Mexico the Undiscovered Country

ANCHOR REPORT

Equity Research

Mexico: The undiscovered country

We turn more bullish on the Mexican banking sector and upgrade BBVA to Buy In this Anchor Report, we undertake a detailed analysis of the Mexican economy ’s dynamics and their implications for the banking sector.

Following this work, we have become more positive on the outlook for profitable growth, and expect the banking sector to account for c. 35% of GDP by 2020, implying potential annual loan growth of 15-17% over the same period.

Although a key risk for BBVA remains the ongoing sovereign/economic difficulties in Spain, we upgrade the stock to Buy from Reduce (and raise our TP to EUR 7.80 from EUR 7.30), as we expect the company to generate 44% of net income from Mexico by 2014.

At the same time, we downgrade Santander to Reduce from Neutral (and cut our TP to EUR 7.10 from EUR 7.40), given greater uncertainty around the outlook for Brazil (33% of net income).

Key analyses in this report include:

a review of the economy and banking sector, and the potential for growth (including positive demographic trends); and

a valuation of BBVA ’s Mexican business.

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

July 10, 2012 Research analysts European Banks Daragh Quinn – NIplc daragh.quinn@nomura.com +44 20 7102 8333

Emerging economies Benito Berber – NSI benito.berber@nomura.com +1 212 667 9503

Industry specialist Duncan Farr – NIplc duncan.farr@nomura.com +44 20 7103 1539

Mexico GLOBAL BANKS

Anchor Report: The undiscovered country

EQUITY RESEARCH

July 10, 2012

Positive economic outlook to support banking growth Bullish economic outlook Over the next decade, Mexico will, in our view, become LatAm’s largest economy and one of the emerging markets’ most dynamic. Given faster growth in China’s US dollar-denominated labour costs, Mexico is an increasingly attractive choice for US-destined, labour-intensive manufacturers. We believe potential GDP growth will recover to 3.5-4.5% over the next decade, supported by foreign direct investment (FDI) and structural reforms.

The politics of reform The PRI party and Enrique Pena Nieto have regained the presidency and the Lower House. Unlike in previous elections, the party supports structural, pro-market, reforms. It will not have a majority in the Lower House or Senate and will most likely have to rely on the PAN party’s support. However, we could say a majority does support the reforms as the PAN party has also supported their approval, and so two of the three key parties are pro-reform.

Mexican banking to come of age In relative terms, the Mexican banking sector remains one of LatAm’s smallest, particularly relative to the level of economic development. Private sector debt to GDP is barely 20% vs. an average of c. 40% for key LatAm peers and as high as almost 80% in Chile. Given our bullish economic outlook, overall lending growth of 15-17% per annum could be sustained.

Hitting a demographic sweet spot This positive environment for the economy and banks is likely to be supported and even accelerated by positive demographics, hitting a sweet spot in 2020. Current projections point not only to Mexico showing one of the strongest levels of population growth among major economies, but also the greatest fall in the dependency ratio (proportion of young/old relative to the working age population). This implies a greater relative increase in resources and potentially stronger GDP growth. Some of the benefits of this demographic dividend would not be automatic, but will likely depend on appropriate policy action/reform.

We believe Mexico is positive for global banks (BBVA, SAN, Citi and HSBC), we therefore upgrade BBVA Given our bullish outlook for Mexico, we upgrade BBVA to Buy from Reduce and raise our target price to EUR 7.80 from EUR 7.30). To maintain a spread in ratings, as we still have a cautious view on European banks, we lower our rating on Santander to Reduce from Neutral and lower our target price to EUR 7.10 from EUR 7.40). We estimate a potential positive impact on EPS of 1% for HSBC and of 2.0-2.5% for Citigroup. However, given the potential downgrades from capital market trends, we leave our earnings forecasts unchanged.

Research analysts European Banks Daragh Quinn - NIplc daragh.quinn@nomura.com +44 20 7102 8333 Prathmesh Dave prathmesh.dave@nomura.com +44 20 7102 8530 Jon Peace - NIplc jon.peace@nomura.com +44 20 7102 4452 Domenico Santoro - NIplc domenico.santoro@nomura.com +44 20 7102 2375 Scott Sheridan - NIplc Scott.Sheridan@nomura.com +44 20 7102 0067 Tarik El Mejjad - NIplc tarik.elmejjad@nomura.com +44 20 7102 9272 Chintan Joshi - NIplc chintan.joshi@nomura.com +44 20 7102 6597 Omar Keenan - NIplc Omar.Keenan@nomura.com +44 20 7102 4341 Marco Kisic - NIplc Marco.Kisic@nomura.com +44 20 7102 1435 Robert Law - NIplc robert.law@nomura.com +44 20 7102 2715 Emerging economies Benito Berber - NSI benito.berber@nomura.com +1 212 667 9503 Industry specialist Duncan Farr - NIplc duncan.farr@nomura.com +44 20 7103 1539

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | Mexico

July 10, 2012

Contents 3

Macroeconomic view: Bullish fundamentals

9

Political outlook – the PRI is back

11

Potential for sustained banking expansion

Research analysts

17

From where will loan growth come?

European Banks Daragh Quinn - NIplc daragh.quinn@nomura.com +44 20 7102 8333 Prathmesh Dave prathmesh.dave@nomura.com +44 20 7102 8530

A closer look at the Mexican housing market

Jon Peace - NIplc jon.peace@nomura.com +44 20 7102 4452

A demographic dividend?

Domenico Santoro - NIplc domenico.santoro@nomura.com +44 20 7102 2375

32

Recent performance of the Mexican banking sector

Scott Sheridan - NIplc Scott.Sheridan@nomura.com +44 20 7102 0067

37

The positive impact of Mexico – upgrading BBVA

Tarik El Mejjad - NIplc tarik.elmejjad@nomura.com +44 20 7102 9272

44

Positive impact for global banks

Chintan Joshi - NIplc chintan.joshi@nomura.com +44 20 7102 6597

45

Overview of the key Mexican banks

Omar Keenan - NIplc Omar.Keenan@nomura.com +44 20 7102 4341

62

Appendix A-1

Marco Kisic - NIplc Marco.Kisic@nomura.com +44 20 7102 1435

22

29

Tathagat Kumar tathagat.kumar@nomura.com +44 20 7102 9177 Robert Law - NIplc robert.law@nomura.com +44 20 7102 2715 Manish Kumar Marodia manishkumar.marodia@nomura.com +44 20 7102 9166 Emerging economies Benito Berber - NSI benito.berber@nomura.com +1 212 667 9503 Industry specialist Duncan Farr - NIplc duncan.farr@nomura.com +44 20 7103 1539

2

Nomura | Mexico

July 10, 2012

Macroeconomic view: Bullish fundamentals Despite the opening of the economy with the signing of free trade agreements since 1994, the privatisation of several sectors and the consolidation of democracy in 2000, the Mexican economy failed to embark on a high-growth trajectory in the past decade.

Mexico average economic growth rate was one of the lowest among emerging markets (EMs) at 2.6% y-o-y in 1994-2012. In addition, rising violence has threatened the investment climate, besides hurting society. However, the outlook is improving rapidly. In the next decade, Mexico is likely to become LatAm’s largest economy and one of the most dynamic among EMs. Fig. 1: Mexico: GDP growth rate 10 % y-o-y 8 6 4 2 0 -2 -4

GDP growth

-6 -8

Average growth (Q1 1994 - Q1 2012)

-10 1Q 1994 1Q 1997 1Q 2000 1Q 2003 1Q 2006 1Q 2009 1Q 2012 Source: Haver Analytics, Nomura research

To understand why we have a positive outlook, it might be useful to describe the status quo of the economy: Rigidities in the labour market, a sizable informal market, high dependency of fiscal accounts on oil revenues, existing monopolistic and oligopolistic structures, and a lack of investment in the state-dominated energy sector are among the problems that have slowed Mexico’s growth in the past. The medicine, in the form of the so-called structural reforms, has proven to be elusive. Congress, which since 1997 has not been dominated by any particular party, has had difficulties in reaching consensus with respect to economic policy. Also, in the past 15 years, two out of the three main parties have opposed the key reforms.

Being linked to the US was a detriment when the US financial sector was the epicentre of the 2008-09 global crisis. However, now that the worst episode in the US appears to be over, while the worst in the eurozone seems still ahead of us, strong US links now prove very advantageous. After all, one-third of total GDP is directly linked to economic activity north of the Rio Grande.

Mexico is becoming an increasingly attractive choice for US-destined, labour-intensive manufacturers owing to rising labour costs in China. When China became a member of the World Trade Organization (WTO), there were warnings about possible repercussions for Mexico, which lost market share to China, particularly in the US. However, over the past 10 years, unit labour costs in China have grown much faster than in Mexico.

In addition to external factors behind our positive outlook, such as being tied to the only G3 country with a positive growth outlook and regained competitiveness against China, there are domestic ones: consumption lending, which was dormant for many years, is now expanding at c. 20% annually. The expansion of credit is taking place amid a sound banking system where 85% is foreign owned (in terms of assets) and from a low level of indebtedness. Furthermore, the outlook for the passage of reforms is promising. Two out of the three main parties support their approval, including the Institutional Revolutionary Party (PRI), which will govern in the 2012-18 term.

3

Nomura | Mexico

July 10, 2012

Cheaper than China Fast-rising labour compensation in Chinese renminbi terms, on top of both real and nominal appreciation of the renminbi, has led to China’s labour costs rising sharply in US dollar terms. In sharp contrast, Mexico’ labour costs in pesos have been remarkably stable. Mexico is becoming an increasingly attractive choice for US-destined, labourintensive manufacturers – a bullish factor over the medium term.

Over the past 10 years, unit labour costs in China have risen much faster than in Mexico.

Although productivity rises quickly in China, an even quicker rise in wages has continued to push up unit labour costs, especially since 2003. The faster rate of wage increases in China than in Mexico implies that China’s cost advantage is dissipating rapidly. Chinese labour rates were 33% of Mexico’s in 1996, yet now they are fairly close or even higher than Mexico’s. Comparing the 2012 minimum wages in Mexico and China, we note that, in almost all parts of China, the legally-mandated cost of hiring has exceeded that in Mexico.

Minimum wages in both countries vary according to the level of development in various jurisdictions. Minimum wages in the most developed (Shanghai), relatively developed (Qingdao, Shandong province), and less developed (Xi’an, Shaanxi province) Chinese cities are all higher than for their Mexican counterparts in nominal US dollar terms.

Fig. 2: Mexico and China: Minimum wage (2012) Minimum wage in Mexico (2012) MXN per day

USD per day

Mexico City

62.33

5.02

Monterrey, Nuevo Leon State of Michoacan

60.57 59.08

4.88 4.76

Minimum Wage in China (2012) RMB per month

USD per day

Shanghai City

1450

7.48

Qingdao, Shangdong

1240

6.40

Xian, Shaanxi

1000

5.16

Note: assuming a 30-day month, we use average 2011 MXN exchange rate of 12.4233 and RMB exchange rate of 6.4611 to make the conversion.

Source: Haver Analytics, Nomura research

Though minimum wages do not necessarily reflect the full cost of manufacturing labour, they do provide a floor for the cost of labour, which is rapidly tilting in Mexico’s favour.

The latest reports from The New York Times indicate that Foxconn, a major Chinese supplier for Apple products, would raise salaries by 16-25% for many workers, to about USD 400 a month, before overtime. In Mexico, assembly-line workers at Volkswagen are paid USD 340 per month according to local newspaper Zonafranca.

On top of the labour cost differential, Mexico has always enjoyed lower transportation costs. This is especially evident in heavier, bulkier items (eg, white goods), where freight has accounted for a higher share of the total cost. Among major US trade partners, except for China, Mexico was the only country that saw its market share in the US rise.

Potential GDP growth, on the cusp of rising Potential GDP growth in Mexico (maximum economic growth that does not generate inflation pressures) has likely fallen to 3.0% currently from 4.0% in 1994 when Mexico entered the North American Free Trade Agreement (NAFTA). Potential GDP rose with the increase in capital investment following its inclusion in NAFTA. A number of factors may explain the failure of potential GDP to remain high after NAFTA: (1) rigid, noncompetitive markets in key sectors (electricity, telecommunications and oil); (2) institutional arrangements that promote rent-seeking; (3) lack of enforcement of contract rights (costs are 1.5 times the OECD median); (4) rigidities in the labour market; and (5) low quality of education. However, we believe the potential output will recover to 3.54.5% in the coming decade owing to a sharp rise in FDI and to the passage of key structural reforms.

4

Nomura | Mexico

July 10, 2012

We have discussed that rising costs in China, coupled with stable unit labour costs in Mexico, could translate into increased investment in the Mexican manufacturing sector.

In addition, Mexico’s unique position of being so close to the US market and the multiple free trade agreements signed with the rest of the world (ie, the Trans-Pacific Partnership), are additional powerful factors that could trigger FDI inflows.

Fig. 3: Mexico: Recently-announced FDI projects Announced Audi

April, 2012

Investment (in $mn) 2,520 2,000

Operational by

Jobs

Puebla Aguascalientes

Location

2016

N/A 3000

150k vehicles/yr 175k vehicles/yr

Guanajuato Guanajuato

2014 2013

3,200 3000

200k vehicles/yr 140k vehicles/yr

2013

Productivity

Nissan

Jan, 2012

Honda

July, 2011

Mazda

June, 2011

800 500

Pirelli

May, 2012

400

Guanajuato

2012

1,800

400k pieces/yr

Unilever

July, 2011

126

Jiutepec

2012

1,000

500k pieces/yr

Source: Bloomberg, Reuters, Nomura research

There are three key structural reforms: energy (to increase private participation in the state-dominated energy sector); labour (to increase flexibility in the very rigid labour market); and fiscal (to eliminate exemptions and increase non-oil revenues). The fact that the PRI party, under the leadership of Enrique Peña Nieto (soon to be named president elect), has become a strong supporter of these reforms significantly increases the likelihood that Congress approves at least some of them.

Fiscal front, strong despite oil dependence The structural weakness of the fiscal accounts is characterised by the fact that more than a third of government revenues derive from oil. Therefore fiscal revenues are subject to price and output volatilities in the oil sector. Although oil production has now stabilised, it has decreased. Furthermore, tax revenue collection, at around 10-11% of GDP, is one of the smallest among EMs. However, these weaknesses are more than offset by a strong fiscal responsibility law, a hedging strategy for oil exports, a low debt-to-GDP ratio, reliance on the local market to finance the deficit and a fiscal stabilisation fund: • By law, the fiscal balance of the central government has to be zero, which means that the overall public sector deficit (including state-owned companies) usually does not exceed 2.5% of GDP. In fact, Mexico’s fiscal deficit is among the lowest in major EM countries and developed economies.

• The government has been hedging its oil exports. In 2012, Mexico bought put options with a strike price of USD 85 per barrel for the Mexican oil mix. This hedge effectively shields the bulk of 2012 oil revenues against a collapse in oil prices.

• Mexico has fairly low ratios of net-debt-to-GDP at around 30%.

• The government finances itself mainly in the local market. The shift to local debt has occurred in tandem with the development of the local market. In this regard, it is important to highlight that, in 2010, Mexican local debt was included in Citi’s World Government Bond Index (WGBI), making it the first and only LatAm country to be included in such a benchmark index.

• The government’s fiscal stabilisation fund amounts to 0.43% of GDP. Although insufficient to offset a prolonged shock by itself, combined with other lines of defence it strengthens the fiscal accounts.

5

Nomura | Mexico

July 10, 2012

Fig. 4: Mexico, Brazil, US & France: Fiscal balance (% GDP)

Fig. 5: Mexico: Gross government debt (as % of GDP)

% GDP

40

% GDP

3.0 35 0.0 30 -3.0

25

-6.0

20 Brazil Mexico France US

15

-9.0

10 1Q 2006

-12.0 2000

2002

2004

2006

2008

2010

Source: Haver Analytics, Nomura research

3Q 2007

1Q 2009

3Q 2010

Source: Haver Analytics, Nomura research

External accounts, relentless portfolio inflows Mexico is likely to continue to have a small and manageable current account deficit that rarely surpasses 2.0% of GDP. This small deficit can be attributed to the bulk of imports being reprocessed for further export and a stable surplus in remittances. In contrast, we expect the surplus in the financial account to remain sizable. Indeed, the financial account had a surplus of USD 52.4bn (4.5% of GDP) in 2011, more than offsetting the USD 8.8bn current account deficit. Furthermore, we expect the surplus in the financial account to remain strong owing mainly to portfolio and FDI flows.

Fig. 6: Mexico: Current and financial account balances (USD bn) 70

$ bn

60 50 40

Current account deficit (4Q sum) Capital account surplus (4Q sum) Basic balance (4Q sum)

30 20 10 0 -10 -20 -30 1Q 2001

1Q 2002

1Q 2003

1Q 2004

1Q 2005

1Q 2006

1Q 2007

1Q 2008

1Q 2009

1Q 2010

1Q 2011

1Q 2012

Source: Haver Analytics, Nomura research

Is the MXN cheap or expensive?

The Mexican peso (MXN) could be among the few EM currencies that are undervalued.

Although it is challenging to find the equilibrium level of the real effective exchange rate (REER), a simple comparison with past averages reveals that the MXN is undervalued.

Latest Bank of Mexico (Banxico) data indicate that, as of 2Q 2012, MXN is around 5% undervalued relative to its 10-year average.

6

Nomura | Mexico

July 10, 2012

Fig. 7: Mexico: REER deviations from long-term averages

70

%

50

overvaluation

30 10 -10 20-yr

-30

10-yr

-50 1994

1998

undervaluation

2002

2006

2010

Source: Banxico, Nomura research

Accumulating reserves a change in strategy The rapid accumulation of reserves has limited MXN appreciation to some extent. After the 2008-09 financial crisis, the Exchange Commission (which is the body that ultimately decides on FX intervention, and is composed of three members from the Finance Ministry and three from Banxico) changed its stance substantially: it now believes reserves are pivotal for FX stability. The rapid accumulation of reserves is bearish in the short term, but could be a positive factor in the long run as it lowers the probability of a currency crisis.

Fig. 8: Mexico: FX reserve accumulation

% GDP 14

US$ bn 150

13 12

130

FX reserves (lhs)

110

Reserves as % GDP (rhs)

11 10

90

9

70

8 7

50 30 Jan-01

6 5 Jan-03

Jan-05

Jan-07

Jan-09

Jan-11

Source: Haver Analytics, Nomura research

In the past 12 months, Banxico accumulated USD 32bn in FX reserves, taking the total to USD 157bn by June. Most of the accumulation was related to oil and derivatives’ net dollar inflows from Pemex, which has to be sold to Banxico by law. The level of reserves in terms of GDP (13%) is now comparable with Brazil’s (14.7% of GDP).

7

Nomura | Mexico

July 10, 2012

Banxico monetary policy, 4.5% until 2014 Since July 2009, the monetary policy rate has been 4.5%, a historical low in nominal terms, and we believe Banxico will delay the start of the tightening cycle to Q1 2014. The output gap (actual GDP minus potential GDP) has now closed after falling to less than -7% in the 2008-09 crisis. We project the output gap to remain around zero in the coming year and a half. Inflation is likely to stabilise to 3.5-4.5%, above the 3.0% +/-1.0% target.

Under normal circumstances, Banxico would be hiking its policy rate, but with sizable risks to global growth owing to the eurozone crisis, we expect it will remain on hold.

