!"# Global Equity Research

Spain UBS Investment Research Investment Services Spain and Portugal Strategy

Equity Strategy Chart 1: Debt in Spain by group (% of GDP) and government cost of debt

450% Household debt 13% Financial institutions debt Corporate debt (ex-banks) 29 April 2010 Government debt 11% Avg. cost of debt -right axis- www.ubs.com/investmentresearch

300% 9% Bosco Ojeda Analyst [email protected] 7% +34 91 436 9050 150% Stephane Deo Economist 5% [email protected] +44-20-7568 8924 Ignacio Carvajal Cebrian 0% 3% Analyst 80's 90's 00 01 02 03 04 05 06 07 08 09 [email protected] +34-91-436 9025 Source: BDE, Tesoro Publico, UBS estimates Ignacio Sanz, CFA Analyst C ontagion from Greece is painful [email protected] +34-91-436 9624 ! Spain and Portugal seem healthier…but not that much on the private side Alberto Gandolfi Our macro team published yesterday a report on Greece, Greece: What now?, in Analyst which it expects the country’s debt to be restructured. The impact on Iberia could be [email protected] material, in our view. While government debt is well below that of Greece (Spain: +44 20 7568 3975 61% of 2010E GDP, Portugal: 85%, and Greece: 125%), we believe this is an Matteo Ramenghi oversimplification since households, corporates and banks are highly leveraged. Analyst ! Leverage ratios are high; liquidity may become very expensive [email protected] +39-02-7210 0286 Households and corporates have doubled their debt in the past decade (to 89% of GDP and c150%, respectively). Aggregated debt in Spain and Portugal exceeds 350% of GDP – above that of Greece. The cost of debt in Spain was more than 8% in the 1990s with debt-servicing costs equating to c5% of GDP versus 2% at present (c6% in Greece). A 400bp increase in the cost of debt seems affordable, in our opinion. Liquidity may be scarce and expensive, but, in our view, Europe is unlikely to allow a €3 trillion-plus debt event. We believe aggressive budget cuts are required. ! We remain cautious on the banks; elsewhere, the situation is mixed The higher cost of debt is likely to compress bank margins, which up to now have reflected relatively cheap liquidity. We remain concerned about the provisioning cycle for banks, while the restructuring costs of the savings banks could be material. As a result, we retain Sell ratings on Banco Santander, BBVA, Banco Popular and Sabadell. ! Renewables cannot be immune; construction looks tough Utilities may be subject to revised regulation, though this may be in the price (we like Brisa, EDP, Iberdrola, Abertis and Abengoa). There are no pure construction stocks, while the risks seem to be on the downside for players such as FCC and ACS, in our view. Companies with relatively low exposure to Spain include: Ebro, Técnicas, NH, Gamesa, Prosegur, Grifols and OHL.

This report has been prepared by UBS Limited ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 22. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Spain and Portugal Strategy 29 April 2010

Contents page Bosco Ojeda Analyst Greek contagion is painful 3 [email protected] +34 91 436 9050 — Can Spain weather a large credit shock? ...... 4 Stephane Deo Still sellers of Spanish banks 10 Economist — Asset quality back to 1993?...... 12 [email protected] +44-20-7568 8924 — A tenth of the loan book may be under stress...... 13 Ignacio Carvajal Cebrian — Is Ireland a comparable?...... 14 Analyst — Alco hedging or carry trade? ...... 14 [email protected] +34-91-436 9025 — Banks’ valuations are full...... 15 Spanish infrastructure 17 Ignacio Sanz, CFA Analyst — Diversification is working, but spending on infrastructure should shrink further...17 [email protected] Spanish exporters: Quite a few 19 +34-91-436 9624 Key Spanish stock ratings 20 Alberto Gandolfi Key Portuguese stock ratings 21 Analyst [email protected] +44 20 7568 3975 Matteo Ramenghi Analyst [email protected] +39-02-7210 0286

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Spain and Portugal Strategy 29 April 2010

Greek contagion is painful

As developments in Greece are evolving, we believe the risk of contagion to the The risk of contagion is increasing for Spanish and Portuguese debt markets is increasing. At the heart of Greece’s Spanish and Portuguese debt markets problems is the difficulty the government is experiencing in coping with significant financial gearing, a heavy budget deficit and a recessionary economy. The risk of potential debt restructuring has substantially increased, in our opinion, and yesterday our macro team has published a thorough update on this topic: Greece: What now? by Stephane Deo.

A first look at the Iberian economies seems to indicate that they are in much Spain and Portugal do not look too better shape: Spanish government debt equated to 57% of GDP in 2009, while heavily indebted at first glance… Portugal is more indebted, at 77%. That said, such levels do not look too bad compared with Greece, at 113%.

In reality, both economies have unprecedented levels of debt. The private sector …but both countries have has been massively increasing gearing levels, taking advantage of lower interest unprecedented levels of debt rates. For instance, families in Spain have increased leverage from 20-30% of GDP in the 1980s and 1990s to a new high of c90% in 2009. The financial burden of such high debt is tempered by the fact that interest rates today are only half of those of the 1990s. However, what happens if investors fear that the risks of default are increasing? Needless to say, investor perception of risk is now a key issue.

Chart 2: Debt in Spain by group (% of GDP) and government Chart 3: US debt by category: Not too far away… cost of debt

450% Household debt 13% 350 Financial institutions debt Government Corporate debt (ex-banks) 300 Government debt 11% Nonfinancial business Avg. cost of debt -right axis- 250 Households 300% Financial Institutions 9% 200

150 7% 150% 100

5% 50

0 0% 3% 1960 1970 1980 1990 2000 2009 80's 90's 00 01 02 03 04 05 06 07 08 09

Source: BDE, Tesoro, UBS estimates Source: Fed Reserve, UBS estimates

Similar to Spanish households, corporates or non-financial institutions have also increased debt to unprecedented levels, to 150% of GDP currently versus c50% in the 1980s and 1990s. However, we believe this is somewhat distorted and may not be all that bad since Spanish corporates, such as Telefonica, Iberdrola and Ferrovial, have strongly diversified into LatAm and Europe, with the result that income sources do not exactly match the GDP of Spain. When comparing aggregated data for Spanish corporates (ex-financials) with that for US or UK corporates (c80% debt/GDP and c110%, respectively), leverage is much higher in Spain, but not exactly comparable.

