2015_03_13_SAB bid on TSB

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

Banco Sabadell

13 March 2015 Banks Update

Diversifying away from Spain Andrea Filtri

Equity Analyst

SAB to bid for TSB at GBp340 by 9 April Yesterday SAB disclosed it is in talks with LLOY and TSB over the potential acquisition of TSB for GBp340 per share, 29% premium on the previous closing price and €2.4bn consideration. SAB will have to submit a bid by 9 April, which the two UK banks would both support. The price implies a valuation of 1.04x TE for 4.5% 2015E RoTE, raising to 6.9% when stripping out c.€0.8bn excess capital.

TSB: a sub-scaled domestic retail franchise positioned for UK rate hikes TSB derives from an EU-Commission mandated spin-off from LLOY following the state support received by the UK giant. 631 branches, and 19% CET1 ratio are oversized compared with the small £19bn loans, implying TSB is a story of organic balance sheet expansion, i.e. the typical profile of a Challenger Bank. High exposure to SVR mortgages positions TSB for UK rate hikes.

Cross border M&A: 1st mover on Banking Union or low confidence on Spain Over the last few weeks we have seen CABK bidding for Portugal’s BPI, POP in talks to buy Citi’s Central American units and SAB in talks to buy domestic, sub-scaled UK retail. More than the M&A move, perhaps attempting to gain a 1st mover advantage in cross border consolidation for the Banking Union, we are surprised about timing. Yesterday’s share price performance (-6.6%) reflects the potential execution risk and the dilution of peripheral pure play premium in a moment where Southern Europe is in vogue. Also, we believe the market could interpret the Spanish banks’ M&A and the several stake placements in Italy (MB, MS, Enel, …) as a sign of rich valuation ahead of visible EPS recovery.

Three scenarios of M&A: CET1 gearing vs EPS accretion ‘SAB expects to finance the transaction on a capital neutral basis’. We run three simulations of SAB-TSB merger based on cost synergies in line with historical cross border average (16% of target costs): 1) pure leverage; 2) ALCO sale; 3) stable CET1, to check the sensitivity of EPS from different ways of funding the acquisition. We find between -15% and +20% impact to 3-yr EPS from the sale of ALCO (CET1 gearing limited to 50bp) or a 150bp CET1 gearing. Raising €1.35bn would keep CET1 stable and +5% to EPS, reflecting the leveraging of TSB’s high capital ratio.

Short-term political risk, complexity and diversification call for a discount UK, Spain and Portugal hold elections in 2015. These could provide uncertain outcomes given the rise of new, challenger parties with anti-EU, anti-Euro and anti-banks manifestos. Political risk, combined with higher geographical diversification and higher regulatory complexity mandate for a valuation discount. As such, we believe the €0.8bn TSB estimated excess capital is unlikely to be fungible to SAB, given the tough approach to domestic capitalization of banks showed by the UK regulator in the last 5 years.

Reiterate Underperform on lower quality capital, earnings and business mix SAB’s capital is highly reliant on DTA/DTC and badwill, while 40-60% of 2015-17E earnings derive from carry trade. Also, the 4 domestic acquisitions (CAM, LLOY ES, CP, BG) made in the last 3 years diluted SAB’s traditional SME-focus. We see SAB on 1x TE for an average 2016E RoTE of 8.6% post-TSB buy. We consider this unattractive and reiterate our Underperform and cut TP to €2.2 (from €2.4).

+44 203 0369 571

[email protected]

Andres Williams

Equity Analyst

+44 203 0369 577

[email protected]

Adam Terelak

Equity Analyst

+44 203 0369 574

[email protected]

Jean Farah

Equity Analyst

+44 203 0369 665

[email protected]

Source: Mediobanca Securities

Price: € 2.32 Target price: € 2.20 Underperform

2014 2015E 2016E 2017E

EPS Adj (€) 0.09 0.18 0.24 0.28

DPS (€) 0.05 0.09 0.12 0.14

TBVPS (€) 2.35 2.40 2.61 2.87

Avg. RoTE Adj (%) 4.2% 8.5% 10.4% 11.0%

P/E Adj (x) 26.0 12.8 9.9 8.4

Div.Yield(%) 2.2% 3.9% 5.1% 5.9%

P/TBV (x) 1.0 1.0 0.9 0.8

Market Data

Market Cap (€m) 9,280

Shares Out (m) 3,998

Main Shareholder Name (%) 10%

Free Float (%) 100%

52 week range (€) 2.66-2.04

Rel Perf vs STOXX EUROPE 600 (%)

