Wholesale Banks
By hook or by book
Following a sharp sector re-rating, we look for future book value growth for stock
differentiation. We thus recommend switching from UBS into BNP Paribas and
continue rate Credit Suisse a Buy. There is likely much worse to come on the
provisioning cycle and we would continue to avoid CASA and Deutsche Bank.
Table 1 : Monoline rating and CDS spread trends
Rec TP Price
Upside /
downside
MTM
TCE, 10F
MTM
TCE, 11F
P/MTM
TCE, 10F
P/MTM
TCE, 11F
RoTCE
(Normal)
Credit Suisse Buy SFr55 47.6 16% 22.8 26.6 2.1 1.8 21%
BNP Paribas Buy €55 47.8 15% 35.5 38.1 1.3 1.3 17%
UBS Hold SFr16 15.9 0% 6.5 7.1 2.5 2.3 24%
Société Générale Hold €44 43.8 0% 26.9 27.0 1.6 1.6 17%
Deutsche Bank Sell €40 49.3 -19% 33.2 34.1 1.5 1.4 14%
Crédit Agricole Sell €9 10.7 -16% 6.6 7.2 1.6 1.5 14%
Source: Bloomberg, S&P, Moody’s
Default cycle goes into full swing
As expected, the credit cycle has gone into full swing with a sharp recent spike in
provisioning and NPL ratios. Provision coverage ratios have come under pressure and, at a
1Q09 average of 59%, are significantly below the US avg of 156%. We expect the default
cycle to get notably worse with global spec grade default rates expected to rise to 15% by
year-end, from 8% currently. We have increased our cumulative loss rate assumptions with
SocGen (4.7% over 2009-2011F), CASA (4.2%) and Deutsche Bank (4.3%) most at risk.
Capital market revenue strength provides hedge
Fixed income strength has been driven by a combination of structural (wider bid-offer
spreads, disintermediation), seasonal (first-half) and ‘rebound’ revenues from a dire 4Q08
although position-taking gains (steep yield curve, monetary easing) should not be
underestimated. Stripping out net rebound revenues (15-20%) and factoring in some bidoffer
spread pressure, fixed income revenues could be down 35-45% qoq although recent
strength in equities should make up part of the shortfall. The bond market sell-off to date
poses idiosyncratic rather than systemic risks, in our view.
Stress tests provide mixed results
Our updated stress tests suggest that Credit Suisse (+65%) and BNP Paribas (+59% predividends)
are best placed to grow tangible book value over 2009-11F, which should offset
capital concerns for BNP Paribas. Indeed, both banks benefit not only from stronger preprovision
profitability but also a relatively lower exposure to the provisioning cycle, notably
Credit Suisse. On the other hand, we see virtually no capital rebuild at CASA (Sell, €9 PT).
Switch from UBS into BNP Paribas
We recommend a switch from UBS (Hold, revised TP SFr16) into BNP Paribas (Buy, revised
TP €55). UBS’s earnings generation capacity has been impaired by franchise attrition and
watch out for ‘event risk’ at UBS into the IRS “John Doe” action (13 July) – although we
believe the more likely scenario is a negotiated solution. In our view, BNP Paribas (1.3x
P/MTM TCE for 17% RoTCE) together with Credit Suisse offers best of both worlds – a
combination of a relatively ‘clean’ balance sheet and strong book value generation.
Contents
By hook or by book 3
Following strong sector re-rating, we believe that book value growth will be a key
driver of share price performance going forward. Our stress-test serves to
determine this, with BNP Paribas and Credit Suisse emerging as the clear winners
on our analysis.
Investment view 3
Capital markets – the engine of 1Q strength 8
Although fixed income revenues are likely to be down 35-45% from exceptional
1Q09 strength, part of this could be made up by strength in equities. The recent
bond sell-off should be manageable by the industry a small number of banks could
get caught-out.
What’s driving fixed income? 9
The credit cycle starts to bite 15
Since the Lehman bankruptcy, there has been a sharp acceleration in provisioning
and NPL formation. With provision coverage levels under pressure and at less than
half of US levels, we believe that the pressure to rebuild reserves is increasing.
Company Profiles
BNP Paribas 24
Credit Agricole S.A. 26
Credit Suisse Group 28
Deutsche Bank 30
Societe Generale 32
UBS 34