Peripheral Europe Where Next1

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Informe de Credit Suisse sobre España

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Peripheral Europe Where Next1

  1. 1. 09 June 2008 Global Equity Research Macro (Strategy) Global Equity Strategy Research Analysts STRATEGY Andrew Garthwaite 44 20 7883 6477 andrew.garthwaite@credit-suisse.com Peripheral Europe: where next? Jonathan Morton When exchange rates don’t adjust, domestic price levels have to, and this tends 1 212 538 9853 to create far more of an asset bubble (e.g. Hong Kong 1993, Middle East today) jonathan.morton@credit-suisse.com or deflation (Germany 1998–2003). Luca Paolini 44 20 7883 6480 Stay short of domestic Spain and Ireland. (1) It is probable that house prices luca.paolini@credit-suisse.com will fall c20% from here. The house price/wage ratio is 50% and 60% above Marina Pronina average in Spain and Ireland (compared to 3% and 35% in the US and UK), 44 20 7883 6476 respectively. The OECD claims housing is overvalued by 16% and 33% in marina.pronina@credit-suisse.com Spain and Ireland, respectively, compared to 10% in the US. (2) Housing is still Mark Richards very oversupplied: starts per capita are nearly 4 times the US in both countries 44 20 7883 6484 and would have to fall 30% and 50%, respectively, to get to previous cycle lows. mark.richards@credit-suisse.com (3) Leverage looks extreme, with credit/GDP of 40% above trend. (4) GDP Sebastian Raedler growth is abnormally geared to property, with finance and construction at peak 44 20 7888 7554 accounting for 38% and 45% of jobs growth in Spain and Ireland, respectively. sebastian.raedler@credit-suisse.com The PMIs are now consistent with close to zero growth. (5) There has been a big loss of competitiveness: the Spanish current account deficit is 10% of GDP and Ireland’s is 6%. Spain and Ireland have the lowest export exposure to emerging markets, and Spain has the worst productivity record in the OECD. What can be done? 80% of mortgage debt is linked to short rates, which are now expected to rise in Europe. Thus, the only choice is significant deflation (and yet the real effective exchange rate is 10% and 21% overvalued in Spain and Ireland, respectively) or massive fiscal easing (with government debt/GDP low in Spain and Ireland). In our view, both will be required, resulting in Irish/Spanish bond spreads rising to 70bps from 20bps currently, threatening all domestic stocks (utilities suffer from a higher discount rate). Is it in the price? Not in Spain. Its respective P/B and P/E relatives are still 37% and 15% above the average. Domestic Spain has outperformed 1% YTD. Domestic Spanish banks trade on a 10% premium on pre-tax, pre-provisioning profits to continental Europe banks. Irish banks are cheap, but still trade on a 27% premium to UK banks (on underlying profits). Stocks with high exposure to Spain or Ireland that are cheap to short and Underperform-rated are Inditex and Bank of Ireland. The following are expensive on Credit Suisse HOLT, trades on a premium to its peer group and has negative earnings momentum: Iberia, Bankinter, Mapfre, Ryanair, NH Hoteles, Zardoya-Otis and Vocento. What about elsewhere? Greece has a current account deficit of 14% and Italy is close to recession, but we would not short banks in these countries for the following reasons: (1) Customer leverage is low: credit/GDP is less than half the average of Ireland and Spain. (2) Bank leverage is low, with particularly high deposit ratios. (3) In Italy and Greece, 35% and 30% of bank lending is to property compared with 64% and 84% in Ireland and Spain, respectively. (4) Housing is less overvalued. (5) The cost/income ratios are higher, implying more self-help potential. (6) Italian banks trade on a 28% discount to Europe. In Italy, though, with debt/GDP of 96%, bond spreads could widen beyond 100bps (from 38bps now), and thus we would sell domestic plays with negative earnings momentum, such as Mediaset and Mediolanum. DISCLOSURE APPENDIX CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, INFORMATION ON TRADE ALERTS, ANALYST MODEL PORTFOLIOS AND THE STATUS OF NON-U.S ANALYSTS. FOR OTHER IMPORTANT DISCLOSURES, visit www.credit-suisse.com/ researchdisclosures or call +1 (877) 291-2683. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
