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  1. 1. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comIMPORTANT DISCLOSURE FOR U.S. INVESTORS: This document is prepared by Mediobanca Securities, the equity research departmentof Mediobanca S.p.A. (parent company of Mediobanca Securities USA LLC (“MBUSA”)) and it is distributed in the United States byMBUSA which accepts responsibility for its content. The research analyst(s) named on this report are not registered / qualified asresearch analysts with Finra. Any US person receiving this document and wishing to effect transactions in any securities discussedherein should do so with MBUSA, not Mediobanca S.p.A.. Please refer to the last pages of this document for important disclaimers.Italy17 June 2013 Country Update-ItalyAntonio GuglielmiEquity Analyst+44 (0)203 0369 570antonio.guglielmi@mediobanca.comRiccardo RovereEquity Analyst+39 02 8829 604riccardo.rovere@mediobanca.comItaly seizing up – caution requiredA lot has changed, nothing has changed - déjà vu of 1992Italy’s investment case seems a revival of 1992, when a political and macro crisis forced it to devaluethe Lira and exit the EMS with €140bn austerity and disposal. Debt service was 12% of GDP thenversus 6% now but current macro situation is worse and devaluation is no longer an option. Henceit cannot be ruled out Italy having to apply for an EU bailout. The 250 bps spread tightening sincethe Nov 2011 peak merely shows the market’s reward for monetary news from Frankfurt (LTRO,OMT), NY and Tokyo (QE) rather than for political news from Rome. Argentina’s default risk, apossible bailout of Slovenia, more macro pain, unplugging of QE, German court issues on OMT, alack of delivery from Letta could all lead to spread widening again, in our view.The recession is spreading to large corporates – take the ILVA caseApril data show Italy’s macro entered its acute phase with €2.3bn new NPLs in the month, VATcollection 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 foreseemore welfare burden on the public accounts. The pain has now spread to large corporates, 160 ofwhich are under special crisis care. Banks’ exposure to ILVA for instance is capped to just 12bpsCT1 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 chanceResidential RE deals are down 26% YoY to 430k, the lowest since 1985. With 0.044constructions 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 wipeout 170bps of 2012 Basel II.5 CT1: MPS, BP, BPER and BPM would sit below 8%, while ISP andUCG would stay anchored at 9%. Deposits up 6% YoY confirm their stickiness, and €20bn AMinflows in Q1 reversed the €270bn outflows since 2006 thanks to low yields on govies. But heavyreliance on €260bn LTRO could erode c14% of our 2015e EPS when refunded to ECB. Draghi’srecent cooling on the ECB potentially buying SMEs loans does not help. ECB-eligible SME loansin our coverage range between €45bn (AA rated) and €145bn (A rated), i.e. between 6-15% ofItalian 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 feasibleThe 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 estatetaxes at 1.6% of Gross Disposable Income vs 1%); 2) only €2trn, i.e. 20% of wealth, is liquidassets – 80% of which is retail savings at risk of outflows; and 3) it would hardly change the longterm dynamics of debt now due to >1x fiscal multiplier depressing consumption. We found roomfor €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 thepopulation (€43bn); the Switzerland deal on repatriated funds (€20bn); and €4bn lower cost ofdebt from the above. The resulting Debt/GDP down 4p.p. and 1p.p. GDP of recurrent growthmeasures could create a virtuous circle but only if Italy can at the same time improve itsextremely poor track record on structural reforms and fight on tax evasion.Mediobanca Italian Corporates Survey: credit access the main problemMore than 50 companies in our coverage responded to our first survey questionnaire aimed atgauging sentiment: 55% of the industrials pointed to credit access as their major issue, which is why85% of them are focused on cost-cutting and only 20% planning to increase their investments. As aresult, 50% foresee no top line growth in 2013. Low revenues and poor macro make less austeritythe clear consensus request: 44% seek growth measures, 26% ask for lower taxes and 21% for PArestructuring vs 6% only for cutting public debt and 3% for complying with the Fiscal Compact.Downgrading BP, BPER, Beni Stabili, Saras, Trevi and YooxAfter a 5% cut post Q1, we keep our EPS estimates broadly unchanged but reflect our cautiousnessin a string of downgrades – analysed separately in the accompanying reports published today: BeniStabili, BPER and Yoox to N from O, BP and Trevi to U from N, and Saras to U from O.Italian Equity TeamSimonetta Chiriotti +39 02 8829 933Gian Luca Ferrari +39 02 8829 482Andrea Filtri +44 203 0369 579Emanuela Mazzoni +39 02 8829 295Fabio Pavan +39 02 8829 633Chiara Rotelli +39 02 8829 931Andrea Scauri +39 02 8829 496Niccolò Storer +39 02 8829 444Alessandro Tortora +39 02 8829 673Massimo Vecchio +39 02 8829 541Change in RecommendationCompany Rating TPBENI STABILINeutral(from Outperform)€0.60BPERNeutral(from Outperform)€5.80BPUnderperform(from Neutral)€0.95SARASUnderperform(from Outperform)€0.95TREVIUnderperform(from Neutral)€4.45YOOXNeutral(from Outperform)€18.1Source: Mediobanca SecuritiesConviction pair trades by sectorSector Long ShortBanks UCG, UBI, PMI ISP, BP, BPERCement Cementir BuzziCapital goods PRY, Danieli TFI, FNCOil ENI SARASBranded /consumersAutogrill GeoxInsurance /assets gath.Unipol, AZM CattolicaTelecom /mediaEl Towers,CairoMediasetAuto Fiat Ind Pirelli, PIASource: Mediobanca Securities
  2. 2. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 2ContentsExecutive Summary 3Recession heading for the worst 14Real Estate – Italy is no Spain, but . . . 25Deposits and Am inflows - the good news 38Tax burden on wealth: Italy versus Europe 46Limited room for a large wealth tax but €75bn seems feasible 52Mediobanca Italian Corporates Survey 2013 63Conviction ideas and ratings changes 68
  3. 3. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 3Executive SummaryWalking on a thin lineA lot has changed, nothing has changed - Reiterating our negative stance on ItalyFour months after the inconclusive elections at the end of February, the investment case of Italy offersa 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 coalitiongovernment will be. However, quite a lot has changed outside of Italy due to the OMT announcement that gainedmomentum 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 offerroom for up to €15bn spending boost to Letta, i.e.1 p.p. of GDP. However, we see this as unlikely andsurely not enough to make us feel more positive on the country. Indeed, with this note we reiterate ournegative 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 betweenBTP and BOT (as a % of BOT yield, red line rhs axis)-200%-100%0%100%200%300%400%0100200300400500600OMTLTRO 2 Japan QEEuropean sovereign crisis withGreeceMonti fiscalconsolidationpackageinconclusiveItalian electionItalian marketlabour reformESM becomesoperativeECB starts buying Italiangovies under theSecurity Market ProgramMonti appointedItalian PrimeMinisterSource: Bank of Italy, Mediobanca Securities analysisThe recession is heading for the worst . . .Italian unemployment subsidy applications increased to more than 1bn hours today from 185m hoursin 2007, highlighting the magnitude of the current crisis. Five years into the recession mean that Italyis 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. Itcould still take more than 10 years to return to pre-crisis output levels. Not only are macro data poorper se, but the most recent (April 2013) figures showed a negative second derivatives with macrodeterioration accelerating: €2.3bn new NPLs generation in April, VAT collection down 7% YoY,LTRO 1
  4. 4. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 4consumer 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 caseIf SMEs and households were first to be hit by the crisis, it now looks like the time has arrived for largecorporates to also pay their toll. Some 160 large Italian corporates are now under special crisisadministration. We highlight in this note the recent example of the ILVA environmental case, maybethe most problematic large corporate situation in Italy today. The good news is that banks’ exposure toILVA seems to cap the capital erosion risk to 12bps of CT1. The bad news is that it looks very difficultto square the circle between job security (12k employees of ILVA at risk, 40k when consideringindirect workers) and respect for EU environmental directives (high mortality rate in the area ofILVA’s operations proved to be due to the plant’s emissions of a carcinogenic polluting agent).We have been here before - A déjà vu of 1992We see many similarities between the situation in the country today and that of 20 years ago, whenpolitical instability and macro meltdown forced Italy to exit the European Monetary System in spite ofthe Lira devaluation, of some Lit 100bn (€50bn) austerity measures undertaken by the Amatogovernment and of a large privatization plan which followed. We think the situation is worse today asmacro is hurting the economy more heavily and Italy can no longer leverage on currency devaluation.What could go wrong? Argentina and moreThis is why we think time is a very scarce resource for Italy: the next six months will be crucial toassess if the country can leverage on the ‘low spread QE-driven momentum’ and on the newgovernment to reverse the poor macro trends of the last decade, or if it will inevitably end up in a EUbailout request, as we currently suspect.The potential default of Argentina, the likely bailout of Slovenia, the recurring risk for the Lettagovernment to fall short of support from the Parliament or the unplugging of the FED QE measuresare just few examples of what could become triggers of renewed market concern on the sustainabilityof the Italian debt. Argentina in particular worries us, as a new default seems likely.Argentina Sovereign curve yield (Lhs) and debt maturity6.07.08.09.010.011.012.013.014.015.03 mnths 1 yrs 2 yrs 3yrs 4yrs 5yrs10/06/2013 01/01/20132.6 2.5 2.24.21.71.11.715.314.40.02.04.06.08.010.012.014.016.0Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 2014 2015$bnsSource: Mediobanca Securities, BloombergNot only could Argentina’s problems reignite concern on debt sustainability in peripheral Europe, butit could also have a direct impact on the Italian economy given the exposure to Argentina of manyItalian corporates. TI and Tenaris, for instance, have double-digit turnover exposure to the country.
