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10 January 2013 European Equity Research Road to Damascus: Long Paul vs. Saul Swiss Banks:

10 January 2013

European Equity Research

Road to Damascus: Long Paul vs. Saul

Swiss Banks: BUY UBS; HOLD Credit Suisse

EUROPE | BANKS | UBSN VX | CSGN VX

We believe that UBS’s decision to radically shrink the capital consumption of its value-destructive IB division by a further 57%, and cut IB headcount by some 7,000 will more than double the Group’s cap- adjusted Return on Basel 3 Equity (RoB3E) from 11.2% in 2012 to 26.0% in 2015. With the capital released we expect dividends of at least CHF1.10 by 2015 implying a sustainable yield of 7.4% with special dividends taking the 2015-17e average yield to 11.9%. We believe that the effect of all this remains markedly underappreciated by the market. BUY with a price target of CHF18. By contrast, CS remains committed to its low-RoE IB division which by 2015 we estimate will still consume c60% of group capital whilst earning returns of just 5.2% - well below the cost of equity. An ongoing risk of cross-division subsidisation will depress the rating. On this basis we believe that CS trades at around fair value. HOLD but watch for any hint of shrinking and capital rationing at the IB, in which case there is the possibility of an immediate 8-15% upside.

Dramatic cost reduction for UBS, less so at CS: By 2015e we expect UBS will have cut operating expenses by CHF3bn (13%) via a 15% reduction in headcount. CS will have reduced costs by a more mundane 4%, CHF0.9bn, with a 4% decline in head count.

Rapidly improving capital positions for both UBS and CS: By YE14e UBS will have a Basel 3 core equity tier 1 of 13.6% (vs 3Q12: 9.3%), well in excess of its self imposed capital target. CS will have reached a less impressive 11.0% (3Q12: 7.5%), but ahead of fully implemented regulatory requirements.

Stable/falling RWAs by 2014/15 imply both UBS and CS will be strongly cash generative: By YE 15e UBS will achieve returns of 26% (capital & regulation adj.) on RWAs of CHF200bn. Declining RWA’s and improving capital ratios can allow for significant distributions eg. A potential dividend of CHF1.75 in 2015 (11.7% yield). Similar logic implies a 7.7% yield for CS (although it is likely to deploy much of this cash in its IB in our view).

UBS has CHF24.6bn of unrecognised potential deferred tax assets (UPDTAs) due to historic losses. We estimate an NPV for these of CHF 7.5bn (13% mkt cap, or CHF2.0/share) which bolsters our valuation case.

Valuation: We use a SoTPs valuation approach taking account of UBS’s superior capital position and UPDTAs as well as the higher regulatory drag CS is likely to experience from coming regulatory changes. For a variety of reasons we apply a higher multiple to UBS’ WM business. We suggest 18% relative upside for UBS vs. CS.

Figure 1: Summary valuation and recommendations UBS CS Avg Target price & ratings   Target
Figure 1: Summary valuation and recommendations UBS CS Avg Target price & ratings   Target

Figure 1: Summary valuation and recommendations

UBS

CS

Avg

Target price & ratings

 

Target

Rec

Price

Price

% Upside

CHF Buy

14.3

18.0

20%

CHF Hold

24.4

25.0

2%

11%

14.3 18.0 20% CHF Hold 24.4 25.0 2% 11% 1) Underlying 2013E   Div Cap Cap

1) Underlying 2013E

 

Div

Cap

Cap surp 3 %mkt cap

EPS

PEx

TCE 1

p/TCE

RoTCE

Yld 6

surplus 2

1.22

12.3

12.0

1.2

10.9%

1.3%

2.5bn

4%

2.40

10.2

22.3

1.1

11.0%

3.1%

0.5bn

2%

11.2 1.2

10.9%

2.2%

3%

11.0% 3.1% 0.5bn 2% 11.2 1.2 10.9% 2.2% 3% 2) U/L Reg&Cap adjusted 2013E 4 EPS

2) U/L Reg&Cap adjusted 2013E 4

EPS

PEx 5

Core TCE p/TCE 5 RoTCE

1.34

10.0

10.1

1.2 13.2%

2.28

10.4

22.2

1.2 10.3%

10.2 1.2

11.7%

1. TCE=Tangible Common Equity per share ; 2. ‘Surplus’ = equity capital surplus under fully loaded Basel III vs. 10% target; 3. surplus as % of market cap ; 4. 2013E Reg&CapAdj numbers are ex 1-offs, ex UBS legacy assets, and after buying back shares to eliminate capital surplus ; 5. ratios calculated after deducting 2012-13E announced dividends, UBS UPDTAs & value of capital allocated against legacy assets to increase comparability. 6. 2013e div yield. Share price data COB 7th January 2013. Source: Liberum Capital, Bloomberg

