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Fixed Income Research

Financial Special

20. December 2016

Outlook 2017

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 2 of 17

Financials Outlook 2017

Analysts:

Michaela Hessmert

Melanie Kiene, CIIA

Review of 2016

The past year has been rather turbulent for the senior unsecured bonds as-

set category. The bail-in regime has been in place in Europe since the start

of 2016 and has led to a change in the risk profile of senior unsecured

bonds. At the end of November, the European Commission prepared to pro-

pose a harmonised European approach for the ranking of unsecured senior

debt. Essentially, the French proposal on establishing a non-preferred senior

asset class has been adopted and will be implemented in all member states

by mid-2017. As a whole, 2016 was characterised by some periods of in-

creased volatility, which has particularly affected financials in the credit seg-

ment. In the first quarter, spread widening was above all caused by concern

about the declining growth momentum in China and the emerging markets.

In this period of greater risk aversion, investors became aware of the fact

that risk pricing of bank bonds did not reflect the potential loss participation

of creditors, which consequently resulted in a revaluation of (senior and sub-

ordinated) bank bonds. A further trigger of spread widening was the surpris-

ing referendum result in the United Kingdom in favour of leaving the Europe-

an Union. Brexit has had the most negative impact on banks in the UK,

which saw spreads widen accordingly. In this phase of increased risk aver-

sion, market players also recognised that problems within the eurozone have

by no means all been resolved, with especially Italy being pilloried for its

exceedingly high proportion of problem loans. In September, Deutsche Bank

was also hit by a breakdown in trust. The U.S. Department of Justice de-

manded it pay a fine of around USD 14bn in relation to its mortgage lending

activities in the USA, which would have drained a significant portion of the

bank's capital and consequently unsettled investors, especially as Deutsche

Bank has in any case been delivering poor results recently due to its restruc-

turing efforts. The German banking market was to some extent held guilty by

association during this period and the matter of often rather weak profitability

was also addressed. In November, the election of Donald Trump as the new

President of the United States also sent shock waves around the world.

However, the insights gained from the market response to the Brexit vote

meant that there was only very cautious spread fluctuation, with some even

being corrected in part on the same day. ^

iTraxx € Senior vs. Subordinated Financial Euro Stoxx Banks

0

50

100

150

200

250

300

350

12. 14 03. 15 06. 15 09. 15 12. 15 03. 16 06. 16 09. 16

BP

Spread Sen vs. Sub. iTraxx € Senior FinancialiTraxx € Subordinated Financial

70

80

90

100

110

120

130

140

Euro Stoxx Banks

Source: Bloomberg, NORD/LB Fixed Income Research Source: Bloomberg, NORD/LB Fixed Income Research

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 3 of 17

Regulation:

banks operating in a more

stable environment

After the financial market crisis, politicians and supervision made great pro-

gress in their common objective of strengthening the stability of the Europe-

an banking market. The Basel III requirements led to the improved capitali-

sation and liquidity position of institutions. In the EBA’s Basel III Monitoring

Exercise (sample of 227 banks) with data as at the end of December 2015,

the average (fully loaded) Common Equity Tier 1 (CET1) ratio stands at

12.4% for banks in Group 1 (tier 1 capital of EUR > 3bn and active interna-

tionally) and 13.6% for banks in Group 2 (all other institutions).

Bail-in regime will be

harmonised in the EU

With the Bank Recovery and Resolution Directive (BRRD), a framework for

European law was established in the EU effective 1 January 2015, the aim of

which is to introduce and harmonise a process for the recovery and resolu-

tion of financial institutions at national level in all EU member states. For

example, this includes institutions having in place an individual resolution

plan or living will. One potential resolution tool is the bail-in of debt instru-

ments. Since 1 January 2016, the Single Resolution Mechanism (SRM), the

Single Resolution Board (SRB) and the Single Resolution Fund (SRF) have

been responsible for the resolution of systemically important banks in the

eurozone. Investors in unsecured debt instruments are undoubtedly aware

that the risk profile of plain vanilla senior unsecured bonds has deteriorated,

because it is now not just shareholders and subordinated creditors that are

being held accountable for loss compensation, but specifically also creditors

of primary unsecured debt instruments. Investors in this asset class must

therefore analyse issuers more intensively than they did in the past, given

that the declared political goal of the bail-in was for both banks and investors

to no longer rely on an implicit guarantee from the state. To ensure sufficient

“bail-inable” capital is held, the bail-in concepts of Total Loss Absorbing Ca-

pacity (TLAC) and Minimum Requirements for own funds and Eligible Liabili-

ties (MREL) were introduced. While the TLAC applies only for global system-

ically important banks (G-SIBs) and goes towards resolving the “too big to

fail” problem in the wake of the financial crisis, all institutions throughout the

EU must satisfy the MREL. Despite the fact that the two concepts apply to

different areas, they will be harmonised for reasons of efficiency and trans-

parency as they are pursuing a shared aim. This was put forward in the pro-

posal by the European Commission at the end of November 2016. Once the

EU proposal on establishing a new asset class, “non-preferred seniors”, has

been finalised, the respective national implementation will be a main focus

over the coming year. Alongside the “bail-inable” non-preferred seniors, the

traditional plain vanilla senior unsecured bonds will therefore continue to

exist, with the distinction “preferred seniors” potentially becoming established

for these bonds in future.

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 4 of 17

Revision of Basel III has

explosive power

Although the European Commission already presented a wide array of re-

vised proposed amendments to the CRR II, the CRD IV and the BRRD II (cf.

Financial View dated 1 December 2016), their implementation is still de-

pendent on the EU Council and EU Parliament, so nothing is set in stone

yet. In general, it is to be welcomed that the leverage ratio, the net stable

funding ratio (NSFR), the harmonisation of the TLAC and the MREL as well

as the issue of proportionality are all being addressed. Several significant

decisions that will have an influence on the market are on the agenda for the

future of banking regulation in the coming weeks. For example, the Basel

Committee on Banking Supervision (BCBS) is currently revising the require-

ments of Basel III, which is being referred to on the market as Basel IV and

is expected to once again intensify the existing regulatory capital require-

ments.

