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Ireland:Blurring the Lines between Banking & Sovereign Risk
November 2010
Assessing the Implications of Sovereign Crisis 2.0 on U.S. Capital Markets
Tom Joyce
Debt Capital Markets Strategy
(212) 250 - 8754
Javier Guzman
Debt Capital Markets Strategy
(212) 250 - 3464
Deutsche Bank Securities Inc., a subsidiary of Deutsche Bank AG, conducts investment banking and securities activities
in the United States.
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Irish banks will become significantly smaller than they have in the past, so that they can
We have to fund ourselves as a state with senior debt. And other banks have to fund
.
~ Brian Cowen, Irish Prime Minister (Nov 21, 2010)
themselves with senior debt. You cannot send out a message in an economy like Ireland that
senior debt can be dishonored. We're far too dependent on international investment."~ Brian Lenihan, Irish Finance Minister (Sept 29, 2010)
There may be a contradiction between the interests of the financial world and the interests ofthe political world. We cannot keep explaining to our voters and our citizens why the taxpayershould bear the cost of certain risks and not those people who have earned a lot of moneyfrom taking those risks. ~ Angela Merkel, German Chancellor (Nov 11, 2010)
"Investors must share the cost of sovereign debt restructuring. All stake holders mustparticipate in the gains and losses of any particular situation.
~ Christine Lagarde, French Finance Minister (Nov 10, 2010)
2
What is better than to sit at the end of the day and drink wine with friends, or substitutes forfriends. ~ James Joyce, Irish author (1882 1941)
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Contents
1. Introduction
2. The Irish Crisis
A. The Bankin S stem
B. The Sovereign
3. Potential Solutions
4. Potential U.S. Capital Markets Implications
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Section 1
n ro uc on
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Key Considerations in Sovereign Risk Analysis
Too often, sovereignrisk analysis focuses
narrowly on theabsolute amount of
government debt, andthe liquidity profile of
the soverei n
Key Factors Critical Questions
Total public sector debt Size vis--vis the economy? Trajectory?
Total private sector debt Distribution across financial sector, corporate sector, and
However, a number ofother critical factorsmust also be
considered
at the consumer level?
Debt ownership profile Foreign ownership percentage? Investor profile?
Dependence on capitalmarkets / li uidit rofile
Reliance on international capital markets? Liquidity? Size and stren th of domestic bond market if an ?
Confidence with investors Reputation issues, if any, on quality of data? Historical track record with key government statistics?
Ability to devalue currency Extent of power over own currency?
Ireland performsvery strongly on
some of thesemetrics (liquidit ,
Reserve currency status Is the sovereign a significant global reserve currency? Are their technical reasons for strong demand even if
fundamentals have some weaknesses?
Competitiveness of theeconomy
Flexibility and competitiveness? Structural issues? Ability of economy to grow from under high debt levels?
competitiveness ofthe economy)
and less so onothers (dependence
on international
Ability to deliver on fiscalausterity programs
Social stability and strength of political institutions? Strength and will of government coalition?
Strength of banking system Transparency? Funding access? Capitalization? Liquidity?
capital markets,strength of banking
system)
Assumption of bank sectorliabilities by Government
Size and timing of sovereign exposure to bank liabilities? Transparency of the exposure?
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Understanding the Irish Sovereign Crisis
Bankin Crisis Soverei n Crisis Potential Solutionscrisis and
sovereign crisishave effectively
converged,making the two
(6 Key Issues)
1. The Irish bankingsystem is too big
(5 Key Issues)
1. 2010 fiscal deficit of 32%(12.9% not including bankrescues)
(5 Key Steps)
1. EUR 80-90 billion fromthe EFSF/IMF/EFSM(subject to change)
indistinguishable
Whereas Greecessovereign crisis
was driven by an
2. Sharp asset and creditquality deterioration
3. Significant governmentcapital injections
.94% (~70% on net basis)
3. Strained access to capitalmarkets
. cce era on o scaadjustment program
3. Continued ECB support(bond purchases and bank
Governmentsector (and a
liquidity crisis),
the heart ofIrelands
(EUR 45 billion)
4. Significant bankliability guarantees
(EUR 147 billion)
4. Contagion to Portugal,Spain and Italy
qu ty
4. Clarity on the EUsplanned Orderly
Restructuring Mechanism5. Growth from Irelands
700
sovere gn e tcrisis is more
closely linked tothe Statesdecision to
directly assume
.policy (NAMA)crystallized losses
6. Exceptionally highdependence on Central
.financial system
competitive economy
300
400
500
600significantfinancial sectorliabilities
10 Year Irish Government Bond Spreads to Germany
2008 2009 2009 2010
bps
0
100
200
Jan08 Mar08 May08 Jul08 Se p08 Nov08 Jan09 Mar09 May09 Jul09 Se p09 Nov09 Jan10 Mar10 May10 Jul10 Se p10 Nov10
Source: Bloomberg
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Escalation of the Irish Crisis Since October 29
9
2yrYield 4yrYield 10yrYield
r s overnmen on e s c o er , resenpublic discussionamong European
leaders sinceOctober 29
regarding the
Peak: November 11
7
8
potential losses for
bondholders hasbeen a primary
driver of thewidening in Irish
October 29
5
6%
overnment onyields
Uncertainty as to
the likelihood andtiming of an EFSF
4
bailout has alsobeen a critical
factor
1
Oct
4
Oct
7
Oct
10
Oct
13
Oct
16
Oct
19
Oct
22
Oct
25
Oct
28
Oct
31
Oct
3
Nov
6
Nov
9
Nov
12
Nov
15
Nov
October 29, 2010
7
European Union leaders endorse idea of linking bondholder losses to future bailouts
November 12, 2010 EU leaders forced to clarify at G-20 meetings that existing bondholders will be protected
Source: Bloomberg
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Escalation of the Irish Crisis Since October 29
The Irish crisis has
Dates Details
escalated rapidlysince October 29,
when GermanChancellor Merkel
and FrenchPresident Sarkoz
October 29 German Chancellor Angela Markel proposes orderly restructuring mechanismrequiring bond holders to take haircuts in the event of a sovereign crisis Investors immediately responded by re-pricing sovereign default risk
November 4 Irish Finance Minister Brian Lenihan announces changes to allocate EUR 6 bn ofthe 4- ear EUR 15 bn fiscal lan to 2011
endorsed the
possibility of bondholder losses onfuture bailouts
November 9 German Finance Minister Wolfgang Schaueble discloses some detail onGermanys 2-tier orderly resolution crisis mechanism (with bondholder losses)
November 10 French Finance Minister Christine Lagarde publicly supports Germanys proposal
later clarified onNovember 12th
Irelands bank liability guarantee program (ELG) extended to June 2011
November 11 Clearinghouse LCH Clearnet increases margin requirements for customers
trading Irish bonds (raised again in following week) Irish soverei n debt markets s ike. The 10 ear ield reaches record levels of 9%
Key Market Dates
and Irish CDS widens above 700 bps
November 12 Joint statement by France, Germany, Italy, Spain, and UK at G-20 Summitconfirming that orderly restructuring will not require existing bond holderhaircuts for debt issued prior to 2013 (investor concerns eased)
Oct. 29 / Nov. 11:Record sell-off inIrish bonds andCDS
November 16 Sharp global sell-off across risk asset classes as Ireland refuses initial EU/ IMF/ECB bailout efforts at EU Finance Minister meetings in Brussels Declines in global equities, HY bonds, commodities, and currencies
November 21 Ireland finall a rees to acce t bailout from EU and IMF details to be ne otiated
.
