
Beautiful deleveragingsUS Reflation ( ‘33-37) 1933 1937 252% 168% -84% 2.90% 9.20% 6.30% 21% 31% -10% 2% 19%
UK post WWII (47-69) 1947 1969 395% 146% -249% 5.20% 6.80% 1.60% 8% 12% -4% 4% 4%
US (6 Mar 09 to pres.) Mar-09 Present 368% 334% -34% 3.20% 3.50% 0.30% 30% 24% 6% 1% 29%
UK (6 Mar 09 to pres.) Mar-09 Present 395% 408% 15%* 2.60% 3.40% 0.80% 20% 19% 1% 2% 18%
Average 353% 265% -88% 2.70% 20% 21% -1% 2% 17%
*UK debt peaked in 1Q10 at 430% and subsequently declined to 408% at 4Q11.Source: Liberum Capital estimate; Bridgewater associates; Moodys manual of investments 1930 to 1939; Barclays ‘1690-1996’, Hannah & Ackrill; McKinsey Global Institute ; Bloomberg
3) Since 2008, the UK banks have significantlystrengthened their balance sheetsWith the UK domestic banks (Barclays, Lloyds and RBS) trading at only 0.4x
YE12E tangible book values, it’s easy to overlook the substantial progress made inrepairing/ improving their balance sheets. For example, in terms of equity capital, on
a Basel III fully-loaded basis, the UK banks’ core tier 1 ratios are on track to reach
9% by YE2012 vs. only 4.5% at YE2008.
Figure 8: UK Banks Basel III common equity tier 1 ratios –deductions fully loaded
2008 2009 2010 2011 2012E 2013E 2014E Ch 2008- 2011 Ch 2011-2014BARC 3.9% 7.4% 7.8% 7.7% 8.8% 9.5% 10.2% 3.8% 2.5%LLOY 4.0% 5.2% 7.2% 6.9% 7.8% 9.1% 9.9% 3.0% 2.9%RBS 3.1% 6.6% 6.6% 7.0% 8.5% 10.2% 11.8% 3.9% 4.8%HSBC 4.9% 7.2% 8.0% 8.1% 9.2% 10.3% 11.0% 3.2% 2.9%STAN 6.5% 7.6% 10.5% 10.5% 10.6% 10.9% 11.1% 4.0% 0.6%Average 4.5% 6.8% 8.0% 8.0% 9.0% 10.0% 10.8% 3.6% 2.8%
Source: Liberum Capital, company reports
Similarly since YE08, the banks average loan deposit ratio has improved from 126%
to 101% by 1Q12. For Lloyds in particular, the decline from 181% to 130% shows a
dramatic improvement in liquidity. Given these fundamental improvements, post
resolution of the Euro-zone crisis, perceptions of the UK banks’ health could
improve dramatically.
Figure 9: UK Banks loan deposit ratios
2008 2009 2010 2011 1Q12 2012E 2013E 2014E 2008-1Q12 ch 1Q12-2014 chBARC 138% 130% 124% 118% 116% 116% 111% 106% -22% -10%LLOY 181% 169% 154% 135% 130% 122% 118% 114% -51% -16%RBS 151% 135% 118% 108% 106% 105% 98% 93% -45% -13%HSBC 84% 77% 78% 75% 75% 75% 77% 77% -9% 2%STAN 75% 79% 78% 76% 76% 76% 73% 71% 1% -5%Average 126% 118% 110% 102% 101% 99% 95% 92% -25% -8%
Source: Liberum Capital, company reports
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4). Threat of disruptive internet technology to bankingfranchises“Retail banks are dinosaurs”, Bill Gates 1994.
From a strategic perspective it’s notable how little banking has, to date, been
disintermediated by the internet, compared to other information-intensive, network-
driven businesses like for instance music distribution, publishing or retail. The limited
impact in banking so far is perhaps due to customer inertia and security concerns.
These attitudes may now be evolving suggesting more rapid change ahead.
Peer to Peer (P2P) lending is growing rapidly in the UK and US with CAGRs of 70-
450% prompting the Bank of England’s executive director of financial stability,
Haldane, to recently speculate whether banks might over time become
redundant in the internet age. P2P lending growth is currently boosted by
financially repressed savers’ hunt for yield and the challenging environment for
borrowers as banks de-lever. The UK government is supporting the sector, recently
announcing it will lend £100m to SMEs via P2P networks. As figure 10 illustrates, we
estimate P2P lending could represent 8-45% of UK lending by 2027E assuming a
sustained CAGR of 50-70%. Significant innovation is also taking place in the
payments area. It looks likely that smart phone technology will increasingly dominate
the provision of consumers’ e-wallets.
We estimate a current 5-15% valuation impact (details in main section) for the UK
banks if 50% of their businesses were no longer economically profitable by 2027E.
Figure 10: UK outstanding loan balances- market share of Peer to Peer lending networks - sensitivity analysis
Gross P2P lending Growth in P2P gross lending %
The Lending Club ZOPA Funding CircleZOPA+ Funding
circleThe Lending
Club ZOPAFunding
CircleZOPA+
Funding circle $m £m £m £m2007 42008 21 13 13 425%2009 51 33 33 143% 160% 160%2010 126 44 44 148% 33% 33%2011 257 58 10 68 104% 33% 56%2012E 530 100 57 157 106% 72% 450% 130%Last 12m growth 106% 72% 450% 130%
Implied Gross l ending @ 60%CAGR2027E 611,048 115,292 65,947 181,239
Outstanding P2P loan balances Total UK loan market - Outstanding balances
millions The Lending Club ZOPA Funding CircleZOPA+ Funding
circleUK
MortgagesUK household
unsecuredNon Fin
Corp loansTotal UK
Market
P2P as %total UKmarket
USD GBP GBP GBP GBP GBP GBP2007 4 - - -2008 25 13 - 132009 76 46 - 462010 202 89 - 892011 456 147 10 158 1,015,089 117,432 423,981 1,556,5022012E 965 235 68 302 1,035,391 119,781 432,461 1,587,632 0%
@ 50% Gross lending CAGR Implied 2027 @ 2% balances CAGR
2027E 558,720 105,419 60,300 165,719 1,393,500 161,209 582,035 2,136,744 8%@ 60% Gross lending CAGR2027E 1,380,826 260,533 149,025 409,558 19%@ 70% Gross lending CAGR2027E 3,243,219 611,928 350,023 961,951 45%
Source: Liberum Capital analysis; company data; Bank of England
We estimate a current 5-15%
negative valuation impact for UK
banks if 50% of their franchises
were not economically profitable
15 years from now.
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5) EPS forecasts vs. consensusWe are on average 11% and 8% below consensus for 2013E and 2014E EPS
respectively. In revenue terms we are 1% below in 2013E and 2% below in 2014E.
See Figure 57 in main section for details.
6) Banks’ capital position, valuation andrecommendationsWe use a capital-adjusted warranted equity valuation approach. Given the binary
nature of the Eurozone crisis, we derive scenario-weighted target prices. See main
section for details.
As Figure 11 illustrates, our top picks are Standard Chartered and HSBC,
where we see 24% and 20% upside currently. Even in our stress scenario, we
see upside of 16% and 8% for these banks respectively.
The UK domestic banks by contrast are un-investable, meaning there is significantand unusually uncertain downside risk in our ‘stress scenario’. That said, we find an
attractive risk-reward ratio for Lloyds with 60% upside provided the peripheral
countries (with the probable exception of Greece) stay in the Euro-zone, vs. 27%
downside in the ‘stress’ Euro break-up scenario.
Upside risk to our target prices:
From a valuation perspective, the wild card is the government policy response in the
stress scenario. Since the Euro-zone break-up is a policy decision, there is no
moral-hazard consideration preventing central banks and governments from being
more aggressive than usual in counterbalancing its impact with QE and for instance
potential fixed-price underwriting for any required rights issues (as seen with the USTARP programme), thereby preventing the typical selloffs in advance of rights
issues.
In addition, as noted in Jonathan Tepper’s short-listed entry for the Wolfson prize,
historically monetary unions have broken up with less disruption than many people
feared ex-ante. In short it’s possible that our stress case loan loss assumptions are
too pessimistic implying upside for the UK domestic banks.
Figure 11: Stress case fair values/share
£/share Barc LLOY RBS HSBC St Ch UK AvgCurrent pri ce 1.74 0.26 2.00 5.03 12.92
Base Case TP 2.66 0.41 3.26 6.85 17.29Bear Case TP 1.22 0.19 1.21 5.42 14.94Stress probability 55% 55% 55% 55% 55% 55%Target Price 1.87 0.29 2.13 6.06 16.00
Base case upside (%) 53% 60% 63% 36% 34% 49%Stest case upside (%) -30% -27% -40% 8% 16% -15%Prob weighted (%) 8% 12% 7% 20% 24% 14%Recommendation Hold Buy Hold Buy Buy
Source: Liberum Capital estimates
We see upside for Standard
Chartered and HSBC even in a
Euro-zone breakup scenario.
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Back to the FutureIn the current environment, top-down macro analysis trumps the standard bottom-up
approaches. The main driver of UK share prices is exposure to the Eurozone crisis
and consequent risk of rights issues and/or insolvency (i.e. bankruptcy resolution).Unsurprisingly, as the European sovereign crisis has intensified, correlations among
UK banks have increased. Regressing daily variations in P/Es for UK banks against
CDS spreads (sovereign, bank and non financial) results in an R-squared over 80%
(see Figure 27). To an unusual extent, banks are currently merely geared plays
on the macro environment.
Bottom up analysis is mainly relevant, in the current environment, to the extent that it
highlights differences in macro exposure since all the UK banks now have broadly
similar ‘me-too’ strategies of prudently rebuilding capital and working through NPLs
(with the exception of STAN where the balance sheet is already in good shape). The
key differentiator by bank is variation in exposure to the ‘high-risk’ countries andcurrent balance sheet strength.
Figure 12: Correlation between UK banks in 2009-10 and from Jan 2011 onwards
2009-2010 2011-to date Change
RBS LLOY HSBA STAN RBS LLOY HSBA STAN RBS LLOY HSBA STANBARC 57% 66% 53% 44% 84% 80% 76% 76% 27% 13% 23% 32%RBS 76% 52% 51% 85% 70% 68% 9% 18% 16%LLOY 58% 49% 65% 65% 7% 16%HSBA 65% 78% 13%
Source: Bloomberg
With that in mind this report addresses two macro questions:
What is the estimated bank valuation impact from the exit of all the
peripheral countries from the Euro-zone?
Post resolution of the Euro-zone crisis, what is the likely TSR for banks as
the UK economy deleverages from a debt/GDP ratio of 408% (the highest in
over a 100 years)?
We then look at:
UK banks’ progress in balance sheet repair since 2008
Valuation impact of banking disruption from Peer to Peer lending
companies which we believe, given their current growth rates (not dissimilar to
those of Google and Amazon in their early years), represent a disruptive-
technology threat for banking within 10-20 years.
Capital, scenario- based valuations and recommendations
Currently UK domestic banks are
almost entirely geared bets on the
Euro-zone crisis.
Over the past 18 months the
correlation between daily moves in
Barclays and RBS has increased
from 57% to 84% (27% increase).
Similarly the correlation of
Barclays and Standard Chartered
has increased from 44% to 76%.
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1) Probability and impact of Euro-zone break-up“I don’t know if the euro will be here in 5 years”, Warren Buffett, May 2012.
BARC, LLOY and RBS are currently un-investable given the political risk of
Greece and other countries leaving the Euro-zone and the potential knock-on impact
on the UK banks. That said, we believe it’s possible to develop useful estimates of
the likelihood of a break-up and its impact on banks, enabling tactical trading in the
domestics banks. By contrast STAN and HSBC are much better positioned with
respect to the Euro-zone issues and are therefore more investable.
Current configuration of Euro-zone is unsustainable
A wide array of macro data points to an escalation of the Eurozone crisis. For
brevity, we present just 2: i) the build-up of TARGET2 imbalances between central
banks ii) EU sovereign bond yields.
i) TARGET21
balances: are the assets and liabilities between European central
banks. The significant rise in these central bank assets/liabilities over the last coupleof years, indicate imbalances in the flow of goods and capital around the Euro-zone
due to fixed exchange rates.
Germany’s exposure to the central banks in the periphery of Europe was EUR644bn
as of April 2012, equivalent to 26% of German GDP. This exposure is rising at a
CAGR of 108% (up €335bn in 12 months). Extrapolating this trend, German
exposure could be as high as €1.9 trillion or 75% of German GDP by the end 2013 –
clearly an unsustainable trend.
Figure 13: Target 2 claims of Germany vs. Liabilities of key peripheral countries
-€ 1,000
-€ 800
-€ 600
-€ 400
-€ 200
€ 0
€ 200
€ 400
€ 600
€ 800
J a n - 0 5
J a n - 0 6
J a n - 0 7
J a n - 0 8
J a n - 0 9
J a n - 1 0
J a n - 1 1
J a n - 1 2
German asset exposure Spain+Italy+Greece liability
Source: Bloomberg ; Liberum Capital estmates. Las t actual data for Spain April 12, For Italy March 12 (April scaled based on Spain), For Greece, January 12 (Feb-April scaled based on Spain and Italy).
ii) Sovereign bond yield differentials for peripheral countries of Europe vs.
Germany indicate rising risks of default. From the prices of these sovereign bonds,
we can derive the expected loss on default. Then making an assumption on losses
given default we estimate the probability of default for each sovereign.
1TARGET2: Trans-European Automated Real-time Gross Settlement Express
Transfer System
Germany’s Target 2 asset exposure could reach €1.9 trillion
by year end 2013E extrapolating
the current 108% CAGR- clearly
an unsustainable trend.
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Figure 14: Yield differentials of 10 year bonds to Germany
0.0
4.0
8.0
12.0
16.0
D e c - 1 0
J a n - 1 1
F e b - 1 1
M a r - 1 1
A p r - 1 1
M a y - 1 1
J u n - 1 1
J u l - 1 1
A u g - 1 1
S e p - 1 1
O c t - 1 1
N o v - 1 1
D e c - 1 1
J a n - 1 2
F e b - 1 2
M a r - 1 2
A p r - 1 2
M a y - 1 2
G reece Portugal Ireland Spain Italy
Source: Bloomberg; Greece off the chart from Sep 11 onwards.
The implied 10 year risk of default for peripheral countries ranges from 51% for
Italy to c100% for Greece (17% for France)
Figure 15: Implied probability of default within 10 years for Euro-zone sovereigns
0%
20%
40%
60%
80%
100%
France Italy Spain Ireland Por tugal Greece
Prob. Default
Source: Bloomberg; Liberum Capital analysis
Clearly these default probabilities would decline substantially if the ECB signalled it
was willing to act as a credible lender of last resort. An active central bank with a
flexible mandate is a major difference between European Sovereign bonds and
those of the UK and US.
Current high peripheral yields make sovereign defaults likely
Current high peripheral yields make the sovereign debt unsustainable thereby
justifying high yields in a vicious cycle. To see this in slightly more detail:
For any sovereign, debt sustainability i.e. the annual change in debt/GDP can be
modelled based on GDP growth; debt/GDP level; primary surplus; funding cost
Δd=-s+d*(r-y)/(1+y), where
d=public debt to GDP
s= primary surplus as % GDP
r=real interest rate on public debt
y= real GDP growth
Greek 10 year government bond
yields are currently 29.4% above
10 year German yields (off the
chart)
Since YE10, the differential for
Spain has increased from 2.5% to
5.3%, implying a current probability
of default within 10 years of 60%
Even France often considered a
core European country is showing
signs of potential sovereign stress
which could become more
pronounced if growth slows and no
progress is made on fiscal
integration.
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We take a first cut look at two scenarios
First (see left side of Figure 16) assume current bond yields, 2013E forecasts for
GDP, primary surplus and gross debt. Our analysis implies debt would rise at on
average 27% per annum implying unsustainable debt positions.
Second (right side of Figure 16) assume, European economic integration, with
issuance of Eurobonds so that real government yields across Europe normalise
at 1.4% (i.e. 2% above current German levels). Even in that scenario of
increased economic integration, debt would continue to rise as a % of GDP in
peripheral countries, although the increases would be slower.
Figure 16: First-cut analysis of debt sustainability dynamics in peripheral European countries
Assume current market rates 2013 GDP & Prim Surplus Assume Eurobond Yields= Current. German+2%; 2013 GDP & Prim Surplus
2013e, %Primarysurplus
Real Interestrate Real GDP
Gross Debtto GDP
Implied Ann. changeDebt /GDP
Primarysurplus
Real Interestrate Real GDP
Public Debt toGDP
Ann. changeDebt /GDP
Variable s r y d chg d s r y d chg dGreece 3.0% 29.4% -7.0% 184% 69% 3.0% 1.4% -7.0% 184% 14%Ireland -2.5% 8.1% -3.0% 121% 16% -2.5% 1.4% -3.0% 121% 8%Portugal -2.0% 11.6% -8.0% 126% 29% -2.0% 1.4% -8.0% 126% 15%Spain -5.0% 6.9% -3.0% 86% 14% -5.0% 1.4% -3.0% 86% 9%Italy 3.0% 4.9% -3.5% 131% 8% 3.0% 1.4% -3.5% 131% 4%Avg -0.7% 12.2% -4.9% 130% 27% -0.7% 1.4% -4.9% 130% 10%
Source: Liberum Capital analysis; Capital Economics, OECD database
Based on this simple first cut analysis, in the absence of Eurobond issuance, inter-
country transfer payments and aggressive ECB QE, the macro situation in the
periphery of Europe will continue to worsen over time, increasing the likelihood of
a Euro-breakup scenario.
It remains to be seen whether market volatility following a GREXIT event would
persuade the Germans and other governments that Eurobonds and QE arenecessary. As our deleveraging section below shows, a virtuous circle could develop
if peripheral sovereign bond yields were held below nominal GDP growth via an
ECB promise of unlimited QE to achieve target rates.
Conclusion: Unless Eurobonds and aggressive QE from ECB are put in place then
sovereign defaults in several European countries appear likely.
Probability of GREXIT
Assuming sovereign defaults occur, what is the probability of countries
exiting the Euro?
Historically across a range of emerging countries, the Bank of England data shows
that, currency crises frequently co-occur with sovereign defaults2.
Intrade, a leading market prediction website operates a market in the probability of a
country leaving the Euro-zone (most likely being Greece) by end of 12E/13E/14E.
The market currently judges an exit by Dec 2014E as 65% likely.
2http://www.bankofengland.co.uk/publications/quarterlybulletin/qb060302.pdf
With Real GDP already negative in
the periphery of Europe combined
with primary deficits, It’s unclear
whether Eurobonds by themselves
would stabilise the sovereign debt
dynamics.
Aggressive QE to boost inflation
would also be required which
would require a sea-change in
attitudes at the ECB
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Figure 17: Market implied probability of partial Eurozone fragmentation
Source: INTRADE, last updated 4th June12.