-1m -1.4%

-3m -9.2%

-12m -17.7%

21dd Avg. Vol. 28,573,233

Reuters/Bloomberg SABE.MC / SAB SM

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Banco Sabadell

13 March 2015 ◆ 2


Valuation Matrix



Profit & Loss Acc(€ m) 2014 2015E 2016E 2017E Multiples 2014 2015E 2016E 2017ENet Interest Income 2,260 2,708 2,871 2,890 P/E 26.0 12.8 9.9 8.4Growth (%) 24.5% 19.9% 6.0% 0.6% P/E Adj. 26.0 12.8 9.9 8.4Non-Interest Income 2,541 1,237 1,298 1,371 P/Net Op.Income 3.5 5.1 4.6 4.4Growth (%) 17.5% -51.3% 5.0% 5.6% P/Revenues 2.0 2.4 2.3 2.2of which Fee Income 861 913 958 1,006 P/TBV 1.0 1.0 0.9 0.8of which Financial Income 1,764 406 422 447 P/Total Deposits (%) 9.7% 9.5% 9.2% 9.0%Total Income 4,801 3,946 4,170 4,261 Yield (%) 2.2% 3.9% 5.1% 5.9%Growth (%) 20.7% -17.8% 5.7% 2.2%Total Costs -2,051 -2,071 -2,091 -2,112Growth (%) 7.2% 1.0% 1.0% 1.0%of which Personnel Costs -1,203 -1,206 -1,208 -1,220Net Operating Income 2,749 1,874 2,078 2,148Growth (%) 33.3% -31.8% 10.9% 3.4%Provisions&Write-downs -2,500 -900 -801 -642 Per Share Data (€) 2014 2015E 2016E 2017EExtraordinary Items 237 32 24 18 EPS 0.09 0.18 0.24 0.28Pre-tax profit 250 974 1,277 1,506 EPS growth (%) 44.9% 103.2% 29.5% 17.2%Tax -110 -239 -313 -369 EPS Adj. 0.09 0.18 0.24 0.28Tax rate(%) 44.0% 24.5% 24.5% 24.5% EPS Adj. growth (%) 44.9% 103.2% 29.5% 17.2%Minorities and others -5 -22 -23 -25 TBVPS 2.35 2.40 2.61 2.87Net profit 372 745 965 1,130 DPS Ord 0.05 0.09 0.12 0.14Growth (%) 50.4% 100.4% 29.5% 17.2%Adjusted net profit 367 745 965 1,130Growth (%) 48.3% 103.2% 29.5% 17.2%

Balance Sheet (€ m) 2014 2015E 2016E 2017E Key Figures & Ratios 2014 2015E 2016E 2017ECustomer Loans 110,836 113,828 118,609 123,828 Avg. N° of Shares (m) 4,104 4,104 4,104 4,104Growth(%) -1.9% 2.7% 4.2% 4.4% EoP N° of Shares (m) na na na naCustomer Deposits 98,208 100,664 103,180 105,760 Avg. Market Cap. (m) 9,522 9,525 9,525 9,525Growth(%) -1.2% 2.5% 2.5% 2.5%Shareholders' Funds 10,224 10,596 11,561 12,691 NII/Total Income (%) 47.1% 68.6% 68.9% 67.8%Minorities 55 110 112 114 Fees/Total Income (%) 17.9% 23.1% 23.0% 23.6%Total Assets 139,856 140,937 142,876 145,236 Trading/Total Income (%) 36.7% 10.3% 10.1% 10.5%

Cost Income ratio 42.7% 52.5% 50.2% 49.6%Personnel costs/Total costs 58.6% 58.2% 57.8% 57.8%Impairment/Average Loans 2.2% 0.8% 0.7% 0.5%NPLs ratio 12.8% 11.2% 10.2% 9.6%Provisions/Loans 6.2% 5.7% 5.2% 4.8%

Avg. RoTE Adj. (%) 4.2% 8.5% 10.4% 11.0%ROA (%) 0.27% 0.53% 0.68% 0.78%Tier 1 ratio 10.6% 10.5% 10.4% 10.7%Basel III Core Tier 1 ratio 11.1% 9.7% 9.6% 9.8%

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M A M J J A S O N D J F M

Banco Sabadell STOXX EUROPE 600

12/03/15

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Banco Sabadell

13 March 2015 ◆ 3


Re-Armada Cross border M&A: 1st mover on Banking Union or low confidence on Spain

Over the last month the market has been hit with a string of acquisition news from Spanish domestic banks:

CABK has bid Portugal’s BPI;

POP has been in negotiations to acquire the Central American businesses of Citi and subsequently walked away;

SAB has disclosed it is in negotiations with LLOY and TSB for the acquisition of the latter.

Within the context of European QE and in the wake of Spanish economic recovery, domestic players are clearly looking outside.

SAB bid on TSB: 340pp per share or 1.04x TE for 4.5% RoTE...

Table 1 summarises the main financials of the SAB offer for TSB shares reported in the regulatory filing made by the banks involved, this morning. The GBp340 offer price is 29% above the closing price of the previous day and implies c.£1.7bn (€2.4bn) total consideration or a valuation of 1.04x TE. This compares with a 2015E RoTE of 4.5%.

...but €0.8bn excess capital is the real target. Not fungible though, in our view.

TSB is running on an overcapitalised balance sheet, with CET1 FL ratio of 19.7%. Realigning this ratio to SAB’s 11.5% implies €0.8bn excess capital. Excluding this would lift RoTE to 6.9%. Even post adjustment, the 1.04x TE valuation looks rich to us.

Table 1: summary of SAB’s offer on TSB TSB shares, m 500

Share price, GBp 264

Offer price, GBp 340

Premium, % 29%

Outflow GBP, m 1,700

Outflow Euro 2,429

TSB TE, GBP m 1,634

Implied P/TE 1.04

RoTE 2015 4.5%

2014 CET1 FL ratio 19.7%

RWAs 2014 6,930

Excess capital vs SAB CET1, € m 812

ROTE excl. excess capital 6.9%

Source: Mediobanca Securities, company data

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Banco Sabadell

13 March 2015 ◆ 4


TSB: subscaled franchise exposed to rate hikes The profile of a ‘Challenger bank’ The TSB franchise consists of the original 631 included earmarked by the European Commission for divestment in Lloyd’s project Verde. As of FY2014 franchise lending was £18.8bn which management intends to grow by c. 50% over the next 4-5 years. Customer deposits were £24.6bn resulting in a 76.4% loan to deposit ratio. On listing last year the franchise held 4% of the UK’s personal current account market, an area in which management retain serious ambitions to grow, targeting 6% of gross ‘current account flow’ each year. FY2014 performance reflects that the franchise is yet to expand fully into the capabilities that 631 branches provides with the loan book someway short of the cost base. Franchise income was £855m against £696m of costs resulting in a cost-income ratio of 81.4%, some way ahead UK peer group average which is trending to c. 50%. Furthermore management expect further increases in costs into FY2015 with a maximum £720m targeted as the full platform is rolled out. FY2014 also demonstrated TSB’s desire to grow market share as they managed to capture 8.4% of the gross current account flow, ahead of the 6.0% target.