Cormac Leech

+44 (0)20 3100 2264 cormac.leech@liberumcapital.com

10 January 2013

Road to Damascus: Long Paul vs. Saul

10 January 2013 Road to Damascus: Long Paul vs. Saul

Contents

UBS

22

Credit Suisse

33

Appendix

44

10 January 2013

Road to Damascus: Long Paul vs. Saul

10 January 2013 Road to Damascus: Long Paul vs. Saul

Road to Damascus: Long Paul vs. Saul

“We Swiss are farmers, not hunter-gatherers. The asset management business suits our

character as well as our historical position. Your investment banking business, though, has

never made a penny for your shareholders

2010

1 , Swiss National Bank to UBS Chairman in

Both UBS and CS are reducing costs to address a weaker revenue environment. However UBS plans a considerably more aggressive 57% shrinkage in IB RWAs, vs 3Q12 level, via radical restructuring. By contrast CS still maintains committed to its IB division which will consume 63% of Group Capital by YE15e while generating returns on Basel 3 equity of only 5.2% (post Basel 3/ Dodd Frank/cost savings). As a result by 2015, UBS will have a capital and regulation adjusted RoB3E of 26.0% vs. only 13.3% for CS – a divergence not yet fully discounted in our view. Over time we expect UBS share price outperformance may encourage CS to follow suit boosting fair value by 8-16%

UBS and CS face a sluggish revenue environment. We estimate by 2015 revenues will be c 13-15% below 2010 levels. However both UBS and CS have credible plans to reduce costs (figure 15) to counter subdued revenue outlook. We estimate cost income ratios for both banks of 72-74% by 2015e from 2012e levels of 78-81%.

Figure 2: Summary underlying P&L excluding 1-offs*

 
 

% Ch

CHF bn

2010

2011

2012e

2013e

2014e

2015e

2011

2012e

2013e

2014e

2015e

2015/2010

Revenues UBS CS Costs UBS CS Cost change UBS CS Revenue adj, cost change UBS CS Cost Income UBS CS PBT UBS CS

31.1

27.9

27.9

27.5

27.4

27.0

-10%

0%

-1%

0%

-1%

-13%

30.4

24.4

25.7

25.6

25.5

25.9

-20%

5%

0%

0%

2%

-15%

-23.9

-22.0

-22.5

-21.2

-20.3

-19.5

-8%

2%

-6%

-4%

-4%

-18%

-23.3

-21.2

-20.0

-19.6

-19.2

-19.2

-9%

-5%

-2%

-2%

0%

-18%

1.9

-0.5

1.3

0.9

0.8

 

2.1

1.1

0.4

0.4

0.0

-0.5

-0.5

1.1

0.8

0.5

-2.4

2.1

0.3

0.4

0.3

77%

79%

81%

77%

74%

72%

2%

2%

2%

-4%

-3%

-5%

77%

87%

78%

77%

75%

74%

10%

10%

-9%

-1%

-1%

-3%

7.1

5.8

5.2

6.3

7.0

7.4

-18%

-10%

20%

13%

5%

4%

7.2

3.1

5.5

5.7

6.1

6.5

-57%

80%

4%

6%

7%

-10%

*Excluding UBS STAB option volatility, business realignment costs, exception litigation, 1-off rebound gains, gains on disposals and other 1-offs Source: Company Reports; Liberum Capital

UBS: 13% PBT CAGR 2013-15e: On a summary divisional basis UBS we expect the asset and wealth management business to grow at an average 11-17% over 2013-15e resulting in average underlying PBT growth for UBS of 13% despite only modest PBT growth in the IB due to exiting of certain FICC business. For full UBS divisional P&Ls, excluding 1-off items, see figures 36-43.

1 http://tinyurl.com/athw8tm , Martin Taylor (former Barclays CEO) FT op-ed 2Nov2012.

10 January 2013

Road to Damascus: Long Paul vs. Saul

10 January 2013 Road to Damascus: Long Paul vs. Saul

Figure 3: UBS summary underlying divisional P&L

 

CHF bn Wealth Mgmt Retail & Corporate Global Asset Management Investment Bank Wealth Management USA Centre Core Total Underlying PBT ex legacy Centre- Legacy

2010

2011

2012e

2013e

2014e

2015e

2016e

2017e

2011

2012

2013

2014

2015

2016

2017

2.4

2.3

2.3

2.8

3.0

3.1

3.3

3.5

-3%

-2%

22%

8%

5%

6%

6%

1.8

1.7

1.6

1.8

1.8

1.8

1.8

1.7

-6%

-3%

12%

0%

-1%

0%

-3%

0.5

0.5

0.5

0.6

0.7

0.7

0.8

0.8

-12%

11%

24%

11%

6%

4%

4%

2.2

1.1

0.9

0.8

1.0

1.0

1.0

1.1

-49%

-15%

-15%

29%

0%

1%

1%

0.3

0.5

0.8

1.1

1.3

1.3

1.4

1.5

86%

75%

32%

14%

6%

6%

3%

0.0

-0.2

-0.9

-0.8

-0.7

-0.6

-0.5

-0.5

 

