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

Assessing the Potential Implications for Credit Markets April 2010

Tom Joyce Debt Capital Markets Strategist (212)-250-8754 Tom.joyce@db.com Deutsche Bank Securities Inc., a subsidiary of Deutsche Bank AG, conducts investment banking and securities activities in the United States.

A Broader Phenomenon of Sovereign Risk
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 the near term, the main risk is that, if unchecked, market concerns about sovereign liquidity and solvency in Greece could turn into a full blown and contagious sovereign debt crisis” ~ IMF, World Economic Outlook (April 2010) “I hope that I am wrong but I fear that by end of the year, they will find out that Greece needs a lot more money in 2011 and 2012, and that we will have serious problems getting another package through.” - Thomas Mayer, Deutsche Bank Chief Economist (April 2010)


Section 1 2 3 Why the Greece Crisis Accelerated Sharply After March 25th? The Broader Phenomenon of Sovereign Risk Focus on Greece: A. B. 4 5 The Problem Potential Solutions

The “Contagion Effect” for the Peripherals Potential Implications for Credit Markets


Why the Greece Sovereign Credit Crisis Accelerated Sharply After March 25th?
Section 1

Why the Greek Crisis Accelerated After March 25th?
The Acceleration of the Greek Credit Crisis after March 25th, 2010 Date
The Greek sovereign credit crisis began to accelerate rapidly after March 25th, 2010

Key Event Joint EU / IMF Commitment Announced with Very Few Details Low Demand for Greek 20 Year Bond Re-Opening Top 4 Greek Banks Turn to Government Fitch Downgrades Greece to BBB- (Negative Outlook) EU / IMF Announce Details of EUR 45 Billion Package Volcanic Ash Delays EU/ IMF/ Greece Meetings IMF Releases Global Financial Stability Report with Sovereign Warnings  Eurostat Increases Greek 2009 Budget Deficit (Again) to 13.6%  Moody's Downgrades Greece to A3 (and Review for Downgrade)  Greek 2 and 10 Year Bond Yields Breach 11 and 9%, Respectively  5 Year Greek CDS Spikes 160 bps to 638 bps  EUR/ USD Exchange Rate Trades Down to 1.32 Greek Prime Minister, George Papandreou, formally activates EU / IMF aid in a live television address

March 25 March 30 April 7 April 9 April 11 April 19 April 20 April 22

April 23


Deutsche Bank Markets Research. increased its leverage over the process Overview of March 25th Joint EU / IMF Package Announced Details  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 The Missing Details?  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? *** Over subsequent weeks. Investors reacted very negatively to the lack of detail *** The sharp acceleration of the Greek credit crisis began on March 25th. and Germany. DB Chief European Economist. in particular. when the EU and IMF announced a “joint-rescue package” with very few details. uncertainty and volatility followed Source: Mark Wall. 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. 6 .March 25: Joint EU / IMF Package with Few Details On March 25th.

77 15‐Apr 19‐Apr 23‐Apr . signaled limited Greek access to public debt markets After-market Performance of Greece’s March 29th 7 Year EUR 5 Billion Bond Deal 9.25 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. 2010  Demand: Greece had initially hoped to re-open this 20 year bond for EUR 1 billion.5 9 8. Corp). negatively impacted demand for March 30 re-opening March 30: EUR 390 Billion Re-Opening  Re-opening: EUR 390 million re-opening of 20 year 2022 bond on March 30. Bloomberg (GGB.5 6 30‐Mar 3‐Apr 7‐Apr 11‐Apr GGB 5. and low demand for its March 30th 20 year re-opening.5 7 6.9% '17s Source: Deutsche Bank. but demand was not sufficient *** The poor performance of Greece’s Mar 29th 7 year bond. or ~ 6% YTM  Demand: Over EUR 6.March 30: Low Demand For Bond Re-opening March 29: EUR 5 Billion New Issue  New Issue: 7 Year bond raising EUR 5 billion at mid swaps + 310 bps.5 Greece’s 7 year EUR 5 billion new issue on March 29th immediately sold-off in secondary markets Yield (%) 8 7.

April 7: Top 4 Greek Banks Turn to Government Comment  On April 7th. Bloomberg 88 . thereby increasing the potential of “contagion” 1‐Sep 30‐Sep 29‐Oct 27‐Nov 26‐Dec 24‐Jan 22‐Feb 23‐Mar 21‐Apr EFG Eurobank 1‐Sep 30‐Sep 29‐Oct 27‐Nov26‐Dec 24‐Jan 22‐Feb23‐Mar21‐Apr National Bank of Greece Source: Deutsche Bank. Greece’s 4 largest Piraeus Bank 14 13 12 11 10 9 8 7 6 5 4 1‐Sep 30‐Sep 29‐Oct 27‐Nov 26‐Dec 24‐Jan 22‐Feb 23‐Mar 21‐Apr Piraeus Bank Alpha Bank 14 13 12 11 10 9 8 7 6 5 4 1‐Sep 30‐Sep 29‐Oct27‐Nov26‐Dec 24‐Jan 22‐Feb23‐Mar21‐Apr Alpha Bank 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  During the prior week. highlighting the pressure on their loan portfolios from the recession  An escalation of the Greek crisis could lead to deposit outflows. Moody’s 14 13 12 11 10 9 8 7 6 5 4 EFG Eurobank Ergasias 26 22 18 14 10 National Bank of Greece downgraded the debt ratings of Greece’s 5 largest banks.

” .from BBB+.April 9: Fitch Downgrades Greece to BBB. Outlook Negative  Downgrade: Greece’s Long Term foreign and local currency Issuer Default Ratings downgraded to BBB.(Neg) Review of Fitch Downgrade On April 9th.Fitch Ratings (April 9. 2010) Source: Fitch Ratings. in combination with a deterioration in the outlook for economic growth. 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 “The sharp rise in interest rates faced by the government this year. 9 . Fitch Ratings downgraded Greece from BBB+ to BBB-.7% of GDP this year and ensuring that public debt peaks at just over 120% of GDP in 2010 and 2011. will make it harder for the government to achieve its fiscal targets of reducing the deficit to 8.

