The Contrarian View

Spain: Macro/Financial/Strategy

April 2010
1
Spain GDP: -0.4% in 2010E and 1.3% in 2011E
Spain GDP history and forecast figures
3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10F 2Q10F 3Q10F 4Q10F 2007 2008 2009 2010F 2011F
Real GDP QoQ -0.6 -1.1 -1.7 -1.0 -0.3 -0.1 -0.1 0.1 0.1 0.3
QoQ a -2.2 -4.3 -6.6 -3.8 -1.1 -0.6 -0.2 0.2 0.4 1.0
YoY 0.5 -1.2 -3.3 -4.2 -4.0 -3.1 -1.4 -0.4 0.0 0.4 3.6 0.9 -3.6 -0.4 1.3
Private Consumption QoQ -1.1 -1.2 -2.5 -1.3 0.0 0.3 -0.1 0.1 -0.3 0.2
(57.9% of GDP) QoQ a -4.3 -4.7 -9.5 -5.3 -0.2 1.4 -0.4 0.4 -1.2 0.8
YoY -1.3 -3.3 -5.5 -6.0 -5.0 -3.5 -1.2 0.3 0.0 -0.1 3.6 -0.6 -5.0 -0.2 1.1
Public Consumption QoQ 1.9 1.6 0.7 0.4 1.4 -1.7 0.3 0.2 0.1 0.0
(22.4% of GDP) QoQ a 7.7 6.4 2.9 1.7 5.5 -6.6 1.2 0.8 0.4 0.0
YoY 5.8 6.3 6.0 4.7 4.1 0.8 0.3 0.1 -1.1 0.6 5.5 5.4 3.9 0.0 -0.3
Total Investment QoQ -3.5 -4.6 -6.0 -4.1 -2.4 -1.0 -0.8 -0.7 -1.0 -1.2
(21.3% of GDP) QoQ a -13.2 -17.1 -22.0 -15.5 -9.1 -4.1 -3.4 -2.9 -4.1 -4.9
YoY -6.0 -10.9 -14.9 -17.0 -16.0 -12.9 -8.1 -4.9 -3.6 -3.8 4.7 -4.3 -15.2 -5.1 -1.7
Capital Goods QoQ -4.3 -7.2 -14.2 -5.9 1.8 3.1 -3.0 0.2 1.0 1.0
(8.5% of GDP) QoQ a -16.1 -25.7 -45.8 -21.7 7.2 13.0 -11.5 0.8 4.1 4.1
YoY -3.0 -11.6 -24.0 -28.3 -23.8 -15.3 -4.3 2.0 1.2 -0.9 6.7 -2.6 -20.7 -3.9 3.6
Construction QoQ -2.9 -3.5 -3.1 -2.8 -2.6 -2.2 -2.7 -1.0 -2.0 -2.5
(13.2% of GDP) QoQ a -11.0 -13.2 -11.7 -10.6 -10.0 -8.5 -10.4 -3.9 -7.8 -9.6
YoY -7.2 -10.2 -11.3 -11.6 -11.4 -10.2 -9.9 -8.2 -7.7 -8.0 3.2 -5.5 -11.1 -8.4 -5.3
Inventories Euros mn 668 703 660 621 634 789 500 600 500 600
Cont GDP 0.0 0.0 0.0 0.0 0.0 0.1 -0.2 0.1 -0.1 0.1 -0.1 0.1 0.0 -0.1 0.0
Exports QoQ -2.4 -5.4 -8.4 0.7 2.1 3.0 -0.2 1.0 1.5 0.5
(20.8% of GDP) QoQ a -9.2 -19.8 -29.5 3.0 8.7 12.5 -0.8 4.1 6.1 2.0
YoY -2.9 -7.1 -16.6 -14.7 -10.8 -2.9 5.7 6.0 5.4 2.8 6.7 -0.9 -11.3 5.0 4.2
Imports QoQ -4.1 -6.3 -10.8 -2.3 1.7 2.1 -1.0 0.4 0.4 -0.1
(22.6% of GDP) QoQ a -15.5 -22.9 -36.8 -8.8 7.0 8.5 -3.9 1.6 1.6 -0.4
YoY -7.6 -13.5 -22.3 -21.7 -17.0 -9.6 0.4 3.2 1.8 -0.3 8.0 -4.8 -17.7 1.3 2.9
Net external sector Euros mn -8116 -7517 -5870 -4808 -4901 -4641 -3658 -3615 -2798 -2303
Cont GDP 0.5 0.4 1.0 0.7 -0.1 0.2 0.6 0.0 0.5 0.3 -0.8 1.1 2.3 1.2 1.0
CPI 2.8 4.1 -0.3 1.3 1.9
Unemployment rate 8.3 11.3 18.0 19.6 18.3
Public Budget (a) 1.9 -4.1 -11.4 -10.0 -8.0
Current account (a) -10.0 -9.6 -5.8 -3.7 -2.4

Source: INE, BoS, Santander Investment Bolsa estimates and forecasts.