rally as worries overrestructuring plandissipate
Nov. 16: Global
8
in subsequent weeks)mar e se -o asIreland initiallyrefuses bailout
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Assessing the Magnitude of Ireland
Country %ofEuro 16 %ofEuro 27
Germany 27.4% 20.5%
France 21.2% 15.9%
Ital 16.9% 12.6%
e a ve conomy ze
Population: 4.6 million
GDP: EUR 156.1 billion
ey ac s on re an s o ov
Spain 11.4% 8.5%
Netherlands 6.4% 4.8%Belgium 3.8% 2.9%
Austria 3.0% 2.3%
Greece 2.5% 1.9%
GDP per capita: EUR 34,907
Finland 1.9% 1.4%
Portugal 1.9% 1.4%
Ireland 1.7% 1.3%
Slovakia 0.7% 0.5%Luxembourg 0.4% 0.3%
.
Sovereign debt outstanding: EUR 146.2 billion
Slovenia 0.4% 0.3%
Cyprus 0.2% 0.1%
Malta 0.1% 0.0%
UK NA 14.0%
Sweden NA 2.8%
op an s o a asse s: ~ on
Top 6 banks total assets / GDP: ~ 3.33x
Poland NA 2.7%Denmark NA 1.9%
Czech Republic NA 1.2%
Romania NA 1.0%
Hungary NA 0.8%
Total bank bailout (Nov 2010): ~ EUR 45 billion
Bank liability guarantees (Nov 2010): ~ EUR 147 billion
Bulgaria NA 0.3%
Lithuania NA 0.2%
Latvia NA 0.1%Estonia NA 0.1%9
Assets transferred to NAMA (bad bank): EUR 53 billion (nominal)
Source: Irish Central Bank. Deutsche Bank Global Markets Research, IMF (October 2010) , Bloomberg, Irish Times (October 2010). EuroStat.
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Reason for Optimism: Irelands Competitive Economy
Reasons for O timism on Irelands RecoverWith a properlystructured bank
sector bailout,Irelands economyoffers a number of
compelling reasons
Consideration Description
Fiscal adjustmenttrack record
Proven track record: Ireland moved early on its fiscal adjustment (begannearly 2 years ago); bodes well for forthcoming EUR 16 billion adjustment
to be optimisticabout its fiscal
turnaround
Irelands economyrew annuall at a
Bank sector loan
clean-up
On target to have removed EUR 73 billion of bad loans from bank balance
sheets via NAMA; only EU country to have moved early on such an initiativePolitical / socialstability
Though current coalition Government has narrow majority, Ireland has strongand stable political institutions
rate of 6.5% from
1990 to 2007
and the economydoubled in size
Highly educated &flexible workforce
Youngest labor force in Europe (36% under age 25); English-speaking Education system ranks 7th globally for higher education Education expenditures over last 10 years increased 10% per year on
average, versus 3% in EU
ending 2006
Most importantly,Irelands foreign
direct investment
,
Strong exportengine
EUR 39 billion balance of trade surplus in 2009, and EUR 28 billion as ofAugust 2010
Highest in EU on a per capita basis
Stron Forei n 5x reater than the OECD avera e
very well during thecrisis
Direct Investment EUR 139 and 169 billion in 2008 and 2009, respectively IDA Ireland, agency targeting FDI, says 2010 has been the best in 7 years
Lowest corporatetax rates in Europe
12.5% corporate tax rate is lowest among major European economies 25% R&D tax credit
10Source: Deutsche Bank Global Markets Research.IMF. IDA Ireland: Vital Statistics (Oct 2010), Central Statistics Office(October 2010). Credit Sights.
Strong GDPoutlook
Only one of Greece, Portugal and Spain with positive 2011 GDP growthforecast (DB estimate of +1.2% growth in 2011)
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Reasons for Concern: Contagion
structured packagefor Ireland, the risk
of contagion isstill the greatest
area of concern in
ey reas o oncern or on ag on
How much further can bank sector losses deteriorate?
Will the country continue to deliver on its strong two year track record forfiscal austerit ro rams?
markets
Thefundamentals of
Greece, Ireland,
Ability to deliver on its fiscal austerity programs? Is the economy competitive enough to eventually grow out from underneath
its debt levels?
ortuga , pa n,and Italy are very
different, butcontagion risk is
still high
Will Portugal be able to improve upon its comparatively poor track record onfiscal austerity (vis--vis other peripherals in 2010)?
Is the economy competitive enough to eventually grow out from underneaths e eve s ow o ump-s ar arge y s a e econom c grow
Potential for bank sector losses to accelerate significantly? Transparencyand market confidence?
Has differentiated itself on fiscal olic direction but how to um -start
Key Market Concern
In a worst case
largely stalled economic growth? 20% unemployment?scenar o, are pa nand Italy effectivelytoo big to fail?
Ability to deliver on fiscal austerity programs?
Ability to continue to tap capital markets in order to meet its massive 2011
11Source: Deutsche Bank Global Markets Research.
2012 funding needs?
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Key Upcoming Dates
upcoming events
will be important toproperly assessing
the path ahead
Key Upcoming Dates
Dates Details
Weeks of Nov 22 / 29 Decisions around current Irish negotiations with EU, IMF and ECB?
November 25 Irish bi-Elections (Donegal)
November 30 Deadline for the approval of the Portuguese 2011 budget
ecem er ounc ee ngs: ec s ons on qu y reg me expec e
December 7 Irish budget meetings Failure to approve the budget would effectively result in a no confidence vote in
the Government, and could force a national election
Dec. 16 17 EU Council Meetings: Draft text for the orderly restructuring mechanism due (criticalfocus area for international bondholders)
December 23 Last ECB 6-month and 12-month LTROs expire
December 28 Final ECB weekly MRO tender of the year
January 12, 2011 Portuguese presidential election
12
2011 EU regulators plan to repeat the EU bank stress tests of July 2010
Source: Deutsche Bank Global Markets Research. Mark Wall. Thomas Mayer. Gilles Moec.
