BANKS ” A NALYST: “ LUÍS MENDES JOÃO ”

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DISCLOSURES AND DISCLAIMER AT THE END OF THE DOCUMENT PAGE 1/31 SEE MORE INFORMATION AT WWW.FE.UNL.PT

E

QUITY

R

ESEARCH

M

ASTERS IN

F

INANCE

.

06JANUARY 2010

“M

ILLENNIUM

BCP

”

C

OMPANY

R

EPORT

“

BANKS

”

ANALYST:

“

LUÍS MENDES JOÃO

”

[email protected]

Recommendation: BUY

Vs Previous Recommendation BUY

Price Target FY10: 1.11 €

Vs Previous Price Target 1.12 €

Price (as of 6-Jan-10) 0.89 €

Reuters: BCP.LS, Bloomberg: BCP PL

52-week range (€) 0.556-1.075

Market Cap (€m) 3850

Outstanding Shares (m) 4695 Free Float 54.7% Source: Bloomberg

Source: Bloomberg

(Values in € millions) 2008 2009E 2010E Net Interest Income 1721 1326 1562 Net Banking Income 2583 2413 2748 Net Income 201 176 321

ROE 3.8% 2.9% 5.0%

ROA 0.2% 0.2% 0.4%

NIM 1.9% 1.4% 1.6%

Cost / Income 64.7% 63.9% 62.4% Loans / Deposits 167% 167% 165% Payout Ratio 39% 30% 40% Tier 1 ratio 7.1% 10% 10% Assets / Equity 17.3 15.5 15.0 RWA (bn €) 67 62 65

Net Loans (bn €) 75 76 80

Deposits (bn €) 44 46 49

Debt Securities(bn €) 21 22 23

EPS 0.04 0.04 0.07

P/E 9.5 20.5 15.2

Source: Company data and analyst estimates

40% 60% 80% 100% 120% 140% 160%

DJ EuroStoxx Banks

BCP

PSI 20

Dec 08 Apr 09 Dec 09

The bottom of the cycle

Valuing with improved earnings visibility

We are initiating coverage of BCP, one of the largest banks in Portugal, with a BUY recommendation and a price target of 1.11€ / share. Our price target is based on the economic profit model for

banks and incorporates the current capital requirements for Portuguese banks.

Largest Private Player in Portugal…

Domestic operations still account for the bulk of earnings. BCP

maintains stable market shares, as it ranks second, only behind state

owned CGD, in loans to customers (24.8%) and customer‟s resources

(22.1%). Domestic operations represent 81% of total loans and 71% of total deposits of the group, and contributed for 97% of total earnings of the group in 1H09 (consequence of the severe recent problems in some of its international operations). Thus, the capacity to deliver operating improvements in the domestic activity is crucial for value creation, namely an efficiency upgrade. For the years to come, we stress the rigorous repricing policy and the exposure to rises in interest rates, which should have a positive impact on margins, but also the risk of further asset quality deterioration.

…while international operations’ importance is increasing

Tough year for international divisions, but a faster recovery is expected now. Polish and Greek operations faced tough times, with net income falling 105% and 37% in 2009E respectively. While we still believe Greece will destroy value going forward, the Polish activities of the bank are now improving side by side with the economy, which is the only to grow in Europe this year. Nevertheless, the risk of another depreciation of the zloty and further provision charges are still possible. African divisions are again core, which has a positive

impact in BCP‟s value in our view, as Mozambique is the fastest

growing and more profitable division, and Angola exhibits good growth prospects.

Deleveraging is harming the sector…

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“MILLENNIUM BCP” COMPANY REPORT

EQUITY RESEARCH 06 JANUARY 2010

PAGE 2/31

behind state owned CGD (Caixa Geral de Depósitos). It is one of the largest companies listed in the Lisbon stock exchange and has a significant amount of free float (54.7%, vs. 26.4% of BPI and 40.5% of BES) and good liquidity, with 19.2m shares in average daily volume. It is now lacking behind BES in terms of market cap, a situation related with the bad stock market

performance in 2008 and 2009, and mainly due to problems affecting its international activities.

Source: Company Data

Statutory rules of BCP set a limit of 10% of voting rights for any shareholder, which clearly has an impact on the ownership of the bank. In fact, the lack of a core shareholder support (unlike BES and BPI) was one of the main reasons for the severe corporate governance problems, related to strong shareholder disagreements, the regulatory and criminal

investigations and the consequent management change (the current management of the bank was elected in January 2008). As we‟ve learned from that, the impact on BCP‟s activity of this

structure is mixed: it is more difficult to reach consensus in difficult times, but it allows also scrutinizing more effectively the bank when management is acting incorrectly.

The abovementioned situation led to difficulties in pursuing its corporate goals, but the strong victory in the election (97.8% in favor) put an end to these problems. It had, in our view, a very good impact on the future perspectives of BCP, as the support of the main shareholders allowed the definition of a strong strategic plan, with clear priorities towards core business in a difficult environment: capital strengthening (has now a Tier 1 ratio of 8.9%); operational turnaround in Portugal (managed to reach strong cost cuts in 2008 and 2009); refocusing in core divisions (capital increase in Poland and expansion plan in Mozambique).

Range of activities: As it is the second largest banking group in Portugal, BCP offers a full

range of banking products and services, with focus on commercial banking, investment banking, private banking and asset management. The bank is mainly retail oriented, and most of its earnings came from stable and retail business units like corporate and retail banking. In fact, trading profits lost its importance in the bank‟s activities, mainly after it sold its BPI 10% stake in

2008, and is reducing slowly its available for sale portfolio.

Domestic Franchise: The activity in Portugal continues to be BCP‟s core market, even after the

strong investments made overseas by the group, following the steps of other big players in Europe with the objectives of diversification of their earnings and also achieving growth in less

developed and penetrated banking systems. In June 2009 BCP‟s Portuguese operations

accounted for 80% of group‟s gross loan, 78% of customer funds and 51% of its branches.

BCP is the largest private bank acting in Portugal (regarding market shares), a position

achieved firstly by a strong and unprecedented organic growth (1985-1995) and then consolidated by an aggressive M&A policy (1995-2000). It is now one of the two main players (in terms of market shares) in the Portuguese Market, operating side by side with Caixa Geral Deposits (the Portuguese state owned bank). According to the Portuguese Banking Association and Bank of Portugal most recent data, its market shares in gross loans and customer’s resources were 24.8% and 22.1% respectively in 1Q09.

Divided ownership has mixed impact on activity

Largest private bank in Portugal in market shares and second largest in market cap

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PAGE 4/31 80%

10%

7% 1% 2%

Loans Geographic breakdown

Portugal

Poland

Greece

Mozambique

Others

71% 17%

7% 2% 3%

Deposits Geographic breakdown

Portugal

Poland

Greece

Mozambique

Others

24% 25% 24% 26% 25% 25% 26%

24% 24% 24% 24% 24% 24% 25%

15% 16% 15% 16% 16% 15% 15%

14% 13% 13% 14% 13% _13% _13%

12% _12% _12% _12% _12%

11% 11%

2006 2007 1Q08 2Q08 3Q08 4Q08 1Q09

Market Shares: Loans

CGD BCP BES Santander Totta BPI

From the graphs we can see a slight increase YoY in the market share of loans and a slight decrease in market share for customer funds (22.8% in June 2008 to 22.1% in June 2009). This was mainly due to a stronger repricing policy of BCP in the deposit side and a weaker one in terms of loans (namely in the corporate segment), a situation we will develop later.

