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Why the Greece Sovereign Credit Crisis

Accelerated Sharply After March 25th?

Assessing the Potential Implications for Credit Markets

April 2010

Tom Joyce
Debt Capital Markets Strategist

Deutsche Bank Securities Inc., a subsidiary of Deutsche Bank AG, conducts investment banking and
securities activities in the United States.
A Broader Phenomenon of Sovereign Risk

“Every once in a while, the world is faced with a major economic development that
is ill-understood at first and dismissed as of limited relevance, and which then
catches governments, companies and households unawares.”

~ Mohamed El-Erian, PIMCO (February 2010)

“In the near term, the main risk is that, if unchecked, market concerns about
sovereign liquidity and solvency in Greece could turn into a full blown and
contagious sovereign debt crisis”
~ IMF, World Economic Outlook (April 2010)

“I hope that I am wrong but I fear that by end of the year, they will find out that
Greece needs a lot more money in 2011 and 2012, and that we will have
serious problems getting another package through.”
- Thomas Mayer, Deutsche Bank Chief Economist (April 2010)



1 Why the Greece Crisis Accelerated Sharply After March 25th?

2 The Broader Phenomenon of Sovereign Risk

3 Focus on Greece:

A. The Problem

B. Potential Solutions

4 The “Contagion Effect” for the Peripherals

5 Potential Implications for Credit Markets

Why the Greece Sovereign Credit Crisis
Accelerated Sharply After March 25th?
Section 1
Why the Greek Crisis Accelerated After March 25th?
The Acceleration of the Greek Credit Crisis after March 25th, 2010

Date Key Event

The Greek sovereign March 25 Joint EU / IMF Commitment Announced with Very Few Details
credit crisis began
to accelerate March 30 Low Demand for Greek 20 Year Bond Re-Opening
rapidly after March
25th, 2010 April 7 Top 4 Greek Banks Turn to Government

April 9 Fitch Downgrades Greece to BBB- (Negative Outlook)

April 11 EU / IMF Announce Details of EUR 45 Billion Package

April 19 Volcanic Ash Delays EU/ IMF/ Greece Meetings

April 20 IMF Releases Global Financial Stability Report with Sovereign Warnings

April 22  Eurostat Increases Greek 2009 Budget Deficit (Again) to 13.6%

 Moody's Downgrades Greece to A3 (and Review for Downgrade)

 Greek 2 and 10 Year Bond Yields Breach 11 and 9%, Respectively

 5 Year Greek CDS Spikes 160 bps to 638 bps

 EUR/ USD Exchange Rate Trades Down to 1.32

Greek Prime Minister, George Papandreou, formally activates EU / IMF

April 23 aid in a live television address

March 25: Joint EU / IMF Package with Few Details
On March 25th, the Overview of March 25th Joint EU / IMF Package
European Council
met in Brussels for
their quarterly Announced Details The Missing Details?
summit meeting
and agreed on a  Joint EU / IMF package of loans  Exact size of the package
rescue package of  IMF involvement is “substantial”
“last resort” that  Euro countries “expected” to pay based  Exact cost
would involve both
on their capital weights
the IMF and the EU
 Duration of the loans
By involving the IMF  Tough conditionality
in the solution  “Last resort” only (not a freely available  Duration of the package
already, the EU backstop facility)
essentially cut off  IMF not part of decision for its use  Exact role of IMF
Greece’s other key  Requires unanimous 27 nation support
option, and  Distribution of funds?
Germany, in  Not cheap  Technical assistance?
particular,  “Risk adequate pricing” that will  Enforcement power / set conditions?
increased its encourage Greece to return to market for
leverage over the
*** Over subsequent weeks, Investors reacted
 Required review of EU budget rules very negatively to the lack of detail ***
 Proposals due by year-end
 Tougher budget rules
 More flexibility for crisis response

The sharp acceleration of the Greek credit crisis began on March 25th, when the EU and IMF
announced a “joint-rescue package” with very few details; uncertainty and volatility followed

Source: Mark Wall, DB Chief European Economist. Deutsche Bank Markets Research. 6
March 30: Low Demand For Bond Re-opening
March 29: EUR 5 Billion New Issue March 30: EUR 390 Billion Re-Opening
 New Issue: 7 Year bond raising EUR 5 billion  Re-opening: EUR 390 million re-opening of 20
at mid swaps + 310 bps, or ~ 6% YTM year 2022 bond on March 30, 2010

 Demand: Over EUR 6.25 billion from 175 +  Demand: Greece had initially hoped to re-open
accounts (10 year bond earlier in year had this 20 year bond for EUR 1 billion, but demand
EUR 16 billion demand from 400 + accounts) was not sufficient

 After-market performance: Immediately *** The poor performance of Greece’s Mar 29th 7 year bond,
sold-off in after-markets; negatively impacted and low demand for its March 30th 20 year re-opening,
demand for March 30 re-opening signaled limited Greek access to public debt markets

After-market Performance of Greece’s March 29th 7 Year EUR 5 Billion Bond Deal

9 Greece’s 7 year EUR 5 billion new issue on March

29th immediately sold-off in secondary markets
Yield (%)



30‐Mar 3‐Apr 7‐Apr 11‐Apr 15‐Apr 19‐Apr 23‐Apr
GGB 5.9% '17s
Source: Deutsche Bank, Bloomberg (GGB, Corp).
April 7: Top 4 Greek Banks Turn to Government