Basel III reform package

1. Reducing variation in risk-weighted assets in the use of internal ap-

proaches (constraints on the use of models and greater standardisation)

2. Improving risk sensitivity (increased granularity and improved methodolo-

gy for standard approaches)

3. Agreeing rules that are as simple as possible

4. Ensuring that overall capital requirements are not increased significantly

(GHOS Statements, January and September 2016)

5. Conclude work by end of 2016

Source: Deutsche Bundesbank, NORD/LB Fixed Income Research

European opposition against

Basel reform package

An overall aim of the Basel reform package is to improve risk sensitivity.

However, this has revealed some conflicting goals. The proposals are cur-

rently encountering some strong opposition on the side of European policy

and national supervisory authorities. Although the schedule of the BCBS,

which develops coordinated rules for banking supervision at international

level, intends to complete the revision of Basel III by the end of 2016, it is

currently likely that the deadline will not be met. At least, international con-

sensus was not reached at the talks in Santiago, Chile, at the start of De-

cember. From a European point of view, the greatest problems are above all

the increasing requirements for capital adequacy (RWA increase through

capital floors/output floors and a new standardised approach for credit risk).

French, German, Dutch and Nordic banks were particularly severely affected

by the floor rule, as they exhibit low risks for mortgage and corporate expo-

sure. The proposal to abolish the internal ratings-based approach (IRBA) for

specialised lending is also problematic as this would result in a sharp in-

crease in the risk weights (cf. table on risk weights). If the BCBS fails to hold

a new voting meeting before the end of the year, the next fixed date is

8 January 2017. In addition to opposition within Europe, it remains to be

seen whether the new U.S. administration headed up by Donald Trump will

potentially become a less willing negotiating partner in terms of actually im-

plementing these changes.

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 5 of 17

Preliminary Basel proposal on risk weights

Risk weights for: IRBA Standardised approach for credit risk

Property finance 20% 80%

Project finance 75% 100-150%

Aircraft finance 55% 120%

Ship finance 50% 120%

Commodities finance 33% 120%

Source: Basel, NORD/LB Fixed Income Research

Political markets? Next year will offer a number of highlights on the political stage. In addition to

Donald Trump’s inauguration in January, there will be elections in France,

Germany and the Netherlands. Furthermore, the UK is expected to trigger

Article 50 of the Lisbon Treaty and officially initiate leaving the EU. As finan-

cials are currently very dependent in the current environment on the respec-

tive risk appetite or aversion of investors, bank bonds have been corre-

spondingly sensitive to changes in the market sentiment. In our opinion,

political influencing factors should also be viewed as negative. The elections

in the eurozone are under the influence of stronger populism and ever-more

widespread Euroscepticism. The negotiations that the UK must conduct with

the EU could provide a blueprint for other countries who wish to follow suit.

Consequently, it must be assumed that the talks will take place with a de-

gree of firmness to ensure that the construct of the eurozone is not put at

risk. The current political developments go against the aim of achieving best-

possible harmonisation within the eurozone through the bank union and its

three pillars: 1) standardised supervisory mechanism, 2) single resolution

mechanism and 3) planned uniform deposit protection. The coming year

could prove to be an acid test for Europe, with a correspondingly negative

impact on market sentiment and the risk spread.

Bail-in makes funding more

expensive

European institutions are obliged to maintain sufficient bail-inable bonds. For

this reason, the issuing activity of non-preferred seniors will be on the agen-

da in the coming year. As they have a poorer risk profile when compared

with preferred seniors, funding will become more expensive for institutions.

We anticipate a spread difference which will of course vary depending on the

specific institution, but will be similar to the currently observable difference

between holding company (HoldCo) and operating company (OpCo) issues

from the same institution. While it can be assumed that French institutions

(above all France’s four G-SIBs) will already start with funding early in the

year (as the French government adopted legislation on 10 December for the

creation of a new senior debt instrument: non-preferred seniors), other coun-

tries might be a little more hesitant. The reason for this is the schedule for

the planned implementation of the European proposal to establish a new

asset class of non-preferred seniors on 30 June 2017. Crédit Agricole was

the first French institution to issue a non-preferred senior bond (maturity:

10 years; volume: EUR 1.5bn; mid swap +115bp; order book: EUR > 5.0bn).

Société Générale followed with a five-year non-preferred senior bond with a

volume of EUR 1.0bn at mid swap +90bp (order book: EUR > 3.5bn).

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 6 of 17

German senior bonds German banks have a lower requirement to issue subordinated senior bonds

as the changes to Section 47f of the German Banking Act (KWG) and the

German Resolution Mechanism Law (AbwMechG) have altered the

insolvency ranking and accordingly all outstanding German plain vanilla sen-

ior unsecured bonds are essentially non-preferred seniors. Through the

harmonisation efforts of the European Commission, Germany will presuma-

bly also be spurred into action once again and possibly adapt the KWG to

ensure German institutions have the option to issue preferred seniors in

future. While the asset category of non-preferred seniors will not have any

ECB eligibility, this is a given for preferred seniors. The collateral capability

of German senior unsecured bonds will continue to exist for the time being,

but will be reviewed again in 2017.

Liability cascade according to the draft for BRRD II

Source: EU Commission, NORD/LB Fixed Income Research

Funding-Ausblick In 2017, senior unsecured bonds in the amount of around EUR 154bn will be

reaching maturity (universe: sector: banks, diversified banks, consumer fi-

nance; currency: euro; collateral type: senior unsecured; amount outstand-

ing/issued: EUR >= 500m; maturity type: bullet; coupon type: fixed/floating;

country: Australia, Canada, New Zealand, Western Europe and the USA).