Notice that market shares have been fairly stable in the past few years for the 5 main players in the Portuguese Market (CGD, BCP, BES, BPI and Santander Totta), which account for more than 88% of the sector in Portugal. This is mainly due to the restructuring of the sector in the 1990‟s (BCP situation for instance) and didn‟t result in low competitiveness

of banks. On the contrary, the size of the main payers gives them the scale to compete in the major business lines and achieve diversification (asset management, retail banking or insurance), which is the reason behind this trend towards concentration in the sector.

More importantly, we should highlight that the case of BCP itself a remarkable one, as the corporate governance problems previously referred could have affected strongly its image and lead to client departure (estimated at 2.6m in Portugal). Despite this, the domestic franchise

showed its resistance, and its market share didn‟t decrease both in loans and in deposits.

Foreign franchises

Banks ability to grow is nowadays limited in the developed countries, as less developed banking system tend to grow much faster than GDP. Investing in emerging markets to search top-line revenue growth has been the trend. With this in mind, and after a

strong organic (1985-1995) and acquisition (1995-2000) growth, BCP took a step forward and expanded internationally.

Some of the smaller international operations are now viewed as disposable, as management has clearly stated that it wants to focus on the core operations. In our view, those investments lacked the commitment from BCP to a reach a size compatible to efficiency levels that could lead to higher profitability. However, sound growth and is being achieved in some operations (Mozambique and Poland) and the final result is yet to be known. In our view, the internationalization of BCP is a positive aspect of it strategy, as it will allow the group to diversify its earnings base, mainly because the Portuguese banking system is small , well penetrated and reached its mature phase. For instance, notice that the total loans in

Portugal represented 193% of GDP in 2008, vs. 102% in Greece in the same year and 37% in Poland for 2007 (central banks data).

With the poor performance in the domestic market in 2007 and 2008 (mainly due to the accumulated losses related to the stake BCP owned at BPI), the importance of the international activities increased, accounting for 19% and 22% of total earnings respectively. However, we are expecting Portugal to continue to be the main market of the group, with 81% of the

group’s loans and 71% of the customer’s deposits in September 2009.

Source: Company Data and analyst estimates Source: Company Data and analyst estimates

Source: Bank of Portugal and Portuguese Banks Association 29%

28% 28% 28% 28% 28% 29%

22% 22% 22% 23% 22% 22% 22%

16% 17% 16% 16% 16% 17% _17%

11% _11% 12% 12% 12% 12% 12%

12% 11% 11% 11% 11% 11% 11%

2006 2007 1Q08 2Q08 3Q08 4Q08 1Q09

Market Shares: Customer resources

CGD BCP BES BPI Santander Totta

Source: Analyst Estimates

Impact on value per unit

Concentration in the sector allows scale

Bus i nes s Uni t Impa ct

Portuga l 0.94

Pol a nd 0.12

Moza mbi que 0.07

Angol a 0.02

Greece 0.05

Pension Fund -0.09

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PAGE 5/31

Recent Stock Market Performance and Multiples

The major Portuguese private banks stock market performance followed the European sector upward trend. This increase was mainly driven by an improvement of the economic outlook, but also by a consistent normalization of global stock markets, namely the significant decrease in volatility levels and the decrease in credit spreads. As for BCP in particular, we believe it was outperformed by its peers because of the awful performance in terms of earnings, with a net income of € 201m and € 176m in 2008 and 2009E, as well as the

nervosism of investors concerning the corporate scandals affecting the previous management.

The drop in earnings for this year was driven mainly by the international divisions, of

which we expect a significant improvement for the upcoming years (as we will explain later in the report). Notice that BES and BPI benefited from its geographic diversification, with international operations accounting for 53% and 34% of total earnings in 3M09, vs. only 3% of BCP. This allowed BES to become the largest private bank in terms of market cap in

Portugal (with € 5.4b, vs. € 3.9b of BCP), despite the fact that BCP is still the leader in

Portugal in terms of market shares.

We used a set of comparable ratios to understand how BCP compares to its peers. We consider the mid cap private banks in Iberia as those peers, as they showed similar prospects of earnings and growth over time. BCP and BES are trading at a discount to book value, against higher P/B ratios of its Spanish peers. In our view, this situations is due to the slow impact on Spanish banks related to very poor asset quality trends (unemployment is set to stay at very high levels in 2010 and the real estate bubble is still hurting the economy). We expect an improvement in ROE in Portugal for 2010E vs. deterioration in Spain. This is being priced by the market: BCP is trading at a P/E of 17.35x, against 10.76x of the sector.

What drives value?

The main question to ask when performing a company valuation is what drives value. Basically, the ability to create value depends on: whether the firm earns a return on the capital invested on the firm which is higher than the cost of that capital; whether the firm can grow (to allow an increase in earnings). We can see that by looking into the economic profit modelformula for bank‟s valuation:

𝑀𝑎𝑟𝑘𝑒𝑡𝑉𝑎𝑙𝑢𝑒=𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑𝐶𝑎𝑝𝑖𝑡𝑎𝑙0+

𝐸𝑐𝑜𝑛𝑜𝑚𝑖𝑐𝑃𝑟𝑜𝑓𝑖𝑡𝑡 (1 +𝑐𝑜𝑠𝑡𝑜𝑓𝑒𝑞𝑢𝑖𝑡𝑦)𝑡

∞

𝑡=1

Banks ability to grow is nowadays limited in the developed countries, as the financial

sector is a mature industry and these countries have well penetrated banking systems.

Investing in emerging markets (Poland, Turkey, Romania and Africa) to search top-line

revenue growth has been the trend. We will focus on this later.

Thus, analyzing ROE is crucial to understand the value creating ability of a bank. The most common (and most effective) way of doing it is to breakdown the ROE formula in order to understand what affects it.

𝑅𝑂𝐸=𝑅𝑂𝐴×𝐴

𝐸 𝑅𝑂𝐴= 𝑁𝐼𝑀+𝑁𝑜𝑛𝐼𝑀+ 𝑆𝑝.𝐼𝑡𝑒𝑚𝑠

𝐴 −

𝑂𝐸 𝐴 −

𝐿𝐿𝑃+𝑜𝑡𝑕𝑒𝑟𝑁𝑂𝐸

𝐴 × (1− 𝑡)

The supervisors of the financial sector center on other approach to understand if banks are in a good solvency position: the CAMEL system, which stands for Capital, Asset quality, management quality, earnings and liquidity. We will use a mix of these two approaches to value the Portuguese, Polish, Greek, Mozambican and Angolan operations of BCP.