Fig. 9: Mexico: Output gap 130

Fig. 10: Mexico: 12-month inflation expectations % y-o-y

Index (2003 = 100)

5.0

125

Actual GDP

4.5

120

115

Potential GDP Output gap

110

4.0 12m ahead expectations 3.5 Target band - top

105 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Source: Haver Analytics, Nomura research

3.0 Jan-08

Oct-08

Jul-09

Apr-10

Jan-11

Oct-11

Source: Banxico, Nomura research

8

Nomura | Mexico

July 10, 2012

Political outlook – the PRI is back And the outlook for reforms The PRI party and its candidate, Enrique Peña Nieto, regained the presidency in the 2012 general elections. This marks the return of the PRI to the executive branch after losing the presidency in 2000 to the right-leaning National Action Party (PAN) when Mexico finally transitioned to democracy. Unlike the PRI regimes of the postrevolutionary era and until the 1980s when centre-left policies were in favour, this PRI seems to be positioning itself between the centre and the moderate right of the political spectrum. It is a party that resembles the technocrats who governed with former PRI presidents Carlos Salinas and Ernesto Zedillo. The PRI is now the undisputable leading party in the country because, as well as the presidency, it will also control 22 of the 32 states. However, the PRI failed to win a majority in Congress. The left-leaning Party of the Democratic Revolution (PRD) will continue to oppose the passage of these reforms.

The final count of votes for the 2012 general election indicates that Mr. Peña Nieto won the election with 38.15% of the votes cast in an electoral process with low abstention (63.14% of the registered voters exercised their right to vote). Andres Manuel Lopez Obrador (also known as ‘AMLO’) from the left-leaning PRD party received the support of 31.64% of the votes. The party that won the presidency in the 2000-06 and 2006-12 terms, the right-leaning PAN party, finished a distant third with 25.40% of the vote.

These numbers paint an interesting picture, characterised by the following facts: • Mr. Peña Nieto of the PRI’s has a weak mandate as 61.85% of voters did not support him.

• Since the consolidation of democracy in 1997-2000, Mexicans have once again divided their votes among the three main parties.

• The left PRD party has become the second-strongest party. Its candidate, AMLO, who in 2006 narrowly lost the election (by only 0.56% of the vote) behind President Felipe Calderon from the PAN, will remain a relevant political figure.

• Mr. Peña Nieto and the PRI, unlike in previous elections, have campaigned with the flag of supporting the passage of structural pro-market reforms. Therefore, given that the PAN has always strongly supported their approval, two out of the three main political parties now support the passage of pro-market reforms.

While the PRI will be dominant political force in both the Lower House and the Senate, it will not have a simple majority. Most likely, the PRI will have to ally itself with the PAN party and other small parties in order to pass structural reforms.

Fig. 11: Mexico: Lower House and Senate composition

Lower House 2009-'12 PRI*

2012-'15**

Senate 2006-'12

2012-'18**

261

240

39

61

PRD*

89

134

35

28

PAN

141

116

50

38

PANAL

7

10

0

1

Others

2

0

4

0

500

500

128

128

Notes: (*) Coalition parties. (**) Preliminary results Source: IFE, El Universal, Nomura research

The PRI has also regained control of two states, but lost the governorship of one.

Therefore, it now governs in 22 out of 32 states, and the PAN and the PRD control five states each.

9

Nomura | Mexico

July 10, 2012

Fig. 12: Mexico: Political map

Source: IFE, Nomura research

and what do the election results mean for the prospects of reform?

Given that the PRI will not have a majority in Congress, it will have to rely on the PAN and the small parties (PVEM, PANAL, PT, MC) for the approval of key structural reforms (labour, energy, fiscal and political reforms).

In particular, the right-leaning PAN could impose conditions on the PRI in exchange for its support. This implies that the outlook for the passage of reforms looks binary: either the approved reforms are very ‘pro-market’ or they will not be passed at all. Indeed, the scope for watered-down reforms has decreased, which is a markedly different outlook from the situation in the past, characterised by a president from the PAN and the PRI as the kingmaker party.

In the next term (2012-18), the party proposing the reforms will be the PRI and the kingmaker party will be the PAN. This scenario means that the PAN will ask for things that the market tends to like (increased private participation in the economy, and increased transparency for unions, among others) in exchange for its vote to pass the reforms. For example, when the PRI eventually asks the PAN for its support in passing the labour and fiscal reforms, the PAN will likely insist on the inclusion of clauses to increase the transparency of monies administered by unions and state governors. Given that the unions are allies of the PRI and this party controls most of the states, the negotiations could become deadlocked.

However, we believe the labour reform will ultimately be approved because both the PRI and PAN understand the need to boost productivity. We assign a 50% likelihood to the passage of the fiscal reform, which is pivotal to funding one of Mr. Peña Nieto’s most important projects – the creation of welfare support (unemployment insurance, insurance for work hazard, minimum retirement and access to health services). We believe the likelihood of the energy reforms being approved is very small given that, after the expropriation of oil in 1938, the concept of allowing private companies into the market is still unpopular.

10

Nomura | Mexico

July 10, 2012

Potential for sustained banking expansion From a low base, we expect to see a significant expansion in bank debt to GDP levels over the medium and long term. We believe that this is supportive of strong double-digit volume growth rates.

The banking sector remains very small relative to peers across LatAm and has never fully recovered in size following the 1994 ‘Tequila’ crisis. Although growing below potential, we believe that the continued outlook for economic, fiscal and financial stability should enable the Mexican banking sector to start recovering some lost ground. Private sector debt in Mexico barely represents 20% of GDP vs. 35% in Colombia, more than 50% in Brazil and almost 80% in Chile.

Overview Despite the growth in the Mexican economy of c. 116% in nominal terms over the past 10 years, the relative size of the banking sector remains one of LatAm’s lowest. Over the same period, real GDP growth has averaged c. 2% pa, which compares with 3.5% pa for the rest of the region. GDP per capita, in US dollar terms, ranks significantly above the average for the region; while the size of the banking sector in relative terms ranks as one of the smallest. Given our outlook for economic growth/stability and the new political environment post the recent elections, we believe the Mexican banking sector could reach c. 35% of GDP by 2020, implying potential per annum loan growth of 15-17% over the same period.

Fig. 13: Lowest level of growth over the past 10 years

Fig. 14: Low bank debt to GDP despite above-average GDP

Average real GDP growth 2001-11, % pa

Private sector debt % GDP. GDP per capital PPP

6% 5%

20,000

90%

18,000

80%

16,000

70%

14,000

4% 3%

12,000

60%

10,000

50%

8,000

40%

6,000

2%

30%

4,000 1%

20%

2,000 0

0% Mexico

LatAm

Source: IMF, Nomura research

Brazil Colombia Chile Argentina Peru

10% Peru

Colombia Brazil

GDP per capita USD (LHS)

Mexico

Chile Argentina

Debt to GDP (RHS)

Source: IMF, Nomura research

We expect deposit growth in Mexico to remain strong. Inflation rates of c. 4.5% should be supportive, but the key driver will likely be continued economic growth, increased formalisation of the economy/job creation and supportive demographic trends. In terms of a regional comparison of deposits as a percentage of GDP, both Mexico and Argentina stand out as significantly below peers. This is to be expected, in our view, and is closely correlated with the low level of bank debt to GDP. However, we believe the economic and financial situation is significantly more stable in Mexico and, as a result, we are more confident that deposits will rise as a percentage of GDP in both the medium and long term.

It is also worth highlighting the relatively low loan-to-deposit ratio of Mexico, in particular in contrast to Brazil. This will likely have played a part in depressing revenues in a low interest rate environment. However, as economic growth is sustained over the coming years, we believe this relatively strong funding position should also be supportive of loan growth.

11

Nomura | Mexico

July 10, 2012

Fig. 15: Low bank penetration also reflected in deposit levels

Fig. 16: Stronger funding capacity

Deposits % GDP. 2011.

Loan-to-deposit ratios 2011.

70%

150%

60%

130% 110%

50%

90%

40%

70% 30%

50%

20%

30%

10%

10%

0%

-10% Argentina Mexico

Peru

Colombia

Brazil

Mexico

Chile

Source: Central banks, IMF, Nomura research

Argentina Colombia

Peru

Chile

Brazil

Source: Central banks, Nomura research

How to expand a banking sector Private sector leverage remains low in Mexico compared with peers; however, as GDP expands, we expect to see loan growth expand at a faster pace. In fact, since 2005, the average loan growth/GDP multiplier has been 1.5x for five of the major economies in LatAm. This compares with just 1.2x for Mexico, and although growth rates in Mexico could still remain below potential, we believe the current economic outlook points to an improvement in this indicator. The scale and effectiveness of reforms from the new government could also potentially improve this outlook. We believe that there should still be sufficient capacity for strong and sustained double-digit loan growth over the next five years.

Fig. 17: Loan growth relative to GDP starting to recover

Fig. 18: Mexico lagging behind regional peers

Loan growth vs. nominal GDP growth

Loan growth multiplier average since 2005

4.0x

2.0x

3.5x

1.8x 1.6x

3.0x

1.4x

2.5x

1.2x

2.0x

1.0x

1.5x

0.8x

1.0x

0.6x

0.5x

0.4x 0.2x

0.0x 2005 2006 Mexico Colombia

2007

2008 Brazil Peru

Source: Central banks, IMF, Nomura research

2009

2010 2011 Argentina Chile

0.0x Argentina Mexico

Chile

Peru

Colombia

Brazil

Source: Central banks, IMF, Nomura research

Figure 19 sets out a basic premise that, as GDP increases, so will the size of the banking sector (measured here by private sector loans as a percentage of GDP). At a certain point of development, there is an exponential expansion in credit given both stronger demand and, importantly, the willingness and ability of the banking system to supply credit (capacity for funding, risk appetite). Banking and sovereign crises, such as those experienced by Mexico and Argentina, can have long-lasting effects on the development potential of the banking sector. In that regard, while the security situation in Mexico still generates a certain level of uncertainty, we believe that there are number of positive developments to highlight: the recent successful handover of power, sustained economic growth (only dipping into recession briefly in 2009), strong/stable fiscal position and sustained low inflation. All of these factors should help provide a platform for a significant increase in the Mexican banking sector over the next 10 to 15 years, in our view.

12

Nomura | Mexico

July 10, 2012

Fig. 19: Debt to GDP increases as an economy develops 2011 data for a mix of developed and emerging economies

Bank debt as % GDP

200%

150%

R² = 0.5864

100% Chile Brazil

50%

Mexico

0% 0%

20%

40%

60%

80%

100%

GDP per capita (PPP) as % US Source: IMF, Datastream, Nomura research

This relationship between private sector debt and GDP growth has been seen across a wide range of countries over the past 10 years. There is a strong correlation between those countries with low levels of debt to GDP and the level of growth that they have seen since 2001. Mexico’s situation in particular is worth highlighting, because despite showing reasonably strong loan growth, the overall level of debt to GDP increased by a relatively small amount vs. peers (ie, the relative size of bubble) and still remains low in relative terms.

Fig. 20: Lower debt allows for faster growth Private sector debt dynamics 2001-2009 23%

India

Bubble Size shows CAGR of Private Debt to GDP from 2001 to date. Bubbles in red indicate negative growth.

Scale: Ireland 10%; Peru 0.3%

Hungary Brazil 18%

Spain Poland Ireland

Pvt DebtCAGR from 2001

Greece South Africa

Colombia

13%

Mexico Czech

UK

Australia

Chile

South Korea Peru

8%

Finland

Denmark

Norway Netherlands

Italy

Sweden

Portugal

Belgium France

United States

Canada Austria Switzerland

3% Germany Japan -2% 0%

25%

50%

75%

100%

125%

150%

175%

Pvt Debt to GDP in 2001 (IMF)

Source: IMF, Datastream, Nomura research

13

Nomura | Mexico

July 10, 2012

However, private sector debt levels will likely not be the only driver, and given the ongoing sovereign crisis in the eurozone, we believe it is worth examining the potential interaction and impact of public debt levels. Again, we believe the relative positioning of Mexico highlights the opportunity to close the gap vs. regional peers. In an empirical study, finance professors Carmen M. Reinhart and Kenneth S. Rogoff 1 show that, when government debt to GDP exceeds 90% (vertical axis in Figure 21), these countries have notably lower growth rates, with the median growth rate falling by 1%, and average growth falling considerably more, in the extensive sample data set they used. Given the correlation between GDP growth and credit growth, this would imply that one should avoid banks in countries that have higher levels of government debt to GDP. Fig. 21: Better to be in the bottom left corner Private/public sector debt dynamics and fiscal deficit forecasts High Sovereign Risk

120%

Bubble Size = Cumulative 2010-12E budget deficit Scale: Sweden =4%; UK = 23%

Portugal

110% Belgium 100% United States

France 90%

Govt. Debt to GDP 2011

Germany

UK

80% India Austria

70%

Spain

Brazil 60%

Netherlands

Poland Mexico

50%

Finland

Argentina

Low Sovereign Risk

40%

Denmark

Czech Rep. Colombia

30%

Indonesia 20%

China

Peru

10% 0%

25%

50%

Better Growth Prospects

75%

100%

125%

Claims on Pvt. Sector to GDP 2011

150%

175%

200%

225%

250%

Poorer Growth Prospects

Source: IMF, Nomura research

1

This Time is Different, Reinhart & Rogoff, 16 April 2008, NBER

14

Nomura | Mexico

July 10, 2012

Can Mexico follow the example of Chile?

What is the possible path of development that Mexico could follow over the coming decade? It is worth highlighting that the experience of other LatAm countries has been varied over the past 10 years. In addition, while most of the key economies of the region have seen an increase in the level of credit to GDP, with the exception of Argentina, it has really been a straight line up for the banking sectors. The one exception has been Chile, which has seen a much more consistent and stable development of the banking sector. Although it started with an already more developed banking sector (as measured by private sector debt to GDP), there has been a sustained gradual increase in the use of debt within the Chilean economy.

Fig. 22: How to follow in Chile’s footsteps?

Private sector debt to GDP %

78% 68% 58% 48% 38% 28% 18% 8% 95

96

97

Mexico

98

99

Brazil

00

01

02

Argentina

03

04

05

06

Colombia

07

08

09

Peru

10

11 Chile

Source: IMF, Nomura research

This growth in the Chilean banking sector is not just a reflection of economic growth, which has seen a pattern much closer to the experience of the rest of the region, but is also a reflection of other factors. The human development index (HDI) is a composite index that aggregates a series of development/economic indicators to act as an indicator of the country’s standard of living. Both the absolute levels and progression of Chile over the past 20 years potentially provides some additional insight into the sustained growth and development of the banking sector.

Fig. 23: UN Human Development Index

Fig. 24: Chile has maintained a gap over time

HDI 2011

HDI over time

0.82

0.85

0.80 0.80

0.78 0.76

0.75

0.74 0.70

0.72 0.70

0.65

0.68 0.66

0.60 Colombia Brazil

Peru

LatAm MexicoArgentina Chile

1990

1995 Chile

Source: UN, Nomura research

2000 Mexico

2005

2011 LatAm

Source: UN, Nomura research

15

Nomura | Mexico

July 10, 2012

Chile consistently moved to the top right of the chart (Figure 25) over the past 16 years, with private sector debt to GDP increasing from c. 50% in 1995 to almost 80% by 2011.

Those countries in the bottom right show reasonably developed economies, certainly more so than the average for the region (assuming this is correctly measured by relative GDP per capita vs. the US), but relatively small banking sectors. Previous financial crises, political instability, high inflation or volatile economic conditions will all likely play a part in this. However, given the recent economic stability in Mexico, we think conditions should enable Mexico to take advantage of continued economic growth and stability over the next 10 to 15 years.

Fig. 25: Try and move towards the top right 2011 data for all countries, except for Chile were indicated

80%

Chile 11

Bank debt as % GDP

70%

Chile 00

Costa Rica

50% 40%

Chile 05

Brazil

60%

LatAm

Bolivia

Chile 95

Ecuador Colombia

30%

Uruguay

Venezuela 20% 10% 10%

Argentina

Guatemala 15%

Mexico 20%

25%

30%

35%

40%

GDP per capita (PPP) as % US Source: Central banks, regulators, IMF, Nomura research

16

Nomura | Mexico

July 10, 2012

From where will loan growth come?

Corporate and consumer lending should dominate initial stages of loan expansion In aggregate, we believe that loan growth of 15% to 18% y-o-y can be sustained over the next 10 to 15 years. In the short term, we expect consumer and corporate to be the main components behind this loan growth. Moreover, while mortgage lending might trail at a system level given the small level of market share (at least in number of mortgage contracts), the commercial banks should be able to grow at double-digit levels.

Corporate lending – leveraging on expanding GDP Overall corporate lending continues to remain low as a percentage of GDP. Issues regarding low usage of banking services, in particular the high usage of supplier finance by companies, has been, and is, a factor behind the low level of debt penetration. As the main banks move to internal models of expected loss for the corporate sector, this could act as an incremental spur to corporate lending growth. These models are being approved this year and will likely start to have an impact in 2013. As banks will be reluctant to lend to small and medium enterprises (SMEs) without a credit/bank history, the increased formalisation of the economy will likely be a key element of structural growth in SME. In terms of segments, the principal sectors of the economy are services and industry, which is largely reflected in the make-up of the commercial loan book for the commercial banks. Although the corporate loan book of real estate developers is currently under pressure, it only represents a very small amount of loans, at just 3% of commercial loans and 1.7% of the total loan book.

Fig. 26: Suppliers remain a key provider of finance

Fig. 27: Breakdown of GDP and commercial loans by sector

Sources of credit, % of companies surveyed

% total. 2011

90

70%

80

60%

70

50%

60 50

%

40%

40

30%

30

20%

20

10%

10 0 Q1 09

Q3 09

Q1 10

Suppliers Other banks Source: Banxico, Nomura research

Q3 10

Q1 11

Q3 11

Q1 12

Com. banks Debt markets

0% Agriculture Services Construction Industry Real estate % commercial loans

% GDP

Source: INEGI, Banxico, Nomura research

Is funding in debt markets an option? The total amount of debt in circulation (medium/long-term debt) amounts to almost MXN 760bn, which represents an increase of c. 8% y-o-y vs. May 2011. State-controlled groups such as the oil company Pemex make up the largest component, followed by the two public sector mortgage providers, Infonavit and Fovissste. Although the size of the market continues to grow, it remains unused by most of the corporate sector or SMEs. In fact, only 3% of companies surveyed by the central bank stated that they used debt markets for funding (Q1 2012).

As a result, corporate funding requirements are likely to remain serviced by suppliers and increasingly banks.

17

Nomura | Mexico

July 10, 2012

Fig. 29: Debt market dominated by Pemex and mortgage providers

Fig. 28: Sustained growth in local debt markets Stock of M/L debt and new issuance

% distribution of debt by issuer type/sector 25%

800 700

20%

MXP bn

600

15%

500 400

10%

300 5%

200 100

0%

0 2008

2009

2010

Stock

2011

2012

Issuance

Source: Banorte-Ixe, Nomura research

Source: Banorte-Ixe, Nomura research

Although growth might have slowed somewhat in H2 2012, in the run-up to elections, we believe the stable interest rate environment and GDP growth of 3-4% should sustain loan growth in double digits over the coming years. In fact, data for May 2012 are already showing signs of an improvement in credit growth, with commercial lending expanding at 14% y-o-y vs. average growth of 10% over the previous three months.

Consistent with low overall level of debt to GDP, the level of corporate debt to GDP for Mexico is one of the lowest in the region. We believe that this will be one of the key segments of growth as Mexico gradually closes the gap vs. peers.

Fig. 30: Varying degrees of corporate debt penetration across the region Corporate debt % GDP. 2011.

