European Banks Individual Analysys

See page 91 for Analyst Certification and Important Disclosures
Industry Report
E Q U I T Y
R E S E A R C H :
E U R O P E
Banks
January 2005
Europe
Not all the same
Simon Samuels
+44-20-7986-4188
simon.samuels@citigroup.com
London
Prospects for European Banks in 2005
Yann Goffinet*
+44-20-7986-3953 ➤ The current high degree of valuation and
yann.goffinet@citigroup.com performance convergence is unusual in an
London
historical context and we forecast normal
European Banking Team divergence will return in 2005
Albert Coll
➤ Our three key themes are:
Ronit Ghose
Azzurra Guelfi* ➤ We remain focused on growth, which is
Yann Goffinet*
Simon Nellis especially attractive given converged valuations
Tom Rayner
Philip Richards ➤ On balance we are more worried about downside
Fred Rizzo* than upside risk to numbers, and hence we
Riccardo Rovere
Simon Samuels prefer banks with strong earnings resilience
Jeremy Sigee
Kiri Vijayarajah ➤ Finally, capital returns will remain important,
although these are not a panacea
*US Investors please contact one ➤ As in previous years, restructuring will provide
of the other analysts listed
some stock specific opportunities and we name
our restructuring stocks to “buy” and “avoid”
➤ While the pace of M&A may accelerate, we do not
believe it is an investable theme given the lack of
clear value creation and unpredictable nature of
combinations
➤ We include our country weightings and key
fundamental “buy” and “avoid” stocks
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Not all the same – January 2005
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2
Table of Contents
Investment Summary..................................................................................................................................3
Not all the same ............................................................................................................................................6
Then and Now.............................................................................................................................................18
Why have European bank valuations converged?.......................................................................................21
Why Convergence is wrong........................................................................................................................28
Convergence…. or is it divergence? ...........................................................................................................34
REVENUE GENERATION FOR MAJOR BANKS .............................................................................49
ABN AMRO ...............................................................................................................................................50
Barclays ......................................................................................................................................................52
BBVA .........................................................................................................................................................54
BNP Paribas................................................................................................................................................56
Credit Suisse ...............................................................................................................................................58
Danske ........................................................................................................................................................60
Deutsche Bank ............................................................................................................................................62
HBOS..........................................................................................................................................................64
HSBC — By Geography.............................................................................................................................66
HSBC — By Business ................................................................................................................................68
HVB............................................................................................................................................................70
Lloyds TSB .................................................................................................................................................72
NORDEA....................................................................................................................................................74
RBS.............................................................................................................................................................76
Santander ....................................................................................................................................................78
SHB.............................................................................................................................................................80
SocGen........................................................................................................................................................82
Standard Chartered .....................................................................................................................................84
UBS.............................................................................................................................................................86
UniCredito ..................................................................................................................................................88
European Banks Summary Recommendations & Target Prices .................................................................90
3
With banks trading in a narrow range and valuations converged, 2004

Investment Summary
was a second consecutive year in which fundamental analysts felt
they could have stayed at home. However, we believe that the current
malaise in the sector — where most banks are valued the same — will
not last. The history of this sector shows that divergence will return,
even between so-called similar banks, and we anticipate normal
performance disparity to resume in 2005. Our key themes are revenue
growth, which is especially attractive given valuation convergence;
earnings resilience, since on balance we are more worried about
downside risk to numbers; restructuring, but selectively; and — as a
supplement — surplus capital generation. Convergence, we believe,
presents a great investment opportunity.
Valuation Convergence
Over the past year valuations in the European bank sector have once again
converged. On our current forecasts over half the sector trades on between 9x-11x
earnings and approaching half the sector trades on between 1.2x-1.6x book value.
The big caps in the sector are even more converged, with two thirds trading
between 9x-11x forward earnings. This level of convergence is not normal, and
indeed has already started to break down.
Why have European bank valuations converged?
We believe banks are always vulnerable to valuation convergence. This reflects
several generic problems — the semi-commoditised nature of their products,
limited economies of scale, weak brands and high gearing. The commoditisation
problem is exacerbated by the absence of product innovation, design and patenting,
which in other industries can provide important advantages. On branding, external
analysis shows that financial institutions, perhaps with the exception of investment
banks, have much weaker brand values than other industries. Europe’s leading bank
brand — HSBC — is worth just 5% of the group market capitalisation, compared
to an average of almost 30% in other industries. In addition to these generic factors,
in 2004 there were other specific drivers of convergence; these included
economic/market uncertainty, the revival of M&A — which upwardly revalued the
weaker, vulnerable banks and depressed valuations of stronger cash generative
banks — and the forthcoming introduction of IFRS.
Why convergence is wrong
Although many commentators like to think of banks as “all the same”, our research
shows the opposite. We have analysed the historical performance of the eight pairs
of banks across Europe that are typically viewed as essentially the same (BNP
Paribas vs. SocGen, Barclays vs. RBS, BBVA vs. Santander, etc). The results show
massive differences in operating performance. Furthermore, credit quality trends
also diverge much more than might be expected. Most importantly, the equity
market usually reflects this in divergent share prices. For example, the average
annual price performance difference between RBS and Barclays since 1990 is 21%
pa; between Santander and BBVA 16% pa; between Commerzbank and HVB 14%
pa; between UniCredito and Banca Intesa 23%. Over the past 15 years the average
annual performance difference between each pair is 15% but in 2004 it was just
6%, the smallest ever. We expect normal differentials to return in 2005.
4
Convergence…or divergence?
Investment Summary
Of course the argument demonstrating sector convergence is based on our earnings
estimates. It could simply be that the equity market is anticipating earnings
revisions, which — once incorporated — might see the sector’s valuations diverge.
Indeed, we start 2005 more worried about downside risk to estimates than upside
risk, given the uninspiring Q304 results season, the weakening economic outlook in
Europe and the growing risk that the next move in interest rates is down, not up. In
this report we have developed a model to stress test earnings estimates across the
sector. We have lowered revenues in each division and — where appropriate —
used each bank’s historical track record on cost control to simulate their likely cost
response. Predictably, Europe’s most vulnerable banks are German plus Credit
Suisse, while the high quality big caps banks — BBVA, HBOS, RBS, BNP Paribas
— all fare well.
In addition to this exercise, we have analysed the diversification of revenue
generation across each major European bank to gauge how vulnerable revenue
forecasts might be; on this measure, Europe’s three most diversified banks are
Standard Chartered, UBS and RBS.
Investment Themes for 2005

We identify three key investment themes across the European bank sector this year.
Firstly, in an equity market where valuations are highly converged, we believe
investors should continue their 2004 focus on the faster growing revenue plays.
Secondly, with our perception that there is on balance more downside than upside
risk to numbers, earnings resilience will be important. Thirdly, as in 2004, capital
returns will remain a useful support, although these are not a panacea.
Additionally, as in previous years, a few specific restructuring situations are likely
to present good investment opportunities. Finally, while M&A will likely continue
in the sector, we do not see it as an investable theme given the unpredictable and
often unattractive nature of combinations (eg the aborted San Paolo IMI/Dexia
merger). By country from a top down perspective we favour France, Greece,
Sweden and Austria. As banking systems we are cautious on Italy and Germany
but recognise that the Italians are heavily driven by economic sensitivities while
the Germans are dominated by restructuring plays. We are neutral on UK/Ireland,
Spain, Investment Banks and Benelux.
Banks Focus List – Fundamental Stocks

➤ Stocks to BUY: Bank Austria, BBVA, BNP Paribas, HBOS, NBG, RBS,
SocGen, Swedbank, UBS
➤ Stocks to AVOID: Alliance & Leicester, Barclays, Credit Suisse, Danske,
HSBC, HVB, Nordea, San Paolo IMI, Santander
Banks Focus List – Restructuring Stocks
➤ Restructuring stocks to BUY: ABN AMRO, Commerzbank, Deutsche Bank
➤ Restructuring stocks to AVOID: Credit Suisse, HVB, Santander
5
Not all the same

➤ We believe that three key themes are set to drive the sector’s
performance in 2005 — growth, earnings and capital return
➤ In addition, two other themes may play a role in the sector in 2005 —
restructuring and M&A — although in each case these are likely to be
limited to a few stock specific situations
➤ With the sector’s valuation heavily converged, growth at many banks
is currently available at an attractive price
➤ We believe earnings risks are on balance to the downside, with
European economic growth deteriorating and the direction of the
next ECB interest rate move not clear. We screen the sector for
earnings resilience in this environment
➤ In 2004 banks returning capital were modestly rewarded by the
market, and we expect more of the same in 2005
➤ After considering growth prospects, earnings resilience, capital
generation and valuation, our key overweight banking countries for
2005 are France, Greece, Sweden and Austria. Our key underweight
areas are Italy and Germany, although restructuring may provide
stock specific support for each.
2004 was the second consecutive year in which equity analysts could have stayed at
home. In 2003 it was the fund managers who drove the sector, with their instinctive
investment in the lower quality recovery plays leaving the fundamental analysts —
typically focused on the high quality names — floundering. 2004 was a year in
which both fund manager and analyst alike struggled to generate significant
performance. Over the entire year the sector travelled sideways with modest
outperformance in the second half of the year following underperformance in the
first half (Figure 1). More importantly the performance difference between the best
and worst banks was the narrowest since 1994 (Figure 2), with a 30% performance
gap in 2004 compared to a period average of 66%.
Figure 1. European Banks Sector Performance in 2004
101
100
European bank sector relative to European equity marke
99
98
97
96
95
94
93
92
91
90
1-Jul
8-Apr
1-Jan
15-Jan
29-Jan
12-Feb
26-Feb
3-Jun
17-Jun
12-Aug
26-Aug
9-Sep
15-Jul
29-Jul
11-Mar
25-Mar
22-Apr
7-Oct
6-May
20-May
23-Sep
4-Nov
2-Dec
21-Oct
18-Nov
Source: DataStream and Smith Barney
6
Figure 2. European Banks Best and Worst Relative Performers, 1990 – 2004
110%
100% Top 15 Banks
90%
Performance relative to European Equity Markets

Bottom 15 Banks
80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Source: DataStream and Smith Barney
Added to this directionless trading, valuations have converged, with many different
banks trading on similar multiples. Investors appear to instinctively recognise this
situation as wrong, but are unsure about the “catalyst”.
The purpose of this report is to address four related issues. These are:
➤ How much has the sector’s valuation converged?
➤ Why has it happened?
➤ Does it make sense?
➤ Is this convergence real, or is the market simply taking positions on likely
earnings revisions?
Subsequent chapters in this report follow this structure, while the remainder of this
first chapter presents our key investment themes and ideas for 2005.
Key Investment Themes and Recommendations for 2005

Our investment thesis on the European bank sector essentially focuses on bringing
together several major themes:
➤ Firstly, in an equity market where valuations are highly converged we believe
investors should continue their 2004 focus on faster growing banks
➤ Secondly, as we enter 2005 we believe that on balance there is more downside
risk than upside risks to earnings estimates across the sector. As a result, we
believe it is important to consider the earnings resilience of each bank
➤ Thirdly, capital return will remain important within the sector and those banks
that are structurally generating surplus capital and doing sensible things with it
should be rewarded
➤ In addition, two other themes may play a role in the sector in 2005 —
restructuring and M&A — although in each case these are likely to be limited
to a few stock specific situations
7
Theme 1 — Growth Matters

The remainder of this report focuses on the valuation convergence that has developed
across the sector over the past few years and argues that this represents a unique
investment opportunity. The great thing about convergence, of course, is that it
means that banks with superior growth prospects are often available at similar ratings
to banks that have weaker prospects. In conjunction with this report, we have also
published an accompanying report looking at the prospects for medium term revenue
growth across the European bank sector1. This focuses purely on the “top down”
perspective, estimating medium term revenue growth from the interplay of economic
growth and banking system penetration. Figure 3 shows our “top down” and our
“bottom up” revenue growth expectations by country. In most cases we are more
optimistic bottom up than top down (CEE being an exception), although in overall
ranking terms our bottom up forecasts are in line with our top down expectations.
Figure 3. Revenue Growth — Top Down vs Bottom Up
12%
11% Top down
10% Bottom up
9%
Medium Term Revenue Growth
8%
7%
6%
5%
4%
3%
2%
1%
0%
Poland
Sweden
Austria
France
Switzerland
Denmark
Netherlands
Turkey
Hungary
Greece
Germany
Spain
Ireland
UK
Norway
Italy
Czech Republic
Note that in each country the ‘bottom up’ is calculated for the domestic banks only.
Source: Smith Barney
Focusing on revenue growth in isolation — and for the moment ignoring issues such
as earnings resilience and valuation — the countries that look attractive on growth
grounds include CEE, Greece and — perhaps more surprisingly — some Nordics
(Sweden, Norway). By contrast, Germany and Netherlands look unattractive.
However, as we discuss in the accompanying report, because of the diversification of
many banks away from their “home” market it is more important to analyse growth
on a bank-by-bank basis rather than on a country aggregate basis (see later).
1
See ‘The View from the Top – Medium Term Growth Prospects for European Banking’, Smith Barney, 5th January 2005.
8
Theme 2 – Earnings resilience

At the start of 2005 we are on balance more concerned about downside risk than
upside risk to numbers. This is being driven by two factors. Firstly, the numbers
reported by the banks themselves are generally seeing some pressure on operating
profit, which in many cases has been offset by lower than expected bad debts. That
clearly raises sustainability issues. The most recent results season showed the lowest
proportion of “good” results (as described by our analysts) since the first quarter of
2002.
Figure 4. European Banks Results Season, Q4 2001 – Q3 2004
100%
90%
80%
70%
As % of banks reporting
60%
50%
"Bad"
40% "Average"
"Good"
30%
20%
10%
0%
Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
2001 2002 2002 2002 2002 2003 2003 2003 2003 2004 2004 2004
Source: Smith Barney analysis
Secondly, the macroeconomic and interest rate environment is currently getting more
hostile. In part due to the strength of the Euro against the US Dollar, economic
growth forecasts are being cut across Europe. This, in turn, is at best delaying an
ECB interest rate rise and, if the current deterioration continues, may see sentiment
turn towards lower rates. This would be unhelpful for many of Europe’s retail banks,
most obviously in Italy. At the same time, financial markets are uncertain; by
definition they always are, but after a range bound trading year in 2004 conviction
levels on the market direction are lower than ever. The final chapter in this report
analyses the results of a model simulation we have carried out on the European bank
sector, where we lower revenue forecasts for different business lines and we
anticipate different degrees of cost response by bank, reflecting their historical track
record on cost management. Figure 5 shows that the most vulnerable earnings across
Europe are among the German, Swiss and Italian banks, while the least vulnerable
are in Spain and the Nordic region.
9
Figure 5. Simulated Net Profit Impact — Using Historical "Jaws" Record

0%
Modelled Net Profit Reduction (on 2005 forecasts)

-2%
-4%
-6%
-8%
-10%
-12%
-14%
-16%
-18%
-20%
-22%
All European Banks

Switzerland
Benelux
Italy
Ireland
Spain
Austria
France
Germany
Greece
Nordics
UK
Source: Smith Barney estimates & analysis
Of course, those banks that have the lowest level of earnings resilience are equally
the same group of banks that stand to benefit most if the revenue environment proves
much better than we currently expect. However, as noted earlier we believe the risk
to numbers is more on the downside than the upside, absent a major market rally.
Theme 3 – Capital Returns

One of the wider equity market themes that our strategy team have been highlighting
over then past six months has been that of “de-equitisation”, which among other
things focuses on the potential reward equity investors are prepared to pay for
companies that are returning capital to shareholders2. At the start of last year we
estimated the European bank sector would generate €84bn of surplus capital over the
next few years, but we recognised then that the interpretation of whether this was
good or bad depended on the individual banks and their likely deployment of that
capital3. Figure 6 shows that, for this year, we project the largest capital generation
(that is ordinary dividend yield plus surplus capital, after funding balance sheet
growth) will come from France/Benelux, and the lowest in Austria/Germany.
2
See ‘De-Equitisation - Honey I Shrunk the Market’, Smith Barney, 8th October 2004.
3
See ‘The Capital Deluge – Which banks in Europe are set to generate Surplus Capital and what we think they’ll do with it’, Smith
Barney, January 2004.
10
Figure 6. Capital Return by Banking Sector, 2005E