Maturities in 2017: senior unsecured bonds*

0

5.000

10.000

15.000

20.000

25.000

30.000

FR AS AU BE CA DE EN FI GE GR IR IT NE NO PO SP SW SZ US

Mat

uri

tie

s EU

Rm

n

*Sector: banks, diversified banks, consumer finance; currency: euro; collateral type: senior unsecured; amt. outstanding / issued: EUR >= 500m.; maturity type: bullet; coupon type: fixed / floating; country: Australia, Canada, New Zealand, Western Europe and the USA Source: Bloomberg, NORD/LB Fixed Income Research

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 7 of 17

Maturities in 2017: particular countries by month*

0

5.000

10.000

15.000

20.000

25.000

30.000

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

Mat

uri

tie

s EU

Rm

n

IT FR GB NL DE SE US

*Sector: banks, diversified banks, consumer finance; currency: euro; collateral type: senior unsecured; amount outstanding/issued: EUR >= 500m; maturity type: bullet; coupon type: fixed/floating; country: IT, FR, GB, NL, DE, SE, US Source: Bloomberg, NORD/LB Fixed Income Research

The TLAC and MREL demand

sufficient bail-inable

liabilities

On account of the regulatory requirements to retain sufficient bail-inable

papers, EU institutions are called on to issue corresponding bonds. While

the TLAC demands subordination for G-SIBs, in the MREL, it will be decided

on an institution-specific basis by the supervisory authority whether papers

should be subordinate or not. As the MREL ratios still need to be released, it

is not yet clear how high the issue requirements of the individual institutions

will be, which means that it is difficult to estimate the total funding require-

ments. In addition, a forecast of issue volume is made more difficult by the

fact that the former senior unsecured bonds will in future be divided into two

different asset categories of non-preferred and preferred seniors.

EUR benchmark issues in 2016*

20%

3%

1%

3%

7%

10%

3%2%10%

1%

4%

10%

2%

4%

19%

FR AU BE CA CH DE DK ES FI GB IS IT LU NL NO SE US

*Sector: banks, diversified banks, consumer finance, commercial finance, financial services; currency: euro; collateral type: senior unse-cured; amount outstanding/issued: EUR >= 500m; maturity type: bullet; coupon type: fixed/floating; country: Australia, Canada, New Zealand, Western Europe and the USA Source: Bloomberg, NORD/LB Fixed Income Research

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 8 of 17

Funding planning in 2017 will

depend on TLAC/MREL

planning

Alongside France, institutions from the USA especially took advantage of the

favourable environment (EUR/USD basis swap) for senior unsecured bonds

in EUR benchmark format in 2016. With the prospect of central bank policies

developing differently in the USA (cycle of rising interest rates) and the euro-

zone (continuation of ultra-expansionary monetary policy) in 2017, the ap-

peal of using the European market for funding and therefore benefiting from

the EUR-USD basis swap can in fact be expected to be even greater for

U.S. institutions. For banks in the eurozone, it has already been the case in

recent years that they were displaying restraint in the issuance of senior

unsecured bonds and that maturities consequently exceeded the new issue

volume. There are many reasons for this situation. It was possible for banks

to secure refinancing at a very affordable rate via the means offered by the

ECB, but the senior unsecured asset class also lost a great deal of its appeal

in the wake of regulatory measures (for example, no LCR eligibility, bail-

inability, illiquid secondary market due to banks’ trading books dwindling

because of regulation). For 2017, funding planning will be greatly dependent

on the MREL and TLAC requirements. The ECB’s targeted longer-term refi-

nancing operations (TLTRO) will in all likelihood be well received again, but

with the corresponding effect of reducing the funding volume. As banks will

also not have any incentive to hold surplus liquidity through senior

unsecured bonds in 2017 due to the high costs associated with maintaining

liquidity, the funding plans for senior unsecured bonds can in contrast be

adjusted so that the TLAC and MREL ratios will be fulfilled – albeit only just.

Overall, we anticipate that the issue volume will range between EUR 130bn

and EUR 160bn in relation to the following universe: sector: banks, diversi-

fied banks, consumer finance; currency: euro; collateral type: senior unse-

cured; amount outstanding/issued: EUR >= 500m; maturity type: bullet; cou-

pon type: fixed/floating; country: AS, AU, BE, CA, DE, EN, FI, FR, GE, GR,

IR, IT, NE, NO, PO, SP, SW, SZ, US.

iBoxx EUR Senior Financial ASW spreads by country

0

50

100

150

200

250

Feb

. 16

Mrz

. 16

Ap

r. 1

6

Ma

i. 1

6

Jun

. 16

Jul.

16

Au

g. 1

6

Sep

. 16

Okt

. 16

No

v. 1

6

De

z. 1

6

ASW

in b

p

DE

DK

ES

FI

FR

GB

IE

IT

NO

SE

Source: iBoxx, NORD/LB Fixed Income Research

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 9 of 17

Economic influencing factors

Event risks influence growth

dynamic

In an environment of wide-ranging external risk factors, the economic situa-

tion in the eurozone is challenging. At 1.7% year on year at the third quarter

of 2016, the GDP of the eurozone continues to indicate moderate economic

momentum. Growth will first and foremost be carried by domestic demand

and monetary policy stimulus. Eurozone countries, companies and private

households all benefit from favourable funding conditions. The ECB is con-

tributing to this positive market environment through ultra-expansionary poli-

cy. The ECB’s most recent bank lending survey reports increased loan de-

mand and improved loan conditions for customers. However, alongside fa-

vourable funding for banks, this is above all due to the strong competition

between institutions. We consider the assessment of market players in re-

gard to global growth momentum, with a particular focus on China and the

emerging markets, to be a fundamental risk factor for the credit market,

which could also be significant in 2017. At the same time, there continues to

be a high level of uncertainty with regard to the medium-term consequences

of the UK leaving the EU. This is above all relevant given the potential for

spill-over effects to those eurozone countries that are holding elections in

2017. Euroscepticism coupled with strongly populist tendencies have the

potential to shake the very foundations of the eurozone. The political situa-

tion in Italy is now fragile following the rejection of constitutional reform in the

recent referendum. The Italian banking sector is particularly affected be-

cause it has a high proportion of problem loans as well as a number of insti-

tutions that are reliant on external capital increases. The “no” result of the

referendum will in all likelihood delay the necessary reforms in the banking

sector, as the resignation of Matteo Renzi means a pro-reform politician is

leaving the political stage. Among other achievements, he was responsible

for the legislative initiative to consolidate the cooperative banking sector in

Italy and for their conversion into joint stock companies (Q2/2015). Together

with his party, he also played a leading role in the initiative to speed up the

lengthy bankruptcy proceedings in Italy. In addition, he was in favour of the

Atlante bank bailout fund.