Annual figures: annual average. (a) as a % of GDP. Cont GDP: contribution to QoQ GDP growth

2
 The “Real Adjustment” of the Spanish Economy

¾ GDP growth has not fallen dramatically thanks to net exports

¾ The adjustment of the economy must be seen though Private Domestic Final Sales

¾ In 2010E, this indicator could come back to the 2004 levels

¾ GDP could be almost flat in 2010E (-0.4% in 2010E and 1.3% in 2011E)

GDP Breakdown, Composition of GDP growth, 1Q07-4Q11E. GDP Private Domestic Final Sales, 1995-2011E.
6.0 600 8.0
=Private Domestic Final Sales
Private Domestic Final Sales Domestic Final Sales GDP
4.0 Annual Groth Rates (RHS)
6.0
550
2.0
4.0
0.0
500 2.0
(%, QoQ annualised)

-2.0

(Billion Euros)
0.0

(%)
-4.0 450
-2.0
-6.0
400 -4.0
-8.0
-6.0
-10.0
350
-12.0 -8.0

-14.0 300 -10.0

Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 1995 1997 1999 2001 2003 2005 2007 2009 2011

Source: IN and Santander Investment Bolsa. Source: IN and Santander Investment Bolsa.

3
De-leveraging is running at full speed in the private sector. Flows vs
Stocks.
¾ The Current Account deficit has been reduced to just 4.7% of GDP in 2009 from 10% in 2007

¾ The private sector is reducing its leverage at a fast pace. Savings are up and investments down

¾ Households pushed savings to around 19% of Gross Disposable Income in 2009

¾ The reduction in Investments is mainly concentrated in Construction; particularly in Real Estate.

¾ Flows almost adjusted. More time needed for adjusting the stocks
Spain - Net Lending (+) or Net Borrowing (-) [=Current Account Balance] (% of GDP) by
Sector, 1995-2009.
8.0

6.0

4.0

2.0

0.0
(% of GDP)

-2.0

-4.0

-6.0 Financial institutions

General Government
-8.0 Non-financial corporations
Households and non-profit Institutions
-10.0
Total Economy
-12.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Mineco, INE, BoS and Santander Investment Bolsa.

4
 The Real Estate sector and Immigration.

¾ The adjustment in the construction sector (real estate) would be almost completed

¾ Building permits have gone down 90% from the peak reached in 2007

¾ Prices would be down btw 20-30% in large cities and even 50% in the coastal area

¾ The current production of houses would be below sustainable demand. Stocks are the problem

¾ Immigration is coming down. The adjustment in population is necessary.

Spain - Housing Starts vs Building Permits, 1984-2009. Spain - Immigration vs Natural Growth, 1960-2030E.
1,000,000 800
Forecasts

900,000
600
800,000

400
700,000

('000, annual change)

600,000
200
(units)

500,000
0
400,000

300,000 -200

200,000 Natural
-400 Inmigration-Pessimistic
100,000 Housing Starts (LHS) Building Permits (LHS)
Inmigration-Base
0 -600
1984 1988 1992 1996 2000 2004 2008 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020 2024 2028

Source: Ministry of Housing, BoS & Santander Investment Bolsa. Source: INE and Santander Investment Bolsa estimates.

5
 GDP is likely to grow at lower rates than in the past

¾ Old economy based on population growth and employment creation is over

¾ New economy should be more biased towards productivity

¾ Growth potential down from around 3.0% to around 1.5%

¾ The Industry and Services leading the way up

Spain - Growth Model-Pessimistic Scenario, 1960-2030F. GDP-Growth Composition from the Supply side, 1996-2009.
10.0 6.0
Forecasts Agricul Industry Construc Services VAT Energy
8.0 5.0

Contribution in pp to annual GDP growth

6.0 4.0

4.0 3.0

2.0 2.0
(% YoY)

0.0 1.0

-2.0 0.0

-4.0 -1.0
Population
-6.0 Employment -2.0
Working Age Population (15-64)
-8.0 Productivity -3.0
GDP per Capita
-10.0 Real GDP
-4.0
1960-70 1971-80 1981-90 1991-2000 2001-08 2009 2010 2011 2012-20 2021-30
9 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: MINECO, AMECO, INE, OECD and Santander Investment Bolsa estimates. Source: INE and Santander Investment Bolsa.