Inves ted Capital

Economic Profit

ROE

growth rate

cos t of equity

Pens ion Fund adjus tments Drivers of Value

A Assets

E Equity

NIM Net Interest M argin

Non IM Non Interest M argin

OE Operating Expenses

LLP Loan Loss Provisions

0.6 0.8 1 1.2 1.4 1.6

BCP BES BPI

Source: Bloomberg

BCP BPI BES Banesto Bankinter Popular Sabadell Price 0.88 2.22 4.61 8.72 7.09 5.81 4.24

Market Cap 4.14b 5.99b 2b 5.99b 3.35b 7.75b 5.08b

P/B 0.73 1.08 0.93 1.07 1.31 0.99 0.97

P/E 17.35 8.18 8.79 8.81 12.15 9.58 13.21

Dec 08 Ap 09 Dec 08

BCP is trading at a high P/E multiple

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PAGE 6/31 -100% -50% 0% 50% 100% 2 0 0 5 J a n 2 0 0 5 A b r 2 0 0 5 J u l 2 0 0 5 O u t 2 0 0 6 J a n 2 0 0 6 A b r 2 0 0 6 J u l 2 0 0 6 O u t 2 0 0 7 J a n 2 0 0 7 A b r 2 0 0 7 J u l 2 0 0 7 O u t 2 0 0 8 J a n 2 0 0 8 A b r 2 0 0 8 J u l 2 0 0 8 O u t 2 0 0 9 J a n 2 0 0 9 A b r 2 0 0 9 J u l

Loan Production in Portugal: 2005-2009

Mortage Corporate SME Consumer 0 2 4 6 8 10 2 0 0 5 J a n 2 0 0 5 A b r 2 0 0 5 J u l 2 0 0 5 O u t 2 0 0 6 J a n 2 0 0 6 A b r 2 0 0 6 J u l 2 0 0 6 O u t 2 0 0 7 J a n 2 0 0 7 A b r 2 0 0 7 J u l 2 0 0 7 O u t 2 0 0 8 J a n 2 0 0 8 A b r 2 0 0 8 J u l 2 0 0 8 O u t 2 0 0 9 J a n 2 0 0 9 A b r 2 0 0 9 J u l

New Loan Spreads in Portugal 2005-2009

mortage corporate SME consumer

Portugal

ROA (operating performance)

Macroeconomic Outlook in Portugal

We expect the revenue growth for Portuguese banks to be very low for 2009E and 2010E, mainly due to the harsh economic environment in Portugal. Real GDP is expected to decrease 3% YoY in 2009 (IMF latest estimate), which is the strongest contraction of the Portuguese economy in many years, caused by the huge slowdown in some of its main trading partners (Spain, Germany and France). From 2011 onwards IMF and the Bank of Portugal expect a modest improvement in the macro scenario.

Source: FMI (World Economic Outlook Database October) This will have a negative impact on loan production. Portuguese banks reacted to the crisis

by increasing loan spreads from 4Q08 only: it is easy to understand from the graph bellow that spreads on new loans were more than 100 basis points higher in 2009 than one year before. Therefore, from 2008 onwards we can see a sharp decrease on loan growth for each sector of activity, with loans to individuals (namely mortgages) being the most affected.

Source: Banco de Portugal, APB and analyst estimates Source: Banco de Portugal, APB and analyst estimates The corporate loan‟s sector has been hurt by the slowdown in the economic activity, but much

less than the mortgage sector. Notice that the mortgage sector grew a lot after 2003, but it

is now slowing down because of the huge drop in house sales (3958 permits issued in June

09, vs 7150 in June 08), the high household indebtness levels (129% of disposable income in 2008, the second highest rate in Europe according to Bank of Portugal), of which 75% represents mortgage loans, and the rise of unemployment (9.6% in August 09).For September 09, the Bank of Portugal estimated a 4.52% YoT increase for SME and a 2.51% YoY increase for corporate loans, against a growth of 1.55% in the mortgage sector. This situation is expected to continue, as unemployment levels are expected to become even higher (more than 10% in 2010E), which will have an impact on mortgage loan book growth rates.

As we can see in the table bellow, BCP grew slightly more than its peers in terms of credit for 9M09, after a poorer performance in 1H09. Notice that CGD is the state owned bank in Portugal, which has traditionally sacrificed margins for some volume growth in times of crisis, and it is possible that it could gain some market share in the upcoming quarters.

Apart from the difficulties in the mortgage segment, we can also say that the corporate segment is becoming more attractive to banks. This is particularly true for BES (with a

2009 2010 2011 2012 2013 2014

GDP real growth -3 0.4 0.9 1.3 1.3 1.3

Inflation -0.6 0.96 1.1 1.6 1.8 1.8

Lending growth in Portugal as of Sep 09 (YoY growth rates)

BCP CGD BES BPI

Total Loans 2.1% 5.8% 1.7% 0.7%

Corporate Loans 0.7% 7.6% 3.6% -1.4%

Mortgage Loans 4.2% 4.4% -1.5% 1.8%

Consumer Loans 3.0% 6.6% 2.1% 11.6%

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PAGE 7/31 traditionally larger exposure to the segment), but BCP is also trying to keep up, after some

market share lost in recent years in the corporate sector. The main reason for this refocusing, is the fact that corporate loan spreads increased more than the other types of loans (as we will show shortly), not only to cover the higher funding costs and lack of liquidity, but also allowing to ease the margin compression.

All in all, we expect loan book growth to decrease relatively to last years, and we do not expect a strong recovery for the future. Our forecast is a CAGR of 4.2% for 2010E-2014E, after a 2.1% in 2009E. The increase in Net Interest Income due to volumes growth will be very limited in our view.

Repricing of the loan book

Mortgage loan repricing in Portugal (as well as in Spain) is limited to the fact that mortgage

loans are determined by the 3m EURIBOR rate, plus a spread. As the spread is fixed for the life of the loan, the repricing can only be done in the new production, which is limited, namely in the current environment (as new mortgage loan production is very low). As the mortgage loan new production has halted the impact of the repricing in margins is low, banks with a larger weight in this sector (like BPI) are penalized, as overall spreads are higher in the corporate segment.

BES had a clear competitive advantage here in the last quarters, as they are the bank in Portugal (of the big players) with the largest proportion of non-mortgage loans. This allowed the bank to begin repricing its loan book in 2008 and to be the only one to achieve an increase in its margin in 1H09 (1.96% in 2Q09 against 1.71% in 2Q08). BES management says that it could do it because with the decrease of interest rates, increasing the spread to corporate didn‟t mean an

increase in the cost to the firms.

However, BPI and BES managements have made clear that the repricing of their corporate loan book has been almost completed. Therefore, further improvements concerning repricing are now only possible for BCP, as management disclosed to have capacity to reprice its loan book only over the next 3 years, which we have already factored into our estimates.

We should highlight that corporate loan repricing is not limited by the contract itself, but in a difficult economic environment asset quality concerns can harm banks repricing intents. That is to say, banks are indeed passing on higher spreads to its corporate clients, but they have also to be cautious about possible non performing loans, as firms may find it difficult to pay higher interest charges. In fact, NPL‟s for corporate have been increasing a lot (as we will explain later), which explains the lower asset quality of BES domestically comparing to its peers.

