tipping point nov 2011 final
TRANSCRIPT
-
8/2/2019 Tipping Point Nov 2011 FINAL
1/51
Deutsche BankCapital Markets and Treasury Solutions
The Tipping Point?Time to Call the ECB
Corporate Solutions & StrategyTom Joyce(212) 250-8754 / [email protected]
Michael D ad uk
November 2011
(212) 250-0470 / [email protected]
Javier Guzman(212) 250-3464 / [email protected]
-
8/2/2019 Tipping Point Nov 2011 FINAL
2/51
The name given to that one dramatic moment in an epidemic when everything can change allat once is the tipping point.
Malcolm Gladwell, author of the Tipping Point
The ECB has to go beyond a narrow interpretation of its mission and should be prepared forforeseeable intervention in the secondary market, not as the central bank has done up tonow It has to be able to be a lender of last resort.
Our membership of the Euro is a guarantee of monetary stability and creates the right
conditions for sustainable growth. Our membership of the Euro is the only choice. Our task is
Anibal Cavaco Silva, Portuguese President
Only Napoleon did more than me, but Im taller than him.
.
~ Lucas Papademos, Greeces Prime Minister
. .
~ Silvio Berlusconi, Italian Prime Minister
11111
~ Lawrence Summers, former U.S. Treasury Secretary (1999 2001)
-
8/2/2019 Tipping Point Nov 2011 FINAL
3/51
Contents
Section
1. Executive Summary: The Tipping Point
2. Recent Escalation of the Crisis
3. Searching for a Solution
.
B. Time to Expedite the Grand Plan
.
22222
-
8/2/2019 Tipping Point Nov 2011 FINAL
4/51
1. Executive Summary: The Tipping Point
-
8/2/2019 Tipping Point Nov 2011 FINAL
5/51
Summary Conclusions
Markets have lost confidence in the EU's institutionalstructures and framework
The Tipping Point Key Resolution Steps Needed
1. More progress on credible fiscal austerity (especiallyItaly)
Italy represents a critical new and dangerous phase of
the crisis (the "Tipping Point")
Italy and Spain have 300 bn and 120 bn of 2012issuance 930 billion combined over next 3 ears
2. Rapid resolution of the EMU's original sin - lack of
fiscal integration (Dec 9 EU Summit meeting)
3. Restore confidence to re-open bank funding markets
4. Time to expedite the "Grand Plan"
- Italian sovereign bond market is broken
The "stakes" have never been higher (including the fate
of the Euro itself)
- Larger Greece debt restructuring
- Bank capital raises and debt guarantees
- Additional bail-out funds for Greece
Politics has become the obstacle: All 5 "peripheral"countries have had leadership change in 2011
The economy (recession) has become the unknownvariable
5. Time to call the ECB
- Investor reluctance on EFSF 1 trillion leverage plan
- Ineffectiveness of ECB monetary policy transmissionmechanism to keep bond yields low
Continued Euro bank sector de-leveraging likely underalmost any scenario (over $2 trillion estimate for next 18months)
Lon er term external current account deficits matter
- Adjustment away from current bond purchase programneeded (away from temporary, limited and sterilized)
- ECB should announce large, targeted buying plan (i.e. 200 bn over 12 months)
44444
more than fiscal deficits
Source: Deutsche Bank Global Markets Research - Economics, Credit, Rates, and FX2012 will become the year of either a more integrated Europe, or a disintegrating one
-
8/2/2019 Tipping Point Nov 2011 FINAL
6/51
The Tipping Point
What Is Now At Stake?
1. Conta ion to Euro es core
.
.
55555
Source: IMF
-
8/2/2019 Tipping Point Nov 2011 FINAL
7/51
#1: Contagion to Europes Core
Italian 2 & 10-Year Bond Yield France 10-Year Bond Yield
3.5
4.0 ermany y e rance y e
6.0
6.5
7.0
7.5
Nov 10: French-German 10y spreadreaches 20-year wide of 169 bpsNov. 9: Italian 10y yield reached nearly 7.5%
3.0
(%)4.55.0
5.5
(%) Gap:510 bps Gap:169 bps
2.0
.
Yiel
3.0
3.5
4.0Yiel
1.0
1.5
1.0
1.5
2.0
.
66666
Source: Bloomberg
-
8/2/2019 Tipping Point Nov 2011 FINAL
8/51
#2: The Global Economy
Will Europe Push theU.S. Into Recession?
2 Scenarios: Detail
Global GDP Growth (2010-2012)
12%
1.Moderate worsening of
Euro zone recession( muddle throughscenario)
Most probable outcome
Not enough to cause U.S. double-dip
- U.S. trade exposure is low vis--vis U.S. GDP
8.3%
10%
Asia America
(1 - 2% EU GDP decline)
- Even a 5% drop in Euro ZoneGDP would only reduce exportsby less than 1/2% of U.S. GDP
2. Severe downturn in Less likely outcome
.
6%
8%
(disruptive creditevent scenario)
(> 5% EU GDP decline)
Would likely drive U.S. double-dip
Channels of contagion:
- High correlation on U.S. / EUstock markets
3.7%
2.3%
2%
4%
- High correlation on U.S. / EUconsumer & business confidence
- Bank funding markets andfinancial channels
0.4%
0%
2010
2011E
2012E
2010
2011E
2012E
2010
2011E
2012E
2010
2011E
2012E
2010
2011E
2012E
77777
Source: Deutsche Bank Global Markets Research Peter Hooper, Thomas Mayer, Torsten Slok, Michael Spencer
Most standard macro models do not adequately capturethe impact of financial and funding channelcontagion
The Euro crisis continues to be the #1 macro risk inthe global economy
-
8/2/2019 Tipping Point Nov 2011 FINAL
9/51
#3: Global Financial System Stability
Stock Price DeclineStock Price Decline
3.5 10.0Systemic risk will
2.0
2.5
3.0
ce(EUR)
5.0
6.0
7.08.0
9.0
ce(USD)
Oct 10: Dexia is nationalized
remain high until
Europe movesmoreaggressively
toward resolution
0.0
0.5
1.0
.Pri
0.0
1.0
2.0
3.0
4.0Pri
Key Date October 10: Nationalization
October 31: Filed for bankruptcy
th
Size
Drivers
Assets: 517 bn
Sovereign exposure: Over 20 bn to peripherals
Reliance on wholesale funding
. .
