Conceptually, we think of the present difficulties of the UK banks in three linked but roughly distinct parts, like acts in a play. First, the impact on capital and earnings from losses associated with risk assets (treasury assets such as US subprime RMBS, CDOs, leveraged loans). Second, the hits to profits from rising loan losses from weaker economic conditions in the UK in particular. Third, the increase in bank capital requirements and regulation which we expect to follow.
The potential for a US$700bn superfund to buy distressed assets could draw a dotted line under the first "act" we believe. Though sector risk assets of £132bn or 103% of sector tangible equity remain significant, we expect our major banks to be able to access the facility - should they wish to - when it is created.
However, the second act of the drama is in its very early stages and its consequences are not yet reflected in share prices, we believe. Despite a year of talking about delevering, UK banks balances sheets are in broadly the same place as at end 2007. Having raised £21bn in new equity in 2008, shareholders funds are up 7% HoH. However loans are up 8% and financial assets by 15% leaving tangible equity/total assets at 2.2%, equal to the level at the end of last year. With liquidity conditions still troubled, banks generally as levered as before, and customers showing a deteriorating capacity to repay debt, we expect property prices to fall further, arrears to rise, bank losses on default to rise and consensus earnings expectations to fall further. We look to avoid thinner capital bases and higher relative exposure to property-related credit risk.
The attached strategy note lays out our sector views in some detail. We have also released a note on Lloyds TSB this morning, downgrading our recommendation from Hold to Sell, with a 200p target price. We believe that Lloyds TSB's acquisition of HBOS will create a UK bank with virtually unassailable market share and that management will beat synergy expectations by > 50%. However, putting two banks together makes funding more difficult, increases exposure to property lending, and we expect will lead to a 5.6% starting core tier 1 ratio. Though Lloyds TSB is trading at 5.5x current pro-forma earnings including synergies, a return to 1992 loan losses and share issuance to achieve a 6.5% core tier 1 ratio would place the stock on 22x - more significant downside in a peak loan-loss scenario than we see at Barclays (38%) or HSBC (22%), for example.
Our top pick is Barclays: The capital raised last week and the acquisition of Lehman Brothers’ US business below book value propels the core tier 1 ratio to ~7%, combined with a loan book which is least exposed to commercial property of the UK domestics. Trading on 6x 2009 we regard the share as inexpensive relative to its prospects. Buy, TP485p.
The UK banks are trading at 8.4x 2009E EPS, a small premium to the European banks on 8.1x. The UK domestic banks are trading on 5.3x, half the multiple of the UK international banks, HSBC and Standard Chartered. The domestic banks are trading at 2.2x pre-provision profit and 1.5x tangible book value per share.
Quelle: DB research -----------
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