6 6.06% 3.0 1.96% 1.8 0.25% 14.11% 12.50% 0. ECB.22% 18.4 N/A 0.17% 0.5 0. the EU and IMF finally announced a more detailed package of “aid” for Greece Overview   EU Member Contributions Contributions by each EU member based on each country’s capital weight at the ECB Size: ~ EUR 45 billion (US$ 60 billion)   EUR 30 billion from Euro nations (commitment) Additional EUR 10 .9 1.99% 1.April 11: EU / IMF Announce EUR45 Billion Package On Sunday. April 11th.1 0. following nearly 3 weeks of sharp deterioration in market conditions for Greece since the March 25th announcement.34% Implied Share of EUR 30 bn (EUR bn) 0.1 0.3 8.5 5.94% 1.7 30 Country  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. or would continued uncertainty around IMF details and nation-state approvals create continued uncertainty? Source: Deutsche Bank Global Markets Research.1 0.69% 8. 10 .43% 0. expected to end by May 6th) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Austria Belgium Cyprus Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovenia Slovakia Spain Critical Question: Would markets be sufficiently satisfied with this detail.14% 1.1 0.8 0.94% 2.75% 0.33% 0.3 3.15 billion from IMF (expected) EMU Contributions Based on ECB Capital Weights Capital Weight at ECB (%) 1.

scheduled for April 19th. the European Central Bank and the IMF The Impact of Iceland’s Eyjafjallajokull Volcano  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.April 19: Volcanic Ash Cloud Delays IMF Meetings The delay in scheduled IMF / Greece meetings. 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 11 . 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.

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.April 20: IMF Warning on Sovereign Credit Risk On April 20th. 2010) 12 .IMF Global Financial Stability Report (April 20th. Vulnerabilities now increasingly emanate from concerns over the sustainability of governments’ balance sheets. 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.

the 4th such revision in the last year Markets reacted very dramatically on the news Greece’s 2009 Fiscal Deficit Forecast  On April 22. to 13.9%  Eurostat indicated that Greece’s debt is 115% of the size of the economy (EUR 273.1% Greece’s 2009 Budget Deficit Revisions April 2009 Forecast 0 ‐2 ‐4 October 2009 Revision January 2010 Revision April. 2010. WSJ. 2010 Percent (%) ‐6 ‐8 ‐10 ‐12 ‐14 ‐16 Greece revised its 2009 budget deficit 4 times. Greece’s 2009 budget deficit was revised higher for the 4th time.6% Source: Deutsche Bank Markets Research.April 22: Greece 2009 Fiscal Deficit Increased Greece’s debt crisis reached a dramatic crescendo on April 22nd as Eurostat upwardly revised Greece’s 2009 fiscal deficit to 13.6% (or US$44. most recently to 13.3 billion).6%. or US $395 billion)  Eurostat indicated that uncertainties around Greek economic data could cause a 5th revision.4 billion. up to 14. Moody’s. 13 . 22. up from a prior estimate of 12.

April 22: Moody’s Downgrades Greece to A3 Review of Moody’s Downgrade On April 22nd.Moody’s Investor Service (April 22.” . 2010) 14 . 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 downgraded Greece from A2 to A3 and placed them on review for further possible downgrade  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 “It is unlikely that the rating will remain at A3.

00 8.00 7.00 2. and actually breached 11% Greek 10 Year and 2 Year Bond Yields 11.1% above 10 Year German bonds  Driven by Eurostat fiscal deficit revision and Moody’s downgrade earlier in the day  Yield on the Greece 2 year note soared by more than 275 bps.April 22: 2 & 10 Year Bond Yields Breach 11 & 9% Greek bond yields posted a dramatic decline on April 22nd to unsustainable levels that are effectively priced for a “catastrophic event” (of default or restructuring) April 22: Sharp Decline in Greek Bond Prices  April 22: Greek 10 year bonds traded as high as 9.00 4.00 1‐Jan 8‐Jan 15‐Jan 22‐Jan 29‐Jan 5‐Feb 12‐Feb 19‐Feb 26‐Feb 5‐Mar 12‐Mar 19‐Mar 26‐Mar 2‐Apr 9‐Apr 16‐Apr 23‐Apr  April 22nd Greece 2 Year Bond Yield: 10. or 6.20% 10. Bloomberg Greek 10yr benchmark yield Greek 2yr benchmark yield 15 15 .20%.23% Yield (%) Source: Deutsche Bank.00 5.00 6.00 9.00 3.00  April 22nd Greece 10 Year Bond Yield: 9.

Bloomberg Greece 2y CDS 16 16 .April 22: 5 Year Greece CDS Rises 160 bps In a sovereign CDS market plagued by low liquidity. closing at an historical high of 638 bps The cost to insure Greek 2 year debt rose even higher to close at 858 bps   Driven by Eurostat fiscal deficit revision and Moody’s downgrade earlier in the day Also created spill-over contagion effect to other European sovereign CDS Greece 5y CDS April 22nd Greece 5 Year CDS: 638 bps 600 550 500 875 775 675 bps Greece 2y CDS April 22nd Greece 2 Year CDS: 858 bps bps 450 400 350 300 250 1‐Jan 23‐Jan 14‐Feb 8‐Mar 30‐Mar 21‐Apr 575 475 375 275 175 1‐Jan 23‐Jan 14‐Feb 8‐Mar 30‐Mar 21‐Apr Greece 5yr cds Source: Deutsche Bank. Greek 5 year CDS spiked an unprecedented 160 bps on April 22nd April 22: Sharp Decline in Greek Bond Prices   April 22: Greek 5 year CDS spiked an unprecedented 160 bps in the same day.

