tipping point nov 2011 final

8/2/2019 Tipping Point Nov 2011 FINAL

1/51

Deutsche BankCapital Markets and Treasury Solutions

The Tipping Point?Time to Call the ECB

Corporate Solutions & StrategyTom Joyce(212) 250-8754 / [email protected]

Michael D ad uk

November 2011

(212) 250-0470 / [email protected]

Javier Guzman(212) 250-3464 / [email protected]


2/51

The name given to that one dramatic moment in an epidemic when everything can change allat once is the tipping point.

Malcolm Gladwell, author of the Tipping Point

The ECB has to go beyond a narrow interpretation of its mission and should be prepared forforeseeable intervention in the secondary market, not as the central bank has done up tonow It has to be able to be a lender of last resort.

Our membership of the Euro is a guarantee of monetary stability and creates the right

conditions for sustainable growth. Our membership of the Euro is the only choice. Our task is

Anibal Cavaco Silva, Portuguese President

Only Napoleon did more than me, but Im taller than him.

.

~ Lucas Papademos, Greeces Prime Minister

. .

~ Silvio Berlusconi, Italian Prime Minister

11111

~ Lawrence Summers, former U.S. Treasury Secretary (1999 2001)


3/51

Contents

Section

1. Executive Summary: The Tipping Point

2. Recent Escalation of the Crisis

3. Searching for a Solution

.

B. Time to Expedite the Grand Plan

.

22222


4/51

1. Executive Summary: The Tipping Point


5/51

Summary Conclusions

Markets have lost confidence in the EU's institutionalstructures and framework

The Tipping Point Key Resolution Steps Needed

1. More progress on credible fiscal austerity (especiallyItaly)

Italy represents a critical new and dangerous phase of

the crisis (the "Tipping Point")

Italy and Spain have 300 bn and 120 bn of 2012issuance 930 billion combined over next 3 ears

2. Rapid resolution of the EMU's original sin - lack of

fiscal integration (Dec 9 EU Summit meeting)

3. Restore confidence to re-open bank funding markets

4. Time to expedite the "Grand Plan"

- Italian sovereign bond market is broken

The "stakes" have never been higher (including the fate

of the Euro itself)

- Larger Greece debt restructuring

- Bank capital raises and debt guarantees

- Additional bail-out funds for Greece

Politics has become the obstacle: All 5 "peripheral"countries have had leadership change in 2011

The economy (recession) has become the unknownvariable

5. Time to call the ECB

- Investor reluctance on EFSF 1 trillion leverage plan

- Ineffectiveness of ECB monetary policy transmissionmechanism to keep bond yields low

Continued Euro bank sector de-leveraging likely underalmost any scenario (over $2 trillion estimate for next 18months)

Lon er term external current account deficits matter

- Adjustment away from current bond purchase programneeded (away from temporary, limited and sterilized)

- ECB should announce large, targeted buying plan (i.e. 200 bn over 12 months)

44444

more than fiscal deficits

Source: Deutsche Bank Global Markets Research - Economics, Credit, Rates, and FX2012 will become the year of either a more integrated Europe, or a disintegrating one


6/51

The Tipping Point

What Is Now At Stake?

1. Conta ion to Euro es core

.

.

55555

Source: IMF


7/51

#1: Contagion to Europes Core

Italian 2 & 10-Year Bond Yield France 10-Year Bond Yield

3.5

4.0 ermany y e rance y e

6.0

6.5

7.0

7.5

Nov 10: French-German 10y spreadreaches 20-year wide of 169 bpsNov. 9: Italian 10y yield reached nearly 7.5%

3.0

(%)4.55.0

5.5

(%) Gap:510 bps Gap:169 bps

2.0

.

Yiel

3.0

3.5

4.0Yiel

1.0

1.5

1.0

1.5

2.0

.

66666

Source: Bloomberg


8/51

#2: The Global Economy

Will Europe Push theU.S. Into Recession?

2 Scenarios: Detail

Global GDP Growth (2010-2012)

12%

1.Moderate worsening of

Euro zone recession( muddle throughscenario)

Most probable outcome

Not enough to cause U.S. double-dip

- U.S. trade exposure is low vis--vis U.S. GDP

8.3%

10%

Asia America

(1 - 2% EU GDP decline)

- Even a 5% drop in Euro ZoneGDP would only reduce exportsby less than 1/2% of U.S. GDP

2. Severe downturn in Less likely outcome

.

6%

8%

(disruptive creditevent scenario)

(> 5% EU GDP decline)

Would likely drive U.S. double-dip

Channels of contagion:

- High correlation on U.S. / EUstock markets

3.7%

2.3%

2%

4%

- High correlation on U.S. / EUconsumer & business confidence

- Bank funding markets andfinancial channels

0.4%

0%

2010

2011E

2012E

2010

2011E

2012E

2010

2011E

2012E

2010

2011E

2012E

2010

2011E

2012E

77777

Source: Deutsche Bank Global Markets Research Peter Hooper, Thomas Mayer, Torsten Slok, Michael Spencer

Most standard macro models do not adequately capturethe impact of financial and funding channelcontagion

The Euro crisis continues to be the #1 macro risk inthe global economy


9/51

#3: Global Financial System Stability

Stock Price DeclineStock Price Decline

3.5 10.0Systemic risk will

2.0

2.5

3.0

ce(EUR)

5.0

6.0

7.08.0

9.0

ce(USD)

Oct 10: Dexia is nationalized

remain high until

Europe movesmoreaggressively

toward resolution

0.0

0.5

1.0

.Pri

0.0

1.0

2.0

3.0

4.0Pri

Key Date October 10: Nationalization

October 31: Filed for bankruptcy

th

Size

Drivers

Assets: 517 bn

Sovereign exposure: Over 20 bn to peripherals

Reliance on wholesale funding

. .