TSB: a tough route to market

Lloyds Banking group was asked to divest 632 branches from its network as part of the agreement with the European Commission for the £20bn state bail-out Lloyds received in 2008 within a 5 year deadline through to November 2013. The process of disposing these branches, subsequently referred to as project Verde, came at some cost to Lloyds who had to carve out a fully operational and independent bank. In 2012, Lloyds confirmed that a £1.25bn deal had been agreed to sell the branch network to the Co-operative banking group, however this deal fell through after a £1.5bn capital hole was discovered in the Co-op’s balance sheet in April 2013. Lloyds has since applied to the EC and has been approved for a 2 year extension to the agreement, with disposal now required

Table 2: TSB

FY2014

Balance sheet (£bn)

Franchise lending 18.8

Targeted growth 50%

Deposits 24.6

Loan-deposit ratio 76%

Personal current accounts

PCA market share (1H14) 4%

Targeted gross flows 6%

Gross flows captured 2014 8.40%

2014 performance (£m)

Franchise income 855

Expenses 696

Maximum 2015 expenses target 720

Cost - income ratio 81%

Other

Branches 631


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Banco Sabadell

13 March 2015 ◆ 5


by the end of this year. In June last year the EC also approved Lloyds’ plans to list the branch network as a stand-alone challenger bank, which would revive the TSB franchise, paving a way for an immediate IPO of the business. Listed at a premium reflecting strong capitalisation and absence of legacy

On 20th June, Lloyds listed 35% of its stake in TSB at 260p per share (it had initially planned to only list 25%) valuing the bank at 0.8x book value although the shares jumped to 290p on the first day’s trading, equivalent to a 0.9x valuation. Since then shares have traded between this level and 0.75x, despite producing only a 4% return on equity for FY2014 and an a subdued outlook for earnings in the short-term with analysts forecasting a 10% return by FY2018. On this basis the shares have thus traded at a premium to UK peers reflecting the strong capitalisation of the bank, which had a 19.7% FLB3 CET1 ratio in FY2014, and an absence of the legacy issues affecting other UK banks, including soaring costs for PPI & interest rate hedging products mis-selling and other litigation issues.

The bull case on TSB TSB is UK’s most geared bank to changes in the Base Rate…

We see TSB as a geared play to UK interest rate recovery. This is owed to its large exposure to a variable-rate mortgage book combined with its sizeable more sticky-current account deposits. At 19%, the share of non-interest bearing deposits is larger than that of other UK banks. As at FY14A, 82% of TSB’s GBP 19bn mortgage book was on variable rates, with 53% on the Standard Variable Rate, capped at 2% above the Base Rate. Mortgages make up 90% of TSB’s loan book, and hence, variable rate products (broadly mimicking base rate moves) account for a hefty 73% of its loans.

... a 50bp increase leads to +20% EPS

Table 3: TSB split of mortgage book (GBP m)

2014A Share of book

Franchise book

Fixed rates 3,199

SVR 10,186

HVR 1,348

Tracker 1,848

Enhancement book

Fixed rates 360

SVR 0

HVR 1,631

Tracker 812

Total

Variable rates 15,825 82%

SVR 10,186 53%

HVR 2,979 15%

Tracker 2,660 14%

Fixed rates 3,559 18%

Total mortgage book 19,384 100%


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Banco Sabadell

13 March 2015 ◆ 6


As such, we estimate that a 50bps increase in the UK base rate could lead to a NII uplift of GBP 45m. This is equivalent to c20% on normalised earnings (ex hedges).

Potential restructuring story from matching the share of branches to that of deposits

Since the publication of the prospectus mid last year, the market is well aware of TSB’s bloated cost base relative to its size. Indeed, this stems from a disconnect between its share of branches to that of deposits. As at FY13A, the group held a 1.3% share of UK deposits, while its market share of branches is 4x higher at 5.5%. Even if TSB manages to grow its Franchise book by a not-so conservative 40-50% until 2018, as guided by management (implying loans of GBP 28-30bn), its branch network relative to its deposit base will remain deficient relative to peers. In other words, the ratio of deposits per branch will remain well below the industry standard in the UK of GBP 150m/branch. We estimate TSB’s deposit per branch today at c. GBP40m. Any strategy to move to industry standard, via branch shrinkage would be a notable positive for profitability of the bank.

Table 4: TSB rate sensitivity to +50bps in BoE rate

Lending yields 2013A Post rate hike Delta

Mortgages 2.9% 3.3% 0.4%

TSB Franchise 4.4% 4.8% 0.4%

Mortgage Enhancement 3.9% 4.4% 0.5%

TSB total 4.4% 4.7% 0.4%

Deposit yields

Non-interest bearing 0.0% 0% 0.0%

Personal current accounts 1.4% 1.6% 0.2%

Savings 1.4% 1.7% 0.3%

TSB Total 1.2% 1.4% 0.2%

Net NII impact (GBP m) 45

Post-tax impact (GBP m) 35


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Banco Sabadell

13 March 2015 ◆ 7


Balance sheet gearing vs EPS dilution £85m cost synergies…

Table 5 shows the estimated cost synergies SAB could target from the TSB integration. We see £85m cost cuts over three years, representing 16% reduction of TSB cost base. This would imply a 1 p.p. deterioration in the combined C/I ratio 2017. We estimate restructuring costs at 1/3 of TSB costs.

...in line with historical average of cross border mergers

Table 6 shows the history of cross border M&A deals in Europe and the targeted cost and revenues synergies as a percentage of the target bank. We adopted the benchmark to estimate TSB cost synergies and have prudently excluded revenue synergies.