6
 The Public sector to start doing its homework in 2010E.

¾ Significant deterioration of Public accounts, with revenues plummeting and expenditures accelerating

¾ Government plans to reduce deficit credible, although GDP estimates would be on the optimistic side

¾ Debt levels are low. The bulk of the Countries debt is in the private side

Public Adms- Investments % of GDP and Annual rate, 2000-2009 Public Adms -Net position lending (+) / borrowing (-)
8.0 4.0 40,
Savings
Gross Fixed Capital Formation 2.0 20,
6.0

0
0.0
4.0
-20
-2.0

(%of GDP)
(%of GDP)

2.0 -40
-4.0
-60
0.0
-6.0
-80
-2.0
-8.0
-10
Net Lending / Borrowing as a % of GDP (LHS)
-4.0 -10.0 bn Euros (RHS) -12

-6.0 -12.0 -14

Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09

Source: INE and Santander Investment Bolsa.

Fiscal Adjustment Path 2009-2013 2009 2010 2011 2012 2013

(Growth rate in percent)
GDP -3.6 -0.3 1.8 2.9 3.1
General Government Budget Balance (% of GDP) -11.4 -9.8 -7.5 -5.3 -3.0
General Government Gross Debt (% of GDP) 55.2 65.9 71.9 74.3 74.1
Source: Annual update of the Stability Programme.

7
BBVA & POP our top picks for a recovery

I. Lower NIM and ongoing high provisioning, will mean lower earnings in
2010 before a recovery in 2011/2012.

II. Revenues to remain flat over the next 3 years as the private sector
continues to deleverage.

III. The restructuring of the S&Ls will alleviate competitive pressures and
allow stable revenues as banks gain market share.

IV. Asset quality deterioration continues to moderate, and points to NPL ratios
peaking in 2010.

V. The reduction in loan losses will be the main earnings driver in our view.
We estimate that ROTE should improve from 7% for domestic banks in
2010E to 11% in 2012E.

8
Market share to improve revenue outlook

„ In a deleveraging economy loan growth will remain under pressure. We expect negative
growth in 2010 for the system, and low single digit growth (2-3%) after that.

„ Banks are gaining market share, and we believe they should continue to do so in the
medium term as savings banks restructure, alleviating the revenue outlook.

YoY Loan Growth Since 2007 Spanish Banks – Mortgage Underwriting Market Share
30.00% 4,000 42.0%
3,500 41.0%
25.00% 40.0%
3,000
39.0%
20.00% 2,500 38.0%
15.00% 2,000 37.0%
1,500 36.0%
10.00%
35.0%
1,000
5.00% 34.0%
500 33.0%
0.00% 0 32.0%
7

9
07

08

09

10
7

9
07

08

09

-5.00%
l-0

l-0

l-0
-0

-0

-0
n-

n-

n-

n-
r-

r-

r-
ct

ct

ct
Ju

Ju

Ju
Ja

Ja

Ja

Ja
Ap

Ap

Ap
O

Source: Bank of Spain, Santander Investment Bolsa

mortgage production Banks Market Share 3m rolling average (rhs)

9
Margin Pressure in 2010
„ The delayed impact of mortgage re-pricing on margins together with increasing asset
spreads and ALM portfolios have meant relatively resilient margins.

„ In turn this should translate into margin pressure in 2010 and 2011, before a recovery in
2012. We estimate -5.3% in 2010 NII and -0.2% in 2011, with Bankinter the most affected.

„ Deposit war has recently intensified which could increase cost of funding, and add
pressure to the savings banks to re-structure.
Front Book Loan spreads 2003-2010 Retail time deposit spreads 2006-2010
1.00
4 .0 0

3 .5 0
0.50
3 .0 0

2 .5 0 -

9
06

07

08

09

10
6

9
06

07

08

09
l-0

l-0

l-0

l-0
-0

-0

-0

-0
2 .0 0
n-

n-

n-

n-

n-
r-

r-

r-

r-
ct

ct

ct

ct
Ju

Ju

Ju

Ju
Ja

Ja

Ja

Ja

Ja
Ap

Ap

Ap

Ap
O

O
-0.50
1 .5 0

1 .0 0
-1.00
0 .5 0

- -1.50
03

04

05

06

07

08

09

10
3

9
l- 0

l- 0

l- 0

l- 0

l- 0

l- 0

l- 0
n-

n-

n-

n-

n-

n-

n-

n-
Ju

Ju

Ju

Ju

Ju

Ju

Ju
Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

-2.00
Re s id e n tia l mo r tg a g e s Co r p o r a te <1 mn Co r p o r a te >1 mn
Cajas Banks
Source: Bank of Spain, Santander Investment Bolsa

10
Savings Banks Restructuring

„ Higher margin pressure (negative NII growth of 20-25% in 2010E), and ongoing high
provisions could trigger €4-5bn losses for the S&Ls in 2010, accelerating consolidation.

„ We have counted up to 32 savings banks that could be involved in mergers, with

combined assets worth €765bn (2/3rds of the savings banks’ total and 1/3rd of the banking
system’s assets).

