European Banks Strategy：Trading ranges, stress tests and downgrades

Europe United Kingdom Banks 15 March 2011 European Banks Strategy Trading ranges, stress tests and downgrades Matt Spick Research Analyst (+44) 20 754-57895 matt.spick@db.com A frustrating search for value The European Banks sector seems to us to be determined to deny its audience positive newsflow. As we look at results season, we find negative earnings momentum overall, directors dealings' weighted to sells, and an upcoming set of stress tests that we expect to disappoint the market. We still see upside in the banks, with the sector back to 1.0x 2012E P/TBV after poor performance over the last month. But we expect the sector to stay range-bound and capped at 1.2x P/TBV (reduced versus our previous 1.3x P/TBV target). Deutsche Bank AG/London All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, 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. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 007/05/2010 Industry Update Companies featured BNP Paribas (BNPP.PA),EUR53.14 Buy2009A 2010E2011EEPS Adjusted (EUR)5.18 6.306.93P/E Adjusted (x) 10.0 8.17.4P/B1.1 1.00.9Unicredit (CRDI.MI),EUR1.77 Buy2009A 2010E2011EEPS Adjusted (EUR)0.12 0.090.15P/E Adjusted (x) 22.9 22.912.3P/B0.7 0.50.5Barclays (BARC.L),GBP298.75 Buy2010A 2011E2012EEPS Adjusted (GBP)27.13 39.9248.13P/E Adjusted (x) 9.6 7.56.2P/B0.6 0.70.6Julius Baer (BAER.VX),CHF41.08Buy2010A 2011E2012EEPS Adjusted (CHF)2.44 2.853.36P/E Adjusted (x) 17.9 14.412.2P/B2.0 1.81.7Swedbank AB (SWEDa.ST),SEK108.70Buy2010A 2011E2012EEPS Adjusted (SEK) 6.68 10.3510.42P/E Adjusted (x) 14.0 10.510.4P/B1.1 1.31.3 DB Bks vs FTSE E300 83.085.087.089.091.093.095.097.099.0101.0103.03/26/20104/9/20104/23/20105/7/20105/21/20106/4/20106/18/20107/2/20107/16/20107/30/20108/13/20108/27/20109/10/20109/24/201010/8/201010/22/201011/5/201011/19/201012/3/201012/17/201012/31/20101/14/20111/28/20112/11/20112/25/20113/11/2011Source: Deutsche Bank Company Global Markets Research Earnings momentum post results With two-thirds of European banks having reported, we record 12 upgrades to 2012 earnings, and 25 downgrades, with an aggregate 5.4% negative revision to adjusted earnings. Management guidance has been mixed, with some cutting RoE or profit guidance (HSBC, Credit Suisse), and some reiterating (UBS, SocGen), but the empirical evidence is for RoTEs in the low-teens, and only modestly above the cost of capital. We can also see this reflected in directors’ dealings. As results season has progressed (and restricted periods have ended), we have identified 11 instances of insider selling, and 6 of insider buying in the European banking sector. This compares adversely with a 45 sell to 67 buy ratio for the wider European market (source: Directors Dealings, Ingo Schmitz). Stress tests: don’t expect too much On Friday 18 March the EBA will announce the criteria for the 2011 stress tests. Last year, we regarded the stress tests as a failure (see our report dated 25 July, A missed opportunity), and we predict the same again for this year. In this report we recap the 2010 stress tests, and take a look at the EBA and its role within the overall European supervisory system. We conclude that the market’s desire to see the EBA enforcing tough standards and capital raising is, in our opinion, unlikely to be fulfilled. Valuation: modestly cheap, but don’t get carried away We previously had a top-down valuation target for the sector of 1.3x P/TBV for 2012 (see our note dated 26 November 2010, 2011 Outlook). With the underlying earnings momentum of the sector poor, we cut our top-down target for the sector to 1.2x 2012E P/TBV, reflecting reduced sustainable RoEs. Based on the directors dealing data, it may well be that the management teams agree with this prognosis. But recent share price weakness has led the banks back towards their recent lows, so we still see modest upside. Furthermore, looking through the next couple of months, we expect the European authorities to successfully negotiate the peripheral sovereign issues. And while regulation has been an ongoing concern, over time Basel 3 has become more, not less, favorable to the