UK Banks
Living on a prayer
Scarce and expensive wholesale funding is likely to constrain unguaranteed new
lending appetite this year and next. This means losses for the domestic UK banks
through to FY11F as rising impairments more than offset declining preimpairment
profit. Reiterate sector Underweight.
Table 1 : Recommendations and valuation multiples
Upside/ Mk to mkt TCE P / MtM TCE
Rec TP Price downside FY08F FY09F FY10F FY08F FY09F FY10F Ro TCE
Barclays Sell 1.1 1.39 -21% 1.67 1.62 1.62 0.8 0.9 0.9 12.2
Lloyds / HBOS Hold 1.05 1.05 0% 1.64 1.52 1.34 0.6 0.7 0.8 13.9
HSBC Sell 4.5 5.68 -21% 3.31 3.20 3.24 1.7 1.8 1.8 18.2
St Ch Sell 6.4 7.83 -18% 5.09 5.12 5.26 1.5 1.5 1.5 14.8
Source: ABN AMRO. Mark-to-market TCE adjusts for our estimate of the unrecognised mark-to-market valuation of credit market
risk assets.
Banks’ wholesale funding likely to remain scarce and expensive
Not unusually at this stage in the economic cycle, the domestic UK banks are technically
insolvent on a fully marked-to-market basis. But RBS credit strategists believe that the
combination of heavy supply, rising defaults and low recovery rates means that credit asset
spreads will hit new wides in 2009. We calculate that the domestic UK banks rely on ￡1.7trn
of wholesale funding, including a ￡490bn maturity mismatch, and with over ￡130bn of longterm
debt maturing in 2009. This probably means that unguaranteed new lending activity will
remain limited, particularly as net interest income gets crushed with the base rate now below
3-3.5%. Credit availability is, historically, a very good lead indicator of economic growth.
Sector-wide losses likely FY09-10F as impairments rise and pre-impairment profit falls
Our historical regression analysis implies ￡143bn of impairments for the domestic UK banks
by FY11F. Even with no dividends, we expect tangible common equity per share to decline
for every bank as underlying annual pre-impairment profit falls by 11% in FY09F. The
resultant post peak (FY11F) impairment charge TCE/RWA ratio of 5.4% implies a ￡36bn
equity shortfall vs our blended 7.5% target. (TCE = Tangible Common Equity; RWA = Risk
Weighted Assets.) Capital-adjusted RoTCE should settle at around 12%, although this falls
to 10% with medium-term swaps at 2%. RWA ratios could differ materially, either from credit
guarantees, revised Basle 2 rules, or by investor acceptance that a thinner capital cushion is
not a problem as impairments rise above normal levels. Our suspicion is that these would
only be credible or affordable once a stabilisation in asset quality trends becomes obvious.
Further government initiatives are likely, but terms & conditions are unpredictable
The UK Government will need to announce further initiatives to improve credit availability, in
our opinion, and further capital injections appear not to be the preferred method for now.
Quantifying and offloading embedded toxic assets sits at the heart of our preferred structural
solution for the UK banking crisis, rather than funding or asset guarantees and/or
government-initiated lending. Implementing the December Citigroup bail out terms in the UK
could double our target prices for beneficiary banks. We upgrade Lloyds from Sell to Hold as
the most geared to any equity friendly Government initiative, and undemanding valuation.
We lower Barclays, HSBC and Standard Chartered from Hold to Sell.

Contents
Living on a prayer 3
The market value of domestic UK banks’ assets is less than their outstanding
liabilities, and we expect losses through to FY11F. This will drive persistent fears of
further equity issuance unless governments or regulators offer equity-friendly bail
outs.
3
We’ve got to hold on to what we’ve got 9
We reiterate our negative conclusion on the six issues that matter for investors:
mark to market vs NPV; wholesale funding costs and availability; cumulative losses;
post peak impairment capital ratios and required levels; new world RoTCE;
government initiatives.
9
Wholesale funding costs 10
Embedded losses 16
Tangible common equity progression 24
RWA ratios 25
New world RoTCE 27
Likely government initiatives 28
Valuation 29
Appendix 31
This section sets out our principal financial forecasts, valuation multiples, target
prices and recommendations for the UK banks.
31
Company profiles
Barclays 33
Lloyds TSB 35
HSBC Holdings 37
Standard Chartered 39