  5. 5. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 5Italian companies’ exposure to ArgentinaRating TP Turnover exposure EBITDA exposure EPS exposureTenaris Underperform 13.6 30.0% 23% 20%Telecom Italia Not Rated - 13.0% 10% 2%Campari Neutral 5.45 2.9% 2.5% 2.5%Fiat Neutral 4.5 2.0% n.m. n.m.Pirelli Underperform 7.0 4.0% n.m. n.m.Trevi Underperform 4.45 3.2% 5.9% 7.9%Generali Neutral 15.0 0.8% n.m. n.m.Source: Company data, Mediobanca SecuritiesNo deposit outflows and AM back to inflows – the good newsBanks deposits’ stickiness . . .Most recent data show that Italian banks are not suffering deposit outflows as the amount of depositsshowed a 6% annual growth as at March 2013, and the stock is broadly stable at c.€1.45trn. Depositssoared by roughly €20bn in March 2013 versus February 2013, almost equally split between timedeposits and current accounts. This trend offset the €20bn monthly drop in bonds. As a result, theEur20bn net funding increase at Italian banks in March versus February is almost entirely explainedby repos.. . . and strong AM inflowsAs well as deposits confirming their stickiness, appetite for risk has emerged when looking at recentstrong AM inflows: after Eur270bn of cumulated outflows since 2006, 1Q 2013 brought Eur20bninflows, benefiting both assets gatherers and banks. Our correlation analysis points to the drop ingovernment bond yields post the OMT announcement as a key driver of the recent AM inflows (Rhschart below).Italian Banks – Funding Mix, € bn Inverse correlation: AUM inflows vs 2Y BTP yield-2505007501,0001,2501,5001,7502,0002,2502,500Dec-98Jun-99Dec-99Jun-00Dec-00Jun-01Dec-01Jun-02Dec-02Jun-03Dec-03Jun-04Dec-04Jun-05Dec-05Jun-06Dec-06Jun-07Dec-07Jun-08Dec-08Jun-09Dec-09Jun-10Dec-10Jun-11Dec-11Jun-12Dec-12Deposits Fixed Maturity Current… Deposits Reedem. at Notice Repos Bonds1.00%1.50%2.00%2.50%3.00%3.50%4.00%4.50%5.00%-50,000-40,000-30,000-20,000-10,000010,00020,00030,000IT asset management sector - flows Yield 2YR IT BTPSource: Bank of Italy, ABI, Mediobanca Securities analysis
  6. 6. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 6Heavy reliance on ECB funding the bad newsWhilst current accounts’ outflow does not seem to be an issue for now, the ECB data confirm Italianbanks’ funding is still over reliant on the central bank. Italian banks have taken c.€260bn from theECB and have deposited just €12bn with it, meaning the vast majority of the LTRO liquidity is stillsitting on Italian banks’ liabilities – thus providing a crucial albeit temporary buffer to their fundingneeds. 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 itssovereign exposure or replace the LTRO funding with more expensive liquidity, at the detriment ofsome 14% of their 2015 profitability, based on our calculations.Italian Banks – ECB Deposits and funding (€bn) ECB Funding by country-275-250-225-200-175-150-125-100-75-50-25025Dec-04Apr-05Aug-05Dec-05Apr-06Aug-06Dec-06Apr-07Aug-07Dec-07Apr-08Aug-08Dec-08Apr-09Aug-09Dec-09Apr-10Aug-10Dec-10Apr-11Aug-11Dec-11Apr-12Aug-12Dec-12Apr-13Deposits at the ECB Liabilities from the ECB0.30.50.70.91.11.31.50%10%20%30%40%50%60%70%80%€ trnGR IRE IT ES PRT Total ECB Facility (RHS)Source: Datastream, Company Data, Mediobanca Securities analysisReal estate: Italy is no Spain, but asset quality will get worstItaly is no SpainRecent data show an ongoing marked slowdown of the Italian real estate market with residentialtransactions down 26% YoY to 430k, the lowest level since 1985. Real estate prices in Italy contractedby 12% since their 2008 peak versus a 25% correction in Spain. There are very good reasons for Italynot to fear a ‘Spanish-like’ real estate contraction: 1) some 40% of the national value added in Spaincame from real estate in 2007, 10 p.p. higher than Italy; 2) housing completions over the last decadewere 2.5x larger in Spain than Italy despite a 30% larger population in Italy: 0.11 houses perinhabitant in Spain versus 0.044 in Italy; 3) Italian households’ indebtedness is the lowest in EU; and4) average loan-to-value stands at 65% in Italy versus 72% in Spain.Italy - Number of RE residential transactions (000) Nomisma Retail real estate prices464558687769835866 87781668961461760344840045050055060065070075080085090019851986198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820092010201120127080901001101201301401501601701801902001H921H931H941H951H961H971H981H991H001H011H021H031H041H051H061H071H081H091H101H111H12Residential Office RetailSource: Agenzia del Territorio, Nomisma, Mediobanca SecuritiesSimulation 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 correctioncould affect Italian banks’ balance sheets currently sitting on a cash coverage of 41%, some 10 p.p.
  7. 7. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 7below the 2007 levels within our coverage universe. In the first approach of our simulation, we findthat Italian banks could bear up to 45% downward revision of their real estate collaterals and stillmaintain coverage above 100%.Simulation 2: 10% RE price drop would erode 17% of CT1 if coverage stays unchangedAlternatively, we are interested in quantifying the capital erosion stemming from 10% real estateprices drop subject to keeping unchanged total coverage ratios at current levels. The result is thatsome 10% lower collateral value at constant coverage ratio would wash out some 17% of the aggregateCT1 capital of our banks with CT1 ratio dropping by 170bps to 8.7% (Rhs chart below).Estimated Max Revision of RE Collaterals Values toHit 100% Coverage Ratio, 2012Estimated CT1 Impact from 10% Drop in Market Priceof RE Collaterals, 2012 (coverage unchanged)0%10%20%30%40%50%60%70%80%90%100%AggregateUBIBPCREDEMCREVALBPERMPSISPBPMUCG0%1%2%3%4%5%6%7%8%9%10%AggregateISPUCGMPSBPUBIBPERBPMCREDEMCREVALCT1 Impact CT1 after RE Collaterals Mark-downSource: Company Data, Mediobanca Securities analysisFive banks would sit below 2012 Basel II.5 8% CT1: MPS, BP, BPER, BPM and CVAL, but the last threeshow room to restore capital ratios through IRB models. ISP and UCG would remain anchored above9% CT1 ratio. In summary, although we recognise Italy is no Spain, we foresee further balance sheetclean-up ahead for Italian banks, possibly triggered by the asset quality stress test that the ECB is setto carry out next year.Tax burden on wealth – Italy versus EuropeSome 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 thetax burden on capital and wealth (and consumption) at the expenses of taxes on income. Based on2010 figures, we calculate that taxes on the stock of capital and wealth accounted for 2.5% of ItalianGDP in 2010 (aligned to the EU average) from c.4% in 1995. The reduction of the taxation of the stockof capital/wealth in Italy has to be ascribed mostly to the progressive relative reduction of the taxationon real estate, culminating in the elimination of ICI on the main property in 2010. In 2010, theamount of direct real estate taxes amounted to €9bn versus almost €13bn in 2007, less than 0.6% ofGDP in 2010 versus 0.85% in 1995.Italy – Taxes on Wealth as % of GDP, 1995-2010 Tax receipts breakdown, 20102.02.22.42.62.83.03.23.43.63.84.01995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010ITALY EU 27 AVGBE BG CZ DK DE EE IE EL ES FR IT CY LV LT LU HUMT NL AT PL PT RO SI SK FI SE UK NO EU27PERSONALINCOME TAXCORPORATEINCOME TAXTAXES ONSTOCK OF CAPITALSource: Eurostat, Mediobanca Securities analysis