Assets: $41 bn
Sovereign exposure: $6 bn to Europeansovereigns
-
88888
Encumbered assets
Moodys Review for downgrade on Oct 3, 2011
Operational: Q2-2011 loss of 4 billion
investment grade
Operational: Q3-2011 loss of $192 million (fromEuropean debt trading losses)
Source: Bloomberg
-
8/2/2019 Tipping Point Nov 2011 FINAL
10/51
#4: The Fate of the Euro Itself
Worlds Largest Currency & Trade UnionOver 60 Years of History
1951: European Coal and Steel Community (ECSC)established (EU predecessor)
# of Countries: 17
Total Population: 330 million
1965: Merger Treaty signed
1973: UK, Denmark and Ireland join EU
1979: European Parliament is elected
Total GDP: 9.5 trillion
Total Debt: 8.4 trillion
Rank Partner TotalTrade(EURBn) %ofTotal
1986: Spain and Portugal enter EU
1992: Maastricht Treaty signed
1998: ECB established through the Treaty of Amsterdam
xtra , .1 U.S. 412 14.4%
2 China 395 13.9%
3 Russia 245 8.6%
2001: Greece enters euro
2010:
May: Greece 110 bn bailout; Creation of EFSF
4 Switzerland 190 6.6%
5 Norway 121 4.2%
6 Japan 109 3.8%
2011:
May: Portugal 78 billion bailout
July: Initial Greece restructuring announced
.
8 India 68 2.4%
9 SouthKorea 67 2.3%10 Brazil 64 2.2%
99999
:
Source: IMF, Bloomberg, European Commission, Eurostat (2010)
At stake, quite simply, is over 50 years of history and the worlds largest currency and trade union
-
8/2/2019 Tipping Point Nov 2011 FINAL
11/51
Key Takeaways for Issuers and Investors
For Issuers For Investors
What Are the Key Takeaways in the Meantime?
. .,Dexia, MF Global)
Contagion to global economy could be significant
Funding market stress will remain unpredictable and
g er rate , non- nanc a s over nanc a s
Lower beta names over higher beta and cyclicals
On the run benchmarks over less liquid alternatives. .
High credit spread correlation between EU and U.S.banks
Continued correlation between new issue volumes and
Higher LCH haircuts (initial margin) for Italian bonds onNov 9 was a critical trigger event
Primary dealer bond inventory and trading volumes atrecord lows
Better market access for higher rated, non-financialnames
More active hedging of rates, FX and commodities riskadvised
Liquidity could be exacerbated by "year-end effect"
EUR / USD is probably the worst instrument toexpress negative Euro area views (peripheral bonds
Euro "tail risk" downside protection increasinglyimportant (especially given current Tipping Point)
an equ t es are a muc etter gauge o stress
Italian bond yields have become the new barometer toevaluate the crisis
1010101010
Until confidence is restored and Europe accelerates its crisisresponse via the ECB, volatility and systemic risk will remain high
Source: Deutsche Bank Global Markets Research - Economics, Credit, Rates, and FX. Credit trading strategist: Richard Salditt
-
8/2/2019 Tipping Point Nov 2011 FINAL
12/51
Looking Ahead: 10 Key Risks
Risks
1. Unsustainable Italian bond yields (especially ifGerman Bundesbank resists ECB ex ansion
Risks
6. Execution risk on new EFSF insurance/ SPV plan toring-fence Italy and Spain
2. Year-end effect: Selling pressure on bank balancesheets going into year end
7. France losing its AAA rating (and negativeimplications for EFSF)
3. European recession deeper than expected / Italiangrowth
8. Downside on EUR / USD (given current Tipping Pointmoment)
. arger sys em c r s even s .e. ex a, o a
5. Greek debt sustainability / PSI execution
.
10. Beginning of Euro unwind (i.e. Greece exit)
It is an understatement to su est there are a lot of balls in the air.
1111111111
You have to be a true optimist to believe that policy makers are going to catch them all.~ Alan Ruskin, Deutsche Bank FX Strategist
-
8/2/2019 Tipping Point Nov 2011 FINAL
13/51
2. Recent Escalation of the Crisis
-
8/2/2019 Tipping Point Nov 2011 FINAL
14/51
5 Recent Problem Areas
Recent escalation of the Euro crisis has occurred around 5 key problem areas in particular:
1. Confidence
. qu y an so vency concerns
3. Political failures
4. Competitiveness concerns
5. Stress in bank funding markets
1313131313
-
8/2/2019 Tipping Point Nov 2011 FINAL
15/51
#1: Confidence
EUR vs. JPY and CHFItalian 10y Bond Yield7.5 EUR J a anese Yen EUR S wiss Fr anc
7.0
2%
4%
6%
8%
The Euro has weakened sharply against safe-havenalternatives such as the Yen and the Swiss Franc
Nov 7: EFSF 3 bn bond prices wide at MS+104 bps
Nov 8:PM Berlusconi finally agrees to resign
Nov 9: LCH increases haircut on Italian bonds
6.0
.
Yield(%)
6%
4%
2%
0%
5.0
.
12%
10%
8%
.
