Can You Bank On European Banking? (DB, UBS, CS)

By Dean Lundell | September 04, 2007 AAA

It used to be that there was a clear dividing line between commercial banks and investment banks. That "line" started at the teller window. Commercial banks had lines; investment banks didn't - although, to be fair, they also didn't have tellers.

This distinction has begun to fade both domestically and abroad. In this article we're going to examine three European banks (one German and two Swiss) that may have teller windows, but there is no doubt that they are investment banking powerhouses.

Trading Its Way to Prosperity
You may be able to stand in line to see a teller at Deutsche Bank (NYSE:DB) but make no mistake, CEO Josef Ackermann plans on building DB into a world-class investment bank. Even now, investment banking functions account for 65% of DB's $28.3 billion in revenue. Of that total, debt trading comprises the single biggest source.

Although Deutsche Bank has 7.8 million retail customers, it makes the majority of its profit from proprietary trading, investment banking fees, syndicated loans and advisory services on leveraged buyouts. Asset management accounts for 18% of DB's profits and the bank is slowly unwinding equity positions in firms such as DaimlerChrysler (NYSE:DAI) and Allianz (NYSE:AZ) which will free up additional capital targeted towards investment banking operations and investments in hedge funds.

Deutsche Bank's revenue growth has been fairly steady these past three years, hovering around 10%. The bigger story is its earnings which have averaged a growth rate of 77.2% over those same three years and almost 65% last year. DB enjoys a net margin of just more than 21% and a return on equity of about 19%. (To learn more, see Analyzing A Bank's Financial Statements.)

Quick on the Trigger
UBS AG (NYSE:UBS) is the combination of Swiss Bank Corporation and Union Bank of Switzerland in 1998 and is the largest of this trio with $105.6 billion in market capitalization and revenue approaching $48.2 billion. UBS is the world's largest asset manager with assets under management of about $3 trillion, which account for 46% of UBS's operating profit. UBS's other star is its investment banking operation which accounts for 40% of the firm's operating profit.

UBS has a distinctly lower risk profile than DB, eschewing proprietary trading in favor of fee-driven business such as M&A advisory fees, underwriting fees and structured products like derivatives origination. (For related reading, check out Paying Your Investment Advisor - Fees Or Commissions?)

UBS has gained a reputation for being quick on the trigger, both to take advantage of situations like opening an office in Singapore for its bank secrecy laws or to cut out an unprofitable operation such as Julius Baer or Dillon Reed (shuttered because of subprime mortgage issues).

UBS's revenue and earnings growth numbers are considerably lackluster. Revenue growth, while averaging 12.4% over the past three years was a -5.5% last year. Earnings growth has been zero for the past five years. Despite these results, UBS operates on a 26.5% net margin and 22.7% return on equity.

Give Credit to the Swiss
Credit Suisse Group (NYSE:CS), with its $73 billion in market cap and $38.6 billion in revenue, operates under one name now, having sold Winterthur to AXA (NYSE:AXA) and no longer using "First Boston" in its name. Credit Suisse is one of Wall Street's top investment banks, with expertise in leveraged finance, hedge funds and M&A advisory services. It also gets top marks for its ability in private banking and asset management.

Between its three major business segments, CS is executing well and taking advantage of cross-selling opportunities. It is the second largest retail bank in Switzerland and has roughly $1.4 trillion under management.

With purchases and divestitures in the mix, Credit Suisse's recent financial results are somewhat confusing. Revenue has growth has gone down the last three years (-9.2% average), dropping to -36.3% last year. Earnings growth comes in at 72.9% when averaged over the last three years; it was 42.9% last year. Credit Suisse's net margin of 29.3% gives a return on equity of 26.4%

Looking East and West
The shares of these banks have done reasonably well over the past three years:

• Deutsche Bank's shares have risen about 80%.
• UBS has returned roughly 50%.
• Credit Suisse has appreciated about 100%.

Having recognized Europe as a limited and mature market, each of these banks is now looking to both Asia and the West to fuel future growth. The first of the trio to make inroads may very well end up being the stock that provides the best returns in the coming years.

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