Banks： an upgrade

DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. FOR OTHER IMPORTANT DISCLOSURES, visit www.credit-suisse.com/ researchdisclosures or call +1 (877) 291-2683. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 08 July 2010 Global Equity Research Investment Strategy (Strategy) Global Equity Strategy STRATEGY Banks: an upgrade Last week we took more money out of cyclicals, putting only some of that money into defensives. We now upgrade European banks to benchmark, given: ■ Macro factors for banks are now less of a headwind: banks tends to be the worst performing sector when credit spreads rise (we believe credit now offers value); banks benefit (relative to cyclicals) from tighter fiscal/looser monetary policy; we believe that European sovereign credit risk is overstated. ■ Valuation: PTBVs of 1x and 0.8x in Continental Europe and the UK are discounting long term RoTE of 11% and 10%, respectively. Yet, RoTEs in the UK may be 12–15% over the next few years, according to our analysts. European Banks are trading some 20% below the historical norm on pre-provisioning profits, after we adjust for write-offs and deleveraging. European banks now account for 12% of total market cap, slightly below the 30-year average of 14%. A better play on the cycle: banks have underperformed cyclicals by 20% YTD and now look much cheaper than cyclicals (especially on Credit Suisse HOLT®); Other positives: de-regulation is being postponed (it took 8 years to implement BIS 2); tax hikes are being watered down; banks are the largest underweight on fund managers surveys in Europe. Bank lending conditions are easing (and this usually precedes a recovery in loan growth). The CEBS’s stress test, due 23 July, may be a positive catalyst (see our banks team’s report Who’s testing who? 8 July 2010). ■ Tactical indicators are close to capitulation levels, suggesting that investors should be starting to add beta. ■ What to buy? UK banks (Lloyds), GEM plays (SAN, STAN and, directly, Sberbank), underleveraged banks with low loan to deposit ratios (JP Morgan, HSBC), domestic Germany (Unicredit, Commerzbank), banks that have been oversold on peripheral European concerns (BNP, SAN). We take off our preference for US over European banks. Figure 1: Cyclicals look priced for a strong recovery—banks do not 0%2%4%6%8%10%12%14%16%19901992199419961998200020022004200620082010E2012E2014E2%3%4%5%6%7%8%9%European banks CFROE®Eu ro pe a n cyclical s CF RO I®, rh sD otted l ine s sho w ma rket-im pl ied leve ls of pro fitab ility, given our assum ptions Source: Credit Suisse HOLT Research Analysts Andrew Garthwaite 44 20 7883 6477 andrew.garthwaite@credit-suisse.com Luca Paolini 44 20 7883 6480 luca.paolini@credit-suisse.com Marina Pronina 44 20 7883 6476 marina.pronina@credit-suisse.com Mark Richards 44 20 7883 6484 mark.richards@credit-suisse.com Sebastian Raedler 44 20 7888 7554 sebastian.raedler@credit-suisse.com 08 July 2010 Global Equity Strategy 2 Table of contents European banks—raising to benchmark 3 1) The macro environment is more supportive 3 2) Valuations 9 3) Banks now offer more attractive beta-exposure than cyclicals 11 4) Taxation and de-regulation are being watered down 14 5) Could investors be too pessimistic on loan growth? 15 6) Stress tests 17 7) Now a reasonably low proportion of market cap 18 8) Banks normally perform better after a typical banking crisis 19 9) Performance relative to US banks 20 10) Don’t sell beta now 22 Why not overweight? 23 Which banks do we like? 26 1) Domestic UK banks 26 2) Attractively valued European banks with strong fundamentals which have been oversold on peripheral European concerns: BNP, SAN and Unicredit 28 3) Plays on the German recovery 29 4) Banks with low leverage and low loan to deposit ratios 29 5) Plays on the emerging market banking story 31 6) US banks 32 Appendix 1: Write-down & deleveraging estimates 37 Appendix 2: European sector valuation scorecard 39 Appendix 3: European banks with high/low leverage and loan to deposit ratios 40 Appendix 4: Country risk table 41 08 July 2010 Global Equity Strategy 3 European banks—raising to benchmark We increase our weightings of European banks from 10% underweight to benchmark, we stay benchmark of US banks and hence now return to be benchmark of global banks. We increase weightings in European banks because: 1) The macro environment is more supportive a) Credit spreads are