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CREDIT RESEARCH U.S. High Grade | 19 May 20

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 8

GLOBAL BANKS

Parallels to the 1980s Latin AmericanDebt Crisis

Summary

The LDC crisis of the 1980s draws many parallels with the sovereign debt crisis in Europe

today. In both cases, the potential failure of a series of highly indebted nations along the

economic periphery posed a risk to the banking sector of nations at the core of financial

flows. Over the course of the 1970s, U.S. commercial banks dramatically increased their

exposure to the sovereign credits of less developed countries (LDC), primarily in Latin

America. When interest rates spiked and economic activity slowed in early 1980s, many ofthese countries were pushed beyond their ability to cover debt payments. In the U.S.,

special regulatory forbearance allowed the banks to delay loss recognition and protect

their capital levels, but poor asset quality, impaired profitability, and numerous rating

downgrades diminished the credit quality of the largest U.S. banks. Still, by 1992, losses

had begun to decline, and credit ratings and spreads eventually recovered. While useful as

historic precedent, we note two important differences in the situation facing European

banks currently. First, the exposure of European banks to Greece, Ireland, Portugal, Spain,

and Italy is significantly smaller in relation to capital than the exposure of U.S. banks to

Latin American sovereigns in the 1980s. We estimate the total exposure of the 21

European banks we currently cover to Greece, Ireland, Portugal, Spain, and Italy is 42% of

capital. In 1982, large U.S. banks had lent over 200% of capital to Latin American

countries, according to the FDIC. Second, regulatory forbearance is less likely to occur inEurope, given the current round of EU banks stress testing and market scrutiny. In terms

of recommendations, there is no change to our Market Weight recommendation on

European banks or our Overweight recommendation on U.S. banks.

Figure 1: Bank Sovereign Debt Exposures in Relation to Capital

0%

50%

100%

150%

200%

250%

300%

Large U.S. Banks during LDC Debt Crisi s,

1982

Large European Banks during European

Sovereign Debt Crisis, 2011

LDCs Greece Ireland Portugal Spain Italy

42%

247%

Note: Eight large US banks in 1982, 21 European banks under coverage. Source: Company reports, FDIC,Barclays Capital

Jonathan Glionna

+1 212 412 5184

[email protected]

Jeroen Julius

+44 (0)20 3134 9642

[email protected]

Conor Pigott

+1 212 412 3441

[email protected]

Miguel Hernandez

+44 (0)20 7773 7241

[email protected]

www.barcap.com


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Barclays Capital | Global Banks: Parallels to the 1980s Latin American Debt Crisis

19 May 2011 2

Parallels between the LDC Crisis of the 1980s and the SovereignDebt Crisis in Europe Today

Over the course of the 1970s, U.S. commercial banks dramatically increased their exposure

to the sovereign credits of less developed countries (LDC) in Latin America. Numerous

factors fuelled the credit expansion. In the U.S., lenders sought to replace gaps in their loanbooks as the advent of the commercial paper market eliminated domestic demand for

profitable, low-risk working capital loans. As U.S. banking operations and the larger

economy became increasingly globalized, foreign nations seeking credit were a natural

alternative source of loan growth. From the LDC borrowers perspective, rising payment

imbalances in the developing nations, partially due to oil shocks in the 1970s, increased the

Latin American demand for financing. In the years leading up to the crisis, large volumes of

loans were provided by the U.S. money-center banks in the form of floating-rate, dollar-

denominated syndicated loans (Figure 2). By the time the crisis erupted in 1982, the U.S.

banks were highly exposed. Among the eight largest U.S. banks, LDC loans outstanding

constituted 16% of total loans and 247% of capital, according to the FDIC.

Though some prognosticators warned of the build-up of large exposures within the U.S.banking system, most observers and industry participants did not recognize the potential

risk until the crisis began in the early-1980s. When interest rates spiked in 1982, so too did

the debt-service burdens of Latin American countries with floating-rate debt tied to dollar

Libor levels. High interest burdens, combined with slow global growth, impaired their ability

to cover debt service payments. The first country to fall in the series of delinquencies was

Mexico, with an announcement that it would not be able to meet debt service obligations in

August 1982. Soon after, a wave of other Latin American countries fell delinquent on their

loan payments and entered into a protracted period of restructuring.