  8. 8. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 8. . . reversed in 12 months (2012) due to higher real estate taxesThe trend has been reversed in 12 months as the IMU (real estate) and the additional 0.15% taxation ofcustodian assets brought the burden of capital taxation to the level of 1995, making Italy the nationwith the third highest taxation of capital in EU-27 after France and the UK. IMU brought the recurrenttaxation of capital and wealth at almost €60bn p.a., equal to c.4% of Gross Disposable Income, thelevel 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 1995 2010Extra Revenues(IMU + Fin. Assets)2010(incl. IMU + Fin. Assets)Real Estate Taxes 13.0 19.6 +16 35.1Financial Assets 5.4 7.9 +5 12.9Total Taxes on Capital 33.8 38.9 +21 59.4GDP 865 1,556 1,556 1,556Taxes on Capital as % of GDP 3.9% 2.5% +1.3% 3.8%Source: Company data, Mediobanca Securities analysis and estimatesSuch 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 propertytaxation was below EU 27 (arithmetic) average of the same year, equal to 0.68% of Gross DisposableIncome. Using a weighted average for the EU, we calculate that taxes on real estate assets wouldaccount for c.1.0% of Gross Disposable Income, pushed upwards by the high level of taxation in Franceand UK, more than balancing the low taxation in Germany. In this case, the taxation of Italian realestate assets was much lower than the EU average.Today we could not make the same statement. Including the incremental revenues from theintroduction of IMU in 2012 (equal to €15.5bn) in respect of ICI in 2010, the total taxes on real estatewould hit c.€24bn, and the weight of real estate taxation would account for c.1.6% of Gross DisposableIncome in 2010, among the highest in the Euro Area and well above the EU average. Hence, with theintroduction of the IMU tax, the direct real estate taxation moved in Italy from 0.6% of grossdisposable income to 1.6% versus 1% EU weighted average.EU – Real Estate Taxation as Percent of Gross Disposable Income, 20102010 Real Estate Taxes (€bn, A) Gross Disp. Income (€bn, B) A / BBE 4.4 359 1.2%CZ 0.3 138 0.2%DK 3.2 237 1.4%DE 11.3 2,511 0.5%IE 1.4 129 1.1%ES 9.5 1,026 0.9%FR 45.7 1,942 2.4%IT 8.6 1,528 0.6%IT (including IMU) 24.1 1,528 1.6%HU 0.3 91 0.3%NL 3.0 570 0.5%AT 0.7 283 0.2%PL 0.8 344 0.2%PT 1.0 168 0.6%RO 0.5 126 0.4%SK 0.2 64 0.3%FI 0.0 179 0.0%SE 2.7 352 0.8%UK 26.2 1,705 1.5%EU Weighted Avg 1.0%Source: Eurostat, OECD, Mediobanca Securities analysis and estimates
  9. 9. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 9Taxation 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 thetotal amount of taxes on financial assets accounted for 0.5% of GDP in Italy versus 0.25% average forFrance, Germany, Spain and UK. In other words, already in 2010 Italy showed the highest tax burdenon financial assets. The situation will change in 2013 with the introduction of the 0.15% taxation offinancial wealth. If we added the estimated €5bn tax receipts, the taxation of financial assets wouldreach 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 ITALY ITALY (IMU/Fin. Ass) FRANCE GERMANY SPAIN UKReal Estate 20 35 56 17 20 66Financial Assets 8 13 6 n.a. n.a. 3Wealth Tax 0 0 5 n.a. 0 0Inheritance Tax 0.5 0.5 8 4 2 3Other 11 11 9 4 3 1Total 39 59 83 25 26 74Source: Eurostat, Mediobanca Securities analysisAlthough being the highest among the five largest countries, the taxation of financial assets accountedfor just 0.22% of the Italian households’ wealth in 2010, below the 0.35% calculated as taxation of realestate assets as percent the Italian households’ wealth in real estate. Adding the estimated additionaltax 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 Wealth Tax ReceiptsTaxes as %of WealthTax Receipts(incl. IMU, Fin. Assets)Taxes as %of WealthReal Assets 5,541 20 0.35% 35 0.63%Financial Assets 3,546 8 0.22% 13 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 DisposableIncome. In 2010, we calculate taxation of capital in Italy accounted for c.2.5% of Gross DisposableIncome (GDI), aligned to the EU average. Adding €21bn from the newly-introduced taxes the ratiowould soar to 3.9%, making Italy the third highest taxation of stock in the Euro Area after UK, Franceand Norway. Hence, we conclude that the taxation of capital in Italy is already among the highest inEurope and is also high in respect of the income generated by the country annually.EU – Taxes on Capital as Percent of Gross DisposableIncome, 2010Italy – Taxes on Capital as Percent of GrossDisposable Income, 1995 - 20100.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%NOUKFRLUIT (Imu + Others)BEISDKHUIEESEU 27 WavgITPTCYPLNLFISEELRODEATLVSIBGCZEESKLT0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%4.5%19951996199719981999200020012002200320042005200620072008200920102010+IMUSource: Company data, Mediobanca Securities analysis and estimates
  10. 10. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 10After 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 theaverage. This leads us to investigate alternative ways for the country to quickly raise taxes should thisbe needed in the case of further pressure on public accoutns.Wealth tax - In search of €75bn alternative sourcesThree reasons to avoid a large wealth taxThe need for a large wealth tax is a recurring debate in Italy. We estimate a €400bn wealth tax wouldbe needed to bring the debt / GDP ratio below 100% without disposals. We think such an approach isnot feasible when considering that: Some 65% of the €9.5trn Italian wealth is already accounted for by real estate, offering noroom for further tax rises relative to Europe. Only 20% of the Italian wealth is constituted of liquid assets, i.e. c.€2trn, 80% of which isretail 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, fartoo 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 long-term dynamics of Italy’s debt, when assuming current >1x fiscal multiplier expected todepress consumers as already confirmed by the lower than expected VAT tax collectionfollowing recent austerity measures.Italy – Breakdown of Gross Wealth, 2011Amount - €bn As % of TotalResidential Property 5,027 53% Not LiquidValuables 125 1% Not LiquidNon-Residential Buildings 342 4% Not LiquidPlants, Machineries et cetera... 237 2% Not LiquidLand 247 3% Not LiquidTotal Real Estate and Physical Assets 5,978 63%Equity in Non-Listed Limited Corporations 421 4% Not LiquidEquity in Non-Limited Firms 205 2% Not LiquidLife Technical Reserves 680 7% Not LiquidOthers (Commercial Loans, Shareholders Loans to Cooperatives, Others) 119 1% Not LiquidBanknotes, Coins 114 1% LiquidBank Deposits 651 7% LiquidPostal Savings 327 3% LiquidItalian Gov. Bonds and T-Bills 184 2% LiquidItalian Corporate Bonds 3 0% LiquidItalian Banks Bonds 373 4% LiquidForeign Securities 146 2% LiquidEquity in Listed Limited Corporations 73 1% LiquidMutual Funds Units 248 3% LiquidTotal Financial Assets 3,542 37%Total Gross Wealth 9,519 100%Source: Bank of Italy, Mediobanca Securities analysisOur doable €75bn wealth tax proposal . . .Adversely affected by such constraints, we investigate the room for up to €75bn alternative sources forthe government, taking tax progression into account aimed at minimizing the negative impact onconsumers. €3bn (up to €7bn if including SMEs) from converging the fiscal treatment of financial assetsto that of real estate. €5bn from a large fortunes tax replicating the French ISF. €43bn wealth tax on 10% of the wealthiest population.