1Ju
l
8Ju
l
15
Ju
l
22
Ju
l
29
Ju
l
5
Aug
12
Aug
19
Aug
26
Aug
2
Sep
9
Sep
16
Sep
23
Sep
30
Sep
7
Oct
14
Oc
t
21
Oc
t
28
Oc
t
4
Nov
11
Nov
5
Aug
12
Aug
19
Aug
26
Aug
2
Sep
9
Sep
16
Sep
23
Sep
30
Sep
7
Oct
14
Oct
21
Oct
28
Oct
4
Nov
11
Nov
The global capital markets have lost confidence in the institutional structures and framework of the Euro
2 sta es of crisis escalation in last 90 da s
1414141414
Source: Bloomberg
1. Collision with U.S. downgrade event on Aug 5
2. Extreme Greece and Italian political turmoil after Grand Plan announced on Oct 27
-
8/2/2019 Tipping Point Nov 2011 FINAL
16/51
#2: Liquidity and Solvency Concerns
Liquidity vs. Solvency Risk
GDP Total Debt Govt Debt / GDP Private SectorDebt / GDP
Type of Risk
220 bn 350 bn 160% ~ 175% Solvency
1,087 bn 733 bn 67% ~ 330% Liquidity
1,590 bn 1,924 bn 121% ~ 145% Liquidity
Italy Shouldnt Be A Solvency Issue But a Liquidity Issue 120% debt / GDP is high but stable
50% of public debt owned domestically
Europes largest sovereign debt market (3rd
Over 2 trillion of sovereign debt outstanding
10-year yields traded near 7.5% (Nov 8 9)
Market demanding:
- Large structural and fiscal austerity
Large, wealthy and unlevered private sector
3rd largest euro zone economy and 4th in the EU
- Strong, credible government leadership
LCH imposing higher margin requirements onItalian debt (haircut increased Nov 9)
Large ECB (or EFSF) liquidity backstop needed
1515151515
Source: Bank of Spain , Bank of Greece , Bank of Italy, IMF, Deutsche Bank Global Markets Research
The Italian political turmoil during Nov 2nd week nearly turned a liquidity issue into a credit event
-
8/2/2019 Tipping Point Nov 2011 FINAL
17/51
#3: Political Failures
Nov 8: Berlusconi resigns
2011: Political Leadership ChangeMultiple Levels of Political Risk
Nov 13: Replaced by Monti
Nov 10: Papandreou resigns
Nov 11: Replaced by Papademos
erman un es an n rans gence regar ngmore expansive ECB role
Limited Italian bond-buying to effectively force- ov : pan s e ect on
- PM Zapatero will not run for re-election
Mar 23: Socrates resigns
Jun 21: Replaced by Passos Coelho
out Berlusconi
Awaiting more aggressive Italian fiscal austerity
Jan 22: Cowen resigns
Jan 26: Replaced by Kenny
Vigorous debate over details of Grand Plan
French delays on own austerity before April election
sca a on o e uro cr s s n as resu e n
political leadership change in all 5 peripherals
New more Euro-centric leadership:
- Greeces Papademos formerly at ECB (Frankfurt)
-
Papandreous high stakes political gamble(confidence vote and referendum proposal)
1616161616
(Brussels)
er uscon s res s ance o epar ure
Delays on comprehensive fiscal austerity
-
8/2/2019 Tipping Point Nov 2011 FINAL
18/51
#4: Competitiveness Concerns
2011E GDP Growth RatesCompetitiveness
concerns haverecentl focused on
6%
8%
Italy: 0.5%
Italy in particular
6%
4%
2%
0%
2%
Estonia
Luxembourg
Slovakia
Finland
Germany
Austria
Malta
Belgium
Slovenia
Netherlands
Ireland
France
Spain
Italy
Cyprus
Portugal
Greece
Ireland
Greece
Spain
France
Portugal
Slovenia
Cyprus
Slovakia
Luxembourg
Italy
Netherlands
Malta
Belgium
Austria
Estonia
Germany
Finland
0%
5%
10%
fGDP
Italy: -3.8%
8%
6%
4%
2%
0%
%ofG
DP
10%
5%
bourg
lands
many
ustria
lgium
tonia
nland
eland
vakia
venia
rance
Italy
Malta
Spain
yprus
rtugal
reece
%
o
1717171717
Source: OECD, Deutsche Bank Global Markets Research; Malta National Statistics Office, IMF, S&P, Slovak Government
12%
10%
Luxem
Nethe
Ger A
Be E F
i IrSl
Slo F C
Po G
Italy: -4.0%
-
8/2/2019 Tipping Point Nov 2011 FINAL
19/51
#5: Stress in Bank Funding Markets
250
Euro Basis SwapEuribor-OIS
200
250 Overnight inter-bank funding costs in Europe haveincreased significantly (~65 bps since July 1)
US$ funding costs have also increasedsignificantly, with the Euro basis swap
-200
150
100
Bps
100
150
Bps
- we e ow eve s ur ng e nanc a cr s s o2008
- Still below levels during the financial crisis of
2008
50
0
Aug08 Feb09 Aug09 Feb10 Aug10 Feb11 Aug11
0
50
Au
g
08
Nov
08
Feb
09
May
09
Au
g
09
Nov
09
Feb
10
May
10
Au
g
10
Nov
10
Feb
11
May
11
Au
g
11
Nov
11
Selected Bank CDS Spread (as of Nov. 14, 2011)
600
700CDSonNov14,2011 PeakCDSlevelsinceJuly21,2011
200
300
400
500
Bps
1818181818
Source: Bloomberg
0
100
MS BAC SocGen GS Citi BNP Barclays UBS DB CS JPM HSBC
-
8/2/2019 Tipping Point Nov 2011 FINAL
20/51
Key Upcoming Dates
Date Detail
November 20 Spanish general election expected (4 months earlier than expected)
. . ,
November 29 - 30 Eurogroup / ECOFIN Finance Ministers meetings
December Troika review of Greece finances to determine 7th quarterly aid installment
, ,
December 8 ECB Governing Council meeting
December 9
EU Summit (leaders expected to discuss EFSF and fiscal union)
December 25 Bank capital raising plans due for meeting 106 billion target
January 2012 Target date for completion of Greece 50% debt haircut exercise (could be sooner)
pr renc res ent a e ect on
June 30, 2012 Deadline for EU Banks to meet 106 billion capital target