Assets: $41 bn

Sovereign exposure: $6 bn to Europeansovereigns

-

88888

Encumbered assets

Moodys Review for downgrade on Oct 3, 2011

Operational: Q2-2011 loss of 4 billion

investment grade

Operational: Q3-2011 loss of $192 million (fromEuropean debt trading losses)

Source: Bloomberg


10/51

#4: The Fate of the Euro Itself

Worlds Largest Currency & Trade UnionOver 60 Years of History

1951: European Coal and Steel Community (ECSC)established (EU predecessor)

# of Countries: 17

Total Population: 330 million

1965: Merger Treaty signed

1973: UK, Denmark and Ireland join EU

1979: European Parliament is elected

Total GDP: 9.5 trillion

Total Debt: 8.4 trillion

Rank Partner TotalTrade(EURBn) %ofTotal

1986: Spain and Portugal enter EU

1992: Maastricht Treaty signed

1998: ECB established through the Treaty of Amsterdam

xtra , .1 U.S. 412 14.4%

2 China 395 13.9%

3 Russia 245 8.6%

2001: Greece enters euro

2010:

May: Greece 110 bn bailout; Creation of EFSF

4 Switzerland 190 6.6%

5 Norway 121 4.2%

6 Japan 109 3.8%

2011:

May: Portugal 78 billion bailout

July: Initial Greece restructuring announced

.

8 India 68 2.4%

9 SouthKorea 67 2.3%10 Brazil 64 2.2%

99999

:

Source: IMF, Bloomberg, European Commission, Eurostat (2010)

At stake, quite simply, is over 50 years of history and the worlds largest currency and trade union


11/51

Key Takeaways for Issuers and Investors

For Issuers For Investors

What Are the Key Takeaways in the Meantime?

. .,Dexia, MF Global)

Contagion to global economy could be significant

Funding market stress will remain unpredictable and

g er rate , non- nanc a s over nanc a s

Lower beta names over higher beta and cyclicals

On the run benchmarks over less liquid alternatives. .

High credit spread correlation between EU and U.S.banks

Continued correlation between new issue volumes and

Higher LCH haircuts (initial margin) for Italian bonds onNov 9 was a critical trigger event

Primary dealer bond inventory and trading volumes atrecord lows

Better market access for higher rated, non-financialnames

More active hedging of rates, FX and commodities riskadvised

Liquidity could be exacerbated by "year-end effect"

EUR / USD is probably the worst instrument toexpress negative Euro area views (peripheral bonds

Euro "tail risk" downside protection increasinglyimportant (especially given current Tipping Point)

an equ t es are a muc etter gauge o stress

Italian bond yields have become the new barometer toevaluate the crisis

1010101010

Until confidence is restored and Europe accelerates its crisisresponse via the ECB, volatility and systemic risk will remain high

Source: Deutsche Bank Global Markets Research - Economics, Credit, Rates, and FX. Credit trading strategist: Richard Salditt


12/51

Looking Ahead: 10 Key Risks

Risks

1. Unsustainable Italian bond yields (especially ifGerman Bundesbank resists ECB ex ansion

Risks

6. Execution risk on new EFSF insurance/ SPV plan toring-fence Italy and Spain

2. Year-end effect: Selling pressure on bank balancesheets going into year end

7. France losing its AAA rating (and negativeimplications for EFSF)

3. European recession deeper than expected / Italiangrowth

8. Downside on EUR / USD (given current Tipping Pointmoment)

. arger sys em c r s even s .e. ex a, o a

5. Greek debt sustainability / PSI execution

.

10. Beginning of Euro unwind (i.e. Greece exit)

It is an understatement to su est there are a lot of balls in the air.

1111111111

You have to be a true optimist to believe that policy makers are going to catch them all.~ Alan Ruskin, Deutsche Bank FX Strategist


13/51

2. Recent Escalation of the Crisis


14/51

5 Recent Problem Areas

Recent escalation of the Euro crisis has occurred around 5 key problem areas in particular:

1. Confidence

. qu y an so vency concerns

3. Political failures

4. Competitiveness concerns

5. Stress in bank funding markets

1313131313


15/51

#1: Confidence

EUR vs. JPY and CHFItalian 10y Bond Yield7.5 EUR J a anese Yen EUR S wiss Fr anc

7.0

2%

4%

6%

8%

The Euro has weakened sharply against safe-havenalternatives such as the Yen and the Swiss Franc

Nov 7: EFSF 3 bn bond prices wide at MS+104 bps

Nov 8:PM Berlusconi finally agrees to resign

Nov 9: LCH increases haircut on Italian bonds

6.0

.

Yield(%)

6%

4%

2%

0%

5.0

.

12%

10%

8%

.

1Ju

l

8Ju

l

15

Ju

l

22

Ju

l

29

Ju

l

5

Aug

12

Aug

19

Aug

26

Aug

2

Sep

9

Sep

16

Sep

23

Sep

30

Sep

7

Oct

14

Oc

t

21

Oc

t

28

Oc

t

4

Nov

11

Nov

5

Aug

12

Aug

19

Aug

26

Aug

2

Sep

9

Sep

16

Sep

23

Sep

30

Sep

7

Oct

14

Oct

21

Oct

28

Oct

4

Nov

11

Nov

The global capital markets have lost confidence in the institutional structures and framework of the Euro