  2. 2. 09 June 2008 Spain and Ireland: more to go for on the downside Country factors should start to dominate again as the ECB starts to raise rates. In an environment where interest rates and the exchange rate can't adjust, there is even more onus on domestic prices and asset prices to decline in those countries which are the most overleveraged, the most reliant on short-term debt, have the most overvalued housing market and have the most overvalued currencies. A year ago, we published a long report (After the boom, dated 14 May 2007) suggesting that investors should be very short of domestic Spain and Ireland. Clearly this has become a consensus call in the same way as shorting domestic UK had become a consensus call by the end of last year, but this does not mean that the consensus is wrong. Indeed, sometimes the most money is to be made on these calls. Macro problems are getting worse: Spain and Ireland (1) Confidence indicators are deteriorating much faster than in other European countries. Figure 1: Business confidence is collapsing... Figure 2: ... followed by consumer confidence 70 Spain - composite PMI 2.5 Spain Ireland Euro-area Ireland- composite PMI Euro-area - composite PMI 2.0 65 1.5 60 1.0 0.5 55 0.0 -0.5 50 -1.0 45 -1.5 -2.0 40 -2.5 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1998 1999 2000 2001 2002 2003 2004 2005 2006 2008 Source: PMIpremium Source: © Datastream International Limited ALL RIGHTS RESERVED, number of standard deviations from long-run average According to our economics team, the regional PMIs are consistent with a GDP growth close to zero in Ireland and Spain (see Appendix 1). The rise in unemployment is even more alarming, especially if compared to the European average. The rise in unemployment reflects weakness in the finance/construction sector (which have accounted for 45% and 38% of total Irish and Spanish employment growth, respectively, in 2007), as shown below. Global Equity Strategy 2
  3. 3. 09 June 2008 Figure 3: Unemployment rates in Spain, Ireland and EU15 Figure 4: Employment growth in Finance/Construction 12% 16% Spain Ireland Spain Ireland EU 15 11% 14% 12% 10% 10% 9% 8% 8% 6% 7% 4% 2% 6% 0% 5% -2% 4% -4% 2003 2004 2005 2006 2007 2008 2003 2004 2005 2006 2007 2008 Source: © Datastream International Limited ALL RIGHTS RESERVED Source: © Datastream International Limited ALL RIGHTS RESERVED (2) The slowdown in construction activity and house prices is accelerating significantly, as shown below. Figure 5: House prices in Spain and Ireland Figure 6: Construction activity in Spain and Ireland Spain House prices y/y% (lhs) Spain building starts y/y% (lhs) 20 35 50 30 Ireland House prices y/y% (rhs) Ireland houses completed y/y% (rhs) 18 30 40 20 16 25 30 14 20 20 10 12 15 10 0 10 10 0 8 5 -10 -10 6 0 -20 -20 4 -5 -30 -30 2 -10 -40 0 -15 -50 -40 Q2 1997 Q2 1999 Q2 2001 Q2 2003 Q2 2005 Q2 2007 Q2 1997 Q2 1999 Q2 2001 Q2 2003 Q2 2005 Q2 2007 Source: © Datastream International Limited ALL RIGHTS RESERVED Source: © Datastream International Limited ALL RIGHTS RESERVED These are the results of the lagged response to higher ECB rates (more than 80% of mortgages are variable-rate) but also of the extreme overvaluation of the property markets. Critically, the Spanish and Irish property markets remain very expensive, as shown below. House prices relative to wages are still 50% above average in Ireland and 60% above average in Spain. This compares to the US and UK, where the house price/wage ratios are 3% and 35% above the average, respectively. Global Equity Strategy 3
  4. 4. 09 June 2008 Figure 7: House prices – deviation from “fair” value (IMF) Figure 8: House prices to wage ratio still very high 5.5 Spain - House prices/wages (lhs) 9.50 5.0 Ireland- House prices/wages (rhs) 8.50 4.5 7.50 4.0 6.50 3.5 5.50 3.0 4.50 2.5 2.0 3.50 1.5 2.50 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 Source: IMF. ”House prices gaps” based on affordability, disposable Source: OECD, © Datastream International Limited ALL RIGHTS income, interest rates, credit growth, equity prices and working age RESERVED population And residential rental yields are low relative to bond yields, as shown below. Figure 9: Residential yields minus bond yields in Spain and Ireland are the lowest in Europe 500 Residential y ields minus bond y ields 400 300 200 100 0 -100 -200 Ireland Austria Portugal Italy Denmark Netherlands UK Spain France Poland Russia Finland Switzerland Belgium Hungary Sweden Germany Norway Source: Global Property Guide And, looking at the level of housing starts, the correction is far from over. Our Spanish banks analyst, Santiago Lopez Diaz, believes that a decline of up to 40% from a 2006 peak of 750k is realistic. A good measure of oversupply is the level of housing starts/permits per capita. Again, Ireland and Spain score at the top, with a level which is about 4 times higher than in the US and UK, as shown below. We can also see that housing starts per capita in Spain and Ireland are only back to levels seen 3 years ago, whereas in the US housing starts per capita are back to levels last seen in 1991. If housing starts per capita fell to the average level seen in US, then there would be a 60% fall in housing permits. Global Equity Strategy 4