8.5%
8.0% Surplus capital generation, after balance
sheet growth and dividend payments
7.5%
7.0% Dividend yield
6.5%
As % market capitalistion
6.0%
5.5%
5.0%
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
Benelux France UK Switzerland Nordics Italy All Spain Greece Ireland Austria Germany
European
Banks
1
Only banks where there was a change in the share count during 2004 have been included in the chart
In 2004 half of the banks in our sector saw a net change in their share count as a
result of share buy backs, rights issues or employee stock awards4. Nine increased
their share capital by more than 1%, “led” by three banks that had rights issues in the
year (HVB, BNL and Sabadell). By contrast 12 banks reduced their share count more
than 1%, with Deutsche (-11%), Nordea (-8%) and Danske/UBS (-5%) enjoying the
largest reductions. As shown in Figure 7, there was a modest correlation between
those banks undertaking net share buy backs and stronger share price performance,
while unsurprisingly the two big rights issue banks (HVB and BNL)
underperformed. However, the relative weakness of the correlation highlights once
again that share buy backs in isolation are no panacea to stronger share price
performance.
1
Figure 7. Share Buy Backs/Rights Issues vs Price Performance, 2004
35%
EFG Eurobank
30%
25%
Share price relative peformance, 2004
20%
Nordea (FDR)
15% Danske Bank
SEB
Swedbank (FSB) Dexia
10% Alpha Bank Allied Irish Banks
SHB
5% UBS Barclays BBVA
Banco Sabadell
0% BNP Paribas HBOS
Northern Rock
Credit Suisse HSBC BNL
-5% RBS
ABN Amro
All. & Leicester Sanpaolo IMI
-10% Deutsche Bank
HVB Group
-15%
-20%
Julius Baer
-25%
-30%
-15% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45%
Net change in shares in issue during 2004
1
Only banks where there was a change in the share count during 2004 have been included in the chart
Source: Company information, DataStream and Smith Barney analysis
4
Note while this covers all ‘normal’ drivers of changes in share count, in 2004 Deutsche Bank also saw a reduction as a result of
changes in accounting for employee stock option awards.
11
Theme 4 – Restructuring
In 2004 so called “restructuring stories” provided some of the best individual stock
performances across the European bank sector. These came in two forms; firstly deal
related restructuring, of which Credit Agricole and DnB NOR were perhaps the two
best examples; secondly, internal restructuring undertaken by (among others)
Nordea, Commerzbank and Deutsche Bank. At the end of the year Credit Suisse
announced the potential spin off of Winterthur along with plans to rebuild CSFB.
The idea of restructuring in nothing new in the European bank sector and each year a
small number of banks perform strongly, driven by this theme. In 2003 it was Banca
Intesa (+40% relative); in 2002 it was Credit Lyonnais (+107% relative); in 2001 it
was HBOS (+52% relative); and in 2000 it was RBS (+65% relative). By definition,
however, restructuring only impacts a small number of European banks in any single
year. Furthermore, it is risky as an investment theme, not least because internal
restructuring is typically a response to things having gone wrong and the
presumption — sometimes right, often wrong — is that things will improve.
What might be the restructuring stocks for 2005? For this exercise we have
considered banks with business models that aren’t working, or banks where we are
expecting progress from already announced integrations. We have identified six
potential contenders. Of these three are German. This is hardly a surprise given the
combination in Germany of meagre profitability levels and possible changes in the
industry structure. Among the other potential banks in this category, we include
Credit Suisse, which at the end of 2004 announced major changes in its corporate
structure. For 2005 the highest profile M&A integration — absent as yet
unannounced deals — will be Santander/Abbey National, and the performance in
2004 of Credit Agricole and DnB NOR might encourage investors into Santander.
Finally, we include ABN AMRO on this potential list, recognising the (admittedly)
lower key corporate changes and substantial amount of surplus capital it has now
accumulated. Given that the very nature of these potential restructuring plays is
trying to anticipate some form of “surprise” — be it earnings or capital usage —
Figure 8 shows some of the key operational sensitivities for each of these potential
restructuring stocks. Figure 9 shows the long-term valuations for this group of banks.
As noted, because of the often inherent volatility in these restructuring stocks,
earnings estimates can change meaningfully.
Figure 8. Potential 2005 Restructuring Stocks — Operational Metrics
Current 2005 forecast Surplus Capital ROE
Profit impact of
Revenue Cost Operating Cost/Inc 3% reduction in Earnings
1
Growth Growth Profit Growth Ratio Cost inc ratio As % mkt cap Resilience 2005 2008 Change
HVB Group 4.7% 3.5% 13.0% 66.5% 32.9% €367m 2.8% -33% 5.1% 9.0% 3.9%
Commerzbank 1.9% 2.5% 5.0% 70.9% 16.6% €775m 8.5% -29% 7.0% 7.7% 0.7%
Deutsche Bank -2.4% -2.6% -1.9% 76.0% 14.0% €630m 2.0% -19% 14.8% 15.9% 1.0%
ABN Amro -7.7% -2.0% -18.1% 68.7% 8.6% €4934m 16.2% -10% 19.0% 18.3% -0.8%
Santander 4.0% 0.4% 9.2% 53.4% 9.9% -€2471m -4.4% -6% 16.1% 18.3% 2.2%
Credit Suisse -3.9% -0.6% -13.1% 76.3% 11.6% SFr2865m 5.0% -30% 16.4% 15.7% -0.6%
1
Earnings resilience shows the modelled reduction in net profit in response to revenue compression and adjusting for each bank's cost management track record (see detailed discussion
later in this report)
Source: Smith Barney estimates
12
Figure 9. Potential 2005 Restructuring Stocks — Valuation Metrics (December 2004)

Price to GOP — reported GOP less
1 2
Underlying P/E Relative to Sector tax, minority interests, preference shares Tangible Price to Book
2005 2006 2007 2008 2005 2006 2007 2008 2005 2006 2007 2008
HVB Group 184% 152% 128% 124% 104% 97% 86% 87% 1.0x 1.0x 1.0x 0.9x
Commerzbank 114% 102% 107% 111% 90% 88% 96% 101% 0.9x 0.9x 0.8x 0.8x
Deutsche Bank 115% 112% 106% 105% 111% 109% 103% 102% 1.9x 1.7x 1.5x 1.4x
ABN Amro 87% 87% 86% 87% 88% 89% 88% 89% 1.7x 1.5x 1.4x 1.3x
Santander 98% 94% 90% 88% 100% 99% 96% 94% 1.7x 1.6x 1.5x 1.4x
Credit Suisse 109% 105% 103% 107% 112% 109% 108% 111% 1.8x 1.6x 1.5x 1.4x
1
Cash Basis
2
Relative to sector
Source: Smith Barney estimates.
So which ones do we back? Of these six potential restructuring banks, our preferred
restructuring stocks for 2005 are Deutsche, Commerzbank and ABN AMRO. By
contrast, we would be cautious on HVB, Credit Suisse and Santander.
Restructuring Stocks to buy in 2005

➤ While the equity market had been expecting major cost cutting in Deutsche’s
Investment Banking and Asset Management division, the group surprised the
market in December 2004 with plans to reduce support function headcount in its
domestic business. Clearly the group has massive operational gearing to a lower
cost income ratio (see Figure 8). We are encouraged by this new cost
aggressiveness.
➤ The scaling back of Commerzbank’s global investment banking ambitions in
late 2004 was a welcome sign of a new realism within the group, and as shown
in Figure 8 its operational gearing is massive. Unlike HVB, we see genuine signs
of an organisation taking restructuring seriously. Given the group’s very poor
track record this is perhaps the most controversial restructuring play, but equally
the valuation is a support.
➤ 2004 was another year of drift (in share price terms) for ABN AMRO which we
believe masked a group that is moving towards a more shareholder orientated
structure. Non-core businesses have been disposed of (leasing, Bank of Asia
stake etc), an unpopular takeover protection embedded in its preference shares
has been removed and, for the first time, the group has neutralised its scrip
dividend alternative with a share buy back. We believe ABN AMRO is
meaningfully overcapitalised (we estimate surplus capital represents 16% of the
market capitalisation, see Figure 8) and the valuation is cheap. Several
businesses are improving and 2005 could be its year.
Restructuring Stocks to avoid in 2005

➤ HVB clearly has the largest operational gearing of this group of banks, reflecting
its current paltry levels of profitability. For 2005 we are already forecasting rapid
operating profit growth, and a 3% improvement in its cost income ratio would
raise earnings by one third. However, we have limited faith in the ability of the
management to extract this type of improved return, and we remain sceptical
over both the logic and the financial benefits of the NPL disposal programme.
Finally, HVB continues to look expensive over the longer term in terms of
earnings (see Figure 9).
13
➤ At the end of 2004 Credit Suisse announced a wide-ranging overhaul of its

business, including deeper integration of its investment bank and the possible
flotation of Winterthur, driving a potential share buyback. We are concerned
over the group’s ability to accelerate revenue growth in a highly competitive
industry while we view a share buyback as somewhat distant at this stage,
despite the current surplus capital position (see Figure 8). The valuation is only
compelling if execution is successful, which is not our central case.
➤ The news flow at Santander in 2005 is likely to be dominated by progress with
the integration of Abbey National. While cost synergies are likely to be achieved
in 2005, we are sceptical over revenue stability at Abbey National. We believe
the Abbey National franchise is even weaker than generally understood, and at
the same time revenue pressures are growing in the UK.
Theme 5 – M&A?
Cross border consolidation became a reality in the European bank sector in 2004
with Santander’s acquisition of Abbey National, and the obvious question is whether
2005 will see further developments. Surplus capital and limited revenue growth is
placing financial pressure on banks to do deals, and Basel II will — we believe —
add a cross border capital synergy. However, we believe that while M&A is likely to
continue to feature in the sector, it is very difficult to invest in as a theme. Consider:
➤ While it is stating the obvious, whether M&A actually happens is not possible to
forecast in any reliable way. All any analyst can do is consider the ingredients
that might drive M&A (eg industry growth, capital generation, regulatory issues
etc.) but that does not mean that M&A will actually take place, which makes any
investment in this theme problematic
➤ Specifically, the biggest single factor in assessing the chances of M&A taking place
is the attitude of the senior management. This is not something that can be neatly
modelled in a spreadsheet. We do not believe Santander acquired Abbey National
because it was the best bank in Europe — it was simply the most available
➤ Even if we were able to reliably predict who will be involved in M&A — both as
a buyer and as a seller — it is by no means certain that any resulting deals would
be a “good thing” from a share price perspective. Particularly with cross border
deals, there is a very wide spectrum between value creation and value
destruction. We would argue that the aborted Dexia/San Paolo IMI combination
— rather like the aborted Unicredito/Commerzbank merger before it — would
have been good examples of value destruction.
➤ Furthermore, even a simple strategy of investing in the shares of the potential
targets will typically migrate towards the poor quality, weak banks, with the
associated risk that they simply stay poor and weak, but also remain independent.
We would argue that the two highest profile transactions in 2004 illustrate these points.
No analytical modelling would have predicted at the start of last year that Santander
would have acquired Abbey National. Equally, how many investors expected Dexia to
try and merge with San Paolo IMI? Furthermore, in its final year as an independent
company, Abbey National underperformed the market, even after the Santander bid. So,
while we acknowledge that M&A is likely to feature in 2005 — as it does in most years
— we are not making it part of our investment decision-making process.
14
Investing in these Themes — by Country and by Bank

Bringing all of this together, Figure 10 shows revenue growth, capital generation (in
excess of dividend payments), earnings resilience and valuation for the countries in
our European bank sector coverage.
Figure 10. Growth, Capital Generation, Earnings Resilience and Valuation by Country
— Trends in words —
Top down Bottom up Surplus Capital Earnings Surplus Capital Earnings

2 3 4
Revenue growth
revenue revenue Generation Resilience PE PE relative Generation Resilience
1
Forecasts CAGR, 2005/6 2005 2005 2005 to sector Top down Bottom up 2005 2005 Valuation
Austria 5.0% 5.0% 1.9% -10.5% 13.2x 122% Average Average Average Average Premium
Benelux 1.9% -1.5% 2.5% -10.2% 9.4x 88% Poor Poor Good Average Discount
France 4.7% 4.6% 2.6% -10.2% 9.6x 89% Average Average Good Average Discount
Germany 3.4% 3.6% 1.3% -20.5% 13.0x 119% Poor Poor Poor Poor Premium
Greece 9.5% 12.1% 1.6% -8.5% 13.6x 125% Good Good Average Good Premium
Ireland 5.2% 6.4% 0.0% -7.8% 10.7x 98% Good Good Poor Good In line
Italy 4.9% 5.7% 1.4% -11.4% 10.8x 99% Average Good Poor Average In line
Nordics n/a 4.1% 2.3% -7.1% 11.0x 101% n/a Average Good Good In line
Spain 5.4% 5.5% 1.7% -5.8% 11.2x 103% Good Average Average Good In line
Switzerland 3.5% 3.2% 3.3% -20.9% 11.7x 106% Poor Poor Good Poor In line
UK 4.6% 6.8% 1.7% -8.3% 10.5x 97% Average Good Average Average In line
All Europe 4.7% 5.0% 1.9% -10.2% 10.9x 100%

1 th
See ‘The View from the Top – Medium Term Growth Prospects for European Banking’, Smith Barney, 5 January 2005 for detailed calculations on this top down revenue growth estimate
2
Calculated as net profit less capital required to fund RWA growth (at Target Tier 1 ratio) less ordinary dividend payments, as % market capitalisation
3
4
Cash basis
Source: Smith Barney estimates.
Using this matrix approach we would make the following observations:

➤ Of the major countries, France looks the most attractive and Germany looks the
least attractive. In France, we see average revenue growth, capital generation and
earnings resilience, yet the sector trades on a notable discount to the European
sector. In Germany every performance metric is poor. However, as noted above,
Germany is also dominated by restructuring stocks.
➤ Spain looks relatively more attractive than Italy, with top down revenue growth
high, very resilient earnings and an in line valuation. By contrast, Italian banks
— while generating stronger revenue growth — have almost double the earnings
risk, which might become important if the ECB actually cuts interest rates in
2005
➤ The UK looks average on most metrics
➤ Of the smaller countries Greece offers good growth, resilient earnings but at a
price. Ireland looks attractive with good revenue growth (both top down and
bottom up) and strong earnings resilience, although it is not a banking system
generating much surplus capital
➤ Selectively the Nordics look attractive with Sweden in particular offering solid
growth, earnings resilience and an undemanding rating
➤ Interestingly, the investment case in the Swiss investment banks appears more
focussed on capital generation, with revenue growth forecast at below the sector
average (due to declining fixed income revenues) and earnings resilience much
lower than elsewhere in Europe
15
Figure 11 shows this same analysis by individual bank. We have segmented it into
those banks growing revenues faster than the sector, those growing in line with the
sector and those growing more slowly than the sector.
Figure 11. Growth, Capital Generation, Earnings Resilience and Valuation by Bank
Trends in Words
Surplus Capital Earnings Surplus Capital Earnings

1 2 3
Revenue Growth Generation Resilience PE PE relative Revenue Growth Generation Resilience
CAGR, 2004-06 2005 2005 2005 to sector CAGR, 2004-06 2005 2005 Valuation
EFG Eurobank 15.6% 1.0% -10.5% 14.1x 129% Good Average Poor Premium
Alpha Bank 10.9% 1.7% -7.0% 11.3x 104% Good Average Average In line
NBG 10.3% 2.2% -8.1% 14.3x 131% Good Good Average Premium
DePfa Bank 9.4% 4.9% -11.4% 10.4x 96% Good Good Poor Discount
Standard C 8.9% 2.0% -7.5% 12.8x 117% Good Average Average Premium
Bankinter 8.5% -7.4% -5.7% 17.9x 164% Good Poor Good Premium
Northern Rock 8.3% 0.5% -4.5% 9.5x 87% Good Poor Good Discount
HBOS 8.1% 1.9% -5.9% 8.7x 80% Good Average Good Discount
Julius Baer 7.8% 1.3% -20.1% 14.2x 130% Good Average Poor Premium
RBS 7.5% 4.0% -7.2% 8.7x 80% Good Good Average Discount
Allied Irish Banks 7.5% -0.2% -7.7% 11.5x 105% Good Poor Average In line
Banco Sabadell 7.5% 0.1% -6.2% 14.3x 131% Good Poor Good Premium
Banco Popular 7.4% -0.6% -5.1% 13.0x 119% Good Poor Good Premium
Barclays 7.3% 2.3% -11.1% 9.8x 90% Good Good Poor In line
Banesto 7.1% -1.6% -5.1% 13.5x 124% Good Poor Good Premium
Unicredito 7.0% 1.2% -9.7% 10.6x 97% Good Average Average In line
BP Verona Novara 6.7% 0.6% -7.2% 10.5x 96% Average Poor Average In line
Deutsche Postbank 6.4% -0.3% -8.1% 14.4x 132% Average Poor Average Premium
HSBC 6.3% 0.9% -8.9% 13.2x 121% Average Poor Average Premium
SHB 6.0% 2.3% -6.5% 11.2x 103% Average Good Good In line
Bank Austria 6.0% 2.9% -11.6% 12.0x 110% Average Good Poor In line
Sanpaolo IMI 5.9% 1.2% -15.0% 12.1x 111% Average Average Poor Premium
SEB 5.4% 2.9% -7.1% 11.5x 105% Average Good Average In line
Bank of Ireland 5.4% 0.3% -7.9% 10.0x 92% Average Poor Average In line
HVB Group 5.3% -2.7% -32.6% 19.5x 178% Average Poor Poor Premium
Banca Intesa 5.1% 2.0% -10.7% 10.6x 97% Average Average Poor In line
Santander 4.8% 2.0% -6.1% 10.7x 98% Average Average Good In line
Nordea (FDR) 4.8% 1.8% -8.9% 11.1x 102% Average Average Average In line
UBS 4.6% 3.5% -15.9% 11.6x 106% Average Good Poor In line
Monte dei Paschi 4.5% 1.4% -12.9% 10.6x 98% Average Average Poor In line
SocGen 4.3% 3.9% -13.7% 10.0x 92% Average Good Poor In line
Danske Bank 4.1% 1.9% -6.9% 11.5x 106% Average Average Good In line
Erste Bank 4.1% 0.9% -9.1% 14.8x 136% Average Poor Average Premium
Lloyds TSB 4.0% -0.7% -9.5% 10.0x 91% Average Poor Average In line
Commerzbank 3.8% -0.2% -29.0% 12.3x 113% Poor Poor Poor Premium
B&B 3.8% -1.8% -6.6% 9.2x 85% Poor Poor Good Discount
All. & Leicester 3.7% 1.4% -7.1% 9.6x 88% Poor Average Average Discount
BNL 3.6% 0.5% -14.8% 14.7x 135% Poor Poor Poor Premium
BBVA 3.3% 3.2% -5.7% 10.9x 100% Poor Good Good In line
DnB NOR 3.0% 2.1% -7.8% 9.9x 91% Poor Good Average In line
BNP Paribas 2.8% 4.5% -7.7% 9.6x 88% Poor Good Average Discount
Swedbank (FSB) 2.3% 3.4% -7.1% 10.5x 96% Poor Good Average In line
Deutsche Bank 1.8% 3.0% -29.5% 12.5x 114% Poor Good Poor Premium
Credit Suisse 1.4% 3.1% -29.6% 11.3x 103% Poor Good Poor In line
ABN Amro -1.5% 2.5% -10.2% 9.6x 88% Poor Good Poor Discount
th
See ‘The View from the Top – Medium Term Growth Prospects for European Banking ’, Smith Barney, 5 January 2005 for detailed calculations on this top down revenue growth estimate
1
Calculated as net profit less capital required to fund RWA growth (at Target Tier 1 ratio) less ordinary dividend payments, as % market capitalisation
2
3
Cash basis
16
Recommendations for 2005