50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Argentina Mexico

Peru

Colombia Brazil

Chile

Source: Central banks, regulators, Nomura research

Fig. 31: Corporate lending offers further opportunities for growth 2011

Market share % of group loans 2011 growth 08-11 pa growth NPL ratio

Bancomer 21% 37% 6% 12% 3.2%

Banamex 14% 39% 16% 9% 0.4%

Santander 15% 53% 26% 13% 1.2%

Banorte 12% 44% 21% 13% 2.8%

HSBC 9% 55% 24% 8% 2.0%

Source: CNBV, Nomura research

18

Nomura | Mexico

July 10, 2012

Consumer credit – building on employment growth Given the still underdeveloped nature of the Mexican banking sector, consumer lending is likely to form a key component of loan growth. Customer demand can remain strong, as wages and disposable income grow. For banks, this segment of loan growth is attractive given the high spreads, low maturities (ie, easier to manage funding and liquidity risk). Although loan losses can be elevated, in an expansionary phase of credit growth the profitability of this segment is high. In addition, although Mexican banks are now provisioning on an expected loss basis, we believe the combination of supportive demand and supply factors means consumer credit will remain a key component of credit growth over the coming years.

Fig. 32: Consumer loans should grow with employment/wage growth Relationship between average consumer loan and average GDP per capital per employee

Germany

Consumer loan per employed (USD 000)

16 14

Denmark

Sweden

12 Portugal

10

France

8 Hungary

6

Thailand

4

Brazil

Chile Romania

0 10

20

R2 = 67%

Mexco

Peru 0

Czech

Turkey

Indonesia

2

Poland

30

40

50

60

70

80

90

GDP per capita (PPP) per employed (USD '000) Source: Central banks, IMF, Nomura research

At the moment, consumer credit accounts for 24% of total lending and 35% of lending growth over the past year. We see all banks looking to maintain or increase market shares in this segment, in particular in payroll credit, the key area of focus for the sector.

In the last credit expansionary phase, credit cards were the key product for expansion and also the area where greater losses were incurred. The elevated levels of growth in some segments, specifically payroll lending, which is currently growing at 74% y-o-y, mean that regulators in Mexico could take an increasingly conservative stance (to avoid the mini consumer credit boom/boost of 2008/09. However, as a product it is much more intrinsically linked with the client and the credit risk profile should be lower vs. other consumer lending segments.

Fig. 33: Consumer lending continues to recover

Fig. 34: Payroll lending increasing in importance

% y-o-y growth

Accounts for c. 50% of personal loans within consumer lending

55%

50%

5.0%

45%

45%

4.5%

35%

40%

4.0%

25%

35%

3.5%

30%

3.0%

25%

2.5%

20%

2.0%

15%

1.5%

10%

1.0%

5%

0.5%

15% 5% -5% -15% -25% J M M J S N J M M J S N J M M J S N J M 09 10 11 12 Total

credit cards

Source: CNBV, Nomura research

Personal

Other

0.0%

0% Credit cards

Personal

% consumer loans (LHS)

Other % NPL ratio (RHS)

Source: CNBV, Nomura research

19

Nomura | Mexico

July 10, 2012

Payroll lending is only a relatively recent addition to the information provided on lending and in Figure 33-35 we have included it in personal lending. As of Q1 2012, payroll lending reached MXN 102bn, which accounts for c. 55% of personal lending and 20% of total consumer lending. The growth rate is extremely fast at c. 74% y-o-y and the nonperforming loan (NPL) ratio is 2.5%, so still well below the levels in the rest of the consumer loan book.

Fig. 35: NPL indicators stable NPL ratio % gross consumer loans 13%

11% 9% 7% 5% 3% 1% J M M J 08 Total

S N J M M J S N J M M J S N J M M J 09 10 11 credit cards Personal

S N J M 12 Other

Source: CNBV, Nomura research

In terms of the individual banks, we expect all major banks to try grow in this segment. In terms of growth rates, HSBC and Santander could see above-average growth rates as they look to recover/rebuild this part of the portfolio post the recent credit bust. This more aggressive approach could put some pressure on the incumbents. In terms of the potential for the market to increase, sustained economic growth, nominal growth of c. 89% and continued job creation in the formal sector should be able to sustain growth rates above 20% y-o-y.

Fig. 36: Consumer lending a key objective for all banks 2011

Market share % of group loans 2011 growth 08-11 pa growth NPL ratio

Bancomer 31% 24% 23% 2.5% 3.8%

Banamex 26% 32% 32% 4.5% 3.9%

Santander 10% 16% 22% -6.8% 2.5%

Banorte 6% 10% 7% 2.4% 3.9%

HSBC 6% 16% 8% -12.5% 4.0%

Source: CNBV, Nomura research

Mortgage growth, but more of a slow burn Mortgage development is perhaps a more complex product to try and anticipate significant growth (in absolute terms, but also in relative size vs. the rest of the loan book). High interest rates can be a significant impediment to loan growth, as the cost in interest for the client can exceed the value of the loan/house. From a supply perspective, reforms needed to improve land ownership records and the legal process for asset recoverability can act as a constraint to banks’ willingness/ability to lend.

For the moment, mortgage growth remains concentrated in the hands of public sector providers (Infonavit and Fovisste). However, sustained economic recovery, low interest rates (and, in particular, the existence of a local interest curve), have contributed to increased supply/growth from the private sector.

20

Nomura | Mexico

July 10, 2012

Fig. 37: Mortgage supply dominated by public sector

Fig. 38: Overall growth remains stable

Stock of mortgage debt

% y-o-y growth rates

1,600 14%

1,400 1,200

9%

MXP bn

1,000 800

4%

600 -1%

400 200

-6%

0 07 Infonavit

08

09

Banks

10 Fovissste

11

Q1 12 Sofoles

Source: Banxico, Nomura research

Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 08 09 09 09 09 10 10 10 10 11 11 11 11 12 Infonavit Banks Fovissste Total Source: Banxico, Nomura research

Demographics should, however, help contribute to continued growth over the coming years. However, the continued dominance of the public sector mortgage providers and lower returns vs. other loan segments could translate into lower growth in comparison with consumer and corporate lending. It is also the one loan segment in which the relative size of the market (vs. GDP) is above most regional peers.

Fig. 39: Still room to grow in mortgages Mortgage debt % GDP

20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% ArgentinaColombia

Peru

Brazil

Mexico

Chile

Source: Central banks, IMF, Nomura research

In terms of the individual banks, while a number of the banks could see significant growth rates, we expect Bancomer to retain its dominant position within the mortgage market. Overall, the issuance should continue to be dominated by the public sector providers.

Fig. 40: Potential for growth, but still dominated by public sector providers 2011. Market share data includes Infonavit and Fovissste in total

Market share % of group loans 2011 growth 08-11 pa growth NPL ratio

Bancomer 10% 23% 1.2% 4.9% 4.3%

Banamex 4% 15% 17% 18% 1.0%

Santander* 5% 20% 82% 29% 3.3%

Banorte 4% 20% 13% 14% 1.2%

HSBC 1% 11% 1% 0% 9.2%

* Santander acquired the mortgage book of GE in 2011, excluding this, 2011 growth would be c. 27% y-o-y, and per annum since 2008 would have been 18% Source: CNBV, Nomura research

21

Nomura | Mexico

July 10, 2012

A closer look at the Mexican housing market Although some excess supply issues are still be worked through, underlying demographics and economic growth point to sustained growth in the Mexican mortgage and housing markets.

Despite the economic recovery and the continued growth in the mortgage market, the housing market continues to show signs of dealing with some excess supply inventory.

While the stable economic outlook and favourable demographics should be supportive of housing demand, it could be until at least 2013 before we see a recovery in the production of new houses. Taking a more medium-term view, however, underlying demand for houses should remain strong. In fact, based on the current outlook for population growth and household formation, Mexico could see sustained demand for c. 0.3m-0.5m new houses through to 2050. Although the mortgage market is dominated by public sector providers (Infonavit and Fovissste), we expect to see continued growth in the mortgage book of commercial banks. However, growth in this loan book could remain lower vs. that of consumer and corporate lending, where we believe demand and supply can be more easily meet by the commercial banks.

Still dealing with some excess inventory following recent recession Overall levels of construction within GDP continue to shows signs of growth and the total construction sector is growing at c. 4.9% y-o-y (Q1 2012). This level of growth is effectively in line with the overall level of GDP growth. In aggregate, construction contributes 6.4% to total GDP, a contribution that has remained relatively stable since 2010. However, this is below the peak level of 7.0% reached in 2008.

Fig. 41: Construction accounts for c. 6.4% of GDP

Fig. 42: Construction remains below previous peak

Breakdown of GDP %

Construction % GDP

1Q 2012 GDP Agriculture Mining Electricity Construction Manufacturing Commerce Transport Financial services Real estate services Health Other Source: INEGI, Nomura research

Total % 100% 3.2% 4.7% 1.4% 6.4% 17.8% 15.8% 7.1% 5.5% 10.1% 2.8% 25.1%

Growth y-o-y 4.6% 6.8% 0.6% 2.7% 4.9% 4.2% 6.7% 5.4% 13.0% 1.2% 2.1% 4.0%

7.2% 7.0% 6.8% 6.6% 6.4% 6.2% 6.0% Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 05 05 06 06 07 07 08 08 09 09 10 10 11 11 12 Source: INEGI, Nomura research

The level of growth from the construction sector since the 2009 recession has been relatively stable at c. 5% y-o-y of GDP. Within this, housing accounts for c. 50%, and although it saw a sharper decline during the recession, has also posted relatively stable growth rates over the past two years.

22

Nomura | Mexico

July 10, 2012

Fig. 43: Construction/housing growth stable

Fig. 44: Employment in construction

% y-o-y growth

% y-o-y growth

8%

10

6%

5

4%

0

2%

-5

0%

-10

-2%

-15

-4% -6%

-20 J M M J S N J M M J S N J M M J S N J M 09 10 11 12 Total construction Housing Source: INEGI, Nomura research

-8% J M M J S N J M M J S N J M M J S N J M 09 10 11 12 Source: INEGI, Nomura research

However, despite this relative stability at an aggregate GDP level, there are a number of indicators specifically within the housing market that suggest some clearing of inventory/stock is an issue. An indication that there are some oversupply issues is reflected in the sharp decline in bridge loans to real estate developers, which are currently down 15% y-o-y. This compares with the rest of the construction-related loan book, which is expanding at 24% y-o-y (data as of May 2012). The pressure that some companies in the sector are facing is also apparent in the significant deterioration in asset quality over the past 12 months. The stock of NPLs rose by 67% y-o-y, with the NPL ratio reaching 15.4%. However, it still remains a relatively small part of the loan book, accounting for 3% of commercial loans and 1.7% of the total loan book.

Fig. 45: Developers loans show sharp contraction

Fig. 46: With a significant deterioration in asset quality

% y-o-y growth for construction lending

% NPL ratio within construction lending

40%

NPL ratio %

yoy % change

30% 20% 10% 0% -10% -20% J MM J S N J MM J S N J MM J S N J MM 09 10 11 12 Total Source: Banxico, Nomura research

Developers

Other

20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% J MM J S N J MM J S N J MM J S N J MM 09 10 11 12 Total

Developers

Other

Source: Banxico, Nomura research

The levels of housing starts and the build-up in housing stock also points to some element of oversupply being worked through. Total housing starts are currently down 10% y-o-y, as of April 2012. In fact, growth rates have been negative for much of 2011.

Annualising the data for April 2012 points to a total reduction of 16% in 2012 vs. the levels seen in 2011. However, this would see the overall stock stabilising. Despite favourable demographics and the likely continued need for additional new houses, the data suggest that 2013 could be again a relatively weak year for new house construction.

23

Nomura | Mexico

July 10, 2012

Fig. 47: Stock of new housing just peaking

Fig. 48: New house production continues to slow

# of housing starts/stock of new housing 000s.

% y-o-y growth in new housing starts. Monthly housing starts 000s

90

140%

80

120%

70

100%

500

60

80%

400

50

60%

40

40%

700 600

300

30

20%

200

20

0%

100

10

-20%

0

0 2008

2009

New housing starts

2010

2011

2012

-40% J M M 10

Stock of new houses

Source: Conavi, Nomura research. 2012 annualised on May data

J

S

N

J M M 11

New housing starts (LHS)

J

S

N

J M 12

Accumulated y-o-y % (RHS)

Source: Conavi, Nomura research

Overall house price increases have been relatively modest and, largely speaking, in line with the overall level of inflation. As of 1Q 2012, house prices have risen by c. 3.2% y-o-y. Over the past five years, there has been a cumulative rise of c. 24%, the same as the cumulative rise in general prices. When we look at the differences between new and used houses, there appears also to be little differentiation. New house prices rose by 3.3% y-o-y in Q1 2012, while used house prices rose by 3.1% y-o-y.

Fig. 49: Steady house price appreciation

Fig. 50: New and old grow alike

% y-o-y

% y-o-y

10%

9% 8%

8%

7%

6%

6%

4%

5%

2%

4% 3%

0%

2% -2% Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 06 06 07 07 08 08 09 09 10 10 11 11 12 % y-o-y Source: SHF, Nomura research

% q-o-q

Inflation y-o-y

1% Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 06 06 07 07 08 08 09 09 10 10 11 11 12 New Used Source: SHF, Nomura research

24

Nomura | Mexico

July 10, 2012

Demographics and economic stability favour sustained demand for housing The total number of houses in Mexico as of 2010 was 27.3m, with a total population of 112m and 28.2m households. The Mexican authorities forecast the total population to rise by 7% to 116m in 2020. In these forecasts the population bracket between 15 and 64 would see a c. 11% rise and the number of houses would need to rise by 21% to 33m.

Fig. 51: Population growth to continue

Fig. 52: Dependency ratio improving and to peak c. 2020

Population projection m and % y-o-y growth

Dependency ratio = age (<15 and >64)/15-64 group * 100

130

1.3%

125

1.2%

120

58

69%

56

68%

54

1.1%

67%

110

1.0%

66%

105

0.9%

65%

100

0.8%

64%

115

millions

70%

95 85

0.6%

80

0.5% 06

08

10

12

14

population m

16

18

50 48 46

63%

0.7%

90

52

62%

44

61%

42

60%

20

40 06

population growth

08

10

12

% 15-64 yrs (LHS)

Source: CONAPO, Nomura research

14

16

18

20

Dependency ratio (RHS)

Source: CONAPO, Nomura research

The Mexican authorities expect the total number of houses to reach 33.1m in 2020 or an rise of 21%, implying the need for c. 500,000 houses per year. This would be in addition to any unmet demand over the past number of years. Although the level of construction for new houses might still be weak in 2013, population trends point to continued strong medium-term demand for houses.

Fig. 54: Growth in houses/population should sustain mortgage growth

Fig. 53: Growth feeds through to more houses needed Projection of growth in housing stock

2.5%

millions

30

2.3%

700

2.1%

600

25

1.9%

20

1.7% 1.5%

15

1.3%

10

1.1% 0.9%

5

0.7%

0

Expected demand for mortgages per annum over the next five years

'000s

35

500 400 300 200 100

0.5% 06

08

10

Total houses m (LHS) Source: CONAPO, Nomura research

12

14

16

18

20

Increase in houses % y-o-y (RHS

0 House reform

New houses

2nd houses

Total

Source: Infonavit, Nomura research

Overall, the level of house ownership is high, with 76% of houses being owner-occupied.

As the population continues to grow, particularly in the 15-64 years old bracket, this underlying desire for house ownership should be supportive of house demand.

25

Nomura | Mexico

July 10, 2012

Infonavit & Fovissste â&#x20AC;&#x201C; public sector providers to maintain key role in mortgage supply The two largest providers of mortgage credit in Mexico are the public sector companies Infonavit (Instituto del Fondo Nacional de la Vivienda para los Trabajadores) and Fovissste (Fondo para la Vivienda del Instituto de Seguridad y Servicios Sociales para los Trabajadores del Estado). These two organisations, established in the 1970s, are charged with providing mortgages to private sector (Infonavit) and public sector (Fovissste) workers. Although both organisations were initially involved in house construction, the current focus is effectively that of providing credit facilities for house purchase or improvement. Both use securitisations as a source of financing and combined account for c .15% of the private sector debt issued in the fixed income medium-/long-term market.

Infonavit. Private sector workers contribute a percentage of their salary into an account held by Infonavit. This balance is then used as partial payment on the house. Infonavit holds this account for the life of a worker, which, if it is not used, is returned to the worker on retirement. Interest rates on the loans given depend on workersâ&#x20AC;&#x2122; salary levels and mortgage payments are deducted automatically from their payroll to be paid directly from the employer into Infonavit. To be eligible, workers must be employed in the formal sector.

As of Q1 2012, Infonavit held a total mortgage portfolio of MXN 827bn. 2011 closed with total growth of c. 10% y-o-y in the loan book, with some 469,000 new credits disbursed (of which c. 28% were co-financed with other entities). There has been a slight upward trend in NPLs. The total NPL ratio has reached 6.5% in Q1 2012 vs. 6.3% in 2011, while refinanced loans have increased to 5.1% in Q1 2012 vs. 4.9% in 2011. Funding in the markets continues, and significant issuance has already taken place in 2012.

Fig. 56: Partly funded by debt issuance

# of mortgages granted

Debt issuance per year

600

16,000

500

14,000 12,000

400

10,000

MXP m

# credits granted

Fig. 55: Mortgages granted remains steady

300 200

8,000 6,000 4,000

100

2,000

0 04

05

06 Shared

Source: Infonavit, Nomura research

07

08

09

Infonavit

10

11

0 04

05

06

07

08

09

10

11 Q2 12

Source: Infonavit, Nomura research

26

Nomura | Mexico

July 10, 2012

Fig. 57: Maintaining volume growth at c. 10%

Fig. 58: Asset quality indicators

% y-o-y growth

NPL and refinanced loans % total

13%

12%

13%

10%

% y-o-y growth

12% 12%

8%

11% 11%

6%

10%

4%

10% 9%

2%

9% 8%

0% Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 07 07 08 08 09 09 10 10 11 11 12

Source: Infonavit, Nomura research

03

04

05

06

NPL

07

08

09

10

11

12

Refinanced

Source: Infonavit, Nomura research

Fovisste. This is a very similar organisation to Infonavit, except that it offers mortgage credit facilities to public sector workers. Funding is provided by the federal government, securitisations and workersâ&#x20AC;&#x2122; contributions. Fovissste underwent a significant restructuring in 2007, following the build-up of credit and functional issues over the previous decades.

This successful restructuring has enabled Fovissste to start a debt issuance programme in the market from 2009, issuing c. MXN 53.8bn since then with a AAA rating. In 2011, c.

75,000 new mortgages (although this was below the initial target of 90,000) were given, with an objective to grant an additional 75,000 during 2012.

The loan book currently stands at MXN 145bn, which is an increase of 4% q-o-q, although a reduction of c. 5% y-o-y. The NPL ratio for 2011 reached 12% (an improvement vs. 14% in 2010). Fovisssteâ&#x20AC;&#x2122;s funded mortgages account for c. 10% of the stock of mortgages in the system.

Fig. 59: Experiencing some volume contraction % y-o-y growth

% y-o-y growth

14%

9%

4%

-1%

-6% Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 08 09 09 09 09 10 10 10 10 11 11 11 11 12 Source: Banxico, Nomura research

27

Nomura | Mexico

July 10, 2012

Improving dynamics reflected in growing mortgage loan book In terms of mortgages, the market continues to be led by the public sector providers that are particularly dominant in lower wage/mortgage segments. The number of new mortgage contracts and the amounts of new mortgages point to activity levels remaining below those reached at the peak. However, the continued demand for mortgages and the likely growth in private sector formal employment over the coming years should see sustained growth in the overall stock of mortgages. Nevertheless, volume growth in this segment is likely to remain dominated by the public sector providers and the capacity for the banks to gain market share will likely be limited relative to consumer/corporate lending.