Table 5: SAB-TSB ‘pure leverage scenario’

Revenues and Cost Synergies,£ mn 2013 2014 2015 2016 2017

TSB revenues 587 927 949 1,018 1,088

TSB Costs (376) (696) (731) (746) (760)

Growth y/y 5.0% 2.0% 2.0%

Cost synergies, net of taxes 43 64 85

- % TSB costs 16.0% 16.0% 16.0%

- % total SAB + TSB costs -1.5% -2.3% -3.0%

C/I (pre-synergies) -57% -55% -54%

C/I (post-synergies) -58% -56% -55%

Restructuring costs

Net restructuring costs, tax @ 0% -241


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Banco Sabadell

13 March 2015 ◆ 8


Table 6: summary revenue and cost synergies, May-04 to Sept-14

Date Revenue Costs

RBS/Charter One May-04 12% 24%

Santander/Abbey Nov-04 5% 17%

Danske/Irish NAB Dec-04 0% 19%

ABN AMRO/Antonveneta Mar-05 5% 15%

UCG/HVB Jul-05 1% 15%

Commerzbank/Eurohypo Oct-05 5% 15%

BNP/BNL Feb-06 7% 14%

Natixis Mar-06 9% 9%

BCP/BPI Apr-06 0% 40%

BIN-SPI Aug-06 3% 19%

BIN-SPI (realised) Aug-06 3% 27%

BPVN-BPI Oct-06 17% 22%

Credit Agricole / Cariparma Oct-06 5% 9%

Danske/Sampo Bank Nov-06 0% 18%

BPU/ BL Nov-06 0% 21%

UCG/CAP May-07 6% 24%

RBS/ABN Amro Jul-07 2% 8%

MPS/Antonveneta Nov-07 6% 25%

ISP/Carifirenze Jun-08 9% 29%

DBK/DPB Sep-08 6% 25%

Lloyds/HBOS Sep-08 0% 15%

BNP/Fortis Oct-08 3% 20%

Bankia May-11 0% 17%

POP/Pastor Oct-11 0% 40%

SAB/CAM Dec-11 4% 32%

BBVA/Unnim Mar-12 3% 40%

CABK/BdV Nov-12 0% 38%

SAN/Banesto Dec-12 4% 51%

BBVA/CX Jul-14 0% 40%

POP/Citi Jun-14 0% 20%

CABK/BARC Sep-14 0% 42%

Average (Mean) 4% 24%

Average in-market (Mean) 4% 31%

Average in Spain (Mean) 1% 36%

Average cross border (Mean) 4% 16%


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Banco Sabadell

13 March 2015 ◆ 9


Interpreting the ‘capital neutral’ indication: 3 simulations from MB

The press release by the company provides the following indication on the potential transaction: ‘Sabadell expects to finance the transaction on a capital neutral basis for the Sabadell group and that the transaction will be broadly neutral to Sabadell earnings in the short term and enhancing to earnings in the medium term’. It is yet unclear whether this refers to capital ratios at SAB remaining the same or if the company is contemplating capital options to fund the deal. Given this uncertainty, we produce three different scenarios:

1. The pure leverage scenario 2. The sale of ALCO scenario 3. The stable CET1 ratio scenario.

Scenario 1 - Pure leverage scenario: 150bp CET1 gearing for 20% 3-yr EPS upgrade

Table 7 shows the simulation of the SAB-TSB merger under the ‘pure leverage scenario’ assuming:

1. Restructuring costs to be taken over 2 years;

2. Cost synergies to emerge over three years;

3. No revenue synergies;

4. No capital increase;

5. No disposals to fund the acquisition;

6. 100% TSB acquisition.

The conclusion is:

20% EPS accretion on the 3-yr EPS;

9.5% 3-yr ROI;

160bp CET1 gearing taking the regulatory ratio to 9.9%.

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Banco Sabadell

13 March 2015 ◆ 10


Table 7: SAB-TSB ‘pure leverage scenario’

Impact on Earnings, € Mn 2013 2014 2015 2016 2017

SAB standalone adj. net profit 247 372 745 965 1,130

SAB diluted shares before, m 4,298 4,104 4,104 4,104 4,104

SAB diluted EPS before, €sh 0.06 0.09 0.18 0.24 0.28

TSB net profit 264 141 105 157 110

Restructuring cost, net -258 -86

Cost synergy, net 61 91 122

Revenue synergy, net 0 0 0

TSB Net profit contribution -93 162 232

Earnings loss from ALCO unwind, € m

SAB+TSB adj. net profit, € m 652 1,127 1,362

SAB diluted shares after deal, m 4,104 4,104 4,104

SAB new EPS, €/sh 0.16 0.27 0.33

EPS impact, % -12% 17% 20%

ROI and Implicit PE 2015 2016 2017

ROI, % 6.7% 9.5%

SAB P/E pre-merger, x 13.7 10.6 9.0

Implied PE post-synergies, x 14.2 8.2 6.8

Impact in capital ratios, €Mn 2013 2014 2015 2016 2017

SAB old RWAs, € m 72,876 74,418 77,403 80,654

SAB old Core tier 1 capital, € m 8,566 8,553 8,773 9,103

CET1 FL ratio pre, % 11.8% 11.5% 11.3% 11.3%

TSB RWAs, € 9,900 10,098 10,401 10,817

SAB new RWAs, € 82,776 84,516 87,804 91,471

SAB tier 1 capital, pre 8,566 8,553 8,773 9,103

-Total goodwill / badwill -93 -93 -93 -93

+TSB net profit contribution -93 162 232

+gains from sales of ALCO

+capital raising

SAB core tier 1 capital, post 8,367 8,842 9,241

CET1 ratio 9.9% 10.1% 10.1%


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Scenario 2 - Sale of ALCO: 50bp CET1 gearing for 15% 3-yr EPS dilution

Table 8 shows the simulation of the SAB-TSB merger under the ‘sale of ALCO scenario’ assuming:




4. No capital increase;

5. Entire sale of the ALCO portfolio to realize the €0.9bn net capital gains deriving from it;


The conclusion is:

15% EPS dilution on the 3-yr EPS;

9.5% 3-yr ROI;

50bp CET1 gearing taking the regulatory ratio to 11%.