Estimated impact on banks of peripheral countries leaving the Euro-zone
If GREXIT occurs, then over time, in the absence of substantive policy changes
(Eurobonds, transfer payments, ECB QE), we believe the market will increasingly
discount exits by other peripherals particularly Portugal and Ireland.
In this scenario, we assume that the UK government would provide unlimited
liquidity and (if necessary) equity capital to the banks. We therefore focus on risk of
equity dilution risk (ignoring bankruptcy/resolution risk). Losses for UK banks in a
Eurozone break-up scenario would be substantial but could be absorbed in an
orderly way, particularly if ex-ante derivatives markets were established to enable
pre-hedging of new currencies and other risks3.
As a bear case scenario, we assume that Greece leaves the Euro in 2012,quickly followed by Portugal/Ireland/ Spain and Italy. We then estimate the
impact on the end 2013E capital position for each bank vs. the base case.
We believe country exits from the Euro would impact the UK banks capital in 4 main
ways: i) foreign exchange (FX) losses, ii) higher loan losses, iii) higher wholesale
funding costs and iv) net lower investment banking revenues. Taking these in turn:
FX losses on assets in the periphery countries
In our potential exit scenario, we assume devaluations in the peripheral
countries. Our devaluation estimates are broadly based on analysis of relative
increases in compensation costs per employee since 1995 (point when financial
markets started to anticipate Euro-zone creation). For instance, since 1995,
labour compensation in Greece increased 110% more than in Germany and 59%
more in Ireland vs. Germany. These differences now need to be reversed to
restore competitiveness in the periphery (Figure 18-19). We also assume some
over shoot in the FX adjustment.
3 http://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay
%20-%20jens%20nordvig.pdf
Market prediction prices implies
65% probability of at least 1
country leaving Euro by end 2014E
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Figure 18: Indexed Labour comp per employee for GIPSI*countries (indexed 1995 = 100) and Germany
Figure 19: Implied FX devaluation on exit from Euro-zonebased on employee compensation + some overshoot.
60
100
140
180
220
1 9 9 5
1 9 9 6
1 9 9 7
1 9 9 8
1 9 9 9
2 0 0 0
2 0 0 1
2 0 0 2
2 0 0 3
2 0 0 4
2 0 0 5
2 0 0 6
2 0 0 7
2 0 0 8
2 0 0 9
2 0 1 0
Germany Greece Ireland
Italy Portugal Spain
91% 142%32%
-70%
-60%
-50%
-40%
-30%
-20%
-10%
0%
G r e e c e
I r e l a n d
P
o r t u g a l
S p a i n
I t a l y
A v g
Economic required deval O vershoot
*GIPSI: Greece, Ireland, Portugal, Spain and Italy
Source: Liberum Capital estimate ; OECD
Source: Liberum Capital analysis
For simplicity, we assume devaluations of 60% for Greece, 45% for both Ireland and
Portugal and 20% for both Spain and Italy, broadly in line with estimates from short-
listed Wolfson exchange4
entries.
Combining these estimated FX adjustments with asset exposure in each peripheral
country we get estimates of FX related losses. For RBS we assume that GBP6.5bn
of local deposits (25% of total deposits) would be retained (i.e. not experience
capital flight) ahead of exit event and therefore base our loss analysis on exposure
of £32.4bn (rather than total Irish assets of £38.9bn as of 1Q12). Barclays would be
most impacted: -£17.5bn pre tax impact
Figure 20: Potential FX losses on Euro exit
BARC LLOY RBS HSBC STAN CCY GBP bn GBP bn GBP bn USD bn USD bn FX deval.AssetsGreece 0.1 0.4 0.4 6 0.6 60%Ireland 5.7 14.9 32.4 5.4 0.6 45%Portugal 9.9 0.6 0.4 1.1 0.6 45%Italy 25.3 0.6 2.6 6.9 0.6 20%Spain 26.5 6.5 5.9 10.3 0.6 20%Total 67.6 23.0 41.7 29.7 3.0
Potential pre tax FX losses, bnGreece -0.1 -0.2 -0.2 -3.6 -0.4Ireland -2.6 -6.7 -14.6 -2.4 -0.3Portugal -4.4 -0.3 -0.2 -0.5 -0.3Italy -5.1 -0.1 -0.5 -1.4 -0.1Spain -5.3 -1.3 -1.2 -2.1 -0.1Total -17.5 -8.6 -16.7 -10.0 -1.1
Source: Liberum Capital
Higher loan losses on slower growth and tighter credit conditions
We assume that loan losses would increase following a breakup of the Euro due
to i) the near term negative GDP shock, ii) tighter credit conditions as banks
become capital constrained, iii) tighter fiscal austerity from UK government as the
political priority of a strong macro position for the UK increases. In absolute
terms, HSBC and Lloyds are the 2 banks most impacted with cumulative
incremental losses of $23.5 bn and £15.2bn respectively by YE13E.
4http://www.policyexchange.org.uk/component/zoo/item/wolfson-economics-prize
In our stress scenario where all 5
peripheral countries exit, Barclays
would have the largest pre tax FX
losses at £17.5bn; least impacted
Standard Chartered at only $1.1bn
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Figure 21: Bear case- Losses from higher loan losses FY12-13E
Reporting CCY billions BARC LLOY RBS HSBC STAN£ bn £ bn £ bn $ bn $ bn
Avg customer loans over FY12-13E, bn 440.6 532.2 439.3 978.9 297.8Base case scenario cumul. loan losses FY12-13E , bn -6.8 -11.7 -11.0 -18.1 -3.0Base case annual loan losses as % loans -0.77% -1.10% -1.26% -0.93% -0.50%
Bear case scenario: cumul. loan losses FY12-13E -15.5 -26.9 -25.4 -41.7 -6.9Bear case annual loan losses as % loans -1.76% -2.53% -2.89% -2.13% -1.16% PBT impact f rom Incremental loan losses FY12-13E -8.8 -15.2 -14.4 -23.5 -3.9
Source: Liberum Capital
Increased Wholesale funding costs
Given likely increased risk aversion, we assume that term wholesale funding
spreads would increase by 30% for 2 years following breakup and that short term
wholesale funding costs would increase by 2-10bps.
Figure 22: Bear case - PBT impact from higher funding costs FY12-13E
Reporting ccy . bn BARC LLOY RBS HSBC STANCumulative long term Wholesale funding requirement, bn 43 50 50 $20 $55 yr CDS (%) 2.31% 3.10% 3.10% 1.47% 1.58% Assumed increase L-T funding 30% 30% 30% 20% 20% Additional funding cost bps 0.69% 0.93% 0.93% 0.29% 0.32%PBT cost -0.6 -0.9 -0.9 -0.1 0.0 Cumulative Short term Wholesale funding 130 92 80 150 60 Assumed increased in funding cost 0.05% 0.10% 0.10% 0.02% 0.02%PBT cost -0.1 -0.2 -0.2 -0.1 0.0 Total cumulative funding cost -0.7 -1.1 -1.1 -0.2 -0.1
Source: Liberum Capital
Lower IB revenues - less customer activity/losses on credit assets
In the bear case, we assume that cumulative revenues in FY12-13E are 40%lower than the base case due to customer risk aversion and losses on credit and
equity inventory as risk premia increase. We assume variable costs are 35% of
revenues. Barclays would be most impacted with a £5.9bn pre tax PBT impact.
Figure 23: Bear case- PBT impact from lower IB revenues
BARC LLOY RBS HSBC STAN£ bn £ bn £ bn $ bn $ bn
Base case cumul. IB revenues FY12-13E 22.6 0.8 11.2 21.2 16.1 Bear case vs. base case cumul . change in trading revenues -9.0 -0.3 -4.5 -8.5 -6.4 Assumed variable cost % 35% 35% 35% 35% 35%Implied change in IB PBT -5.9 -0.2 -2.9 -5.5 -4.2
Source: Liberum Capital
Combining these impacts we get the following capital impact by bank FY13e. RBS
is most impacted with a total £26.3bn negative impact net of tax vs. base case.
Figure 24: Bear case- Total cumulative impact of Euro-exit bear case vs. base case
BARC LLOY RBS HSBC STAN£ bn £ bn £ bn $ bn $ bn
FX losses -17.5 -8.6 -16.7 -10.0 -1.1Extra loan losses -8.8 -15.2 -14.4 -23.5 -3.9Higher funding costs -0.7 -1.1 -1.1 -0.2 -0.1Lower IB revenues -5.9 -0.2 -2.9 -5.5 -4.2Total pre tax impact -32.8 -25.2 -35.1 -39.2 -9.3Tax 8.5 6.4 8.8 8.5 2.5Impact net of tax -24.3 -18.7 -26.3 -30.7 -6.7
Source: Liberum Capital
As figure 25 illustrates, in the bear case scenario, the year end 2013E Basel 3
common equity tier one is significantly lower for BARC/LLOY/RBS with HSBC and
In our stress scenario we assume
that the loan loss runrate increases
by 130% for a period of two years
(broadly as seen during the
financial crisis of 2008-09).
..Assume Wholesale funding costs
increase for a period of 2 years.
Lloyds and RBS are most
impacted with a cost of £1.1bn
each.
After 2 years, we assume the debt
could be refinanced more cheaply.
..Assume net investment banking
revenues decline 40% relative to
base case for 2 years (although
revenues in some areas such as
FX would increase) with
corresponding decreases in
variable costs. Most impacted
Barclays £5.9bn PBT.
Adding up the stress scenario
impacts: RBS is most impacted at
£26.3bn; least impacted Standard
Chartered at $6.7bn
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STAN much less impacted. For instance for Lloyds the Basel III common equity tier
1 (B3CET1) drops from 9.1% in the base case to 3.6% in the Bear case. By contrast
STAN is much less impacted with the B3CET1 only dropping from 11.1% to 9.3%.
Figure 25: Bear case- capital adequacy position post Euro exitsYear end 2013E, bn BARC LLOY RBS HSBC St Ch£ bn £ bn £ bn $ bn $ bn
Base case Basel 3 equity tier 1 (B3 CET1) 46.3 29.7 48.0 140.6 39.0Bear case difference vs. base case -24.3 -18.7 -26.3 -30.7 -6.7Bear case Basel 3 equity tier 1 22.0 11.0 21.8 109.9 32.3
Base Case Basel 3 RWAs 485.3 328.5 470.9 1,369.1 352.7Bear case difference vs. base case -26.2 -23.8 -31.1 -33.5 -5.0Bear case Basel 3 RWAs 459.0 304.6 439.8 1,335.6 347.7 Base case B3CET1 9.5% 9.1% 10.2% 10.3% 11.1%Bear case B3CET1 4.8% 3.6% 4.9% 8.2% 9.3% Required B3CET1 10.0% 10.0% 10.0% 10.0% 10.0%Bear case capital deficit -5.2% -6.4% -5.1% -1.8% -0.7%
Bear case capital deficit -23.9 -19.5 -22.2 -23.7 -2.5Source: Liberum Capital
In a bear case scenario, the UK banks would probably be ‘strongly encouraged’ by
regulators to execute rights issues (Govt. underwritten if necessary) with share
prices declining in anticipation- we assume a 30% share price decline. We assume
equity is then issued at the then prevailing market prices (to avoid TERP
adjustments).
Table 26 shows our bear case p/TCEs and bear case fair values. See valuation
section below for more details.
Figure 26: Bear case- summary valuationsBARC LLOY RBS HSBC STAN Avg
£ £ £ $ $Bear case TCE/share, capital adjusted 1.63 0.20 1.74 6.35 13.8Current share price 1.74 0.26 2.00 7.74 19.9Bear case p/TCE 1.1 1.3 1.1 1.2 1.4 1.2Bear case fair value per share 1.22 0.19 1.21 8.34 23.0Implied % upside/downside (+/-) -30% -27% -40% 8% 16% -15%
Source: Liberum Capital
Conclusion: HSBC and STAN best positioned with respect to Eurozone risk;
Our analysis above shows HSBC and STAN are least impacted by direct
Eurozone breakup risk. In addition, any fragmentation of the Eurozone is likely to
be met with substantial liquidity provision by ECB and other central banks whichwill benefit emerging markets and in particular STAN and HSBC.
Tactically, immediately post a GREXIT event, policy action would probably more
than offset the negative impact (as seen for instance with the LTRO-induced rally
around the Greek PSI event) implying ‘trading buys’ on UK domestic banks once
a policy response becomes evident. However in the absence of substantive
policy change (including Eurobonds, common Euro-treasury), any rally in
BARC/LLOY/RBS would likely be short-lived in our view.
Regression of UK bank P/Es to CDS spreads produces R2 of 80-85%
It’s unsurprising that a bank’s cost of equity-and therefore it’s P/E multiple- is
correlated with credit spreads. Regressions of the UK banks’ historical Bloomberg
rolling forward P/Es vs. CDS spreads (Sovereign, ITRAXX, bank CDS spreads) yield
a surprisingly high R2
and often generate useful short term trading signals. Currently
In the stress scenario before rights
issues, for Lloyds the Basel 3 core
equity tier 1 ratio would be only
3.6% (vs. 9.1% in the base case),
implying a capital deficit of £19.5bn
vs. a 10% target ratio.
By contrast for Standard Chartered
the core equity tier 1 would only
decline to 9.3%. The implied
$2.5bn capital deficit could be
addressed via retained earnings.
In our stress scenario, RBS has
the most downside (40%) with a
fair value per share of £1.18.
Standard Chartered still has 16%
upside.
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the CDS models point to further downside of 18% for Barclays as illustrated in
Figure 27.
Figure 27: Barclays share price vs. CDS implied fair value
-100
-50
-
50
100
150
200
250
300
350
400
J a n - 1 0
M a r - 1 0
M
a y - 1 0
J u l - 1 0
S e p - 1 0
N o v - 1 0
J a n - 1 1
M a r - 1 1
M
a y - 1 1
J u l - 1 1
S e p - 1 1
N o v - 1 1
J a n - 1 2
M a r - 1 2
M
a y - 1 2
-100
-50
0
50
100
150
200
250
300
350
400
Implied Fair Value/share (p) Price (p) Upside (%)
Source: Liberum Capital, Bloomberg
Our CDS spread regression model
currently implies fair value of 143p
for Barclays
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2) Implications of macro debt deleveraging“Apart from that Mrs Lincoln how did you enjoy the play?”, Tom Lehrer
Post resolution of the Euro-zone crisis (one way or another), investors’ attention will
shift to the outlook for UK banks in the context of the coming decade-long debt/GDPdeleveraging process we expect in the UK (and US).
The UK’s total debt to GDP is uncomfortably high at 408%.
The UK now faces a debt deleveraging which comes along only every 50-80 years.
Reassuringly, the UK has done it before: from 1947 to 1969, UK Debt/GDP fell from
395% to 146%5. In assessing the outlook for banks during the unusual macro period
ahead, we believe it’s instructive to study: i) the US banks during the 1930s ii) the
UK banks during the 50s and 60s, as well as iii) banks’ TSR performance during
less successful deleveragings.
Figure 28: UK total debt*/GDP 1900-2011 Figure 29: UK total debt*/GDP 2000-11
0%
50%
100%
150%
200%
250%
300%
350%
400%
450%
500%
1 9 0 1
1 9 1 1
1 9 2 1
1 9 3 1
1 9 4 1
1 9 5 1
1 9 6 1
1 9 7 1
1 9 8 1
1 9 9 1
2 0 0 1
2 0 1 1
debt/GDP
0%
50%
100%
150%
200%
250%
300%
350%
400%
450%
500%
0 0 Q 4
0 1 Q 4
0 2 Q 4
0 3 Q 4
0 4 Q 4
0 5 Q 4
0 6 Q 4
0 7 Q 4
0 8 Q 4
0 9 Q 4
1 0 Q 4
1 1 Q 4
Household Corporate Public Adj. Fin
408
114
83
109
102
430
130
70
120
110
*total debt: public, household, corporate and financial
Source: Liberum Capital; ONS; Bridgewater Associates, McKinsey; ONS
*total debt: public, household, corporate and financial
Source Liberum Capital; ONS; McKinsey
Basic deleveraging framework:
Typically there are four stages to a debt deleveraging with 1) an initial economic
slowdown, followed by 2) defaults, 3) attempted austerity before transitioning to 4) a
balanced deleveraging with QE offsetting the depressing/deflationary impact of debt
reduction. Not every deleveraging goes through all 4 phases.
5See: http://www.bwater.com/Uploads/FileManager/research/deleveraging/an-in-
depth-look-at-deleveragings--ray-dalio-bridgewater.pdf
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Figure 31: Historical Debt*/GDP deleveragings
Country/period Start date End date Start Debt/ GDP End Debt/ GDP NGDP growth less Govt bond yield Ugly deleveragingsUS Depression 1930 1932 155% 252% -20.4%Japan 1990 Present 403% 498% -2.0%
US (Sep08-Mar09) Sep-08 Feb-09 342% 368% -8.8%Spain (Sept '08 to pres.) Sep-08 Present 348% 389% -4.5%UK Sep08 - Feb09 Sep-08 Feb-09 388% 395% -9.2%Average -9.0% Beautiful deleveragingsUS Reflation 1933 1937 252% 168% 6.3%UK post WWII 1947 1969 395% 146% 1.6%US March09 to present Mar-09 Present 368% 334% 0.3%UK (Mar 09 to pres.) Mar-09 Present 395%** 408% 0.8%Average 2.2%
*Total debt : Public, household, non financial corporate and financial **UK debt peaked in 1Q10 at 430%
Source: Bloomberg; Liberum Analysis, Bridgewater Associates
So, historically how did banks fare under deleveragings?During ugly-deflationary deleveragings: banks tend to significantly underperform due
to defaults and loan losses, with share prices dropping on average by 47% per
annum vs. a 30% decline for the broader equity market (Figure32). On average bank
p/TCE multiples decline by 2/3rd
during this process (Figure 33).
