null

Greece: Containing “the Contagion”

Deutsche Bank Securities Inc., a subsidiary of Deutsche Bank AG, conducts investment banking and securities activities in the United States.

May 2010

Assessing the Rapid Escalation of the Sovereign Credit Crisis

Jay AndersonDebt Capital Markets(212) 250 - [email protected]

Tom JoyceDebt Capital Markets Strategist(212) 250 - [email protected]

2

Containing “the Contagion”

“Every once in a while, the world is faced with a major economic development that is ill-understood at first and dismissed as of limited relevance, and which then catches governments, companies and households unawares.”

~ Mohamed El-Erian, PIMCO (February, 2010)

“In our super-cycle era of Western market leverage, we need capital markets to be fully functioning 24 / 7. Any blockages leave the numerous refinancing entities vulnerable. It just so happens that those currently in need of the most refinancing are Governments.”

~ Jim Reid, Deutsche Bank Macro Strategist (April, 2010)

"A continental currency, with a dual metallic and fiduciary base, resting on all Europe as its capital, and driven by the activity of 200 million men: this one currency would replace and bring down all the absurd varieties of money that exist today with their effigies of princes, those symbols of misery.“

- Victor Hugo (1855)

1. Week of May 3: Failure to Contain the Contagion

2. May 9th: The €750 billion / US$1 Trillion Stabilization Plan

3. Focus on Greece:A. The Problem

B. Potential Solutions

4. The Global “Contagion”

A. The “Peripherals”

B. The European Financial System

Contents

Appendix

A. Why the Greece Crisis Accelerated Sharply After March 25th?

Section 1

Week of May 3: Failure to Contain the Contagion

5

Global Equity Markets Plunge (Week of May 3rd)

Source: Deutsche Bank Global Markets Research

MondayMay 3

TuesdayMay 4

WednesdayMay 5

ThursdayMay 6

FridayMay 7

WeeklyChange

FTSE 100 Index Closed

-2.56% -1.28% -3.20% -2.62% -8.81%

DAX Index

0.51%

-2.60% -0.81% -0.84% -3.27% -6.86%

CAC 40

0.30%

-3.64% -1.44% -2.20% -4.60% -11.12%

Nikkei 225 Closed Closed Closed

-3.27% -3.10% -7.18%

Hang Seng Index

-1.41% -0.23% -2.10% -0.96% -1.06% -5.63%

Dow Jones

1.30%

-2.02% -0.54% -3.20% -1.33% -5.71%

1.25

1.30

1.35

1.40

1.45

1-Jan 13-Jan 25-Jan 6-Feb 18-Feb 2-Mar 14-Mar 26-Mar 7-Apr 19-Apr 1-May

Euro

/ US

$

6

Euro Drops Sharply to 1.25


EUR / USD Spot (Jan 1, 2010 – Present)

The Euro collapsed sharply during the week of May 3rd, dipping to 1.2529 on Thursday, May 6, its lowest point since March 5, 2009 Rallied back above 1.27 on Friday, May 7

May 6 Low: 1.2529

There have been times during the escalation of the Sovereign crisis

where the Euro has been remarkably

resilient…

…to be sure, this resilience broke down during the week of May 3rd

7

Significant Stress in the Banking System


3m EURIBOR / OIS Spreads Since March 25 (September 2010 Contract)Perhaps the most serious global

market impact of the escalating Greek

credit crisis was felt in the global

banking system as inter-bank lending

rates spiked sharply over the week of

May 3rd

May 7 Close: 45 bps The 3M EURIBOR-OIS spreads was in excess of 350 bps at the peak of the financial crisis in Q4, 2008

The sharp rise over the week of May 3rd, in particular, signals a renewal of stress in the banking system, albeit not yet nearly as high as in 2008 (still less than 20 bps)

15

20

25

30

35

40

45

25-Mar 30-Mar 4-Apr 9-Apr 14-Apr 19-Apr 24-Apr 29-Apr 4-May

Bps

Euribor - OIS spread

8

VIX Volatility Index Leaps 85%


VIX Daily Closing Values (Jan 1, 2010 to Present)

15

17

19

21

23

25

27

29

31

33

35

4‐Jan 17‐Jan 30‐Jan 12‐Feb 25‐Feb 10‐Mar 23‐Mar 5‐Apr 18‐Apr 1‐May

May 7 Close: 33.8

During the week of May 3rd, the VIX jumped a breathtaking 85%, as investors rapidly re-priced risk and embarked on a massive “flight to quality”

In addition to re-pricing risk, and seeking safe haven investments, investors continued their focus on “the weakest links” in the system

We expect the highly levered

Western economies (Europe + UK + the

U.S.) to be a primary source of global market volatility

over the next few years

This increased volatility is likely to

be particularly acute, episodically,

throughout the remainder of 2010

75

100

125

150

175

200

225

250

1-Jan 26-Jan 20-Feb 17-Mar 11-Apr 6-May

Spr

ead

to A

SW

(bps

)

iBx $Dom Corp AA iBx $Dom Corp A iBx $Dom Corp BBB

80 130 180 230 280 330 380 430 480


Spr

ead

to A

SW

(bps

)

iBx $Dom Fin AA iBx $Dom Fin A iBx $Dom Fin BBB

9

US Dollar Credit Spreads Somewhat Resilient


US$ Financials Credit Spreads Since March 25

US$ Corporates Credit Spreads Since March 25 Pre-fund!!!

More execution risk

High volatility

Higher new issue premiums (15 bps+)

Less liquidity

Wider spreads

Tighter US Treasury Yields

Key Takeaways

for US$ Issuers

Credit spreads typically perform poorly when

volatility is high, as was the case during the

week of May 3

New issue volume in the IG bond market was also its lowest since

Sept 2008 (US$450 million)

U.S. financial spreads, especially banks, will be more vulnerable than U.S. corporates

10

Euro & Sterling Credit Spreads More Volatile


Euro and Sterling Financial Credit Spreads Since March 25

Euro and Sterling Corporate Credit Spreads Since March 25

Euro and Sterling credit spread

volatility has been markedly higher than in the US$

market, and with substantively less

liquidity, as the sovereign credit

crisis has escalated in 2010

Similar to the U.S. market, spreads

performed poorly as volatility increased

This has been especially true

among European financial names

100

150

200

250

300

350


Spr

ead

to A

SW

(bps

)

iBx £ Corp AA iBx £ Corp A iBx £ Corp BBB

150

200

250

300

350

400

450

500

1-Jan 26-Jan 20-Feb 17-Mar 11-Apr

Spr

ead

to A

SW

(bps

)

iBx £ Fin AA iBx £ Fin A iBx £ Fin BBB

50

75

100

125

150

175

200

225


Spr

ead

to A

SW

(bps

)

iBx € Corp AA iBx € Corp A iBx € Corp BBB

50 100 150 200 250 300 350 400 450 500 550


Spr

ead

to A

SW

(bps

)

iBx € Fin AA iBx € Fin A iBx € Fin BBB

11

Investor Asset Allocations in “Flight to Quality”


Flight to Quality After March 25, 2010

10yr UST Yields Gold (US$ per oz.)

Market re-pricing of risk picked up pace after March 25th, in particular Recognition that the core cause of the financial crisis has still not been resolved; that is, leverage Strong asset allocation shifts:

Out of: Equities, Commodities and Euros Into: Bonds, US Treasuries, US Dollar and Gold

1070

1090

1110

1130

1150

1170

1190

1210

25‐Mar 1‐Apr 8‐Apr 15‐Apr 22‐Apr 29‐Apr 6‐May

Gold

3.3

3.4

3.5

3.6

3.7

3.8

3.9

4

25‐Mar 1‐Apr 8‐Apr 15‐Apr 22‐Apr 29‐Apr 6‐May

10yr UST yield

May 7 Close: 3.425%

May 7 Close: $1,206.68

US 10 Yr Treasuries closed at a 3.43% yield on May 7, its biggest 2 week drop since December 2008 (38 bps)

The Treasury will auction US$78 billion the wk of May 10

Gold posted its 3rd straight week of gains on May 7th, a reflection of its safe-haven appeal

Section 2

May 9th: The €750 Billion / US$1 Trillion Stabilization Plan

13

Overview of May 9th Stabilization Announcement


€ 60 billion

The European Union / IMF The European Central Bank (ECB)

New “Securities Markets Program” to purchase private securities Size and details still TBD Expected to be sovereign debt purchases

Size Initiative

EU emergency balance of payments facility Additional size to a pre-

existing €50 billion facility

€ 440 billion 3 year EU loan program guaranteed by Euro-zone members Via a special purpose

vehicle (SPV), that will possibly issue securities to fund

€ 250 billion IMF Loans (expected to be at least 50% of total EU contribution, but still TBD)

€ 750 billion

Expansion of ECB refi liquidity facilities Resumption of full-allotment on 3 month

LTROs on May 26 and June 30 Resumption of 6 month LTRO on May 12

(6 month and 1 year previously discontinued)

Reactivation of US Dollar swap facilities with the U.S. Federal Reserve Ensures access to U.S. dollar funds for

European banks to fund U.S. dollar assets

Highly effective facility during the financial crisis; had been discontinued in Feb 2010

On Sunday, May 9th, the European

Union (and the IMF/ ECB)

announced a massive EUR 750

billion policy response to the

European sovereign credit

crisis

To be sure, the sheer size of the plan

(nearly US$1 trillion) eclipsed

the U.S. TARP capital injections

of $700 billion by a wide margin

For many market observers, a

pattern of increased moral hazard in global

financial markets has been escalated

14

Breaking Down the €750 Billion EU / IMF Response

Source: Deutsche Bank Global Markets Research. Credit Sights (May 2010).