3235 1.April 22: Euro/ USD Trades Down to 1. Bloomberg 17 17 .40 1.33 for the first time since May 1. 2009 Euro Reaches 11 month low  March 23.35 1. the Euro dips below 1. reaching an 11 month low against the USD of 1.35 for first time since May 2009 (10 month low)  April 22.32 on continued negative news earlier that day  EU downwardly revised 2009 Greece budget deficit to 13. the Euro traded down to an 11 month low against the USD.50 1. dipping below 1. 2010: Euro slide continues.30 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 Source: Deutsche Bank. 2010: With no formal aid package for Greece yet announced.6%  Moody’s downgrades Greece to A3 (4 notches from “junk” status)  Greece CDS and bond yields widen to record levels Euro – USD Spot (May 1. 2009 to April 22. 2010) April 22nd EUR/ USD Rate: 1.32 On April 22nd.45 Euro / US$ 1.

but rather. in a live televised address. Deutsche Bank Chief European Economist “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. 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. announces the decision to seek EU loans in a live televised address (April 23.April 23: Greece Formally Activates EU / IMF Aid Key Next Steps Following the sharpest deterioration in Greek bond market conditions on April 22nd since the crisis began. Greece’s Prime Minister George Papandreou. 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. 2010) 18 . 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. George Papandreou. 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.

The Broader Phenomenon of Sovereign Risk Section 2 .

SNL Financial. the high sovereign %. McKinsey Global Institute. *Data for Switzerland represent year-end 2007 Source: Haver Analytics. the increase in financial sector leverage was dwarfed by the collective growth of debt in the “real economy”: Households. it is very important to focus on where in the economy the debt resides Overview  Policymakers and regulators focused much of their attention on financial sector leverage during the financial crisis  However. non-financial businesses and governments accounted for the remaining $29 trillion (split relatively evenly) Sector Composition of Debt Across Economies 469 Government 380 459 Nonfinancial business Households Financial institutions 52 114 188 Percent of GDP 350 300 250 200 150 100 50 0 52 114 342 331 313 47 101 96 67 202 108 113 101 85 75 136 28 115 80 108 308 298 37 75 290 274 73 110 101 81 40 77 60 78 96 56 245 69 66 62 76 230 60 54 84 47 115 159 118 44 84 81 32 96 18 142 129 71 66 30 42 11 5 40 16 *The UK financial sector was adjusted to reflect its position as a financial hub. the financial sector accounted for $11 trillion of the $40 trillion increase in total debt in mature markets Households. have created a “crisis” 500 450 400 From 2000 – 2009. across mature economies.Assessment of Global Financial Sector Leverage In analyzing leverage within an economy. 20 . non-financial businesses and Governments   Although the Greek economy has lower absolute debt than other economies. Federal Reserve. and its characteristics. FDIC. IMF Global Financial Stability Report.

6% 8.2% 26.9% 13.2% 56.7% 17.1% 69.Sovereign Market Vulnerability Indicators There are several key indicators. that are critical to understanding the vulnerability of sovereign leverage to an economy Review of Selected Sovereign Vulnerability Indicators Depository Bank Claims Gov't Debt Held Abroad Country (% of GDP) on Government (1) (% of GDP) Greece Portugal Italy Ireland Spain United States United Kingdom Japan 99.5% 10. beyond the absolute amount of sovereign debt. 21 . Includes all claims of depository institutions.7% 17.4% 5.2% 5. on the Government.4% 47.3% 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 (i) Source: IMF Global Financial Stability Report (April 2010).9% 24. excluding the Central Bank.2% 29.0% 60.8% 20.

and economic weakness contributed to fiscal strains. Portugal. . Ireland and Italy) 10 Year Sovereign Swap Spreads as the Sovereign Crisis Evolved 400 350 300 250 200 Phase I: Financial Crisis Buildup Phase II: Systemic Outbreak Phase III: Systemic Response Phase IV: Sovereign Risk bps 150 100 50 0 ‐50 ‐100 Jul‐07 Jan‐08 Jul‐08 Jan‐09 Jul‐09 Jan‐10 Germany France Italy Spain Netherlands Belgium Austria Greece 22 Source: IMF Global Financial Stability Report (April 2010). Italy and the Netherlands) Phase 3: As sovereign utilized public balance sheets to support the banks. systemic risk subsided Phase 4: As private sector leverage shifted to the public sector.The 4 Stages of the Sovereign Credit Crisis The sovereign credit crisis evolved through several stages during the 2007 – 2010 global financial crisis 4 Stages of the Sovereign Credit Crisis     Phase 1: As risk increased. Ireland. Germany) benefited from an initial flight to quality among investors Phase 2: Post Lehman. sovereign credit risk accelerated (Greece. sovereigns with financial systems directly weakened by the crisis gapped wider (Austria. core sovereign spreads (France. Spain.

” 23 . public debt nearly doubles within 3 years  Private sector deleveraging begins approximately 2 years after the beginning of the crisis.” McKinsey Global Institute: “Debt and Deleveraging: The Global Credit Bubble and its Economic Consequences. and lasts for ~ 6 – 7 years  Accompanied by sharp escalation of Government debt Sovereign CDS Default Triggers  Failure to Pay Repudiation / Moratorium Restructuring In over 50% of banking crises. Carmen Reinhart and Kenneth Rogoff: “This Time is Different. well beyond cost of bailout packages  On average. private sector deleveraging results in a sharp escalation of Government debt and sovereign defaults   The Evolution of the 2007 – 2010 Global Financial Crisis Early 2007 . the sovereign credit crisis can be viewed as an evolution of the global banking crisis The Historical Legacy of Banking Crises  Historical Perspective Sovereign Crises (1970 – 2000) Type of Sovereign Default Default Only Default & Currency Crisis Default & Banking Crisis Triple Crisis All Crises # of Crises 4 13 7 21 45 Median Length (Years) 3 yrs 5 yrs 8 yrs 10 yrs 8 yrs 2 historical trends that accompany most banking crises: 1) Credit-less recoveries 2) Sovereign defaults  Significantly higher public indebtedness.Present 2010 Real Estate Crisis   Residential Commercial Banking Crisis – Phase 1  Banking Crisis – Phase 2  Sovereign Credit Crisis Securities Market Bank Loans Source: Deutsche Bank Global Markets Research.An Evolution of the Global Banking Crisis Analyzed from a more historical and systemic perspective.Present Mid 2007 – 2008 2008 .

Focus on Greece Section 3 .

The Problem Section A .