Comment Piraeus Bank Alpha Bank

 On April 7th, Greece’s 4 largest 14 14

banks requested access to the 13 13
12 12
remaining EUR 17 billion of a
11 11
total EUR 28 billion state support
10 10
package established in 2008 9 9
 Combination of loan guarantees 8 8
and Greek government bonds 7 7
6 6
which the banks could use as
5 5
collateral for credit lines from 4 4
the ECB 1‐Sep 30‐Sep 29‐Oct 27‐Nov 26‐Dec 24‐Jan 22‐Feb 23‐Mar 21‐Apr 1‐Sep 30‐Sep 29‐Oct27‐Nov26‐Dec 24‐Jan 22‐Feb23‐Mar21‐Apr
 Prior requests entailed preferred Piraeus Bank Alpha Bank

stock issuance for capital

injections EFG Eurobank Ergasias National Bank of Greece

13 26
 During the prior week, Moody’s
downgraded the debt ratings of 11 22
Greece’s 5 largest banks, 10
highlighting the pressure on their 9
loan portfolios from the
recession 6 14
4 10
 An escalation of the Greek crisis 1‐Sep 30‐Sep 29‐Oct 27‐Nov 26‐Dec 24‐Jan 22‐Feb 23‐Mar 21‐Apr 1‐Sep 30‐Sep 29‐Oct 27‐Nov26‐Dec 24‐Jan 22‐Feb23‐Mar21‐Apr
could lead to deposit outflows, EFG Eurobank
National Bank of Greece
thereby increasing the potential
of “contagion”

Source: Deutsche Bank, Bloomberg

April 9: Fitch Downgrades Greece to BBB- (Neg)
Review of Fitch Downgrade

On April 9th, Fitch  Downgrade: Greece’s Long Term foreign and local currency Issuer Default Ratings downgraded
Ratings to BBB- from BBB+, Outlook Negative
Greece from BBB+
to BBB-, Outlook  Drivers of the Downgrade:
Negative  Fiscal challenge increases
 More adverse prospects for economic growth
 Increased interest costs
 Ongoing uncertainties on the Government’s financing strategy amidst market volatility

“The sharp rise in interest rates faced by the government this year, in
combination with a deterioration in the outlook for economic growth, will
make it harder for the government to achieve its fiscal targets of reducing the
deficit to 8.7% of GDP this year and ensuring that public debt peaks at just
over 120% of GDP in 2010 and 2011.”
- Fitch Ratings (April 9, 2010)

Source: Fitch Ratings. 9

April 11: EU / IMF Announce EUR45 Billion Package
On Sunday, April 11th, Overview EU Member Contributions
following nearly 3  Contributions by each EU member based on each
weeks of sharp  Size: ~ EUR 45 billion (US$ 60 billion) country’s capital weight at the ECB
deterioration in
 EUR 30 billion from Euro nations
market conditions
for Greece since (commitment) EMU Contributions Based on ECB Capital Weights
the March 25th  Additional EUR 10 - 15 billion from Implied Share of
announcement, the IMF (expected) Capital Weight EUR 30 bn (EUR
EU and IMF finally Country at ECB (%) bn)
announced a more
 Cost: Approximately 5%
detailed package
 Equal to Euribor + 300bps + 100 bps 1 Austria 1.94% 0.9
of “aid” for Greece
step-up in year 3 + 50 bps service 2 Belgium 2.43% 1.1
charge 3 Cyprus 0.14% 0.1
4 Finland 1.25% 0.6
5 France 14.22% 6.3
 Duration: 3 years 6 Germany 18.94% 8.4
7 Greece 1.96% N/A
 Key Hurdles / Considerations: 8 Ireland 1.11% 0.5
 Several EU national Parliaments 9 Italy 12.50% 5.5
would have to approve 10 Luxembourg 0.17% 0.1
11 Malta 0.06% 0.0
 Greece would have to officially
12 Netherlands 3.99% 1.8
request the assistance
13 Portugal 1.75% 0.8
 Details with IMF would need to be 14 Slovenia 0.33% 0.1
negotiated (multi-week process, 15 Slovakia 0.69% 0.3
expected to end by May 6th)
16 Spain 8.34% 3.7

Critical Question: Would markets be sufficiently satisfied with this detail, or would continued
uncertainty around IMF details and nation-state approvals create continued uncertainty?

Source: Deutsche Bank Global Markets Research. ECB. 10

April 19: Volcanic Ash Cloud Delays IMF Meetings
The delay in The Impact of Iceland’s Eyjafjallajokull Volcano
scheduled IMF /
Greece meetings,  The virtual shutdown of European air travel for 5 days caused the cancellation of in-person
scheduled for April meetings planned for Athens between the EU, the IMF and Greece on April 19th
19th, only  Scaled back meetings took place instead by phone, but slowed down a critical negotiation
exacerbated the
uncertainty that
had been driving  Negotiations have since resumed, and are expected to end by May 6th
low liquidity and
high volatility in
Greek securities  Markets reacted very negatively to the continued uncertainty and delays
 Greek bond yields and CDS levels spiked each day as the April 19th week progressed
Planned attendees in
Athens included
senior officials
from the European
Union, the
European Central
Bank and the IMF

April 20: IMF Warning on Sovereign Credit Risk
On April 20th, the IMF
released its
updated Global
Financial Stability
Report …

…and sovereign
credit risks among
countries were “Risks to global financial stability have eased as the economic
emphasized as a
primary source of recovery has gained steam, but concerns about advanced
renewed risk in the
global financial country sovereign risks could undermine stability gains and
prolong the collapse of credit.”

“The deterioration of fiscal balances and the rapid accumulation of

public debt have altered the global risk profile. Vulnerabilities
now increasingly emanate from concerns over the sustainability
of governments’ balance sheets.”

