Unicredit: Better results than expected but still a mixed picture.

Close the 5 year CDS trade: “Sell Unicredit/ Buy Intesa SanPaolo” and take your 28bp gains

On March 17th 2010, Unicredit released its preliminary FY09 figures and beat the
consensus by posting a 57.6% decline in net profit (to EUR1.7bn) VS an expected
66.9% drop (to EUR1.3bn). In more details and based on our calculations, Net
Operating Result (NOR) registered a 27.5% growth (to EUR11.9bn) YoY. This was
underpinned by an increase in operating income (+ 7.2% to EUR27.2bn), coupled with a
5.3% decrease in operating costs (to EUR15.3bn). The latter benefited from cuts in
headcounts, reduction in administrative expenditures and a rise in expense recovery.

In addition to its improved operating performance, Unicredit strengthened its
capitalisation. It reduced its leverage by i) increasing its capital and ii) downsizing its
total assets by 11% through cuts in both the trading book and the interbank loan
portfolio in particular. The group's core Tier 1 has gone up by 189bp to 8.5%, including
the EUR4bn capital increase. Based on our calculations, the adjusted book equity ratio
gained about 60bp to 3.5%.

Nevertheless, the increase in the NOR was largely wiped down by the ballooning in loan
loss provisions, which more than doubled (to EUR8.3bn from EUR3.7bn) due to the
material deterioration in asset quality. From 2008 to 2009, the proportion of impaired
loans to total gross loans rose from 6.6% to 9.7% based on the group's figures. Loan
loss provisions and other impairments pushed profit before tax and extraordinary items
down by 36.4% to EUR3.6bn.

All in all, we still view Unicredit's credit profile as poor. We believe it will be challenging
for Unicredit to find sustainable revenue drivers as the increase in 2009 operating
income was largely dependent on the volatile trading revenues, since recurring
revenues went down by 11%. We also remain sceptical about the group's ability to
clean up its balance sheet, which is crippled by about 10% of impaired loans, ranking
Unicredit amongst European banks' worst asset quality ratios. As we expect loan loss
provisions to grow due to the adverse economic environment, we think the group's
weak profitability - reflected by a return on asset of 0.2% - will stay under pressure. It is
important to note also that the group took advantage of the EC regulation on
“Reclassification of financial assets” to reclassify some assets held for sale and for
trading in its loan book. At 3Q09, the value of the reclassified assets was of EUR21bn,
of which EUR6bn worth of structured products. Given the lack of details in FY09 results,
we suspect the overall exposure to toxic assets to be higher than EUR6bn. Unicredit, as
an investor, posted a net exposure to structured credit products of EUR10.6bn in 1H09.
As a sponsor, it also has a EUR6bn exposure to conduits.

Unicredit is rated Aa3 Stable, A Stable and A Negative by Moody's, S&P and Fitch
respectively. We think Moody's ratings are generous and do not stress the weaknesses
of the group's fundamentals enough. According to Bloomberg data, the 5 year CDS on
Unicredit and Intesa SanPaolo were trading respectively at 84bp and 67bp on March
17th 2010. On August 6th 2009, CDS on both names were trading respectively about
91bp and 46bp and we recommended Selling CDS on Unicredit and Buying that on
Intesa SanPaolo. We expect further convergence on both group's spreads. We however
recommend being cautious and taking the 28bp pick up gains on this trade.

Samson Jakuel