Europe Credit Research

14 March 2012

Italian Banks
New Capital, New Collateral... Old Problems
 We revise our expectations on asset quality trends and we foresee an increase of loan loss charges similar to the one experienced in 2008/2009 based on expectations that the austerity measures introduced in H2’11 increase the probabilities of an economic recession. We highlight that on the previous occasion Italian banks managed to withstand asset quality deterioration and maintained their investorfriendly policies, but this time we note that BPIM, MONTE and UBIIM are showing depleted loan loss reserves, hence we think are likely to suffer more.  In spite of €17.5bn of capital raised together with the more recent liability management exercises, we note that solvency shortfalls persist for the 2nd tier institutions. We highlight that ISPIM and UCGIM are now in compliance with EBA requirements and UBIIM is also likely to bridge its capital deficit by exercising the option on its €1bn convertible. However MONTE and BPIM still face a €3bn and €2.5bn shortfall respectively, which in our view represents a challenge relative to their respective market capitalisations. Ultimately we see a risk of these issuers having to resort to the issuance of contingent convertible instruments, as designed by the EBA, triggering an embargo on Tier I coupon payments and on calls of all subordinated debt.  Recent measures taken by the government and the Bank of Italy contributed to build a solid buffer of central bank eligible assets that should safeguard senior investors. The issuance of €60bn of government guaranteed bonds helped manufacture collateral ahead of the first 3yr LTRO, while relaxed collateral requirements should have generated an additional €70-90bn buffer, taking estimated unencumbered assets for Italian banks post February LTRO up to €136-156bn.  In light of the weak capital position and potential issuers with regard to the availability of collateral, we decided to downgrade MONTE from Overweight to Neutral (5Yr Senior CDS at 389/399bp). While we note that the potential sale of a significant participation by the main shareholder, Fondazione Montepaschi, together with the recent change of CEO might improve corporate governance, we think that it is unlikely to bridge its capital shortfall on its own.
Table 1: Italian banks recommended buy list
ISIN XS0545782020 XS0527624059 XS0324790657 XS0243399556
Source: J.P. Morgan.

European Credit - Financials Enrico Longato

(44-20) 7777-3147

Roberto Henriques, CFA
(44-20) 7777-4506

Alan Bowe
(44-20) 7325-6281 J.P. Morgan Securities Ltd.

All prices as of March 13th, 2012 at 4pm GMT


Sub T1 T1 LT2 LT2


Coupon 9.5 9.375 6.375% 3m€+25bp

Post-call coupon 3m€+757bp 3m€+749bp 3m€+135bp 3m€+25bp

1st call date 01/06/16 21/07/20 12/11/2012 20/02/2013

Maturity Perp. Perp. 12/11/2017 20/02/2018

Amt (mn) 722 339 250 750

Price 92.25 / 93.25 91.5 / 93.5 93.06 / 95.94 89 / 89.25

See page 15 for analyst certification and important disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

We like ISPIM and UCGIM’s high coupon tier Is for their attractive risk-return profile Under these circumstances we recommend ISPIM 9. while TIs should still pay coupons.375% €20.5bn rights issue concluded in 2012. but calls are fairly unlikely Instruments might suffer from an liquidity even if there is sporadic market given the economic conditions and a embargo on coupon payments as there is access possible embargo if the EBA deadline is a high probability of missing the EBA missed deadline   (low probability of call) X We do not expect losses on LTII Senior should be supported by ECB No call expected after the LME and instruments. In particular we note that both instruments were subject to liability management with limited acceptance thereby reiterating investor confidence in these structures and also leaving sufficient liquidity in the outstanding instruments. Considering the issuance of senior unsecured from ISPIM. even if levels are unfavorable. Table 2: Relative value recommendations across the capital structure UCGIM Recommendation Overweight Senior Lower Tier II Tier I   (high probability of call)  UCGIM displays solid capitalization after the €7.5% €16 and the UCGIM 9. and 2nd tier banks. UBIIM and BPIM. but calls are extremely Instruments might suffer from an Senior should be supported by ECB unlikely after the LME. such as Montepaschi. the differential among Italian banks has been widening.P. We think that the most important differences among these two groups can be found in their relative levels of capitalisation. In addition we also note that as asset quality deterioration advances. instruments. UBI Banca and Banco Popolare. Senior should be supported by ECB instruments. and has recently accessed the senior unsecured market with two benchmark issues (1. highlighting two tiers of institutions. as stressed by the shortfalls shown by the European Banking Authority (EBA) as well as the ability to access the market at economically viable levels. However. Profitability has proven stable over the cycle and the management has always kept an investor-friendly attitude. 2 . medium-term we believe that senior bondholders will be safe-guarded by the significant liquidity guaranteed by the ECB and by the substantial amount of unencumbered assets eligible for refinancing operations. Tier Is might get a slightly better treatment at UCGIM’s given the softer language in the tender offer memorandum. we think that UCGIM can currently access the market.Enrico Longato (44-20) 7777-3147 enrico. as they provide a significant yield-to-maturity (just below 11%) as well as yield-to-call (~11% as well) with the extension risk being effectively mitigated by the high post-call spread of these Europe Credit Research 14 March 2012 Summary and trade ideas The sovereign crisis has increased the differential between ISPIM and UCGIM on the one hand and MONTE. the previous embargo on coupon payments as there is liquidity even if there is no market access deferrals and the possible embargo if the a high probability of missing the EBA EBA deadline is missed deadline ISPIM Neutral MONTE Neutral UBIIM Neutral BPIM Underweight Source: J. In our view this set of challenges will pose particular pressure on MONTE. resulting in potential suboptimal outcomes such as extension risk and coupon deferral.longato@jpmorgan. Morgan. as stated by the management. in spite of the zero dividend policy for 2011. the 2nd tier institutions will be more exposed to the downturn given their depleted loan loss reserves at a point where the credit cycle threatens to turn down again.5yr and 5yr). making us confident that LTII will be taken out at first call date and TIs will keep paying coupons   (low probability of call) X We do not expect losses on LTII No call expected in the near future. UBIIM and BPIM on the other hand In our opinion since the outset of the sovereign crisis. 1st tier institutions such as Intesa San Paolo and Unicredit. speaking of future calls UCGIM mentions “best interest” rather than “economic incentive" as a reason for exercising its options   (high probability of call)  The bank shows no capital shortfall. but calls are fairly unlikely liquidity even if there is no market access previous statements from the bank given market conditions   (very low probability of call) X We do not expect losses on LTII No call expected in the near future. Calls on LTII bonds should still be exercised as highlighted by the 2011 calls.