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Section 2
e r s r s s
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Section A
e an ng ys em
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The Irish Banking Crisis: 6 Key Issues
ey ssues
The Irish Banking System is Too Big
Top 6 banks assets represent 3.33x GDPIssue # 1
Shar bank asset and credit ualit deterioration:
crisis
perspective, adefining momentof the Irish crisis,
in retrospect,
Issue # 2- Phase 1: Construction and commercial real estate loan losses
- Phase 2: Residential mortgage losses
Significant government capital injections into banking system:
may e race othe decision by
the IrishGovernment to
assumesignificant
Issue # 4
- EUR 45 billion to date
- Significantly more expected in EU / IMF bailout underway
Significant banking sector liability guarantees-
liabilities from anoversized
banking sector
Issue # 5
,
Irelands Bad Bank policy (NAMA) crystallized losses
Ireland is among the few countries to have actually removed toxic loansfrom the balance sheets of its banking system
Issue # 6 Exceptionally high dependence on Central Bank funding
Driven by deposit outflows and limited access to capital markets
Size of the program (EUR 73 billion) and discounts (~58%) have resultedin massive bank sector capital injections
15
Record ECB funding: EUR 130 billion (~30% of all ECB funding)
Record Irish Central Bank funding: EUR 20 billion of exceptionalliquidity extended to Irish banks in Sept and Oct (in addition to ECB funds)
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Issue # 1: The Irish Banking System is Too Big
The size of theIrish banking
system relative toits economy has
been a core issuein this crisis
Irelands GDP EUR 156 billion
Irelands Top 6 Banks Assets ~ EUR 520 billion
~ .
Estimated Irish Banking System Crisis Losses
(Includes Foreign-Owned Banks in Ireland)
EUR 85 billion
Estimated Bank Losses / GDP ~ 50%
By contrast, thenearly 8,000banks in theUnited Statesrepresent approx0.85x (or 85%) ofU.S. GDP
Bank of Ireland Allied Irish Banks Anglo Irish Bank
Government Aid Received EUR 3.5 bn EUR 3.5 bn EUR 23 bn
Government Stake 36% Over 90% 100% Nationalized
The banks were too big a problem for the country. I accept that.
(currently 18% but set to rise)
Note: Irelands 6 largest banks used as a proxy for the Irish banking system (Allied Irish Banks, Bank of Ireland,Anglo Irish, Permanent TSB, Irish Nationwide and Ulster Bank). Life insurance assets not included.
Source: Central Bank of Ireland.
~ Brian Lenihan, Irish Finance Minister (on Nov 19, 2010)
16
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Issue # 2: Asset and Credit Quality Deterioration
-
The seniorunsecuredratings of
Irelands 3 largest
Phase 1: Construction and developer losses
Commercial real estate prices declined over
Phase 2: Residential mortgage losses
Over 40,000 borrowers (5% of Irish mortgage
public policy
decisions of theIrish Government,
for now, topreserve the
Primary driver of EUR 45 billion in bank capitalinjections to date
Sept 30, 2010); represents EUR 7.8 billion of
mortgages 25% of outstanding home loans (nearly 200k
mortgages) expected to be underwater by2011; some estimates as high as 350k
sanc y o ebank senior debtmarket (and notmandate senior
bondholderlosses)
Irish residential mortgage debt soared toEUR113 billion in March 2010 from EUR 49billion in 2003
1000
1200
AngloIrish AIB BoI
A1 / A- (Neg) / A- (Neg)
200
400
600
bpsA1 / BBB+ (Neg) / A- (Neg)
17Source: The Irish Times (November 2010), Wall Street Journal (November 2010). DB Global Markets Research. CreditSights.
Oct08
Nov
08
Dec
08
Jan
09
Feb
09
Mar09
Apr09
May
09
Jun
09
Jul09
Aug
09
Sep
09
Oct09
Nov
09
Dec
09
Jan
10
Feb
10
Mar10
Apr10
May
10
Jun
10
Jul10
Aug
10
Sep
10
Oct10
Nov
10
-
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Issue # 3: Significant Government Capital Injections
Total ca ital in ections to date: EUR 45 billion ~ 30% of GDPbillion of capital
injections intoIrish banks dwarfs
the planned EUR15 billion fiscal
- Anglo Irish Bank: EUR 29 billion recapitalization to date (split into asset recovery and fundingbanks with 10-15 year workout)
- Bank of Ireland: Recapitalized through EUR 3.4 billion equity offering earlier this year (throughwhich Irelands national pension fund (NPRF) converted EUR 1.7 billion preferred to equity)
a us men , anhas exceeded the
fiscal capacity ofthe State (over
30% of GDP)
- Allied Irish: Total capital need of EUR 10.4 billion; approx EUR 3.5 raised, and remainder well
underway through asset sales, and potential share offerings and conversions to / with NPRF
- Irish Nationwide: EUR 5.4 billion re-capitalized; no viable future as independent entity
-
- Irish Life & Permanent: has not required any government support
Gross Fiscal Costs of Banking Crises Bank Bail-outs (% of Home Country GDP)
Thailand
Turkey
SouthKorea
ng o r s an 11.26%
AngloIrish
RBS
In total, Ireland hasspent ~EUR 45 billion,
% of GDP
1997
2000
1997
~18%
Ireland
Uruguay
Malaysia
UBS
or ~30% of GDP,rescuing its banks2008
2002
1991
0 10 20 30 40 50
apan
Finland
Source: Irish Central Bank. Wall Street Journal. Financial Times. DB Global Markets Research.
180% 2% 4% 6% 8% 10% 12%
Citigroup1997
1991
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Issue # 4: Significant Bank Liability Guarantees
verv ew
Name
Irelands decision inSeptember 2010 to
extend over EUR 30billion in bank debt
September 30, 2008: Originally introduced as CIFS (Credit InstitutionsFinancial Support Scheme)
December 9, 2009: Changed to ELG (Eligible Liabilities Guarantee)
Expiry Date
guaran ees was apivotal moment in
the Irish crisis
June 2011:- Originally due to expire on September 29, 2010
- First extension to December 31, 2010
Size
- econ ex ens on o une
- Subject to EU review every 6 months
EUR 147 billion
CoveredLiabilities
New senior bonds with maturities up to 5 years
Excludes dated subordinated debt (as of Sept 29, 2010)
EUR 31 billion bank debt issuance
Corporate and retail deposits Short term bank liabilities and debt securities
19Source: Irish Finance Ministry. Financial Times. Wall Street Journal.
