European Investment Banks
New IB World: restructuring inevitable to create value
Banks
Kian AbouhosseinAC
(44-20) 7325-1523
kian.abouhossein@jpmorgan.com
Jacob Kruse
(44-20) 7325-1847
jacob.m.kruse@jpmorgan.com
Delphine Lee
(44-20) 7325-3971
delphine.x.lee@jpmorgan.com
J.P. Morgan Securities Ltd.
See page 67 for analyst certification and important disclosures, including non-US analyst disclosures.
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Scenario analysis: IB Restructuring
leading to 15% net ROE in 2010E
UBS CSG DB
1. Staff Right Sizing (since 3Q 08)
Announced -2,000 -3,800 0
JPM Base 0 0 -534
15% ROE
Scenario
-1,100 -200 -4,000
Total -3,100 -4,000 -4,534
Base % -11% -18% -2%
15%
ROE %
-16% -19% -20%
2. Cash IC Reduction
2008E/07 -76% -60% -66%
15% ROE
2010E/08E
-13% -20% -14%
Total
2010E/07
-79% -68% -71%
3. IB Capital Shrinkage since 3Q 08)
Base Case -13% -17% -8%
15% ROE
Scenario
-31% 0% -13%
Total -44% -17% -21%
Net ROE 2010E
ROE Base
Case
9.5% 13.1% 11.1%
ROE
Scenario
15.0% 15.0% 15.0%
Source: J.P. Morgan estimates.
• We witnessed 'super' returns within the IB industry over the last 6 years
with capital consumed increasing 60% between 02-07 and ROEs rising from
9% in 02 to 29% in 06. The marginal ROE increased materially despite
capital consumed increasing, illustrating the over-leverage and risk-taking
business expansion within the IB industry.
• With the death of ‘super’ leverage profit, such as structuring, risk warehousing
and position taking, as well as the simultaneous client flow revenue slowdown
from a peak (FX, Commodities) 2008E level, the IB revenue run-rate is
structurally going to change, with i) 2009E revenues at the lowest level in
the last 10 years, leading to on average -66% EPS cuts as outlined in the
Table below, and ii) 2010E forecasted as a normalized IB revenue level, inline
with 2003 levels.
• Our base case IB ROE of -2% in 2009E and 11% in 2010E is unlikely to be
acceptable to shareholders in our view, triggering necessary IB industry
restructuring in 2009E in order to generate an acceptable net 15% ROE in
2010E, through 3 ‘levers’ in our scenario analysis:
1. Based on our base case, we expect 2010E staffing levels in-line with 2005
based on -10% reduction compared to 3Q08, but revenues are only in-line
with 2003. Hence right-sizing is required. We estimate reduction of -
8% additional staffing relative to 3Q 08.
2. We expect IB cash incentive compensation cuts of 67% in 2008E/07.
However, further structural adjustment is required in 2010E even in
an improving revenue year leading to an additional -16% cuts from
2008E level in our scenario analysis.
3. With fewer risk-taking businesses and an industry refocus on flow
revenues, IB allocated capital should be reduced. We already forecast
13% decline in 2010E compared to 3Q08 in our base case, however our
15% ROE scenario analysis requires additional -15% cuts vs. 3Q 08.
• Within European Banks, we prefer IBs over Retail Banks due to i) cost
restructuring flexibility and ii) ongoing markdowns of risk as the traditional
credit provisions are just starting to increase. However with ongoing NAV at
risk concerns and consensus EPS far too high, IBs need to announce
material restructuring to trigger a revaluation. Within IBs, our pecking
order continues to be i) CSG, ii) UBS and iii) DB, with CSG NAV risk
limited and private banking franchise intact.