2 1.4 0. n.1 0.7 1.0 11.2 0.Summary of Greece’s Problem Greece has the most acute and complex sovereign debt problem in the European Union Although Greece is small on a relative basis… … the fragility of the global financial system remains VERY high… … and therefore the contagion risk of sovereign credit issues among smaller states is significant Assessing the Greece Problem Greece’s 3 Part Problem  Country Germany France Italy Spain Netherlands Belgium Austria Greece Finland Ireland Portugal Slovakia Luxembourg Slovenia Cyprus Malta UK Poland Sweden Denmark Czech Republic Romania Hungary Bulgaria Lithuania Latvia Estonia % of Euro .1 12.2 0.3 16.2 0.9 1. Mark Wall.3 17.9 1.9 8.a.8 2. n. 26 .0 13.a.3 2.3 0. n.5 0.8 2. n.0 2.7 0. n.1 #1: Credibility Problem #2: Liquidity Problem #3: Insolvency Problem   Source: Mark Wall.5 1. n.9 4.5 2.a.4 3.a.1 0. n.2 0.a.8 6. n.9 1. DB Chief European Economist Source: Deutsche Bank Markets Research.3 0.6 2. n.0 0.3 0.4 1.a.8 0.7 21.4 1.7 3.27 20. DB Chief European Economist.a.a. n.16 26. % of Euro .0 n.a.a.8 0.a.0 1.

Greece’s 2009 budget deficit was revised higher for the 4th time.0% -6. Greece has a significant credibility problem that has been building for many years Sources of Greece’s Credibility Problem    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   2009 Fiscal Deficit Revisions On April 22.6%.Problem #1: Credibility Problem Greece is highly dependent on the capital markets to solve its liquidity problem… …and to this end.9% Eurostat indicated that uncertainties around Greek economic data could cause a 5th revision. 2010. WSJ.0% -2. up to 14.0% -12.0% -4. up from a prior estimate of 12. to 13.1%   Accounting irregularities Derivatives transactions (to mask debt levels) 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 '98 0. 27 .0% Greece revised its 2009 budget deficit 4 times Original Revised '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 Greece revised its 2003 budget deficit 5 times -14.0% -10. Moody’s.0% Source: Deutsche Bank Markets Research.0% -8.

000 800 $589 600 $395 400 200 0 $144 $129 Spain Portugal Italy Ireland Greece Spain Critics of the current Greek Government would say that they inherited a significant fiscal deficit crisis.400 1.600 $1. created an unparalleled liquidity crisis. Greek sovereign debt costs had reached unsustainably high levels ( > 9% on 10 year) Next Critical Maturity: EUR 8.391 1.200 (US$ billions) $445 (US$ billions) USD bn USD bn 300 250 200 150 100 50 0 Portugal Italy Ireland Greece $49 $50 $73 1.36 Euro exchange rate 28 . Source: Fitch. and in the course of several months.Problem #2: Liquidity Problem Greece’s 2010 Liquidity Needs 2010 liquidity needs for European sovereigns are sharply higher than in prior years… …with Greece facing significant maturities (in excess of US$20 billion) in April and May of this year 500 450 400 350 $279   Total Debt Outstanding: Greece has nearly US$ 400 billion of total outstanding debt Near-term Maturities: Greece has US$ 73 billion of maturities in 2010 alone (~US$27 bn of which is due in April and May) Cost of Financing: As of April 22nd. US$ values based on 1. Wall Street Research. 2010  2010 Liquidity Needs (Bond Maturities + ST Debt Roll + Fiscal Deficit) Total Debt Outstanding (US$) 1.5 billion 10 Year Bond on May 19.

and well above the 3% limits set by the EU’s Maastricht Treaty in 1992 Greece’s Current Account Deficit: Peaked in Q3 2008. and (ii) fiscal deficits.6% of 2009 GDP.Problem #3: Insolvency Problem Twin deficits are a key determinant for analyzing sovereign credit risk Greece has one of the highest fiscal deficits in the EU Assessing Euro Sovereign Risk Through the Lens of Twin Deficits  An IMF regression analysis of 24 countries indicates that (i) current account deficits. should be down sharply in 2010 – 2011 with aid packages (but still projected to be negative in 2010) 2010E Fiscal Deficit (% of GDP) 0  2010E Current Account Deficit (% of GDP) 8 6 4 2 % of GDP 0 -2 -4 -10 % of GDP 3% limit set -2 by EU Maastricht -4 Treaty -6 -8 -6 -8 It a ly Sp Ne a i th e n r la nd Be s lg i um Au st r ia Fin lan Gr d ee c Po e rtu ga Ire l lan d UK Eu ro -A rea an y Fr an ce Ge rm -12 I ta ly Sp Ne a i th e n r la n Be ds lg i um Au st r ia Fin lan Gr d ee c Po e rtu ga Ire l lan d U Eu K ro -A rea Ge rm an y Fr an ce 29 Source: Deutsche Bank Global Markets Research. are highly correlated with higher sovereign CDS spreads  Greece’s Fiscal Deficit: At 13. IMF Global Financial Stability Report (April 2010). . it is among the largest in the European Union.

Potential Solutions Section B .

45 billion (EUR 30 treaties challenging)  Bilateral arrangements (moral hazard issues. and US$73 billion of maturities in 2010. I have a problem. difficult precedent)  EU Bond issuance (reconciliation with EU tenor provided  April 23: Greece formally activates request for the money  Details:  Size: ~ EUR 40 . pricing too high)  March 25: Formal announcement of EU/ IMF commitment (no details)  April 11: Details on size. little German domestic support)  Infrastructure advances: not sufficient billion from Euro nations and EUR 1015 billion from IMF)  Cost: Approximately 5% (Equal to size Euribor + 300bps + 100 bps step-up in year 3 + 50 bps service charge)   Duration: 3 years IMF’s Greece Focus    Key Question How to address the potential liquidity crisis that may arise with Greece’s significant 2011 and 2012 maturity obligations? Healthcare reform Pension reform Labor market reform “If I owe you a pound. triggered an immediate and short-term liquidity crisis However. the problem is yours.Critical Step #1: Address Liquidity Problem Joint EU / IMF Solution (for 2010) Greece has US$27 billion of maturities in April/ May.” ~ John Maynard Keynes (English Economist. but if I owe you a million. 1883 – 1946) 31 . cost and  EU Debt guarantees (violation of EU treaties. the EU / IMF rescue package would solve the liquidity crisis for 2010 only  Key Dates: Other Options Considered  Raise debt in capital markets (too little demand for Greek debt.