Figure 60 shows the amount of new mortgage contracts issued each year, with Infonavit issuing the largest amount at c. 80% of the total. The overall number of new contracts still remains well below the peak levels reached in 2008. However, the amount of new business volumes is starting to stabilise, pointing to a potential improvement in growth rates in the short term (Figure 61).

Fig. 60: Number of mortgages

Fig. 61: Volumes stable

# mortgage credits issued

Volume of new issuance

800

300

700

250 200

500

MXP m

# mortgages

600

400

150

300

100

200 50

100 0

0 01

02

03

04

Infonavit

05

06

07

08

09

Banks / Sofoles

10 11*

01

Fovissste

Source: Infonavit, Fovisste, Conavi, SHF, Nomura research

02

03

04

Infonavit

05

06

07

08

Banks / Sofoles

09

10

11*

Fovissste

Source: Infonavit, Fovisste, Conavi, SHF, Nomura research

In terms of growth in the overall stock of mortgages, this has recovered from a slowdown in 2010 to recover to c. 8.0-9.0% y-o-y. As of Q1 2012, total growth was 8.0% y-o-y, with c. 10% growth from banks and Infonavit, which was partially offset by declines in outstanding volumes at Fovissste and Sofoles/other. Banks (including development banks) currently account for 31% of the mortgage book, which continues to be dominated by the public sector providers. Infonavit and Fovissste have a 58% and 10% market share, respectively.

Fig. 62: Stock of mortgage debt continues to grow

Fig. 63: Overall growth remains stable

Total mortgage debt by issuer 1,600

% y-o-y growth 14%

1,400 1,200

9%

MXP bn

1,000 800

4%

600

-1%

400 200

-6%

0 07 Infonavit

08 Banks

09

10 Fovissste

11

Q1 12 Sofoles

Source: Infonavit, Fovisste, Conavi, SHF, Banxico, Nomura research

Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 08 09 09 09 09 10 10 10 10 11 11 11 11 12 Infonavit Banks Fovissste Total Source: Infonavit, Fovisste, Conavi, SHF, Banxico, Nomura research

28

Nomura | Mexico

July 10, 2012

A demographic dividend?

Population growth and a reduction in the dependency ratio create an opportunity to improve GDP growth and longer-term potential

What is the demographic dividend?

The demographic dividend is essentially the positive impact on the economy and economic growth from changes in the age profile and characteristics of age groups. As the profiles of populations change, in particular falling fertility rates, this leads gradually to a fall in the proportion of children, but before an increase in the older segments of the population. As a result, there is an improvement in the dependency ratio, freeing up resources for investment, among other things.

The second element behind the demographic dividend occurs as the increased workforce heads towards retirement; at this stage, there is an increased tendency to save/accumulate assets. This can have an important impact on aggregate savings and investment, effectively providing a strong boost to income.

Fig. 64: Population growth and declining fertility rates

Fig. 65: Dependency ratio to improve until 2020 peak 26

110

1.5%

24

100

1.3%

22

1.1%

20

0.9%

18

0.7%

16

0.5%

14 1996 1998 2000 2002 2004 2006 2008 2010 Population growth y-o-y (LHS)

Dependency ratio

1.7%

Births per thousand

%

Dependency ratio (<15 yrs + >64 yrs)/15-64 yrs * 100

90 80 70 60 50 40 1970

Fertility rate (RHS)

Source: INEGI, Conapo, Nomura research

1990

2010

2030

2050

Source: Conapo, Nomura research

Figure 66 highlights some of the work done to quantify the impact of these demographic trends. This shows the potential contribution to GDP growth per effective consumer from the first and second demographic dividend. In the case of LatAm, demographic trends could have contributed 1.7% per year, although actual growth was lower than this. In contrast, the growth rates in Asia and South-East Asia have benefitted very strongly from the demographic dividend.

Fig. 66: Impact of the demographic dividend on growth %

First

Second

Total

Actual growth in GDP/N

0.3

0.7

1.0

2.3

SE Asia

0.6

1.3

1.9

4.3

LatAm

0.6

1.1

1.7

0.9

Sub-Saharan Africa

-0.1

0.2

0.1

0.1

1970-2000 Industrial economies

Contribution to growth in GDP/N

Middle East North Africa

0.5

0.7

1.2

1.1

Transition economies

0.2

0.6

0.8

0.6

Pacific Islands

0.6

1.2

1.7

0.9

Note : GDP/N = actual growth in GDP per effective consumer (GDP/N), 1970-2000, % y-o-y. Effective consumer is number of consumers weighted for age variation in consumption needs Source: Demographic Transition and Demographic Dividends in Developed and Developing Countries, Mason, 2005, Nomura research

29

Nomura | Mexico

July 10, 2012

As shown by the regional differences, the positive impact of these population trends is not automatic, but rather opens windows of opportunity for countries. The political environment, education policies/opportunities and financial/economic stability all are factors in the benefits from demographic changes. In essence, it will be the right combination between public policy and demographic trends that will enable countries to fully exploit the demographic dividend.

Mexico is heading for a sweet spot The current outlook for population growth and trends in Mexico highlights the opportunity from the demographic dividend. On the one hand, population growth is expected to continue, and based on the UNâ&#x20AC;&#x2122;s current estimates should outpace other EM peers and regions. However, it is not just the level of growth in the population that is positive, but the age profile of the population. Based on current population forecasts, Mexico should see one of the largest reductions in the dependency ratio by 2025, implying a correspondingly greater freeing-up of resources and potential growth in the workforce.

This increase in input into the economy, even in the absence of any productivity/ competitiveness gains, should see an improvement in GDP growth.

Fig. 68: Most potential in the bottom right quadrant

Cumulative population growth 05-50

Reduction in dependency and population growth

150

2005 index 100

140 130 120 110 100 90 80 05 10 15 Mexico Asia

20

25 30 Brazil CEE

35

40

45 50 LatAm

Source: UN, US Census, Nomura research

Change in dependency ratio by 2025

Fig. 67: Mexican population to increase the most?

25

Japan

20 W. Europe

15 10

E. Europe

USA

More developed

5

Less developed

Asia

0

Brazil

LatAm

-5

Mexico

-10 -5

0 5 10 15 Cummulative population growth by 2025 %

20

Source: UN, Nomura research

In Figures 69 and 70, we look at the current population distribution by age group â&#x20AC;&#x201C; the population pyramid, which shows quite a heavy skew towards a younger population, with 38% of the population under the age of 20. Based on the current projections of the Mexican authorities for 2020, this profile widens at lower middle age groups, but still remains low at the top, ie, implying a strong reduction in the dependency ratio.

Fig. 69: Large youth population

Fig. 70: With positive trends expected through to 2050

2010

2050

85+ 80-84 75-79 70-74 65-69 60-64 55-59 50-54 45-49 40-44 35-39 30-34 25-29 20-24 15-19 10-14 5-9 0-4

% Men

11

9

7

5

3

Source: Conapo, Nomura research

85+ 80-84 75-79 70-74 65-69 60-64 55-59 50-54 45-49 40-44 35-39 30-34 25-29 20-24 15-19 10-14 5-9 0-4

% Women

1 % 1

3

5

7

9

11

% Men

11

9

7

5

3

% Women

1% 1

3

5

7

9

11

Source: Conapo, Nomura research

30

Nomura | Mexico

July 10, 2012

Potential positive impact for banks and the economy We have concluded that Mexican demographics have the potential to be materially positive for GDP growth. As the current young population cohorts enter the workforce, the lifecycle hypothesis 2 (according to which individuals borrow and then save/invest to support consumption post retirement), would point towards increased borrowing, followed by saving and finally debt repayment before retirement. Therefore, an initial impact for the banking sector would be increased demand for credit. Over time, this growing middle age work force should also be positive for aggregate saving levels, which could have a positive impact on domestic equity and bond markets. As baby-boomers age and start to save for retirement, their demand for capital increases, which in turn is supportive of asset prices. This increased level of savings could have a positive impact on the Mexican current account and also potentially put appreciation pressure on the Mexican peso.

2

F. Modigliani (1976). Life-cycle, individual thrift, and the wealth of nations, American Economic Review, 76(3), 297-313

31

Nomura | Mexico

July 10, 2012

Recent performance of the Mexican banking sector Recent trends remain supportive (loan growth/asset quality); credit conditions also continue to be expansive and expectations for credit demand remain positive.

Overall lending trends in 2012 remain relatively stable. Corporate lending remains the key driver behind the continued expansion in the credit book, which as of May is expanding at c. 15% y-o-y. The overall stock of NPLs remains relatively low and stable, with only one sub-segment of consumer credit showing some deterioration. The total NPL ratio stands at 2.9% vs. 2.7% at end-2011 and 2.8% in May 2011. In terms of deposits, as with loans, these continue to expand, albeit at a slower pace, growing at c. 8% y-o-y.

Lending and deposit growth After showing some initial signs of slowdown in the first few months of the year, total lending growth for May has recovered to 15.2% y-o-y, the fastest yearly growth rate for 2012. The key component of this loan growth is the corporate loan book, which accounts for c. 53% of total loans and with growth of c. 14.1% y-o-y accounted for 50% of the yearly loan growth for the system. Total consumer lending (credit cards, personal loans, and payroll loans, among others) expanded at 23.6% y-o-y, maintaining its growth following the recovery post the write-offs/asset quality issues from the 2009 recession.

Although a smaller part of the private banks loan book, mortgages (at c. 20% of total loans) also maintained the +10% y-o-y growth seen so far in 2012. This compares with an average yearly growth during 2011 of c. +7.5% y-o-y.

Fig. 72: Corporate lending the main driver

% y-o-y loan growth

Contribution to yearly lending growth and total loans (%)

yoy % change

Fig. 71: Loan growth has reached 15% 30%

60%

20%

50% 40%

10%

30%

0%

20% -10%

10% -20% J A J O J A 09 10 Consumer Corporate Source: Banxico, Nomura research

J

O

J A 11

J

O

J A 12 Mortgage Total

0% Mortgages

Consumer Corporate Other finance % loan book Contribution to growth YTD

Source: Banxico, Nomura research

The majority of the economic segments of the corporate loan book show an improvement in loan growth. The service sector, which accounts for c. 65% of GDP and 50% of the corporate loan book, is currently growing at c. 18% y-o-y vs. an average 15% during 2011. This growth accounts for nearly 60% of the growth in the corporate loan book over the past 12 months. The construction-related loan book is growing at c. 16% y-o-y and is providing c. 20% of the yearly growth. The one sector that shows a little more moderation in growth is loans related to the industrial sector (excluding construction). Although growth rates have recovered somewhat over the past two months, at c. +8.4% y-o-y, they still are significantly below the rest of the sectors.

32

Nomura | Mexico

July 10, 2012

Fig. 74: Strong contribution from the services sector

% y-o-y loan growth

Contribution to yearly lending growth and total corporate loans (%)

yoy % change

Fig. 73: Most sectors of the economy are expanding

29%

70%

24%

60%

19%

50%

14%

40%

9% 4%

30%

-1%

20%

-6%

10%

-11% J MM J S N J MM J S N J MM J S N J MM 09 10 11 12 Agriculture Industry Construction Services Source: Banxico, Nomura research

0% Agriculture

Industry

% loan book

Construction

Services

Contribution to growth y-o-y

Source: Banxico, Nomura research

After being at the epicentre of credit losses during the recent recession, the consumer loan portfolio continues to show a recovery. In absolute terms, the consumer loan book has now recovered and exceeded the pre-crisis levels, although the make-up of the loan book is now different. Total consumer lending growth stands at c. 23.6% y-o-y for May, with payroll credits making the strongest contribution (included in ‘other’). Credit card lending, the source of most of the credit problems in the previous cycle, still remain an important part of the loan book (c. 45%) and with growth of c. 15% y-o-y, make a strong contribution to overall levels of growth. However, the total credit card loan book still remains some 22% below pre-crisis peak levels.

Fig. 76: With payroll loans a key driver (including in ‘other’)

% y-o-y loan growth

Contribution to yearly lending growth and total consumer loans (%)

yoy % change

Fig. 75: Sustained growth in consumer lending 50%

70%

40%

60%

30%

50%

20%

40%

10% 0%

30%

-10%

20%

-20%

10%

-30% J MM J S N J MM J S N J MM J S N J MM 09 10 11 12 Cards Source: Banxico, Nomura research

Personal

Other

0% Cards % loan book

Personal

Other

Contribution to growth y-o-y

Source: Banxico, Nomura research

Asset quality With economic conditions remaining relatively stable, overall asset quality indicators are also relatively stable. The total NPL ratio stands at 2.9% in May 2012, which compares with 2.7% in December 2011 and 2.8% in May 2011. The bulk of the NPLs are generated by consumer and corporate lending, although, in aggregate, both segments remain stable. The corporate lending NPL ratio currently stands at 2.5% vs. 2.4% in 2011. For consumer lending, the one segment showing an upward trend is ‘other personal lending’, which includes the fast-growing payroll lending segment. Here the NPL ratio stands at 4.3% in May 2011, although it is still below the NPL ratio in cards at 4.8%.

33

Nomura | Mexico

July 10, 2012

Fig. 77: Overall NPL ratio remains relatively stable

Fig. 78: Also stable for main loan segments

NPLs % total loans commercial banks

NPL ratio by main loan segments

10%

4.5%

9% 8%

NPL ratio

4.0% 3.5%

7% 6% 5% 4%

3.0%

3% 2%

2.5%

1% J A 09

2.0% J M M J S N J M M J S N J M M J S N J M M 09 10 11 12

J

O

J A 10

Consumer

J

O

J A 11

J

Mortgage

O

J A 12

Corporate

Source: Banxico, Nomura research

Source: Banxico, Nomura research

Fig. 79: Consumer lending showing a little more deterioration

Fig. 80: Increase in payroll lending pushing up NPLs? Breakdown of consumer lending NPL ratios

Contribution to yearly NPL growth and total stock of NPLs (%)

15%

60%

13% NPL ratio

50% 40% 30%

11% 9% 7% 5%

20%

3%

10%

1% 0% Corporate

Consumer

% NPLs

Contribution to growth y-o-y

Source: Banxico, Nomura research

Mortgage

J A 09

J

O

J A 10

Cards

J

O

J A 11

Personal

J

O

J A 12 Other

Source: Banxico, Nomura research

1Q 2012 corporate survey supportive of continued growth The following is a quick summary of the quarterly survey conducted by the central bank on credit conditions for corporate. Overall conditions appear to remain supportive of further corporate lending growth (as indicated by use of credit and expectations for the next quarter). A significant source of corporate funding continues to be given by suppliers, although bank finance (from commercial and other banks, eg, development and foreign banks) continues to increase.

Almost 81% of companies surveyed used their suppliers as a source of funding, a level that has remained relatively stable over the past few years (see Figure 81). However, total banking funding is showing a continued rise, being used in 46.5% of corporate. This represents a significant increase vs. the c. 33% at the end of 2009. Commercial banks make up the bulk of this source of financing and in total are being used by c. 35% of corporate as a source of funding.

As of 1Q 2012, c. 45.5% of those surveyed were using bank credit; this compares with 47.6% the previous quarter and 49.9% in 2Q 2012. However, there has been an increase in the percentage of companies that expect to ask for bank credit in the next quarter, reaching 40% vs. 38.1% the previous quarter.

34

Nomura | Mexico

July 10, 2012

Fig. 81: Suppliers remain a key source of credit

Fig. 82: Expectations for 2Q 2012 increase

Sources of credit, % of companies surveyed

% of companies with bank credit and those you expect to solicit next quarter

90

55

80 70

50

60

45

%

50

%

40

40 30

35

20

30

10

25

0 Q1 09

Q3 09

Q1 10

Q3 10

Q1 11

Suppliers Other banks

Q3 11

Q1 12

20 Q1 09

Com. banks Debt markets

Q3 09

Q1 10

Q3 10

Expect to ask for credit

Source: Banxico, Nomura research

Q1 11

Q3 11

Q1 12

Have credit

Source: Banxico, Nomura research

Figures 83 and 84 summarise some of the factors that are an influence on companies asking for and receiving credit. A score above 50 indicates credit is more accessible/cheaper, with a score of less than 50 indicating the contrary (ie, more restrictive credit conditions apply). Conditions regarding loan size and duration were perceived by companies as being more favourable, whereas those regarding restructurings remained more restrictive. Although collateral requirements remained marginally restrictive, at 48.9 they showed a significant improvement vs. 4Q 2011. Both interest rates and fees/other charges were perceived by companies as favourable.

Fig. 83: Loan size/duration support loan growth

Fig. 84: Improvement in both interest rates/fees

Access indicators

Indicators of cost

65

60

60

55

55

50

50

45

45

40

40

35

35

30

30 Q1 09

Q3 09

Q1 10

Loan size Restructuring Source: Banxico, Nomura research

Q3 10

Q1 11

Duration Other (avrg.)

Q3 11

Q1 12

Collateral

25 Q1 09

Q3 09

Q1 10

Interest rates

Q3 10

Q1 11

Q3 11

Q1 12

Fees

Source: Banxico, Nomura research

In total, some 75.6% of the companies surveyed did not receive new credit facilities during the quarter, with the bulk of this accounted for by companies that did not request any new or additional credit. Figure 86 shows some of the factors highlighted as being behind that decision. Although economic conditions featured in c. 55% of the reasons for not asking for/receiving credit, this has dropped from c. 63% of respondents in 3Q 2011.

35

Nomura | Mexico

July 10, 2012

Fig. 85: No credit requested/received

Fig. 86: Factors behind this decision

% of companies

Key factors limiting access/demand for credit

65

90 80

60

70 60

55 %

%

50 40

50

30 45

20 10

40

0 Q1 09

Q3 09

In process

Q1 10

Q3 10

Too expensive

Source: Banxico, Nomura research

Q1 11 Denied

Q3 11

Q1 12

Not requested

Q4 10

Q1 11

Q2 11

Economic situation Interest rates

Q3 11

Q4 11

Q1 12

Firm performance Other loan conditions

Source: Banxico, Nomura research

36

Nomura | Mexico

July 10, 2012

The positive impact of Mexico – upgrading BBVA We upgrade the stock to Buy from Reduce, although events in Europe are likely to remain a key driver in the short term. We lift our target price to EUR 7.80 from EUR 7.30 and increase our EPS estimates by c. 5% Given our bullish medium-term outlook for Mexico and the Mexican banking sector, we upgrade BBVA to Buy. We acknowledge that events in Spain and the eurozone will likely continue to remain a key driver for the stock in the short term. However, our view on BBVA is not a specific call on events and outcomes for the euro. This is reflected in our overall cautious stance on European banks (where we maintain a Neutral rating), and a preference for northern European banks vs. southern ones. However, with an improving outlook for Mexican banking, we believe there has been a significant widening in the potential value of this for BBVA relative to what is currently discounted in the group valuation.

Our willingness to take a more positive view on BBVA is based on the bank’s marketleading subsidiary in Mexico, Bancomer. Of the four international banks in Mexico, BBVA generates the largest contribution at a group level (c. 33% of pre-provision profits vs. an average of 6% for the other global banks). We estimate that, by 2014, Mexico could account for c. 40% of pre-tax profits and 15% of group loans. We believe that this could offset a prolonged period of economic weakness in Spain.

In terms of Spanish exposure and in a stressed economic scenario, we believe that additional capital demand cannot be ruled out at a group level. However, in the short term, we do not expect the upcoming bank stress tests in Spain (being conducted by Oliver Wyman) to identify any capital shortfall for BBVA. Notwithstanding this, this contrasts with management’s actual day-to-day strategy, which appears to be to strengthen capital as much as possible (non-core assets sales, scrip dividends, and liability management actions, among others). Therefore, we believe that additional dilution/share issuance cannot be ruled out.