Despite ultra-expansionary

monetary policy, structural

reforms are faltering

In general, it can be said that the efforts to implement structural and fiscal

reform have lost notable momentum since the sovereign debt crisis eased.

Even if the ECB is in principle giving decision-makers time for these struc-

tural reforms by maintaining its ultra-expansionary monetary policy, the

pressure from the market is not sufficient to make politicians carry out the

necessary reforms. As neither austerity policy nor growth policy appear to be

the preferred path, the eurozone will most likely continue to muddle through

in the coming year. This gives a strengthening populism movement

throughout Europe the opportunity to come to the fore, offering another

possible variant for Brexit.

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 10 of 17

Influencing factor in USA A further reason for uncertainty is the new U.S. President who will be inau-

gurated in January 2017. It will only become apparent over the course of

time which geopolitical course the Trump-led U.S. administration will choose

to follow. Even if Europe can remain detached from the cycle of interest rate

hikes in the USA for a while longer and given that the Fed will without doubt

turn the interest rate screw in a very cautious and controlled way, it must be

assumed that the European bond market will also feel a certain amount of

pressure to increase interest rates. On account of the homeopathic dosage

of potential interest rate moves, the search for yield will nonetheless contin-

ue to be a dominating factor for investors. This supports the generally high-

risk asset classes, such as senior unsecured bonds. However, in principle,

the zero-interest-rate policy means that the risks are being underestimated

by investors. It is quite probable that 2017 will be characterised by increased

volatility, which will in some periods lead to considerable risk aversion and

can be expected to have a negative impact on growth dynamics and risk

assets. We identify political uncertainty as the most significant risk factor and

cause for uncertainty in the coming year. Banking markets are affected to

varying degrees.

Key events and elections in 2017

Source: German Bundestag, national parliaments and governments, NORD/LB Fixed Income Research

Banks: challenges for 2017 –

bottleneck factor for equity

and earnings weakness

Banks in the eurozone continued to be subject to the low interest rate envi-

ronment and historically low yield curves in 2016, which above all placed a

negative burden on banks that were highly dependent on the net interest

margin. Institutions that exhibit a stronger income diversification have ac-

cordingly developed more favourably. An ongoing challenge is the high pro-

portion of problem loans held by some countries in the periphery. Institutions

generally have to battle against intensive competition, which is restricting the

assertiveness of spreads. All institutions are affected by the higher cost of

regulation, which will in part be offset by cost savings at other levels. Alt-

hough the capitalisation of European institutions has been steadily improved

over many years, institutions will be required to further strengthen their capi-

tal in light of the further intensifying regulation (Basel IV).

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 11 of 17

Challenges for internal

capital generation capacity

Institutions that have demonstrated no or insufficient profits in order for them

to be retained are faced with the dilemma of having to acquire capital exter-

nally. However, investors are only willing to support institutions whose profit-

ability is weak to a limited extent. Too-low equity ratios will in turn reduce the

option of banks to provide credit to the real economy. For 2017, we antici-

pate that weak bank profitability will remain problematic in a sustained low-

interest environment with moderate growth rates and that the affected banks

will continue to face major challenges as a result. This is also addressed by

the supervisory authority and is likely to be investigated in the Supervisory

Review and Evaluation Process (SREP). In our view, the institutions have

several options for action. First, they could take greater risks in credit busi-

ness to increase profitability. However, this is not a route that the supervisory

authority would welcome. Second, the institutions must implement higher

margins to increase profitability. Given the competitive situation, it is difficult

as non-banks are also making the business environment controversial. A

sustained steeper yield curve would help banks in their efforts to transform

maturities, but is outside their influence. For example, the German 10y2y

yield curve has in fact doubled since the end of September (~50bp) to reach

its current level of more than 100bp. To cut costs, institutions are increasing-

ly turning their attention to the topic of digitisation. Processes must be

streamlined in order to improve efficiency. While European banks take risks

on their own balance sheets and these must accordingly be backed by capi-

tal, U.S. banks have also been operating according to an originate-to-

distribute business model for some time. This type of risk transfer disencum-

bers the institutions and diversifies income sources. In 2017, banks will face

major challenges and these will only be mastered in the long term by those

that adjust their business model to the changed general conditions.

Outlook: ECB creates more

positive market environment

with a large number of

potential stress factors

For senior unsecured bonds, 2017 is not expected to differ from the past

year all too significantly. We will continue to see the ECB’s ultra-

expansionary monetary policy and the continuation of various purchase pro-

grammes as spread-dominating factors. The ECB will continue to ensure a

relatively positive market environment, from which banks will benefit, if not

directly through bond purchases, then at least because of the improved mar-

ket sentiment. Although the allocation of senior unsecured bonds has deteri-

orated in the liability cascade (non-preferred seniors), it must be noted that

alongside the improved environment for banks, the fundamentals of institu-

tions have often improved considerably. This applies equally to both capitali-

sation and cash position. Furthermore, banks have reduced their balance

sheet total in a deleveraging process and have reduced, divested or sold

non-core assets. Banking supervision has in the meantime been operating

proactively and is able to intervene in and control processes in good time.

On account of the improved influencing parameters, we therefore predict that

the actual involvement of creditors (bail-in) will become less probable. In

terms of regulation, a tough struggle lies ahead for the eurozone and the

BCBS.

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 12 of 17

Search for yield leads to

mispricing of risk assets

Spreads of senior unsecured

bonds should increase over

the course of 2017

From a European perspective, the Basel proposals to introduce a permanent

output floor on the basis of the standardised approach for credit risk as well

as the constraints on the IRBA are problematic. A considerable increase in

RWA cannot be accepted by Europe, as a potential increase in RWAs of

“only” 10% on average could prove to be extremely problematic for a number

of institutions. We are operating on the assumption that, in this heightened

atmosphere of banking regulation, certain topics will lead to periods of in-

creased volatility on the financial markets and, in a worst-case scenario, will

cause affected institutions to lose their funding access in the short term. As

we have seen in 2016, the whole banking market is often held collectively

responsible for the actions of a particular institution. In 2016, idiosyncratic

risks of individual institutions (for example, Deutsche Bank) had the potential

to influence the whole market segment (for example, market for subordinate

securities). This trend is likely to continue in 2017. In our view, this is con-

nected with the fact that the risk (in this case, credit risk) has not been cor-

rectly priced in, which is in turn one of the consequences of cheap money.