Bringing together both the results of this framework, plus our own stock views,
Figure 12 presents our key country weightings for 2005:
Figure 12. Top Down Country Weightings for 2005
Overweight Countries Neutral Counties Underweight Countries
Austria Benelux Germany

France UK Italy
Greece Ireland Denmark
Sweden Investment Banks
Spain
Our country weightings very much follow the analysis shown in Figure 10. Note,
however, that while from a country perspective we are negative on Germany, as
discussed earlier it will be dominated in 2005 by restructuring stories. The only
banking country that we have not included as an overweight despite scoring well in
Figure 10 is Ireland, where, although we are currently forecasting good revenue
growth, we remain concerned that Eurozone interests may actually be cut this year,
which would challenge our margin assumptions in Ireland.
Figure 13 shows our key fundamental stock recommendations for 2005
Figure 13. Key Fundamental Stock Recommendations for 2005
Key Stocks to Buy Key Stocks to Avoid
Bank Key Driver(s) Valuation Bank Key Driver(s) Valuation
Bank Austria Revenue growth In line Alliance & Leicester Weak revenues Discount
BBVA Capital generation, defensive earnings In line Barclays Earnings vulnerability In line
BNP Paribas Capital generation, defensive earnings Discount Credit Suisse Weak revenues, vulnerable earnings In line
HBOS Revenue growth, capital generation Discount Danske Least preferred of Nordics, weaker revenues In line
NBG Revenue growth Premium HSBC Valuation Premium
RBS Revenue growth, capital generation Discount HVB Earnings vulnerability Premium
SocGen Capital generation, valuation Modest discount Nordea Least preferred of Nordics, weaker revenues In line
Swedbank Capital generation, defensive earnings Modest discount San Paolo IMI Earnings vulnerability, esp if ECB cuts rates Premium
UBS Capital generation, relative earnings resilience In line Santander Integration concerns In line
In addition to our fundamental stock focus list, we show in Figure 14 our stocks to
buy and stocks to avoid among the potential restructuring stocks as discussed earlier.
Figure 14. Restructuring Stock Recommendations for 2005
Restructuring Stocks to Buy Restructuring Stocks to Avoid
Bank Comment Bank Comment
ABN Amro Surplus capital/portfolio disposals/valuation Credit Suisse Aspirational revenue targets/uncertain buy backs
Deutsche Bank Aggressive cost cutting HVB Questionable strategy/valuation
Commerzbank Business reshaping/valuation Santander Risk of Abbey National disappointment
17
Then and Now

➤ The European bank sector is more converged now than it has been
for many years
➤ On our 2005 forecasts, we estimate half the sector trades on a P/E of

between 9-11x, compared with just less than a quarter of the sector
in 2000
➤ This increase in convergence is also apparent in price to book

multiples
➤ And it is especially true among the big cap banks; currently two
thirds of the big caps trade on 9-11x 2005E earnings, compared with
less than 15% in 2000
The European bank sector currently trades on a forward P/E (2005E) of 11x. That is
85% of the market P/E, which in an historical context is modestly expensive.
However, a widely observed feature of the sector’s valuation is the narrowness of
valuation differences between banks. Figures 15 to 20 show that currently 55% of the
sector is valued on a P/E multiple between 9-11x. This current level of concentration
is high. At the most divergent period – 2000 – not much more than one seventh of
the sector was in any single P/E “band”. 2002 saw the maximum convergence, there
was some modest divergence in 2003, but 2004 has again seen the sector’s valuations
converge.
Figure 15. P/E Dispersion — December 1999 Figure 16. P/E Dispersion — December 2000
35% 35%
30% 30%
Percentage of European bank sector
25% 25%
20% 20%
15% 15%
10% 10%
5% 5%
0% 0%
Under 7x 7-8x 8-9x 9-10x 10-11x 11-12x 12-13x 13-14x 14-15x 15-16x 16-17x Over 18x Under 7x 7-8x 8-9x 9-10x 10-11x 11-12x 12-13x 13-14x 14-15x 15-16x 16-17x Over 18x
2000 Underlying PE 2001 Underlying PE
35% 35%
30% 30%
25% 25%
20% 20%
15% 15%
10% 10%
5% 5%
0% 0%
18
35% 35%
30% 30%

25% 25%
20% 20%
15% 15%
10% 10%
5% 5%
0% 0%
Source for all charts: Company information, DataStream and Smith Barney estimates
The other popular measure of valuation in the European bank sector — price to book
— also shows a similar pattern, with a current large proportion of the sector trading
between 1.2 to 1.6 times tangible book. Again, convergence was lowest in 2000,
highest in 2002 and in 2004 has increased again.
Figure 21. Price to Book Multiple Dispersion — December 1999 Figure 22. Price to Book Multiple Dispersion — December 2000
30% 30%
28% 28%
26% 26%
24% 24%
22% 22%
20% 20%
18% 18%
16% 16%
14% 14%
12% 12%
10% 10%
8% 8%
6% 6%
4% 4%
2% 2%
0% 0%
Over 4x
0.4-0.6x
0.6-0.8x
0.8-1.0x
1.0-1.2x
1.2-1.4x
1.4-1.6x
1.6-1.8x
1.8-2x
2-2.2x
2.2-2.4x
2.4-2.6x
2.6-2.8x
2.8-3x
3-3.2x
3.2-3.4x
3.4-3.6x
3.6-3.8x
3.8-4x
0.4-0.6x
0.6-0.8x
0.8-1.0x
1.0-1.2x
1.2-1.4x
1.4-1.6x
1.6-1.8x
1.8-2x
2-2.2x
2.2-2.4x
2.4-2.6x
2.6-2.8x
2.8-3x
3-3.2x
3.2-3.4x
3.4-3.6x
3.6-3.8x
3.8-4x
Over 4x
Price to Book, 1999 Price to Book, 2000
30% 30%
28% 28%
26% 26%
24% 24%
22% 22%
20% 20%
18% 18%
16% 16%
14% 14%
12% 12%
10% 10%
8% 8%
6% 6%
4% 4%
2% 2%
0% 0%
Over 4x
Over 4x
1.8-2x
2-2.2x
2.8-3x
3-3.2x
3.8-4x
1.8-2x
2-2.2x
2.8-3x
3-3.2x
3.8-4x
0.4-0.6x
0.6-0.8x
0.8-1.0x
1.0-1.2x
1.2-1.4x
1.4-1.6x
1.6-1.8x
2.2-2.4x
2.4-2.6x
2.6-2.8x
3.2-3.4x
3.4-3.6x
3.6-3.8x
0.4-0.6x
0.6-0.8x
0.8-1.0x
1.0-1.2x
1.2-1.4x
1.4-1.6x
1.6-1.8x
2.2-2.4x
2.4-2.6x
2.6-2.8x
3.2-3.4x
3.4-3.6x
3.6-3.8x
30% 30%
28% 28%
26% 26%
24% 24%
22% 22%
20% 20%
18% 18%
16% 16%
14% 14%
12% 12%
10% 10%
8% 8%
6% 6%
4% 4%
2% 2%
0% 0%
Over 4x
0.4-0.6x
0.6-0.8x
0.8-1.0x
1.0-1.2x
1.2-1.4x
1.4-1.6x
1.6-1.8x
1.8-2x
2-2.2x
2.2-2.4x
2.4-2.6x
2.6-2.8x
2.8-3x
3-3.2x
3.2-3.4x
3.4-3.6x
3.6-3.8x
3.8-4x
0.4-0.6x
0.6-0.8x
0.8-1.0x
1.0-1.2x
1.2-1.4x
1.4-1.6x
1.6-1.8x
1.8-2x
2-2.2x
2.2-2.4x
2.4-2.6x
2.6-2.8x
2.8-3x
3-3.2x
3.2-3.4x
3.4-3.6x
3.6-3.8x
3.8-4x
Over 4x
Source for all charts: Company information, DataStream and Smith Barney estimates
19
This convergence trends is even more pronounced when focusing on the largest 20
banks in Europe. Figures 27 and 28 show both forward P/E and price to book
dispersion in 2000 and currently. At the moment, 14 of the top 20 banks in Europe
trade on between 9-11x earnings and over half trade between 1.2x – 1.4x book. Back
in 2000, there was nothing like this degree of valuation concentration.
Figure 27. PE Dispersion Top 20 Banks — 2000 and 2004 Figure 28. P/B Dispersion Top 20 Banks — 2000 and 2004
35% 35%
2004 2004
30% 30%
2000 2000
Percentage of Top 20 European bank sector

25% 25%
20% 20%
15% 15%
10% 10%
5% 5%
0% 0%
0.4-0.6x
0.6-0.8x
0.8-1.0x
1.0-1.2x
1.2-1.4x
1.4-1.6x
1.6-1.8x
1.8-2x
2-2.2x
2.2-2.4x
2.4-2.6x
2.6-2.8x
2.8-3x
3-3.2x
3.2-3.4x
3.4-3.6x
3.6-3.8x
3.8-4x
Over 4x
Under 7x 7-8x 8-9x 9-10x 10-11x 11-12x 12-13x 13-14x 14-15x 15-16x 16-17x Over 18x
Underlying PE (2001 and 2005 respectively)
Price to Book, (2000 and 2004 respectively)
Source for both charts: Company information, DataStream and Smith Barney estimates
Before considering why this convergence has happened in the bank sector, there is
one final comment to make. The convergence that has developed within the
European bank sector is part of a wider convergence trend across the entire European
equity market. Figure 29 shows the P/E dispersion across European sectors over the
past 15 years. It is clear that the wider equity market has also seen a dramatic
reduction in the dispersion of valuation over the period.
Figure 29. Valuation Dispersion Across the European Equity Market, 1989 - 2004
20
18
Standard Deviation of European Equity Market
16
14
12
10
0
Dec-89
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
The next section of this report considers the reasons why this convergence has
happened.
20
Why have European bank valuations

converged?
➤ Banks are always vulnerable to valuation convergence, given the
semi-commoditised nature of their products and — as we show —
their typically weak brand values
➤ In addition, massive leverage leaves investors wary of differentiating

on valuation; we estimate that across the sector balance sheet
assets are 171x net profit, leaving earnings highly vulnerable to
changes in balance sheet values
➤ Furthermore, there are some 2004/5 specific drivers of convergence;

these include economic/market uncertainty, the revival of M&A —
which upwardly revalues the weak banks, and places downward
pressure on the strong banks — and the impending introduction of
IFRS
Generic Drivers of Convergence

The banking sector is, we believe, potentially always vulnerable to valuation
convergence. It is driven by a variety of factors. Specifically, we would cite four
major influences that typically encourage convergence — commoditisation, limited
economies of scale, weak brands and high leverage.
Driver of Convergence 1 — Products

Perhaps the strongest argument for why banks should be valued more similarly than
other industries is that their products are “commoditised”. Typically,
commoditisation in this context has two meanings; firstly, that the products are all
the same and can be easily replicated; secondly, that softer issues (such as brand
values) are weaker in banking. It hardly needs spelling out, but there are indeed no
unique products in financial services. There is no precedent of banks achieving
patents or copyrights over product designs/features5. If a bank develops a successful
new product, competitors can easily copy it. This contrasts with other industries —
most obviously the pharmaceutical and the technology industries — which regularly
achieve a degree of market protection (often time limited) via patenting and
copyrighting arrangements
Driver of Convergence 2 — Economies of Scale

Clearly it is a gross oversimplification to state that all banking is commoditised.
Indeed, there are sustainable advantages that certain banks have over others, the most
obvious being capital. In theory, while all products are easy to replicate, some banks
will be better able to design and offer those products than others. Perhaps the best
examples are capital-intensive products (for example, corporate lending) where large
banks with large balance sheets have an advantage over smaller competitors.
5
We can only think of one bank – Halifax (pre HBOS) – that toyed with the idea of achieving a patent for a product design with the
launch of its Intelligent Finance offset product in 2000. We have heard nothing of that plan since.
21
However, there is little evidence that any size advantages are manifested
operationally in terms of either higher margins or lower costs. Figures 30 and 31
show that, if anything, there is actually a small positive correlation between size (as
measured by balance sheet assets in Figure 30 and group revenues in Figure 31) and
cost income ratios.
Figure 30. Assets and Cost Efficiency — Does size matter? Figure 31. Revenues and Cost Efficiency — Does size matter?
80% 80%
2
2 R = 0.0774
R = 0.1019
70% 70%
Cost Income Ratio (2004E)
Cost Income Ratio (2004E)

60% 60%
50% 50%
40% 40%
30% 30%
20%
20%
0 200 400 600 800 1000 1200 1400
0 5 10 15 20 25 30 35 40 45 50 55
Balance Sheet Assets (US$bn) Revenues (US$bn)
Source for both charts: Company information and Smith Barney estimates
Given that there are little obvious size advantages operationally, it is perhaps equally
not a surprise that the equity market similarly does not seem to reward size within the
sector. Figures 32 and 33 show a small negative correlation between size (as
measured by market capitalisation in Figure 32 and balance sheet assets in Figure 33)
and the P/E ratio allocated to that bank.
Figure 32. Market Capitalisation and Rating — Does size matter? Figure 33. Balance Sheet Size and Rating — Does size matter?
20.0x 20.0x
18.0x 18.0x
16.0x 16.0x
2005 PE (cash basis)
2005 PE (cash basis)
14.0x 14.0x
12.0x 12.0x
10.0x 10.0x 2
R = 0.048
2
R = 0.0439
8.0x 8.0x
6.0x 6.0x
0 20 40 60 80 100 120 140 160 180 0 200 400 600 800 1000 1200 1400
Market Capitalisation (US$bn) Balance Sheet Assets (US$bn)
Source for both charts: Company information and Smith Barney estimates
So while in theory larger banks might enjoy operational or strategic advantages over
smaller banks — and this might be a source of competitive differentiation in a
commoditised industry — there is simply no evidence that larger banks have turned
that into an advantage, and no evidence that the equity market rewards it.
22
Driver of Convergence 3 — Brands

What can we say on the softer issues that may afford banks the ability to overcome
the product commoditisation discussed above? This is clearly a subjective area,
although one of the more “objective” metrics to consider here is brand value. Brand
consultants around the world attempt to place values on brands, and typically their
approach has taken two forms. Firstly, they try and quantify the “superior” pricing
that one brand can extract over another, for essentially the same product. Perhaps the
best example of this is branded food (say Coca Cola) compared to own label food
(say a supermarket Cola). Secondly, they attempt to quantify how much repeat
business a company generates purely because of the brand and its associated values.
A repeat customer buying a new Mercedes would be good example of this.
Using this framework, it should be clear why financial service companies are seen as
having low brand values. Where they are very strong is in name recognition, which is
often confused with brand value. However, using the two tests of brand value noted
above, banks look weak. There is very little tangible evidence of banks being able to
charge premium prices for identical products. Usually these so called “premium”
product propositions — for example a “Premier Current Account” — are made
attractive by offering free add-on services. One of the few and best known examples
of a genuine financial service brand (as defined) is the American Express card, where
similar features command a premium price over competitor cards.
In terms of the other brand value measure — repeat business — it is difficult to
disentangle customer inertia from genuine brand value. However, brand valuation
consultants have measured repeat banking business lowly.
To partly illustrate these points, Figure 34 shows the Top 45 brands in the world (as
measured by Interbrand). In absolute value terms, the Top 45 brands include 8
financial service companies (three banks, four pure investment banks and a credit
card company). Perhaps more interestingly, if we express these assigned brand
values as a percentage of the company market capitalisation, then the financial
service companies look much weaker. Against an average brand value/market cap of
28% for these top 45 brands, brands for financial service companies account for only
14% of market cap. Perhaps more significantly, for the commercial banks — JP
Morgan, Citigroup, and HSBC — the assigned brand value represents only 5% to 8%
of market capitalisation.
23
Figure 34. Top 45 Brands in the World