25 billion)  Increase value added tax from 19% to 21%  Excise tax on petrol. #1: Revenue Raising Initiatives (EUR 2.8 billion (USD 6.4 billion / US 3.5 billion. or 2% of GDP) On March Greece announced a more detailed plan for achieving its 3 year fiscal and growth targets 3rd.4 billion / USD 3. which should conclude by May 6th Unprecedented EU Role in Europe  The EU has embarked on a path of not just intensely monitoring Greek policy. alcohol. healthcare and pension system reforms Key Question: How will Greece mitigate the vicious circle of fiscal cuts and economic slowdown as it strives to meet its 3 Year Stability and Growth Program targets? 32 .Critical Step #2: Address Long-Term Solvency Greece’s Fiscal Plan: EUR 4.25 billion)  Reduce public sector wages and pensions (EUR 1. cigarettes and luxury goods  Sale of selected state assets #2: Expenditure Reductions (EUR 2.7 billion)  Reduce size of public investment programs (EUR 500 million)  Reduce education expenditures (EUR 200 million) *** Implementation Risk on Greece’s Fiscal Plan is Very High *** The IMF will increase these fiscal austerity measures in its negotiations with Greece. 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.

Greek bond repayments  Market Precedents:    Most precedents to date are largely emerging market. or highly managed (with modest to medium haircuts of < 50%)? “We wouldn’t touch Greece at the moment. the market seems to be increasingly pricing in a greater risk of some sort of partial. and recovery values. early 1990s (approximately 50% haircuts)  Impact of IMF / EU Aid on Existing Creditors: The IMF always takes a senior position in the capital structure (EU likely to as well). Greek membership in the EU makes the application of such historical emerging market precedents complicated Aggressive Precedent: Argentina. Gillian Edgeworth and Thomas Mayer. The market needs some clarity on whether or not there will be some kind of restructuring of Greek bonds. or delayed. There’s too much uncertainty and volatility.Head of Fixed Income at UK Asset Manager & FTSE 100 Company (April. of existing Greek bonds  Potential implications of a Greek restructuring/ default:  Will depend entirely upon whether a Greek default is somewhat uncontrolled (with aggressive haircuts similar to Argentina). 2010) Source: Deutsche Bank Global Markets Research. and so the IMF / EU aid of EUR45 billion will adversely impact the subordination. 33 .” investor sentiment appears to believe that a reduction or delay in Greek bond interest payments is inevitable… …some even calling it an “overwhelming probability”  Greek Government Position: Debt restructuring is “off the table”  Capital Markets Position: Following the declines of April 22 in particular. 2002 (75% haircuts on outstanding debt) Moderate Precedent: Poland.” .Critical Step #3: Greek Debt Restructuring? Will a Greek Debt Restructuring Be Needed at Some Point? Although Greece has firmly stated that a Greek debt restructuring is “off the table.

8% 2.5%) DB Forecast: (-4. Greece will have to deliver on its official 3 Year “Stability and Growth Program” targets Fiscal Deficit Forecast (% of GDP) 12.4% 120.5% 10.5% 10.5% Projected Unemployment Rate 10.0%) 1. Greece needed to tap the assistance offered by the EU and IMF To avoid a similar “rescue” in 20112012.7% 113.Critical Step #4: Meet 3 Year Fiscal & Growth Targets Greece’s 3 Year “Growth and Stability Program” Forecasts In 2010.0% 2009 2010E 2011E 2012E 2013E 2009 2010E 2011E 2012E 2013E Projected GDP Growth 2.7% 5.7%  Debt / GDP Forecast Debt / GDP will peak in 2011 120.9%   EU Forecast: (-2.3% 9.0% -0.6% 2.3% 2010E 2011E 2012E 2013E 2009 2010E 2011E 2012E 2013E 34 Source: Deutsche Bank Global Markets Research .4% 113.9% 2010 Greece GDP Forecasts: 1. in accordance with EU guidelines 8.4% 3 Year Plan to reduce fiscal deficit below 3%.5% 9.6% 117.

France and the European Union will likely not allow this to happen (in 2010) 2) Removal of a member from the EMU:   3) Default of Greece:  4) Bailout from the European Central Bank (ECB). market response Although patience is not unlimited. massive reputational issues at stake Although patience is not unlimited. if needed  Central banks are the lenders of last resort to banks. Germany. prohibited by Maastricht Treaty of 1992 (see key Articles below)  The 2009 Treaty of Lisbon provided additional flexibility for the possibility of direct financial assistance for a Member State in a bilateral arrangement with other Member States. regardless of rating  Article 125: Explicit “no bail-out clause” for any member states by other member states  Article 123: Explicit “no bail-out clause” by ECB or national central banks for a member state (either by purchasing debt or extending loans)  Article 122: Creates an exception for assistance by member states (not by the ECB) for “severe difficulties caused by natural disasters or exceptional occurrences beyond its control…” “Because throwing (a state out) would have momentous.What We Believe Will Not Happen in 2010? Potential Solutions That We Do Not Believe Will Happen in 2010? A break-up of the EMU. are likely “off the table” in the near term resolution efforts of this crisis  4 things that we believe will likely Not happen (over the near-to-medium term): 1) Break-up of the European Monetary Union (and abandonment of the Euro):   Very complex construction that took decades of effort to create Exceptionally difficult to unwind. 2010) 35 . Jean-Claude Juncker (February. uncontrollable consequences… we must prevent a state from getting close to bankruptcy. not Governments ECB could move to accept all Euro sovereigns as repo-eligible. the removal of a member near-term is very unlikely Contagion effect could impact other members. precedent. and a default of Greece.” ~ Eurogroup Chairman.