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Table 8: SAB-TSB ‘sale of ALCO’ scenario





TSB net profit 264 141 105 157 110





Earnings loss from ALCO unwind, € m -470 -430 -401

SAB+TSB adj. net profit, € m 181 697 961


SAB new EPS, €/sh 0.04 0.17 0.23

EPS impact, % -76% -28% -15%


ROI, % 6.7% 9.5%




SAB old RWAs, € m 72,876 74,418 77,403 80,654


CET1 FL ratio pre, % 11.8% 11.5% 11.3% 11.3%

TSB RWAs, € 9,900 10,098 10,401 10,817

SAB new RWAs, € 82,776 84,516 87,804 91,471




+gains from sales of ALCO 900 900 900

+capital raising


CET1 ratio 11.0% 11.1% 11.1%


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Scenario 3 - Stable CET1 ratio scenario: no CET1 gearing, 5% 3-yr EPS upgrade

Table 9 shows the simulation of the SAB-TSB merger under the ‘stable CET1 ratio scenario’ assuming:




4. Capital increase to keep a stable CET1 ratio;

5. Entire sale of the ALCO portfolio to realize the €0.9bn net capital gains deriving from it;


The conclusion is:

5% EPS dilution on the 3-yr EPS;

9.5% 3-yr ROI;

No CET1 gearing.

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Table 9: SAB-TSB ‘stable CET1 ratio’ scenario





TSB net profit 264 141 105 157 110





Earnings loss from ALCO unwind, € m

SAB+TSB adj. net profit, € m 652 1,127 1,362


SAB new EPS, €/sh 0.14 0.24 0.29

EPS impact, % -24% 2% 5%


ROI, % 6.7% 9.5%




SAB old RWAs, € m 72,876 74,418 77,403 80,654


CET1 FL ratio pre, % 11.8% 11.5% 11.3% 11.3%

TSB RWAs, € 9,900 10,098 10,401 10,817

SAB new RWAs, € 82,776 84,516 87,804 91,471




+gains from sales of ALCO

+capital raising 1,350 1,350 1,350


CET1 ratio 11.5% 11.6% 11.6%


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High RoTE volatility depending on M&A funding source

Table 10 shows the summary of the pre-deal P/TE vs RoTE for SAB. This is also replicated for all the merger scenarios we have simulated. We see SAB at 1x 2015E TE for a range of 2015E RoTE of 1.7-6.6%, comparing with the 7.6% stand alone RoTE. Looking forward to 2016 and 2017, we see the capital hike and the pure leverage scenarios as RoTE accretive to the standalone option. The sale of the ALCO portfolio would instead be the most dilutive option, given the gigantic contribution of this investment to SAB’s earnings.

Reiterating Underperform and cutting TP to €2.2

Table 11 is our valuation table on SAB. We cut our Target Price to €2.2 from €2.4 following the TSB news. Our three scenarios indicate an average 2016E RoTE of 8.6%, below our previous stand alone through the cycle level. Adjusting for this explains the cut in valuation. We believe SAB suffers from:

Lower quality capital as a consequence of the high incidence of DTA/DTC and of the badwill generated from CAM;

Lower quality earnings deriving from the high contribution from carry trade which represents an unsustainable short term boost;

The string of acquisitions made has diluted the pure SME-profile of SAB, exposing it to the deleverage of the Spanish consumer and reducing the focus on the higher growth prospects of Spanish SMEs.

Also, we would see a successful bid on TSB diluting the Spanish recovery angle of SAB, increase short term political risk and reduce the exposure to the potential positives deriving from European QE and Regulatory harmonization within Banking Union. In turn, these factors could trigger a multiple de-rating on SAB.

We believe Spanish domestic players should focus on grasping the benefits that the ongoing QE program should bring to NPL recovery, loan and GDP growth (see Click Here, Click Here).

Table 10: P/TE vs RoTE under the different MB scenarios

2014 2015 2016 2017

RoTE SAB standalone 3.8% 7.6% 9.0% 9.6%

RoTE SAB-TSB - k hike 5.8% 9.3% 10.4%

RoTE SAB-TSB - pure leverage 6.6% 10.5% 11.6%

RoTE SAB-TSB - ALCO sale 1.7% 6.0% 7.6%

P/TE SAB standalone, pre-deal 1.0 1.0 0.9

P/TE SAB-TSB, k hike 1.0 0.9 0.8

P/TE SAB-TSB, k pure leverage 1.0 0.9 0.8

P/TE SAB-TSB, ALCO sale 1.0 0.9 0.8


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Double up on political risk: good and bad UK, Spain and Portugal will hold elections in 2015. Through the TSB bid and the BCP stake, SAB could be exposed on all fronts. We see two relevant aspects:

1) The risk of political instability 2) The banking debate in the UK

Following Greek elections earlier this year and domestic corruption scandals and disillusionment from the electorate, new challenger parties are taking ground across Europe. Syriza in Greece, M5S in Italy, Front Nationale in France, Podemos in Spain, UKIP in UK. In the case of the latter two, we summarise the main points of their manifestos:

UKIP:

Leave the European Free Trade Area (EFTA) or European Economic Area (EEA) and negotiate a bespoke trade agreement with the EU to enable businesses to continue trading to mutual advantage.