  11. 11. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 11 €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€bn Total GoalRecurring Interventions 8Alignment Taxes Fin. Assets 2013 3 Reduce Income TaxesWealth Tax on Wealthy Population 5 Reduce Income TaxesUna Tantum Interventions 67Wealth Tax 43 Debt ReductionTaxation of Repatriated Funds 20 Debt ReductionLower Cost of Debt 4 Reduce Income TaxesTotal 75Source: Eurostat, Mediobanca Securities estimates. . . resulting in 4 p.p. of debt/GDP reduction and growth measures for 1 p.p. GDPThe conclusion would be a mix of 4 p.p. of debt/GDP reduction, not necessarily over-penalisingconsumers as it would come from the wealthiest population, and room for recurring growth measuresamounting to 1 p.p. of GDP. A proper attack on tax evasion and the black economy would clearly bringus to a much larger number, but the poor track record of Italy in this regard leads us to prefer not toinclude such options in our analysis.Mediobanca Italian Corporates SurveyCredit access is the main problem for 55% of our sample; 50% expect no top line growthMore than 50 Italian companies in our coverage responded to our survey questionnaire aimed atgauging expectations on the back of the recent political deadlock. Although roughly one out of threecompanies considered the latter as a very negative on their economics, it is not politics per se the mainsource of concern. Some 55% of industrials point to credit access as their major problem, whilst banksmentioned the high and volatile cost of funding (lhs chart below). If 85% of the banks foresee a decenttop line growth this year, more than 50% of industrials expect no top line growth (rhs chart).Worrying factors for the coming future Revenue growth expectations in 201329%57%23%16%43%10%11%13%45%55%0%10%20%30%40%50%60%70%80%90%100%MB Sample Financials IndustrialsCredit access Capital markets access Interest rates volatility Interest rates30%37%14%14%13%11%13%27%33%16%71%3%3%14%0%10%20%30%40%50%60%70%80%90%100%MB Sample Financials IndustrialsExtremely A lot Moderatly Neither much nor little Slightly NoSource: Mediobanca Securities85% focus on cost-cutting and only 20% is increasing investments versus last yearThis is why 85% of our sample are considering further costs rationalisation and only 20% are planningto raise investments versus last year. The recent decree to speed up payments to corporate by theItalian PA does not seem to represent a game changer, as only 24% say this could have a significant
  12. 12. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 12impact. 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 Plan to further optimise costs, 2013No17%Slightly30%Neither much norlittle20%Moderatly13%A lot17%Extremely3%Slightly10%Neither muchnor little14%Moderatly31%A lot28%Extremely17%Source: Mediobanca SecuritiesPriorities: 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 Lettagovernment. As shown in the chart below, out of the five options proposed, 44% of the pool indicatedgrowth strategies as a necessity to revitalise the stagnant economy. The rest of the companiesprioritise 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, andonly 3% care about respecting the Fiscal Compact. Austerity.Priorities for the next government3% 3%6% 7%21%22%21%26%22%26%44%56%43%0%10%20%30%40%50%60%70%80%90%100%MB Sample Financials IndustrialsGrowth strategy Reducing fiscal pressureRestructuring Public Administration Reducing public debtComply with fiscal compactSource: Mediobanca SecuritiesConclusion: softening austerity is the government conundrumThe overall picture of our survey is for a country in a ‘wait and see’ mood with companies reluctant toinvest, 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 stancethe clear consensus request emerging from our survey.
  13. 13. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 13Stocks ideas and rating changesPair trades by sectorFollowing a weak set of Q1 results, we ended up downgrading our 2013 and 2014 estimates by 5% onaverage on our Italian coverage. We remain cautious on the growth prospects for 2013 and 2014, andexpect 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 highearnings diversification outside of the country or stocks with corporate action/ restructuring potential.Our key high conviction pair trades are: 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 PiaggioRating changesIn 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)
  14. 14. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 14Recession heading for the worstTime is a very scarce resource for Italy. Five years into recession mean that theeconomy is now heading for the worst with unemployment subsidies up to more than1bn hours from 185m hours in 2007. April data show a rise of €2.3bn in NPLs in thebanking 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 Aprilversus -0.7% in March). Not only is the second derivative turning more negative andsignalling further deterioration ahead, but if SMEs and households were hit first by thecrisis, 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 mostproblematic 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 newstough is that it looks very difficult to square the circle between job security (12,000employees of ILVA at risk) and respect for EU environmental directives (high mortalityrate in the area proved to be due to the plant’s emissions of a carcinogenic pollutingagent).We see many similarities between the situation in the country today and that of 20 yearsago, when political instability and macro meltdown forced Italy to exit the EuropeanMonetary System in spite of the Lira devaluation, of some Lit 100bn (50bn) austeritymeasures undertaken by the Amato government, and of a privatization plan ofLit180trn (€90bn). We think the situation is worse today as the macro headwinds arehurting the economy more heavily, and Italy cannot leverage on currency devaluationanymore. This is why we think the next six months will be crucial to assess if the countrycan leverage on the ‘low spread QE driven momentum’ to reverse the poor macro trendof the last decade, or if it will inevitably end up in a EU bailout request. The potentialdefault of Argentina, the likely bailout of Slovenia, the recurring risk for the Lettagovernment to fall short of support from the Parliament or the unplugging of the FEDQE measures are just few examples of potential events triggering renewed marketconcern on the sustainability of the Italian debt.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. Onthe one hand it is difficult to indentify major discontinuity signs: Same President. After several attempts, the Italian parliament ended up appointing MrNapolitano as President of the State for the second time – based on no agreement among thevarious parties on any other potential candidate. It is the first time in the history of theItalian Republic that the same President has secured a double-seven years mandate. Same large coalition government. PD and PDL, the two opposite parties that reluctantlysupported Monti’s technocrat cabinet in 2011/2012 have now both agreed to fully endorse anew large coalition government under the premiership of PD deputy head Letta. This is inline with our expectations set out in our Perfect Storm note (26 February) when immediatelyafter 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.
  15. 15. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 15 Same high public debt issues. The Italian debt has reached record levels of €2.035trnand is now expected to reach 135% of GDP in 2014. This was, still is, and will remain, in ourview, the priority number one for the country.. . . but much has changed outside Italy Spread contraction. The contraction of the Italian spread could become a real gamechanger if it were to prove sustainable. The OMT announcement from the ECB and the QEstrategies in place at FED, BoE and most importantly at BoJ provided a significant window ofopportunity for the Italian momentum to build up on the back of spread contraction. SinceJapan’s QE announcement at the beginning of April, the spread versus German bundscontracted by almost 100bps. EDP. The removal of the EU excessive deficit procedure (EDP) on Italy could we believe pavethe 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 torevert to the 3% deficit threshold. Whether Italy has sufficient argument to aim for the sameremains to be seen, but France and Spain represent the precedent on which Italy could rely toobtain similar concessions.Some €15bn gift on the table but . . .Our back-of-the-envelope calculation suggests that spread contraction + EDP removal + extra deficitspending allowance might create a ‘little treasury’ in the hands of the Letta government in the regionof €15bn – offering scope for a nice spending boost to the economy without harming Italy’s fiscaltargets. 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 byConfindustria above the €100bn region) to Italian SMEs. Were we facing a marked positive u-turn inEU growth prospects (to potentially benefit the Italian export driven GDP) coupled with a clearroadmap towards EU convergence, we could conclude that the new government has a nice window ofopportunity to try and push for Italy to become a successful EU restructuring story. Unfortunatelythough, this is far from being our base case scenario.. . . time is running out fastWe 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 BTProse sharply in few days last couple of weeks on market concern on the unplugging of QEmeasures from the FED and on the German court ruling on OMT, showing that it is far tooearly to assume the EU sovereign crisis has normalised. We do not believe Italy can rely inthe 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 (regionsand municipalities) to be operating with best practice in terms of governance and publicaccounts 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 macrodata, recently revised downwards both for Italy and Europe, will face further downgrades in2H 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 speedtowards EU convergence is slowing down too much, and we believe the risk for the sovereigncrisis to resurface is high. The potential delay or the weak implementation of the bankingunion project for instance would be particularly negative for Italy in our view.