  5. 5. 09 June 2008 Figure 10: Housing starts/permits per capita very high in Figure 11: Housing starts/permits per capita in Spain and Spain and Ireland Ireland 18 25.4 Spain - Housing permits per capita (lhs) 25.00 Housing starts/permits per Capita (x1000) 16 Ireland- Housing permits per capita (rhs) 20.4 20.00 14 12 15.4 15.00 10 8 10.4 10.00 6 4 5.4 5.00 2 0.4 0.00 0 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Portugal Ireland France US UK Germany Spain 1992 1994 1996 1998 2000 2002 2004 2006 Source: © Datastream International Limited ALL RIGHTS Source: OECD, © Datastream International Limited ALL RIGHTS RESERVED, Global Property Guide RESERVED We would highlight that housing starts are collapsing in Spain and Ireland, but to return to previous cycle lows they would have to fall by an additional 30% and 50%, respectively, as shown below. Figure 12: Spanish housing starts, '000s annual rate Figure 13: Irish housing starts, '000s annual rate 250 80 230 70 210 60 190 170 50 150 40 130 30 110 20 90 70 10 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Source: © Datastream International Limited ALL RIGHTS Source: © Datastream International Limited ALL RIGHTS RESERVED, Credit Suisse European economics team RESERVED, Credit Suisse European economics team Of course, the Spanish and Irish economies are very sensitive to the property market. Construction investment accounts for a disproportionately large share of Spanish and Irish GDP, 11% and 8%, respectively (13% share of total employment). Global Equity Strategy 5
  6. 6. 09 June 2008 Figure 14: Construction as a share of GDP and total employment (4Q 2007) Construction as % GDP Construction employment as a % of total employment Ireland 8 13.2 Spain 10.9 13 Finland 5.9 7.5 Austria 7.1 na Netherlands 5 5.8 Euro area 5.9 7.7 France 6.1 7 Portugal 5.5 na Italy 5.6 7.7 Germany 3.5 5.4 United Kingdom 6.2 4.7 US 4.8 5.3 Source: Credit Suisse European economics team However, they have contributed 0.8% to annual GDP growth over the past 3 years in both Ireland and Spain. (The construction and financial sectors have accounted for 46% and 20% of total Irish and Spanish employment growth, respectively, since 2004.) (3) Excessive leverage for Spain/Ireland, as shown in the high level of private domestic debt relative to GDP per capita. Figure 15: Domestic credit to GDP and GDP per capita 200% Domestic credit to private sector /GDP(%) Netherlands Ireland Spain 160% Portugal 120% Austria Germany Italy France Greece Belgium 80% Finland 40% 15000 30000 45000 60000 75000 GDP Per capita (US$) Source: © Datastream International Limited ALL RIGHTS RESERVED High leverage is also reflected in high interest rate payments, which therefore curb discretionary spending. Global Equity Strategy 6
  7. 7. 09 June 2008 Figure 16: Spanish housing interest rate payments as % Figure 17: Irish housing interest rate payments as % GDP GDP 7.5 5.0 7.0 4.5 6.5 6.0 4.0 5.5 5.0 3.5 4.5 3.0 4.0 3.5 2.5 3.0 2.5 2.0 2.0 1.5 1.5 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source: © Datastream International Limited ALL RIGHTS Source: © Datastream International Limited ALL RIGHTS RESERVED, Credit Suisse European economics team RESERVED, Credit Suisse European economics team An additional problem is that in Spain and Ireland a high proportion of mortgage debt is floating, making these countries much more vulnerable to concerns that European inflation remains above target (and that the ECB will postpone rate cuts). Figure 18: High proportion of variable-rate mortgages in peripheral Europe 100 90 80 70 60 50 40 30 20 10 0 Netherlands United Kingdom Italy Finland Luxembourg Ireland Belgium Germany Sweden Portugal Denmark Spain Average Austria France Greece Source: OECD, European Mortgage Federation (4) Big loss of competitiveness, as shown by the large current account deficits and the overvalued real effective exchange rate (due to respective Spanish and Irish domestic inflation rising, cumulatively, 11% and 12% faster than Euro-area average since 1997). Global Equity Strategy 7