- IMF Global Financial Stability Report (April 20th, 2010)

April 22: Greece 2009 Fiscal Deficit Increased
Greece’s debt crisis Greece’s 2009 Fiscal Deficit Forecast
reached a dramatic
crescendo on April
 On April 22, 2010, Greece’s 2009 budget deficit was revised higher for the 4th time,
22nd as Eurostat
to 13.6% (or US$44.3 billion), up from a prior estimate of 12.9%
upwardly revised
Greece’s 2009  Eurostat indicated that Greece’s debt is 115% of the size of the economy (EUR
fiscal deficit to 273.4 billion, or US $395 billion)
13.6%, the 4th such
revision in the last
year  Eurostat indicated that uncertainties around Greek economic data could cause a 5th
revision, up to 14.1%
Markets reacted very
dramatically on the Greece’s 2009 Budget Deficit Revisions
April 2009 Forecast October 2009 Revision January 2010 Revision April, 22, 2010



Percent (%)





‐16 Greece revised its 2009 budget deficit 4 times, most recently to 13.6%

Source: Deutsche Bank Markets Research. Moody’s. WSJ. 13

April 22: Moody’s Downgrades Greece to A3
Review of Moody’s Downgrade

On April 22nd,  Downgrade: Greece’s government bond rating downgraded from A2 to A3 and placed on review
Moody’s for further possible downgrade
 A3 is just 4 notches above “junk” (non-investment grade) on Moody’s ratings spectrum
Greece from A2 to
A3 and placed
them on review for  Drivers of the Downgrade:
further possible
downgrade  Debt will only stabilize at a more costly level than previously anticipated
 Uncertainty about credible debt stabilization
 Headwinds of higher interest rates and lower economic growth
 EU’s fractious mobilization of emergency aid

“It is unlikely that the rating will remain at A3, unless the government’s
actions can restore confidence in the markets and counteract the prevailing
headwinds of higher interest rates and low growth that could ultimately
undermine the government’s ability to sustainably cut debt levels.”
- Moody’s Investor Service (April 22, 2010)

April 22: 2 & 10 Year Bond Yields Breach 11 & 9%
Greek bond yields April 22: Sharp Decline in Greek Bond Prices
posted a dramatic  April 22: Greek 10 year bonds traded as high as 9.20%, or 6.1% above 10 Year German bonds
decline on April
22nd to  Driven by Eurostat fiscal deficit revision and Moody’s downgrade earlier in the day
unsustainable  Yield on the Greece 2 year note soared by more than 275 bps, and actually breached 11%
levels that are
effectively priced
Greek 10 Year and 2 Year Bond Yields
for a “catastrophic
event” (of default 11.00
or restructuring)  April 22nd Greece 10 Year Bond Yield: 9.20%
10.00  April 22nd Greece 2 Year Bond Yield: 10.23%



Yield (%)





1‐Jan 8‐Jan 15‐Jan 22‐Jan 29‐Jan 5‐Feb 12‐Feb 19‐Feb 26‐Feb 5‐Mar 12‐Mar 19‐Mar 26‐Mar 2‐Apr 9‐Apr 16‐Apr 23‐Apr

Source: Deutsche Bank, Bloomberg Greek 10yr benchmark yield Greek 2yr benchmark yield 15

April 22: 5 Year Greece CDS Rises 160 bps
In a sovereign CDS April 22: Sharp Decline in Greek Bond Prices
market plagued by
 April 22: Greek 5 year CDS spiked an unprecedented 160 bps in the same day, closing at an
low liquidity, Greek
5 year CDS spiked historical high of 638 bps
an unprecedented  The cost to insure Greek 2 year debt rose even higher to close at 858 bps
160 bps on April
22nd  Driven by Eurostat fiscal deficit revision and Moody’s downgrade earlier in the day
 Also created spill-over contagion effect to other European sovereign CDS

Greece 5y CDS Greece 2y CDS

April 22nd Greece 5 Year CDS: 638 bps April 22nd Greece 2 Year CDS: 858 bps

600 875

550 775

500 675

450 575

400 475

350 375

300 275

250 175
1‐Jan 23‐Jan 14‐Feb 8‐Mar 30‐Mar 21‐Apr 1‐Jan 23‐Jan 14‐Feb 8‐Mar 30‐Mar 21‐Apr

Greece 5yr cds Greece 2y CDS
Source: Deutsche Bank, Bloomberg 16
April 22: Euro/ USD Trades Down to 1.32
On April 22nd, the
Euro traded down Euro Reaches 11 month low
to an 11 month low  March 23, 2010: With no formal aid package for Greece yet announced, the Euro dips below
against the USD, 1.35 for first time since May 2009 (10 month low)
dipping below 1.33
for the first time
 April 22, 2010: Euro slide continues, reaching an 11 month low against the USD of 1.32 on
since May 1, 2009
continued negative news earlier that day
 EU downwardly revised 2009 Greece budget deficit to 13.6%
 Moody’s downgrades Greece to A3 (4 notches from “junk” status)
 Greece CDS and bond yields widen to record levels

Euro – USD Spot (May 1, 2009 to April 22, 2010)

April 22nd EUR/ USD Rate: 1.3235


Euro / US$



May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10

Source: Deutsche Bank, Bloomberg 17

April 23: Greece Formally Activates EU / IMF Aid
Key Next Steps
Following the
1) ECB and EC will formally assess Greece’s application for aid
deterioration in  Should be a formality
Greek bond market
conditions on April
22nd since the 2) European Council must unanimously grant the joint-aid package
crisis began,  Low risk of rejection; can be done via teleconference
Greece’s Prime
Minister George
Papandreou, in a 3) Various EU Governments/ Parliaments must approve
live televised
 Risk of one or more nations failing to gain approval
address, formally
activated the  Would not jeopardise the EU deal; but rather, could reduce its size of EUR 30 billion
“request for aid”
from Europe
4) EU / IMF negotiations must be completed on the conditions of additional IMF aid of ~ EUR
15 billion
 Will take additional 1-2 weeks and scheduled to conclude by May 6th
 IMF focused on reform of Greece labor markets, healthcare and pension systems