So long as the ECB maintains its current ultra-expansionary monetary policy,

this mispricing is likely to continue. With the start of tapering, the spreads of

senior unsecured bonds will also be affected and widen (directly also

through the reactions of other asset classes, such as covered bonds). In

terms of event risks, it is above all political risks that will continue to grip the

financial markets in 2017. Elections in a number of countries in Western

Europe have the potential to seriously challenge the eurozone. In this re-

gard, the negotiations for the UK’s exit from the EU are of particular im-

portance. Geopolitical risks are in any case a latent risk factor which will

continue to result in increased risk aversion throughout some periods of

2017. Despite the dominating ECB monetary policy, which is ensuring a

positive credit environment, we anticipate that the spreads of cash bonds will

continue to increase over the course of the year. The potential risk factors

that operate in the market for financials are in our view too significant. As

was the case in 2016, we are assuming that risks spread reactions will be

more notable in the CDS market than in the ECB-dominated cash market in

2017.

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 13 of 17

Appendix Contacts

Fixed Income Research

Michael Schulz Head +49 511 361-5309 michael.schulz@nordlb.de

Kai Ebeling Covered Bonds +49 511 361-9713 kai.ebeling@nordlb.de

Mario Gruppe Public Issuers +49 511 361-9787 mario.gruppe@nordlb.de

Michaela Hessmert Banks +49 511 361-6915 michaela.hessmert@nordlb.de

Melanie Kiene Banks +49 511 361-4108 melanie.kiene@nordlb.de

Jörg Kuypers Corporates / Retail Products +49 511 361-9552 joerg.kuypers@nordlb.de

Matthias Melms Covered Bonds +49 511 361-5427 matthias.melms@nordlb.de

Sascha Remus Corporates / Retail Products +49 511 361-2722 sascha.remus@nordlb.de

Norman Rudschuck Public Issuers +49 511 361-6627 norman.rudschuck@nordlb.de

Thomas Scholz Corporates / Retail Products +49 511 361-4710 thomas.scholz@nordlb.de

Martin Strohmeier Corporates / Retail Products +49 511 361-4712 martin.strohmeier@nordlb.de

Kai Witt Corporates / Retail Products +49 511 361-4639 kai.witt@nordlb.de

Markets Sales

Carsten Demmler Head +49 511 361-5587 carsten.demmler@nordlb.de

Institutional Sales (+49 511 9818-9440)

Thorsten Bock thorsten.bock@nordlb.de Gabriele Schneider gabriele.schneider@nordlb.de

Uwe Kollster uwe.kollster@nordlb.de Dirk Scholden dirk.scholden@nordlb.de

Daniel Novotny-Farkas daniel.novotny-farkas@nordlb.de Uwe Tacke uwe.tacke@nordlb.de

Sales Savings Banks / Regional Banks (+49 511 9818-9400)

Christian Schneider (Head) christian.schneider@nordlb.de Martin Koch martin.koch@nordlb.de

Thorsten Aberle thorsten.aberle@nordlb.de Stefan Krilcic stefan.krilcic@nordlb.de

Oliver Bickel oliver.bickel@nordlb.de Bernd Lehmann bernd.lehmann@nordlb.de

Tobias Bohr tobias.bohr@nordlb.de Jörn Meißner joern.meissner@nordlb.de

Kai-Ulrich Dörries kai-ulrich.doerries@nordlb.de Lutz Schimanski lutz.schimanski@nordlb.de

Jan Dröge jan.droege@nordlb.de Ralf Schirrling ralf.schirrling@nordlb.de

Sascha Goetz sascha.goetz@nordlb.de Brian Zander brian.zander@nordlb.de

Sales Asia (+65 64 203136)

Jefferson Ko jefferson.ko@nordlb.com Muhammad Peter Shep-herd

muhammad-peter.shepherd@nordlb.com

Fixed Income / Structured Products Sales Europe (+352 452211-515)

René Rindert (Head) rene.rindert@nordlb.lu Toni Martikainen toni.martikainen@nordlb.lu

Morgan Kermel morgan.kermel@nordlb.lu Laurence Payet laurence.payet@nordlb.lu

Patricia Lamas patricia.lamas@nordlb.lu

Corporate Sales

Shipping / Aircraft +49 511 9818-8150 Corporate Clients +49 511 9818-4003

Real Estate / Structured Finance

+49 511 9818-8150 FX/MM

+49 511 9818-4006

Syndicate / DCM (+49 511 9818-6600)

Thomas Cohrs (Head) thomas.cohrs@nordlb.de Julien Marchand julien.marchand@nordlb.de

Axel Hinzmann axel.hinzmann@nordlb.de Wlada Pesotska wlada.pesotska@nordlb.de

Thomas Höfermann thomas.hoefermann@nordlb.de Andreas Raimchen andreas.raimchen@nordlb.de

Tobias Jesswein tobias.jesswein@nordlb.de Udo A. Schacht udo.schacht@nordlb.de

Alexander Malitsky alexander.malitsky@nordlb.de Marco da Silva marco.da.silva@nordlb.de

Financial Markets Trading

Corporates +49 511 9818-9690 Collat. Mgmt / Repos +49 511 9818-9200

Covereds / SSAs +49 511 9818-8040 Cust. Exec. & Trading +49 511 9818-9480

Financials +49 511 9818-9490 Frequent Issuers +49 511 9818-9640

Governments +49 511 9818-9660 Structured Products +49 511 9818-9670

Länder & Regions +49 511 9818-9550

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 14 of 17

Disclaimer

This investment recommendation/investment strategy recommendation (hereinafter the „Investment Recommendation”) was drawn up

by NORDDEUTSCHE LANDESBANK GIROZENTRALE („NORD/LB“). The supervisory authorities in charge of NORD/LB are the Euro-

pean Central Bank („ECB“), Sonnemannstraße 20, D-60314 Frankfurt am Main, and the Federal Financial Supervisory Authority (Bun-

desanstalt für Finanzdienstleitungsaufsicht - „BaFin“), Graurheindorfer Str. 108, D-53117 Bonn, and Marie-Curie-Str. 24-28, D-60439

Frankfurt am Main. Details about the extent of NORD/LB´s regulation by the respective authorities are available on request. Generally,

this Investment Recommendation or the products or services described therein have not been reviewed or approved by the competent

supervisory authority.

