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Italy

17 June 2013
Antonio Guglielmi Equity Analyst +44 (0)203 0369 570 antonio.guglielmi@mediobanca.com

Country Update-Italy

Italy seizing up caution required


A lot has changed, nothing has changed - dj vu of 1992 Italys investment case seems a revival of 1992, when a political and macro crisis forced it to devalue the Lira and exit the EMS with 140bn austerity and disposal. Debt service was 12% of GDP then versus 6% now but current macro situation is worse and devaluation is no longer an option. Hence it cannot be ruled out Italy having to apply for an EU bailout. The 250 bps spread tightening since the Nov 2011 peak merely shows the markets reward for monetary news from Frankfurt (LTRO, OMT), NY and Tokyo (QE) rather than for political news from Rome. Argentinas default risk, a possible bailout of Slovenia, more macro pain, unplugging of QE, German court issues on OMT, a lack of delivery from Letta could all lead to spread widening again, in our view. The recession is spreading to large corporates take the ILVA case April data show Italys macro entered its acute phase with 2.3bn new NPLs in the month, VAT collection at -7% YoY, consumers -4.4% YoY (vs -3.3% last year), and further credit tightening (1.1% YoY vs -0.7% in March). Unemployment subsidies are now up 7x since 2007 and we foresee more welfare burden on the public accounts. The pain has now spread to large corporates, 160 of which are under special crisis care. Banks exposure to ILVA for instance is capped to just 12bps CT1 risk, but 40k jobs are at risk (12k directly) equivalent to 10% of the total jobs Italy lost in 2012. Italian banks: Real estate and funding the threat, SME ABS the missed chance Residential RE deals are down 26% YoY to 430k, the lowest since 1985. With 0.044 constructions per inhabitant in 2000-10, Italy is nowhere near Spain, which is 2.5x higher. However, at the current coverage (10 p.p. below 2007), a further 10% RE price drop would wipe out 170bps of 2012 Basel II.5 CT1: MPS, BP, BPER and BPM would sit below 8%, while ISP and UCG would stay anchored at 9%. Deposits up 6% YoY confirm their stickiness, and 20bn AM inflows in Q1 reversed the 270bn outflows since 2006 thanks to low yields on govies. But heavy reliance on 260bn LTRO could erode c14% of our 2015e EPS when refunded to ECB. Draghis recent cooling on the ECB potentially buying SMEs loans does not help. ECB-eligible SME loans in our coverage range between 45bn (AA rated) and 145bn (A rated), i.e. between 6-15% of Italian corporate loans. No delivery here will be a big missed chance for Italy to sustain growth. No room for a large wealth tax but 75bn seems feasible The debate on a large wealth tax aimed at cutting debt/GDP to 100% has three constraints: 1) 65% of the 9.5trn Italian wealth is RE already taxed above the EU average (direct real estate taxes at 1.6% of Gross Disposable Income vs 1%); 2) only 2trn, i.e. 20% of wealth, is liquid assets 80% of which is retail savings at risk of outflows; and 3) it would hardly change the long term dynamics of debt now due to >1x fiscal multiplier depressing consumption. We found room for 75bn extra resources from: convergence between RE and financial assets tax rate (3bn); large fortunes tax a la French ISF (5bn); a progressive wealth tax on the wealthiest 10% of the population (43bn); the Switzerland deal on repatriated funds (20bn); and 4bn lower cost of debt from the above. The resulting Debt/GDP down 4p.p. and 1p.p. GDP of recurrent growth measures could create a virtuous circle but only if Italy can at the same time improve its extremely poor track record on structural reforms and fight on tax evasion. Mediobanca Italian Corporates Survey: credit access the main problem More than 50 companies in our coverage responded to our first survey questionnaire aimed at gauging sentiment: 55% of the industrials pointed to credit access as their major issue, which is why 85% of them are focused on cost-cutting and only 20% planning to increase their investments. As a result, 50% foresee no top line growth in 2013. Low revenues and poor macro make less austerity the clear consensus request: 44% seek growth measures, 26% ask for lower taxes and 21% for PA restructuring vs 6% only for cutting public debt and 3% for complying with the Fiscal Compact. Downgrading BP, BPER, Beni Stabili, Saras, Trevi and Yoox After a 5% cut post Q1, we keep our EPS estimates broadly unchanged but reflect our cautiousness in a string of downgrades analysed separately in the accompanying reports published today: Beni Stabili, BPER and Yoox to N from O, BP and Trevi to U from N, and Saras to U from O.

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Riccardo Rovere Equity Analyst +39 02 8829 604 riccardo.rovere@mediobanca.com


Italian Equity Team Simonetta Chiriotti Gian Luca Ferrari Andrea Filtri Emanuela Mazzoni Fabio Pavan Chiara Rotelli Andrea Scauri Niccol Storer Alessandro Tortora Massimo Vecchio +39 02 8829 933 +39 02 8829 482 +44 203 0369 579 +39 02 8829 295 +39 02 8829 633 +39 02 8829 931 +39 02 8829 496 +39 02 8829 444 +39 02 8829 673 +39 02 8829 541

Change in Recommendation Company BENI STABILI BPER BP SARAS TREVI YOOX Rating Neutral (from Outperform) Neutral (from Outperform) Underperform (from Neutral) Underperform (from Outperform) Underperform (from Neutral) Neutral (from Outperform) TP 0.60 5.80 0.95 0.95 4.45 18.1

Source: Mediobanca Securities

Conviction pair trades by sector Sector Banks Cement Capital goods Oil Branded / consumers Insurance / assets gath. Telecom / media Auto Long UCG, UBI, PMI Cementir PRY, Danieli ENI Autogrill Unipol, AZM El Towers, Cairo Fiat Ind Short ISP, BP, BPER Buzzi TFI, FNC SARAS Geox Cattolica Mediaset Pirelli, PIA

Source: Mediobanca Securities

IMPORTANT DISCLOSURE FOR U.S. INVESTORS: This document is prepared by Mediobanca Securities, the equity research department of Mediobanca S.p.A. (parent company of Mediobanca Securities USA LLC (MBUSA)) and it is distributed in the United States b y MBUSA which accepts responsibility for its content. The research analyst(s) named on this report are not registered / qualified as research analysts with Finra. Any US person receiving this document and wishing to effect transactions in any securities discussed herein should do so with MBUSA, not Mediobanca S.p.A.. Please refer to the last pages of this document for important disclaimers.

Italy

Contents

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Executive Summary Recession heading for the worst Real Estate Italy is no Spain, but . . . Deposits and Am inflows - the good news Tax burden on wealth: Italy versus Europe Limited room for a large wealth tax but 75bn seems feasible Mediobanca Italian Corporates Survey 2013 Conviction ideas and ratings changes

3 14 25 38 46 52 63 68

17 June 2013 2

Italy

Executive Summary
Walking on a thin line
A lot has changed, nothing has changed - Reiterating our negative stance on Italy Unauthorized redistribution of this report is prohibited. This report is intended for
Antonio.Guglielmi@mediobanca.co.uk from MB.Antonio.Guglielmi@mediobanca.com Four months after the inconclusive elections at the end of February, the investment case of Italy offers a mixed picture, in our view:

Not much seems to have changed in Italy on the political side if Italian commentators favourite game at the moment is guessing how short-lived the Letta large coalition government will be. However, quite a lot has changed outside of Italy due to the OMT announcement that gained momentum and the Japanese QE measures that provided a strong relief to the Italian spread.

We believe the lower spread coupled with the removal of the excessive deficit procedure could offer room for up to 15bn spending boost to Letta, i.e.1 p.p. of GDP. However, we see this as unlikely and surely not enough to make us feel more positive on the country. Indeed, with this note we reiterate our negative stance on Italy in light of further macro deterioration that we see ahead. As we show below, the spread contraction of the last 18 months is more related to QE and monetary newsflow from NY, Tokyo and Frankfurt (LTRO, OMT) than the markets appreciation of what is happening in Rome. Italian spread (vs German Bund, blue line lhs axis) and short term yield gap between BTP and BOT (as a % of BOT yield, red line rhs axis)
600
Italian marke t labo u r re fo rm

400%

500

Mo n ti ap pointed Italian Prime Min iste r

300%

400

ECB starts bu yin g Italian go vie s under th e Se cu rity Marke t Pro gram

200%

300
Mo n ti fiscal co n solidation p ackage

100%

200

ESM be co me s o p erative

in co n clusive Italian e le ctio n 0%

100
European sovereign crisis with Greece

LTRO 1

LTRO 2

OMT

Jap an QE

-100%

-200%

Source: Bank of Italy, Mediobanca Securities analysis

The recession is heading for the worst . . . Italian unemployment subsidy applications increased to more than 1bn hours today from 185m hours in 2007, highlighting the magnitude of the current crisis. Five years into the recession mean that Italy is heading for the worst, in our view. As recently highlighted by the BoI, over the 2007-12 period, Italian GDP contracted by 7 p.p., disposable income by 9 p.p. and industrial production by 25pp. It could still take more than 10 years to return to pre-crisis output levels. Not only are macro data poor per se, but the most recent (April 2013) figures showed a negative second derivatives with macro deterioration accelerating: 2.3bn new NPLs generation in April, VAT collection down 7% YoY,

17 June 2013 3

Italy

consumer expenditure down 4.4% YoY (versus -3.3% YoY last year), and further credit tightening (1.1% YoY lending in April versus -0.7% in March). . . . and is now hurting the large corporates the ILVA case If SMEs and households were first to be hit by the crisis, it now looks like the time has arrived for large corporates to also pay their toll. Some 160 large Italian corporates are now under special crisis administration. We highlight in this note the recent example of the ILVA environmental case, maybe the most problematic large corporate situation in Italy today. The good news is that banks exposure to ILVA seems to cap the capital erosion risk to 12bps of CT1. The bad news is that it looks very difficult to square the circle between job security (12k employees of ILVA at risk, 40k when considering indirect workers) and respect for EU environmental directives (high mortality rate in the area of ILVAs operations proved to be due to the plants emissions of a carcinogenic polluting agent). We have been here before - A dj vu of 1992 We see many similarities between the situation in the country today and that of 20 years ago, when political instability and macro meltdown forced Italy to exit the European Monetary System in spite of the Lira devaluation, of some Lit 100bn (50bn) austerity measures undertaken by the Amato government and of a large privatization plan which followed. We think the situation is worse today as macro is hurting the economy more heavily and Italy can no longer leverage on currency devaluation. What could go wrong? Argentina and more This is why we think time is a very scarce resource for Italy: the next six months will be crucial to assess if the country can leverage on the low spread QE-driven momentum and on the new government to reverse the poor macro trends of the last decade, or if it will inevitably end up in a EU bailout request, as we currently suspect. The potential default of Argentina, the likely bailout of Slovenia, the recurring risk for the Letta government to fall short of support from the Parliament or the unplugging of the FED QE measures are just few examples of what could become triggers of renewed market concern on the sustainability of the Italian debt. Argentina in particular worries us, as a new default seems likely.

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Argentina Sovereign curve yield (Lhs) and debt maturity


15.0
14.0

$bns
16.0 14.0 12.0 10.0 15.3 14.4

13.0
12.0 11.0 10.0 9.0 8.0 7.0 6.0 3 mnths 1 yrs 2 yrs 3yrs 4yrs 5yrs 10/06/2013 01/01/2013

8.0
6.0 4.2 2.6

4.0
2.0 0.0

2.5

2.2

1.7

1.1

1.7

Jun-13

Jul-13

Aug-13

Sep-13

Oct-13

Nov-13

Dec-13

2014

2015

Source: Mediobanca Securities, Bloomberg

Not only could Argentinas problems reignite concern on debt sustainability in peripheral Europe, but it could also have a direct impact on the Italian economy given the exposure to Argentina of many Italian corporates. TI and Tenaris, for instance, have double-digit turnover exposure to the country.

17 June 2013 4

Italy

Italian companies exposure to Argentina


Rating Tenaris Underperform Not Rated Neutral Neutral Underperform Underperform Neutral TP 13.6 5.45 4.5 7.0 4.45 15.0 Turnover exposure 30.0% 13.0% 2.9% 2.0% 4.0% 3.2% 0.8% EBITDA exposure 23% 10% 2.5% n.m. n.m. 5.9% n.m. EPS exposure 20% 2% 2.5% n.m. n.m. 7.9% n.m.

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Telecom Italia Campari Fiat Pirelli Trevi Generali

Source: Company data, Mediobanca Securities

No deposit outflows and AM back to inflows the good news


Banks deposits stickiness . . . Most recent data show that Italian banks are not suffering deposit outflows as the amount of deposits showed a 6% annual growth as at March 2013, and the stock is broadly stable at c.1.45trn. Deposits soared by roughly 20bn in March 2013 versus February 2013, almost equally split between time deposits and current accounts. This trend offset the 20bn monthly drop in bonds. As a result, the Eur20bn net funding increase at Italian banks in March versus February is almost entirely explained by repos. . . . and strong AM inflows As well as deposits confirming their stickiness, appetite for risk has emerged when looking at recent strong AM inflows: after Eur270bn of cumulated outflows since 2006, 1Q 2013 brought Eur20bn inflows, benefiting both assets gatherers and banks. Our correlation analysis points to the drop in government bond yields post the OMT announcement as a key driver of the recent AM inflows (Rhs chart below). Italian Banks Funding Mix, bn
2,500 2,250
20,000 4.50%

Inverse correlation: AUM inflows vs 2Y BTP yield


30,000 5.00%

2,000 1,750 1,500 1,250


1,000
-20,000 2.50% 10,000 4.00%

3.50%

-10,000

3.00%

750 500
250
-30,000 2.00%

-40,000

1.50%

Deposits Fixed Maturity

Dec-98 Jun-99 Dec-99 Jun-00 Dec-00 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12

-50,000

1.00%

Current

Deposits Reedem. at Notice

Repos

Bonds

IT asset management sector - flows

Yield 2YR IT BTP

Source: Bank of Italy, ABI, Mediobanca Securities analysis

17 June 2013 5

Italy

Heavy reliance on ECB funding the bad news Whilst current accounts outflow does not seem to be an issue for now, the ECB data confirm Italian banks funding is still over reliant on the central bank. Italian banks have taken c.260bn from the ECB and have deposited just 12bn with it, meaning the vast majority of the LTRO liquidity is still sitting on Italian banks liabilities thus providing a crucial albeit temporary buffer to their funding needs. The refunding of such ECB liquidity is scheduled for late 2014/early 2015. Should Italian banks cost of funding remain at high levels, the Italian banking system may be forced to cut back its sovereign exposure or replace the LTRO funding with more expensive liquidity, at the detriment of some 14% of their 2015 profitability, based on our calculations. Italian Banks ECB Deposits and funding (bn)
25

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ECB Funding by country


trn
80% 70% 60% 50% 40% 30% 20% 10% 0.5 0.3 1.1 0.9 0.7

0 -25 -50 -75 -100


-125

GR

IRE

IT

ES

PRT

Total ECB Facility (RHS)

1.5 1.3

-150 -175 -200 -225 -250


-275

Aug-05

Aug-06

Aug-07

Aug-08

Aug-09

Aug-10

Aug-11

Aug-12

Apr-08

Apr-09

Apr-10

Apr-11

Apr-12

Apr-05

Apr-06

Apr-07

Dec-04

Dec-05

Dec-10

Dec-11

Deposits at the ECB

Liabilities from the ECB

Source: Datastream, Company Data, Mediobanca Securities analysis

Real estate: Italy is no Spain, but asset quality will get worst
Italy is no Spain Recent data show an ongoing marked slowdown of the Italian real estate market with residential transactions down 26% YoY to 430k, the lowest level since 1985. Real estate prices in Italy contracted by 12% since their 2008 peak versus a 25% correction in Spain. There are very good reasons for Italy not to fear a Spanish-like real estate contraction: 1) some 40% of the national value added in Spain came from real estate in 2007, 10 p.p. higher than Italy; 2) housing completions over the last decade were 2.5x larger in Spain than Italy despite a 30% larger population in Italy: 0.11 houses per inhabitant in Spain versus 0.044 in Italy; 3) Italian households indebtedness is the lowest in EU; and 4) average loan-to-value stands at 65% in Italy versus 72% in Spain. Italy - Number of RE residential transactions (000)
900 850 866 835 769 687 689 617 614 603 558 877 816

Dec-12

Dec-06

Dec-07

Dec-08

Dec-09

Apr-13

0%

Nomisma Retail real estate prices


200

190 180 170 160 150 140 130 120 110 100

800
750 700 650

600
550 500 450 464

90

448

80 70 1H 92 1H 93 1H 94 1H 1H 1H 95 96 97 Residential 1H 98 1H 99 1H 00 1H 01 1H 1H 1H 02 03 04 Office 1H 05 1H 06 1H 07 1H 1H 1H 08 09 10 Retail 1H 11 1H 12

400

Source: Agenzia del Territorio, Nomisma, Mediobanca Securities

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Simulation 1: up to 45% RE price correction would still leave coverage above 100% Whilst Italy is no Spain, we think it fair to assume that a likely further real estate price correction could affect Italian banks balance sheets currently sitting on a cash coverage of 41%, some 10 p.p.

17 June 2013 6

Italy

below the 2007 levels within our coverage universe. In the first approach of our simulation, we find that Italian banks could bear up to 45% downward revision of their real estate collaterals and still maintain coverage above 100%. Simulation 2: 10% RE price drop would erode 17% of CT1 if coverage stays unchanged Unauthorized redistribution of this report is prohibited. This report is intended for
Antonio.Guglielmi@mediobanca.co.uk from MB.Antonio.Guglielmi@mediobanca.com Alternatively, we are interested in quantifying the capital erosion stemming from 10% real estate prices drop subject to keeping unchanged total coverage ratios at current levels. The result is that some 10% lower collateral value at constant coverage ratio would wash out some 17% of the aggregate CT1 capital of our banks with CT1 ratio dropping by 170bps to 8.7% (Rhs chart below). Estimated Max Revision of RE Collaterals Values to Hit 100% Coverage Ratio, 2012
100%

Estimated CT1 Impact from 10% Drop in Market Price of RE Collaterals, 2012 (coverage unchanged)
10% 9% 8% 7% 6% 5% 4% 3% 2% 1%

90% 80%
70%

60% 50% 40% 30% 20% 10% 0%

CREDEM

BPER

Aggregate

CREVAL

UCG

MPS

BPM

UBI

BP

ISP

0%

UCG

Aggregate

MPS

UBI

ISP

BP

BPER

BPM

CREDEM

CT1 Impact

CT1 after RE Collaterals Mark-down

Source: Company Data, Mediobanca Securities analysis

Five banks would sit below 2012 Basel II.5 8% CT1: MPS, BP, BPER, BPM and CVAL, but the last three show room to restore capital ratios through IRB models. ISP and UCG would remain anchored above 9% CT1 ratio. In summary, although we recognise Italy is no Spain, we foresee further balance sheet clean-up ahead for Italian banks, possibly triggered by the asset quality stress test that the ECB is set to carry out next year.

Tax burden on wealth Italy versus Europe


Some 15 years of divergence from Europe . . . From 1995 to 2010, Italy has pursued a fiscal policy divorcing from the rest of Europe, i.e. lowering the tax burden on capital and wealth (and consumption) at the expenses of taxes on income. Based on 2010 figures, we calculate that taxes on the stock of capital and wealth accounted for 2.5% of Italian GDP in 2010 (aligned to the EU average) from c.4% in 1995. The reduction of the taxation of the stock of capital/wealth in Italy has to be ascribed mostly to the progressive relative reduction of the taxation on real estate, culminating in the elimination of ICI on the main property in 2010. In 2010, the amount of direct real estate taxes amounted to 9bn versus almost 13bn in 2007, less than 0.6% of GDP in 2010 versus 0.85% in 1995. Italy Taxes on Wealth as % of GDP, 1995-2010
4.0 3.8 3.6 3.4 3.2 3.0 2.8 2.6 2.4 2.2 2.0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 ITALY EU 27 AVG

Tax receipts breakdown, 2010

BE BG CZ DK DE EE IE EL ES FR IT CY LV LT LU HU MT NL AT PL PT RO SI SK FI SE UK NO EU 27
PERSONAL INCOME TAX CORPORATE INCOME TAX TAXES ON STOCK OF CAPITAL

Source: Eurostat, Mediobanca Securities analysis

17 June 2013 7

CREVAL

Italy

. . . reversed in 12 months (2012) due to higher real estate taxes The trend has been reversed in 12 months as the IMU (real estate) and the additional 0.15% taxation of custodian assets brought the burden of capital taxation to the level of 1995, making Italy the nation with the third highest taxation of capital in EU-27 after France and the UK. IMU brought the recurrent taxation of capital and wealth at almost 60bn p.a., equal to c.4% of Gross Disposable Income, the level of 1995. The trend of the past 15 years was thus reversed in one year (2012). Italy Taxes on Capital as Percent of GDP, 1995-2010
bn Real Estate Taxes Financial Assets Total Taxes on Capital GDP Taxes on Capital as % of GDP 1995 13.0 5.4 33.8 865 3.9% 2010 19.6 7.9 38.9 1,556 2.5% Extra Revenues
(IMU + Fin. Assets)

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2010
(incl. IMU + Fin. Assets)

+16 +5 +21 1,556 +1.3%

35.1 12.9 59.4 1,556 3.8%

Source: Company data, Mediobanca Securities analysis and estimates

Such jump has to be ascribed to a much more severe taxation of real estate assets. Using Eurostat data (i.e. the items named 29A in Eurostat statistics), we calculate that taxes on real estate assets (8.6bn) represented 0.57% of the Italian Gross Disposable Income in 2010. The Italian level of property taxation was below EU 27 (arithmetic) average of the same year, equal to 0.68% of Gross Disposable Income. Using a weighted average for the EU, we calculate that taxes on real estate assets would account for c.1.0% of Gross Disposable Income, pushed upwards by the high level of taxation in France and UK, more than balancing the low taxation in Germany. In this case, the taxation of Italian real estate assets was much lower than the EU average. Today we could not make the same statement. Including the incremental revenues from the introduction of IMU in 2012 (equal to 15.5bn) in respect of ICI in 2010, the total taxes on real estate would hit c.24bn, and the weight of real estate taxation would account for c.1.6% of Gross Disposable Income in 2010, among the highest in the Euro Area and well above the EU average. Hence, with the introduction of the IMU tax, the direct real estate taxation moved in Italy from 0.6% of gross disposable income to 1.6% versus 1% EU weighted average. EU Real Estate Taxation as Percent of Gross Disposable Income, 2010
2010 BE CZ DK DE IE ES FR IT IT (including IMU) HU NL AT PL PT RO SK FI SE UK EU Weighted Avg Real Estate Taxes (bn, A) Gross Disp. Income (bn, B) 4.4 0.3 3.2 11.3 1.4 9.5 45.7 8.6 24.1 0.3 3.0 0.7 0.8 1.0 0.5 0.2 0.0 2.7 26.2 359 138 237 2,511 129 1,026 1,942 1,528 1,528 91 570 283 344 168 126 64 179 352 1,705 A/B 1.2% 0.2% 1.4% 0.5% 1.1% 0.9% 2.4% 0.6% 1.6% 0.3% 0.5% 0.2% 0.2% 0.6% 0.4% 0.3% 0.0% 0.8% 1.5% 1.0%

Source: Eurostat, OECD, Mediobanca Securities analysis and estimates

17 June 2013 8

Italy

Taxation of financial wealth already looks high as well . . . In 2010, also taxation of financial assets at 0.5% of GDP in Italy stands above the Eu average, as the total amount of taxes on financial assets accounted for 0.5% of GDP in Italy versus 0.25% average for France, Germany, Spain and UK. In other words, already in 2010 Italy showed the highest tax burden on financial assets. The situation will change in 2013 with the introduction of the 0.15% taxation of financial wealth. If we added the estimated 5bn tax receipts, the taxation of financial assets would reach approximately 13bn, more than double the amount charged in France (excluding the ISF). Selected EU Countries Breakdown of Taxes on Stock of Capital/Wealth, 2010
bn Real Estate Financial Assets Wealth Tax Inheritance Tax Other Total ITALY 20 8 0 0.5 11 39 ITALY (IMU/Fin. Ass) 35 13 0 0.5 11 59 FRANCE 56 6 5 8 9 83 GERMANY 17 n.a. n.a. 4 4 25 SPAIN 20 n.a. 0 2 3 26 UK 66 3 0 3 1 74

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Source: Eurostat, Mediobanca Securities analysis

Although being the highest among the five largest countries, the taxation of financial assets accounted for just 0.22% of the Italian households wealth in 2010, below the 0.35% calculated as taxation of real estate assets as percent the Italian households wealth in real estate. Adding the estimated additional tax receipts from IMU (16bn) and financial assets (5bn), the gap will widen further to c.25bps. Italy Tax Receipts on Real Estate and Financial Assets as Percent of Wealth, 2010
bn Real Assets Financial Assets Wealth 5,541 3,546 Tax Receipts 20 8 Taxes as % of Wealth 0.35% 0.22% Tax Receipts (incl. IMU, Fin. Assets) 35 13 Taxes as % of Wealth 0.63% 0.36%

Source: Eurostta, Bank of Italy, Mediobanca Securities analysis and estimates

. . . and will move from 2.5% of Gross Disposable Income in 2010 to 3.9% Another way to look at the weight of taxation of capital is to measure it against Gross Disposable Income. In 2010, we calculate taxation of capital in Italy accounted for c.2.5% of Gross Disposable Income (GDI), aligned to the EU average. Adding 21bn from the newly -introduced taxes the ratio would soar to 3.9%, making Italy the third highest taxation of stock in the Euro Area after UK, France and Norway. Hence, we conclude that the taxation of capital in Italy is already among the highest in Europe and is also high in respect of the income generated by the country annually. EU Taxes on Capital as Percent of Gross Disposable Income, 2010
LT SK EE CZ BG SI LV AT DE RO EL SE FI NL PL CY PT IT EU 27 Wavg ES IE HU DK IS BE IT (Imu + Others) LU FR UK NO 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%

Italy Taxes on Capital as Percent of Gross Disposable Income, 1995 - 2010


4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

1995

Source: Company data, Mediobanca Securities analysis and estimates

17 June 2013 9

2010+IMU

Italy

After benchmarking the Italian tax profile of wealth both capital and real estate with its EU peers, we find no room to further close the gap through higher taxation as Italy already sits above the average. This leads us to investigate alternative ways for the country to quickly raise taxes should this be needed in the case of further pressure on public accoutns.

Wealth tax - In search of 75bn alternative sources


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Antonio.Guglielmi@mediobanca.co.uk from MB.Antonio.Guglielmi@mediobanca.com Three reasons to avoid a large wealth tax The need for a large wealth tax is a recurring debate in Italy. We estimate a 400bn wealth tax would be needed to bring the debt / GDP ratio below 100% without disposals. We think such an approach is not feasible when considering that:

Some 65% of the 9.5trn Italian wealth is already accounted for by real estate, offering no room for further tax rises relative to Europe. Only 20% of the Italian wealth is constituted of liquid assets, i.e. c.2trn, 80% of wh ich is retail savings: (bank deposits 30% of total liquid assets, postal savings 15%, banks bonds 18% and Italian govies 9%). Raising 400bn from this pot means 35% of Net Liquid Wealth, far too high not to run the risk of deposits outflows and over penalisation of small retail savers. A large one-off wealth tax spread over the whole population would hardly change the longterm dynamics of Italys debt, when assuming current >1x fiscal multiplier expected to depress consumers as already confirmed by the lower than expected VAT tax collection following recent austerity measures.
Amount - bn As % of Total 53% 1% 4% 2% 3% 63% 4% 2% 7% 1% 1% 7% 3% 2% 0% 4% 2% 1% 3% 37% 100% Not Not Not Not Not Liquid Liquid Liquid Liquid Liquid

Italy Breakdown of Gross Wealth, 2011


Residential Property Valuables Non-Residential Buildings Plants, Machineries et cetera... Land Total Real Estate and Physical Assets Equity in Non-Listed Limited Corporations Equity in Non-Limited Firms Life Technical Reserves Others (Commercial Loans, Shareholders Loans to Cooperatives, Others) Banknotes, Coins Bank Deposits Postal Savings Italian Gov. Bonds and T-Bills Italian Corporate Bonds Italian Banks' Bonds Foreign Securities Equity in Listed Limited Corporations Mutual Funds Units Total Financial Assets Total Gross Wealth
Source: Bank of Italy, Mediobanca Securities analysis

5,027 125 342 237 247 5,978 421 205 680 119 114 651 327 184 3 373 146 73 248 3,542 9,519

Not Liquid Not Liquid Not Liquid Not Liquid Liquid Liquid Liquid Liquid Liquid Liquid Liquid Liquid Liquid

Our doable 75bn wealth tax proposal . . . Adversely affected by such constraints, we investigate the room for up to 75bn alternative sources for the government, taking tax progression into account aimed at minimizing the negative impact on consumers.

3bn (up to 7bn if including SMEs) from converging the fiscal treatment of financial assets to that of real estate. 5bn from a large fortunes tax replicating the French ISF. 43bn wealth tax on 10% of the wealthiest population.

17 June 2013 10

Italy


bn

20bn from an agreement with Switzerland on repatriated funds. 4bn from lower interest service on debt stemming from the above measures.

Italy Summary of Interventions


Total 8 3 5 67 43 20 4 75 Goal Reduce Income Taxes Reduce Income Taxes Debt Reduction Debt Reduction Reduce Income Taxes Recurring Interventions Alignment Taxes Fin. Assets 2013 Wealth Tax on Wealthy Population Una Tantum Interventions Wealth Tax Taxation of Repatriated Funds Lower Cost of Debt Total
Source: Eurostat, Mediobanca Securities estimates

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. . . resulting in 4 p.p. of debt/GDP reduction and growth measures for 1 p.p. GDP The conclusion would be a mix of 4 p.p. of debt/GDP reduction, not necessarily over-penalising consumers as it would come from the wealthiest population, and room for recurring growth measures amounting to 1 p.p. of GDP. A proper attack on tax evasion and the black economy would clearly bring us to a much larger number, but the poor track record of Italy in this regard leads us to prefer not to include such options in our analysis.