5) Formal approval from IMF Board

 Size and timing of co-investment from EU will be critical factors

Source: Mark Wall, Deutsche Bank Chief European Economist

“We believe our European partners will act decisively and provide Greece with a safe
haven to rebuild our ship of state with strong and reliable materials.”
-Greek Prime Minister, George Papandreou, announces the decision

to seek EU loans in a live televised address (April 23, 2010)

The Broader Phenomenon of Sovereign Risk
Section 2
Assessment of Global Financial Sector Leverage
In analyzing leverage Overview
within an
economy, it is very  Policymakers and regulators focused much of their attention on financial sector leverage during the
important to focus financial crisis
on where in the
 However, across mature economies, the increase in financial sector leverage was dwarfed by
economy the debt
resides the collective growth of debt in the “real economy”: Households, non-financial businesses
and Governments
Although the Greek  From 2000 – 2009, the financial sector accounted for $11 trillion of the $40 trillion increase in
economy has total debt in mature markets
lower absolute
debt than other  Households, non-financial businesses and governments accounted for the remaining $29
economies, the trillion (split relatively evenly)
high sovereign %,
and its Sector Composition of Debt Across Economies
have created a Government Nonfinancial business Households Financial institutions
“crisis” 500 469 380
450 52
188 342 331
114 52 313
Percent of GDP

350 308 298 290

47 28
300 37 274
114 73 245
250 101 101 60 230
115 75 69
96 136 60
200 78 159
110 66 115 142
101 81 54 129
150 67 80 118 32
85 96 62 66 71
100 202 44 40 84 96
113 30 5
50 108 108 84 81 42 40
75 77 56 76
47 18 11 16

*The UK financial sector was adjusted to reflect its position as a financial hub. *Data for Switzerland represent year-end 2007
Source: Haver Analytics, FDIC, SNL Financial, Federal Reserve. McKinsey Global Institute. IMF Global Financial Stability Report.
Sovereign Market Vulnerability Indicators
There are several key Review of Selected Sovereign Vulnerability Indicators
indicators, beyond
the absolute
Depository Bank Claims
amount of Gov't Debt Held Abroad on Government (1)
sovereign debt,
that are critical to Country (% of GDP) (% of GDP)
understanding the
vulnerability of
sovereign leverage Greece 99.0% 17.5%
to an economy
Portugal 60.2% 10.2%
Italy 56.4% 29.4%
Ireland 47.2% 5.8%
Spain 26.9% 20.6%
United States 24.7% 8.2%
United Kingdom 17.9% 5.1%
Japan 13.7% 69.3%

Why is Japan’s High Debt Seemingly Lower Risk?

 High domestic savings
 Low foreign ownership of debt (< 14% of GDP)
 Strong home bias
 Stable institutional investors
 Local banks purchase high % of Govt debt

(i) Source: IMF Global Financial Stability Report (April 2010). Includes all claims of depository institutions, excluding the Central Bank, on the
Government. 21
The 4 Stages of the Sovereign Credit Crisis
4 Stages of the Sovereign Credit Crisis
The sovereign credit
crisis evolved
 Phase 1: As risk increased, core sovereign spreads (France, Germany) benefited from an initial flight
through several
to quality among investors
stages during the
2007 – 2010 global  Phase 2: Post Lehman, sovereigns with financial systems directly weakened by the crisis gapped
financial crisis wider (Austria, Ireland, Italy and the Netherlands)
 Phase 3: As sovereign utilized public balance sheets to support the banks, systemic risk subsided
 Phase 4: As private sector leverage shifted to the public sector, and economic weakness contributed
to fiscal strains, sovereign credit risk accelerated (Greece, Portugal, Spain, Ireland and Italy)

10 Year Sovereign Swap Spreads as the Sovereign Crisis Evolved

350 Phase I: Phase II: Phase III: Phase IV:
Financial Systemic Systemic Sovereign
300 Crisis Buildup Outbreak Response Risk


Jul‐07 Jan‐08 Jul‐08 Jan‐09 Jul‐09 Jan‐10

Germany France Italy Spain Netherlands Belgium Austria Greece

Source: IMF Global Financial Stability Report (April 2010). 22
An Evolution of the Global Banking Crisis
Analyzed from a more
historical and The Historical Legacy of Banking Crises Historical Perspective
 2 historical trends that accompany most banking crises: Sovereign Crises (1970 – 2000)
perspective, the
sovereign credit 1) Credit-less recoveries Type of Median
crisis can be Sovereign # of Length
2) Sovereign defaults
viewed as an Default Crises (Years)
evolution of the
Default Only 4 3 yrs
global banking  Significantly higher public indebtedness, well beyond
crisis cost of bailout packages Default &
13 5 yrs
Currency Crisis
 On average, public debt nearly doubles within 3 years
Default &
7 8 yrs
Banking Crisis
 Private sector deleveraging begins approximately 2 years Triple Crisis 21 10 yrs
after the beginning of the crisis, and lasts for ~ 6 – 7
years All Crises 45 8 yrs
 Accompanied by sharp escalation of Government debt
Sovereign CDS Default Triggers
 Failure to Pay
In over 50% of banking crises, private sector deleveraging results in a  Repudiation / Moratorium
sharp escalation of Government debt and sovereign defaults  Restructuring

The Evolution of the 2007 – 2010 Global Financial Crisis

Early 2007 - Present Mid 2007 – 2008 2008 - Present 2010

Real Estate Crisis Banking Crisis Banking Crisis Sovereign

– Phase 1 – Phase 2 Credit Crisis
 Residential
 Commercial
 Securities Market  Bank Loans