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Issue # 5: Bad Bank (NAMA) Crystallized Losses
Ireland was oneof the only
countries duringthe financial
Purchases to Date
Established: December 2009
Program Overview
Target Size: EUR 73 billion (nominal)
quickly around
the concept of abad bank toremove the toxic
loans from its
Chief Executive: Brendan McDonagh
Approval / Timing: by European Commission;all loans must be transferred by Feb 2011
Purpose: Bring stability to the banking system
Expected average discount rate: 58%
Purchases to Date: EUR 53 billion (nominal)
an a ancesheets
Such early action
to cleanse theIrish bank
by removing impaired loans from balance sheetsof individual banks
Domicile of Loans: 33% outside Ireland (6 %
Northern Ireland, 21% UK)
The creation of Irelands bad bank (NAMA)has allowed Ireland to crystallize losses in itsbanking sector much more quickly, and
transparently, than most other global banking
balance sheetswill pay benefits
through therecovery
un ng: oans pa or w overnmenguaranteed securities (NAMA bonds)
Impact to Sovereign Debt: Treated as off-balance sheet and not included in EuroStat debtmetrics
sys ems mpac e y e nanc a cr s s
The United States, for example, pursued asimilar initiative for toxic bank loans in 2009,called the PPIP loan program, but ultimatelyabandoned the lanned olic
20Source: National Asset Management Agency
If the discount is too light, the banks are enriched as a result. If the discount is too deep,the banks become illiquid. A balance has to be struck.
Brian Lenihan, Irish Finance Minister
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Issue # 6: High Dependence on Central Bank Funding
Record ECB borrowings (as of Oct. 2010): EUR 130 billion
Irish bank borrowings account for ~30% of total ECB loans (EUR 440 bn)
ECB currently funding ~20% of Irish bank assets
Irish banks havemade record useof both ECB and
Irish Central bankfunding
ey ssues
Figures includefunding for bothIrish and foreign
Equal to ~ 83% of Irish GDP
Driven by deposit outflows and limited access to capital markets
Record Irish Central Bank borrowings: EUR 20 billion of exceptional liquidity extended toIrish banks in Sept and Oct (in addition to ECB funds)
The accelerationof this need has
been driven by anincrease in
deposit outflows,and limited access
Ireland
130
to private capitalmarkets funding Irish Bank ECB Borrowings
(Jan. Oct. 2010)
European Peripheral Euro-Zone Share of GDP
vs. Share of ECB Funding
Shareof
GDP Share
of
FundingTotal ECB loans: EUR 440 bn
110
120
Rbn
Ireland
Portugal
~
80
90
E
U
Greece
S ain
70
Jan
10
Feb
10
Mar
10
Apr
10
May
10
Jun
10
Jul
10
Aug
10
Sep
10
Oct
10
21
Source: Central Bank of Ireland, Central Bank of Spain, Central Bank of Greece, Central Bank of Portugal, Wall Street Journal (Nov. 2010)
0% 5% 10% 15% 20% 25%
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Section B
e overe gn
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Irelands Sovereign Crisis: 5 Key Issues
An accurate ey ssues
2010E Fiscal deficit of 32% (12.9% excluding bank rescues)
2011 Target: Under 10%
Issue # 1
assessment of theIrish States debt
burden necessarilyrequires more
certainty around
Issue # 2 2010E Gross debt / GDP of 94% (~ 70% on a net debt basis) Ireland has over EUR 45 billion in cash (EUR 22 billion + SWF assets)
Gross and net debt / GDP projected to peak in 2013
Irish banking
system
Although Ireland ispre-funded
Issue # 3 Highly strained access to capital markets
Sovereign pre-funded through mid 2011
Suspended remaining 2010 Government bond auctions on Sept 30
- ,its ability to accessthe capital markets
in early 2011remains very
uncertain
Issue # 4
Market access and pricing effectively prohibitive at this time
Contagion to Portugal, Spain and Italy
The fundamentals of Ireland, Portugal, Spain and Italy are very different
From an EU policyperspective,
containing thecontagion from
Spain and Italy is a
Issue # 5
ar e s expec or uga o nee un s soon a er re an
Contagion to Spain and Italy would be a game changer
Contagion to the European financial system
primary goal
23
UK banks have most exposure, followed by Germany and France
Significant ECB exposure as wellSource: DB Global Markets Research. Irelands National Treasury Management Agency.
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Issue #1: 32% Fiscal Deficit (12.9% Excl. Bank Rescues)
Overview of Irelands Twin DeficitsExcludin bank
2010E Fiscal Deficit (% of GDP) 2010E Current Account Deficit (% of GDP)
2010E Including Bank Rescues: (- 32%)
bailouts, Irelands2010E fiscal deficit
is still high at12.9%, but is
projected to come 2010E Current Account: (-1.0%)
2010E Excluding Bank Rescues: (-12.9%)
Irish Government Fiscal Austerity Plan: 4years; EUR15 billion; EUR 6 billion front-loaded to 2011
2011, targeting 3%
by 2014
2011E Current Account: 0.0%
2010 Balance of Payments: EUR 28 billionsurplus as of August 2010
=
-3
: - .
2014E Fiscal Deficit: (-3.0%)
6
8
+ Balance of payments (exports, less imports)+ Net factor income (interest; dividends)+ Net transfer payments (i.e., foreign aid)
-13
-8
%o
fGDP
-2
0
2
4
ofGDP
3% limit set byEU MaastrichtTreaty
-28
-23
-
-8
-6
-4
%
Excluding bank rescues
Including bank rescues Ireland had a EUR 28 billionbalance of payment surplusas of August 2010
-33
24
-12
-32%
Source: Deutsche Bank Global Markets Research. Mark Wall. Thomas Mayer. Gilles Moec.
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Issue #2: Irish Gross Debt to GDP at 94%
verv ew
Irish government gross debt stands at EUR146.8 bn or 94% of GDP
Approximately 70% on a net debt basis
Ireland has over EUR 45 billion in cash (EUR 22 billion + SWF assets)
Irelands debt to GDP(gross and net) are
projected to peakin 2013
The current debt levels, and lack of clarity around Irelands bank sector, have createdsignificant solvency concerns with investors
Liquidity is not a primary concern as was the case with Greece (pre-funded through mid 2011)
2010E Peripheral Total Debt (EUR bn) 2010E Peripheral Total Debt as % of GDP
Spain Greece
Greece Ireland 94%
Ireland PortugalEUR 146.8 bn
250 200 400 600 800
Portugal
0% 50% 100% 150%
Spain
Source: IMF (October 2010)
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Issue #3: Highly Strained Access to Capital Markets
7
8
9
,-funded through
mid 2011 (with ~EUR 46 billion in
liquid assets), butthe primary
Sept 30: Irish government suspendsbond sales for the remainder of 2010
4
5
6
the Irish debt crisis
are not liquiditybased %
15
20
at er, t esolvency of the
banking system,and the State itself,
has been theprimary focus of
Irelands Favorable Maturity Profile is Not the Primary Focus of Investors
5
10
investors, and theprimary obstacle to
capital marketsaccess E
URbn
0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
In our super-cycle era of Western market leverage, we need capital markets to be fully functioning 24 / 7. Any
26
Source: Bloomberg. Irelands National Treasury Management Agency
.most refinancing are Governments.