  16. 16. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 16Next six months will give us the answer – stay cautious on Italy in the meantimeThis is why we maintain our cautious stance on Italy for now. Time is the crucial variable here, as fiveyears into recession has put Italy in a border-line situation now. We think the next six months will becrucial in assessing the final outcome. Either Italy will soon build momentum in terms of growth bycashing in on the benefits of Monti’s reforms and leveraging on its export-driven GDP, or it will face alikely 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 factorsThe Italian spread has halved since the resignation of Berlusconi in November 2011. Roughly one-third 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 Montiand the large coalition backing the recent Letta cabinet. However, as we try and show in the chartbelow, such spread improvement has little to do with the Italian political landscape, and much more todo 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)-200%-100%0%100%200%300%400%0100200300400500600OMTLTRO 2 Japan QEEuropean sovereign crisis withGreeceMonti fiscalconsolidationpackageinconclusiveItalian electionItalian marketlabour reformESM becomesoperativeECB starts buying Italiangovies under theSecurity Market ProgramMonti appointedItalian PrimeMinisterSource: Bank of Italy, Bloomberg, Mediobanca Securities analysis The Monti government took office in November 2011, which basically coincided with Draghi’sLTRO 1 announcement in early December (see Europe’s last minute deal, 5th December2011). Equity and fixed income markets rerated on the back of such newsflow, so that theItalian spread enjoyed three months of marked improvement. It is with the LTRO 2 announcement in March 2012 that the market started questioning sucha facility: if three months after providing €490bn funding to EU banks through LTRO 1 theECB felt the need of an extra €530bn injection, it clearly meant the problem was not fixed.But more importantly, ECB deposits’ data in Q1 2012 confirmed that the vast majority ofLTRO funding ended up being parked at the ECB, hence providing tangible evidence of howthe monetary transmission mechanism was not properly functioning. It appeared evidentthat the ECB’s ability to stimulate the economy in the lack of printing power was capped. TheItalian spread reflected such concern, widening back to pre-Monti levels just three monthsafter the LTRO 2 announcement.LTRO 1
  17. 17. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 17 In November 2012 we would have expected the market (and the spread) to negatively react tothe end of the Monti government. Rather, we noticed that the spread kept narrowing until theFebruary 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 ofsuch spread improvement in 2H 2012, but even today it is on the back of the ECB potentiallyactivating such a tool that sovereign funding conditions remain relatively benign inperipheral Europe. The February inconclusive elections followed by two months of negotiation to form agovernment and to appoint the president of the State started to be reflected in spreadwidening (see Election approaching, uncertainty raising, 18th February 2013). However, it isthe ‘Abenomics’ massive QE announcement from the BoJ at the beginning of April that seemsto have provided another window of spread relief for Italy.Don’t look at the spread but monitor the yield gap between BTP and BOTThe conclusion from the above is that the Italian political uncertainty of the last 18 months playedmore like a second derivative on the spread, whilst it is monetary newsflow from NY, Frankfurt andTokyo 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 stanceor the unusual Letta grand coalition Government. If we agree that an accommodating monetary policy around the world ended up becoming thefirst ally for the Italian spread, we believe it must follow now that Italy runs the risk ofbecoming a key victim of market concern on the FED starting to unplug its five years’ QEmeasures. Post OMT announcement, the spread lost its relevance as a ‘barometer’ of solvency riskperception 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 18February) we introduced a new measure for the Italian solvency risk. This is the yield differencebetween BTP and BOT. Such a gap has no reason to exist unless the market wants to differentiatebetween bonds at risk of restructuring (BTP) and bonds not subject to restructuring (BOT as anymoney 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 atspecific 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 sovereigncrisis started, the relative yield gap in Italy between BTP and BOT ranged between 1x and 3.5x theyield on BOT, far too much. We interpret such finding as the real underlying solvency concern of themarket, which would have otherwise closed such a profitable arbitrage.A déjà vu of 1992 – we have been here beforeHistory repeating itself . . .History repeats itself and Italy seems to make no exception to this. It is interesting, in our view, to notethe many similarities between the Italian situation today and 20 years ago: Dissatisfaction with politics. Now, as in 1992, the dissatisfaction towards the existingpolitical class has brought Italians to openly and publicly criticise its politicians. Implosion of existing parties. In 1992 the Christian Democrats and the Socialist partiesessentially disappeared under corruption scandals, paving the way for Berlusconi’s arrival.Additionally, the former PCI (Communist party) broke down in its social democrats
  18. 18. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 18component (today PD) and its more leftish representation. Equally today, we have had thedissatisfaction towards Monti and all the central catholic parties disappearing coupled withthe ongoing tension within the PD party, which leads many commentators to expect the PD topotentially break down. It is the strong leadership of Berlusconi that makes the PDL immunefor the time being from internal tensions, but one could reasonably expect that the PDL isalso destined to internal attrition when Berlusconi decides not to lead the party anymoreafter 20 years of strong leadership. New parties. The consequence of such turmoil was dissatisfaction towards existing parties.In early nineties this led to Berlusconi’s new Forza Italia party and the Northern Leaguesuccess at the expense of Socialist and Christian democrats parties, which essentiallydisappeared or converged into Berlusconi’s new party. Twenty years later the two traditionalparties (PD and PDL) together lost almost 10m votes in the February 2013 elections, whichended up rewarding a brand new movement, Five Star, which became the first party at itsfirst election catalysing the Italians’ dissatisfaction against the political class. Institutional bottleneck. Now as then, Italy faced a dangerous institutional bottleneckwith the overlapping between national elections (April 1992) and the appointment of the newpresident of the state (May 1992). It took a record 16 attempts at that time for the newlyappointed Italian Parliament to find a convergence on Oscar Luigi Scalfaro as the newPresident. This time around it only took six attempts, but simply because it appearedimmediately 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 socialdemocrats party to take the lead of the Government.. . . hopefully not in fullWe firmly hope that the similarities will stop here, because what happened next 20 years ago provedvery painful. Then as now the economic situation of Italy was particularly difficult (in the early 1990sit was the emerging markets bubble that triggered the macro slowdown) so to challenge thesustainability 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 painfuldecree (worth almost €50bn in Lira equivalent at that time) aimed at calming down themarkets: from higher retiring age to real estate tax and most importantly a 0.6% tax on bankdeposits. In spite of such austerity measures, three months later Italy was forced to exit the EuropeanMonetary System and devaluate its currency. This was followed by Amato’s resignation, who was replaced by a technocrat governmentheaded by the governor of the Bank of Italy Ciampi.The situation is worse todayItaly transformed the Euro from opportunity to threatWe believe the situation is more problematic today than it was 20 years ago, as the recession is dentingGDP growth much more heavily than in 1992. The lack of room to manoeuvre on currency devaluation today is probably the most negativedifference versus 20 years ago. It is due to the Lira devaluation and assets’ disposals that Italymanaged to put its debt / GDP on a virtuous path starting from 1994 – as shown below. TheEuro straitjacket is clearly not providing a similar currency adjustment flexibility today.
  19. 19. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 19Italian growth vs debt evolutionSource: Mediobanca Securities It was due to a Lit 180trn (€90bn) disposal plan that the country managed to improve itsdebt-to-GDP ratio in the following 10 years. But as we show below, that proved short livedand 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 thedouble 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 ratherthan using the Euro low rates relief as a key opportunity to implement painful but wellneeded structural reforms. The lack of action in leveraging on the Euro-driven low cost offunding and the assets disposal plan, largely explain Italy’s lack of competitiveness today, inour view.Debt / GDP, 1992-2005 Debt / GDP, 2001-12e1001051101151201251992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005Withoutprivatizations Withprivatizations95%100%105%110%115%120%2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012Source: Mediobanca Securities, Bank of Italy dataRecent macro data do not helpOn 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 inflatedebt away, which it clearly cannot do today. This is why we think the major difference between todayand 20 years ago is that the current recession is the worst ever seen in Italy – as recently stated by theMinister 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 10years to revert to pre-crisis output levels.
  20. 20. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 20 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 furtherdowngrades. Low R&D investments explain part of the competitive gap of Italy, given that investmentshave 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 inApril up 22.3% YoY versus 21.7% YoY growth in March reaching €133bn, i.e. c9% of theItalian 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 outof 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 accountstoday from 185m hours in 2007. It follows that consumers’ expenditure keeps contracting so that in the first four months of2013 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. Also, credit contraction continues to cap the room for investments. Banks loans were down1.1% 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 secondderivative keeps turning negative – signalling further deterioration ahead. If households and SMEshave been hit first, it is for sure now the large corporates that are adding further concern to the Italianeconomy, as confirmed by the ILVA case study proposed below.The crisis is moving from SMEs to large corporate – the ILVA caseMore NPLs and less lending for corporatesIf Italian households and SMEs have been the first to suffer from credit contraction, recent data showthat the problem is now expanding to large corporates. The delta €2.3bn NPLs generated in April, forinstance, come entirely from corporates versus a flattish trend in households. Construction and realestate, for instance, show NPLs +33% YoY and +35%, respectively. Lending contraction clearly doesnot help either. BoI data show that if households are facing a stable lending availability scenario nowversus 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 crisisadministration, and ILVA, the eighth largest steel plant in the world, based in Southern Italy, isprobably 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, beganin 2010 when the largest company’s plant (located in Taranto, Southern Italy, and on which some 75%of city’s GDP – directly and indirectly – depends) was blamed by a local association for environmentprotection to be the source of a carcinogenic polluting agent above the limits set by the Italian law. Theproblem was temporary solved by Berlusconi’s government, which waived the law with a decree(155/2010). However, since then the focus on the pollution released by the plant has increasedexponentially and subsequently drawn the attention of public prosecutors. In light of the results ofseveral technical reports showing a clear correlation between the plant’s emissions and the mortalityrate of the area, Italian magistrates disposed the sequestration of all the products coming from theplant as being not compliant with the legal standards.