Mediobanca Italian Corporates Survey


Credit access is the main problem for 55% of our sample; 50% expect no top line growth More than 50 Italian companies in our coverage responded to our survey questionnaire aimed at gauging expectations on the back of the recent political deadlock. Although roughly one out of three companies considered the latter as a very negative on their economics, it is not politics per se the main source of concern. Some 55% of industrials point to credit access as their major problem, whilst banks mentioned the high and volatile cost of funding (lhs chart below). If 85% of the banks foresee a decent top line growth this year, more than 50% of industrials expect no top line growth (rhs chart). Worrying factors for the coming future
Credit access
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% MB Sample Financials Industrials 29% 11% 16% 57% 13% 10% 23% 45% 43% 55%

Revenue growth expectations in 2013


Interest rates

Capital markets access

Interest rates volatility

Extremely
100% 90% 80%

A lot
3% 16%

Moderatly

Neither much nor little

Slightly
3%

No

14%

33% 27% 13% 11% 14% 71%

70%
60% 50% 40% 30%

13%

20%
10% 0%

30% 14%

37%

MB Sample

Financials

Industrials

Source: Mediobanca Securities

85% focus on cost-cutting and only 20% is increasing investments versus last year This is why 85% of our sample are considering further costs rationalisation and only 20% are planning to raise investments versus last year. The recent decree to speed up payments to corporate by the Italian PA does not seem to represent a game changer, as only 24% say this could have a significant

17 June 2013 11

Italy

impact. Some 80% of the panel expects that the weak scenario could lead to some sector consolidation, but only 8% believe M&A opportunity would come from distressed PA assets. Plan to increase investments
Extremely 3% No 17%

Plan to further optimise costs, 2013


Extremely 17%

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A lo t 17%

Slightly 10% Neither much nor little 14%

Mo deratly 13% Slightly 30%

A lot 28% Moderatly 31%

Neither much nor little 20%

Source: Mediobanca Securities

Priorities: growth (44%), lower taxes (26%), public debt (6%), Fiscal Compact (3%) The companies interviewed are all well aligned in terms of their priorities for the new Letta government. As shown in the chart below, out of the five options proposed, 44% of the pool indicated growth strategies as a necessity to revitalise the stagnant economy. The rest of the companies prioritise the reduction of fiscal pressure (26%) and the restructuring of the Public Administration (21%). Surprisingly, only 6% of the pool believe the reduction of the high public debt is a priority, and only 3% care about respecting the Fiscal Compact. Austerity. Priorities for the next government
Gro wth strate gy Re stru ctu ring Pu blic Ad ministration Co mp ly with fiscal co mp act 100% Re d u cing fiscal p re ssure Re d u cing public d e bt

90% 80%
70% 60% 50% 40% 30% 20% 21% 6% 3% MB Samp le 22% Fin an cials 26% 22% 21% 7% 3% In d u strials 26% 44% 43% 56%

10%
0%

Source: Mediobanca Securities

Conclusion: softening austerity is the government conundrum The overall picture of our survey is for a country in a wait and see mood with companies reluctant to invest, more focused on cost-cutting plans and in strong need of increasing their credit conditions. Low prospects for revenues and poor macro expectations make the softening of the austerity stance the clear consensus request emerging from our survey.

17 June 2013 12

Italy
Stocks ideas and rating changes
Pair trades by sector Following a weak set of Q1 results, we ended up downgrading our 2013 and 2014 estimates by 5% on average on our Italian coverage. We remain cautious on the growth prospects for 2013 and 2014, and expect further downgrades in 2H 2013, driven by the macro outlook further deteriorating. As a result, we maintain a cautious stance on Italy, which leads us to favour defensive stocks and names with high earnings diversification outside of the country or stocks with corporate action/ restructuring potential. Our key high conviction pair trades are:

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Banks: long UCG, PMI and UBI vs short ISP, BP and BPER Cement: long Cementir vs short Buzzi Capital goods: long Prysmian and Danieli vs short Trevi and Finmeccanica Oil: Long ENI vs short Saras Branded and consumers: long Autogrill vs short Geox Insurance and asst gatherers: long Unipol and Azimut vs short Cattolica Telecom and media: long El Towers and Cairo vs short Mediaset Auto: long Fiat Industrial vs short Pirelli and Piaggio

Rating changes In light of our incrementally negative view we downgrade the following stocks:

Banco Popolare (Underperform from Neutral, TP 0.95 ) Beni Stabili (Neutral from Outperform, TP 0.60) BPER (Neutral from Outperform, TP 5.80) Saras (Underperform from Outperform, TP 0.95) Trevi Fin. (Underperform from Neutral; TP 4.45) Yoox (Neutral from Outperform, TP 18.10)

17 June 2013 13

Italy

Recession heading for the worst


Time is a very scarce resource for Italy. Five years into recession mean that the economy is now heading for the worst with unemployment subsidies up to more than 1bn hours from 185m hours in 2007. April data show a rise of 2.3bn in NPLs in the banking system, VAT collection down 7% YoY, consumer expenditures down 4.4% YoY (versus -3.3% YoY last year), and further credit tightening (-1.1% YoY lending in April versus -0.7% in March). Not only is the second derivative turning more negative and signalling further deterioration ahead, but if SMEs and households were hit first by the crisis, it looks like the time has now arrived for large corporates to pay their toll as well. Some 160 large Italian corporates are now under special crisis administration. In this note, we take a closer look into the ILVA environmental case, probably the most problematic large corporate situation in Italy today. The good news is that banks exposure to ILVA seems to cap the capital erosion risk to 12bps of CT1. The bad news tough is that it looks very difficult to square the circle between job security (12,000 employees of ILVA at risk) and respect for EU environmental directives (high mortality rate in the area proved to be due to the plants emissions of a carcinogenic polluting agent). We see many similarities between the situation in the country today and that of 20 years ago, when political instability and macro meltdown forced Italy to exit the European Monetary System in spite of the Lira devaluation, of some Lit 100bn (50bn) austerity measures undertaken by the Amato government, and of a privatization plan of Lit180trn (90bn). We think the situation is worse today as the macro headwinds are hurting the economy more heavily, and Italy cannot leverage on currency devaluation anymore. This is why we think the next six months will be crucial to assess if the country can leverage on the low spread QE driven momentum to reverse the poor macro trend of the last decade, or if it will inevitably end up in a EU bailout request. The potential default of Argentina, the likely bailout of Slovenia, the recurring risk for the Letta government to fall short of support from the Parliament or the unplugging of the FED QE measures are just few examples of potential events triggering renewed market concern on the sustainability of the Italian debt.

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Turnaround story or is it too late?


Little has changed in Italy . . . Four months after the inconclusive elections at the end of February, Italy offers a mixed picture. On the one hand it is difficult to indentify major discontinuity signs:

Same President. After several attempts, the Italian parliament ended up appointing Mr Napolitano as President of the State for the second time based on no agreement among the various parties on any other potential candidate. It is the first time in the history of the Italian Republic that the same President has secured a double-seven years mandate. Same large coalition government. PD and PDL, the two opposite parties that reluctantly supported Montis technocrat cabinet in 2011/2012 have now both agreed to fully endorse a new large coalition government under the premiership of PD deputy head Letta. This is in line with our expectations set out in our Perfect Storm note (26 February) when immediately after the elections we attached a 70% probability to a Grosse Koalition outcome. Same macro picture. The Italian macro situation has not improved over the last quarter, rather the contrary, as we show later.

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Italy

Same high public debt issues. The Italian debt has reached record levels of 2.035trn and is now expected to reach 135% of GDP in 2014. This was, still is, and will remain, in our view, the priority number one for the country.

. . . but much has changed outside Italy

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Spread contraction. The contraction of the Italian spread could become a real game changer if it were to prove sustainable. The OMT announcement from the ECB and the QE strategies in place at FED, BoE and most importantly at BoJ provided a significant window of opportunity for the Italian momentum to build up on the back of spread contraction. Since Japans QE announcement at the beginning of April, the spread versus German bunds contracted by almost 100bps. EDP. The removal of the EU excessive deficit procedure (EDP) on Italy could we believe pave the way for Italy to access EU funds aimed at providing some support to its economy. Softening austerity. France and Spain have recently been given extra time from Europe to revert to the 3% deficit threshold. Whether Italy has sufficient argument to aim for the same remains to be seen, but France and Spain represent the precedent on which Italy could rely to obtain similar concessions.

Some 15bn gift on the table but . . . Our back-of-the-envelope calculation suggests that spread contraction + EDP removal + extra deficit spending allowance might create a little treasury in the hands of the Letta government in the region of 15bn offering scope for a nice spending boost to the economy without harming Italys fiscal targets. This means some 1.0 p.p. of GDP, which couples with the boost potentially stemming from the 40bn late payments of the public administration debt (the total amount being estimated by Confindustria above the 100bn region) to Italian SMEs. Were we facing a marked positive u-turn in EU growth prospects (to potentially benefit the Italian export driven GDP) coupled with a clear roadmap towards EU convergence, we could conclude that the new government has a nice window of opportunity to try and push for Italy to become a successful EU restructuring story. Unfortunately though, this is far from being our base case scenario. . . . time is running out fast We actually think the reality is quite different, and we have little faith in the above materialising:

Spread. Relying on low spreads for extra budget spending is risky. The yield on Italian BTP rose sharply in few days last couple of weeks on market concern on the unplugging of QE measures from the FED and on the German court ruling on OMT, showing that it is far too early to assume the EU sovereign crisis has normalised. We do not believe Italy can rely in the long term on lower interest service of its debt as a driver of extra deficit spending. EDP. Accessing EU funds is a potential 2014 option which needs local authorities (regions and municipalities) to be operating with best practice in terms of governance and public accounts in order to gain access to such funds. It remains very unlikely to us to expect that Italy will be allowed to temporarily exceed the 3% deficit cap in light of its high public debt. Recent macro data point to further deterioration. Chances are high in our view that macro data, recently revised downwards both for Italy and Europe, will face further downgrades in 2H 2013. Also, as we argued in our recent downgrade of the EU banking sector to Underperform (Banks Briefing Risk up and capital not enough, dated 25 March) we fear the speed towards EU convergence is slowing down too much, and we believe the risk for the sovereign crisis to resurface is high. The potential delay or the weak implementation of the banking union project for instance would be particularly negative for Italy in our view.

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Italy

Next six months will give us the answer stay cautious on Italy in the meantime This is why we maintain our cautious stance on Italy for now. Time is the crucial variable here, as five years into recession has put Italy in a border-line situation now. We think the next six months will be crucial in assessing the final outcome. Either Italy will soon build momentum in terms of growth by cashing in on the benefits of Montis reforms and leveraging on its export-driven GDP, or it will face a likely worsening of the macro and sovereign crisis that might force the country into a bailout request. The spread improvement is mainly related to exogenous monetary factors The Italian spread has halved since the resignation of Berlusconi in November 2011. Roughly onethird of this improvement came after the appointment of the Letta large coalition government in April. Hence, at first sight the market seems to have appreciated the austerity measures proposed by Monti and the large coalition backing the recent Letta cabinet. However, as we try and show in the chart below, such spread improvement has little to do with the Italian political landscape, and much more to do with monetary action around the world. Italian spread (vs German Bund, blue line lhs axis) and yield gap between BTP and BOT (as a % of BOT yield, red line rhs axis)
600
Italian marke t labo ur refo rm

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400%

500

Mo n ti appointed Italian Prime Min iste r

300%

400

ECB starts buying Italian go vies under the Security Market Pro gram

200%

300
Mo n ti fiscal co n solidation package

100%

200

ESM be co me s o perative

inco nclusive Italian electio n 0%

100
European sovereign crisis with Greece

LTRO 1

LTRO 2

OMT

Japan QE

-100%

-200%

Source: Bank of Italy, Bloomberg, Mediobanca Securities analysis

The Monti government took office in November 2011, which basically c oincided with Draghis LTRO 1 announcement in early December (see Europes last minute deal, 5th December 2011). Equity and fixed income markets rerated on the back of such newsflow, so that the Italian spread enjoyed three months of marked improvement. It is with the LTRO 2 announcement in March 2012 that the market started questioning such a facility: if three months after providing 490bn funding to EU banks through LTRO 1 the ECB felt the need of an extra 530bn injection, it clearly meant the problem w as not fixed. But more importantly, ECB deposits data in Q1 2012 confirmed that the vast majority of LTRO funding ended up being parked at the ECB, hence providing tangible evidence of how the monetary transmission mechanism was not properly functioning. It appeared evident that the ECBs ability to stimulate the economy in the lack of printing power was capped. The Italian spread reflected such concern, widening back to pre-Monti levels just three months after the LTRO 2 announcement.

17 June 2013 16

Italy

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In November 2012 we would have expected the market (and the spread) to negatively react to the end of the Monti government. Rather, we noticed that the spread kept narrowing until the February 2013 elections, clearly showing the benefit of the whatever is needed announcement of Draghi backing his OMT plan as announced at the end of the summer 2012 (see Time to Call the German Bluff, 6th June 2012). Not only was OMT the only reason of such spread improvement in 2H 2012, but even today it is on the back of the ECB potentially activating such a tool that sovereign funding conditions remain relatively benign in peripheral Europe. The February inconclusive elections followed by two months of negotiation to form a government and to appoint the president of the State started to be reflected in spread widening (see Election approaching, uncertainty raising, 18th February 2013). However, it is the Abenomics massive QE announcement from the BoJ at the beginning of April that seems to have provided another window of spread relief for Italy.

Dont look at the spread but monitor the yield gap between BTP and BOT The conclusion from the above is that the Italian political uncertainty of the last 18 months played more like a second derivative on the spread, whilst it is monetary newsflow from NY, Frankfurt and Tokyo that seems to have represented the first derivative of the spread contraction Italy has enjoyed. This means:

The low spread does not necessarily mean the market is rewarding the Italian austerity stance or the unusual Letta grand coalition Government. If we agree that an accommodating monetary policy around the world ended up becoming the first ally for the Italian spread, we believe it must follow now that Italy runs the risk of becoming a key victim of market concern on the FED starting to unplug its five years QE measures. Post OMT announcement, the spread lost its relevance as a barometer of solvency risk perception on any EU country, given the backup of the ECB.

This is why in our recent update on Italy (see Elections approaching, uncertainty raising, of 18 February) we introduced a new measure for the Italian solvency risk. This is the yield difference between BTP and BOT. Such a gap has no reason to exist unless the market wants to differentiate between bonds at risk of restructuring (BTP) and bonds not subject to restructuring (BOT as any money market instrument). The chart above shows such a gap (red line) in relative terms, i.e. as a percent of the BOT yield. Reconstructing a proper time series is not an easy exercise, which is why we only show such ratio at specific times where available data allowed us to construct such ratio minimising the margin of error. The key message is that since 2010, i.e. when the Greek deficit problem emerged and the sovereign crisis started, the relative yield gap in Italy between BTP and BOT ranged between 1x and 3.5x the yield on BOT, far too much. We interpret such finding as the real underlying solvency concern of the market, which would have otherwise closed such a profitable arbitrage.

A dj vu of 1992 we have been here before


History repeating itself . . . History repeats itself and Italy seems to make no exception to this. It is interesting, in our view, to note the many similarities between the Italian situation today and 20 years ago:

Dissatisfaction with politics. Now, as in 1992, the dissatisfaction towards the existing political class has brought Italians to openly and publicly criticise its politicians. Implosion of existing parties. In 1992 the Christian Democrats and the Socialist parties essentially disappeared under corruption scandals, paving the way for Berlusconis arrival. Additionally, the former PCI (Communist party) broke down in its social democrats

17 June 2013 17

Italy

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component (today PD) and its more leftish representation. Equally today, we have had the dissatisfaction towards Monti and all the central catholic parties disappearing coupled with the ongoing tension within the PD party, which leads many commentators to expect the PD to potentially break down. It is the strong leadership of Berlusconi that makes the PDL immune for the time being from internal tensions, but one could reasonably expect that the PDL is also destined to internal attrition when Berlusconi decides not to lead the party anymore after 20 years of strong leadership.

New parties. The consequence of such turmoil was dissatisfaction towards existing parties. In early nineties this led to Berlusconis new Forza Italia party and the Northern League success at the expense of Socialist and Christian democrats parties, which essentially disappeared or converged into Berlusconis new party. Twenty years later the two traditional parties (PD and PDL) together lost almost 10m votes in the February 2013 elections, which ended up rewarding a brand new movement, Five Star, which became the first party at its first election catalysing the Italians dissatisfaction against the political class. Institutional bottleneck. Now as then, Italy faced a dangerous institutional bottleneck with the overlapping between national elections (April 1992) and the appointment of the new president of the state (May 1992). It took a record 16 attempts at that time for the newly appointed Italian Parliament to find a convergence on Oscar Luigi Scalfaro as the new President. This time around it only took six attempts, but simply because it appeared immediately clear there was no room for convergence on any new name but Napolitano. Letta versus Amato. Today (Letta) as then (Amato) it is the former number 2 of the social democrats party to take the lead of the Government.

. . . hopefully not in full We firmly hope that the similarities will stop here, because what happened next 20 years ago proved very painful. Then as now the economic situation of Italy was particularly difficult (in the early 1990s it was the emerging markets bubble that triggered the macro slowdown) so to challenge the sustainability of its public debt.

The Amato government remained in power for only 10 months. The market speculation against the Lira forced Amato in July 1992 to pass a very painful
decree (worth almost 50bn in Lira equivalent at that time) aimed at calming down the markets: from higher retiring age to real estate tax and most importantly a 0.6% tax on bank deposits.

In spite of such austerity measures, three months later Italy was forced to exit the European
Monetary System and devaluate its currency.

This was followed by Amatos resignation, who was replaced by a technocrat government
headed by the governor of the Bank of Italy Ciampi.

The situation is worse today


Italy transformed the Euro from opportunity to threat We believe the situation is more problematic today than it was 20 years ago, as the recession is denting GDP growth much more heavily than in 1992.

The lack of room to manoeuvre on currency devaluation today is probably the most negative difference versus 20 years ago. It is due to the Lira devaluation and assets disposals that Italy managed to put its debt / GDP on a virtuous path starting from 1994 as shown below. The Euro straitjacket is clearly not providing a similar currency adjustment flexibility today.

17 June 2013 18

Italy

Italian growth vs debt evolution

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Source: Mediobanca Securities

It was due to a Lit 180trn (90bn) disposal plan that the country managed to improve its debt-to-GDP ratio in the following 10 years. But as we show below, that proved short lived and as soon as the crisis started denting Italian GDP growth again, Italy reverted to the >120% debt / GDP region. Essentially over the last ten years Italy has managed to waste the double benefit of low funding rates following the Euro introduction and of its disposal plan. Or to put it differently, Italy took the luxury of remaining sited over the last decade rather than using the Euro low rates relief as a key opportunity to implement painful but well needed structural reforms. The lack of action in leveraging on the Euro-driven low cost of funding and the assets disposal plan, largely explain Italy s lack of competitiveness today, in our view. Debt / GDP, 2001-12e
With privatizations
120%

Debt / GDP, 1992-2005


Without privatizations

125
115%

120
110%

115
105%

110
105
100%

100
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

95%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: Mediobanca Securities, Bank of Italy data

Recent macro data do not help On the one hand, one should note that the interest service on debt today amounts to just 6% of GDP, exactly half of the level registered in 1992. However, with the Lira devaluation Italy managed to inflate debt away, which it clearly cannot do today. This is why we think the major difference between today and 20 years ago is that the current recession is the worst ever seen in Italy as recently stated by the Minister of Finance Saccomanni. Most recent data unfortunately support such a stance:

As recently highlighted by the BoI, over the 2007-12 period Italian GDP contracted by 7 p.p., disposable income by 9 p.p., and industrial production by 25 p.p. It could take more than 10 years to revert to pre-crisis output levels.

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Italy

The ECB just revised downwards its 2013 GDP growth expectations for the Eurozone to -0.6% from -0.5%. We see downside risk to such a number putting Italy at risk of further downgrades. Low R&D investments explain part of the competitive gap of Italy, given that investments have not exceeded 1.2% of GDP over the last decade, versus the EU average of 1.9%. Banks asset quality remains a source of major concern. Recent BoI data point to NPLs in April up 22.3% YoY versus 21.7% YoY growth in March reaching 133bn, i.e. c9% of the Italian GDP. Hence the system generated 2.3bn new NPLs in the month. Additionally, coverage decreased to 50% in April from 51% in March. Unemployment rate reached 12% with 40% youth unemployment. This means 3m people out of the job market in 2012, half a million more than in 2011. Unemployment subsidies may best capture the fast deterioration of the Italian economy: rising to more than 1 billion hours of unemployment subsidy burdening public accounts today from 185m hours in 2007. It follows that consumers expenditure keeps contracting so that in the first four months of 2013 it is down 4.4% YoY versus - 3.3% YoY recorded over the same period last year. This explains why VAT tax collection in Q1 2013 is down 7% YoY.

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Also, credit contraction continues to cap the room for investments. Banks loans were down 1.1% YoY in April versus - 0.7% in March. It follows that what really worries us is not the negative picture per se but the fact that the second derivative keeps turning negative signalling further deterioration ahead. If households and SMEs have been hit first, it is for sure now the large corporates that are adding further concern to the Italian economy, as confirmed by the ILVA case study proposed below.

The crisis is moving from SMEs to large corporate the ILVA case
More NPLs and less lending for corporates If Italian households and SMEs have been the first to suffer from credit contraction, recent data show that the problem is now expanding to large corporates. The delta 2.3bn NPLs generated in April, for instance, come entirely from corporates versus a flattish trend in households. Construction and real estate, for instance, show NPLs +33% YoY and +35%, respectively. Lending contraction clearly does not help either. BoI data show that if households are facing a stable lending availability scenario now versus last year, it is the corporate world that is facing an acceleration in shrinkage to lending access: to 4.3% YoY in April from -3.3% YoY in March. Not surprisingly, in our view, some 160 large corporates in Italy are now under special crisis administration, and ILVA, the eighth largest steel plant in the world, based in Southern Italy, is probably the most relevant case. ILVA recent events: from the 2010 environmental problems managed by Berlusconi . . . Troubles at ILVA, which is part of one of the main European steel producer groups RIVA FIRE, began in 2010 when the largest companys plant (located in Taranto, Southern Italy, and on which some 75% of citys GDP directly and indirectly depends) was blamed by a local association for environment protection to be the source of a carcinogenic polluting agent above the limits set by the Italian law. The problem was temporary solved by Berlusconis government, which waived the law with a decree (155/2010). However, since then the focus on the pollution released by the plant has increased exponentially and subsequently drawn the attention of public prosecutors. In light of the results of several technical reports showing a clear correlation between the plants emissions and the mortality rate of the area, Italian magistrates disposed the sequestration of all the products coming from the plant as being not compliant with the legal standards.

17 June 2013 20

Italy

. . . to the 2012 temporary fixing by Monti . . . In 2012 Mario Montis government passed a decree (213/2012) to bypass the verdict of the public prosecutors, thus allowing ILVA to restart production. Despite this move and the resulting inability to reorder the seizure of production, the prosecutors did not give up and disposed the seizure of 8.1bn of assets belonging to the Riva family (owner of ILVA), accused of environmental disaster and therefore asked to compensate for the damages created. . . . followed by recent Letta decree Although the seizure did not directly affect the production of Tarantos plant, fears of indirect repercussions and of cash flow problems led Lettas government a few weeks ago to pass a decree to un-seize the 8.1bn assets and to appoint a special commissioner (Mr Bondi) to lead the company and to elaborate a plan to tackle the environmental issue, while keeping operations running. Potential clash with EU directive The substantial importance given by the last three Italian governments to ILVA derives from the high level of employees at risk in the case of a shutdown of the plant: currently some 12,000 people directly work at ILVAs plant, but the total number of workers at stake could reach the 40,000 threshold when considering all the Italian companies directly and indirectly linked to ILVA. As shown above, for the time being the Italian governments have managed to avoid the shutdown of the plant and the consequent unavoidable bankruptcy of the company with ad-hoc decrees aimed at buying time. That notwithstanding, Italian measures could clash with some EU directives (for example, directive 2010/75, which sets limits on industrial emissions, or directive 35/2004, which affirms the polluter pays principle) so that the efforts of the respective Italian governments might still be nullified. According to press reports, ILVA is currently losing some 50m per month and the lack of final fixing plus the potential clash with EU discipline, forces us to attach high probability to the worst case scenario for ILVA. Banks potential losses in 3-12bps CT1 region Analysing ILVAs accounts in order to determine the current banks exposure is not an easy exercise for the following reasons:

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FY2012 Annual Report for both ILVA and RIVA FIRE (the controlling company) are still not available. In 2012, the Riva Group was largely reshaped following a massive restructuring plan aimed at separating the two main activities of the group, the so-called long products from hot and cold rolls, the latter produced in ILVAs plants. FY2012, ILVA perimeter does not correspond to that in FY2011, as some foreign activities have been conferred to another holding, leaving only the Italian operations at ILVA. In FY2011, RIVA FIRE consolidated Annual Report showed 2.7bn of bank debt, of which 0.7bn was allocated to ILVA. As the RIVA Group has been split into two holdings one of which retaining ILVA activities the debt of the Group might have been re-allocated, but we do not know in what way. In 2011, ILVA reported an additional c.2.2bn debt exposure to Groups companies. At the current stage, it is not possible to assess whether the beleaguered financial position of ILVA may put at risk the financial strength of the other entities of the Group.

As such, the above-mentioned restructuring of the group means that our calculations should be taken with considerable caution. Mindful of the fact that the reshaping of the Group may have significantly altered the financial position of the different entities within the RIVA Group, we attempt to make some calculations starting from ILVAs FY2011 Annual Report. As at the end of FY2011, ILVAs bank debt exposure amounted to 719m, split as follows:

120m of short term debt.

17 June 2013 21

Italy

599m of long term debt, 175m of which is due to expire within one year (i.e. in 2012). The company had a negligible amount of cash and cash equivalents on balance sheet.

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As a consequence, at the end of FY2012 we could infer ILVAs bank exposure to range between 424m (assuming the full repayment and no renewal of the 295m credit lines expired 2012) and 719m (in case of roll-out of maturing debt). In both cases, such amounts should not represent a threat for the Italian banking system: assuming the whole of ILVAs bank debt is classified as NPLs and covered 66% (we would expect some kind of collateral/guarantees backing the credit line), we calculate the amount of provisions could stand in the 450m region for the system, equal to 350m impact on CT1 capital as at Mar-13, i.e. 3bps of the aggregate CT1 of the nine Italian banks under MB coverage. Should we expand such a simulation to the entire group, i.e. to the RIVA FIRE consolidated accounts, the potential losses for the banking system could reach the still manageable 12bps region given banks exposure of 2.7bn, i.e. more than 4x the 720m banks exposure of ILVA on which we based our exercise.

Argentina the next source of concern for Italy?


The 2001 default secured 93% backing from bondholders . . . Following the 2001 financial crises, Argentina was unable to roll over its debts and following the resignation of President de la Rua the country defaulted on $81.8bn debt, which at that time was the largest sovereign default in history. Following negotiations with the IMF, the country moved to a tender offer on the debt outstanding in 2005 and in 2010. This managed to secure the backing of 93% of the defaulted debt holders who agreed to exchange their holding for new securities at a 65% loss. . . . but litigation on the remaining 7% could open up to a new default . . . The remaining holdouts have been targeting better payment terms or a repayment in par, utilising litigation. The old bonds had pari passu clauses, which means that should Argentina be in a position to pay bondholders of the new securities then the holdouts should also be paid. As such, the holdouts have proceeded to sue the country for $1.3bn, which was given the backing of US courts. The amount has been derived from past principal and past interest. Argentinas reaction so far has been to reject the verdict and reiterate the offers of 2005 and 2010, which unsurprisingly have not been accepted. The current Argentine President Cristina Fernandez has vowed not to pay the vultures, however, so that a feasible way to end this story would be to enter another technical default in order to avoid having to make any payments to any holder. . . . which is why yields are rising The yield curve for Argentina is somewhat limited given its reputation as a serial defaulter, but we show in the chart below how the observable yield levels have increased since the start of the year as investor fears increased. Argentina Sovereign curve price (rhs) and yield (Lhs)
15.0
14.0

Price 120.0
110.0 100.0 100.7

13.0
12.0 11.0 10.0 9.0 8.0 7.0 6.0 3 mn th s 1 yrs 2 yrs 3yrs 4yrs 5yrs 10/06/2013 01/01/2013

101.3
90.0 87.8

89.3
83.6

80.0
70.0 60.0 50.0 3 mn th s 1 yrs

79.7
10/06/2013 01/01/2013

2 yrs

3yrs

4yrs

5yrs

Source: Mediobanca Securities, Bloomberg

17 June 2013 22

Italy

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In the rhs chart below, we also outline the current debt maturity schedule for the country. Whilst the majority of the debt is zero coupon securities, we note there are two floating securities maturing in July and August and a fixed coupon in September, which could trigger a technical default in case of no-coupon payment to the holdouts. Not surprisingly, the risk of an Argentina default coupled with the Asian and China slowdown and with the recent S&P downgrade of the outlook in Brazil to negative from stable have triggered a severe correction, which brought the emerging markets index back to summer 2012 levels (lhs chart below). Emerging markets index
JPMorgan Emerging Global Total Return Index
700.00 680.00 660.00 640.00 640.88 620.00 600.00 580.00 679.23

Argentina debt maturity schedule, $bn


$bns
16.0 14.0 12.0 10.0 15.3 14.4

8.0
6.0 4.2 2.6

4.0
2.0 0.0

2.5

2.2

1.7

1.1

1.7

Jun-13

Jul-13

Aug-13 Sep-13

Oct-13

Nov-13

Dec-13

2014

2015

Source: Mediobanca Securities, Bloomberg

Tenaris and TI the Italian companies most exposed to Argentina The potential default of Argentina could have a double negative impact on Italy, in our view. On the one hand it could reignite concern on debt sustainability in peripheral Europe, while on the other it could directly affect the Italian economy particularly exposed to Argentina. The table below summarises the key companies under MB coverage with exposure to Argentina, none of them on an Outperform rating. Italian companies exposure to Argentina
Rating Tenaris Telecom Italia Campari Fiat Pirelli Trevi Generali Underperform Not Rated Neutral Neutral Underperform Underperform Neutral TP 13.6 5.45 4.5 7.0 4.45 15.0 Turnover exposure 30.0% 13.0% 2.9% 2.0% 4.0% 3.2% 0.8% EBITDA exposure 23% 10% 2.5% n.m. n.m. 5.9% n.m. EPS exposure 20% 2% 2.5% n.m. n.m. 7.9% n.m.