Brand Rank Brand Value Market Cap Brand Value as % Rank by Brand Value
2004 Brand ($m) ($m) Market Cap as % Market Capital
1 COCA-COLA 67,394 95,108 71% 1
2 MICROSOFT 61,372 291,467 21% 23
3 IBM 53,791 151,021 36% 14
4 GE 44,111 373,830 12% 36
5 INTEL 33,499 141,509 24% 21
6 DISNEY 27,113 55,227 49% 7
7 MCDONALD'S 25,001 38,646 65% 2
8 NOKIA 24,041 75,660 32% 17
9 TOYOTA 22,673 135,808 17% 30
10 MARLBORO 22,128 118,003 19% 27
11 MERCEDES 21,331 45,385 47% 8
12 HEWLETT-PACKARD 20,978 60,987 34% 15
13 CITIBANK 19,971 232,241 9% 40
14 AMERICAN EXPRESS 17,683 69,926 25% 20
15 GILLETTE 16,723 43,177 39% 12
16 CISCO 15,948 123,464 13% 35
17 BMW 15,886 26,308 60% 3
18 HONDA 14,874 45,137 33% 16
19 FORD 14,475 24,940 58% 5
20 SONY 12,759 33,859 38% 13
21 SAMSUNG 12,553 61,148 21% 25
22 PEPSI 12,066 84,072 14% 33
23 NESCAFE 11,892 103,617 11% 37
24 BUDWEISER 11,846 39,575 30% 18
25 DELL 11,500 102,231 11% 38
26 MERRILL LYNCH 11,499 51,734 22% 22
27 MORGAN STANLEY 11,498 55,745 21% 24
28 ORACLE 10,935 65,337 17% 29
29 PFIZER 10,635 209,136 5% 43
30 J.P.MORGAN 9,782 134,110 7% 41
31 NIKE 9,260 15,653 59% 4
32 MERCK 8,811 62,139 14% 34
33 HSBC 8,671 189,969 5% 44
34 SAP 8,323 56,147 15% 32
35 CANON 8,055 44,656 18% 28
36 KELLOGG'S 8,029 18,044 44% 9
37 GOLDMAN SACHS 7,954 50,723 16% 31
38 GAP 7,873 19,747 40% 11
39 SIEMENS 7,470 71,157 10% 39
40 IKEA 7,182 n/a n/a n/a
41 HARLEY-DAVIDSON 7,057 16,987 42% 10
42 HEINZ 7,026 12,986 54% 6
43 APPLE 6,871 26,010 26% 19
44 LOUIS VUITTON 6,602 34,741 19% 26
45 UBS 6,526 90,999 7% 42
Top 20 Average 28%

Financial Services Average 14%
Source: Interbrand, DataStream and Smith Barney analysis
Driver of Convergence 4 — Leverage

A fourth and final reason why banks valuations typically converge is that they are
massively leveraged institutions whose earnings are accordingly volatile. As a result,
tiny differences in the value of balance sheet assets (be it credit quality, bond
valuations, derivative contracts etc….) can have a large impact on EPS and equity.
24
This is, we believe, the main reason why banks trade on a discount to other sectors in
the equity market, but it is also a reason why the market is usually reluctant to place
significantly divergent values on banks. Figure 35 illustrates the point well. It is an
unusual measure — balance sheet assets as a multiple of net profit — but this ratio
neatly captures the potential impact on profit from changes in balance sheet asset
valuations. On average across Europe, balance sheet assets are 171x net profit.
Figure 35. European Bank Sector “Gearing”
550
Balance Sheet Assets as Multiple of Net Profit (2006E
500
450
400
350
300
250
Average 171x
200
150
100
50
0
SocGen
All. & Leicester

Barclays
SHB
HSBC
Bank of Ireland
Banco Sabadell
Bankinter
Sanpaolo IMI
Julius Baer
Allied Irish Banks
UBS
HBOS
RBS
BBVA
B&B
SEB
DePfa Bank
Danske Bank
BNL
Banesto
Banca Intesa
Unicredito
NBG
HVB Group
Monte dei Paschi
Santander
Banco Popular
BNP Paribas
Nordea (FDR)
Swedbank (FSB)
Lloyds TSB
Deutsche Bank
Credit Suisse
Erste Bank
ABN Amro
Northern Rock
BP Verona Novara
Alpha Bank
Bank Austria
DnB NOR
Standard C
Deutsche Postbank
Commerzbank
EFG Eurobank
This leverage manifests in an ROE for the European bank sector that is indeed
volatile. Figure 36 shows the annual change in ROE for the sector each year since
1990 (expressed as a percentage of the prior year ROE). On average over the 14-year
period, the annual change is ±21% (or ±25% excluding the UK banks).
Figure 36. Volatility in Return on Equity in the European Bank Sector, 1990-2004E
60%
55% All European Banks
Annual Change in Return on Equity (Change as % of prior year ROE)
50%
45% Europe excluding UK
40%
35%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
-25%
-30%
-35%
-40%
-45%
-50%
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E
Source: Company information and Smith Barney estimates
25
Current Factors Driving Convergence

In addition to these two generic factors that contribute to valuation convergence, we
believe that there are three additional factors that have increased the level of
valuation convergence recently.
(1) Economic and Capital Markets Uncertainty

In a way it sounds almost glib to simply say that the economic outlook and capital
markets are uncertain. They are, of course, never certain and to that extent there is
nothing especially new about uncertainty. However, we believe that at the end of
2004/start of 2005 there is an unusually high degree of uncertainty, and this is
restricting the amount of valuation divergence within the European bank sector. On
economics, there seem an almost equal number of participants worried about too
little growth in 2005, as there are those worried about inflationary pressure. As
evidence of this, the next move in ECB interest rates is uncertain not only in timing
but also in direction (will it be up or down?). Capital market uncertainty is, in some
ways, less of a surprise and reflects the simple fact that markets have traded in a very
narrow band throughout the past year (typically described as directionless). Across
the European equity markets the DJ Stoxx has traded in a tight 10% range during
2004, while in the bond market the benchmark German bund yield has traded
between 3.8% and 4.3%.
(2) Surplus Capital/M&A – Good or bad?

Secondly, 2004 has seen the European bank sector generate its highest level of
surplus capital ever. At the start of the year we estimated that European banks would
generate over €84bn of surplus capital over the 2004-2006 period, after funding
balance sheet expansion and after paying ordinary dividends. At the time we
commented that this should be viewed as good for some banks (those we trust) and
bad for others (those we didn’t trust). Unsurprisingly, 2004 has seen a revival of
M&A activity in the sector, with most of it taking the form of European banks doing
the acquiring. There has also been some progress in cross border M&A, with
Santander successfully acquiring Abbey National, although the aborted Dexia/San
Paolo IMI merger was not a great advert for this type of transaction. However, a
growing investment issue is whether generating surplus capital is good or bad?
Should the market reward banks generating surplus capital or penalise them because
of the risk they deploy it badly?
We believe the revival of M&A activity has added convergence pressure to the sector
since it often means that poorly performing banks might be more highly rated
because there is the ultimate escape route of them being acquired (and, of course,
those banks generating surplus capital are perceived to be the buyers, thus pressuring
their own rating). The bottom line is that capital generation — and a revival in M&A
— has, we believe, increased valuation convergence through upwardly valuing the
weak banks and placing downward pressure on the strong banks.
To partly illustrate this, Figures 37 and 38 show the 2004 share price performance of
the banks generating the most and least capital in the sector. There is indeed only a
very weak correlation; of the most capital generative banks, only five meaningfully
outperformed the sector in 2004. While that was better than the weakest generators
of capital, it was only modestly so.
26
Figure 37. Capital Generation and Share Price Performance — Top Capital Generators
50%
Bank Austria
40%
NBG
2004 Share price performance (relative to

30%
DnB NOR
European bank sector)
20%
Danske Bank SEB
10% Swedbank (FSB)
SHB BBVA
Standard C UBS
Banca Intesa
0%
Credit Suisse SocGen BNP Paribas
Sanpaolo IMI
ABN Amro RBS
-10% Santander
Deutsche Bank
-20%
4% 5% 6% 7% 8% 9% 10% 11%
2005 and 2006 Surplus Capital generated as % of Market Capitalisation (post dividends)
Source: DataStream and Smith Barney estimates
Figure 38. Capital Generation and Share Price Performance — Bottom Capital Generators
50% Erste Bank
40%
EFG Eurobank
2004 Share price performance (relative to
30%
20%
European bank sector)
Nordea (FDR)
10% Alpha Bank
Allied Irish Banks
Banesto Banco Sabadell BP Verona Novara Barclays
0%
Northern Rock BNL
Bank of Ireland
Banco Popular HSBC Sanpaolo IMI
-10% HVB Group Unicredito
Commerzbank All. & Leicester Monte dei Paschi
B&B Lloyds TSB
-20%
Julius Baer
-30%
-6% -5% -4% -3% -2% -1% 0% 1% 2% 3% 4% 5%
2005 and 2006 Surplus Capital generated as % of Market Capitalisation (post dividends)
(3) IFRS
A final topical reason why valuations may have converged is the forthcoming
changes to reported numbers as a result of the introduction of IFRS in 2005. The
obvious uncertainly over the size of accounting driven restatements means that there
will be a lower degree of confidence than usual over forward earnings projections.
Having considered some of the reasons why convergence has taken place, the next
section of this report explains why, we believe, this degree of valuation convergence
is wrong.
27
Why Convergence is wrong

➤ While commentators often claim “banks are all the same”, the reality
is very different
➤ We analyse over several years the operational, credit quality and

share price performance of 8 pairs of banks that are typically viewed
as “the same”
➤ The results show massive differences in operating profit per share

evolution — with the stronger bank of the “pair” outperforming the
weaker bank by 25% to 300%
➤ Credit quality also typically differs each year, usually by at least 20%
➤ And the equity market usually reflects this in divergent share prices.
Since 1990, the average annual performance difference between each
“pair” of banks is c15%. 2004 saw the smallest annual difference, at
just 6%
To argue that convergence is wrong is, we believe, stating the obvious. The
alternative view — that convergence is right and appropriate — is essentially saying
that all banks are the same. It would be the most amazing of all coincidences if each
banks’ different growth prospects, strategy, execution, market environment,
management, etc…all averaged out to 10x forward earnings.
While it is easy to state that convergence is wrong, proving it is wrong is a lot harder.
We decided that the most powerful way to try and convince the reader of the flaws in
the convergence argument is to simply show how divergent the performance has
been over the years between banks that are widely seen as pairs. The “these banks
are the same” argument is strongest when comparing some of the most similar banks
in the sector to each other. For our analysis, we have focused on 8 pairs of apparently
similar banks. These are:
➤ BNP Paribas vs. SocGen
➤ Barclays vs. RBS
➤ AIB vs. Bank of Ireland
➤ Credit Suisse vs. UBS
➤ Santander vs. BBVA
➤ HVB vs. Commerzbank
➤ Banca Intesa vs. Unicredito
➤ HSBC vs. Standard Chartered
Our conclusions are, we believe, revealing, since they show that on a range of
metrics apparently similar banks have performed wildly differently. Figures 39 to 54
show some of these trends.
28
European Banking “Pairs” — Gross Operating Profit per Share

Figure 39. BNP Paribas vs SocGen — The Same? Figure 40. HVB vs Commerzbank — The Same?
200 140
Commerzbank
SocGen 130
190 120 HVB
BNP Paribas 186
110
180
100
Operating Profit per Share (1997=100)

90
170
80 77
160 162 70
60
150 50
46
40
140 30
20
130
10
0
120
-10
110 -20
-30
100 -40
1997 1998 1999 2000 2001 2002 2003 2004E 1999 2000 2001 2002 2003 2004E
Figure 41. UBS, Credit Suisse and Deutsche — The Same? Figure 42. AIB vs Bank of Ireland — The Same?
340 230 229
328
320 UBS Bank of Ireland
220
300
Deutsche Bank 210 AIB
280
260 Credit Suisse
200
240
190
220
200 180
180 170 172
160 157
140 160
120 115 150
100
140
80
60 130
40 120
20
110
0
-20 100
1997 1998 1999 2000 2001 2002 2003 2004E 1997 1998 1999 2000 2001 2002 2003 2004E
Figure 43. Unicredito vs Banca Intesa — The Same? Figure 44. BBVA and Santander — The Same?
230 220
220 Unicredito BBVA
210
210 Banca Intesa Santander
200
200
190
190
180
180
175 170
170 163
160
160
150 152
150
140
140
130 130
127
120 120
110 110
100 100
1997 1998 1999 2000 2001 2002 2003 2004E 1997 1998 1999 2000 2001 2002 2003 2004E
Figure 45. Barclays vs RBS — The Same? Figure 46. HSBC and Standard Chartered — The Same?
230 200
190 HSBC 193
220 RBS
180 Standard Chartered
210 Barclays 209
170
200
160
190
150
180 140
170 130
167
160 120
150 110 109

100
140
90
130
80
120
70
110 60
100 50
1999 2000 2001 2002 2003 2004E 1997 1998 1999 2000 2001 2002 2003 2004E
Source for all charts: Company information and Smith Barney estimates
29
European Banking “Pairs” — Bad Debt Charges

Figure 47. BNP Paribas vs SocGen — Comparing bad debt records Figure 48. HVB vs Commerzbank — Comparing bad debt records
45% 80%
SocGen annual charge in excess of BNP Paribas 70% HVB annual charge in excess of Commerzbank
40% 60%
Average difference, 1999-2004E Average difference, 1999-2004E
50%
35%
HVB bad debt charge (in bps) in excess of

SocGen bad debt charge (in bps) in excess of
40%
Commerzbank bad debt charge (in bps)

BNP Paribas bad debt charge (in bps)
30% 30%
20%
25% 10%
0%
20% -10%
-20%
15%
-30%
10% -40%
-50%
5% -60%
-70%
0%
-80%
-5% -90%
-100%
-10% -110%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E
Figure 49. Credit Suisse vs UBS — Comparing bad debt records Figure 50. AIB vs Bank of Ireland — Comparing bad debt records
240% 120%
220% Credit Suisse annual charge in excess of UBS AIB annual charge in excess of Bank of Ireland
110%
200% Average difference, 1999-2004E
Average difference, 1999-2004E
Credit Suisse bad debt charge (in bps) in excess of
100%
180%
AIB bad debt charge (in bps) in excess of
160% Bank of Ireland bad debt charge (in bps) 90%
UBS bad debt charge (in bps)
140%
80%
120%
70%
100%
80% 60%
60%
50%
40%
40%
20%
0% 30%
-20%
20%
-40%
10%
-60%
-80% 0%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E
Figure 51. Unicredito vs Banca Intesa — Comparing bad debt Figure 52. BBVA vs Santander — Comparing bad debt records
records 120%
110% Santander annual charge in excess of BBVA
70% 100% Average difference, 1999-2004E
Banca Intesa annual charge in excess of Unicredito 90%
Santander bad debt charge (in bps) in excess of
60%
80%
Average difference, 1999-2004E
Banca Intesa bad debt charge (in bps) in excess of
50% 70%
BBVA bad debt charge (in bps)
60%
UniCredito bad debt charge (in bps)
40% 50%
40%
30% 30%
20%
20% 10%
0%
10%
-10%
0% -20%
-30%
-10% -40%
-50%
-20% -60%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E
-30%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E
Figure 53. Barclays vs RBS — Comparing bad debt records Figure 54. HSBC vs Standard Chartered — Comparing bad debt
50%
records
Barclays annual charge in excess of RBS
40% Average difference, 1999-2004E

110%
100%
30%
Barclays bad debt charge (in bps) in excess of
90%
Standard Chartered bad debt charge (in bps) in excess of
80%
20%
70%
RBS bad debt charge (in bps)
10% 60%
HSBC bad debt charge (in bps)
50%
0% 40%
30%
-10%
20%
-20% 10%
0%
-30% -10%
-20%
-40% -30%
-40%
-50%
-50%
-60% Standard C annual charge in excess of HSBC
-60%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E -70% Average difference, 1999-2004E
-80%
Source for all charts: Company information and Smith Barney estimates 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E
30
Gross Operating Profit Trends (Figures 39 to 46)

➤ Among these eight pairs, they have all shown divergent trends in pre provision
operating profit over the respective period. Note that we have calculated this on a
per share basis, which is to make the analysis more comparable even after major
acquisitions
➤ The “poster child” for this idea that banks are not all the same is UBS vs. Credit
Suisse; indexed to 100 in 1997, UBS has grown its operating profit per share
almost three times as much as Credit Suisse (and, as an aside, just over twice as
much as Deutsche Bank)
➤ But the performance divergence does not stop there. For example, Figures 39 to
46 also show that over the seven years there is an 80% performance difference
between HSBC and Standard Chartered (in favour of HSBC), a 33%
differential between AIB and Bank of Ireland (in favour of Bank of Ireland), a
40% differential between Banca Intesa and Unicredito (in favour of Unicredito)
and a 25% differential between RBS and Barclays (in favour of RBS)
➤ Even Commerzbank and HVB – despite both reporting a collapse in operating
profit per share since 1997 — have performed differently from each other, albeit
both disastrously (HVB operating profits per share have fallen 54% since 1997,
Commerzbank have “only” fallen 23%)
➤ However, not all the pairs are divergent. For example, over the seven year period
we estimate that there has only been a 7% performance differential between
BBVA and Santander (in favour of BBVA) and a slightly larger 15%
differential between BNP Paribas and SocGen (in favour of SocGen)
Credit Quality (Figures 47 to 54)