~ Jim Reid, Deutsche Bank Macro Strategist (April, 2010)
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Issue #4: Contagion to Portugal, Spain & Italy
Peri heral 10 r Credit S reads vs. German Peri heral 5 r CDS S reads(Oct. 1, 2010 Present)
(Oct. 1, 2010 Present)
Irish 10y spread over Germany reachedrecord levels of 646 bps (and bond yields9.1%) on November 11, 2010
Irish 5y CDS reached record levels of 595bps on November 11, 2010
The risks posed byGreece, Ireland
and Portugal(combined 5% of
EU) can be wellabsorbed by EU
1000
1200
a y reece or uga pa n
1000
1200
a y reece or uga pa nrescue
mechanisms
however,contagion to Spainand Ital over 20%
600
800
600
800
b
ps b
ps
of EU) would raisesignificant
questions on boththe willingness and
ability of the EU to
0
200
400
0
200
400
To be sure, theEFSF would not be
sufficientlyadequate in size
1O
ct
8O
ct
15
O
ct
22
O
ct
29
O
ct
5N
ov
12
Nov
1Oct
8Oct
15
Oct
22
Oct
29
Oct
5No
v
12
No
v
(and some insistthe same is true for
Spain)
The Irish say they are not Greece. The Portuguese say they are not Irish. The Spanish
27Source: Bloomberg
.what Italy is not.
~ Wolfgang Munchau, Editorialist, The Financial Times(Nov 22, 2010)
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Issue #4: Contagion to Portugal, Spain & Italy
expect Portugal
will have to followGreece and Irelandin tapping EU / IMF
funds
2010E Portugal Spain Italy
Spain has
positivelydifferentiated itself
on fiscal policy,but markets are
ons . , ,
% of EU Economy 1.4% 8.5% 12.6%
Unemployment Rate 10.7% 20% 8.7%
still very focusedon this risk
To be sure,
contagion of thecrisis to Spain and
2010 Sovereign Debt 142.2 667.2 1,843.6
2010 Debt / GDP 83.1% 63.5% 118.4%
2010 Fiscal Deficit -7.5% -9.0% -4.9%Italy would be a
watershed momentin the European
debt crisis
a ame-chan er
10 Yr Govt Yield(Nov 20, 2010)
6.7% 4.3% 4.7%
5 Year CDS(Nov 20, 2010)
416 bps 260 bps 181 bps
This containmenthas become theprimary focus ofthe EU and ECB
Key Questions:
Although the fundamentals of Portugal, Spain and Italy are very different from Ireland,how will the markets react in the weeks / months ahead?
28Source: Bloomberg as of November 20. DB Global Markets Research, IMF (October 2010), Portugal Finance Ministry, Spain Finance Ministry, ItalyFinance Ministry
In particular, how vulnerable are Spain and Italy to contagion? How would the Euro construct survive contagion to these two countries (over 20% of EU)?
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Issue #5: Contagion to European Financial System
Investors havebegun to pay much
closer attention on acountrys reliance
on internationalcapital markets for
omes c vs. ore gn o ngs o e y oun ry
Ireland heavily relies on foreign investors to finance government debt:
- A sovereigns dependency on international capital markets is a critical area of focus in sovereign riskanalysis
funding
To this end, Irelandis one of the most
heavil reliant
- Japan, for example, has had significant sovereign debt levels for two decades but has largely
avoided a funding crisis because it has been able to finance its onerous debt levels domestically
Domestic Foreign
Irish Debt Holdings
countries on foreignholdings of itspublic debt (a
concern which the
EU / IMF bailout
Foreign holdingsDomestic holdings
%
28% 72%
mitigate)
A large part of Irishdebt is held by the
sector includingbanks, insurance
companies, andpension funds
29
Source: IMF: Fiscal Exit: From Strategy to Implementation, OECD
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Ke Details To 20 Banks b Net Ex osure
Issue #5: Contagion to European Financial System
Bank sector exposure to the Irish crisiscan take many different forms:
Direct losses on loans, bonds and otherdebt issued
Similar to the Greececrisis, the European
banking system isthe primary source
Bank
1 RBS 4.3 bn
2 Allied Irish Banks 4.1 bn
Exposure
Losses at individual, corporate or sovereign
level Higher costs of capital
Less lendin activit
o con ag on n eIrish crisis
3 Bank or Ireland 1.2 bn
4 Credit Agricole 929 mm5 HSBC $816 mm
6 Danske Bank 655 mm
Lower profitability via economic impact7 BNP Paribas 571 mm
8 Group BPCE 491 mm
9 Societe Generale 453 mm
10 Banco BPI 408 mmForeign Banks Total Exposure to Irelandmm
12 Bank of Cyprus 356 mm
13 DZ Bank 310 mm
14 Postbank 300 mm
15 Norddeutsche Landesbank 274 mm
, ,
(US$ Billions)
UK
Germany
16 WestLB 244 mm17 WGZ Bank 244 mm
18 Caixa Gral. De Depositos 231 mm
19 Rabobank 222 mm
U.S.
France
Italy
Japan
30Source: Financial Times. Wall Street Journal. Bank of International Settlements.
20 SNS Bank 209 mm
0 50 100 150 200 250
Spain
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DB European Peripheral Economic Forecast
ea(% Growth)
onsumer(% Growth)
Current Account(% of GDP)
sca a ance(% of GDP)
2010E 2011E 2010E 2011E 2010E 2011E 2010E 2011E
-0.5% 1.2% -1.5% 0.5% -1.0% 0.0% -29.2% -9.8%
-4.3% -2.7% 4.7% 1.7% -8.0% -7.0% -8.0% -7.6%
1.6% 0.0% 1.4% 1.5% -10.5% -8.0% -7.5% -6.0%
-0.5% 0.0% 1.6% 1.4% -5.0% -4.5% -9.0% -7.1%
31Source: Deutsche Bank Global Markets Research. Mark Wall. Thomas Mayer. Gilles Moec.