2 sta es of crisis escalation in last 90 da s

1414141414

Source: Bloomberg

1. Collision with U.S. downgrade event on Aug 5

2. Extreme Greece and Italian political turmoil after Grand Plan announced on Oct 27


16/51

#2: Liquidity and Solvency Concerns

Liquidity vs. Solvency Risk

GDP Total Debt Govt Debt / GDP Private SectorDebt / GDP

Type of Risk

220 bn 350 bn 160% ~ 175% Solvency

1,087 bn 733 bn 67% ~ 330% Liquidity

1,590 bn 1,924 bn 121% ~ 145% Liquidity

Italy Shouldnt Be A Solvency Issue But a Liquidity Issue 120% debt / GDP is high but stable

50% of public debt owned domestically

Europes largest sovereign debt market (3rd

Over 2 trillion of sovereign debt outstanding

10-year yields traded near 7.5% (Nov 8 9)

Market demanding:

- Large structural and fiscal austerity

Large, wealthy and unlevered private sector

3rd largest euro zone economy and 4th in the EU

- Strong, credible government leadership

LCH imposing higher margin requirements onItalian debt (haircut increased Nov 9)

Large ECB (or EFSF) liquidity backstop needed

1515151515

Source: Bank of Spain , Bank of Greece , Bank of Italy, IMF, Deutsche Bank Global Markets Research

The Italian political turmoil during Nov 2nd week nearly turned a liquidity issue into a credit event


17/51

#3: Political Failures

Nov 8: Berlusconi resigns

2011: Political Leadership ChangeMultiple Levels of Political Risk

Nov 13: Replaced by Monti

Nov 10: Papandreou resigns

Nov 11: Replaced by Papademos

erman un es an n rans gence regar ngmore expansive ECB role

Limited Italian bond-buying to effectively force- ov : pan s e ect on

- PM Zapatero will not run for re-election

Mar 23: Socrates resigns

Jun 21: Replaced by Passos Coelho

out Berlusconi

Awaiting more aggressive Italian fiscal austerity

Jan 22: Cowen resigns

Jan 26: Replaced by Kenny

Vigorous debate over details of Grand Plan

French delays on own austerity before April election

sca a on o e uro cr s s n as resu e n

political leadership change in all 5 peripherals

New more Euro-centric leadership:

- Greeces Papademos formerly at ECB (Frankfurt)

-

Papandreous high stakes political gamble(confidence vote and referendum proposal)

1616161616

(Brussels)

er uscon s res s ance o epar ure

Delays on comprehensive fiscal austerity


18/51

#4: Competitiveness Concerns

2011E GDP Growth RatesCompetitiveness

concerns haverecentl focused on

6%

8%

Italy: 0.5%

Italy in particular

6%

4%

2%

0%

2%

Estonia

Luxembourg

Slovakia

Finland

Germany

Austria

Malta

Belgium

Slovenia

Netherlands

Ireland

France

Spain

Italy

Cyprus

Portugal

Greece

Ireland

Greece

Spain

France

Portugal

Slovenia

Cyprus

Slovakia

Luxembourg

Italy

Netherlands

Malta

Belgium

Austria

Estonia

Germany

Finland

0%

5%

10%

fGDP

Italy: -3.8%

8%

6%

4%

2%

0%

%ofG

DP

10%

5%

bourg

lands

many

ustria

lgium

tonia

nland

eland

vakia

venia

rance

Italy

Malta

Spain

yprus

rtugal

reece

%

o

1717171717

Source: OECD, Deutsche Bank Global Markets Research; Malta National Statistics Office, IMF, S&P, Slovak Government

12%

10%

Luxem

Nethe

Ger A

Be E F

i IrSl

Slo F C

Po G

Italy: -4.0%


19/51

#5: Stress in Bank Funding Markets

250

Euro Basis SwapEuribor-OIS

200

250 Overnight inter-bank funding costs in Europe haveincreased significantly (~65 bps since July 1)

US$ funding costs have also increasedsignificantly, with the Euro basis swap

-200

150

100

Bps

100

150

Bps

- we e ow eve s ur ng e nanc a cr s s o2008

- Still below levels during the financial crisis of

2008

50

0

Aug08 Feb09 Aug09 Feb10 Aug10 Feb11 Aug11

0

50

Au

g

08

Nov

08

Feb

09

May

09

Au

g

09

Nov

09

Feb

10

May

10

Au

g

10

Nov

10

Feb

11

May

11

Au

g

11

Nov

11

Selected Bank CDS Spread (as of Nov. 14, 2011)

600

700CDSonNov14,2011 PeakCDSlevelsinceJuly21,2011

200

300

400

500

Bps

1818181818

Source: Bloomberg

0

100

MS BAC SocGen GS Citi BNP Barclays UBS DB CS JPM HSBC


20/51

Key Upcoming Dates

Date Detail

November 20 Spanish general election expected (4 months earlier than expected)

. . ,

November 29 - 30 Eurogroup / ECOFIN Finance Ministers meetings

December Troika review of Greece finances to determine 7th quarterly aid installment

, ,

December 8 ECB Governing Council meeting

December 9

EU Summit (leaders expected to discuss EFSF and fiscal union)

December 25 Bank capital raising plans due for meeting 106 billion target

January 2012 Target date for completion of Greece 50% debt haircut exercise (could be sooner)

pr renc res ent a e ect on

June 30, 2012 Deadline for EU Banks to meet 106 billion capital target

1919191919

With elevated stress in both the sovereign crisis and bank funding markets, the year-end effectfor bank balance sheets this year could create heightened pressure for sovereign bond markets


21/51

3. Searching for a Solution


22/51

A. Time to Call the ECB


23/51

Time to Call the ECB

Why Larger ECB Role Now?EFSF Financings to Date

Date: Nov 7, 2011 1. Ineffectiveness of current ECB monetary policytransmission mechanism to kee bond ields low