Source: Company data, Mediobanca Securities

It can be seen that the exposure to Argentina ranges from 1% of turnover at Generali up to 30% at Tenaris.

Some 50% chance of a government crisis in Italy this year


In conclusion, this introductory chapter points to what we consider the most scarce resource for Italy today time. Five years into the most severe recession of the past century means that without inverting the trend soon Italy could be facing a very problematic situation ahead. It is fair to argue that Italys destiny is now in EU hands more than in Italian hands. Without Europe, i.e. the ECB, to keep

17 June 2013 23

Italy

buying the required time and without Italian politicians using such time for painful but inevitable structural reforms, we think the country might end up requiring a European bailout support. The large coalition government is facing a crucial role in implementing structural reforms. But its ability to deliver is dependent on a number of moving parts, which is why Italian commentators and opinionmakers are split: Unauthorized redistribution of this report is prohibited. This report is intended for
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The bullish argue that for various reasons this government can stay together for a long time and deliver what is needed: the common interest of both PD and PDL in buying time, some 70% of new PMs appointed willing to secure their future, Napolitano threatening his resignation in the case of government crisis, and the time required to implement constitutional reforms all seem to call for a long life of this government. However, the list of obstacles potentially forcing a short term government is equally if not more convincing to us: Berlusconis trials make the government road particularly bumpy in the case of conviction, potentially forcing him to unplug his partys support to Letta and to advocate new elections. Also, the potential implosion and break-down of the PD party at his winter congress could pave the way for this. But more in general, we think that any external factor turning against the Italian spread could affect the government: from the unplugging of the QE measures to reigniting the sovereign crisis triggered for instance from Argentina or Slovenia or the OMT constitutional debate.

Given the above, we think it fair to attach no more than 50% chance for this government to remain in power longer than this year. This means that the many uncertainties surrounding this unusual large coalition government could implode any time leaving the market with a totally unpredictable situation on what would happen next.

17 June 2013 24

Italy

Real Estate Italy is no Spain, but . . .


Recent data show an ongoing marked slowdown of the Italian real estate market, with residential transactions down 26% YoY to 430k the lowest level since 1985. Real estate prices in Italy have contracted by 12% since their 2008 peak versus a 25% correction in Spain. We believe there are very good reasons for Italy not to fear a Spanish-like real estate contraction: 1) some 40% of the national value added in Spain came from real estate in 2007, 10 p.p. higher than Italy; 2) housing completion over the last decade was 2.5x larger in Spain than Italy despite 30% larger population in Italy; 3) Italian household indebtedness is the lowest in the EU; and 4) Average loan-to-value stands at 65% in Italy versus 72% in Spain. In spite of such differences, we fear that further real estate price correction could affect Italian banks balance sheets, which are currently sitting on a cash coverage of 41%, some 10 p.p. below the 2007 levels within our coverage. We propose two approaches. In the first, we investigate how much real estate prices could drop in Italy without its banks suffering total coverage (cash + collateral) dropping below 100%. Our reassuring answer is that by our estimates Italian banks could bear up to 45% downward revision of the fair value of their real estate collaterals and still maintain coverage above 100%. In our second approach, we aim to quantify the capital erosion stemming from 10% real estate prices drop subject to keeping unchanged total coverage ratios at current levels. The result is that some 10% lower collateral value at constant coverage ratio would wash out some 17% of the aggregate 2012 Basel II.5 CT1 capital of our banks with CT1 ratio dropping by 170bps to 8.7%. Five banks would sit below 8% CT1: MPS, BP, BPER, BPM and CVAL, but the last three show room to restore capital ratios through IRB models adoption. ISP and UCG would remain anchored above 9% 2012 Basel II.5 CT1 ratio. In summary, although we recognise that Italy is no Spain, we foresee further balance sheet clean-up ahead for Italian banks, possibly triggered by the asset quality stress test that the ECB is set to carry out next year. Draghis recent cooling on the ECB potentially buying SMEs loans does not help. ECB-eligible SME loans in our coverage range between 45bn (AA rated) and 145bn (A rated), i.e. between 6-15% of Italian corporate loans. No delivery here will be a big missed chance for Italy to sustain growth.

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Marked slowdown in Italian real estate


With an owner occupation rate of 80%, Italian households remain among the most exposed to the residential real estate among large European countries. Selected European Countries Owner Occupation Rate (%)
90

80
70 60 50 40

30
20 10 0

Source: EMF, Mediobanca Securities

17 June 2013 25

Italy

Residential transactions are down 26% YoY in 2012 . . . In 2012 the total number of residential transactions dropped by 26% YoY to 448,000, the highest drop recorded to-date and the lowest amount since 1985 when residential transactions were 430,000 (Lhs chart below). In value terms, residential transactions declined 26.3% to 74.4bn. The magnitude of the drop in the number of transactions largely exceeded expectations. In the first months of 2012, Nomisma still expected 594,000 transactions in the year, 33% above the actual number. The picture worsened during the year as shown by the acceleration in the quarterly drop (Rhs chart below). Number of transaction (000) Residential
900 850 835 769 687 689 866 877 816

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Number of quarterly residential transactions, YoY


3.0% 2.0% 1.8% 1.6% 1.5% 1.7% 1.3%

800
750 700 650

1.0% 0.0%
2Q 09 4Q 09
1Q 09 3Q 09

1.2% 0.0%
1Q 10 2Q 10

3Q 10

1Q 11

3Q 11

1Q 12

3Q 12

600
550 500 450 464 558

614617 603

-1.0%
-2.0% -3.0%

-1.5%

-1.9%

-3.0%

-2.6%

-3.4% -4.2%
-4.6% -4.1%

448

-4.0% -5.0%

400

Source: Agenzia del Territorio, Mediobanca Securities

Average number of yearly salary to buy a house

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

The number of mortgage loans for house purchases fell by 38.6% in 2012, even more than the overall number of transactions. Consequently, transactions that involved a mortgage loan declined to 37% of the total, eight percentage points below that in 2011. The amount of total mortgage loans granted to households for house purchases declined by 43% in 2012 to 19.6bn; and the ratio between mortgage loans and the total value of transactions decreased to 26% from 34%. . . . due to several factors Lower prices coupled with lower interest rates helped to sustain the so-called affordability index, which was unchanged in 2012 at the 2011 level. In light of the stable affordability index, worsening expectations, higher taxes on houses (IMU), and lower credit availability appear to be the main drivers of the drop in transacted volumes. House Affordability index for Italian households

Source: Agenzia del Territorio, Mediobanca Securities

17 June 2013 26

4Q 12

4Q 10

2Q 11

4Q 11

2Q 12

-0.1%

Italy

Commercial real estate does not provide a better picture Transactions in commercial real estate among large professional corporations declined below 2.0bn in 2012, down from around 4.0bn p.a. in the prior three years. Insufficient re-pricing, especially for non-core assets, is the main driver of the low volumes. Low liquidity in commercial real estate is a problem in view of the relevant amount of funds approaching maturity and of the potential sale of real estate assets held as guarantees by the banks. Commercial real estate transaction volumes ( bn)
9.0 8.0 7.0 6.0
2.0

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Transaction volumes by quarters ( bn)


3.5 3.0 2.5

5.0 4.0 3.0 2.0 1.0 0.0 2006 2007 2008 2009 2010 2011 2012
1.5 1.0 0.5 0.0

1Q 06

2Q 06

4Q 06

2Q 07

4Q 07

1Q 08

3Q 08

1Q 09

3Q 09

4Q 09

2Q 10

4Q 10

2Q 11

3Q 11

1Q 12

3Q 12

Source: Nomisma, Quotidiano Immobiliare,JLLS, Mediobanca Securities

So far, 2013 point to flat/slightly increasing investment volumes. According to JLLS, in the first quarter of 2013 total transaction volumes amounted to around 0.6bn, up from 0.5bn in 1Q 12 while some important negotiations are ongoing on the market (mainly involving foreign opportunistic investors) and should be closed during the year.

Real estate overview - Italy versus Spain


The magnitude of Spains residential real estate bubble was twice that of Italy Using the European Mortgage Federation (EMF) data, we calculate that Spanish residential real estate prices ballooned by c.135% in seven years, a rise that is twice the magnitude of that of Italian real estate (c.+70% in eight years). Since their highs, real estate prices have fallen by c.25% in Spain as of September 2012, and we expect they have kept falling over the past few months. According to EMF data, residential real estate prices in Italy have stabilised over the period 20082011, fluctuating at level c.70% higher than in 2000. As the EMF does not provide quarterly updates on Italys real estate prices progression, we cannot provide an exhaustive comparison based on a homogeneous dataset for what happened in 2012 in Italy. Nomisma data show that the increase in Italys retail real estate prices hit 70% of 2000 levels in 2008, similar to that flagged by the EMF. With two different sources showing a maximum 70% increase in real estate prices in Italy, we conclude the magnitude of Italys real estate bubble was much smaller than that of the Spanish one. Unlike the EMF, Nomisma data show a different picture since the peaks, with retail real estate correcting by c.12% at the end of 2012 from the peak hit in 2008. We regard such an indication as more realistic than a substantial stabilisation at peak-prices (as shown by the EMF data till 2011). In addition, such a correction would be equal to 50% of that of Spains, i.e. equivalent to a growth of roughly 50% of the Spanish one.

17 June 2013 27

1Q 13

3Q 06

1Q 07

3Q 07

2Q 08

4Q 08

2Q 09

1Q 10

3Q 10

1Q 11

4Q 11

2Q 12

4Q 12

Italy

Italy and Spain EMF Residential RE Prices, 2000-07


240

Italy Nomisma Retail RE Prices, 1992-2012


200

230 220 210 200 190 180 170 160 150 140 130 120 110 100 90 80 2000 2001 2002 2003 2004 Spain 2005 2006 2007 2008 2009 2010 2011 III 12 Italy

190 180 170 160 150 140 130 120 110 100 90 80 70 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Residential Office Retail

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Source: EMF, Mediobanca Securities analysis, Nomisma

Differences in Italian and Spanish real estate markets


In our view, the prices of real estate collateral are theoretically safer in Italy than in Spain, for a number of reasons listed below.

Italian economy less dependent upon real estate and construction. The Spanish economy relies more on real estate and construction activity than Italy: at the peak of the real estate market (2007), we calculate that real estate/construction sector accounted for c.40% of the national value added in Spain (the EU second highest after the UK), c.10 percentage points higher than Italy. In addition, the interdependence between the Spanish economy and the real estate sector is exacerbated by the ongoing government cost-cutting programmes in infrastructure after years of heavy spending. Unlike in Spain, Italy s investment in infrastructure has been relatively poor, while the so-called Stability Pact imposed by the Central Government to regions and municipalities virtually stopped any local spending and investments. Housing completions 2.5x larger in Spain than Italy. Over the period 1999-2010, housing completions exceeded five million units in Spain versus less than three million in Italy, despite a population 30% larger in Italy. In 2011 housing completions in Spain collapsed by 75% from the peak hit in 2007 versus -50% in Italy on a number already 50% below Spains peak (317,000 in 2006 versus 640,000 in Spain in 2007). Over the period 2000-2010, we calculate that Spain completed the construction of 0.11 houses per inhabitant versus 0.044 per inhabitant in Italy, i.e. 2.5x . Housing Completions, 2000-11
650,000

RE/Construction % of Value Added, 2007


45%

40%
35%

600,000 550,000 500,000 450,000 400,000 350,000 300,000

30%
25%

20%
15%

250,000 200,000 150,000 100,000

10%
5%

0%

EU-27

Belgium

Italy

Germany

Denmark

Hungary

France

Finland

Norway

Austria

Poland

UK

Spain

Ireland

Greece

Czech R.

Netherl.

Slovakia

Sweden

50,000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Spain Italy

Construction/Total VA

RE, Rent. and bus. activ./Tot VA

Source: Bank of Italy, Mediobanca Securities analysis

Household indebtedness much lower in Italy. The personal indebtedness in Spain is much higher than in Italy. A higher level of debt by definition translates into higher probability of default and in a higher quantity of real estate assets up for sale. Aside from

17 June 2013 28

Italy

Norway, data show that the country with the highest debt (residential mortgage per capita) is Denmark (43k), followed by Netherlands (38k), Ireland and Sweden (30k). Italy actually has the lowest level of debt per capita in Europe. The debt per capita must be put in context with the disposable income in each country. In this respect, the highest ratios are shown by Denmark, Ireland, Netherlands, Portugal, Spain, Sweden and the UK. Again Italy is the most virtuous country in this respect. Unauthorized redistribution of this report is prohibited. This report is intended for
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115%
45

Res. Mtg. Debt per Capita, 2005-10 (000)


40 35 30 25 20 15 10 5 0

105% 95% 85% 75% 65% 55% 45% 35% 25% 15%

Belgium

France

Norway

Spain

Netherlands

Netherlands

Belgium

Germany

Denmark

Sweden

2005

2006

2007

2008

2009

2010

2005

2006

2007

2008

2009

2010

Source: Eurostat, EMF, Mediobanca Securities analysis

Loan-to-Value (LTV) below the average in Italy. Generally, a high LTV is associated with high default risk, and a high default risk may translate into a larger number of forced sellers, i.e. into a larger amount of properties coming to the market. Using the LTV of first time buyer provided by the ECB for Eurozone countries and various indications from Central Banks, we calculate approximately c.73% LTV in Europe, peaking at c.100% in the Netherlands. Italy stands below the EU average and below Spain.
Loan-to-Value % 84 80 45 80 81 91 70 73 61 65 83 101 48 65 71 68 80 65 72 70 80 73

Loan-To-Value, 2007-10
Country Austria Belgium Czech Republic Denmark Finland France Germany Greece Hungary Italy Ireland Netherlands Norway Poland Portugal Romania Slovakia Slovenia Spain Sweden UK AVERAGE
Source: ECB, Central Banks, Statistical Offices, Mediobanca Securities analysis

17 June 2013 29

Germany

Denmark

Norway

Finland

Ireland

France

Sweden

Finland

Ireland

Spain

Italy

Italy

UK

UK

Italy

Broad definition of financial distress in Italy


Financial distress is captured one way or another within the four categories The definition of impaired loans (sofferenze, incagli, ristrutturati, scaduti) in Italy is broader than in most European countries, as it comprises insolvency, temporary financial difficulty, restructuring (with or without a loss for the lender) and payment overdue. On past-due loans, Italy also looks to be in line with its European peers. Current Bank of Italy guidelines specify that, after 90 days of arrears, a loan must be classified at least as past due, in line with EU best practice. However, management has the discretion to classify it as incaglio or sofferenza after just one day of delay in the loan payment. As such, we believe that the possibility of not capturing a situation of distress in one of the four Italian categories is limited. Outside of Italy, the 90-day past due rule dominates as the main criteria to classify a loan, generally causing the exposure to be classified as Non-Performing and possibly assigning a 100% probability of default. On the other hand, loans less than 90 days overdue and restructured loans are generally regarded as performing outside of Italy and not impaired. Italy Criteria of Classification of Problematic Loans
Category Definition Non-Performing Loan: on- and off-balance sheet exposures to borrowers in a state of insolvency (even when not recognised in a court) or in an essentially similar situation, regardless of any loss forecasts made by the bank, irrespective of whether any collateral or guarantees have been established to cover the exposures. Also included are Italian local authorities in a state of financial distress for the amount subject to the associated liquidation procedure. Doubtful Loan: on- and off-balance sheet exposures to borrowers in a temporary situation of difficulty, which may be expected to be solved within a reasonable period of time; irrespective of whether any collateral or guarantees have been established to cover the exposures. Sub-standard loans should include exposures to issuers who have not regularly honoured their repayment obligations (capital or interest) relating to quoted debt securities.

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Sofferenza

Incaglio

Restructured Loan: on- and off-balance sheet exposures for which a bank, as a result of the deterioration of the borrowers financial situation, agrees to amendments to the original terms and conditions (for example, rescheduling of deadlines, reduction of the debt and/or the interest) that give rise to a loss. These do not include exposures to corporates where the termination of the business is expected. The requirements relating to the deterioration in the Ristrutturato/ In Ristrutturazione borrowers financial situation and the presence of a loss are assumed to be met when the restructuring involves exposures already classified under the classes of substandard or past due exposures. If the restructuring relates to exposures to borrowers classified as performing or to unimpaired past due/overdrawn exposures, the requirement relating to the deterioration in the borrowers financial situation is assumed to be met when the restructuring involves a pool of banks. This is irrespective of whether any collateral or guarantees have been established. Scaduto Past due Loan: on- and off-balance sheet exposures, other than those classified as doubtful, substandard or restructured exposures that, as at the reporting date, are past due or overdrawn by over 90 days on a continuous basis. This is irrespective of whether any collateral or guarantees have been established to cover the exposures.

Source: Intesa Sanpaolo, Bank of Italy, Mediobanca Securities analysis

Cash coverage ratio of problem loans is down 10 pp in five years By our calculations, the cash coverage ratio of Italian banks problematic loans drop ped by 10 percentage points in five years (see table below) to 41% in 2012 from 51% in 2007 within our coverage. Such a calculation does not include the allowance on performing loans, which could add a few additional points of coverage ratio. We would point the following:

The drop in gross problem loans coverage ratio is partially explained by the fact that the problem loans category with the highest coverage ratio (i.e. sofferenze) has reduced its weight over time to 55% in March 2013 from 67% of problem loans in 2007. The aggregate data of the sample of banks under MB coverage show that the secured problem loans have only marginally increased in five years, to 76% in 2012 from 75% in 2007.

17 June 2013 30

Italy

The aggregate data of the sample of banks under MB coverage show that the fully secured problem loans (i.e. where the secured exposure is larger than the net residual exposure) ballooned to 63% of total net secured loans in 2012, from 40% in 2007. In our view, this could explain why the aggregate data of the sample of banks under MB coverage show a declining coverage ratio in all the four categories, with the exclusion of past due loans.

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Italian Banks: Cash Coverage Ratio of Gross Problem Loans, 2007 March 2013
2007 Aggregate ISP UCG MPS BP UBI BPER BPM CREDEM CREVAL 51% 54% 54% 38% 37% 37% 46% 47% 39% 51% 1H 08 50% 51% 55% 44% 31% 37% 44% 46% 43% 49% 2008 48% 49% 52% 43% 35% 36% 43% 42% 39% 45% 1H 09 44% 43% 50% 39% 34% 32% 40% 32% 39% 43% 2009 41% 41% 46% 40% 27% 29% 37% 27% 36% 36% 1H 10 41% 42% 45% 40% 27% 30% 37% 26% 35% 35% 2010 41% 43% 45% 42% 27% 30% 37% 24% 36% 39% 1H 11 41% 45% 45% 41% 27% 28% 36% 24% 36% 37% 2011 41% 46% 45% 42% 26% 27% 34% 28% 36% 33% 3M 12 40% 43% 44% 40% 25% 26% 32% 28% 35% 30% 1H 12 40% 43% 44% 39% 25% 26% 32% 29% 35% 31% 9M 12 39% 43% 43% 38% 24% 25% 32% 28% 34% 29% 2012 41% 43% 45% 41% 27% 26% 37% 34% 35% 35% 1Q 13 40% 43% 44% 40% 26% 26% 36% 34% 35% 33%

Source: Company Data, Mediobanca Securities analysis

Aggregate Italian Banks: Cash Coverage Ratio of Gross Problem Loans, 2007 March 2013, break down
2007 NPL Doubtful Restructured Past Due TOTAL 67% 23% 3% 6% 100% 1H 08 65% 24% 3% 8% 100% 2008 62% 27% 3% 7% 100% 1H 09 55% 31% 7% 7% 100% 2009 52% 34% 7% 8% 100% 1H 10 54% 33% 8% 6% 100% 2010 55% 31% 9% 5% 100% 1H 11 56% 29% 10% 5% 100% 2011 57% 28% 10% 5% 100% 3M 12 55% 28% 10% 7% 100% 1H 12 55% 28% 10% 7% 100% 9M 12 54% 28% 9% 8% 100% 2012 54% 30% 9% 7% 100% 1Q 13 55% 30% 8% 7% 100%

Source: Company Data, Mediobanca Securities analysis

IT Banks Breakdown of Secured and Unsecured Net Problem Loans, 2007

IT Banks Breakdown of Secured and Unsecured Net Problem Loans, 2012

25%

24%

40%

Fully Secured Net Problem Loans Partially Secured Net Problem Loans Unsecured Net Problem Loans 13% 63%

Fully Secured Net Problem Loans Partially Secured Net Problem Loans Unsecured Net Problem Loans

35%

Source: Company Data (UCG, ISP, MPS, BP, UBI, BPER, BPM, CE, CVAL), Mediobanca Securities analysis

17 June 2013 31

Italy

Fair value of collaterals cover 100% of the gross deteriorated exposures The fair value of collaterals backing deteriorated assets tends not to be disclosed in most of the EU countries outside of Italy. In 2012, Italian banks value of collateral covered c.100% of gross problem loans, bringing the total coverage ratio to well above 100% in all the banks under scrutiny. Italian banks disclose the fair value of collateral as follows: Unauthorized redistribution of this report is prohibited. This report is intended for
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Since 2012 banks disclose the fair value of collateral backing deteriorated exposures, not just up to a contractual limit (generally the exposure itself). This explains why the fair value of the collaterals is above the gross deteriorated exposure. The limit of such disclosure is that it is not possible to ascertain whether a valueless collateral is allocated to a large NPL and vice versa. Italian banks disclose the fair value of collaterals, breaking it down in real estate collaterals, securities collaterals, other real collateral and personal guarantees. Real estate accounts for c.75% of the fair value of collaterals, while personal guarantees account for an additional 20%. Banks disclose the fair value of collateral covering >100% of the secured exposure and the fair value of collateral offering just a partial coverage. In 2012, c.90% of the collaterals fair value was allocated to exposures whose collaterals cover >100% of the exposure itself. Breakdown of Fair Value of Collaterals, 2012
225%

Coverage Ratio of Problem Loans Including Fair Value of Collaterals, 2012


225%

200% 175% 150% 125% 100% 75% 50% 25% 0%

200% 175% 150% 125% 100% 75% 50% 25% 0%

CREDEM

BPER

Aggregate

Aggregate

CREDEM

CREVAL

Fair Value of Collaterals as % of Gross Deteriorated Exposure Fair Value of RE Collaterals as % of Gross Deteriorated Exposure

Cash Coverage Ratio

Fair Value of Collaterals

Source: Company Data, Mediobanca Securities analysis

Breakdown of Fair Value of Collaterals, 2012

Breakdown of Fair Value of Collaterals, 2012


7%

20%

4%

Real Estate Securities Other Real Guarantees Personal Guarantees

CREVAL

UCG

MPS

BPER

BPM

1%

Fair Value of Collaterals Allocated to Exposures Covered >100% by Collaterals

74% 93%

Fair Value of Collaterals Allocated to Exposures Covered 0% - 100% by Collaterals

Source: Company Data, Mediobanca Securities analysis

17 June 2013 32

UCG

MPS

BPM

UBI

BP

UBI

ISP

ISP

BP

Italy

Stressing Italian banks capacity to cope with R.E. correction


Nominal prices fell by just 4% in 2012 in Italy In 2012, nominal real estate prices decreased 4% and, as we show below, the consensus expectation is for further de-rating this year and a modest pick-up in 2014. Unauthorized redistribution of this report is prohibited. This report is intended for
Antonio.Guglielmi@mediobanca.co.uk from MB.Antonio.Guglielmi@mediobanca.com Nominal Real Estate Prices - YoY change
11% 9% 7%

5% 3% 1%
-1% -3% -5%

-7% -9% -11%

Residential

Office

Retail

Source: Nomisma, Mediobanca Securities

As shown in the table below, nominal real estate prices dropped by a low double-digit figure since their peak in 2007. Although Italy is nowhere near the real estate bubble that Spain is currently experiencing, it is not impossible to expect further real estate price contraction. What would be the impact on the collateral value of Italian banks? Italy Real Estate Prices Drop from 2007 Peak
Residential Nominal prices Real prices
Source: Nomisma, Mediobanca Securities analysis

Office -10.2% -17.2%

-12.3% -19.8%

Option 1: extra 45% RE price drop would still leave total coverage above 100% We run a simulation on the fair value of real estate collaterals aiming at showing what kind of devaluation would be needed to reduce the overall coverage ratio to 100%. We proceed as follows:

We start from the stock of gross problem loans, as disclosed by each bank at the end of 2012. We assume the cash coverage (allowance for loan impairments) as at 2012 unchanged. Such allowance includes the evidence of the inspections carried out by the Bank of Italy at the end of 2012, and hence should account for the partial repayment of problem loans and the updated fair value of collaterals (real estate and personal guarantees). We leave 2012 fair value of personal guarantees unchanged, as we assume the financial strength of the counterparties providing personal guarantees unchanged. We start from the fair value of collaterals, as disclosed by each bank. We flag that in 2012 Italian banks reporting was homogeneous, as all banks under scrutiny reported the total fair value of collaterals (in 2011 some banks were still reporting the value of collaterals up to a contractual limit). We simulate what reduction in the fair value of real estate collaterals would be required for the overall coverage ratio (unchanged cash allowance for loan impairments plus unchanged fair value of personal guarantees plus revised fair value of real estate collaterals) to hit 100%. If the coverage fell below 100%, a replenishment of the cash coverage would be necessary.

17 June 2013 33

2014e
Retail -12.5% -19.4%

2013e

1994

1996

1998

1999

2001

2003

2005

2007

2008

2010

2011

2012

1993

1995

1997

2000

2002

2004

2006

2009

Italy

The outcome of our analysis (lhs chart below) shows that the aggregate sample of Italian banks under scrutiny could bear a 45% downwards revision of the fair value real estate collaterals without suffering total coverage ratio below 100% (lhs chart below). We regard 45% maximum downward revision of the real estate collateral value as plausible in an auction process. However, the outcome of our analysis is scattered: Unauthorized redistribution of this report is prohibited. This report is intended for
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UBI, BP and CREDEM could afford a severe revision of collaterals fair value, without necessitating a replenishment of cash coverage. Around 100% maximum downwards revision of real estate collaterals would mean that every deteriorated position is allocated personal guarantees covering a large portion of the exposure. This is an overstatement of the effectiveness of collaterals, but explains the low cash coverage (26% at UBI and BP). CREVAL, BPER, MPS and ISP could suffer a revision of real estate collaterals ranging between 60% and 40%, a level compatible with the likely outcome of an auction sale. UCG and BPM could suffer only 20% devaluation of collaterals, a level unlikely to match the haircut of fair value in the case of an auction sale.

Option 2: extra 10% RE price drop would erode 17% of CT1 if coverage unchanged As a second approach, we calculate the impact on the Italian banks capital assuming the following:

Unchanged total coverage ratio as at 2012, including the fair value of collaterals (real estate and personal guarantees). A further 10% reduction in the fair value of the real estate collaterals backing deteriorated exposures, almost matching the descent of real estate prices experienced in Spain since the peak in 2007. The amount of provisions needed to replenish the coverage ratio, after having marked-down the fair value of real estate collaterals by 10%. We calculate c17% of the CT1 capital of Italian banks under scrutiny would be washed-out. The Basel II.5 CT1 ratio as at 2012 would fall to 8.7% at aggregated level, i.e. c170bps drop. 50% of the banks in the sample (MPS, BP, BPER, BPM and CVAL) would fall below 8%, but adoption of IRBA models would restore the regulatory capital ratios at more comfortable levels in three out of five (i.e. BPER, BPM and CVAL). The CT1 ratios of the two national champions (ISP, UCG) would remain anchored above 9%. Estimated CT1 Impact from 10% drop in market price of RE collaterals, 2012 (coverage unchanged)
10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%

The outcome of our analysis is as follows (rhs chart below):

Estimated max revision of RE collaterals values to hit 100% coverage ratio, 2012
100%

90% 80%
70%

60% 50% 40% 30% 20% 10% 0%

UCG

Aggregate

MPS

UBI

ISP

BP

BPER

BPM

CREDEM

CREDEM

Aggregate

CREVAL

CT1 Impact

CT1 after RE Collaterals Mark-down

Source: Company Data, Mediobanca Securities analysis

The landscape tables in the following page provide all the numerical details and the key findings of our simulation.