Deposit Spreads: The fall in deposit spreads was inevitable, due to the sharp decrease in the

reference interest rates, as the price of risk (passed to the bank trough the cost of funding) cannot be totally covered by the increase in spreads. This was the main reason for margin

compression in Portugal and led to negative margins on sight deposits for some competitors (namely in the last few months), a situation avoided by BCP by an aggressive

repricing policy, according to management. This led to a slight decrease in market share for customer funds (22.8% in June 2008 to 22.1% in June 2009), a situation we expect to be reversed in 2010 and 2011, as soon as reference interest rates increase and BCP eases its repricing policy.

Asset-Liability Management: With loan book repricing limited in the mortgage segment

because of the low activity and in the corporate sector due to asset quality concerns and the squeezing of deposit margins, this low interest rate environment has led to a strong margin compression. Spanish banks have traditionally hedged against falling interest rates by buying ALCO portfolios, which are mainly composed of government debt and earn a spread over Euribor. It is very difficult to get significant and accurate information about these portfolios, as their composition changes a lot trough time, but BPI disclosed in June a € 4.5b exposure to this.

Now that the situation will reverse (with reference rates set to rise), they will no longer benefit

58% 36%

6%

Loan Book breakdown as of Sep 09

Corporate Mortgage Consumer

71% 23%

6%

57% 39%

4%

BCP

BES

BPI

BCP Margin evolution BES Margin evolution

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09

Credit Margin 1.64% 1.71% 1.74% 1.79% 1.96% 2.06% Credit Margin 1.68% 1.47% 1.58% 2.18% 3.58% 3.38%

Deposit Margin 3.49% 3.45% 3.68% 2.39% 1.01% 0.55% Deposit Margin 1.55% 1.88% 1.98% 0.90% -0.74% -0.54%

NIM 1.81% 1.82% 1.75% 1.89% 1.78% 1.33% NIM 1.76% 1.71% 1.70% 1.76% 1.93% 1.96%

BES’ margin hold

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PAGE 8/31 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% -5% 0% 5% 10% 15% 2 0 0 5 J a n 2 0 0 5 A b r 2 0 0 5 J u l 2 0 0 5 O u t 2 0 0 6 J a n 2 0 0 6 A b r 2 0 0 6 J u l 2 0 0 6 O u t 2 0 0 7 J a n 2 0 0 7 A b r 2 0 0 7 J u l 2 0 0 7 O u t 2 0 0 8 J a n 2 0 0 8 A b r 2 0 0 8 J u l 2 0 0 8 O u t 2 0 0 9 J a n 2 0 0 9 A b r 2 0 0 9 J u l

Corporate loan growth and NPL's: Portugal

Corporate growth YoY Corporate NPL

0.00% 0.50% 1.00% 1.50% 2.00% 0% 5% 10% 15% 20% 2 0 0 5 J a n 2 0 0 5 A b r 2 0 0 5 J u l 2 0 0 5 O u t 2 0 0 6 J a n 2 0 0 6 A b r 2 0 0 6 J u l 2 0 0 6 O u t 2 0 0 7 J a n 2 0 0 7 A b r 2 0 0 7 J u l 2 0 0 7 O u t 2 0 0 8 J a n 2 0 0 8 A b r 2 0 0 8 J u l 2 0 0 8 O u t 2 0 0 9 J a n 2 0 0 9 A b r 2 0 0 9 J u l

Mortgage loan growth and NPL's: Portugal

Mortage growth YoY Mortgage NPL from the low interest rate environment, and in the future they may have to dispose of these

portfolios by incurring trading losses, depending on the timing of that disposal.

As for BCP, it is known that the bank has a less active ALM policy when compared to its peers (namely BPI and BES). With the current balance sheet structure, BCP’s Management

estimates a € 20m increase in Net Interest Income for every 25 basis points increase in

interest rates (based on the estimated increase on deposit spreads). ECB is already giving

signs of possible reference rate increases for 2010 and 2011, and this is already priced in the European yield curve, and we are factoring that into our estimates.

All things considered, the compression in Net Interest Margin of BCP seemed inevitable in the past quarters, but it is now easing due to a higher capacity of repricing the loan book compared to its peers, as well as the current structure of its Balance Sheet. BCP will be in our view the first of the largest players in Portugal to reach pre-crisis NIM, as soon as the interest rate environment eases, which will take some time to occur. We forecast Net Interest Income to increase a 4.5% CAGR in 2010E-2014E.

Asset quality

Earnings in the financial sector will be strongly affected by asset quality trends. NPL have

risen throughout the year but didn‟t reach peak levels as they have in Spain, where the situation

is much worse. The corporate credit continues to be more affected in terms of asset quality, mainly the construction and real estate sectors. Mortgage credit is also expected to deteriorate more in 2010E, as unemployment will reach double digits and interest rates are set to rise. The outlook is therefore negative (but much better than Spain).

Corporate lending growth rates continue larger than in the mortgage and consumer segments. The latest figures released by the Bank of Portugal show an increase YoY of 7.07% in October in the corporate sector (versus 1.76% and 3.06% in the consumption and mortgage sector). In our view, _{loan growth will continue at low levels and NPL’s as a percentage of the loan}

books increasing.

Corporate lending quality is not evolving equally in every sector of activity, as we can see in the table below. In fact, three of the largest sectors of activity in Portugal (construction, retail and real estate) accounted for the bulk of NPL‟s in the last months. As we have explained before, the fact that BCP is more exposed to the mortgage segment means it is harder to reprice the loan book, but it is also less affected in terms of asset quality (as mortgage NPL‟s are lower).

As for its peers, it is very important to understand that BES has a larger exposure to these sectors, which is the main reason for the larger provision charges it makes when compared to its competitors, as well as a larger exposure to the corporate segment as a whole. For the

future, we expect the corporate segment to improve only with the economic recovery; with low

volume growth, NPL‟s represent a big part of the loan book, which increases the need for

provision charges.

Source: Company data

Margin performance in Portugal (Annualized Net Interest Margins)

Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09

CGD 1.99% 1.92% 1.90% 1.88% 1.76% 1.45% 1.07%

BCP 1.63% 1.65% 1.61% 1.68% 1.56% 1.18% 1.14%

BES 1.52% 1.44% 1.56% 1.64% 1.66% 1.69% 1.48%

BPI 1.25% 1.26% 1.23% 1.24% 1.28% 1.02% 0.92%

Source: Bank of Portugal and INE

BCP will be the first to benefit from interest rate

increases….