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Spain and Portugal Strategy 29 April 2010

To a large extent, families and corporates have grown through borrowing from The low savings ratio has prompted financial institutions. The credit to deposit ratio in Spain stands at c160%, and banks to seek external and wholesale c140% in Portugal – above that of its European peers. In addition, Spanish financing, which raises the spectre banks hold substantial positions in Spanish government bonds and have of margin compression aggressively financed the expansion of Spanish families into real estate. Typically, a bank would lend for 25-30 years at a Euribor rate (now at 1.2%) plus a small spread. These loans would be partly funded by deposits, but, given the low savings ratio, banks have notably used external and wholesale financing. This imposes risks, in our opinion, because contagion from the Greek credit crisis implies margin contraction. Banks have compensated for weaker margins by increasing their positions in government bonds, financed by short-term liquidity lines. However, while this has provided support for Spanish bonds, this impact could come to an end as the value of those portfolios is deteriorating and financing is now more expensive. Can Spain weather a large credit shock? This question cannot be answered directly, in our opinion, since market perception and government policy may not perform in a completely rational way. That said, we have conducted some sensitivity analysis that helps to put things into context: we assume, for instance, that the cost of refinancing government debt increases by 400bp from 3.5% currently to 7.5%. On the one hand, it implies significantly higher 2010-11 debt service costs for the government debt that matures, and, on the other hand, there is additional deficit to finance. We estimate the incremental financial expense from higher rates over the period 2010-11 for the government could reach a maximum of €20bn, representing c2% of GDP. Accordingly, total financial expenses for the government could increase from 2% over the period 2004-09 (see Table 1 below) to 4% in 2011. This is clearly a very tough impact, but nonetheless it would be below the peak levels of 5-6% of GDP reached in 1995-96. In comparison, the cost to the Greek government of servicing its country’s debt stands at present at 6% of GDP – well above Spain’s worst case scenario.

Table 1: Key statistics on Spain’s debt

€ m FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 10E

Spain GDP nominal 841,042 908,792 984,284 1,052,730 1,088,502 1,051,151 1,054,304

Government budget deficit -2,862 8,759 -19,847 -20,066 -44,260 -119,831 -94,887

Budget deficit as a % of GDP -0.3% 1.0% -2.0% -1.9% -4.1% -11.4% -9.0%

Government debt 388,701 391,083 389,507 380,660 432,233 559,650 643,126

Government debt as a % of GDP 46% 43% 40% 36% 40% 53% 61%

Non-financial corporates debt 978,000 1,129,000 1,408,000 1,655,000 1,497,000 1,587,000 1,555,260

Corporates debt as a % of GDP 116% 124% 143% 157% 138% 151% 148%

Household gross debt 590.8 702.6 831.8 921.6 954.3 939.6 925.2

Household gross debt as a % of GDP 70% 77% 85% 88% 88% 89% 88%

Government avg cost of debt (%) 4.6% 4.4% 4.4% 4.5% 4.3% 3.5% 4.0%

Gov financial expense est (% GDP) 2% 2% 2% 2% 2% 2% 3%

Source: BDE, Tesoro Publico, UBS estimates

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Spain and Portugal Strategy 29 April 2010

! Watch for liquidity shocks; Spain requires external financing: The above simulation, based on a 400bp cost-of-debt increase, which we estimate would consign an additional 2% of GDP to cover incremental financial expense, seems affordable, in our opinion. However, this would be in addition to the very severe restrictions required by the Spanish budget, with the result that strong political will would be required to implement the necessary cuts. At the moment, we believe the announced budget cuts totalling €50bn are not realistic enough, though we would assume the government is likely to be subjected to incremental pressure from the EU authorities. Credibility is key since market perception may impact access to liquidity, particularly from foreign investors. Therefore, in reality, the major risks of a restructuring event could be on two fronts: (1) continued liquidity calls, given the government and financial institutions require heavy refinancing; and (2) potential events involving private financing and financial institutions. Spanish savings banks have delayed restructuring plans for some time and the exact results of this process are, at present, quite uncertain.

! Credit rating: This has been a key concern for Greece, which yesterday lost its investment grade (it was downgraded by S&P from BBB+ to BB+). That extra notch lost means that some mutual and/or pension funds that have mandates to invest exclusively in investment grade issuers might become forced sellers. To some extent, this is probably being priced into Greek bonds (10-year bond at 10% versus Spain at 4% and Portugal at 5%). Spain is rated AA+ and Portugal A+, which is three to five notches away from investment grade risk.

Chart 4: Credit rating – Greece has lost its investment grade; Spain is five notches away

Germany Italy Netherlands Spain Ireland Greece Portugal

AA+ (effective from 1999 3/31/99)

Upgraded to AAA on 2001 10/3/01 Upgraded to A on 3/13/01 Upgraded to A+ on 2003 6/10/03 Downgraded to AA- on Upgraded to AAA on Downgraded to A on 2004 7/7/04 12/13/04 11/17/04

Downgraded to 2005 AA- on 6/27/05 Downgraded to A+ on 2006 10/19/06

Downgraded to AA+ on Downgraded to A- on 3/30/09 1/14/09 Downgraded to AA+ Downgraded to AA on Downgraded to BBB+ on Downgraded to 2009 on 1/19/09 6/8/09 12/16/09 A+ on 1/21/09 AAA(effective from AAA(effective from Downgrded to BB+ on Downgraded to A 2010 3/17/95) 3/17/95) April 26th on 27/4/10

Source: Bloomberg

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Spain and Portugal Strategy 29 April 2010

Chart 5: Debt/GDP and cost of debt – Spain has gone through tougher times

90% 12% Government debt as a % GDP 80% CPI Avg. cost debt for government 10% 70%

60% 8%

50% 6% 40%

30% 4%

20% 2% 10%

0% 0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010E 2011E

Source: Thomson Datastream, Tesoro Publico

! The cost of debt, refinancing and debt maturities: When comparing the debt/GDP ratios of Spain and Portugal with those of previous cycles, the situation is somehow affordable, in our opinion. Both countries are removed from the peak in Spanish debt, reached in 1995-98 (73-75%). At that time, the average cost of debt was 6-8% – well above the current 3.5%. The cost of servicing debt was 3.5% in 2009 compared with 6-10% over the period 1995-98. Consequently, as is evident, Spain has been in difficult times before, although in the mid-1990s Spain was able to devalue its currency – which is not an option at present. As a result, the situation can only be corrected through a tough process of deflation and budget cuts. And then there is the gearing level of the private sector to address, which implies that the deleveraging process could also further pressurise the prospects for macro growth.

That said, the situation nevertheless seems somehow affordable, except that a forecast budget deficit of c9% in 2010 and a potential increase in Spanish spreads could cause the situation to deteriorate, in our opinion. The average time to debt maturity is 6.8 years as of February 2010, but this is heavily weighted to 2010 with maturities of €120bn (25% of the total). In addition, the 2010E deficit and the restructuring of the financial sector could add additional financing requirements totalling €90bn, which means that Spain will have to actively tap the market this year. Spanish financial authorities have recently stated that gross issuance in 2010 could reach €97bn, although exact details have not been released. Chart 6 below shows the maturity profile of Spanish public debt.