Figure 2: LDC Loan Exposure for Eight of the Largest U.S. Banks for the Period ($bn)

0

10

20

30

40

50

60

70

1977 1978 1979 1980 1981 1982 1983 1984 1985

0%

50%

100%

150%

200%

250%

300%

LDC Loans LDC Loans/Capital (RHS)

Source: FDIC, Barclays Capital

Despite their differences, the LDC crisis of the 1980s draws some parallels with the

sovereign debt crisis in Europe today. Two points of particular comparison are the sovereign

credits at risk of potential default and the exposure of the banks to a possible restructuring.


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19 May 2011 3

The Sovereigns at Risk

The current European crisis, focused mainly on Greece, Portugal, and Ireland, with the potential

to include Spain and Italy, has gained momentum over the past year. Certain areas of risk

appear to be deteriorating, and we note that our economics research team has recently stated

the opinion that Greek debt dynamics are unsustainable and require eventual restructuring (see

Greece: The (long) road to restructuring, 11 May 2011). A broad review of the public finances

involved in both crises reveals that the LDCs debt burden was lower in comparison to GDP

than most of the European sovereigns currently at risk. For instance, Mexico had public debt

outstanding near 70% of GDP in the year it announced its inability to meet debt service

obligations, compared with Portugals current ratio of 83% and Greeces ratio of 144% (Figure

3). Still, a variety of factors beyond debt-to-GDP exacerbated the situation of the LDCs in the

early 1980s. Most obvious is the sharp spike in interest rates which sent the 2y U.S. Treasury

rate over 16% in late 1981. Extreme tightening raised floating-rate payments and depreciated

local currencies, which had to be converted to dollars to make interest payments on loans. As

outlined in Figure 4, debt service costs as a percentage of gross domestic income (GNI)

skyrocketed in response. In Europe, debt service costs are lower and should be more stable as

they are denominated in local currency (EUR) and typically fixed rate (Figure 5).

Figure 3: Public Debt/GDP (%)

0

20

40

60

80

100

120

140

160

Spain Mexico 1982 Portugal Ireland Italy Greece

Source: Bloomberg, Federal Reserve Bank of Dallas, Barclays Capital

Figure 4: Debt Service/Gross National Income (%) Figure 5: Public Debt Interest Payments/Government Revenue

(%)

81.9%

52.5%

29.5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

1977 1978 1979 1980 1981 1982 1983 1984 1985 1986

Brazil Mexico Venezuela

0%

10%

20%

30%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Greece Ireland Italy Portugal Spain

Source: World Bank Source: World Bank
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19 May 2011 4

Bank Exposure to Sovereigns at Risk

Notwithstanding the uncertainties surrounding banks current positions, we believe that

banks exposures to the ongoing European sovereign crisis are of a more manageable size

than that of the U.S. banks to LDCs in the early 1980s. This is noteworthy, given that some

of the large European banks reside in peripheral countries and naturally have large

exposures. In absolute terms, our aggregate of 21 of the largest banks in Europe have a net

sovereign bond exposure to Greece, Spain, Portugal, Ireland, and Italy of approximately

$509bn (Figure 6). Amongst the five nations, the European banks have more limited

exposures to Ireland, Portugal, and Greece amounting to $91bn in total. The majority of the

exposure lies in Spanish and Italian debt, which have more stable credit profiles. As outlined

in Figures 1, 7, and 8, the exposure to the present sovereign crisis is much lower as a

percentage of capital for the European banks when compared to the position of U.S. banks

in the LDC debt crisis. Whereas the U.S. banks had exposures amounting to roughly 250%

of capital largely concentrated in many of the most unstable nations, our sample of

European banks currently only have 42% of capital at risk, largely concentrated in the

relatively more stable nations of the group (i.e., Spain and Italy).