…but margins will

take time to reach pre-crisis levels

Earnings will be strongly affected by asset quality

BCP has lower exposure to

corporate NPL’s

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PAGE 9/31 41%

7% 7% 3% 38%

4%

BCP loan book breakdown by sector in 2008YE

Other

Construction

Real Estate

Retail

Mortgages

Consumer

Forecasts asset quality of BCP: Portugal

2009E 2010E 2011E 2012E 2013E 2014E

Cos t of Ri s k 0.75% 0.75% 0.70% 0.65% 0.59% 0.53%

NPL's ra ti o 2.21% 2.70% 2.10% 1.80% 1.65% 1.50%

Covera ge ra ti o 1.25 0.82 0.93 1.01 1.06 1.12

NPL's 1,329 1,692 1,367 1,220 1,163 1,107

Gros s Loa ns 60,097 62,648 65,085 67,794 70,467 73,814

Source: Company Data and analyst estimates

Source: Bank of Portugal

Mortgage segment: The household credit contraction is mainly driven by mortgages in

Portugal, as they account for 79% of household loans (Bank of Portugal data). The main factor affecting mortgage loan quality is clearly the labor market, namely unemployment trends. Unemployment in Portugal has not increased as much as in other countries, namely Spain (where it stands above 18%), and the number of job losses has been low. Moreover, unemployment benefits in Portugal help to limit the possibility of new unemployed people to default on their loans, and these benefits have been increased by the Portuguese government since the crisis burst.

House prices increased in the last years bellow the inflation rate, and therefore there was not a creation of a real estate bubble. NPL in the mortgage sector are therefore at much lower

levels than in the corporate segment: 1.72% in October 2009, vs. 1.49% in October 2008.

Actually, BPI is already benefiting from this fact, as its loan book is directed more towards mortgage lending than any other segment. Moreover, the risk profile of its clients is also

lower. As for consumption lending (which represents only 6% of household indebtness in

Portugal), NPL‟s are rising much faster, and we expect this numbers to deteriorate in 2010E as

interest rates are set to begin rising.

It is important to stress that the cost of risk (provision charge for overdue loans for more than

90 days) targets for the three larger private players in Portugal are in line with their loan book and the risk profile of their clients: BES loan book has a larger share in the corporate segment, which is being (and will continue in our view) more affected by asset quality problems; BPI loan book is more directed towards mortgage lending.

% of corporate NPL ratio total corporate 100% 3.5%

agriculture 2% 2.3%

industry 16% 2.9% mining 0% 3.4% manufacturing 13% 5% electricity 3% 0.1%

construction 20% 5.1%

services 62% 3%

Retail 14% 4.5% tourism sector 3% 3.1% transport 6% 1% real estate 35% 2.9%

other 4% 1.5

Cost of Risk (NPL's >90 days / Gross Loans)

Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09

BCP 0.42% 0.87% 0.77% 1.18% 0.77% 0.74%

BPI 0.24% 0.26% 0.29% 0.40% 0.36% 0.37%

BES 0.51% 0.57% 0.67% 0.61% 0.80% 1.03%

Cost of risk = NPL / Gross Loans

Coverage Ratio = Impairments / NPL

NPL ratio = NPL / Gross Loans

NPL‟s are defined as overdue loans by more than 90 days

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PAGE 10/31

61.4% 59.6% 45.1%

44.3% 44.2% 41.6% 39.4% 30.8%

BPI BCP Sabadell Bankinter BES Santander BBVA Popular

Cost to Income: BCP and peers (consolidated Figures)

Non interest income€

Before the recent financial crisis burst , the weight of non interest income in the banking product of BCP was significant, as the bank tryed to cope with a difficult macroeconomic environment (slow economic growth) by relying less in interest income. However, the recent events showed that such a growth in importance, namely in trading income (15% of banking product in 2007), was not sustainable, and we expect the current levels to prevail.

Commissions have decreased YoY for 6% in 1H09, as they were strongly hurt by the financial markets turmoil, which led customers to shift their savings from mutual funds to deposits. As we can see from the table bellow, the market related fees (namely asset management fees and securities fees) were the most affected.

We can see from the table above that the market related commissions were 26% of total commissions, which compares with 41% in 2007. This was the result of the market

turbulence after Lehman Brothers fell. For the next years, we are expecting a recovery in this

front, as investors‟ risk aversion is expected to decrease given the normalization of the financial

markets situation, as well as the recent recovery in the stock markets: we expect market related commissions to account for 30% of total commissions in 2014E. Moreover, interest rates are expected to increase slowly, as the European Central Bank continues very careful about announcing the end of the Financial Crisis, meaning deposits aren‟t yet sufficiently attractive. Thus, we are forecasting a (moderate) 3.3% CAGR increase for 2010E-2014E.

Trading fees: BCP showed negative results of € 47m in 3Q09, mainly due to a loss of € 84m

relative to the decrease in value of liabilities held for trading at fair value. BCP used these liabilities to protect against the deterioration of CDS spreads and they generated large gains in 2008. As credit spreads are improving, BCP‟s trading line is affected, and management

estimates more € 40m of losses with these instruments until the year ends.

For 2010E onwards, we are forecasting more stable gains from trading activity, as those instruments mature and also due to the sale of the position on BPI. Nevertheless, we expect banks to rely less in these revenues in the near future, as the risk appetite of the banking sector is still low, after the recent financial crisis. In fact, as we said above, the weight of trading as a percentage of banking product was unsustainable during the years preceding 2008, and we expect it to account for 8% of total banking product in 2014E for BCP in Portugal.

Operating Leverage (efficiency)

9M08 9M09 YoY % 2009E 2010E 2011E 2012E 2013E 2014E Banking Fees 273 294 8% 387 414 427 442 459 479 Ca rds 82 85 4% 108 114 117 121 125 130 Loa ns 74 77 4% 98 102 105 108 112 116 Others 118 131 11% 180 197 205 214 222 233

Market Related commissions 123 105 -15% 152 170 179 188 195 205 As s et ma na gement 67 64 -4% 94 106 113 119 124 130 Securi ti es 56 40 -29% 54 58 61 63 65 68

Total commissions 397 399 1% 538 583 606 630 654 684

5% 13% 10%

30% 33% 33%

55% 54% 57%

BCP BES BPI

Breakdown Banking Product (domestic): 9M09 Trading commissions net interest income

350 290 276 117 66 113 136 527 561 460 ₅₃₅

538 583 606 1,133 1,074 _1,104

1,195

941 1,096 1,198

2005 2006 2007 2008 2009E 2010E 2011E

Evolution of domestic banking product : BCP (€m)

Trading commissions net interest income

Relevant efficiency ratios in 2008 (domestic activity)

BCP BPI BES

Branches / Income 0.55 0.76 0.46 Employees / Income 6.34 8.36 4.94 Adm Costs / Income 0.22 0.21 0.21

Moderate increase in commissions

And a lower weight of trading in earnings

Branches/Income and Employees/Income are per million € ratios

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PAGE 11/31 0

5000 10000 15000 20000

Number of Employees evolution

0 500 1000 1500

Number of branches evolution

As we‟ve explained before, BCP pursued a strong M&A policy before the year 2000. Thus, this past decade the strategy of BCP was largely focused on managing the assimilation and integration of the activities of the acquired institutions, essentially by improving the efficiency of its activity concerning the branch network and related employees. Despite this efforts, BCP is not an efficient bank today in our view (in relative terms), and has therefore a lot to improve.

Domestically, BCP has managed to reduce drastically the number of employees and branches for the past years. For the next years, it is not expected that BCP would decrease its branch network, otherwise it could be sacrificing market share in the future (namely for BPI, which has been expanding its retail network: increased the number of branches to 701 in June 2009, against 508 in December 2004).