Size: 3 bn, 10-year

Pricing: MS + 104 bps (+177 bps over German bunds) 2. Italian bond market is now broken

- Sharp contagion of the crisis to Italy the week ofNov 7

a e: une ,

Size: 3 bn, 5-year

Pricing: MS + 6 bps

3. Investor reluctance on the EFSF 1 trillionleverage plan

- Insurance guarantee plan-

Date: June 15, 2011

Size: 5 bn, 10-year

Pricin : MS + 17 b s

-

4. Weakness of the EFSFs 3 billion financing onNov 7

- Contagion from Greece and Italy turmoil

- Less confidence in credit resilience of guarantors(i.e. France)

- Uncertainty around EFSF leverage plan

2222222222

Source: Deutsche Bank Global Markets Research Thomas Mayer, Giles Moec, Mark Wall, Peter Hooper, Torsten Slok, EFSF


24/51


200

ECB Sovereign Bond PurchasesKey Steps Needed From ECB

Significant expansion of ECB balance sheet(analogous to U.S. Fed) Total: 187 billion

120

140

160

ions

- To fulfill role previously planned for fully levered EFSF

Key steps recommended in new ECB approach:

40

60

80

100

EURBill

1. Depart from current bond purchase program("limited" and "temporary")

2. Formal end to "sterilization" of urchases (alread

0

20

ay

10

un

10

Jul10

ug

10

ep

10

ct10

ov

10

ec

10

an

11

eb

11

ar

11

pr11

ay

11

un

11

Jul11

ug

11

ep

11

ct11

underway due to unlimited liquidity facilities)

3. Pre-announce a volume of purchases such as EUR200 billion over 12 months

MJ A S N D J F M M

J A S- "Unlimited" commitment more impactful butpolitically unrealistic

~ 50 billion of Greek bonds

Over 100 billion of largely Italian and Spanish bondurchases since Au ust

2323232323

Source: Deutsche Bank Global Markets Research Thomas Mayer, Giles Moec, Mark Wall, Peter Hooper, Torsten Slok, ECB, Bloomberg


25/51


Stron , credible Italian Government under Mario

Potential Consequences of ECBNot Expanding Role

Key Pre-Conditions Neededfor New Approach

Monti

Passage of large, credible Italian fiscal austerity

limited approach

Loss of ECB credibility over time

Progress on EU fiscal "integration" at Dec 9 EUSummit, or earlier (recognizing that true politicaland/or fiscal union is not a realistic goal)

Possible bank system runs from Southernperiphery to Northern banks

At least "passive tolerance" from a reluctant

German Bundesbank in Frankfurt

- Draghi will not get unanimous support

One of the severest forms of monetary policy being roped in for fiscal purposes is monetary financing, incolloquial terms also known as the financing of public debt via the money printing press. The prohibitionof monetary financing in the Euro Area is one of the most important achievements in central banking ands ecificall for German it is also a ke lesson from the ex erience of h erinflation after World War I.

2424242424

~ Jens Weidmann, Head of Germanys Bundesbank (& ECB Council Member)

Source: Deutsche Bank Global Markets Research Thomas Mayer, Giles Moec, Mark Wall, Peter Hooper, Torsten Slok


26/51


ECB Sovereign Bond PurchasesTotal ECB Lending

ECB Monetary Policy Transmission to Euro Zone Ineffective

The ECB monetary policy transmission mechanism hasbecome ineffective at keeping Euro bond yields low

- Even though the 10y Eonia rate declined over 30 bps sinceSeptember, Euro Zone and peripheral interest rates have

Peripheral bond yields: Now negatively correlated to theEonia rate

Core European yields: Decreasing their correlation to Eonia(20% drop in French yield correlation)

2525252525

Note: Eonia rate is an effective overnight interest rate computed as a weighted

average of all overnight unsecured lending transactions in the interbank marketSource: Deutsche Bank Global Markets Research - Francis Yared

This suggests that monetary policy alone is not enough,

and that further SMP purchases are necessary to containinterest rates in the region


27/51


LTRO MRO Other li uidit rovidin o erations

ECB Liquidity FacilitiesTotal ECB Lending

Continued Liquidity Support Until Bank Funding Stress Subsides

700

800

900

1000

784 bn 3-month and 6-month Longer Term Refinancing

Operations (LTRO)- Full allotment

- Unlimited

300

400

500

600

EURBillions

12-month LTRO

- Reintroduced Oct 6

- Full allotment

0

100

200

Jan

07

pr

07

Jul07

Oct07

Jan

08

pr

08

Jul08

Oct08

Jan

09

pr

09

Jul09

Oct09

Jan

10

pr

10

Jul10

Oct10

Jan

11

pr

11

Jul11

- Unlimited

US$ Funding

-

As of Nov. 14, 2011:

LTRO: 374 bn

MRO: 193 bn

Sept 15- Critical given pull-back from $2.7 trillion U.S. money

market funds

2626262626

Other: 217bn

Total: 784 bn

Source: Deutsche Bank Global Markets Research Thomas Mayer, Giles Moec, Mark Wall, Peter Hooper, Torsten Slok, ECB, Bloomberg


28/51


Evolution of U.S. Federal Reserve Balance Sheet Expansion

03,000,

CPFundingFacility MoneyMarketFundingFacility

0

0

2,000,

2,500,

n

PrimaryCredit FederalAgencyDebtSecurities

MBS Repos

U.S.TreasurySecurities OtherCredit

AssetBackedFundingFacility RescueFundsforAIG

0

0

1,000,

1,500,US$ TermAssetBackedLoanFacility Treasuries

0

0500, MBS

The Fed aggressively grew its Balance Sheet from ~ $800 billion in 2008, to over $2.5 trillion today