Table of Contents
Executive Summary .................................................................3
Investment Case Summary......................................................8
Long-term preference for Wholesale & Investment Banks over Retail banks.............8
So when do I buy IBs on absolute basis? Not yet!.......................................................8
Positioning within the Investment Banking sector.....................................................10
Credit Suisse ..........................................................................12
UBS..........................................................................................13
Deutsche Bank .......................................................................14
‘Super’ IB returns through leveraging and risk-taking
business build-up...................................................................16
2000-2007: a period of leverage build-up and Capital at risk....................................16
Base Case IB ROE 2009E-10E – unacceptable to
shareholders...........................................................................19
2009E one of the worst IB revenue years – ROE at -2%...........................................19
Normalised IB revenues in 2010E, in-line with 2003: ROE 11%..............................20
2009E/10E staff levels still in line with 2005 – unsustainable...................................23
Base Case – IB capital reduction not acceptable........................................................24
Can banks reach 15% IB net ROE over the cycle –
implications for staff and capital levels? .............................25
Sensitivity analysis summary – the route to 15% ROE .............................................25
Methodology and assumptions – Detailing restructuring revenue loss impact ..........31
Detailed Staff Analysis – right-sizing potential....................32
What has been announced so far on headcount reduction..........................................33
Detailed Incentive compensation (IC) Analysis – Structural Adjustment .................35
Compensation expense analysis breakdown ..............................................................36
IB Capital Allocation Analysis – reduction required ...........40
Current banks strategy on IB equity reductions.........................................................41
Sensitivity to 10% changes in staff, equity and IC ‘Levers’43
Sensitivity to 10% staff reductions ............................................................................43
Sensitivity to 10% cut in IB incentive compensation ................................................44
Sensitivity to 10% reduction in IB capital .................................................................45
Revenue run rate 2009E-2010E – detailed analysis.............47
Summary split by business.........................................................................................49
UBS..........................................................................................54
Credit Suisse ..........................................................................59
Deutsche Bank .......................................................................63

Executive Summary
In our view, in 2008 the Investment Banking industry was fire-fighting “blow ups”
with some restructurings announced at the end of the year. We believe 2009E will be
the year for major strategic business right sizing, as further measures will be
required to improve net ROE to more sustainable 15% level, especially given the
deteriorating flow revenue environment in 2009/10E. As of 2010E, we see the
potential for the pecking order within the IB landscape to change. In this report we
discuss the structural changes expected within the IB business environment and traits
of long-term champions.
The end of over-leverage and super profit...
We already noted in our report “Global Banks: Acid Test - Earnings and Capital at
Risk Analysis” of 15 June 06, the issue of over-leverage and super profit built-up
with:
• Capital consumed increasing 10% per annum or by 60% in total between 2002
and 2007.
• At the same time net ROEs increased from 9% in 2002 to 29% in 2006, even
beating 2000 at 21% when there was less capital allocated.
The data illustrates that marginal net ROE increased materially despite capital
consumed increasing.
The question we ask ourselves is, how is it possible that i) despite full agency flow
revenue margins declining annually and ii) electronic trading penetration increasing
at even lower spreads, ROEs are still increasing? Even analyzing the progression of
transaction volumes does not justify the “super” returns witnessed over the last 6
years in our view.
We conclude, in a competitive IB environment, super profits over the last 6
years could only be generated through i) material prop risk taking, ii)
origination and warehousing of ABS, and iii) increasing client origination of
exotic & hybrid business. All of these businesses involve capital leverage.
... with the death of ‘super’ profits and at the same time flow revenue slowdown,
IB revenues run-rate structurally changing to normal IB year 2010 = 2003... We
forecast a detailed revenue breakdown by business for each bank (summary see
Table 3 below). We illustrate that markdowns and prop/hedging related losses
overshadowed the peak results in 2008 flow revenues within almost all sub-business
segments. We witnessed:
• one of the best cash equity years since 2000,
• peak revenues in commodities and FX for the last 10-15 years,
• very strong derivative flow such as CDS and equity derivatives, with increasing
spreads and strong volumes
• very strong 1H08 performance in underwriting and Emerging Market businesses,
although materially deteriorating in 2H08.