Savings Banks – Merger Process

(€ mn) Assets Loans Deposits Equity Employees Branches

Caja Madrid + CAM 267,009 172,584 129,877 13,931 21,550 3,210
Caixa Catalunya + Tarragona + Manresa 82,466 57,859 39,735 3,560 7,678 1,423
Caixanova + Caixa Galicia 77,178 56,549 46,683 3,548 8,236 1,460
CAN + CG Canarias + Sa Nostra + Caja Burgos 59,357 41,326 40,545 3,779 6,069 1,070
Cajasur + Unicaja + Jaen 54,820 39,227 38,295 3,698 8,105 1,476
Caja España + Caja Duero 46,802 29,393 31,831 2,373 5,961 1,166
Cajastur + CCM 42,481 28,885 27,694 1,573 3,604 944
Sabadell + Terrasa + Manlleu + Girona 35,295 26,238 26,943 1,739 3,280 707
Laietana + Penedes 32,498 23,230 21,756 1,540 4,102 939
Cajasol + Guadalajara 29,660 23,571 21,828 1,745 5,154 889
C- Rioja + C.I. Canarias + C. Inmaculada 24,994 17,944 18,275 1,475 2,951 556
Caja Avila + Segovia 13,097 8,742 9,268 634 1,203 244
Total 765,657 525,548 452,730 39,595 77,893 14,084
Source: Press and company reports.

11
€10-12bn FROB Capital Injection Required

„ Losses, coupled with the relatively tight capital ratios and the inability to raise capital, lead
us to believe that mergers will go ahead despite resistance from regional politicians.

„ We believe savings banks will require €10-12bn of funds to cover accumulated losses (€7-
8bn 2009E-10E) and restructuring charges (€3-4bn).

„ FROB funds are awarded in the form of preference shares, which have to be repurchased in
a maximum period of five years. This implies the institutions involved will need asset
disposals/downsizing in order to be able to repay the FROB.

„ Announced mergers have proposed job cuts of up to 20-25% and 1/3 of branches closed. If
we extrapolate this we would be talking about closing or selling 5000 branches with close to
€180bn in loans, and 20,000 employees. This is around 10% of the whole banking system.

„ Savings banks’ profitability is likely to remain under pressure until 2012 and will not return
to a 10% ROE until 2014. Assuming a cost of 8% for the FROB funds, we estimate the
institutions could generate close to €6bn, which implies the remaining €6bn would be repaid
either through disposals or downsizing their loan book by close to 20%, or €100bn.

12
NPL Ratios to peak in 2010

„ We expect interest rates to be supportive until 2012, which makes us think the
improvement in the flow of NPL entries in 2H09, will be sustained in 2010 and NPLs will
peak in 2010 at 6.5% vs. 5.1% Dec 09.

„ Current NPL entries continue to be driven by SMEs and real estate, while residential
mortgages continue to show relative stability at 2.87% (Dec 2009).

NPL ratio vs. Employment growth (reversed) Real estate Asset quality
12.00%
8.0% 6.0%
6.0% 10.00%
5.0%
4.0% 8.00%
4.0%
2.0%
6.00%
0.0% 3.0%
Jun-99
Dec-99
Jun-00
Dec-00
Jun-01
Dec-01
Jun-02
Dec-02
Jun-03
Dec-03
Jun-04
Dec-04
Jun-05
Dec-05
Jun-06
Dec-06
Jun-07
Dec-07
Jun-08
Dec-08
Jun-09
Dec-09

-2.0% 4.00%
2.0%
-4.0% 2.00%
1.0%
-6.0%
0.00%
-8.0% 0.0%
P

P
ar
AR

AR

AR

AR
SE

SE

SE

SE

SE
M
M

09
05

06

07

08

09
05

06

07

08
Employment creation (reversed) System NPL ratio rhs

20
20

20

20

20

20
20

20

20

20
Residential Mortgages Construction Real Estate
Source: Bank of Spain, Company data, Santander Investment Bolsa

13
Real estate adjustment well advanced

„ Banks average exposure to residential real estate developers is 9% of the loan book with
an NPL ratio close to 10%. If we add back the acquired real estate (€14bn gross) we
estimate the adjusted NPL ratio would be close to 28% in this segment.

„ This does not include €59bn of restructured loans (substandard risk), equivalent to 18%
of real estate loans, and 3.2% of the system loans. We expect some of them to become
non performing over the next 2 years.

“Problem” loans close to 10% of the system loan book Developer NPL ratio including purchased assets
6.0% 40.0%
5.1%
5.0% 35.0% 34.7%
30.4%
4.0% 29.0% 28.7%
30.0% 27.1%
3.2%
24.0% 23.8%
3.0% 25.0%

2.0% 1.6% 20.0%

1.0% 15.0%
ar

ll
r
er

to
VA
or
0.0%

de

de
l

nt

s
st
pu

BB

ne
an

ba
Pa

i
System NPL ratio Substandard risk Real Estate Purchases

nk
Po

Ba
nt

Sa
Ba

Sa
Source: Bank of Spain, Santander Investment Bolsa

14
Provisioning efforts still high in 2010

„ Coverage is close to 60%, but increased provisioning requirements in real estate and
substandard risk, mean 2010 will still be a year of high loan loss charges.