Fig. 87: Upgrading earnings and target price based on positive outlook for Mexico Despite further downgrades to Spain

BBVA

BBVA

Old EPS

New EPS

Old EPS

New EPS

Old EPS

New EPS

2012

2012

2013

2013

2014

2014

0.60

0.30

0.85

0.84

0.90

0.96

New TP 7.8

Old TP 7.3

% change 7%

New rating Old rating Buy Reduce

Source: Nomura estimates

Increasing contribution from Mexico Since buying out the minorities shareholders in 2003, Mexico has made a significant and growing contribution to the overall group at BBVA. Given our outlook for growth in Mexico, we believe that, by 2014, it should account for c. 40% of pre-tax profits and just over 30% of group revenues. This is in part owing to our view that profitability in Spain will continue to be depressed as the Spanish economy remains in recession in 2013, on our forecasts.

In Figure 89, we look at what the potential valuation of the Mexican business has looked like over the years relative to overall market value of the group. We have a maintained a steady valuation of 8.2x the following year’s earnings (this is the implied P/E in our current illustrative sum-of-the-parts model for BBVA – see Figure 92). This would see the Mexican subsidiary accounting for c. 30% of the value of the group pre-crisis (pre-2008).

Based on BBVA’s current market value, however, the Mexican business potentially accounts for c. 63% of the total.

37

Nomura | Mexico

July 10, 2012

Fig. 88: Increasing contribution from Bancomer

Fig. 89: Implying ever bigger share of market cap

Mexico contribution to group level results

Implied contribution of Mexico to BBVA's market cap

70%

90% 80%

60%

70% 60%

50%

50%

40%

40%

30%

30% 20%

20%

10%

10%

0% 04 05 06 07 08 Mexico % revenues

09

10 11 12 13 Mexico % pre-tax

14

Source: Nomura estimates

0% 04

05

06

07

08

09

10

11

12

Source: Nomura estimates

In Figures 90 and 91, we highlight the recent (past two years’) relative performance of BBVA vs. the main listed Mexican bank, Banorte. Figure 90 looks just at the relative stock performance of BBVA relative to Banorte, which has seen BBVA underperform significantly over this period, particularly in the first half of this year. In Figure 91, we compare the relative earnings valuations of the two banks over the same period; this measures Banorte’s one-year forward P/E vs. that of BBVA’s. Banorte’s forward P/E of 12.8x is c. 62% above that of BBVA’s at 7.9x.

Fig. 90: Banorte share price outperformance

Fig. 91: Banorte trading at a significant premium

Share price relative performance of BBVA vs. Banorte. July 2010 = 100

Forward P/E (IBES) relative (100 implies P/E stock = P/E sector)

140 130 120 110 100 90 80 70 60 50 40 Jul-10

Nov-10

Apr-11

Source: Datastream, Nomura research

Sep-11

Jan-12

Jun-12

250 240 230 220 210 200 190 180 170 160 150 140 130 120 Jul-10

Nov-10

Apr-11

Sep-11

Jan-12

Jun-12

Source: Datastream, Nomura research

Group overview Although we value the group using the consolidated returns and equity, in Figure 92, we highlight what this implies in a potential sum-of-the-parts. The adjustment element is for the corporate centre, group equity not allocated to the divisions and consolidated goodwill at a group level. This illustrates that, in our current valuation of EUR 7.80 per share, the Mexican business is valued at EUR 16.8bn or EUR 2.8 per share, equivalent to c. 35% of our estimate of the value for the group.

38

Nomura | Mexico

July 10, 2012

Fig. 92: Mexico makes the strongest single contribution to the value of the group Illustrative sum-of-the-parts, 2013, based on our current group valuation of EUR 7.80 per share Net Attrib Allocated Division Income Equity RoE LT Growth P/NAV Cost of EURm EURm % capital Spain Eurasia Mexico USA South America Adjustment Total

1013 1162 2058 312 1230 -799 4977

10546 5384 7317 3492 4065 -3082 36398

9.8% 22.8% 31.7% 9.2% 32.7% 13.7%

0.0% 3.0% 3.0% 0.0% 3.0%

1.0 2.5 2.3 1.0 2.4

10.0% 11.0% 15.5% 9.5% 15.5%

1.3

12.0%

Valuation EURm Per share 10377 13340 16822 3365 9673 -5872 47705

1.7 2.2 2.8 0.6 1.6 -1.0 7.8

Implied PE % 22% 28% 35% 7% 20% -12% 100%

10.2 11.5 8.2 10.8 7.9 7.3 9.6

Source:, Nomura estimates

An issue for BBVA is the ongoing uncertainty in both Spain and the eurozone. We believe this uncertainty is reflected quite heavily in group’s valuation and goes beyond just what the potential earnings outlook for their Spanish business is. However, we acknowledge that, in a stressed scenario, additional capital could be required for the Spanish business. At a consolidated level, we maintain our view that BBVA can absorb Spanish losses. We expect the upcoming stress tests to confirm this.

In Figure 93, we take a look at what kind of implicit valuations BBVA’s individual subsidiaries would be worth based on the current multiples of peers. In contrast to our sum-of-the-parts exercise above, here we allocate proportionally the losses in the corporate centre to the various operating subsidiaries. We then apply the earnings multiple of peers. This implies a group value of EUR 7.50 per share, not too dissimilar to our current target price of EUR 7.80. In the final column, we take the current price (EUR 5.40 as of 6 July) and calculate the implied valuation for the Spanish business.

Assuming a market valuation for other subsidiaries, the current price of BBVA implies a negative value for the Spanish business of EUR -1.1 per share.

Fig. 93: What is the market discounting for Spain?

Division Domestic Spanish banks Wholesale / Asia Banorte US LatAm Banks Corporate centre Total

P/E of peers 2013 P/E 10.1 6.0 12.0 9.9 7.0 5.0

Adjusted net income EUR m 644 1076 1921 238 1122 -25 4977

Implied valuation EUR m 6507 6457 23050 2359 7855 -125 46103

Valuation

Valuation

Per share 1.1 1.1 3.8 0.4 1.3 0.0 7.5

Per share -1.1 1.1 3.8 0.4 1.3 0.0 5.4

Source: Nomura estimates

2020 Mexican vision As part of our positive medium-term outlook for Mexico and the Mexican banking sector, and to illustrate the potential impact for BBVA, we analyse three different scenarios. The key question we ask is to what level of GDP private sector lending will rise. In a bull-case scenario, we envisage Mexico reaching debt penetration levels similar or approaching those of Chile (the most developed nation in LatAm).

In reality though, reaching the debt-to-GDP levels of Chile would take longer than just eight years. In fact, it took 16 years for Chile to go from 50% bank debt to GDP to 75%.

However, we believe the mid-case scenario is plausible, where we forecast bank debt to GDP to reach 40%, similar to the LatAm region’s average. This would imply loan growth, in nominal terms, of 15-17% per annum if the target was reached by 2020. It would also see net income growth of 9% pa for Bancomer.

39

Nomura | Mexico

July 10, 2012

Fig. 94: 2020 outlook for Bancomer Three different scenarios

2012 Base case Nomura Loans/ GDP 20% Loan growth (CAGR 12-20) Asset growth (CAGR 12-20) Net income growth, EUR (CAGR 12-20) Cost-Income Ratio 38.9% RoE 30.3%

2020 Bull case Mid case Bear case Scenario 1 Scenario 2 Scenario 3 "Chile" "LatAm avrg" "No change" 75% 40% 20% 27% 17% 6% 20% 12% 4% 14.9% 8.7% 2.8% 28.0% 35.3% 44.2% 22.6% 23.3% 24.3%

Source: Nomura estimates

From this analysis, we estimate that in a bull-case scenario Bancomer would be worth EUR 25bn, a 55% premium to the valuation we estimate in our model/target price. The mid-case scenario returns a value that is effectively in line with our current valuation.

This discounts a relatively conservative outlook for Bancomer, in our view, as it assumes average earnings growth of 9% through to 2020. In our valuation for the group, we estimate that Bancomer will increase earnings by 14% pa through to 2014.

Fig. 95: Significant potential upside in valuation Bancomer equity valuations

60%

25

xx% = assumed loans/GDP in 2020

20 40%

EUR bn

15 20% 10 5 0 Base line

Bull case

Mid case

Bear case

Source: Nomura estimates

In Figure 90, we show the results of the different scenarios for Bancomer in 2020. We also highlight the key assumptions that lead us to these outcomes. As we show in the bull-case scenario, we estimate net income growth of 15% pa over the next eight years.

This compares with 3% pa net income growth in the more bearish scenario. In terms of lending growth, the scenarios vary from 7% to 27% pa.

Of all the assumptions used in the three different scenarios, the most important is that of the net interest margin. Here the range is from 4.8% in the bear case to 2.5% in the bull case. Our bull-case scenario of a margin of 2.5% is appropriate, in our view, given the margin in countries with a similar level of debt penetration and also factoring in an appropriate cost of risk (100bp in this case).

Our bull-case scenario models Mexico reaching a debt penetration of 80%, which would put it on levels close to those of Chile within LatAm. The average margins in Chile at the moment are c. 3.60%. A country in Europe with a similar level of debt penetration is Greece, where the margin for the sector is c. 3.00% (pre-crisis). As a result, we do not believe our margin assumptions in these scenarios are unrealistic.

40

Nomura | Mexico

July 10, 2012

Fig. 96: 2020 vision for Mexico Scenario analysis

Macro inputs: Loans/GDP Real GDP (% growth pa) Inflation (CPI) 28-day Cetes (average) MXP-EUR (average) Bancomer inputs: Average Gross Lending Average Securities Portfolio Average Other Assets Average Total Assets Average Deposits Equity/Assets NIM Non-Interest Income as % Revs Expenses (% growth pa) Loan Loss Charge/ Lending (bp) Tax Rate Income statement: Net Interest Income Other Revenues Total Revenues % change pa Expenses Operating Income Net Loan Loss Charge Other Income Pre-tax Profit Tax Minorities Net Income (MXPm) % change pa Net Income (EURm) % change pa Ratios/ growth rates: Loan growth (% pa) Asset growth (% pa) Loans/ Deposits Loans/ Assets Securities/ Assets Cost-Income Cost/ ATA RoA Leverage ROE

2004 Actual

2012E Actual Nomura

MXPm

MXPm

12% 4.8% 4.1% 7.23% 14.04

20% 2.9% 3.5%

Bull case Scenario 1 "Chile" MXPm

2020 Mid case Scenario 2 "Brazil" MXPm

Bear case Scenario 3 "No change" MXPm

17.29

75% 5.0% 3.0% 5.5% 15.59

40% 4.0% 3.5% 6.0% 15.59

20% 2.0% 4.5% 6.5% 15.59

154,166 285,913 202,341 642,420 449,586 4.9% 3.85% 33.8% 8.1% 189 29.0%

657,849 415,173 236,948 1,309,970 685,171 6.3% 5.25% 23.9% 7.3% 320 25.0%

4,566,124 750,000 250,000 5,566,124 3,811,791 5.5% 2.50% 25% 5.0% 90 25.0%

2,346,519 550,000 250,000 3,146,519 2,204,974 6.0% 3.50% 28% 5.5% 170 25.0%

1,088,738 450,000 250,000 1,788,738 1,116,059 6.5% 4.75% 33% 6.0% 300 25.0%

24,733 12,626 37,359

68,773 21,647 90,420

-18,031 19,328

-35,164 55,257

139,153 46,384 185,537 9.4% -51,953 133,585

110,128 42,828 152,956 6.8% -53,965 98,991

84,965 41,848 126,813 4.3% -56,045 70,768

-2,914 -1,372 15,043 -4,359

-21,051 -700 33,506 -8,376

10,683

25,129

761

1,453

-41,095 -400 92,090 -23,022 0 69,067 13.5% 4,429 14.9%

-39,891 -400 58,700 -14,675 0 44,025 7.3% 2,823 8.7%

-32,662 -400 37,706 -9,427 0 28,280 1.5% 1,814 2.8%

15.8% -0.8% 34.3% 24% 45% 48.3% 2.81% 1.66% 20.4x 33.9%

11.0% 7.5% 96.0% 50% 32% 38.9% 2.68% 1.92% 15.8x 30.3%

27.4% 19.8% 119.8% 82% 13% 28.0% 0.93% 1.24% 18.2x 22.6%

17.2% 11.6% 106.4% 75% 17% 35.3% 1.72% 1.40% 16.7x 23.3%

6.5% 4.0% 97.6% 61% 25% 44.2% 3.13% 1.58% 15.4x 24.3%

Source: Company data, Nomura estimates

41

Nomura | Mexico

July 10, 2012

In our theoretical sum-of-the-parts model, we estimate that Bancomer is worth EUR 16.8bn. This uses a P/NAV multiple derived from a growing perpetuity formula based on a sustainable or adjusted ROE (we use 2014 as the sustainable base year).

The resulting valuation is then discounted back to the present to reflect the time value of money. Using our estimates for 2014 and a perpetuity growth rate of 3%, we arrive at this valuation of EUR 16.8bn.

We can sense-check this by using comparative multiple. Banorte, a quoted Mexican bank, trades at a 2013E P/E of 12.0x (based on Bloomberg consensus – priced 6 July).

Using our earnings estimates for Bancomer, this implies a valuation of EUR 24bn.

However, the value of this comparative is influenced by the fact that we can use only one bank to calculate the multiple (as the bulk of the Mexican banking sector is foreignowned).

Three scenarios In Figure 97, we calculate a DCF-based valuation for the three scenarios. Under this methodology, we estimate that Bancomer would be worth EUR 11bn in the bear-case scenario to EUR 24bn in the bull-case scenario. The mid-case valuation is in line with the implicit valuation for Bancomer in our current valuation of BBVA. The DCF valuation methodology is an explicit five-year period, with a terminal value at the end of this period. It also includes a deduction for the capital required to fund this growth. This deduction is included in our calculation of the net income terminal value, which we estimate using the following formula: P/NAV = (ROE – g)/(COE – g), where COE is the cost of equity and ‘g’ the growth rate in perpetuity.

The COE is a key assumption in this formula: Present value. To calculate the present value of the cash flows and the terminal value we use a cost of equity of 13%. This includes a risk-free rate of 5%, a market risk premium of 5% and an assumed beta of 2 for Mexico. We use the beta to capture the risk for Mexico rather than the risk free rate given that our estimates are in hard currency.

Terminal value. To calculate the terminal value (TV), we have used different rates. For the bull case, we have used just 8.5%, ie, the beta falls to 1, but note that we assume a perpetuity growth rate of 0%. If Mexico delivers our ‘Chilean’ bull case and sustains five years of high GDP and lending growth, with a broadly stable currency, then we believe the perceived risk of investing in Mexico (and the uncertainty of future cash flows) will have diminished rapidly. Conversely, our ‘no change’ bear case implies precisely that – no change in people’s perception of risk. We do, however, assume a 5% perpetuity growth rate, which we regard as generous.

42

Nomura | Mexico

July 10, 2012

Fig. 97: Valuation scenarios Scenario 1. Bull case Cost of Equity Growth Average Total Assets (EURm) Average Equity Net Income (EURm) Working Capital Free Cash Flow PV Free Cash Flow NPV Scenario 2. Mid case Cost of Equity Growth Average Total Assets (EURm) Average Equity Net Income (EURm) Working Capital Free Cash Flow PV Free Cash Flow NPV Scenario 3. Bear case Cost of Equity Growth Average Total Assets (EURm) Average Equity Net Income (EURm) Working Capital Free Cash Flow PV Free Cash Flow NPV

2012 EURm 15.0%

2013 EURm

2013 EURm

2014 EURm

2015 EURm

2016 EURm

2017 EURm

2018 EURm

2019 EURm

75,762

91,960

111,620

135,484

164,451

199,610

242,285

294,085

356,960

1,453 -1,650 -197 -197 23,569

1,671 -891 780 678

1,920 -1,081 839 730

2,207 -1,313 895 677

2,537 -1,593 944 621

2,916 -1,934 983 562

3,352 -2,347 1,005 500

3,853 -2,849 1,004 434

4,429 -3,458 971 365

2012 EURm 15.0%

2013 EURm

2013 EURm

2014 EURm

2015 EURm

2016 EURm

2017 EURm

2018 EURm

2019 EURm

75,762

85,631

96,786

109,394

123,644

139,751

157,956

178,532

201,789

1,453 -1,800 -347 -347 15,111

1,579 -592 987 858

1,716 -669 1,047 910

1,864 -756 1,108 838

2,026 -855 1,171 770

2,201 -966 1,235 706

2,391 -1,092 1,299 646

2,598 -1,235 1,364 590

2,823 -1,395 1,428 537

2012 EURm 15.0%

2013 EURm

2013 EURm

2014 EURm

2015 EURm

2016 EURm

2017 EURm

2018 EURm

2019 EURm

75,762

79,794

84,041

88,514

93,225

98,187

103,412

108,916

114,713

1,453 -1,950 -497 -497 10,989

1,494 -262 1,232 1,071

1,536 -276 1,260 1,096

1,579 -291 1,288 974

1,624 -306 1,317 866

1,669 -323 1,347 770

1,716 -340 1,376 684

1,764 -358 1,406 608

1,814 -377 1,437 540

2020/TV EURm 10.0% 2.0% 356,960 19,633 58,734 58,734 19,200

2020/TV EURm 12.5% 3.5% 201,789 12,107 29,377 29,377 9,603

2020/TV EURm 15.0% 5.0% 114,713 7,456 14,917 14,917 4,876

Source: Nomura estimates

43

Nomura | Mexico

July 10, 2012

Positive impact for global banks We upgrade BBVA to Buy from Reduce, and raise our target price to EUR 7.80 from EUR 7.30. We downgrade Santander to Reduce from Neutral, and lower out target price to EUR 7.10 from EUR 7.40.

As part of our positive outlook for the Mexican economy and banking sector, we upgrade our rating on BBVA to Buy (previously Reduce), increasing our earnings estimates at a group level by 5%, and raising our target price to EUR 7.80 from EUR 7.30. We expect Mexico to account for c. 42% of group net income by 2014. Key risks for BBVA remain the ongoing sovereign/economic risks in Spain and the eurozone, and were this situation to deteriorate, the need to strengthen capital cannot be ruled out.

We continue to prefer non-eurozone banks.

We downgrade Santander to Reduce (from Neutral). In contrast, given greater uncertainty around the outlook for Brazil and the subsidiary model of SAN (which is moving towards listing all the major subsidiaries), we now have a preference for BBVA over SAN. To maintain a spread in our ratings, and in the context of remaining cautious on European banks, we downgrade our rating on Santander to Reduce from Neutral.

The continued asset quality deterioration in Brazil also contributes to a further cut to our group 2014 EPS estimates by c. 4% (partially offset by an upgrade to Mexican earnings) and we lower our target price to EUR 7.10 from EUR 7.40.

Although the potential impact for HSBC and Citigroup is more moderate, we believe the current outlook for Mexico should be positive. For HSBC, we estimate that the potential lift to EPS at a group level would be in the region of c. 1%. For Citigroup, with larger relative exposure, we estimate potential uplift to group EPS of 2.0-2.5%. However, current trends in capital markets, which make a significantly higher contribution, are negative downgrades and would outweigh any positive impact from our outlook for Mexico. As a result, our earnings estimates for HSBC and Citigroup are unchanged.