This Investment Recommendation is addressed exclusively to recipients which are professional and institutional clients in Germany, the

United Kingdom, Austria, Belgium, Italy, Spain, Denmark, Finland, Estonia, France, Greece, Ireland, Luxembourg, the Netherlands,

Poland, Portugal, Sweden, the Czech Republic, Canada, Switzerland and Cyprus (hereinafter the „Relevant Persons” or „Recipients”).

The contents of this Investment Recommendation are disclosed to the Recipients on a strictly confidential basis and, by accepting this

Investment Recommendation, the Recipients agree that they will not forward to third parties, copy and/or reproduce this Investment

Recommendation without NORD/LB’s prior written consent. The figures discussed in this Investment Recommendation are only ad-

dressed to the Relevant Persons and any persons other than the Relevant Persons must not rely on this Investment Recommendation.

In particular, neither this Investment Recommendation nor any copy thereof must be forwarded or transmitted to the United States of

America or its territories or possessions or distributed to any employees or affiliates of Recipients resident in these jurisdictions.

This Investment Recommendation was drawn up in compliance with the applicable provisions of the German Securities Trading Act

(Wertpapierhandelsgesetz) and the Regulation Governing the Analysis of Financial Instruments (Verordnung über die Analyse von

Finanzinstrumenten). In organizational, hierarchical, functional and local terms, the Research Division of NORD/LB is independent of any

divisions responsible for the issuance of securities and investment banking activities, for trading (including proprietary trading) in and

sales of securities as well as for lending activities.

This Investment Recommendation and the information contained herein have been compiled and are provided exclusively for information

purposes. This Investment Recommendation is not intended as an investment incentive. It is provided for the Recipient’s personal infor-

mation, subject to the express understanding, which is acknowledged by the Recipient, that it does not constitute any direct or indirect

offer, individual recommendation, solicitation to purchase, hold or sell or to subscribe for or acquire any securities or other financial

instruments nor any measure by which financial instruments might be offered or sold.

All actual details, information and statements contained herein were derived from sources considered reliable by NORD/LB. However,

since these sources are not verified independently, NORD/LB cannot give any assurance as to or assume responsibility for the accuracy

and completeness of the information contained herein. The opinions and prognoses given herein on the basis of these sources consti-

tute a non-binding evaluation by the analysts of NORD/LB. Any changes in the underlying premises may have a material impact on the

developments described herein. Neither NORD/LB nor its governing bodies or employees can give any assurance as to or assume any

responsibility or liability for the accuracy, adequacy and completeness of this Investment Recommendation or any loss of return, any

indirect, consequential or other damage which may be suffered by persons relying on the information or any statements or opinions set

forth in this Investment Recommendation (irrespective of whether such losses are incurred due to any negligence on the part of these

persons or otherwise).

Past performances are not a reliable indicator of future performances. Exchange rates, price fluctuations of the financial instruments and

similar factors may have a negative impact on the value and price of and return on the financial instruments referred to herein or any

instruments linked thereto. An evaluation made on the basis of the historical performance of any security does not necessarily give an

indication of its future performance.

This Investment Recommendation neither constitutes any investment, legal, accounting or tax advice nor any representation that an

investment or strategy is suitable or appropriate in the light a Recipient’s individual circumstances, and nothing in this Investment Rec-

ommendation constitutes a personal recommendation to the Recipient thereof. The securities or other financial instruments referred to

herein may not be suitable for the Recipient’s personal investment strategies and objectives, financial situation or individual needs.

Also this Investment Recommendation as a whole or any part thereof is not a sales or other prospectus. Correspondingly, the infor-

mation contained herein merely constitutes an overview and does not form the basis for an investor‘s potential decision to buy or sell. A

full description of the details relating to the financial instruments or transactions which may relate to the subject matter of this Investment

Recommendation is set forth in the relevant (financing) documentation. To the extent that the financial instruments described herein are

NORD/LB’s own issues and subject to the requirement to publish a prospectus, the conditions of issue applicable to any individual finan-

cial instrument and the relevant prospectus published with respect thereto as well NORD/LB’s relevant registration form, all of which are

available for downloading at www.nordlb.de and may be obtained, free of charge, from NORD/LB, Georgsplatz 1, 30159 Hanover, shall

be solely binding. Any potential investment decision should at any rate be made exclusively on the basis of such (financing) documenta-

tion. This Investment Recommendation cannot replace personal advice. Before making an investment decision, each Recipient should

consult an independent investment adviser for individual investment advice with respect to the appropriateness of an investment in

financial instruments or investment strategies as contemplated herein as well as for other and more recent information on certain in-

vestment opportunities.

Each of the financial instruments referred to herein may involve substantial risks, including capital, interest, index, currency and credit

risks, political, fair value, commodity and market risks. The financial instruments could experience a sudden substantial deterioration in

value, including a total loss of the capital invested. Each transaction should only be entered into on the basis of the relevant investor’s

assessment of its individual financial situation as well as of the suitability and risks of the investment.

NORD/LB and its affiliates may, for their own account or for the account of third parties, participate in transactions involving the financial

instruments described herein or any underlying assets, issue further financial instruments having terms that are the same as or similar to

those governing the financial instruments referred to herein as well as enter into transactions to hedge positions. Such actions may affect

the price of the financial instruments described in this Investment Recommendation.

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 15 of 17

To the extent the financial instruments referred to herein are derivatives, they may involve an initial negative market value from the

customer’s point of view, depending on the terms and conditions prevailing as of the transaction date. Furthermore, NORD/LB reserves

the right to pass on its economic risk from any derivative transaction it has entered into to third parties in the market by way of a mirror

image counter-transaction.

Further information on any fees which may be included in the sales price is set forth in the brochure „Customer Information Relating to

Securities Transactions“ which is available at www.nordlb.de.The information set forth in this Investment Recommendation shall super-

sede all previous versions of any relevant Investment Recommendation and refer exclusively to the date as of which this Investment

Recommendation has been drawn up. Any future versions of this Investment Recommendation shall supersede this present version.