Lower taxes: Abolish inheritance tax, decrease income tax (introduce a 35% income tax rate between £42,285 and £55,000, whereupon the 40% rate becomes payable, abolish 50% tax).

Remove tuition fees for students taking approved degrees in science, medicine, technology, engineering, maths on the condition that they live, work and pay tax in the UK for five years after the completion of their degrees. Scrap the target of 50% of school leavers going to university. EU students will pay the same student fee rates as International students.

Protect the Green Belt. Planning rules will be changed to make it easier to build on brownfield sites instead of greenfield sites.

UKIP would like to leave the EU, and take back control of UK borders. Work permits will be permitted to fill skills gaps in the UK jobs market. Migrants will only be eligible for benefits (in work or out of work) when they have been paying tax and NI for five years and will only be eligible for permanent residence after ten years.

There is a risk that a large vote for UKIP in the upcoming elections (May 2015) would bring a referendum on the UK staying in the EU and therefore exiting the common economic area that has benefited the UK so far.

Nevertheless, in a more traditional struggle of Labour vs Tories, the structure of the UK banking sector will remain high on the agenda and will come under further scrutiny in the run-up to May’s general election. Within this context, TSB, as a new challenger bank focused on retail, should not feel the ramifications of the political agenda, which is more likely to target the larger, wholesale

Table 11: SAB 2015E valuation

2015E PBT Taxes Minority

interests

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MB

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Weight

range ROAC

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ROAC

Cost of

capital P/TBV Value

Banco Sabadell 974 -239 -22 32 745 77,403 10.0% 6-9% 9.6% 8.6% 8.3% 1.x 8,069

Capital deficit/excess 976

Per share 2.2


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banks with market concentration, ring-fencing of investment banking and banker’s conduct remaining under discussion.

PODEMOS:

Public Banking: Credit and finance is an essential public service. Public banks will be subject to strict conditions to ensure their submission to the above principle.

Financial Transaction Tax: Transaction Tax on all financial transactions, progressive so as to weigh on shorter transactions.

Minimum Wage Rules: Minimum wage increase coupled with rules stipulating the maximum difference between the highest wages and the average wage in companies.

Labor Reform: Repeal recent labor reform.

Pension Reform: A minimum and maximum contribution base to ensure that the system is progressive and trading for real income in the case of autonomous and self-employed.

Higher Business Taxes: Extraordinary increase of corporate social contributions via higher taxes on businesses.

Work Rules: 35 hour work-week, retirement at 65, with flexibility in case someone wants to keep working longer.

Mortgage Reform: Restructuring household debt to provide the greatest possible stability to the system and repair the damage received by families in previous years.

Flat Tax on Everything: Improve income tax collection by having an extensive single rate tax on all types of income, but elimination of joint taxation of marriages.

Wealth Tax: Central government taxation of wealth.

Budget Rules: Delete Article 135 of the Constitution, the newly inscribed constitutional obligation limiting public deficit.

Work Sharing to Protect Women: change the pattern of distribution of working time paid by imposing shorter hours but also by regulating the distribution of housework and unpaid care. Unequal distribution is the main source of discrimination against women and one of the major impediments to advancing equality.

Cooperative Business Models: democratize business by introducing co-management by employees.

Restructure Debt: Europe must adopt debt restructuring, especially in the peripheral countries to achieve sustainable debt levels.

Minimum Income: A guaranteed minimum income system as a subjective right of all people, to eradicate child poverty.

Universal Right to Nourishment: Recognition in the Constitution of the right to food as a universal human right.

Podemos's mostly far left stance risks higher taxes in order to support their social agenda. Mortgage and labor reform would also impact the banks profitability negatively.

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GENERAL DISCLOSURES

This research report is prepared by Mediobanca - Banca di credito finanziario S.p.A. (“Mediobanca S.p.A.”), authorized and supervised by Bank of Italy and Consob to provide financial services, and is compliant with the relevant European Directive provisions on investment and ancillary services (MiFID Directive) and with the implementing law.

Unless specified to the contrary, within EU Member States, the report is made available by Mediobanca S.p.A. The distribution of this document by Mediobanca S.p.A. in other jurisdictions may be restricted by law and persons into whose possession this document comes should inform themselves about, and observe, any such restrictions. All reports are disseminated and available to all clients simultaneously through electronic distribution and publication to our internal client websites. The recipient acknowledges that, to the extent permitted by applicable securities laws and regulations, Mediobanca S.p.A. disclaims all liability for providing this research, and accepts no liability whatsoever for any direct, indirect or consequential loss arising from the use of this document or its contents. This research report is provided for information purposes only and does not constitute or should not be construed as a provision of investment advice, an offer to buy or sell, or a solicitation of an offer to buy or sell, any financial instruments. It is not intended to represent the conclusive terms and conditions of any security or transaction, nor to notify you of any possible risks, direct or indirect, in undertaking such a transaction. Not all investment strategies are appropriate at all times, and past performance is not necessarily a guide to future performance. Mediobanca S.p.A. recommends that independent advice should be sought, and that investors should make their own independent decisions as to whether an investment or instrument is proper or appropriate based on their own individual judgment, their risk-tolerance, and after consulting their own investment advisers. Unless you notify Mediobanca S.p.A. otherwise, Mediobanca S.p.A. assumes that you have sufficient knowledge, experience and/or professional advice to undertake your own assessment. This research is intended for use only by those professional clients to whom it is made available by Mediobanca S.p.A. The information contained herein, including any expression of opinion, has been obtained from or is based upon sources believed to be reliable but is not guaranteed as to accuracy or completeness although Mediobanca S.p.A. considers it to be fair and not misleading. Any opinions or estimates expressed herein reflect the judgment of the author(s) as of the date the research was prepared and are subject to change at any time without notice. Unless otherwise stated, the information or opinions presented, or the research or analysis upon which they are based, are updated as necessary and at least annually. Mediobanca S.p.A. may provide hyperlinks to websites of entities mentioned in this document, however the inclusion of a link does not imply that Mediobanca S.p.A. endorses, recommends or approves any material on the linked page or accessible from it. Mediobanca S.p.A. does not accept responsibility whatsoever for any such material, nor for any consequences of its use. Neither Mediobanca S.p.A. nor any of its directors, officers, employees or agents shall have any liability, howsoever arising, for any error, inaccuracy or incompleteness of fact or opinion in this report or lack of care in its preparation or publication.