Management set the achievement of cost efficiency both at home and abroad as one of

the top priorities for 2009 and 2010.BCP wants to compensate the earnings compression by

adopting an aggressive strategy of cutting expenses and improving efficiency. In fact, we

believe BCP and BPI have a lot of room for improvement here, as they compare negatively

with BES in the number of employees and branches per income. We believe it is possible for them to continue their cost cutting programs, including staff reduction, reducing outsourcing activities and strong IT improvements. We stress that BCP has stopped hiring new employees in Portugal and continues reallocating some of them from back office to commercial activities. This plan is underway both in Portugal and in Poland, and has been producing very strong results this year. In Portugal BCP cut its staff by 150 and reduced administrative costs by 13.4% YoY for 9M09. In Poland BCP was even more aggressive, as it outlined a target of PLN

100m decrease in costs for 2009, which was already achieved in the first 3 quarters of the year:

Bank Millennium reduced its staff by more than 15% this year. As the bank is expected to continue this process, we forecast a cost to income ratio of 56.3% in 2014, which compares positively with 62.3% in 2008 and.

From a consolidated point of view, we should stress that the low profitability of the

international operations in recent years (some of them in the incipient stage, like Romania) and the continuing group expansion are a main drag on the group‟s efficiency (consolidated cost to

income ratio of 63% in 2009E). This is a direct consequence of the aggressive network branch expansion abroad: international operations accounted for 49% of total branches and only 20% of total loans in 2008. Therefore, strong and sustained profitability from these divisions, which we expect to be reached in Mozambique and Poland, will be a main driver for efficiency gains.

It is important to stress that Portuguese banks should look to Spanish banks when analyzing their efficiency (see graph above): they are some of the most efficient players in the European context, as they have an average cost to income ratio of 41%. Notice that this lower operating leverage should be viewed as cushion against revenue losses: for the same loss in revenues for a bank, institutions that exhibit a lower operating leverage have their earnings less affected than other institutions. Actually, it allowed Spanish banks to cope better with the

Source: Company Data and analyst estimates Cost/Income = Operating costs / Banking product

0 500 1,000 1,500 2,000 2,500

52.0% 54.0% 56.0% 58.0% 60.0% 62.0% 64.0%

2008 2009 2010 2011 2012 2013 2014

BCP's Cost to Income evolution (domestic): 2008-2014E

Operating Costs (m€) Revenues (m€) Cost to income ratio

Worse operating efficiency than

peers…

…and a lot of room

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PAGE 12/31

31%

22% 24%

35%

53%

29% _21%

19%

60%

34%

10% 11%

19% 22% 3%

2005 2006 2007 2008 1H2009

International Divisions contribution to earnings

BES BPI BCP

losses in margins and the huge provision charges that they were forced to make due to severe asset quality deterioration. Also, in terms of growth by M&A, we should notice that banks with such high levels of efficiency as Santander and Popular (and even BES in Portugal) seem to be best positioned to capture synergies trough M&A by reallocating employees and offices and restructuring their activity. Santander is one remarkable case of success in restructuring, as it can be seen by its achievements in its subsidiaries in Portugal (Santander Totta) and in the UK (Abbey).

International operations

Banks’ ability to grow is nowadays limited in the developed countries, as the financial

sector is a mature industry and most of these countries have well penetrated banking systems. As we said before, investing in emerging markets to search top-line revenue growth has been the trend. This is because recently deregulated banking systems, as well as developing countries banking systems, tend to grow much faster that GDP and to approach the rest of the world levels. We should stress that the ratio of loans to GDP in 2008 was 193% in Portugal; that same ratio was 36.6% in 2007 for Poland and 102% in 2008 for Greece (according to national central banks data). For Angola and Mozambique more recent and

accurate data is unavailable, but their banking systems (mainly in credit to households) are even less developed.

Our analysis will be focused on the main operations for BCP, namely the ones that have been set by management as core operations of the group. We decided not to analyze the other operations (Romania, Turkey and USA) of the bank for two main reasons:

 Their impact in the valuation is residual;

 They are flagged as potential divestures, as the disposal of these activities could strengthen the capital ratios and allow management to focus in its core strategic plan. This also holds for Greece, the size of the operation itself implied an analysis.

In terms of internationalization, the outlook for BCP has been much poorer that its peers, a

situation that is affecting the group‟s earnings. This is in fact what is driving BES and BPI‟s

earnings nowadays, as we can see in the graph bellow.

Source:Bloomberg

BPI and BES have focused on countries which have strong cultural, linguistic and commercial links with Portugal, which is the case of Angola, Brazil and Spain. _{BPI’s exposure}

to Angola is large and the bank is reaping out the rewards for that, as the country has been one

of the fastest growing in the world, while exhibiting a low penetrated banking system. BES strategic triangle (as it is called by management) is allowing not only to increase earnings

abroad, but also to increase its leadership in trade finance of the corporate sector, as these are countries with strong economic relationships with Portugal (both exports and imports).

BCP’s new management seems to have the same view, and it is now focusing on Africa, with an extensive expansion plan in Mozambique and new alliances in Angola, but their impact on the value of BCP is still low. Moreover, the development of the Eastern Europe activities will be crucial, as they have pressed down the group‟s profit for the last years.

Poland

Bank Millennium Poland (in which the bank has a 65.5% stake) is the largest foreign operation of BCP. It is the 5th largest bank in Poland, with a market share of 7.4% in loans and 5.6% in

Cost to Income ratios

2003 3M2009

Sa nta nder Totta 44% 39%

2004 2008

Abbey 59% 45%

BCP’s foreign

operations share of earnings vis-à-vis its peers has been small

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PAGE 13/31 59% 41%

Weight of Net Income in 2008: Poland

Poland Group

12%

88%

Weight of Assets in 2008: Poland

Poland Group

deposits; it has 474 branches in the country and 6303 employees. The Polish activity

represented 59% of the total earnings of the group in 2008, after which it suffered a serious hit just to reach negative expected profits of € 3m in 2009E.

The Polish economy

It is always good to remember that the financial sector is the mirror of the economy. It was true in the years preceding 2008, when the Polish economy showed to be one of the best places to own a bank in Europe, with strong GDP growth rates and a still low penetrated banking system (with a 36.6% loans to GDP ratio in 2007). However, the financial crisis and the Global slowdown in the economic activity also hit the country, and BCP felt it the hard way in 2009. The recent FMI forecasts (from its World Economic Outlook October report) show that Poland continues to be one of the best performing economies in Europe, as it will be the only country with a positive growth rate of real GDP in 2009. Nevertheless, the financial system in Poland took a severe hit, and will take more time to recover. It was mainly hit trough its foreign exchange rate, as we will explain later. In our forecasts we used the latest predictions of FMI and the concept of relative Purchasing Power Parity to reach the forward exchange rates, which

we expect to be 4.27 PLN / € in 2010E against the maximum value reached of 4.84 PLN / €. All

growth rates in our analysis will be presented in zlotys, unless specifically told.