  8. 8. 09 June 2008 Figure 19: Spain and Ireland have big current account Figure 20: ...reflecting a significant loss of deficits... competitiveness (Real effective exchange rate) 6% Spain - current account/GDP (lhs) 8% 150% Euro-area - current account/GDP (lhs) Spain Ireland 4% Ireland- current account/GDP(rhs) 6% Germany France 2% 140% 4% 0% 2% 130% -2% -4% 0% 120% -6% -2% -8% -4% 110% -10% -12% -6% 100% -14% -8% Q2 1995 Q2 1997 Q2 1999 Q2 2001 Q2 2003 Q2 2005 Q2 2007 90% Q2 1995 Q2 1997 Q2 1999 Q2 2001 Q2 2003 Q2 2005 Q2 2007 Source: © Datastream International Limited ALL RIGHTS RESERVED Source: OECD This probably means that we need to see a 20% and 10% decline in the real effective exchange rate in Ireland and Spain, respectively, just to get back to a ‘neutral’ level. We suspect that given the problems in housing/construction, we have to see the real effective exchange rate undershoot. Since productivity growth is very weak (as we show below), this can only be achieved by a sharp decline in wage costs relative to the rest of Europe, maybe by as much as 10–15% relative to Europe in Spain and more so in Ireland. This has to be very bad for domestic consumer-based stocks in these countries. (5) Very low productivity growth. Spain, in particular, has experienced an almost unprecedented decline in labour productivity in the last decade, as shown below. (The good news is that productivity growth has been positive since 2006.) Figure 21: Productivity growth and level very low in Spain 55 France Germany Spain 50 UK Ireland GDP per Hour (USD PPP) 45 40 35 30 25 20 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Source: The Conference Board Global Equity Strategy 8
  9. 9. 09 June 2008 (6) Low exposure to emerging markets, as shown below. Figure 22: Ireland and Spain have relative low exposure to emerging markets 45% Exports to developing countries, % total 40% 35% 30% 25% 20% 15% 10% 5% 0% Ireland UK Spain European France Germany Austria Italy Greece Union Source: IMF In addition, Spain is more exposed to competition from emerging markets than the European average (35% of total imports come from emerging economies, 31% in the EU). The positives: fiscal surplus and demographics We, of course, acknowledge that both Ireland and Spain have the fiscal flexibility to support their economies (both countries have budget surpluses and central government debt/GDP ratio of 21% and 30%, respectively). Figure 23: Fiscal debt to GDP (central government, 2007) 120 Gov ernment debt/GDP 100 80 60 40 20 0 United States Australia Ireland Austria Portugal Denmark Netherlands Italy United Kingdom Switzerland Canada Spain Finland Poland France Greece Belgium Czech Republic Hungary Mexico Sweden Slovak Republic Turkey Germany Norway Source: OECD But investors always underestimate the degree to which fiscal positions deteriorate into a sharp economic downturn as tax revenues decelerate. In a normal downturn we would expect the cycle alone to add about 2-3 pp to the fiscal deficit; for instance, in 2000–03 the deficit rose from 0% to 3.1% of GDP in the Euro-area. (Government revenues rose 1.5% and spending 9% in real terms.) Global Equity Strategy 9
  10. 10. 09 June 2008 Spain has just announced a fiscal stimulus package worth €10bn over 2 years. This € amounts to 0.9% of GDP, including an income tax rebate of €400 for this year and next; a € programme to retrain unemployed construction workers; and a plan to promote more housing subsidized by the state. However, we feel that we are likely to get very aggressive fiscal spending. After all, even in the good times Italy and France were running budget deficits of more than 2% of GDP, and of course the Maastricht criteria allow countries to run budget deficits of 3% of GDP or more in a recession. Thus, we believe that there could be massive fiscal easing, as this is the only way to counter the deflationary threat to these economies. If the exchange rate can’t devalue and rates can’t fall, then all the hard work has to be done via domestic prices, wage levels and fiscal policy. In addition, population growth has been very strong in the last decade, especially in comparison with other European countries, and it remains so. This is, of course, an offset for declining productivity growth. Figure 24: Solid fiscal balance in Spain and Ireland... Figure 25: …and exceptional population growth (2007) 4.0 Spain - fiscal balance/GDP (lhs) 6.0 3.0% Ireland- fiscal balance/GDP(rhs) 4.0 2.5% 2.0 2.0 2.0% 0.0 1.5% 0.0 -2.0 1.0% -2.0 -4.0 0.5% -6.0 0.0% -4.0 -8.0 -0.5% -10.0 -1.0% -6.0 Brazil US UK JP Ireland