Figure 32: Banks TSR during historical deleveragings
Country/period Start date End date
StartDebt/ GDP
End Debt/ GDP
Debtchange
AvgGovt.bondyield
AvgNominal
GDPgrowth
NGDPgrowth
less Govtbond yield
Banksannual
TSRannual
Equitymarketannual
Banks vs.EquityMarket
annual TSR InflationReal Bank
TSR Ugly deleveragingsUS Depression 1930 1932 155% 252% 97% 3.4% -17.0% -20.4% -31% -30% -1% -8% -23%
Japan 1990 Present 403% 498% 95% 2.6% 0.6% -2.0% -11% -5% -6% -1% -10%US Sep08 - Mar09 Sep-08 Feb-09 342% 368% 26% 3.4% -5.4% -8.8% -82% -52% -30% 2% -84%Spain Sept '08 to now Sep-08 Present 348% 389% 41% 5.0% 0.5% -4.5% -23% -11% -12% 1% -23%UK Sep08 - Feb09 Sep-08 Feb-09 388% 395% 7% 3.5% -5.7% -9.2% -92% -57% -35% 2% -94%Average 327% 380% 53% -9.0% -47% -30% -17% -1% -46% Beautiful deleveragingsUS Reflation ( ‘33-37) 1933 1937 252% 168% -84% 2.9% 9.2% 6.3% 21% 31% -10% 2% 19%UK post WWII (47-69) 1947 1969 395% 146% -249% 5.2% 6.8% 1.6% 8% 12% -3% 4% 4%US (6 Mar 09 to pres.) Mar-09 Present 368% 334% -34% 3.2% 3.5% 0.3% 30% 24% 6% 1% 29%UK (6 Mar 09 to pres.) Mar-09 Present 395% 408% 15% 2.6% 3.4% 0.8% 20% 19% 1% 2% 17%Average 353% 265% -88% 2.7% 20% 21% -1% 2% 17%
Source: Liberum Capital estimate; Bridgewater associates; Moodys manual of investments 1930 to 1939; Barclays ‘1690-1996’, Hannah & Ackrill; Bloomberg
By contrast, during beautiful deleveragings (Figure 32) banks’ TSR has averaged
20% per annum vs. 21% for the broader market. Taking their higher beta intoaccount, banks tend to underperform during beautiful deleveragings. On average
p/TCE multiples tend to expand by c 20% (Figure 34) -although the UK 1947-69 is
an exception.
Successful or ‘beautiful’
deleveragings invariably have
growth in Nominal GDP held
above government bond yields,
achieved via QE
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Figure 33: Ugly deleveraging: Banks p/TCE before andafter
Figure 34: Beautiful deleveraging: Banks p/TCE beforeand after
-
0.5
1.0
1.5
2.0
2.5
3.0
US Sep08 -
Mar09
US Depression Spain Sept '08
to now
UK Sep08 -
Feb09
Ugly avg
Start p/TCE End p/TCE
0.0
0.5
1.0
1.5
2.0
2.5
3.0
UK post WWII
(1947-69)
US Reflation
(1933-37)
US (Mar 09 to
pres.)
UK (Mar 09 to
pres.)
Beautiful
average
Start p/TCE End p/TCE
Source: Liberum Capital analysis; Bloomberg; Moodys archives Source: Liberum Capital analysis; Bloomberg; Moodys archives
Operating trends during ‘Beautiful deleveragings’: Stable or shrinking loan
books and subdued profitability
From a balance sheet perspective, we find that during beautiful deleveraging,
balance sheets are relatively static, shrinking by on average 0.7% per annum in
nominal terms and declining 3.5% per annum inflation adjusted.
Evidence on earnings is somewhat mixed: during the US reflation from 1933, US
banks on average achieved an RoE of only 1.65% as they worked through loan
losses averaging 1.70% annually. By comparison in the UK during the 50’s and 60’s
Barclays’ UK domestic bank achieved an RoE of 7.62% with average loan losses of
0.09% annually – remarkably low loan losses for a deleveraging period starting with
a debt /GDP ratio of 395%.
Figure 35: Bank operational metrics during 3 beautiful deleveragings
Loan growth annualised Real loan growth annualised LLPs/Loans annualised RoEUS Reflation (1933-37) -3.3% -5.3% 1.70% 1.7%Barclays post WWII (1947-69) 5.3% 1.3% 0.09% 7.6%BARC/LLOY/RBS post Mar 09 -4.0% -6.4% 1.80% 3.0%*Average -0.7% -3.5% 1.2% 4.1%
*Underlying RoTCE
Source: Bloomberg; Liberum Analysis, Barclays bank 1690-1996, Leslie Hannah; Federal Reserve Bank of St. Louis FRASER
So what does this macro framework predict for banks currently?
To apply this framework currently, for relevant countries we collate:
Current debt/GDP levels and debt trends since end 2008.
The current gap between nominal GDP growth and the government bond
yields (we use the average of 5 year and 10 year government bonds). As
discussed above, a positive gap between nominal GDP growth and government
bond yield means that the debt/GDP ratio will tend to decline in an orderly way.
Loan losses were only 9bps per
annum for Barclays UK domestic
bank during the 1947-1969 period
as the UK economy de-levered.
By contrast losses were higher for
US banks during the 1933-37 reflation
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Figure 36: Prospective sovereign debt dynamics
Avg. Gov't bond yi eld NGDP growth Gap 2008 Debt/ GDP 2011 debt/ GDP Chg i n Debt /GDP Delev. TypeSelected Europe & USUS 1.1% 4.2% 3.1% 342% 334% -8% Beaut.UK 1.1% 3.1% 2.0% 402% 408% 6% Beaut*.Germany 0.8% 2.0% 1.3% 277% 278% 1% n/a
France 1.8% 1.7% -0.1% 311% 346% 35% UglyItaly 5.7% -0.7% -6.4% 302% 314% 12% UglyIreland 7.3% -0.4% -7.7% 490% 448% -42% UglySpain 6.3% -2.1% -8.4% 348% 389% 41% UglyPortugal 12.9% -2.3% -15.2% 290% 356% 66% UglyGreece 30.8% -3.8% -34.6% 230% 295% 65% UglyChina 3.1% 11.9% 8.8% 159% 184% 25% n/aSingapore 1.0% 8.0% 7.0% 262% 266% 4% n/aIndia 8.4% 14.7% 6.3% 129% 122% -7% n/aBrazil 2.5% 8.5% 6.0% 142% 148% 6% n/aIndonesia 6.1% 11.2% 5.1% 79% 69% -10% n/aHong Kong 0.8% 5.8% 5.0% 231% 298% 67% n/aMalaysia 3.4% 6.2% 2.8% 191% 223% 33% n/aCanada 1.5% 4.2% 2.7% 245% 276% 31% n/aSouth Africa 7.7% 9.1% 1.4% 230% 246% 16% n/aSouth Korea 3.6% 4.9% 1.3% 330% 314% -16% Beaut.Mexico 5.6% 6.6% 1.0% 85% 91% 6% n/a
Avg 4.0% 8.3% 4.3% 189% 203% 14%*UK debt/GDP peaked in 1Q10 at 430%
Source: Liberum Capital; McKinsey Global Institute; OECD; IMF; Bloomberg as of 1st June 2012
The data suggests the following:
The US and UK on track for beautiful deleveragings: As figure 36 shows,
both the US and UK currently have high debt to GDP ratios of 334% and 408%
but have positive NGDP-yield gaps (US: 3.1% and UK 2.0%) suggesting they are
on track to achieve beautiful deleveragings over the medium term. While UK
debt/GDP has risen between YE08 and YE11, it peaked at 430% in 1Q10 and
subsequently declined to 408% by YE11.
The peripheral countries of Europe face an ugly deleveraging: As Figure 36
indicates, high debt levels and, more importantly, negative NGDP- yield gaps
point to an ugly deleveraging for the European periphery with corresponding
adverse asset quality issues for banks. France has bond yields just 0.1% above
nominal GDP growth making its classification somewhat borderline.
More positively, the rest of world is generally not deleveraging: Outside the
UK & US & Europe, debt levels on the footprint of the UK banks are generally
lower and NGDP-yield gaps are uniformly positive.
So which UK banks are best/worst positioned from a macro perspective?
To identify relative winners and losers, we first calculate the loan exposure by
geography for each bank (Figure 37).
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Figure 39: Weighted average total debt/GDP by bank Figure 40: Weighted average Nom. GDP growth minusGovt. bond yield by bank
0%
100%
200%
300%
400%
500%
BARC LLOY RBS HSBC STAN
Avg D ebt/G DP Avg
-1.0%
1.0%
3.0%
5.0%
BARC LLO Y RBS HSBC STAN
Avg NG DP-Yld Gap Avg
Source: Liberum Capital Source: Liberum Capital
Figure 41 shows average yield gaps where the banks are exposed to Ugly
deleveraging. HSBC has the least negative gap as most of its exposure is to France
where the gap is only slightly negative.
Figure 41: Nominal Gap* on Ugly deleveraging portion of loan book
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
B A R C
L L O Y
R B S
H S B C
S T A N
% Ugly Yield gap Average
*Nominal Gap: the difference between nominal GDP growth and average nominal government borrowing costs
Source: Liberum Capital Analysis
Although debt levels are rising relatively rapidly where HSBC and STAN operate
(Figure 42), absolute levels are low suggesting 10-15 years of rapid loan growthahead before they too will face the requirement to deleverage.
Looking only at the ugly
deleveraging portion of loan books:
HSBC has the least negative gap
of nominal GDP growth to
sovereign yield, as most of its ugly
exposure is in France where the
gap is just slightly negative -0.1%
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3) Balance sheet repair since 2008Since Mar 2009, the UK and US have aggressively cut interest rates and started
quantitative easing thereby establishing a ‘beautiful debt deleveraging process’
(previous section).
In this benign environment, the UK banks have dramatically strengthened their
balance sheets by: 1) Offloading non-core assets, 2) Restructuring/writing-off non
performing loans, 3) Improving liquidity positions/ reducing dependency on
wholesale funding, 4) Doubling their Basel 3 equity capital ratios.
Looking at each of these briefly in turn:
1) Reducing non core assets:
These are typically poorly performing or excessively risky assets. As figure 43
illustrates since 2008, the UK banks have managed to significantly shrink their
holdings of unwanted assets either through assets sales, write-offs or natural runoff.
Taking Lloyds for example, non core assets have reduced by 59% from £300bn at
YE2008 to only £122bn by 1Q12. For the UK banks in aggregate, non core assets
have declined from 17% of the balance sheet at YE 2008 to 7% at 1Q12 and we
forecast non-core assets to be only 4% of the funded balance sheet by YE2014. In
contrast to the others, Standard Chartered has not had to offload non-core assets
Figure 43: Non core assets as % of balance sheet
2008 2009 2010 2011 1Q12 2012E 2013E 2014E %ch 2008- 1Q12 %ch 2008- 2014BARC Credit market exposures, £bn 41.7 26.9 23.9 15.2 13.6 12.0 11.0 10.0 -67% -76%
% Funded assets 4% 3% 2% 1% 1% 1% 1% 1%
LLOY Non Core assets, £bn 300 236 194 141 122 110 97 81 -59% -73%% Funded assets 43% 33% 30% 24% 22% 19% 20% 17%
RBS Non Core assets, £bn 258 201 138 94 83 65 40 28 -68% -89%% Funded assets 21% 19% 13% 10% 9% 7% 5% 3%
HSBC HFC runoff & Legacy Credit, $bn 191 158 106 85 83 72 66 61 -57% -68%% Funded assets 10% 8% 5% 4% 4% 3% 3% 3%
STAN Non Core, $bn 0 0 0 0 0 0 0 0 nm nm% Funded assets n/a n/a n/a n/a n/a n/a n/a n/a
Total Non Core assets, £bn 721 564 422 304 271 232 189 158 -62% -78% % Funded assets 17% 14% 10% 7% 7% 5% 4% 4%
Source: Liberum Capital
2) Stabilisation and decline in Non Performing Loans (NPLs):
Initially after the crisis, NPLs were rising, by £54.4bn in 2009 and £21.9bn in 2010.
However by 2011 they had started to decline (down £8.4bn). In 1Q12 NPLs started
to decline for RBS which had been the only bank with NPLs still rising in 2011. This
overall stabilisation and then decline in NPLs combined with adequate coverage with
balance sheet provisions, means that P&L loan loss provisions can continue to
improve (figure 49).
Figure 44: UK Bank NPLs 2008-1Q12
Rep ccy bn Period change
2008 2009 2010 2011 1Q12 2009 2010 2011 1Q12BARC 15.7 22.5 24.3 21.3 21.8 6.8 1.8 -3.0 0.5LLOY 31.3 58.8 64.6 60.3 57.0 27.5 5.8 -4.3 -3.3RBS 18.8 35.0 38.6 40.8 39.8 16.2 3.6 2.2 -1.0HSBC 25.4 30.6 46.9 41.6 n/a 5.3 16.3 -5.3 n/a
STAN 2.7 3.5 4.1 4.2 n/a 0.8 0.6 0.0 n/aTotal , £ 83.5 138.0 159.8 151.4 n/a 54.4 21.9 -8.4 n/a
Source: Liberum Capital company reports
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We see a broadly similar benign asset quality trend looking at NPLs as a % of gross
loans (Figure 45), although slightly less pronounced due to shrinkage in gross loans,
particularly for RBS and Lloyds
Figure 45: UK Bank NPLs % gross Loans 2008-1Q12NPLs/Gross loans (%) Period change
2008 2009 2010 2011 1Q12 2009 2010 2011 1Q12BARC 3.4% 5.2% 5.5% 4.8% 4.8% 1.9% 0.3% -0.7% 0.0%LLOY 4.5% 9.0% 10.4% 10.2% 10.0% 4.5% 1.4% -0.2% -0.1%RBS 3.1% 6.1% 7.4% 8.6% 8.6% 3.0% 1.3% 1.2% 0.0%HSBC 2.6% 3.3% 4.8% 4.3% n/a 0.7% 1.5% -0.4% STAN 1.5% 1.7% 1.7% 1.6% n/a 0.2% -0.1% -0.1% Total 3.4% 5.8% 6.8% 6.6% n/a 2.5% 0.9% -0.2%
Source: Liberum Capital company reports
3) Reduced dependency on wholesale funding:
Between 2008 and 1Q12, the average loan deposit ratio for UK banks has improved
from 126% to 101%. However this masks significant differences by bank. Lloyds
improved from 181% down to 130%. Lloyds has a longer term target loan depositratio of 120% (reduced at 1Q12 from 130%). RBS management targets a 100% loan
deposit ratio.
By contrast HSBC and Standard Chartered have already very strong liquidity
positions and are already compliant with the LCR and NSFR Basel 3 liquidity
requirements (required by 2015).
Figure 46: UK Banks loan deposit ratios
2008 2009 2010 2011 1Q12 2012E 2013E 2014E 2008-1Q12 ch 1Q12-2014 chBARC 138% 130% 124% 118% 116% 116% 111% 106% -22% -10%LLOY 181% 169% 154% 135% 130% 122% 118% 114% -51% -16%RBS 151% 135% 118% 108% 106% 105% 98% 93% -45% -13%
HSBC 84% 77% 78% 75% 75% 75% 77% 77% -9% 2%STAN 75% 79% 78% 76% 76% 76% 73% 71% 1% -5%Average 126% 118% 110% 102% 101% 99% 95% 92% -25% -8%
Source: Liberum Capital company reports
While loan deposit ratios are a relatively crude liquidity measure, the same trends of
improved liquidity are evident in rising primary liquidity buffers, reduced reliance on
short term wholesale funding and reduced reliance on the UK government’s CGS
liquidity scheme (Lloyds will exit the scheme in Oct 2012, RBS exited in May 2012).
4) Stronger equity capital ratios
The capital position of the UK banks has improved significantly from 2008 to 2001,
through a combination of rights issues, retained earnings and balance sheetshrinkage. In terms of fully loaded Basel III common equity tier one ratios, the UK
average has increased from 4.5% to 8.0%. By 2014E we forecast the average will
have increased further to 10.8%.
Figure 47: UK Banks Basel III common equity tier 1 ratios –deductions fully loaded
2008 2009 2010 2011 2012E 2013E 2014E Ch 2008- 2011 Ch 2011-2014BARC 3.9% 7.4% 7.8% 7.7% 8.8% 9.5% 10.2% 3.8% 2.5%LLOY 4.0% 5.2% 7.2% 6.9% 7.8% 9.1% 9.9% 3.0% 3.0%RBS 3.1% 6.6% 6.6% 7.0% 8.5% 10.2% 11.8% 3.9% 4.8%HSBC 4.9% 7.2% 8.0% 8.1% 9.2% 10.3% 11.0% 3.2% 2.9%STAN 6.5% 7.6% 10.5% 10.5% 10.6% 10.9% 11.1% 4.0% 0.6%Average 4.5% 6.8% 8.0% 8.0% 9.0% 10.0% 10.8% 3.6% 2.8%
Source: Liberum Capital company reports
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forecast average RoTCEs of only 4.9% in 2012E and 6.7% in 2013E, well below a
generally estimated 10% cost of equity.
Normalising LLOY and RBS loan losses to TTC (Though-The-Cycle) levels would
boost their respective 2014E RoTCEs to 10.8% and 11.1% (impact is smaller for theother banks).
However, on the surface, the profitability recovery still looks weak.
Figure 51: Base case UK banks’ RoTCE (returns on tangible common equity)
2010 2011 2012E 2013E 2014E Ch 2011- 2014EBARC 7.9% 6.0% 8.8% 9.1% 9.5% 3.4%LLOY -1.4% 0.9% 2.9% 5.7% 7.0% 6.1%RBS 2.4% 1.9% 3.0% 5.3% 7.6% 5.6%HSBC 12.3% 13.4% 12.8% 12.8% 13.2% -0.2%STAN 17.1% 15.3% 15.2% 14.8% 15.0% -0.3%Average 7.7% 7.5% 8.6% 9.5% 10.4% 2.9%Avg domestics 2.9% 3.0% 4.9% 6.7% 8.0% 5.0%
Source: Liberum Analysis
The banks’ low RoTCEs reflect the impact of low interest rates and higher liquidity
buffer requirements on net interest income, as well as increased costs due to
regulatory change.
However a significant driver of lower RoTCE’s is the reduction in the banks’
balance sheet leverage to comply with Basel III requirements. As a sensitivity
analysis, (figure 52), we calculate the RoTCEs of the UK banks from 2010 to 2014E
if they were able to operate at a 7% Basel II core tier 1 which, before the financial
crisis, would have been viewed as a more than sufficient capital base.
At a 7% Basel II core tier 1 the average RoTCE for the UK banks would be 12.3% in2012E increasing to 16.8% by 2014E, a much more impressive result by historical
standards and well above a notional 10% cost of equity. So, although RoTCE’s are
low, banks are actually on track to generate attractive returns if capital targets were
set at the levels of 5 to 10 years ago.
Figure 52: UK bank RoTCE adjusting capital levels to a 7% Basel 2 Core Tier
2010 2011 2012E 2013E 2014E Ch 2011- 2014EBARC 10.7% 8.1% 12.2% 13.1% 14.1% 6.0%LLOY -2.4% 0.5% 3.5% 8.6% 11.7% 11.2%RBS 2.5% 1.9% 3.5% 7.5% 12.8% 10.8%HSBC 17.1% 18.9% 18.3% 19.5% 21.4% 2.5%STAN 24.4% 24.2% 24.2% 23.6% 24.1% -0.1%Average 10.5% 10.7% 12.3% 14.5% 16.8% 6.1%
Avg domestics 3.6% 3.5% 6.4% 9.7% 12.8% 9.4%Source: Liberum Analysis
Over time, as the banks NPLs decline further and the macro environment gradually
improves, a 10% Basel III common equity tier 1 will almost certainly be seen as
more than adequate. At that point, based on Modigliani-Miller6
logic, it’s likely that
the cost of equity for banks will decline, so that for instance, an 8-9% RoTCE would
merit trading at above 1x TCE (see valuation section).