17 June 2013 34

CREVAL

BPER

UCG

MPS

BPM

UBI

BP

ISP

Italy
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Italian Banks Estimated Maximum Fall of Fair Value of Real Estate Collaterals to Match 100% Coverage Ratio, 2012
bn GROSS PROBLEM LOANS ALLOWANCE FOR LOAN IMPAIRMENTS SIMULATED DROP IN R. ESTATE PRICES FV OF REAL ESTATE COLLATERALS FV OF PERSONAL GUARANTEES FAIR VALUE OF COLLATERALS CASH COVERAGE COVERAGE OF COLLATERALS TOTAL COVERAGE

Aggregate ISP UCG MPS BP UBI BPER BPM CREDEM CREVAL

203.0 49.7 79.8 29.5 16.2 11.0 8.2 4.2 1.1 3.2

82.3 21.2 35.7 12.1 4.3 2.9 3.0 1.4 0.4 1.1

44% 36% 18% 36% 98% 100% 54% 18% 97% 65%

82.4 23.3 36.4 14.0 0.2 4.1 2.6 0.0 1.7

39.0 5.2 7.6 3.4 11.7 8.7 1.1 0.2 0.7 0.4

121.4 28.5 44.1 17.4 11.9 8.7 5.2 2.8 0.7 2.1

41% 43% 45% 41% 27% 26% 37% 34% 35% 35%

60% 57% 55% 59% 73% 80% 63% 66% 65% 65%

100% 100% 100% 100% 100% 106% 100% 100% 100% 100%

Source: Mediobanca Securities estimates

Italian Banks Estimated Maximum Basel II.5 CT1 Impact from 10% Fall in Fair Value of Real Estate Collaterals, 2012
bn GROSS B LOANS ALLOWANCE FV COVERAGE DROP IN FV RE FV CASH TOTAL LOAN PERSONAL OF RE PRICES COLLATERALS COLLATERALS COVERAGE COVERAGE IMPAIR. GUARANTEES COLLATERALS DELTA INCREASE IN COVERAGE PROVISIONS CT1 IMPACT CT1 IMPACT CT1 IMPACT CT1 Ratio 2012

Aggregate ISP UCG MPS BP UBI BPER BPM CREDEM CREVAL

203.0 49.7 79.8 29.5 16.2 11.0 8.2 4.2 1.1 3.2

82.3 21.2 35.7 12.1 4.3 2.9 3.0 1.4 0.4 1.1

10% 10% 10% 10% 10% 10% 10% 10% 10% 10%

131.5 32.6 40.1 19.7 12.7 10.1 8.1 2.8 1.1 4.3

39.0 5.2 7.6 3.4 11.7 8.7 1.1 0.2 0.7 0.4

170.5 37.8 47.8 23.1 24.4 18.8 9.2 3.0 1.8 4.7

41% 43% 45% 41% 27% 26% 37% 34% 35% 35%

84% 76% 60% 78% 150% 172% 111% 72% 161% 145%

125% 119% 105% 119% 177% 198% 148% 106% 196% 180%

-13% -11% -14% -10% -12% -15% -13% -8% -14% -18%

25.7 5.6 11.4 3.0 2.0 1.7 1.1 0.3 0.2 0.6

18.7 4.0 8.3 2.2 1.5 1.2 0.8 0.2 0.1 0.4

17% 12% 18% 25% 26% 15% 21% 8% 7% 30%

-1.7% -1.4% -1.9% -2.3% -2.6% -1.6% -1.7% -0.6% -0.7% -2.1%

8.7% 9.9% 9.1% 6.8% 7.4% 8.7% 6.6% 6.7% 8.7% 5.0%

Source: Mediobanca Securities estimates

17 June 2013 35

Italy

SME lending: a missed opportunity


In the occasion of the last ECB meeting, the ECB Governor Mario Draghi confirmed the governing council had detailed discussions of all potential measures available: asset-backed-securities market for SME loans, LTROs, credit claims, collateral policies, negative rates on deposit facility. According to the Governor, some of them are ready to be implemented if needed. Unauthorized redistribution of this report is prohibited. This report is intended for
Antonio.Guglielmi@mediobanca.co.uk from MB.Antonio.Guglielmi@mediobanca.com However, with regard to ways and means to revive the SME lending and facilitate the flow of credit to the real economy, the Governor admitted disagreements on how to rate and price SME loans, among other issues. Most importantly the Governor stated that, whatever the decision will be, this is not going to be a short term delivery, as it would require a new EU discipline on liquidity and capital treatment of ABS. Despite having been postponed, we try to quantify the size of Italian banks portfolio of SME loans that may be involved in ECB measures. We calculate that Italian banks SME lending eligible for the ECB could hover over 145bn at best, representing c15% of Italys corporate loans. If we raised the bar on the quality of the eligible loans to AA (max 20% risk-weight), the amount of eligible portfolios would reduce to 45bn, i.e. c6% of Italys corporate book. In estimating the amount we assume:

Only SME loans of good quality could be accepted by the ECB, as we believe the Central Bank cannot take on board excessive risk. We started from the exposure to SME and corporate in general, when exposure to SME is not available disclosed in the Pillar III. In our view, using the corporate exposure when the SME exposure is not available should not overstate excessively the outcome of the analysis, as the Italian banks economy is largely dominated by SME. With regard to the exposures under the Standardised Approach, we use the exposures weighted not less than 50%, as the Standardised Approach imposes a rating not below A. We believe exposures rated below A are unlikely to be accepted by the ECB. With regard to the exposures under the IRB Approach, we use only the exposures whose PD and LGD models lead to a maximum risk-weight of 50%, assuming a maximum 50% IRB risk-weight to coincide A rating under the Standardised Approach. In estimating the SME portfolio of UCG, the only one with sizeable exposure outside of Italy, we assume only 45% of the consolidated exposures rated not below A under the Standardised Approach and with risk-weight.

Claims on Corporate Credit Assessment and Risk-Weights Standardised Approach


AAA to AARisk-weight 20% A+ to A50% BBB+ to BB100% Below BB150% Unrated 100%

Source: Mediobanca Securities estimates

Italian Banks Estimated SME Portfolios Eligible for ECB Measures, 2012, bn
bn Total UCG ISP MPS UBI BP BPER BPM CREDEM CREVAL
IRB Max 50% RW Standardised Min A Rating Total IRB Max 20% RW Standardised Min AA Rating Total

115 16 30 17 6 38 0 0 7 0

29 2 8 1 3 1 5 5 0 4

144 19 38 18 9 39 5 5 8 4

37 6 10 4 1 12 0 0 3 0

8 1 6 0 0 0 0 0 0 0

45 7 17 4 2 12 0 0 3 0

Source: Mediobanca Securities estimates

17 June 2013 36

Italy

In trying to revive the SME lending across Europe, we see two possible ways to proceed:


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Conferring SME portfolios pro-solvendo Good quality portfolios could be used as collaterals with the ECB in exchange of liquidity. Conferring SME portfolios pro-soluto Good quality portfolios could be sold to the ECB and off-loaded from the banks balance sheet.

The first solution has already proved unsuccessful at the time of the LTRO auctions, when the majority of the 1trn liquidity injected by the ECB in the European banking system remained parked at the ECB itself for the banks operating in countries not suffering a sovereign debt crisis or used to buy Government bonds and avoid the access to the institutional market for banks operating in countries suffering a sovereign crisis. In other words, there is little evidence that the liquidity injected by the ECB eased banks credit standards or revived credit demand from corporations. The second solution could be problematic as:

We are firmly convinced that the ECB could not take excessive risk and would accept only good quality portfolios. In other words, we do not see Germany accepting the ECB to embark Italy, Spains SMEs risks. Should the ECB buy SME portfolios, we believe the ECB would likely apply a haircut, despite the portfolios being of good quality, generating e problems related to the quantification of the haircut. Aside the quantification of the haircut, we see little reasons why banks should sell at discount portfolios of performing loans. Banks would aspire to offload non-performing loans rather than good quality SME portfolios. Should these portfolios being securitised, it is not sure that banks would benefit from a capital requirement point of view.

Recent comments from ECB governor Draghi highlighted the many controversial issues surrounding this plan and contributed to cool down high markets expectations. A lack of delivery on SME ABS would be a missed opportunity for Italy in its attempts to try and boost growth.

17 June 2013 37

Italy

Deposits and AM inflows the good news


Market concerns of potential deposits outflows at Italian banks post the Cyprus events have now receded somewhat. Recent evidence showed that Italian banks are not suffering deposit outflows, as the amount of deposits (net of repos) showed +6% annual growth in March 2013, and the stock is broadly stable at c.1.4trn. The most recent system data show the stock of deposits soared by roughly 20bn in March 2013 versu s February 2013, almost equally split between time deposits and current accounts. This trend offset the 20bn monthly drop in bonds. As a result, the Eur20bn net funding increase at Italian banks in March versus February is almost entirely explained by repos. It is also worth flagging the seasonality of deposits collection at Italian banks: in 13 of our 16 years observation period we found a descent trend in the stock of deposits in the first two months of the year and 2013 makes no exception. Whilst current accounts outflow does not seem to be an issue, the ECB data confirm Italian banks funding is still over reliant on the central bank. Italian banks have taken c.260bn from the ECB and have deposited just 12bn with the Central Bank, meaning the vast majority of the LTRO liquidity is still sitting on Italian banks liabilities, providing a crucial although temporary buffer to their funding needs. The refunding of such ECB liquidity is scheduled for late 2014/early 2015. Should Italian banks cost of funding remain at high levels, the Italian banking system may be forced to cut back its sovereign exposure or replace the LTRO funding with more expensive liquidity at detriment of some 14% of 2015 profitability at current market conditions, based on our estimates. Not only deposits confirm their stickiness, but appetite for risk emerges when looking at recent strong AM inflows: after Eur270bn of cumulated outflows since 2006, Q1 2013 brought Eur20bn inflows benefiting both assets gatherers and banks. Our correlation analysis points to the drop in government bond yields post the OMT announcement as a key driver of the recent AM inflows.

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A reality check on deposits stickiness


Elections, Cyprus and MPS data raised deposits outflows concerns . . . Concerns about the risk of potential deposits outflow at Italian banks started to emerge among the investors community following the inconclusive outcome of the Italian elections at the end of February this year, and more significantly, following the events that occurred in Cyprus at the end of March. The release of MPS fourth quarter results on 15 May exacerbated market concerns, given a surprising 6% QoQ drop in current accounts. . . . which have receded with Q1 results Recent central bank data and Italian banks Q1 results seem to offer room for reassurance, at least for the time being. The graph below illustrates the historical trend of Italian banks funding sources, over the period June 1998 to March 2013. The stock of Italian banks funding reached 2.4trn in March 2013, up 25bn versus February 2013. The stock of deposits soared by roughly 20bn in March 2013 versus February 2013, almost equally split between time deposits and current accounts. This trend offset the Eur20bn monthly drop in bonds, so that the Eur20bn funding increase at Italian banks in March versus February is almost entirely explained by repos which grew of a similar amount over the month.

17 June 2013 38

Italy

Italian Banks Funding Mix, bn


2,500 2,250 2,000 1,750

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1,500 1,250
1,000

750 500
250

Deposits Fixed Maturity

Source: Bank of Italy, Mediobanca Securities analysis

Funding mix unchanged Italian banks funding mix has not changed much over the last 12 months, with time deposits amounting to 14% of total funding, current accounts to 30%, deposits refundable with notice to 13%, repos to 6% and bonds to 37%. It is worth noting the higher share of fixed maturity deposits at the expense of current accounts over the last two years, driven by customers seeking higher yields on deposits. Italian Banks funding mix, Mar 2011- Mar 2013
Deposits Fixed Maturity Mar-13 Mar-12 Mar-11 13.9% 12.4% 10.1% Current Accounts 29.7% 29.6% 32.8% Deposits Redeem. at Notice 13.5% 13.5% 14.2% Repos 5.7% 4.6% 6.2% Bonds 37.1% 39.8% 36.6%

Source: Bank of Italy, Mediobanca Securities analysis

Some slowdown in deposits collection emerged recently . . . The average annual growth rate of total funding over the last decade is equal to +9%. However, such a growth pattern has stalled over recent months (i.e. +3% in Feb 2013 and Mar 2013). In March, banks deposits amounted to 1.44trn, after reaching a maximum in Dec 2012 (1.52trn). Italy Deposits YoY Growth, Jun 1999 to Mar 2013
30% 25% 20%
15% 10% 5% 0%
Dec-01 Dec-06
Dec-11

deposits YoY

Oct-02

Oct-07

Aug-03

Aug-08

Apr-05

Nov-99

Nov-04

Nov-09

Sep-00

Sep-05

Feb-01

Feb-06

Apr-10

Apr-00

Sep-10

May-02

May-07

Feb-11

May-12

Mar-03

Mar-08

Oct-12

Jan-04

Jun-99

Jun-04

Jan-09

Jun-09

Jul-06

Jul-11

Jul-01

-5%

Mar-13

Source: Bank of Italy, ABI, Mediobanca Securities analysis

Dec-98 Jun-99 Dec-99 Jun-00 Dec-00 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12
Current Deposits Reedem. at Notice Repos Bonds

Italy Deposits MoM Growth, Jan 2011 to Mar 2013


5.0% 4.0% 3.0% 2.0% 1.0% 0.0% deposits MoM bonds MoM

bonds YoY

-1.0%
-2.0%

17 June 2013 39

Italy

. . . but watch seasonality Italian banks deposits follow a cyclical trend, as their growth seems to stop and become negative during the first two months of each year (i.e. in 13 years out of 16 years under scrutiny, with 2011, 2005 and 200o being the exceptions). Hence, we could argue that the drop experienced in February 2013 versus December 2012 could be related to seasonal factors, such as tax payments and the Christmas season. Italy Deposits Growth in the First two Months of the Year vs Year-end, 1998-2013
bn Dec Avg Jan/Feb Change 1998 1999 443 439 485 483 2000 511 511 2001 550 531 2002 2003 597 587 663 632 2004 671 658 2005 708 738 2006 807 796 2007 867 843 2008 2009 2010 2011 2012 1,418 1,424 2013 1,520 1,471 1,053 1,138 1,227 1,466 1,049 1,129 1,221 1,440

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-0.9% -0.5% +0.1% -3.5% -1.8% -4.7% -1.9% +4.1% -1.3% -2.7% -0.4% -0.8% -0.5% -1.8% +0.4% -3.2%

Source: Bank of Italy, ABI, Mediobanca Securities analysis

Reassuring message from Italian banks Q1 results on funding . . . The data disclosed by Italian banks at their Q1 2013 results lead to similar reassuring conclusions:

We calculate approximately stable stock of customer deposits in March 2013 versus December 2012. We note no major difference in the growth pattern shown by the different banks (most of which hovering over -1%/+1% range, with the exclusion of Banco Popolare (4%) and Creval (+7%). We calculate current accounts i.e. potentially the easiest source of funding to move remained stable in March 2013 versus December 2012, with MPS alone showing a marked drop (c.6%). In any case, such a drop was balanced by the growth in other sources of funding accounted as deposits, which brought the total deposits up c.2% in March 2013 versus December 2012 in MPS too, despite a turbulent period and extremely negative press campaign. We calculate the stock of bonds issued by Italian banks (including those classified at fair value) is down c.2% in March 2013 versus December 2012. We believe this is mostly due to the LTRO liquidity drained by Italian banks in late 2011 and early 2012, which allowed Italian banks not to tap the institutional funding markets.

Italian Banks Growth in Customer Deposits and Current Accounts


bn UCG ISP MPS UBI BP BPER BPM CREDEM CREVAL Aggregate Deposits Dec 12 410 218 81 54 50 32 26 14 16 901 Deposits Mar 13 408 220 83 55 48 33 26 14 17 903 q-o-q Deposits -0% +1% +2% +2% -4% +2% -1% -1% +7% +0% Curr. Acc. Dec 12 240 195 56 45 37 24 22 13 12 644 Curr. Acc. Mar 13 239 203 53 45 36 25 22 13 12 648 q-o-q Curr. Acc. -0% +4% -6% +0% -2% +3% +2% -2% -1% +1%

Source: Company Data, Mediobanca Securities estimates

17 June 2013 40

Italy

The table below shows that Q1 2013 outflows affected almost all the banks on the bonds issuance side, with a quarterly drop in the mid-single digit region. Italian Banks Growth in Securities Issued by Banks
bn UCG ISP MPS UBI BP BPER BPM CREDEM CREVAL Aggregate Securities Issued - Dec12 171 186 54 45 45 15 12 5 6 540 Securities Issued - Mar13 162 184 52 44 45 14 12 5 6 526 q-o-q -5% -1% -4% -3% +1% -4% +2% -5% -4% -2%

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Source: Company Data, Mediobanca Securities estimates

. . . but Italian banks are still over-relying on ECB facilities The fact that deposits are not showing any significant outflow does not necessarily mean that the funding of Italian banks is immune from risks. This is particularly evident when considering the overreliance of Italian banks on ECB funding. The lhs chart below shows that the amount deposited to the ECB by Italian banks (net of the minimum reserve) stands at approximately 12bn in March 2013. We also show the liabilities that Italian banks have with the ECB, amounting to c.260bn in March 2013, basically the same amount of liquidity drained at the time of the two LTRO auctions in late 2011 and beginning of 2012. If Italian banks have taken c.260bn from the ECB and have deposited just 12bn with the Central Bank, it follows that the vast majority of the LTRO liquidity is still sitting on Italian banks liabilities providing a crucial although temporary buffer to their funding needs. Italian Banks Deposits at the ECB versus Funding from the ECB (bn)
25

ECB Funding by country


trn
80% 70% 60% 50% 40% 30% 20% 10% 0% 0.5 0.3 1.1 0.9 0.7

0 -25 -50 -75 -100


-125

GR

IRE

IT

ES

PRT

Total ECB Facility (RHS)

1.5 1.3

-150 -175 -200 -225 -250


-275

Aug-05

Aug-06

Aug-07

Aug-08

Aug-09

Aug-10

Aug-11

Aug-12

Apr-08

Apr-09

Apr-10

Apr-11

Apr-12

Apr-05

Apr-06

Apr-07

Dec-04

Dec-05

Dec-10

Dec-11

Deposits at the ECB

Liabilities from the ECB

Source: Datastream, Company Data, Mediobanca Securities analysis

The ECB funding ballooned since the end of 2011 and at the start of 2012, coinciding with soaring exposure in domestic sovereign (up 75bn in March 2013 versus December 2011, +47%, looking just at nine banks under MB coverage). The dependence upon ECB funding has not reduced recently, despite the drop in Italys and Italian banks CDS, meaning that the regained access to the institutional markets still remains too expensive for the Italian banking system. In the absence of a renewal of the LTRO auctions (something that may still be possible, although likely for a smaller amount than the 1trn injected with LTRO1 and LTRO2), the refunding of the massive

Dec-12

Dec-06

Dec-07

Dec-08

Dec-09

Apr-13

17 June 2013 41

Italy

liquidity drained by Italian banks is scheduled for late 2014/early 2015. Should Italian banks cost of funding remain at high although bearable levels, the system may be forced to cut back its sovereign exposure or replace the LTRO funding with more expensive liquidity at detriment of profitability in both cases. A back of the envelope calculation suggests that at current funding conditions LTRO money could erode on average 14% of our 2015e EPS when refunded to ECB. Unauthorized redistribution of this report is prohibited. This report is intended for
Antonio.Guglielmi@mediobanca.co.uk from MB.Antonio.Guglielmi@mediobanca.com 5 Years Senior CDS (bps)
1100 1000 900

Italian banks - Domestic Sovereign Exposure (bn)


250

225 200 175 150 125 100 75 50 25 0 UCG ISP MPS UBI 1Q13 BP FY12 BPER FY11 BPM CREDEM CREVAL TOTAL

800 700 600 500 400 300 200 100 0

Source: Datastream, Coampny Data, Mediobanca Securities analysis

Italian Asset Management Sector Net Inflows by Quarter, (m, 2006-Mar-13)


30,000

Source: Assogestioni

1-Aug-08

1-Aug-09

1-Aug-10

1-Aug-11

1-Aug-12

1-Feb-09

1-Feb-10

1-Feb-11

1-Feb-12

1-Feb-13

1-May-09

1-May-10

1-May-11

1-May-12

1-May-13

20,000

10,000

-10,000

-20,000 -20,676
-25,602

-30,000

-40,000

-50,000

1-Nov-08
0

ITALY

1-Nov-09

1-Nov-10

1-Nov-11

1-Nov-12

ISP

UCG

MPS

BP

Asset management back en vogue due to low interest rates


Eur20bn AM inflows in Q1 2013 2013 looks to be marking a strong turning point for the asset management industry as a whole. As shown in the chart below, the Italian asset management sector reported more than 270bn of cumulated outflows in the 2006-2012 period, or some 40bn outflows per year. Such a gloomy picture strongly reverted in 1Q13 as the industry turned in positive territory, posting 20bn net inflows and such trend is confirmed by the latest figures reported by Assogestioni, which shows additional 7bn inflows in April.

20,222

6,217 4,125 1,665 -680 -5,676 -9,721 2,382

-1,466
-6,766 -10,170 -12,431 -12,451 -12,934

-2,221 -4,586 -7,034 -6,514 -6,990 -7,658

-2,507

-3,886

-4,945

-17,871

-29,100

-36,794

-40,054

17 June 2013 42

Italy

In the table below, we show inflows and assets under management of the ten major asset management companies. As a general comment, we see improving momentum, with the sector turning positive in 3Q and 4Q 2012, after the negative start reported in the first two quarters of the year. While asset gatherers are confirming their already positive performance, it is interesting to note the strong recovery of banks. Unauthorized redistribution of this report is prohibited. This report is intended for
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1Q13A ( m) INTESA SAN PAOLO GROUP UNICREDIT GROUP GENERALI GROUP AM HOLDING MEDIOLANUM AZIMUT ARCA BNP PARIBAS ITALY AMUNDI TOTAL ITALIAN AM SECTOR
Source: Assogestioni

4Q12A Inflows 546 217 -3,005 424 943 588 25 -317 -69 1,544 AuM 109,047 53,864 41,266 28,412 23,972 16,387 15,470 14,072 11,812 481,551

3Q12A Inflows -902 -82 -70 345 418 457 -79 -317 -493 2,515 AuM 106,711 52,698 18,432 27,056 23,038 15,810 14,579 14,516 11,785 445,957

2Q12A Inflows -2,309 -1,159 -172 -249 466 178 -293 7 371 -1,551 AuM 104,057 51,033 17,819 25,843 21,696 15,244 14,085 14,417 11,907 428,065

1Q12A Inflows -2,218 -1,254 50 -238 238 385 1,521 -445 3 -1,452 AuM 107,803 52,724 18,411 26,526 21,638 14,679 14,474 14,564 11,745 434,811

Inflows 2,132 1,300 264 206 883 758 33 -117 -9 13,905

AuM 112,405 56,223 41,923 28,905 25,929 17,337 15,998 14,354 11,944 507,150

NNM/AuM annualised
1Q13 INTESASANPAOLO GROUP UNICREDIT GROUP GENERALI GROUP AM HOLDING MEDIOLANUM AZIMUT ARCA BNP PARIBAS ITALY AMUNDI TOTAL ITALY AM SECTOR
Source: Mediobanca Securities

4Q12 2.0% 1.6% -29.1% 6.0% 15.7% 14.4% 0.6% -9.0% -2.3% 1.3%

3Q12 -3.4% -0.6% -1.5% 5.1% 7.3% 11.6% -2.2% -8.7% -16.7% 2.3%

2Q12 -2.2% -2.3% -1.0% -1.0% 2.1% 1.2% -2.1% 0.0% 3.1% -0.4%

1Q12 -2% -2% 0% -1% 1% 3% 11% -3% 0% -0.3%

7.6% 9.2% 2.5% 2.8% 13.6% 17.5% 0.8% -3.3% -0.3% 11.0%

AuM vs short term rates on govies We believe there is an evident inverse correlation between short term interest rates on Italian Government bonds and inflows into asset management products (but such correlation is valid for the new business of traditional life insurance too). As we show in the chart below, inflows into asset management always recovered in a context of falling yields, while proved to be negative during periods with increasing or high yields on short terms Government bonds.

17 June 2013 43

Italy

Italy Inverse Correlation Between AUM inflows and Yield on 2-Years BTP
30,000 5.00%

20,000

4.50%

10,000

4.00%

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3.50%

-10,000

3.00%

-20,000

2.50%

-30,000

2.00%

-40,000

1.50%

-50,000

1.00%

IT asset management sector - flows

Yield 2YR IT BTP

Source: Datastream, Assogestioni

A commonly asked question relates to where these inflows are coming from, given that the saving rate of Italian households is constantly decreasing (from c13-14% in 2002-2008 to the current 8%) and Italians financial wealth is stable at 3.6trn. Where are inflows coming from? Analysing the composition of Italian households financial wealth, we conclude that the recomposition is benefiting AUM products to the detriment of custodian assets. In our view, government bonds low yields and high volatility on equities are triggering an increasing demand for advice and potentially higher returns offered by managed products.

The stock of wealth in cash is increasing slightly year-on-year (latest available figures from Italian Banking Association ABI relates to 3Q12), though the low 3% increase is equivalent to a 37bn increase in absolute terms. The amount of mutual funds and technical reserves increased over the period. Mindful of the fact that such trend could be affected by the market performance, we note that the starting point discounts the severe outflows reported by the industry in 3Q11 and 4Q11. Thus, we believe the YoY increase in mutual funds and life technical reserves reported in 3Q12 is even more relevant and expect the growth pattern to have strengthened in 4Q12 and in 1Q13.

Italy Composition of Financial Assets of Italian Households (bn)


3Q11 Cash Fixed income Equities Mutual funds Life technical reserves Credits Total
Source: ABI, April 2013 Bulletin

3Q12 1,149 691 637 274 691 178 3,619

Y/Y 3% -1% -11% 10% 2% 4% 0%

Delta abs 37 -10 -78 24 12 6 -8

1,111 701 714 250 679 171 3,627

The table above includes the fair value of Italian households, and therefore our conclusions might be affected by market performance. As for fixed income, the Bank of Italy provides a detailed picture of the fixed income held by Italians at nominal value. We note a vast reduction in the direct ownership of fixed income, falling to the current 658bn from 734bn at end of 2011.

17 June 2013 44

Italy

Italy Fixed Income Investments Held by Households vs Total (Nominal Value, bn)
2011 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 Italian Households 734.0 738.0 731.3 730.5 728.5 726.0 725.1 717.1 714.4 709.1 689.6 683.1 672.8 667.3 658.3 Total 1,562.0 1,557.4 1,541.4 1,551.8 1,545.4 1,546.2 1,541.6 1,538.7 1,524.0 1,522.1 1,503.4 1,487.9 1,487.0 1,479.1 1,468.2 % 47% 47% 47% 47% 47% 47% 47% 47% 47% 47% 46% 46% 45% 45% 45%

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Source: Bank of Italy; Mediobanca Securities analysis

Also, we focus on the quarterly variation in the stock of fixed income investments held by Italian residents and by foreign investors (external debt). We note how the quarterly variation among the two investor types was somewhat similar in the first two quarters of 2012, while the trend diverged in 3Q and 4Q with Italian households being net sellers of bonds and foreign investors being net buyers. Fixed Income Investments IT households vs foreign owners, quarterly trend bn
30.0 20.0 10.0 0.0 -10.0 -20.0 -30.0 -40.0 1Q12 2Q12 3Q12 4Q12

24.7

21.3

4.0

3.9

-5.5

-3.0 -11.4

-27.4

Italian households

External debt

Source: Bank of Italy

In conclusion, we explain the current inflows of Italian households as follows:

The financial wealth of Italian households is no longer growing, due to the drop in the savings rate of Italian families. Within the existing 3.6tn of financial wealth, we note a decreasing direct exposure to equities and fixed income, while Italians are asking for more advice and returns increasing their exposure towards managed products such as mutual funds and life insurance policies. This is also confirmed by our analysis, which shows an inverse correlation between inflows into asset management products and yields on short term government bonds. In such a context, we do not see deposit outflows, but rather an increase in cash (small in relative terms, but significant in absolute). Analysing the current quarterly trend of fixed income assets, we see that in the last few quarters a decrease in the direct investments held by households, while we contextually observe an increase in the assets held by foreign investors.

17 June 2013 45

Italy

Tax burden on wealth: Italy vs Europe


From 1995 to 2010 Italy has pursued a fiscal policy divorced from the rest of Europe, lowering the tax burden on capital/wealth (and consumption) at the expenses of taxes on income. Based on 2010 figures, we calculate that taxes on the stock of capital and wealth accounted for 2.5% of Italian GDP (aligned to the EU average) from c.4% in 1995. Such a trend has been reversed in the past 12 months as the IMU (real estate) and the additional 0.15% taxation of custodian assets brought the burden of capital taxation to the level of 1995, making Italy the nation with the third highest taxation of capital in the EU-27 after France and UK. IMU brought the recurrent taxation of capital and wealth at almost 60bn p.a., equal to c.4% of Gross Disposable Income. Hence, with the introduction of the IMU tax, the direct real estate taxation moved in Italy from 0.6% of Gross Disposable Income to 1.6% versus 1% EU weighted average. Also taxation of financial assets at 0.5% of GDP in Italy stands above the Eu average of 0.25% in France, Germany, Spain and UK. Despite being taxed more than in the other large EU countries, taxation of financial assets is lower than that of property in Italy and the introduction of IMU widened the gap further given that real estate taxes account for 0.63% of wealth (real estate, land, excluding plants/machineries and valuables) in Italy versus 0.36% on financial assets. In conclusion, after benchmarking the Italian tax profile of wealth, both capital and real estate, with its EU peers we find no room to close the gap as Italy already sits above the average. This fact leads us in the following chapter to explore alternative ways for the country to try and find resources should this be required to support public accounts but without harming consumers too much.

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Italy: 15 years of divergence from Europe . . .