€ 440 billion

EU Loan Program IMF Loans

€ 250 billion (expected) € 60 billion

Balance of Payments Facility

Size

Will require EU member state approval Given this risk, the

concurrent ECB purchase announcement was critical for the market

Provides the bulk of the total €750 billion package

Intended as a “complement” to the Balance of Payments facility

3 year loans Funded and guaranteed by Euro-

zone member countries on a pro rata basis (ECB paid in capital) The UK opted out

No funding details for new SPV provided, but is expected to issue its own securities

Exact size still TBD, but expected to be at least 50% of total EU contribution

Unprecedented size for IMF As of Feb 2010, IMF had

total outstanding commitments of US$ 191 billion

Clearly indicates their view of Europe’s impact on the total global economy

Can be done quickly and easily Expansion of a pre-existing €50

billion facility to €110 billion Previously used to provide

assistance to Hungary, Latvia and Romania in 2008

Restriction on further Euro-zone use was lifted, and its size expanded

Activation will be subject to strong conditionality (IMF-like terms)

Previously financed by European Commission bond issuance, backed by 27 member states

Additional Detail

€750 billion is sufficient in size

to cover the entire financing

needs (maturities + deficits) of

Greece, Ireland, Italy, Portugal

and Spain until March 2012

15

Breaking Down the ECB’s Response

Source: Deutsche Bank Global Markets Research. CreditSights (May 2010).

Return to full allotment at fixed rate for its next two 3 Month long term financing operations (LTRO) scheduled for May 26 and June 30

Resumption of 6 Month LTRO (previously discontinued) on May 12 Will alleviate refi fears on

the July expiry of the “jumbo” 12 month LTRO from June 2009

Provides much needed longer term LTRO liquidity, and eliminates some of the auction risk for participating banks(because of full allotment)

Expansion of ECB Refi Liquidity Facilities

Reactivation of US$ Swap Facilities

Re-activated with the U.S. Federal Reserve, Bank of England, Swiss National Bank, Bank of Canada and Bank of Japan Foreign Central Banks ship

US dollars to ECB via currency swaps

ECB then lends US$ to EU banks to fund their US$ assets

Very successful program during the Financial Crisis (Peak usage with U.S. Fed of US$583 billion in December 2008) Terminated in Feb 2010

prior to May 9th reactivation Mitigates some of the risk of US$

investors potentially being unwilling to roll-over dollar denominate Euro-area bank debt

Size to be determined by the ECB Governing Council

Given ECB sensitivity to inflation, purchases will be “sterilized” so that total money supply does not grow Sterilization mechanism

unclear (offsetting sales of assets or other “fine tuning”operations)

Possible sale of €52 billion of recently purchased covered bonds

Some view true ECB Quantitative Easing (without offsets) as just a matter of time

Purchases began on Monday, May 10th

Given the approval risk on the EU €440 billion loan facility, this program was very important to the market

Securities Market Purchase Program

The ECB’s role was a particularly

interesting part of the package…

…and its decision to actively purchase

sovereign debt securities,

although perhaps anticipated, was by

no means widely expected

To be sure, the independence and

reputation of the ECB will continue to be a key focus

of the market, and moral hazard

concerns will be increasingly raised

over time

The new ECB measures should take significant pressure off the European banking system

May 10th Market Response

Market

FTSE 100 Index

DAX Index

CAC 40

IBEX 35

Hang Seng

Nikkei 225

May 10th Response Market

EUR / USD

VIX Volatility Index

3M EURIBOR-OIS(Sept ’10 Contract)

10 Year UST Yields

Gold (US$ per oz)

May 10th Response

Global Equity Markets Fixed Income / Currency MarketsFollowing the €750

billion rescue package, global markets rallied sharply on May 10th as investor

risk appetite returned

Notable Developments

The sheer speed and magnitude of recent market moves (very HIGH market volatility continues)

On May 10th specifically, the initial sharp rise of Euro from 1.27 to 1.31 intra-day, only to close at 1.27 later in the day

+ 5.16%

+ 5.30%

+ 9.66%

+ 14.40%

+ 2.54%

+ 1.60%

28%

30%

12 bps

2.1%

• Close: Unchanged

• Intra-day: Volatile swings

DOW Jones + 3.90%

The May 10th rally was particularly strong among European banks and financials, with bank equities up over 14%, and bank credit spreads tightening 60 bps on the day

Greece CDS 280 bps

Greece 2 year bond yield

1,073 bps

17

May 10th Market Response Both the VIX and

LIBOR-OIS spreads tightened sharply in the first 24 hours following

the new EUR 750 billion EU / IMF /

ECB rescue package

Nonetheless, we expect volatility to

continue to be a dominant theme in

the 2010 capital markets due in

large part to continued

sovereign credit risk issues

EURIBOR – OIS (March 25 – May 10, 2010)

Source: Bloomberg

VIX Volatility Index (March 25 – May 10, 2010)

15

20

25

30

35

40

45

25-Mar 4-Apr 14-Apr 24-Apr 4-MayB

ps

Euribor - OIS spread

May 7: 44.5 bps

May 10: 31 bps

12

15

18

21

24

27

30

33

36

39

42

25-Mar 4-Apr 14-Apr 24-Apr 4-MayVIX Index

May 7: 41

May 10: 30

18

Looking Ahead: Will this Work?

However, several critical risks remain longer-term: Insolvency risk: continued high public and private debt levels in Europe Implementation risk: on aggressive fiscal austerity programs Restructuring risk: has it been eliminated, or merely pushed further into the future? Economic risk: tight austerity measures impact on EU GDP; double-dip recession risk? ECB Balance Sheet risk: impact on ECB “independence” and decision-making going forward?

Constrained counterparties will continue to post “the worst” collateral to the ECB? Rating Agency Risk: impact of further downgrades, if any, to non-investment grade status Longer Term Bank Sector Risk: longer term exposure of European financial system to above Volatility / Confidence Risk: will continue to be very high in 2010 Unintended Consequences?

Markets in 2010 will continue to test the will of the EU / ECB (and member states) on how to deal with the enormous existing debt burdens

Near Term

Long Term

Assessment of Forward-Looking Risks

The EU actions on May 9th were very clearly targeted at sharply reducing 2 risks in particular: Contagion risk: both to countries (Portugal / Spain), and capital markets Bank-sector funding risk: provide much needed relief to stress build-up in banking system

“Sovereign risk hasn’t gone away in the slightest. What this package has done is massively reduced the tail risk in European markets without necessarily changing the medium-to-longer term dynamics of financial markets.”

~ Jim Reid, Deutsche Bank Macro Strategist (May 10, 2010)

For now, any risk of sovereign debt

restructurings have likely been pushed out to beyond the 3 year

term of the new European Stabilization

Fund, UNLESS a specific sovereign falls significantly short on

its fiscal austerity targets over the interim

time period

Source: Deutsche Bank Global Markets Research. CreditSights (May 2010).

Section 3

Focus on Greece

Section A

The Problem

21

Greece’s 4 Part Problem

Source: Deutsche Bank Markets Research. Mark Wall, DB Chief European Economist.