Spain India Euro-area China Russia -12.0 -8.0 -14.0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 Source: © Datastream International Limited ALL RIGHTS RESERVED Source: © Datastream International Limited ALL RIGHTS RESERVED We worry that often demographic inflows are a function of opportunities as well as wage differentials. Both clearly have diminished. Below, we show that the boost to the supply side in Spain in terms of population growth has largely come from immigration. Figure 26: Population growth in Spain Figure 27: Immigration has been a key driver of the supply side stimulus in Spain 3,000 Spain Contribution of Migration toPopulationChange 3.5 2,500 3.0 2,000 2.5 1,500 2.0 1,000 (%) 1.5 500 1.0 0 0.5 -500 0.0 -1,000 -0.5 1950- 1960- 1970- 1980- 1990- 2000- 2010- 2020- 1955 1965 1975 1985 1995 2005 2015 2025 1980-1981 1987-1988 1994-1995 2001-2002 2008-2009 2015-2016 Spain World Natural Population Change Change due to Migration Source: OECD Source: OECD Global Equity Strategy 10
  11. 11. 09 June 2008 Valuation not attractive We calculate that roughly 50% of the Spanish and Irish markets are related to domestic earnings. We show in aggregate that Spain is looking expensive on a P/E and P/B basis relative to history, while Ireland is not. Figure 28: Spain 12m fwd P/E relative to Europe ex-UK Figure 29: Ireland 12m fwd P/E relative to Europe ex UK 120% 110% 100% 110% 90% 100% 80% 90% 70% 80% 60% Price to Forward earnings - Spain relative to Europe Ex UK Price to Forward earnings - Ireland relative to Europe Ex 70% 50% UK Average Average 60% 40% Jul-90 Jul-92 Jul-94 Jul-96 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Jul-90 Jul-92 Jul-94 Jul-96 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Source: I/B/E/S, MSCI, © Datastream International Limited ALL Source: I/B/E/S, MSCI, © Datastream International Limited ALL RIGHTS RESERVED, Credit Suisse research RIGHTS RESERVED, Credit Suisse research On a price/book basis, Spain looks even more expensive and Ireland a bit cheaper. Figure 30: Spain price-to-book relative to Europe ex-UK Figure 31: Ireland price-to-book relative to Europe ex-UK 130% 130% 120% 120% 110% 110% 100% 100% 90% 90% 80% 80% 70% 60% Price to Book - Spain relative to Europe Ex UK 70% Price to Book - Ireland relative to Europe Ex UK Average Average 50% 60% Jul-90 Jul-92 Jul-94 Jul-96 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Jul-90 Jul-92 Jul-94 Jul-96 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Source: MSCI, © Datastream International Limited ALL RIGHTS Source: MSCI, © Datastream International Limited ALL RIGHTS RESERVED, Credit Suisse research RESERVED, Credit Suisse research It is clearly far more relevant to focus on domestic area, and here we find that domestic Spanish stocks have slightly outperformed, while domestic Irish stocks have underperformed the European market since January. Global Equity Strategy 11
  12. 12. 09 June 2008 Figure 32: Domestic Spain relative to Europe and Domestic Ireland relative to Europe 1.20 1.10 1.00 Domestic Spain rel Europe 0.90 Domestic Ireland rel Europe 0.80 0.70 0.60 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Source: MSCI, © Datastream International Limited ALL RIGHTS RESERVED, Credit Suisse research Banks We are still short of the Spanish domestic banks: First, their performance has been surprisingly strong – though BBVA and Santander, which have a big earnings exposure to booming Latin America (respectively 45% and 34% of net income) have performed better than domestic banks, as shown below. Figure 33: Spanish banks have outperformed European Figure 34: Domestic Spain banks relative price banks performance 0.5 1.7 Spain banks vs. EMU banks (rhs) 1.6 0.5 1.5 0.4 1.4 1.3 0.4 1.2 1.1 0.4 1.0 Spanish domestic banks rel Cont 0.9 Europe banks 0.4 Spanish domestic banks rel BBVA & 0.8 SAN 0.7 0.4 Jul-98 Mar-00 Nov-01 Jul-03 Mar-05 Nov-06 Jul-08 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: © Datastream International Limited ALL RIGHTS RESERVED Source: © Datastream International Limited ALL RIGHTS RESERVED, Credit Suisse research Global Equity Strategy 12