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Spain and Portugal Strategy 29 April 2010

Chart 6: Maturity profile of Spanish public debt: The average is six years, but heavily weighted to 2010

140000

120000

Treasury Bills 100000 Treasury Bills, Notes and Bonds Total Amount (includes foreign debt/other) 80000

60000

40000

20000

0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020- 2024 2029 2032 2037 2040 2041 2023

Source: Tesoro Público

! Who owns Spain’s debt? Around 50% of Spain’s public debt is owned by foreign institutions. This is important in terms of potential buyers, but also when trying to analyse a hypothetical restructuring event. The largest buyer of Spanish debt is France with 25% of the total, followed by Asian countries (30%). Europe has a significant weight (c65-70%), while central banks (33%), and households and corporates (28%) are the heaviest buyers. However, this picture is somewhat distorted since it only reflects public debt. Spanish households and banks are quite heavily leveraged, which is also a significant issue. European financial institutions are likely to be very heavily exposed to Spain. We estimate that Spanish banks would need to refinance around €90bn or more in 2010, though banks have further flexibility in the short term as a result of ECB collateral, due to regulatory requirements.

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Spain and Portugal Strategy 29 April 2010

Chart 7: Who owns Spanish public debt? France and Benelux. Europe accounts for 65-70% and Asia for 30% (% of total)

30

2000 2006 2007 2008 Dec-09 25

20

15

10

5

0 France Japan Germany Italy Benelux The rest of the Asia, Africa and America The rest of countries in the other Europe EU

Source: Tesoro Publico

Chart 8: Ten-year bond yields: Germany versus Spain

4.2%

10Y Bonds Germany 4.0% Spain

3.8%

3.6%

3.4%

3.2%

3.0%

2.8% Sep-09 Oct-09 Oct-09 Nov-09 Nov-09 Dec-09 Dec-09 Dec-09 Jan-10 Jan-10 Feb-10 Feb-10 Mar-10 Mar-10 Apr-10 Apr-10

Source: Bloomberg

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Spain and Portugal Strategy 29 April 2010

Chart 9: Who owns Spanish public debt? Central banks, Chart 10: Spanish households are quite heavily indebted households and mutual funds

165%

145% Mutual and Household liabilities as a % of GDP pension funds Household liabilities as a % of disposible income 17% 125% Central banks Insurance 33% companies 105% 6%

85% Financial institutions 16% 65%

Families, corporates 45% 28%

25% 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

Source: Tesoro Publico Source: Bank of Spain

Chart 11: Spread on 10-year bond yields: Greece stands out, followed by Ireland/Portugal

8.0% Spain/Germany 7.0% Greece/Germany 6.0% Italy/Germany

5.0% Ireland/Germany

4.0% Portugal/Germany

3.0%

2.0%

1.0%

0.0% Sep-09 Oct-09 Oct-09 Nov-09 Nov-09 Dec-09 Dec-09 Dec-09 Jan-10 Jan-10 Feb-10 Feb-10 Mar-10 Mar-10 Apr-10 Apr-10

Source: Bloomberg

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Spain and Portugal Strategy 29 April 2010 Still sellers of Spanish banks

The NPL ratio exceeded 8% in 1993. At the time, GDP contracted by 1% versus Nearly a tenth of the loan book in Spain 3.7% in 2009 and unemployment reached 22.7%, which compares with c20% at is already under stress present. Short-term rates may provide some support this time (three-month interbank rates are less than 1%, which compares with more than 10% in 1993), but at the expense of lower currency flexibility. However, the overall leverage of the Spanish economy has nearly doubled, or actually tripled as far as households are concerned. Based on the previous correlation with unemployment, we think that the NPL ratio could reach levels above 8% again, reflecting a near 60% increase from the current levels. This analysis appears to be supported by the recent disclosure by the Bank of Spain that the construction sector accounts for €62bn of substandard loans (equivalent to more than 3% of total loans). Therefore, total substandard and restructured loans may account for more than 4% of total loans. On this basis, 9-10% of the Spanish loan book may be under some stress.

The NPL ratio in Ireland is already c11% – more than double the level reached Is Ireland a comparable? in Spain. While there are certainly differences between the Irish and Spanish banking structures, we believe that some of the underlying factors that we usually consider to be the main drivers of asset quality are quite similar: Ireland showed a sharper GDP contraction in 2009, but unemployment has reached a considerably higher level in Spain, where the economy’s dependence on the construction sector was more pronounced. That said, the two countries are among the most geared in Europe when considering the household, corporate and government sectors together.

We believe that the cost of credit shown in the P&Ls of Spanish banks is a Over the past two decades, coverage lagging indicator and that investors should look further out to understand the has been as low only in 1993-94; real profitability of the Spanish banking system. In fact, while the rules set by provisions may rise in the next the Bank of Spain, and in particular, the generic provisions, have worked two to three years extremely well to protect the P&Ls of Spanish banks so far, we think that banks will have to increase their cost of credit. Furthermore, we expect the sharp decrease in coverage to lead to increased market and regulatory pressure on banks to strengthen their overall loan-loss reserves. Even excluding the use of generic provisions, provisions peak several months if not years after the peak in NPLs has been reached. We also run through the generic provisioning system and, from a top-down perspective, think that coverage has already reached what we consider to be a minimum threshold. This is the main reason why we are reluctant to value Spanish banks on a PE basis.

Spanish banks have loan-to-deposit ratios well above 100%, as they fund a Alco hedging or carry trade? significant part of their assets wholesale. The increase in the loan-to-deposit ratios during the past decade mostly reflects rapid lending expansion and has resulted in their sensitivity to interest rates being diluted. Nevertheless, our analysis suggests that Spanish banks have been aggressive in building large carry trades to take advantage of cheap short-term funding. They have increased their holdings of government debt by more than €80bn over the past 18 months, taking up more than 50% of the government issuance compared with the 15- 20% take-up by their European peers in their respective countries. In the last quarter of last year, Spanish banks bought an amount equivalent to 63% of net

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Spain and Portugal Strategy 29 April 2010 bond issuance. Since July 2008, Spanish banks have bought on a net basis more euro area government bonds than the banks of any other euro area country. We estimate that the contribution from the Alco portfolio was c6% of NII.

We expect Spanish banks’ earnings to fall by a third in 2010 without meaningful Earnings: First down, then flat signs of recovery in 2011 and 2012. This is in sharp contrast to most European banks where we expect recovery to commence in the second part of this year. This reflects our cautious view on the Spanish macro environment, and the further de-leveraging that we expect to occur in the construction, residential developers and household sectors. The two main reasons why we expect such a delayed earnings cycle in Spanish banks relates to the provisioning system and NII sensitivity to rates, due to fading returns on the Alco portfolio and yearly re- pricing.