4 Primary ProblemsGreece has the most acute and complex

sovereign debt problem in the

European Union…

…and is currently the primary driver of “contagion” risk

across the global economy and

capital markets

4 Primary Risks

Problem Consideration

#1: Credibility Problem Restated budget deficits each of last 10 years; 4x in 2009 alone

#2: Liquidity Problem Largely addressed through record EU / IMF bailout packages

#3: Insolvency Problem The market took little comfort from a EUR 110 billion EU/ IMF Greek rescue as it focused on this core long-term issue

#4: Banking System Problem Came under intense pressure week of May 3; ratings downgrades; decline in confidence; rapidly rising LIBOR

Risk Consideration

#1: Socio - Political Risk Limited social acceptance of fiscal reforms; “All sovereign crises are political crises”

#2: Implementation Risk Aggressive fiscal targets, monitored quarterly, for next 4 years

#3: Debt Restructuring Risk Market currently focused on when, not if? Size of haircut will be the pivotal issue for the European financial and banking system

#4: Contagion Risk Spillover to global capital markets; Portugal, Spain & others

-14.0%

-12.0%

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%'98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09

Original Revised

22

Problem # 1: Credibility ProblemGreece is highly

dependent on the capital markets to solve its liquidity

problem…

…and to this end, Greece has a

significant credibility problem

that has been building for many

years

Inconsistent budget forecasts and revisions Tax system Fiscal irregularities

Overstatement of social security surpluses Incorrect reporting of military expenditures Incorrect reporting of healthcare expenditures Treatment of certain EU subsidies as revenue

Accounting irregularities Derivatives transactions (to mask debt levels)

Sources of Greece’s Credibility Problem

Source: Deutsche Bank Markets Research. Moody’s. WSJ.

Greece has habitually under-reported the

severity of its Deficit-to-GDP ratio

The deficit limit to be allowed into the Euro-zone (red

line) is 3%

Greece’s Budget Deficit / GDP

Greece revised its 2003 budget deficit 5 times

Greece revised its 2009 budget deficit 4 times

2009 Fiscal Deficit Revisions

On April 22, 2010, Greece’s 2009 budget deficit was revised higher for the 4th time, to 13.6%, up from a prior estimate of 12.9%

Eurostat indicated that uncertainties around Greek economic data could cause a 5th revision, up to 14.1%

23

Problem # 2: Liquidity Problem

Total Debt Outstanding: Nearly US$ 400 billion of total outstanding debt

Near-term Maturities: Nearly US$ 73 billion of maturities in 2010 alone

Capital Markets Access: As of late March, Greece has effectively lost access to the capital markets to refinance its upcoming maturities

Total 2010 Liquidity Needs (Bond Maturities + ST Debt Roll + Fiscal Deficit)

Source: Fitch, Wall Street Research. US$ values based on 1.36 Euro exchange rate

(US$ billions)

Greece’s 2010 Liquidity Needs

$49

$445

$50$73

$279

0

50

100

150

200

250

300

350

400

450

500

Portugal Italy Ireland Greece Spain

US

D b

n

Although Greece has lost access to the capital markets to

refinance its maturities, the EUR 110 billion EU / IMF

rescue package announced on May

2nd will address Greece’s liquidity needs for 2010…

…and assuming Greece hits its

fiscal targets, this package will be

sufficient to cover Greece’s 2011 and

2012 liquidity needs

Next Critical GreeceMaturity Date

EUR 8.5 billion 10 Year Bond on May 19, 2010

Critics of the current Greek Government would say that they inherited a significant fiscal deficit crisis, and in the course of several months, created an unparalleled liquidity crisis.

-12

-10

-8

-6

-4

-2

0

% of

GDP

Problem # 3: Insolvency Problem

Source: Deutsche Bank Global Markets Research. IMF Global Financial Stability Report (April 2010).

An IMF regression analysis of 24 countries indicates that (i) current account deficits, and (ii) fiscal deficits, are highly correlated with higher sovereign CDS spreads

Greece’s Fiscal Deficit: At 13.6% of 2009 GDP, it is the second largest in the EuropeanUnion (after Ireland), and well above the 3% limits set by the EU’s Maastricht Treaty in 1992

Greece’s Current Account Deficit: Peaked in Q3 2008; should be down sharply in 2010 –2011 with aid packages (but still projected to be negative in 2010)

Assessing Euro Sovereign Risk Through the Lens of Twin DeficitsTwin deficits are a key determinant

for analyzing sovereign credit

risk

2010E Current Account Deficit (% of GDP) 2010E Fiscal Deficit (% of GDP)

3% limit set by EU Maastricht Treaty

-8

-6

-4

-2

0

2

4

6

% of

GDP

Problem # 4: Banking System Problem

Source: Deutsche Bank, Bloomberg

Piraeus Bank Alpha Bank

EFG Eurobank Ergasias National Bank of Greece

The Greek Banking System is currently under significant, unsustainable pressure

On May 2nd, after previously lowering its collateral standards, continued Rating Agency downgrades forced the ECB to eliminate its minimum rating requirements for Greek bonds used as collateral to the ECB

On April 7th, Greece’s 4 largest banks requested access to the remaining EUR 17 billion of a total EUR 28 billion state support package established in 2008

Combination of loan guarantees and Greek government bonds which the banks could use as collateral for credit lines from the ECB

Prior requests entailed preferred stock issuance for capital injections

Greece’s Top 4 Banks (Stock Price Performance)

456789

1011121314

1‐Sep 12‐Oct 22‐Nov 2‐Jan 12‐Feb 25‐Mar 5‐May

Piraeus Bank

4

5

6

7

8

9

10

11

12

13

14


Alpha Bank

4567891011121314


EFG Eurobank

10

14

18

22

26


National Bank of Greece

26

Why the Greek Crisis Accelerated After March 25th?

Date Key Event

March 25 Joint EU / IMF Commitment Announced with Very Few Details

March 30 Low Demand for Greek 20 Year Bond Re-Opening

April 7 Top 4 Greek Banks Turn to Government

April 9 Fitch Downgrades Greece to BBB- (Negative Outlook)

April 11 EU / IMF Announce Details of EUR 45 Billion Package

April 19 Volcanic Ash Delays EU/ IMF/ Greece Meetings

April 20 IMF Releases Global Financial Stability Report with Sovereign Warnings

April 22 Eurostat Increases Greek 2009 Budget Deficit (Again) to 13.6%

Moody's Downgrades Greece to A3 (and Review for Downgrade)

April 23Greek Prime Minister, George Papandreou, formally activates EU / IMF aid in a live television address

April 27 S&P Downgrades Greece to non-investment grade status (BB+)

May 2 EU/IMF announce larger Greek aid package of EUR110 billion (US$146 bn)

The Acceleration of the Greek Credit Crisis after March 25th, 2010

The Greek sovereign credit crisis began

to accelerate rapidly after March

25th, 2010

On April 27, S&P also forecasted a 30% recovery value for Greek bonds in default, an estimate S&P is required to make when it downgrades a name to non-investment grade;

Markets reacted very negatively

Pivotal Event

Section B

Potential Solutions

28

Step # 1: Address Greece’s Liquidity Problem

“If I owe you a pound, I have a problem, but if I owe you a million, the problem is yours.”~ John Maynard Keynes (English Economist, 1883 – 1946)

Raise debt in capital markets (too little demand for Greek debt; pricing too high)

EU Debt guarantees (violation of EU treaties; difficult precedent)

EU Bond issuance (reconciliation with EU treaties challenging)

Bilateral arrangements (moral hazard issues; little German domestic support)

Infrastructure advances: not sufficient size

Joint EU / IMF Solution (for 2010) Other Options Considered

Key Question Will Greece meet the aggressive fiscal targets required to ensure

continued future installments on the EUR 110 billion rescue package?

As of Friday, May 7th, over 10 EU nations

(including Germany) had

already received legislative

approval for initial installments on the

EUR 110 billion rescue program for

Greece (EUR 80 billion from the EU)

As such, the liquidity risk has essentially been eliminated on

Greece’s closely watched EUR 8.5

billion redemption obligation on May

19, 2010

Key Details:

May 2nd, 2010: ~ EUR 110 billion (nearly US$ $150 billion)

May 9th, 2010: Expanded for region to ~ EUR 750 billion (nearly US$ $1 trillion)

Cost: Approximately 5% (Equal to Euribor + 300bps + 100 bps step-up in year 3 + 50 bps service charge)

Duration: 3 years

29

Step # 2: Decisive ECB Support for Euro Bank System

Source: Deutsche Bank Global Markets Research. Soniya Sadeesh, Mohit Kumar, Mark Wall and Gillian Edgeworth

ECB Benchmark Main Refinancing Rate

0.5

1

1.5

2

2.5

3

3.5

4

4.5

Jan‐08 May‐08 Sep‐08 Jan‐09 May‐09 Sep‐09 Jan‐10 May‐10

Percent (%)

Possible ECB Actions

Expand Refi Liquidity Facilities

Status: Announced on May 9th

Prior facilities (as of May 7): Unlimited (full allotment basis) and

cheap liquidity via 1W and 1M tenders

3M tenders shifted to variable rate, fixed allotment basis

6M and 1Y tenders have been discontinued

Changes as of May 9th: Move 3M tenders back to full

allotment basis (avoids over-bidding problems)

Reintroduce long term tenders (6M)

Relax Mark-to-Market Margin Calls on ECB Collateral

Status: Unlikely (for now); would put ECB Balance Sheet at risk

Banks don’t necessarily have to mark-to-market their government bond holdings; however, they must do so if they use them as collateral to the ECB