Source: Deutsche Bank Global Markets Research. Carmen Reinhart and Kenneth Rogoff: “This Time is Different.” McKinsey Global Institute: “Debt
and Deleveraging: The Global Credit Bubble and its Economic Consequences.” 23
Focus on Greece
Section 3
The Problem
Section A
Summary of Greece’s Problem
Greece has the most Assessing the Greece Problem
acute and complex
sovereign debt Country % of Euro - 16 % of Euro - 27
problem in the
Greece’s 3 Part Problem
Germany 26.7 20.3
European Union France 21.3 16.1
Italy 17.0 12.9
Although Greece is  #1: Credibility Problem Spain 11.8 8.9
small on a relative
Netherlands 6.4 4.8
Belgium 3.7 2.8
Austria 3.0 2.3
… the fragility of the  #2: Liquidity Problem Greece 2.7 2.0
global financial
Finland 1.9 1.5
system remains
Ireland 1.9 1.4
VERY high…
Portugal 1.8 1.4
… and therefore the  #3: Insolvency Problem Slovakia 0.7 0.5
contagion risk of Luxembourg 0.3 0.2
sovereign credit Slovenia 0.3 0.2
issues among Cyprus 0.1 0.1
smaller states is Source: Mark Wall, DB Chief European Economist Malta 0.0 0.0
significant UK n.a. 13.5
Poland n.a. 2.6
Sweden n.a. 2.4
Denmark n.a. 1.9
Czech Republic n.a. 1.2
Romania n.a. 1.0
Hungary n.a. 0.8
Bulgaria n.a. 0.3
Lithuania n.a. 0.2
Latvia n.a. 0.2
Estonia n.a. 0.1

Source: Deutsche Bank Markets Research. Mark Wall, DB Chief European Economist. 26
Problem #1: Credibility Problem
Greece is highly Sources of Greece’s Credibility Problem
dependent on the
capital markets to
 Inconsistent budget forecasts and revisions
solve its liquidity 2009 Fiscal Deficit Revisions
problem…  Tax system
 Fiscal irregularities
…and to this end,  On April 22, 2010, Greece’s 2009
Greece has a  Overstatement of social security surpluses budget deficit was revised higher for
significant  Incorrect reporting of military expenditures the 4th time, to 13.6%, up from a prior
credibility problem estimate of 12.9%
 Incorrect reporting of healthcare expenditures
that has been  Eurostat indicated that uncertainties
building for many  Treatment of certain EU subsidies as revenue around Greek economic data could
years  Accounting irregularities cause a 5th revision, up to 14.1%
 Derivatives transactions (to mask debt levels)

Greece has habitually Greece’s Budget Deficit / GDP

under-reported the
severity of its '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09
Deficit-to-GDP ratio 0.0%

The deficit limit to be
allowed into the -4.0%
Euro-zone (red
line) is 3% -6.0%


-10.0% Original Revised Greece revised its 2003 budget deficit 5 times

Greece revised its 2009 budget deficit 4 times

Source: Deutsche Bank Markets Research. Moody’s. WSJ. 27

Problem #2: Liquidity Problem
Greece’s 2010 Liquidity Needs

2010 liquidity needs  Total Debt Outstanding: Greece has nearly US$ 400 billion of total outstanding debt
for European
sovereigns are  Near-term Maturities: Greece has US$ 73 billion of maturities in 2010 alone (~US$27 bn of which
sharply higher is due in April and May)
than in prior
 Cost of Financing: As of April 22nd, Greek sovereign debt costs had reached unsustainably high
…with Greece facing levels ( > 9% on 10 year)
maturities (in Next Critical Maturity: EUR 8.5 billion 10 Year Bond on May 19, 2010
excess of US$20
billion) in April and
2010 Liquidity Needs
May of this year Total Debt Outstanding (US$)
(Bond Maturities + ST Debt Roll + Fiscal Deficit)

(US$ billions) 1,600 (US$ billions)
$445 $1,391
450 1,400
300 $279 1,000

USD bn
USD bn

250 800
200 600
150 $395
100 $73
$49 $50 $144 $129
50 200

0 0
Portugal Italy Ireland Greece Spain Portugal Italy Ireland Greece Spain

Critics of the current Greek Government would say that they inherited a significant fiscal
deficit crisis, and in the course of several months, created an unparalleled liquidity crisis.

Source: Fitch, Wall Street Research. US$ values based on 1.36 Euro exchange rate
Problem #3: Insolvency Problem
Twin deficits are a Assessing Euro Sovereign Risk Through the Lens of Twin Deficits
key determinant
for analyzing  An IMF regression analysis of 24 countries indicates that (i) current account deficits, and (ii)
sovereign credit fiscal deficits, are highly correlated with higher sovereign CDS spreads
risk  Greece’s Fiscal Deficit: At 13.6% of 2009 GDP, it is among the largest in the European
Union, and well above the 3% limits set by the EU’s Maastricht Treaty in 1992
Greece has one of the
highest fiscal
deficits in the EU  Greece’s Current Account Deficit: Peaked in Q3 2008; should be down sharply in 2010 –
2011 with aid packages (but still projected to be negative in 2010)

2010E Current Account Deficit (% of GDP) 2010E Fiscal Deficit (% of GDP)