Index ISPIM 9.25 93. Perp. As opposed the market we believe that ISPIM will keep calling its LTII instruments. Issuer ISPIM ISPIM Sub LT2 LT2 Ccy GBP EUR Coupon 6.5% €16 vs.Index UCGIM 9. the ISPIM 6.000 1.000 500 0 Feb-11 ISPIM .375% 3m€+25bp Post-call coupon 3m€+135bp 3m€+25bp First call date 12/11/2012 20/02/2013 Maturity 12/11/2017 20/02/2018 Amt (mn) 250 750 Price (ask) 95. SUSI Banks Tier I Index ASW bp 2.Enrico Longato (44-20) 7777-3147 Europe Credit Research 14 March 2012 Table 3: Recommended buys in Tier Is ISIN XS0545782020 XS0527624059 Source: J. Morgan. Morgan.57 YTM 10. regardless of the currency they were issued in and regardless of the stress in the wholesale funding market.375% €20 vs.375% €20 SUSI Banks Tier I Index Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 0 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Source: J.375% £12-17 and the ISPIM FRN €13-18 that we believe will get called at the first call date.375 Post-call coupon 3m€+757bp 3m€+749bp First call date 01/06/2016 21/07/2020 Maturity Perp. Under these circumstances we think that ISPIM may use ECB liquidity for early repayment of senior subordinated instruments. Amt (mn) 722 339 Price (ask) 93. maintaining its positive track record.5% €16 SUSI Banks Tier I Index 1. Morgan. just prior to the 1st 3yr LTRO. SUSI Banks Tier I Index ASW bp Figure 2: UCGIM 9.45 YTM 4.P.31 3. Table 4: Recommended buys in Callable Lower Tier IIs ISIN XS0324790657 XS0243399556 Source: J.P.500 1.250 1.5% $ 11-16 in December.60 ZTC/ DM 1149 1258 ZTM/ DM 247 273 3 .000 750 500 250 UCGIM .65 ZTC 1023 861 ZTM 753 794 Figure 1: ISPIM 9.5 YTC 11. Issuer ISPIM UCGIM Sub T1 T1 Ccy EUR EUR Coupon 9.60 10. maintaining its positive track record Looking at the coming calls we highlight two ISPIM lower tier IIs.40 13. we note that.82 10.5 9.25 YTC 12.P. We remind investors that Intesa called the ISPIM 5. Source: J. as the Bank of Italy removed the restriction on liability management exercises by removing the pre-funding requirement which will allow banks the option of calling capital instruments without having to explicitly refinance. We believe this will be the most likely scenario as the bank has kept calling all its instruments so far.longato@jpmorgan.500 1. Furthermore.94 89.P. Morgan.

375% £12-17 SUSI Banks Lower Tier II Index 40. Table 5: Cost of risk (maxima in bold) bp Q4 07 BPIM BPIM standalone* ISPIM MONTE UBIIM UCGIM 112 54 n/a 71 39 Q1 08 32 34 n/a 25 44 Q2 08 59 43 n/a 39 41 Q3 08 76 88 50 42 68 Q4 08 192 99 112 128 83 Q1 09 62 72 76 68 104 Q2 09 64 108 105 100 157 Q3 09 84 79 83 92 82 143 Q4 09 99 104 109 98 110 139 Q1 10 70 68 78 83 53 120 Q2 10 84 83 83 77 75 116 Q3 10 88 77 72 76 52 111 Q4 10 65 92 90 74 96 115 Q1 11 83 81 69 71 40 102 Q2 11 77 71 84 72 60 77 Q3 11 77 73 70 72 51 124 Source: J.0 Feb-11 0.0 20. we believe that it is fairly conservative to forecast an increase of the cost of risk comparable to that one seen in between Q4 08 and Q4 09. the Italian GDP is expected to decline by 1.375% £12-17 vs. -6 -5.0 30.0 ISPIM .Index ISPIM FRN €13-18 SUSI Banks Lower Tier II Index 10. Morgan estimates. and assuming that there is no tail event like a breakup of the Euro Area.2 0. in their base case. we note that our economics research colleagues expect the downturn to be milder that the one seen in 2008/2009. Source: J. after the collapse of Lehman Europe Credit Research 14 March 2012 Figure 3: ISPIM 6.Enrico Longato (44-20) 7777-3147 enrico.4 The deterioration of the European macroeconomic environment and the implementation of the austerity measures are expected to be a drag on Italy. Company data.6 -0.P. Note: see Appendix for full updated asset quality tables. Yet. according to both official estimates and our Economic Research team.0 ISPIM . Morgan.7 -1. Morgan estimates. The clear consequence on Italian banks will be substantial asset quality deterioration and consequently higher loan loss provisions.7% in 2012 and 2013 respectively (see Nicola Mai – Money and credit flag downside risk for Italian growth).0 0. The slowdown of the Italian economy will stress differences… The Italian economy is expected to be in a recession in 2012/13 Figure 5: Italian GDP forecasts % 2 0 -2 -4 1.0 20. SUSI Banks Lower Tier II Index Yield-to-call % Figure 4: ISPIM FRN €13-18 vs.0 10.8 0. the country should be in a recession in both 2012 and 2013.0 -10. Under the circumstances outlined above.longato@jpmorgan.P. 4 .8% and 0.P.P.0 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Source: J.Index ISPIM 6.0 30. Morgan. Note (*): “BPIM standalone” excludes Banca Italease. marking a clear reversion of current trends. SUSI Banks Lower Tier II Index Yield-to-call % 40.2 2009 2010 2011 2012 2013 2014 Source: J.