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Section 3
o en a o u ons
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Potential Solutions: 5 Key Steps
otent a o ut ons: ey teps
Step # 1:
EUR 80 90 billion from the EFSF / IMF / EFSM
For both the sovereign and bank sector
a o cap a mar e s nves ors wan
Transparency:
On bank sector losses (in stress-case scenario)
Consistency:
Step # 2:
Acceleration of Irelands EUR 15 billion fiscaladjustment
Credible support from opposition parties critical
On Government policy decisions, both nationally
and at the EU level Agreement among EU countries on path forward
Clarity:
Step # 3:
Continued ECB support
Sovereign bond purchases / bank liquidity
Ste # 4:
On the treatment of bondholders, currently and inthe future
Markets will re-price risk accordingly
Confidence:
EU creation of an Orderly Restructuring Mechanism
Clarity around treatment of bondholders, bothcurrently, and in the future
Step # 5:
On ability to deliver fiscal austerity measures
In commitment of opposition political parties, andsocial willingness to support
Certainty:
Growth from Irelands competitive economy Maintaining Irelands corporate tax rate of 12.5%, and
strong FDI flows, will be important to its growth outlook
On all of the above, as much as possible
33
There may be a contradiction between the interests of the financial world and the interests of the political world. We cannotkeep explaining to our voters and our citizens why the taxpayer should bear the cost of certain risks and not those people whohave earned a lot of money from taking those risks. ~ Angela Merkel, German Chancellor (Nov, 2010)
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Step # 1: EUR 80-90 billion from EFSF/ IMF/ EFSM
On Nov 21, IrelandsPrime Minister
and EU officialsindicated that
Ireland will in factapply for a bailout
Question What we do and dont know (as of Nov 21)?
What? Sunday, Nov 21: Irelands cabinet approves application for EU / IMF aid Negotiations on details should continue for several weeks
from the EuropeanUnion and IMF
To be sure,negotiations
underwa in Dublin
2 part bailout package expected (though details not finalized as of Nov 21):1. Sovereign: Funds for the Sovereign to cover 2011 2012 funding
2. Banks: Ireland pushing for contingency fund structure to recapitalize itsbanks (details to be determined by further stress testing of the system)
will continue overthe coming weeks
and be focused on acloser examination
of Irish bank balance
How much? EUR 80 90 billion expected (less than Greeces EUR 110 billion) Approximately 1/3 expected to come from the IMF
When? EU/ IMF/ ECB Assessment: Began in Dublin on Thurs, Nov 18
as well asresolving the
inherent conflict ofinterest between the
Application: On Nov 21, Irelands cabinet approves application for EU/ IMF aid
Negotiations on Conditionality: Likely to take weeks; structure of bankcontingent capital fund, and Irish corporate tax rate, will be a key focus
contain thecontagion, andIrelands desire to
maintain theindependence of its
Where? Review and negotiations underway in Dublin, Ireland
At the Irish Central Bank, Irelands bond agency, and the Finance Ministry
34
econom c po cy
Source: Deutsche Bank Global Markets Research. Public comments of key Irish and EU officials on Nov 21, 2010.
The European authorities have agreed to our request. The formal process of negotiation willnow commenceto be finalized shortly, within the next few weeks.
~ Brian Cowen, Irish Prime Minister (on Nov 21, 2010)
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Step # 1: EUR 80-90 billion from EFSF/ IMF/ EFSM
Sources of EU / IMF Rescue Funds EUR 750 billion / US 1 TrillionIn addition to
440 billion 250 billion
European Financial StabilityFacility (EFSF)
European FinancialStability Mechanism (EFSM)IMF Loans
60 billion
potential bilateral
loans from the UKand Sweden, the EU
has assembled aEUR 750 billion war
chest to address the
Source ofFundin
Self funding vehicle:
- AAA rated
IMF Expansion of pre-existing EU Balance of
EU sovereign crisis(over US $1 Trillion)
Approximately 1/3 of
- Will not pre-fund (as needed)
Guarantees from EU memberstates
UK not involved in funding
ayments ac tyfunded with EU bondissuance
Previously used in 2008
for Hungary, Latvia, andRomania
expected to come
from the IMF
However, use of the
UK is involved infunding
Terms EU Approval: Must have
unanimous support from all Subject to IMF
ne otiation and EU Approval: Only
ma orit needed not
significant portion of
the package couldbe viewed as critical
to its credibility inthe market
members
Maturity: 3-5 years (expected)
3 year Rate: 3m Euribor + 300bps
4-5 ear Rate: 3m Euribor +
conditionality
unanimous as for EFSF)
Requires unanimous EU
35
400 bps
Service Fee: +50 bps
Source: Deutsche Bank Global Markets Research. Mark Wall. Thomas Mayer. Gilles Moec.
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Step # 1: EUR 80-90 billion from EFSF/ IMF/ EFSM
Self-Funding vehicle:
Funding
Headquarters: Luxembourg
DetailsUse of the EFSF forthe Irish Crisis will
be important for itscredibility, and will
verv ew o e
- Executed by German Debt Office(DMO), but EFSF is issuer
- Guaranteed by member states
-
CEO: Klaus Regling
Operational: August 4, 2010
Ratings: AAA/ Aaa/ AAA
e y e wereceived by markets
No pre-funding (funds only upon request) Expiry: Later of June 30, 2013 (3 years),
or at latest maturity date of outstandingloans (up to 5 years)
Conditionality: Linked to strict policyTerms
billions
Germany 122.8
France 92.3
Guarantees
Guarantee: Over-collateralized; 20% inexcess of total funding volume
ECB eligible: Yes
Maturity limits: None (3 5 yearsexpected)
No currency limitations (EUR, US$, etc.)
Rates: Same as Greece
a y .
Spain 53.9
Netherlands 25.9
Belgium 15.7
Austria 12.6
Portu al 11.4
Approvals: Requires unanimous supportby participating countries - 3 years: 3m Euribor + 300 bps
- 5 years: 3m Euribor + 400 bps
Finland 8.1
Ireland 7.2
Slovakia 4.5
Slovenia 2.1
Luxemburg 1.1
36
Cyprus 0.9
Malta 0.4
Total 440.0
EFSF funds in place are sufficient to cover Ireland, Portugal and Spain, but not Italy The implications of Italy having to tap the EFSF would be devastating
Source: Deutsche Bank Global Markets Research. Mark Wall. Thomas Mayer. Gilles Moec.