  13. 13. 09 June 2008 Second, domestic Spanish banks are expensive relative to their European peers on both P/E and P/B (they still trade at a 25% premium on forward P/E). Figure 35: Spanish domestic banks price/book relative Figure 36: Spanish domestic bank 12m fwd P/E relative 3.20 160% Domestic Spain banks PB rel to Europe ex UK banks Spain domestic banks 12m fwd P/E rel to Europe x UK 150% banks 2.70 Domestic Spain banks PB rel to Spain market Spain domestic banks 12m fwd P/E rel to Spain mkt 140% 2.20 130% 120% 1.70 110% 1.20 100% 90% 0.70 80% 70% 0.20 Jul-95 Sep-97 Nov-99 Jan-02 Mar-04 May-06 Jul-08 Jul-90 Jul-92 Jul-94 Jul-96 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Source: MSCI, © Datastream International Limited ALL RIGHTS Source: I/B/E/S, MSCI, © Datastream International Limited ALL RESERVED, Credit Suisse research RIGHTS RESERVED, Credit Suisse research And, above all, domestic Spanish banks trade on a 10% premium to the rest of Europe on price to pre-tax, pre-provisioning profits. Irish banks trade on a discount. Figure 37: Domestic Spanish banks trade on price to provisioning profits Loan-to- Leverage Price-to- Pre-prov pre- Credit Suisse Company Country deposit (tangible) book 12m fwd PE tax PE Rating BANKINTER, S.A. ESP 2.41 28.6 2.8 12.8 6.6 UNDERPERFORM BANCO PASTOR, S.A. ESP 1.64 17.1 1.9 9.9 5.8 UNDERPERFORM BANCO POPULAR ESPANOL ESP 2.29 18.7 2.3 9.3 5.5 UNDERPERFORM BANCO SABADELL ESP 2.09 19.7 2.0 10.4 6.5 UNDERPERFORM BANCO BILBAO VIZCAYA ARGENTARIA SA ESP 1.46 26.0 2.3 8.1 5.1 OUTPERFORM BANCO SANTANDER SA ESP 1.90 22.9 1.7 8.6 5.6 OUTPERFORM Spain average (median) 1.99 21.3 2.1 9.6 5.7 Spain average ex BBVA & BSCH (median) 2.19 19.2 2.1 10.2 6.2 European average (median) 1.58 25.9 1.6 8.6 5.6 Source: Credit Suisse HOLT Both Spanish and Irish banks have very high exposure to property and construction, as shown below. Figure 38: Exposure of banks to property and construction, % total lending % of bank lending to property % point and construction increase 2000 Current Spain 59% 84% 25% UK 63% 73% 10% Portugal 54% 64% 10% Ireland 39% 64% 25% US 43% 55% 12% France 27% 44% 17% Japan 33% 41% 8% Germany 35% 37% 2% Italy 30% 35% 5% Greece - 30% - Source: Credit Suisse European banks team. Credit Suisse research Global Equity Strategy 13
  14. 14. 09 June 2008 It is only now that we are beginning to see the slowdown in loan growth and a rise in provisioning as unemployment starts to rise. Clearly, in both economies loan growth has to slow further and there is significant operationally leverage to this. Moreover, provisioning has to rise a lot further. Figure 40 shows that NPLs could easily rise to 3% from 1% currently if the unemployment rate rises by 2 pp. Figure 39: Loan growth in Spain and Ireland (y/y%) Figure 40: Provisioning rises as unemployment rises 40% 9.0% Spain Ireland NPLs (lhs) 21 8.0% 35% Spain umployment rate (rhs) 7.0% 19 30% 6.0% 17 25% 5.0% 15 20% 4.0% 13 15% 3.0% 10% 11 2.0% 5% 1.0% 9 0% 0.0% 7 1996 1998 2000 2002 2004 2006 2008 2Q89 4Q91 2Q94 4Q96 2Q99 4Q01 2Q04 4Q06 Source: © Datastream International Limited ALL RIGHTS RESERVED Source: Credit Suisse research We do acknowledge that Spanish banks tended to have more conservative LTV ratios (a capital charge is applied if LTV is higher than 80%), far less use of SIVs (owing to the penalty imposed by the Bank of Spain) and stricter NPL standards. Also, into a default scenario, banks can take control of all the assets of an individual (not only his property). From this point of view, Spanish banks have potentially better recovery ratios than their European counterparts. Irish banks have performed worse, and look relatively cheaper against both their history and their peer group. Figure 41: Irish banks have underperformed in the last Figure 42: ...and they look much cheaper now 12M... 9 125% Ireland banks vs. EMU banks (lhs) Price to forward Earnings - Ireland Banks rel. to 115% Europe xUK Banks 8 7 105% 6 95% 5 85% 4 75% 3 65% 2 55% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Jul-95 Sep-97 Nov-99 Jan-02 Mar-04 May-06 Jul-08 Source: © Datastream International Limited ALL RIGHTS RESERVED Source: I/B/E/S, MSCI, © Datastream International Limited ALL RIGHTS RESERVED, Credit Suisse research Global Equity Strategy 14
  15. 15. 09 June 2008 But when we look at pre-provisioning profits, we find that valuations are again not particularly cheap: Irish banks trade on a 27% premium to UK banks on underlying profits and BoI has nearly 40% of its exposure to UK commercial and residential real estate. Figure 43: Irish banks trade on a discount to European peers on price to provisioning profits Loan-to - Price-to- Pre-prov p re- Credit Suisse Company Co untry deposit Leverag e book 12m fwd PE tax PE Ratin g ANGLO IRISH BANK CORPORATION PLC IRL 1.48 24.2 2.1 5.4 4.5 NEUTRAL ALLIED IRISH BANKS PLC IRL 1.90 19.3 1.4 6.2 4.2 UNDERPERFORM BANK OF IRELAND IRL n/a 31.8 1.3 5.5 4.0 UNDERPERFORM Irish average (median) 1.69 24.2 1.4 5.5 4.2 UK average (median) 1.53 36.6 1.4 5.6 3.3 European average (median) 1.58 25.9 1.6 8.6 5.6 Source: Credit Suisse HOLT Other domestic stocks We believe investors should be short of domestic Spain and Ireland not only because of the growth outlook but also because a likely widening in bond spreads, as fiscal positions deteriorate, would require a higher discount rate on all domestic stocks We screen for stocks with more than 40% of their revenue from Spain and Ireland. Below we show stocks with downside on HOLT and negative earnings momentum. We also include those companies rated Underperform by Credit Suisse analysts. The stocks that trade on a premium to their global peer group with negative earnings momentum and expensive on HOLT are: Mapfre, Bankinter, Vocento, NH Hoteles, Iberia, Zardoya- Otis and in Ireland, Ryanair and Irish Continental Group. Figure 44: Domestic Spanish stocks that have downside on HOLT and negative earnings momentum OR are rated Underperform by Credit Suisse analysts -----P/E (12m fwd) ------ ------ P/B ------- Yield (08e) HOLT ----------- Momentum -------------- Momentum score Valuation score Overall score 3m Sales rel to mkt % rel to mkt % Implied CFROI Price, % Consensus 1m EPS 3m EPS CFROI Name Abs rel to Industry above/below Abs above/below FCY DY less 5-year change to (buy less holds Credit Suisse rating average average average best & sells) Cia Esp Petroleos 28.5 n/a 162% 3.6 85% 3.8% 1.7% 2.9 -38.6 0.0 -1.4 -6.9 -14.2 2.9 0.5 -100.0 1.5 NR Abertis Infraestr 16.7 99% 34% 2.7 26% 5.8% 3.0% 1.7 -15.3 2.0 0.9 -1.3 -0.4 0.8 1.0 50.0 3.0 NR Zardoya-Otis 27.1 201% 59% 31.4 100% 3.5% 3.4% -17.9 -61.8 2.0 -10.3 -0.2 -3.6 -0.1 0.0 -33.3 3.0 NR Aguas De Barcelona 22.4 n/a 47% 1.8 -3% 2.0% 2.4% 0.6 -9.4 1.0 -0.7 0.4 -1.9 -3.7 0.5 -100.0 2.5 NR Iberia Lineas Aere 13.9 127% 39% 0.9 -24% 12.1% 2.7% 1.8 -27.8 2.0 -0.4 -13.9 -28.0 -0.2 0.0 -39.1 3.0 NR Ebro Puleva Sa 14.7 90% 53% 1.6 10% -3.3% 2.8% 4.9 -40.7 2.0 0.6 -3.9 -8.1 2.3 1.0 75.0 3.0 NR Nh Hoteles 16.7 113% 13% 1.3 -12% 4.9% 2.4% 1.9 -42.1 1.0 0.1 -2.7 -8.5 0.4 1.0 -81.8 3.0 NR Vocento 19.2 131% n/a 2.3 n/a 6.8% 3.2% 6.7 -33.5 3.0 -1.5 -13.5 -27.3 -3.6 0.0 -42.9 4.0 NR Viscofan Sa 14.0 86% 9% 2.5 5% 8.1% 3.0% 2.9 -1.6 3.0 1.7 -0.8 -1.1 -1.4 0.5 66.7 3.5 NR Inditex 13.3 95% -24% 5.3 -25% 4.9% 3.7% -2.4 20.5 6.0 1.4 0.4 -0.5 -1.0 1.0 24.1 7.0 Underperform Banco Popular Espa 9.0 97% 9% 2.0 -24% n/m 5.2% -4.2 9.8 6.0 -0.2 -1.0 -2.9 -1.3 0.0 -72.4 7.0 Underperform Bankinter Sa 13.1 141% 30% 2.1 -10% n/m 3.5% 1.3 -13.2 1.0 0.2 -2.1 -5.2 -4.7 0.5 -100.0 2.5 Underperform Bco Esp De Credito 8.7 n/a n/a 1.7 n/a 5.7% 5.5% -0.6 10.6 7.0 -0.2 0.0 -1.3 -1.2 0.0 -30.0 8.0 Underperform Acerinox Sa 11.2 96% 31% 1.9 29% 6.8% 2.8% -2.7 15.4 5.0 -3.4 -0.4 -6.5 -4.0 0.0 -9.1 6.0 Underperform Bco Pastor 9.8 106% 12% 1.7 -20% n/m 3.1% n/a n/a 2.0 n/a 4.0 6.4 4.5 2.0 -62.5 5.0 Underperform Mapfre 9.5 105% -27% 1.9 8% n/m 4.3% -1.0 -32.7 4.0 1.2 4.0 9.2 3.1 2.0 -42.9 7.0 Neutral Source: © Datastream International Limited ALL RIGHTS RESERVED, Factset, IBES, Credit Suisse HOLT Global Equity Strategy 15
  16. 16. 09 June 2008 Figure 45: Domestic Irish stocks that have downside on HOLT and negative earnings momentum OR are rated Underperform by Credit Suisse analysts -----P/E (12m fwd) ------ ------ P/B ------- Yield (08e) HOLT ----------- Momentum -------------- Momentum score Valuation score Overall score 3m Sales rel to mkt % rel to mkt % Implied CFROI Price, % Consensus 1m EPS 3m EPS CFROI Name Abs rel to Industry above/below Abs above/below FCY DY less 5-year change to (buy less holds Credit Suisse rating average average average best & sells) Ryanair Hldgs 14.6 133% 1% 1.6 -57% -5.0% 0.0% -3.4 -4.8 2.0 -3.9 -12.1 -35.0 1.2 0.5 -14.3 3.5 Neutral Allied Irish Banks 6.0 65% -23% 1.1 -44% n/m 6.7% -8.6 62.6 7.0 -2.0 -0.4 -1.9 -0.5 0.0 17.7 7.0 Underperform Bank Of Ireland 5.2 56% -33% 1.0 -51% n/m 8.7% -11.7 89.2 7.0 -2.9 -3.9 -6.7 2.9 0.5 -33.3 8.5 Underperform Iaws Group 13.9 85% 42% 0.3 -92% 3.6% 1.1% -0.5 -11.4 3.0 0.1 0.0 1.1 14.6 1.5 100.0 4.5 NR Irish Contl Group 11.6 116% 42% 2.4 54% 2.3% 4.2% 2.6 -13.1 1.0 -0.1 NM NM NM 0.0 n/a 1.0 NR Source: © Datastream International Limited ALL RIGHTS RESERVED, Factset, IBES, Credit Suisse HOLT Shorting stocks One of the criticisms with our view of Spain and Ireland is that it is shared by many investors. But consensual positions can still be profitable. Below, we show how many shares are currently borrowed as a percentage of those available (the “utilization” column in the table). This gives an indication to the