Our salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are contrary to the opinions expressed in this research. Our proprietary trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this research. The analysts named in this report may have from time to time discussed with our clients, including Mediobanca S.p.A. salespersons and traders, or may discuss in this report, trading strategies that reference catalysts or events that may have a near-term impact on the market price of the equity securities discussed in this report, which impact may be directionally counter to the analysts' published price target expectations for such stocks. Any such trading strategies are distinct from and do not affect the analysts' fundamental equity rating for such stocks, which rating reflects a stock's return potential relative to its coverage group as described herein.

ADDITIONAL DISCLAIMERS TO U.S. INVESTORS: This research report is prepared by Mediobanca S.p.A. and distributed in the United States by Mediobanca Securities USA LLC, which is a wholly owned subsidiary of Mediobanca S.p.A., is a member of Finra and is registered with the US Securities and Exchange Commission. 565 Fifth Avenue - New York NY 10017. Mediobanca Securities USA LLC accepts responsibility for the content of this report. Any US person receiving this report and wishing to effect any transaction in any security discussed in this report should contact Mediobanca Securities USA LLC at 001(212) 991-4745. Please refer to the contact page for additional contact information. All transactions by a US person in the securities mentioned in this report must be effected through Mediobanca Securities USA LLC and not through a non-US affiliate. The research analyst(s) named on this report are not registered / qualified as research analysts with Finra. The research analyst(s) are not associated persons of Mediobanca Securities USA LLC and therefore are not subject to NASD rule 2711 and incorporated NYSE rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst.

ADDITIONAL DISCLAIMERS TO U.K. INVESTORS: Mediobanca S.p.A. provides investment services in the UK through a branch established in the UK (as well as directly from its establishment(s) in Italy) pursuant to its passporting rights under applicable EEA Banking and Financial Services Directives and in accordance with applicable Financial Services Authority requirements.

ADDITIONAL DISCLAIMERS TO U.A.E. INVESTORS: This research report has not been approved or licensed by the UAE Central Bank, the UAE Securities and Commodities Authority (SCA), the Dubai Financial Services Authority (DFSA) or any other relevant licensing authorities in the UAE, and does not constitute a public offer of securities in the UAE in accordance with the commercial companies law, Federal Law No. 8 of 1984 (as amended), SCA Resolution No.(37) of 2012 or otherwise. This research report is strictly private and confidential and is being issued to sophisticated investors.

REGULATORY DISCLOSURES

Mediobanca S.p.A. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Mediobanca S.p.A. or its affiliates or its employees may effect transactions in the securities described herein for their own account or for the account of others, may have long or short positions with the issuer thereof, or any of its affiliates, or may perform or seek to perform securities, investment banking or other services for such issuer or its affiliates. The organisational and administrative arrangements established by Mediobanca S.p.A. for the management of conflicts of interest with respect to investment research are consistent with rules, regulations or codes applicable to the securities industry. The compensation of the analyst who prepared this report is determined exclusively by research management and senior

Disclaimer

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management (not including investment banking). Analyst compensation is not based on investment banking revenues, however, compensation may relate to the revenues of Mediobanca S.p.A. as a whole, of which investment banking, sales and trading are a part.

For a detailed explanation of the policies and principles implemented by Mediobanca S.p.A. to guarantee the integrity and independence of researches prepared by Mediobanca's analysts, please refer to the research policy which can be found at the following link: http://www.mediobanca.it/static/upload/b5d/b5d01c423f1f84fffea37bd41ccf7d74.pdf

Unless otherwise stated in the text of the research report, target prices are based on either a discounted cash flow valuation and/or comparison of valuation ratios with companies seen by the analyst as comparable or a combination of the two methods. The result of this fundamental valuation is adjusted to reflect the analyst's views on the likely course of investor sentiment. Whichever valuation method is used there is a significant risk that the target price will not be achieved within the expected timeframe. Risk factors include unforeseen changes in competitive pressures or in the level of demand for the company's products. Such demand variations may result from changes in technology, in the overall level of economic activity or, in some cases, from changes in social values. Valuations may also be affected by changes in taxation, in exchange rates and, in certain industries, in regulations. All prices are market close prices unless differently specified.

Since 1 July 2013, Mediobanca uses a relative rating system, based on the following judgements: Outperform, Neutral, Underperform and Not Rated.

Outperform (O). The stock’s total return is expected to exceed the average total return of the analyst’s industry (or industry team’s) coverage universe, on a risk-adjusted basis, over the next 6-12 months.

Neutral (N). The stock’s total return is expected to be in line with the average total return of the analyst’s industry (or industry team’s) coverage universe, on a risk-adjusted basis, over the next 6-12 months.

Underperform (U). The stock’s total return is expected to be below the average total return of the analyst’s industry (or industry team’s) coverage universe, on a risk-adjusted basis, over the next 6-12 months.