Potential losses should be a marginal risk. BPIM. Company data. Figure 7: Italian banks – evolution of coverage ratios from 2007 to Q3 11 70% 65% 60% 55% 50% 45% 40% 35% 30% 25% 66% 52% 62% 50% 51% 44% 33% 55% 50% … in fact the decline in coverage ratios for MONTE. Average of for the banks in our coverage (BPIM. however some will suffer more than others… Looking back at asset quality figures and the financial performance of the institutions in our coverage (see charts from Figure 8 to Figure 12) we note that impact of the previous downturn has been relatively contained and it mainly affected second tier banks.longato@jpmorgan. MONTE.Best & worst case (LHS) Q4 08 Q4 09 Q4 10 Q4 11 Q4 12 Avg.RHS) -15 -10 -5 0 5 Source: J. UBIIM and UCGIM). as highlighted by the sharp decline in coverage ratios over the past years. Hence we think that our second tier banks.P. resulting in a more marked differential between their performance and that one of ISPIM and UCGIM. Nevertheless we highlight that banks remained committed to their bondholder-friendly policy and kept paying coupons on their Tier Is all the way through the period. ISPIM. even after they received the government’s support in the form of Tremonti Bonds. leaving them more exposed to the downturn 30% BPIM ** ISPIM UCGIM 2007 2008 MONTE * 2009 2010 UBIIM Q3 11 Source: J.Enrico Longato (44-20) 7777-3147 enrico. will be more exposed than peers to the cycle. What in our view will be different this time is that the previous recession depleted the stock of provisions. Morgan estimates. GDP growth bp (LHS). i. and UBIIM implies smaller buffers. cost of risk (LHS) GDP % q/q saar (inverted scale . UBIIM and BPIM. 5 . Note (*): BPIM’s 2007 and 2008 data is pre-Italease consolidation. on the basis of 2008/09 performance. MONTE.e. Morgan estimates. and BPIM and UBIIM in particular. % (RHS) 140 120 100 80 60 40 20 0 Q4 07 Estimated Avg cost of risk Europe Credit Research 14 March 2012 Figure 6: Average cost of risk vs.

500 -2.longato@jpmorgan. 140 120 100 80 60 40 20 0 Q3 10 Q1 11 Q3 11 Cost of risk Figure 12: BPIM – Quarterly net profit vs. cost of risk € million. Morgan estimates. bp 2. cost of risk € million.2011 April . Morgan estimates. Company data.P.2010 April . Note (*): Q311 includes €8bn goodwill writedown. cost of risk € million.P. Amount issued BPIM UBIIM ISPIM 2 1 5 2 7.000 500 0 -500 -1. bp Table 6: Recent rights issues € billion 400 300 200 100 0 -100 -200 Q1 09 Q3 09 Q1 10 Net income Q3 10 Q1 11 Q3 11 Cost of risk 120 100 80 60 40 20 0 MONTE UCGIM Source: J. Figure 10: MONTE – Quarterly net profit vs.Enrico Longato (44-20) 7777-3147 enrico. cost of risk € million.2011 Source: J.P.500 Q1 08 Q3 08 Q1 09 Q3 09 Q1 10 Q3 10 Q1 11 Q3 11 Net income Source: J. Morgan. Morgan estimates.2011 April .2011 November .000 Net income Cost of risk -10.500 Europe Credit Research 14 March 2012 Figure 8: ISPIM – Quarterly net profit vs.000 1. Company data.500 1.P. 6 . Morgan estimates.000 1.6bn 180 160 140 120 100 80 60 40 20 0 Q1 08 Q3 08 Q1 09 Q3 09 Q1 10 Q3 10 Q1 11 Q3 11 * Source: J.P.000 -1. Company data. Company data.000 500 0 -500 -1. bp 700 600 500 400 300 200 100 0 -100 -200 -300 Q1 08 Q3 08 Q1 09 Q3 09 Q1 10 Net income Source: J. bp Figure 9: UCGIM – Quarterly net profit vs. cost of risk € million.P.000 -1.5 Announcement date October . Morgan estimates. Company data. bp Figure 11: UBIIM – Quarterly net profit vs. 120 100 80 60 40 20 0 Cost of risk 2. 120 100 80 60 40 20 0 Q3 10 Q1 11 Q3 11 Cost of risk 400 300 200 100 0 -100 -200 -300 -400 -500 -600 Q1 08 Q3 08 Q1 09 Q3 09 Q1 10 Net income Source: J.