Who are the Key Players? Greece  Prime Germany  Chancellor: European Union  European IMF  Managing Minister: George Papandreou Minister: George Papaconstantinou Angela Merkel  Finance Central Bank President: JeanClaude Trichet Union President: Herman Van Rompuy  Finance Minister: Wolfgang Schaeuble  European  (Rotating)  European Director (President): Dominique Strauss-Kahn Deputy Managing Director (IMF # 2): John Lipsky  First  Opposition  Leader: Antonis Samaras Currently endorsing Government plan President of EU: Spain (Prime Minister Jose Luis Rodriguez Zapatero) Commission President: Jose Manuel Barroso (former Prime Minister of Portugal) Chairman (Chair of Euroarea Finance Ministers): Jean-Claude Juncker (also Prime Minister of Luxembourg) & Monetary Affairs Commissioner: Olli Rehn France  President:  Eurogroup Nicolas Sarkozy  Finance Minister: Christine Lagarde  Economic 36 .

The “Contagion Effect” for the Peripherals Section 4 .

PIMCO.” as quoted by Bill Gross. the IMF said that Portugal.The “Ring of Fire” A “ring of fire” contagion effect is spreading around a multitude of sovereign credits with debt burdens comparably high to Greece The “Contagion Effect” on the Peripherals  The debt burdens of several European “peripheral” sovereigns are being closely watched by investors  Italy. Portugal. Ireland and Spain (in particular)  Countries within the “ring of fire” will be particularly vulnerable  In its April 2010 Global Financial Stability Report. Debt / GDP Netherlands Germany Portugal France Italy Belgium “Ring of Fire” Greece Ireland 80% 90% 100% 2010 Debt / GDP 110% 120% 130% Source: Deutsche Bank forecasts. would be the most likely to suffer from a Greece “contagion effect” 2010 Debt / GDP 140 120 100 % of GDP 80 60 40 20 0 Ita ly Sp Ne a in th e r la nd Be s lg i um Au str ia Fin lan Gr d ee c Po e rtu ga l Ire lan Eu d ro -A rea Ge rm Fr an ce an y -4% -5% -6% 2010 Budget Deficit -7% -8% -9% -10% -11% -12% -13% -14% 70% UK Spain Austria 2010 Budget Deficit vs. The “Ring of Fire. 38 . and to a lesser extent Spain and Italy.

The “Contagion Effect” for the Peripherals Although Greece is the clear outlier on both credit and CDS spread levels.0 5.0 4.0 0 NL FI FR AT BE SP IT IE PT GR Oct-07 Mar-08 Greece Aug-08 Jan-09 Ireland Jun-09 Portugal Nov-09 Spain 10Y spreads to Germany Euro Sovereign 5 Yr CDS Spreads 600 500 400 300 200 100 0 bps 640 600 560 520 480 440 400 360 320 280 240 200 160 120 80 40 “Peripherals” CDS Under Pressure  CDS levels in Portugal.0 Record spikes in Greek bond yields on April 22nd had a spillover effect on the peripherals  Bps % 300 200 100 3.0 0. several other countries have come into close focus The deterioration of the Greece situation has directly impacted these levels in recent weeks as well Euro Sovereign 10 Yr Credit Spreads 600 500 400 “Peripherals” 10 Yr Bond Spread over Germany 6. Spain and Italy were dragged sharply higher on April 22nd by Greece Sep-09 Apr-10 Source: Deutsche Bank.0 2.0 1. Bloomberg Jun-09 Jul-09Aug-09Oct-09Nov-09Dec-09Jan-10Feb-10Mar-10Apr-10 Portugal Italy Greece Spain Ireland 39 39 .

The “Contagion Effect” for the Peripherals Given their current ratings. Philippines Ireland Italy SOAF Poland Israel S. 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 5 Year CDS Spread Differentiation (As of April 22. FR GE China MX Thailand Malaysia -50 Ratings (avg. Peru Kazakhstan Lebanon 250 150 Spain Chile Belgium 50 Austria UK USA. Bloomberg 40 40 . of Moody's/S&P) Aa2 A1 A3 Baa2 Ba1 Ba3 B2 Aaa Source: Deutsche Bank. 2010) 650 Spread 5y CDS (bp) Greece 550 450 Iceland 350 Egypt Portugal Vietnam Bulgaria Hungary Uruguay Turkey. Korea Russia Colombia Brazil.

The “Contagion Effect” for the Peripherals Rating Recent Action Rating Recent Action Rating Recent Action Aa2 (Neg) Portugal Negative outlook in Sep '09 A+ (Neg) Negative outlook in Dec '09 AA.(Stable) 1 notch downgrade in Nov '09 A3 (Neg) Greece 1 notch downgrade in Apr '10 BBB+ (Negative) Negative outlook in Mar '10 BBB.(Neg) 2 notch downgrade in Apr '10 Aaa (Stable) Spain n/a AA+ (Neg) Negative outlook in Dec '09 AAA (Stable) n/a Downgrades in recent weeks have demonstrated how ratings can become a loose cannon as the Sovereign Crisis unfolds. by market reaction. and can lead to a spiraling of both sovereign and. bank spreads throughout the region Source: Bloomberg 41 .(Neg) 1 notch downgrade in Mar '09 Aa1 (Neg) Ireland 1 notch downgrade in Jul '09 AA (Neg) 1 notch downgrade in Jun '09 AA.

Potential Implications for Credit Markets Section 5 .

which could contribute to upward pressure on interest rates and increased funding pressure for banks. Such strains can intensify the short-term funding challenges facing advanced country banks and may have negative implications for private credit.Potential Implications “In some cases.IMF Global Financial Stability Report (April 2010) 43 .” . Small and medium size enterprises are feeling the brunt of the reduction in credit. the longer-run solvency concerns could translate into short-term strains on funding markets as investors require higher yields to compensate for potential future risks.” “Ballooning sovereign financing needs may bump up against limited credit supply.