The market implicitly believes that Spanish banks’ superior profitability (11.7% Sells reiterated on Santander, BBVA, Spanish banks ROE 2010E versus 10% sector 10%) is sustainable, which we Sabadell, Popular think is challenging, given: (1) Diverging macro trends between Spain and the rest of Europe together with sustained asset deflation in Spain; (2) Spanish banks are benefiting from the release of generic provisioning (with a boost of more than 40% to 2009 aggregated net profit); (3) Spanish banks have very limited leverage to a capital markets recovery, and its potential impact in 2010 and onwards; (4) Spanish banks are still in the early stages of the credit cycle (current NPL ratio of 4.5% represents less than half our estimated losses for Spanish banks at the expected peak in first half 2011).

All in all, earnings momentum is likely to remain supportive over the next We maintain our negative view on the couple of quarters in Spain (if we forget about balance sheets and just look at sector P&Ls), especially if interest rate rises are delayed to 2011. However, we think further valuation de-rating is lying ahead once P&Ls start to reflect current balance sheet issues. Given our cautious outlook for Spanish banks’ earnings and the premium valuations of the most geographically diversified banks, we maintain our negative view on the sector. Our price targets are based on several methods (Gordon growth model, sum of the parts and sector multiples).

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Spain and Portugal Strategy 29 April 2010

Asset quality back to 1993? We show below some comparisons between 1993 and the current situation.

Chart 12: Selected macro indicators Chart 13: Household, corporate and government leverage

25 300

20 250

15 200 1993 Gov ernment 10 (%) 2009 150 Corporate 5 Household

As % of GDP 100 - 50 -5 GDP grow th Unemployment 3 months 0 y /y ratio interest rate 1993 2009

Source: UBS estimates Source: UBS estimates

Spain’s economic performance in the recent past has indeed shown an acute Twenty years of history show that the deterioration, starting with the construction sector. We think that there were correlation between unemployment bubbles both in terms of the size of this sector and house prices. However, the and the NPL ratio is very strong problems are not unique to that sector. As a result of the downturn, unemployment reached 18.8% at the end of last year and most economists expect it to exceed 20% in 2010. Spain presents a high correlation between unemployment and NPLs. In fact, throughout the years, most Spanish banks have suggested that employment represents a lead indicator of asset quality.

Chart 14: Developments in unemployment and the NPL ratio Chart 15: Correlation between unemployment and the NPL ratio

30% 10% 9% 30% 25% 8% 7% 25% 20% 6% 20% 15% 5% 4% 15% 10% 3% NPL ratio

Unemploymentrate 2% 10%

5% Unemployment rate 1% 0% 0% 5% 0% 2% 4% 6% 8% 10% Q1 Q1 90 Q1 92 Q194 Q106 Q196 Q198 Q100 Jan10 Q102 Q104 Q108 NPL ratio NPL/Loans(RHS) Unemployment Rate(LHS)

Source: Bank of Spain, INE, UBS estimates Source: UBS estimates. Note: During the period 1990-2009.

Our analysis, based on historical data, confirms a strong correlation between unemployment and the NPL ratio (mathematically summarised by R2 of c79%), as shown in Chart 15 above. We do not believe this correlation has weakened recently; if anything, we think it may have strengthened, given that: (1) Spanish households are more leveraged than ever before (more than 80% of GDP), so that unemployment can relatively easily translate into a credit event, obviously with some delay (unemployment benefits last on average eight months); and (2) the residential real estate market is still subdued and has one of the largest

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Spain and Portugal Strategy 29 April 2010 number of unsold homes in Europe, with the result that disposing of properties to repay mortgages is not always an option.

Based on the past correlation and excluding the higher exposure to the Unemployment ratio of more than 20% construction sector, 20% unemployment would translate into a NPL ratio of could translate into an NPL ratio of more than 7%, while 22% unemployment would push the NPL ratio above 8% – more than 8% – a nearly 60% rise a near 60% increase from the current level. from the present A tenth of the loan book may be under stress The Bank of Spain introduced stricter rules for NPL recognition in December Recent disclosure suggests that NPLs 2004, essentially defining NPLs as 90 days past due. This is one of the fastest and restructured loans combined would NPL recognitions in a European context. Yet, in our view, it is a narrow one, amount to 9-10% of total loans given that it does not provide investors with visibility on potential problem loans and particularly restructured loans, ie, all those situations where the debtor has financial difficulties in meeting his obligations and the bank decides to change the terms of its loan to accommodate the debtor, for example, by lengthening maturities. In fact, banks are not obliged to disclose restructured loans in Spain. However, at the sector level, we get some disclosure in the Bank of Spain’s November Financial Stability Report: “The assets affected by these transactions (refinancing, dation in payment and asset foreclosures) account for around 2.4% of the consolidated balance sheet.” In the same document, the consolidated balance sheet is indicated to be €3.75tn. Assuming that total real estate swaps amount to €20bn, the resulting amount of other forms of restructured loans would be c€70bn (nearly 4% of loans). Hence, NPLs and restructured loans would represent cumulatively 9-10% of total loans already, and the overall coverage would then amount to just 35-40%.

Chart 16: Estimated total doubtful loans, including restructured Chart 17: Estimated coverage, including restructured loans and loans and real estate swaps (2009E) real estate swaps (2009E)

10% 70% 60% 8% 50% 6% 40% 4% 30% 20% 2% 10% 0% 0% NPLs Estimated Estimated RE Estimated total NPLs Estimated Estimated RE Total restructured sw aps restructured sw aps loans loans

Source: Bank of Spain, UBS estimates Source: Bank of Spain, UBS estimates

More recent disclosure by the Bank of Spain suggests that the situation may be Developers and construction represent even more complex. In mid-March, the Bank of Spain published a speech given nearly a quarter of the overall loan book by José María Roldan, head of regulation at the Spanish Mortgage Association, for the Spanish banking system; 23% of which, in our view, sheds some light on the banking sector’s exposure to this exposure is NPLs or substandard, developers and construction. First, the cumulative exposure to developers and and coverage is just 35% construction is quantified at €445bn – equating to nearly a quarter of the total loan book. Second, the document explains that the NPL ratio based on this exposure is 9.6% (c€43bn), while the substandard loans ratio is 14% (€62bn).

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Spain and Portugal Strategy 29 April 2010

Including generic provisions, coverage of NPLs and substandard loans is reported to average 35%, which, in our view, leaves open the question of whether it will be enough or will more write-downs on the existing positions be required, particularly given how illiquid the markets for land and unfinished developments are these days. In any event, the document is quite clear in suggesting that in 2010, the tensions in the construction and development sectors will continue, and that banks will have to make greater efforts to reinforce coverage and capitalisation. Is Ireland a comparable? The situation in Ireland has been difficult for banks, which have had to undertake recapitalisations and seek government support to withstand the crisis. At AIB, nearly 37% of Irish loans were criticised (impaired, watch list and vulnerable), while Lloyds has reported impairments amounting to a third of its property investment lending and two-thirds of its lending to property development. We estimate the overall NPL ratio at c11%. Spanish banks so far have reported much lower levels of non-performing loans, ie, NPL ratios of just more than 5%, and even including restructured loans, total doubtful loans would amount to ‘only’ 8.7% on our estimates (as discussed above). Yet, while there are certainly differences between the structures of the Irish and Spanish banking industries, we note that some of the underlying factors that we usually consider to be the main drivers of asset quality are quite similar: Ireland showed a sharper GDP contraction in 2009, but unemployment has reached considerably higher levels in Spain, where the economy’s dependence on the construction sector was more pronounced, and the two countries are among the most geared in Europe when considering the household, corporate and government sectors together.