5bn of capital raised and 4 liability management exercises out of 5 banks Together with our renewed concerns about asset quality.5) post EBA sovereign buffer The EBA highlighted a €15.5bn rights issue that. contributed to a total capital raise for the system of about €17. de-facto implying a nonzero risk-weight for Italian Treasuries. we believe that the old capitalisation issues are still lingering. and we believe that our 2nd institutions are likely to face difficulties correcting their capital deficit.4% 9.0% 8.5) Source: Europe Credit Research 14 March 2012 … and capitalisation issues will point in the same direction There has been some improvement.0% ISPIM UCGIM* Core Tier I (B2.0% 6. 7 .2% 6.0% 10. The operation made Unicredit’s management announce a €7.5% 6.4bn capital shortfall that has only partially been addressed EBA: Setting the benchmark As Italian banks were started to address their capitalisation issues. Figure 13: Italian banks – Basel 2. in an attempt to add precious basis points to their Core Tier I ratios.0% 2. while we note that UBI Banca can almost erase the gap with the conversion of its €1bn convertible bond. was completed in 2012.5% 6. Yet second tier banks still have to address their EBA capital shortfalls 10.Enrico Longato (44-20) 7777-3147 enrico.5bn. we also conclude that it will be challenging for Montepaschi and Banco Popolare to fill the gap without taking extraordinary measures. and the EBA came up with the ill-fated decision of stressing government bonds held in the banking books of financials across Europe.P. despite market challenges .0% 4. BPIM and UBIIM still have to raise approximately €7bn of capital to meet the requirements set by the European Banking Authority (EBA) on December 8th. Secondly we highlight that the changed stance of Bank of Italy (BoI) with regards to liability management exercises on subordinated debt.4% 7.2% 9.longato@jpmorgan.0% 8. leaving MONTE.5 capital under ratios before and after EBA sovereign buffer 12.1% MONTE UBIIM BPIM Core Tier I (B2. However. Firstly. we note that the sector has undergone a series of recapitalisations that. Now.0% 9.5 and to have sufficient support for their holdings of government bonds. in spite of these efforts we estimate that MONTE. the sovereign crisis spread to Italy. together with the latest effort from UCGIM.0% 0. prompting an unprecedented series of tender offers for cash.9% 9. even though notable steps forwards have been made.4bn of fresh capital to compensate for the transition from Basel 2 to Basel 2. Morgan estimates. especially with regards to capitalisation levels: €17. BPIM and UBIIM as the only institutions with a capital gap. As a result the authority concluded that the main five Italian banks still needed €15.

we think that there will be a fragmented sale to various investors.MONTE aims to meet the requirement by obtaining the inclusion of its FRESH 2008 instruments (€950mn) into Core Tier I. Additional capital management actions will also be taken into consideration. yet we do not believe that this will be a game changer for the bank and for its EBA capital requirement.98bn and €2. and it is then likely to remain the kingmaker.€2. as Fondazione Montepaschi. but a rights issue has been excluded so far .97bn €3.4bn from restructuring of CASHES for inclusion in Core Tier I (€0.6bn remain as Tier I capital) .73bn €1. With regards to Montepaschi we also note that the ownership structure is being partially reshuffled. in an attempt to generate additional capital 8 .51bn €1. and capital accretion BPIM UBIIM €2. still remain way behind their earnings generation capability and any clearly executable measure like restructuring the FRESH 2008 for MONTE or exercising the option on the €1bn convertible for BPIM cannot provide a comprehensive solution to any of the two institutions.51bn respectively. the main shareholder with 49.UBIIM expects to meet requirements thanks to its convertible bond (€1bn). at the end of January. prompting a sequence of tender offers for cash on subordinated debt.An estimated €0. deleveraging action currently underway. The reshuffling of MONTE’s shareholders composition will be a small positive but not enough to turn around the situation While the EBA chose to stand by its decision the Bank of Italy has eased its regulation of LMEs. to change its rules on debt buybacks. It is difficult to see how MONTE and BPIM can fulfil their requirements by June At the moment the capital shortfalls of Montepaschi and Banco Popolare.longato@jpmorgan. asset disposals and possible revaluation of assets . While this event should be seen as a positive.No dividend paid for 2011 . as prescribed by the EBA.29bn from the conversion of FRESH 2003 into equity .27bn Current shortfall €0bn €2. Fondazione Montepaschi would still remain the main shareholder of the bank. furthermore. Morgan estimates. ranging from private equity funds to Italian entrepreneurs.P. expanding the use of advanced internal rating models. and ultimately put an embargo on coupon payments on Tier Is and on the exercise of call options on subordinated instruments.The bank plans to use its €1bn soft mandatory convertible and to adopt internal rating models that should generate an 80bp increase of its capital ratios (equal to €0.22bn from the liability management exercise . this will then trigger state-aid resolutions from the European Commission.98bn Update . Under these circumstances we believe that these two are likely to require the issuance of contingent convertible instruments.5bn rights issue .Enrico Longato (44-20) 7777-3147 enrico. is being forced to sell a 15% stake in order to partially repay its creditors.1%. as it can limit the impact that the financial situation of the Fondazione has on the bank.39bn €2.€0. making an eventual impact on corporate governance relatively limited. the progressive migration to the advanced internal rating models. and in particular on institutional Tier Is.€7.77bn capital increase). €2. with a ~34% Europe Credit Research 14 March 2012 Table 7: EBA sovereign stress results: capital shortfalls and banks' plans Bank UCGIM MONTE Shortfall €7. Liability management: when it rains it pours While capital shortfalls were still gripping Italian banks the Bank of Italy has finally decided.39bn Source: European Banking Authority and J.