Fig. 98: Summary of earnings estimates and rating changes Old EPS

New EPS

Old EPS

New EPS

Old EPS

New EPS

2012

2012

2013

2013

2014

2014

BBVA

0.60

0.30

0.85

0.84

0.90

0.96

SAN

0.58

0.32

0.74

0.67

0.89

0.86

New rating Buy Reduce

Old rating Reduce Neutral

New TP 7.8 7.1

Old TP 7.3 7.4

% change 7% -4%

BBVA SAN

Source: Nomura estimates

Exposure to Mexico While the relative difference between the absolute size of the banksâ&#x20AC;&#x2122; subsidiaries is small, there is a significant difference in the relative contribution to profits at a group level. By quite a distance Mexico makes the largest contribution to BBVA at a group level, accounting for c. 10% of the loan book and c. 33% of pre-provision profits. The next largest beneficiary is Citigroup given the c. 10% contribution to pre-tax and preprovision profits. The impact for Santander and HSBC is less relevant and unlikely to be visible at a group level. However, with Santander looking to list a 25% minority stake of its Mexican business, this could increase the marketsâ&#x20AC;&#x2122; attention on the Mexican banking sector and the relevance for these four global banks.

Fig. 99: BBVA most exposed to Mexico 2011

Mexico % group Revenues Pre-provision Pre-tax Loans

BBVA 27% 33% 61% 10%

Source: Company data, Nomura research

SAN 5% 6% 10% 2%

HSBC 4% 2% 3% 1%

Citi 7% 10% 10% 5%

HSBC 2011 pre-tax contribution adjusted for restructuring charges

44

Nomura | Mexico

July 10, 2012

Overview of the key Mexican banks A system dominated by international subsidiaries The five largest Mexican, which account for c. 74% market share in total lending, are dominated by the subsidiaries of international groups. BBVA’s Bancomer subsidiary is the largest bank in the country, while Santander is planning a potential IPO for a minority stake of its Mexican subsidiary. Citigroup’s subsidiary is Banamex, with HSBC closing the group. The largest ‘domestic’ owned bank is Banorte.

In Figure 100, we set out the key financial indicators and ratios to give a brief overview of the profitability of the different financial groups and key drivers behind this profitability. In aggregate, profitability for the sector remains relatively strong at c. 13%, in line with the average for the five major banks (although there are some important differences). Both Bancomer and Santander stand out for above-average returns, explained not only by cost efficiencies, but by higher revenues. In the case of Bancomer, this is particularly the case, in part a result of a greater proportion of the balance sheet used for lending activities. In the case of Santander, as with many of its subsidiaries across the world, it is a leader in cost efficiency (measured here by costs as a percentage of average total assets). For Banamex, part of the lower levels of returns are explained by a lower utilisation of the balance sheet for lending activities, while HSBC maintains a higher cost base relative to the size of assets.

Fig. 100: An overview of Mexican banks 2011, Mexican GAAP

Market share Revenues: NIM (exc LLC) NIM (inc LLC) Total revenue/ATA Total revenue/loans+deposits NII/Total revenue Non interest income/Total revenue Costs: Costs/ATA Costs/loans+deposits Cost-Income Ratio (inc. LLC) Cost-Income Ratio (ex LLC) Loans+Deposits/employee (m) Profitability: Operating Income/ATA Effective Tax Rate RoA Leverage (RoE/RoA) RoE Credit quality: LLC/NII NPL ratio NPL Coverage Balance sheet: Loans/Assets Loans/Deposits Basic capital

BBVA 25.4%

Banamex 16.0%

Banorte 12.4%

HSBC 7.6%

Santander 12.8%

Average 74.2%

5.84% 4.20% 6.40% 6.69% 66% 34%

4.80% 3.29% 5.20% 7.53% 63% 37%

3.51% 2.84% 4.55% 5.34% 62% 38%

4.72% 3.24% 6.32% 6.40% 51% 49%

4.05% 3.13% 4.85% 6.28% 65% 35%

4.59% 3.34% 5.46% 6.45% 61% 39%

3.31% 3.46% 51.8% 26.1% 34.1

3.47% 5.01% 66.6% 37.5% 32.1

2.91% 3.42% 64.0% 49.1% 30.2

5.29% 5.36% 83.7% 60.3% 25.4

2.55% 3.30% 52.6% 33.6% 48.9

3.51% 4.11% 63.7% 41.3% 34.1

3.09% 27.0% 2.27% 9.4x 21.4%

1.74% 27.9% 1.26% 7.4x 9.4%

1.64% 35.1% 1.06% 10.6x 11.2%

1.03% 21.9% 0.55% 9.5x 5.3%

2.30% 12.0% 2.63% 8.5x 22.4%

1.96% 24.8% 1.55% 9.1x 13.9%

28.1% 3.12% 126%

31.4% 1.56% 284%

19.3% 1.94% 143%

31.3% 2.71% 214%

22.8% 1.69% 211%

26.6% 2.21% 196%

48% 109% 11.3%

33% 84% 15.1%

43% 98% 15.3%

39% 64% 11.7%

42% 107% 14.5%

41% 93% 13.6%

Source: Company data, CNBV, Nomura research

45

Nomura | Mexico

July 10, 2012

HSBC Mexico (subsidiary of HSBC covered by Chintan Joshi) â&#x20AC;&#x201C; recovering lost ground HSBCâ&#x20AC;&#x2122;s Mexican subsidiary has a market share of c. 8% and by assets is the fifth-largest bank in the country. The bank had built up a substantial consumer credit portfolio during the credit boom of 2004-07, which suffered especially high losses as the Mexican economy entered recession in 2009. During this period, there was a significant reduction in the loan book; in fact, total loans are still 2% below the peak reached in 2007.

However, given the current outlook for the economy and banking sector, management is comfortable that overall loan growth will be sustained in the 10-15% range in the near future.

Fig. 101: Distribution of loan book

Fig. 102: Market shares 10%

60%

9%

50%

8% 7%

40%

6% 5%

30%

4%

20%

3% 2%

10%

1%

0%

0% Consumer

Mortgage

Corporate

Consumer

Govt.

Source: Company data, CNBV, Nomura research

Mortgage

Corporate

Govt.

Total

Source: Company data, CNBV, Nomura research

Following this rebalancing of the loan book, there has also been a restructuring of the business model. Within the overall group strategy of improving efficiency, the Mexican franchise has dedicated significant efforts to remodelling the internal structure and distribution model of the business. This has seen a reduction in branches of 15% since the peak in 2007 (although total square footage of branch space has recovered to precrisis levels) and a 23% reduction in headcount. Although the cost/income ratio has remained stubbornly high, there has been an improvement in the cost base relative to average assets. However, HSBC continues to have a cost opportunity given the levels of efficiency seen in the other comparable Mexican banks.

Fig. 103: Trying to improve efficiency

Fig. 104: Significant reduction in headcount/branches

Costs % total revenues and costs % average total assets

# of branches and employees

6.0%

90%

24,000

1600

5.8%

80%

23,000

1400

5.6%

70%

22,000

1200

60%

21,000

50%

20,000

40%

19,000

30%

18,000

4.4%

20%

17,000

400

4.2%

10%

16,000

200

5.4% 5.2% 5.0% 4.8% 4.6%

4.0% 08

0% 09 10 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Cost income ratio (RHS) Costs % ATA (LHS)

Source: Company data, Nomura research

1000 800 600

15,000

0 07

08

09

10 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12

Employees (LHS)

Branches (RHS)

Source: Company data, Nomura research

Following a recovery in economic conditions over the past year and a half, HSBC has again started to try and improve its growth profile. Although the bulk of the loan book remains to corporate, there is an increased focus on improving the market share in consumer finance, particularly in payroll accounts and lending.

46

Nomura | Mexico

July 10, 2012

Growth in consumer lending currently stands at 14% y-o-y and payroll loans are growing at 74% (including other personal loans). There is a particular focus on regaining market share in this segment to at least double digits. Although this implies a more aggressive approach vs. peers, management is conscious of avoiding the pitfalls in building up a consumer portfolio. Indeed, this time around, the focus is on retaining and growing lending with the existing client base and not using third-party distribution networks.

For the rest of the loan book, HSBC will continue to leverage the capabilities of a global bank to help expand corporate and SME lending. Although management believes mortgages will continue to show sustained growth at an industry level, this is not an area of focus at the moment. In fact, it appears that HSBC is still managing some of the accumulated asset quality deterioration in the mortgage book where the NPL ratio stands at 9% vs. a system average of 3.7%.

Fig. 105: Consumer & commercial lead the way

Fig. 106: Most the growth comes from commercial lending

Loan growth by category % y-o-y Q1 2012

Increase in loans by segment % of total yearly increase. Q1 2012

20%

120%

15%

100% 80%

10%

60%

5%

40% 0%

20%

-5%

0%

-10%

-20%

-15%

-40% Consumer

Mortgage Commercial

Other

Consumer

Total

Source: Company data, Nomura research

Mortgage

Commercial

Other

Source: Company data, Nomura research

In terms of recent results, underlying profitability has been hampered by the lower interest rate environment, which is slightly more negative for HSBC vs. peers given the larger deposit base. Although inflation over the past three years has been c. 4% per annum, HSBC has managed average cost growth of 2% y-o-y. Loan loss charges and asset quality remain stable, and we believe that the improved outlook for loan growth (particularly in higher margin business), stable interest rates and economic conditions should allow for an improvement in profitability over the coming two to three years.

Fig. 107: Still some progress to be made in efficiency Q1 2012. Growth rates y-o-y

NIM Revenue growth Cost growth Efficiency ratio Loan loss charge bp Net income growth

Q1 2012 4.2% -7.6% -15.0% 65% 355 40.1%

RoA RoE NPL ratio Loan growth Deposit growth Capital ratio

Q1 2012 1.0% 10.5% 2.6% 7.9% 16.3% 11.4%

Source: Company data, Nomura research

47

Nomura | Mexico

July 10, 2012

Fig. 108: HSBC recent full-year results Mexican GAAP, MXN m

Grupo Financiero HSBC Net interest income Fees Other Total revenues

2008A 25,189 11,364 3,380 39,933

2009A 21,220 9,705 3,695 34,620 -13.3%

0.3%

2.3%

-22,505

-21,697

-23,113

-24,121

-3.6%

6.5%

4.4%

17,428

12,923

11,623

11,429

-25.8%

-10.1%

-1.7%

-14,881 1,329 234 4,110

-14,472 1,683 1,420 1,554

-9,284 19 -239 2,119

-6,737 -1,478 -704 2,510

-62.2%

36.4%

18.5%

159,952

171,421

187,638

-7.5%

7.2%

9.5%

238,975

233,139

249,140

292,093

-2.4%

6.9%

17.2%

38,600

47,462

49,576

45,864

23.0%

4.5%

-7.5%

474,664

393,790

425,387

486,062

-17.0%

8.0%

14.3%

4.9% 1.6% 63% 5.0% 0.4% 3.6% 869 5.0% 132% 41% 12.1% 69% 13.8%

5.3% 3.0% 67% 5.6% 0.5% 4.4% 560 3.1% 174% 40% 11.7% 69% 11.2%

4.7% 3.2% 68% 5.3% 0.6% 5.3% 375 2.7% 214% 39% 9.4% 64% 11.7%

% change

Costs % change

Pre provision profits % change

Loan loss provisions Other Taxes & MI Net profits % change

Loans

172,938

% change

Deposits % change

Shareholders equity % change

Total assets % change

Net Interest Margin (NIM) NIM net of provisions Cost-Income Ratio Operating Costs/ATA RoA RoE Net LLP/Net Loans (bp) NPL Ratio Coverage Ratio Lending/Assets Equity as % Assets Lending/Deposits Capital ratio

6.1% 2.5% 56% 5.5% 1.0% 9.6% 798 5.9% 126% 36% 8.1% 72% 10.1%

2010A 21,504 6,471 6,761 34,736

2011A 21,495 5,995 8,060 35,550

Source: Company data, Nomura research

48

Nomura | Mexico

July 10, 2012

Bancomer (BBVA) â&#x20AC;&#x201C; maintaining lead position Bancomer is the largest Mexican bank by assets and has the leading market share across most segments. Its position as the market leader was cemented by the acquisition of a mortgage provider (Hipotecario Nacional in 2005). The challenge for Bancomer will be to maintain its leading position in a more competitive market as the banking sector returns to stronger levels of growth. However, as some of its competitors have fully recovered following the credit cycle of 2008/09, it is very likely that some market share, particularly in consumer finance, is lost.

Fig. 109: Distribution of loan book

Fig. 110: Market shares

% 2011

2011

40%

40%

35%

35%

30%

30%

25%

25%

20%

20%

15%

15%

10%

10%

5%

5%

0%

0% Consumer

Mortgage

Corporate

Govt.

Source: CNBV, Company data, Nomura research

Consumer

Mortgage

Corporate

Govt.

Total

Source: CNBV, Company data, Nomura research

As shown in Figure 110, Bancomer has a leading market share across the main banking products. Although corporate loans, at 37% of the total, are the largest within Bancomerâ&#x20AC;&#x2122;s loan book, consumer finance, in particular payroll lending, is likely to be an area of focus (as with all the other banks). Indeed, at the moment, it is the loan book that is showing the fastest rate of growth, +20% y-o-y as of 1Q 2012. This compares with a slight contraction in corporate lending and growth of c. 5% in mortgages. The weakness in corporate lending is driven in large part by a strong contraction in the real estate developer book (a trend seen at a sector level).

Fig. 111: Consumer lending growth leads the way

Fig. 112: Offsetting weakness in corporate lending

% y-o-y growth Q1 2012

Increase in lending % total yearly increase, Q1 2012

80%

25%

70% 20%

60% 50%

15%

40% 10%

30% 20%

5%

10% 0%

0% Consumer

Mortgage Commercial

Source: Company data, Nomura research

Other

Total

Consumer

Mortgage

Commercial

Other

Source: Company data, Nomura research

Recent results at Bancomer have been affected by the reduction in certain segments of the corporate loan book and the low interest rate environment, which has put pressure on all the Mexican banks during 2011. However, overall levels of profitability and efficiency at Bancomer continue to remain extremely strong relative to peers. The sustained growth in lending, both in corporate and consumer lending, combined with stable interest rates, should see a marked improvement in profitability over the next 12 to 18 months.

49

Nomura | Mexico

July 10, 2012

Fig. 113: Recent results Q1 2012

NIM Revenue growth Cost growth Efficiency ratio Loan loss charge bp Net income growth

Q1 2012 5.7% 6.0% 11.5% 42% 306 4.6%

RoA RoE NPL ratio Loan growth Deposit growth Capital ratio

Q1 2012 2.1% 20.9% 3.3% 6.9% 10.8% 11.0%

Source: Company data, Nomura research

Fig. 114: Bancomer recent full-year results Mexican GAAP, MXN m

Bancomer Net interest income Fees Other Total revenues

2008A 62,775 21,614 470 84,859

2009A 67,240 20,840 4,504 92,584 9.1%

1.0%

4.8%

-32,328

-35,771

-37,163

-40,383

10.7%

3.9%

8.7%

56,813

56,351

57,654

8.2%

-0.8%

2.3%

-27,251 318 -8,268 21,612

-19,621 311 -10,346 26,695

-20,011 321 -10,254 27,710

-16.6%

23.5%

3.8%

524,408

579,725

629,897

1.2%

10.5%

8.7%

484,024

515,491

545,661

576,119

6.5%

5.9%

5.6%

107,431

114,016

125,430

133,392

6.1%

10.0%

6.3%

1,107,780

1,114,171

1,324,736

-3.8%

0.6%

18.9%

6.0% 3.5% 39% 3.2% 1.9% 19.5% 523 3.8% 136% 47% 10.3% 102% 11.9%

6.0% 4.3% 40% 3.3% 2.4% 22.3% 355 2.5% 174% 52% 11.3% 106% 12.1%

5.8% 4.2% 41% 3.3% 2.3% 21.4% 331 3.1% 126% 48% 10.1% 109% 11.3%

% change

Costs % change

Pre provision profits

52,531

% change

Loan loss provisions Other Taxes & MI Net profits

-23,969 3,699 -6,362 25,899

% change

Loans

518,249

% change

Deposits % change

Shareholders equity % change

Total assets

1,151,281

% change

Net Interest Margin (NIM) NIM net of provisions Cost-Income Ratio Operating Costs/ATA RoA RoE Net LLP/Net Loans (bp) NPL Ratio Coverage Ratio Lending/Assets Equity as % Assets Lending/Deposits Capital ratio

5.6% 3.5% 38% 2.9% 2.3% 24.9% 487 3.2% 156% 45% 9.3% 107% 11.7%

2010A 67,053 20,612 5,849 93,514

2011A 71,264 20,408 6,365 98,037

Source: Company data, Nomura research

50

Nomura | Mexico

July 10, 2012

Banorte – consolidating gains from recent acquisition Banorte is the largest domestic-owned Mexican bank and is listed on the local stock exchange. It has an aggregate market share of c. 14%, is the fourth-largest Mexican bank by assets and has a market cap of EUR 9bn or MXN 154bn. In 2011, it acquired a smaller competitor, Ixe Banco, which is being integrated into the group. This has increased the group’s size by 11% (gross loans) and total market share by 1%. It also significantly increased its capital markets and asset management business. In addition, Banorte hopes to generate significant synergies from the merger and deliver a ROTE of 18% to 20%.

Fig. 115: Corporate lending dominates

Fig. 116: Key market shares – room for growth in consumer?

% distribution of loan book by category. 2011

2011 market shares 25%

50% 45% 40%

20%

35% 30%

15%

25% 20%

10%

15% 10%

5%

5% 0%

0% Consumer

Mortgage

Corporate

Govt.

Source: CNBV, Company data, Nomura research

Consumer

Mortgage

Corporate

Govt.

Total

Source: CNBV, Company data, Nomura research

Banorte has traditionally had substantial focus and strength in corporate and SME banking. This focus and conservative risk approach resulted in a significantly lower level of losses in 2008 and 2009. Banorte had a significantly lower risk exposure to credit cards and consumer finance during the previous credit cycle. While SME banking is likely to remain a key strength and source of growth for the bank, Banorte is looking to expand its consumer credit exposure.

Fig. 117: High loan growth driven by merger with IXe

Fig. 118: Corporate lending remains key driver

% y-o-y loan growth, Q1 2012

Increase in lending % total yearly lending increase

50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Consumer

Mortgage Commercial

Source: Company data, Nomura research

Other

Total Source: Company data, Nomura research

As with the other key banks in the system, Banorte is placing increased focus in capturing market share and expanding the consumer and household lending segment.

The initial strategy is to try and increase penetration within the existing client base, where use of credit cards and payroll loans is relatively low. This strategy is based on the more attractive spreads and potential to improve margins. The acquisition of Ixe Banco should help improve the group’s ability to increase its consumer loan book.

The other main focus for the bank is to successfully integrate the 2011 acquisition Ixe Banco. The merger was completed in Q2 2011 and Banorte estimates that overall the group should be able to deliver a ROTE of c. 18-20%. Some of the cost synergies have already been captured and, although there are still some restructuring costs to book, underlying costs are improving. Management expects to reach a cost-income ratio of under 55% for 2012, with a medium-term target of 45%.