➤ Figures 47 to 54 show the annual difference in bad debts between each pair of
banks, expressed as a percentage of average loan books, over an extended time
period. For example, where we show that Barclays has on average a bad debt
charge 20% higher than RBS’s over the past few years, that is calculated as the
difference between Barclays’ bad debts over the period (average charge 58bps of
the loan book) compared to RBS’ (48bps)
➤ As with the operational trends, there are clear differences between apparently
similar pairs of banks. Our analysis shows average differences of around 20%
between HVB/Commerzbank (HVB worse) and Banca Intesa/Unicredito
(Banca Intesa worse)
➤ There are more substantial differences in average bad debt charges between
AIB/Bank of Ireland and HSBC/Standard Chartered
➤ While UBS and Credit Suisse once again show dramatically different trends,
this is exaggerated due to UBS’ extensive use of credit derivatives
➤ The only pair of banks to show essentially similar bad debt trends over the past
few years are BNP Paribas and SocGen, where the difference has averaged just
12% per annum.
31
Proof is in the Pudding

So, having established what we believe are clear operational differences between
different pairs of banks that are often viewed as similar, perhaps the key question is
whether any of this matters from a stock market perspective? Do these differences get
recognised by the market, or is the market always prone to the “they are all the same”
syndrome?
If we look at the share price performance of these pairs of banks, the answer is
mixed. Over the period since 1990 RBS has outperformed Barclays by almost 300%,
while Bank of Ireland has outperformed AIB by almost 80%. Over the period since
1998, SocGen has outperformed BNP Paribas by 30% while UBS has outperformed
Credit Suisse by over 50%. However, while these pairs of banks have indeed
diverged in share price performance, there are some pairs that have essentially
moved together (BBVA/Santander, Commerzbank/HVB) over the entire period.
However, this masks a very important observation — in most years there is
significant performance differential between each pair of banks. Figure 55 shows the
annual share price performance difference between each of these pairs of banks. The
most correlated performers are HSBC/Standard Chartered and Bank of Ireland/AIB,
but even for this group the average annual performance difference is 11%. Across all
16 banks, the average annual performance difference since 1990 between each
pair is 15% per annum.
Figure 55. Share Price Performance of European Bank Sector Pairs, 1990-2004
BNP RBS UBS Bank of Ireland Santander Commerzbank HSBC Unicredito
vs vs vs vs vs vs vs vs Simple
1
SocGen Barclays Credit Suisse AIB BBVA HVB Standard C Banca Intesa Average
1990 nm -15% 9% -4% 28% -7% nm -22% 14%
1991 nm -4% 16% -2% -21% -16% nm 16% 13%
1992 nm 29% -6% 18% 24% -5% nm 55% 23%
1993 nm 31% -3% -1% 12% 18% -8% -40% 16%
1994 18% -10% 0% 12% -11% 8% -20% -14% 11%
1995 -17% 23% -1% 21% -10% 7% -27% 8% 14%
1996 -2% -29% -23% 1% -15% -22% -1% 7% 12%
1997 9% -15% 9% 17% -13% -3% 32% -25% 15%
1998 30% 55% 5% -22% -17% -33% -2% 23% 23%
1999 -18% -17% -31% 12% 27% 39% 15% 23% 23%
2000 -15% 34% 26% 22% -10% -9% 14% -11% 18%
2001 13% -4% 1% -6% -6% 0% -4% 48% 10%
2002 -12% 31% 83% -5% 6% 0% -1% 18% 20%
2003 2% -15% -16% 12% 20% 36% -2% -27% 16%
2004 0% -9% 4% -6% -16% 2% -3% -11% 6%
Average annual differential1 12% 21% 15% 11% 16% 14% 11% 23% 15%
1
Ignoring signs (i.e. taking absolute numbers)
"nm" means that due to changes in the composition of the groups we do not believe performance comparison in these earlier years is meaningful
Source: DataStream and Smith Barney analysis
As can be seen in Figure 55, 2004 was indeed an unusual year for these banks pairs,
with an average performance differential of just 6%. This was the narrowest since
before 1990.
32
All of this analysis suggests to us that our expectation for greater performance
divergence is well founded. This is a sector where operational trends are typically
diverse, and where share price performances are equally divergent. The fact that
2004 has not seen a “normal” level of dispersion is, we believe, anomalous. In most
years investors are more discriminating than they were in 2004, and we believe that
2005 will be a year in which “normal service” should be resumed. That is, of course,
assuming that we have got our earnings forecasts correct, and that is something that
we address in the next chapter.
33
Convergence…. or is it divergence?
➤ While the sector appears highly converged on valuations, this is of
course dependent on our earnings forecasts being accurate; if our
estimates are wrong, then the sector is more divergent than it might
appear
➤ We have developed a model to stress test estimates across the

sector. We have analysed the business mix of each bank,
compressed revenues and where we think it relevant have used
banks’ historical track records on cost control to simulate their likely
response and used this to calculate new forecasts
➤ Predictably, Europe’s most vulnerable banks are German plus Credit

Suisse; less predictably, BNP Paribas has twice the earnings
resilience of SocGen
➤ Europe’s high quality big caps all fare well — BBVA, HBOS,
Santander, RBS and BNP Paribas
➤ Finally, we have analysed the diversification of revenue generation

across each major European bank to gauge how vulnerable revenue
forecasts might be; on this measure the three most diversified
revenue streams across Europe are Standard Chartered, UBS and
RBS
The preceding chapters have argued three things; firstly, that convergence in the
sector’s valuation is unusually high at the moment; secondly, that it has happened
due to a variety of generic issues (gearing, commoditisation), supplemented by some
specific 2004 factors (economic uncertainly, IFRS, capital allocation); and, finally,
that such valuation convergence is unlikely to last, as evidenced by the wide
difference in operational performance and share price performance over many years.
Implicit within these earlier three chapters is the assumption that our forecasts are
accurate. However, this final chapter presents the opposite view. Simply put, what if
our numbers are wrong? If that were the case, then what may seem highly converged
valuations today may not, after all, be so similar on changed estimates. Perhaps, it
could be argued, the equity market is simply guessing the likely direction of estimate
changes within individual bank share prices?
What if we are wrong?

This is a difficult area to address since, by implication, our earnings forecasts are our
best estimate (or base case) forecasts across the sector. If we strongly believed our
estimates were wrong, we would obviously change them.
However, that ignores the fact that at any point in time there are degrees of
confidence surrounding any earnings estimates. And it is those degrees of confidence
that are important.
34
Earnings Revisions Matter

Testing the robustness of our earnings forecasts is important for another reason. As
well as checking whether the sector’s valuation really is as converged as it seems,
earnings revisions are typically the most important single driver of share price
performance. Last year was no exception. Figure 56 shows the relationship between
earnings revisions (to 2005 cash EPS forecasts) and share price performance. It is
clear that in 2004 there was, as is usual, a reasonably strong correlation. So getting
the forecast right does matter to stock performance.
Figure 56. 2005E Forecast changes and Share Price Performance, 2004
50%
Erste Bank Bank Austria
40% KBC Holding

2004 Share Price Performance Relative to market
NBG
EFG Eurobank
30%
2
DnB NOR R = 0.357
20%
Danske Bank
SEB Nordea (FDR) DePfa Bank
Dexia
10% Credit Agricole Swedbank (FSB) Alpha Bank
Bankinter SHB BBVA
UBS Allied Irish Banks
Barclays Standard C
0% Credit Suisse BP VeronaBanca Intesa
Novara
Bank of Ireland BNP Paribas
Northern Rock SocGen
BNL Sanpaolo IMI HBOS
Deutsche Bank ABN Amro Banco RBS
Popular HSBC
-10% MonteAll.dei Leicester Commerzbank
& Paschi
Unicredito Santander
HVB Group Lloyds TSB
B&B
-20%
Julius Baer
-30%
-60% -40% -20% 0% 20% 40% 60%
Changes to 2005 underlying (cash) EPS forecast during 2004
Stress testing our forecasts

We have produced a comprehensive model that attempts to stress test our forecasts
by bank to get a sense of the level of risk posed to what are currently converged
valuations across the sector. Our approach has four stages:
➤ Firstly, we look at the business mix for each bank in Europe and allocate
revenues and costs into standardised business lines.
➤ Secondly, we assume a degree of revenue compression by business
➤ Thirdly, we assume a degree of cost flexibility within each business for each
bank. This cost flexibility varies by bank, and has been assessed using each
bank’s historical record in terms of “jaws”
➤ Finally, using these assumptions, we are able to compare the potential earnings
compression across the sector, and are therefore able to model the potential
valuation differences that arise.
The following pages explain the approach in more detail and analyse the results.
35
Stage 1 – Allocating the business mix

For several years we have been allocating the business mix of each bank in Europe
between four standard business lines. These are Retail Banking,
Corporate/Commercial Banking, Investment Banking/Markets and Asset
Management/Private Banking (including Life). Of course banks typically disclose
their business through different divisional splits. Our approach is to ignore the
chosen divisional information given by each bank and instead to estimate our own
business split along the standard lines indicated. Figure 57 shows the estimated
business mix of each bank in our universe.
Figure 57. Business mix of European Banks
100%
90%
Estimated Proportion of Group Revenues
80%
70%
60%
50%
40%
30%
20%
10%
0%
All. & Leicester
SocGen
Barclays
SHB
HSBC
Banco Sabadell
KBC Holding
Bank of Ireland
Dexia
Bankinter
Sanpaolo IMI
Julius Baer
Allied Irish Banks
HBOS
BBVA
RBS
UBS
B&B
SEB
Banesto
NBG
Danske Bank
Credit Agricole
Banca Intesa
Unicredito
BNL
DePfa Bank
Monte dei Paschi
Banco Popular
Santander
HVB Group
Nordea (FDR)
Swedbank (FSB)
BNP Paribas
Lloyds TSB
Northern Rock
Alpha Bank
BP Verona Novara
ABN Amro
Erste Bank
Deutsche Bank
Credit Suisse
Bank Austria
Standard C
DnB NOR
Deutsche Postbank
EFG Eurobank
Commerzbank
Retail Corporate & Commercial Investment Banking & Markets Asset Management, Life & Private Banking
Stage 2 – Revenue compression

Given that the entire approach in this report is to argue that valuations should be
more divergent than is currently the case, we believe that it is important to try and
assess “downside risk” to estimates. As a result, we have assumed a standardised
revenue reduction for each business line, to be applied to each bank in Europe. This
alternative forecast is based on an assumption that revenues decline by:
➤ 3% in retail banking;
➤ 5% in corporate and commercial banking;
➤ 10% in investment banking and markets; and
➤ 10% in asset management, private banking and life
It hardly needs stating, but these are of course hugely simplistic assumptions. More
importantly, for our modelling purposes we are assuming that all banks suffer the
identical revenue compression in each of their respective business units. In certain
areas — such as market and investment banking — this may seem reasonable.
However, there is a much lower level of correlation in retail banking revenues across
Europe. Nevertheless, we believe that these serve as a reasonable basis for thinking
about revenue resilience.
36
Stage 3 – Cost response

If the modelled revenue compression noted above happened, we would expect many
banks to respond with cost cutting programmes. In estimating the potential for cost
cutting, we believe that there are two key considerations — business mix and
institutional track record.
Business Mix
Our approach is to allow for different levels of cost flexibility within different
business lines. For example, in response to the modelled 3% reduction in retail
banking revenues, our base case (or “Average” in Figure 58) for each bank assumes
that retail banking costs could only be reduced by 1%, recognising that costs in retail
banking are typically inflexible. By contrast, areas such as investment banking afford
much greater scope for cost reduction in response to revenue weakness, and our base
case revenue compression in investment banking of 10% is matched by a 10%
reduction in investment banking costs. Figure 58 shows the range of modelled cost
cutting in response to the revenue compression discussed above. For each business
we show cost cutting assuming the bank is either aggressive at cost control, average
at cost control or poor at cost control.
Figure 58. Cost Flexibility Scenarios
Cost Response
Revenue
Business Unit Compression Aggressive Average Poor
Retail Banking -3% -2% -1% 0%
Corporate & Commercial Banking -5% -5% -3% -2%
Investment Banking & Markets -10% -10% -10% -5%
Asset Management, Private Banking & Life -10% -7% -5% -3%
Bank track record

The key question, however, is which of the three different cost response scenarios
should we allocate to each bank? As we argue, not all banks are the same.
Specifically, some banks have a long history of being able to flex costs aggressively
in response to revenue pressures, while other banks are much less successful.
Sometimes these differences reflect factors relevant to the specific institution, while
other times it reflects external influences (an example of which would be the
relatively inflexible labour markets in Germany). Our approach here is to calculate
the track record of each bank over time in terms of revenue and cost management
(often referred to as “jaws”) and then to decide whether to “accept” or “reject” the
track record as a guide to future cost flexibility.
Figure 59 shows the track record of each bank in the sector over the past eleven years
in terms of being able generate positive “jaws” (revenues growing faster than costs).
Note that in constructing Figure 59 we have included data as far back as we are able.
However, for many banks this will not cover the entire decade, and the footnote
makes clear which years are included for each bank. Across the sector as a whole, we
estimate that over the eleven-year period 1993-2004 jaws were positive in six years,
negative in five years, but with significant performance differences by bank.
37
1
Figure 59. Historical "Jaws" Management, 1993 – 2004E
100%
90%
Years with positive/negative "jaws", 1993-2004E

80%
70%
60%
50%
40%
30%
20%
10%
0%
Banco Sabadell
Alpha Bank
Commerzbank
EFG Eurobank
Bank of Ireland
Swedbank (FSB)
NBG
RBS
UBS
Sanpaolo IMI
Banesto
Santander
Erste Bank
Standard C
Banco Popular
Northern Rock
B&B
Bank Austria
Bankinter
Julius Baer
Unicredito
BNL
SEB
SHB
HSBC
Deutsche Bank
Banca Intesa
Danske Bank
Dexia
Credit Agricole
DePfa Bank
KBC Holding
SocGen
Nordea (FDR)
BNP Paribas
Barclays
Allied Irish Banks

HBOS
BBVA
Monte dei Paschi
Abbey National
All. & Leicester
Lloyds TSB
DnB NOR
ABN Amro
Credit Suisse
HVB Group
Deutsche Postbank
BP Verona Novara
Years with Positve Jaws Years with Negative Jaws

1
For all banks the period covers 1993-2004 except for NBG, Alpha Bank, MPS, Standard Chartered, Bankinter, Lloyds TSB (all 1994 onwards);
Unicredito, DnB NOR, Danske (1995 onwards); Erste, Bank of Ireland, B&B, (1996 onwards); BNP Paribas, Dexia, SocGen, San Paolo, Nordea
(1997 onwards); BPVN, Banca Sabadell, KBC (1998 onwards); Deutsche Postbank, Banesto, HVB, Bank Austria, Swedbank, Julius Baer, Credit
Agricole, DePfa, EFG Eurobank (1999 onwards); HBOS, (2000 onwards)
Source: Company information and Smith Barney analysis
Of the major banks included for an extended period, the most impressive cost and
revenue management performances have been achieved at the two large Spanish
banks (Santander, BBVA), BNP Paribas and the two domestic UK banks (Barclays
and RBS). At the other extreme, the worst major bank is Credit Suisse, which over
the past eleven years has generated positive jaws only four times. The weak
performance of all domestic German banks is perhaps not a surprise, but the weak
operational performance of SocGen is perhaps more surprising, especially when
compared to BNP Paribas, which has benefited from the BNP and Paribas
combination.
Figure 60 repeats this analysis, but this time focuses only on the past five years,
which is perhaps more relevant for our assessment of which banks might be able to
show cost flexibility going forward.
Figure 60. Historical "Jaws" Management, Last Five Years
100%
90%
Years with positive/negative "jaws", 2000-2004E
80%
70%
60%
50%
40%
30%
20%
10%
0%
ABN Amro
SHB
HBOS
SEB
DnB NOR
B&B
HSBC
BNL
Dexia
SocGen
NBG
BBVA
RBS
UBS
Standard C
Lloyds TSB
Deutsche Postbank
Banesto
Erste Bank
Bank Austria
DePfa Bank
Credit Suisse
Santander
HVB Group
Swedbank (FSB)
Nordea (FDR)
BNP Paribas
Barclays
BP Verona Novara
Northern Rock
Deutsche Bank
Alpha Bank
Banca Intesa
Commerzbank
Bankinter
Julius Baer
EFG Eurobank
Abbey National
Danske Bank
All. & Leicester
KBC Holding
Monte dei Paschi
Sanpaolo IMI
Credit Agricole
Unicredito
Banco Popular
Allied Irish Banks

Banco Sabadell
Bank of Ireland
Years with Positve Jaws Years with Negative Jaws
Source: Company information and Smith Barney analysis
38
Again, the large Spanish banks impress over this period (five consecutive years of
positive jaws) as do the two UK banks heavily involved in M&A over the period
(RBS and HBOS). The worst record in Europe belongs to Lloyds TSB, where four of
the past five years has seen negative jaws and — somewhat surprisingly — at
Unicredito, where jaws have been negative each year since 2000.
Having looked at the respective track record of each bank, the next stage of our
analysis is to decide whether to accept it as a guide to the future, or to ignore that
bank’s history and make different assumptions about the future ability to flex costs.
Figure 61 summarises the key inputs and the decisions made.
For 25 banks we have simply accepted their track record on jaws management and
assume that this continues over the next few years. For 18 banks their track record is
more ambiguous and we have made decisions on their aggressiveness or otherwise
based on our view of their existing business mix, management and the external
operating environment. For 4 banks we have decided to “reject” their cost
management track record and instead assume a different level of cost flexibility.
These are Deutsche Bank, Nordea, Danske and Credit Agricole, which all have
historically very poor jaws records, but where we have a greater degree of
confidence in the operational performance going forward. In the case of Credit
Agricole this in part reflects the realisation of merger synergies.
39
Figure 61. Historical Jaws Track Record and Jaws Forecast