8 0

3% limit set -2
4 by EU
Maastricht -4
2 Treaty

% of GDP
% of GDP

0 -6

-2 -8


-8 -12

Be ds

Ire l
Gr d


th e n

Po e



Eu K
Be s

Ire l

Ne a i

Gr d


st r

I ta
th e n

Po e





Ne a i



lg i

r la
st r
It a





lg i


r la







Source: Deutsche Bank Global Markets Research. IMF Global Financial Stability Report (April 2010).
Potential Solutions
Section B
Critical Step #1: Address Liquidity Problem
Joint EU / IMF Solution (for 2010) Other Options Considered
Greece has US$27
billion of maturities  Key Dates:  Raise debt in capital markets (too little
in April/ May, and demand for Greek debt; pricing too high)
US$73 billion of
maturities in 2010,  March 25: Formal announcement of
triggered an EU/ IMF commitment (no details)  EU Debt guarantees (violation of EU
immediate and treaties; difficult precedent)
 April 11: Details on size, cost and
short-term liquidity
crisis tenor provided
 April 23: Greece formally activates  EU Bond issuance (reconciliation with EU
However, the EU / IMF request for the money treaties challenging)
rescue package
would solve the
liquidity crisis for  Details:  Bilateral arrangements (moral hazard
2010 only issues; little German domestic support)
 Size: ~ EUR 40 - 45 billion (EUR 30
billion from Euro nations and EUR 10-
15 billion from IMF)  Infrastructure advances: not sufficient
 Cost: Approximately 5% (Equal to
Euribor + 300bps + 100 bps step-up in
IMF’s Greece Focus year 3 + 50 bps service charge) Key Question
 Healthcare reform  How to address the potential liquidity crisis
 Pension reform
 Duration: 3 years
that may arise with Greece’s significant
 Labor market 2011 and 2012 maturity obligations?

“If I owe you a pound, I have a problem, but if I owe you a million, the problem is yours.”
~ John Maynard Keynes (English Economist, 1883 – 1946)
Critical Step #2: Address Long-Term Solvency
Greece’s Fiscal Plan: EUR 4.8 billion (USD 6.5 billion, or 2% of GDP)
On March 3rd,
announced a more #1: Revenue Raising Initiatives #2: Expenditure Reductions
detailed plan for
achieving its 3 year (EUR 2.4 billion / USD 3.25 billion) (EUR 2.4 billion / US 3.25 billion)
fiscal and growth
 Increase value added tax from 19% to  Reduce public sector wages and
21% pensions (EUR 1.7 billion)

 Excise tax on petrol, alcohol, cigarettes  Reduce size of public investment

and luxury goods programs (EUR 500 million)

 Sale of selected state assets  Reduce education expenditures (EUR 200


*** Implementation Risk on Greece’s Fiscal Plan is Very High ***

The IMF will increase
these fiscal Unprecedented EU Role in Europe
austerity measures  The EU has embarked on a path of not just intensely monitoring Greek policy, but actually steering
in its negotiations Greek policy
with Greece, which
should conclude  Greek interest rate policy: to be determined by the ECB
by May 6th  Greek currency policy: to be determined by the EMU
 Greek fiscal policy: to be (effectively) determined and monitored by the EU & IMF
 Economic policy?
 The IMF will focus on 3 critical areas in its new fiscal austerity demands: labor market reform,
healthcare and pension system reforms

Key Question: How will Greece mitigate the vicious circle of fiscal cuts and economic
slowdown as it strives to meet its 3 Year Stability and Growth Program targets?
Critical Step #3: Greek Debt Restructuring?
Will a Greek Debt Restructuring Be Needed at Some Point?
Although Greece has
firmly stated that a  Greek Government Position: Debt restructuring is “off the table”
Greek debt
restructuring is
“off the table,”  Capital Markets Position: Following the declines of April 22 in particular, the market seems to
investor sentiment be increasingly pricing in a greater risk of some sort of partial, or delayed, Greek bond repayments
appears to believe
that a reduction or
delay in Greek  Market Precedents:
bond interest  Most precedents to date are largely emerging market; Greek membership in the EU
payments is makes the application of such historical emerging market precedents complicated
 Aggressive Precedent: Argentina, 2002 (75% haircuts on outstanding debt)
…some even calling it  Moderate Precedent: Poland, early 1990s (approximately 50% haircuts)
an “overwhelming
 Impact of IMF / EU Aid on Existing Creditors: The IMF always takes a senior position in the
capital structure (EU likely to as well), and so the IMF / EU aid of EUR45 billion will adversely
impact the subordination, and recovery values, of existing Greek bonds

 Potential implications of a Greek restructuring/ default:

 Will depend entirely upon whether a Greek default is somewhat uncontrolled (with
aggressive haircuts similar to Argentina), or highly managed (with modest to medium
haircuts of < 50%)?

“We wouldn’t touch Greece at the moment. The market needs some clarity on whether or not
there will be some kind of restructuring of Greek bonds. There’s too much uncertainty and
- Head of Fixed Income at UK Asset Manager & FTSE 100 Company (April, 2010) 33

Source: Deutsche Bank Global Markets Research. Gillian Edgeworth and Thomas Mayer.
Critical Step #4: Meet 3 Year Fiscal & Growth Targets
Greece’s 3 Year “Growth and Stability Program” Forecasts
In 2010, Greece
needed to tap the Fiscal Deficit Forecast Debt / GDP Forecast
assistance offered
by the EU and IMF (% of GDP)  3 Year Plan to reduce fiscal Debt / GDP will peak in 2011
12.7% 120.6%
deficit below 3%, in accordance 120.4%
To avoid a similar with EU guidelines 117.7%
“rescue” in 2011-
2012, Greece will 113.4% 113.4%
have to deliver on
its official 3 Year 5.6%
“Stability and
Growth Program” 2.8%
targets 2.0%

2009 2010E 2011E 2012E 2013E 2009 2010E 2011E 2012E 2013E

Projected GDP Growth Projected Unemployment Rate

10.5% 10.5%
2010 Greece GDP Forecasts: 10.3%
 EU Forecast: (-2.5%) 1.5% 9.9%
 DB Forecast: (-4.0%)