1919191919
With elevated stress in both the sovereign crisis and bank funding markets, the year-end effectfor bank balance sheets this year could create heightened pressure for sovereign bond markets
-
8/2/2019 Tipping Point Nov 2011 FINAL
21/51
3. Searching for a Solution
-
8/2/2019 Tipping Point Nov 2011 FINAL
22/51
A. Time to Call the ECB
-
8/2/2019 Tipping Point Nov 2011 FINAL
23/51
Time to Call the ECB
Why Larger ECB Role Now?EFSF Financings to Date
Date: Nov 7, 2011 1. Ineffectiveness of current ECB monetary policytransmission mechanism to kee bond ields low
Size: 3 bn, 10-year
Pricing: MS + 104 bps (+177 bps over German bunds) 2. Italian bond market is now broken
- Sharp contagion of the crisis to Italy the week ofNov 7
a e: une ,
Size: 3 bn, 5-year
Pricing: MS + 6 bps
3. Investor reluctance on the EFSF 1 trillionleverage plan
- Insurance guarantee plan-
Date: June 15, 2011
Size: 5 bn, 10-year
Pricin : MS + 17 b s
-
4. Weakness of the EFSFs 3 billion financing onNov 7
- Contagion from Greece and Italy turmoil
- Less confidence in credit resilience of guarantors(i.e. France)
- Uncertainty around EFSF leverage plan
2222222222
Source: Deutsche Bank Global Markets Research Thomas Mayer, Giles Moec, Mark Wall, Peter Hooper, Torsten Slok, EFSF
-
8/2/2019 Tipping Point Nov 2011 FINAL
24/51
Time to Call the ECB
200
ECB Sovereign Bond PurchasesKey Steps Needed From ECB
Significant expansion of ECB balance sheet(analogous to U.S. Fed) Total: 187 billion
120
140
160
ions
- To fulfill role previously planned for fully levered EFSF
Key steps recommended in new ECB approach:
40
60
80
100
EURBill
1. Depart from current bond purchase program("limited" and "temporary")
2. Formal end to "sterilization" of urchases (alread
0
20
ay
10
un
10
Jul10
ug
10
ep
10
ct10
ov
10
ec
10
an
11
eb
11
ar
11
pr11
ay
11
un
11
Jul11
ug
11
ep
11
ct11
underway due to unlimited liquidity facilities)
3. Pre-announce a volume of purchases such as EUR200 billion over 12 months
MJ A S N D J F M M
J A S- "Unlimited" commitment more impactful butpolitically unrealistic
~ 50 billion of Greek bonds
Over 100 billion of largely Italian and Spanish bondurchases since Au ust
2323232323
Source: Deutsche Bank Global Markets Research Thomas Mayer, Giles Moec, Mark Wall, Peter Hooper, Torsten Slok, ECB, Bloomberg
-
8/2/2019 Tipping Point Nov 2011 FINAL
25/51
Time to Call the ECB
Stron , credible Italian Government under Mario
Potential Consequences of ECBNot Expanding Role
Key Pre-Conditions Neededfor New Approach
Monti
Passage of large, credible Italian fiscal austerity
limited approach
Loss of ECB credibility over time
Progress on EU fiscal "integration" at Dec 9 EUSummit, or earlier (recognizing that true politicaland/or fiscal union is not a realistic goal)
Possible bank system runs from Southernperiphery to Northern banks
At least "passive tolerance" from a reluctant
German Bundesbank in Frankfurt
- Draghi will not get unanimous support
One of the severest forms of monetary policy being roped in for fiscal purposes is monetary financing, incolloquial terms also known as the financing of public debt via the money printing press. The prohibitionof monetary financing in the Euro Area is one of the most important achievements in central banking ands ecificall for German it is also a ke lesson from the ex erience of h erinflation after World War I.
2424242424
~ Jens Weidmann, Head of Germanys Bundesbank (& ECB Council Member)
Source: Deutsche Bank Global Markets Research Thomas Mayer, Giles Moec, Mark Wall, Peter Hooper, Torsten Slok
-
8/2/2019 Tipping Point Nov 2011 FINAL
26/51
Time to Call the ECB
ECB Sovereign Bond PurchasesTotal ECB Lending
ECB Monetary Policy Transmission to Euro Zone Ineffective
The ECB monetary policy transmission mechanism hasbecome ineffective at keeping Euro bond yields low
- Even though the 10y Eonia rate declined over 30 bps sinceSeptember, Euro Zone and peripheral interest rates have
Peripheral bond yields: Now negatively correlated to theEonia rate
Core European yields: Decreasing their correlation to Eonia(20% drop in French yield correlation)
2525252525
Note: Eonia rate is an effective overnight interest rate computed as a weighted
average of all overnight unsecured lending transactions in the interbank marketSource: Deutsche Bank Global Markets Research - Francis Yared
This suggests that monetary policy alone is not enough,
and that further SMP purchases are necessary to containinterest rates in the region
-
8/2/2019 Tipping Point Nov 2011 FINAL
27/51
Time to Call the ECB
LTRO MRO Other li uidit rovidin o erations
ECB Liquidity FacilitiesTotal ECB Lending
Continued Liquidity Support Until Bank Funding Stress Subsides
700
800
900
1000
784 bn 3-month and 6-month Longer Term Refinancing
Operations (LTRO)- Full allotment
- Unlimited
300
400
500
600
EURBillions
12-month LTRO
- Reintroduced Oct 6
- Full allotment
0
100
200
Jan
07
pr
07
Jul07
Oct07
Jan
08
pr
08
Jul08
Oct08
Jan
09
pr
09