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Step # 2: Acceleration of Fiscal Adjustment
Details Planned Composition of Fiscal Adjustment
Ireland is in theprocess of
accelerating a veryaggressive (and IMF-
like) fiscaladjustment program
Nov. 4, 2010: Ireland Proposes further Fiscal Adjustment
Largely Mix (broadly Largely
Late November announcement expected
Inclusion in Dec 7 budget deadline
Subject to EU / IMF conditionality
that is impressivelyfront-loaded for 2011
Credible supportfrom opposition
olitical arties and
Deficit (2009) Expenditure-
based
equally-
based)
Revenue-
based
Ireland Greece
Japan India
High deficit(above 10% of
GDP)
Total Size:
Total Adjustment: EUR 15 billion over 4 years
Breakdown:
the broaderpopulation, will becritical to investor
reaction
UK
Portugal Russia
Canada
FranceMedium
- EUR 6bn in 2011 (front-loaded)
- EUR 9bn 2012-2015
Fiscal Targets:
announced plan, of
course, is nowsubject to EU / IMF
conditionality
Italy
Latvia
Lithuania
South Africa
deficit
(between 5%
and 10% of
GDP)
2011 fiscal deficit: Below 10% by 2011 (from12.9% currently, excluding bank rescues)
2014 fiscal deficit: Below 3% (as required byEUs Maastricht Treaty)
Turkey
Australia Mexico China
Germany
Korea
Low deficit
(below 5% of
GDP)
37
We can opt to do this adjustment or we can keep expressing ourselves through anger andthe denial of the problem.
Brian Lenihan, Irish Finance Minister
au ra a
Source: IMF: Fiscal Exit: From Strategy to Implementation
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Step # 3: Continued ECB Support
130
Continued ECBsupport is critical
to resolving theIrish and European
Overview
Continued ECB support is critical on both:
Irish Bank ECB Borrowings
(Jan. Oct. 2010)
Ireland bank funding
100
110
120sovereign debtcrisis
One of the keygoals of the EU/
IMF rescue
. ,
2. Bank sector liquidity, as needed
Sovereign debt purchases: sharplyreduced since June put recent pick-up in Irishbonds
EURbn
now accounts for~30% of ECB funding
70
80
90
n10
b10 r
10 r10 y10
n10
ul10 g
10p10
ct10
package, however,will be to reduce
Irelands banksector dependence
on ECB funding
Bank sector liquidity: ECB role has beenformidable, especially for Ireland (~30% of ECBtotal)
Key goal of EU / IMF bailout is toJ F
eM A M
Ju J A Se O
14000
16000
ECB Sovereign Debt Purchases Since May 10, 2010
Cumulative Total: EUR 65.1 bn
4000
6000
8000
10000
12000
EURMm
Recent pick-up in Irish bond purchases
0
2000
38Source: ECB
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Step # 4: Clarity on EUs Restructuring Mechanism
October 29, 2010: Germany presents a proposal of a 2 tier permanent debt crisis mechanism to beeffective by 2013:
- Phase 1: Fiscal austerity measures for EU countries struggling with fiscal targets
Clarity on thetreatment of
bondholders iscritical to well
functioning bondmarkets
ey ac s on e s r er y es ruc ur ng ec an sm
- Phase2: Private creditors would be subject to haircuts
November 12, 2010: Joint announcement at G-20 partially alleviating market concerns:- Mechanism will only apply to new debt issued after 2013
- No forced losses for existin bondholders
The uncertainty on
this topic betweenOctober 29th and
November 12th wasver disru tive to
December 15 16, 2010: Details of a future Orderly Restructuring Mechanism (applicable after2013) to be disclosed in the European Council meetings
markets
Investors willadjust and re-price
risk accordingly (as Pros and Cons of Orderly Restructuringprovided)
For now, theconfusion around
the details and
Pros Cons
Could potentially improve market confidence:
- Assures tax payers that creditors will bearrestructurin costs
Adverse selection:
- Restructuring premium would makerestructurin more ex ensive for countries tr in
new plan hascreated anoverhang issue in
the market
- Cheap pre-funding option for Ireland and Portugal- Proposes a more organized and standardized
restructuring process
Could potentially smoothen crisis situations by
to correct fiscal imbalances
- Fiscally mismanaged countries might opt to usethe mechanism as a cheaper restructuring option
Potential opposition from other governments
39
ma ng use o t e
- Less risk of lengthy litigation
- Flow of priority financing
Lack of clarity if not designed and executedwith consistency
Source: Deutsche Bank Global Markets Research. Mark Wall. Thomas Mayer. Gilles Moec.
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Step # 5: Growth from Irelands Competitive Economy
uropean orpora e ax a es y oun ry
25
30
35
re an s os on n o a an ngs
Rank Competitiveness Ranking
# 1 For corporate taxes
Despite the crisis,Ireland still ranks
as one of the mostcompetitive
economies in theworld
Ireland: 12.5%EU Average: 23%
%
10
15
20# 4 For availability of skilled labor
# 4 For openness to new ideas
# 6 For labor productivity
To be sure,
maintaining itscompetitivenesswill be critical todeliverin on an
0
5
# 7 For availability of financial skills
# 7 For flexibility and adaptability of people
aggressive fiscalausterity program
Importantly,
Irelands foreign
DBs 2011E Euro Peripheral Real GDP Growth Estimates
1.2
0 00.5
1.0
1.5
(FDI) has held up
very well during thecrisis
DB has forecasted
%
2.5
2.0
1.5
1.00.5
0.0
growth for Irelandin 2011
40
2.73.0
Ireland Portugal Spain Greece
Source: Deutsche Bank Global Markets Research (Mark Wall, Thomas Mayer, Gilles Moec. IMD WorldCompetitiveness Yearbook 2010). EuroStat.