6http://en.wikipedia.org/wiki/Modigliani%E2%80%93Miller_theorem
By 2014E we forecast an average
RoTCE of 8.0% for the UK
domestic banks, subdued by
historical standards but still a
significant improvement on the
3.0% achieved in 2011
If the UK banks were to operate at
a 7% Basel 2 Core tier 1 rather
than the currently targeted Basel 3
10% ratio, then by 2014E the
average RoTCE for the domestic
banks would be a relatively
‘healthy’ 12.8%
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Assuming average loan maturities of 5 years, this implies (Figure 55) that P2P’s
market share of total UK loans could range from 8% to 45% of all household and
corporate lending in the UK by 2027E.
Valuation impact of Peer to Peer technology disruptionWhile the growth and valuation impact of peer to peer lending for the incumbent
banks is clearly uncertain, by way of illustration, we consider a scenario where a
stylised bank with £100bn of equity capital is impacted by peer to peer lending and
other banking innovation (e.g in the payments area).
We use an economic profit model for the bank: Fair Value = TCE+
TCE*(RoTCE-Ke)/(Ke-g)
Assumptions:
Incumbent bank is ex growth with a sustainable RoTCE of 13% and cost of
equity of 10%; implying an economic profit margin of 3% per annum (13%-10%).
15 years into the future, peer to peer banking impacts 50% of the bank’s
business driving returns to below the cost of capital.
The bank winds down the non-economic half of its business with a loss of
20% of invested capital (a £10bn loss in our example).
With these assumptions the PV impact on fair value is 6% of current invested
equity (see Figure 56) or £6bn for our hypothetical bank.
At the current 0.4x TCE multiples for the UK domestic banks, the impact as a %
of current market cap would be c15% vs. c5% for Standard Chartered and HSBC
given their higher current p/TCE multiples.
Figure 56: Estimated impact of Peer to peer lending
Total Bankvalue if no P2P
impact50% of bank notimpacted by P2P
50% of bankimpacted by P2P
Total bank fairvalue net ofP2P impact
Loss of fairvalue
Invested equity 100 50 50RoTCE 13% 13% 13%Ke 10% 10% 10%g 0% 0% 0%
Valuation impactInvested Capital 100 50 50PV Economic profit next 15 years 22.8 11.4 11.4
PV Economic profit after 15 years 7.2 3.6 0
Loss on half business shutdown -10PV of shutdown costs -2.4
Total bank equity fair value 130 65 59 124 -6 Loss as % TCE -6% Loss as % of price @0.4x TCE -15% Loss as % of price @1.2x TCE -5% *UK domestics currently trade at 0.4x TCE Source: Liberum estimates
Growth drivers for peer to peer lending:
Competitive rates for borrowers and lenders. Zopa enables lenders to achieve
rates of interest net of losses of 7-8% pre tax. Net of tax, these rates exceedmost cash ISAs available in the UK.
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Zopa currently focuses on unsecured personal lending but believes its model is
also suited to mortgage lending in the future.
Funding Circle has effectively established a new corporate bond market for the
SME sector on a low cost platform. Once loans are made at gross yields of 7-10%, they can be bought / sold in small parts via an exchange. Lending is on
both a secured and unsecured basis.
The UK government is planning to lend up to £100m to SMEs via P2P networks
and other alternative lenders (May 2012 announcement). Funding Circle has
announced it will apply for £30m of the government money.
According to Zopa and Funding Circle, pension funds and insurance companies
are considering providing funding to the P2P lending sector which would boost
growth rates substantially.
In general regulators are likely to welcome Peer to Peer lending since i) it helpsreduce the systemic importance of the banking sector thereby lowering risk for
the tax payer ii) P2P lenders provide credit to the SME sector – a key
government priority.
Competitive cost structure: majority of P2P lending process is automated and
scalable, enabling the lending networks to earn profits with relatively low
commission spreads – Zopa charges lenders and borrowers annually 1% and
2.5% respectively; funding circle charges lenders 1% and borrowers an upfront
fee of 2-5% (average 3%).
Existing banks may launch separately branded challenger P2P businesses
(despite cannibalisation issues) which would further accelerate the sectors
growth.
Potential headwinds for peer to peer lending:
P2P lenders are not yet regulated by the FSA: making savers less inclined to
get involved despite the attractive returns.
Tax disadvantages: P2P lending is not yet possible from ISAs although it is
possible from within a SIPP and within an IRA in the US. Zopa believes that UK
tax law may become more favourable once the P2P industry is more established.
Maturity transformation: Banks have access to central bank lending of last
resort and deposit guarantees enabling the transformation of instant access
guaranteed deposits into loan-able funds. This is a key advantage for banks
although the ability of P2P lenders to sell their loans does provide a degree of
liquidity transformation.
Other potentially disruptive technologies also evolving and merit attention:
Payments: According to a recent Economist article8: Google and Paypal are
developing online payment solutions which could develop functionally into a
current account offering, while Intuit and Square are entering the (high-margin)
merchant acquisition space (providing credit-card readers to shops)
8Economist 19
thMay2012: http://www.economist.com/node/21554744
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Retail Foreign exchange dealing is another area where crowd sourced
companies are competing with the banks- see http://www.transferwise.com/
whose strapline is “Convert money for nothing. And send for cheap”!.
Conclusion:Growth rates of P2P lenders and other innovators warrant close attention from bank
investors over the next 5 – 10 years. A sustained CAGR of 50-70% combined with
other innovation in Retail banking could already warrant a reduction in bank
valuations of as much as 5-15%.
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5) EPS forecasts vs. consensusOn average we are 11% below consensus EPS for 2013E and 8% below for 2014E.
For revenues, we are 1% below consensus in 2013E and 2% below in 2014E.
Figure 57: Liberum EPS and Revenue forecasts vs. consensus2012E Adj EPS 2013E Adj EPS 2014E Adj EPS
Reporting Ccy LIBe Cons. LIB/Cons LIBe Cons. LIB/Cons LIBe Cons. LIB/ConsBARC 34.2 31.6 8% 37.2 37.2 0% 41.5 41.3 1%LLOY 1.7 2.8 -38% 3.5 5.1 -31% 4.5 6.0 -26%RBS 0.1 1.8 -94% 2.6 3.2 -17% 4.0 4.3 -6%HSBA 92.5 92.2 0% 101.0 103.4 -2% 113.0 120.4 -6%STAN 217.0 216.9 0% 234.4 238.9 -2% 261.6 262.5 0%Average nm -11% -8%
2012E Revenue 2013E Revenue 2014E Revenue
Rep ccy billions LIBe Cons. LIB/Cons LIBe Cons. LIB/Cons LIBe Cons. LIB/ConsBARC 29.1 29.4 -1% 30.1 30.5 -2% 31.5 32.2 -2%LLOY 18.6 19.1 -3% 18.0 18.8 -4% 16.9 18.5 -9%RBS 24.2 23.6 2% 23.4 23.1 1% 23.4 23.4 0%HSBA 67.3 69.9 -4% 72.0 72.1 0% 75.7 76.8 -1%STAN 19.4 19.3 1% 21.7 21.35 2% 24.2 23.5 3%Average -1% -1% -2%
Source: Liberum Capital, Bloomberg
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6) Capital, valuations and recommendationsValuation methodology:
Our approach to bank valuation reflects the unusually binary situation facing bank
equity investors by probability-weighting a base case and a more pessimistic fair
value if all of the peripheral countries exit the Euro (see section 1).
Figure 58: Summary valuation approach schematic
1. Forecast Normalised 2013E PBT ex 1-offs, ex non-core divs & disposals; Adj. LLPs1
Base Case fair value
3. Assume rights issue2 to reach 10% Basel 3 equity tier 1 by 2013E, at 30% discount
4. Calculate FinReg & Capital-adjusted 2013 EPS, TCE3 /share (year end) and RoTCE
5. Base case fair value= PV of (2013 WEV4 value/share + 2012/13 DPS+ non-core val)
1. Estimate capital destruction (FX, loan losses etc) if all peripheral countries exit Euro
Stress Case fair value
2. Calc. TCE3 /sh post (larger) rights issue2 to reach 10% B3 equity tier 1 at 30% discount
3.Stress fair value= PV (2013 WEV4 val/sh.+ 2012/13 DPS+non-core val); Base RoTCE
Target Price = (1-Stress prob.) X Base FV+ (Stress prob.) X Stress fair value
Target price
2. Include FinReg earnings impact (Dodd Frank, LCR liquidity, ICB ring fencing etc..)
Note: 1. LLPs: Loan loss provisions: are adjusted to average of 2013E and long term average level (to reflect mean reversion)
2. Conversely a capital surplus would imply a share buyback (assumed at a 10% premium to current share price)3. TCE used in WEV excludes capital allocated to non-core divisions which are effectively in run-off and valued separately 4. WEV: Warranted Equity Valuation: Fair Value = TCE*(RoTCE-g)/(Ke-g) where TCE/sh is tangible common equity per share, RoTCE is Return on TCE; Ke cost of equity typically 10%; and g is growth (assumed 0% for BARC, LLOY, RBS)
Source: Liberum Capital
5 step process to get base case fair values
As shown (Figure 58), to get a base case fair value per share, we calculate
underlying earnings ex 1-offs, non core divisions and planned disposals with
reported loan losses ½ adjusted towards Through-The-Cycle levels. Next we adjust
for financial regulation. Then, any capital deficit (or surplus) is eliminated via a rightsissue preceded by an assumed 30% share price decline (buybacks are at a 10%
premium to current prices). We assume the rights issues are executed at market
prices to avoid TERP adjustments. A 30% discount seems appropriate based on the
declines in UK bank share prices before rights issue in recent years. Since capital
deficits are small in the base case, the discount is really only relevant in the stress
case where rights issues are larger in proportion to the current market
capitalisations.
Once we have year end 2013E estimates for capital adjusted TCE/share and
RoTCE we apply the WEV (warranted equity valuation formula) to get a fair value
per share at end 2013E and then discount back to present adding in dividends andsome value for any non core divisions (if previously stripped out of earnings and
TCE).
The current bi-modal Eur0-zone
environment requires a scenario
approach to valuation
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Capital adjusting EPS and TCE/share
Next, we calculate the Basel capital position at YE 2013 fully loaded for Basel 3
deductions. As indicated (Figure 60), in aggregate we forecast the UK banks will
have a small surplus by YE 2013E of £0.4bn. Barclays capital position has recently
improved by £2.4bn due to the Blackrock disposal announced in May 2012.
In terms of notable detail, for Barclays we assume a pension adjustment of
£2.5bn representing the net of tax present value of proposed incremental
pension payments from 2017 to 2012, to reduce the net pension funding deficit of
£4.6bn (being £6.4bn less £1.8bn of payments made in Dec 11).
Figure 60: Fully phased Basel 3 capital positions for UK banks YE13E
Reporting ccy billions 2013E BARC LLOY RBS HSBC St Ch Sum/ AvgGBP GBP GBP USD USD
Tier 1 capital 57.9 46.3 63.0 164.8 45.0Hybrids and Pref shares -9.7 -6.1 -9.9 -17.9 -5.5Basel II Core Tier 1 (LIB Defn) 48.2 40.2 53.1 146.8 39.5 262.5Deduct Minorities 0.0 -0.2 0.0 0.0 0.0Include AFS reserves 0.7 1.0 -0.4 0.5 0.0Deferred tax -1.7 -3.0 -1.9 -4.94 -0.6Shortfall in provisions vs. exp. losses -0.5 -1.0 -3.7 -3.22 -0.5Pension -2.5 -1.0 -1.5 0.0 0.0Reverse securitis. deductions 50% 1.4 0.2 1.5 1.2 0.1Impact disposals 0.0 0.0 0.7 0.0 0.0 Add back Basel 2 Fin Investments 0.7 0.1 0.3 1.0 0.5B3 CET1 pre fin invest deductions 46.3 36.2 48.0 141.3 39.0 Financial Investments 3.2 10.1 0.6 14.9 1.042Max recognisable Fin Investments 4.6 3.6 4.8 14.1 3.9Deduction of Fin Investments 0.0 -6.5 0.0 -0.8 0.0Basel III equity tier 1 46.3 29.7 48.0 140.6 39.0 240.7 Basel 2.5 RWAs 417.8 291.0 393.6 1,219.1 335.0 2,112CVA RWA increase 63 49 39 150 15Securitisation gross up 34 4 38 30 3Mgmt mitigation -30 -15 0 -30 0
Basel III RWAs 485.3 328.5 470.9 1,369.1 352.7 2,404 Basel II Core Tier 1 11.5% 13.8% 13.5% 12.0% 11.8% 12.4% Basel III Equity Tier 1 9.5% 9.1% 10.2% 10.3% 11.1% 10.0%Bus mix required capital estimate 10.0% 10.0% 10.0% 10.0% 10.0% 10.0%Surplus capital -0.5% -0.9% 0.2% 0.3% 1.1% 0.0%Surplus (deficit) reporting ccy bn -2.3 -3.1 1.0 3.7 3.7 0.4
Source: Liberum Capital
Exclude non-core divisions
Next we show core tangible equity excluding capital required for non core divisions.
Only RBS and Lloyds are impacted where we allocate non-core equity capital equal
to 10% of non-core RWAs.
Figure 61: Estimating Core Tangible Common Equity for LLOY and RBS
2013E Rep ccy bn Barc LLOY RBS HSBC St Ch SumGBP GBP GBP USD USD GBP
Tangible common equity 53.2 43.1 57.0 152.8 40.3 278.8
Non core Basel 3 RWAs - 66.6 60.0 - -TCE/RWA non-core requirement 10% 10% 10% 10% 10%Non Core tangible common equity 0 6.7 6.0 - -
Core tangible Equity, bn 53.2 36.5 51.0 152.8 40.3 268.1
Source: Liberum Capital
We are now in a position to calculate capital-adjusted normalised EPS and capital
adjusted TCE /share as shown in Figure 62. Adjusting for capital we find the UK
banks trade on 0.73x 2013 TCE with RBS and Barclays trading on the lowest
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for UK banks is 10% with the largest increases for RBS (+37%) and Lloyds (+30%)
mainly due to excluding the non-core divisions). Barclays has the largest decrease (-
20%) due to its capital deficit of £2.3bn and also the impact of Financial Regulation.
Figure 63: Estimating EPS – adjusted for Regulation, Capital and ex 1-offs2013E Barc LLOY-core RBS-core HSBC St Ch Sum/avgGBP GBP GBP USD USD
Norm. PBT net of RWA mitigation 7.43 5.34 6.34 27.03 7.94 41.8Earnings on New Cash 0.06 0.08 -0.02 -0.09 -0.09 -0.0Cap adjusted PBT pre Regulation 7.48 5.41 6.32 26.94 7.85 41.8
Impact regulationOTC Derivative to Exchange/SEF -0.35 -0.02 -0.19 -0.42 -0.18NSFR / Liquidity -0.14 -0.15 -0.12 0.04 0.01ICB Ring fencing/ Living Will -0.49 -0.10 -0.28 -0.68 -0.07Other regulation -0.24 -0.05 -0.13 -0.23 -0.11Gross impact pre mitigation -1.22 -0.32 -0.71 -1.30 -0.35Mitigation 0.85 0.12 0.21 0.59 0.17Net Impact -0.38 -0.20 -0.50 -0.71 -0.18 -1.7Regulation impact as % PBT -5% -4% -8% -3% -2%
FinReg Cap-adjusted PBT 7.11 5.22 5.82 26.23 7.66 40.2Tax -1.83 -1.21 -1.48 -5.77 -2.08Tax Rate 26% 23% 26% 22% 27%PAT 5.28 4.00 4.33 20.46 5.58Minorities -0.94 -0.07 -0.48 -1.85 -0.22 Attributable Earnings 4.33 3.93 3.86 18.61 5.36#shares 14.61 86.52 10.62 18.14 2.26EPS - FinReg Cap Adj 29.6 4.5 36.3 102.6 237Cap Adj. TCE/Sh (pence/cents) 379.5 44.6 471.3 821.9 1618RoTCE- FinReg Cap Adj 7.8% 10.2% 7.7% 12.5% 14.6%
Price 174 26 200 774 1987p/E fin reg & cap adj. 5.9 5.7 5.5 7.6 8.4
Reported EPS 37.0 3.5 26.5 101.0 234.4EPS - FinReg Cap Adj 29.6 4.5 36.3 102.6 236.8%change -20% 30% 37% 2% 1% +10%
Source: Liberum Capital estimates
Calculate base case fair values
We are now in a position to calculate base case fair values per share (Figure 64).
These fair values represent our target prices if the Euro-zone were to remain intact
and stable. In that scenario the UK banks would have on average 49% upside with
for instance RBS having 63% upside. Note that our valuation values the non core
divisions separately putting allocated equity (which is 10% of non core RWAs) on a
multiple of 0.2x. Note that for HSBC and Standard Chartered we attribute some
assumed growth in dividends reflecting emerging market exposure and also a
slightly lower cost of equity given balance sheet and capital strength.
Figure 64: Base case fair values/share
Rep ccy unless indicated Barc LLOY RBS HSBC St Ch AvgCap adj TCE, 2013E/share 3.80 0.446 4.71 8.22 16.18RoTCE* 7.8% 10.2% 7.7% 12.5% 14.6% 10.6%Ke 10.0% 10.0% 10.0% 9.5% 9.5% 9.8%g 0.0% 0.0% 0.0% 1.0% 2.7% 0.7%FV** 2013E core/share 2.96 0.45 3.63 11.1 28.5DPS 2012E 0.06 0.0 0.0 0.41 0.84DPS 2013E 0.07 0.0 0.0 0.44 0.94#years to discount 1.50 1.50 1.50 1.50 1.50Non Core division -0.04*** 0.02 0.11Base tgt price £2.66 £0.41 £3.26 $10.54 $26.60Fair value/share GBP £2.66 £0.41 £3.26 £6.85 £17.29 Current price £1.74 £0.26 £2.00 £5.03 £12.92%upside 53% 60% 63% 36% 34% 49%
* RoTCE: Regulatory and capital adjusted, 2013E; **Future value; ***Lehman litigation contingent liability Source: Liberum Capital Estimates
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Stress Case capital position and required rights issues
In the pessimistic scenario where all of the peripheral countries leave the Euro in
2012E, as discussed in more detail in section 1, we find that the UK banks in
aggregate would require £82.7bn of new capital to reach a 10% Basel III equity tier 1
by YE 2013E. Capital adjusted TCE/share would decline by on average 42% relativeto the base case with RBS’s TCE having the largest drop at 63%.