Jul09
Oct09
Jan
10
pr
10
Jul10
Oct10
Jan
11
pr
11
Jul11
- Unlimited
US$ Funding
-
As of Nov. 14, 2011:
LTRO: 374 bn
MRO: 193 bn
Sept 15- Critical given pull-back from $2.7 trillion U.S. money
market funds
2626262626
Other: 217bn
Total: 784 bn
Source: Deutsche Bank Global Markets Research Thomas Mayer, Giles Moec, Mark Wall, Peter Hooper, Torsten Slok, ECB, Bloomberg
-
8/2/2019 Tipping Point Nov 2011 FINAL
28/51
Time to Call the ECB
Evolution of U.S. Federal Reserve Balance Sheet Expansion
03,000,
CPFundingFacility MoneyMarketFundingFacility
0
0
2,000,
2,500,
n
PrimaryCredit FederalAgencyDebtSecurities
MBS Repos
U.S.TreasurySecurities OtherCredit
AssetBackedFundingFacility RescueFundsforAIG
0
0
1,000,
1,500,US$ TermAssetBackedLoanFacility Treasuries
0
0500, MBS
The Fed aggressively grew its Balance Sheet from ~ $800 billion in 2008, to over $2.5 trillion today
Jan
06
Apr
06
Jul
06
Oct
06
Jan
07
Apr
07
Jul
07
Oct
07
Jan
08
Apr
08
Jul
08
Oct
08
Jan
09
Apr
09
Jul
09
Oct
09
Jan
1
Apr
1
Jul
10
Oct
1
Jan
11
Apr
11
Jul
11
Oct
11
2727272727
Source: Federal Reserve
Comparably aggressive growth of the ECB Balance Sheet is a key missing ingredient in EuropesGrand Plan and, we believe, will ultimately be needed to resolve the crisis
-
8/2/2019 Tipping Point Nov 2011 FINAL
29/51
B. Time to Expedite the Grand Plan
-
8/2/2019 Tipping Point Nov 2011 FINAL
30/51
Time to Expedite the Grand Plan
Pillars July 21, 2011Agreement
October 27Grand Plan
Greek Debt 21 % 50%Pillar 1
oan ma ur es ex en e rom .years to as much as 30 years
Based on Greece Debt / GDP target in2020 of approx 160%
ey e a s on new on s s
Based on Greece Debt / GDP target in
2020 of approx 120%
an ngSector Capital(& DebtGuarantees)
. on
Based on July 2011 stress test results
No haircuts on banking book sovereignexposures (trading book only)
on
June 2012 deadline to meet target
Mark-to-market of sovereign exposures
Debt guarantee program re-introduced
Pillar 2
Leverage EFSFto ~ 1 Trillion
440 billion
Upsized from ~ 250 billion
Expansion of new powers to buy bondsand support banks
~ 1 Trillion
Assumes 4 5x leverage through new:
1) Insurance guarantee scheme
Pillar 3
AdditionalGreek Bailout
109 billion
~ 20 billion for Greek banks
130 billion
30 billion for Greek banksPillar 4
2929292929
PSI debt restructuring
(1) 210 bn of the 350 bn of Greek debt outstanding is held privately; assumes 100% participationSource: EBA, EU Commission
-
8/2/2019 Tipping Point Nov 2011 FINAL
31/51
Pillar # 1: Greek Debt Haircut
PSI Plan Overview
Haircut: 50% on all bonds held by private sector
Debt reduction target:160%
Debt / GDP of European Peripherals
160%
100 bn area (50% write-down of 210 bn of the 350bn total Greek debt)
Target reduction of Debt / GDP from160% to 120%
Reduced interest payments of approx 6 bn per year120%
140%
Target Debt / GDPreduction from EuropesGrand Plan
120%
Participation / New bonds:
Voluntary (would therefore not trigger CDS)
New bond details still TBD (maturity, coupons)
New bonds expected to be issued under English law60%
80%
Restructuring sweetener: 30 bn of collateral tosupport bond swaps
Conditionality:
More stringent Troika monitoring of Greece0%
20%
40%
Commitment to 15 billion of privatizationsGreeceItalyIrelandPortugalSpain
Restructuringnot on the
Open torestructuring
21% Greekdebt haircut
50% Greekdebt haircut
3030303030
Source: IMF, European Council
tablea eronly
announce announce
May 2010 Nov 2010 July 2011 Oct 2011
-
8/2/2019 Tipping Point Nov 2011 FINAL
32/51
Pillar # 1: Greek Debt Haircut
Top Banks Holdings ofGreek Sovereign Debt
Size of CDS Markets onSovereign Debt
reece
France
Germany
48.4 bn
9.6 bn
7.6 bn
France
Italy
24.0 bn
22.0 bn
Cyprus
Belgium
UK
5.8 bn
3.9 bn
2.2 bn
Germany
Spain
19.6 bn
18.0 bn
Portugal
Italy
1.4 bn
1.4 bn
1.2 bn
Portugal
U.S.
.
5.6 bn
5.5 bn
0 10 20 30 40 50
Austria 0.9 bn
0 5 10 15 20 25 30
Greece 3.7 bn
EUR BnEUR Bn
3131313131
Source: EBA, Wall Street Research, Wall Street Journal
sovereign debt by a large margin
Many banks have already done a full mark-to-market EU trading restrictions, and a restructuring that
side-stepped CDS triggers, have marginalized
this market
-
8/2/2019 Tipping Point Nov 2011 FINAL
33/51
Pillar # 2: EU Bank Sector Capital
Greece
Indicative Bank CapitalShortfalls by Country
30.0 bn
Recap requirement: 106 billion
Scope: 70 banks (details on individual banks TBD)
Plan Overview & Observations
Spain
Italy
France
26.2 bn
14.8 bn
8.8 bn
Test criteria: 9% Core Tier 1 target ratio
- MTM treatment of sovereign bond holdings as of Sept2011; Basel 2.5 methodology for RWA
Timeline: 6- 9 months (June 2012)
Portugal
Germany
7.8 bn
5.2 bn
4.1 bn
Source of Capital:
- Step # 1: Private sector
- Step # 2: Government (if needed)
Cyprus
Austria
3.6 bn
2.9bn
- ep : nee e
Greek banks receiving most capital (approx 30 bngiven 50% haircut on ~ 50 bn of Greek bond holdings)
Higher than expected capital shortfalls for Spanishand Italian banks 2/3 of total
we en
Norway
Slovenia
.