Eurostats data on tax revenues distinguish between income taxes, taxes on capital (including stock of capital/wealth), taxes on consumption and social contribution. It should be noted that Eurostat regards as taxes on the stock of capital/wealth stamp duties and registration fees (stamp taxes), taxes on financial transactions and financial capital and those on land, buildings and their use. Such a definition in Italy comprises mostly financial wealth taxes (stamp duty on securities portfolios, imposta di bollo su conti correnti, conto titoli) on both financial transactions and on real estate assets (Imposta Comunale Immobili, ICI in 2010). EU Tax Receipts Breakdown (excluding Social Contribution), 2010
9% 10%

EU Tax Receipts Breakdown (excluding Social Contributions and Consumption), 2010

37%
44%

54%

46%

BE BG CZ DK DE EE IE EL ES FR IT CY LV LT LU HU MT NL AT PL PT RO SI SK FI SE UK NO EU 27
INCOME TAXES TAXES ON CONSUMPTION TAXES ON STOCK OF CAPITAL

BE BG CZ DK DE EE IE EL ES FR IT CY LV LT LU HU MT NL AT PL PT RO SI SK FI SE UK NO EU 27
PERSONAL INCOME TAX CORPORATE INCOME TAX TAXES ON STOCK OF CAPITAL

Source: Eurostat, Mediobanca Securities analysis

17 June 2013 46

Italy

Selected EU Countries Breakdown of Taxes on Stock of Capital/Wealth, 2010


ITALY Real Estate Financial Assets Wealth Tax Inheritance Tax Other Total 51% 20% 0% 1% 28% 100% FRANCE 67% 7% 5% 9% 11% 100% GERMANY 65% n.a. n.a. 17% 17% 100% SPAIN 77% n.a. 0% 9% 13% 100% UK 90% 4% 0% 4% 2% 100%

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Source: Eurostat, Mediobanca Securities analysis

Lower taxes on wealth, higher taxes on income . . . According to Eurostat data, in the period 1995-2010 Italy has pursued a fiscal policy divorced from that of the rest of Europe, lowering the tax burden on wealth at the expenses of taxes on income. As shown below, in 1995 Italy was among the countries with the higher share of tax revenues coming from the taxation of capital (9.8%), not far from the UK (10.5%) and France (9.9%). Germany, the exception among the major economies of the EU, in 1995 came a little over 3% of total tax revenues. In 2010, the share of revenues from taxes of capital in Italy had fallen by almost 4%, to 5.9% of tax revenues, a level lower than the weighted EU average (6.6%), in turn strongly influenced by Germanys soft taxation. In respect of GDP, Italy reduced the fiscal burden on stock from c.4% of GDP in 1995 to c.2.5% in 2010. Such a number remained unchanged in 2012 effectively realigning Italy to the European average, which floated around this level between 1995 and 2010. Italy Taxes on Stock of Capital/Wealth as Percent of Tax Revenues, 1995 - 2010
10.0 9.5 9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 ITALY EU 27 AVG

Italy Taxes on Stock of Capital/Wealth as Percent of Domestic GDP, 1995 - 2010


4.0 3.8 3.6 3.4 3.2 3.0 2.8 2.6 2.4 2.2 2.0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 ITALY EU 27 AVG

Source: Eurostat, Mediobanca Securities analysis

. . . largely due to real estate The reduction of the taxation of the stock of capital/wealth in Italy is ascribed mostly to the progressive relative reduction of the taxation on real estate, culminating in the elimination of ICI on the main property in 2010. In 2010, the amount of direct real estate taxes amounted to 9bn versus almost 13bn in 2007, less than 0.6% of GDP in 2010 versus 0.85% in 1995.

17 June 2013 47

Italy

Italy Real Estate Taxation Breakdown as Percent of GDP, 1995-2010


Taxes (bn) ICI Immobili/Terreni ICI Aree Edificabili Direct RE Taxes Imposta Registro Imposta Ipotecaria Diritti Catastali SOCOF INVIM Total RE Taxes Total RE Tax % GDP 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 6.7 0.7 7.4 3.3 0.7 0.2 0.0 0.1 13.1 7.2 0.8 8.0 3.2 0.9 0.3 1.5 0.0 0.1 14.0 7.7 0.9 8.6 3.5 1.3 0.6 1.5 0.0 0.1 15.6 7.9 0.9 8.8 3.8 1.4 0.7 1.8 0.0 0.1 16.6 8.3 0.9 9.2 4.3 1.2 0.6 1.5 0.0 0.1 16.9 8.4 0.9 9.3 3.7 1.1 0.6 1.5 0.0 0.1 16.3 8.7 1.0 9.7 3.8 1.0 0.5 1.2 0.0 0.1 16.3 9.6 1.0 10.6 4.6 1.3 0.7 1.3 0.0 0.0 18.5 10.0 1.1 11.1 4.6 1.2 0.7 1.4 0.0 0.0 19.0 10.4 1.1 11.5 5.3 1.2 0.7 1.4 0.0 0.0 20.1 10.9 0.8 11.7 5.0 1.5 0.8 1.4 0.0 0.0 20.4 11.4 0.6 12.0 6.1 2.3 1.1 1.5 0.0 0.0 23.0 12.0 0.8 12.8 6.4 2.5 1.2 1.5 0.0 0.0 24.4 9.1 0.6 9.7 5.9 2.3 1.1 1.5 0.0 0.0 20.5 8.9 0.6 9.5 5.3 2.1 1.0 1.8 0.0 0.0 19.7 8.6 0.6 9.2 5.7 2.1 0.9 1.7 0.0 0.0 19.6

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Imposta Surr. Registro 1.4

1.51% 1.40% 1.47% 1.52% 1.49% 1.36% 1.30% 1.42% 1.42% 1.44% 1.42% 1.54% 1.57% 1.30% 1.29% 1.26%

Direct RE Tax % GDP 0.85% 0.80% 0.81% 0.80% 0.81% 0.78% 0.77% 0.81% 0.83% 0.82% 0.81% 0.80% 0.82% 0.62% 0.62% 0.59%
Source: Eurostat, Mediobanca Securities analysis

Looking at the tax revenues composition, Eurostat data show that in 2010 taxes on capital accounted for c.6% of total tax revenues in Italy, not far from the EU average. Overall, we conclude that in 2010 the taxation of capital in Italy was broadly aligned to the European average, despite having pursued a different strategy in taxation. EU Taxes on Capital as % of Tax Receipts, 2010
14

EU Taxes on Stock of Capital as % of GDP, 2010


6.0

13 12 11 10 9 8 7 6 5 4 3 2 1 0
NO UK FR BE IS ES IE PT LU HU EU27 W Avg DK IT PL CY EU27 Avg MT NL RO EL LV FI SE BG DE LT SI AT SK CZ EE

5.5 5.0
4.5

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0

Source: Company data, Mediobanca Securities analysis

. . . reversed in 12 months (2012)


IMU tax changed the picture Despite the relatively low taxation of real estate assets, the taxation of wealth in Italy in 2010 was aligned to the EU average, either in respect of GDP or in respect of the weight on total tax revenues. In 2011, the Berlusconi government introduced a mini-tax on financial wealth and real estate assets (IMU), starting from 2014. At the end of 2011 and in 2012, the Monti Government corrected the tax on financial assets and anticipated the IMU to 2012. The Italian Treasury is estimated to have collected 24bn from the possession of real estate assets (IMU, first indications pointed to 19bn, then upped

NO FR UK BE DK IS LU ES IT HU EU27 W Avg PT IE CY NL PL EU27 Avg MT FI SE EL RO DE LV AT SI BG CZ LT EE SK

17 June 2013 48

Italy

due to ballooning municipal brackets), while the 0.15% tax on financial wealth is expected to generate c.5bn. The aggregate of the two new taxes on wealth should stand at c.28/30bn, c.70% of the tax revenues on capital in 2010 (39bn). As in 2010, direct taxes on land, building and other structures amounted to 9bn according to Eurostat, and we add 15.5bn revenues from real estate tax (IMU) and 5bn from the new tax on financial wealth. Adding 21bn to the 39bn total taxes on capital in 2010, we calculate the taxation on capital would stand at 3.8% of 2010 GDP, the level of 1995. The trend of the past 15 years was reversed in one year (2012). Italy Taxes on Capital as Percent of GDP, 1995-2010
bn Total Real Estate Taxes (Direct/Indirect) Financial Assets Total Taxes on Capital GDP Taxes on Capital as % of GDP 1995 13.1 5.4 33.8 865 3.9% 2010 19.6 7.9 38.9 1,556 2.5% Extra Revenues
(IMU + Fin. Assets)

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2010
(incl. IMU + Fin. Assets)

+16 +5 +21 1,556 +1.3%

35.1 12.9 59.4 1,556 3.8%

Source: Company data, Mediobanca Securities analysis and estimates

Property taxation in Europe


Accounting real estate assets for c66% of Italys net wealth, we start assessing if the current level of taxation of property assets in Italy is below/above the EU AVG. Being real estate an asset class that cannot be considered as cash or cash-equivalent, in our view it is correct to measure it against the Disposable Income of a nation, rather than against GDP. From 0.6% of GDI in 2010, below the EU average . . . Using Eurostat data (i.e. the items named 29A in Eurostat statistics), we calculate direct taxes on real estate (9bn, excluding indirect taxes such as stamp duties, cadastral taxes et cetera ) assets represented 0.57% of the Italian Gross Disposable Income in 2010, the Italian level of property taxation was below EU 27 (arithmetic) average of the same year, equal to 0.68% of Gross Disposable Income. Using a weighted average for EU, we would calculate that taxes on real estate assets would account for c1.0% of Gross Disposable Income, pushed upward by the high level of taxation in France and UK, more than balancing the low taxation in Germany. In this case, the taxation of Italian real estate assets was much lower than the EU average. . . . to 1.6% in 2012 post the introduction of IMU, above the EU average Today we could not make the same statement. Including the incremental revenues from the introduction of IMU in 2012 (equal to 15.5bn) in respect of ICI in 2010, the total direct taxes on real estate would hit c24bn, and the weight of direct real estate taxation would account for c1.6% of Gross Disposable Income in 2010, the second-highest in the Euro Area after France and well above the EU average.

17 June 2013 49

Italy

EU Direct Real Estate Taxation as Percent of Gross Disposable Income, 2010


2010 BE BG CZ DK DE EE IE EL ES FR IT (ICI on Buildings and Land) IT (incl. extra 16bn Taxes from IMU) CY LV LT LU HU NL AT PL PT RO SI SK FI SE UK NO IS EU Average EU Weighted Avg Real Estate Taxes (bn, A) 4.4 0.1 0.3 3.2 11.3 0.1 1.4 0.0 9.5 45.7 8.6 24.1 0.1 0.1 0.1 0.0 0.3 3.0 0.7 0.8 1.0 0.5 0.2 0.2 0.0 2.7 26.2 1.1 0.2 Gross Disp. Income (bn, B) 359 36 138 237 2,511 14 129 214 1,026 1,942 1,528 1,528 17 19 28 26 91 570 283 344 168 126 35 64 179 352 1,705 318 8 A/B 1.2% 0.3% 0.2% 1.4% 0.5% 0.4% 1.1% 0.0% 0.9% 2.4% 0.6% 1.6% 0.6% 0.7% 0.3% 0.1% 0.3% 0.5% 0.2% 0.2% 0.6% 0.4% 0.5% 0.3% 0.0% 0.8% 1.5% 0.3% 2.7% 0.7% 1.0%

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Source: Eurostat, OECD, Mediobanca Securities analysis and estimates

Taxation of financial wealth looks the highest in Italy, but below real estate Our analysis compares the taxation on financial assets across Europe. We neglect taxation of capital gains and the withholding tax on deposits for households and corporations, and we limit our analysis to a sample including the five major European countries (Italy, France, Germany, Spain and the UK). Unlike real estate, the levies on financial wealth are heterogeneous and more difficult to compare. Eurostat does not provide data for Germany and Spain, for which taxation on financial wealth looks to be very low: if we assume all taxes on the stock of capital/wealth other than real estate and inheritance to be allocated to financial assets, we calculate the residual would account for 0.2% of GDP in Germany and 0.3% of GDP in Spain. In 2010, the total amount of taxes on financial assets accounted for 0.5% of GDP in Italy versus 0.3% in France and 0.15% in the UK. In other words, already in 2010 Italy showed the highest tax burden on financial assets. The situation changed in 2013 with the introduction of the 0.15% taxation of financial wealth. If we add the estimated 5bn tax receipts, the taxation of financial assets would reach approximately 13bn, more than doubling the amount charged in France (excluding the ISF). Although being the highest among the five largest countries, the taxation of financial assets accounted for 0.2% of the Italian households wealth in 2010, below the 0.33% calculated as taxation of real estate assets as a percentage of the Italian households wealth in real estate. Adding the estimated additional tax receipts from IMU (16bn) and financial assets (5bn), the gap will widen further to c.25bps, by our estimates.

17 June 2013 50

Italy

Selected EU Countries Breakdown of Taxes on Stock of Capital/Wealth, 2010


bn Real Estate Financial Assets Wealth Tax Inheritance Tax Other Total ITALY 20 8 0 0.5 11 39 ITALY (IMU/Fin. Ass) 35 13 0 0.5 11 59 FRANCE 56 6 5 8 9 83 GERMANY 17 n.a. n.a. 4 4 25 SPAIN 20 n.a. 0 2 3 26 UK 66 3 0 3 1 74

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Source: Eurostat, Mediobanca Securities analysis

Italy Tax Receipts on Real Estate Assets and Financial Assets as Percent of Wealth, 2010
bn Real Assets (RE, ex Valuables, Plants) Financial Assets Wealth 5,541 3,546 Tax Receipts 20 8 Taxes as % of Wealth 0.35% 0.22% Tax Receipts (incl. IMU, Fin. Assets) 35 13 Taxes as % of Wealth 0.63% 0.36%

Source: Eurostat, Bank of Italy, Mediobanca Securities analysis and estimates

Capital taxation at 2.5% of Gross Disposable Income Another way to look at the weight of taxation of capital is to measure it against Gross Disposable Income, i.e. the amount of money that a nation has available for spending and saving after income taxes have been accounted for (disposable income is often monitored as one of the many key economic indicators used to gauge the overall state of the economy). In 2010, we calculate taxation of capital in Italy accounted for c.2.5% of Gross Disposable Income (GDI), aligned to the EU average. Adding 21bn, we calculate the ratio would soar to 3.9%, making Italy the country with the fourth highest taxation of stock in Europe after Norway and the third highest in the Euro Area after the UK and France and excluding a marginal nation such as Luxembourg. Hence, we conclude that the taxation of capital in Italy is already among the highest in Europe and proves to be high in respect of the income generated by the country annually. EU Taxes on Capital as Percent of Gross Disposable Income, 2010
LT SK EE CZ BG SI LV AT DE RO EL SE FI NL PL CY PT IT EU 27 Wavg ES IE HU DK IS BE IT (Imu + Others) LU FR UK NO 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%

Italy Taxes on Capital as Percent of Gross Disposable Income, 1995 - 2010


4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
1995

Source: Company data, Mediobanca Securities analysis and estimates

In summary, there seems to be very limited room for Italy to increase its taxes on wealth, both on real estate and on financial assets. The comparison with its EU peers does not in fact show any significant gap to be closed, given the already above-average tax rate of wealth in Italy. Harmed with such finding, in the following chapter, we investigate the room that the country has to realistically tap a potential emergency situation eventually forcing it to quickly try and raise extra taxes should it be needed.

17 June 2013 51

2010+IMU

Italy

Limited room for a large wealth tax


The need for a large wealth tax is a recurring debate in Italy. We estimate that a 400bn wealth tax would be needed in order to bring the debt / GDP ratio below 100% without disposals. We believe such an approach is hardly feasible when considering that: 1) some 65% of the 9.5trn Italian wealth is real estate, offering no room for further tax rises relative to Europe; 2) only 20% of the Italian wealth comprises liquid assets, i.e. c.2trn, 80% of which is retail savings (bank deposits 30% of total liqui d assets, postal savings 15%, banks bonds 18% and Italian govies 9%). Raising 400bn from this pot means 35% of Net Liquid Wealth (net of 900bn debt), far too high not to run the risk of deposit outflows and over penalisation of small retail savers; 3) a large one-off wealth tax spread over the whole population would hardly change the long-term dynamics of Italys debt when assuming current > 1x fiscal multiplier to depress consumers. Harmed by such constraints, we investigate the room for up to 75bn alt ernative sources for the government, taking tax progression into account: 1) 3bn (up to 7bn if including SMEs equity) from converging the fiscal treatment of financial assets to that of real estate; 2) 5bn from a large fortunes tax replicating the French ISF; 3) 43bn wealth tax on 10% of the wealthiest population; 4) 20bn from an agreement with Switzerland on the repatriated funds; 5) 4bn from lower interest service on debt stemming from the above measures. We also looked into the feasibility of another building amnesty and concluded that the potential 2bn extra funds are not worth the political cost, hence we have not include it in our exercise. Our conclusion would be a mix of 4 p.p. of debt/GDP reduction, not necessarily over-penalising consumers as it would come from the wealthiest population, and room for recurring growth measures amounting to at least 1 p.p. of GDP. A proper attack on tax evasion and the black economy would clearly bring us to a much larger number, but the poor track record of Italy in this regard leads us to prefer not to include such options.

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Some 9.5trn wealth in Italy but only 2trn is liquid assets


Real estate is 65% of Italian wealth As the fiscal pressure on personal and corporate income has reached untenable levels, it is generally debated in Italy the fact that any further large fiscal intervention should involve Italys wealth. In 2011, Italys wealth amounted to 9.5trn (gross of 900bn debt), with c.65% of such wealth comprising real estate and physical assets. The residual third comprises financial wealth, scattered in a constellation of asset classes, of which only bank deposits and life technical reserves show a relatively high weight (7% of total wealth in both cases). Only 20% of Italian wealth is easily sellable . . . In our view, the most important feature of Italys wealth is that c.80% of it cannot be regarded as liquid or easily sellable (cash-equivalent). A further tax levied on real estate assets for instance would have a cash impact on households, but real estate property cannot be converted in cash in a short period of time. In our view, the asset classes that could be considered cash/cash-equivalent are:

Bank deposits and postal savings (980bn), accounting for 10% of Italys gross wealth. Italian corporate bonds (375bn), which should all be relatively easy to transfor m in cash. We assume banks bonds to be listed and sellable, although bid and ask may be distant. Italian T-bonds and T-bills (185bn), as we assume levying a tax on a debt the Government owes to Italian people does not constitute a credit event. We assume foreign securities (150bn) held by Italians to be sellable, as we assume those to be mostly constituted of Government bonds and liquid foreign corporate bonds.

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Equity in Italian and foreign listed corporations (c75bn). Mutual funds units (c250bn).

We regard life technical reserves as not entirely liquid (i.e. easily sellable), as:

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Investors may incur severe penalties when selling the assets underlying reserves ahead of the scheduled timing Contracts may have capital and yield protection, potentially affecting the capital of insurers in absence of an appropriate legislation.

Italy Breakdown of Gross Wealth, 2011


Amount - bn Residential Property Valuables Non-Residential Buildings Plants, Machineries et cetera... Land Total Real Estate and Physical Assets Equity in Non-Listed Limited Corporations Equity in Non-Limited Firms Life Technical Reserves Others (Commercial Loans, Shareholders Loans to Cooperatives, Others) Banknotes, Coins Bank Deposits Postal Savings Italian Gov. Bonds and T-Bills Italian Corporate Bonds Italian Banks' Bonds Foreign Securities Equity in Listed Limited Corporations Mutual Funds Units Total Financial Assets Total Gross Wealth
Source: Bank of Italy, Mediobanca Securities analysis

As % of Total 53% 1% 4% 2% 3% 63% 4% 2% 7% 1% 1% 7% 3% 2% 0% 4% 2% 1% 3% 37% 100% Not Liquid Not Liquid Not Liquid Not Liquid Liquid Liquid Liquid Liquid Liquid Liquid Liquid Liquid Liquid Not Liquid Not Liquid Not Liquid Not Liquid Not Liquid

5,027 125 342 237 247 5,978 421 205 680 119 114 651 327 184 3 373 146 73 248 3,542 9,519

. . . and 80% of such liquid wealth is retail savings Excluding life technical reserves, we calculate that the Gross Liquid Wealth (GLW) would amount to c.2.1trn, reaching 2.8trn including life technical reserves. Taking into consideration the debt of Italian households (900bn), the Net Liquid Wealth (NLW) would reduce to 1.2trn (excluding life reserves) and to 1.9trn including life technical reserves. Overall, we could argue that approximately 2trn is the amount of liquid wealth that could be considered for extra wealth taxation. The vast majority of such gross liquid wealth (c.70/75%) typically comprises retail savings, i.e. bank deposits (30% of total), postal savings (15% of total), banks bonds (18% of total), Italian Governments and TBills (9% of total).

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Italy Breakdown of Gross Wealth, 2011

Italy Breakdown of Gross Liquid Wealth, 2011


5%

3%

26%

7%

9%

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46%

7%

12% 71%
18%

Deposits Not Liquid Life Technical Reserves Liquid Foreign Securities

IT Corporate Bonds Banknotes, Coins

Mutual Funds Listed Equity

IT Gov Bonds

Source: Bank of Italy, Mediobanca Securities analysis

Why a large wealth tax aimed at reducing debt is hardly feasible


400bn wealth tax would bring debt / GDP below 100% but . . . We simulate the magnitude of a wealth tax aimed at increasing the tax pressure and reducing the Debt/GDP ratio from the 127% reported in 2012 to 100%. In this simple exercise shown in the table below, we start from 1.99trn Public Debt and 1.57trn GDP at the end of 2012 as reported by the Italian Treasury. Italy Estimated Impact on Debt/GDP Ratio from a Wealth Tax, 2012
Wealth Tax - trn Gross Wealth - trn Net Wealth - trn Gross Liquid Wealth - trn Net Liquid Wealth - trn Debt - trn GDP - trn Debt / GDP Ratio Tax on Gross Wealth Tax on Gross Liquid Wealth Tax on Net Liquid Wealth
Source: Mediobanca Securities estimates

0.00 9.52 8.62 2.12 1.22 1.99 1.57 127% 0% 0% 0%

0.05 9.47 8.57 2.06 1.16 1.94 1.57 124% 1% 2% 4%

0.11 9.41 8.51 2.01 1.11 1.88 1.57 120% 1% 5% 9%

0.16 9.36 8.46 1.96 1.06 1.83 1.57 117% 2% 7% 13%

0.21 9.31 8.41 1.91 1.01 1.78 1.57 114% 2% 10% 17%

0.26 9.26 8.36 1.85 0.95 1.73 1.57 110% 3% 12% 22%

0.32 9.20 8.30 1.80 0.90 1.67 1.57 107% 3% 15% 26%

0.37 9.15 8.25 1.75 0.85 1.62 1.57 104% 4% 17% 30%

0.42 9.10 8.20 1.70 0.80 1.57 1.57 100% 4% 20% 35%

. . . it would amount to 35% of net liquid wealth too much As shown above, we calculate that a wealth tax exceeding 400bn would reduce the Debt/GDP ratio to 100%. At first sight, 400bn would account for less than 5% of Italys gross wealth (9.5trn in 2011), but such a finding is clearly misleading for the following reasons:

A wealth tax of such magnitude should be imposed suddenly and rapidly, allowing no time to transfer the wealth outside the country. This would impose a sudden cash outflow with banks/insurers implementing a withholding tax, leaving no time to sell the less liquid assets (i.e. real estate). Hence, the impact would fall only onto the Gross Liquid Wealth (2.1trn) and 100% Debt/GDP ratio would impose a withholding tax equal to 20% of GLW.

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As it is reasonable to assume that Italian households will not stop to be obligors (i.e. they will have to continue to amortise their debts, mortgages, etc), 400bn wealth tax would translate into a withholding tax equal to 35% of the Net Liquid Wealth (NLW). The soaring fiscal pressure would hit retail savings the most, as bank deposits, postal savings, bank bonds and Government bonds represent c.70/75% of GLW, resulting in a politically unacceptable intervention.

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The above calculations not only show that reducing the Debt/GDP ratio to 100% through a wealth tax is not feasible, but are also overly simplified, as they do not take into consideration the collateral damage of an intervention of such magnitude on the domestic financial institutions liquidity profile:

Representing bank and postal savings the majority of GLW (650bn bank deposits, 330bn postal savings), we calculate approximately 200bn sudden outflows from Italian MFIs, representing c.15% of Italian MFIs deposits, i.e. unthinkable. An intervention on corporate bonds would hit banks the most (representing almost 100% of the Italian corporate bonds held by Italians), potentially denting the trust of Italian savers in banks.

The impact of a wealth tax on GDP the fiscal multiplier Not only is the introduction of a large wealth tax constrained by the largely non-liquid Italian wealth, but even more importantly it needs to be taken with care when considering the effect of the fiscal multiplier. If on the one hand it is fair to expect that a wealth tax aimed at reducing the Debt/GDP ratio would improve the creditworthiness of the Republic of Italy, on the other it would also negatively affect the already-low growth prospects of the country, and adversely affect the GDP in the medium term, i.e. potentially affecting the Debt/GDP Ratio too. Recent austerity measures in Europe provide plenty of evidence on the GDP contraction stemming from consumers shrinkage post tax raises. In its recent report for instance, the IMF not only states that the late bailout intervention in Greece was a mistake, but it also admits that the 0.5x estimated fiscal multiplier was overly optimistic as in reality it ended up depressing GDP more than expected, a common issue for the whole peripheral Europe we would assume. Recurring versus one-off taxes and the fiscal multiplier We know that GDP is equal to the aggregate real income of a country, i.e. to the sum of consumption (C), savings (S) and taxes (T): GDP = Consumption + Saving + Taxes, where C + S = Disposable Income = GDP - T

It is necessary to distinguish between ordinary wealth tax and una tantum one (one off). An intervention aimed at reducing the countrys debt would qualify as una tantum intervention. Hence, in year one, we could argue that GDP would not change, as resources would only be transferred from savings to taxation, with an immediate and sudden improvement in the Debt/GDP ratio. From year two though, we argue that an increase in tax pressure would change the disposable income (DI), i.e. a change in both the consumption and savings in accordance to a Tax Multiplier (TM), i.e. the change in the aggregate production caused by a change of one unit in government taxes. The simplest versions of the tax multiplier include only induced consumptions, while more complex versions also include other components (government purchases, exports). A Tax Multiplier (TM) is given by the ratio between the negative marginal propensity to consume (mpc) and marginal propensity to save (mps). The savings rate would be hit by the one-off intervention, while the marginal propensity to consume would likely fall, fearing additional actions.

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A large one-off wealth tax alone would hardly improve debt / GDP in the long term In other words, the introduction of a massive wealth tax would probably result in the freezing of growth and in the increase of the Debt/GDP ratio, after its temporary reduction. Indeed, a large una tantum wealth tax does not necessarily have any influence on the Debt/GDP ratio, as such a tax would lower the debt level in the immediate term but it would not change its long-term dynamic, and after few years Italy could be back to the same level. We should learn from history: this is a road already travelled in 1992 at the time of the Amato government. In that period, privatisations and wealth tax (including an intervention on current accounts) reduced the Public Debt/GDP ratio of over ten percentage points but, due to the absence of political reforms aimed at sustaining growth, the benefit obtained was lost over the next decade. Hence, we argue the ingredients necessary to reduce the Debt/GDP ratio are growth, a surplus in public accounts and low interest rates.

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Alternative ways to free up 75bn extra resources


The previous sections set the boundaries of the limited manoeuvring room in terms of a wealth tax. We know that:

including IMU the taxation of real estate is already above the EU average in Italy; the taxation of financial assets is also in line or above EU standards; a large wealth tax in Italy is constrained by the fact that 80% of wealth is not liquid; any one-off large wealth tax would not fix the problem in the long run when considering the negative impact on growth (and hence on tax collection) due to >1x fiscal multiplier.

Our receipt for 75bn extra resources We have written extensively in the past about Italys urgent need to reduce its public debt (see our Cassa Depositi e Prestiti Italys gate to debt cut, of 28 February 2012 and Elections approaching, uncertainty rising, of 18 February 2013). We have highlighted the ample room for the government to dispose of its assets when considering 110bn worth of gold, 90bn of equity stakes, 30bn worth of state concessions, and most importantly 450bn of real estate assets. Here we look at alt ernative ways to free up resources without harming Italian consumers and before considering any potential disposal. We will therefore focus on the progressivity of the tax rate. The analysis that follows identifies room for up to 75bn resources coming fr om a combination of recurring and one offs as follows:

3bn (up to 7bn) from re aligning the tax treatment of financial assets to that of real estate assets; 5bn from a recurring tax on large fortunes in line with French ISF; 43bn one-off tax on the wealthiest 10% of the population; 20bn from extra taxation on repatriated funds from Switzerland; 4bn from lower cost of debt.

Aligning the taxation of financial assets to real estate: 3bn


Closing the gap between 0.56% wealth tax on real estate and 0.46% on financial assets... In this analysis we account only for real estate assets, excluding plants/machineries and valuables from physical wealth. In the definition of financial assets, we exclude commercial loans and other assets. Including the equity owned by the Italian population in small to medium enterprises and family businesses, we calculate that the taxation of financial assets accounted for 0.22% of the Italian households financial wealth in 2010, below the 0.35% calculated as taxation of real estate assets as a percentage of the households wealth in real estate. In other words, the tax burden on real estate assets was 50% higher than that on financial assets. As we show in the table below, adding the estimated tax

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receipts from IMU (c.16bn in 2012) and financial assets (5bn) introduced by the Monti Government in 2012, the gap widens further to 27 bps (0.63% versus 0.36%).