Figure 65: Estimating stress case capital adjusted TCE/share
Reporting ccy, bn Barc LLOY-core RBS-core HSBC St Ch Sum AvgGBP GBP GBP USD USD GBP
Base Case Cap Adjusted TCE bn 55.4 38.6 50.1 149.1 36.6
FX losses- Ireland -2.6 -6.7 -14.6 -2.4 -0.089 -25.5FX losses- Portugal -4.4 -0.3 -0.2 -0.5 -0.16 -5.3FX losses- Greece -0.1 -0.2 -0.2 -3.6 -0.214 -3.0FX Losses- Spain -5.3 -1.3 -1.2 -2.1 -0.04 -9.1FX Losses- Italy -5.1 -0.1 -0.5 -1.4 -0.038 -6.6Total FX loss -17.5 -8.6 -16.7 -10.0 -0.5 -49.6
Incremental loan losses -8.8 -15.2 -14.4 -23.5 -3.9Lower IB PBT -5.9 -0.2 -2.9 -5.5 -4.2Higher wholesale funding costs -0.7 -1.1 -1.1 -0.2 -0.1Tax benefit 8.5 6.4 8.8 8.5 1.9Total TCE change vs. base case -24.3 -18.7 -26.3 -30.7 -6.7
Capital benefit of reduced RWAs 2.6 2.4 3.1 3.4 0.5
Base case capital deficit -2.3 -3.1 1.0 3.7 3.7 0.4Stress capital deficit, rep ccy -23.9 -19.5 -22.2 -23.7 -2.5 -82.7Req. rights issue/(buyback), rep ccy bn 23.9 19.5 22.2 23.7 2.5 82.7Share price for Issuance/buyback (p/cent) 121 18.0 140 542 1391Incremental shares, bn 19.72 108.10 15.89 4.37 0.18reported #diluted shares, bn 12.74 69.21 11.05 18.57 2.43#shares, capital adjusted 32.45 177.31 26.94 22.95 2.61% change in shares 155% 156% 144% 24% 7% 97% Stress Cap Adj. TCE rep ccy bn 52.8 36.22 46.9 145.8 36.1
Stress Cap Adj. TCE/Sh (pence/cents) 163 20.4 174.3 635 1382
Base Case Cap Adj TCE/Sh (pence/cents) 380 44.6 471.3 822 1,618% decline cap-adj TCE/share -57% -54% -63% -23% -15% -42%
Source: Liberum Capital estimates
Calculating stress case fair value per share
Once we have stress case 2013 cap-adjusted TCE/share we can calculate stress
case fair value /share (Figure 66). In a stress case, RBS has the largest downside
dropping to 121p/share. On average stress values per share imply 15% downside.
HSBC and Standard Chartered would still have upside of 8% and 16% respectively.
Figure 66: Stress case fair values/shareReporting ccy, unless indicated Barc LLOY RBS HSBC St Ch AvgCap adj TCE, 2013E/share 3.80 0.45 4.71 8.22 16.2Stress test impact -2.2 -0.2 -2.97 -1.9 -2.4%change -57% -54% -63% -23% -15% -42%Stest Cap adj TCE/share 1.63 0.20 1.74 6.35 13.82 RoTCE 7.8% 10.2% 7.7% 12.5% 14.6% 10.6%Ke 10.0% 10.0% 10.0% 9.5% 9.5% 9.8%g 0.0% 0.0% 0.0% 1.0% 2.7% 0.7%FV** 2013E core 1.27 0.21 1.34 8.6 24.3DPS 2012E 0.06 0.0 0.0 0.4 0.8DPS 2013E 0.07 0.0 0.0 0.4 0.9#years to discount 1.5 1.5 1.5 1.5 1.5Non Core division -0.02 0.01 0.04Stress test fair value 1.22 0.19 1.21 8.34 22.98Fair Value/share GBP 1.22 0.19 1.21 5.42 14.94 Current price , GBP 1.74 0.26 2.00 5.03 12.92
%upside -30% -27% -40% 8% 16% -15%* RoTCE: Regulatory and capital adjusted, 2013E; **Future value
Source: Liberum Capital Estimates
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Calculating target prices and recommendations
Weighting the base and bear cases at 45% and 55% respectively we get our target
prices and recommendations as illustrated in Figure 67.
Top BUY picks: Standard Chartered and HSBC have fundamental upside of24% and 20% on a scenario weighted basis. Even in the stress case, we see
upside for both banks of 16% and 8% respectively.
We have a buy on Lloyds, with 12% upside on a scenario weighted basis.
However uncertainty with respect to the Euro-zone makes this a speculative
recommendation.
Figure 67: Target prices and recommendations
Barc LLOY RBS HSBC St Ch UK AvgCurrent pri ce 1.74 0.26 2.00 5.03 12.92Base Case TP 2.66 0.41 3.26 6.85 17.29Bear Case TP 1.22 0.19 1.21 5.42 14.94Stress probability 55% 55% 55% 55% 55% 55%
Target Price 1.87 0.29 2.13 6.06 16.00
Base case upside (%) 53% 60% 63% 36% 34% 49%Stest case upside (%) -30% -27% -40% 8% 16% -15%Prob weighted (%) 8% 12% 7% 20% 24% 14%Recommendation Hold Buy Hold Buy Buy
Source: Liberum Capital Estimates
Other valuation factors: P2P lending approximately offset by Modigliani Miller
P2P lending: The impact of Peer to Peer lending and other internet-related
innovation on fair value for UK banks is difficult to quantify but nevertheless we
believe it would be naïve to ignore it. We estimate a current impact of 5-15 % for
UK banks (section 4).
Reduced cost of equity: From a valuation perspective, the impact of innovation
is likely to be more than offset in the short/medium term, by a declining cost of
equity (Ke) once investors start to discount the substantial improvement in the
banks’ capital position (section 3) as per Modigliani Miller Logic.
Quantifying the Modigliani Miller impact of excess capital:
By YE 2013E we forecast that in our base case the UK banks will have an average
Basel III common equity tier 1 of 10.0%, equivalent to a Basel 2 core tier 1 of 12.6%.
Given that 5% Basel 2 was sufficient for a 10% Ke prior to the crisis, we believe that
8% Basel 3 (10% Basel 2) will in time be judged as more than adequate for a 10%
Ke (particularly when increases in liquidity strength are also considered). On thatbasis the UK banks on average will have excess capital equivalent to 2% of RWAs.
So looking at the UK banks in aggregate, by YE2013E we forecast the fully loaded
Basel 3 equity will be £238bn of which 20% or £48bn in time will be viewed as
excess capital.
Since the Ke of a group of businesses is the weighted average of their individual Ke
we get, assuming a 2.5% Ke of cash net of tax:
UK Banks Ke = (238-48)/238 *10% +(48/238)*2.5%= 8.5%
Using a Ke of 8.5% rather than 10%, boosts valuations by approximately
10%/8.5%-1 = 18% ( if g=0).
Since the impact of P2P and Modigliani Miller will broadly offset each other, for
now we exclude both from valuations.
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BUY
HSBCNice footwork for an elephantPRICE: 503p | UK | BANKS | HSBA.L | HSBA LN
HSBC’s prescient underweight position in the troubled periphery of
Europe, combined with its valuable emerging market operations,
limits potential dilution in our stress scenario to only 17% of current
market cap. This minor dilution risk in addition to its rock-solid
liquidity position, credible capital re-allocation story, and ‘flight-to
quality’ dynamics (if the crisis worsens), make HSBC’s risk-reward
profile attractive at the current depressed valuation multiples. BUY.
HSBC has wisely avoided significant asset exposure to the
periphery of Europe (in contrast to its 2003 mis-step into US
subprime with the Household acquisition). HSBC’s total exposure to
the periphery of Europe is only 21% of market cap compared to an
average of 203% for the domestic banks (Barclays/Lloyds/RBS).
Relatively small stress-case dilution risk: If the peripheral countries
exit the Euro, we estimate incremental losses for HSBC of $31bn net
of tax, resulting in a 2013E fully loaded Basel 3 equity tier 1 of 8.2%
(base case 10.3%). The $24bn rights issue to boost capital to 10%
would be only 17% of current market cap (compared to 106% for the
domestic banks). Instead of a rights issue, HSBC could address this
deficit (vs. 10% target) within 2 years via retained earnings.
HSBC’s strong liquidity position is a key competitive advantage:
the Group’s liquidity coverage ratio was over 110% at YE11 both at a
group level and for its individual banking entities making the Group
already Basel 3 compliant on liquidity. As of 1Q12 the loan deposit
ratio was 74.8% (vs domestic bank avg: 117%). Consistent with its
strong liquidity position, HSBC’s 5 year CDS spread is 150bps vs.
domestics avg 324bps suggesting a lower cost of equity for HSBC.
Continued progress in shrinking non-core US subprime and GBMlegacy assets: Non-core assets were c$83bn (or 3.7% of funded
assets) as of 1Q12 down from $106bn at YE10; Non-core RWAs
were c$182bn as of YE11, and are shrinking by c$30bn per annum.
This implies current capital consumption of $18.2bn with c $3bn per
annum being reallocated to more profitable Asian markets.
Valuation and recommendation: HSBC trades on 2013E: PEx 7.7x;
p/TCE 0.94 for RoTCE of 12.8%; yielding 5.3%. Our scenario
weighted target price is 606p based on a FinReg&Capital adj. RoTCE
of 12.5% (see figure 63). From a historical perspective the current
p/TCE of 1.1x is 2.0 standard deviations below the 14 year average of2.8x while the forward PEx of 8.0x is 1.5x standard deviations below
its 10 year average of 11.8x.
Stock Data
Target Price (pence) 606
52-Week Range (pence) 456-631
Current price (pence) 503
Shares Outstanding (bn) 18.1
Free Float (%) 100%Market Cap (GBP bn) 91
Avg daily volume (m) 23 *E=Liberum Capital estimates
Stock Performance
300
350
400
450
500
550
600
650
Jun-11 Aug-11 Nov-11 Feb-12 Apr-12
HSBA EURO Banks ( rebased)
Price Performance 1M 3M 12M
Price 565 568 632
Absolute -11% -11% -20%
Rel FTSE -1% 0% -9%
Rel Eurobanks 2% 11% 16%
Source: Bloomberg
Summary Financials & Valuation
Dec y/e ($ bn) FY11A FY12E FY13E FY14E
Revenue, bn 72.3 67.3 71.9 75.6
Op Costs -41.5 -40.8 -41.5 -42.8
Impairments -12.1 -9.6 -8.5 -8.1
PBT, bn 21.9 23.5 26.0 29.3
Adj EPS, $cent 87.8 92.5 100.9 112.9
P/Adj EPS 8.8 8.4 7.7 6.9
DPS, $cent 34.0 39.0 39.0 40.9
Yield % 4.4 5.0 5.0 5.3
TCE/share, cent 683 758 821 894
RoTCE % 13.4 12.8 12.8 13.2
P/TCE 1.1 1.0 0.9 0.9
Basel 3 Risk Weighted Assets 1,360 1,357 1,369 1,436
B3CET1* reported (%) 9.1 10.0 10.9 11.4
B3CET1* full phasing (%) 8.1 9.2 10.3 11.0 Source: Liberum Capital estimates
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HSBCWith HSBC making significant progress in shrinking non core assets and improving
asset quality, the investment debate is primarily on valuation in the context of a
sharply slowing global economy. As Figures 68-69 illustrate, relative to historicalmultiples, HSBC is currently cheap:
Current p/current TCE of 1.1x which is 2.0 standard deviations below the 14 year
average of 2.8x.
Current rolling forward PE multiple 8.0x which is 1.5 standard deviation below the
10 year average of 11.8x.
Figure 68: HSBC price/TCE, current TCE Figure 69: HSBC : PEx, rolling next 12month
-
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
J a n - 9 9
J a n - 0 0
J a n - 0 1
J a n - 0 2
J a n - 0 3
J a n - 0 4
J a n - 0 5
J a n - 0 6
J a n - 0 7
J a n - 0 8
J a n - 0 9
J a n - 1 0
J a n - 1 1
J a n - 1 2
p/TCE Average Avg-2SD Avg+2SD
5.0
7.0
9.0
11.0
13.0
15.0
17.0
19.021.0
23.0
25.0
J a n - 0 3
J a n - 0 4
J a n - 0 5
J a n - 0 6
J a n - 0 7
J a n - 0 8
J a n - 0 9
J a n - 1 0
J a n - 1 1
J a n - 1 2
PE Avg Avg-1SD Avg+1SD
Source: Liberum Capital; Bloomberg Source: Liberum Capital; Bloomberg
HSBC: resilient earnings since 1990
In figure 70 we show underlying pre-impairment profits from 1990 to 2011 as well as
forecasts to 2014E (estimated Basel 3 RWAs throughout). Over the period 1990 to
2011 the average pre impairment profits for HSBC were 2.9% while average loan
losses were 0.9% giving average PBT/RWAs of 2.0%.
Figure 70: Pre-impairment profits vs. loan losses and operating PBT/RWAs
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
2 0 1 0
2 0 1 2 E
2 0 1 4 E
PIP/Avg RWAs LLP/Avg RWA PBT/Avg RWA Avg PBT/RWA
Avg PIP /RWAs: 2.9 % Avg P BT/RWAs : 2.0% Avg LLPs/RW As: 0.9%
Source: Company websites, management discussion; Liberum Analysis; Estimated Basel 3 RWAs throughout to improve comparability
by grossing up historical RWAs by 7%
Loan losses peaked at 2.1% of RWAs in 2009. The minimum pre-impairment profits
(2.0% of RWAs) occurred in 1990. HSBC has remained consistently profitable since1990 with solid pre-impairment profitability.
Average pre-impairment
profitability: 2.9% of
RWAs with a min of 2.0% since 1990
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HSBC reallocating capital to Emerging markets
For several years, HSBC has had a clearly defined strategy to reallocate capital from
developed markets (North America and Europe) to emerging markets. Analysis of the
group’s RWAs shows that this transition is now well underway.
Figure 71: HSBC Basel 3 RWAs by Geography
$bn YoY % ch
2009 2010 2011 2012E 2013E 2014E 2010 2011 2012E 2013E 2014EEurope 399 357 386 387 380 395 -11% 8% 0% -2% 4%Hong Kong 137 123 120 125 133 139 -10% -3% 4% 7% 5%RoAP 196 247 310 329 363 401 25% 26% 6% 10% 10%MENA 63 63 67 67 72 77 0% 7% 0% 7% 6%NA 396 356 363 323 285 280 -10% 2% -11% -12% -1%LATAM 92 109 115 127 136 145 18% 5% 11% 7% 6%Total 1,283 1,253 1,360 1,357 1,369 1,436 -2% 8% 0% 1% 5%
Source: Liberum Capital analysis; Company reports
Over the period 2009 to 2011, Emerging market RWAs have increased as a % of
Group RWAs from 38% to 45%. We forecast this % will increase to 48% by year end
(assisted by the sale of the US Cards and Retail Services business with $42bn of
RWAs to Capital One), and will reach 53% by YE14E.
Figure 72: HSBC RWA mix by geography (2009-14E), Basel III basis
20%
30%
40%
50%
60%
2009 2010 2011 2012E 2013E 2014E
Hong Kong RoAP MENA LAT AM
Source: Liberum Capital analysis; Company reports
We forecast HSBC’s capital adjusted underlying RoTCE will increase from
10.1% in 2010 to 13.9% in 2014 as non core assets decline and capital is
reallocated to Emerging markets
To forecast core returns on tangible equity for HSBC Group we first strip out non
core assets both from capital and from earnings. The non core assets we identify
are i) the US cards & Retail services businesses being sold to Capital One ii) The
US Household run-off portfolio iii) Legacy GBM assets.
Figure 73 shows the breakout of Group TCE to these non core assets and
geographic regions. We allocate tangible common equity in proportion to Basel 3
RWAs.
RWAs in LATAM and Rest of
Asia Pacific are growing
rapidly YoY while growth in
Europe and North America is
slower or negative
We forecast emerging
markets will account for
53% of HSBC’s RWAs
by YE14E up from 38%
at YE2009.
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Figure 73: HSBC: allocating TCE* to geographical regions and to non core assets.
2010 2011 2012E 2013E 2014EEurope ex GBM legacy assets 29.7 30.5 32.8 36.5 39.8Hong Kong 10.7 11.0 11.9 13.8 15.6RoAP 18.2 25.1 30.9 37.1 43.7MENA 5.1 5.9 6.5 7.5 8.5
NA ex non-core assets 12.5 15.4 19.6 21.6 21.5LATAM 8.2 10.1 11.7 14.1 16.0Core 84.4 97.8 113.4 130.5 145.1Run-off portfolio 14.8 13.3 11.6 11.0 10.8US Cards & Retail Svcs 3.4 3.8 2.0 0.0 0.0Legacy GBM assets 1.3 3.0 4.6 4.6 4.5Non Core total 19.6 20.0 18.2 15.6 15.3Total 104.0 117.9 131.7 146.1 160.4
*period average TCE
Source: Liberum Capital analysis; Company reports
Similarly we can attribute net income to the same categories (figure 74). We forecast
that the negative PBT impact of non core assets in aggregate will decline to $1.2bn
by 2014E. Excluding losses from the run-off portfolio and legacy assets, the Group’s
PBT would have been 20% higher in 2011.
Figure 74: HSBC underlying* net income by geographical region; separating out noncore assets
2010 2011 2012E 2013E 2014EEurope ex GBM legacy assets 3.7 3.1 3.4 3.9 4.4Hong Kong 3.5 3.5 3.7 4.0 4.1RoAP 4.4 5.6 6.1 7.1 7.9MENA 0.7 1.1 1.1 1.2 1.3NA ex non-core assets 1.7 1.8 1.5 2.1 2.2LATAM 1.3 1.8 1.8 2.0 2.3Core 15.3 16.9 17.7 20.2 22.3Run-off portfolio -2.6 -2.9 -1.9 -1.4 -1.0US Cards & Retail Svcs 1.3 1.3 0.8 0.0 0.0Legacy GBM assets -0.4 -0.3 -0.2 -0.2 -0.2Non Core total -1.7 -1.9 -1.3 -1.6 -1.2Total 13.5 15.1 16.4 18.6 21.1
*underlying excludes Non Qualifying Hedges.Source: Liberum Capital analysis; Company reports
Having estimated TCE and net income we can now calculate RoTCE as illustrated in
Figure 75. Hong Kong is by far the most profitable part of the group with an RoTCE
of 32.1% in 2011.