1.3 bn
0.3 bn
Lower than expected capital shortfalls for French andGerman banks
EBA (bank regulator) asked to work with the ECB, EIBand EU Commission to explore options for a
3232323232
0 5 10 15 20 25 30
EURBillionSource: EBA, Wall Street Research, Wall Street Journal
Total: 106 bn
coordinated bank debt new issue guarantee scheme
Guarantee not to come from pooled resources
Therefore likely to only benefit AAA rated countries
-
8/2/2019 Tipping Point Nov 2011 FINAL
34/51
Pillar # 2: EU Bank Sector Capital
Potential Capital Raising Actions (To Reach $106 Billion)
Actions Potential Size Comment
as est pat or pro ta e an s to meet cap ta s ort a s
Dividends / hybriddistributions 10 15 billion area Combination of distribution cancellation and scrip dividends
Increased deferred compensation and equity consideration foremployees
Disposal of RWAs TBD
Focus on capital intensive assets (e.g., first loss securitizationpieces, correlation loan books, and unrated leveraged loans)
Subject to regulator oversight to ensure no excessivedeleveraging
Liability management 20 30 billion area
Subordinated debt tenders and debt for equity swaps availablefor banks with large amount of paper trading below par
Potentially as much as 45 bn available
Contingent capital TBD Unlikely to be popular until clarity that CoCos would be eligibleunder Basel 3
Rights issuance / common Market estimates suggest 10 30 billion area, although
3333333333
Source: EBA, Deutsche Bank Global Markets Research
equity
Stronger banks likely to pursue conventional rights issues
-
8/2/2019 Tipping Point Nov 2011 FINAL
35/51
Pillar # 2: EU Bank Sector Capital (& Guarantees)
2012 2014 EuropeanSenior Bank Debt Redemptions Bank Debt Issuance Guarantees
Coordinated State guarantees on new bank bonds845900
Scheme will be harmonized, but guarantee will notcome from pooled sources (i.e., EU)
Therefore, only AAA rated country banking
673
583600
700
800
systems likely to benefit
Much of the detail still TBD (EBA required to
coordinate with ECB, EIB and EU Commission)
400
500
EURBn
Observations
DB expects take up of guaranteed fundingscheme to be low
100
200
Maturity wall of ~ 800 billion in 2012
Usage of such scheme will trigger State Aid
penalties on same basis as October 2008 EUguidance:
- Business constraints
-
2012 2013 2014
3434343434
Source: Deutsche Bank Global Markets Research, European Council, Dealogic
- Potential restructuring
-
8/2/2019 Tipping Point Nov 2011 FINAL
36/51
Pillar # 3: Leverage EFSF to ~ 1 Trillion
EFSF 2.0: 450 Billion
2 Plans: Detail
1. Insurance EFSF to provide partial first loss
EFSF 3.0: ~ 1 Trillion
EFSF1.0 EFSF2.0Germany 119.4 211.1 AAA/Aaa/AAA
France 89.7 158.5 AAA/Aaa/AAA
GuaranteePlan
insurance on new sovereign debtissuance (20 30% expected)
- Unclear if insurance will be attachedor separately traded instrument
Netherlands 25.1 44.5 AAA/Aaa/AAA
Austria 12.2 21.6 AAA/Aaa/AAA
Finland 7.9 13.9 AAA
/
Aaa
/
AAALuxembourg 1.1 1.9 AAA/Aaa/AAA
Belgium 15.3 27 AA+/Aa1/AA+
Spain 52.4 92.5 AA/Aa2/AA+
2. SpecialPurposeVehicle (SPV)
for privatesector ca ital
SPV with multi-tranche capitalstructure, based on seniority:
1. Senior debt instrument: targeted at
traditional fixed income investors
oven a . . a
Estonia 1.9 AA /A1/A+
Slovakia 4.4 7.7 A+/Aaa/A+
Italy 78.8 139.3 A+/Aa2/AA
Malta 0.4 0.7 A/A1/A+
Cyprus 0.9 1.5 A
/A2
/A
Ireland 7 12.4 BBB+/Baa3/BBB+
2. Mezzanine capital participationinstrument: targeted at sovereignwealth funds
3. EFSF first loss absorbing tranche
Portugal 11 19.5 BBB /Baa1/BBB
Greece 12.4 21.9 CCC/Caa1/B+
GrossTotal 440.0 779.8NetTotal 255.4 451.5 Effectivecapacity EFSF (2.0) total capacity: ~ 440 billion
EFSF (2.0) unused capacity: 250 billion (net ofGreece, Ireland and Portugal bailouts)
DB believes the 1 trillion leverage plan for the EFSFannounced on Oct 27 ma no lon er be a viable o tion
3535353535
(1) Effective lending capacity of 440 bn minus bailouts for Portugal, Ireland, and GreeceSource: European Council, Deutsche Bank Global Markets Research
. s ze: wou ever - x to ~ r on area(although smaller leverage of 3-4x may be more likely)
-
8/2/2019 Tipping Point Nov 2011 FINAL
37/51
Pillar # 3: Leverage EFSF to ~ 1 Trillion
EFSF Insurance Scheme Pricing Considerations
Amount of Equivalent CDS for Various Guarantee Value Assuming 25% First LossProtection at Various Recover Rates
FirstLossProtection 30% 25% 20%
CDSRecovery ImpliedEquivalentAmountofCDSprotectionfor100mbond
0% 30 25 20
10% 33 28 22
20% 38 31 25
30% 43 36 29
40% 50 42 33
50% 60 50 40
60% 75 63 50
the proposed EFSF insurance guarantee scheme Higher first loss protections are analogous to higher
CDS protection for any given recovery rate
Using CDS replication, DB has measured the
e expecte va ue o t e guarantee or ta y an pa n
10y bonds is approx. 200 bps and 175 bps, respectively(based on 25% guarantee / 40% recovery)
Key Question: Will investors buy Italian bonds at yields
3636363636
Source: Deutsche Bank Global Markets Research Frances Yared.
t eoret ca va ue o t e nsurance sc eme atvarious recovery rates
-
8/2/2019 Tipping Point Nov 2011 FINAL
38/51
Pillar # 3: Leverage EFSF to ~ 1 Trillion
Detailed Overview of Option 1: Insurance Scheme
DescriptionFor illustrative purposes only actual structure TBD
(critical details to be discussed with investors and Rating Agencies)
$
1. EFSF provides sovereign issuers with partial firstloss insurance
Leverage size depends on percentage of insuranceprovided (20 30% insurance or 4-5x leverage
3a
25% First Loss $ (in case of default)
,
Considering 250 bn as the EFSF base fire power, thefund would be able to insure approx 1 trillion of newissuance (theoretically); actual could be lower
1
InvestorsSovereign
Issuers
$
2. Sovereigns issue bonds with guarantee aimed atreducing yields (unclear if guarantee will be attachedor separately traded instrument)
3b
on s
with creditenhancement
3a. EFSF funds possibly held in a Trust to ensure
payment to investors in case of default (othercontingent funding arrangements also underconsideration to avoid grossing up member state balancesheets in advance of trigger event)
2
New Bonds
*** In both structures, the EU would be subordinated to
3737373737
3b. Trust repays investors 20% - 30% of losses ondefault
the private sector
-
8/2/2019 Tipping Point Nov 2011 FINAL
39/51
Pillar # 3: Leverage EFSF to ~ 1 Trillion
Description
Detailed Overview of Option 2: Creation of SPV
For illustrative purposes only actual structure TBD(critical details to be discussed with investors and Rating Agencies)
1. SPV is created: multi-tranche capital structure expected:
- Senior debt tranche (with ratings): targeted attraditional fixed income investors
SPV
1
2
- Mezzanine capital participation instrument: targetedat sovereign wealth funds
- EFSF first loss absorbing tranche (EU subordinated to
private sector)
Investors
SWFs China Japan
BRICS
3en or etranche
Mezzanine
2. Issues senior bonds backed by EFSF contingentcapital (to further lever size)
3. Foreign official sector (IMF) and non-Europeansovereigns provide mezzanine capital
IMF role?