  21. 21. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 21. . . to the 2012 temporary fixing by Monti . . .In 2012 Mario Monti’s government passed a decree (213/2012) to bypass the verdict of the publicprosecutors, thus allowing ILVA to restart production. Despite this move and the resulting inability toreorder the seizure of production, the prosecutors did not give up and disposed the seizure of €8.1bnof assets belonging to the Riva family (owner of ILVA), accused of environmental disaster andtherefore asked to compensate for the damages created.. . . followed by recent Letta decreeAlthough the seizure did not directly affect the production of Taranto’s plant, fears of indirectrepercussions and of cash flow problems led Letta’s government a few weeks ago to pass a decree toun-seize the €8.1bn assets and to appoint a special commissioner (Mr Bondi) to lead the company andto elaborate a plan to tackle the environmental issue, while keeping operations running.Potential clash with EU directiveThe substantial importance given by the last three Italian governments to ILVA derives from the highlevel of employees at risk in the case of a shutdown of the plant: currently some 12,000 people directlywork at ILVA’s plant, but the total number of workers at stake could reach the 40,000 threshold whenconsidering all the Italian companies directly and indirectly linked to ILVA. As shown above, for thetime being the Italian governments have managed to avoid the shutdown of the plant and theconsequent unavoidable bankruptcy of the company with ad-hoc decrees aimed at buying time. Thatnotwithstanding, Italian measures could clash with some EU directives (for example, directive2010/75, 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 fixingplus the potential clash with EU discipline, forces us to attach high probability to the worst casescenario for ILVA.Banks’ potential losses in 3-12bps CT1 regionAnalysing ILVA’s accounts in order to determine the current banks exposure is not an easy exercise forthe following reasons: FY2012 Annual Report for both ILVA and RIVA FIRE (the controlling company) are still notavailable. In 2012, the Riva Group was largely reshaped following a massive restructuring plan aimed atseparating the two main activities of the group, the so-called ‘long products’ from hot andcold rolls, the latter produced in ILVA’s plants. FY2012, ILVA perimeter does not correspond to that in FY2011, as some foreign activitieshave 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 ofwhich retaining ILVA activities – the debt of the Group might have been re-allocated, but wedo not know in what way. In 2011, ILVA reported an additional c.€2.2bn debt exposure to Group’s companies. At thecurrent stage, it is not possible to assess whether the beleaguered financial position of ILVAmay 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 takenwith considerable caution. Mindful of the fact that the reshaping of the Group may have significantlyaltered the financial position of the different entities within the RIVA Group, we attempt to makesome calculations starting from ILVA’s FY2011 Annual Report.As at the end of FY2011, ILVA’s bank debt exposure amounted to €719m, split as follows: €120m of short term debt.
  22. 22. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 22 €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.As a consequence, at the end of FY2012 we could infer ILVA’s bank exposure to range between €424m(assuming the full repayment and no renewal of the €295m credit lines expired 2012) and €719m (incase of roll-out of maturing debt). In both cases, such amounts should not represent a threat for theItalian banking system: assuming the whole of ILVA’s bank debt is classified as NPLs and covered 66%(we would expect some kind of collateral/guarantees backing the credit line), we calculate the amountof provisions could stand in the €450m region for the system, equal to €350m impact on CT1 capitalas 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 ourexercise.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 theresignation of President de la Rua the country defaulted on $81.8bn debt, which at that time was thelargest sovereign default in history. Following negotiations with the IMF, the country moved to atender 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, utilisinglitigation. The old bonds had pari passu clauses, which means that should Argentina be in a positionto pay bondholders of the new securities then the holdouts should also be paid. As such, the holdoutshave proceeded to sue the country for $1.3bn, which was given the backing of US courts. The amounthas been derived from past principal and past interest. Argentina’s reaction so far has been to rejectthe 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, sothat a feasible way to end this story would be to enter another technical default in order to avoidhaving to make any payments to any holder.. . . which is why yields are risingThe yield curve for Argentina is somewhat limited given its reputation as a serial defaulter, but weshow in the chart below how the observable yield levels have increased since the start of the year asinvestor fears increased.Argentina Sovereign curve price (rhs) and yield (Lhs)6.07.08.09.010.011.012.013.014.015.03 mnths 1 yrs 2 yrs 3yrs 4yrs 5yrs10/06/2013 01/01/2013101.387.879.7100.789.383.650.060.070.080.090.0100.0110.0120.03 mnths 1 yrs 2 yrs 3yrs 4yrs 5yrsPrice10/06/2013 01/01/2013Source: Mediobanca Securities, Bloomberg
  23. 23. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 23In the rhs chart below, we also outline the current debt maturity schedule for the country. Whilst themajority of the debt is zero coupon securities, we note there are two floating securities maturing inJuly and August and a fixed coupon in September, which could trigger a technical default in case ofno-coupon payment to the holdouts. Not surprisingly, the risk of an Argentina default coupled withthe Asian and China slowdown and with the recent S&P downgrade of the outlook in Brazil to negativefrom stable have triggered a severe correction, which brought the emerging markets index back tosummer 2012 levels (lhs chart below).Emerging markets index Argentina debt maturity schedule, $bn679.23640.88580.00600.00620.00640.00660.00680.00700.00JPMorgan Emerging Global Total Return Index2.6 2.5 2.24.21.71.11.715.314.40.02.04.06.08.010.012.014.016.0Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 2014 2015$bnsSource: Mediobanca Securities, BloombergTenaris and TI the Italian companies most exposed to ArgentinaThe potential default of Argentina could have a double negative impact on Italy, in our view. On theone hand it could reignite concern on debt sustainability in peripheral Europe, while on the other itcould directly affect the Italian economy particularly exposed to Argentina.The table below summarises the key companies under MB coverage with exposure to Argentina, noneof them on an Outperform rating.Italian companies’ exposure to ArgentinaRating TP Turnover exposure EBITDA exposure EPS exposureTenaris Underperform 13.6 30.0% 23% 20%Telecom Italia Not Rated - 13.0% 10% 2%Campari Neutral 5.45 2.9% 2.5% 2.5%Fiat Neutral 4.5 2.0% n.m. n.m.Pirelli Underperform 7.0 4.0% n.m. n.m.Trevi Underperform 4.45 3.2% 5.9% 7.9%Generali Neutral 15.0 0.8% n.m. n.m.Source: Company data, Mediobanca SecuritiesIt can be seen that the exposure to Argentina ranges from 1% of turnover at Generali up to 30% atTenaris.Some 50% chance of a government crisis in Italy this yearIn conclusion, this introductory chapter points to what we consider the most scarce resource for Italytoday – time. Five years into the most severe recession of the past century means that withoutinverting the trend soon Italy could be facing a very problematic situation ahead. It is fair to argue thatItaly’s destiny is now in EU hands more than in Italian hands. Without Europe, i.e. the ECB, to keep
  24. 24. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 24buying the required time and without Italian politicians using such time for painful but inevitablestructural reforms, we think the country might end up requiring a European bailout support. The largecoalition government is facing a crucial role in implementing structural reforms. But its ability todeliver is dependent on a number of moving parts, which is why Italian commentators and opinion-makers are split: The bullish argue that for various reasons this government can stay together for a long timeand deliver what is needed: the common interest of both PD and PDL in buying time, some70% of new PMs appointed willing to secure their future, Napolitano threatening hisresignation in the case of government crisis, and the time required to implementconstitutional 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 notmore convincing to us: Berlusconi’s trials make the government road particularly bumpy inthe case of conviction, potentially forcing him to unplug his party’s support to Letta and toadvocate new elections. Also, the potential implosion and break-down of the PD party at hiswinter congress could pave the way for this. But more in general, we think that any externalfactor turning against the Italian spread could affect the government: from the unplugging ofthe QE measures to reigniting the sovereign crisis triggered for instance from Argentina orSlovenia or the OMT constitutional debate.Given the above, we think it fair to attach no more than 50% chance for this government to remain inpower longer than this year. This means that the many uncertainties surrounding this unusual largecoalition government could implode any time leaving the market with a totally unpredictable situationon what would happen next.