Would reduce bank margin calls and significantly reduce pressure on the system

However, would effectively pose unsecured lending risk on the ECB

Purchase Sovereign Debt

Status: Announced on May 9th Investors had been disappointed that

Trichet avoided this on May 6th

Blurs boundary between ECB independence and EU sovereigns

Had been viewed as an option of last resort

Likely to put downward pressure on Euro over time

On May 6, the ECB kept rates unchanged at 1%, as expected

DB does not expect an ECB to raise rates before Q1, 2011

1.00%

30

Step # 3: U.S. Federal Reserve Swap Lines to ECB


Renewal of U.S. Federal Reserve Swap Lines to ECB

Financial Crisis Precedent

Program Peak: December 2008 (US$ 583 billion)Fed viewed as low risk since its counterparties

were foreign central banksHighly successful program

Program Discontinued: February 2010 (no longer needed)

Renewal of Program: Announced on May 9th

Description

Origin: US Federal Reserve lending program put in place during the 2007 – 2009 Global Financial Crisis

Mechanics: US Fed shipped US dollars overseas through currency swaps with foreign central banks (ECB, Swiss National Bank, Bank of England)European Central Banks then lent the US dollars to

banks in home countries that required funding for their US dollar assets

0

50

100

150

200

250

300

350

400

Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09

3 M

Libor

- OI

S Sp

read

(bps

)

Fed Balance Sheet Expansion

LIBOR – OIS Spreads (Sept 2008 – Dec 2009)

The 3M Libor-OIS Spread was > 300 bps when the Fed extended its Balance Sheet during the Financial Crisis for US$ currency swaps to the ECB

Although this metric has risen sharply in recent weeks (~ 20 bps), it is still well below Dec 2008 peak stress levels

The Fed / ECB renewed this facility on May 9th nonetheless, given the rapid escalation of the sovereign crisis

Positive impact on: Would relieve short-term US$ funding pressures only

No impact on: Non US$ funding needs (Euros); bigger non-bank sovereign issues; inability of European banks to unload illiquid sovereign debt

31

Step # 4: Address Long-Term Solvency

Key Question: How will Greece mitigate the vicious circle of fiscal cuts and economic slowdown as it strives to meet its 4 Year Stability and Growth Program targets?

Greece’s Fiscal Plan: EUR 4.8 billion (USD 6.5 billion, or 2% of GDP)

Increase value added tax from 19% to 21%

Excise tax on petrol, alcohol, cigarettes and luxury goods

Sale of selected state assets

#1: Revenue Raising Initiatives

(EUR 2.4 billion / USD 3.25 billion)

#2: Expenditure Reductions

(EUR 2.4 billion / US 3.25 billion)

Reduce public sector wages and pensions (EUR 1.7 billion)

Reduce size of public investment programs (EUR 500 million)

Reduce education expenditures (EUR 200 million)

Unprecedented EU Role in Europe The EU has embarked on a path of not just intensely monitoring Greek policy, but actually steering

Greek policy

Greek interest rate policy: to be determined by the ECB

Greek currency policy: to be determined by the EMU

Greek fiscal policy: to be (effectively) determined and monitored by the EU & IMF

Economic policy? The IMF will focus on 3 critical areas in its new fiscal austerity demands: labor market reform,

healthcare and pension system reforms

On March 3rd, Greece announced a more

detailed plan for achieving its 3 year

fiscal and growth targets

The IMF will increase these fiscal

austerity measures in its negotiations

with Greece, which should conclude

by May 6th

*** Implementation Risk on Greece’s Fiscal Plan is Very High ***

12.7%

8.1% 7.6%6.5%

4.9%

<3%

2009 2010E 2011E 2012E 2013E 2014E

32

Step # 5: Greece Must Meet its Fiscal Targets


Projected Unemployment Rate

Fiscal Deficit Forecast Debt / GDP Forecast

9.0%

9.9%

10.5% 10.5%10.3%

2009 2010E 2011E 2012E 2013E

113.4%

120.4% 120.6%

117.7%

113.4%

2009 2010E 2011E 2012E 2013E

(% of GDP) Debt / GDP will peak in 2011 4 Year Plan to reduce fiscal deficit below 3%, in accordance with EU guidelines

In 2010, Greece needed to tap the

assistance offered by the EU and IMF

To avoid a potential default, Greece will

have to deliver on its official 4 Year

“Stability and Growth Program”

targets

2010 Greece GDP Forecasts:

EU Forecast: (-4.0%)

DB Forecast: (-4.0%)

Greece’s 4 Year “Growth and Stability Program” Forecasts

-4.0%

-2.6%

1.1%

2.1% 2.1%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

2010E 2011E 2012E 2013E 2014E

Projected GDP Growth

33

Critical Step # 6: Potential Debt Restructuring?

Official EU & Greek Position: Debt restructuring is “off the table”

Market Position: Already pricing in either partial reductions, or delays, in Greek debt repayments

Key Question: If Greece was to “trip” in its fiscal consolidation program, and a restructuring of Greek debt

followed, would such a default unfold more aggressively (with the 75% haircuts of Argentina’s precedent), or

in a highly managed and orderly fashion (with modest to medium haircuts of < 50%)?

Source: Deutsche Bank Markets Research.

Potential Implication of a Greece Debt Restructuring?A Greece restructuring could

possibly be the largest sovereign default in history

While the EU is calling a debt

restructuring “off the table”…

…many investors are viewing it as an “overwhelming

probability”

Would be a “devastating” event for the European financial system Defaults of many creditor institutions Massive investor losses and cross-

exposures Greek debt / GDP would decline to ~ 30% Would likely trigger a European financial and

banking crisis (and possibly global) Analogous to a “Lehman-type” event with full

range of unintended consequences Confidence in European “peripherals” would

evaporate immediately (significant contagion effects to Portugal, Spain, Ireland, Italy and others)

Significant questions for Euro longer term

Argentina Precedent, 2002(Less controlled; 75% Haircuts)

Poland Precedent, early 1990s(More Managed; ~ 50% Haircuts)

Would be a “significant” event for the European financial system If managed in “orderly” fashion, most

creditors would avoid default themselves However, losses would be significant

Greek Debt / GDP would decline to ~ 60% Could trigger a European financial crisis, but

should be more contained Range of significant “unintended

consequences” likely Significant contagion and spill-over effects to

European peripherals likely Significant downward pressure on European

growth Significant questions for Euro longer term

Historical Note:

Greece’s last sovereign debt

default was resolved in the

mid-1960s

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

Euro

/ US$

May 7 Close: 1.2725

34

Step # 7: Strengthen Long Term Viability of the Euro?


EUR / USD Spot (Jan 1, 1999 – Present)

Critical Mechanisms to Ensure Long Term Viability of the Euro

Bankruptcy regime for failing member states Exit mechanism from EMU for failing member states Efficient fiscal transfer mechanisms for member states requiring assistance More effective fiscal monitoring and enforcement mechanisms

Although Europe will not attain the political union so many have cited as critical to monetary union, more aggressive fiscal enforcement mechanisms will be critical to the long-term viability of the Euro

More effective fiscal monitoring

mechanisms, with real accountability,

will be critical to the long-term

viability of the Euro

Many have also raised the longer

term possibility of EMU membership

returning to a much smaller

group of nations in line with its

original construct…

…such an unwind would be

exceptionally difficult to execute,

but should not be ruled out as a

longer term possibility

35

Precedent Large IMF Sovereign Bailouts


Selected Large IMF Bailouts

IMF aid to Greece will likely be accompanied by aggressive fiscal reforms, particularly: Pension reform Healthcare reform Labor system reform

There has actually been significant precedent for sovereign default, even after IMF aid

0

20

40

60

80

100

120

Greece South Korea Mexico Indonesia Brazil

Dollars in billions

IMF Share Partners' Contributions

2010 1995 199819971997

Argentina

Indonesia

Uruguay

Dominican Republic

Selected IMF Sovereign Bailouts that Subsequently

Defaulted

The IMF EUR 30 billion aid to

Greece represents 3200% of Greece’s

official quota, the largest ever such disbursement of

IMF aid to any country

36

Who are the Key Players in Europe?