DB Chief European Economist.Key Areas of Concern The expected ebb and flow of the sovereign debt crisis throughout 2010 will impact a full range of markets globally The most immediate and direct threat to financial market stability is Greece. Mark Wall. but a “contagion effect” could have more far reaching implications Key Areas of Concern       Potential debt restructuring Banking system Market volatility Credit markets Currency markets Economic growth Source: Deutsche Bank Markets Research. 44 .

losses would be significant  Could trigger a European financial crisis.” investor sentiment appears to believe that a reduction or delay in Greek bond interest payments is inevitable… …some even calling it an “overwhelming probability”  Market Position: Following the sharp declines of April 22nd. and a restructuring of Greek debt followed. 2002 (Less controlled. early 1990s (More Managed. 45 . Spain. or in a highly managed and orderly fashion (with modest to medium haircuts of < 50%)? Argentina Precedent. most creditors would avoid default themselves  However. Ireland.Potential Greek Debt Restructuring? Potential Implication of a Greece Debt Restructuring? Although Greece has firmly stated that a Greek debt restructuring is “off the table. or delays. would such a default unfold more aggressively (with the 75% haircuts of Argentina’s precedent). in Greek debt repayments  Key Question: If Greece was to “trip” in its fiscal consolidation program. ~ 50% Haircuts)  Greek Debt / GDP would decline to ~ 60%  Would be a “significant” event for the European financial system  Defaults of many creditor institutions  Massive investor losses and cross- European financial system  If managed in “orderly” fashion. Italy and others)  Significant questions for Euro longer term to European peripherals likely  Significant downward pressure on European growth  Significant questions for Euro longer term Source: Deutsche Bank Markets Research. 75% Haircuts)  Greek debt / GDP would decline to ~ 30%  Would be a “devastating” event for the Poland Precedent. the market seems to be increasingly pricing in the likelihood of either partial reductions. but exposures  Would likely trigger a European financial and banking crisis (and possibly global)  Analogous to a “Lehman-type” event with full should be more contained  Range of “unintended consequences” likely range of unintended consequences  Confidence in European “peripherals” would but likely manageable  Significant contagion and spill-over effects evaporate immediately (significant contagion effects to Portugal.

Implications for US$ Bond Issuance The sovereign credit crisis has only magnified one of the key lessons of the Global Financial Crisis.S. less secondary market liquidity) US Treasury Yields: creates downward pressure near-term as and if volatility rises sharply. more likely to create upward pressure Liquidity: more downward pressure. longer-term. which historically may have been closer to 5-10% area Source: Bloomberg Issuer Origin Focus  Differentiation and Focus on Country of Origin: more pressure on bank. higher risk. we have seen overseas demand on several recent non-financial corporate bond financings in excess of 20% of total issuance size (for BBB type names). utility and telecom spreads from Europe that have frequently tapped US$ markets in the past 46 . creates upward pressure on spreads Overseas Demand: potentially much higher as US$ assets become more attractive. that is. Issuers can no longer rely on “just-in-time financing” Increased volatility increases the risk of “windows of opportunity” opening and closing with little notice Financing Costs  Credit Spreads: potentially wider as a result of several factors including negative economic implications. less liquidity as broker-dealers push back risk Bank Spreads: particularly vulnerable given recent Financial Crisis and contagion exposure New Issue Premiums: more upward pressure (more risk. high debt levels in the U. the importance of prefunding Review of Potential Implications for US$ Investment Grade Debt Issuance  Strategy Strategy: Significantly heightens the importance of pre-funding redemption and capital expenditure obligations   As evident in the financial crisis. global capital flows toward US$      Overseas Demand  For example. especially as and if broker-dealers pull-back on risk. potentially higher new issue premiums.

more volatility)  Erosion in perceived value of Government guarantees  Ratings downgrades can drive higher haircuts susceptible to economic slowdowns and market instability on government securities used for central bank or commercial repo Sources of contagion: Higher losses. difficult financing markets. February 8.Massive Exposure for European Banks European Banks may represent the most significant channel for “contagion” from the sovereign credit crisis Sources of European Bank Exposures Asset Side  Losses on government bond portfolios  Losses on loan portfolios (cross-border.36 . and less financing market access (less demand. Based on Euro Exchange Rate of 1. and German banks have $45 billion Holdings of Eurozone Government Debt Loans to Euro Governments 800 700 600 USD billion 500 400 300 200 100 0 German Banks 284 $329 488 271 337 242 87 $185 158 27 Belgian Banks $173 112 61 Dutch Banks 47 French Banks Italian Banks Spanish Banks Source: Autonomous. 2010. bank business models highly Liabilities Side  Higher bank funding costs. local)  Counterparty exposures on derivatives  Generally. less lending European Bank Exposure to Eurozone Governments (December 2009) 900 $849 $767 360 496 $622 BIS data shows that Frenchbased banks have $75 billion of exposure to Greek debt.

S. banking system relies very little on overseas earnings (< 20%) Tier 1 capital is well in excess of direct exposures  However. Bank Exposure vs.Less Exposure for U. 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. banking system to overindebted European sovereign credits is reasonably limited… …but the indirect impact of “contagion” effects on a vulnerable global financial system could be substantive Implications for U. Portugal.S.S. and Spain Top 10 US bank Tier 1 capital $178 Source: Federal Financial Institutions Examination Council. and downward pressure on earnings) Claims on Sovereigns Held by U. claims from derivatives. Bank Capital 900 800 700 600 $850 Total: $178 billion USD bn USD bn 50 40 30 20 10 0 Ireland Spain Ireland Spain Greece Greece Portugal Portugal $18 $9 500 400 300 200 100 0 Aggregate exposure to Greece. Banks  Direct Losses from Lending / Derivatives: limited. (1) Claims consist of cross-border loans. and foreign office claims on local residents 48 .S.S. Top 10 U. Ireland. especially compared to European banks   The U. Banks Direct exposure of the U.S. Banks (1) (September 2009) 90 80 70 60 $68 $82 Aggregate U.S.

