Banking is a heavily regulated industry,
and the industry will need 15% ROEs to
be able to support onerous capital
adequacy requirements and finance
economic growth
􀀗 True, regulators will demand the
industry holds more capital, but returns
are the product of leverage and ROA,
and although the former is shrinking,
the latter will expand to compensate
􀀗 We reiterate Overweight (V) rating on
our three UK names
The main impediment to an improvement in return on assets is
margin compression. But the squeeze on liabilities is a
temporary phenomenon which will diminish once nominal rates
head back over 2%. More pressing new FSA liquidity
guidelines could be extremely damaging if they entail switching
significant proportions of short-term wholesale funding into
long-term maturities, as well as increasing holdings of
government bonds. However, realistic estimates for the cost of
liquidity are comparable to the potential gain from the radical
re-pricing of the mortgage market currently underway.
Deliberate adverse selection determines assets going into the
Asset Protection Scheme. This process effectively de-risks
residual portfolios and if, as was the case in Q1, the vast
majority of credit losses are incurred on scheme assets, then
book values and core tier 1 ratios of Lloyds and RBS will
emerge higher than consensus expectations.
Our ratings and price targets assume the restoration of a 15%
ROE which enables stocks to trade at premium to book value.