Figure 75: HSBC RoTCE by geography and breaking out non core assets
2010 2011 2012E 2013E 2014EEurope ex GBM legacy assets 12.6% 10.2% 10.3% 10.6% 11.1%Hong Kong 32.7% 32.1% 31.5% 28.6% 26.6%RoAP 24.0% 22.4% 19.6% 19.1% 18.2%
MENA 14.3% 19.6% 17.4% 15.8% 14.7%NA ex non-core assets 13.3% 11.5% 7.9% 9.8% 10.0%LATAM 15.2% 17.8% 15.8% 14.3% 14.6%Core 18.1% 17.3% 15.6% 15.5% 15.3%Run-off portfolio -17.8% -21.9% -16.3% -12.7% -9.5%US Cards & Retail Svcs* 37.3% 35.4% 38.8% n/a n/aLegacy GBM assets -29.4% -10.2% -4.6% -4.1% -3.4%Non Core total -8.9% -9.3% -7.2% -10.2% -7.7%Total 13.0% 12.8% 12.5% 12.8% 13.1%
*Sold to Capital One in May 2012
Source: Liberum Capital analysis; Company reports
Focusing on 2011E returns (figure 76), it’s seems likely that allocating incremental
capital to emerging markets is likely to generate higher Group returns (and higher
growth).
Allocating TCE to RWAs
we find that non core
assets account for 17%
of group equity capital at
YE11 dropping to 14%
by YE12E
We forecast the negative
net income of the run-off
portfolio will ameliorate
to minus $1.0bn by
2014E vs. minus $2.9bn
in 2011.
By 2014E, the reported
group RoTCE gains from
shrinkage of the non
core portfolio but this is
largely offset by reducing
leverage as equity capital accumulates
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Figure 76: HSBC 2011E RoTCE by geography (ex non core)
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
E u r o p e e x
G B M l e
g a c y
N A e x r u n - o f f
p o r t f o l i o
L A T A M
M E N A
R o A P
H o n g K o n g
C o r e H S B C
N o n C o r e
t o t a l
H S B C G
r o u p
Source: Liberum Capital analysis; Company reports
Finally, we can look at returns in 3 separate categories: i) Emerging Regions, ii)
Core-Developed-Regions and iii) Non-Core. As Figure 77 indicates, the returns from
core developed markets are c10% broadly in line with the cost of equity. By contrast
the RoTCE from the emerging regions is 21% on average or broadly double that of
the developed markets. As more capital is allocated to the emerging regions, the
Group RoTCE will tend to rise with positive implications for valuation. To see the
underlying improvement in the Group RoTCE we must adjust for capital changes
over time. While in 2010E, the Group had a capital deficit of $30bn, we forecast it will
have a capital surplus of $9bn by 2014E. After capital-adjusting each year (to a 10%
Basel 3 equity tier 1), we find that from 2010 to 2014E the Group RoTCE improves
from 10.1% to 13.9% with positive implications for valuation.
Figure 77: HSBC Underlying RoTCE by developed and emerging markets
2010 2011 2012E 2013E 2014ECore Developed Regions 12.8% 10.6% 9.4% 10.3% 10.8%Emerging regions 23.3% 23.2% 21.0% 19.7% 18.7%Core RoTCE 18.1% 17.3% 15.6% 15.5% 15.3%Non Core RoTCE -8.9% -9.3% -7.2% -10.2% -7.7%Reported group 13.0% 12.8% 12.5% 12.8% 13.1%Capital adjusted Group RoTCE 10.1% 10.5% 10.9% 12.4% 13.9%
Source: Liberum Capital analysis; Company reports
In 2011 HSBC achieved
much higher RoTCEs in
emerging markets (e.g.
32.1% in HK) than in
Europe (10.2%) or North
America (11.5%) even
after excluding non-core
assets from the
developed market
returns.
As Non-core assets
shrink and capital is
reallocated to emerging
markets we estimate that
the capital adjusted
underlying Group RoTCE
will increase to 13.9% by
2014E from 10.1% in
2010.
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Figure 78: HSBC Summary Financials
Income Statement Ratio Analysis$m,unless indicated FY11 FY12E FY13E FY14E FY11 FY12E FY13E FY14E Per Share DataNet interest income 40,662 40,200 40,814 43,439 EPS reported, $cents 90.5 89.9 100.9 112.9
% YoY change 3% -1% 2% 6% EPS Adjusted, $cents 87.8 92.5 100.9 112.9
Non-interest income 31,618 27,074 31,099 32,206 % YoY change 21% 5% 9% 12%Fees & commissions 17,719 16,492 17,629 18,544 DPS($cents) 34.0 39.0 39.0 40.9% YoY change 6% -7% 7% 5% % YoY change 0% 15% 0% 5%Trading revenues 5,805 5,403 5,775 6,075 Div idend yield 4.4% 5.0% 5.0% 5.3%Other income 8,094 5,180 7,694 7,587 Payout ratio 38.7% 42.2% 38.7% 36.2%
Total operating revenues 72,280 67,274 71,914 75,645 BV per share(p) 8.43 9.16 9.77 10.48% YoY change 6% -7% 7% 5% TCE per share($cents) 6.83 7.58 8.21 8.94
Admin expenses -41,545 -40,839 -41,490 -42,840 Shares outstanding 18,144 18,399 18,605 18,801% YoY change 10% -2% 2% 3%
Other expenses 0.0 0.0 0.0 0.0 Return ratios FY11 FY12E FY13E FY14EPre-provision operating profit 30,735 26,435 30,424 32,805 RoRWA 1.40% 1.36% 1.54% 1.68%
% YoY change 1% -14% 15% 8% RoE 11.0% 10.2% 10.6% 11.1%Loan loss provisions -12,127 -9,649 -8,465 -8,057 RoTCE 13.4% 12.8% 12.8% 13.2%Other Income 3,264 6,696 4,082 4,513Pretax profit 21,872 23,483 26,040 29,261 Revenues FY11 FY12E FY13E FY14E
% YoY change 15% 7% 11% 12% NIM (NII / AIEA) 2.5% 2.5% 2.6% 2.7%Tax -3,928 -4,459 -5,525 -6,243 Non-IR / average assets 1.3% 1.0% 1.2% 1.2%
% Tax rate 18% 19% 21% 21% Total rev / average assets 2.9% 2.6% 2.7% 2.7%Minorit ies -1,720 -1,804 -1,874 -1,936 NII / Tot revenues 56.3% 59.8% 56.8% 57.4%Net Income (Reported) 16,224 16,423 18,643 21,082 Trading / Tot revenues 8.0% 8.0% 8.0% 8.0%
Balance sheet$bn FY11 FY12E FY13E FY14E FY11 FY12E FY13E FY14EASSETS Cost ratiosNet customer loans 940.4 977.4 1,020.1 1,073.4 Cost / income 57.5% 60.7% 57.7% 56.6%
% YoY change -2% 4 % 4 % 5% Staff numbers ('000s) 288 282 275 268Loan loss reserves 17.51 14.85 13.85 12.45Other interest earning assets 1,509 1,536 1,602 1,671 Balance Sheet Gearing FY11 FY12E FY13E FY14E Average interest earning assets 1,623 1,589 1,589 1,604 Loan / deposit 75% 76% 78% 77%Goodwill 29 29 29 29 RWAs/Loans 129% 123% 120% 120%Other assets 77 79 82 86Total assets 2,556 2,622 2,734 2,859 Asset Quality / Capital FY11 FY12E FY13E FY14E
Loan loss reserves / loans 1.9% 1.5% 1.4% 1.2%LIABILITIES NPLs / loans 4.9% 4.4% 2.2% 2.0%
Customer depos its 1,254 1,291 1,313 1,389 LLP / RWA 1.0% 0.8% 0.7% 0.6%% YoY change 2% 3% 2% 6% Loan loss reserves / NPLs 42.1% 69.0% 67.9% 58.0%Long term funding 961 960 1,020 1,037Interbank funding 113 124 136 149 Basel 2/2.5 RWAs 1,210 1,207 1,219 1,286 Average interest bearing liabs 2,285 2,351 2,422 2,522 Basel 2/2.5 Core Tier 1 10.1% 11.1% 12.1% 12.7%Other liabil ities 61 65 69 73 Total Tier 1 Basel 2/2.5 11.5% 12.5% 13.5% 14.0%Shareholders' equity 152.87 168.53 181.79 197.07 Basel 3RWAs (+CRE slotting) 1,360 1,357 1,369 1,436Minor it ies 13.22 13.46 13.71 13.98 B3 Eq. tier1 rep. 9.1% 10.0% 10.9% 11.4%Total l iabil ities 2,556 2,622 2,734 2,859 B3 Eq. tier1 full loaded 8.1% 9.2% 10.3% 11.0%
Source: Company data; Liberum Capital estimates
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BUY
Standard CharteredLocation, location, location!PRICE: 1292p | UK | BANKS | STAN.L | STAN LN
Standard Chartered (like HSBC) can credibly avoid a rights-issue
even if all the PIIGS exit the Euro-zone, with the fully loaded Basel 3
equity tier 1 dropping to a still adequate 9.3% (YE13E). The Group
has Euro-zone exposure of just 6% of market cap (other UK banks
avg 157%). The current p/TCE and PEx are both circa 2.0 standard
deviations below long run averages which seems excessive. Buy.
Standard Chartered operates in low debt countries (relative to
Europe and US) with low total debt/GDP of only 270% (other UK
bank avg: 355%). Only 30% of the Group’s assets (mainly South
Korea) are in countries that are currently de-levering (HSBC: 56%;
Domestic avg: 81%). Operating in countries with healthy balance
sheets implies ongoing revenue growth for the Group- we forecast a
top line CAGR of 11% FY12-14E (1% above consensus).
Strongest balance sheet among UK banks: The Group is the least
exposed to the periphery of Europe with total exposure only $3bn or
6% of market cap (other UK banks avg: 157%). Besides Euro-zone
exposure, property lending is only 5% of the loan book (other UK
banks: 12%). The Group has the highest loaded Basel 3 equity 10.5%
among UK banks (YE11) and is already Basel 3 compliant on liquidity.
Over 20 years of high pre-impairment profitability demonstrates
earnings resilience: Since 1990 the Group’s pre-impairment profit
(PIP) has averaged 2.8% of RWAs ranging from 1.9% to 3.4% with
loan loss provisions averaging 28% of PIP (range 7% to 80%). The
group has been consistently profitable for over 22 years.
No rights issue required in a Eurozone-breakup scenario: In a
Euro-zone breakup scenario, we estimate the Group would incur
losses of only $7bn (net of tax) of which FX $1bn, higher loan losses$3bn, lower IB revenues $3bn. In this scenario the 2013E Basel 3
equity ratio would still be 9.3% (vs. other UK banks avg 5.3%). The
capital deficit of $2.5bn is less than 1 year of retained earnings.
Valuation and recommendation: Standard Chartered trades on
2013: 8.4x EPS; p/TCE 1.2x for RoTCE of 14.8%; yielding 4.2%.
While few would dispute the quality of the Group’s franchise, the
investment debate revolves around valuation. From a historical
perspective the current p/TCE of 1.4x is 2 standard deviations below
the 15 year average of 3.1x and forward PEx of 8.8x is 1.9 standard
deviation below its 10 year average of 12.7x. Our scenario weightedtarget price of 1600p implies 24% upside (see valuation section).
BUY.
Stock Data
Target Price (pence) 1600
52-Week Range (pence) 1142-1684
Current price (pence) 1291.5
Shares Outstanding (bn) 2.38
Free Float (%) 100%Market Cap (GBP bn) 30.8
Avg daily volume (m) 4.1 *E=Liberum Capital estimates
Stock Performance
10001100
1200
1300
1400
1500
1600
1700
1800
Jun-11 Aug-11 Nov-11 Feb-12 Apr-12
STAN EURO Banks ( rebased)
Pr ice Per fo rmance 1M 3M 12M
Price 1,512 1,639 1,606
Absolute -15% -21% -20%
Rel FTSE -5% -10% -8%
Rel Eurobanks -2% 1% 17% Source: Bloomberg
Summary Financials & Valuation
Dec y/e ($ bn) FY11A FY12E FY13E FY14E
Revenue, bn 17.6 19.4 21.7 24.2
Op Costs -9.9 -10.9 -11.9 -13.0
Impairments -1.0 -1.2 -1.7 -2.0
PBT, bn 6.7 7.4 8.1 9.1
Adj EPS, $cent 195.4 219.1 236.4 263.7
P/Adj EPS 10.2 9.1 8.4 7.5
DPS, $cent 76.0 83.6 93.6 104.9
Yield % 3.8 4.2 4.7 5.3
TCE/share, cent 1,349 1,499 1,658 1,833
RoTCE % 14.9 15.4 15.0 15.1
P/TCE 1.5 1.3 1.2 1.1
Basel 3 RWAs 288 321 353 388
B3CET1* reported (%) 11.0 11.0 11.2 11.4
B3CET1* ful l phasing (%) 10.5 10.6 10.9 11.1 Source: Liberum Capital estimates
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Standard CharteredRelative to historical multiples, Standard Chartered is excessively cheap in
our view
Most investors would agree on the quality of the Group’s franchise. Valuation is the
key area for debate. The Euro-zone crisis and related concerns regarding global
contagion are currently depressing Standard Chartered valuation multiples to levels
last seen in 4Q08 following the Lehman bankruptcy. While growth in Asia is likely to
slow it will almost certainly be less impacted than the UK. In addition i) Asian policy
makers still have fiscal and monetary scope to stimulate their economies ii) Any
potential QE from the US or Europe in response to the crisis would also significantly
benefit Asia.
Current p/current TCE of 1.4x, 2 standard deviations below the 15 year average
of 3.1x.
Current rolling forward PE multiple 8.8x which is 1.9 standard deviations below
the 10 year average of 12.7x.
Figure 79: Standard Chartered price/TCE, current TCE Figure 80: Standard Chartered : PEx, rolling next12month
-
1.0
2.0
3.0
4.0
5.0
6.0
1997 1999 2001 2003 2005 2007 2009 2011
p/TCE Average Avg-2Std dev Avg+ 2Std dev
5.0
7.0
9.0
11.0
13.0
15.0
17.0
19.0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
PE Average Avg-2SD Avg+2SD
Source: Liberum Capital; Bloomberg Source: Liberum Capital; Bloomberg
Standard Chartered has resilient earningsStandard Chartered has been consistently profitable going back as far as 1990. As
illustrated in Figure 81, pre impairment profit (PIP) and loan losses have averaged
2.8% and 0.8% of RWAs respectively resulting in average PBT/RWAs of 2.0%. Over
this time period max loan losses were 1.7% of RWAs in 1992 while the minimum
PIP/RWA was 1.9% in 1990. Going forward, we expect the Group’s strong PIP
profits as a % of RWA (highest among UK banks –see below) to enable the group to
weather adverse macro conditions comparatively well.
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Figure 81: STAN pre-impairment profits vs. loan losses and operating PBT/RWAs
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
2 0 1 0
2 0 1 2 E
2 0 1 4 E
PIP/Avg RWAs LLPs/Avg RWAs PBT/Avg RWAs Avg PBT/RW As
Avg PIP /RWAs: 2.8% Av g PBT/RWAs: 2 .0% Avg L LPs/R WAs: 0 .8%
Source: Company websites, management discussion; Liberum Analysis; estimated Basel 3 RWAs through to increase comparability
In 2012E we forecast Standard Chartered will have pre-impairment profits (PIP)
equal to 2.8% of average Basel 3 RWAs, 0.7% higher than its UK banking peers.
Figure 82: 2012E Pre-impairment profits as % average Basel 3 RWAs
2.3% 2.2%
1.7%
2.4%
2.8%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
BARC LLO Y RBS HSBC STAN
PIP/RWAs Average
Source: Company websites, management discussion; Liberum Analysis; Basel 3 RWAs
Looking forward a couple of years to 2014E we expect Standard Chartered will still
have the highest PIP/RWA among the UK banks although we anticipate
improvements for the entire sector as their balance sheets are restructured.
Figure 83: 2012E Pre-impairment profits as % Basel 3 RWAs
2.4%2.5%
2.7%
3.0%
2.2%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
BARC LLOY RBS HSBC STAN
PIP/RWAs Average
Source: Company websites, management discussion; Liberum Analysis; Basel 2/2.5 RWAs
Average preimpairment profits
(PIP) as % of RWAs are 2.8%
since 1990, with a minimum of
1.9%; good PIP profitability
enables the group to weather adverse macro conditions.
We forecast Standard Chartered
will have the highest pre-
impairment profitability among the
UK banks in 2012E
By 2014E, the other banks will
have partially caught up in terms of PIP/RWA with the average rising
to 2.6% vs. 2.3% in 2012E.
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A key driver of Standard Chartered’s earnings resilience is the diversity of its income
sources by geography and product. As figures 84 and 85 illustrate, in 2012E no
more than 21% of revenues are derived from any one product (Financial markets
being the largest driver) and no Geography accounts for more than 23% of PBT
(Hong Kong being the largest contributor).
Figure 84: Standard Chartered 2012E revenues byproduct
Figure 85: Standard Chartered 2012E PBT by region
Mortage & Auto
8%
Other 1%
Wealth &
Deposits
16%
Cash
management10%
Trade
9%
Wholesale
lending
5%
Corp. Finance
11%
Principal Finance
2%
Un- secured
consumer Financial markets
21%
ALM
5%
Africa
9%
MESA
11%
India
10%
Other AP
19%
Korea
5%
Singapore
15%
HK
23%
UK&EU&US
8%
Source: Liberum Capital Source: Liberum Capital
Balance sheet strength
Standard Chartered has a strong balance sheet in terms of capital, liquidity and
conservative loan exposure. At YE2011, Standard Chartered was the only UK bank
with a common equity tier above 10% on a fully loaded Basel 3 basis.
Figure 86: Basel III equity tier 1 YE 2011 UK banks
7.7%8.1%
10.5%
6.9% 7.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
BARC LLO Y RBS HSBC STAN
Source: Company websites, management discussion; Liberum Analysis
In terms of liquidity, Standard Chartered already exceeded the Basel 3 minimum
100% standard on NSFR and LCR at YE11 (these minimum standards will go
live in 2015).
As with earnings, the YE11 loan book is diversified by geography and sector. Themaximum geographic concentration is 17% to UK&Europe&US and the
maximum sector concentration is 26% to mortgages.
As of YE2011, Standard Chartered
was the only UK bank already
above a 10% Basel 3 equity tier 1
level (fully loaded)
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Exposure to riskier commercial real estate exposure is only $10.2bn and
leveraged finance is less than $6bn. As figure 87 illustrates as a % of equity tier
1, Standard Chartered is more conservative than the other UK banks.
Figure 87: Year End 2011 Commercial Real Estate (incl. construction) and LeverageFinance as % of Basel 3 Equity tier 1
0%
50%
100%
150%
200%
250%
300%
350%
BARC LLOY RBS HSBC StCh
Commercial real es tate Leverage Finance
Source: Liberum Analysis; Company reports
Another positive feature the Group’s balance sheet is the short duration of its loans.
48% of Standard Chartered’s loan book is payable within 1 year vs. 34% for the
other UK banks. This is largely due to the Group’s significant focus on trade finance.
A shorter loan book duration has 2 advantages, it enables i) the group to increase
loan pricing when general credit conditions tighten ii) enables the group to more
rapidly reduce credit risk in a severe recession scenario. Excluding mortgages, 63%
of the loan book has contractual maturity less than 1 year.