-12%

-15%

-17%

-11%

-11%

7.1

5.8

5.2

6.3

7.0

7.4

7.8

8.1

-19%

-10%

20%

13%

5%

5%

4%

0.0

0.0

0.0

-3.5

-3.5

-1.0

0.0

0.0

 

U/L PBT including legacy

7.1

5.8

5.2

2.8

3.5

6.4

7.8

8.1

-19%

-10%

-47%

29%

81%

21%

4%

1-offs

0.3

-0.4

-7.5

0.0

0.0

0.0

0.0

0.0

 

Reported PBT Group MI s U/L Attributable U/L EPS Basel 3 RWAs RoTCE at 10% CT1*

7.4

5.4

-2.3

2.8

3.5

6.4

7.8

8.1

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

5.3

4.2

3.8

4.6

5.2

5.5

5.8

6.0

-19%

-11%

22%

13%

5%

5%

4%

1.4

1.1

1.0

1.2

1.4

1.5

1.5

1.6

-19%

-11%

23%

13%

5%

5%

4%

380

380

266

226

211

200

192

195

 

13.8%

11.2%

11.7%

18.8%

24.0%

26.9%

29.6%

31.2%

*not adjusted for financial regulation (e.g. Dodd Frank, ring-fencing etc) Source: Company Reports; Liberum Capital

CS: 5% PBT CAGR 2013-15e: Similarly for CS in the asset and wealth management divisions we forecast average 2013-15 annual PBT growth of 9-26% resulting in group PBT growth of 5% despite flat PBT in the IB (due to sluggish FICC revenues). For full divisional P&L, ex 1-off items, see figures 51-57.

Figure 4: CS summary underlying divisional P&L

 
 

2010

2011

2012e

2013e

2014e

2015e

2011

2012e

2013e

2014e

2015e

Wealth Mgmt Corporate & Institutional Investment Bank Asset Management Corporate Centre

2.5

1.9

2.2

2.5

2.7

2.9

-26%

19%

9%

9%

9%

0.9

0.9

0.9

0.9

0.9

0.9

-2%

3%

0%

0%

3%

3.6

0.1

2.7

2.6

2.6

2.6

nm

nm

-3%

0%

2%

0.5

0.6

0.3

0.5

0.6

0.6

18%

-43%

47%

23%

9%

-0.3

-0.3

-0.6

-0.7

-0.7

-0.6

19%

92%

14%

0%

-8%

U/L Total PBT Rev 1-offs Cost 1-offs

7.2

3.1

5.5

5.7

6.1

6.5

-57%

80%

4%

6%

7%

0.2

1.0

-1.8

 

-0.6

-1.3

-0.8

-0.5

-0.3

-0.3

1-offs

-0.4

-0.3

-2.6

-0.5

-0.3

-0.3

Reported Total PBT Reported total check U/L PAT U/L Attributable

6.8

2.7

3.0

5.2

5.8

6.3

6.8

2.7

3.0

5.2

5.8

6.3

5.6

2.3

4.5

4.4

4.7

5.0

4.9

2.0

3.9

3.8

4.1

4.3

Basel 3 RWAs U/L PBT/Avg RWAs Ro B3E @10% CT1*

398.7

330.0

298.7

277.4

284.7

295.4

1.8%

0.8%

1.8%

2.0%

2.2%

2.2%

12.2%

5.6%

12.5%

13.3%

14.4%

15.0%

*not adjusted for financial regulation Source: Company Reports; Liberum Capital

Below consensus for UBS and CS EPS by 2% and 8% respectively For UBS we are on average 2% above consensus EPS and 2% below on revenues. For CS we are on average 8% below consensus EPS and 10% below on revenues.