„ The 2 year provisioning calendar and the lower NPL formation since 2H09 point to
provisions comning down more materially in 2011.

„ We estimate domestic banks will have provisioned 6% of their loan book by 2011,
including MVC writen-down to €15 vs. €32, and coverage on RE purchases reaching 35%.
Average provision charge estimates
Coverage on purcahsed RE assets (Dec 2009)
2.50%
40.0%
2.00% 35.0% 32.0% 32.0%
0.3%
0.6% 30.0%
1.50%
25.0% 22.7%
0.2% 20.2%
1.00%
1.7% 20.0%
1.3% 14.0% 14.0% 14.0%
0.50% 1.0% 15.0%
0.9%
0.6%
10.0%
0.00%
-0.2%

ar
l
r

er
to
VA

or
2008 2009E 2010E 2011E 2012E

el
de

l
s

nt

st
pu
BB

ne
an

ba

Pa
i
nk

Po
-0.50%
Ba
nt

Sa
Ba
Sa

Net provisioning charge Generic Provision

Source: Bank of Spain, Santander Investment Bolsa

15
BBVA & POP our top picks for a recovery

„ We have a €15 price target on BBVA. We believe BBVA will offer higher-than-
average resilience in earnings in Spain in 2010E, while at the same time it is a play
on recovery in Mexico and the US. The stock is trading at 1.8x P/TBV on our
estimates, with sustainable ROEs north of 20%.

„ We have a €7.20 target price on POP. We believe it could more than double
earnings as its provision charge should fall from 160bp to a more normalised 60bp
in 2012E. On our estimates the stock is trading on 7.0x normalised earnings vs
8.0x for the average European banks.

COUNTRY CURRENT PE P/TgBV

Bank PRICE M. Cap Outstanding Rating 2009E 2010E 2011E 2009A 2010E 2011E
SPAIN 12.00 14.29 12.32 1.35 1.27 1.21
SANTANDER 10.37 85,292 8228.826 NR 9.96 9.29 8.30 1.95 1.77 1.61
BBVA 10.93 40,947 3747.969 Buy 9.91 8.51 8.16 1.89 1.78 1.75
B. POPULAR 5.76 7,679 1333.152 Buy 9.64 13.16 8.49 1.04 0.99 0.93
BANESTO 8.46 5,817 687.387 NR 10.40 8.97 8.18 1.08 0.92 0.86
B. SABADELL 4.13 4,957 1200 Underweight 9.88 16.16 11.58 1.16 1.12 1.07
B. PASTOR 4.39 1,172 266.919 Underweight 11.37 23.08 17.58 0.82 0.80 0.77
BANKINTER 6.28 2,973 473.448 Hold 10.99 11.84 12.96 1.23 1.17 1.11
Average Domestic 10.46 14.64 11.76 1.07 1.00 0.95
AVERAGE EUROPE 22.08 12.06 10.25 1.13 1.06 0.98
AVERAGE EUROPE EX UK 26.75 12.29 10.64 1.11 1.05 0.97

16
Fiscal and Regulatory Environment Deteriorates
C o n s u m p tio n
Government Measures
F is c a l t r e a t m e n t R e g u l a ti o n
V A T r a i s e d to 1 8 % f r o m 1 6 % (8 % fr o m 7 % b a s ic ) in J u ly
2010 E n l a r g e m e n t o f r e t i r e m e n t a g e f r o m 6 5 to 6 7
E x te n s i o n o f u n e m p l o y m e n t b e n e fi t s t o l o n g te r m
E lim in a t io n o f d e d u c t io n o f € 4 0 0 / p e r s o n u n e m p lo y e d
R a is e in s p e c ia l t a x e s ( g a s o lin e a n d t o b a c c o )
R e ve rs a l o f " B e ck h a m L a w "
E l i m i n a t i o n o f t a x i n c e n t i v e s to a c q u i s i t i o n o f h o u s e s
C a p i ta l g a i n s t a x ra i s e d fr o m 1 8 % t o 1 9 - 2 1 %

E l i m i n a t i o n o f g o o d w i l l d e d u c ta b i l i ty f o r a c q u i s i ti o n s a f te r
C o r p o r a te s 2007

E le c t r ic U t i li t ie s A id t o b u r n d o m e s t ic c o a l

T e le c o m s + 0 . 9 % T a x o n r e v e n u e s t o f in a n c e T V E ( in
T e le c o m s / m e d i a r e v ie w b y E U )
M e d ia F T A + 3 . 0 % T a x o n r e v e n u e s t o f in a n c e T V E