Italy Tax Receipts on Real Estate and Financial Assets as a Percentage of Wealth Unauthorized redistribution of this report is prohibited. This report is intended for
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bn Wealth - 2010 Taxes - 2010 Taxes as % of Wealth - 2010 Additional Taxes from IMU 2013E Additional Taxes on Fin. Assets 2013E Estimated Real Estate Tax Receipts - 2013E Taxes as % of Wealth 2013E Suspension of IMU on Main Property 2013E Estimated Real Estate Tax Receipts - 2013E Taxes as % of Wealth 2013E Extra Tax Receipts from Tax Realignment As % of GDP
Source: Eurostat, Mediobanca Securities analysis and estimates

Real Estate 5,541 19.5 0.35% 15.5 0.0 35.0 0.63% -4.0 31.0 0.56%

Financial Wealth
(including SME equity)

Financial Wealth
(excluding SME equity)

3,546 7.8 0.22% 0.0 5.0 12.8 0.36% 0.0 12.8 0.36% 7.0 0.45%

2,807 7.8 0.28% 0.0 5.0 12.8 0.46% 0.0 12.8 0.46% 2.9 0.18%

. . . but excluding the equity tied up in SMEs and family businesses . . . We think there is sufficient argument to aim for a convergence between the two fiscal treatments, as in general terms it is a hard to accept the principle that the taxation of financial wealth has to be lower than that of real estate. Our calculation above is aimed at closing such gap with a conservative approach based on the following considerations:

The majority of the financial wealth (especially the liquid part) is composed of current accounts, postal savings, Government bonds, bank bonds, life technical reserves, i.e. typically retail investments. In other words, the straight realignment of the taxation would largely penalise retail savers. Taxing the equity of SMEs in a country whose economy is largely based on small and medium enterprises and family businesses could be particularly damaging, discouraging the birth of new enterprises/initiatives. If we exclude the equity in SMEs and account only for the equity in Italian and foreign-listed corporations, the tax burden gap would shrink to 7bps in 2010 (0.35% on real estate versus 0.28% on financial assets ex SME equity), i.e. the taxation of real estate assets would be just 25% higher than that on real estate. In the attempt to eliminate the taxation of the main property (the one in which Italian households live), the current Government has suspended the taxation on the main property. Hence, we may lower the overall impact of IMU introduction to 12bn in 2013E, deducting the estimated 4bn tax receipts from IMU on main property collected in 2012. This would reduce the gap between the taxation of real estate wealth and financial wealth to 10bps.

. . . would generate 3bn additional tax receipts Based on our assumptions of excluding the equity tied in SME and family-businesses from a wide and indiscriminate taxation and deducting the estimated 4bn tax receipts from IMU on main property collected in 2012, we calculate 3bn additional tax receipts from aligning the taxation of financial wealth to that of real estate assets. If we maintain a more aggressive approach by realigning taxation also on SME equity it would generate up to 7bn tax receipts.

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Wealth tax on large fortunes: 5bn


A wealth tax in Italy should only apply to very large wealth . . . There is a recurring debate in Italy on the need for a wealth tax. Our analysis so far has showed the limited room for such intervention on a large scale when considering that the current taxation of real estate assets in Italy is already above the EU average. Additionally, starting from January 2013, a 0.15% tax on the financial wealth is already in place in Italy, levied on mutual funds, unit-linked, index linked, equities, bonds, with the exclusion of current accounts (subject to a flat tax of 34) and some life insurance policies (e.g. pension funds and traditional policies). . . . like Frances ISF which generates 4bn Hence, we believe a wealth tax should be focused only on the large wealth. Frances Government charges the ISF (Impot de Solidarite sur la Fortune). In 2013 the ISF will tax net wealth above 800k in a progressive way, reaching a maximum of 1.50% for wealth above 10m. The French ISF taxes the main following items: residential property (the value of the property in which the household lives is reduced by 30%), land, all equity holdings (although holdings in SME are subject just to a contribution), bonds, bank deposits, mutual funds, valuables. Such tax treatment generates approximately 4bn p.a. for France as shown below. France ISF 2013 (Impot de Solidarite sur la Fortune)
Taxable Wealth <800K 800K to 1.3m 1.3m to 2.57m 2.57m to 5.00m 5.0m to 10.0m >10m Revenues - m
Source: Eurostat, Mediobanca Securities analysis

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Tax 2013 0% 0.50% 0.70% 1.00% 1.25% 1.50%

2005

2006

2007

2008

2009

2010

3,023

3,658

4,390

4,155

3,580

4,461

5bn from 0.16% large wealth tax in Italy According to the Bank of Italy, c.40% of the net wealth in Italy is owned by c.10% of the households, meaning that 2.5m households own 3.0trn of net wealth, i.e. 1.2m net wealth per household. Based on such breakdown of the Italian wealth, we estimate in the table below that introducing a tax similar to Frances ISF could generate 5bn of recurring revenues per annum, implying 16bps recurring tax rate on large wealth. This could possibly free up resources to reduce the burden on labour taxes for the whole population, supporting the consumption of 90% of the Italian households. Italy Estimated Tax Revenues from Replicating Frances ISF Wealth Tax
Italy Net Wealth bn Wealth of 10% of Households (40% of Total) bn 10% of IT Households (millions) Net Wealth per Household m Tax Per Household Tax Revenues bn

Property Equities Bonds Deposits/Post Savings Valuables Mutual Funds Debt Net Wealth

5,615 698 705 978 125 248 -900 7,469 (A) 2,988 (B=40%*A) 2.52 (C) 1.19 (B/C)/1000 1,934 (D) 4.9 (E=D*C) 7

Source: Bank of Italy, Istat, Mediobanca Securities analysis and estimates

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One-off wealth tax: 43bn should not endanger consumers


Only progressivity can make a wealth tax work The 8bn of further tax receipts we have calculated so far stem from a higher taxation of financial assets and from the imposition of a solidarity contribution levied on the 10% wealthiest population owning c.40% of the national wealth. These measures have a recurrent nature and would bring the total taxation on the stock of capital/wealth at 4% of 2010 GDP, above the level reached in 1995 and well above the EU average (almost matching France and UK). However, such interventions would not address the debt of the country. In our view, the only way to start reducing Italys debt would be a una tantum levy charged on a larger part of the net wealth of the richest population to try and minime the negative impact on consumers. In this analysis, and unlike in Frances ISF, we include 680bn assets held in insurance life technical reserves, bringing the total net taxable wealth at 8.3trn (3.3trn owned by 10% of the population). We exclude plants machineries, and commercial loans, as we believe those are related to the production/manufacturing of domestic SMEs, which are already under financial pressure due tightening banks credit conditions. A 1.3% tax on 10% wealthiest people generates 43bn, i.e. 5% of liquid net wealth . . . As the vast majority of the Italians wealth is concentrated in real estate, we believe the una tantum wealth tax could not exceed a certain threshold, in order not to stress the households liquidity (albeit wealthy). We set such a maximum threshold at 1.3% of the Net Wealth, generating 43bn of tax revenues to be drawn from the 10% wealthiest households. Such an amount would account for c.5% of the liquid net wealth of the wealthiest Italians, a level we regard as bearable, and unlikely to endanger the households liquidity profile. . . . and reduces debt / GDP ratio by 3 p.p. Such an initiative would reduce Italys Debt/GDP ratio by c.3 percentage points to 124% without reshaping it. Provided the Government takes actions on the spending side to keep the trajectory of the Central Government Debt under control, it may generate a positive spill-over on the deficit front, as it would reduce the cost of servicing the Italian debt by some 2bn p.a., again resources that may be devoted to lower the burden on labour tax and support consumption. The una tantum wealth tax on the wealthiest 10% of the population would be on top of the 5bn identified as recurrent. In our view, the payment of the una tantum wealth tax could be done in instalments. Italy Estimated Tax Revenues from Una Tantum Wealth Tax on 10% Wealthiest Households
Italy Net Wealth bn Wealth of 10% of Households (40% of Total) bn 10% of IT Households (millions) Net Wealth per Household m Tax Per Household Tax Per Household as% of Liquid Assets Tax Revenues bn

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Property Equities Bonds Deposits/Saving Valuables Mutual Funds Insurance Cash Gross Wealth Debt Net Wealth -o/w Liquid

5,615 698 705 978 125 248 680 114 9,163 -900 8,263 2,117 3,305 847 2.52 1.31 0.34 17,067 5% 43

Source: Bank of Italy, Istat, Mediobanca Securities analysis and estimates

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The 2009 tax amnesty: 20bn potential revenues


Only 6bn tax collection from tax amnesty in Italy Under the last Berlusconi government, Italians holding funds outside the country were permitted to legalise their money through a 5% taxation. The amnesty was largely a success as c.100bn was indicated to be declared (c.60% kept in Switzerland under the so-called rimpatrio giuridico while the remaining 40% was physically repatriated) which generated some 6bn taxes for the Italian government as shown below. Italy Revenues from Tax shield (Imposta straordinaria sui capitali rientrati dall'estero - Scudo fiscale)
m Tax 1995 0 1996 0 1997 0 1998 0 1999 0 2000 0 2001 0 2002 1,480 2003 617 2004 0 2005 0 2006 0 2007 0 2008 0 2009 5,013 2010 656

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Source: Eurostat, Mediobanca Securities analysis

Deals between Switzerland/UK/Germany envisage 20-30% burden on repatriated funds The agreement reached with Switzerland by Germany and the UK pointed to a taxation in the 20-30% region, largely above the 5% applied by Italy in 2009.

The Tax Agreement between the UK and Switzerland was first signed in October 2011 by the Exchequer Secretary David Gauke and the Swiss Finance Minister Eveline Widmer-Schlumpf and came into force on 1 January 2013. The agreement foresees for clients of banks in Switzerland who are taxable in the UK a path to tax compliance while maintaining their financial privacy. The maximum tax rate for regularising the past is 34%, but the effective tax rate for most clients should be 20-25% of total assets. The bilateral tax treaty agreement between Germany and Switzerland, initially rejected by the German Parliament provides for a 25% withholding tax (plus solidarity surcharge) on capital gains received by German taxpayers with accounts held in Switzerland, ensuring that capital gains realised in Switzerland were in future treated in the same way as in Germany. The agreement also provides for a 50% tax to be imposed on inheritances in Switzerland, unless German residents opted to declare their inheritance to the German tax authorities. The tax deal also provided for the taxation of until now undeclared and untaxed assets held by German taxpayers in the Confederations banks, at withholding tax rates varying from 2141%.

Deal between Italy and Switzerland could be worth 20bn In the previous paragraph, we identified actions to drain wealth out of the country to free up resources to support internal consumption. The current taxation of the stock of wealth and capital already hits the whole population, and the measures we have identified would increase the tax burden even further. Increasing the fiscal pressure without tackling the funds repatriated from the tax amnesty could be politically unacceptable. During the last electoral campaign, several politicians have referred to the opportunity to re-open the file of the Italians that benefited from the tax amnesty in 2009. We estimate that using the average taxation imposed by similar deals struck by the UK and Germany could generate 20bn additional taxes for Italy. Feasibility is the key question However, the feasibility of such initiative may be debatable for the following reasons:

The intervention may be considered as retroactive, possibly generating legal issues. The intervention may be considered as not compliant with the principle of the so-called capacita contributiva (taxes should be related to the current capacity to contribute, not to the past or future capacity to pay taxes). Such a principle is part of the Italian Constitution. The amount of money repatriated with the tax amnesty may have already been used, invested or injected in corporations.

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Building and fiscal amnesty: upside not worth the political cost
Six large amnesties over the last 40 years The history of the building amnesties introduced by Italian governments is quite long and complex. According to Italian Tax Authorities (Agenzia delle Entrate), all amnesties (mainly fiscal and building amnesties) introduced from 1973 to 2005 generated a total amount of 26bn tax receipts. Unauthorized redistribution of this report is prohibited. This report is intended for
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The first large fiscal amnesty dates back to 1973 and generated total proceeds equal to c1.5bn at current prices. In 1982 the Minister of Economics and Finance R. Formica introduced the so-called condono tombale(5.8bn). In 1985 Prime Minister Bettino Craxi introduced a building amnesty that was promised as a one-off action for people who had violated zoning laws and built without the permission of the local authorities. In 1994 Berlusconis first term as prime minister allowed a building amnesty and a fiscal one (so-called Concordato Fiscale). The latter mainly targeted autonomous workers/holder of business income. The taxpayer subscribing to the Concordato Fiscale accepted a higher taxable income for direct taxes purposes (Irpef, Irpeg, Ilor) and VAT in exchange of any future claim from the tax authorities. The combination of building and fiscal amnesty generated 2.6bn tax receipts. In 2003-04 Berlusconis Government introduced a building amnesty (generating c.4bn tax revenues) and a fiscal one (generating 23bn tax revenues). The tax amnesty again involved direct taxes and VAT. Finally, in 2009 Berlusconis Government introduced the tax shield, generating c.5bn tax revenues.

In our view, another amnesty could only be applied to real estate. A tax amnesty in fact cannot involve VAT anymore, as VAT is now a European tax and tax amnesties are not permitted on European levies. With particular reference to a building amnesty, the third and last one was launched in 2003-04 and it only applied to breaches occurred by and not later than the 31 March 2003. As showed in the table below, the cumulative income related to that amnesty amounted to c.4.6bn. In our view, a new building amnesty will generate lower tax revenues than the 4bn collected in 2003 -04. Provisionally and given the table below we could assume 2bn, which we do not consider worth the political risk and hence do not include in our simulation. Italy Building Amnesty
m Building Amnesty 2003 0 2004 2,312 2005 1,785 2006 171 2007 142 2008 92 2009 70 2010 59 Total 4,631

Source: Eurostat, Mediobanca Securities

Conclusion: 75bn to reduce debt without harming consumption


In light of the limited scope to introduce a large wealth tax aimed at reducing and reshaping the Debt/GDP ratio of the country, we focused in this chapter on potential fiscal measures aimed at freeing-up resources to lower personal and corporate taxation over time and support consumption. Needless to say all measures should be accompanied by the rationalisation of Government spending, by the disposal of public assets, and fighting tax evasion. In the absence of such a commitment, any measure would be useless, as the trajectory of the Central Government debt would remain unchanged. Our suggested measures can be classified in two groups:

Recurring interventions. A re-alignment of the tax burden for property and financial assets levied on the whole population could generate c.3bn revenues. A recurring wealth tax levied on the wealthiest households (replicating Frances ISF) could generate c.5bn

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revenues. The mentioned interventions would bring the taxation on the stock of capital/wealth at 4% of GDP as shown below, above the EU average and almost matching the UK and France. Italy Realigning Tax Treatment of Real Estate and Financial Assets Unauthorized redistribution of this report is prohibited. This report is intended for
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bn Tax Receipts on Capital 2010 Tax Receipts from IMU 2012 Suspension of IMU Prima Casa 2013 Additional Taxes Fin. Assets 2013 Alignment Taxes Fin. Assets 2013 Wealth Tax on Wealthy Population Total As % of GDP France - Germany - Spain - UK
Source: Eurostat, Mediobanca Securities estimates

Real Estate 19.5 15.5 -4.0 0.0 0.0 0.0 31.0 2.0%

Financial Wealth 7.8 0.0 0.0 5.0 2.9 0.0 15.7 1.0%

Wealth Tax 0.0 0.0 0.0 0.0 0.0 4.9 4.9 0.3%

Inherit. Tax 0.5 0.0 0.0 0.0 0.0 0.0 0.5 0.0%

Others 10.8 0.0 0.0 0.0 0.0 0.0 10.8 0.7%

Total 38.7 15.5 -4.0 5.0 2.9 4.9 63.0 4.0% 4.3% 2.8% 2.5% 4.3%

One-off interventions. A wealth tax levied on the wealthiest population could generate 43bn in of one-off revenues. A more penalising taxation of the wealth repatriated with the tax shield in 2009 could generate a maximum of 20bn, although the feasibility remains debatable. A combination of the two could reduce the Debt/GDP Ratio to 123% from 127%.

The table below summarises our findings where we estimate the above initiatives could also bring some 4bn lower cost of interest on the Italian public debt. Italy Summary of Interventions
bn Recurring Interventions Alignment Taxes Fin. Assets 2013 Wealth Tax on Wealthy Population Una Tantum Interventions Wealth Tax Taxation of Repatriated Funds Lower Cost of Debt Total
Source: Eurostat, Mediobanca Securities estimates

Total 8 3 5 67 43 20 4 75

Goal Reduce Income Taxes Reduce Income Taxes Debt Reduction Debt Reduction Reduce Income Taxes

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Mediobanca Italian Corporates Survey 2013


More than 50 Italian companies in our coverage universe responded to our first survey aimed at gauging expectations on the back of the recent political deadlock. Although roughly one out of three companies considered the latter as a very negative on their companys economic situations, it is not politics per se that is the main source of concern. Some 55% of the industrials responding pointed to credit access as their major problem, whilst banks mentioned the high and volatile cost of funding. If 85% of the banks seem confident to report a decent top line growth this year, some 50% of industrials expect no top line growth, which is why 85% of them are considering further costs rationalisation, and only 20% of them are planning to raise their investments significantly versus last year. The recent decree to speed up payments to corporates by the Italian PA does not seem to represent a game changer, with only 24% of respondents saying this could have a significant impact on their economics. This is probably due to the fact that large to medium corporates (which is what our panel represents in the context of the average size of the Italian enterprises) have more bargaining power in negotiating payment terms. Some 80% of the panel expect that the weak scenario could lead to some sector consolidation, but only 8% believe the M&A opportunity would come from distressed PA assets. The final result is that some 44% of the answers point to growth measures as a priority number one for the government followed by softening of the fiscal pressure (26%) and restructuring of the public administration (21%). Only 3% call for the respect of the fiscal compact, and 6% are worried about the public debt. The overall picture is of a country in a wait and see mood, with companies reluctant to invest, more focused on cost-cutting plans and in strong need of increasing their credit conditions. Low revenues prospects and poor macro expectations make the softening of the austerity stance to be the clear consensus request emerging from our survey.

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A gloomy picture ahead from Italian corporates


We outline in this chapter the key findings of our first Mediobanca Italian Corporates Sentiment Survey aimed at capturing expectations into 2013 and 2014. Although these kinds of exercises should clearly be taken with extreme care and should not be seen as fully representative of the entire country, we stress that the fairly large sample of the companies surveyed under our coverage (more than 50 between corporate and financials) and their size makes the responses to our questionnaire an interesting reference point on where to set expectations, in our view. Our answers were collected one week before the appointment of the Letta government, and as such one might argue that expectations could feasibly have improved post the government appointment compared with our findings. Financials more than corporates worried for the political deadlock Italian political instability has had a mixed impact in our sample. According to the questionnaire, 72% of the Financials interviewed believe that the Italian political deadlock has impacted their economics somehow versus 55% of industrials. Only one third of our sample though says that such issue had a very high impact on its activity.

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Italian political instability impact on companies economics


Extre me ly A lo t Mo deratly Ne ith e r mu ch nor little Sligh tly No

100% 90%

11%

14%
43%

80%

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70%

28%

24%
17%

60%
50% 40%

19%
29% 19% 14% 17% 6% MB Sample 14% Financials

30%
20%

21% 17% 7% Industrials

10%
0%

Source: Mediobanca Securities

Easing credit access a prerequisite for growth from 55% of the corporates We asked our sample to pick, among four options, what makes them more worried about the future. The results mirror the differences of financial versus industrial businesses. The latter, which need frequent access to credit in order to increase investments and growth prospective, are in 55% of the cases more worried about the difficulties in obtaining loans from the banks. Financials, on the other hand are mainly concerned about the interest rate on Italian government bonds and high rates volatility in the market. Factors to be worried about in the future
Credit access
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% MB Sample Financials Industrials 29% 11% 16% 57% 13% 10% 23% 45% 43% 55%

Revenue growth expectations for 2013


Extremely
100% 90% 80%

Capital markets access

Interest rates volatility

Interest rates

A lot
3% 16%

Moderatly

Neither much nor little

Slightly
3%

No

14%

33% 27% 13% 11% 14% 71%

70%
60% 50% 40% 30%

13%

20%
10% 0%

30% 14%

37%

MB Sample

Financials

Industrials

Source: Mediobanca Securities

Two out of three Italian corporates expect zero or negative growth . . . The picture offered in the right hand side chart above shows two different views when it comes to growth expectations.

On the one hand, 85% of Financials in our sample foresee an improvement of the general economic and political conditions. Therefore they expect an increase of their revenue stream in Italy in 2H 2013. For Industrials however, 96% expect either no or moderate future revenues growth in Italy in 2013. Indeed, 50% of them expect zero or little revenue growth in 2013 from Italy, and only 3% of the sample expects good revenue increase.

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. . . which is why only 20% of them are investing As a result of such expectations, Industrials have not only reduced their plan to invest in Italy but they are also implementing further cost rationalisation plans. As shown in the two pie charts below, only two companies out of 10 are planning to increase significantly their investments, while the majority will wait for the economic situation to improve. In addition, 85% of the Industrials are putting in place cost rationalisation plans, which will most probably translate in a number of job losses. Few Industrials plan to increase investments (lhs) and many to further optimise costs (rhs), 2013
Extremely 3% No 17%

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A lot 17%

Extremely 17%

Slightly 10% Neither much nor little 14%

Moderatly 13% Slightly 30%

A lot 28% Moderatly 31%

Neither much nor little 20%

Source: Mediobanca Securities

Payment of commercial debt is not considered a game changer . . . In a second set of questions, we asked the Industrial companies what they think is necessary to boost the Italian economy. One of the measures that has been announced by the Italian government in the past weeks is to start repaying around Eur40bn of commercial debt to Italian companies. Although we welcomed such move, according to the Industrial companies in our pool it wont help solving the growth problem of the country. As shown in the right hand side chart below, two thirds of the sample believe this move will have limited/moderate impact on the Italian GDP. In addition, 62% of the Industrial companies do not expect any major benefit for themselves from such a payment. PA payment of commercial debt benefits on Industrial companies (lhs) and on Italian GDP (rhs)
How much will the speed up of the payment of commercial debts by the public administration impact your company?...

Extremely 100%

A lot 9% 29%

Moderatly

Neither much nor little

Slightly 10%

No

Extremely 7% A lot 17%

90%
No 24%

80% 70% 60%


50%

50%

34%

29%

Moderatly 14% Slightly 31%

40%

24%

30% 20%

11% 20% 3% MB Sample

33% 14% 17% Financials 17% Industrials

Neither much nor little 7%

10% 0%

Source: Mediobanca Securities

. . . as 70% of the sample aims for growth measures and softening of austerity stance The companies interviewed are all well aligned in terms of their priorities for the new Letta government. As shown in the chart below, out of the five options proposed, 44% of the pool indicated growth strategies as a necessity to revitalise the stagnant economy. The rest of the companies prioritise the reduction of fiscal pressure (26%) and the restructuring of the Public Administration

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(21%). Surprisingly, in our view, only 6% of the pool believe the reduction of the high public debt is a priority, and only 3% care about respecting the Fiscal Compact. Priorities for the next government
Gro wth strategy Restructuring Public Administration Co mply with fiscal co mpact Reducing fiscal pressure Reducing public debt

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100%

90% 80%
70% 60% 50% 40% 30% 20% 21% 6% 3% MB Sample 22% Financials 26% 22% 21% 7% 3% Industrials 26% 44% 43% 56%

10%
0%

Source: Mediobanca Securities

Some 60% of the corporates have credit access issues . . . We also asked the Industrial companies in our pool to give us more detail on their accessibility to credit. Some 60% of the interviewed sample confirmed they are currently experiencing difficulties in opening credit lines. Italian Industrial relationship with credit market
Do you experience difficulties in opening/increasing credit lines in Italy?

Extremely 10%

No 13%

A lot 17%
Slightly 20%

Moderatly 33%

Neither much nor little 7%

Source: Mediobanca Securities

. . . and more than 50% of them plan to increase their cash position at Italian banks Some 56% of Industrials in our panel have increased their cash reserves or accessed the capital market more than needed. Despite the several hurdles they need to overcome to obtain loans by banks, Industrials seem to look at their relationship with banks in a less negative stance. Although none of the companies interviewed believe their attitude towards Italian banks will sharply increase in the near future, 92% of them at least does not expect it to worsen.

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Italian Industrials attitude vs Italian banks in the past 3 months (lhs) and in the future (rhs)
How has your attitude to holding cash/cash equivalents at Italian banks changed in the last three months?...

And how will it evolve in the near future?


Slightly decreased 8% Moderatly increased 54%

Increased a lot 8% Extremely decreased 4%

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Moderatly increased 56%

Slightly decreased 8%

Stable 24%

Stable 38%

Source: Mediobanca Securities

The overall picture is for a country in a wait and see mood with companies reluctant to invest, more focused on cost-cutting plans and in strong need of improving their credit conditions. Low revenue prospects and poor macro expectations make the softening of the austerity stance the clear consensus request emerging from our survey.

The Questionnaire
The Questionnaire - Q&A
Questions How much is the absence of the government impacting your company? Do you expect revenue growth in Italy in 2013? Are you considering further costs rationalisations in 2013? Have you changed your cost structure as a consequence of the crisis? Do you plan to increase investments in Italy in 2013? Do you see opportunities for consolidation in your sector? Have you increased cash reserves or accessed capital markets more frequently? Do you have difficulties in opening/increasing new credit lines in Italy? Which portion of your cash/cash equivalents is held at Italian banks? Has your attitude to hold cash at Italian banks increased in the last 3 months? Will your attitude to hold cash at Italian banks improve in the near future? Will your company benefit from the payment of commercial debts by PA? Will GDP expectation benefit from the payment of commercial debts by PA? Do you see opportunities to acquire assets from PA given its financing needs?
Source: Mediobanca Securities

No Slightly 6% 30% 0% 3% 17% 7% 20% 13% 4% 4% 0% 24% 3% 16% 17% 14% 10% 17% 30% 11% 20% 20% 7% 8% 8% 31% 20% 32%

Neither much nor little 19% 11% 14% 7% 20% 21% 10% 7% 11% 24% 38% 7% 11% 16%

Moderately 19% 27% 31% 28% 13% 21% 20% 33% 29% 56% 54% 14% 29% 28%

A Extremely lot 28% 16% 28% 34% 17% 32% 20% 17% 32% 8% 0% 17% 29% 8% 11% 3% 17% 10% 3% 7% 10% 10% 18% 0% 0% 7% 9% 0%

Other questions asked were:

Which of the following factors are you more worried about? Answers: Interest rate: 29%, Interest rate volatility 16%, Capital market access 11%, Credit access 45%.

How is your liquidity invested? Answers: Cash/Cash equivalent 85%, EU treasuries 4%, US treasuries 1%, Corporate bonds 3%, Other 7%.

What should be the priorities of the next government? Answers: Introduction of growth strategies 44%, Restructuring of Public Administration 21%, Reducing fiscal pressure 26%, Reducing public debt 6%, Respect fiscal compact rules 3%.

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Conviction ideas and ratings changes


Following a weak set of Q1 results, we ended up downgrading our 2013 and 2014 estimates by 5% on average for our Italian coverage. We remain cautious on the growth prospects for 2013 and 2014 and expect further downgrades in 2H 2013, driven by the macro outlook further deteriorating. As a result, we maintain a cautious stance on Italy, which leads us to favour defensive stocks and names with high earnings diversification outside of the country or stocks with corporate action/ restructuring potential. Our key high conviction longs are: Autogrill, Azimut, Cementir, Cairo, Danieli, EI Towers, ENI, Fiat Industrial, PMI, Prysmian, UBI, Unicredit and Unipol. Following our more cautious stance on Italy we downgrade Beni Stabili, BPER and Yoox from Outperform to Neutral, BP and Trevi from Neutral to Underperform and Saras from Outperform to Underperform.

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Cautious view on Italy


We reiterate our cautious stance on Italy. This leads us to favour defensive stocks with diversification of their earnings outside of Italy or potential stock specific catalysts. This means: Long: Autogrill, Azimut, Cementir, Cairo, Danieli, EI Towers, ENI, Fiat Industrial, PMI, Prysmian, UBI, Unicredit, Unipol; Short: BPER, Banco Popolare, Buzzi Unicem, Finmeccanica, Geox, IntesaSanpaolo, Mediaset, Piaggio, Pirelli, Saras, Trevi. In this chapter we summarise our by-sector overviews suggesting our high conviction pair trades. We also address the key rational behind our downgrades which are analysed separately in the accompanying reports published today.

Banks: macro and asset quality put our EPS at risk of downgrade
The uneasy macroeconomic outlook in the foreseeable future leads us to stay cautious: Vanishing inflationary pressure across the Euro Area and abundant liquidity may prompt further rate cuts in the ECB policy rates. Euro Area HICP inflation is projected by the ECB to decline from an average rate of 2.5% in 2012 to 1.4% in 2013 and 1.3% in 2014. Our current estimates are built on the assumption of a progressive realignment of Euribor 3-Months (currently at 0.2%) to the current base rate (0.5%). In other words, our estimates incorporate c25bps increase in short-term rates in 2014E, which may be a debatable assumption given the low inflationary pressure. Should this not happen, we see further deposit margin pressure, affecting NII negatively. Long lasting recession in Italy may dent loan growth in the medium-term. First quarter results showed a reduction in the loan book of many Italian banks (UCG, ISP, MPS, UBI, BP, CE, CVAL). In general terms, we expect Italian banks loan book to stabilise in 2013E and start growing again in 2014E (+3% nominal in Italy). Such assumption is coherent with the GDP outlook depicted by the ECB. The Central Bank expects real GDP to increase during 2013 supported by the favourable impact on export of a gradually rising external demand. Domestic demand should also pick up over time, initially benefiting from a fall in commodity price inflation and from accommodative monetary policy stance. In 2014, internal demand should also be supported by progress made in fiscal consolidation. On the other hand, the ECB itself sees remarkable downside risks and this holds particularly true for Italy (GDP forecasts have been revised downward several times over the past few months and economic recovery postponed quarter after quarter). Needless to say that a longer than expected recession in Italy may dent the forecast resume in lending growth. Asset quality remains a key concern to us. First quarter results provided a mixed picture from Italian banks, with management conveying moderately reassuring messages in some cases. On the other hand, Bank of Italy data show that NPL (sofferenze) kept growing in Apr-13 versus Mar-13

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(+2.3bn). In our view, it is premature to call a stabilisation in deteriorated loans inflow. Longer than expected recession may prevent any asset quality improvement, while we currently estimate a general decrease of loan loss provisions in 2014E; Aside the impact on the forecast returns, asset quality may become an issue also for regulatory capital. Italian banks capital may come under the spotlight again in light of the steady increase in the stock of deteriorated loans since the start of the crisis in late 2007 and the possible start of an ECB-led review of lenders asset quality. An exercise stressing banks capital adequacy on asset quality deterioration could be a matter of concern for Italian banks, as the combination of soaring Gross Problem Loans since 2007 and relaxation of coverage ratios resulted in Net Deteriorated Loans accounting for c120% of CT1 in Mar-13. Needless to say, stress-scenario assumptions on something exceeding 100% of CT1 would have a remarkable impact on regulatory capital.