10 January 2013

Road to Damascus: Long Paul vs. Saul

10 January 2013 Road to Damascus: Long Paul vs. Saul

Figure 5: Liberum revenue and EPS forecasts vs. Bloomberg consensus

 
 

% Ch

CHF bn

2011

2012e

2013e

2014e

2015e

2016e

2017e

2012e

2013e

2014e

2015e

2016e

2017e

UBS LC e u/l revenue bn LC e reported revenue Consensus

27.9

27.9

27.5

27.4

27.0

27.8

28.5

0%

-1%

0%

-1%

3%

3%

29.8

25.6

27.5

27.4

27.0

27.8

28.5

 

25.5

27.3

28.2

28.1

n/a

n/a

-14%

7%

3%

0%

LCe/ Consensus

0%

1%

-3%

-4%

 

LC e Adj EPS Consensus

 

0.99

1.22

1.38

1.46

1.53

1.59

-11%

23%

13%

5%

5%

4%

1.03

1.08

1.34

1.61

2.10

n/a

-7%

5%

24%

20%

31%

LCe/ Consensus

-4%

13%

3%

-9%

-27%

 

CS LC e u/l revenue bn LC e reported revenue Consensus

 

25.7

25.6

25.5

25.9

5%

0%

0%

2%

24.0

25.6

25.5

25.9

 

24.4

27.0

28.4

30.6

-4%

10%

5%

8%

LCe/ Consensus

-2%

-5%

-10%

-15%

 

LC e Adj EPS Consensus

 

2.29

2.40

2.54

2.73

86%

5%

6%

8%

1.84

2.51

2.90

2.99

50%

36%

16%

3%

LCe/ Consensus

24%

-4%

-13%

-8%

 

Source: Company Reports; Liberum Capital

For UBS sharp rise in RoB3E due to reduced Capital Consumption

Capital consumption change 2011-15: down 47% for UBS; down 13% for CS For Credit Suisse, the reduction in RWAs from YE11-YE15e is likely to be much less than for UBS. From YE11-15e, UBS will have reduced its RWAs by 47% to CHF200bn vs. a 13% decline for CS to CHF295bn.

UBS’s Capital consumption will drop by 47% 2011-2015 vs. a drop of only 13% for CS

Figure 6: UBS and CS Basel 3 RWAs CHFbn 2010-2017e

450 400 350 300 250 200 150 2010 2011 2012e 2013e 2014e 2015e 2016e 2017e
450
400
350
300
250
200
150
2010
2011
2012e
2013e
2014e
2015e
2016e
2017e
UBS
CS

Source:

UBS RWA shrinkage implies a reduction in required capital of CHF18bn by YE15e vs. YE11 equivalent (32% of mkt cap) vs. a decline in RWAs of only 14% for Credit Suisse (11% of mkt cap).

10 January 2013

Road to Damascus: Long Paul vs. Saul

10 January 2013 Road to Damascus: Long Paul vs. Saul

2012-15e: UBS RoB3E will more than double; limited improvement for CS Despite both banks making significant improvements in attributable income, UBS will deliver a stronger increase in Cap&Reg adjusted RoB3E 2012-15e, rising from 11.2% to 26.0% compared to CS’s more subdued rise from 9.8% to 13.3% for CS. This divergence explains much of expected TSR outperformance we expect for UBS.

For UBS the underlying RoB3E will more than double from 2012- 2015e vs. a much more muted 32% rise for CS mainly due to differences in divergence in capital consumption but also due to more rapid earnings growth due to business mix changes

Figure 7: Change in RWAs and impact on Return on Basel 3 equity at 10% gearing

 

2011

2012e

2013e

2014e

2015e

RWAs Basel 3 UBS CS Capital requirement at 10% UBS CS Cumul. Chnge in Capital required UBS CS Cumulative capital release as % mkt cap UBS CS Attributable Income UBS CS Return on Basel 3 equity at 10% gearing to RWAs UBS CS

380

266

226

211

200

339

299

277

285

295

38

27

23

21

20

34

30

28

28

30

(11)

(15)

(17)

(18)

(4)

(6)

(5)

(4)

-20%

-27%

-30%

-32%

-10%

-16%

-14%

-11%

4.3

3.8

4.6

5.2

5.5

1.5

3.6

3.8

4.1

4.4

11.2%

11.7%

18.8%

24.0%

26.9%

4.0%

11.4%

13.3%

14.4%

15.1%

Return on Basel 3 equity adjusted for regulation*

UBS

10.7%

11.2%

18.1%

23.2%

26.0%

CS

2.7%

9.8%

11.5%

12.6%

13.3%

*assume minus CHF0.5bn net of tax impact for CS and minus CHF0.2bn impact for UBS due to Dodd Frank and Ring-Fencing etc Source: Liberum Capital

Comparing Return on Basel 3 equity (RoB3E) is more meaningful than RoTCE due to differences in composition of TCE for both banks:

As figure 8 illustrates due to items such as unrealised losses from cash flow hedges, TCE per share is 73% higher than Basel 3 equity regulatory capital for UBS vs. only 42% for CS which misleadingly depresses UBS’s relative RoTCE. Since Basel 3 equity capital determines capital adequacy, RoB3E is a more meaningful

10 January 2013

Road to Damascus: Long Paul vs. Saul

10 January 2013 Road to Damascus: Long Paul vs. Saul

Analysis of composition of TCE shows that a relatively large proportion of UBS’s tangible book value is not eligible Basel 3 equity capital which tends to ‘misleadingly understate relative returns on equity vs. CS.