  25. 25. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 25Real Estate – Italy is no Spain, but . . .Recent data show an ongoing marked slowdown of the Italian real estate market, withresidential transactions down 26% YoY to 430k – the lowest level since 1985. Real estateprices in Italy have contracted by 12% since their 2008 peak versus a 25% correction inSpain. We believe there are very good reasons for Italy not to fear a ‘Spanish-like’ realestate contraction: 1) some 40% of the national value added in Spain came from realestate in 2007, 10 p.p. higher than Italy; 2) housing completion over the last decade was2.5x larger in Spain than Italy despite 30% larger population in Italy; 3) Italianhousehold indebtedness is the lowest in the EU; and 4) Average loan-to-value stands at65% in Italy versus 72% in Spain.In spite of such differences, we fear that further real estate price correction could affectItalian 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. Inthe first, we investigate how much real estate prices could drop in Italy without itsbanks suffering total coverage (cash + collateral) dropping below 100%. Our reassuringanswer is that by our estimates Italian banks could bear up to 45% downward revisionof 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% realestate 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 washout some 17% of the aggregate 2012 Basel II.5 CT1 capital of our banks with CT1 ratiodropping by 170bps to 8.7%. Five banks would sit below 8% CT1: MPS, BP, BPER, BPMand 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. Insummary, although we recognise that Italy is no Spain, we foresee further balance sheetclean-up ahead for Italian banks, possibly triggered by the asset quality stress test thatthe ECB is set to carry out next year. Draghi’s recent cooling on the ECB potentiallybuying 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. Nodelivery here will be a big missed chance for Italy to sustain growth.Marked slowdown in Italian real estateWith an owner occupation rate of 80%, Italian households remain among the most exposed to theresidential real estate among large European countries.Selected European Countries – Owner Occupation Rate (%)0102030405060708090Source: EMF, Mediobanca Securities
  26. 26. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 26Residential transactions are down 26% YoY in 2012 . . .In 2012 the total number of residential transactions dropped by 26% YoY to 448,000, the highest droprecorded to-date and the lowest amount since 1985 when residential transactions were 430,000 (Lhschart below). In value terms, residential transactions declined 26.3% to €74.4bn. The magnitude ofthe 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 pictureworsened during the year as shown by the acceleration in the quarterly drop (Rhs chart below).Number of transaction (000) – Residential Number of quarterly residential transactions, YoY464558687769835866 8778166896146176034484004505005506006507007508008509001985198619871988198919901991199219931994199519961997199819992000200120022003200420052006200720082009201020112012-3.0%-2.6%-1.5%0.0%1.2%1.5% 1.7% 1.8% 1.6%1.3%-0.1%-1.9%-3.4%-4.2%-4.6%-4.1%-5.0%-4.0%-3.0%-2.0%-1.0%0.0%1.0%2.0%3.0%1Q092Q093Q094Q091Q102Q103Q104Q101Q112Q113Q114Q111Q122Q123Q124Q12Source: Agenzia del Territorio, Mediobanca SecuritiesThe number of mortgage loans for house purchases fell by 38.6% in 2012, even more than the overallnumber of transactions. Consequently, transactions that involved a mortgage loan declined to 37% ofthe total, eight percentage points below that in 2011. The amount of total mortgage loans granted tohouseholds for house purchases declined by 43% in 2012 to €19.6bn; and the ratio between mortgageloans and the total value of transactions decreased to 26% from 34%.. . . due to several factorsLower 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, worseningexpectations, higher taxes on houses (IMU), and lower credit availability appear to be the main driversof the drop in transacted volumes.Average number of yearly salary to buy a house House Affordability index for Italian householdsSource: Agenzia del Territorio, Mediobanca Securities
  27. 27. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 27Commercial real estate does not provide a better pictureTransactions in commercial real estate among large professional corporations declined below €2.0bnin 2012, down from around €4.0bn p.a. in the prior three years. Insufficient re-pricing, especially fornon-core assets, is the main driver of the low volumes. Low liquidity in commercial real estate is aproblem in view of the relevant amount of funds approaching maturity and of the potential sale of realestate assets held as guarantees by the banks.Commercial real estate – transaction volumes (€ bn) Transaction volumes by quarters (€ bn)0.01.02.03.04.05.06.07.08.09.02006 2007 2008 2009 2010 2011 20120.00.51.01.52.02.53.03.51Q062Q063Q064Q061Q072Q073Q074Q071Q082Q083Q084Q081Q092Q093Q094Q091Q102Q103Q104Q101Q112Q113Q114Q111Q122Q123Q124Q121Q13Source: Nomisma, Quotidiano Immobiliare,JLLS, Mediobanca SecuritiesSo far, 2013 point to flat/slightly increasing investment volumes. According to JLLS, in the firstquarter of 2013 total transaction volumes amounted to around €0.6bn, up from €0.5bn in 1Q 12 whilesome important negotiations are ongoing on the market (mainly involving foreign opportunisticinvestors) and should be closed during the year.Real estate overview - Italy versus SpainThe magnitude of Spain’s residential real estate bubble was twice that of ItalyUsing the European Mortgage Federation (EMF) data, we calculate that Spanish residential real estateprices ballooned by c.135% in seven years, a rise that is twice the magnitude of that of Italian realestate (c.+70% in eight years). Since their highs, real estate prices have fallen by c.25% in Spain as ofSeptember 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 2008-2011, fluctuating at level c.70% higher than in 2000. As the EMF does not provide quarterly updateson Italy’s real estate prices progression, we cannot provide an exhaustive comparison based on ahomogeneous dataset for what happened in 2012 in Italy.Nomisma data show that the increase in Italy’s 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 inreal estate prices in Italy, we conclude the magnitude of Italy’s real estate bubble was much smallerthan 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 suchan indication as more realistic than a substantial stabilisation at peak-prices (as shown by the EMFdata till 2011). In addition, such a correction would be equal to 50% of that of Spain’s, i.e. equivalent toa growth of roughly 50% of the Spanish one.
  28. 28. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 28Italy and Spain – EMF Residential RE Prices, 2000-07 Italy – Nomisma Retail RE Prices, 1992-201280901001101201301401501601701801902002102202302402000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 III 12Spain Italy7080901001101201301401501601701801902001H921H931H941H951H961H971H981H991H001H011H021H031H041H051H061H071H081H091H101H111H12Residential Office RetailSource: EMF, Mediobanca Securities analysis, NomismaDifferences in Italian and Spanish real estate marketsIn our view, the prices of real estate collateral are theoretically safer in Italy than in Spain, for anumber of reasons listed below. Italian economy less dependent upon real estate and construction. The Spanisheconomy relies more on real estate and construction activity than Italy: at the peak of the realestate market (2007), we calculate that real estate/construction sector accounted for c.40% ofthe national value added in Spain (the EU second highest after the UK), c.10 percentagepoints higher than Italy. In addition, the interdependence between the Spanish economy andthe real estate sector is exacerbated by the ongoing government cost-cutting programmes ininfrastructure after years of heavy spending. Unlike in Spain, Italy’s investment ininfrastructure has been relatively poor, while the so-called Stability Pact imposed by theCentral Government to regions and municipalities virtually stopped any local spending andinvestments. 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 inItaly, despite a population 30% larger in Italy. In 2011 housing completions in Spaincollapsed by 75% from the peak hit in 2007 versus -50% in Italy on a number already 50%below Spain’s peak (317,000 in 2006 versus 640,000 in Spain in 2007). Over the period2000-2010, we calculate that Spain completed the construction of 0.11 houses per inhabitantversus 0.044 per inhabitant in Italy, i.e. 2.5x .RE/Construction % of Value Added, 2007 Housing Completions, 2000-110%5%10%15%20%25%30%35%40%45%UKSpainFranceNetherl.DenmarkSwedenEU-27BelgiumAustriaItalyGermanyFinlandIrelandNorwayPolandGreeceCzechR.HungarySlovakiaConstruction/Total VA RE, Rent. and bus. activ./Tot VA050,000100,000150,000200,000250,000300,000350,000400,000450,000500,000550,000600,000650,0002000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011Spain ItalySource: Bank of Italy, Mediobanca Securities analysis Household indebtedness much lower in Italy. The personal indebtedness in Spain ismuch higher than in Italy. A higher level of debt by definition translates into higherprobability of default and in a higher quantity of real estate assets up for sale. Aside from