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Section 4
o en a . . ap a ar e s mp ca ons
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Summary Implications for MarketsDirectional
Markets Impact Potential Implications (Depending on Crisis Depth)
U.S.TreasuryYields
Currently being driven by 3 macro themes:
1) Federal Reserve policy and QE2
2) China tightening and inflation risk
3) European sovereign credit risk
Impact of Irish and European Debt Crisis: If crisis accelerates, directional impact on UST
yields will be decidedly downward as investors seek safe haven
US$ Bond Currently: marginal impact (so far); volatility has put a soft lid on volumes, and introduced avolatilit remium into ricin albeit limited im act so farar e
Week of Nov 15th was expected to be a blockbuster US$ issuance week
Ended up being the lowest volume week of the (3 week) month so far (US$15 billion ofissuance was a sizeable drop from the nearly US$24 billion the prior week)
Potential: If crisis accelerates, could be significant (U.S. bond markets effectively closed therdbe a game changer
Credit Spreads: Some upward pressure, but limited so far
US$ market in 2010 has been driven largely by favorable technicals (record fund flows)
If crisis accelerates, that can change quickly
New Issue Premiums: Some upward pressure, but minimal so far
YankeeBankIssuance(US$ Market)
Impact of Irish crisis already evident in November
As of Sept 30, non-U.S. issuers accounted for ~ 35% of US$ IG bond market issuance
However, volumes from Europe have been down sharply in November
42
The two main concerns [in markets] are the sovereign debt crisis in Ireland and the inflation bubble risk in China.Global growth depends on the resolution of those two problems. ~ European Asset Manager (November 19, 2010)
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Summary Implications for Markets
Directional
Markets Impact Potential Implications (Depending on Crisis Depth)
U.S. Banks Direct Exposure: $114 billion of direct exposure to Ireland (loans, bonds and other debtissued by Irish companies, individuals and governments)
More indirect impact: U.S. bank spreads still very vulnerable to exogenous shocks at this
European IGBond Markets
Full impact will depend on extent of the contagion Sovereign Market: Stabilization of this sector is critical to the overall market
Corporates: European corporate credit markets have proven to be remarkably resilient as
time; contagion effect; higher cost of capital
compared to the peak of the Greek crisis in May 2010
The blue-chip iTraxx Europe index of 125investment grade corporates (as well as theEurope Crossover index of 50largely non-IG names) has remained resilient as the Irishcrisis has peaked
Corporate credit curves have also steepened (bullish sign showing comfort on front end) Financials: Significantly more vulnerable, but market still very much open for stronger
financial players
Mid-caps and second tier financial names have been more impacted
Public Policy Issues: Critical to get market clarity on the issue of bail-ins (creditor losseson rescues) very soon in order to improve investor risk appetite
EuropeanBanks
UK Bank Exposure: US$ 222 billion of direct exposure to Ireland (loans, bonds and otherdebt issued by Irish companies, individuals and governments)
German Bank Exposure: US$ 206 billion
French Bank Exposure: US$ 86 billion
Italian Bank Exposure: US 29 billion
Spanish Bank Exposure: US$ 16 billion
Cost of capital: Strong upward pressure if crisis accelerates; higher debt costs and
increased equity capital needs43
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Summary Implications for Markets
Directional
Markets
Impact Potential Implications (Depending on Crisis Depth)
Commodities
(Oil, Other)
Impact from acceleration of Irish crisis in November has been limited
Will increase markedly if contagion not contained
days in the market (such as November 16th when Ireland initially refused EU rescueloans)
Gold Has and will continue to be a safe haven for investors when the Euro crisisaccelerates
Has also been an important market for investors to hedge sovereign risk generally
Euro / US$
Exchange
Relief rally expected on the back of the Irish application for EU / IMF aid on Nov
21 (and likely to track the pace of negotiations in subsequent weeks)Rate As the crisis accelerated in early November, the Euro moved down sharply from
1.43 to 1.35
Not nearly as strong a decline as with the Greece crisis in May
Generally, if the contagion accelerates, downward pressure on the Euro has theotential to be uite stron
Contagion to Spain and Italy would be a game-changer
Potentially too big to fail?
Would raise questions about the longer term viability of the Euro
44
The VIX Volatility Index
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The VIX Volatility Index
. ,
Greece Crisis Peaks (Week of May 3rd): VIX jumped a breathtaking 85%
Irish Crisis Accelerates (Oct 29 Nov 16): VIX jumps ~ 5%, but then rallies to lower levels asdetails of Irelands reluctant acceptance of EU / IMF aid begins to emerge
The VIX has notreturned to the 80
levels of the Lehmanbankruptcy, but didreach as high as 40
80
in May during thepeak of the Greece
crisis
For now, the indexhas remained
Lehman Bankruptcy
60
largely contained asthe Irish crisis has
accelerated inNovember 2010
40
20
O
ct08
N
ov08
D
ec08
Jan09
F
eb
09
M
ar09
A
pr09
M
ay09
J
un09
Jul09
A
ug09
S
ep09
O
ct09
N
ov09
D
ec09
Jan10
F
eb
10
M
ar10
A
pr10
M
ay10
J
un10
Jul10
A
ug10
S
ep10
O
ct10
N
ov10
45Source: Bloomberg
I t th E
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Impact on the Euro
,expect a relief rally
in the Eurofollowing the
Ireland EU/ IMFrescue package
verv ew as o ov ,
Despite a strong rally since September, the Euro declined sharply in November as the IrishCrisis accelerated:
- Irish Crisis High: On Nov 4, Euro /US$ hit its highest point since January ($1.43)
However, the scopeand pace of
contagion will becritical to any
longer term
- Irish Crisis Low: On Nov 16, following Irelands refusal to tap EFSF funds, Euro/ US$ closed at a3 month low (1.35)
What to expect from here?
Relief rally expected coming out of the Irish bailout announcements of Nov 21
Euro USD PPP PPP+20% Band 20%
assessments
The Euro has
Euro/USD Spot vs. Euro/USD Purchasing Power Parity (PPP) (January 1, 2010 Present)
The ability to contain the contagion of the crisis will be critical to any forecasts from here
1.3
1.4
1.5
traded around 20%above its
purchasing powerparity since
January
1
1.1
1.2
USD/E
UR
Irish Crisis Accelerates
0.8
0.9
Jan10 Feb
10 Mar
10 Apr
10 May
10 Jun
10 Jul
10 Aug
10 Sep
10 Oct
10 Nov
10
46Source: Bloomberg
Impact on the Euro
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Impact on the Euro
Bullish View Bearish View
Market has priced in the EFSF:
- EFSF is now read and full o erational
The EFSF has not been proven:
- Si nificant uncertaint as to its ca acit be ond
ua ews ver e u ure o e uro
rally in the Eurofollowing the
Ireland EU/ IMFrescue package
- After unofficial rumors surfaced on November 12th
about an Irish bail-out, European credit markets
rallied
QE2 announcement impact:
Ireland and Portugal
Contagion effect to euro financial system:
- Possible contagion effect across Europeanperipherals, leading the market concerns overfurther use of the EFSF by Spain or Italy
over the medium to
longer term must
consider a range offactors
-policy, despite global market criticism
Irish fiscal adjustment plan:
- Plan will be approved by Dec 7, and will be a
turning point in the balancing the deficit
- EFSF would not be capable of financing Spain orItaly if needed, leading to crisis in the Euro zone
European financial system, the primary creditprovider in the European economy, will bestressed with dra on lendin and li uidit -
-20 announcement regar ng or er yrestructuring:
- Confirmed that creditors will not take hits on debtissued prior to 2013
More transparent European market:
provider activities)
Market reaction to December 16th:
- Details on the orderly restructuring mechanismdisclosed in December might not be positivelyviewed by the market
- Orderly restructuring and fiscal adjustments could
be perceived as a more transparent and potentiallymore stable market in the mid to long term
Portugal may need EFSF funds, but crisis will becontained from impacting Spain and Italy
Possible failures of fiscal adjustment:
- Fiscal adjustment of EUR 15 bn is only a fractionof the increasing Irish bank bail-outs
- Greece, Portugal, Spain and Italy have long and
47
European economy will stabilize, and embark ona steady path of GDP growth (albeit slower thanhistorical cycles)
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