Italian banks. Update following recent volatility. Equity Research

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1 Equity Research Independent European Research 07 April 2016 Italian banks Update following recent volatility The sector is currently facing many changes. The ECB and the Italian government are both focused increasingly on sector NPLs. In the short term government attention is on the closure of BP Vicenza and Veneto Banca capital increases. In the mid-term Italy is considering the creation of a state-backed fund that would help troubled lenders by buying up bad loans and plug capital shortfalls. However pending further clarity we calculate that on average the sector needs EUR18.8bn extra LLP net of tax, equal to 2.14x the sum of sector net profit over the next two years. We expect greater clarity from banks during Q reporting. Macro picture is deteriorating Italian gross NPLs rose 11% YOY in FY2015 to EUR200bn. The ratio of NPLs to all loans climbed to 12.9% from 11.6% in FY2014. At 12.9% last year s NPL ratio is well ahead of the EU average of 7.7%. Such adverse market conditions will weigh on the sector in the form of higher loan-loss provisions. Enrico Racioppi enrico.racioppi@ hammer-partners.com.racioppi@ hammer-partners.com Pan-European Sales Desk sales@ hammer-partners.com Italian government and the ECB increasingly focused on NPLs Italy s short-term versus long-term focus: In the near-term Italy is occupied with the closure of two significant capital increases: EUR1.75bn at BP Vicenza, guaranteed by Unicredit, and a further EUR1bn guaranteed by Intesa Sanpaolo. In the mid-term Italy is considering the creation of a state-backed fund to help troubled lenders by buying bad loans and plugging capital shortfalls. Ultimately there may be two funds: one for capital increases and one to buy bad loans. Conclusions We believe that sector profit could come under pressure in the next two years: on average the sector needs EUR18.8bn extra LLP net of tax, equal to 2.14x sector net profit over the next two years. Banks at risk in our view are: Unicredit (EUR3.3bn capital need and could wipe out 1.24x its E net profit) and Intesa Sanpaolo, which despite its excess capital we see risk for our profit and dividend forecast (62% of our E net profit forecast at risk). We also see risk for Banca MPS (748%), Banco Popolare (370%), BP Milano (116%). We prefer Mediobanca with EUR2.1bn excess capital and only 5% of profit at risk. Banks Rec PBV16e PBV17e PBV18e PE16e PE17e PE18e DY16e DY17e DY18e Deutsche Bank Sell 0,33 0,32 0,30 10,4 6,1 4,6 0,0% 3,8% 6,1% Santander Buy 0,58 0,56 0,53 8,6 7,5 6,8 5,0% 5,4% 5,7% Bbva Buy 0,73 0,69 0,66 9,1 7,7 7,1 5,7% 5,6% 5,8% Credit Suisse Sell 0,60 0,58 0,56 16,6 8,8 6,6 5,2% 5,1% 6,1% Bnp Sell 0,59 0,57 0,54 7,6 7,0 6,7 5,8% 6,4% 7,0% Unicredit Sell 0,36 0,35 0,33 7,2 5,4 4,4 4,7% 6,4% 7,8% Ubs Sell 1,00 0,95 0,91 11,0 9,5 8,6 4,9% 6,1% 7,3% Soc gen Sell 0,49 0,47 0,45 8,0 7,3 6,8 5,7% 6,4% 7,6% Mediobanca Buy 0,61 0,58 0,54 9,0 8,2 7,4 4,7% 5,1% 5,6% Banco Popolare NR 0,21 0,21 0,21 6,2 4,9 4,2 4,5% 6,1% 8,9% Intesa Sanpaolo Sell 0,80 0,79 0,77 10,5 9,1 8,2 7,9% 9,9% 10,4% avg 0,51 0,49 0,47 9,23 7,15 6,27 4,4% 5,5% 6,6% 1

2 Italian government and ECB focus on NPLs Macro picture seen deteriorating: From several perspectives it is clear that NPLs are now the main focus of both the Italian government and indeed the ECB. Italian gross NPLs climbed 11% YOY in FY2015 to EUR200bn. The ratio of NPLs to loans reached 12.9%, up from 11.6% in FY2014. In addition to the system producing EUR19.8bn in new gross NPLs in just one year, the weight of NPL relative to sector loans is also deteriorating. Loan growth has tracked at zero for the past year. At 12.9%, the most recently published NPL ratio is well ahead of the EU average of 7.7%. Such market conditions will weigh on the sector in the form of higher loan loss provisions. Lower volume growth and low NII spread complete the negative picture. NPL ratio FY15 FY14 YoY Gross NPL % Loans % Italy NPL to Loans ratio 12,9% 11,6% Uk 4,5% Germany 3,9% France 4,9% Spain 7,5% Portugal 12,5% Eu average 7,7% Recent trends: on several fronts it is clear that NPLs are the main focus of both the Italian government and the ECB, as both entities grapple with measures to limit the damage with potential NPL disposals and writedowns: 1. Italian Banks expect the ECB to start setting deadlines for some banks to sell their NPL as they come under pressure to improve asset quality. Current NPL prices mean banks could face a loss if they sell bad loans now, thereby limiting their ability to provide new loans to the system. 2. BP+BP Milano announced a strong plan of EUR10bn NPL reduction within 2019E. It seems that the ECB rejected the banks original plan and the timeframe was reduced from five years to three. Sooner or later the ECB will have to take formal steps with other lenders as well. 3. The intricacies of Italy s judicial system delay recovery times of creditors. On average it takes more than seven years to complete a bankruptcy procedure. This compares to 2.6 years on average in most other eurozone countries. 2