NORD/LB shall not be under any obligation to update and/or review this Investment Recommendation at regular intervals. Therefore, no

assurance can be given as to its currentness and continued accuracy.

By making use of this Investment Recommendation, the Recipient shall accept the foregoing terms and conditions.

NORD/LB is a member of the protection scheme of Deutsche Sparkassen-Finanzgruppe. Further information for the Recipient is set

forth in clause 28 of the General Terms and Conditions of NORD/LB or at www.dsgv.de/sicherungssystem.

Additional information for recipients in the UK

NORD/LB subject to limited regulation by the Financial Conduct Authority (“FCA”) und Prudential Regulation Authority (“PRA”). Details

about the extent of our regulation by the FCA and PRA are available from NORD/LB on request.

This Investment Recommendation is a financial promotion. Relevant Persons in the UK should contact NORD/LB’s London Branch,

Investment Banking Department, Telephone: 0044 / 2079725400 with any queries.

Investing in financial instruments referred to in this Investment Recommendation may expose an investor to a significant risk of losing all

of the amount invested.

Additional information for recipients in France

NORD/LB is partially regulated by the Autorité des Marchés Financiers for the conduct of French business. Details about the extent of

our regulation by the respective authorities are available from us on request.

This Investment Recommendation constitutes investment research within the meaning of Article 24(1) Directive 2006/73/EC, Article

L.544-1 and R.621-30-1 of the French Monetary and Financial Code and does qualify as research recommendation under Directive

2003/6/EC and Directive 2003/125/EC.

Additional information for recipients in Austria

None of the information contained in this Investment Recommendation constitutes a solicitation or offer by NORD/LB or its affiliates to

buy or sell any securities, futures, options or other financial instruments or to participate in any other strategy. Only the published pro-

spectus pursuant to the Austrian Capital Market Act should be the basis for any investment decision of the Recipient.

For regulatory reasons, products mentioned in this Investment Recommendation may not being offered into Austria and are not available

to investors in Austria. Therefore, NORD/LB might not be able to sell or issue these products, nor shall it accept any request to sell or

issues these products, to investors located in Austria or to intermediaries acting on behalf of any such investors.

Additional information for recipients in Belgium

Evaluations of individual financial instruments on the basis of past performance are not necessarily indicative of future results. It should

be noted that the reported figures relate to past years.

Additional information for recipients in Cyprus

This Investment Recommendation constitutes investment research within the meaning of the definition section of the Cyprus Directive

D1444-2007-01(No 426/07). Furthermore, this material is provided for informational and advertising purposes only and does not consti-

tute an invitation or offer to sell or buy or subscribe any investment product.

Additional information for recipients in Denmark

This Investment Recommendation does not constitute a prospectus under Danish securities law and consequently is not required to be

nor has been filed with or approved by the Danish Financial Supervisory Authority as this Investment Recommendation either (i) has not

been prepared in the context of a public offering of securities in Denmark or the admission of securities to trading on a regulated market

within the meaning of the Danish Securities Trading Act or any executive orders issued pursuant thereto, or (ii) has been prepared in the

context of a public offering of securities in Denmark or the admission of securities to trading on a regulated market in reliance on one or

more of the exemptions from the requirement to prepare and publish a prospectus in the Danish Securities Trading Act or any executive

orders issued pursuant thereto.

Additional information for recipients in Greece

The information contained herein describes the view of the author at the time of its publication and it must not be used by its Recipient

unless having first confirmed that it remains accurate and up to date at the time of its use.

Past performance, simulations or forecasts are therefore not a reliable indicator of future results. Mutual funds have no guaranteed

performance and past returns do not guarantee future performance.

Additional information for recipients in Ireland

This Investment Recommendation has not been prepared in accordance with Directive 2003/71/EC, as amended, on prospectuses (the

“Prospectus Directive”) or any measures made under the Prospectus Directive or the laws of any Member State or EEA treaty adherent

state that implement the Prospectus Directive or those measures and therefore may not contain all the information required where a

document is prepared pursuant to the Prospectus Directive or those laws.

Additional information for recipients in Luxembourg

Under no circumstances shall this Investment recommendation constitute an offer to sell, or issue or the solicitation of an offer to buy or

subscribe for Products or Services in Luxembourg.

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 16 of 17

Additional information for recipients in Netherlands

The value of your investments may fluctuate. Results achieved in the past do not offer any guarantee for the future (De waarde van uw

belegging kan fluctueren. In het verleden behaalde resultaten bieden geen garantie voor de toekomst).

Additional information for recipients in Poland

This Investment Recommendation does not constitute a recommendation within the meaning of the Regulation of the Polish Minister of

Finance Regarding Information Constituting Recommendations Concerning Financial Instruments or Issuers thereof dated 19 October

2005.

Additional information for recipients in Portugal

This Investment Recommendation is intended only for institutional clients and may not be (i) used by, (ii) copied by any means or (iii)

distributed to any other kind of investor, in particular not to retail clients. This Investment Recommendation does not constitute or form

part of an offer to buy or sell any of the securities covered by the report nor can be understood as a request to buy or sell securities

where that practise may be deemed unlawful. This Investment Recommendation is based on information obtained from sources which

we believe to be reliable, but is not guaranteed as to accuracy or completeness. Unless otherwise stated, all views herein contained are

solely expression of our research and analysis and subject to change without notice.

Additional information for recipients in Sweden

This Investment Recommendation does not constitute or form part of, and should not be construed as a prospectus or offering memo-

randum or an offer or invitation to acquire, sell, subscribe for or otherwise trade in shares, subscription rights or other securities nor shall

it or any part of it form the basis of or be relied on in connection with any contract or commitment whatsoever. This Investment Recom-

mendation has not been approved by any regulatory authority. Any offer of securities will only be made pursuant to an applicable pro-

spectus exemption under EC Prospectus Directive, and no offer of securities is being directed to any person or investor in any jurisdic-

tion where such action is wholly or partially subject to legal restrictions or where such action would require additional prospectuses, other

offer documentation, registrations or other actions.