51

Nomura | Mexico

July 10, 2012

Fig. 119: Recent results Q1 2012

NIM Revenue growth Cost growth Efficiency ratio Loan loss charge bp Net income growth

Q1 2012 3.8% 32.7% 41.6% 56% 162 35.7%

RoA RoE NPL ratio Loan growth Deposit growth Capital ratio

Q1 2012 1.2% 13.7% 1.8% 32.5% 24.7% 11.6%

Source: Company data, Nomura research

Fig. 120: Banorte recent full-year results Mexican GAAP. 2011 incorporates Ixe Banco from 2Q 2011. MXN m

Banorte Net interest income Fees Other Total revenues

2008A 22,584 7,246 3,385 33,215

2009A 23,183 6,953 3,096 33,232 0.1%

3.6%

22.0%

-15,807

-17,024

-17,691

-23,409

7.7%

3.9%

32.3%

17,408

16,208

16,737

18,600

-6.9%

3.3%

11.1%

-6,896 276 -3,773 7,015

-8,286 312 -2,381 5,854

-6,889 320 -3,462 6,705

-5,438 -41 -4,604 8,517

-16.6%

14.5%

27.0%

245,107

270,214

357,506

-0.1%

10.2%

32.3%

260,769

274,908

288,837

363,337

5.4%

5.1%

25.8%

40,078

43,170

49,022

73,370

7.7%

13.6%

49.7%

577,023

567,138

590,558

829,277

-1.7%

4.1%

40.4%

4.04% 2.59% 51% 3.0% 1.0% 13.8% 342 2.5% 122% 43% 7.6% 89%

3.87% 2.70% 51% 3.0% 1.1% 14.4% 270 2.5% 124% 46% 8.3% 94%

3.70% 2.98% 56% 3.1% 1.1% 12.9% 169 1.9% 143% 43% 8.8% 98%

% change

Costs % change

Pre provision profits % change

Loan loss provisions Other Taxes & MI Net profits % change

Loans

245,246

% change

Deposits % change

Shareholders equity % change

Total assets % change

Net Interest Margin (NIM) NIM net of provisions Cost-Income Ratio Operating Costs/ATA RoA RoE Net LLP/Net Loans (bp) NPL Ratio Coverage Ratio Lending/Assets Equity as % Assets Lending/Deposits Capital ratio

5.85% 4.06% 48% 4.1% 1.8% 17.3% 305 2.0% 135% 43% 6.9% 94%

2010A 22,732 7,686 4,009 34,428

2011A 28,242 8,175 5,592 42,009

Source: Company data, Nomura research

52

Nomura | Mexico

July 10, 2012

Banamex (subsidiary of Citigroup covered by Glen Schorr) â&#x20AC;&#x201C; looking to leverage the balance sheet Citigroupâ&#x20AC;&#x2122;s subsidiary, Banamex, has a total market share of loans of c. 16% and is the second-largest bank in Mexico after Bancomer. Banamex has a particularly strong franchise in consumer lending, where it has a c. 26% market share and it accounts for c. 32% of the total loan book. This is the highest proportion of consumer lending for any of the major banks.

Fig. 121: Distribution of loans

Fig. 122: Market share

2011

2011 30%

45% 40%

25%

35%

20%

30% 25%

15%

20%

10%

15% 10%

5%

5%

0%

0% Consumer

Mortgage

Corporate

Consumer

Govt.

Source: CNBV, Nomura research

Mortgage

Corporate

Govt.

Total

Source: CNBV, Nomura research

Overall loan growth remains strong, reaching 20% in Q1 2012. The key driver behind this growth is the expansion in consumer lending, which grew at 36% y-o-y. With a loan-todeposit ratio of 84%, Banamex should be well placed to take advantage of growth opportunities over the coming years.

Fig. 123: Consumer lending fastest growth

Fig. 124: Bulk of lending growth comes from consumer

% y-o-y loan growth

Increase in lending % total yearly increase 60%

40% 35%

50%

30%

40%

25% 20%

30%

15%

20%

10%

10%

5% 0%

0% Consumer

Mortgage Commercial

Source: CNBV, Nomura research

Other

Total

Consumer

Mortgage

Commercial

Other

Source: CNBV, Nomura research

With a strong level of capital (15% basic capital ratio) we believe Banamex has a strong balance sheet to take advantage of growth opportunities in Mexico. Within the group, consumer franchise is a key area of focus for growth. The ability to increase revenues, from higher yield consumer loans, while maintaining cost control, will likely be the key to generating improving returns. The increased weight of consumer loans on the balance sheet should also see an improvement in profitability. Recent results show a further improvement in the level of loan growth, reaching 20% y-o-y as of Q1 2012. This growth is being driven by the acceleration in consumer lending, now growing at 36% y-o-y. With a stable interest rate environment, this increase in the credit portfolio is driving the increase in revenues, growing at 27% y-o-y in Q1 2012. Cost control remains a feature and in Q1 were 8% higher vs. average quarterly costs in 2011, resulting in an improvement in the efficiency ratio to 49%. Asset quality indicators remain stable and there was actually an improvement in the loan loss charges to 424bp vs. c. 490bp during 2011. As a result, overall net income increased by 83% to MXN 4.65bn or an RoE of c. 12%.

53

Nomura | Mexico

July 10, 2012

Fig. 125: Recent results Q1 2012

NIM Revenue growth Cost growth Efficiency ratio Loan loss charge Net income growth

Q1 2012 5.5% 27.2% 8.4% 49% 424 83.0%

RoA RoE NPL ratio Loan growth Deposit growth Capital ratio

Q1 2012 1.6% 11.7% 1.6% 20.3% 5.0% 14.7%

Source: Company data, Nomura research

Fig. 126: Banamex recent full-year results Mexican GAAP, MXN m

Banamex Net interest income Fees Other Total revenues

2008A 52,267 19,819 3,476 75,562

2009A 54,409 19,203 8,460 82,072 8.6%

0.9%

-4.8%

-35,601

-37,135

-38,431

-40,700

4.3%

3.5%

5.9%

39,961

44,937

44,411

38,177

12.5%

-1.2%

-14.0%

-26,420 967 -1,772 12,736

-22,680 1,594 -5,060 18,791

-14,964 280 -7,549 22,178

-17,747 148 -5,749 14,829

47.5%

18.0%

-33.1%

350,065

332,744

394,838

26.7%

-4.9%

18.7%

318,850

354,949

423,774

472,838

11.3%

19.4%

11.6%

139,472

155,913

160,378

156,660

11.8%

2.9%

-2.3%

1,019,611

1,124,690

1,149,480

1,199,607

10.3%

2.2%

4.4%

5.1% 3.0% 45% 3.5% 1.8% 12.7% 724 2.0% 244% 31% 13.9% 99% 18.3%

4.9% 3.6% 46% 3.4% 2.0% 14.0% 438 1.4% 255% 29% 14.0% 79% 19.4%

4.8% 3.3% 52% 3.5% 1.3% 9.4% 488 1.6% 284% 33% 13.1% 84% 15.1%

% change

Costs % change

Pre provision profits % change

Loan loss provisions Other Taxes & MI Net profits % change

Loans

276,356

% change

Deposits % change

Shareholders equity % change

Total assets % change

Net Interest Margin (NIM) NIM net of provisions Cost-Income Ratio Operating Costs/ATA RoA RoE Net LLP/Net Loans (bp) NPL Ratio Coverage Ratio Lending/Assets Equity as % Assets Lending/Deposits Capital ratio

5.3% 2.6% 47% 3.6% 1.3% 9.6% 958 2.9% 206% 27% 13.7% 87% 17.4%

2010A 56,104 20,033 6,705 82,842

2011A 56,436 20,357 2,084 78,877

Source: Company data, Nomura research

54

Nomura | Mexico

July 10, 2012

Santander – getting ready for local listing Santander’s Mexican subsidiary has a total loan market share of c. 13% and is the thirdlargest bank in Mexico by assets. It had significant exposure to credit cards in the recession and it was only during 2011 that the contraction of this loan book stabilised.

Performing consumer loans are still c. 23% below their 2007 peak. However, given that economic conditions have stabilised, Santander is retaking advantage of the growth opportunities in the sector.

Fig. 127: Distribution of loan book

Fig. 128: Market share

% total 2011

% 2011

18%

60%

16%

50%

14% 12%

40%

10%

30%

8% 6%

20%

4%

10%

2%

0%

0% Consumer

Mortgage

Corporate

Consumer

Govt.

Source: CNBV, Nomura research

Mortgage

Corporate

Govt.

Total

Source: CNBV, Nomura research

As with Santander subsidiaries elsewhere, the Mexican business is characterised by high levels of efficiency and an aggressive commercial strategy. Organic (ie, ex acquisitions) loan growth is currently (Q1 2012) running at c. 18%. Santander also acquired GE’s mortgage business in 2011 to strengthen its position in that market.

Fig. 129: Growth in mortgages following acquisition

Fig. 130: Sources of growth

%, y-o-y

Increase in lending % total yearly increase in lending.

80%

50%

70%

45% 40%

60%

35%

50%

30%

40%

25%

30%

20% 15%

20%

10%

10%

5%

0%

0% Consumer

Mortgage Commercial

Source: Company data, Nomura research

Other

Total

Consumer

Mortgage

Commercial

Other

Source: Company data, Nomura research

Santander remains committed to its current subsidiary model that promotes the listing of its subsidiaries in local markets. Brazil was listed in 2009, a listing is planned for the UK in 2013 and there are plans to increase the free float in Poland to c. 25%. A listing in Argentina was also planned, but ultimately cancelled given market conditions at the time.

Santander has confirmed that it intends to list up to a 25% stake of its Mexican subsidiary.

We estimate that Santander’s Mexican business could be worth c. EUR 12bn. Based on the current multiples of Banorte, Santander Mexico could be worth EUR 18bn, although this is distorted by being the only main listed Mexican bank.

55

Nomura | Mexico

July 10, 2012

With a return to strong growth in credit, overall profitability has improved, with net income increasing 19% y-o-y and reaching an RoE of c. 27%. As with other subsidiaries, Santanderâ&#x20AC;&#x2122;s Mexican business is delivering strong efficiency metrics. Although the business is expanding (branches increased by 14% y-o-y), total cost growth as of 1Q 2012 stands at c. 12% y-o-y. With stronger revenue growth, there has been an improvement in the cost-income ratio (ex loan loss charges) to 36% vs. 40% in 2010.

Fig. 131: Recent results Q1 2012

NIM Revenue growth Cost growth Efficiency ratio Loan loss charge bp Net income growth

Q1 2012 4.3% 29.0% 13.4% 36% 249 45.2%

RoA RoE NPL ratio Loan growth Deposit growth Capital ratio

Q1 2012 2.6% 22.1% 1.4% 24.7% 20.3% 14.0%

Source: Company data, Nomura research

Fig. 132: Santander recent results Mexican GAAP, MXN m

Santander

Net interest income Fees Other Total revenues

2008A 30,659 9,663 411 40,733

2009A 27,252 8,767 8,463 44,482 9.2%

-10.3%

2.7%

-16,285

-15,907

-16,075

-18,111

-2.3%

1.1%

12.7%

24,448

28,575

23,844

22,882

16.9%

-16.6%

-4.0%

-15,832 -563 473 8,526

-15,320 -74 -1,356 11,825

-8,425 865 -2,434 13,850

-6,556 4,892 -2,536 18,682

38.7%

17.1%

34.9%

207,737

227,556

313,673

-9.5%

9.5%

37.8%

251,145

236,861

263,002

292,785

-5.7%

11.0%

11.3%

69,770

72,416

80,004

86,813

3.8%

10.5%

8.5%

656,180

582,034

681,817

739,175

-11.3%

17.1%

8.4%

4.4% 1.9% 36% 2.6% 1.9% 16.6% 701 1.7% 319% 36% 12.4% 88% 12.0%

4.2% 2.8% 40% 2.5% 2.2% 18.2% 387 1.7% 269% 33% 11.7% 87% 15.3%

4.1% 3.1% 44% 2.5% 2.6% 22.4% 242 1.7% 211% 42% 11.7% 107% 14.5%

% change

Costs % change

Pre provision profits % change

Loan loss provisions Other Taxes & MI Net profits % change

Loans

229,661

% change

Deposits % change

Shareholders equity % change

Total assets % change

Net Interest Margin (NIM) NIM net of provisions Cost-Income Ratio Operating Costs/ATA RoA RoE Net LLP/Net Loans (bp) NPL Ratio Coverage Ratio Lending/Assets Equity as % Assets Lending/Deposits Capital ratio

5.8% 2.8% 40% 3.1% 1.6% 12.3% 706 3.1% 138% 35% 10.6% 91% 11.5%

2010A 26,289 9,412 4,218 39,919

2011A 28,806 10,232 1,955 40,993

Source: Company data, Nomura research

56

Nomura | Mexico

July 10, 2012

Fig. 133: New BBVA earnings estimates Buy (upgrade from Reduce), target price EUR 7.80 (up from EUR 7.30)

BBVA Group Financials: Net Interest Income % change Net Income Equity Method Fees Other income Trading Income Total Revenue % change Net Revenues from Non-Fin Activities General Expenses Depreciation and Amortisation Other Revenues and Expenses (Net) Cost synergies Total Costs Operating Income % change Net Loan Loss Provisions Other Provisions / Impairments Sales of Financial Stakes Other

Recent Results and Forecasts 2004 A

2005 A

2006 A

2007 A

2008 A

2009 A

2010 A

2011 E

2012 E

2013 E

2014 E

EURm

EURm

EURm

EURm

EURm

EURm

EURm

EURm

EURm

EURm

EURm

6,160 97 3,413 391 1,059 11,119 126 -5,098 -449 -109 0 -5,530

8,374

9,770

11,577

13,878

13,320

13,160

14,276

15,053

16,130

16.2%

16.7%

18.5%

19.9%

-4.0%

-1.2%

8.5%

5.4%

7.2%

122 3,940 487 1,268 13,024

308 4,335 650 2,033 15,700

242 4,723 729 1,823 17,287

6 4,488 1,407 1,444 18,922

0 4,430 810 1,543 20,661

0 4,531 1,159 1,894 20,904

0 4,561 1,367 1,479 20,566

0 4,769 1,495 1,531 22,072

0 4,942 1,566 1,559 23,120

0 5,180 1,654 1,523 24,488

17.1%

20.5%

10.1%

9.5%

9.2%

1.2%

-1.6%

7.3%

4.7%

5.9%

126 -5,763 -449 -115 0 -6,201

131 -6,330 -472 -147 0 -6,818

187 -7,053 -578 -146 0 -7,590

8 -7,589 -699 -129 0 -8,409

0 -7,659 -697 0 0 -8,355

0 -8,206 -761 0 0 -8,967

0 -9,104 -847 0 0 -9,951

0 -9,826 -888 0 0 -10,714

0 -10,389 -900 0 0 -11,288

0 -10,992 -915 0 0 -11,907 12,581

6,823

8,882

9,697

10,513

12,305

11,937

10,615

11,358

11,831

22.1%

30.2%

9.2%

8.4%

17.0%

-3.0%

-11.1%

7.0%

4.2%

6.3%

-784 -850 0 181

-813 -454 0 36

-1,477 -1,339 771 191

-1,902 -110 0 -11

-2,912 -166 5 -511

-5,474 -4 776 -2,345

-4,717 -1,040 237 0

-4,227 -2,689 70 0

-3,861 -2,579 0 0

-4,353 -210 0 0

-4,525 19 0 0

4,136 -1,029

5,593 -1,522

7,029 -2,059

7,674 -1,984

6,929 -1,543

5,258 -667

6,417 -1,425

3,768 -284

4,919 -1,009

7,269 -1,599

8,075 -1,857

Net Income Minority interests

3,107 -185

4,071 -265

4,970 -235

5,690 -287

5,386 -365

4,591 -384

4,991 -389

3,484 -481

3,909 -579

5,670 -654

6,218 -774

Net Attributable Income (stated)

2,922

Pre-tax Profit Corporate Income Tax

5,589

7,208 17.0%

% change DIVISIONAL DATA - Net attributable income Spain South America Mexico of which: Bancomer Eurasia of which: Turkey USA Corporate Centre

3,806

4,735

5,402

5,021

4,207

4,603

3,003

3,330

5,016

5,445

30.3%

24.4%

14.1%

-7.1%

-16.2%

9.4%

-34.8%

10.9%

50.6%

8.6%

2,255 889 1,707 1,397 588 236 -1,072

1,363 1,007 1,741 1,426 1,027 263 -722 -1,413

1,073 1,076 1,690 1,453 1,098 395 330 -1,936

1,319 1,230 1,810 1,560 1,162 423 312 -819

1,451 1,416 1,874 1,609 1,218 424 304 -819

4,603

3,003

3,330

5,015

5,445

Total Number of Shares (y/e; m) EPS stated (EUR) EPS adjusted 1 - core (EUR) DPS (EUR) Net Asset Value per share (stated) Net Asset Value per share (adjusted 1) Main Balance Sheet Measures: Shareholders' Equity Net Lending - Group % change Group Gross Lending - Spain % change European Retail Gross Lending - Mexico % change Mexico (local currency) Risk Weighted Assets % change P&L Ratios: Net Interest Margin exc Dividends Net Interest Margin inc Divs - Spain Net Interest Margin inc Divs - Mexico Cost-Income Ratio (all costs) Effective Tax Rate RoRWA RoA RoE (stated) RoE (adjusted) Asset Quality: Non-performing loans/Gross lending Coverage of non-performing loans Net LLP/Gross Loans (average) Capital - Group: Core Capital Ratio (T1 ex Prefs) Prefs as % Tier I BIS Ratio

3,391 0.86 0.85 0.44 3.23 2.99

3,391 1.12 1.08 0.53 3.84 3.23

3,557 1.33 1.14 0.64 5.12 4.20

3,748 1.44 1.45 0.73 6.62 4.42

3,748 1.34 1.31 0.61 7.09 4.84

3,748 1.12 0.95 0.42 7.83 5.90

4,491 1.02 1.07 0.42 8.17 6.43

4,903 0.61 0.63 0.42 8.35 6.58

5,531 0.60 0.60 0.42 7.78 5.92

5,691 0.88 0.85 0.42 8.21 6.38

5,851 0.93 0.90 0.42 8.68 6.88

10,961 172,083

13,036 216,850

18,210 256,565

24,811 310,882

26,586 324,721

29,362 323,615

36,689 338,857

40,952 351,900

43,018 366,365

46,697 387,033

50,760 410,620

26.0%

18.3%

21.2%

4.5%

-0.3%

4.7%

3.8%

4.1%

5.6%

6.1%

132,061

154,928

178,307

197,524

203,117

199,165

213,281

209,622

205,430

209,538

213,729

17.3%

15.1%

10.8%

2.8%

-1.9%

7.1%

-1.7%

-2.0%

2.0%

2.0%

12,464

22,398

25,225

27,907

26,463

27,373

34,626

34,544

38,344

42,178

47,240

49.6%

27.7%

24.0%

13.6%

1.8%

10.9%

8.6%

11.0%

10.0%

12.0%

182,683

216,890

252,373

268,491

283,320

291,026

313,327

330,771

342,728

362,063

384,128

18.7%

16.4%

6.4%

5.5%

2.7%

7.7%

5.6%

3.6%

5.6%

6.1%

3.85% 50.9% 24.9% 1.71% 0.96% 27.5% 31.6%

1.92% 2.01% 4.82% 48.6% 27.2% 2.04% 1.13% 31.7% 34.8%

1.99% 1.95% 6.03% 44.3% 29.3% 2.12% 1.24% 30.3% 30.7%

2.06% 2.00% 6.00% 45.0% 25.9% 2.18% 1.24% 25.1% 33.6%

2.15% 2.16% 5.98% 44.5% 22.3% 1.95% 1.03% 19.5% 28.2%

2.57% 2.25% 5.29% 40.4% 12.7% 1.60% 0.85% 15.0% 17.7%

2.45% 1.90% 5.15% 42.9% 22.2% 1.65% 0.92% 13.9% 17.4%

2.29% 1.45% 5.33% 48.4% 7.5% 1.05% 0.61% 7.7% 9.6%

2.40% 1.48% 5.25% 48.5% 20.5% 1.16% 0.66% 7.9% 9.6%

2.48% 1.44% 5.25% 48.8% 22.0% 1.61% 0.93% 11.2% 13.8%

2.51% 1.44% 5.20% 48.6% 23.0% 1.67% 0.97% 11.2% 13.6%

1.25% 208.4% 0.47%

1.05% 238.7% 0.41%

0.95% 257.0% 0.61%

1.06% 211.9% 0.65%

2.54% 87.9% 0.90%

4.69% 55.9% 1.65%

4.50% 59.9% 1.39%

4.39% 59.3% 1.19%

4.39% 57.0% 1.05%

3.74% 65.7% 1.13%

3.17% 80.2% 1.11%

5.8% 26.4% 12.5%

5.6% 25.4% 12.1%

6.2% 20.6% 12.0%

6.0% 22.0% 12.1%

6.2% 24.1% 12.2%

7.9% 18.3% 13.8%

9.4% 15.7% 13.7%

10.3% 5.2% 12.9%

10.6% 4.9% 13.2%

11.1% 4.4% 13.7%

11.5% 4.0% 14.1%

1.83%

Source: Company data, Nomura estimates

57

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July 10, 2012

Fig. 134: New Santander earnings Reduce (downgrade from Neutral), target price EUR 7.10 (down from EUR 7.40)