2010E 2011E 2012E 2013E 2009 2010E 2011E 2012E 2013E

Source: Deutsche Bank Global Markets Research 34
What We Believe Will Not Happen in 2010?
Potential Solutions That We Do Not Believe Will Happen in 2010?
A break-up of the  4 things that we believe will likely Not happen (over the near-to-medium term):
EMU, and a default 1) Break-up of the European Monetary Union (and abandonment of the Euro):
of Greece, are
likely “off the  Very complex construction that took decades of effort to create
table” in the near  Exceptionally difficult to unwind; massive reputational issues at stake
term resolution
2) Removal of a member from the EMU:
efforts of this crisis
 Although patience is not unlimited, the removal of a member near-term is very unlikely
 Contagion effect could impact other members; precedent; market response
3) Default of Greece:
 Although patience is not unlimited, Germany, France and the European Union will likely
not allow this to happen (in 2010)
4) Bailout from the European Central Bank (ECB); prohibited by Maastricht Treaty of 1992
(see key Articles below)
 Central banks are the lenders of last resort to banks, not Governments
The 2009 Treaty of  ECB could move to accept all Euro sovereigns as repo-eligible, regardless of rating
Lisbon provided
additional flexibility  Article 125: Explicit “no bail-out clause” for any member states by other member states
for the possibility of
 Article 123: Explicit “no bail-out clause” by ECB or national central banks for a member
direct financial
assistance for a state (either by purchasing debt or extending loans)
Member State in a  Article 122: Creates an exception for assistance by member states (not by the ECB) for
bilateral arrangement “severe difficulties caused by natural disasters or exceptional occurrences beyond its
with other Member
States, if needed

“Because throwing (a state out) would have momentous, uncontrollable consequences…

we must prevent a state from getting close to bankruptcy.”

~ Eurogroup Chairman, Jean-Claude Juncker (February, 2010) 35

Who are the Key Players?

Greece Germany European Union IMF

 Prime
Minister:  Chancellor: Angela  European Central Bank President: Jean-  Managing Director
George Papandreou Merkel Claude Trichet (President): Dominique
 Finance Minister:  FinanceMinister:  European Union President: Herman Van
George Wolfgang Schaeuble Rompuy  First
Papaconstantinou Managing Director
 (Rotating)President of EU: Spain (Prime (IMF # 2): John Lipsky
 OppositionLeader: Minister Jose Luis Rodriguez Zapatero)
Antonis Samaras  European Commission President: Jose
 Currently endorsing Manuel Barroso (former Prime Minister of
Government plan Portugal)

France  Eurogroup Chairman (Chair of Euro-

area Finance Ministers): Jean-Claude
 President: Nicolas Juncker (also Prime Minister of
Sarkozy Luxembourg)
 Finance Minister:  Economic
& Monetary Affairs
Christine Lagarde Commissioner: Olli Rehn

The “Contagion Effect” for the Peripherals
Section 4
The “Ring of Fire”
A “ring of fire” The “Contagion Effect” on the Peripherals
contagion effect is
 The debt burdens of several European “peripheral” sovereigns are being closely watched by
spreading around
a multitude of investors
sovereign credits  Italy, Portugal, Ireland and Spain (in particular)
with debt burdens
 Countries within the “ring of fire” will be particularly vulnerable
comparably high to
 In its April 2010 Global Financial Stability Report, the IMF said that Portugal, and to a lesser
extent Spain and Italy, would be the most likely to suffer from a Greece “contagion effect”

2010 Debt / GDP 2010 Budget Deficit vs. Debt / GDP

140 -4% Austria

120 Netherlands Italy
-6% Belgium
100 -7% Portugal
2010 Budget Deficit

% of GDP

60 “Ring of Fire”
-10% Spain Greece
40 -11%
20 UK
70% 80% 90% 100% 110% 120% 130%
Be s

Gr d


Ne a in

Po e







lg i

r la

2010 Debt / GDP





th e


Source: Deutsche Bank forecasts. The “Ring of Fire,” as quoted by Bill Gross, PIMCO.
The “Contagion Effect” for the Peripherals
Euro Sovereign 10 Yr Credit Spreads “Peripherals” 10 Yr Bond Spread over Germany
Although Greece is
the clear outlier 600
on both credit  Record spikes in Greek bond
500 yields on April 22nd had a spill-
and CDS spread 5.0
over effect on the peripherals
levels, several
other countries 400 4.0
have come into

close focus 300 3.0

The deterioration of 200
the Greece 1.0
situation has 100
directly impacted 0.0
these levels in 0 Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09
recent weeks as NL FI FR AT BE SP IT IE PT GR
well Greece Ireland Portugal Spain
10Y spreads to Germany

Euro Sovereign 5 Yr CDS Spreads “Peripherals” CDS Under Pressure

600  CDS levels in Portugal, Spain
560 and Italy were dragged sharply
520 higher on April 22nd by Greece
500 Sep-09 Apr-10 480
400 400
100 120
Source: Deutsche Bank,
0 40
Jun-09 Jul-09Aug-09Oct-09Nov-09Dec-09Jan-10Feb-10Mar-10Apr-10
Portugal Greece Ireland
Italy Spain
The “Contagion Effect” for the Peripherals
5 Year CDS Spread Differentiation (As of April 22, 2010)
Given their current
ratings, the
European 650
Spread Greece
“peripherals” are 5y CDS (bp)
clearly trading
“above the trend
line” from a credit 550
risk perspective
vis-à-vis a very
broad range of
sovereign credits 450


Egypt Lebanon
Portugal Vietnam
250 Bulgaria
150 Spain Italy
Ireland SOAF Russia Colombia
Israel MX Brazil,
Chile Peru
Belgium China S. Korea Malaysia
50 Austria