practicalities of going short. Allied Irish stands out as a stock that does not appear to have been aggressively sold short. Note how large the number is for some of the Spanish banks. For more information please speak to the Credit Suisse Stock Lending desk. Figure 46: Cost of shorting domestic Spanish and Irish stocks that are rated Underperform by Credit Suisse analysts Utiliz ation, % of available Indicative borrow Consensus (buy less Company CS rating Short Interest stocks borrowed fee* holds & sells) Allied Irish Banks Underperform 2,510,000 2% 0.35% fee 18 Ryanair Hldgs Neutral 1,520,000 5% 0.4% fee -14 Bank Of Ireland Underperform 20,630,000 12% 0.35% fee -33 Mapfre Neutral 25,000,000 29% 0.75% fee -43 Inditex Underperform 20,390,000 34% 0.4% fee 24 Vocento NR 700,000 51% 11% fee -43 Ac erinox Sa Underperform 13,500,000 55% 2.5% fee -9 Bc o Esp De Credito Underperform 4,350,000 56% 4.5% fee -30 Zardoya-Otis NR 4,760,000 64% 8% fee -33 Bc o De Sabadell Underperform 46,740,000 65% 15% fee -92 Bankinter Underperform 13,210,000 68% 10% fee -100 Iberia Lineas Aere NR 52,190,000 72% 1% fee -39 Nh Hoteles NR 3,860,000 74% 5% fee -82 Bc o Pastor Underperform 4,460,000 75% 10% fee -63 Banco Popular Espa Underperform 106,580,000 79% 7.5% fee -72 Source: Data Explorer, Credit Suisse, *Credit Suisse Stock Lending desk Italy and Greece – are they different? Superficially, Italy and Greece may look as vulnerable as Spain and Ireland. They have slowing growth and consumer confidence and slowing house price inflation, as well as high current account deficits and real effective exchange rates – which is, of course, hurting their competitiveness. Global Equity Strategy 16
  17. 17. 09 June 2008 Figure 47: OECD lead indicators (6M ann.) for Italy and Figure 48: Consumer confidence in Italy and Greece Greece 10% Italy Greece Euro-area 4.0 Italy Greece Euro-area 8% 3.0 6% 2.0 4% 2% 1.0 0% 0.0 -2% -1.0 -4% -6% -2.0 -8% -3.0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2008 1998 1999 2000 2001 2002 2003 2004 2005 2006 2008 Source: OECD Source: © Datastream International Limited ALL RIGHTS RESERVED Figure 49: Italy and Greece have overvalued currencies… Figure 50: ...and high negative current accounts 120% 6% Italy - current account/GDP (lhs) 0% Italy Greece 5% Greece- current account/GDP(rhs) -2% 115% Germany France 4% -4% 3% 110% -6% 2% 1% -8% 105% 0% -10% -1% 100% -12% -2% -3% -14% 95% -4% -16% 90% Q2 1995 Q2 1997 Q2 1999 Q2 2001 Q2 2003 Q2 2005 Q2 2007 Q2 1995 Q2 1997 Q2 1999 Q2 2001 Q2 2003 Q2 2005 Q2 2007 Source: OECD Source: © Datastream International Limited ALL RIGHTS RESERVED We, of course, acknowledge that Italy and Greece have government debt/GDP ratios of 96% and 105%, respectively (which make aggressive fiscal stimulus packages unlikely), and Greece has a current account deficit of 14% - which must be financed by capital inflows. However, the two countries look better than Spain and Ireland for the following reasons: (1) Low consumer leverage (low household debt/GDP). Global Equity Strategy 17
  18. 18. 09 June 2008 Figure 51: Italy and Greece have relatively low leverage 120% Household debt/GDP 100% 80% 60% 40% 20% 0% United States Portugal Ireland Austria United Kingdom Netherlands Italy Spain Japan Europe Finland France Greece Poland Belgium Hungary Czech Republic Luxembourg Sweden Slovenia Germany Source: © Datastream International Limited ALL RIGHTS RESERVED (2) Low financial product penetration. Figure 52: Life premiums as a share of GDP and GDP per capita 14% South Africa United Kingdom Ireland 12% Taiwan 10% Hong Kong Life premiums, % of GD Japan 8% South Korea France Finland Belgium 6% Portugal Switzerland Sweden Denmark Singapore Italy Netherlands US 4% Malaysia Germ any Australia Canada Norway Israel Austria Chile Spain Thailand 2% Hungary China Poland Philippines Brazil Argentina Czech Republic New Zealand Colombia IndonesiaMexico Greece 0% Russia 0 10 20 30 40 50 60 70 80 90 GDP per capita, US$ '000s Source: OECD, Credit Suisse Insurance Team (3) Less of a housing bubble. During the last 10 years, house prices have risen 102% in Italy and 150% in Greece, against an increase of 240% in Ireland and 190% in Spain. As a consequence of that, rental yields relative to bond yields remain well below Spanish or Irish levels. According to our European bank team, there is no evidence to suggest that there has been a housing bubble in either Italy or Greece – so banks’ exposure to the sector is not a big concern. Global Equity Strategy 18

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