Source: Analyst estimates and FMI (World Economic Outlook Database of October 2009)

Capital Increase

Millennium Bank is a listed stock on the Warsaw stock exchange. Before beginning our analysis of the Polish operations, it is important to explore the capital increase it will make in

1Q10 of PLN 1b, or € 235m, by issuing 425m shares of stock, which is 50% of the present

number of shares.

Investors reacted with some nervosism after this announcement, but managements both in Poland and in Portugal justified this increase with the ambitious growth plan for the next years established by Millennium Bank, which points towards a 15% ROE in 2012 (which will not be achieved, according to our predictions). In our view, the solvency position of the group is improving even without this increase (as we explained above), and therefore we believe this capital increase will finance the investments predicted for the next years. This will help Millennium bank to increase the size of its operations, which is in our view crucial to achieve better cost efficiency, one of its main problems. The important question here is

whether the return on that investment will be enough to create value to domestic shareholders,

and that‟s what we will explain next.

Bank Millennium is focused mainly in the mortgage loans segment in Poland (with a market share of 11.5% as of 2008). As of 3Q09, mortgages represented 65% of the total loan

book of Millennium bank, against 26% of corporate loans and 9% of consumer finance.

The good performance of NIM was mainly driven in the last years by a strong volumes growth (namely 53% YoY in 2008). However, in the last few quarters, credit growth has actually been decreasing QoQ, as we can see in the graph bellow. The main reasons for this fact are:

 Millennium Bank stop in 2009 producing FX mortgage loans, as they were at the center of the financial sector crisis in Poland; as we mentioned above, the risk management approach of the bank is now more rigid, and it wants therefore to reduce the large weight of foreign currency denominated loans in its loan portfolio (85% of the loan book in June was made of mortgages denominated in Swiss Francs);

 Millennium Bank‟s conditions to grant loans have become also more rigid, a measure

created to reduce the risk of asset quality problems in 2010

For the near future, we are expecting mortgage loans to increase by only 1% in 2009E and 2% in 2010E, whereas corporate loans (5% in 2010E) and consumer loans (22%) are expected to reduce the impact of that slowdown. For consumer loans, we believe this is a very undeveloped segment due to the still low banking penetration in the country. For corporate loans, the fact that

26%

65% 9%

Loan breakdown Sep 09

Corporate Mortgage Consummer

Source: Company Data Source: Company Data

2007 2008 2009 2010 2011 2012 2013 2014

Poland gdp 6.79 4.89 0.98 2.19 3.99 3.95 3.88 4.00 Poland inflation 2.49 4.22 3.37 2.59 2.71 2.50 2.50 2.50

PLN / € 3.66 3.51 4.45 4.27 4.33 4.31 4.32 4.35

Market Shares

Millennium Bank (2008)

M. Share Ranking

Mortgages 11.5% 2º

Corporates 3.2% 8º

Total Loans 7.4% 4º

Total Deposits 5.6% 6º

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PAGE 14/31

0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00%

M

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r/

0

8

Ju

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/0

8

S

e

p

/0

8

D

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c/

0

8

M

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0

9

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/0

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Millennium Bank

Competition

management has decided to focus in SME (small and medium enterprises) segment is allowing it to act in a corporate segment where competition is hard and where Millennium Bank is far from being a big player (ranks 8th_{in market share, according to company data).}

All in all, loan growth is improving, but the figures achieved in the last years (namely in 2007) will not return in the next years.

Net Interest Margin

Source: Bloomberg Source: Company Data and analyst estimates

In order to understand what happened to the margin of Millennium Bank in Poland, it is crucial to go back a few quarters. A large share of mortgage lending in Poland is denominated in foreign currencies (namely Swiss Francs): the share of foreign currency loans in the mortgage portfolio of Millennium Bank was 82% in FY2008. At the end of 2008, the Zloty (Polish currency) depreciated from 3.22 PLN/€ to a maximum of 4.84PLN/€. As those loans were denominated in foreign currencies, their value increased a lot relatively to deposits, leading to an increase of the Loans / deposits ratio. When this happens for a bank, they have to increase their deposit base, which triggered a deposit war (banks running for deposits).

The ultimate result of this was negative deposit margins and an enormous compression of NIM: NIM decreased from 2.8% in 2008 to an annualized value of 0.8% in 1H09. The other part of the NIM which was also affected by this depreciation was the cost of funding of foreign currency swaps, which BCP has to use to cover for currency risk.

However, our view was that the 1H09 was the trough of the cycle for NIM, and perspectives are good for the near future, especially related to the recent recovery in NIM (1.7% in3Q09) and deposit margin (-0.29% in 3Q09). We base this conclusion on:

 the zloty has stabilized in value throughout 2009, and the recent FMI forecasts for the Polish economy point towards to economic growth and therefore no need of interest rate cuts by the Central Bank of Poland;

 the other Polish banks are being helped in terms of funding by their parent firms, which helped to end the deposit war;

 financial markets are now stabilized, and therefore the cost of funding of foreign exchange swaps is now much lower than at the beginning of the year.

All things considered, we forecast a NIM of 1.3% in 2009E and 1.55% in 2010E, with net interest income increasing a CAGR of 20% in 2010-2014E. Despite this short term recovery, we should stress that we do not expect earnings to reach the levels witnessed in 2007 and 2008 to return in the next years.

Source: Bloomberg Source: Company Data and analyst estimates

3.22

4.84

4.11

3 3.5 4 4.5

5 PLN / Euro Exchange rate evolution

PLN / €

1.00% 2.00%

0 1000 2000

2009 2010 2011 2012 2013 2014

Expected NII and NIM evolution in Poland (in m. PLN)

NII (lhs) NIM (rhs)

50% 60% 70% 80% 90% 100% 110%

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000

2005 2006 2007 2008 2009

Loans

Deposits

Loans / Deposits

BCP’s Loans and deposits evolution (in m. PLN)

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PAGE 15/31

Asset quality: The mortgage portfolio of Millennium bank, which accounts for 69% of total loans, is not being affected by asset quality deterioration, as interest rate cuts increased

households‟ disposable income. The main problem regarding non performing loans is within the corporate segment, as firms (mainly the SME segment, which is very important for the bank) are struggling with the slowdown in economic activity in 2009.

In the 3Q09 there was an extraordinary provision charge regarding corporate credit of €24.4m

(after a similar charge in 1Q09). Management believes there is a strong exposure of its corporate clients to FX derivatives, but also considers this an extraordinary charge that will not be repeated in 2010. Notice that the impact in the cost of risk of this charge was of 25bp.

As Millennium Bank has a larger exposure than its peers to the mortgage segment (the best performing by far in terms of asset quality in Poland), and the Polish economy is expected to grow stronger in 2010 and 2011, we do not expect more unexpected problems in terms of asset quality for BCP.

Source: analyst estimates

Operating Leverage: As we explained before, BCP‟s operating leverage is extremely large and

is one of the main value destroyers for BCP. If domestically it is difficult to explain the lack of efficiency, abroad we can justify it with the need to expand the activities in the bank. Therefore, the recent improvements in terms of operational efficiency achieved by management in Poland are remarkable. Millennium bank has reduced its staff by 635 employees this year, and

staff costs and administrative costs were down 20.5% and 2.8% YoY in 3M09. This process

is expected to continue in the next years, as targets set by management are clear and it showed ability to achieve them.