M e d i a P a y T V + 1 .5 % T a x o n r e v e n u e s to fi n a n c e T V E

P harm a C h a n g e s i n r e fe r e n c e p r i c e m e c h a n i s m
R e d u c t io n o f 2 5 % in g e n e r ic d r u g s p r ic e s

F i n a n c ia l s I n t ro d u c t i o n o f F R O B t o f o s t e r S & L r e s tr u c tu r i n g
P r o v i s i o n i n g r e q u i r e m e n ts s o f te n e d

R e d u c t i o n i n p u b l i c i n v e s tm e n ts o n t h e b a c k o f a u s te r i r t y
C o n s t ru c t i o n p la n

ƒ Government fiscal imbalances and mounting international pressure to fix them might require more measures in
the future

ƒ Consumers and corporations are progressing on their deleveraging process, but are likely to be the target of
raising fiscal and regulatory pressures

ƒ Salary contention, increasing taxes and stubbornly high unemployment will limit progresses on consumer
spending

ƒ Reduced remuneration on regulated assets, anaemic demand and more intervention should affect regulated
sectors

17
The Spanish State Could Dispose Some Assets

Portfolio of Companies with State Participation

Lis te d Compa nies Stak e Sec tor Va lue (€ mn)

EA DS 5.48 Ae ro sp ace 616 .9
Ebro P uleva 8.45 Food 184 .5
Ena gás 5.00 G as G rid 182 .9
Iberia 5.26 Airlines 106 .6
REE 20.00 Electricity Grid 970 .4
TO TAL listed 2,061 .3
Non Listed Companies Stak e Sec tor Va lue (€ mn)
AE NA 100.00 Airports
ADIF 100.00 Railways
Age ncia E FE 100.00 Me dia
RTVE 100.00 Me dia
Apu est as del Estado 100.00 G am bling
Hispasat 7.41 Sa tellite s
Hunosa 100.00 Minin g
Navantia 100.00 Sh ipb uilding
TO TAL n on listed 4 2,100 .0

TO TAL listed a nd no n listed stakes 4 4,161 .3

ƒ The Spanish state sold 61 public companies in 1992-2007 with proceeds totalling €45bn

18
Utilities: The Tariff Deficit Piles-up

Tariff Deficit Expected Evolution Sources of Deficit

50 0 0 0 14 ,0 0 0 R ENE WAB LE 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E
Ou tp ut %
W ind 41% 42% 42% 43% 43% 44% 44% 45%
4 50 0 0
H ydro 6% 6% 5% 5% 5% 4% 4% 4%
12 ,0 0 0 P ho tovo ltaic 7% 7% 8% 8% 8% 8% 7% 7%
40000 T herm osolar 0% 1% 2% 3% 4% 4% 4% 4%
B iomas s 3% 3% 4% 4% 4% 4% 4% 4%
10 ,0 0 0 W as te 3% 3% 3% 3% 3% 3% 3% 3%
3 50 0 0
W as te T reat 4% 4% 4% 4% 3% 3% 3% 3%
C ogeneration 36% 34% 33% 31% 31% 30% 30% 30%
30000 T OTAL 100% 100% 100% 100% 100% 100% 100% 100%
8 ,0 0 0 S ub sid y %
W ind 22% 22% 22% 21% 20% 20% 21% 22%
2 50 0 0
H ydro 3% 3% 3% 3% 2% 2% 2% 2%
P ho tovo ltaic 39% 40% 38% 37% 37% 36% 36% 35%
6 ,0 0 0
20000 T herm osolar 1% 4% 8% 11% 14% 16% 17% 17%
B iomas s 3% 3% 3% 3% 3% 3% 3% 3%
W as te 1% 1% 1% 1% 1% 1% 1% 1%
150 0 0
4 ,0 0 0 W as te T reat 4% 4% 4% 3% 3% 3% 3% 3%
C ogeneration 26% 23% 22% 20% 19% 18% 17% 17%
10 0 0 0 T OTAL 100% 100% 100% 100% 100% 100% 100% 100%

2 ,0 0 0
50 0 0

0 0
2002 2004 2006 2008 2 0 10 2 0 12 2 0 14 2 0 16

Cummulat iv e S ec ur it ised Tar if f Def ic it

ƒ Tariff deficit expected to total €10bn in 2010 and growing by more than €4bn/year

ƒ System revenue increases do not cover the high inflation in costs generated by the shift to renewables

ƒ Aids to domestic coal highly the higher degree of government intervention

ƒ Photovoltaic accounts for the largest portion of subsidies

19
Telecoms: Telefónica, a good Value Story

EuropeanDivTelecoms
id e n d y ie ld – DY (%) Telefónica – Relative P/E Ratio
F o rw ard P E p e rf o rma nc e