Greece Germany

France

Prime Minister:George Papandreou

Finance Minister:George Papaconstantinou

Opposition Leader:Antonis Samaras

Currently endorsing Government plan

Chancellor: Angela Merkel

Finance Minister:Wolfgang Schaeuble

President: Nicolas Sarkozy

Finance Minister: Christine Lagarde

European Union

European Central Bank President: Jean-Claude Trichet

European Union President: Herman Van Rompuy

(Rotating) President of EU: Spain (Prime Minister Jose Luis Rodriguez Zapatero)

European Commission President: Jose Manuel Barroso (former Prime Minister of Portugal)

Eurogroup Chairman (Chair of Euro-area Finance Ministers): Jean-Claude Juncker (also Prime Minister of Luxembourg)

Economic & Monetary Affairs Commissioner: Olli Rehn

IMF

Managing Director(President): Dominique Strauss-Kahn

First Deputy Managing Director (IMF # 2): John Lipsky

Section 4

The Global “Contagion”

A. The Peripherals

202

108 11375

10884 81 77

56 7647 18 11 16

101

67101

85

80 118

44 40 96 6284

114

96

114

136115 75

11081

7866

54

9630

42 40

52

18852

47 2837

73101

6069

60

115

32

66

5

0

50

100

150

200

250

300

350

400

450

500

Perc

ent o

f GD

P

Government Nonfinancial business Households Financial institutions

39

Markets Shifts Focus to “Total Economic Leverage”

*The UK financial sector was adjusted to reflect its position as a financial hub. *Data for Switzerland represent year-end 2007Source: Haver Analytics, FDIC, SNL Financial, Federal Reserve. McKinsey Global Institute. IMF Global Financial Stability Report.

469 459

380

342331

313 308 298 290274

245

159142 129

71

Market attention has shifted toward a

renewed focus on balance sheet

adjustment

In analyzing leverage within an

economy, it is very important to focus

on where in the economy the debt

resides

The market has begun to focus not only on sovereign

leverage, but on both public and

private sector leverage

throughout the economy

230

Sector Composition of Debt Across Economies

Greek government debt levels (115% of GDP) were the catalyst for the current sovereign credit crisis

The very high private AND public debt in the UK and Spain has increasingly become the focus of investors as contagion spreads from Greece

Japan’s sovereign debt, though exceptionally high, has not created a crisis because it relies very little on foreign capital markets to refinance

40

Sovereign Market Vulnerability Indicators

(i) Source: IMF Global Financial Stability Report (April 2010). Includes all claims of depository institutions, excluding the Central Bank, on the Government.

There are several key indicators, beyond

the absolute amount of

sovereign debt, that are critical to

understanding the vulnerability of

sovereign leverage to an economy

Why is Japan’s High Debt Seemingly Lower Risk?

High domestic savings Low foreign ownership of debt (< 14% of GDP) Strong home bias Stable institutional investors Local banks purchase high % of Govt debt

Review of Selected Sovereign Vulnerability Indicators

Depository Bank Claims

Gov't Debt Held Abroad on Government (1)

Country (% of GDP) (% of GDP)

Greece 99.0% 17.5%

Portugal 60.2% 10.2%

Italy 56.4% 29.4%

Ireland 47.2% 5.8%

Spain 26.9% 20.6%

United States 24.7% 8.2%

United Kingdom 17.9% 5.1%

Japan 13.7% 69.3%

According to Ken Rogoff and Carmen Reinhart in “This Time is Different,”

most emerging market countries run into trouble at external debt

levels above 60% of GDP

For many of these leverage models to work, capital

markets must be open 24 / 7

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09

%

Greece Ireland Portugal Spain Italy

41

The “Contagion Effect” for the Peripherals


“Peripherals” 10 Yr Bond Spread over Germany

“Peripherals” CDS Under Pressure

Greece continues to be an outlier, but has clearly had a direct impact on

the “peripherals”,

especially over the last few

weeks

The market will continue to be

focused on “the weakest links” in

the system

40100160220280340400460520580640700760820880940

Jun-09 Jul-09 Aug-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10

bps

Portugal Greece Ireland Italy Spain

May 7 Close (Greece): + 938 bps

May 7 Close (Greece): + 9.65%

-50

50

150

250

350

450

550

650

750

850

950

Ireland

GE

USA, FRUK

Austria

Spain

Belgium

Portugal

Italy

S. Korea

Chile

China

Israel

Greece

Poland

MalaysiaThailand

Hungary

MX

SOAF Russia

IcelandBulgaria

Kazakhstan

EgyptBrazil, Peru

Colombia

Lebanon

Turkey, Philippines

Spread5y CDS (bp)

Aaa Baa2Aa2 A1 A3 Ba1 Ba3 B2

Ratings (avg. of Moody's/S&P)

Uruguay Vietnam

42

The “Ring of Fire”


5 Year CDS Spread Differentiation (As of May 7, 2010)Given their current

ratings, the European

“peripherals” are clearly trading

“above the trend line” from a credit

risk perspective vis-à-vis a very broad range of

sovereign credits globally

“Ring of Fire”

43

2010 - 2011 Peripheral Redemptions (Monthly)

Source: Bloomberg, DB Global Markets Research, Gillian Edgeworth

(Euro Billions)

Portugal Bills Bonds Coupon TotalMay-10 1.3 5.9 0.3 7.5Jun-10 1.6 1.6Jul-10 3.9 0.0 3.9

Aug-10 0.0 0.0Sep-10 2.2 0.4 2.6Oct-10 1.2 1.2Nov-10 2.6 0.0 2.6Dec-10 0.0 0.0Jan-11 1.3 0.0 1.3Feb-11 1.8 0.0 1.8Mar-11 1.5 0.0 1.5Apr-11 5.0 0.7 5.7May-11 0.0 0.0Jun-11 6.8 1.6 8.4Jul-11 0.0 0.0

Aug-11 0.0 0.0Sep-11 0.4 0.4Oct-11 1.2 1.2Nov-11 0.0 0.0Dec-11 0.0 0.0

Greece Bills Bonds Coupon TotalMay-10 0.0 8.4 2.2 10.7Jun-10 0.0 0.0 0.0 0.0Jul-10 2.0 0.0 3.0 5.0

Aug-10 0.0 0.0 1.6 1.6Sep-10 0.0 0.2 0.8 1.0Oct-10 1.3 0.0 1.1 2.4Nov-10 0.0 0.0 0.0 0.0Dec-10 0.0 0.0 0.1 0.1Jan-11 1.0 0.0 0.3 1.4Feb-11 0.0 0.0 0.0 0.0Mar-11 0.0 9.0 1.9 10.9Apr-11 0.0 0.0 0.0 0.0May-11 0.0 6.9 1.7 8.6Jun-11 0.0 0.0 0.3 0.3Jul-11 0.0 0.0 3.0 3.0

Aug-11 0.0 6.0 2.1 8.1Sep-11 0.0 0.0 0.8 0.8Oct-11 0.0 0.0 1.1 1.1Nov-11 0.0 0.0 0.0 0.0Dec-11 0.0 5.8 0.1 5.8

44

2010 - 2011 Peripheral Redemptions (Monthly)

Spain Bills Bonds Coupon TotalMay-10 8.3 0.0 0.0 8.3Jun-10 6.5 0.0 0.0 6.5Jul-10 6.7 17.7 7.3 31.6

Aug-10 5.4 0.0 0.0 5.4Sep-10 4.4 0.0 0.0 4.4Oct-10 4.9 0.0 0.0 5.0Nov-10 5.5 0.0 2.4 7.9Dec-10 4.6 0.0 0.0 4.6Jan-11 4.5 0.0 5.4 9.9Feb-11 4.0 0.0 0.1 4.1Mar-11 4.7 0.0 0.0 4.7Apr-11 0.0 0.0 0.0 0.0May-11 0.0 0.0 1.7 1.7Jun-11 0.0 0.0 0.0 0.0Jul-11 0.0 17.0 0.0 17.0

Aug-11 2.8 0.0 6.7 9.5Sep-11 0.0 0.0 0.0 0.0Oct-11 0.0 14.1 2.4 16.5Nov-11 0.0 0.0 0.0 0.0Dec-11 0.0 0.0 0.0 0.0

Ireland Bills Bonds Coupon TotalMay-10 4.2 0.0 4.2Jun-10 1.0 0.3 1.3Jul-10 2.0 0.0 2.0

Aug-10 0.0 0.0Sep-10 0.0 0.0Oct-10 0.4 1.0 1.4Nov-10 0.2 0.2Dec-10 0.0 0.0Jan-11 0.4 0.4Feb-11 0.0 0.0Mar-11 0.7 0.7Apr-11 1.1 1.1May-11 0.0 0.0Jun-11 0.3 0.3Jul-11 0.0 0.0

Aug-11 0.0 0.0Sep-11 0.0 0.0Oct-11 1.0 1.0Nov-11 4.4 0.2 4.6Dec-11 0.0 0.0

Source: Bloomberg, DB Global Markets Research, Gillian Edgeworth

(Euro Billions)

Economy Size: US$ 228 billion

Unemployment Rate: 10.1%

2010E GDP Growth: 0.7%

2010E Fiscal Deficit: ( - 8.3%)

Debt Outstanding: EUR 191 billion

Foreign Ownership of debt (% of GDP): 60.2%

Focus: Portugal

Key Facts Key Considerations

Remaining Redemptions & Coupon Payments (EUR bn)

19.2 19.6

11.710.5

14.3

0

5

10

15

20

25

2010 2011 2012 2013 2014

Source: DB Global Markets Research. IMF.