Chart 18: Comparing selected metrics for Spain and Ireland

20 18 16 14 12 10 8 Spain 6 4 Ireland 2 0 -2 -4 -6 -8 NPL ratio GDP growth (%) Unemployment ratio Construction sector / Total country debt / Banking loans / GDP (%) GDP (%) GDP (x) (x)

Source: UBS estimates. Note: Total country debt defined as government debt, household debt and corporate debt. Alco hedging or carry trade? Spanish banks have loan-to-deposit ratios well above 100%, as they fund a Alco portfolios have contributed on significant part of their assets wholesale. The increases in the loan-to-deposit average c6% of NII, but we expect ratios during the past decade have been mostly the result of rapid lending banks to reduce the size of their expansion and have resulted in their sensitivity to interest rates being diluted. exposure to government bonds in 2010 Nevertheless, our analysis suggests that Spanish banks have been aggressive in building large carry trades, to take advantage of cheap short-term funding. In

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Spain and Portugal Strategy 29 April 2010

Chart 19 below, it can be seen that Spanish banks have increased their holdings of government debt by more than €80bn over the past 18 months, taking up more than 50% of government issuance compared with the 15-20% take-up by its European peers in their respective countries. In the last quarter of last year, Spanish banks bought an amount equivalent to 63% of net bond issuance. Since July 2008, Spanish banks bought on a net basis more euro area government bonds than the banks of any other euro area country.

We believe that the CDS volatility affecting southern European countries, the concerns relating to the Spanish double-digit public deficit and more uncertain short-term funding, and increased market focus will induce banks to be less aggressive in terms of this kind of trade in 2010. Indeed, perhaps the banks may even reduce their overall exposure, which we estimate to generate c6% of NII on average and could possibly fade this year. In fact, according to the Spanish Treasury, Spanish banks did not increase their holdings of Spanish government bonds in January, while a temporary fall in net buying was already evident in July 2009 before rising again.

Chart 19: Net change in bank holdings of government debt Chart 20: CDS spreads (bp) since July 2008

700 100 Germany 600 80 Spain 500 60 400 France 40 300 200 € billion 20 Greece 100 0 Ireland 0 -20 Italy -40 01/12/09 08/12/09 15/12/09 22/12/09 29/12/09 05/01/10 12/01/10 19/01/10 26/01/10 02/02/10 09/02/10 Portugal Spain Greece Jul-08 Jul-09 Jan-09 M ar-09 N ov-08 N ov-09 Sep-08 Sep-09 M ay-09

Source: ECB Source: Thomson Financial

Table 2: Summary of Alco portfolio

Bond portfolio (€m) As % of assets Contribution to NII (UBSe) LTD ratio (*)

Pastor 6,700 20.5% 7.5% 179%

Bankinter 6,900 11.1% 14.2% 227%

Popular 10,424 8.1% 5.2% 222%

Banesto 8,000 6.5% 7.2% 141%

Santander 64,000 5.8% 6.0% 136%

BBVA 31,000 5.8% 6.0% 127%

Sabadell 3,000 2.9% 1.9% 161%

Source: Company data, UBS estimates. Note: (*) Ex repo. Banks’ valuations are full When looking at forecast 2010/11 PE multiples across Spanish banks, we find a wide dispersion (from 7x PE 2010E to more than 30x) depending on the generic provisioning buffers, geographical diversification and different risk profiles.

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Spain and Portugal Strategy 29 April 2010

Clearly, the gap narrows when looking at P/NAVs, with all the banks trading between 0.8x and 1.6x, and with the 1.4x average multiple still reflecting a healthy premium to EU banks on 0.9x P/NAV 2010E. In terms of 2010 forecast P/GOP or PE multiples, the Spanish banks trade in line with their EU peers, which implies that the market believes that the Spanish banks’ superior profitability (11.7% Spanish banks ROE 2010E versus 10% sector) is sustainable. However, we think this implication is challenging, given:

(1) Diverging macro trends between Spain and the rest of Europe together with sustained asset deflation in Spain;

(2) Spanish banks are benefiting from the release of generic provisioning (with a boost of more than 40% to 2009 aggregated net profit);

(3) Spanish banks have very limited leverage to a capital markets recovery and its potential impact in 2010 and onwards;

(4) Spanish banks are still in the early stages of the credit cycle (current NPL ratio of 4.5% represents less than half our estimated losses for Spanish banks at the expected peak in first half 2011).

All in all, earnings momentum is likely to remain supportive over the next We maintain our negative view on the couple of quarters in Spain (if we forget about balance sheets and just look at sector P&Ls), especially if interest rate rises are delayed to 2011. However, further valuation de-rating is lying ahead once P&Ls start to reflect current balance sheet issues.

UBS 16

Spain and Portugal Strategy 29 April 2010 Spanish infrastructure Diversification is working, but spending on infrastructure should shrink further We continue to have a bearish view on the outlook for infrastructure spending in We are still bearish on the outlook for Spain. We base our view on the double-digit budget deficit at the central infrastructure spending in Spain government level, and an even tighter situation at some of the key regional governments and municipalities, which account for more than 50% of total civil works investment in Spain. To give some sense of scale, the table below compares the current situation with the performance during the previous crisis (1991-94), when construction output decreased by a total of 13% over two years. From the peak in 2007, construction output should have shrunk by c50% at the end of 2010, but should still represent c8% of Spain’s GDP – well above Ireland and EU peers.

The impact of this adjustment on the Spanish constructors is three-fold: (1) it We see further margin pressure ahead obviously lowers sales, although international and business diversification (as shown in the table below) has helped to smooth the impact; (2) it has a negative impact on working capital, with an even larger impact on valuations; and (3) we still expect further margin compression. EBITDA margins in domestic construction have narrowed from 7.5% at the peak to 5.5% on average now, but in 1995 they fell to 4% – more in line with EU peers. We therefore see further margin pressure ahead.

Finally, Spanish infrastructure groups are highly exposed to environmental Exposure to spending by municipalities (street cleaning, waste management and recycling, etc) and urban services, is a risk where the major clients are municipalities, which are also facing tough budget restrictions and high leverage. Although these are medium-term concessions and not that volatile (revenues are based on metrics like CPI and volumes), we also see the risk of further working capital deterioration for construction players exposed to these businesses.