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Italian Banks Net Problem Loans as Percent of CT1 Capital, 1Q13-2007 (ex. State Capital)
2007 Aggregate CREDEM ISP BPM UCG UBI BPER CREVAL BP MPS 45% 13% 35% 22% 53% 25% 45% 28% 70% 63% 1H 08 52% 14% 42% 23% 54% 26% 50% 35% 75% 116% 2008 61% 20% 48% 35% 66% 36% 57% 52% 98% 120% 1H 09 78% 24% 65% 71% 75% 50% 90% 63% 109% 154% 2009 98% 33% 80% 80% 91% 71% 108% 101% 235% 156% 1H 10 97% 35% 77% 81% 91% 75% 111% 128% 220% 167% 2010 102% 36% 81% 99% 97% 80% 110% 108% 235% 173% 1H 11 94% 37% 65% 101% 95% 74% 119% 116% 163% 188% 2011 97% 41% 69% 71% 103% 80% 118% 124% 162% 148% 3M 12 96% 43% 73% 76% 89% 85% 135% 149% 167% 168% 1H 12 101% 45% 77% 75% 93% 89% 141% 132% 188% 184% 9M 12 107% 47% 80% 81% 97% 98% 149% 154% 200% 203% 2012 108% 45% 85% 89% 94% 103% 140% 148% 215% 205% 1Q 13 117% 46% 91% 93% 96% 109% 151% 174% 228% 328%

Source: Company Data, Mediobanca Securities analysis

Long UCG versus ISP and long UBI versus BP are our two high conviction pair trades Long UCG (Outperform, TP 5.1) Adjusting 2012 reported RoTEs shows underlying profitability would move to 4.3% already in 2012. Furthermore, the reallocation of UCGs German excess capital to CEE (16% RoTE) and the realignment of CIB to EU peer average profitability imply 1.1bn net profit boost. UCG is a restructuring play with: 1) large cost cutting (we estimate 780m pending cost cuts at UCG); 2) CIB makeover potential; 2) EPS potential from capital redeployment into CEE from CIB and GER; 3) faster inversion of LLP trends than ISP from a faster credit cycle. Finally, in a scenario of possible further macro deterioration in Italy, the weight of German, Austrian, Polish, Turkish and Russian operations should work as a mitigating factor. Short ISP (Neutral, TP 1.1) Adjusting 2012 reported RoTEs shows underlying profitability at 2.5%. ISP shows positive aspects (capital adequacy, liquidity strength, low leverage and regulatory risk) and a major weakness: the large incidence of TE to bad loans. We see ISP as a focused and efficiently run bank. However, its asset quality worsened much faster than UCG (3x vs 2x using since 2006), reflecting Italys issues. ISPs higher carry trade and deposit hedging support is positive short-term P&L management to us, but it is but unsustainable in the medium-term. Long UBI (Outperform, TP 4.0) Our positive stance on UBI is mostly related to the minorities angle: Basel III makes further rationalisation of minorities necessary, adding up to 70bps of CET1. Minorities rationalisation could be seen also as a way of weathering potential further macro deterioration in Italy and surviving a potential EU-wide exercise on asset quality in the future. We also see some short-term catalyst: we regard the guided 50bps improvement in the CT1 ratio from the roll-out of retail IRBA models as prudent and the validation expected by Jun-13 may work as a catalyst.

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Short Banco Popolare (Underperform, TP 0.95) With a fully-phased Basel III CET1 below 8% in 2013E, we see BP as undercapitalised. We view this as light in both absolute terms, given the magnitude of the deteriorated loan book, and relative to peers. Re-aligning BP to the peers average (10%) would require a 1.3bn capital infusion, making BP trading at 0.5X TE, a generous multiple in light of 4% return in 2014E. The combination of low CET1 ratio, lack of options to replenish it, potential risks underlying the large deteriorated loan portfolio and generous multiples after theoretical recapitalisation lead us to downgrade BP today. Long BP Milano (Outperform, TP 0.60). The transformation of BPM into a limited company looks like a remote option. Hence, the premium the market might attach to a speculative angle related to a change in the governance is unlikely to resurface soon. Nevertheless, we believe the market has over-reacted to the shattered dream of a radical governance change: based on our numbers, BPM trades at 0.35X TE 2014E, below UBI and BPER and aligned to BP a multiple hard to justify in light of the expected c6% return in 2014E. Unlike peers like BP, such low multiples cannot be justified neither by the asset quality situation (total deteriorated loan coverage ratio at 34% is above peers one, net deteriorated loans accounting for 90% of CT1 is below the peers average of c120%) nor by the capital outlook (pro-forma Basel II CT1 at 10% in FY12, without IRB models validation and with marginal impact from Basel III). Short BP Emilia Romagna (Neutral, TP 5.80). After reducing 2014E earnings by 33%, we expect BPER to deliver c.5% RoTE in 2014E. This makes the current 2013E 0.5X T/E fair. First quarter results show that the current profitability hovers over 3% RoTE, unlikely to expand soon due to the asset quality burden. Moreover, our estimates are based on short-term rates matching the 0.5% policy rate and on lowering cost of risk, leaving little margin of safety in our forecasts. Finally, apart from the roll-out of IRB models, we see few options to improve the banks capital ratios, a weakness in a deteriorating macro environment and in light of the ECB-led review of lenders asset quality.

Cement: Cementir is our high conviction long


First quarter results have highlighted a very soft start for the Italian cement market. Cement and ready mix selling volumes fell by a double-digit amount y-o-y due to a very negative performance by the residential and public works segments. The picture gradually improved in April and May due to better weather conditions, but growth drivers for the sector remain limited.

According to our estimates, domestic cement consumption is expected to be some 20.5m tons in 2013E (down by some 20% Y/Y), reflecting a utilisation rate close to 52%. Despite this gloomy picture, market leader Italcementi has right-sized its production capacity significantly (from 15m tons to 9m tons) over the last two years, and now plants are currently running with a utilisation rate of around 60%. The other players, including Buzzi Unicem and Cementir have also optimised their production footprint. This ongoing rationalisation of the Italian cement production footprint should result in better price discipline than in the past, in our view. Next steps for the industry are to right-size the ready mix industry plus further plant closures. The key question for producers remains the visibility on a potential recovery in volumes. In our opinion, a normalised level of capacity utilisation close to 70% (to be reached in three years) would be a satisfactory result. Long Cementir (Outperform TP 2.35) We reiterate our positive stance on Cementir based on the wealthy geographical mix combined with the projected cost savings related to headcount rationalisation; Short Buzzi Unicem (Underperform TP 11.2) We reiterate our negative stance on the stock. The geographical mix is solid due to the groups exposure to the US, Mexico and Russia, but we believe that its growth potential has been overvalued by the market. The stock

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is trading at 6.3x, above its mid-cycle multiple of 5.7x. The timing and shape of the cycle recovery factored in by the market seems too bullish, in our view.

Capital goods: Prysmian and Danieli


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Antonio.Guglielmi@mediobanca.co.uk from MB.Antonio.Guglielmi@mediobanca.com First quarter results did not produce a significant trend due to seasonal reasons for our capital goods coverage. Delays in payments from Public Administration (PA) have further stressed the companies working capital management. The recent news relating to the gradual unlocking of payments from PA (some 21bn to be released in a first tranche) could inject some liquidity into the sector and potentially restart some infrastructural projects. The high-conviction buys in our capital goods universe remain Prysmian and Danieli.

Long Prysmian (Outperform TP 17.50) The stock reacted quite well after the warning given by the CEO on the cyclical businesses during the first quarter results. Given the worsening of the cycle, the company has immediately increased its efforts on production optimisation and upgraded the cost synergies target from 150m to 175m (at full speed in 2015). This upgrade is mainly related to a second round of production footprint optimisation to be implemented in Europe; Long Danieli (Outperform ordinary shares TP 24.90, Outperform 16.20 saving shares) We see good momentum on backlog. The 3.05bn current backlog does not include two jumbo orders that the company has already won, given its very cautious accounting policy. It would mean a book-to-build for the plant making of above 1.2x. Additionally, we expect a positive impact on earnings from the recent acquisition of a steel plant in Croatia, integrating the ABS mill in Italy; Short Trevi (Underperform; 4.45 TP) We downgrade the stock today given the modest cash flow generation, demanding multiples and our overall bearish stance on Italy. We cut the TP by 24% to 4.45 (from 5.85). Our valuation is the average of a DCF analysis (4.30 fair value) and peer multiples comparison on 2013 and 2014 figures (4.5); Finmeccanica (Underperform TP 3.40) In our view, the stock has been supported by the speculation surrounding potential disposals. We believe the current government (as clearly expressed by many of its members several times) would not support asset sales to foreign companies. Meanwhile, the companys reputation is badly damaged and this is evident from the poor order intake. This is expected to translate later into poor cash flows and P&L numbers.

Oil: ENI remains our core long


In our latest sector report (1H 13 outlook: cautiousness with a pinch of M&A, 15 January 2013), we suggested an overall cautiousness in the oil and oil service sector, holding onto oil-integrated stocks rather than oil services/oil-related names in the first half of the year. We confirm this view also for the second half of 2013:

With the oil service industry currently experiencing further delays in tendering activity and the award of new contracts, we see opportunities for oil integrated stocks to keep on outperforming given 1) sustained earnings momentum in the E&P activity; 2) sustained exploration activity; and 3) stabilisation in the negative trend of the downstream activities. We assume a scenario of declining oil price. The charts below highlight the historical overperformance of Oil Integrated stocks vs. Oil Services in this scenario, confirmed also in 1H13.

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Italy

Oil Integrated vs Oil Services performance (rebased to 100) in the long term (left) and YtD (right)
120

110

115

110 105
105

100

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95 100
90

85

80

95

75

70 31/12/2010

31/03/2011

30/06/2011

30/09/2011

31/12/2011

31/03/2012

30/06/2012

30/09/2012

31/12/2012

31/03/2013

90 01/01/2013 Oil services Integrated

22/01/2013

12/02/2013

05/03/2013

26/03/2013

16/04/2013

07/05/2013

28/05/2013

Oil services

Integrated

Source: Thomson Reuters Datastream, Mediobanca Securities

Long ENI (Outperform TP 22.20) ENI remains our high conviction outperform in the Oil space. We expect earnings momentum to improve in the coming quarters after a slow start of the year, with a slight improvement in production in 2Q and a robust acceleration in 2H. We feel confident the company will meet its 3% target of production growth, including the start-up of Kashagan as scheduled. As far as the gas marketing division is concerned, positive news might come from the take-or-pay contracts renegotiations, driving to a lower loss than what the market is estimating thanks to the positive contribution of the retrospective effects that we quantify in some 300m. A 6.5% dividend yield coupled with the contribution of the share buyback lead us to confirm our preference for ENI among Italian industrial names. The icing on the cake would be the solving of the SPM issue that could represent a strong catalyst for both stocks. Short Saras (Underperform TP 0.95) Today we downgrade the stock to Underperform (from Outperform). The reason is twofold: on the one hand M&A appeal should wane, following last Fridays termination of Rosneft partial tender offer on 7.29% of the capital. On the other hand market fundamentals are showing signs of deterioration. Our new TP points to 0.95, following a revision in estimated profitability from the refining business.

Branded & Consumers: Autogrill vs Geox


Limited exposure to the Italian risk On average some 23% of the luxury sectors turnover is generated in Italy (17% for consumers companies). This falls below 10% for Luxottica a nd Ferragamo, while it reaches 40% for Tods. Based on our estimates, the contribution to the turnover generated in Italy by local customers is approximately 17%, since luxury demand in Italy is mostly driven by travellers flows from Asia and China, and appetite for buying luxury products in Italy is mainly supported by the existing gap in retail price between Asia and Italy (at 35-40% in China). Tods and GEOX are the most exposed to domestic purchases (28% and 35%, respectively), and Ferragamo and Prada the least exposed (2% and 5%).

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Branded & Consumers Goods: exposure to domestic consumptions


REVENUES IN ITALY BRANDED AEFFE BRUNELLO CUCINELLI FERRAGAMO GEOX LUXOTTICA PRADA SAFILO TOD'S YOOX CONSUMERS AUTOGRILL CAMPARI DE LONGHI INDESIT
Source: Mediobanca Securities on company data

o/w domestic 17% 25% 16% 2% 35% 5% 5% 20% 28% 16% 17% 20% 23% 11% 12%

23% 39% 25% 8% 35% 5% 16% 20% 40% 16% 17% 20% 23% 11% 12%

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The luxury is in good shape The branded goods sector has experienced a solid start to the year, reporting average mid-single digit top line growth in 1Q13, despite a challenging basis of comparison (sales grew double digits YoY in 1Q12 on average). The major macro event affecting the sector in the quarter was the depreciation of the Yen against the Euro (17% on average), which hit all companies with a high exposure to such a market, but on the other hand it pushed domestic purchases by Japanese consumers. This was partly faced by some brands raising retail prices in Japan (more notably Louis Vuitton raised prices by 1015% in mid-February, Richemont by 9%, and Gucci is set to do it in 2Q). Geographically speaking, the driver of the sector has been North America, where the demand was helped by healthy consumer confidence pushing up domestic consumption. In Europe the picture is mixed, with Southern Europe (Italy and Spain) being very weak, and France and the UK outperforming. Overall, performance was softer in March than in January and February, as the sell-out of Spring/Summer 2013 collections was delayed by poor weather conditions. In the region, the sector reported mid-single digit growth in 1Q13, mostly driven by travellers flows. The mix is changing as travellers are increasingly from Russia, while tourist flows from Japan and China are reducing their purchases in Europe due to the narrowing of the price gap, as some luxury companies increased prices in Europe. On the other hand, local demand for luxury goods has not yet picked up. Most luxury companies in Europe are now focused on cleaning up their independent wholesale channels to reduce their credit risk profiles, and implementing a much more cautious retail plan. The Asia Pacific is again the area where all companies are focused in terms of better brand penetration and expansion of distribution networks. This seems likely to happen in China, while South Korea is seen as likely to be in trouble. Although most companies do not expect to replicate in China the outstanding performance recorded in 2012, the environment there is still buoyant and luxury companies efforts are still focused on expanding the direct retail network in tier II and III cities to capture new customers and their appetite for luxury goods. The new anti-corruption actions by the new government might have an impact on the giving of gifts, hitting luxury sales, especially watches, while some boost might come from increasing consumption in womens apparel for personal use. In terms of outlook for the remainder of the year, the common attitude among listed luxury companies is a more cautious approach to providing indications, but almost all companies reported a solid start to 2Q, with April seen as a continuation of 1Q.

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On the back of buoyant macro conditions in the major luxury markets, the sector experienced a strong share price performance (+30% YTD on average), and given that consensus estimates were not materially revised up, there was a rerating of the sector that in most cases is at its all times peak (i.e.29x 2013 PE on average). Consumers: a tough start of the year Unauthorized redistribution of this report is prohibited. This report is intended for
Antonio.Guglielmi@mediobanca.co.uk from MB.Antonio.Guglielmi@mediobanca.com All consumer companies experienced a weak start to the year, due to depressed demand in Europe and particularly tough conditions in Italy, partly compensated by good growth in North America and emerging markets. Weakness in Italy affected 1Q13 results in particular in terms of one-off destocking activities for Campari, weak motorways business for Autogrill, and poor volumes for Indesit. Emerging markets continued to drive the growth, with the exception of Russia for the large domestic appliances industry. It is worth underlining that the manufacturers of domestic appliances are now increasingly focused on improving price-mix to protect profitability: Indesit has planned to increase prices in 2Q and 3Q13; DeLonghi was able to improve its profitability in 1Q13 due to better price-mix and the management expects further improvements over the year. After a tough start of the year, consumer companies started to experience improvements in trading conditions. Autogrill sales grew slightly in the first 18 weeks of the year (+0.5% ex forex) with F&B supported by less negative trends in Italian motorways and further growth in North America. DeLonghi and Indesit experienced better growth trends in April and May.

Long Autogrill (Outperform, TP 11.80) Autogrill is our high conviction long among Branded and Consumer companies since the forthcoming demerger of the Travel Retail & Duty Free division is expected to reveal additional value which is currently not priced in and to be a first step for a consolidation with other operators in the sector. Short Geox (Underperform, TP 1.30) Geox is our short idea since quarterly results and current trading conditions are not showing any reverse in the very negative business trend, with Italy and Europe still down double digit and a very cautious guidance provided by the company on the remainder of the year, which put current consensus estimates at risk.

Insurance: Unipol vs Cattolica


First quarter results in the P&C business showed the consequences of the current poor macroeconomic situation of Italy in two ways:

Top line remains under pressure in Motor, as the fall in new car registrations coupled with limited tariff increases. In addition, non-mandatory Motor products still reported a midsingle digit drop as a consequence of lower disposable income. The flipside of the coin is that frequency remained at historical lows and this translates into low loss ratios and low combined ratios.

We therefore see some top line pressure in the Italian property and casualty business, but profitability remains sound. On the financial income side, Italian insurers remain net buyers of Italian BTPs and are therefore subject to the volatility of this asset class. Going forward, we believe the mix between the drop in the top line and high margins will be key in assessing the overall profitability of this business. Against this background, we believe the continued pressure in the macroeconomic situation of the country will put top line pressure with combined ratios remaining at the current low levels. We do not expect Motor tariffs to be a game changer, as we see limited room for increasing prices going forward, particularly after a year of low single-digit increases. In terms of the Life insurance business, the fall in short term rates increased the appeal of traditional Life insurance products. Volumes are therefore in an expansion-mode, though the reinvestment yield remains a concern going forward. In the above-mentioned environment, we favour stories with a specific catalyst more than a bias on the sector overall.

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Long Unipol (Outperform, TP 3.40) We remain buyers into the Unipol/Fondiaria restructuring story, as we still see the two stories trading at a significant discount to peers. We are aware of the risks that are still surrounding this investment case, but we see an interesting risk/reward profile in any case. July will be a decisive month, in our view, with the deadline of the green light from IVASS being the main catalyst. The release of second quarter results will be the second main catalyst in our view, with the potential marginal good news coming from the Life business. Short Cattolica (Underperform TP 14.5) lack of upside on fundamentals (our TP is 4% below current prices) is the main reason of our negative stance on Cattolica, coupled with limited liquidity and suboptimal governance (per capita vote).

Asset gathering: Azimut


The current year is proving to be a golden year for Italian asset gatherers, as inflows are close to historical highs and in some cases to record highs. The weighted average performance year-to-date is good too, and both items are supporting AUM growth. Margins are generally flattish, with average management fees confirming to be resilient and sustainable, while performance fees were a bit less generous compared to the first part of 2012, but still above the historical average. The asset gathering business is confirming to be a low capital intensive business with a strong free cash flow generation. In this context, sound top line growth couples with high visibility of dividends which are sustainable, in our view. Recruitment is a positive surprise to us, as the three listed Italian asset gatherers are finding a good source of recruitment from private bankers working for the major retail banks.

Azimut (Outperform TP 18.0) Even though we remain convinced that all the three listed asset gatherers are high quality names, our preference at the moment is Azimut. We believe Azimut is cheaper compared to other two names, particularly on P/Es calculated on recurring earnings. We also see market consensus too low on both inflows and 2013E-2015E EPS.

Real Estate sector: downgrading Beni Stabili


The disclosure of first quarter results by Italian real estate stocks confirmed the trends highlighted in the last year and in particular:

Negative impact of IMU on net rental income while in 1Q 12 companies charged the IMU tax on the basis of provisional rates then amended in full year results, the application in 1Q 13 of the definitive and higher IMU rates had a negative impact on net rents. Subdued rental market in retail falling consumption rates by Italian households was reflected in an increasing weakness of some shopping malls that saw growing vacancy and decreasing rents. Negligible income of trading not surprisingly considering the low market liquidity and lack of debt financing, portfolio rotation in the first quarter was very low.

Partially in contrast with the uninspiring picture emerging from first quarter results, the comments on the prospects for the sector in the rest of the year were generally more positive, highlighting a slight improvement in the investment market liquidity due to increasing interest by opportunistic investors for peripheral markets such as Italy after the strong rally of core European markets. Conversely, the ongoing weakness of the Italian economy coupled with a large vacancy in most markets, points towards a continuing weakness in the rental market in the coming months.

Beni Stabili (Neutral TP 0.60) We downgrade Beni Stabili to Neutral since despite the groups traditional strength - high quality portfolio, sustainable leverage and good

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management, the stock performance is expected to suffer from worsening macro conditions and financial volatility.

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Prelios (Neutral TP 0.90) Prelios remains the riskier name in the sector. Pending the finalisation of the groups recapitalisation and debt restructuring, we see Prelios plan of gradually becoming a pure asset manager as ambitious in the current market environment while the gradual divestment of its large portfolio of co-invested assets is particularly difficult in the current market environment. IGD (Neutral, TP 0.96) In the first quarter the groups cashflows were resilient despite worsening sectors fundamentals reflected in a decrease of the financial occupancy in Italian shopping malls from 96.3% in December 2012 to 95% in March on the back of the ongoing weakness of retail sales (around -5% in the quarter) We are confirming our Neutral recommendation on IGD with a target price of 0.96 considering on one side its attractive 9.3% yield and on the other the difficult moment of retail sales in Italy.

Telecom and Media: Long EI Towers and Cairo


The release of the first quarter results has confirmed our fears over a prolonged negative trend for the domestic advertising collection, notwithstanding a less challenging comparison: first feedback on the second quarter seems to suggest the second derivative is still far from showing any improvement, while the optimistic stance on the recovery expected for the last months of 2013 is losing momentum. In the first months of 2013, the domestic telecom market has come under pressure mainly as a result of increased competition, the weak macroeconomic environment and adverse regulation such as the most recent reduction in MTR: we believe this trend will persist in the rest of the year, with the likelihood of a partial recovery from 2014 onwards. We think the most important topics for the rest of the year in the TMT space are: the continued weakness of the domestic advertising market, the auction for the new frequencies, the tough situation of the state-owned RAI TV, the possible spin-off of the Network Business from Telecom Italia, and a possible market consolidation in the domestic mobile industry. Italian advertising market down 19% in 4M 13, risks of further audience fragmentation Our estimates call for 12% YoY decline for the domestic advertising market in 2013 (after the -14% YoY drop recorded in 2012). This would reduce the Italian advertising market below the 7bn threshold in 2013, the lowest level of the last ten years. We note at the beginning of the year some industry operators suggested a more optimistic stance, expecting some recovery in the second half, but recent comments seem to suggest a more cautious approach is needed: unemployment remains at record levels, and consumptions remain extremely week. Waiting for more visibility to come (for the time being we are at 10-15 days in the TV space), we note April figures on Italian advertising market released by Nielsen confirmed a 18% drop. Auditel figures recently confirmed the long tail of fragmentation, with thematic channels getting close to the 20% threshold, and the core channels of RAI and Mediaset under severe pressure: Mr Flavio Zanonato Minister of Economic Development recently confirmed the Government will complete the auction to assign three national frequencies (in order to avoid the EU fine pending on Italy because of the lack of TV pluralism); as a consequence, new international players could decide to join an already-crowded arena (SKY still extremely aggressive, Discovery doubled its presence a couple of months ago, Cairo new owner of La7). Online is the only segment with positive results (+1% YoY growth in 4M 13, now representing 8% of the total advertising pie), we believe tablet PCs and video content will further sustain this growth, but we note for the time being there is not a clear winner in the space, net of the over-the-top international giants (Google, Apple, Amazon, Facebook, Netflix). We also note the circulations figures for newspapers & magazines are suggesting visible high single-digit drops.

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Network spin-off, possible market consolidation, new attitude from EU regulators The mixed impact of adverse regulation, a weak macroeconomic environment and a fierce competition translated in an extremely negative outcome for the telecom industry: in the first quarter, mobile service revenues posted a double-digit decline, with operators confirming the tough environment for the next months as well as a straight focus on costs reduction. Waiting for some visibility to come from the EU regulator (Ms Neelie Kroes, vice-president of EU telecommunications commission and responsible of the Digital Agenda is expected to unveil measures in order to harmonise the industry, aimed at helping telecoms companies to speed up the rollout of faster 4G & NGA services), the focus in Italy will be on the possible spin-off of the TI network. At the end of May, Telecom Italias Board of Directors approved the network spin-off plan: i) the new structure will result in the so-called Equivalence of Input model of equality of treatment, which could allow for more favourable rules on the incumbent for what concerns its retail offers, ii) the BoD also confirmed the powers granted to management in order that contacts continue with CDP about its potential acquisition of a stake in the access network companys share capital, and iii) TI has informed the Communications Regulatory Authority about the plan which now has to assess its impact on the current regulatory framework. At the same time, local press argued about a potential market consolidation in the mobile industry, with Hutchs 3 Italia that recently became the most aggressive player in the market rumoured to be interested in an integration with TIM or Wind. Long Cairo & EI Towers short Mediaset

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Long EI Towers (Outperform TP 36.1) In our view, EI Towers has clear options for emerging as a winner in the space, as the new owner of frequencies will need a tower company to broadcast the signal and the option of a national tower company could represent a game changer in the industry. EI Towers seems well-positioned to benefit from the potential TV Auction and potential M&A activity, in our view; Long Cairo Communications (Outperform TP 3.58) We identify Cairo as an extremely appealing name, because of the turnaround story of La7. La 7 is achieving brilliant audience results (close to the 5% threshold in 24/7, +50% increase in prime time to 6%) and a solid cash position. At current prices, Mediaset is implying a 12% year-on-year advertising growth for the next year, while for La7 estimates are suggesting a flattish trend: the cross between these data and the audience ones leaves space for interesting upside on Cairo, in our view; Mediaset (Neutral, TP 1.70) The demanding multiples (18x 2014E EV/EBIT, more than twice the sector average) and new international players that could join an already crowded arena, identify Mediaset as the short side of our media trade.

Automotive sector FIAT Industrial the core long


The recent trends in the sector are mixed and vary by geographical area: Central/Northern Europe is weakening (German car registrations down double digits in May) while Southern Europe seems to be bottoming out (Italian car sales still negative in May with a positive new orders figure) although with some discontinuities (2Ws sales still strongly negative although, again, improving versus the YtD trend).

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German car sales (YoY trend)


5.0%
2.9% 0.5%

Italian car sales and order intake (YoY trend)


3.8%

10.0%
5.0% 0.0% -5.0%

0.0%

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-5.0%

-5.0% -4.7%

-3.5%

-10.0%

-4.5%
-12.0% -17.0% -17.2% -19.7% -21.8% -10.8%

-8.0%

-15.0%
-10.0% -10.9% -15.0% -16.4% -20.0% Jun 12 Jul 12 Aug 12 Sep 12 Oct 12 Nov Dec 12 12 Jan 13 Feb 13 Mar 13 Apr 13 May 13 -17.1% -8.6% -10.5% -9.9%

-20.0%

-19.9% -20.9% -25.0% -24.0% -25.5% -30.0% -35.0% Jun 12 Jul 12 Aug 12 Sep 12

Oct Nov Dec 12 12 12

Jan Feb Mar 13 13 13

Apr May 13 13

Car sales
Source: Thomson Reuters Datastream, Mediobanca Securities

Order intake

Asia has been deteriorating recently, mostly on the construction side, but also 3Ws and 2Ws seem volatile. Elsewhere, the reference markets are booming and accelerating or in some cases, as in the US, are not showing the signs of weakness that some were expecting: the market is growing high singledigit with solid pricing and supported by cheap financing. Latam is growing at double-digit pace, with astonishing numbers on tractors/combines (+27% and +65% YtD in Brazil, respectively). We remain cautious going forward due to the fact that many company indications and consensus figures factor in a strong 2H13, accelerating versus 1H13. Therefore, the only stock we are positive on is Fiat Industrial, while we remain negative on Pirelli and Piaggio.

Long Fiat Industrial (Outperform, TP 10.4). Our positive stance on the stock derives from the fact that the share price valuation does not reflect the benefits of the merger with CNH, which will be evident from September when the deal will be closed and the company will meet investors on road shows. Although we remain negative on the macro cycle, the tractor market is unrelated to GDP, and this is exactly why Fiat Industrial has been a laggard in the recent industrials rebound: a positive going forward if our top-down view is correct. For the remaining two businesses, Iveco and CE, the former will benefit from some pre-buy that should help to weather difficult reference markets. The stock trades at a discount both versus peers (15%) and on its SoP (20%). Short Pirelli (Underperform, TP 7.0). The stock has been supported by a speculative appeal that faded away recently when Mr Tronchetti and Mr Malacalza finalised an agreement on Camfin stabilising the shareholder base. We are now back to fundamentals that are solid elsewhere but weak in Europe, where we see price pressure and do not share the +5/6% price/mix embedded in companys guidance. Industry overcapacity would push price cuts, and the negative registration figures seen in Germany are making the situation even worse. The stock trades at premium versus peers and is not as cheap on an absolute basis (11x 2013E earnings versus peers at 9.3x). Short Piaggio (Underperform, TP 1.6). Our negative stance on the stock is related to the high exposure of the company to Europe (60% of its annual turnover) and to Italy in particular (17% of sales), which are still showing a downward trend although the pace of the decline is somehow improving. Exposure to emerging countries (25% to India and 15% to SE Asia) is not proving as supportive as expected: macro conditions in India remain difficult and high borrowing costs and inflation hit demand of vehicles, while the SE Asian sales have been affected by an economic slowdown in Vietnam (which accounts for c.70% of the sales in the area) and by some company-specific issues in penetrating the Indonesian market. EPS

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estimates on the stock have continuously been cut in the past months, but this trend has not been followed by the stock price, which remains resilient. On our estimates, the stock trades at a 15% premium versus peers on 1YR fwd earnings.