Small economy (2% of European GDP)

Very little economic diversification

Economic competitiveness and productivity growth has been especially weak; no ability to devalue currency to improve competitiveness

Very high twin deficits (current account and fiscal)

Less public debt than Greece, but still high

Very high foreign ownership of debt (and so highly dependent on capital markets)

Highly levered private sector as well

Does not have same market credibility problem as Greece

Moved earlier on many of its fiscal austerity measures

More implementation risk with minority Government

Historical Note:

Portugal had an IMF assistance

program as recently as 1984

Focus: Spain

Key Facts

[TJ – to come]

Key Considerations


Economy Size: US$ 1.46 trillion


2010E GDP Growth: ( - 0.2%)

2010E Fiscal Deficit: ( -10.2%)

Debt Outstanding: EUR 560 billion


70.8

84.2

65.658.5

52.1

0

10

20

30

40

50

60

70

80

90

2010 2011 2012 2013 2014

Historical Note:

Despite a relatively better modern history, Spain

holds a record for the most

independent sovereign default

episodes (12)

Source: DB Global Markets Research. IMF. Kenneth Rogoff and Carmen Reinhart: This Time is Different

Large economy (greater potential contagion impact)

20% unemployment among highest in Europe

Very weak banking system; real estate crisis was greater than most European EMU peers

One of the most highly levered private sectors in Europe

Weak economic competitiveness; no ability to devalue currency to increase growth and competitiveness; labor system reform progress needed

Very high twin deficits (current account and fiscal), but manageable

Better liquidity position than Greece and Portugal with less dependence on foreign bond ownership; Spanish banks absorb much bond issuance; EUR 40 billion to raise by July 2010

Does not have same market credibility problem, or capital market dependence, as Greece

Focus: Italy

Key Facts

[TJ – to come]

Key Considerations






Debt Outstanding: EUR 1.76 trillion


259.7 254.8

197.6

135.3 125.4

0

50

100

150

200

250

300

2010 2011 2012 2013 2014


Large economy (greater potential contagion impact)

More powerful and diversified economic engine, and so more ability to grow through debt burden

Strong manufacturing sector has shown improvement with recent Euro weakness

Unemployment rate not as high as many Euro peers

Public sovereign debt levels among the highest in Europe; however, household leverage reasonably low

Very high twin deficits (current account and fiscal)

Relatively high foreign ownership of debt

Does not have same market credibility problem as Greece

Focus: Ireland

Key Facts

[TJ – to come]

Key Considerations


Economy Size: US$ 223 billion


2010E GDP Growth: ( - 0.3%)


Debt Outstanding: EUR 104.7 bn


9.068.1

9.210.4

12.7

0

2

4

6

8

10

12

14

2010 2011 2012 2013 2014


Small economy (2% of European GDP)

Likely to outperform other peripheral economies over the next 1 – 2 years

Moved early on fiscal austerity measures

Weak banking system with significant exposure still to real estate crisis; majority Government stake or full nationalization of several Irish banks

Highly levered private sector as well

Double-digit fiscal deficits

Much less public debt than Greece, but a series of needed bank bailouts have sharply increased public debt (90% of GDP by 2013)

Less dependent on capital markets and foreign investors than Portugal and Greece

Has suffered from among the highest GDP declines during the Financial Crisis in all of Europe; however, the economy is showing more signs of recovery than many other peripherals

307

258

57

28

0

50

100

150

200

250

300

350

Conservative Party

Labour Party Liberal Democrat Party

Other1.45

1.5

1.55

1.6

1.65

1.7

May‐09 Aug‐09 Nov‐09 Feb‐10 May‐10

GBPU

SD

Focus: United KingdomKey Facts

[TJ – to come]

UK May 6th Election Results





Debt Outstanding: GBP 923 billion


GBP / USD

May 7 Close: 1.4788


Number of Seats in the UK General Election

Required for overall majority (326)

Inconclusive, producing first hung Parliament in over 35 years (1974) Conservatives fell 19 votes shy of 326 seats

required for majority in 650 seat House of Commons

Likely minority Government or a coalition Conservative / Liberal deal most likely

Likely Prime Minister: David Cameron (Conservative)

Potential Market Risk: Any significant delays in forming a new Government, and any subsequent delays in implementing fiscal austerity measures

With the national elections on May

6th now over, markets and

Rating Agencies are likely to

increase the intensity of their

focus on the U.K.

Any significant delays in forming a

new Government, and any delays in

implementing fiscal austerity

measures, could create increased

volatility in the market

Focus: United KingdomUnited Kingdom Credit Risk

The UK has several key advantages

over “the peripherals” in managing the leverage in its

economy…

…and several very substantive

weaknessesUK Bond Yields Over Germany Net Notional UK CDS

50

60

70

80

90

100

110

Jan‐10 Feb‐10 Mar‐10 Apr‐10 May‐10

Spread to Bunds (bps)

3,500

4,000

4,500

5,000

5,500

6,000

6,500

7,000

7,500

8,000

8,500

Jan‐10 Feb‐10 Mar‐10 Apr‐10

US Do

llars (b

illions)

UK CDS Net Notional Amt

May 7 Close: 103bps

Source: DB Global Markets Research

Larger, more diversified economy than the peripherals

Ability to devalue its currency to increase competitiveness (and inflate through debt)

Less coordination to implement fiscal cuts “Flight to quality” at times of peak stress Strong access to capital markets

Positives Considerations Significant private sector leverage (consumer, financial

and corporate debt among highest in Europe) Sovereign debt rapidly rising toward 90% of GDP by

end of 2010 Financial sector/ banks still weak from Financial Crisis High exposure to the “peripherals”

Doubling in UK CDS outstanding

Rising UK bond yields

Sterling weakness

Evidence of More UK Investor Concern

Rating Recent Action Rating Recent Action Rating Recent Action

Aa2 (Neg)Negative outlook in Sep '09

Review for negative outlook May '10 A- (Neg)2 notch downgrade in

Apr '10 AA- (Neg)1 notch downgrade in

Mar '09

Aa1 (Neg) 1 notch downgrade in Jul '09 AA (Neg)1 notch downgrade in

Jun '09 AA- (Stable)1 notch downgrade in

Nov '09

A3 (Neg) 1 notch downgrade in Apr '10 BB+ (Neg)3 notch downgrade in

Apr '10 BBB- (Neg)2 notch downgrade in

Apr '10

Aaa (Stable) n/a AA (Neg)1 notch downgrade in

Apr '10 AAA (Stable) n/a

Portugal

Ireland

Greece

Spain

51

Recent Downgrades “Feeding the Contagion”

Source: Bloomberg

On April 27th, S&P downgraded Greece from BBB+ to BB+, making Greece the first EU nation to be rated non-investment grade (and also warned investors could recover as little as 30% on a restructuring) Recent downgrades of Greece, Spain and Portugal (including both the sovereign and selected banks) have demonstrated how ratings can become a loose cannon as the Sovereign Crisis unfolds

Rating Downgrades Impact on Banking System

As sovereign funding increases, bank funding costs will also increase

Mark-to-market impact of government bond holdings for banks Likely to be limited Most German and French banks, for

example, carry government bonds at face value (held to maturity book) rather than market value

Margin calls due to falling value of government bonds used as collateral in repo operations with (i) other banks; and (ii) central banks Greek banks were funding EUR 61 billion

via the ECB through Repo A 10% increase in 2 year yields on Greek

bonds since February, for example, would require Greek banks to post an additional 20% of collateral, or EUR 12 billion

Systemic Impact of Ratings Downgrades on the European Banking System

The recent sovereign ratings

downgrades have put an enormous

amount of systemic pressure

on the European banking system

Drivers of Bank Pressure

Source: Deutsche Bank Global Markets Research. Mohit Kumar and Abhishek Singhania.