Figure 8: Bridge from TCE to Basel 3 equity capital 3Q12

 
 

B3 equity =

 

% Basel 3 RWAs UBS

CS

100%

Per Share

CHF bn

UBS

CS

UBS

CS

UBS

CS

Shareholders equity

52.4

35.7

 

14.0

22.4

 

Goodwill

-6.6

(8.9)

-1.8

-5.6

Mandatory convert

0.0

3.6

0.0

2.3

   

15.2

Tangible Common Equity Unrealised losses from Cash flow hedges Treasury shares ex Fair Value Own Debt (FVoD) Pension plan adjustments Qualifying non controlling interest Other Capital deductions

45.8

30.4

173%

142%

12.2

19.1

%

9.9%

-3.2

-12%

0%

-0.9

0.0

-1.1%

0.0%

-0.7

-3%

0%

-0.2

0.0

-0.2%

0.0%

-0.1

(0.3)

-1%

-1%

0.0

-0.2

0.0%

-0.1%

0.0

2.8

0%

13%

0.0

1.8

0.0%

0.9%

0.0

3.2

0%

15%

0.0

2.0

0.0%

1.1%

(3.7)

(1.8)

-14%

-8%

-1.0

-1.1

-1.2%

-0.6%

     

12.6

11.2

Basel II core tier 1 Ex non controlling interests Deferred tax Pension StabFund Option Net Other deductions

38.0

34.4

144%

160%

10.1

21.6

%

%

(3.2)

0%

-15%

0.0

-2.0

0.0%

-1.1%

-5.3

(7.2)

-20%

-34%

-1.4

-4.5

-1.8%

-2.3%

-3.8

-14%

0%

-1.0

0.0

-1.3%

0.0%

-1.0

-4%

0%

-0.3

0.0

-0.3%

0.0%

0.0

(1.0)

0%

-5%

0.0

-0.6

0.0%

-0.3%

Basel III equity tier 1 co def Libor rigging litigations/fines

28.0

22.9

106%

107%

7.5

14.4

9.3%

7.5%

(1.5)

(1.5)

-6%

-7%

-0.4

-0.9

-0.5%

-0.5%

Basel III equity tier 1 LCe def

26.5

21.4

100%

100%

7.1

13.5

8.8%

7.0%

#shares outstanding diluted Basel 3 RWAs

3.7

1.6

301

307

Attributable 2012e

3.8

3.2

 

10.7

RoTCE Ratio of RoTCE for CS vs. UBS in 2012**

8.3%

%

1.3x

RoB3CT1

14.3%

15.1%

Ratio of RoB3CT1 for CS vs. UBS in

2012**

1.1x

*Fully loaded; CS returns are higher due to a lower capital ratio. Source: Company accounts; Liberum Capital

Figures 9 and 10 show our forecasted returns for UBS and CS on an i) underlying basis ii) After assuming a buyback/ special dividend to eliminate excess capital iii) After also adjusting for the earnings drag from more onerous regulation: By 2015 on a FinReg and Cap adjusted basis we expect UBS and CS to achieve a RoB3E of 26.0% and 13.3% respectively which is the most meaningful valuation metric in our view

Figure 9: UBS underlying return on Basel 3 equity

30% 25% 20% 15% 10% 5% 0%
30%
25%
20%
15%
10%
5%
0%
30% 25% 20% 15% 10% 5% 0% 2011 2012 2013 2014 2015 UBS underlying UBS Cap

2011

2012

2013

2014

2015

UBS underlying

UBS underlying UBS Cap Adj UBS FinReg Cap Adj

UBS Cap Adj

UBS FinReg Cap Adj

UBS FinReg Cap Adj

*FinReg: Financial Regulation such as Dodd Frank and Ring Fencng Source: Liberum Capital

Figure 10: CS underlying return on Basel 3 equity

30% 25% 20% 15% 10% 5% 0%
30%
25%
20%
15%
10%
5%
0%
30% 25% 20% 15% 10% 5% 0% 2011 2012 2013 2014 2015 CS underlying CS Cap

2011

2012

2013

2014

2015

CS underlying

CS underlying CS Cap Adj CS F inReg Cap Adj

CS Cap Adj

CS underlying CS Cap Adj CS F inReg Cap Adj

CS F inReg Cap Adj

*FinReg: Financial Regulation such as Dodd Frank and Ring Fencng Source: Liberum Capital

10 January 2013

Road to Damascus: Long Paul vs. Saul

10 January 2013 Road to Damascus: Long Paul vs. Saul

UBS could annually yield 11.9% 2015-17e; CS 8.6%

UBS has scope to pay significant dividends: 9.5% by 2015e (7.4% sustainable)

Our base case forecasts UBS will pay a cash dividend equivalent to a 3.3% yield in 2014, rising to a 9.5% in 2015-2017e. Despite this substantial yield, the Basel 3 core tier 1 continues to climb reaching 15.8% in 2017e.