Figure 6: Exposure to Sovereign Debt, 21-Bank Aggregate of Large European Banks ($bn)

0

50

100

150

200

250

300

350

Portugal Greece Ireland Spain Italy

Source: Company reports, Barclays Capital

Figure 7: National Banking Sectors Public Sector Exposure($bn)

Figure 8: National Banking Sectors Public Sector Exposure/Tier 1 Capital (%)

0

10

20

30

40

50

60

70

80

90

100

GermanySpain France Italy Other

Euro

UK US Japan

Greece Ireland Portugal Spain

0%

5%

10%

15%

20%

25%

30%

35%

40%

GermanySpain France Italy Other

Euro

UK US Japan

Greece Ireland Portugal Spain

Source: BIS, The Banker, The Bank of Japan, Barclays Capital Source: BIS, The Banker, The Bank of Japan, Barclays Capital


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19 May 2011 5

The U.S. Bank Experience during the LDC Crisis

The experience of U.S. banks during the LDC crisis provides an interesting comparison to

the current European sovereign debt crisis. In 1982, the risk of LDC exposure to U.S. banks

became obvious following Mexicos failure to meet its obligations. Still, U.S. bank regulators

were faced with a difficult choice. If normal regulatory requirements for loan provisioning

were applied to the non-paying LDC debt, a number of the largest banks in the industry

would be immediately de-capitalized. Anticipating the destabilizing effects of such a course

of action, U.S. banking regulators instead exercised a form of regulatory forbearance.

Regulators did not require the banks with large LDC debt portfolios to immediately set up

reserves against past-due and restructured LDC loans; rather, banks steadily built up

reserves over five to 10 years before beginning in earnest the painful process of recognizing

LDC loan losses through charge-offs. Evidence of this strategy is illustrated in the industry-

wide data for all U.S. commercial banks over the period. From a relatively low level of

reserves entering the 1980s, U.S. banks steadily established sizeable reserve balances in the

years following 1982 (Figure 9). Reserves at U.S. commercial banks increased 437% from

$11.4bn at year-end 1981 to $49.9bn at the end of 1987. Meanwhile, the delayed

recognition of losses allowed banks to maintain adequate capitalization and solvency. In

fact, aggregate banking sector capitalization, as measured by a ratio of equity to assets,increased from 1980 to 1986 (Figure 10).

Though delayed recognition of loan losses preserved bank capitalization, the fundamental

asset quality issues led the ratings agencies to quickly downgrade the U.S. money-center

institutions. A number of large U.S. banks had received Aaa ratings in the mid- to late-1970s

and had carried these high ratings into the crisis. When problems underlying LDC debt

surfaced, nonaccrual loans grew consistently from 1985 to 1990, as banks slowly

recognized non-paying loans (Figure 11). Due to the asset quality issues, essentially all of

the U.S. banks with exposure to the Latin American sovereigns lost their high ratings and

eventually fell to single-A or below (Figure 12). BankAmerica Corporation, a predecessor of

the Bank of America which exists today, was downgraded to non-investment grade after

having been triple-A rated just six years earlier. The cycle of downgrades continued for

almost a decade, as the non-paying loans remained on banks balance sheets for an

extended period.

Figure 9: Loan Loss Reserves, U.S. Commercial Banks ($bn) Figure 10: Equity/Assets, U.S. Commercial Banks ($bn)

0

10

20

30

40

50

60

1996199319901987198419811978197519721969

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

1995199019851980

Source: FDIC, Barclays Capital Source: FDIC, Barclays Capital


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19 May 2011 6

Figure 11: Nonaccrual Loans, U.S. Commercial Banks ($bn)

0

10

20

30

40

50

60

70

80

1993199219911990198919881987198619851984

Source: FDIC, Barclays Capital

Figure 12: Long-term Senior Unsecured Debt Ratings for Selected Large U.S. Banks

0123456789

1011121314

1977 1979 1981 1983 1985 1987 1989 1991

JP Morgan & Co. Citi corp BankAmericaF irst Chicago Manufacturers Hanover Chase Manhattan

Aaa

Aa2

A1

A3

Baa2

Ba1

Ba3

Source: Moodys, Barclays Capital

Finally in 1987, after five years of growing provisions, accumulating reserves, and ratings

downgrades, banks began to recognize loan losses through massive provisions and charge-

offs. Provisions had increased steadily during the first part of the 1980s, from very low levels

during the 1960s and 1970s. Nevertheless, provisions jumped up even more dramatically in

the final years of the 1980s, as stalled restructuring talks demonstrated to banks that losses

on the large exposures were inevitable. In May 1987, Citigroup was the first major bank to

announce an extraordinarily large provision to address LDC debt in the loan book.