5 78.3 15. with the exception of those of UCIGM and ISPIM LTIIs should be judged on an economic basis 9 .4 82. UBIIM and BPIM should be based on cost of funding and eligibility criteria.Enrico Longato (44-20) 7777-3147 enrico.364 9 75.P. LMEs offer a chance for capital structure optimization.6 n/a 3.1 84.5 70 71 43 78 75 78 78 76 89 91 90.5 90 3.500 1.000 1.6 81.047 8. so that banks can decline any responsibility in the event of missed call for economic reasons.000 1.7 3.4 n/a 74.7 34.8 10.8 78.769 6.125 8. Company data. A similar argument can in our view apply to Unicredit that stated that its decisions will be taken on a “best interest” basis.0 Price (preoffer) 34.2 61.0 76.3 15.7 3. as they will allow even the better geared issuers to claim that their benevolent tender was a sufficient effort to keep an investor-friendly behaviour.0 EUR EUR EUR 96 186 73 Premium 15.2 75.5 67. each call.625 9.028 5.0 56.3 68.156 6.0 9.9 4. While we do not exclude the chance of a better treatment in case of a significant improvement of market conditions.000 900 542 21/06/2017 21/06/2017 06/06/2016 30/06/2015 28/06/2011 15/06/2011 22/11/2011 08/02/2012 Bullet Bullet Bullet Bullet 278 494 454 29 41 29 First call date 28/10/2011 22/03/2012 27/10/2015 27/10/2015 21/07/2020 10/12/2019 27/06/2018 05/06/2018 01/02/2016 01/02/2016 193 140 79 127 11 70 11 57 32 218 264 6 278 494 454 23% 18% 28% Acceptance (local mn) 152 99 470 244 161 165 140 165 82 90 193 140 79 127 11 70 11 57 32 218 264 6 28% 33% 36% Acceptanc e (€mn) 152 99 470 294 161 165 168 165 82 108 71% 50% 54% 26% 14% 30% 6% 31% 10% 23% 44% 2% Takeup 61% 66% 63% 90% 32% 22% 44% 16% 9% 20% Source: J. as the have been doing so far.9 5.1 83. and an attempt to offer a way out to investors.5 7.8 11.396 9.0 1. we believe that these offers will be fundamental in addressing future calls.5 4.7 12.3 3.9 2. this language is in our view slightly more accommodating to investors as it leaves the door open to non-economical considerations like reputation or a good relationship with investors. as the regulator’s attention shifts to the Core Tier I ratio.375 8.0 73.473 6 6.8 74.4 31. aside from UCGIM’s.250 96 186 73 Ccy EUR EUR EUR GBP EUR EUR GBP EUR EUR GBP 269 279 145 487 76 235 168 181 318 950 600 298 1.0 3.5 79.95 5 6.5 EUR EUR EUR EUR EUR EUR EUR EUR EUR EUR EUR EUR 1. Going forward. taking the responsibility for missed calls off the issuer We believe this represents both a chance to achieve a better capital structure. while we still expect that UCGIM and ISPIM will keep calling their Tier II bonds.5925 6.4 9. local mn) 250 150 750 270 500 750 318 1.7 2.000 900 450 269 279 145 487 76 235 168 181 318 950 600 298 01/06/2016 14/10/2019 20/06/2018 29 41 29 Amt out (preoffer.6 5.375 4.17 8.0 90 91 88 5.0 86.longato@jpmorgan.3 74.5 8.1 73.250 10/03/2010 15/02/2011 27/06/2011 Amt out (preoffer.5 8.7 EUR EUR EUR Tender price 50 50 71 66 79 81 72 87 86 75 3.5 11.2 69. Morgan estimates. is the “economic incentive” language with regards to future calls.2 2.1 85.742 3m€ + 55bp 3m€ + 40bp 3m€ + 45bp 3m€ + 35bp 5.9 7.756 2.3 59. Consequently we think that any consideration with regards to the potential call of Italian Tier I instruments and on Tier II bonds issued by MONTE.375 8.3 80 80 80 Europe Credit Research 14 March 2012 Table 8: Italian banks: tender offers ISIN Sub UCGIM (24-Jan-12) DE000A0DD4K8 T1 DE000A0DYW70 T1 XS0231436238 T1 XS0231436667 T1 XS0527624059 T1 XS0470937243 T1 XS0372556299 T1 XS0367777884 UT2 XS0241369577 UT2 XS0241198315 UT2 BPIM (6-Feb-12) XS0304963290 T1 XS0304963373 T1 XS0255673070 T1 XS0223454512 T1 XS0259400918 LT2 XS0256368050 LT2 XS0276033510 LT2 XS0284945135 LT2 XS0464464964 LT2 XS0555834984 LT2 XS0632503412 LT2 XS0215451559 UT2 ISPIM (6-Feb-12) XS0545782020 T1 XS0456541506 T1 XS0371711663 T1 UBIIM (7-Feb-12) XS0108805564 T1 XS0123998394 T1 XS0131512450 T1 Coupon 6 7.6 11. €mn) 250 150 750 325 500 750 383 1.500 1. With this regards we note that the common denominator of all these offers.