EFSF
EFSF firstloss
tranche
4. SPV purchases sovereign debt, relieving some of theburden of the ECB
SPV could possibly purchase primary or secondarydebt, or even extend loans for bank recaps
45
3838383838
5. EFSF provides partial first loss insurance (% guaranteecurrently unknown but 20 - 30% expected)
on ar et(primary or secondary) *** or to even extend
loans for bank
recaps
-
8/2/2019 Tipping Point Nov 2011 FINAL
40/51
Pillar # 3: Leverage EFSF to ~ 1 Trillion
Given recent escalation of the crisis to Italy, execution of the 1 trillion EFSF leverage plan hasbecome more difficult, and may no longer be a viable option
Important Additional Points on the EFSF Leverage Plan
- Investor reluctance- Sharp crisis escalation since Oct 27
In both structures, the EU would effectively become subordinated to private capital (a new and
It could take significant time to work through final structure details, given the requireddiscussions and negotiations with both investors and the Rating Agencies
ppears ess e y t at nvestors w ass gn t e same va ue to t e nsurance o new ssuebonds as theoretical calculations would suggest (i.e., nearly 200 bps for 10 year Italian bonds)
Still unclear if the guarantee would be attached to the bonds or if they would trade separatelythe latter ma offer a ood solution for the otential im act of the lan on existin bonds
While the insurance scheme may be generally more targeted toward primary bonds, the SPVcould possibly purchase primary bonds, secondary bonds or even extend loans for bank recaps
3939393939
,critical details still to be determined (and escalation of the crisis to Italy)
-
8/2/2019 Tipping Point Nov 2011 FINAL
41/51
Grand Plan Missing Pieces: Greek Debt Haircut
Grand Plan Missing Pieces: Greek Debt Haircut
Maturity and coupon of new bonds
Details related to planned 30 billion in credit enhancement on new bonds
Details around NPV calculation based on proposed haircut and terms of new bonds
Will such a large haircut (i.e., 50%) attract target investor participation rate above 90%? Will sufficientmeasures be put in place to ensure high voluntary participation?
What will be next steps if investor participation is lower than expected?
, ,
Will the restructuring exercise be completed before January as planned?
Will Greeces debt burden post-exercise (at 120% of GDP) be sustainable?
Will such large haircuts reduce the pressure on Greece around structural reform and fiscal austerity?
Will the combination of EU trading restrictions, and the side-step of CDS triggers in the voluntaryGreece restructuring, lead to the demise of the sovereign CDS market?
4040404040
The implementation challenge is as high, if not higher, than the design challenge.
~ Mohamed El-Erian, PIMCO
-
8/2/2019 Tipping Point Nov 2011 FINAL
42/51
Grand Plan Missing Pieces: EU Bank Sector
Grand Plan Missing Pieces: EU Bank Sector
Types of qualifying capital that constitute "highest quality
Final individual bank ca ital shortfalls (current #s are indicative onl ; EBA will not ublish bank b bank data;rather, they leave it to the banks to disclose themselves)
Scope of permissible deleveraging to reach target (will be subject to close regulator monitoring)
Details on bank debt guarantee scheme
Key Questions
What will be the capital target plans for the weakest banks (presumably Government or EFSFca ital as re uired ?
Is the capital target size large and rigorous enough to restore confidence, such that bankfunding markets re-open?
How extensively will the new bank debt guarantee scheme be utilized (presumably by banks inAAA countries only)?
Given high market uncertainty (sovereign crisis, economic, regulatory), will banks continue tode-lever balance sheets in size and pull back sharply on credit extension?
4141414141
-
8/2/2019 Tipping Point Nov 2011 FINAL
43/51
Grand Plan Missing Pieces: EFSF Leverage Plan
Grand Plan Missing Pieces: EFSF Insurance / SPV Leverage Plan
Final size (will be much smaller if leverage is only 3-4x, instead of 4-5x as planned)
% guarantee on EFSF bond insurance plan (20 30% area expected)?
Timing and scope of bond purchases (primary vs. secondary market purchases)
Role of the IMF (Capital contribution? Oversight role? Exercise control? Conditionality?)
SPV capital structure (seniority of tranches)
Collateral uarantees and/ or conditionalit re uired b forei n ublic sector investors China Brazil etc
Key Questions
Is the plan still viable given crisis escalation since Oct 27?
Will investors value guarantee to full theoretical value (i.e., 200 bps)?
Will the guarantee be attached or trade separately (possibly aimed at alleviating pressure on existing bonds)?
What will be the impact of the guarantee on the trading levels of existingbonds?
Will SPV structure attract outside sovereign wealth fund (i.e., China, BRICs) and private capital in size? IMF role?
Execution risk related to com lexit of ca ital structure, cor orate overnance and/or covenant issues in the new SPVstructure? Will there be one large SPV or several different ones?
How much time will it take to gather sufficient investor and rating agency feedback to finalize structure?
Should EU instead pursue a larger and more flexible AA rated EFSF, rather than smaller and more restricted AAA fund?
Who, in the end, is Europes lender of last resort?
