Next up on our compendium of analyst reaction — some commentary from the European analysts.
And, as with the US banks, it’s notable that opinion is also rather divided about the potential impacts of Obama’s financial reform proposals on European banks.
To begin with, here’s JP Morgan’s european banking team, led by Kian Abouhossein:
• Although fixed income disappointment in 4Q09 has been discounted now, and valuations within IBs are becoming more interesting, we reiterate our preference for credit banks over IBs from Sept 09 given the ongoing regulatory headwind and curve balls. Barney Frank indicated that reform might not for happen for another 3-5 years, which might delay the impact from Obama’s proposal. However, the implied uncertainty for the IB sector remains a material risk in our view.
• Overall, we estimate a negative 2011E EPS impact of -21% on average from IB proposed regulations including proposed OTC derivatives regulation. Obama’s proposals . . . have a bigger impact on earnings with -15% EPS dilution on average in 2011E, compared to B. Frank’s proposed OTC derivatives regulation with estimated -6% on average.
• Within our IB stocks, GS is most at risk with its principal investments business at risk and high fixed income gearing, with a potential total negative 27% EPS impact in 2011E from the Obama proposals (-20%) and proposed OTC derivatives regulation (-8%). GS is followed by DB due to its high fixed income profit generation with estimated -23% EPS impact.
And from UBS’s team, led by Philipp Zieschang:
Although not directly targeted at (and affected) these developments impact the European (wholesale) banks. While we think the stocks might continue to experience some weakness, we h.ighlight four points which contribute to our nevertheless rather positive view on these stocks:
… but we see reason to be nevertheless positive on the sector (1) Prop (<5% of revenues) is of limited relevance for group earnings of the European players as is private equity; (2) the absence of these activities would likely reduce income and NAV growth but may not have much effect on free cash-flows; (3) current earnings momentum in the capital markets businesses is good and we expect this to continue; (4) we think valuations are reaching supportive levels. On average, the stocks trade at more than 40% discount to multiy. ear P/B multiples.
We keep our Buy ratings on Barclays (PT 392p), Deutsche Bank (PT €60) and the two French banks SocGen (PT €63.6) and BNP Paribas (PT €66). Credit Suisse is rated Neutral (CHF60). All price targets are based on Gordon growth models.
From Landesbank Baden-Wurttemberg — a succinct view on German banks:
Bottom line: Obama’s proposal is no threat for Deutsche Bank or any other German bank, but it prepares the ground for tougher regulation in Europe. Therefore the sentiment for European banking stocks will remain weak.
And from Nomura’s Raul Sinha:
Although further details around the exact nature of the new rules are yet to be disclosed, we believe that the direction of the proposals indicates tougher than previously anticipated regulatory moves. The proposals are likely to have a potentially negative revenue impact for the Investment banking operations of US banks and international banks with a presence in the US. We would make the following points in relation to the impact on the sector:
- Perhaps most importantly, rather than the proposals themselves, is the message it sends. New regulations are being proposed thick and fast and the industry faces major uncertainty from these. As the Barclays Chairman commented, banking faces a ‘tsunami of regulatory, public and political pressure.’ The latest proposals are only a week after the announcement of the tax on wholesale liabilities. What’s next? Regulation threatens dilution to the normalized earnings estimates of banks in our view.
- As seen with other recent initiatives, these proposals show that regulation is particularly targeting the investment banks, rather than the commercial banks. We have argued that investment banks will face quicker and harsher regulation than commercial banks and switching out of IBs into commercials is an investable strategy. However, in the longer run, the proposals could raise interesting implications for the transparency of IB revenues.
- Given the current regulatory climate, we see a material risk of similar measures being adopted more broadly across other countries, especially in Europe, particularly in more hawkish regulatory environments. Therefore European banks that combine deposit taking with proprietary activities are vulnerable, not just in their US operations, but in their activities globally.
- A key issue is likely to be the definition of proprietary trading operations by the authorities, in our view. The proposals refer to restrictions around owning hedge funds, private equity or proprietary trading business, but acting in ways that facilitate customer activity is allowed. This would affect house trading books but most banks are likely to indicate that this is a very small or negligible proportion of trading (less than 5% of revenues for most if not all European banks in our view). Goldman Sachs has indicated that proprietary trading comprises roughly 10% of total group revenues, with the Principal Strategies Group on top of this figure. In our view, dedicated prop trading historically could have been as much as 20% of trading revenues at investment banks. Firms most affected would be those where proprietary activities is most integrated into their business models, eg private equity and hedge fund businesses, which are integral to generating revenues for other parts of the firm’s activities.
In [this table] we show the proportion of market risk weighted assets as a crude measure of capital held against trading operations. While banks in the US that would be affected would include Goldman Sachs, Morgan Stanley, Citigroup, JP Morgan and Bank of America, in Europe we believe that banks that would be most affected would include RBS, DBK, CS, UBS, Barclays, BNP Paribas, Soc Gen.
Whereas short term focus is likely to be on the proprietary trading restrictions, the limitation on size is also potentially a major change in policy and could have significant long term implications. It would cap the growth of the big firms domestically in the US on an inorganic basis at least. This could imply lower valuations for takeovers of US banks in the future and possibly push big US groups to look outside the domestic market for growth, opening up opportunities for foreign banks in the US (eg SAN/BBVA); it might even cause some non US banks that currently don’t plan US expansion to reconsider. However, there is also a possibility that similar restrictions are adapted by other countries on size and market share of liabilities. Given the relatively large sized balance sheets of pan European banks, any similar restriction on market share of liabilities could be a significant constraint on future growth. In [this table] we show the size of liabilities in the US and in total in local currency terms for the large European banks. Furthermore, once regulators embark on limiting size on inorganic transactions, not just for competitive reasons, but also on grounds of too big to fail, it is possible that this policy is extended to making them shrink.
And an interesting thought from Evolution Securities’ Gary Jenkins, regarding Barclays’ off-balance-sheet vehicle, Protium:
Well that’s put the cat amongst the pigeons. It is said that when President Obama had his first meeting with the heads of the major US banks he said that “my administration is the only thing between you and the pitchforks.” A great line, but one that it looks like he has now crossed, because it appears that he is now leading the angry mob. The banks can hardly complain, after the crises of 2008 they needed to show humility and restraint, and have failed to do so spectacularly. Thus they are now in danger of losing any control over the debate of what the industry should look like and how it should be regulated. Much of the media coverage has focused upon the parts of Obama’s speech where he talked about ending proprietary trading and investing in hedge / private equity funds. But he also said that he intended to “close loopholes that allowed big financial firms to trade risky financial products like credit default swaps and other derivatives without oversight.” The restriction on size will also be interesting from a definition viewpoint (the same could be said for proprietary trading).
Market making should not be impacted but one problem might be that definition thing again. After all, how long do you have to own a security before it becomes a proprietary position? One unintended consequence of these proposals is that it could increase the liquidity premium, thus illiquid asset prices could be negatively affected. How would you account for Barclays sale of assets to Protium? The truth is though that the devil will be in the detail. Will other countries follow the Obama lead? We will have to wait and see but a change of government in the UK may well lead to similar proposals.
Next up the implications for inter-dealer brokers and exchanges.
Related link:
‘Volcker rule’ takes bankers by surprise – FT
Obama and Wall Street in depth – FT