3 EU - Real estate foreclosures years CYP 10 ITA 7 GRE 2 POR 2 FRA 1,5 BEL 1,4 LUX 1,1 AUS 1 GER 1 SPA 0,8 NED 0,5 Average 2,6 Source: ECB 4. NPL market is moving: Banca Popolare di Bari is using a state guarantee scheme to sell EUR800m of its NPLs. Banca Popolare Emilia Romagna has put EUR900m up for sale. Banca Ifis has bought EUR450m worth of NPLs. 5. Italian government short-term vs. long-term focus: Short-term focus is on the closure of two significant capital increases: EUR1.75bn BP Vicenza capital increase guaranteed by Unicredit and EUR1bn capital increase guaranteed by Intesa Sanpaolo. In the mid-term Italy is considering the creation of a state-backed fund that would help troubled lenders to buy up bad loans and plug capital shortfalls. Ultimately, there may be two funds: one for capital increases and one to buy bad loans. 3

4 Update of our calculations On 30 December 2015, four Italian Banks went bust: Banca delle Marche, Banca Popolare dell Etruria e del Lazio, Cassa di Risparmio di Chieti and Cassa di Risparmio di Ferrarra. The four banks account for 1% of the Italian deposit base and EUR1.8bn book value before the recovery process. Which tools does the Bank of Italy have left to deploy? Bridge banks: Bank of Italy, in collaboration and agreement with the Italian government and the competent authorities of the European Union, launched the sales process for the four bridge banks: Nuova Banca delle Marche, Nuova Banca dell'etruria e del Lazio, Nuova Cassa di Risparmio di Chieti, Nuova Cassa di Risparmio di Ferrara. The activities of the four banks have been restructured to facilitate the sales process: each bridge bank is capitalised at 9% of risk-weighted assets. Management of the four new banks is currently entrusted to the specially appointed board of directors, chaired by Roberto Nicastro. Disposal process: The sales process will be implemented almost immediately, and will be overseen by the Unità di Risoluzione, a BOI unit for crisis management through the Fondo di Risoluzione, an institution under both Italian and European law financed by contributions from the Italian banking system in compliance with European rules on state aid. REV spa: the NPLs of the four distressed banks will be transferred to a new separate vehicle called REV Spa. REV Spa again has been capitalised by the Fondo di Risoluzione. Fondo di Risoluzione will benefit from proceeds from the sale or management of those assets. We believe that the relevant figures are that the aggregated NPL of the four insolvent Italian Banks reached EUR8.55bn, credit allowances will reach EUR7.035bn thus net NPL are EUR1.5bn. The adjustment means 82.3% of coverage ratio. Our assumptions: On average Italian NPLs are priced at 38.4% in the Italian banks balance sheet (average coverage is 61.6%). NPL market prices average 8-10%, thus the potential writedown is % of gross NPLs. Even assuming that all NPL could be senior tranches, a 0.9% state guarantee on senior tranches means a potential writedown of % of the stock of gross NPLs. We are using a conservative assumption with a 21% writedown on existing average 61.6% that should be increased to 82.3%. Conclusion: We estimate that with a coverage ratio of 82.3% on NPLs (not the entire stock of NPA) the three banks that need capital are Unicredit (EUR3.3bn capital deficit), Banca MPS (EUR1.8bn capital deficit) and Banco Popolare (EUR1.1bn capital deficit). Intesa Sanpaolo and Mediobanca have enough capital even under that extreme assumption. We believe that sector profits are at risk over the next two years: on average the sector needs EUR18.8bn extra LLP net of tax, equal to 2.14x the sum of sector net profit of the next two years. 4

5 Banks Coverage ratio REV spa level Gross NPL only Extra LLP net of tax Unicredit 61% 82% Intesa Sanpaolo 63% 82% Mediobanca 68% 82% Banco Popolare 58% 82% Banca MPS 64% 82% Unipol Banca 55% 82% BP Milano 55% 82% Average 61,6% Banks Capital Capital post exrwa CET1 post extra LLP SREP Capital need Unicredit ,9% 9,75% Intesa Sanpaolo ,7% 9,50% 6186 Mediobanca ,3% 8,75% 2123 Banco Popolare 5671, ,0% 9,55% Banca MPS ,7% 10,20% Unipol Banca ,1% 9,55% -542 BP Milano ,9% 9,00% 665 Average Banks Extra LLP net osum net profit FY16e/FY17e As a % Unicredit % Intesa Sanpaolo % Mediobanca % Banco Popolare % Banca MPS % Unipol Banca % BP Milano % Average % 5

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