Not Rated (NR). Currently the analyst does not have adequate confidence about the stock’s total return relative to the average total return of the analyst’s industry (or industry team’s) coverage, on a risk-adjusted basis, over the next 6-12 months. Alternatively, it is applicable pursuant to Mediobanca policy in circumstances when Mediobanca is acting in any advisory capacity in a strategic transaction involving this company or when the company is the target of a tender offer.

Our recommendation relies upon the expected relative performance of the stock considered versus its benchmark. Such an expected relative performance relies upon a valuation process that is based on the analysis of the company's business model / competitive positioning / financial forecasts. The company's valuation could change in the future as a consequence of a modification of the mentioned items.

Please consider that the above rating system also drives the portfolio selections of the Mediobanca's analysts as follows: long positions can only apply to stocks rated Outperform and Neutral; short positions can only apply to stocks rated Underperform and Neutral; portfolios selection cannot refer to Not Rated stocks; Mediobanca portfolios might follow different time horizons.

Proportion of all recommendations relating to the last quarter

Outperform Neutral Underperform Not Rated

51.47% 43.99% 3.63% 0.91%

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

Outperform Neutral Underperform Not Rated

12.50% 12.86% 14.29% 33.33%

The current stock ratings system has been used since 1 July 2013. Before then, Mediobanca S.p.A. used a different system, based on the following ratings: outperform, neutral, underperform, under review, not rated. For additional details about the old ratings system, please access research reports dated before 1 July 2013 from the restricted part of the “MB Securities” section of the Mediobanca S.p.A. website at www.mediobanca.com.

Disclaimer

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COMPANY SPECIFIC REGULATORY DISCLOSURES

MARKET MAKER Mediobanca S.p.A. is currently acting as market maker on equity instruments, or derivatives whose underlying financial instruments are materially represented by equity instruments, issued by Banco Sabadell. CORPORATE FINANCE SERVICE CONTRACTS Mediobanca S.p.A. or one or more of the companies belonging to its group are currently providing corporate finance services to Banco Sabadell or one or more of the companies belonging to its group.

RATING The present rating in regard to Banco Sabadell has not been changed since 10/03/2011.

INITIAL COVERAGE Banco Sabadell initial coverage as of 10/03/2011.

COPYRIGHT NOTICE No part of the content of any research material may be copied, forwarded or duplicated in any form or by any means without the prior consent of Mediobanca S.p.A., and Mediobanca S.p.A. accepts no liability whatsoever for the actions of third parties in this respect. END NOTES The disclosures contained in research reports produced by Mediobanca S.p.A. shall be governed by and construed in accordance with Italian law. Additional information is available upon request.

Disclaimer Disclaimer Disclaimer Disclaimer Disclaimer

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Mediobanca S.p.A. Antonio Guglielmi

Head of European Equity Research +44 203 0369 570

[email protected] ANALYSTS

European Banks

Alain Tchibozo France/IBK +44 203 0369 573 [email protected]

Adam Terelak France/IBK +44 203 0369 574 [email protected]

Andrea Filtri Spain/Italy +44 203 0369 571 [email protected]

Andreas Williams Spain +44 203 0369 577 [email protected]

Riccardo Rovere Italy/Scandinavia/CEE/Germany +39 02 8829 604 [email protected]

European Insurance

Gianluca Ferrari Italy and Reinsurance +39 02 8829 482 [email protected]

Simonetta Chiriotti Nordics +39 02 8829 933 [email protected]

Italian Research

Alessandro Tortora Building Materials/Industrials/Capital Goods +39 02 8829 673 [email protected]

Andrea Scauri Oil & Oil Related/Capital Goods +39 02 8829 496 [email protected]

Chiara Rotelli Branded Goods/Consumers Goods +39 02 8829 931 [email protected]

Fabio Pavan Media/Telecommunications/Consumer Goods +39 02 8829 633 [email protected]

Javier Suárez Utilities +39 028829 036 [email protected]

Massimo Vecchio Auto & Auto Components/Industrials/Holdings +39 02 8829 541 [email protected]

Niccolò Storer Auto & Auto Components/Industrials/Holdings +39 02 8829 444 [email protected]

Nicolò Pessina Consumer Goods/Infrastructure +39 02 8829 796 [email protected]

Simonetta Chiriotti Real Estate/ Industrials +39 02 8829 933 [email protected]

FOR NON US PERSON receiving this document and wishing to effect transactions in any securities discussed herein, please contact:

Mediobanca S.p.A. Charlotte Roden

Head of Equity Sales +44 203 0369 537

[email protected] SALES

Angelo Vietri +39 02 8829 989 [email protected]

Christopher Seidenfaden +44 203 0369 610 [email protected]

Lorenzo Angeloni +39 02 8829 507 [email protected]

Timothy Pedroni +44 203 0369 635 [email protected]

Stephane Langlois +44 203 0369 582 [email protected]

European Spec Sales

Gaelle Jarrousse Banks +44 203 0369 530 [email protected]

Carlo Pirri Banks +44 203 0369 531 [email protected]

Gert-Jaap Kraan Insurance +44 203 0369 510 [email protected]

Mediobanca S.p.A. Dominic Bidwell

Head of Equity Trading and Sales Trading +44 203 0369 627

[email protected] SALES/TRADERS Alessandro Gobbi +39 02 8829 263 [email protected]

Matteo Agrati +44 203 0369 629 [email protected]

Michael Sherry +44 203 0369 605 [email protected]

Roberto Riboldi +39 02 8829 639 [email protected]

FOR US PERSON receiving this document and wishing to effect transactions in any securities discussed herein, please contact:

Mediobanca Securities USA LLC Pierluigi Gastone

Head of Mediobanca Securities USA LLC +1 212 991 4745

[email protected]

Massimiliano Pula +1 646 839 4911 [email protected]

Robert Perez +1 646 839 4910 [email protected]

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

2015_03_13_SAB bid on TSB

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