For the reasons explained above, we expect Poland to return to be an important value driver for BCP in the next years, reaching 21% of total earnings of the group in 2011E. Net

income is expected to grow a CAGR of 26% in 2010E-2014E. Still, it is important to stress that we do not expect this division to recover the earnings levels of 2007 and 2008 in the near future, as the Polish financial system will take some time to adjust. We are only predicting a return to the 2008 net income for 2012E (€ 117m in both years).

Greece

The future of this operation isn‟t still clear: it is not included on that group of priorities for

BCP, but management isn’t also willing to sell its Greek subsidiary at or below book

value. Having this said, it is firstly important to analyze Greece for the share of assets it represents on the group: in 1H2009 total assets in Greece were 7% of total assets, and

approximately one third of the total assets in international operations. Despite this, its

performance has been poor following the financial crisis, and Net Income was € 7m,

representing a 50% decrease YoY.

Millenium Bank in Greece is nowadays more of a universal bank than it was initially when BCP decided to invest there, providing private banking and investment banking, among other services. However, Millenium Bank is mainly focused on its retail operations, with a market share of 1% in deposits and 2% in loans.

46%

39% 15%

Loan Book Breakdown at Sep-09

corporate mortgages consumer

2009E 2010E 2011E 2012E 2013E 2014E

NPL ratio 4.94% 3.47% 2.73% 2.37% 2.18% 2.00%

Cost of Risk 1.06% 0.77% 0.63% 0.55% 0.52% 0.48%

Coverage ratio 66% 72% 75% 77% 77% 78%

Cost of risk = NPL / Gross Loans

Coverage Ratio = Impairments / NPL NPL‟s are defined as overdue loans by more than 90 days

149 150 157 153 ₁₁₆ ₁₂₄

110 125 122 140

115 113

13 18 19 21

19 20

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09

Breakdown of operating costs (m. PLN)

Staff costs Other administrative costs Depreciation

60% 61% 62% 63% 64% 65%

0 500 1,000 1,500 2,000 2,500 3,000

2010E 2011E 2012E 2013E 2014E

Cost to Income evolution

Banking Product (m. PLN) Operating Costs (m. PLN) Cost to income

Millennium Bank is showing strong improvements in operating

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PAGE 16/31

2007 2008 2009 2010 2011 2012 2013 2014

Greece GDP 4.0 2.9 - 0.8 - 0.1 0.7 1.2 1.6 1.9 Greece inflation 3.0 4.2 1.1 1.7 1.6 1.8 2.0 2.0

Source: FMI (World Economic Outlook Database of October 2009)

Even though Greece is behaving slightly better than Portugal concerning the economic downturn (facing a smaller drop in GDP of -1.3% YoY), in the last few quarters there was huge decrease on corporate loans in the country. It was precisely this segment that was driving loan growth for Millennium Bank (with +61% in FY2007 YoY, which dropped to + 31% in FY2008 YoY and +18% in 1H09 YoY). The mortgage segment has hold up better, and is now growing at 15% YoY.

Regarding the future, the banking sector is not as developed in Greece as it is in Portugal, and

there is still some room for further growth in loans and deposits: notice that the total loans in Portugal represented 193% of GDP in 2008, vs. 102% in Greece. In fact, BCP‟s

main reason to invest in Greece is the same as the other international operations: to grow more than in Portugal. As the bank has a market share of 4% in branches and only 2% in loans, we expect this to continue. Our drivers for the balance sheet of Millennium bank account for this, as we predict a CAGR 12% increase in loans and 12% in deposits for the period 2010E-2014E. Nevertheless, we stress that the potential for growth is now much lower than in Poland or Mozambique. The four largest banks in Greece (NBG, Alpha Bank, EFG and Piraeus) have been expanding rapidly in Southeastern Europe in the past years, and justify this expansion with their view of a Greek market that is smaller and more penetrated than a few years ago.

Earnings forecast

The net interest margin of Millennium Bank in Greece has been strongly affected by the

negative margins on deposits felt since the end of 2008, with a minimum spread of -0.85% in 1Q09. Margins on deposits were always traditionally low in Greece, and with reference rates reaching historical lows, they have immediately became negative. Moreover, management justifies the drop of 22 bps in NIM (1.96% in 2009E against 2.18% in 2008) with the rise in the cost of funding. Our prediction is that the deposit spread will stay negative until 2010, and the loans spread will have to decrease in the long term as competition is increasing in the sector (as it is becoming more mature),with a negative impact on margins. The net interest margin will therefore be mainly driven by volumes growth (CAGR increase of 12% 2010-2014E).

Banking sectors and Millennium Bank (2008)

PT GR Millennium Bank

Cost / Income 53.8 55.15 75.3

ROA 0.49 0.58 0.25

ROE 8.09 10.7 4.82

Source: ECB Financial Stability Report 2009 and company data Source: Company Data and analyst estimates

Concerning the cost to income ratio, we are incorporating a small decrease from 76% in

2010E to 72% in 2014E, as the bank is expected to expand its branch network in order to increase its penetration in the country. We should highlight that the high administrative costs are a problem for BCP in Greece: they are related to the aggressive network expansion (4% of market share in branches), but also with the small size of the operation. We highlight that this is a greenfield operation and that the largest banks in Greece have solid market shares there, which means the potential growth of the operation will be limited in the future.

As an increase in profitability of the bank in the future will take some time to materialize, we expect efficiency gains to be limited, _{and the bank will continue to lack behind the sector’s}

cost to income ratio of 55% and ROA of 0.58%. This is why we expect this division to continue destroying value for the group (more on this on the valuation section).

One important note should be made regarding the recent evolution of the Greek economy, as the budget deficit is now expected to reach 12.3% of GDP in 2009 and country‟s debt is

amounting to 117% of GDP, reaching € 300bn. Jean Claude Trichet has already informed that

Comparision PT GR

Loans / GDP 193% 102%

pop. / branch (th) 1.7 2.7

Source: ECB (EU Bank Stability Report 2009)

Sector affected by negative deposit spreads

Lower efficiency and profitability than peers in Greece

2.68% 2.87% _3.17% 3.28% 3.42% 0.53%

-0.33%

-0.85% -0.35% -0.21%

3Q08 4Q08 1Q09 2Q09 3Q09

Evolution of Spreads on loans and deposits

BANKS ” A NALYST: “ LUÍS MENDES JOÃO ”

E

QUITY

R

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M

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F

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“M

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BCP

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“

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ANALYST:

“

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[email protected]

The bottom of the cycle

Valuing with improved earnings visibility

Table of Contents



Investment Summary ………

.... 3



Wh

at drives value ………

... 5



Co

mpany analysis ……….…….…... 6



Valuation ……….……… 23



Financial Statements ………..…

...

……. 27

BCP's Shareholder Structure

Investment Summary

What drives value?

Portugal

International operations

Poland

Greece

_{Valuation ……….……… 23}

_{Financial Statements ………..…}