European Investment Banks--The Beginning of the End?

Summary and Recommendation
In this update, we introduce our 2012 estimates, update our forecasts for fourth-quarter 2009, and adjust our price targets to reflect a
higher cost of equity, given increased regulation and a less positive outlook on revenues. We also downgrade UBS to
Underperform (it has underperformed the sector just shy of 10% since our July initiation) to reflect its position as our least preferred
investment bank and maintain our recommendations on the other three names—all of which have significant upside to our version of
fair value.
When we initiated on the European investment banks in mid-July 2009 (“The End of the Beginning”), we focused on the improving
fixed-income and equity outlook, and we argued that margins had expanded as far as they were likely to and market share gains were
largely done after the dislocation. In our section on capital for investment banks, we concluded that market risk-weighted assets
(RWAs) would at least double and that both Tier 1 and equity to assets would be important metrics. Since then, the momentum of
consensus EPS forecasts has stalled, and the proposed regulatory intervention has been severely stiffened. For this reason, we continue
to be cautious on the investment banks and maintain Barclays as our preferred medium-term pick on valuation and overly discounted
concerns about its regulatory capital levels.
Key Points
• Fourth-quarter reporting. We detail in the note our expectations for sales & trading evolution, quarter over quarter, of all four
names in light of the U.S. results reported over the past two weeks with a fall of between 10% and 35%, depending on the group.
We also believe that cost management in light of weaker revenues will be key and highlight Credit Suisse, where we believe
revenues could hold up and cost management appears most stringent.
• New Basel proposals and other headline noise. We quantify the worst-case scenarios of the Basel proposals on our estimated
2011 equity Tier 1 ratios and conclude that UBS, Credit Suisse, and Barclays should all attain levels acceptable to the local
regulators. We remain concerned, however, about the second derivative impact of a leverage ratio, particularly for the Swiss. We
also look at the likely impact of a cessation of prop trading and put a high-level figure on the impact of the mooted Obama tax.
• Barclays (BARC LN – Outperform – 395p price target). We expect that the Barclays Capital business should be able to deliver
revenues (pre-marks) at close to 3Q09 levels and believe that, medium term, the relative attractions of the business remain intact.
We cut our 2010 and 2011 forecasts by about 10% to reflect a lower run-rate of sales and trading revenues; and, as a result of this
and a higher cost of equity, we lower our price target to 395p (from 470p), which still offers more than 30% upside from current
levels.
• Credit Suisse (CSGN VX – Market Perform – CHF63.5 price target). We maintain our Market Perform rating, trim our
estimates, lower our price target to CHF63.5 (from CHF65.5), and reiterate that Credit Suisse is our second preferred European
investment bank. We believe that the dividend payout ratio announced at the full year will be a key indicator of how much capital
Credit Suisse will be required to hold going forward. As with Barclays, we cut our 2010 and 2011 EPS estimates by 5%–10% to
reflect lower sales & trading revenues.
• UBS (UBSN VX – Underperform – CHF14.3 price target). We downgrade UBS to underperform despite its 10%
underperformance since we initiated last July and lower our price target to CHF14.4 from CHF17.4. We also lower our numbers
significantly, leaving us some 20% and 30% below consensus for 2011 and 2012 and reiterate that UBS remains our least favorite
European investment bank.

FULL REPORT HERE