Rating Changes
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Banco Popolare (Underperform from Neutral, TP 0.95 )


Stretched Basel III Capital levels With a fully-phased Basel III CET1 below 8% in 2013E, we see BP as undercapitalised. We view this as light in both absolute terms, given the magnitude of the deteriorated loan book, and relative to peers. Risk of converting 1bn convertible bond cannot be neglected in case of further macro deterioration; Multiples after theoretical recapitalisation do not look compelling Re-aligning BP to the peers average CET1 ratio (10%) would require 1.3bn capital infusion, making BP trading at 0.5X TE 2013E TE, a generous multiple in light of 4% return in 2014E; The most exposed to risks related to an ECB-led review of lenders asset quality In Mar-13 BPs net deteriorated loans accounted for more than 200% of CT1 and coverage stood at a low 26%. Adding 1.3bn of shortfall in the stock of provisions for expected loss, the coverage would rise to 34%, but net deteriorated loans would still account for 200% of CT1 (ex. collaterals). Needless to say, stress-scenario on something exceeding 100% of CT1 would have a large impact on capital; Limited options to replenish capital in case something goes wrong BP benefits from the roll-out of IRBA models and cannot count on a sudden reduction of RWA. Aside from organic capital generation, BP could only count on challenging assets disposal to strengthen regulatory capital. The sale of the 39% stake in consumer finance arm would free-up 50bps of CET1, but we do not see CASA as interested. We see no other asset whose sale could contribute to capital strengthening.

BP Emilia Romagna (Neutral from Outperform, TP 5.80)


Fairly valued after earnings cut After reducing 2014E earnings by 33%, we expect BPER to deliver c.5% RoTE in 2014E. This makes the current 2013E 0.5X T/E fair; Little margin of safety in our forecasts Our estimates are based on short-term rates matching the 0.5% policy rate and on lowering cost of risk, debatable assumptions in absence of a macroeconomic recovery; Faint memories of halcyon days First quarter results show that the current profitability hovers over 3% RoTE, unlikely to expand soon due to the asset quality burden; Little room to improve capital ratios Apart from the roll-out of IRB models, we see few options to improve the banks capital ratios. This is a weakness in a deteriorating macro environment and in light of the ECB-led review of lenders asset quality.

Beni Stabili (Neutral from Outperform, TP 0.60)


On the back of our cautious stance on the Italian macroeconomic and financial picture, we do not see room for improvement for the Italian real estate sector for which we expect further low liquidity and price weakness and we prefer to reduce the exposure to the real estate sector, downgrading Beni Stabili from Outperform to Neutral (TP from 0.65 to 0.60). We have updated our 2013-2014 estimates on Beni Stabili, the main change being the inclusion of some asset write-downs this year, the logical consequence of the macro and sector picture outlined above. Relatively speaking, we still regard Beni Stabili as the best name in the Italian real estate sector, in the light of its high quality and resilient portfolio, lower financial leverage and

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strong management. We think that Beni Stabili is well positioned in the current difficult environment as the groups management has reacted to the prolonged crisis of the Italian real estate sector by focusing on fundamentals:

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Sustain rental income and asset value through active asset management carefully selected capex and refurbishments and continuous contact with tenants in order to anticipate their needs, are the basis of Beni Stabili asset management. This activity allowed the group to keep the vacancy rate at minimal levels (less than 2% in core portfolio) while in 1Q 13 Beni Stabili has already renewed 95% of the contracts expiring in FY 13 and achieved an overall 1.2% increase in gross rents. On the other hand, asset rotation in the current market conditions is marginal and after a good first quarter, when the group was able to close sales for 64.2m, Beni Stabili has seen a slow down in the market as even potential Italian buyers are in a wait and see mood in the current uncertain situation. Deleverage, early renegotiation of expiring debt and diversification of funding Beni Stabili aims to decrease its LTV from the current 49% to 45%, a process that will take time in the current illiquid environment. On the other hand, after the huge work done in 2012 and in 1Q 13, the groups financial structure is now secure having covered 2013-2014 maturities. In particular, in 1Q 13 the group successfully issued 225m of convertible bonds at 3.375% increasing the diversification of its L/T financial sources.

Saras (Underperform from Outperform, TP 0.95)


Last Friday, the offer by Rosneft on 7.29% of Saras capital terminated. We believe that ove r the last two months Saras share price has benefitted from the ongoing tender offer, also given the uncertainty related to the final number of shares delivered by investors (foreign investors in fact needed special authorization to adhere to the offer, as it was promoted only in Italy). Going forward, the lack of M&A support should bring the focus back to fundamentals, which in 2Q13 were quite weak: so far, EMC benchmark averaged ca. USD-0.9/bll and the factors which allow Saras to overperform the market have somehow eased (heavy-light spread almost zeroed and conversion spread fallen to below USD300/ton). In light of these poor figures and of the adverse macro trends we are cutting our 2013E and 2014E comparable EBITDA for the refining business to -29m and 69m (from the previous 18m and 76m respectively). Following the revision in estimates our new SoP valuation points to a 0.95 fair value for the stock. The bulk of the revision stands in the refining business valuation which passes from 279m EV to 104m. Marketing valuation was increased by some 25m EV as we included 2014E figures in the valuation while Power Gen and Wind businesses were left broadly unchanged. Although the Rosneft deal gave the market a clear indication on how much the refining business of Saras might be worth and although we consider it a realistic possibility for Rosneft to further increase its stake in Saras in the future, we downgrade the stock to Underperform as we believe that, for the time being, the focus of the market will go back to fundamentals.

Trevi Fin. (Underperform from Neutral; TP 4.45)


After the stocks recent rally, driven by US investors appreciation of the technological level of the drilling equipment and management efforts to penetrate new markets and clients, the stock is currently trading at too demanding multiples in our view. The overall excitement on drilling business growth prospects is grounded, but the key point is that the core business, which accounts for 60% of sales and 50% of consolidated EBITDA, is

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still sluggish, with material risks of further contraction on European markets (particularly with reference to Soilmec).

The US market and the historically rich niche of dam repair are still missing, with few contracts expected to be awarded. The backlog is broadly stable, but consists of small-scale contracts that do not generate material synergies with the equipment unit. Cash flow generation remains the big issue. Although cash flow should peak in 2Q and 3Q, following the delivery and payments of rigs manufactured in 2012 (for a total amount of around 80m), net debt is expected to remain stable at 417m by year -end, or 3.5x debt/EBITDA. In addition, the current macro picture might lead to a further deterioration in receivables, increasing the level of write-downs and shaving some percentage points off profitability.

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Yoox (Neutral from Outperform, TP 18.10)


Since our upgrade in November 2012, YOOX has been a strong outperformer, with the share price jumping by 46% vs. 6% for the Italian market. Since the IPO in November 2009, it has even trebled its market cap to the current 1bn thanks to its positive track record of growth and latest business developments, which have supported investor confidence in its unique growth profile and hidden potential. Our TGT price of 18.1 per share leaves only 9% upside on current price, and we currently see no reason for a further re-rating in the short term. Accordingly we are adjusting our rating to NEUTRAL. We continue to like YOOX business model but suggest time has arrived for some profit taking profit. We see no catalyst in the short term, but on a long term perspective we see some industryspecific growth opportunities YOOX might leverage on and namely m-commerce, and cross channelling.

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Disclaimer

GENERAL DISCLOSURES This research report is prepared by Mediobanca - Banca di credito finanziario S.p.A. ("Mediobanca S.p.A."), authorized and supervised by Bank of Italy and Consob to provide financial services, and is compliant with the relevant European Directive provisions on investment and ancillary services (MiFID Directive) and with the implementing law. Unless specified to the contrary, within EU Member States, the report is made available by Mediobanca S.p.A. The distribution of this document by Mediobanca S.p.A. in other jurisdictions may be restricted by law and persons into whose possession this document comes should inform themselves about, and observe, any such restrictions. All reports are disseminated and available to all clients simultaneously through electronic distribution and publication to our internal client websites. 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Our salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are contrary to the opinions expressed in this research. Our proprietary trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this research. The analysts named in this report may have from time to time discussed with our clients, including Mediobanca S.p.A. salespersons and traders, or may discuss in this report, trading strategies that reference catalysts or events that may have a near-term impact on the market price of the equity securities discussed in this report, which impact may be directionally counter to the analysts' published price target expectations for such stocks. Any such trading strategies are distinct from and do not affect the analysts' fundamental equity rating for such stocks, which rating reflects a stock's return potential relative to its coverage group as described herein. ADDITIONAL DISCLAIMERS TO U.K. INVESTORS: Mediobanca S.p.A. provides investment services in the UK through a branch established in the UK (as well as directly from its establishment(s) in Italy) pursuant to its passporting rights under applicable EEA Banking and Financial Services Directives and in accordance with applicable Financial Services Authority requirements. ADDITIONAL DISCLAIMERS TO U.S. INVESTORS: This research report is prepared by Mediobanca S.p.A. and distributed in the United States by Mediobanca Securities USA LLC, which is a wholly owned subsidiary of Mediobanca S.p.A., is a member of Finra and is registered with the US Securities and Exchange Commission. 565 Fifth Avenue - New York NY 10017. Mediobanca Securities USA LLC accepts responsibility for the content of this report. Any US person receiving this report and wishing to effect any transaction in any security discussed in this report should contact Mediobanca Securities USA LLC at 001(212) 991-4745. Please refer to the contact page for additional contact information. All transactions by a US person in the securities mentioned in this report must be effected through Mediobanca Securities USA LLC and not through a non-US affiliate. The research analyst(s) named on this report are not registered / qualified as research analysts with Finra. The research analyst(s) are not associated persons of Mediobanca Securities USA LLC and therefore are not subject to NASD rule 2711 and incorporated NYSE rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst. ADDITIONAL DISCLAIMERS TO U.A.E. INVESTORS: This research report has not been approved or licensed by the UAE Central Bank, the UAE Securities and Commodities Authority (SCA), the Dubai Financial Services Authority (DFSA) or any other relevant licensing authorities in the UAE, and does not constitute a public offer of securities in the UAE in accordance with the commercial companies law, Federal Law No. 8 of 1984 (as amended), SCA Resolution No.(37) of 2012 or otherwise. This research report is strictly private and confidential and is being issued to sophisticated investors.

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REGULATORY DISCLOSURES Mediobanca S.p.A. 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. Mediobanca S.p.A. or its affiliates or its employees may effect transactions in the securities described herein for their own account or for the account of others, may have long or short positions with the issuer thereof, or any of its affiliates, or may perform or seek to perform securities, investment banking or other services for such issuer or its affiliates. The organisational and administrative arrangements established by Mediobanca S.p.A. for the management of conflicts of interest with respect to investment research are consistent with rules, regulations or codes applicable to the securities industry. The compensation of the analyst who prepared this report is determined exclusively by research management and senior

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management (not including investment banking). Analyst compensation is not based on investment banking revenues, however, compensation may relate to the revenues of Mediobanca S.p.A. as a whole, of which investment banking, sales and trading are a part. For a detailed explanation of the policies and principles implemented by Mediobanca S.p.A. to guarantee the integrity and independence of researches prepared by Mediobanca's analysts, please refer to the research policy which can be found at the following link: http://www.mediobanca.it/static/upload/b5d/b5d01c423f1f84fffea37bd41ccf7d74.pdf Unless otherwise stated in the text of the research report, target prices are based on either a discounted cash flow valuation and/or comparison of valuation ratios with companies seen by the analyst as comparable or a combination of the two methods. The result of this fundamental valuation is adjusted to reflect the analyst's views on the likely course of investor sentiment. Whichever valuation method is used there is a significant risk that the target price will not be achieved within the expected timeframe. Risk factors include unforeseen changes in competitive pressures or in the level of demand for the company's products. Such demand variations may result from changes in technology, in the overall level of economic activity or, in some cases, from changes in social values. Valuations may also be affected by changes in taxation, in exchange rates and, in certain industries, in regulations. All prices are market close prices unless differently specified. Rating system - methodology 6 months horizon relative to local & European indices

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Outperform: >+10% performance vs benchmark;

Neutral: -10% to +10% performance vs benchmark;

Underperform: <-10% performance vs benchmark;

Under review: fair value (and rating) under scrutiny for a possible change;

Not rated: impossible to determine a fair value (and rating) due to either because there is no sufficient visibility on the company's key items or because it has not been finalized yet a complete analysis of the company. Alternatively, it is applicable pursuant to Mediobanca S.p.A. policy in circumstances when Mediobanca S.p.A. is acting in any advisory capacity in a strategic transaction involving this company. Our rating relies upon the expected relative performance of the stock considered versus its benchmark. Such an expected relative performance relies upon forecasts for the company's financials that we now consider accurate but that could change in the future as a consequence of unexpected events. Our recommendation relies upon the expected relative performance of the stock considered versus its benchmark. Such an expected relative performance relies upon a valuation process that is based on the analysis of the company's business model / competitive positioning / financial forecasts. The company's valuation could change in the future as a consequence of a modification of the mentioned items.

Proportion of all recommendations relating to the first quarter 2013

Outperform

Neutral

Underperform

Under Review

Not Rated

37,41%

44,22%

17,69%

0%

0,68%

Proportion of issuers to which Mediobanca S.p.A. has supplied material investment banking services relating to the first quarter 2013

Outperform

Neutral

Underperform

Under Review

Not Rated

14,55%

6,15%

0%

0%

0%

To access previous research reports and establish trends in ratings issued, please see the restricted access part of the "MB Securities" section of the Mediobanca S.p.A. website at www.mediobanca.it.

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COMPANY SPECIFIC REGULATORY DISCLOSURES RATING The present rating in regard to AEFFE has not been changed since 14/05/2013. In the past 12 months, the rating on YOOX has been changed. The previous rating, issued on 13/11/2012, was OUTPERFORM.

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The present rating in regard to ANSALDO STS has not been changed since 16/01/2013. In the past 12 months, the rating on UNIONE DI BANCHE ITALIANE has been changed. The previous rating, issued on 25/03/2013, was NEUTRAL. The present rating in regard to ASTALDI has not been changed since 23/04/2013. In the past 12 months, the rating on TREVI FINANZIARIA has been changed. The previous rating, issued on 18/04/2012, was NEUTRAL. The present rating in regard to AUTOGRILL has not been changed since 06/02/2013. In the past 12 months, the rating on TENARIS has been changed. The previous rating, issued on 15/10/2012, was NEUTRAL. The present rating in regard to AZIMUT has not been changed since 14/03/2011. In the past 12 months, the rating on SARAS has been changed. The previous rating, issued on 18/09/2012, was OUTPERFORM. The present rating in regard to BANCA MONTE PASCHI SIENA has not been changed since 27/07/2011. In the past 12 months, the rating on SAIPEM has been changed. The previous rating, issued on 30/01/2013, was UNDERPERFORM. The present rating in regard to BANCA POP. MILANO has not been changed since 18/01/2012. In the past 12 months, the rating on SAFILO has been changed. The previous rating, issued on 24/11/2011, was OUTPERFORM. The present rating in regard to BANCO POPOLARE has not been changed since 17/06/2013. In the past 12 months, the rating on PRYSMIAN has been changed. The previous rating, issued on 26/11/2012, was NEUTRAL. The present rating in regard to BENI STABILI has not been changed since 17/06/2013. In the past 12 months, the rating on PRADA has been changed. The previous rating, issued on 26/09/2012, was OUTPERFORM. The present rating in regard to BP EMILIA ROMAGNA has not been changed since 17/06/2013. In the past 12 months, the rating on PIRELLI & C. has been changed. The previous rating, issued on 20/07/2012, was NEUTRAL. The present rating in regard to BRUNELLO CUCINELLI has not been changed since 12/06/2012. In the past 12 months, the rating on PIAGGIO has been changed. The previous rating, issued on 13/09/2012, was NEUTRAL. The present rating in regard to BUZZI UNICEM has not been changed since 27/03/2013. In the past 12 months, the rating on MEDIOLANUM has been changed. The previous rating, issued on 05/12/2006, was OUTPERFORM. The present rating in regard to CAIRO COMMUNICATION has not been changed since 26/10/2011. In the past 12 months, the rating on MEDIASET has been changed. The previous rating, issued on 01/08/2012, was UNDERPERFORM. The present rating in regard to CAMFIN has not been changed since 23/01/2013. In the past 12 months, the rating on FINMECCANICA has been changed. The previous rating, issued on 01/08/2012, was NEUTRAL. The present rating in regard to CAMPARI has not been changed since 29/10/2012. In the past 12 months, the rating on FIAT has been changed. The previous rating, issued on 04/05/2009, was OUTPERFORM. The present rating in regard to CATTOLICA ASSICURAZIONI has not been changed since 05/03/2007. In the past 12 months, the rating on FERRAGAMO has been changed. The previous rating, issued on 05/10/2011, was OUTPERFORM. The present rating in regard to CEMENTIR has not been changed since 21/05/2012. In the past 12 months, the rating on DANIELI has been changed. The previous rating, issued on 22/11/2012, was NEUTRAL. The present rating in regard to CREDEM has not been changed since 05/01/2009. In the past 12 months, the rating on CAMPARI has been changed. The previous rating, issued on 03/09/2012, was OUTPERFORM. The present rating in regard to CREDITO VALTELLINESE has not been changed since 06/06/2012. In the past 12 months, the rating on CAMFIN has been changed. The previous rating, issued on 27/03/2012, was OUTPERFORM.

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The present rating in regard to DANIELI has not been changed since 06/05/2013. In the past 12 months, the rating on BUZZI UNICEM has been changed. The previous rating, issued on 06/02/2012, was NEUTRAL. The present rating in regard to DE LONGHI has not been changed since 13/02/2012. In the past 12 months, the rating on BP EMILIA ROMAGNA has been changed. The previous rating, issued on 06/06/2012, was OUTPERFORM. The present rating in regard to EI TOWERS has not been changed since 24/10/2006.

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In the past 12 months, the rating on BENI STABILI has been changed. The previous rating, issued on 22/02/2010, was OUTPERFORM. The present rating in regard to ENI has not been changed since 25/02/2004. In the past 12 months, the rating on BANCO POPOLARE has been changed. The previous rating, issued on 05/07/2011, was NEUTRAL. The present rating in regard to FERRAGAMO has not been changed since 18/10/2012. In the past 12 months, the rating on AUTOGRILL has been changed. The previous rating, issued on 02/08/2012, was NEUTRAL. The present rating in regard to FIAT has not been changed since 31/10/2012. In the past 12 months, the rating on ASTALDI has been changed. The previous rating, issued on 07/08/2009, was OUTPERFORM. The present rating in regard to FIAT INDUSTRIAL has not been changed since 19/03/2012. In the past 12 months, the rating on ANSALDO STS has been changed. The previous rating, issued on 25/07/2012, was OUTPERFORM. The present rating in regard to FINMECCANICA has not been changed since 09/11/2012. In the past 12 months, the rating on AEFFE has been changed. The previous rating, issued on 22/03/2011, was OUTPERFORM. The present rating in regard to GENERALI ASS. has not been changed since 30/07/2012. The present rating in regard to YOOX has not been changed since 17/06/2013. The present rating in regard to GEOX has not been changed since 11/05/2012. The present rating in regard to UNIPOL has not been changed since 14/03/2013. The present rating in regard to IMMOBILIARE GRANDE DISTRIBUZIONE has not been changed since 20/11/2007. The present rating in regard to UNIONE DI BANCHE ITALIANE has not been changed since 30/05/2013. The present rating in regard to IMPREGILO has not been changed since 22/10/2009. The present rating in regard to UNICREDIT has not been changed since 26/03/2012. The present rating in regard to INDESIT has not been changed since 04/05/2011. The present rating in regard to TREVI FINANZIARIA has not been changed since 17/06/2013. The present rating in regard to INTESA SANPAOLO has not been changed since 08/04/2011. The present rating in regard to TOD''S has not been changed since 05/10/2011. The present rating in regard to ITALCEMENTI has not been changed since 10/08/2010. The present rating in regard to TENARIS has not been changed since 15/01/2013. The present rating in regard to LUXOTTICA has not been changed since 24/11/2011. The present rating in regard to TELECOM ITALIA has not been changed since 25/01/2012. The present rating in regard to MEDIASET has not been changed since 26/11/2012. The present rating in regard to SARAS has not been changed since 17/06/2013. The present rating in regard to MEDIOLANUM has not been changed since 25/03/2013. The present rating in regard to SAIPEM has not been changed since 03/06/2013. The present rating in regard to PIAGGIO has not been changed since 12/10/2012. The present rating in regard to SAFILO has not been changed since 22/04/2013. The present rating in regard to PIRELLI & C. has not been changed since 17/10/2012. The present rating in regard to PRYSMIAN has not been changed since 01/03/2013. The present rating in regard to PRADA has not been changed since 09/04/2013.

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The present rating in regard to PRELIOS has not been changed since 13/02/2009. INITIAL COVERAGE AEFFE initial coverage as of 17/09/2007. YOOX initial coverage as of 21/01/2010. ANSALDO STS initial coverage as of 04/07/2006.

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UNIPOL initial coverage as of 21/07/2003. ASTALDI initial coverage as of 22/06/2009. UNIONE DI BANCHE ITALIANE initial coverage as of 16/04/2007. AUTOGRILL initial coverage as of 21/02/2003. UNICREDIT initial coverage as of 30/06/2003. AZIMUT initial coverage as of 01/08/2005. TREVI FINANZIARIA initial coverage as of 06/03/2006. BANCA MONTE PASCHI SIENA initial coverage as of 12/02/2004. TOD''S initial coverage as of 28/01/2003. BANCA POP. MILANO initial coverage as of 05/03/2003. TENARIS initial coverage as of 15/04/2003. BANCO POPOLARE initial coverage as of 25/07/2007. TELECOM ITALIA initial coverage as of 12/02/2003. BENI STABILI initial coverage as of 18/06/2007. SARAS initial coverage as of 22/05/2012. BP EMILIA ROMAGNA initial coverage as of 06/06/2012. SAIPEM initial coverage as of 20/02/2003. BRUNELLO CUCINELLI initial coverage as of 12/06/2012. SAFILO initial coverage as of 19/12/2006. BUZZI UNICEM initial coverage as of 21/03/2003. PRYSMIAN initial coverage as of 26/06/2007. CAIRO COMMUNICATION initial coverage as of 12/02/2003. PRELIOS initial coverage as of 20/02/2003. CAMFIN initial coverage as of 27/03/2012. PRADA initial coverage as of 21/02/2012. CAMPARI initial coverage as of 21/03/2003. PIRELLI & C. initial coverage as of 12/05/2004. CATTOLICA ASSICURAZIONI initial coverage as of 11/04/2005. PIAGGIO initial coverage as of 14/09/2006. CEMENTIR initial coverage as of 23/01/2003. MEDIOLANUM initial coverage as of 19/03/2003. CREDEM initial coverage as of 21/03/2003. MEDIASET initial coverage as of 19/03/2003. CREDITO VALTELLINESE initial coverage as of 18/12/2007. LUXOTTICA initial coverage as of 27/06/2003. DANIELI initial coverage as of 23/05/2006. ITALCEMENTI initial coverage as of 31/01/2003.

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DE LONGHI initial coverage as of 28/01/2003. INTESA SANPAOLO initial coverage as of 16/04/2007. EI TOWERS initial coverage as of 24/10/2006. INDESIT initial coverage as of 16/02/2006. ENI initial coverage as of 25/02/2004.

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IMPREGILO initial coverage as of 24/06/2005. FERRAGAMO initial coverage as of 05/09/2011. IMMOBILIARE GRANDE DISTRIBUZIONE initial coverage as of 18/06/2007. FIAT initial coverage as of 07/07/2003. GEOX initial coverage as of 01/03/2005. FIAT INDUSTRIAL initial coverage as of 04/01/2011. GENERALI ASS. initial coverage as of 23/01/2003. FINMECCANICA initial coverage as of 28/03/2003. SPECIALIST This report was prepared by Mediobanca S.p.A. in its capacity as specialist of the following companies, in compliance with the obligations set forth by the rules of the markets organized and managed by Borsa Italiana S.p.A.: AEFFE, ANSALDO STS, EI TOWERS, YOOX. Mediobanca S.p.A. expects to prepare research reports on the following companies at least on a semi-annual basis: AEFFE, ANSALDO STS, EI TOWERS, YOOX. MARKET MAKER Mediobanca S.p.A. is currently acting as market maker on equity instruments, or derivatives whose underlying financial instruments are materially represented by equity instruments, issued by the following companies: ASTALDI, AUTOGRILL, AZIMUT, BANCA POP. MILANO, BANCO POPOLARE, BP EMILIA ROMAGNA, BUZZI UNICEM, CAMPARI, CATTOLICA ASSICURAZIONI, CREDEM, ENI, FIAT, FIAT INDUSTRIAL, FINMECCANICA, GENERALI ASS., GEOX, IMPREGILO, INTESA SANPAOLO, ITALCEMENTI, LUXOTTICA, MEDIASET, MEDIOLANUM, PIRELLI & C. , PRYSMIAN, SAIPEM, SARAS, TELECOM ITALIA, TENARIS, UNICREDIT, UNIONE DI BANCHE ITALIANE, UNIPOL. MEDIOBANCA REPRESENTATION ON GOVERNING BODIES Mediobanca S.p.A. or one or more of the companies belonging to its group have a representative on one of the governing bodies of the following companies: ANSALDO STS, FINMECCANICA, GENERALI ASS., PIRELLI & C. , TELECOM ITALIA. MEDIOBANCA SIGNIFICANT FINANCIAL INTERESTS As of the date of publication of this research report, Mediobanca Securities USA LLC's parent company, Mediobanca S.p.A. beneficially owns 1% or more of any class of common equity securities of the securities of the following companies: ANSALDO STS, PRYSMIAN. Mediobanca S.p.A. or one or more of the companies belonging to its group hold material open positions in financial instruments, or derivatives whose underlying financial instruments are materially represented by financial instrument, issued by the following companies: GENERALI ASS.. Mediobanca S.p.A. or one or more of the companies belonging to its group owns a "major holding" (as defined in the EU Transparency Directive as implemented in each relevant jurisdiction) in the following companies: GENERALI ASS., PIRELLI & C. , PRELIOS. Please consult the website of the relevant competent authority for details. As of the date of publication of this research report, Mediobanca Securities USA LLC's parent company, Mediobanca S.p.A. beneficially owns 1% or more of any class of common equity securities of the securities of the following companies: GENERALI ASS., PIRELLI & C. , PRELIOS. ISSUER REPRESENTATION ON MEDIOBANCA GOVERNING BODIES Certain members of the governing bodies of the following companies are also members of the governing bodies of Mediobanca S.p.A. or one or more of the companies belonging to its group: ANSALDO STS, BANCA MONTE PASCHI SIENA, CAIRO COMMUNICATION, CAMFIN, CREDITO VALTELLINESE, DANIELI, ENI, FINMECCANICA, INDESIT, INTESA SANPAOLO, ITALCEMENTI, LUXOTTICA, MEDIASET, MEDIOLANUM, PIRELLI & C. , PRELIOS, SAFILO, SAIPEM, TREVI FINANZIARIA. The following companies have a representative on one of the governing bodies of Mediobanca S.p.A. or one or more of the companies belonging to its group: TELECOM ITALIA, UNICREDIT. ISSUER SIGNIFICANT FINANCIAL INTERESTS ON MEDIOBANCA The following companies own a "major holding" (as defined in the EU Transparency Directive as implemented in each relevant jurisdiction) in Mediobanca S.p.A.: MEDIOLANUM, UNICREDIT, UNIPOL. Please consult the website of the relevant competent authority for details. LENDING RELATIONSHIP Mediobanca S.p.A. or one or more of the companies belonging to its group have a significant lending relationship with the following companies or one or more of the companies belonging to their group: AUTOGRILL, GENERALI ASS., TELECOM ITALIA, UNIPOL.

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CORPORATE FINANCE SERVICE CONTRACTS In the past 12 months, Mediobanca S.p.A. or one or more of the companies belonging to its group have entered into agreements to deliver corporate finance services to the following companies or one or more of the companies belonging to its group: BANCA MONTE PASCHI SIENA, ENI, IMMOBILIARE GRANDE DISTRIBUZIONE, ITALCEMENTI. Mediobanca S.p.A. or one or more of the companies belonging to its group are currently providing corporate finance services to the following companies or one or more of the companies belonging to its group: BANCO POPOLARE, CATTOLICA ASSICURAZIONI, FINMECCANICA, GENERALI ASS., IMPREGILO, TELECOM ITALIA.

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CONTRACTUAL AGREEMENTS RE: FINANCIAL INSTRUMENTS Mediobanca S.p.A. or one or more of the companies belonging to its group are currently fulfilling agreements to issue financial instruments linked to financial instruments of the following companies: MEDIASET. UNDERWRITING Mediobanca S.p.A. is committed to purchase financial instruments remaining unsubscribed in the context of financial instruments offering of the following companies: BANCA POP. MILANO.

ANALYST'S PERSONAL FINANCIAL INTERESTS FERRARI GIANLUCA holds no.600 shares of AZIMUT. PAVAN FABIO holds no.100 shares of EI TOWERS

COPYRIGHT NOTICE No part of the content of any research material may be copied, forwarded or duplicated in any form or by any means without the prior consent of Mediobanca S.p.A., and Mediobanca S.p.A. accepts no liability whatsoever for the actions of third parties in this respect. END NOTES The disclosures contained in research reports produced by Mediobanca S.p.A. shall be governed by and construed in accordance with Italian law. Additional information is available upon request. Mediobanca is acting as financial co-advisor to Telecom Italia for the network spin-off. Mediobanca will act as co-underwriter of the capital increase.

MEDIOBANCA Banca di Credito Finanziario S.p.A. Piazzetta Enrico Cuccia, 1 - 20121 Milano - T. +39 02 8829.1 33 Grosvenor Place London SW1X 7HY T. +44 (0) 203 0369 530