Bank equities under-performing

Libor/ Euribor levels have increased

Libor / OIS spreads have widened

Swap spreads have widened

EUR / USD cross currency basis has widened

Signs of Bank Pressure

These stresses in the banking sector make the current situation unsustainable for the ECB Must either ease current collateral

standards or risk triggering a liquidity crisis for banks)

Section

C. The European Financial System

54

Ownership of Greek Government Bonds

Source: Deutsche Bank Global Markets Research, Gillian Edgeworth, Greek Public Debt Management Agency. Institute of International Finance (IIF)

Ownership of Greek Government Bonds (2009)The European

financial system has most of the

exposure to Greek Government bonds

(banks, pension funds and investors)

By Owner Type (2005 – 2009) By Country Region

Banks & Trusts, 45%

Fund Managers, 19%

Insurance / Pension Funds,

14%

Asset Management,

10%

Hedge Funds, 5%

Central Banks / Sovereigns, 5%

Other, 4%

Greece, 29%

UK/Ireland, 23%

France, 11%

Germany/Switzerland/Austria,

9%

Italy, 6%

Benelux, 6%

Other, 6%

Scandinavia, 3%USA, 3% Asia, 2% Spain/Portugal,

1%

Total Greek Government Debt: EUR 273 billion (2009)

Domestic (Greek) Ownership: EUR 59 billion (EUR 44 billion banks; EUR 15 billion “Other”)

Foreign Ownership: EUR 214 billion (EUR 75 billion banks; EUR 139 billion “Other”) “Other” comprised largely of European fund managers, pension funds and insurance U.S. ownership (3%) and Asia ownership (2%) is de minimus

55

Foreign Claims: Who do the Peripherals Owe Money To?

Source: Deutsche Bank Global Markets Research, Gillian Edgeworth, BIS

Breakdown of Ownership

Total Foreign Claims Austria Belgium France Germany Ireland Italy Netherlands Portugal Spain Sweden Switzerland UK US

European Banks

303 6 8 75 43 9 8 12 10 1 1 64 12 16 253

939 9 72 78 193 23 34 22 16 6 18 193 74 692

1463 21 50 494 209 47 78 6 51 4 22 76 61 1072

287 3 9 36 47 6 7 12 89 1 4 25 6 239

1154 9 46 196 240 32 31 127 29 6 14 119 53 868

3809 27 108 389 503 233 57 207 13 393 40 238 550 2304

(US$ Billions)

56

488

271 337

87 27 61

360

496284

242

158 112

$849$767

$622

$329

$185 $173

0

100

200

300

400

500

600

700

800

900

German Banks French Banks Italian Banks Spanish Banks Belgian Banks Dutch Banks

USD

billio

n

Holdings of Eurozone Government Debt

Loans to Euro Governments

Massive Exposure for European Banks

Source: Autonomous, February 8, 2010. Based on Euro Exchange Rate of 1.36

Losses on government bond portfolios Losses on loan portfolios (cross-border, local) Counterparty exposures on derivatives Generally, bank business models highly

susceptible to economic slowdowns and market instability

European Bank Exposure to Eurozone Governments (December 2009)

Sources of European Bank ExposuresEuropean Banks may represent the most significant channel

for “contagion”from the sovereign

credit crisis

Asset Side Liabilities Side Higher bank funding costs, and less financing

market access (less demand, more volatility) Erosion in perceived value of Government

guarantees Ratings downgrades can drive higher haircuts

on government securities used for central bank or commercial repo

Sources of contagion: Higher losses; difficult financing markets; less lending

57

Less Exposure for U.S. BanksDirect exposure of

the U.S. banking system to over-

indebted European sovereign credits

is reasonably limited…

…but the indirect impact of

“contagion”effects on a

vulnerable global financial system

could be substantive Claims on Sovereigns Held by U.S. Banks (1)

(September 2009)

Source: Federal Financial Institutions Examination Council.

(1) Claims consist of cross-border loans, claims from derivatives, and foreign office claims on local residents

Aggregate U.S. Bank Exposure vs. Top 10 U.S. Bank Capital

$82

$68

$18

$9

0

10

20

30

40

50

60

70

80

90

Ireland Spain Greece Portugal

US

D b

n

Ireland Spain Greece Portugal

$178

$850

0

100

200

300

400

500

600

700

800

900

Aggregate exposure toGreece, Ireland, Portugal,

and Spain

Top 10 US bankTier 1 capital

US

D b

n

Total: $178 billion

Direct Losses from Lending / Derivatives: limited, especially compared to European banks The U.S. banking system relies very little on overseas earnings (< 20%) Tier 1 capital is well in excess of direct exposures

However, indirect impact of an escalating crisis could be significant: Bank spreads are particularly vulnerable to exogenous shocks in the global financial system Negative impact on lending and bank facilities Contagion through increased systemic risk Heightens focus on financial regulation (with upward pressure on capital, and downward pressure on

earnings)

Implications for U.S. Banks

Appendix A

Why the Greece Sovereign Credit Crisis Accelerated Sharply After March 25th?

59

March 25: Joint EU / IMF Package with Few DetailsOverview of March 25th Joint EU / IMF Package

Joint EU / IMF package of loans IMF involvement is “substantial” Euro countries “expected” to pay based

on their capital weights

Tough conditionality “Last resort” only (not a freely available

backstop facility) IMF not part of decision for its use Requires unanimous 27 nation support

Not cheap “Risk adequate pricing” that will

encourage Greece to return to market for financing

Required review of EU budget rules Proposals due by year-end Tougher budget rules More flexibility for crisis response

Announced Details The Missing Details?

On March 25th, the European Council

met in Brussels for their quarterly

summit meeting and agreed on a

rescue package of “last resort” that

would involve both the IMF and the EU

By involving the IMF in the solution

already, the EU essentially cut off

Greece’s other key option, and

Germany, in particular,

increased its leverage over the

process

Source: Mark Wall, DB Chief European Economist. Deutsche Bank Markets Research.

Exact size of the package

Exact cost

Duration of the loans

Duration of the package

Exact role of IMF

Distribution of funds? Technical assistance? Enforcement power / set conditions?

The sharp acceleration of the Greek credit crisis began on March 25th, when the EU and IMF announced a “joint-rescue package” with very few details; uncertainty and volatility followed

*** Over subsequent weeks, Investors reacted very negatively to the lack of detail ***

60

March 30: Low Demand For Bond Re-opening

Source: Deutsche Bank, Bloomberg (GGB, Corp).

After-market Performance of Greece’s March 29th 7 Year EUR 5 Billion Bond Deal

6

6.5

7

7.5

8

8.5

9

9.5

30‐Mar 3‐Apr 7‐Apr 11‐Apr 15‐Apr 19‐Apr 23‐Apr

Yield (%)

GGB 5.9% '17s

New Issue: 7 Year bond raising EUR 5 billion at mid swaps + 310 bps, or ~ 6% YTM

Demand: Over EUR 6.25 billion from 175 + accounts (10 year bond earlier in year had EUR 16 billion demand from 400 + accounts)

After-market performance: Immediately sold-off in after-markets; negatively impacted demand for March 30 re-opening

March 29: EUR 5 Billion New Issue March 30: EUR 390 Billion Re-Opening

Re-opening: EUR 390 million re-opening of 20 year 2022 bond on March 30, 2010

Demand: Greece had initially hoped to re-open this 20 year bond for EUR 1 billion, but demand was not sufficient

Greece’s 7 year EUR 5 billion new issue on March 29th immediately sold-off in secondary markets

*** The poor performance of Greece’s Mar 29th 7 year bond, and low demand for its March 30th 20 year re-opening, signaled limited Greek access to public debt markets

61

April 9: Fitch Downgrades Greece to BBB- (Neg)

Downgrade: Greece’s Long Term foreign and local currency Issuer Default Ratings downgraded to BBB- from BBB+, Outlook Negative

Drivers of the Downgrade: Fiscal challenge increases More adverse prospects for economic growth Increased interest costs Ongoing uncertainties on the Government’s financing strategy amidst market volatility

Review of Fitch Downgrade

“The sharp rise in interest rates faced by the government this year, in combination with a deterioration in the outlook for economic growth, will make it harder for the government to achieve its fiscal targets of reducing the deficit to 8.7% of GDP this year and ensuring that public debt peaks at just over 120% of GDP in 2010 and 2011.”

- Fitch Ratings (April 9, 2010)

On April 9th, Fitch Ratings

downgraded Greece from BBB+

to BBB-, Outlook Negative

Source: Fitch Ratings.

62

April 11: EU / IMF Announce EUR45 Billion Package On Sunday, April 11th,

following nearly 3 weeks of sharp deterioration in

market conditions for Greece since

the March 25th

announcement, the EU and IMF finally

announced a more detailed package

of “aid” for Greece

Size: ~ EUR 45 billion (US$ 60 billion) EUR 30 billion from Euro nations

(commitment) Additional EUR 10 - 15 billion from

IMF (expected)

Cost: Approximately 5% Equal to Euribor + 300bps + 100 bps

step-up in year 3 + 50 bps service charge

Duration: 3 years

Key Hurdles / Considerations: Several EU national Parliaments

would have to approve Greece would have to officially

request the assistance Details with IMF would need to be

negotiated (multi-week process, expected to end by May 6th)

Overview Contributions by each EU member based on each

country’s capital weight at the ECB

EU Member Contributions

Critical Question: Would markets be sufficiently satisfied with this detail, or would continued uncertainty around IMF details and nation-state approvals create continued uncertainty?

