UBS research examines how higher capital requirements impact the stock prices of European banks. Despite a lack of «visibility,» the Swiss bank maintains a positive outlook on the sector.
It's routine for a bank's equity research to scrutinize other companies, but it's less common when a bank evaluates other banks, essentially its competitors. When a major bank assesses the impact of regulations on the stock prices of other major banks, it can add some intrigue.
Last week, UBS's Global Research and Evidence Lab examined how «Basel 4» (the informal term for the capital requirements adopted under Basel III in 2017 but not yet fully implemented nationally) will affect European banks.
Higher Capital Requirements Should Be Manageable
UBS analysts noted in their nearly 40-page report, «The Bankroll #5,» that bank stocks have performed strongly post-COVID-19 due to rising profits and improved payout ratios. With central bank interest rate cuts, the profit cycle is maturing; returns on capital and the potential revaluation of price-earnings ratios are increasingly key factors in UBS's positive view of the banking sector.
According to UBS, even with Basel 4, banks should be able to consistently deliver dividend yields of 10 percent, which is «extremely attractive both absolutely and relatively.» The good news is that the higher core capital requirements are manageable because sufficient equity can be built up organically. The bad news is that Basel 4 won't mark the end of regulatory changes.
European Banking Supervision as a «Disruptive Factor»
Regulators are currently reviewing the methods banks use to calculate risk-weighted assets. UBS points to 140 pending «actions» by the European Banking Authority (EBA), 50 of which are technical regulatory standards on the same legal level as Basel regulations, expected to be implemented between 2025 and 2028.
«There is almost no visibility from lenders regarding the scope and timeline of what these standards might entail. At present, we can only qualitatively highlight that this will likely lead to more regulatory capital for EBA-regulated institutions,» UBS notes.
Earnings Strength and Free Cash Flows in Focus
However, these concerns are not sufficient for UBS to revise its favorable view of the banking sector. Regarding risk and visibility of potential capital returns, the Swiss bank cites Italian institutions Unicredit, Mediobanca, and Intesa Sanpaolo, as well as Danske Bank, Allied Irish Banks, and HSBC as positive examples.
They combine particularly high returns with strong free cash flow generation and/or have surplus projected capital positions. Banks like ING and Caixabank excel in payout strength, while others like Bawag show high levels of free cash flow.
UBS itself is currently facing stricter capital requirements. The Swiss Federal Department of Finance, Finma, and the Swiss National Bank are collectively insisting, based on the Credit Suisse experience, that the parent company better capitalizes foreign subsidiaries in the interest of systemic stability. Those interested in how this might affect UBS's stock price will have to wait for research studies from other banks.