Jan

06

Apr

06

Jul

06

Oct

06

Jan

07

Apr

07

Jul

07

Oct

07

Jan

08

Apr

08

Jul

08

Oct

08

Jan

09

Apr

09

Jul

09

Oct

09

Jan

1

Apr

1

Jul

10

Oct

1

Jan

11

Apr

11

Jul

11

Oct

11

2727272727

Source: Federal Reserve

Comparably aggressive growth of the ECB Balance Sheet is a key missing ingredient in EuropesGrand Plan and, we believe, will ultimately be needed to resolve the crisis


29/51

B. Time to Expedite the Grand Plan


30/51

Time to Expedite the Grand Plan

Pillars July 21, 2011Agreement

October 27Grand Plan

Greek Debt 21 % 50%Pillar 1

oan ma ur es ex en e rom .years to as much as 30 years

Based on Greece Debt / GDP target in2020 of approx 160%

ey e a s on new on s s

Based on Greece Debt / GDP target in

2020 of approx 120%

an ngSector Capital(& DebtGuarantees)

. on

Based on July 2011 stress test results

No haircuts on banking book sovereignexposures (trading book only)

on

June 2012 deadline to meet target

Mark-to-market of sovereign exposures

Debt guarantee program re-introduced

Pillar 2

Leverage EFSFto ~ 1 Trillion

440 billion

Upsized from ~ 250 billion

Expansion of new powers to buy bondsand support banks

~ 1 Trillion

Assumes 4 5x leverage through new:

1) Insurance guarantee scheme

Pillar 3

AdditionalGreek Bailout

109 billion

~ 20 billion for Greek banks

130 billion

30 billion for Greek banksPillar 4

2929292929

PSI debt restructuring

(1) 210 bn of the 350 bn of Greek debt outstanding is held privately; assumes 100% participationSource: EBA, EU Commission


31/51

Pillar # 1: Greek Debt Haircut

PSI Plan Overview

Haircut: 50% on all bonds held by private sector

Debt reduction target:160%

Debt / GDP of European Peripherals

160%

100 bn area (50% write-down of 210 bn of the 350bn total Greek debt)

Target reduction of Debt / GDP from160% to 120%

Reduced interest payments of approx 6 bn per year120%

140%

Target Debt / GDPreduction from EuropesGrand Plan

120%

Participation / New bonds:

Voluntary (would therefore not trigger CDS)

New bond details still TBD (maturity, coupons)

New bonds expected to be issued under English law60%

80%

Restructuring sweetener: 30 bn of collateral tosupport bond swaps

Conditionality:

More stringent Troika monitoring of Greece0%

20%

40%

Commitment to 15 billion of privatizationsGreeceItalyIrelandPortugalSpain

Restructuringnot on the

Open torestructuring

21% Greekdebt haircut

50% Greekdebt haircut

3030303030

Source: IMF, European Council

tablea eronly

announce announce

May 2010 Nov 2010 July 2011 Oct 2011


32/51

Pillar # 1: Greek Debt Haircut

Top Banks Holdings ofGreek Sovereign Debt

Size of CDS Markets onSovereign Debt

reece

France

Germany

48.4 bn

9.6 bn

7.6 bn

France

Italy

24.0 bn

22.0 bn

Cyprus

Belgium

UK

5.8 bn

3.9 bn

2.2 bn

Germany

Spain

19.6 bn

18.0 bn

Portugal

Italy

1.4 bn

1.4 bn

1.2 bn

Portugal

U.S.

.

5.6 bn

5.5 bn

0 10 20 30 40 50

Austria 0.9 bn

0 5 10 15 20 25 30

Greece 3.7 bn

EUR BnEUR Bn

3131313131

Source: EBA, Wall Street Research, Wall Street Journal

sovereign debt by a large margin

Many banks have already done a full mark-to-market EU trading restrictions, and a restructuring that

side-stepped CDS triggers, have marginalized

this market


33/51

Pillar # 2: EU Bank Sector Capital

Greece

Indicative Bank CapitalShortfalls by Country

30.0 bn

Recap requirement: 106 billion

Scope: 70 banks (details on individual banks TBD)

Plan Overview & Observations

Spain

Italy

France

26.2 bn

14.8 bn

8.8 bn

Test criteria: 9% Core Tier 1 target ratio

- MTM treatment of sovereign bond holdings as of Sept2011; Basel 2.5 methodology for RWA

Timeline: 6- 9 months (June 2012)

Portugal

Germany

7.8 bn

5.2 bn

4.1 bn

Source of Capital:

- Step # 1: Private sector

- Step # 2: Government (if needed)

Cyprus

Austria

3.6 bn

2.9bn

- ep : nee e

Greek banks receiving most capital (approx 30 bngiven 50% haircut on ~ 50 bn of Greek bond holdings)

Higher than expected capital shortfalls for Spanishand Italian banks 2/3 of total

we en

Norway

Slovenia

.