CountryCapital Weight

at ECB (%)

Implied Share of EUR 30 bn (EUR

bn)

1 Austria 1.94% 0.92 Belgium 2.43% 1.13 Cyprus 0.14% 0.14 Finland 1.25% 0.65 France 14.22% 6.36 Germany 18.94% 8.47 Greece 1.96% N/A8 Ireland 1.11% 0.59 Italy 12.50% 5.5

10 Luxembourg 0.17% 0.111 Malta 0.06% 0.012 Netherlands 3.99% 1.813 Portugal 1.75% 0.814 Slovenia 0.33% 0.115 Slovakia 0.69% 0.316 Spain 8.34% 3.7

30

EMU Contributions Based on ECB Capital Weights

Source: Deutsche Bank Global Markets Research. ECB.

63

April 19: Volcanic Ash Cloud Delays IMF MeetingsThe delay in

scheduled IMF / Greece meetings,

scheduled for April 19th, only

exacerbated the uncertainty that

had been driving low liquidity and high volatility in Greek securities

Planned attendees in Athens included

senior officials from the European

Union, the European Central Bank and the IMF

The virtual shutdown of European air travel for 5 days caused the cancellation of in-person meetings planned for Athens between the EU, the IMF and Greece on April 19th Scaled back meetings took place instead by phone, but slowed down a critical negotiation

process Negotiations have since resumed, and are expected to end by May 6th

Markets reacted very negatively to the continued uncertainty and delays Greek bond yields and CDS levels spiked each day as the April 19th week progressed

The Impact of Iceland’s Eyjafjallajokull Volcano

64

April 20: IMF Warning on Sovereign Credit Risk

On April 20th, the IMF released its

updated Global Financial Stability

Report …

…and sovereign credit risks among

advanced countries were

emphasized as a primary source of

renewed risk in the global financial

markets

“Risks to global financial stability have eased as the economic recovery has gained steam, but concerns about advanced country sovereign risks could undermine stability gains and prolong the collapse of credit.”

“The deterioration of fiscal balances and the rapid accumulation of public debt have altered the global risk profile. Vulnerabilities now increasingly emanate from concerns over the sustainability of governments’ balance sheets.”

- IMF Global Financial Stability Report (April 20th, 2010)

65

April 22: Greece 2009 Fiscal Deficit IncreasedGreece’s debt crisis reached a dramatic crescendo on April

22nd as Eurostat upwardly revised

Greece’s 2009 fiscal deficit to

13.6%, the 4th such revision in the last

year

Markets reacted very dramatically on the

news

On April 22, 2010, Greece’s 2009 budget deficit was revised higher for the 4th time, to 13.6% (or US$44.3 billion), up from a prior estimate of 12.9%

Eurostat indicated that Greece’s debt is 115% of the size of the economy (EUR 273.4 billion, or US $395 billion)

Eurostat indicated that uncertainties around Greek economic data could cause a 5th revision, up to 14.1%

Greece’s 2009 Fiscal Deficit Forecast

Source: Deutsche Bank Markets Research. Moody’s. WSJ.

Greece’s 2009 Budget Deficit Revisions

‐16

‐14

‐12

‐10

‐8

‐6

‐4

‐2

0

April 2009 Forecast October 2009 Revision January 2010 Revision April, 22, 2010

Percent (%)

Greece revised its 2009 budget deficit 4 times, most recently to 13.6%

66

April 22: Moody’s Downgrades Greece to A3

Downgrade: Greece’s government bond rating downgraded from A2 to A3 and placed on review for further possible downgrade

A3 is just 4 notches above “junk” (non-investment grade) on Moody’s ratings spectrum

Drivers of the Downgrade: Debt will only stabilize at a more costly level than previously anticipated Uncertainty about credible debt stabilization Headwinds of higher interest rates and lower economic growth EU’s fractious mobilization of emergency aid

Review of Moody’s Downgrade

“It is unlikely that the rating will remain at A3, unless the government’s actions can restore confidence in the markets and counteract the prevailing headwinds of higher interest rates and low growth that could ultimately undermine the government’s ability to sustainably cut debt levels.”

- Moody’s Investor Service (April 22, 2010)

On April 22nd, Moody’s

downgraded Greece from A2 to

A3 and placed them on review for

further possible downgrade

67

April 23: Greece Formally Activates EU / IMF Aid

Following the sharpest

deterioration in Greek bond market conditions on April

22nd since the crisis began,

Greece’s Prime Minister George

Papandreou, in a live televised

address, formally activated the

“request for aid”from Europe

1) ECB and EC will formally assess Greece’s application for aid Should be a formality

2) European Council must unanimously grant the joint-aid package Low risk of rejection; can be done via teleconference

3) Various EU Governments/ Parliaments must approve Risk of one or more nations failing to gain approval Would not jeopardise the EU deal; but rather, could reduce its size of EUR 30 billion

4) EU / IMF negotiations must be completed on the conditions of additional IMF aid of ~ EUR 15 billion Will take additional 1-2 weeks and scheduled to conclude by May 6th

IMF focused on reform of Greece labor markets, healthcare and pension systems

5) Formal approval from IMF Board Size and timing of co-investment from EU will be critical factors

Source: Mark Wall, Deutsche Bank Chief European Economist

Key Next Steps

“We believe our European partners will act decisively and provide Greece with a safe haven to rebuild our ship of state with strong and reliable materials.”

-Greek Prime Minister, George Papandreou, announces the decision

to seek EU loans in a live televised address (April 23, 2010)

68

April 27: S&P Downgrades Greece to BB+ (Non-IG)

Downgrade: On April 27th, S&P downgraded Greece’s government bond rating from BBB+ to BB+ (“junk”) and assigned a negative outlook

Drivers of the Downgrade: Government policy options are narrowing due to weakening economic growth prospects Medium-term financing risks are growing Massive political pressures for stronger fiscal adjustments Uncertain capacity to implement reform quickly (and questionable resolve)

Review of Moody’s Downgrade

“Based on our updated assessment, we estimate that the adjustment needed in Greece's primary fiscal balance relative to that of 2008 in order to stabilize the government debt burden amounts to at least 13% of GDP - a very high level compared with that which other sovereigns…At the same time, we expect official lender support to be highly conditional and revocable, and as such, we do not believe that it provides a floor under Greece's sovereign ratings.

- Standard & Poor’s (April 27, 2010)

S&P also warned that investors

could recover as little as 30% of face value if a

Greek debt restructuring were to occur

On April 27, Greece became the first

EU member to have its debt rating cut to

“non-investment grade”

69

DisclaimerThe information herein is believed to be reliable and has been obtained from sources believed to be reliable, but we make no representation or warranty, express or implied, with respect to the fairness, correctness, accuracy, reasonableness or completeness of such information. In addition we have no obligation to update, modify or amend this communication or to otherwise notify a recipient in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.

We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. We therefore strongly suggest that recipients seek their own independent advice in relation to any investment, financial, legal, tax, accounting, or regulatory issues discussed herein. Analyses and opinions contained herein may be based on assumptions that if altered can change the analyses or opinions expressed. Nothing contained herein shall constitute any representation or warranty as to future performance of any financial instrument, credit, currency rate or other market or economic measure. Furthermore, past performance is not necessarily indicative of future results.

This communication is provided for information purposes only. It is not an offer to sell, or a solicitation of an offer to buy any security, nor to enter into any agreement or contract with Deutsche Bank AG or any affiliates. Any offering or potential transaction that may be related to the subject matter of this communication will be made pursuant to separate and distinct documentation and in such case the information contained herein will be superseded in its entirety by such documentation in final form.

Because this communication is a summary only it may not contain all material terms, and therefore this communication in and of itself should not form the basis for any investment decision. Financial instruments that may be discussed herein may not be suitable for all investors, and potential investors must make an independent assessment of the appropriateness of any transaction in light of their own objectives and circumstances, including the possible risks and benefits of entering into such a transaction. By accepting receipt of this communication the recipient will be deemed to represent that they possess, either individually or through their advisers, sufficient investment expertise to understand the risks involved in any purchase or sale of any financial instrument discussed herein. If a financial instrument is denominated in a currency other than an investor’s currency, a change in exchange rates may adversely affect the price or value of, or the income derived from, the financial, and any investor in that financial instrument effectively assumes currency risk. Prices and availability of any financial instruments described in this communication are subject to change without notice.

Securities and investment banking activities in the United States are performed by Deutsche Bank Securities Inc., member NYSE, FINRA and SIPC, and its broker-dealer affiliates. Lending and other commercial banking activities in the United States are performed by Deutsche Bank AG, and its banking affiliates. This communication and the information contained herein is confidential and may not be reproduced or distributed in whole or in part without our prior written consent. (C) 2009 Deutsche Bank AG.

For more information contact Tom Joyce (212-250-8754)

null

Documents

Transcript of null