5bn €1bn €1. A direct exchange offer into equity would also contribute to a more significant capital benefit for Monte. should still provide the broader sector with the support needed.5yr and a 5yr senior unsecured bonds for a total of €2. Morgan estimates. In this sense we expect the bank to propose a buyback of not only on Tier I instruments. raising questions on the amount of eligible collateral still available. together with occasional market access.Enrico Longato (44-20) 7777-3147 enrico. but we believe premia will be limited With regards to the quality of the offers we note that while the first buyback launched by Unicredit carried a significant premium.6 XS0238916620 LT2 EUR 3m € + 40bp Total potential pre-tax gain from 50% take-up Source: J.5yr 5yr 5yr 2yr Amount issued €1.875 XS0255817685 UT2 GBP 5. in the 2-3pts area.5bn. it also fuelled a rally among other Italian tier Is contributing to lower premia on subsequent offers. Perp. together with UCGIM’s and MONTE’s highlights that. the smaller issuers will have to rely on the ECB In spite of the tentative improvements on capital and the threats posed by worsening asset quality we still remain confident that Italian banks have access to sufficient liquidity to withstand the crisis. However we note that both the government and the regulator have been supporting the banks’ effort to expand the pool of resources.603 750 200 500 500 500 150 Take-up (hypothesis) 50% 50% 50% 50% 50% 50% 50% 50% 50% 50% Discount to par 26% 32% 1% 1% 3% 19% 6% 18% 4% 20% Implied pre-tax gain (€mn) 46 35 1 8 10 23 15 45 9 15 207 Liquidity should provide support While the senior unsecured market should be open for ISPIM and UCGIM. while on the other hand the 3yr LTRO and the sizable amount of ECB eligible assets. Morgan. With this regards we highlight that even if the Italian banking system has increased its reliance on the ECB. Table 9: Montepaschi: candidates for tender and potential gain ISIN Sub Ccy Coupon XS0121342827 T1 EUR 7. Post-call coupon 3m € + 630bp 3m € + 630bp 3m € + 630bp First call date 07/05/2012 27/03/2012 21/03/2011 3m € + 100bp 3m € + 100bp 30/11/2012 15/01/2013 Maturity Perp. On the one hand we note that ISPIM’s recent issuance of a 1. given that the these categories represent a larger component of the subordinated bonds issued by the institution.P.99 XS0131739236 T1 EUR 3m € + 310bp XS0122238115 T1 EUR 3m € + 375bp IT0004352586 UT2 EUR 3m € + 250bp XS0255820804 UT2 EUR 4. 15/05/2018 31/05/2016 30/09/2016 21/04/2020 30/11/2017 09/09/2020 15/01/2018 Amt out (local mn) 350 220 80 1. However we expect that given the precedents the premia would be fairly small. with a tender offer across the whole capital Europe Credit Research 14 March 2012 We expect MONTE to follow its peers. regardless of the levels. Date 31-Jan-2012 20-Feb-2012 29-Feb-2012 29-Feb-2012 Tenure 1. the first one by setting up a new government guarantee scheme and the second one by relaxing the collateral requirements.5bn €1.P. and there is potential for the creation of further liquidity via the issuance of covered bonds. 10 . but also on Upper Tier II and Lower Tier II bonds. We also note that among the institutions in our coverage Montepaschi is the only one that has not taken any action yet. but in our view a similar operation is imminent.longato@jpmorgan.75 XS0503326083 LT2 EUR 5 XS0236480322 LT2 EUR 3m € + 40bp XS0540544912 LT2 EUR 5.25bn Price MS+295 MS+355 MS+345 MS+365 The government issuance of government guarantees and the relaxed collateral requirements have expanded the pool of ECB eligible assets substantially Recent statistics from the Bank of Italy show that reliance on the central bank’s funding has increased significantly over the past few months. Table 10: New senior unsecured Bank ISPIM ISPIM UCGIM MONTE Source: J. first tier institutions can still access the market. Perp. there is still a substantial pool of unpledged assets.

it/interventi/integov/2012/forex18022012/en_Visco_180212. Haircut 42% 62% 70% 78% 78% 80% Figure 14: Italian banks: ECB/National Central Bank eligible assets and utilisation € billion 400 350 300 250 200 150 100 50 0 60 280 70-90 297 357 70 147-167 ~80 136-156 Estimated net Estimated total use of 2nd 3yr unencumbered LTRO assets (Mar-12) Eligible (Nov-11) Government guaranteed issued Source: Bank of Italy and J. is applying severe haircuts to compensate for the illiquidity of the collateral and to prevent banks from pledging lower quality assets first. BoI decided to relax its collateral requirements and to start accepting bank loans with probability of default below 1% as a guarantee for its refinancing operations. 2 Estimate from Bank of Italy (see http://www. 2011. as it exits from the sovereign-bank loop. As a result.longato@jpmorgan. under recommendation of the ECB. But while this decision seems to have the potential of unleashing a vast amount of assets we note that the regulator. and pledged it as collateral at the two 3yr LTRO auctions in December and February. At the end of January. On the other hand we believe that the action taken by the Bank of Italy. however we do not expect further significant issuance. over the span of less than two months. Italian banks issued €60bn worth of new government guaranteed paper. We note that the programme technically allows for a total issuance of more than €200bn1. adding another €70-90bn of central bank eligible asset Table 11: New eligible assets – haircut applied by BoI Residual maturity 0-1ys 1-3ys 3-5y 5-7ys 7-10ys >10ys Source: Bank of Italy. BoI relaxed collateral requirements. giving to the banks the possibility of manufacturing additional ECB eligible collateral. according to what stated by the governor of the BoI. the regulator expects this new change to increment the pool of eligible assets by an estimated €70-90bn2. given that each additional bond increments the already vast pile of government debt.P. 11 . and the strained Italian public finances cannot be stretched further. Under these circumstances we believe that the existence of this option remains just as a form of an indirect safety net that could be reactivated in case of a new exacerbation of the sovereign crisis.pdf). Morgan estimates. as we already outlined in The power of money. is much more effective.bancaditalia. Eligible (Jan-12) Utlised (Jan-12) New Unencumbered Estimated unencumbered assets pre-2nd increase in assets 3yr LTRO eligible assets 1 The maximum issuance of government guaranteed bonds that each bank can issue is capped to the amount of total regulatory Europe Credit Research 14 March 2012 The Italian government instituted a government guarantee scheme that provided the fostered issuance of €60bn of new bonds to be retained and pledged as additional collateral With regards to the guarantee scheme we note that the government implemented the plan presented by the European Commission on December 1st. As a result.Enrico Longato (44-20) 7777-3147 enrico. following the new stance of the ECB.