4242424242
-
8/2/2019 Tipping Point Nov 2011 FINAL
44/51
Looking Ahead: Risk of Additional Downgrades
Rating / Outlook
Germany Aaa / Stable AAA / Stable AAA / Stable
Selected European Country Credit Ratings
France Aaa / Stable AAA / Stable AAA / Stable
Austria Aaa / Stable AAA / Stable AAA / Stable
Finland Aaa / Stable AAA / Stable AAA / Stable
Luxembourg Aaa / Stable AAA / Stable AAA / Stable
AAA
Netherlands Aaa / Stable AAA / Stable AAA / Stable
Slovakia Aaa / Stable A+ / Positive A+ / Stable
Belgium Aa1 / Neg. Watch AA+ / Negative AA+ / Negative
Spain A1 / Negative AA- / Negative AA- / Negative
Slovenia Aa3 / Stable AA / Negative AA -/ Negative
Estonia A1 / Stable AA- / Stable A+ / Stable
Italy A2 / Negative A / Negative A+ / Negative
Malta A2 / Ne ative A / Stable A+ / Stable
InvestmentGrade
(below AAA)
Cyprus Baa1 / Negative BBB+ / Neg. Watch BBB / NegativeIreland Ba1 / Negative BBB+ / Stable BBB+ / Negative
Portugal Ba2 / Negative BBB- / Negative BBB- / Neg. WatchSubInvestment
4343434343
Source: Moodys, S&P, Fitch; Moodys developing outlook reflects the uncertainty about the exact market value of the securities creditors would receive in an exchange
Ratings on negative watch or outlook in red font
-
8/2/2019 Tipping Point Nov 2011 FINAL
45/51
4. Outlook for the Euro
-
8/2/2019 Tipping Point Nov 2011 FINAL
46/51
Outlook for the Euro
EUR Currency Performance (2011) DB EUR 2011 2012 Forecasts
Currency Q4 - 2011 Q1-2012 Q3-2012 Q4-201215%
EUR/USD EUR/CHF EUR/JPY
EUR / USD 1.30 1.27 1.25 1.23
EUR / JPY 101 99 105 1110%
5%
10%
EUR / GBP 0.86 0.86 0.84 0.79
15%
10%
5%
EUR / CHF 1.30 1.25 1.25 1.2525%
20%
Despite the escalation of the crisis, the EUR has heldup well vs. the USD
However, the EUR declined significantly against the
DB 2011YE EUR/ USD Forecast: 1.30
DB 2012YE EUR/ USD Forecast: 1.25
- Downside risks could be significant depending on crisis
4545454545
Yen and the Swiss Franc unt anintervention)
resolution
Source: Deutsche Bank Global Markets Research Bilal Hafeez, Alan Ruskin, George Saravelos
-
8/2/2019 Tipping Point Nov 2011 FINAL
47/51
Outlook for the Euro
EUR / USD (2011)
Why Has EUR / USD Held Up So Strong?
Drivers of 2011 EUR Resilience
1.45
. 1. Capital flows to core Europe (C/A + FDI)
- EU maintains a current account deficit of -0.7% vs.
U.S. current account deficit of -3.1%
- EUR FDI in the 12 months through August of +0.2% ofGDP vs. US FDI of -1.1%
1.35
1.40
EUR/USD
- China retains strong investment in core Europe
2. EUR has traded as a risk currency
- Correlation between S&P 500 and EUR near all time
hi hs
1.30DB 2011E Year-End: $1.30
Drivers of Recent EUR / USD Weakness
Contagion to France is key turning point for capitalflows into core Europe
1.25
DB 2012E Year-End: $1.25- ep a a revea e consecu ve mon s o nega ve
foreign inflows Escalation of the crisis causing heightened risk
aversion and wide scale risk-off trades
4646464646
Source: Deutsche Bank Global Markets Research Bilal Hafeez, Alan Ruskin, George Saravelos
,with both periphery bonds and equities purer gauges of stress.
~ Alan Ruskin, DB FX Strategist
-
8/2/2019 Tipping Point Nov 2011 FINAL
48/51
Outlook for the Euro
S&P 500 and EUR/USD Highly Correlated
EUR / USD has been resilient to the Euro eancrisis, partly because of its behavior as a riskcurrency
Correlation between EUR and S&P 500 is close toall-time highs, signaling that the euro is beingportrayed by the market as a risk asset
However, EUR bearish outlook will increase if riskaversion due to an escalation of the crisisincreases
Given the current Tipping Point moment, further escalation
4747474747
Source: Deutsche Bank Global Markets Research Bilal Hafeez, Alan Ruskin, George Saravelos
-
8/2/2019 Tipping Point Nov 2011 FINAL
49/51
Outlook for the Euro
2011 Performance of Selected
What Has Been a Critical Driver of Euro and Other Currencies in 2011?
.
10%
12%
14%
20%
25% NOK SEK CHF JPY
4%
6%
8%
5%
10%
15%
4%
2%
0%
5%
0%
Top performing currencies in 2011 have included theSwiss Franc (CHF), Norwegian Krone (NOK),Swedish Krona (SEK) and the Japanese Yen (JPY)
Sovereign account surpluses have become a goodproxy for currency performance
In 2011, top performing currencies are all of current
4848484848
account surplus countries
Source: Deutsche Bank Global Markets Research Bilal Hafeez, Alan Ruskin, George Saravelos
-
8/2/2019 Tipping Point Nov 2011 FINAL
50/51
Outlook for the Euro
In Downside Scenario, How Would Greece Euro Exit Mechanics Work?
Low (but rising)
Merkel and Sarkoz comments at Nov. 3 4 G-20 Summit crossed an im ortant s cholo ical barrier interms of their willingness to consider Greek exit
The economic, banking system and political costs of Euro unwind would far exceed the cost ofmaintaining current EMU construct (even if only 1 country exits)
Mechanism
n ecem er , t e reaty o s on prov e an exp c t ex t c ause vo untary as s on y or t efirst time in the history of the EU (simply notice required without specific reason)
Mechanism provides formal framework for EU exit
Voluntary exit only
What Would Be The Potential Cost and Implications?
Economic cost could be > 30% of GDP
Significant devaluation of the local currency andprivate sector assets
Soverei n default (lar er restructurin )
Massive disruption in EU payment systems
EU Greek corporate exposure are far in excess ofsovereign
Possible eri heral bank runs
4949494949
Capital controls
Collapse of Greek banking system
Negative impact on international trade
Significant political and credibility costs
-
8/2/2019 Tipping Point Nov 2011 FINAL
51/51