  29. 29. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 29Norway, data show that the country with the highest debt (residential mortgage per capita) isDenmark (€43k), followed by Netherlands (€38k), Ireland and Sweden (€30k). Italy actuallyhas the lowest level of debt per capita in Europe. The debt per capita must be put in contextwith the disposable income in each country. In this respect, the highest ratios are shown byDenmark, Ireland, Netherlands, Portugal, Spain, Sweden and the UK. Again Italy is the mostvirtuous country in this respect.Res. Mtg. Debt/Gross Disposable Income per Capita,2005-10Res. Mtg. Debt per Capita,2005-10 (€’000)15%25%35%45%55%65%75%85%95%105%115%NetherlandsIrelandDenmarkUKSwedenNorwaySpainGermanyBelgiumFinlandFranceItaly2005 2006 2007 2008 2009 2010051015202530354045NorwayDenmarkNetherlandsIrelandSwedenUKBelgiumSpainFinlandGermanyFranceItaly2005 2006 2007 2008 2009 2010Source: Eurostat, EMF, Mediobanca Securities analysis Loan-to-Value (LTV) below the average in Italy. Generally, a high LTV is associatedwith high default risk, and a high default risk may translate into a larger number of forcedsellers, i.e. into a larger amount of properties coming to the market. Using the LTV of firsttime buyer provided by the ECB for Eurozone countries and various indications from CentralBanks, we calculate approximately c.73% LTV in Europe, peaking at c.100% in theNetherlands. Italy stands below the EU average and below Spain.Loan-To-Value, 2007-10Country Loan-to-Value %Austria 84Belgium 80Czech Republic 45Denmark 80Finland 81France 91Germany 70Greece 73Hungary 61Italy 65Ireland 83Netherlands 101Norway 48Poland 65Portugal 71Romania 68Slovakia 80Slovenia 65Spain 72Sweden 70UK 80AVERAGE 73Source: ECB, Central Banks, Statistical Offices, Mediobanca Securities analysis
  30. 30. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 30Broad definition of financial distress in ItalyFinancial distress is captured one way or another within the four categoriesThe definition of impaired loans (sofferenze, incagli, ristrutturati, scaduti) in Italy is broader than inmost 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 bein line with its European peers. Current Bank of Italy guidelines specify that, after 90 days of arrears, aloan must be classified at least as past due, in line with EU best practice. However, management hasthe discretion to classify it as incaglio or sofferenza after just one day of delay in the loan payment. Assuch, we believe that the possibility of not capturing a situation of distress in one of the four Italiancategories is limited. Outside of Italy, the 90-day past due rule dominates as the main criteria toclassify a loan, generally causing the exposure to be classified as Non-Performing and possiblyassigning a 100% probability of default. On the other hand, loans less than 90 days overdue andrestructured loans are generally regarded as performing outside of Italy and not impaired.Italy – Criteria of Classification of Problematic LoansCategory DefinitionSofferenzaNon-Performing Loan: on- and off-balance sheet exposures to borrowers in a state of insolvency (even when notrecognised 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 areItalian local authorities in a state of financial distress for the amount subject to the associated liquidationprocedure.IncaglioDoubtful Loan: on- and off-balance sheet exposures to borrowers in a temporary situation of difficulty, which maybe expected to be solved within a reasonable period of time; irrespective of whether any collateral or guaranteeshave been established to cover the exposures. Sub-standard loans should include exposures to issuers who have notregularly honoured their repayment obligations (capital or interest) relating to quoted debt securities.Ristrutturato/In RistrutturazioneRestructured Loan: on- and off-balance sheet exposures for which a bank, as a result of the deterioration of theborrower’s financial situation, agrees to amendments to the original terms and conditions (for example, reschedulingof deadlines, reduction of the debt and/or the interest) that give rise to a loss. These do not include exposures tocorporates where the termination of the business is expected. The requirements relating to the “deterioration in theborrower’s financial situation” and the presence of a “loss” are assumed to be met when the restructuring involvesexposures already classified under the classes of substandard or past due exposures. If the restructuring relates toexposures to borrowers classified as “performing“ or to unimpaired past due/overdrawn exposures, the requirementrelating to the “deterioration in the borrower’s financial situation” is assumed to be met when the restructuringinvolves a pool of banks. This is irrespective of whether any collateral or guarantees have been established.ScadutoPast due Loan: on- and off-balance sheet exposures, other than those classified as doubtful, substandard orrestructured exposures that, as at the reporting date, are past due or overdrawn by over 90 days on a continuousbasis. This is irrespective of whether any collateral or guarantees have been established to cover the exposures.Source: Intesa Sanpaolo, Bank of Italy, Mediobanca Securities analysisCash coverage ratio of problem loans is down 10 pp in five yearsBy our calculations, the cash coverage ratio of Italian banks’ problematic loans dropped by 10percentage 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 fewadditional points of coverage ratio. We would point the following: The drop in gross problem loans coverage ratio is partially explained by the fact that theproblem loans category with the highest coverage ratio (i.e. sofferenze) has reduced its weightover 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 problemloans have only marginally increased in five years, to 76% in 2012 from 75% in 2007.
  31. 31. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 31 The aggregate data of the sample of banks under MB coverage show that the fully securedproblem 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, thiscould explain why the aggregate data of the sample of banks under MB coverage show adeclining coverage ratio in all the four categories, with the exclusion of past due loans.Italian Banks: Cash Coverage Ratio of Gross Problem Loans, 2007 – March 20132007 1H 08 2008 1H 09 2009 1H 10 2010 1H 11 2011 3M 12 1H 12 9M 12 2012 1Q 13Aggregate 51% 50% 48% 44% 41% 41% 41% 41% 41% 40% 40% 39% 41% 40%ISP 54% 51% 49% 43% 41% 42% 43% 45% 46% 43% 43% 43% 43% 43%UCG 54% 55% 52% 50% 46% 45% 45% 45% 45% 44% 44% 43% 45% 44%MPS 38% 44% 43% 39% 40% 40% 42% 41% 42% 40% 39% 38% 41% 40%BP 37% 31% 35% 34% 27% 27% 27% 27% 26% 25% 25% 24% 27% 26%UBI 37% 37% 36% 32% 29% 30% 30% 28% 27% 26% 26% 25% 26% 26%BPER 46% 44% 43% 40% 37% 37% 37% 36% 34% 32% 32% 32% 37% 36%BPM 47% 46% 42% 32% 27% 26% 24% 24% 28% 28% 29% 28% 34% 34%CREDEM 39% 43% 39% 39% 36% 35% 36% 36% 36% 35% 35% 34% 35% 35%CREVAL 51% 49% 45% 43% 36% 35% 39% 37% 33% 30% 31% 29% 35% 33%Source: Company Data, Mediobanca Securities analysisAggregate Italian Banks: Cash Coverage Ratio of Gross Problem Loans, 2007 – March 2013, break down2007 1H 08 2008 1H 09 2009 1H 10 2010 1H 11 2011 3M 12 1H 12 9M 12 2012 1Q 13NPL 67% 65% 62% 55% 52% 54% 55% 56% 57% 55% 55% 54% 54% 55%Doubtful 23% 24% 27% 31% 34% 33% 31% 29% 28% 28% 28% 28% 30% 30%Restructured 3% 3% 3% 7% 7% 8% 9% 10% 10% 10% 10% 9% 9% 8%Past Due 6% 8% 7% 7% 8% 6% 5% 5% 5% 7% 7% 8% 7% 7%TOTAL 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%Source: Company Data, Mediobanca Securities analysisIT Banks – Breakdown of Secured and UnsecuredNet Problem Loans, 2007IT Banks – Breakdown of Secured and UnsecuredNet Problem Loans, 201240%35%25%Fully Secured Net ProblemLoansPartially Secured Net ProblemLoansUnsecured Net Problem Loans63%13%24%Fully Secured Net ProblemLoansPartially Secured Net ProblemLoansUnsecured Net Problem LoansSource: Company Data (UCG, ISP, MPS, BP, UBI, BPER, BPM, CE, CVAL), Mediobanca Securities analysis
  32. 32. Unauthorizedredistributionofthisreportisprohibited.ThisreportisintendedforAntonio.Guglielmi@mediobanca.co.ukfromMB.Antonio.Guglielmi@mediobanca.comItaly17 June 2013 ◆ 32Fair value of collaterals cover 100% of the gross deteriorated exposuresThe fair value of collaterals backing deteriorated assets tends not to be disclosed in most of the EUcountries outside of Italy. In 2012, Italian banks’ value of collateral covered c.100% of gross problemloans, bringing the total coverage ratio to well above 100% in all the banks under scrutiny. Italianbanks disclose the fair value of collateral as follows: Since 2012 banks disclose the fair value of collateral backing deteriorated exposures, not justup to a contractual limit (generally the exposure itself). This explains why the fair value ofthe collaterals is above the gross deteriorated exposure. The limit of such disclosure is that itis not possible to ascertain whether a valueless collateral is allocated to a large NPL and viceversa. 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 forc.75% of the fair value of collaterals, while personal guarantees account for an additional20%. Banks disclose the fair value of collateral covering >100% of the secured exposure and the fairvalue of collateral offering just a partial coverage. In 2012, c.90% of the collaterals’ fair valuewas allocated to exposures whose collaterals cover >100% of the exposure itself.Coverage Ratio of Problem Loans Including FairValue of Collaterals, 2012Breakdown of Fair Value of Collaterals, 20120%25%50%75%100%125%150%175%200%225%AggregateUBICREDEMCREVALBPBPERISPMPSUCGBPMCash Coverage Ratio Fair Value of Collaterals0%25%50%75%100%125%150%175%200%225%AggregateUBICREDEMCREVALBPBPERMPSISPBPMUCGFair Value of Collaterals as % of Gross Deteriorated ExposureFair Value of RE Collaterals as % of Gross Deteriorated ExposureSource: Company Data, Mediobanca Securities analysisBreakdown of Fair Value of Collaterals, 2012 Breakdown of Fair Value of Collaterals, 201274%1%4%20%Real EstateSecuritiesOther Real GuaranteesPersonal Guarantees93%7%Fair Value of CollateralsAllocated to ExposuresCovered >100% by CollateralsFair Value of CollateralsAllocated to ExposuresCovered 0% - 100% byCollateralsSource: Company Data, Mediobanca Securities analysis

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