Santander

Recent Results and Forecasts

Financials: Net Interest Income Net Income Equity Method Fees Insurance Income Trading Income Revenue synergies Total Revenue Net Revenues from Non-Fin Activities General Admin Expenses Depreciation and Amortisation Other Revenues and Expenses (Net) Cost synergies Total Costs Operating Income Net Loan Loss Provisions Other Pre-tax Profit Corporate Income Tax Net Income Discontinued Operations Minority interests

Net Extraordinary Gains and Writedowns Net Attributable Income (stated) % change

2004A

2005 A

2006 A

2007 A

2008 A

2009 A

2010 A

2011 A

2012 E

2013 E

2014 E

EURm

EURm

EURm

EURm

EURm

EURm

EURm

EURm

EURm

EURm

EURm

7,761 450 4,583 162 1,100 0 14,056 140 -6,695 -839 0 0 -7,394 6,662 -1,574 -507 4,581 -596 3,985 11 -390 0 3,606

10,669 619 6,256 227 1,562 0 19,333 -24 -9,382 -1,017 0 0 -10,424 8,909 -1,615 -457 6,837 -1,320 5,517 225 -530 1,008 6,220 72.5%

12,488 427 7,223 298 2,180 0 22,616 -71 -10,025 -1,151 0 0 -11,247 11,369 -2,467 548 9,450 -1,986 7,464 354 -562 340 7,596 22.1%

15,295 441 8,040 319 2,998 0 27,094 -45 -10,940 -1,268 0 0 -12,253 14,842 -3,470 -446 10,926 -2,392 8,534 112 -520 934 9,060 19.3%

21,174 97 9,021 50 2,597 0 32,939 551 -13,579 -1,366 0 0 -14,394 18,545 -6,601 -516 11,428 -2,391 9,037 319 -480 0 8,876 -2.0%

26,420 -15 9,079 -64 3,422 0 38,843 537 -14,825 -1,593 0 0 -15,881 22,962 -9,483 -1,713 11,766 -2,337 9,429 40 -526 0 8,943 0.7%

29,288 -2 9,734 423 2,606 0 42,049 0 -16,256 -1,940 0 0 -18,196 23,853 -10,258 -1,543 12,052 -2,923 9,129 -27 -921 0 8,181 -8.5%

30,878 5 10,471 407 2,500 0 44,262 0 -17,781 -2,109 0 0 -19,889 24,373 -10,562 -2,994 10,817 -2,936 7,881 -24 -836 -1,670 5,351 -34.6%

33,132 15 10,961 441 1,709 11 46,269 0 -19,186 -2,058 0 56 -21,188 25,081 -18,163 -1,267 5,652 -1,616 4,035 0 -836 0 3,199 -40.2%

34,836 15 11,691 450 1,795 13 48,800 0 -20,697 -2,089 0 63 -22,722 26,077 -14,494 -991 10,592 -2,850 7,743 0 -925 0 6,818 113.1%

38,001 15 12,368 446 1,892 16 52,737 0 -21,978 -2,052 0 92 -23,938 28,799 -14,306 -762 13,731 -3,637 10,094 0 -1,175 0 8,919 30.8%

2555 758 96 1200 1074 547 353 4097 954 555 2136 -5427 3,199

2344 515 70 1305 1280 557 428 4304 1069 642 2121 -2094 6,818

2924 978 64 1380 1330 580 490 5689 1505 765 2940 -2094 8,919

DIVISIONAL DATA - Net attributable income Europe (European Retail pre IFRS) of which: Spain (SAN + BTO) of which: Portugal of which: SCF UK US Poland LatAm (LatAm Retail) of which: Mexico of which: Chile of which: Brazil Corporate Centre Total

2160 1293 255 333

2979 1783 345 468 811

4144 2765 423 565 1003

4439 2475 527 719 1201

4706 2639 530 696 1247

5030 2753 531 631 1726 -25

3355 1265 457 810 1965 424

1470 324 233 569 -24 3,606

1779 376 338 591 650 6,220

2287 528 489 751 162 7,596

2666 654 543 905 754 9,060

3608 600 545 1768 -685 8,876

3832 495 563 2166 -1620 8,943

4728 665 671 2814 -2292 8,181

2616 790 174 1228 1145 526 232 4664 939 611 2610 -3833 5,351

EPS adjusted 1 - core (EUR) Average Number of Shares (m) DPS (EUR) Net Asset Value per share (adjusted 1)

0.73 4,947 0.33 2.72

0.83 6,254 0.42 3.78

1.16 6,254 0.52 4.40

1.22 6,254 0.65 5.7

1.05 7,124 0.63 5.3

1.03 8,112 0.59 5.4

0.93 8,279 0.60 5.7

0.57 8,619 0.60 5.9

0.32 9,379 0.60 5.7

0.67 9,988 0.60 6.0

0.86 10,268 0.60 6.4

17,021 369,350

23,636 435,829 18.0% 88,659 26.6% 412,734

27,507 484,790 11.2% 105,476 19.0% 478,733

38,115 533,751 10.1% 116,798 10.7% 515,050

44,932 611,811 14.6% 121,466 4.0% 514,013

47,141 672,748 10.0% 115,582 -4.8% 561,684

50,651 715,642 6.4% 111,372 -3.6% 604,885

55,540 730,296 2.0% 102,643 -7.8% 565,958

56,182 759,508 4.0% 97,510 -5.0% 564,250

60,382 808,876 6.5% 93,610 -4.0% 587,088

66,620 861,453 6.5% 93,610 0.0% 605,709

1.02% 19.7% 25.0%

1.39% 2.53% 53.8% 19.3% 1.46% 0.75% 18.3% 26.4%

1.47% 2.37% 49.4% 21.0% 1.67% 0.91% 20.0% 28.4%

1.70% 2.52% 45.1% 21.9% 1.72% 0.98% 19.7% 24.8%

2.11% 2.86% 45.4% 20.9% 1.76% 0.92% 15.3% 21.4%

2.40% 3.35% 42.3% 19.9% 1.75% 0.87% 13.4% 19.4%

2.48% 2.72% 43.3% 24.3% 1.57% 0.78% 11.3% 16.7%

2.46% 2.95% 44.9% 27.1% 1.35% 0.64% 6.9% 10.1%

2.59% 3.00% 45.8% 28.6% 0.71% 0.32% 3.9% 5.7%

2.67% 2.85% 46.6% 26.9% 1.35% 0.60% 8.1% 11.7%

2.83% 2.85% 45.4% 26.5% 1.69% 0.76% 10.0% 14.0%

1.12% 162.7% 0.81% 31.3%

0.98% 174.7% 0.39% 37.3%

0.94% 177.0% 0.53% 0.0%

1.12% 143.2% 0.67% 0.0%

2.24% 89.2% 1.13% 40.0%

3.48% 74.4% 1.44% 0.0%

3.94% 69.1% 1.45% 40.0%

4.28% 59.1% 1.43% 30.0%

4.58% 67.7% 2.37% 40.0%

4.52% 64.8% 1.79% 40.0%

3.92% 68.3% 1.66% 40.0%

4.9% 31.2% 13.0%

6.4% 23.6% 13.4%

5.9% 21.1% 12.5%

6.2% 19.6% 11.2%

7.1% 19.2% 12.2%

8.6% 13.7% 13.5%

8.8% 12.1% 13.5%

10.0% 9.5% 14.5%

10.0% 9.4% 14.6%

10.2% 8.9% 14.8%

10.7% 8.3% 15.2%

Main Balance Sheet Measures Shareholders' Equity (exc G/will) Net Lending - Group % change Net Lending - SCH % change Risk Weighted Assets P&L Ratios: Net Interest Margin exc Dividends Net Interest Margin inc Divs - SCH Cost-Income Ratio (inc depn and other costs Effective tax rate RoRWA RoA RoE (stated) RoE (adjusted) Asset Quality Non-performing loans/Gross lending Coverage of non-performing loans Net LLP/Gross Loans (average) Write-offs as % last year's NPLs Capital - Group: Core Capital Ratio (T1 ex Prefs) Prefs as % Tier I BIS Ratio

70,018 340,946 1.88% 2.69% 53.6% 13.0%

Source: Company data, Nomura estimates

58

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60

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61

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Appendix A-1 Analyst Certification We, Daragh Quinn and Benito Berber, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures The term "Nomura Group Company" used herein refers to Nomura Holdings, Inc. or any affiliate or subsidiary of Nomura Holdings, Inc. Nomura Group Companies involved in the production of Research are detailed in the disclaimer below.

Issuer name BBVA Citigroup HSBC Holdings plc Santander

Ticker BBVA SM C US HSBA LN SAN SM

Price EUR 5.11 USD 26.11 561p EUR 4.82

Price date 09-Jul-2012 09-Jul-2012 09-Jul-2012 09-Jul-2012

Stock rating Reduce Buy Buy Reduce

Sector rating Neutral Not rated Neutral Neutral

Disclosures A4,A5,A6,A9 A22,A1,A2,A3,A4,A5,A6,A7,A9 A4,A5,A6,A9,A10 A4,A5,A6,A9

A1

Nomura Securities International, Inc has received compensation for non-investment banking products or services from the issuer in the past 12 months.

A2

Nomura Securities International, Inc had a non-investment banking securities related services client relationship with the issuer during the past 12 months.

A3

Nomura Securities International, Inc had a non-securities related services client relationship with the issuer during the past 12 months.

A4

A Nomura Group Company had an investment banking services client relationship with the issuer during the past 12 months.

A5

A Nomura Group Company has received compensation for investment banking services from the issuer in the past 12 months.

A6

A Nomura Group Company expects to receive or intends to seek compensation for investment banking services from the issuer in the next three months.

A7

A Nomura Group Company has managed or co-managed a publicly announced or 144A offering of the issuer's securities or related derivatives in the past 12 months.

A9

Nomura Securities International Inc. makes a market in securities of the issuer.

A10 A Nomura Group Company is a registered market maker in the securities / related derivatives of the issuer.

A22 A household member of an analyst who is involved in preparing the contents of strategy and quantitative research reports which may include recommendations on the issuer, holds a financial interest in equity securities of the issuer.

Previous Rating Issuer name BBVA Citigroup HSBC Holdings plc Santander

Previous Rating Neutral Not Rated Neutral Neutral

Date of change 24-Mar-2011 06-Oct-2010 15-Sep-2011 10-Jul-2012

Rating and target price changes Santander

Ticker

Old stock rating

New stock rating

Old target price

New target price

SAN SM

Neutral

Reduce

EUR 7.40

EUR 7.10

62

Nomura | Mexico

Santander (SAN SM)

July 10, 2012

EUR 4.82 (09-Jul-2012) Reduce (Sector rating: Neutral)

Rating and target price chart (three year history) Date 27-Apr-12 13-Mar-12 03-Oct-11 13-Sep-11 28-Jul-11 29-Apr-11 29-Oct-10 04-Oct-10 30-Jul-10 10-Jun-10 20-May-10 10-Jan-10 29-Oct-09 15-Oct-09 13-Sep-09 13-Sep-09 30-Jul-09

Rating

Target price 7.40 7.90 8.00 8.90 9.90 10.70 11.00

NEUTRAL 12.10 12.90 BUY NEUTRAL 12.70 12.30 BUY 11.90 9.20

Closing price 4.84 6.032 5.721 5.231 7.019 8.212 8.792 8.678 9.495 7.652 8.03 11.392 10.811 10.954 10.154 10.154 9.534

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology Our target price is EUR 7.10. We value Santander using a normalised cost of risk to arrive at a sustainable level of profitability, which is then discounted back to reflect the time value of money (2014 ROTE discounted back two years). We adjust the stated ROE to arrive at a sustainable banking franchise or adjusted ROE primarily by stripping out goodwill and the impact of non-core equity holdings. Various nominal perpetuity growth inputs are used depending on where we are in the economic cycle. They range from 0% to a 5% maximum (we use 1.5% for Santander). The cost of equity is calculated using a common equity risk premium, a 4.5% risk-free rate and a blended beta of 1.5, driven by the different business type or if developed or emerging economies. We also adjust our target price to sustain a Tier I ratio of 9%. The benchmark index for this stock is Dow Jones STOXX速 600 Banks.

Risks that may impede the achievement of the target price SAN's operating performance is affected by the Spanish/European economic environment. In addition, with about one-third of its equity allocated to LatAm, SAN is particularly vulnerable to market sentiment in respect of LatAm economic and political concerns. SAN also has significant exposure to the UK, which could see the stock price adversely affected by the economic deterioration in the UK. Other material disclosures Nomura International plc is acting as adviser to Banco Santander on the proposed tender offer for up to 100% of BZ WBK, including Allied Irish Banks' 70.36% stake in BZ WBK. HSBC Holdings plc (HSBA LN)

561p (09-Jul-2012) Buy (Sector rating: Neutral)

Rating and target price chart (three year history) Date Rating Target price 28-Feb-12 650.00 15-Sep-11 BUY 28-Jun-10 NEUTRAL 28-Jun-10 725.00 02-Mar-10 800.00 16-Dec-09 890.00 13-Sep-09 750.00

Closing price 559.30 521.10 639.00 639.00 700.60 709.00 654.50

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology Our 650p target price is based on a multiple of c. 9.6x our tangible 2013 EPS estimate of 106.4 US cents. The benchmark index for this stock is Dow Jones STOXX速 600 Banks.

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July 10, 2012

Risks that may impede the achievement of the target price HSBC is a global bank with significant exposures to Asian, European and U.S. banking markets and relatively high-risk areas of banking, such as unsecured personal lending, corporate and SME lending. It is exposed to adverse events in these markets and to currency risk due to its business spread.

Citigroup (C US)

USD 26.11 (09-Jul-2012) Buy (Sector rating: Not rated)

Rating and target price chart (three year history) Date 01-Jun-12 02-Apr-12 01-Mar-12 17-Jan-12 19-Dec-11 17-Oct-11 03-Oct-11 06-Sep-11 27-Jun-11 11-Jan-11 06-Oct-10 06-Oct-10

Rating Target price 41.00 47.00 41.00 34.00 36.00 38.00 41.00 44.00 50.00 55.00 Buy 50.00

Closing price 25.39 36.87 34.13 28.25 24.82 27.93 23.11 27.68 39.99 49.40 41.00 41.00

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology Our $41 target price for Citigroup is based on 9x our 2013 EPS estimate of $4.59, below Citi's historical average, as we expect ROEs to remain below historical levels in the near term. The benchmark for this stock is the S&P 500 Financials Sector Index.

Risks that may impede the achievement of the target price Risks to our price target for Citigroup include the following factors that could be below or worse than our expectations: regulatory risk, interest rate risk, general economic conditions that affect credit costs, changes in asset prices, availability of funding, credit spreads, capital market activity levels, litigation risk, and potential losses on sales of businesses in Citi Holdings.

BBVA (BBVA SM)

EUR 5.11 (09-Jul-2012) Reduce (Sector rating: Neutral)

Rating and target price chart (three year history) Date 26-Apr-12 13-Mar-12 27-Oct-11 13-Sep-11 29-Jul-11 06-May-11 24-Mar-11 24-Mar-11 03-Feb-11 12-Jan-11 28-Oct-10 29-Jul-10 20-May-10 05-Feb-10 28-Jan-10 28-Oct-09 15-Oct-09 13-Sep-09 13-Sep-09 29-Jul-09

Rating

Target price 7.30 7.70 8.30 8.40 9.90 10.00

REDUCE 10.40 11.70 12.30 12.50 14.20 14.00 NEUTRAL 15.00 15.50 15.10 BUY 14.60 13.00

Closing price 5.153 6.396 6.761 5.32 7.239 8.312 8.923 8.923 8.892 7.652 8.839 9.913 8.008 9.152 10.386 11.526 11.734 11.573 11.573 10.343

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology We set a target price of EUR 7.80 for BBVA using a normalised cost of risk to arrive at a sustainable level of profitability, which is then discounted back to reflect the time value of money (currently discounted back two years). We adjust the stated ROE to arrive at a sustainable banking franchise or adjusted ROE primarily by stripping out goodwill and the impact of non-core equity holdings. Various nominal perpetuity growth inputs are used depending on where we are in the economic cycle. They range from 0% to a 5% maximum (we currently use 1.5% for BBVA). The cost of equity is calculated using a common equity risk premium, a 4.5% risk free rate and a blended beta of 1.5, driven by the different business type or if

64

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July 10, 2012

developed or emerging economies. We also adjust target prices to sustain a Tier I ratio of 9%. The benchmark index for this stock is Dow Jones STOXX速 600 Banks.

Risks that may impede the achievement of the target price BBVA's operating performance is affected by the Spanish/European economic environment. In addition, with a significant portion of its equity allocated to LatAm, BBVA is particularly vulnerable to market sentiment in respect of LatAm economic and political concerns.

65

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July 10, 2012

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The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Unless otherwise noted, the non-US analysts listed at the front of this report are not registered/qualified as research analysts under FINRA/NYSE rules, may not be associated persons of NSI, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account.

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Distribution of ratings (US) The distribution of all ratings published by Nomura US Equity Research is as follows: 43% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 0% of companies with this rating are investment banking clients of the Nomura Group*.

51% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 0% of companies with this rating are investment banking clients of the Nomura Group*.

6% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 0% of companies with this rating are investment banking clients of the Nomura Group*.

As at 30 June 2012. *The Nomura Group as defined in the Disclaimer section at the end of this report.

Distribution of ratings (Global) The distribution of all ratings published by Nomura Global Equity Research is as follows: 46% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 40% of companies with this rating are investment banking clients of the Nomura Group*.

43% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 46% of companies with this rating are investment banking clients of the Nomura Group*.

11% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 21% of companies with this rating are investment banking clients of the Nomura Group*.

As at 30 June 2012. *The Nomura Group as defined in the Disclaimer section at the end of this report.

Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America The rating system is a relative system indicating expected performance against a specific benchmark identified for each individual stock.

Analysts may also indicate absolute upside to target price defined as (fair value - current price)/current price, subject to limited management discretion. In most cases, the fair value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as discounted cash flow or multiple analysis, etc.

STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating, target price and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including, but not limited to, when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the company.

Benchmarks are as follows: United States/Europe: please see valuation methodologies for explanations of relevant benchmarks for stocks, which can be accessed at: http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology.

SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months.

Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia.

Explanation of Nomura's equity research rating system in Japan and Asia ex-Japan STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc.

A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company.

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Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies.

SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation.

Target Price A Target Price, if discussed, reflect in part the analyst's estimates for the company's earnings. The achievement of any target price may be impeded by general market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if the company's earnings differ from estimates.

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