1.3 bn

0.3 bn

Lower than expected capital shortfalls for French andGerman banks

EBA (bank regulator) asked to work with the ECB, EIBand EU Commission to explore options for a

3232323232

0 5 10 15 20 25 30

EURBillionSource: EBA, Wall Street Research, Wall Street Journal

Total: 106 bn

coordinated bank debt new issue guarantee scheme

Guarantee not to come from pooled resources

Therefore likely to only benefit AAA rated countries


34/51

Pillar # 2: EU Bank Sector Capital

Potential Capital Raising Actions (To Reach $106 Billion)

Actions Potential Size Comment

as est pat or pro ta e an s to meet cap ta s ort a s

Dividends / hybriddistributions 10 15 billion area Combination of distribution cancellation and scrip dividends

Increased deferred compensation and equity consideration foremployees

Disposal of RWAs TBD

Focus on capital intensive assets (e.g., first loss securitizationpieces, correlation loan books, and unrated leveraged loans)

Subject to regulator oversight to ensure no excessivedeleveraging

Liability management 20 30 billion area

Subordinated debt tenders and debt for equity swaps availablefor banks with large amount of paper trading below par

Potentially as much as 45 bn available

Contingent capital TBD Unlikely to be popular until clarity that CoCos would be eligibleunder Basel 3

Rights issuance / common Market estimates suggest 10 30 billion area, although

3333333333

Source: EBA, Deutsche Bank Global Markets Research

equity

Stronger banks likely to pursue conventional rights issues


35/51

Pillar # 2: EU Bank Sector Capital (& Guarantees)

2012 2014 EuropeanSenior Bank Debt Redemptions Bank Debt Issuance Guarantees

Coordinated State guarantees on new bank bonds845900

Scheme will be harmonized, but guarantee will notcome from pooled sources (i.e., EU)

Therefore, only AAA rated country banking

673

583600

700

800

systems likely to benefit

Much of the detail still TBD (EBA required to

coordinate with ECB, EIB and EU Commission)

400

500

EURBn

Observations

DB expects take up of guaranteed fundingscheme to be low

100

200

Maturity wall of ~ 800 billion in 2012

Usage of such scheme will trigger State Aid

penalties on same basis as October 2008 EUguidance:

- Business constraints

-

2012 2013 2014

3434343434

Source: Deutsche Bank Global Markets Research, European Council, Dealogic

- Potential restructuring


36/51

Pillar # 3: Leverage EFSF to ~ 1 Trillion

EFSF 2.0: 450 Billion

2 Plans: Detail

1. Insurance EFSF to provide partial first loss

EFSF 3.0: ~ 1 Trillion

EFSF1.0 EFSF2.0Germany 119.4 211.1 AAA/Aaa/AAA

France 89.7 158.5 AAA/Aaa/AAA

GuaranteePlan

insurance on new sovereign debtissuance (20 30% expected)

- Unclear if insurance will be attachedor separately traded instrument

Netherlands 25.1 44.5 AAA/Aaa/AAA

Austria 12.2 21.6 AAA/Aaa/AAA

Finland 7.9 13.9 AAA

/

Aaa

/

AAALuxembourg 1.1 1.9 AAA/Aaa/AAA

Belgium 15.3 27 AA+/Aa1/AA+

Spain 52.4 92.5 AA/Aa2/AA+

2. SpecialPurposeVehicle (SPV)

for privatesector ca ital

SPV with multi-tranche capitalstructure, based on seniority:

1. Senior debt instrument: targeted at

traditional fixed income investors

oven a . . a

Estonia 1.9 AA /A1/A+

Slovakia 4.4 7.7 A+/Aaa/A+

Italy 78.8 139.3 A+/Aa2/AA

Malta 0.4 0.7 A/A1/A+

Cyprus 0.9 1.5 A

/A2

/A

Ireland 7 12.4 BBB+/Baa3/BBB+

2. Mezzanine capital participationinstrument: targeted at sovereignwealth funds

3. EFSF first loss absorbing tranche

Portugal 11 19.5 BBB /Baa1/BBB

Greece 12.4 21.9 CCC/Caa1/B+

GrossTotal 440.0 779.8NetTotal 255.4 451.5 Effectivecapacity EFSF (2.0) total capacity: ~ 440 billion

EFSF (2.0) unused capacity: 250 billion (net ofGreece, Ireland and Portugal bailouts)

DB believes the 1 trillion leverage plan for the EFSFannounced on Oct 27 ma no lon er be a viable o tion

3535353535

(1) Effective lending capacity of 440 bn minus bailouts for Portugal, Ireland, and GreeceSource: European Council, Deutsche Bank Global Markets Research

. s ze: wou ever - x to ~ r on area(although smaller leverage of 3-4x may be more likely)


37/51


EFSF Insurance Scheme Pricing Considerations

Amount of Equivalent CDS for Various Guarantee Value Assuming 25% First LossProtection at Various Recover Rates

FirstLossProtection 30% 25% 20%

CDSRecovery ImpliedEquivalentAmountofCDSprotectionfor100mbond

0% 30 25 20

10% 33 28 22

20% 38 31 25

30% 43 36 29

40% 50 42 33

50% 60 50 40

60% 75 63 50

the proposed EFSF insurance guarantee scheme Higher first loss protections are analogous to higher

CDS protection for any given recovery rate

Using CDS replication, DB has measured the

e expecte va ue o t e guarantee or ta y an pa n

10y bonds is approx. 200 bps and 175 bps, respectively(based on 25% guarantee / 40% recovery)

Key Question: Will investors buy Italian bonds at yields

3636363636

Source: Deutsche Bank Global Markets Research Frances Yared.

t eoret ca va ue o t e nsurance sc eme atvarious recovery rates


38/51


Detailed Overview of Option 1: Insurance Scheme

DescriptionFor illustrative purposes only actual structure TBD

(critical details to be discussed with investors and Rating Agencies)

$

1. EFSF provides sovereign issuers with partial firstloss insurance

Leverage size depends on percentage of insuranceprovided (20 30% insurance or 4-5x leverage

3a

25% First Loss $ (in case of default)

,

Considering 250 bn as the EFSF base fire power, thefund would be able to insure approx 1 trillion of newissuance (theoretically); actual could be lower

1

InvestorsSovereign

Issuers

$

2. Sovereigns issue bonds with guarantee aimed atreducing yields (unclear if guarantee will be attachedor separately traded instrument)