Aggregate provisions in the U.S. banking sector spiked 70% y/y, as banks beganrecognizing LDC losses on a large scale (Figure 13). The first stages of resolution regarding

the LDC debt crisis emerged in 1989. After previous negotiations had failed, Nicholas Brady,

the newly appointed Secretary of the Treasury, announced a plan encouraging U.S banks to

engage in voluntary principal reductions and exchanges of LDC debt. Under the Brady Plan,

private creditors forgave roughly $61bn of principal between 1989 and 1994, with much of

the debt charged off by U.S. banks, leading to a wave of net charge-offs, Figure 14.


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19 May 2011 7

Figure 13: Loan Loss Provisions, U.S. Commercial Banks ($bn)

Figure 14: Net Charge-Offs, U.S. Commercial Banks ($bn)

0

5

10

15

20

25

30

35

40

1996199319901987198419811978197519721969

0

5

10

15

20

25

30

35

1996199319901987198419811978197519721969


Year after year of provision increases and record levels of net charge-offs diminished

banking sector profitability. After generating a solid 12% average return on equity from

1970-81, U.S. banks achieved only an 8.9% average return on equity over the next 10 years

(Figure 15). The worst performance of the period was aligned with the large provisioning of

1987, but even excluding the industrys results from that year, returns on equity fell over

200bp in the 10 years following the eruption of the crisis in 1982, compared with the 12

years before. This reduction in profitability over the period can be directly attributed to the

costs of dealing with the LDC debt crisis, as the ROA of the banking sector excluding the

effect of provisions actually increased (Figure 16). In other words, setting aside the costs of

loan losses, banking operations were increasing profitable over the period. The cost of

charge-offs on LDC debt overwhelmed these improvements elsewhere in banking

operations, as provisions became an increasing weighty drag on returns.

Figure 15: Return on Equity, All U.S. Commercial Banks (%)

Figure 16: Return on Assets ex. Provisions and Effect ofProvisions on Return on Assets, All U.S. Commercial Banks (%)

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

19911988198519821979197619731970

Avg. ROE 1970-81: 12.0%

Avg. ROE 1982-91: 8.9%

-1.5%

-1.0%

-0.5%

0.0%0.5%

1.0%

1.5%

2.0%

2.5%

1995199219891986198319801977

ROA ex. Provisions Effect of Provisions on ROA



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19 May 2011 8

Conclusions

The LDC debt crisis and the European debt crisis have broad similarities that make an

analysis of the experience of large U.S. banks in the 1980s relevant for current investors in

European banks. In the case of U.S. banks, regulatory forbearance preserved capital

adequacy, but financial performance and credit ratings deteriorated over a period of almost

10 years following Mexicos 1982 failure to meet its debt obligations. Ultimately, no majorbanks failed, credit ratings returned to the high end of investment grade by the end of 1995,

and spreads recovered, with the banking sector of the U.S. Credit index tightening 41bp

from 1993-96 and trading inside the index by as much as 10bp (Figures 17 and 18).

While useful as historic precedent, we note two important differences in the situation facing

European banks currently. First, the exposure of European banks to Greece, Ireland,

Portugal, Spain, and Italy is significantly smaller in relation to capital than the exposure of

U.S. banks to Latin American sovereigns in the 1980s. We estimate the total exposure of the

21 European banks we currently cover to Greece, Ireland, Portugal, Spain, and Italy is 42%

of capital. In 1982, large U.S. banks had lent over 200% of capital to Latin American

countries, according to the FDIC. Second, regulatory forbearance is less likely to occur in

Europe, given the current round of EU banks stress testing (results expected in June 2011)and market scrutiny. While the potential debt restructuring that will occur in peripheral

Europe remains uncertain, banks which fail the EU stress tests will be required to prepare

recapitalization plans ahead of the results announcement.