Figure 88: % of customer loans with contractual maturity less than 1 year
7.7%8.1%
10.5%
6.9% 7.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
BARC LLO Y RBS HSBC STAN
Source: Company websites, management discussion; Liberum Analysis; Basel 2/2.5 RWAs
As discussed in section 2, 70% Standard Chartered’s loan book is in countries that
are not currently in debt deleveraging mode. These countries are likely to continueto have debt growth in excess of nominal GDP growth for another 10-15 years which
will tend to support Standard Chartered’s revenue growth and asset quality.
Standard Chartered’s loan book is
conservative with exposure
commercial real estate and
leverage finance equal to only 65%
of Basel 3 equity capital vs. a peer
average of 192%
Excluding mortgages, 63% of
Standard Chartered’s loan book
has a maturity of less than 1 year
giving the group considerable
flexibility in responding to macro
conditions.
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Divisional Forecasts
Figure 89: Standard Chartered Divisional forecasts
$, billion YoY %Change
2010 2011 2012E 2013E 2014E 2011 2012E 2013E 2014E 1H11 2H11 1H12E 2H12EGroup
Revenues 16.1 17.6 19.4 21.7 24.2 10% 10% 11% 11% 8.8 8.9 9.6 9.9Costs -9.0 -9.9 -10.9 -11.9 -13.0 10% 10% 10% 10% -4.7 -5.2 -5.0 -5.9Pre impairment profit 7.0 7.7 8.6 9.8 11.1 10% 11% 14% 14% 4.1 3.6 4.5 4.0Loan loss provisions -1.0 -1.0 -1.2 -1.7 -2.0 6% 13% 45% 19% -0.5 -0.5 -0.6 -0.6 Associates 0.0 0.1 0.0 0.0 0.0 nm nm nm nm 0.0 0.0 0.0 0.0PBT 6.1 6.8 7.4 8.1 9.2 11% 10% 9% 13% 3.6 3.1 4.0 3.4 Net Customer loans 246 269 299 327 359 9% 11% 9% 10% 268 269 284 299Deposits 317 352 396 447 506 11% 13% 13% 13% 343 352 383 396Basel 3 RWAs, 263 288 321 353 388 10% 11% 10% 10% 280 288 305 321Cost Income ratio 56% 56% 56% 55% 54% 53% 59% 53% 59%Loan losses % Avg RWAs 0.39% 0.37% 0.38% 0.49% 0.54% 0.36% 0.38% 0.38% 0.38% Wholesale divisionRevenues 10.0 10.8 12.1 13.7 15.5 9% 12% 13% 13% 5.4 5.4 6.0 6.1Costs -4.8 -5.1 -5.8 -6.5 -7.1 6% 14% 11% 10% -2.6 -2.6 -2.8 -3.0Pre impairment profit 5.1 5.7 6.3 7.2 8.4 11% 10% 16% 16% 2.9 2.8 3.2 3.1
Loan loss provisions -0.4 -0.5 -0.5 -0.8 -1.1 31% -5% 82% 32% -0.3 -0.2 -0.2 -0.2PBT 4.8 5.2 5.8 6.4 7.3 9% 11% 10% 13% 2.6 2.6 2.9 2.9 Customer loans 130 147 167 186 206 13% 14% 11% 11% 143 147 157 167Basel 3 RWAs 195 216 242 267 294 11% 12% 10% 10% 207 216 229 242Cost Income ratio 49% 47% 48% 47% 46% 47% 48% 47% 50%Loan losses % Avg RWAs -0.20% -0.23% -0.20% -0.33% -0.40% -0.27% -0.20% -0.20% -0.21% Consumer divi sionRevenues 6.1 6.8 7.3 8.0 8.7 12% 8% 9% 9% 3.3 3.5 3.6 3.8Costs -4.2 -4.6 -4.8 -5.2 -5.6 10% 4% 8% 8% -2.1 -2.5 -2.2 -2.6Pre impairment profit 1.9 2.2 2.5 2.8 3.0 15% 16% 9% 9% 1.2 1.0 1.4 1.2Loan loss provisions -0.6 -0.5 -0.7 -0.8 -0.9 -9% 29% 19% 7% -0.2 -0.3 -0.3 -0.4PBT 1.3 1.650 1.9 2.0 2.2 26% 12% 6% 10% 1.0 0.6 1.0 0.8 Customer loans 116 121 132 142 152 4% 8% 8% 8% 125 121 127 132Basel 3 RWAs 68 72 79 86 94 7% 10% 9% 9% 73 72 76 79Cost Income ratio 69% 68% 65% 65% 65% 63% 72% 62% 69%Loan losses % Avg RWAs -0.98% -0.77% -0.91% -1.00% -0.97% -0.61% -0.88% -0.91% -0.91% Centre division PBT 0.0 -0.1 -0.2 -0.2 -0.3 0.0 -0.1 0.0 -0.2
Source: Liberum Capital
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Figure 90: Standard Chartered Summary Group Financials
Income Statement Ratio Analysis$ in millions,year-end Dec FY11A FY12E FY13E FY14E Per Share Data FY11A FY12E FY13E FY14ENet interest income 10,153 10,427 11,599 12,814 EPS reported($cents) 198.2 217.0 234.4 261.6
% YoY change 20% 3% 11% 10% EPS Adjusted, $cents diluted 195.4 2 19.1 236.4 263.7Non-interest income 7,484 9,021 10,076 11,351 % YoY change -1% 12% 8% 12%
Fees & commissions 4,046 4,811 5,735 6,835 DPS($cents) 76.0 83.6 93.6 104.9Trading revenues 2,645 2,715 2,786 2,860 Dividend yield 3.8% 4.2% 4.7% 5.3%% YoY change 3% 3% 3% 3% Payout ratio 38.9% 38.2% 39.6% 39.8%Other income 793 1,495 1,555 1,656 BV per share $ 16.45 17.93 19.48 21.20
Total operating revenues 17,637 19,448 21,675 24,165 TCE per share, $ 13.49 14.99 16.58 18.33% YoY change 10% 10% 11% 11% Shares outstanding, end 2,384 2,406 2,432 2,460
Admin expenses -9,296 -10,192 -11,148 -12,192% YoY change 10% 10% 9% 9% Return ratios FY11A FY12E FY13E FY14E
Other expenses -621 -691 -770 -858 RoRWA (Basel 3) 1.72% 1.71% 1.68% 1.73%Pre-provision operating profit 7,720 8,565 9,758 11,115 RoE 11.8% 12.0% 11.9% 12.3%
% YoY change 10% 11% 14% 14% RoTCE 14.9% 15.4% 15.0% 15.1%Loan loss provisions -1,019 -1,150 -1,664 -1,985Pretax profit 6,701 7,415 8,094 9,130 Revenues FY11A FY12E FY13E FY14E
% YoY change 10% 11% 9% 13% NIM (NII / AIEA) 2.30% 2.12% 2.12% 2.12%Tax -1,842 -2,044 -2,230 -2,514 Non-IR / average assets 1.34% 1.42% 1.42% 1.45%
% Tax rate 27% 28% 28% 28% Total rev / average assets 3.16% 3.06% 3.06% 3.09%Minorities -185 -204 -224 -246 NII / Tot revenues 57.6% 53.6% 53.5% 53.0%
Net Income (Reported) 4,748 5,198 5,670 6,399 Trading / Tot revenues 15.0% 14.0% 12.9% 11.8%
Balance sheet$ bn,year-end Dec FY11A FY12E FY13E FY14E FY11A FY12E FY13E FY14EASSETS Cost ratiosNet customer loans 263.8 299.7 328.0 359.4 Cost / income 56.2% 56.0% 55.0% 54.0%
% YoY change 10% 14% 9% 10% Staff numbers 86,865 91,208 95,769 100,557Loan loss reserves 2.7 3.0 3.3 3.6Investments 85.3 85.3 85.3 85.3Other interest earning assets 92.8 106.8 133.8 159.8 Balance Sheet Gearing FY11A FY12E FY13E FY14E
% YoY change 38% 15% 25% 19% Loan / deposit 77% 76% 73% 71% Avg int. earning assets 441.9 491.8 547.1 604.4 RWAs/Loans 44% 44% 44% 44%Goodwill 7.1 7.1 7.1 7.1Other assets 157 182 196 215 Asset Quality FY11A FY12E FY13E FY14ETotal assets 599.1 673.7 742.7 819.3 Loan loss reserves / loans 1.0% 1.0% 1.0% 1.0%
NPLs / loans 1.6% 1.6% 1.6% 1.6%LIABILITIES LLP / RWA 0.4% 0.4% 0.5% 0.5%
Customer deposits 342.7 396.0 447.3 505.5 Loan loss reserves / NPLs 64.0% 63.8% 63.7% 63.6%% YoY change 12% 16% 13% 13%Long term funding 136.9 153.2 168.0 184.4 CapitalInterbank funding 35 40 44 48 Basel 2/2.5 RWAs 271 303 335 370 Average interest bearing liabs 475 552 624 699 Basel 2/2.5 Core Tier 1 11.8% 11.8% 11.9% 12.0%Other liabilities 41 37 31 24 Total Tier 1 Basel 2/2.5 13.7 13.5 13.4 13.4Shareholders' equity 41.38 45.40 49.75 54.66 Basel 3RWAs (+CRE slott ing) 288 321 353 388Minorities 2.2 2.3 2.4 2.5 Basel3 Eq. tier1 as reported 11.0% 11.0% 11.2% 11.4%Total liabilities 599.1 673.7 742.7 819.3 B3 Eq. tier1 fully loaded 10.5% 10.6% 10.9% 11.1%
Source: Company data; Liberum Capital estimates
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BUY
Lloyds Banking GroupAttractive risk rewardPRICE: 26p | UK | BANKS | LLOY.L | LLOY LN
While Lloyds is un-investable due to significant peripheral exposure
of £23bn, we estimate that the current share price largely discounts
Euro-fragmentation. In this stress case, Lloyds would require a
rights issue of £19bn (probably govt. underwritten) which we
assume is preceded by a further 30% share price decline. At current
levels this stress-case is already 70% priced-in which looks too
pessimistic relative to other traded securities. Speculative BUY.
Beside its PIIGS exposure, substantial progress has been made
in de-risking the Lloyds balance sheet. Non-core (‘risky’) assets
have declined from 43% of the funded balance sheet in 2008 to 22%
as of 1Q12. Similarly wholesale funding of loans has declined from
45% to 23%, thereby improving the stability of the Group’s earnings.
Primary liquid assets (cash, gilts etc) of £106bn now exceed short-
term wholesale funding of £91bn, reducing liquidity risk.
We believe our stress case capital deficit of £19bn is
conservative. If all the peripheral countries exit the Euro we estimate
(net of tax): FX losses of £6bn, £12bn of additional loan losses and
£1bn in higher wholesale funding costs (figures 20-22).
Earnings outlook: Since November 2010, the Bloomberg forward 12
month EPS has declined by 47% to 5.5p due to i) rising wholesale
funding costs, ii) faster than expected increases in low-yielding
primary liquidity holdings to comply with new regulation, iii) worse than
expected loan losses in Ireland, iv) some rebasing of expectations
with the arrival of the new CEO. We believe these factors have largely
run their course. On the positive side for EPS: post publication of the
ICB competition review, mortgage margins have now started to
increase. In addition we believe loan losses will continue to decline as
the UK keeps nominal GDP growth above government bond yields via
QE (currently a +2.0% gap, see section 2).
Valuation and recommendation: Lloyds trades on 2013: 7.4x EPS;
p/TCE 0.41x for RoTCE of 5.8%; yielding 0%. If post GREXIT, further
Eurozone exits are ruled out - we believe Lloyds would trade at 41p
(60% upside). Our stress-case fair value per share of 19p assumes a
£19bn rights issue after a 30% share price decline. Reverse
engineering the current share price, we get an implied stress-case
probability of 70%. Contrasting this with the INTRADE probability of a
Greek exit by 2014 of only 65%, suggests that the current Lloyds
share price looks cheap. Assigning instead a 55% probability to ourstress case (exit of all peripheral countries) implies fair value for
Lloyds of 29p and 12% upside.
Stock Data
Target Price (pence) 29
52-Week Range (pence) 22 - 51
Current price (pence) 25.72
Shares Outstanding (bn) 68.73
Free Float (%) 61%Market Cap (GBP bn) 17.7
Avg daily volume (m) 190
*E=Liberum Capital estimates
Stock Performance
10.0
15.020.0
25.0
30.0
35.0
40.045.0
50.0
55.0
J u n - 1 1
A u g - 1 1
N o v - 1 1
J a n - 1 2
A p r - 1 2
LLO Y EURO Banks (rebased)
Price Performance 1M 3M 12M
Price 34 35 50
Absolute -23% -26% -49%
Rel FTSE -14% -15% -37%
Rel Eurobanks -11% -3% -12%
Source: Bloomberg
Summary Financials & Valuation
Dec y/e (GBP bn) FY11A FY12E FY13E FY14E
Revenue 21.2 18.6 18.0 16.9Op Costs -10.6 -10.0 -9.3 -8.6
Impairments -9.8 -6.4 -5.3 -4.1
PBT -3.5 1.5 2.3 3.3
Adj EPS, pence 0.5 1.7 3.5 4.5
P/Adj EPS 47.7 14.9 7.4 5.8
DPS, pence 0.0 0.0 0.0 2.0
Yield % 0.0 0.0 0.0 7.8
TCE/share, pence 59 60 62 65
RoTCE % 0.9 2.9 5.7 7.0
P/TCE 0.43 0.43 0.41 0.40
Basel 3 Risk Weighted Assets 390 356 328 325
B3CET1* reported (%) 9.7 10.9 12.3 12.4
B3CET1* full phasing (%) 6.9 7.8 9.1 9.9 Source: Liberum Capital estimates
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Figure 91: Lloyds Banking Group Summary Financials
Income Statement Ratio Analysis£m,year-end Dec FY11A FY12E 2013E 2014E Per Share Data FY11A FY12E 2013E 2014ENet interest income 12,233 10,153 9,911 8,950 EPS reported, pence -4.1 0.9 2.3 3.4
% YoY change -11% -17% -2% -10% EPS Adjusted, p dil 0.5 1.7 3.5 4.5Non-interest income 9,307 8,747 8,432 8,325 % YoY change -167% 220% 102% 28%
Other / Ins Claims -343 -346 -353 -364 DPS(p) 0.0 0.0 0.0 2.0Total op. revenues 21,197 18,553 17,990 16,911 Dividend yield 0.0% 0.0% 0.0% 7.8%
% YoY change -10% -12% -3% -6% Payout ratio 61.6% 61.6% 61.6% 61.6% Admin expenses -10,621 -9,984 -9,314 -8,623 BV per share, pence 67 67 70 72
% YoY change -4% -6% -7% -7% TCE per share, pence 59.2 59.8 62.1 64.9Other expenses -- -- -- -- Shares outs diluted 68,727 69,431 69,431 69,431Pre-prov op profi t 10,576 8,569 8,676 8,288
% YoY change -14% -19% 1% -4% Return rat ios FY11A FY12E 2013E 2014ELoan loss provisions -9,787 -6,362 -5,332 -4,126 RoRWA -0.72% 0.26% 0.51% 0.81%Other 1-offs -4,257 -712 -1,078 -878 Pre-tax RoE -7.5% 3.2% 4.8% 6.7%Pretax profit -3,468 1,495 2,266 3,284 RoE -6.1% 1.4% 3.3% 4.9%
% YoY change -1334% -143% 52% 45% RoTCE 0.9% 2.9% 5.7% 7.0%Tax 828 -539 -586 -790 Revenues FY11A FY12E 2013E 2014E
% Tax rate 23.9% 36.1% 25.8% 24.0% NIM (NII / AIEA) 2.1% 1.9% 2.1% 2.0%Minorities -73 -73 -100 -100 Non-IR / avg assets 0.9% 0.9% 0.9% 1.0%Net Income (Rep) -2,713 883 1,581 2,394 Total rev / avg assets 2.2% 1.9% 2.0% 2.0%
NII / Tot revenues 57.7% 54.7% 55.1% 52.9%
Balance sheet£m,year-end Dec FY11A FY12E 2013E 2014E FY11A FY12E 2013E 2014EASSETS Cost ratiosNet customer loans 565,638 516,156 444,529 441,278 Cost / income 50.1% 53.8% 51.8% 51.0%
% YoY change -5% -9% -14% -1% Cost / assets 1.08% 1.04% 1.02% 1.00%Loan loss reserves 27,718 23,350 20,045 16,902 Staff numbers 103,374 99,581 97,738 96,829Other int. earn assets 70,012 68,612 62,623 61,370 Balance Sheet Gearing FY11A FY12E 2013E 2014E
% YoY change -4% -2% - 9% -2% Loan / deposit 139% 122% 118% 114% Avg int earn assets 579,118 540,897 480,343 442,903 Loan / assets 58% 54% 51% 52%Goodwi ll 5,212 5,212 5,212 5,212 Asset Quality / Capital FY11A FY12E 2013E 2014EOther assets 301,966 337,805 335,703 325,988 Loss reserves / loans 4.7% 4.3% 4.3% 3.7%Total assets 970,546 951,135 868,112 850,750 NPLs / loans 10.7% 10.3% 10.3% 9.2%LIABILITIES LLP / RWA 2.8% 2.0% 1.8% 1.4%Customer depos its 405,900 424,323 376,963 387,716 Loss reserves / NPLs 46.0% 44.1% 43.9% 41.6%
% YoY change 6% 5% -11% 3% Growth in NPLs 0.0% -12.1% -13.9% -10.9%Long term funding 185,059 139,314 133,908 111,121Interbank funding 39,810 45,858 41,565 40,586 Basel 2/2.5 RWAs 352,341 318,082 302,178 287,069
Avg int liabs Basel 2/2.5 Core Tier 1 10.8% 12.2% 12.1% 12.2%Other l iabi li ties 293,183 294,208 266,665 260,383 Total Tier 1 Basel 2/2.5 12.5% 14.0% 15.9% 16.8%Shareholders' equity 45,920 46,758 48,339 50,270 Basel 3RWAs 389,841 355,582 328,466 324,560Minorities 674 674 674 674 B3 Eq. tier1 rep. 9.7% 10.9% 12.3% 12.4%Total liabilities 970,546 951,135 868,112 850,750 B3 Eq Tier1 rep. 6.9% 7.8% 9.1% 9.9%
Source: Company data; Liberum Capital estimates
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HOLD
Royal Bank of ScotlandStrengthening balance sheet but low returnsPRICE: 213p | UK | BANKS | RBS.L | RBS LN
While RBS is commendably shrinking non-core assets and boosting
its capital and liquidity ratios, 2 key problems will continue to weigh
on the stock: i) weak earnings partly due to the spinoff of RBS
insurance, downsizing of GBM and continued workout of non-core
assets, ii) £39b of asset exposure to Ireland with consequent FX risk
on a potential Ireland-exit from the Euro-zone making currently RBS
un-investable. We see 40% downside risk for RBS if all the PIIGS
leave the Euro-zone vs. 63% upside if the Euro-zone stabilises.