1 8 .0
1 2 .0 %
1 6 .0
1 0 .0 %
1 4 .0
8 .0 % 1 2 .0
- 1 7% -2 0%
6 .0 % 1 0 .0

4 .0 % 8 .0
6 .0
2 .0 %
4 .0
0 .0 %
2 .0
TI KPN PT PT T EF DT FT T EF T EF
0 .0
2 01 0 2 0 10 2 01 1 2 01 0 2 01 0 2 01 0 2 01 1 2 01 2
2004 2005 2006 2007 2008 20 0 9 e 20 1 0 e

ƒ Appealing multiples: 9.3x P/E 2010

ƒ The strongest value story in the sector: 12% yield in the next 16 months (€2.05 per share)

ƒ Catalysts: negative news flow could disappear across the year

ƒ No takeover bid on Telecom Italia

ƒ No overpayment for spectrum in Germany

ƒ Gap capacity vs. America Movil in Mexico to be reduced, Vivendi won’t bid for spectrum

ƒ GVT will not enter in Sao Paulo this year, Telesp could upgrade the network meanwhile

ƒ Competition in Spain is not tangible

20
Construction: Sharp Reduction in Civil Works Activity

Spain – Public Tenders (2004-2013E) Spain – Public Investments (2004-2013E)

50000000
60000 6.0%

45000000

50000 5.0%
40000000

35000000
40000 4.0%
30000000

25000000
30000 3.0%

20000000

20000 2.0%
15000000

10000000
10000 1.0%

5000000

0 0 0.0%
2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E
2008 2009 2010E 2011E 2012E 2013E
C entral Go v ernm ent A uto no m o us R egio ns Lo c al A utho rities
P ublic Inves tm ents % GD P

ƒ Public Tenders flat in 2009 thanks to local (+58% on the back of the Plan E) offsetting the negative evolution of Central (-28%) and
regional (-6%) governments

ƒ Plan E incentives to be trimmed from €8bn in 2009 to €5bn in 2010

ƒ The government aims to cut public investments by some 14%in 2008/2013 and the weight on GDP from 4.0% to 2.9%

ƒ In order to partially offset the decline, €15bn PPIs could be auctioned in 2010-2011

21
Cyclicals: Some Compelling Valuation Stories
Iberian Cyclicals – Gap between current valuation and average multiples

11.0 7.0

10.0 6.0

9.0 5.0

8.0 4.0

7.0 3.0

6.0 2.0

5.0 1.0

4.0 0.0

3.0 -1.0

EV/Norm EBITDA Average EV/EBITDA Difference

22
Preference Towards Internationally Diversified Companies

US$ Exposure
Iberian Companies by Domestic Exposure
S pain - IBEX 35 Latam U S$ L atam+U S$
Reven u es EBIT R evenu es Reven ues A bengoa 25 23 48
Do mestic Do mestic Do mestic D om estic B anco Santander 47 0 47
S pain - IBEX 35 (%) (%) Sp ain - SM C (%) P ortug al (%)
B ME 100 100 Banc o Guipuzcoano 100 R EN 100
B BVA 30 16 46
E nagas 100 100 Banc o Pastor 100 S onaeCom 100 E bro Pulev a 5 39 44
T elecinco 100 100 Banc o de Valencia 100 Z ON Mul tim edia 100 Grifols 8 35 43
B anesto 100 100 Antena 3 100 S onae SGPS 92
Iberdrola Renovabl es 6 35 41
B anco Sabadell 100 100 Jazztel 100 B ri sa 88
B ankinter 100 100 Vocento 100 Galp 79 E ndesa 40 0 40
B anco Popular 100 100 Zardoy a O tis 93 B PI 78 T elefonica 37 0 37
R EE 98 98 Clini ca Baviera 90 E DP 78 A cerinox 0 35 35
S acy rVallehermos o 84 88 Corporacion Derm oestetic a 90 B CP 74
A CS 77 81 Rovi 85 S emapa 73
M apfre 23 9 32
A cciona 67 88 Solaria 80 A ltri 71 IBEX 35 25 6 31
Indra 65 69 Cem entos Portl and 76 M ota Engil 69 S pain - SM C Latam U S$ L atam+U S$
Iberia 61 61 Dinam ia 75 M artifer 67
V isc ofan 20 25 45
E ndesa 60 60 Grupo Prisa 75 Jeronim o M artins 61
Gas Natural 60 66 Baron de Ley 70 P ortugal Telec om 55 S ol M elia 30 0 30
F CC 57 65 Faes 70 E DP Renovaveis 51 P ros egur 27 0 27
M apfre 54 77 Catalana Occidente 66 T eixeira Duarte 49 Grupo Pris a 25 0 25
A bertis 51 55 CF Alba 65 S onae Industria 26
R eps ol 51 40 Zel tia 64 B ES 23
T ubac ex 0 20 20
C riteria C aixaCorp 49 48 Alm irall 59 C im por 23 C em entos Portland 4 13 17
Iberdrola Renovabl es 48 48 Prosegur 51 P ortuc el 0 E NCE 13 0 13
E bro Puleva 45 40 Vidrala 50
N H Hoteles 9 0 9
OH L 44 33
Iberdrola 43 46 Sol Melia 40 A lmirall 0 6 6
B BVA 39 41 EN CE 20 S MC 4 3 7
T elefonica 37 47 NH H oteles 18 P ortug al Latam U S$ L atam+U S$
B anco Santander 37 37 Viscofan 15
Gam esa 36 47 Tubac ex 10 P ortugal Telec om 41 0 41
F errovial 35 19 B ES 18 8 26
Inditex 32 36 C im por 19 0 19
A bengoa 28 30
Grifols 24 28
E DP 17 0 17
T ecnicas R eunidas 23 25 B ri sa 12 0 12
A cerinox 12 17 E DP Renov aveis 0 10 10
A rc elor Mittal 7 7
P ortuc el 0 10 10
Ibex 35 44 47 Spain - SM C 71 P ortugal 61
S onae Industria 8 0 8
T eixeira Duarte 5 0 5
M ota Engil 2 0 2
P ortugal 11 2 13