Table 3: Spanish construction output, 1991-96 and 2006-12E

(€bn) 1991 1992 1993 1994 1995 2006 2007 2008 2009 2010E 2011E 2012E

Total residential 54.374 53.671 52.701 54.605 58.771 111.993 114.358 82.345 47.747 44.384 46.061 47.578

-3.6 -1.3 -1.8 3.6 7.6 7.2 2.1 -28.0 -42.0 -7.0 3.8 3.3

Total non-residential 35.312 34.201 30.122 32.301 33.398 49.475 50.596 47.395 40.520 36.268 36.157 36.920

6.4 -3.1 -11.9 7.2 3.4 1.9 2.3 -6.3 -14.5 -10.5 -0.3 2.1

Total building 89.686 87.872 82.822 86.906 91.920 161.468 164.954 129.740 88.266 80.651 82.218 84.497

0.1 -2.0 -5.7 4.9 5.8 5.5 2.2 -21.3 -32.0 -8.6 1.9 2.8

Total civil engineering 43.705 38.246 33.695 34.200 35.397 55.069 58.112 54.790 56.654 50.158 49.869 50.248

9.5 -12.5 -11.9 1.5 3.5 7.2 5.5 -5.7 3.4 11.5 -0.6 0.8

Total construction output 133.404 126.200 116.735 121.288 127.716 216.537 223.067 184.530 144.856 130.805 132.113 134.755

3.0 -5.4 -7.5 3.9 5.3 6.0 3.0 -17.3 -21.5 -9.7 1.0 2.0

Source: Euroconstruct

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Spain and Portugal Strategy 29 April 2010

Table 4: Breakdown of sum-of-the-parts valuations

FCC Ferrovial ACS OHL Sacyr

Domestic construction 7% 6% 5% 4% 4%

International construction 11% 4% 9% 11% 2%

Real estate 5% 0% 0% 0% 40%

Cement 15% 0% 0% 0% 0%

Engineering 0% 0% 19% 0% 0%

Environmental and urban services 48% 35% 12% 7% 7%

Energy 9% 0% 39% 0% 36%

Concessions 5% 55% 16% 78% 11%

TOTAL 100% 100% 100% 100% 100%

Source: UBS estimates

Stock ideas

We like stocks with: (1) strong exposure to long-term concessions (OHL, We like stocks with exposure to toll Abertis, Ferrovial); (2) international diversification (OHL obtains more than roads and international assets; 88% of EBITDA from abroad, followed in terms of business outside of Spain by cautious on names more Ferrovial and Abertis); and (3) deep value. We remain cautious on those names exposed to Spain more exposed to the Spanish economic cycle (through real estate, cement, domestic construction or urban services).

Table 5: Summary of UBS ratings and price targets, absolute and relative performance

Rating PT (€) Upside/downside Performance YTD Vs IBEX 35

FCC Neutral 28.5 12% -17% -3%

ACS Neutral 35.5 3% -5% 7%

OHL Buy 28 25% 17% 29%

Ferrovial Buy 10 48% -20% -7%

Sacyr Buy 7.8 33% -27% -15%

Acciona Buy 112 43% -17% -5%

Abertis Buy 18 29% -15% -3%

Cementos Portland Neutral 21 11% -16% -4%

Source: UBS estimates

UBS 18

Spain and Portugal Strategy 29 April 2010 Spanish exporters: Quite a few Table 6: Geographical sales for Spanish companies – significant proportion external to Spain

Continental Europe Rest of

Spain UK (ex Spain and UK) the world

BANCO ESPANOL DE CREDITO* 100.0%

BANKINTER* 100.0%

BOLSAS Y MERCADOS ESPANOLES 100.0%

ENAGAS 100.0%

RED ELECTRICA CORPN. 100.0%

TELECINCO 100.0%

BANCO DE SABADELL* 97.0% 3.0%

BANCO POPULAR ESPANOL* 94.6% 5.4% 0.0%

SACYR VALLEHERMOSO 79.3% 15.5% 5.2%

ACS ACTIV.CONSTR.Y SERV. 78.3% 21.7%

CATALANA 67.7% 4.7% 23.1% 4.5%

ACCIONA 67.0% 11.0% 22.0%

INDRA SISTEMAS 65.9% 16.3% 17.8%

GAS NATURAL SDG 63.3% 3.1% 33.6%

MAPFRE* 59.3% 4.6% 36.1%

ENDESA 58.1% 4.7% 37.2%

FOMENTO CONSTR.Y CNTR. 56.0% 23.4% 20.6%

ABERTIS INFRAESTRUCTURAS 50.7% small <45.6% 3.7%

OBRASCON HUARTE LAIN 48.6% 51.4%

REPSOL YPF 48.0% 10.2% 41.8%

IBERDROLA 46.3% 32.5% 21.2%

ACERINOX <44% (>56% non-domestic)

IBERDROLA RENOVABLES 43.8% 6.8% 49.4%

IBERIA 38.1% 23.3% 38.6%

FERROVIAL 36.0% 38.0% 14.0% 12.0%

INDITEX 35.8% 46.3% 17.9%

ABENGOA 34.5% 16.0% 49.5%

BBV.ARGENTARIA* 34.0% (66% non-domestic)

TECNICAS REUNIDAS 30.4% 8.5% 61.1%

BANCO SANTANDER* 29.0% 12.3% 17.5% 41.2%

EBRO PULEVA 27.1% 43.2% 29.7%

GRIFOLS 25.0% 24.6% 50.4%

TELEFONICA 18.3% 6.1% 35.9% 39.7%

GAMESA CORPN.TEGC. 17.0% 83.0%

ARCELORMITTAL 6.8% 47.1% 46.1%

Source: Thomson Datastream, UBS.