6 3. (***) pre 3yr LTRO estimates related to the beginning of Dec-11.9bn) by Banco Popolare.longato@jpmorgan.Enrico Longato (44-20) 7777-3147 enrico.5 5.8bn repos with banks.6 220 Unencu mbered 7-17 33. Furthermore. we believe that there is still room for the creation of high quality assets. 2nd 3yr LTRO take-up Gross Net ECB ECB taketakeup up 10 10 24 18 10-15 0 3 3 6 6 53-63 37 116 81 Estimates post 3yr LTROs Additional collateral created by BoI Unencu New mbered Loans (% eligible collateral system) collateral (Mar-12) 24% 17-21 39-50 16% 11-14 34-37 7% 5-6 10-11 4% 2. even for Unicredit that has a stronger track record due to its German operations.6 60-70 77 Total eligible 27-37 52 20.8 60 30 Est. while on a sector-wide basis we know that the amount of collateral available is quite substantial.9 25. Looking back at the data presented by the banks when reporting Q3 11 results we note that Unicredit and Montepaschi were the banks in which the utilisation of ECB liquidity versus the amount of unencumbered assets was more pronounced.8 10 10 10 4 6 2. contributing to a further lengthening of the debt maturity profile. while we note that the amount of unencumbered collateral is on a declining trend.5 5 12 4. to a smaller extent.4 10. In particular we note that the issuance of government guaranteed bonds allowed for a substantial rollover of short term operations and we estimate that part of the second 3yr LTRO was used to decrease the amount of repo with other counterparties. (**) estimates based on Q3 11 data. BPIM are the banks in our peer group that show an above average utilisation. We believe that a large chunk of the first LTRO has been used to roll already existing facilities Table 12: Estimates of ECB utilisation by bank € billion Estimates pre 3yr LTROs Est. we estimate the benefit of the expanded collateral requirements to be proportional to the relative size of the loan books of the institutions. through the issuance of new covered bonds.7-3. Finally we can conclude that our thesis is clearly supported by the recent inauguration of a €25bn retained covered bond programme by Unicredit and a smaller one (€ Europe Credit Research 14 March 2012 We can estimate the ECB eligible assets on a bank specific basis only relying on several assumptions Now.5 15 3. as the ratio of covered bonds to loans outstanding is extremely low.5 7.4 6.1st 3yr LTRO take-up Gross Net ECB ECB taketakeup up 12. taking into consideration the 3yr LTRO and the relaxed collateral requirements we believe that the differential among institutions is being reduced and we estimate that MONTE and.1 121-131 297 Pledged 35 41 25 14 12 127 361 Unencu mbered 22-28 23 5 6 12 68-74 66 Total eligible 57-63 64 30 20 24 195-201 427 Source: J.8bn repos with clients and €32. 12 .4 8-9 4% 3-4 15-16 54% 38-49 106-123 100% 70-90 136-156 UCGIM* ISPIM MONTE** BPIM *** UBIIM Total System Pledged 20 18. both with the sole purpose of increasing the pool of eligible securities. even if we acknowledge that this approach does not take into consideration the peculiarities of each bank. We note that there is scope for further creation of collateral through issuance of new covered bonds Furthermore. we have to rely on estimates to be able to draw any conclusion for single institutions.5 60.P. Notes: (*) UCGIM unencumbered and total eligible assets estimates encapsulate the deduction of €38.1 11. However.5 50. Specifically we highlight that Italian banks should have enough room for manoeuvre. Morgan estimates.

13 .com Europe Credit Research 14 March 2012 Figure 15: Covered bonds still remain a small portion of funding so there is scope for an increase € billion 200 180 160 140 120 100 80 60 40 20 0 167 130 6% 50 21 ISPIM UCGIM Securities issued 65 9 MONTE Covered bonds 9% 7% 6% 55 7 BPIM 48 6 UBIIM 6% 12% 10% 8% 6% 4% 2% 0% Covered bonds as % of lonas Source: J.longato@jpmorgan.Enrico Longato (44-20) 7777-3147 enrico. Morgan estimates.P. Company data.