3b

on s

with creditenhancement

3a. EFSF funds possibly held in a Trust to ensure

payment to investors in case of default (othercontingent funding arrangements also underconsideration to avoid grossing up member state balancesheets in advance of trigger event)

2

New Bonds

*** In both structures, the EU would be subordinated to

3737373737

3b. Trust repays investors 20% - 30% of losses ondefault

the private sector


39/51


Description

Detailed Overview of Option 2: Creation of SPV

For illustrative purposes only actual structure TBD(critical details to be discussed with investors and Rating Agencies)

1. SPV is created: multi-tranche capital structure expected:

- Senior debt tranche (with ratings): targeted attraditional fixed income investors

SPV

1

2

- Mezzanine capital participation instrument: targetedat sovereign wealth funds

- EFSF first loss absorbing tranche (EU subordinated to

private sector)

Investors

SWFs China Japan

BRICS

3en or etranche

Mezzanine

2. Issues senior bonds backed by EFSF contingentcapital (to further lever size)

3. Foreign official sector (IMF) and non-Europeansovereigns provide mezzanine capital

IMF role?

EFSF

EFSF firstloss

tranche

4. SPV purchases sovereign debt, relieving some of theburden of the ECB

SPV could possibly purchase primary or secondarydebt, or even extend loans for bank recaps

45

3838383838

5. EFSF provides partial first loss insurance (% guaranteecurrently unknown but 20 - 30% expected)

on ar et(primary or secondary) *** or to even extend

loans for bank

recaps


40/51


Given recent escalation of the crisis to Italy, execution of the 1 trillion EFSF leverage plan hasbecome more difficult, and may no longer be a viable option

Important Additional Points on the EFSF Leverage Plan

- Investor reluctance- Sharp crisis escalation since Oct 27

In both structures, the EU would effectively become subordinated to private capital (a new and

It could take significant time to work through final structure details, given the requireddiscussions and negotiations with both investors and the Rating Agencies

ppears ess e y t at nvestors w ass gn t e same va ue to t e nsurance o new ssuebonds as theoretical calculations would suggest (i.e., nearly 200 bps for 10 year Italian bonds)

Still unclear if the guarantee would be attached to the bonds or if they would trade separatelythe latter ma offer a ood solution for the otential im act of the lan on existin bonds

While the insurance scheme may be generally more targeted toward primary bonds, the SPVcould possibly purchase primary bonds, secondary bonds or even extend loans for bank recaps

3939393939

,critical details still to be determined (and escalation of the crisis to Italy)


41/51

Grand Plan Missing Pieces: Greek Debt Haircut

Grand Plan Missing Pieces: Greek Debt Haircut

Maturity and coupon of new bonds

Details related to planned 30 billion in credit enhancement on new bonds

Details around NPV calculation based on proposed haircut and terms of new bonds

Will such a large haircut (i.e., 50%) attract target investor participation rate above 90%? Will sufficientmeasures be put in place to ensure high voluntary participation?

What will be next steps if investor participation is lower than expected?

, ,

Will the restructuring exercise be completed before January as planned?

Will Greeces debt burden post-exercise (at 120% of GDP) be sustainable?

Will such large haircuts reduce the pressure on Greece around structural reform and fiscal austerity?

Will the combination of EU trading restrictions, and the side-step of CDS triggers in the voluntaryGreece restructuring, lead to the demise of the sovereign CDS market?

4040404040

The implementation challenge is as high, if not higher, than the design challenge.

~ Mohamed El-Erian, PIMCO


42/51

Grand Plan Missing Pieces: EU Bank Sector

Grand Plan Missing Pieces: EU Bank Sector

Types of qualifying capital that constitute "highest quality

Final individual bank ca ital shortfalls (current #s are indicative onl ; EBA will not ublish bank b bank data;rather, they leave it to the banks to disclose themselves)

Scope of permissible deleveraging to reach target (will be subject to close regulator monitoring)

Details on bank debt guarantee scheme

Key Questions

What will be the capital target plans for the weakest banks (presumably Government or EFSFca ital as re uired ?

Is the capital target size large and rigorous enough to restore confidence, such that bankfunding markets re-open?

How extensively will the new bank debt guarantee scheme be utilized (presumably by banks inAAA countries only)?

Given high market uncertainty (sovereign crisis, economic, regulatory), will banks continue tode-lever balance sheets in size and pull back sharply on credit extension?

4141414141


43/51

Grand Plan Missing Pieces: EFSF Leverage Plan

Grand Plan Missing Pieces: EFSF Insurance / SPV Leverage Plan

Final size (will be much smaller if leverage is only 3-4x, instead of 4-5x as planned)

% guarantee on EFSF bond insurance plan (20 30% area expected)?

Timing and scope of bond purchases (primary vs. secondary market purchases)

Role of the IMF (Capital contribution? Oversight role? Exercise control? Conditionality?)

SPV capital structure (seniority of tranches)

Collateral uarantees and/ or conditionalit re uired b forei n ublic sector investors China Brazil etc

Key Questions

Is the plan still viable given crisis escalation since Oct 27?

Will investors value guarantee to full theoretical value (i.e., 200 bps)?

Will the guarantee be attached or trade separately (possibly aimed at alleviating pressure on existing bonds)?

What will be the impact of the guarantee on the trading levels of existingbonds?

Will SPV structure attract outside sovereign wealth fund (i.e., China, BRICs) and private capital in size? IMF role?

Execution risk related to com lexit of ca ital structure, cor orate overnance and/or covenant issues in the new SPVstructure? Will there be one large SPV or several different ones?

How much time will it take to gather sufficient investor and rating agency feedback to finalize structure?

Should EU instead pursue a larger and more flexible AA rated EFSF, rather than smaller and more restricted AAA fund?