Additional information for recipients in Switzerland

This Investment Recommendation has not been approved by the Federal Banking Commission (merged into the Swiss Financial Market

Supervisory Authority “FINMA” on 1 January 2009).

NORD/LB will comply with the Directives of the Swiss Bankers Association on the Independence of Financial Research, as amended.

This Investment Recommendation does not constitute an issuing prospectus pursuant to article 652a or article 1156 of the Swiss Code

of Obligations. This Investment Recommendation is published solely for the purpose of information on the products mentioned in this

advertisement. The products do not qualify as units of a collective investment scheme pursuant to the Federal Act on Collective Invest-

ment Schemes (CISA) and are therefore not subject to the supervision by the Swiss Financial Market Supervisory Authority (FINMA).

Additional information for recipients in Canada

This Investment Recommendation has been prepared for informational purposes only in relation to the products contained in this materi-

al and is not, under any circumstances to be construed as an offering memorandum or as an offering of any securities for sale directly or

indirectly in any province or territory of Canada.

No securities commission or similar regulatory authority in Canada has passed on the merits of these securities nor has it reviewed this

material and any representation to the contrary is an offence.

Relevant selling restrictions, if any, are contained in the prospectus or other documentation for the respective product.

Additional information for recipients in Estonia

It is advisable to examine all the terms and conditions of the services provided by NORD/LB. If necessary, Recipient of this Investment

Recommendation should consult with an expert.

Additional information for recipients in Finland

The financial products described in this Investment Recommendation may not be offered or sold, directly or indirectly, to any resident of

the Republic of Finland or in the Republic of Finland, except pursuant to applicable Finnish laws and regulations. Specifically, in the case

of shares, those shares may not be offered or sold, directly or indirectly, to the public in the Republic of Finland as defined in the Finnish

Securities Market Act (746/2012, as amended). The value of investments may go up or down. There is no guarantee to get back the

invested amount. Past performance is no guarantee of future results.

Additional information for recipients in Czech Republic

There is no guarantee to get back the invested amount. Past performance is no guarantee of future results. The value of investments

could go up and down

The information contained in this Investment Recommendation is provided on a non-reliance basis and its author does not accept any

responsibility for its content in terms of correctness, accuracy or otherwise.

Financial Special 20. December 2016

NORD/LB Fixed Income Research

page 17 of 17

Arrangements for the confidential treatment of sensitive customer and business data as well as for avoiding and handling conflicts of

interest

NORD/LB has separated its business divisions that may have access to sensitive customer and business data (confidential areas) from

its other divisions (e.g. NORD/LB Research) in terms of functions and locations and/or via relevant data processing arrangements.

The disclosure of confidential information that may have an impact on the prices of securities is monitored by NORD/LB’s Compliance

Unit which is independent of its trading, operational and settlement divisions. This independent unit controls the transactions undertaken

by NORD/LB and its employees on a daily basis to ensure that they are in line with market conditions. The Compliance Unit may impose

such trading bans and restrictions as may be necessary to ensure that information, which may affect the prices of securities, is not mis-

used and to prevent confidential information from being disclosed to divisions that are only allowed to use information available to the

general public. To avoid conflicts of interest in connection with the preparation of financial analyses, the analysts of NORD/LB are

obliged to inform the Compliance Unit of any studies being drawn up and must not invest in the financial instruments handled by them.

They are obliged to notify the Compliance Unit of all transactions (including external transactions) undertaken by them for their own

account or for the account or on behalf of third parties. Thus the Compliance Unit is in a position to identify all unauthorized transactions

undertaken by the analysts, such as insider trading and front and parallel running. When a Investment Recommendation involving con-

flicts of interest to be disclosed within the NORD/LB Group is drawn up, any information on such conflicts of interest will only be made

available by the Compliance Unit upon completion of the Investment Recommendation. Any subsequent amendment of the relevant

Investment Recommendation may only be made upon consultation with the Compliance Unit and when it has been ensured that the

results of the study are not affected by the knowledge of such conflicts of interest. Further information on these matters is set forth in our

Investment Recommendation or Conflict of Interest Policy which is available from the Compliance Unit of NORD/LB upon request.

Time of going to press

15 December 2016 10:34h (CET)

Disclosure of NORD/LB’s potential conflicts of interest according to § 34b Abs. 1 WpHG and

Article 5 and 6 according to the Commission Delegated Regulation (EU) 2016/958 of 9 March 2016

None.

Additional disclosures

Sources and price indications

Depending on the issuer, we use information from financial data suppliers, our own estimates, company data and the public media for the

preparation of our Investment Recommendations. Unless otherwise stated in the report, prices indicated relate to the closing price on the

previous day. Fees and commissions apply to securities (buy, sell, hold) and these may reduce the yield on investments.

Analytical methods and updates

In the preparation of Investment Recommendations, we take company-specific methods used for fundamental securities’ analysis and

quantitative/statistical methods, as well as technical analytical methods as the basis for valuations and for the regular updates. All as-

sumptions and analytical derivations related to our recommendation may be extracted from the underlying research analysis. It should be

noted that the results of analyses provide a snapshot overview and that past developments do not constitute a reliable indicator for future

profits. The basis of the valuations is subject to unforeseen change at any time, potentially leading to different conclusions. The present

report is prepared irregulary. Recipients are not automatically entitled to receive report update publications. Detailed information with

respect to our rating methodology is available at the webpage www.nordlb-pib.de/Bewertungsverfahren.

Recommendation system Share of recommendation (12 months)

Positive: Positive expectations for the issuer, a security type or a specif-

ic security of an issuer.

Neutral: Neutral expectations for the issuer, a security type or a specif-

ic security of an issuer.

Negative: Negative expectations for the issuer, a security type or a

specific security of an issuer.

Relative value (RV): Relative value recommendation in comparison to

a market segment, an issuer or a maturity.

Positive: 47%

Neutral: 46%

Negative: 7%

Recommendation history (12 months)

An overview of all our bond recommendations during the last 12 months is available at the webpage www.nordlb-pib.de/empfehlungsuebersicht_renten. Corresponding password: "renten/Liste3".

Issuer / security Date Recommendation Bond type Cause