2009 – Present ) 1. DB view that Euro is already over-valued on fundamentals and so has room to fall) Euro as Reserve Currency: Could slip on a trend basis with potential benefit to USD.25 Ma y Ju l -0 9 Au g09 Se p09 Oc t.35 1.S.45 Euro / US$ 1. though will depend on depth and volatility of the sovereign credit crisis.9 0.35 1.2 1.4 Euro / US$ Spot (May.7 1. JPY.7 49 .Implications for Foreign Exchange The ultimate impact on Eur/USD.Present) DB 2010 EUR/ USD Forecast: 1.0 0.50 1.0 9 No v-0 9 De c-0 9 Ja n10 Fe b-1 0 Ju n09 -09 Euro / US$ Source: Bloomberg 1. Government bond market is still someway off Euro sovereigns are clearly still 16 separate markets with their own distinct credit risk and liquidity profiles  USD: strong upward pressure to rally vis-à-vis Euro.55 1.5 1. CAD and Gold    Euro Government bond market as rival to U.30 1.1 1.8 0. strong move expected into USD assets (equities and bonds) Euro / US$ Spot (1999 .40 1.3 1.6 1. will ultimately depend on the depth and volatility of the crisis… …but the impact could be significant Euro Declines to 9 Month Low  Euro: More downward pressure (pre-sovereign crisis. and related capital flows.

weaker industrial capacity will negatively impact commodity pricing    Impact may be exacerbated by an already vulnerable financial system and global economic recovery outlook In addition. negatively impacting profitability.150 1.000 950 900 850 800 60 50 40 30 20 Source: Bloomberg Feb-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Feb-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 50 . Gold prices would be the exception to the generally downward pressure on commodity prices DB 2010 Gold (oz) Forecast: $1. could reinforce 2009 downward pressure on refining margins. and potentially increasing prospect of sales and/ or shutdowns  Flight to Quality (Risk-aversion): to the extent the crisis spikes sharply.050 1.Implications for Commodities A stronger USD reinforces downward pressure on nearly all commodities. especially oil… …Gold may be the exception to the extent volatility spikes sharply if the sovereign crisis escalates Implications for Commodities of the Sovereign Credit Crisis  Impact of Stronger USD: extent of USD rally will be linked to depth of crisis and is likely to reinforce downward pressure on nearly all commodity asset classes.100 Oil (Feb 2009 – Apr 2010) DB 2010 Oil (bbl) Forecast: $70 $ per troy oz 1.175 1. especially oil Impact of Economic Weakness: will depend on depth of crisis and potential contagion effects.Apr 2010) 100 90 80 70 $ per bbl 1.200 Gold (Feb 2009 .

less lending.S. Economy Increases risk of double-dip. UK likely to extend quantitative easing.S. exports on stronger USD. reduced lending. of facilities  51 . and upward pressure on cost. lower corporate earnings. risk and liquidity premiums  Treasury yields: Creates downward pressure on rates if volatility and global systemic risk rises    U. lower overseas earnings. contagion effect. creates downward pressure on size. China will continue to tighten as needed. contagion. higher taxes. Germany and many of the peripheral sovereigns themselves  Sharply higher costs of capital  Full range of meaningful indirect impact: already vulnerable. Asia (ex-China) will likely pause on any tightening in current environment Bank Facilities Creates downward pressure on tenor (more focus < 3 years).Summary of Potential Implications Markets / Entities US$ Bond Market New Issue Conditions Directional Impact Potential Implications (Depending on Crisis Depth) Strategic: Pre-funding more important than ever (volatility creates shorter issuance windows) Spreads: Upward pressure on new issue. social unrest. lower U. Eastern Europe    Central Bank Policy Generally creates downward pressure on Central Bank tightening and “exit strategies” Will vary by region: Little impact on U. Significantly increases full range of ECB considerations and variables. Fed unless crisis spikes sharply. sharply higher cost of capital. high debt levels creates higher inflation over time. Banks   European Banks Very significant direct bank exposures: In excess of 20% of GDP for France. austerity measures to reduce debt. repo eligibility with ECB Limited direct lending and/or derivative losses (especially vis-à-vis capital) More indirect impact: bank spreads very vulnerable to exogenous shocks at this time. systemic risk and contagion. contagion effects. would take sharp spike in crisis to bring back down to Financial Crisis peak levels of < 365 days  Potential negative impact and focus on Risk Weighted Assets (and therefore capital)  Hedging via CDS becomes more expensive (as CDS widens).S.S. higher costs of capital Significant potential drag on recovery: Large exposures for banking system. higher cost of capital. increases focus on financial regulatory reform European Economy  U. coordinating policy.

K. higher costs for “Peripherals” to be sure. multi-jurisdictional focus. economic drag and USD rally will create downward pressure on virtually all commodity asset classes. and tighter regulation of certain products)  Sharply higher focus on systemic risk (more need for international coordination. the effectiveness of the response. Too Big to Fail. leverage limits)   The impact on all of the above markets will ultimately depend on the depth of the crisis.S. still unclear  Financial Regulatory Reform Heightens focus on financial regulatory reform (both negatively and positively) Increases focus on derivatives (particularly on bank margin requirements for counterparty exposures. CAD. JPY and gold). contagion impact on other regions. especially oil. Euro sovereigns will clearly be viewed as 16 separate markets with distinct credit risk and liquidity profiles  Commodities Price: If crisis escalates. systemic regulator.Summary of Potential Implications Markets / Entities Sovereign Bond Market New Issue Conditions Impact Potential Implications (Depending on Crisis Depth) Supply: increases already high needs coming out of the financial crisis to fund deficits  Spreads: Sharply wider. and U. additional negative premium for Euro members than U. capital flows. more liquidity in Index product. and the level of volatility and risk aversion that follows 52 .  Gold: Potentially positive benefit depending on depth of crisis and flight to quality. due to coordination challenges on EMU policy  Delays: Creates a heavy pause in what is otherwise expected to be a very high issuance year  Capital Flows Not very transparent at this time (due to 3 – 6 month lags in high quality data)  USD Assets: depending on depth of crisis. especially for investors  Foreign Exchange USD: potential continued rally depending on depth of crisis and volatility  Euro: Increases downward pressure (currently on 9 month decline versus USD)  Euro as Reserve Currency: could slip on a trend basis (with potential benefit to USD. as well as developed European sovereigns (depending on role in potential bail-out and contagion)  Euro / USD basis could make USD market particularly attractive for European issuance  CDS: sharply wider for single names in particular. strong moves into USD assets likely (equities and bonds)  Strong overseas demand on US$ bond deals already apparent  Repatriation strategies: increased focus.

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