Limiting the UBS capital ratio to 13.6% implies a 11.9% yield 2015- 17e of which 7.9% is sustainable and 4% special

Alternatively solving for a steady 13.6% Basel 3 equity ratio (the YE13e level) implies an average annual 11.9% yield over 2015-17.

The maximum sustainable underlying yield over the same period assuming 5% annual growth would be 7.9% (assuming 5% normalised RWA growth) implying a 4% annual special dividend from 2015-17e (i.e. 7.9%+4.0%=11.9%) as the business transitions.

Put differently from YE14-YE17e, UBS will generate distributable cash of CHF20.3bn after which a sustainable c8.4% dividend (from 2018e) looks feasible equivalent to a payout ratio of c 80% growing broadly in line with invested assets, with improving operating leverage roughly offsetting likely margin pressure.

10 January 2013

Road to Damascus: Long Paul vs. Saul

10 January 2013 Road to Damascus: Long Paul vs. Saul

For UBS, in our base case despite paying a dividend of CHF1.42 per share from 2015e, yield of 9.5%, the Basel 3 equity ratio continues to climb to 15.8% by 2017e.

For UBS, solving for the dividend required to keep the equity capital ratio fixed at 13.6%, implies a dividend of CHF 1.75 in 2015e and an average yield 2015-17e of

11.9%

Assuming long run RWA growth of 5% (c NGDP) implies a payout ratio of 79%, sustainable long term dividend yield of 7.9%, growing at perhaps 4-5% per annum

Figure 11: UBS dividend scenarios: conservative; targeting stable Basel 3 equity 2014- 17e; long run sustainable dividend

CHF bn RWAs Basel 3 equity Basel 3 equity as % RWAs – base case

2011

2012e

2013e

2014e

2015e

2016e

2017e

Avg 2015-17e

380

266

226

211

200

192

195

25

25

27

29

29

30

31

6.7%

9.3%

11.8%

13.6%

14.2%

15.4%

15.8%

Statutory Attributable CHF Underlying Attributable avg #shares bn Adj EPS

4.2

-3.1

2.1

2.8

5.2

6.4

6.6

4.3

3.8

4.6

5.2

5.5

5.8

6.0

3.8

3.8

3.8

3.8

3.796

3.8

3.8

1.11

0.99

1.22

1.38

1.46

1.53

1.59

i)

Base case

 

Payout ratio statutory Payout ratio underlying Dividend CHF bn Announced DPS Current share price Implied yield

9%

-18%

36%

68%

102%

84%

81%

 

9%

15%

16%

36%

96%

91%

88%

0.4

0.6

0.7

1.9

5.3

5.3

5.3

0.10

0.15

0.20

0.50

1.42

1.42

1.42

15

0.7%

1.0%

1.3%

3.3%

9.5%

9.5%

9.5%

9.5%

ii)

DIV for unch. Capital from 2014

 

Basel 3 equity Basel 3 equity % Payout ratio underlying Dividend CHF bn DPS Implied yield

25

25

27

29

27

26

25

 

6.7%

9.3%

11.8%

13.6%

13.6%

13.6%

13.0%

9.0%

15.1%

16.4%

36.2%

120%

127%

104%

0.4

0.6

0.7

4.8

6.6

7.4

6.3

0.10

0.15

0.20

0.50

1.75

1.95

1.66

0.7%

1.0%

1.3%

3.3%

11.7%

13.0%

11.1%

11.9%

iii) Sustainable Dividend

   

Underlying Attributable RWAs Assumed RWAs Growth RWA Growth CHF bn Cap. Consumption @13% Implied Payout ratio Implied DPS Implied Yield

4.3

3.8

4.6

5.2

5.5

5.8

6.0

 
 

200

192

195

5%

5%

5%

10

10

10

1.3

1.3

1.3

76%

78%

79%

1.1

1.2

1.3

7.4%

8.0%

8.4%

7.9%

Source: Liberum Capital estimates

CS base case: cash dividend yield of 4.7% by 2015e

For CS the capacity to distribute cash is less impressive due to lower returns and

less reduction in capital requirements. That said, our base case forecast of 2015e DPS of CHF 1.15 (underlying payout ratio of 42%) is still equivalent to a 4.7% yield.

Alternatively solving for a steady 11.0% Basel 3 equity ratio (the YE13e level) implies an average annual 8.6% yield over 2015-17.

For CS, we estimate the max sustainable yield to be 6.2% assuming 6% RWA growth (higher RWA growth than UBS given higher IB mix).