Management has prioritised balance sheet strength over
earnings. Since 2008, the RBS Basel 3 equity tier one has increased
from 3.1% to 7.2% (excluding the APS scheme). By the end of 2013E,
we forecast RBS’ capital ratio will have reached 10.2% (post the
insurance IPO) giving a small £1bn capital surplus. Similarly since
2008, liquidity has significantly improved with the % of customer loans
wholesale funded decreasing from 34% to 6%. Non core assets
declined 12% in 1Q12 to £83bn, and are likely to reach £40bn by YE
2013 (1 year ahead of schedule).
Planned disposals unhelpful for near term earnings and RoTCE:
The EU mandated disposal of RBS insurance and the consequent
loss of balance sheet-double gearing is clearly unhelpful for the
Group’s RoTCE (reducing Core RoTCE by 0.9% in 2013E). Similarly
the sale of branches to Santander, (expected to complete in 1Q13)
will reduce earnings in the short term by £0.3 bn (although the £11bn
reduction in RWAs is helpful for the Group’s capital position).
Net asset exposure to Ireland is the key downside risk: As of
1Q12, RBS has £38.9bn of asset exposure to Ireland of which
£25.9bn was domestically funded. We assume that 75% of this
funding would dissipate ahead of an exit, leaving a net exposure of
£32.4bn. Assuming a 45% ‘new punt’ FX devaluation implies a pre tax
FX loss of £14.6bn (Figure 20). In a stress scenario where all the
PIIGS exit, the YE13E capital deficit is £22bn (101% of market cap.).
Valuation & Recommendation: RBS trades on 2013E: 7.5x EPS;
p/TCE 0.4x for RoTCE of 5.3%; yielding 0%. For valuation purposes
we value the RBS core and non core businesses separately (see
Figure 61). For the core business, post the Insurance IPO and sale of
branches, the RoTCE is only 7.3%. After adjusting for capital and
financial regulation we get an RoTCE of 7.7% used in our scenario-
weighted valuation. We get a fair value per share of 205p for the coredivision which combined with 8p for the Non-core division gets us to a
target price of 213p. HOLD.
Stock Data
Target Price (pence) 213
52-Week Range (pence) 173 - 421
Current price (pence) 199.9
Shares Outstanding (bn) 11.0
Free Float (%) 18.0Market Cap (GBP bn) 22.0
Avg daily volume (m) 12.7 *E=Liberum Capital estimates
Stock Performance
10.0
60.0
110.0
160.0
210.0
260.0
310.0
360.0
410.0
460.0
J u n - 1 1
A u g - 1 1
N o v - 1 1
F e b - 1 2
A p r - 1 2
RBS EURO Banks ( rebased)
Price Performance 1M 3M 12M
Price 245 262 415
Absolute -18% -24% -52%
Rel FTSE -12% -16% -42%
Rel Eurobanks -11% -8% -19%
Source:
Summary Financials & Valuation
Dec y/e (GBP bn) FY11A FY12E FY13E FY14E
Revenue 24.8 24.2 23.4 23.4Op Costs -15.5 -14.6 -13.9 -13.5
Impairments -7.4 -6.4 -4.7 -3.1
PBT -0.8 -0.9 3.8 5.9
Adj EPS, pence -9.1 1.2 26.5 40.4
P/Adj EPS nm 170.9 7.5 4.9
DPS, pence 0.0 0.0 0.0 0.0
Yield % 0.0 0.0 0.0 0.0
TCE/share, pence 501 492 516 552
RoTCE % -1.8 0.2 5.3 7.6
P/TCE 0.40 0.41 0.39 0.36
Basel 3 Risk Weighted Assets 588 525 471 441
B3CET1* reported (%) 8.1 9.8 11.5 12.9
B3CET1* full phasing (%) 7.0 8.3 10.1 11.7 Source: Liberum Capital estimates
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Figure 92: Royal Bank of Scotland Summary Financials
Income Statement Ratio Analysis£ in millions,year-end Dec FY11E FY12E FY13E FY14E Per Share Data FY11E FY12E FY13E FY14ENet interest income 12,689 12,378 11,743 11,625 EPS Reported, pence -18.5 -10.9 21.5 36.1
% YoY change -11% -2% -5% -1% EPS Adjusted, pence, diluted -9.1 1.2 26.5 40.4Non-interest income 11,073 10,717 10,411 10,534 % YoY change nm. -113% 2164% 53%
Fees & commissions 7,751 7,502 7,288 7,374 DPS, pence 0.0 0.0 0.0 0.0Trading revenues 3,322 3,215 3,123 3,160 Dividend yield 0.0% 0.0% 0.0% 0.0%
Total operating revenues 24,809 24,153 23,389 23,407 Payout rat io 0.0% 0.0% 0.0% 0.0%% YoY change -11% -3% -3% 0% Book Value per share (p) 679 669 693 729
Admin expenses -13,687 -12,844 -12,153 -11,754 TCE per share (p) 501 492 516 552% YoY change -8% -6% -5% -3% Shares outstanding 11,023 11,055 11,055 11,055
Other expenses -1,791 -1,791 -1,791 -1,791Pre-prov. operating profit 9,331 9,518 9,445 9,862 Return ratios FY11E FY12E FY13E FY14E
% YoY change -16% 2% -1% 4% RoRWA -0.44% -0.27% 0.57% 1.06%Loan loss provisions -7,439 -6,367 -4,673 -3,149 RoE -2.7% -1.6% 3.2% 5.1%Other non recurrent i tems -3,298 -1,281 -700 -600 RoTCE, (adjusted EPS) -1.8% 0.2% 5.3% 7.6%Pretax profit -766 -930 3,802 5,870
% YoY change 92% 21% -509% 54% Revenues FY11E FY12E FY13E FY14ETax -1,250 103 -950 -1,409 NIM (NII / AIEA) 1.3% 1.3% 1.3% 1.3%
% Tax rate -163% 11% 25% 24% Total rev / average assets 1.7% 1.6% 1.7% 1.7%Minorities & Other -934 -422 -478 -478 NII / Tot revenues 51.1% 51.2% 50.2% 49.7%Net Income (Reported) -1,997 -1,200 2,378 3,988 Trading / Tot revenues 13.4% 13.3% 13.4% 13.5%
Balance sheet£ in millions,year-end Dec FY11E FY12E FY13E FY14E FY11E FY12E FY13E FY14EASSETS Cost ratiosNet customer loans 454,112 444,929 401,265 389,690 Cost / income 55.17% 53.18% 51.96% 50.21%
% YoY change -10% -2% -10% -3% Staff numbers 171,046 162,494 154,369 146,651Loan loss reserves 19,760 21,643 21,832 20,497Investments 332,219 319,936 301,882 307,401 Balance Sheet Gearing FY11E FY12E FY13E FY14EOther int . earning assets 645,735 625,592 595,986 605,036 Loan / deposit 108% 105% 98% 93% Average int. earning assets 977,954 945,528 897,869 912,436 Loan / assets 30% 30% 29% 28%Goodwill 14,858 14,858 14,858 14,858Other assets 59,943 57,727 54,469 55,465 Asset Quality / Capital FY11E FY12E FY13E FY14ETotal assets 1,506,867 1,463,041 1,368,460 1,372,449 Loan loss reserves / loans 4.5% 5.1% 5.8% 5.6%LIABILITIES NPLs / loans 8.5% 7.8% 7.8% 7.2%Customer depos its 414,143 419,259 429,522 438,690 LLP / RWA -1.7% -1.4% -1.2% -0.9%
% YoY change -3% 1% 2% 2% Loan loss reserves / NPLs 51.4% 62.5% 70.1% 73.1%Long term funding 162,621 153,818 134,135 132,457 Basel 2/2.5 RWAs 439,000 444,985 390,862 360,914
Interbank funding 69,113 65,372 57,007 56,293 Basel 2/2.5 Core Tier 1 10.6% 11.2% 13.4% 15.7% Average int. bearing liabs 645,877 638,449 620,664 627,440 Total Tier 1 Basel 2/2.5 13.0% 13.6% 16.1% 18.6%Other liabilities 784,937 749,404 669,953 663,176Shareholders' funds 74,819 73,955 76,610 80,598 Basel 3RWAs (+CRE slotting) 588,456 524,985 470,862 440,914Minorities 1,234 1,234 1,234 1,234 Basel3 Eq. tier1 as reported 8.1% 9.8% 11.5% 12.9%Total liabilities 1,506,867 1,463,041 1,368,460 1,372,449 Basel3 Eq. tier1 full phased 7.0% 8.3% 10.1% 11.7%
Source: Company data; Liberum Capital Estimates
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HOLD
BarclaysSpanish fluPRICE: 174p | UK | BANKS | BARC.L | BARC LN
While Barclays has proven much more resilient than RBS and
Lloyds, it remains un-investable due to its exposure to the periphery
of Europe of £68bn, or 306% of market cap. If the PIIGS leave the
Euro-zone, we estimate a fair value of 122p per share and 30%
downside. Our base case fair value of 266p implies 53% upside if
the Euro-zone remains intact. Hold.
Surprisingly resilient loan book during financial crisis: From 2008
to 2011, Barclays’ loan loss run rate has been 1.35% of loans vs. an
average for Lloyds, HSBC and RBS of 2.07%. Similarly as of 4Q11,
Barclays’ NPLs were only 4.8% of loans vs. 10.2% for Lloyds and
8.6% for RBS
However Barclays peripheral Euro-zone exposure is
uncomfortably high at £68bn (1Q12), equivalent to 306% of current
market cap making Barclays currently un-investable. Barclays has the
highest exposure, £27bn, to the rapidly deteriorating situation in
Spain. In a scenario where all of the periphery exit the Euro-zone, we
estimate a 2013E capital deficit of £24bn, 108% of current market cap,
following i) FX losses £13bn, ii) Higher loan losses £6bn, iii) Lower IB
revenues £4bn, iv) Higher funding costs £1bn. This stress scenario is
likely to overhang the stock until the Euro-zone crisis is resolved.
£0.8bn impact from ICB ring-fencing and Dodd Frank Regulation.
Among the UK banks, Barclays has the highest gearing to investment
banking- accounting for 45% of the Group’s PBT in 2013E (vs. 33%
for HSBC and 25% for RBS) putting the Group at a disadvantage
regarding coming financial regulation. For Barclays we estimate PBT
impacts of £0.49bn for ring fencing and £0.35bn for Dodd Frank.
Pension liabilities: To address the £5bn pension deficit in its UKretirement fund (triennial pension fund valuation as of 3Q11), Barclays
made a contribution of £1.8bn in 4Q11. Over the remainder of 2012E,
Barclays plans a payment of £0.5bn to the fund with further payments
after 2017E of £3.5bn. Net of tax, the NPV of these future payments is
£2.5bn which we deduct from Basel III equity capital for valuation
purposes.
Valuation and recommendation: Barclays trades on 2013E: PE
4.7x; p/TCE 0.41x for RoTCE 9.1%; yielding 3.8%. We estimate a
Basel 3 equity tier 1 of 9.5% by 2013E implying a £2.3bn capital deficit
(net of £2.4bn benefit from Blackrock stake sale in May). Our targetprice is 187p (see figures 59-67 for calculation) based on a 7.8%
RoTCE after adjusting for capital and regulation. HOLD.
Stock Data
Target Price (pence) 187
52-Week Range (pence) 134 -268
Current price (pence) 174
Shares Outstanding (bn) 12.53
Free Float (%) 100%Market Cap (GBP bn) 21.7
Avg daily volume (m) 50
*E=Liberum Capital Estimates
Stock Performance
120
170
220
270
320
Jun-11 Aug-11 Nov-11 Feb-12 Apr-12
BARC
EURO Banks (rebased)
FTSE (rebased)
Price Performance 1M 3M 12M
Price 208 239 264
Absolute -17% -27% -34%
Rel FTSE -11% -19% -25%
Rel Eurobanks -9% -11% -1%
Source: Bloomberg
Summary Financials & Valuation
Dec y/e (GBP bn) FY11A FY12E FY13E FY14E
Revenue 28.5 29.1 30.1 31.5Op Costs -19.2 -18.5 -19.0 -19.7
Impairments -4.0 -3.4 -3.4 -3.4
PBT 5.9 4.3 7.7 8.5
Adj EPS, pence 22.3 34.2 37.2 41.5
P/Adj EPS 7.8 5.1 4.7 4.2
DPS, pence 6.0 6.0 7.0 8.0
Yield % 3.5 3.5 4.0 4.6
TCE/share, pence 391 392 422 456
RoTCE % 6.0 8.8 9.1 9.5
P/TCE 0.44 0.44 0.41 0.38
Basel 3 Risk Weighted Assets 460 471 485 501
B3CET1* reported (%) 9.7 9.8 10.4 10.8
B3CET1* ful l phasing (%) 7.7 8.8 9.5 10.2 Source: Liberum Capital estimates
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Figure 93: Barclays Summary Financials
Income Statement Ratio Analysis£m FY11A FY12E FY13E FY14E Per Share Data FY11A FY12E FY13E FY14ENet interest income 12,201 13,372 13,617 14,136 EPS reported(p) 24.0 17.3 37.2 41.5
% YoY change -3% 10% 2% 4% EPS Adjusted, diluted, pence 22.3 34.2 37.2 41.5Non-interest income 15,976 15,237 16,167 17,094 % YoY change -11% 53% 9% 12%
Fees & commissions 8,622 8,781 9,386 9,978 DPS(p) 6.0 6.0 7.0 8.0% YoY change -3% 2% 7% 6% % YoY change 9% 0% 17% 14%Trading revenues 5,010 5,185 5,440 5,708 Dividend yield 3.5% 3.5% 4.0% 4.6%% YoY change -36% 3% 5% 5% Payout ratio 26.9% 17.5% 18.8% 19.3%
Other income 2,344 1,271 1,340 1,408 BV per share(p) 456 464 495 531Total operating revenues 28,512 29,140 30,074 31,522 TCE per share(p) 391 392 422 456
% YoY change -9% 2% 3% 5% Shares outstanding, diluted 12,526 12,737 12,737 12,737 Admin expenses -19,180 -18,489 -19,021 -19,700
% YoY change -4% -4% 3% 4% Return ratios FY11A FY12E FY13E FY14EPre-provision Op profit 9,332 10,652 11,054 11,822 RoRWA 0.76% 0.55% 1.16% 1.24%
% YoY change -17% 14% 4% 7% RoE 5.6% 3.9% 8.1% 8.5%Loan loss provisions -4,025 -3,395 -3,360 -3,387 RoTCE 6.0% 8.8% 9.1% 9.5%Other 1-off items -2,419 -400 0 0Pretax profit 5,879 4,278 7,735 8,477 Revenues FY11A FY12E FY13E FY14E
% YoY change -3% -27% 81% 10% NIM (NII / AIEA) 5.2% 5.6% 5.5% 5.5%Tax -1,928 -1,134 -1,998 -2,133 Non-IR / average assets 1.0% 1.0% 1.0% 1.1%
% Tax rate 33% 27% 26% 25% Total rev / average assets 1.9% 1.9% 1.9% 2.0%
Minorities -944 -942 -992 -1,048 NII / Tot revenues 42.8% 45.9% 45.3% 44.8%Net Income (Reported) 3,007 2,202 4,745 5,295 Trading / Tot revenues 17.6% 17.8% 18.1% 18.1%Balance sheet£m FY11A FY12E FY13E FY14E FY11A FY12E FY13E FY14EASSETS Cost ratiosNet customer loans 431,934 456,160 465,284 474,589 Cost / income 67.3% 63.4% 63.2% 62.5%
% YoY change 1% 6% 2% 2% Cost / assets 1.26% 1.18% 1.20% 1.23%Loan loss reserves 4,872 2,211 -328 -2,683 Staff numbers 127,263 127,965 128,896 129,885Other int earning assets 269,602 265,749 267,053 269,144
% YoY change -13% -1% 0% 1% Balance Sheet Gearing FY11A FY12E FY13E FY14E Avg int earning assets 235,005 239,265 246,614 254,957 Loan / deposit 118% 116% 111% 106%Goodwill 7,846 7,846 7,846 7,846 Loan / assets 28% 29% 29% 29%Other assets 849,273 844,786 854,817 864,786 Asset Quality / Capital FY11A FY12E FY13E FY14ETotal assets 1,563,527 1,576,753 1,594,672 1,613,682 Loan loss reserves / loans 1.1% 0.5% -0.1% -0.6%
NPLs / loans 5.7% 4.9% 4.3% 3.8%LIABILITIES LLP / RWA 1.0% 0.8% 0.8% 0.8%Customer deposits 366,032 391,654 419,070 448,405 Loan loss reserves / NPLs 19.7% 9.9% -1.6% -14.9%
% YoY change 6% 7% 7% 7%Long term funding 129,736 128,206 126,672 124,994 Basel 2/2.5 RWAs 390,999 403,428 417,850 433,227Interbank funding 91,116 90,042 88,964 87,786 Basel 2/2.5 Core Tier 1 11.0% 11.2% 11.7% 12.3% Avg interest bearing liabs 212,634 214,220 219,659 225,370 Total Tier 1 Basel 2/2.5 12.9% 13.4% 13.9% 14.2%Other liabilities 911,447 900,699 889,922 878,134Shareholders' equit y 55,589 56,546 60,437 64,756 Basel 3RWAs 460,424 470,853 485,275 500,652Minorities 9,607 9,607 9,607 9,607 B3 Eq. tier1 reported 9.7% 9.8% 10.4% 10.8%Total liabil iti es 1,563,527 1,576,753 1,594,672 1,613,682 B3 Eq Tier1 ful l loaded 7.7% 8.8% 9.5% 10.2%
Source: Company data; Liberum Capital Estimates
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Innes UrquhartAlternatives & Funds+44 (0)20 3100 [email protected]
Cormac LeechBanks+44 (0)20 3100 [email protected]
Peter HydeBusiness Services, Leisure & Transport+44 (0)20 3100 [email protected]
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Charlie CampbellConstruction & Building Materials+44 (0)20 3100 [email protected]
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Kate CraigMining, Metals+44 (0)20 3100 [email protected]
Andrew WhittockOil & Gas+44 (0)20 3100 [email protected]
Rob MundyOil & Gas+44 (0)20 3100 [email protected]
Naresh ChouhanPharmaceuticals+44 (0)20 3100 [email protected]
Roger FranklinPharmaceuticals+44 (0)20 3100 [email protected]
Alison WatsonReal Estate+44 (0)20 3100 [email protected]
Conor FinnReal Estate+44 (0)20 3100 [email protected]
Nick WalkerRenewable Energy, Agriculture & Water+44 (0)20 3100 [email protected]
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Jonathan Plant
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Convertibles
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