MODELLED COST RESPONSE
Accept/ Cost response
% Positive Jaws Jaws Management
Reject to revenue Retail Corporate/ Investment Asset Man/
Last decade Last five years Last Decade Last five years History? pressure Commercial Bnkg/Markets Private Bnkg
Deutsche Postbank 100% 100% Aggressive Aggressive Accept Aggressive -2% -5% -10% -7%
Banesto 100% 100% Aggressive Aggressive Accept Aggressive -2% -5% -10% -7%
BP Verona Novara 83% 100% Aggressive Aggressive Accept Aggressive -2% -5% -10% -7%
Banco Sabadell 83% 80% Aggressive Aggressive Accept Aggressive -2% -5% -10% -7%
Santander 82% 100% Aggressive Aggressive Accept Aggressive -2% -5% -10% -7%
HBOS 75% 75% Aggressive Aggressive Accept Aggressive -2% -5% -10% -7%
Erste Bank 75% 80% Aggressive Aggressive Accept Aggressive -2% -5% -10% -7%
BBVA 73% 100% Aggressive Aggressive Accept Aggressive -2% -5% -10% -7%
BNP Paribas 71% 60% Aggressive Average Mixed Aggressive -2% -5% -10% -7%
Banco Popular 64% 100% Average Aggressive Mixed Aggressive -2% -5% -10% -7%
Bankinter 60% 80% Average Aggressive Mixed Aggressive -2% -5% -10% -7%
SEB 55% 80% Average Aggressive Mixed Aggressive -2% -5% -10% -7%
Alpha Bank 80% 60% Aggressive Average Mixed Average -1% -3% -10% -5%
Standard C 70% 60% Aggressive Average Mixed Average -1% -3% -10% -5%
Monte dei Paschi 70% 60% Aggressive Average Mixed Average -1% -3% -10% -5%
RBS 64% 80% Average Aggressive Mixed Average -1% -3% -10% -5%
Northern Rock 64% 80% Average Aggressive Mixed Average -1% -3% -10% -5%
Barclays 64% 60% Average Average Accept Average -1% -3% -10% -5%
All. & Leicester 64% 60% Average Average Accept Average -1% -3% -10% -5%
Bank of Ireland 63% 40% Average Poor Mixed Average -1% -3% -10% -5%
B&B 63% 60% Average Average Accept Average -1% -3% -10% -5%
Swedbank (FSB) 60% 60% Average Average Accept Average -1% -3% -10% -5%
Lloyds TSB 60% 20% Average Poor Mixed Average -1% -3% -10% -5%
Julius Baer 60% 60% Average Average Accept Average -1% -3% -10% -5%
Bank Austria 60% 60% Average Average Accept Average -1% -3% -10% -5%
Unicredito 56% 20% Average Poor Mixed Average -1% -3% -10% -5%
DnB NOR 56% 60% Average Average Accept Average -1% -3% -10% -5%
UBS 55% 40% Average Poor Mixed Average -1% -3% -10% -5%
SHB 55% 60% Average Average Accept Average -1% -3% -10% -5%
HSBC 55% 60% Average Average Accept Average -1% -3% -10% -5%
BNL 55% 80% Average Aggressive Mixed Average -1% -3% -10% -5%
Allied Irish Banks 55% 40% Average Poor Mixed Average -1% -3% -10% -5%
NBG 50% 40% Average Poor Mixed Average -1% -3% -10% -5%
Deutsche Bank 45% 60% Poor Average Reject Average -1% -3% -10% -5%
Banca Intesa 45% 60% Poor Average Mixed Average -1% -3% -10% -5%
ABN Amro 45% 60% Poor Average Mixed Average -1% -3% -10% -5%
Danske Bank 44% 20% Poor Poor Reject Average -1% -3% -10% -5%
Nordea 43% 40% Poor Poor Reject Average -1% -3% -10% -5%
Credit Agricole 40% 25% Poor Poor Reject Average -1% -3% -10% -5%
Commerzbank 45% 40% Poor Poor Accept Poor 0% -2% -5% -3%
SocGen 43% 40% Poor Poor Accept Poor 0% -2% -5% -3%
Sanpaolo IMI 43% 40% Poor Poor Accept Poor 0% -2% -5% -3%
Dexia 43% 25% Poor Poor Accept Poor 0% -2% -5% -3%
HVB Group 40% 40% Poor Poor Accept Poor 0% -2% -5% -3%
EFG Eurobank 40% 40% Poor Poor Accept Poor 0% -2% -5% -3%
DePfa Bank 40% 40% Poor Poor Accept Poor 0% -2% -5% -3%
Credit Suisse 36% 40% Poor Poor Accept Poor 0% -2% -5% -3%
40
Stage 4 — The Results

So, having applied revenue compression assumptions (as shown in Figure 58) to each
bank’s business mix (as shown in Figure 57), and making cost responsiveness
assumptions (as shown in Figure 61), we are now able to estimate potential earnings
revisions arising from this stress tested revenue environment.
Figure 62 shows the operating profit reduction for each country based on the
individual bank analysis performed above. Across the whole of the European bank
sector the reduction in operating profit would be 8.5% (on 2005 estimates) with the
worst impacted countries being Switzerland and Germany and the least impacted
Spain and Greece.
Figure 62. Simulated Operating Profit Impact — Using Historical "Jaws" Record
0%
Modelled Operating Profit Reduction (on 2005 forecasts
-2%
-4%
-6%
-8%
-10%
-12%
-14%
-16%
-18%
-20%
All European Banks
Switzerland
Benelux
Ireland
Austria
Germany
Italy
France
Nordics
Greece
Spain
UK
At the net profit level, the impact is obviously greater (10% across Europe on 2005
estimates) and Switzerland/Germany are again the most at risk countries. The least
affected countries would be Spain and Nordics.
41
0%
Modelled Net Profit Reduction (on 2005 forecasts)

-2%
-4%
-6%
-8%
-10%
-12%
-14%
-16%
-18%
-20%
-22%
All European Banks

Switzerland
Benelux
Ireland
Austria
Germany
Italy
France
Greece
Nordics
Spain
UK
Figure 64 shows the net profit impact by individual bank, using the business mix,
revenue compression and cost response assumptions discussed above.
0%
-2%
Modelled Net Profit Reduction (on 2005 forecsats)
-4%
-6%
-8%
-10%
-12%
-14%
-16%
-18%
-20%
-22%
-24%
-26%
-28%
-30%
-32%
-34%
All. & Leicester
Barclays
BP Verona Novara
Nordea (FDR)
SocGen
Julius Baer
Banco Sabadell
Lloyds TSB
HSBC
SHB
Commerzbank
Banca Intesa
Swedbank (FSB)
ABN Amro
Danske Bank
Banesto
HVB Group
Bank of Ireland
UBS
Sanpaolo IMI
Monte dei Paschi
Allied Irish Banks
RBS
HBOS
BBVA
Bankinter
Banco Popular
BNP Paribas
SEB
B&B
NBG
Credit Suisse
Deutsche Bank
BNL
Bank Austria
DePfa Bank
EFG Eurobank
Erste Bank
Alpha Bank
Northern Rock
Santander
DnB NOR
Standard C
Deutsche Postbank
Unicredito
We believe that there are some interesting observations worth making on the results
in Figure 64:
➤ Unsurprisingly, it is the German banks where profit estimates would be most at
risk, with net profit projected to decline by around one third at HVB and
Commerzbank and almost 20% at Deutsche Bank
➤ The investment banks would also suffer, although it is worth noting the
magnitude of the differential at Credit Suisse (simulated profits down 30%) and
UBS (down just half the Credit Suisse level)
42
➤ In France, there is also a clear difference between SocGen (profits down 14%)
and BNP Paribas (down 8%), largely reflecting SocGen’s poorer record at cost
control
➤ Indeed, there is a group of generally regarded as “high quality” large European
banks where the profit impact is similar and quite small (in the 6% to 8% range);
this group includes BBVA, HBOS, Santander, RBS and BNP Paribas
➤ All of the Nordic banks are pretty similar, with profit impacts for SHB,
Swedbank, SEB, DnB NOR, Danske and Nordea ranging from 6% to 8%
Implied Valuation
The purpose of the analysis in this chapter was to critically challenge the earnings
estimates that form the current valuation convergence in the sector. The final stage of
this analysis, therefore, is to look at how valuations in the sector compare after
making the simulated earnings revisions discussed above. Figures 65 to 68 show P/E
dispersions for 2005, 2006 and 2007 based on our current estimates and then based
on these flexed estimates. Unsurprisingly, after putting through estimate changes, the
sector’s valuation looks much more divergent than is currently the case. Indeed, the
dispersion looks more akin to what we saw in the late 1990s/early 2000 period.
Figure 65. P/E Dispersions — 2005 Cash EPS Forecasts Figure 66. P/E Dispersions — 2005 Flexed Cash EPS Forecasts
20% 30%
18%
25%
16%
Percentage of Sector Trading on PE Band
14%
20%
12%
10% 15%
8%
10%
6%
4%
5%
2%
0% 0%
Under 7x 7-8x 8-9x 9-10x 10-11x 11-12x 12-13x 13-14x 14-15x Over 15x Under 7x 7-8x 8-9x 9-10x 10-11x 11-12x 12-13x 13-14x 14-15x Over 15x
Figure 67. P/E Dispersions — 2006 Cash EPS Forecasts Figure 68. P/E Dispersions — 2006 Flexed Cash EPS Forecasts
35% 35%
30% 30%
25% 25%
20% 20%
15% 15%
10% 10%
5% 5%
0% 0%
Under 7x 7-8x 8-9x 9-10x 10-11x 11-12x 12-13x 13-14x 14-15x Over 15x Under 7x 7-8x 8-9x 9-10x 10-11x 11-12x 12-13x 13-14x 14-15x Over 15x
Source for all charts: Smith Barney estimates
43
Figure 69 shows how the country P/E ratings which of course follows the country
estimate revisions discussed above.
Figure 69. 2005E P/E Multiples by Country
18.0x
17.0x Current forecasts
16.0x Flexed forecasts

15.0x
Cash PE Multiples (2005)
14.0x
13.0x
12.0x
11.0x
10.0x
9.0x
8.0x
7.0x
6.0x
Austria
Spain
UK
France
Greece
Ireland
Switzerland
Germany
Italy
Nordics
Benelux
All European Banks
Finally, Figure 70 shows the entire European bank sector ranked by 2005E P/E, as
flexed for the revised earnings scenario.
Figure 70. European Banks Ranked by 2005E P/E, on Flexed Assumptions

29.7x
20.0x
19.0x
18.0x
17.0x
16.0x
2005 P/E (cash basis)
15.0x
14.0x
13.0x
12.0x
11.0x
10.0x
9.0x
8.0x
7.0x
6.0x
SocGen
All. & Leicester

Barclays
Nordea (FDR)
BP Verona Novara
HVB Group
Julius Baer
UBS
Banco Popular
HBOS
RBS
Banco Sabadell
HSBC
Sanpaolo IMI
SHB
Lloyds TSB
BNP Paribas
NBG
BNL
Commerzbank
Erste Bank
Banesto
Danske Bank
Banca Intesa
DePfa Bank
Swedbank (FSB)
ABN Amro
Bank of Ireland
Bankinter
Monte dei Paschi
Allied Irish Banks
BBVA
SEB
B&B
Credit Suisse
EFG Eurobank
Deutsche Bank
Bank Austria
Alpha Bank
Unicredito
Northern Rock
Santander
Standard C
DnB NOR
Deutsche Postbank
Source: Smith Barney analysis and estimates
44
Revenue Resilience
The analysis above has focussed on the potential cost response from each bank to
revenue weakness, and did so using a standardised business mix analysis for the
entire sector. The last part of our analysis to test the robustness of estimates is to
focus on the diversification of revenues at different banks. For the purpose of this
analysis we have restricted ourselves to the largest European banks that provide
divisional disclosure (note that many Italian banks do not provide detailed enough
disclosure to do meaningful analysis).
Our approach is to look at the spread of revenues generated by each bank across their
divisions. Generally, the more diversified the growth in revenues is, the more robust
the estimates are likely to be. As an example, we are more confident in our RBS
revenue forecasts than we are with our Barclays revenue forecast given the fact that
around half of the revenue growth at Barclays is forecast to come from Barclays
Capital, whereas at RBS the revenue base is much more diversified.
We then consider how correlated revenue streams across different divisions might
be. For example, there is likely to be a very low correlation (which should be good)
between Santander’s revenue growth from European retail banking and from Latin
American retail banking; however, there will clearly be a high correlation (which
could be bad) between revenue growth in UBS’s Wealth Management division and
its Investment Banking & Securities division. Figure 71 shows for each bank how
reliant it is on its most important revenue generating division. Thus, for example, the
division described as “Banking Activities” is forecast to account for almost 90% of
Danske’s revenue growth over the next three years, whereas at the other extreme
Standard Chartered’s most significant revenue contributor — Middle East/South
Asia — only accounts for a quarter of its revenue growth over the next three years.
Figure 71. Revenue Growth Concentration for Largest European Banks
100%
262%
Largest division's contribution to revenue growth, 2004-2007
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
ABN AMRO
HSBC —
Business
BBVA
RBS
UBS
Lloyds TSB
HVB
Danske
Suisse
Unicredito
Deutsche
Barclays
HBOS
SHB
Santander
Nordea
Paribas
SocGen
Chartered
Geographic
Credit
Standard
HSBC —
BNP
Bank
line
C&CC Banking Branch Retail European Personal UK Retail Barclays Private Retail Austria Spain North Retail Corp. Asset Int'l Int'l Wealth Middle
North Activities Offices Banking Retail Financial Banking Capital Banking Banking & & America Division Banking & Retail Retail Mgmt East
America Banking Services & CEE Portugal & Markets Wealth & Banking (Private &
Mortgages Retail Mgmt Fin Serv & Banking) S Asia
Fin Serv
Bank/Division
45
Generally we have been a little reluctant to rely too much on divisional disclosure and
there is one obvious limitation to this analysis. Simply put, the more divisions a bank
chooses to divide its group into, the more diversified its revenue base might appear,
regardless of the economic reality. And indeed the opposite is also true. In Figure 71 the
high reliance at Danske on one generically described division (“Banking Activities”)
might simply reflect the way it divides its business. Nevertheless, this is a valuable
exercise since it does serve to highlight which banks are better/worse placed. Note that
the following chapter includes (in chart form) revenue generation across divisions
historically and prospectively for each of these 20 banks.
As noted, it is not just the revenue concentration that matters, but also how correlated
the various revenue bases are for each bank. Figure 72 identifies for each bank the
two largest revenue-contributing divisions (ie the two that are forecast to account for
the highest proportion of revenue growth across the group over the next three years).
We also then comment on the likely correlation between each of these two divisions.
Figure 72. Concentration on Key Divisions for Europe's Largest Banks
Top 2 Divisional Contributions
Change in Concentration Correlation
Bank Group Revenues Division % of Group Division % of Group (total of top between top
2004-2007 Revenue Growth Revenue Growth 2 divisions) 2 divisions
Standard Chartered US$1488m Middle East & S Asia 24% India 18% 43% Low
UBS SFr6375m Wealth Management (Private Banking) 30% Investment Banking & Securities 27% 58% High
RBS £4536m Corporate Banking & Markets 39% Retail Banking 19% 58% Low
SocGen €2438m International Retail Banking & Fin Services 34% International Retail Banking 27% 61% Low
BNP Paribas €2667m International Retail & Fin Services 36% French Retail 25% 61% Low
BBVA €1277m Spain and Portugal Retail 44% LatAm Retail 21% 66% Low
Barclays £3061m Barclays Capital 51% Barclaycard 16% 67% Low
Deutsche Bank €2263m Asset & Wealth Management 39% Corporate Banking & Securities 31% 70% High
HSBC — Geographic US$10275m North America 44% Europe 28% 73% Low
Unicredito €1501m Retail Division 41% Corporate & Investment Banking 32% 73% Low
HBOS £2342m Retail Banking 45% Corporate Banking 31% 76% Low
HSBC — Business line US$10275m Personal Financial Services 64% Corp, Investment Banking & Markets 18% 82% Low
Credit Suisse SFr3714m Private Banking 47% Institutional Securities 35% 82% High
Nordea €831m Retail Banking 77% Corporate & Institutional Banking 10% 87% Low
HVB €1575m Austria & CEE 45% Germany 43% 88% Medium
Lloyds TSB £1144m UK Retail Banking & Mortgages 55% Wholesale & International 35% 90% Low
SHB SKr4576m Branch Offices 79% Markets 12% 91% Low
Danske DKr3762m Banking Activities 88% Mortgage Finance 12% 99% Medium
Santander €1783m European Retail Banking 68% Latin America 50% 118% Low
ABN AMRO €314m C&CC North America 262% Wholesale Clients 224% 486% Medium
There are several observations on Figure 72:

➤ The most diversified revenue base of any of these major banks appears to be
Standard Chartered. Its two largest divisions contribute just 43% of group
revenue growth over the next three years, and we believe that the correlation
between these two revenue streams is likely to be low
➤ Ignoring ABN (see below), Santander appears to have the highest reliance on
just two divisions, although the correlation between European Retail banking
revenues and LatAm revenues will clearly be low
➤ Both UBS and RBS have well diversified revenue bases; although in the case of
UBS there will be a strong correlation between its divisions given their capital
market focus. For RBS, this is likely to be less of a problem
46
➤ Each of SHB, Danske and Nordea appear to have a high reliance on one key
division (“Branch Offices”, “Banking Activities” and “Retail Banking”
respectively). However, this might simply serve to highlight one of the
limitations of divisional reporting — namely that it is a function of how the bank
chooses to disclose its performance. The (descriptively named) “Banking
Activities” at Danske will cover a range of activities which other banks might
disclose separately
➤ Finally, note that the ABN AMRO analysis showing a massive reliance on two
key divisions is an exaggeration because it largely reflects the 2004 disposal of
the group’s leasing business which means forecast revenue contribution from
that division has collapsed, causing all other divisions to increase their “share”
Finally, Figure 73 brings together these two estimate resilience measures, looking at
the ability to flex costs in response to revenue pressures discussed earlier in this
chapter and the revenue diversification analysis included above.
Figure 73. Summary of Earnings Resilience and Revenue Diversification for Europe's Leading Banks
Earnings Concentration Correlation

Resilience (total of top between
2005 2 divisions) top 2 divisions Comment
Banks we feel (relatively) confident in earnings/revenue resilience

Standard C -7% 43% Low High earnings resilience, diversified revenue base, low correlation
UBS -16% 58% High Low earnings resilience (but better than other Invest banks), diversified revenue base but highly correlated
RBS -7% 58% Low High earnings resilience, diversified revenue base, low correlation
BNP Paribas -8% 61% Low High earnings resilience, average revenue diversification, low correlation
BBVA -6% 66% Low High earnings resilience, some revenue concentration, low correlation between Spain and LatAm
HSBC (Geographic Split) -9% 73% Low Average earnings resilience, some revenue concentration (based on geography) but low correlation
HBOS -6% 76% Low High earnings resilience, some revenue concentration, low correlation
HSBC (Business Split) -9% 82% Low Average earnings resilience, more revenue concentration (based on business mix) but low correlation
Nordea (FDR) -7% 87% Low Average earnings resilience, high revenue concentration, low correlation
Lloyds TSB -10% 90% Low Average earnings resilience, high revenue concentration, low correlation
SHB -6% 91% Low Average earnings resilience, high revenue concentration, low correlation
Danske Bank -7% 99% Medium Average earnings resilience, high revenue concentration, medium correlation
Santander -6% 118% Low Average earnings resilience, high revenue concentration, low correlation between European & LatAm retail
ABN Amro -10% 486% Medium Average earnings resilience, distorted revenue concentration, medium correlation
Banks we feel less confident in earnings/revenue resilience

SocGen -14% 61% Low Low earnings resilience (esp compared to BNP Paribas), diversified revenue base, low correlation
Barclays -11% 67% Low Average earnings resilience, some revenue concentration low correlation (but worse then RBS on all measures)
Deutsche Bank -19% 70% High Low earnings resilience, some revenue concentration in highly correlated areas
Unicredito -10% 73% Low Average earnings resilience, some revenue concentration, low correlation
Credit Suisse -30% 82% High Low earnings resilience, high revenue concentration, high correlation
HVB Group -33% 88% Medium Low earnings resilience, high revenue concentration, medium correlation
Of these 20 largest banks, those that we feel a little less confident on their ability to
either flex costs in response to a revenue slowdown or to generate good top line
momentum are SocGen, Barclays, Deutsche Bank, Unicredito, Credit Suisse and
HVB.
The final section of this report analyses the sources of revenue growth and the mix of
revenues for each one of these 20 banks.
47
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48
REVENUE GENERATION
FOR MAJOR BANKS
49
ABN AMRO — Sources of Revenue

Growth
Figure 74. ABN AMRO — Sources of Revenue Growth (€m), 2001 – 2004
22,000
174 41 10
21,000
226 653
446
20,000 907
1,414
19,000
18,000
19,565
18,834
17,000
16,000
2001 Group and C&CC RoW Private C&CC C&CC Brazil Leasing C&CC North Wholesale 2004
Revenues Other Clients & Netherlands America Clients Revenues
Asset Mngt
Figure 75. ABN AMRO — Sources of Revenue Growth (€m), 2004 – 2007
23,000
22,000 274 27
385 760
392
21,000
702 1,474
20,000 822
19,000
18,000 19,565
19,565
17,000
16,000
2004 C&CC North Wholesale Private C&CC Brazil C&CC C&CC RoW Leasing Group and 2007
Revenues America Clients Clients & Netherlands Other Revenues
Asset Mngt
Source for both charts: Company Information and Smith Barney estimates
50
ABN AMRO — Mix of Revenues

Figure 76. ABN AMRO — Mix of Revenues, 2001
Group and Other

Leasing 1%
Private Clients & Asset Mngt 4%
8% C&CC North America
23%
Wholesale Clients
C&CC Netherlands
32%
16%
C&CC Brazil
C&CC RoW 10%
6%
Figure 77. ABN AMRO — Mix of Revenues, 2007

Group and Other
Leasing
1%
0%
Private Clients & Asset Mngt C&CC North America
10% 22%
Wholesale Clients
31%
C&CC Netherlands
17%
C&CC RoW C&CC Brazil

7% 12%
51
Barclays — Sources of Revenue

Growth
Figure 78. Barclays — Sources of Revenue Growth (£m), 2001 – 2004
15,000
53
368 217
14,500
560 692
14,000
579
13,500
13,000 1018
12,500
12,000 13957
1254
11,500
11,000
10,500 11138
10,000
2001 Barclays Barclaycard International UK Retail BGI Group and UK Business Private 2004
Revenues Capital Banking Other Banking Clients Revenues
Figure 79. Barclays — Sources of Revenue Growth (£m), 2004 – 2007

18,000
17,000 129
149
195
261
271
16,000
487
15,000
1570
17018
14,000
13,000 13957
12,000
2004 Barclays Barclaycard BGI UK Retail UK Business Private Clients International 2007
Revenues Capital Banking Banking Revenues
52
Barclays — Mix of Revenues

Figure 80. Barclays — Mix of Revenues, 2001
BGI Group and Other

5% 1%
UK Retail Banking
Barclays Capital 26%
18%
Barclaycard
12%
UK Business Banking
International 21%
3%
Private Clients
14%
Figure 81. Barclays — Mix of Revenues, 2007

Group and Other
BGI
1%
7%
UK Retail Banking
22%
Barclays Capital
27%
UK Business Banking
14%
Private Clients
Barclaycard 6%
International
17% 6%
53
BBVA — Sources of Revenue Growth

Figure 82. BBVA — Sources of Revenue Growth (€m), 2001 – 2004
13,000
94 42 121
362
12,000
1551
11,000
12214
10,000 10957
9,000
2001 Revenues Spain and Wholesale Group and Other Asset LatAm Retail 2004 Revenues
Portugal Retail Banking Management
Figure 83. BBVA — Sources of Revenue Growth (€m), 2004 – 2007

13,000
106
12,000 112
222
270
567
11,000
12234
10,000 10957
9,000
2004 Revenues Spain and LatAm Retail Group and Other Wholesale Asset 2006 Revenues
Portugal Retail Banking Management
54
BBVA — Mix of Revenues

Figure 84. BBVA — Mix of Revenues, 2001
Group and Other

Wholesale Banking 1%
8%
Asset Management
7%
Spain and Portugal Retail

35%
LatAm Retail
49%
Figure 85. BBVA — Mix of Revenues, 2007
Group and Other

Wholesale Banking 2%
10%
Asset Management
7%
Spain and Portugal Retail

43%
LatAm Retail
38%
55
BNP Paribas — Sources of Revenue

Growth
Figure 86. BNP Paribas — Sources of Revenue Growth (€m), 2001 – 2004
20,000
95 256
19,000 504
601
539
18,000
850
17,000
18582
17450
16,000
15,000
2001 Revenues International Asset French Retail Group and BNP Paribas Corporate & 2004 Revenues
Retail & Fin Management & Other Capital Investment
Services Services Banking
Figure 87. BNP Paribas — Sources of Revenue Growth (€m), 2004 – 2007
22,000
35 19
21,000 451
574
20,000 670
19,000 956
21248
18,000
18582
17,000
16,000
2004 Revenues International French Retail Asset Corporate & BNP Paribas Group and 2007 Revenues
Retail & Fin Management & Investment Capital Other
Services Services Banking
56
BNP Paribas — Mix of Revenues

Figure 88. BNP Paribas — Mix of Revenues, 2001
BNP Paribas Capital Group and Other

1% 0.03%
French Retail
25%
Corporate & Investment

Banking
36%
International Retail & Fin

Asset Management &
Services
Services
25%
13%
Figure 89. BNP Paribas — Mix of Revenues, 2007
BNP Paribas Capital Group and Other

0.1% 0.4%
French Retail
Corporate & Investment 26%
Banking
28%
Asset Management & International Retail & Fin

Services Services
16% 30%
57
Credit Suisse — Sources of Revenue

Growth
Figure 90 Credit Suisse — Sources of Revenue Growth (SFr m), 2001 – 2004
35,000
34,000 565
1,087
702
33,000
867
32,000
1,237
31,000
1,333
30,000
29,000 33,209
1,479
28,000
27,000
28,112
26,000
25,000
2002 Revenues Non Life (net of Life & Pensions Private Banking Wealth & Asset Corporate & Group and Other Institutional 2004 Revenues
claims) (net of Management Retail Banking Securities
claims/benefits)
Figure 91. Credit Suisse — Sources of Revenue Growth (SFr m), 2004 – 2007
38,000
308 8
37,000 339
321
356
36,000
1,308
35,000
34,000 1,752
36,922
33,000
32,000
33,209
31,000
30,000
2004 Revenues Private Banking Institutional Life & Pensions Corporate & Non Life (net of Group and Other Wealth & Asset 2007 Revenues
Securities (net of Retail Banking claims) Management
claims/benefits)
58
Credit Suisse — Mix of Revenues

Figure 92. Credit Suisse — Mix of Revenues, 2001
Group and Other

4%
Wealth & Asset Management
10%
Non Life (net of claims)

7%
Life & Pensions (net of

claims/benefits) Institutional Securities
4% 46%
Corporate & Retail Banking

9%
Private Banking
20%
Figure 93. Credit Suisse — Mix of Revenues, 2007
Group and Other

Wealth & Asset Management
2%
9%
Non Life (net of claims)

10%
Institutional Securities
38%
Life & Pensions (net of

claims/benefits)
7%
Corporate & Retail Banking

10%
Private Banking
24%
59
Danske — Sources of Revenue Growth

Figure 94. Danske — Sources of Revenue Growth (DKr m), 2001 – 2004
29,500
72 75
154 148
198
29,000
28,500 1032
28,000
29177
27,500
27,000 27949
26,500
26,000
2001 Revenues Danske Markets Life & Pensions Mortgage Group and Danske Capital Banking 2004 Revenues
Finance Other Activities
Figure 95. Danske — Sources of Revenue Growth (DKr m), 2004 – 2007
33,000
211 127
32,000 672
367
435
31,000
30,000
3294
29,000
31711
28,000
27,000
27949
26,000
25,000
2004 Revenues Banking Mortgage Danske Markets Life & Pensions Danske Capital Group and 2007 Revenues
Activities Finance Other
60
Danske — Mix of Revenues

Figure 96. Danske — Mix of Revenues, 2001
Group and Other

Danske Capital 6%
3%
Danske Markets
7%
Life & Pensions

4%
Mortgage Finance
12%
Banking Activities
68%
Figure 97. Danske — Mix of Revenues, 2007
Danske Capital Group and Other

3% 3%
Danske Markets
9%
Life & Pensions

4%
Mortgage Finance
12%
Banking Activities
69%
61
Deutsche Bank — Sources of Revenue

Growth
Figure 98. Deutsche Bank — Sources of Revenue Growth (€m), 2001 – 2004
26,000
129 180
25,000 692
3,562 1,270
24,000
23,000
2,397
22,000
21,000
20,000 22,265
21,159
19,000
18,000
2002 Revenues Group and Corporate Asset & Wealth Transaction Private & Corporate 2004 Revenues
Other Banking & Management Banking Business Investments
Securities Clients
Figure 99. Deutsche Bank — Sources of Revenue Growth (€m), 2004 – 2007
24,000
198 41 162
23,000 611
690
22,000
884
21,000
23,421
20,000
21,159
19,000
18,000
2004 Revenues Asset & Wealth Corporate Private & Transaction Group and Corporate 2007 Revenues
Management Banking & Business Banking Other Investments
Securities Clients
62
Deutsche Bank — Mix of Revenues

Figure 100. Deutsche Bank — Mix of Revenues, 2001
Group and Other

13%
Corporate Banking &

Corporate Investments Securities
10% 37%
Asset & Wealth Management

12%
Private & Business Clients Transaction Banking

19% 9%
Figure 101. Deutsche Bank — Mix of Revenues, 2007
Group and Other

Corporate Investments
2%
2%
Asset & Wealth Management

18%
Corporate Banking &

Securities
48%
Private & Business Clients

21%
Transaction Banking
9%
63
HBOS — Sources of Revenue Growth

Figure 102. HBOS — Sources of Revenue Growth (£m), 2001 – 2004
11,000
129 118
10,000
469 764
9,000
1377
8,000
1602 9425
7,000
6,000
6493
5,000
2001 Revenues Corporate Retail Banking International Insurance & Treasury Group and 2004 Revenues
Banking Investment Other
Figure 103. HBOS — Sources of Revenue Growth (£m), 2004 – 2007

12,000
65
142
11,500
350
11,000
727
10,500
10,000 1059 11767
9,500
9,000
9425
8,500
8,000
2004 Revenues Retail Banking Corporate Banking Insurance & International Treasury 2007 Revenues
Investment
64
HBOS — Mix of Revenues

Figure 104. HBOS — Mix of Revenues, 2001
Group and Other

12%
International
2%
Treasury
4%
Insurance & Investment Retail Banking

17% 52%
Corporate Banking
13%
Figure 105. HBOS — Mix of Revenues, 2007
International Group and Other

6% 0%
Treasury
4%
Insurance & Investment

13%
Retail Banking
50%
Corporate Banking
27%
65
HSBC — Sources of Revenue Growth

(By Geography)
Figure 106. HSBC — Sources of Revenue Growth ($m), 2001 – 2004
55,000
715 26 253
50,000 1138
45,000 6475
40,000
35,000 50617
16629
30,000
25,000
25888
20,000
2001 Revenues North America Europe Asia Pacific Hong Kong South America Group and 2004 Revenues
Other
Figure 107. HSBC — Sources of Revenue Growth ($m), 2004 – 2007

63,000
366 74
60,000 1059
1470
57,000 2917
54,000
4537 60892
51,000
48,000 50617
45,000
2004 Revenues North America Europe Hong Kong Asia Pacific South America Group and 2007 Revenues
Other
66
HSBC — Mix of Revenues (By

Geography)
Figure 108. HSBC — Mix of Revenues, 2001
Group and Other
South America
1%
7%
Hong Kong
23%
North America
15%
Asia Pacific
10%
Europe
44%
Figure 109. HSBC — Mix of Revenues, 2007
Group and Other

South America 1%
4% Hong Kong
13%
Asia Pacific
8%
North America
40%
Europe
34%
67
HSBC — Sources of Revenue Growth

(By Business)
Figure 110. HSBC (By Business) — Sources of Revenue Growth($m), 2001 – 2004
55,000
50,000 652 115

2178
2392
45,000
40,000
35,000 19391 50617
30,000
25,000
25888
20,000
2001 Revenues Personal Financial Corp, Investment Commercial Private Banking Group and Other 2004 Revenues
Services Banking & Banking
Markets
Figure 111. HSBC (By Business) — Sources of Revenue Growth ($m), 2004 – 2007
65,000
607 21
60,000 1253
1851
55,000
6585
60892
50,000
50617
45,000
2004 Revenues Personal Financial Corp, Investment Commercial Private Banking Group and Other 2007 Revenues
Services Banking & Banking
Markets
68
HSBC — Mix of Revenues (By

Business)
Figure 112. HSBC (By Business) — Mix of Revenues, 2001
Private Banking Group and Other

5% 1%
Corp, Investment Banking & Personal Financial Services

Markets 40%
30%
Commercial Banking
24%
Figure 113. HSBC (By Business) — Mix of Revenues, 2007
Private Banking Group and Other

4% 0.4%
Corp, Investment Banking &

Markets
20%
Personal Financial Services

60%
Commercial Banking
16%
69
HVB — Sources of Revenue Growth

Figure 114. HVB — Sources of Revenue Growth (€m), 2001 – 2004
11,500
11,000 6
245
721
10,500
10,000 543
9,500 618
10800
9,000
9157
8,500
8,000
2001 Revenues Austria & CEE Real Estate Corporates & Group and Other Germany 2004 Revenues
Workout Markets
Figure 115. HVB — Sources of Revenue Growth (€m), 2004 – 2007

11,000
2 87
283
10,500
672
10,000
9,500 709
10732
9,000
9157
8,500
8,000
2004 Revenues Austria & CEE Germany Corporates & Real Estate Group and Other 2007 Revenues
Markets Workout
70
HVB — Mix of Revenues