In terms of recommendations, we continue to recommend a Market Weight position in

European banks. Select Overweight recommendations include Royal Bank of Scotland,

Banco Santander, and Unicredit SpA, and select Underweight recommendations include

Banco Monte Dei Paschi Di Siena, Dexia SA, and Banco Commercial Portugues. There is no

change to our Overweight sector recommendation on U.S. banks. Specifically, we

recommend Overweight positions in Bank of America and Citigroup among the large liquid

U.S. banks.

Figure 17: Banking Sector of the U.S. Credit Index followingLDC Crisis, OAS (bp)

Figure 18: Long-term Senior Unsecured Debt Ratings forSelected Large U.S. Banks

40

50

60

70

80

90

100

Sep-1993 Sep-1994 Sep-1995 Sep-1996

U.S. Credi t Index Bank ing Sector

0

1

2

3

4

5

6

7

8

9

10

1991 1992 1993 1994 1995

JP Morgan & Co. Citi corp First Chicago

Aaa

Aa2

A1

A3

Baa2

Ba1

Ba3

Source: Barclays Capital Source: Moodys, Barclays Capital


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Analyst Certification(s)We, Jonathan Glionna, Jeroen Julius, Conor Pigott and Miguel Hernandez, hereby certify (1) that the views expressed in this research report accuratelyreflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, isor will be directly or indirectly related to the specific recommendations or views expressed in this research report.

Important DisclosuresFor current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital

Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgi-bin/all/disclosuresSearch.pl or call 212-526-1072.Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capitalmay have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/oran affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debtsecurities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and /or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permittedand subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel todetermine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including,but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), theprofitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potentialinterest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing informationwas obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads arehistorical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document.Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis,and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of researchproducts, whether as a result of differing time horizons, methodologies, or otherwise.

Explanation of the High Grade Sector Weighting SystemOverweight:Expected six-month excess return of the sector exceeds the six-month expected excess return of the Barclays Capital U.S. Credit Index, thePan-European Credit Index, or the EM Asia USD High Grade Credit Index, as applicable.Market Weight:Expected six-month excess return of the sector is in line with the six-month expected excess return of the Barclays Capital U.S. CreditIndex, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index, as applicable.Underweight:Expected six-month excess return of the sector is below the six-month expected excess return of the Barclays Capital U.S. Credit Index, thePan-European Credit Index, or the EM Asia USD High Grade Credit Index, as applicable.

Explanation of the High Grade Research Rating SystemThe High Grade Research rating system is based on the analyst's view of the expected excess returns over a six-month period of the issuer's index-eligible

corporate debt securities relative to the Barclays Capital U.S. Credit Index, the Pan-European Credit Index or the EM Asia USD High Grade Credit Index, asapplicable.

Overweight:The analyst expects the issuer's index-eligible corporate bonds to provide positive excess returns relative to the Barclays Capital U.S. CreditIndex, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months.

Market Weight:The analyst expects the issuer's index-eligible corporate bonds to provide excess returns in line with the Barclays Capital U.S. Credit Index,the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months.Underweight:The analyst expects the issuer's index-eligible corporate bonds to provide negative excess returns relative to the Barclays Capital U.S. CreditIndex, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months.

Rating Suspended (RS):The rating has been suspended temporarily due to market events that make coverage impracticable or to comply with applicableregulations and/or firm policies in certain circumstances including where Barclays Capital is acting in an advisory capacity in a merger or strategictransaction involving the company.

Coverage Suspended (CS):Coverage of this issuer has been temporarily suspended.Not Rated (NR):An issuer which has not been assigned a formal rating.For Australia issuers, the ratings are relative to the Barclays Capital U.S. Credit Index or Pan-European Credit Index, as applicable.


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