23
Spanish Companies have Significant Exposure to Latam
Spanish IBEX 35 Members – Latam Exposure
Reven ues EB IT
Oth er To tal Other To tal
C om pan y Arg entina B raz il M exico Latam Latam Arg entina Brazil Mexico Latam Latam
B anco Santander 3 22 8 14 47 3 22 8 14 47
E ndesa 2 8 0 30 40 2 8 0 30 40
T elefonica 3 18 3 13 37 1 18 0 15 34
R eps ol 23 1 1 5 30 33 1 1 10 45
B BVA 2 0 25 3 30 1 0 30 4 35
C riteria C aixaCorp 8 7 3 7 25 8 10 3 12 32
Gas Natural 4 7 6 8 25 0 6 6 16 28
A bengoa 0 14 5 6 25 0 17 4 4 25
M apfre 2 8 3 10 23 1 4 1 4 10
Iberia 2 3 4 5 14 2 3 4 6 14
OH L 0 6 2 4 12 0 29 21 8 58
A rc elor Mittal 2 8 1 1 12 2 8 1 1 12
Iberdrola 0 6 3 2 11 0 5 5 3 13
Indra 1 2 2 3 10 1 2 2 3 8
Inditex 0 1 7 1 9 0 1 5 0 6
Grifols 1 2 3 2 8 1 1 2 2 6
T ec nicas R eunidas 0 2 2 3 7 0 1 1 3 5
Iberdrola Renovabl es 0 2 2 2 6 0 0 0 0 0
A CS 1 1 1 1 4 1 1 1 1 4
A bertis 1 0 0 2 3 1 0 0 1 2
S acy rVallehermos o 0 0 0 3 3 0 0 0 7 7
F errovial 0 0 0 2 2 0 0 0 9 9
R EE 0 0 0 2 2 0 0 0 2 2
IBEX 35 3 9 5 8 25 3 9 5 9 26
IBEX 35 (ex financial 3 8 2 7 20 3 8 2 9 21
ƒ Amongst Small & Mid Caps, Sol Melia (30%), Prosegur (50%), Prisa (25%), Viscofán (20%) and NH Hoteles (9%)

24
Stock Selection

Spanish Equity Market – Main Stock Recomendations

International Latam Financial Low Refinancing Low low Interest Rate Valuation Growth
Diversification Exposure Strength Risk FlowBack Sensitivity

Telefónica ☺ ☺ ☺ ☺ ☺ ○ ☺ ○
BBVA ☺ ☺ ☺ ☺ ☺ ○ ☺ ☺
Inditex ☺ ○ ☺ ☺ ☺ ☺ ☺ ☺
Tecnicas Reunidas ☺ ○ ☺ ☺ ☺ ☺ ☺ ☺
Acerinox ☺ ○ ☺ ☺ ☺ ☺ ☺ ☺
Tubacex ☺ ○ ☺ ☺ ☺ ☺ ☺ ☺
B: Popular ○ ○ ☺ ☺ ☺ ○ ☺ ☺
Enagás ○ ○ ○ ☺ ○ ○ ☺ ○
Sol Melia ☺ ☺ ○ ☺ ☺ ☺ ☺ ☺
Vocento ○ ○ ○ ☺ ☺ ☺ ☺ ☺
Ferrovial ☺ ○ ○ ○ ☺ ○ ☺ ○
Acciona ○ ○ ○ ○ ☺ ○ ☺ ☺

25
Spanish Equity Market – Sector and Stock Selection

International
BBVA
Banks

Basic Materials Acerinox

Overweight Industrials Tubacex

Telecoms Telefónica

Oils Técnicas Reunidas

Domestic
B. Popular
Banks

Utilities Acciona, Enagás

Underweight Media Vocento

Consumer
Inditex, Sol Melia
Sectors

Construction Ferrovial

26
27