8 n/a 3.9 9.5 3.5 7.2 13.7 13.9 7.4 9.longato@jpmorgan.9 4.2 6.6 8.2 4.9 10.1 12.9 8.2 9.0 10.2 5.8 Europe Credit Research 14 March 2012 Appendix Table 13: NPL ratios % Q4 07 BPIM BPIM standalone* ISPIM MONTE UBIIM UCGIM 4. Morgan estimates.3 10.0 Source: J.6 13.6 11.5 9.2 Q2 09 7.3 9.0 11.7 12.8 10.1 13.6 6.2 6.9 n/a 3. Company data.6 6.6 7.2 10.4 10.7 3.5 9. Company data. Note (*): “BPIM standalone” excludes Banca Italease.0 13.6 Q1 09 7.7 10.0 9.Enrico Longato (44-20) 7777-3147 enrico.5 4.8 11.8 9.1 9.3 13.8 10.0 11.0 6.0 Q4 08 7.1 11.4 6.7 8.6 6.6 11.9 7.1 7.7 5.1 Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 12.0 13.9 8. Morgan estimates.P.2 9.P.1 7.9 12.8 n/a 2.5 5.0 9.1 8.4 4.0 10.6 14.2 9. 14 .1 7.6 4.0 Q3 08 5.0 6.7 11.0 Q2 08 5.4 13.8 6. Table 14: Coverage ratios % Q4 07 BPIM BPIM standalone* ISPIM MONTE UBIIM UCGIM 55 66 n/a 50 62 Q1 08 46 63 n/a 49 63 Q2 08 42 63 n/a 26 63 Q3 08 40 63 51 24 63 Q4 08 45 60 51 48 59 Q1 09 42 58 49 46 58 Q2 09 41 54 44 42 56 Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 35 34 30 27 31 32 31 34 30 38 35 34 33 33 34 33 34 32 52 48 49 51 51 51 52 51 52 46 45 45 44 45 46 46 45 44 41 37 36 37 35 36 35 34 33 55 51 52 50 50 49 49 49 50 Source: J.6 12.1 10.2 Q1 08 4. Note (*): “BPIM standalone” excludes Banca Italease.2 9. with your request. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for UniCredit.longato@jpmorgan. Other Significant Financial Interests: J. or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. and (2) no part of any of the research analyst's compensation was. and/or an affiliate is a market maker and/or liquidity provider in UniCredit.Enrico Longato (44-20) 7777-3147 enrico. Important Disclosures    Market Maker/ Liquidity Provider: J.P.P. Company-Specific Disclosures: Important disclosures are available for compendium reports and all J. Morgan owns a position of 1 million USD or more in the debt securities of UniCredit. UBI. or emailing research. Lead or Co-manager: J.disclosure. the research analyst denoted by an “AC” on the cover or within the document individually certifies. Banco Popolare. 15 . Monte Paschi di Siena. Banco Popolare. where multiple research analysts are primarily responsible for this IntesaSanpaolo. Banco Popolare. Morgan Securities Ltd. is. Morgan–covered companies by visiting https://mm. calling 1-800-477-0406. with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers.P. IntesaSanpaolo. UBI. Monte Paschi di Siena within the past 12 Europe Credit Research 14 March 2012 Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or. Monte Paschi di Siena.

the recommended risk position is expected to perform in line with the relevant index. such as revenue and earnings growth rates. margins. which is equivalent to a Neutral rating. the most recent change). We assess this by analyzing. 16 . IntesaSanpaolo . Morgan Credit Research Analysts in the subject company over the past 12 months (or. Morgan Recommendation History Date 27 May 11 Rating Underweight Instrument 5yr CDS Recommendation changes made by J.J. UBI . we assign a rating to each issuer (Overweight. Monte Paschi di Siena . Morgan's credit research.J.P. if no recommendation changes were made in that period. if no recommendation changes were made in that period. Morgan Credit Research Analysts in the subject company over the past 12 months (or. if no recommendation changes were made in that period. Morgan Credit Research Analysts in the subject company over the past 12 months (or. Valuation & Methodology: In J. sector. Explanation of Credit Research Ratings: Ratings System: J.Enrico Longato (44-20) 7777-3147 enrico. Morgan Recommendation History Date 27 May 11 Rating Overweight Instrument 5yr CDS Recommendation changes made by J. Morgan Recommendation History Date 27 May 11 Rating Neutral Instrument 5yr senior CDS Recommendation changes made by J. J. if no recommendation changes were made in that period. Morgan Recommendation History Date 20 Feb 06 Rating Neutral Instrument CDS Recommendation changes made by J. sector.longato@jpmorgan. Morgan's Emerging Market research uses a rating of Marketweight. the most recent change).com Europe Credit Research 14 March 2012 UniCredit .P. Morgan Credit Research Analysts in the subject company over the past 12 months (or.P.P.P.J. if no recommendation changes were made in that period.P. Morgan Credit Research Analysts in the subject company over the past 12 months (or. Morgan Recommendation History Date 27 May 11 Rating Overweight Instrument 5yr CDS Recommendation changes made by J. the issuer's credit position using standard credit ratios such as cash flow to debt and fixed charge coverage (including and excluding capital investment).J. among other things.P.J. the most recent change). the most recent change).P. Underweight or Neutral) based on our credit view of the issuer and the relative value of its securities. the recommended risk position is expected to outperform the relevant index. or benchmark). the recommended risk position is expected to underperform the relevant index.P. or benchmark). and the composition of the issuer's balance sheet relative to the operational leverage in its business.P. taking into account the ratings assigned to the issuer by credit rating agencies and the market prices for the issuer's securities. Banco Popolare . the most recent change).P. We also analyze the issuer's ability to generate cash flow by reviewing standard operational measures for comparable companies in the sector. and Underweight (over the next three months.P. Our credit view of an issuer is based upon our opinion as to whether the issuer will be able service its debt obligations when they become due and payable.P. sector. Neutral (over the next three months. or benchmark). Morgan uses the following sector/issuer portfolio weightings: Overweight (over the next three months.

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