10 January 2013

Road to Damascus: Long Paul vs. Saul

10 January 2013 Road to Damascus: Long Paul vs. Saul

For CS, in our base case despite paying a dividend of CHF1.15 per share from 2015e, yield of 4.7%, the Basel 3 equity ratio continues to climb to 12.6% by 2017e

For CS, solving for the dividend to keep the Basel 3 capital ratio at 11.0% in 2015e implies a dividend of 1.88, yielding 7.7% and an average 2015-17e yield of 8.6%

Assuming RWA growth of 6% implies a payout ratio of 52% and a sustainable yield of 6.2% growing at perhaps 4%

Figure 12: CS dividend scenarios: conservative; targeting stable Basel 3 equity 2014- 17e; long run sustainable dividend

CHF bn RWAs Basel 3 equity Basel 3 equity %

2011

2012e

2013e

2014e

2015e

2016e

2017e

Avg 2015-17e

339

299

277

285

295

304.3

313.4

12

24

28

31

34

36.8

39.4

3.6%

8.2%

10.2%

11.0%

11.6%

12.1%

12.6%

Statutory Attributable CHF Underlying Attributable avg #shares bn Adj EPS

1.6

3.1

3.5

3.9

4.2

4.4

4.6

1.9

3.8

3.8

4.1

4.4

4.4

4.6

1.2

1.6

1.6

1.6

1.6

1.6

1.6

1.58

2.37

2.40

2.54

2.73

2.87

3.01

i)

Base case

 

Payout ratio statutory Payout ratio underlying Dividend CHF bn Announced DPS Current share price Implied yield

55%

32%

39%

41%

44%

 

48%

26%

35%

39%

42%

43%

43%

0.9

1.0

1.4

1.6

1.8

2.0

2.1

0.75

0.75

0.85

1.00

1.15

1.23

1.30

24.38

3.1%

3.1%

3.5%

4.1%

4.7%

5.1%

5.3%

5.0%

ii)

DIV for unch. Capital from 2014

 

Basel 3 equity Basel 3 equity % Payout ratio underlying Dividend CHF bn DPS Implied yield

12

24

28

31

32

33

34

 

3.6%

8.2%

10.2%

11.0%

11.0%

11.0%

11.0%

55%

32%

39%

79%

72%

78%

78%

0.9

1.0

1.4

3.1

3.0

3.4

3.6

0.75

0.75

0.85

1.00

1.88

2.14

2.26

3.1%

3.1%

3.5%

4.1%

7.7%

8.8%

9.3%

8.6%

iii) Sustainable Dividend

   

Underlying Attributable RWAs Assumed RWAs Growth RWA Growth CHF bn Cap. Consumption @11% Implied Payout ratio Implied DPS Implied Yield

1.6

3.1

3.5

3.9

4.2

4.4

4.6

 
 

285

295

316.1

338.2

6%

6%

6%

6%

17

18

19

20

1.9

1.9

2.1

2.2

51%

53%

52%

52%

0.75

0.75

0.85

1.3

1.5

1.5

1.6

3.1%

3.1%

3.5%

5.4%

6.0%

6.2%

6.4%

6.2%

Source: Company Reports; Liberum Capital

As a summary comparison, Figures 13 and 14 illustrate that UBS is likely to return significantly more cash over the next 5 years under the various scenarios.

UBS: Obvious future risk of substantial cash generation leading to complacency/ value- dilutive M&A; manageable risk in our view with the right management incentives

Figure 13: UBS dividend yield scenarios

15.0% 10.0% 5.0% 0.0%
15.0%
10.0%
5.0%
0.0%
15.0% 10.0% 5.0% 0.0% 2011 2012e 2013e 2014e 2015e 2016e 2017e base case maintain 13.6% capital

2011

2012e

2013e 2014e

2015e 2016e

2017e

base case

maintain 13.6% capital

maintain 13.6% capital

sustainable

sustainable

Source: Liberum Capital

Figure 14: CS dividend yield scenarios

15.0% 10.0% 5.0% 0.0% 2011 2012e 2013e 2014e 2015e 2016e 2017e base case maintain 11%
15.0%
10.0%
5.0%
0.0%
2011
2012e
2013e
2014e
2015e
2016e
2017e
base case
maintain 11% capital
sustainable

Source: Liberum Capital

Given UBS’s significant cash generation, we see downside risk from potentially value destroying acquisitions. It remains to be seen whether management will distribute the maximum appropriate level of capital to shareholders.

10 January 2013

Road to Damascus: Long Paul vs. Saul

10 January 2013 Road to Damascus: Long Paul vs. Saul

For UBS we assume CHF3bn of cost reduction 2015e vs. 2012e

Both UBS and CS undertaking significant cost save initiatives through 2015e – likely to significantly improve PBT

UBS cost reduction plan, 2013-2015e

Limited efficiency gains in 2012e: On an underlying basis UBS will increase

costs by CHF0.5bn in 2012 to CHF 22.5bn vs. 2011 adversely impacted by a CHF0.6bn adverse FX move.