Figure 116. HVB — Mix of Revenues, 2001
Real Estate Workout Group and Other

0.1% 4%
Corporates & Markets

25%
Germany
42%
Austria & CEE

29%
Figure 117. HVB — Mix of Revenues, 2007
Real Estate Workout Group and Other

0.1% 2%
Corporates & Markets

20%
Germany
41%
Austria & CEE

37%
71
Lloyds TSB — Sources of Revenue

Growth
Figure 118. Lloyds TSB — Sources of Revenue Growth (£m), 2001 – 2004
12,000
11,500 604
976
11,000
10,500 1569
10,000 1782
9,500
9,000
9644
8,500 9059
8,000
2001 Revenues Wholesale & UK Retail Banking & Insurance & Group and Other 2004 Revenues
International Mortgages Investments
Figure 119. Lloyds TSB — Sources of Revenue Growth (£m), 2004 – 2007
10,500
4
120
10,000
402
9,500
626
10203
9,000
8,500 9059
8,000
2004 Revenues UK Retail Banking & Wholesale & Insurance & Group and Other 2007 Revenues
Mortgages International Investments
72
Lloyds TSB — Mix of Revenues

Figure 120. Lloyds TSB — Mix of Revenues, 2001
Group and Other

15%
UK Retail Banking &

Mortgages
44%
Wholesale & International
20%
Insurance & Investments

21%
Figure 121. Lloyds TSB — Mix of Revenues, 2007

Group and Other
3%
Wholesale & International

36%
UK Retail Banking &
Mortgages
51%
Insurance & Investments

10%
73
NORDEA — Sources of Revenue

Growth
Figure 122. NORDEA — Sources of Revenue Growth (€m), 2001 – 2004
6,500
45 17
6,000 50
139 236
5,500
5837 5889
5,000
4,500
2001 Revenues Retail Banking Asset Group Treasury Group and Other Corporate & 2004 Revenues
Management Institutional
Banking
Figure 123. NORDEA — Sources of Revenue Growth (€m), 2004 – 2007
7,000
19 2
70
86
6,500
638
6,000
6720
5,500
5889
5,000
2004 Revenues Retail Banking Corporate & Asset Group Treasury Group and Other 2007 Revenues
Institutional Management
Banking
74
NORDEA — Mix of Revenues

Figure 124. NORDEA — Mix of Revenues, 2001
Group Treasury Group and Other

Asset Management 1% 2%
4%
Corporate & Institutional

Banking
20%
Retail Banking
73%
Figure 125. NORDEA — Mix of Revenues, 2007
Group Treasury Group and Other

Asset Management 2% 2%
6%
Corporate & Institutional

Banking
16%
Retail Banking
74%
75
RBS — Sources of Revenue Growth

Figure 126. RBS — Sources of Revenue Growth (£m), 2001 – 2004
19,000 1 1
243
677
18,000
704
17,000 840
16,000 844
18910
15,000
1992
14,000
13,000
13610
12,000
2001 Corporate Retail RBS Citizens Retail Direct Ulster Bank Wealth Group and 2004
Revenues Banking & Banking Insurance Management Other Revenues
Markets
Figure 127. RBS — Sources of Revenue Growth (£m), 2004 – 2007

24,000
146 106
23,000 258
341
434
22,000 626
21,000 852
23446
20,000
1774
19,000
18,000 18910
17,000
2004 Corporate Retail Retail Direct RBS Citizens Wealth Ulster Bank Group and 2007
Revenues Banking & Banking Insurance Management Other Revenues
Markets
76
RBS — Mix of Revenues

Figure 128. RBS — Mix of Revenues, 2001
Group and Other

Citizens 2%
Ulster Bank 8%
3%
RBS Insurance
4%
Corporate Banking & Markets
Wealth Management 38%
7%
Retail Direct
10%
Retail Banking
28%
Figure 129. RBS — Mix of Revenues, 2007

Group and Other
Citizens 1%
9%
Ulster Bank
4%
RBS Insurance
8% Corporate Banking & Markets
38%
Wealth Management
5%
Retail Direct
11%
Retail Banking
24%
77
Santander — Sources of Revenue

Growth
Figure 130. Santander — Sources of Revenue Growth (€m), 2001 – 2004
24,000
137 191
23,000 1377
2055
22,000
21,000
20,000
3068
19,000
22241
18,000
17,000
18167
16,000
15,000
2001 Revenues European Retail Asset Wholesale Group and Other Latin America 2004 Revenues
Banking Management Banking
Figure 131. Santander — Sources of Revenue Growth (€m), 2004 – 2007

21,000
129 64
520
20,000
896
19,000
1213
18,000
19950
17,000
18167
16,000
15,000
2004 Revenues European Retail Latin America Asset Wholesale Group and Other 2006 Revenues
Banking Management Banking
78
Santander — Mix of Revenues

Figure 132. Santander — Mix of Revenues, 2001
Group and Other European Retail Banking

28% 28%
Wholesale Banking
5%
Asset Management
5%
Latin America
34%
Figure 133. Santander — Mix of Revenues, 2007
Group and Other

18%
Wholesale Banking
4% European Retail Banking
45%
Asset Management
5%
Latin America
28%
79
SHB — Sources of Revenue Growth

Figure 134. SHB — Sources of Revenue Growth (SKr m), 2001 – 2004
27,000
6
404
26,000
1213
25,000 2703
24,000
3192
23,000
22,000
21,000 23765
20,000 21654
19,000
18,000
2001 Revenues Branch Offices Markets Pension & Asset Group and Other 2004 Revenues
Insurance Management
Figure 135. SHB — Sources of Revenue Growth (SKr m), 2004 – 2007
29,000
91 31
28,000 333
568
27,000
26,000
3615
25,000
24,000 28341
23,000
22,000 23765
21,000
20,000
2004 Revenues Branch Offices Markets Asset Pension & Group and Other 2007 Revenues
Management Insurance
80
SHB — Mix of Revenues

Figure 136. SHB — Mix of Revenues, 2001
Group and Other

12%
Pension & Insurance
1%
Asset Management
5%
Markets
10%
Branch Offices
72%
Figure 137. SHB — Mix of Revenues, 2007
Pension & Insurance

2% Group and Other
Asset Management 1%
5%
Markets
14%
Branch Offices
78%
81
SocGen — Sources of Revenue

Growth
Figure 138. SocGen — Sources of Revenue Growth (€m), 2001 – 2004
17,000
274
610
473
16,000
1,103
15,000
1,169
14,000 16,210
13,000 14,075
12,000
2001 Revenues International Retail Global Investment French Retail Group and Other Corporate & 2004 Revenues
Banking & Fin Management Banking Investment
Services Banking
Figure 139. SocGen — Sources of Revenue Growth (€m), 2004 – 2007
19,000
15
439
18,000 524
663
17,000
18,649
827
16,000
16,210
15,000
2004 Revenues International Retail French Retail Corporate & Global Investment Group and Other 2007 Revenues
Banking & Fin Banking Investment Management
Services Banking
82
SocGen — Mix of Revenues

Figure 140. SocGen — Mix of Revenues, 2001
Group and Other

1%
Corporate & Investment French Retail Banking

Banking 36%
36%
Global Investment
International Retail Banking &
Management
Fin Services
8%
19%
Figure 141. SocGen — Mix of Revenues, 2007
Group and Other

1%

Banking French Retail Banking
27% 34%
Global Investment
Management
14% International Retail Banking &
Fin Services
24%
83
Standard Chartered — Sources of

Revenue Growth
Figure 142. Standard Chartered — Sources of Revenue Growth ($m), 2001 – 2004
5,500
32 0 34
118 45
166
5,000 196
201
4,500 290
5329
4,000
4405
3,500
3,000
2001 Other Asia Africa Middle East India Singapore Malaysia Group and UK, Head Hong Kong 2004
Revenues & S Asia Other Office, Revenues
Americas
Figure 143. Standard Chartered — Sources of Revenue Growth ($m), 2004 – 2007
7,000
76.3 18 0
143
6,500 193
201
220
6,000
273
5,500 363
6817
5,000
5329
4,500
4,000
2004 Middle East India Other Asia Hong Kong Africa Singapore Malaysia UK, Head Group and 2007
Revenues & S Asia Office, Other Revenues
Americas
84
Standard Chartered — Mix of

Revenues
Figure 144. Standard Chartered — Mix of Revenues, 2001
India
8%
Middle East & S Asia
10%
Hong Kong
33%
Africa
8%
UK, Head Office, Americas

14%
Singapore
10%
Other Asia Malaysia

12% 5%
Figure 145. Standard Chartered — Mix of Revenues, 2007

India
12%
Hong Kong
23%
Middle East & S Asia

15%
Singapore
10%
Africa
11%
Malaysia
5%
UK, Head Office, Americas
9% Other Asia
15%
85
UBS — Sources of Revenue Growth

Figure 146. UBS — Sources of Revenue Growth (SFr m), 2001 – 2004
40,000
145 29
412
39,000 741
740
38,000 922
1296
37,000
37612
36,000 37001
35,000
2001 Investment Wealth Private Global Asset Group and Business Wealth 2004
Revenues Banking & Management Banking & Management Other Banking Management Revenues
Securities (Private GAM Switzerland USA (Paine
Banking) Webber)
Figure 147. UBS — Sources of Revenue Growth (SFr m), 2004 – 2007
44,000
155 70
426
796
42,000
1387
40,000 1753
38,000 1928
43377
36,000
34,000
37001
32,000
30,000
2004 Wealth Investment Wealth Business Global Asset Private Group and 2007
Revenues Management Banking & Management Banking Management Banking & Other Revenues
(Private Securities USA (Paine Switzerland GAM
Banking) Webber)
86
UBS — Mix of Revenues

Figure 148. UBS — Mix of Revenues, 2001
Private Banking & GAM

3% Group and Other
2%
Global Asset Management
5%
Wealth Management USA Investment Banking &

(Paine Webber) Securities
17% 39%
Business Banking Switzerland

15%
Wealth Management (Private
Banking)
19%
Figure 149. UBS — Mix of Revenues, 2007
Private Banking & GAM

3% Group and Other
Global Asset Management 1%
6%
Wealth Management USA

(Paine Webber) Investment Banking &
15% Securities
40%
Business Banking Switzerland

13%
Wealth Management (Private

Banking)
22%
87
UniCredito — Sources of Revenue

Growth
Figure 150. UniCredito — Sources of Revenue Growth (€m), 2001 – 2004
11,000
113 110
156
390
194
10,500
10,000
10465 10428
9,500
9,000
2003 Revenues Corporate & New Europe Private Banking & Group and Other Retail Division 2004 Revenues
Investment Division Asset
Banking Management
Figure 151. UniCredito — Sources of Revenue Growth (€m), 2004 – 2007

12,500
12,000 201 94
301
11,500
476
11,000
618
10,500 11929
10,000
10428
9,500
9,000
2004 Revenues Retail Division Corporate & New Europe Private Banking & Group and Other 2006 Revenues
Investment Division Asset
Banking Management
88
UniCredito — Mix of Revenues

Figure 152. UniCredito — Mix of Revenues, 2001
Group and Other
Unicredit Spa and Others 1%
10%
New Europe Division

14% Retail Division
40%
Private Banking & Asset

Management
9%

Banking
26%
Figure 153. UniCredito — Mix of Revenues, 2007

Group and Other
Unicredit Spa and Others 0%
10%
New Europe Division Retail Division

16% 36%
Private Banking & Asset

Management
10%

Banking
28%
89
European Banks Summary

Recommendations & Target Prices
Figure 154. Summary of European Bank Recommendations, December 2004
1
Bank Rating Currency Current Price Target Price Country
ABN AMRO 1M EUR 19.49 21.00 Netherlands

Alliance & Leicester 3M GBP 9.12 7.50 United Kingdom
Allied Irish Banks 2M EUR 15.35 12.50 Ireland
Alpha Bank 1M EUR 25.66 26.10 Greece
Banca Intesa 1H EUR 3.54 3.90 Italy
Banca Monte dei Paschi di Siena 2M EUR 2.63 2.70 Italy
Banca Nazionale del Lavoro 2H EUR 2.19 1.85 Italy
Banco Bilbao Vizcaya Argentaria 2M EUR 13.05 11.90 Spain
Banco Popolare Verona e Novara 1M EUR 14.96 16.80 Italy
Banco Popular Espanol 2L EUR 48.50 49.00 Spain
Banco Sabadell 2M EUR 17.20 18.50 Spain
Banesto 2M EUR 67.80 10.40 Spain
Bank Austria 1M EUR 10.51 71.00 Austria
Bank of Ireland 2L EUR 12.25 11.25 Ireland
Bankinter 3M EUR 39.19 31.00 Spain
Barclays PLC 3M GBP 5.86 5.00 United Kingdom
BNP Paribas 1M EUR 53.30 60.00 France
Bradford & Bingley 2M GBP 3.36 2.80 United Kingdom
Commerzbank 2S EUR 15.16 14.25 Germany
Credit Suisse Group 2H CHF 47.80 48.00 Switzerland
Danske Bank 3M DKK 167.75 154.00 Denmark
DePfa-Bank 2H EUR 12.35 12.20 Germany
Deutsche Bank 1M EUR 65.32 78.00 Germany
Deutsche Postbank 2H EUR 32.50 31.00 Germany
DnB NOR 2M NOK 59.75 54.00 Norway
EFG Eurobank Ergasias 1M EUR 25.28 24.10 Greece
ForeningsSparbanken (Swedbank) 1M SEK 165.50 175.00 Sweden
HBOS 1M GBP 8.48 8.50 United Kingdom
HSBC Holdings 3M GBP 8.79 7.75 United Kingdom
HVB Group 3S EUR 16.70 13.00 Germany
Julius Baer 2H CHF 342.25 360.00 Switzerland
Lloyds TSB Group 2M GBP 4.73 4.30 United Kingdom
National Bank of Greece 1M EUR 24.28 25.40 Greece
Nordea 3M EUR 7.47 6.75 Finland
Northern Rock 2M GBP 7.82 7.50 United Kingdom
Royal Bank of Scotland 1M GBP 17.52 19.00 United Kingdom
Sanpaolo IMI 2M EUR 10.60 10.40 Italy
Santander Central Hispano 3M EUR 9.13 7.50 Spain
SEB 2M SEK 128.50 120.00 Sweden
Societe Generale 1M EUR 74.45 85.00 France
Standard Chartered 1M GBP 9.69 11.00 United Kingdom
Svenska Handelsbanken 2M SEK 173.00 165.00 Sweden
UBS 1M CHF 95.35 105.00 Switzerland
UniCredito Italiano 1M EUR 4.23 4.90 Italy
1
Current Price & Ratings taken 31/12/04
90
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See page 91 for Analyst Certification and Important Disclosures

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With banks trading in a narrow range and valuations converged, 2004

Investment Themes for 2005

Banks Focus List – Fundamental Stocks

Not all the same

Source: DataStream and Smith Barney

Performance relative to European Equity Markets

Key Investment Themes and Recommendations for 2005

Theme 1 — Growth Matters

Theme 2 – Earnings resilience

Source: Smith Barney analysis

Figure 5. Simulated Net Profit Impact — Using Historical "Jaws" Record

Modelled Net Profit Reduction (on 2005 forecasts)

All European Banks

Theme 3 – Capital Returns

Figure 6. Capital Return by Banking Sector, 2005E

Figure 9. Potential 2005 Restructuring Stocks — Valuation Metrics (December 2004)

Restructuring Stocks to buy in 2005

Restructuring Stocks to avoid in 2005

➤ At the end of 2004 Credit Suisse announced a wide-ranging overhaul of its

Investing in these Themes — by Country and by Bank

Top down Bottom up Surplus Capital Earnings Surplus Capital Earnings

All Europe 4.7% 5.0% 1.9% -10.2% 10.9x 100%

Using this matrix approach we would make the following observations:

Surplus Capital Earnings Surplus Capital Earnings

Recommendations for 2005

Austria Benelux Germany

Bank Key Driver(s) Valuation Bank Key Driver(s) Valuation

Bank Comment Bank Comment

Then and Now

➤ On our 2005 forecasts, we estimate half the sector trades on a P/E of

➤ This increase in convergence is also apparent in price to book

2000 Underlying PE 2001 Underlying PE

Percentage of European bank sector

Percentage of European bank sector

Price to Book, 1999 Price to Book, 2000

Percentage of European bank sector

Price to Book, 2001 Price to Book, 2002

Percentage of European bank sector

Price to Book, 2003 Price to Book, 2004

Percentage of European bank sector

Source: Smith Barney

Why have European bank valuations

➤ In addition, massive leverage leaves investors wary of differentiating

➤ Furthermore, there are some 2004/5 specific drivers of convergence;

Generic Drivers of Convergence

Driver of Convergence 1 — Products

Driver of Convergence 2 — Economies of Scale

Cost Income Ratio (2004E)

Driver of Convergence 3 — Brands

Figure 34. Top 45 Brands in the World

Top 20 Average 28%

Driver of Convergence 4 — Leverage

All. & Leicester

Monte dei Paschi

Source: Company information and Smith Barney estimates

Current Factors Driving Convergence

(1) Economic and Capital Markets Uncertainty

(2) Surplus Capital/M&A – Good or bad?

2004 Share price performance (relative to

Source: DataStream and Smith Barney estimates

Source: DataStream and Smith Barney estimates

Why Convergence is wrong