UBS 19

Spain and Portugal Strategy 29 April 2010 Key Spanish stock ratings Table 7: Rating for Spanish stocks

Stock UBS Mkt. cap Stock perf Adj PE Adj PE EV/ EV/ price, € target, € UBS rating (€m) 12m 2009E 2010E EBITDA 09E EBITDA 10E

Abengoa 19 3 29 0 Buy (CBE) 1 746 56 3% 86 89 75 75 Abertis 13.9 18 Buy 9,812 13.8% 14.6 15.7 10.2 9.9 Acciona 78.1 112.0 Buy 4,966 2.1% 27.3 18.0 14.4 8.3 Acerinox 15.3 12.6 Sell 3,900 32.8% -15.0 25.6 -25.1 12.4 ACS 35.1 35.5 Neutral 11,052 -6.3% 13.2 14.9 5.4 3.6 Alba 37.6 51.0 Buy 2,259 16.7% ------Banco de Sabadell 4.0 3.62 Sell 4,776 -8.8% 10.5 11.0 -- -- Banesto 8.2 7.8 Neutral 5,714 1.8% 9.8 8.5 -- -- Bankinter 5.8 6.2 Neutral 2,762 -32.5% 14.4 10.5 -- -- Banco Pastor 4.2 5.0 Neutral 1,120 -16.4% -5.5 32.4 -- -- BBVA 10.7 8.5 Sell 40,122 31.8% 8.3 9.8 -- -- Banco Popular 5.6 5.0 Sell 7,509 -10.4% 11.3 13.9 -- -- Santander 10.0 7 Sell 78,845 47.2% 8.3 11.3 -- -- Catalana Occidente 15.6 21.7 Buy 1,868 37.5% 15.4 10.1 -- -- Cementos Portland 19.4 21 Neutral 737 -10.0% 18.4 14.3 9.4 9.3 Clinica Baviera 8.4 8.0 Neutral 137 -4.5% 66.8 25.4 12.3 9.8 Mapfre 2.6 2.9 Neutral 7,713 25.6% 7.8 7.8 -- -- Grupo Codere 8.2 10.7 Buy 453 38.6% 18.0 12.6 4.5 4.4 Criteria Caixa Corp 3.8 3.89 Buy 12,813 33.3% ------Dinamia 10.1 13.2 Buy (CBE) 161 8.6% ------Ebro Puleva 14.0 16.7 Buy 2,153 32.6% 9.4 15.9 7.7 9.5 Enagas 15.2 19.0 Buy 3,629 22.4% 10.8 11.2 8.8 8.8 Ence 2.9 3.1 Neutral 744 24.8% -5.5 15.2 -55.7 6.6 Endesa 21.6 23.5 Neutral 22,890 43.5% 8.8 10.4 7.2 6.1 FCC 25.9 28.5 Neutral 3,304 -4.5% 11.0 10.6 7.9 7.3 General Alq.r Maquinaria 3.0 3.5 Neutral 132 -17.2% -17.4 341.8 10.1 6.1 Gamesa 9.5 14 Buy 2,299 -24.5% 20.0 22.0 7.0 7.9 Gas Natural 13.2 14.5 Neutral 12,124 10.4% 11.8 9.8 8.7 7.1 Grifols 10.5 12 Buy 2,233 -17.4% 17.8 15.9 11.8 10.5 Grupo Prisa 3.4 2.7 Sell 753 52.8% 12.9 8.8 9.9 9.4 Iberdrola 6.3 7.25 Buy 32,969 7.0% 11.8 12.1 9.2 8.0 Iberdrola Renovables S.A. 2.9 3.2 Neutral 12,102 1.4% 36.3 26.9 14.0 11.0 Iberia 2.6 3.35 Buy 2,511 84.7% -6.8 65.8 -4.1 11.3 Inditex SA 48.8 50.0 Neutral 30,473 49.7% 14.9 17.2 8.3 8.8 Indra 15.7 16.5 Neutral 2,608 7.9% 13.4 13.7 8.4 8.3 Inmobiliaria Colonial 0.1 0.1 Sell 957 -8.7% -4.8 -8.4 75.7 59.4 Metrovacesa 11.3 11 Sell 786 -36.3% -3.0 -2.3 -1002.1 -100.9 NH Hoteles 3.6 4.5 Buy (CBE) 885 23.6% -7.9 -41.7 27.7 14.2 Obrascon Huarte SA 22.9 28 Buy 2,282 142.6% ------Prosegur 35.7 38.8 Buy 2,203 69.6% 10.2 14.1 5.5 7.3 Realia 1.8 1.5 Sell 502 -20.0% -9.4 102.5 28.0 21.6 Red Eléctrica de España 36.5 40.0 Neutral 4,939 21.8% 13.6 12.9 9.3 9.1 Repsol YPF 18.1 21.5 Buy 22,061 26.2% 15.8 12.1 5.1 4.9 Laboratorios Rovi 6.8 8.8 Buy 340 34.9% 16.1 14.0 11.6 9.3 Sol Melia 6.7 6.85 Neutral 1,241 81.2% 88.3 76.4 8.7 11.3 Grupo SOS 2.0 1.1 Sell 311 -49.3% -3.6 22.2 21.1 15.8 Telefonica 17.3 22 Buy 82,796 16.8% 9.7 9.3 5.7 5.8 Reyal Urbis 2.9 1.5 Sell 858 42.6% -4.8 -10.3 -40.1 571.4 Sacyr Vallehermoso 6.1 7.8 Buy 1,866 -23.2% -14.9 11.4 65.1 10.8 Tecnicas Reunidas S.A. 47.1 51.6 Buy 2,634 80.1% 12.0 16.6 6.8 9.8 Vocento 4.4 2.1 Sell 554 21.3% -8.2 -31.4 -35.6 23.5

Source: UBS estimates

UBS 20

Spain and Portugal Strategy 29 April 2010 Key Portuguese stock ratings Table 8: Key data on Portuguese stocks

UBS EV/ EV/ Stock target Mkt cap Stock perf Adj PE Adj PE EBITDA EBITDA price, € price, € UBS rating (€m) 12m 2009E 2010E 2009E 2010E

Banif SGPS 1.0 1.1 Neutral (CBE) 433 -1.7% 39.7 32.5 -- -- BCP 0.7 0.8 Neutral 3,408 0.9% 31.0 11.3 -- -- Banco Espirito Santo SA 3.5 5.3 Buy 4,082 -9.8% 9.2 8.7 -- -- BPI 1.8 2.2 Neutral 1,582 -5.5% 10.0 8.1 -- -- Brisa 5.6 8.0 Buy 3,358 9.0% 22.3 20.2 9.4 8.8 Cimpor 5.4 3 Sell 3,618 22.0% 10.0 9.8 6.4 6.5 Energias de Portugal 2.7 3.5 Buy 9,968 2.0% 10.3 9.0 8.2 7.9 EDP Renovaveis 5.1 6.25 Neutral-Short Term Buy 4,447 -10.6% 39.1 31.3 14.0 12.3 Espirito Santo F. Group 14.4 16.0 Neutral 1,121 32.1% ------GALP 12.3 13 Neutral 10,221 22.9% 39.7 32.2 15.2 14.3 Impresa 1.6 1.0 Sell 264 93.8% 23.7 25.5 12.7 13.4 Jeronimo Martins 7.7 7.5 Neutral 4,876 90.4% 14.8 21.4 7.9 10.5 Portucel 2.0 2.5 Buy 1,566 33.5% 15.7 12.6 8.6 7.5 Portugal Telecom 8.0 8.0 Neutral 7,007 38.6% 15.1 13.4 5.5 5.3 ZON 3.6 5.5 Buy 1,117 -13.6% 20.4 14.0 7.8 6.7 Mota Engil 3.0 5.0 Buy 614 -8.9% 42.0 15.2 8.4 7.8 REN 2.7 3.3 Neutral (CBE) 1,447 -14.6% 14.6 13.5 8.6 8.2 Sonae 0.8 0.9 Neutral 1,652 30.6% 10.6 15.8 7.7 7.1 Sonaecom 1.4 2.5 Buy 515 -28.9% 63.6 31.0 5.6 4.8

Source: UBS estimates

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Spain and Portugal Strategy 29 April 2010

! Statement of Risk

There are substantial risks of investing in Spanish and Portuguese stocks at the moment, most of the risks are well highlighted on the current report and include high financial leverage, macro risk and exposure to emerging markets. In addition to generic risks there are also substantial risks at the specific company level.