Mgmt target CHF4bn of cost saves by 2015e: From the 2012e cost run-rate of CHF22.5bn, Management have committed to a further CHF4bn reduction by 2015 to cCHF18.5bn in 2015e, or CHF2.5bn net of CHF1.5bn of investment spend.

We assume reduced investment spend due to weak revenues: Our own forecasts assume underlying 2015e costs of 19.5bn (down CHF3.0bn from 2012e), CHF0.5bn lower than management guidance – in effect we are forecasting that management will cut back on investment spend due to a weak revenue environment. Our 2015e revenues are CHF1.1bn below consensus and our 2015e EPS is conservatively 9% below Bloomberg consensus.

Our base case forecasts revenue-adjusted cost reduction of CHF2.3bn by 2015e after changes in costs are adjusted for changes in revenues assuming a marginal 75% cost income ratio vs. the 2012 run-rate.

Base case forecasted CHF3bn cost reduction looks achievable: equivalent to 13% of cost base and seems feasible given the planned 15% reduction in headcount (10,000 staff) and also the IB business exits within credit and rates. See figure 24 below for detailed analysis costs per employee by division for UBS.

For CS we assume CHF0.9bn of cost reduction by 2015e vs. 2012e.

Our 2015e CS cost income ratio of 74% is below an estimated Bloomberg consensus 76%

CS cost reduction plan, 2013-2015e

Improved efficiency in 2012e: On an underlying basis CS reduced costs by CHF0.8bn in 2012e to CHF 20.3bn vs. 2011, reducing the clean cost income ratio to 78% from the uncomfortably high 87% in 2011.

Management guide for CHF2bn reduction by 2015 (excluding variable compensation) vs. 9M12 level. This would imply 2015e costs of c CHF18.3bn. Our own forecasts assume underlying 2015e costs of 19.3bn down CHF0.9bn from 2012e or CHF1.1bn higher than management guidance as we expect investment spend and other factors (such as e.g. regulatory spend, PAF3/ Bond Plus etc) to significantly impact costs. As context, our 2015e revenues are CHF4.7bn below consensus (admittedly small Bloomberg sample) and our EPS is 8% below consensus. Reverse engineering this consensus implies consensus 2015e group costs of CHF23.2bn and a cost income ratio of 76% vs. our 74% implying consensus cost reduction expectations (even revenue adjusted) are lower than our own forecasts.

On a revenue adjusted basis where changes in costs are adjusted for changes in revenues assuming a marginal 75% cost income ratio, we forecast CS will eliminate CHF1.0bn in costs by 2015e equivalent to 5% of total costs. This looks feasible given

10 January 2013

Road to Damascus: Long Paul vs. Saul

10 January 2013 Road to Damascus: Long Paul vs. Saul

opportunities to rationalise FICC, Underwriting and advisory business in some geographies

scope to consolidate back office systems.

high 2012e starting point cost income ratio of 78%

progress being made: the CHF1.8bn of cost saving progress achieved in 2012 also point to further efficiency gains over 2013-2015.

Figure 15 summaries our cost forecasts for UBS and CS

Taking changes in revenue into consideration we are forecasting CHF2.3bn of cost reduction for UBS and CHF1.0bn for CS

Figure 15: Cost reduction plans absolute and revenue adjusted.

 
 

2010

2011

2012

2013

2014

2015

2016

2017

Cumul. FY13-15 inclusive

Clean Revenues UBS CS Clean Costs UBS CS Cost income ratio UBS CS Clean PBT UBS CS Change in Clean PBT UBS CS Change in Revenues UBS CS Change in costs UBS CS Assumed incremental Cost income ratio UBS CS

Cost change due to Revenue Change UBS CS

Revenue adjusted cost reduction UBS CS

31.1

27.9

27.9

27.5

27.4

27.0

27.8

28.5

30.4

24.4

25.7

25.6

25.5

25.9

23.9

22.0

22.5

21.2

20.3

19.5

19.9

20.4

23.3

21.2

20.0

19.6

19.2

19.2

77%

79%

81%

77%

74%

72%

72%

71%

77%

87%

78%

77%

75%

74%

7.1

5.8

5.2

6.3

7.0

7.4

7.8

8.1

7.2

3.1

5.5

5.7

6.1

6.5

-1.3

-0.6

1.0

0.8

0.4

0.4

0.3

2.2

-4.1

2.5

0.2

0.3

0.4

1.0

-3.1

-0.1

-0.4

-0.1

-0.4

0.8

0.8

-0.9