Who, in the end, is Europes lender of last resort?

4242424242


44/51

Looking Ahead: Risk of Additional Downgrades

Rating / Outlook

Germany Aaa / Stable AAA / Stable AAA / Stable

Selected European Country Credit Ratings

France Aaa / Stable AAA / Stable AAA / Stable

Austria Aaa / Stable AAA / Stable AAA / Stable

Finland Aaa / Stable AAA / Stable AAA / Stable

Luxembourg Aaa / Stable AAA / Stable AAA / Stable

AAA

Netherlands Aaa / Stable AAA / Stable AAA / Stable

Slovakia Aaa / Stable A+ / Positive A+ / Stable

Belgium Aa1 / Neg. Watch AA+ / Negative AA+ / Negative

Spain A1 / Negative AA- / Negative AA- / Negative

Slovenia Aa3 / Stable AA / Negative AA -/ Negative

Estonia A1 / Stable AA- / Stable A+ / Stable

Italy A2 / Negative A / Negative A+ / Negative

Malta A2 / Ne ative A / Stable A+ / Stable

InvestmentGrade

(below AAA)

Cyprus Baa1 / Negative BBB+ / Neg. Watch BBB / NegativeIreland Ba1 / Negative BBB+ / Stable BBB+ / Negative

Portugal Ba2 / Negative BBB- / Negative BBB- / Neg. WatchSubInvestment

4343434343

Source: Moodys, S&P, Fitch; Moodys developing outlook reflects the uncertainty about the exact market value of the securities creditors would receive in an exchange

Ratings on negative watch or outlook in red font


45/51

4. Outlook for the Euro


46/51

Outlook for the Euro

EUR Currency Performance (2011) DB EUR 2011 2012 Forecasts

Currency Q4 - 2011 Q1-2012 Q3-2012 Q4-201215%

EUR/USD EUR/CHF EUR/JPY

EUR / USD 1.30 1.27 1.25 1.23

EUR / JPY 101 99 105 1110%

5%

10%

EUR / GBP 0.86 0.86 0.84 0.79

15%

10%

5%

EUR / CHF 1.30 1.25 1.25 1.2525%

20%

Despite the escalation of the crisis, the EUR has heldup well vs. the USD

However, the EUR declined significantly against the

DB 2011YE EUR/ USD Forecast: 1.30

DB 2012YE EUR/ USD Forecast: 1.25

- Downside risks could be significant depending on crisis

4545454545

Yen and the Swiss Franc unt anintervention)

resolution

Source: Deutsche Bank Global Markets Research Bilal Hafeez, Alan Ruskin, George Saravelos


47/51


EUR / USD (2011)

Why Has EUR / USD Held Up So Strong?

Drivers of 2011 EUR Resilience

1.45

. 1. Capital flows to core Europe (C/A + FDI)

- EU maintains a current account deficit of -0.7% vs.

U.S. current account deficit of -3.1%

- EUR FDI in the 12 months through August of +0.2% ofGDP vs. US FDI of -1.1%

1.35

1.40

EUR/USD

- China retains strong investment in core Europe

2. EUR has traded as a risk currency

- Correlation between S&P 500 and EUR near all time

hi hs

1.30DB 2011E Year-End: $1.30

Drivers of Recent EUR / USD Weakness

Contagion to France is key turning point for capitalflows into core Europe

1.25

DB 2012E Year-End: $1.25- ep a a revea e consecu ve mon s o nega ve

foreign inflows Escalation of the crisis causing heightened risk

aversion and wide scale risk-off trades

4646464646


,with both periphery bonds and equities purer gauges of stress.

~ Alan Ruskin, DB FX Strategist


48/51


S&P 500 and EUR/USD Highly Correlated

EUR / USD has been resilient to the Euro eancrisis, partly because of its behavior as a riskcurrency

Correlation between EUR and S&P 500 is close toall-time highs, signaling that the euro is beingportrayed by the market as a risk asset

However, EUR bearish outlook will increase if riskaversion due to an escalation of the crisisincreases

Given the current Tipping Point moment, further escalation

4747474747



49/51


2011 Performance of Selected

What Has Been a Critical Driver of Euro and Other Currencies in 2011?

.

10%

12%

14%

20%

25% NOK SEK CHF JPY

4%

6%

8%

5%

10%

15%

4%

2%

0%

5%

0%

Top performing currencies in 2011 have included theSwiss Franc (CHF), Norwegian Krone (NOK),Swedish Krona (SEK) and the Japanese Yen (JPY)

Sovereign account surpluses have become a goodproxy for currency performance

In 2011, top performing currencies are all of current

4848484848

account surplus countries



50/51


In Downside Scenario, How Would Greece Euro Exit Mechanics Work?

Low (but rising)

Merkel and Sarkoz comments at Nov. 3 4 G-20 Summit crossed an im ortant s cholo ical barrier interms of their willingness to consider Greek exit

The economic, banking system and political costs of Euro unwind would far exceed the cost ofmaintaining current EMU construct (even if only 1 country exits)

Mechanism

n ecem er , t e reaty o s on prov e an exp c t ex t c ause vo untary as s on y or t efirst time in the history of the EU (simply notice required without specific reason)

Mechanism provides formal framework for EU exit

Voluntary exit only

What Would Be The Potential Cost and Implications?

Economic cost could be > 30% of GDP

Significant devaluation of the local currency andprivate sector assets

Soverei n default (lar er restructurin )

Massive disruption in EU payment systems

EU Greek corporate exposure are far in excess ofsovereign

Possible eri heral bank runs

4949494949

Capital controls

Collapse of Greek banking system

Negative impact on international trade

Significant political and credibility costs


51/51

tipping point nov 2011 final

Documents