! Analyst Certification

Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report.

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Spain and Portugal Strategy 29 April 2010

Required Disclosures

This report has been prepared by UBS Limited, an affiliate of UBS AG. UBS AG, its subsidiaries, branches and affiliates are referred to herein as UBS.

For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request.

UBS Investment Research: Global Equity Rating Allocations

UBS 12-Month Rating Rating Category Coverage1 IB Services2 Buy Buy 50% 39% Neutral Hold/Neutral 40% 33% Sell Sell 11% 24% UBS Short-Term Rating Rating Category Coverage3 IB Services4 Buy Buy less than 1% 29% Sell Sell less than 1% 0% 1:Percentage of companies under coverage globally within the 12-month rating category. 2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months. 3:Percentage of companies under coverage globally within the Short-Term rating category. 4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months.

Source: UBS. Rating allocations are as of 31 March 2010. UBS Investment Research: Global Equity Rating Definitions

UBS 12-Month Rating Definition Buy FSR is > 6% above the MRA. Neutral FSR is between -6% and 6% of the MRA. Sell FSR is > 6% below the MRA. UBS Short-Term Rating Definition Buy: Stock price expected to rise within three months from the time the rating was assigned Buy because of a specific catalyst or event. Sell: Stock price expected to fall within three months from the time the rating was assigned Sell because of a specific catalyst or event.

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Spain and Portugal Strategy 29 April 2010

KEY DEFINITIONS Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months.

EXCEPTIONS AND SPECIAL CASES UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.

Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are not registered/qualified as research analysts with the NASD and NYSE and therefore are not subject to the restrictions contained in the NASD and NYSE rules on communications with a subject company, public appearances, and trading securities held by a research analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any, follows. UBS Securities España SV SA: Bosco Ojeda; Ignacio Carvajal Cebrian; Ignacio Sanz, CFA. UBS Limited: Stephane Deo; Alberto Gandolfi. UBS Italia SIM SpA: Matteo Ramenghi.

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Spain and Portugal Strategy 29 April 2010

Company Disclosures

Company Name Reuters 12-mo rating Short-term rating Price Price date Abengoa13, 20 ABG.MC Buy (CBE) N/A €18.56 27 Apr 2010 Abertis5 ABE.MC Buy N/A €13.27 27 Apr 2010 Acciona12 ANA.MC Buy N/A €76.70 27 Apr 2010 ACS4, 6 ACS.MC Neutral N/A €33.92 27 Apr 2010 Banco de Sabadell2, 4 SABE.MC Sell N/A €3.82 27 Apr 2010 Banco Popular POP.MC Sell N/A €5.29 27 Apr 2010 BBVA2, 4, 5, 15, 16, 22 BBVA.MC Sell N/A €10.09 27 Apr 2010 Brisa BRI.LS Buy N/A €5.15 27 Apr 2010 Cementos Portland CPLN.MC Neutral N/A €18.36 27 Apr 2010 Ebro Puleva EVA.MC Buy N/A €13.65 27 Apr 2010 EDP Renovaveis EDPR.LS Neutral Buy €5.06 27 Apr 2010 Energias de Portugal5, 16 EDP.LS Buy N/A €2.62 27 Apr 2010 FCC FCC.MC Neutral N/A €24.65 27 Apr 2010 Ferrovial FER1.MC Buy N/A €6.59 27 Apr 2010 Gamesa16 GAM.MC Buy N/A €9.40 27 Apr 2010 Greece2, 4, 5 Grifols16 GRLS.MC Buy N/A €10.27 27 Apr 2010 Iberdrola2, 4, 5, 16, 22 IBE.MC Buy N/A €6.03 27 Apr 2010 NH Hoteles16, 20 NHH.MC Buy (CBE) N/A €3.41 27 Apr 2010 OHL OHL.MC Buy N/A €21.91 27 Apr 2010 Portuguese Republic Prosegur PSG.MC Buy N/A €35.20 27 Apr 2010 Sacyr Vallehermoso SVO.MC Buy N/A €5.68 27 Apr 2010 Santander2, 3, 5, 16 SAN.MC Sell N/A €9.50 27 Apr 2010 Spain Tecnicas Reunidas S.A. TRE.MC Buy N/A €45.79 27 Apr 2010 Source: UBS. All prices as of local market close. Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date

2. UBS AG, its affiliates or subsidiaries has acted as manager/co-manager in the underwriting or placement of securities of this company/entity or one of its affiliates within the past 12 months. 3. UBS Limited is acting as Adviser to Alliance & Leicester on the announced Exchange of A&L Preference Shares for New Santander UK Preference Shares and Proposed Amendments to the Terms of the A&L Preferred Securities 4. Within the past 12 months, UBS AG, its affiliates or subsidiaries has received compensation for investment banking services from this company/entity. 5. UBS AG, its affiliates or subsidiaries expect to receive or intend to seek compensation for investment banking services from this company/entity within the next three months. 6. This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and investment banking services are being, or have been, provided. 12. Directors or employees of UBS AG, its affiliates or subsidiaries are directors of this company. 13. UBS AG, its affiliates or subsidiaries beneficially owned 1% or more of a class of this company`s common equity securities as of last month`s end (or the prior month`s end if this report is dated less than 10 days after the most recent month`s end). 15. UBS AG, its affiliates or subsidiaries has issued a warrant the value of which is based on one or more of the financial instruments of this company. 16. UBS Securities LLC makes a market in the securities and/or ADRs of this company. 20. Because UBS believes this security presents significantly higher-than-normal risk, its rating is deemed Buy if the FSR exceeds the MRA by 10% (compared with 6% under the normal rating system). 22. UBS AG, its affiliates or subsidiaries held other significant financial interests in this company/entity as of last month`s end (or the prior month`s end if this report is dated less than 10 working days after the most recent month`s end).

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Spain and Portugal Strategy 29 April 2010

Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report.

For a complete set of disclosure statements associated with the companies discussed in this report, including information on valuation and risk, please contact UBS Securities LLC, 1285 Avenue of Americas, New York, NY 10019, USA, Attention: Publishing Administration.

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Spain and Portugal Strategy 29 April 2010

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