Ratings (avg. of Moody's/S&P)
Aaa Aa2 A1 A3 Baa2 Ba1 Ba3 B2

Source: Deutsche Bank, Bloomberg 40

The “Contagion Effect” for the Peripherals

Rating Recent Action Rating Recent Action Rating Recent Action

Negative outlook in 1 notch downgrade in

Aa2 (Neg) Negative outlook in Sep '09 A+ (Neg) AA- (Neg)
Dec '09 Mar '09


1 notch downgrade in 1 notch downgrade in

Aa1 (Neg) 1 notch downgrade in Jul '09 AA (Neg) AA- (Stable)
Jun '09 Nov '09


Negative outlook in 2 notch downgrade in

A3 (Neg) 1 notch downgrade in Apr '10 BBB+ (Negative) BBB- (Neg)
Mar '10 Apr '10


Negative outlook in
Aaa (Stable) n/a AA+ (Neg) AAA (Stable) n/a
Dec '09


Downgrades in recent weeks have demonstrated how ratings can become a loose
cannon as the Sovereign Crisis unfolds, and can lead to a spiraling of both
sovereign and, by market reaction, bank spreads throughout the region

Source: Bloomberg 41
Potential Implications for Credit Markets
Section 5
Potential Implications

“In some cases, the longer-run solvency concerns could translate

into short-term strains on funding markets as investors require
higher yields to compensate for potential future risks. Such
strains can intensify the short-term funding challenges facing
advanced country banks and may have negative implications for
private credit.”

“Ballooning sovereign financing needs may bump up against

limited credit supply, which could contribute to upward pressure
on interest rates and increased funding pressure for banks.
Small and medium size enterprises are feeling the brunt of the
reduction in credit.”

- IMF Global Financial Stability Report (April 2010)

Key Areas of Concern
The expected ebb and Key Areas of Concern
flow of the
sovereign debt
crisis throughout
2010 will impact a
 Potential debt restructuring
full range of
markets globally
 Banking system
The most immediate
and direct threat to
financial market
stability is Greece,  Market volatility
but a “contagion
effect” could have
more far reaching
 Credit markets

 Currency markets

 Economic growth

Source: Deutsche Bank Markets Research. Mark Wall, DB Chief European Economist. 44
Potential Greek Debt Restructuring?
Potential Implication of a Greece Debt Restructuring?
Although Greece has
firmly stated that a  Market Position: Following the sharp declines of April 22nd, the market seems to be increasingly pricing in
Greek debt
restructuring is the likelihood of either partial reductions, or delays, in Greek debt repayments
“off the table,”
 Key Question: If Greece was to “trip” in its fiscal consolidation program, and a restructuring of Greek debt
investor sentiment
appears to believe followed, would such a default unfold more aggressively (with the 75% haircuts of Argentina’s precedent), or
that a reduction or
delay in Greek in a highly managed and orderly fashion (with modest to medium haircuts of < 50%)?
bond interest
payments is Argentina Precedent, 2002 Poland Precedent, early 1990s
inevitable… (Less controlled; 75% Haircuts) (More Managed; ~ 50% Haircuts)

…some even calling it  Greek debt / GDP would decline to ~ 30%  Greek Debt / GDP would decline to ~ 60%
an “overwhelming  Would be a “devastating” event for the  Would be a “significant” event for the
probability” European financial system European financial system
 Defaults of many creditor institutions  If managed in “orderly” fashion, most
 Massive investor losses and cross-
creditors would avoid default themselves
exposures  However, losses would be significant
 Would likely trigger a European financial and  Could trigger a European financial crisis, but
banking crisis (and possibly global) should be more contained
 Analogous to a “Lehman-type” event with full  Range of “unintended consequences” likely
range of unintended consequences but likely manageable
 Confidence in European “peripherals” would  Significant contagion and spill-over effects
evaporate immediately (significant contagion to European peripherals likely
effects to Portugal, Spain, Ireland, Italy and  Significant downward pressure on European
others) growth
 Significant questions for Euro longer term  Significant questions for Euro longer term

Source: Deutsche Bank Markets Research. 45

Implications for US$ Bond Issuance
The sovereign credit
Review of Potential Implications for US$ Investment Grade Debt Issuance
crisis has only  Strategy: Significantly heightens the importance of pre-funding redemption and
magnified one of Strategy capital expenditure obligations
the key lessons of
 As evident in the financial crisis, Issuers can no longer rely on “just-in-time financing”
the Global
Financial Crisis,  Increased volatility increases the risk of “windows of opportunity” opening and closing
that is, the with little notice
importance of pre-
 Credit Spreads: potentially wider as a result of several factors including negative
Costs economic implications, higher risk, potentially higher new issue premiums, less liquidity
as broker-dealers push back risk
 Bank Spreads: particularly vulnerable given recent Financial Crisis and contagion
 New Issue Premiums: more upward pressure (more risk; less secondary market
 US Treasury Yields: creates downward pressure near-term as and if volatility rises
sharply; longer-term, high debt levels in the U.S. more likely to create upward pressure
 Liquidity: more downward pressure, especially as and if broker-dealers pull-back on
risk; creates upward pressure on spreads

 Overseas Demand: potentially much higher as US$ assets become more attractive;
global capital flows toward US$
 For example, we have seen overseas demand on several recent non-financial
corporate bond financings in excess of 20% of total issuance size (for BBB
type names), which historically may have been closer to 5-10% area

 Differentiation and Focus on Country of Origin: more pressure on bank, utility and
Issuer Origin
Focus telecom spreads from Europe that have frequently tapped US$ markets in the past
Source: Bloomberg

Massive Exposure for European Banks
European Banks may Sources of European Bank Exposures
represent the most
significant channel Asset Side Liabilities Side
for “contagion”
from the sovereign  Losses on government bond portfolios  Higher bank funding costs, and less financing
credit crisis  Losses on loan portfolios (cross-border, local)
market access (less demand, more volatility)
 Erosion in perceived value of Government
 Counterparty exposures on derivatives
 Generally, bank business models highly
 Ratings downgrades can drive higher haircuts
susceptible to economic slowdowns and market
instability on government securities used for central bank
or commercial repo

Sources of contagion: Higher losses; difficult financing markets; less lending

European Bank Exposure to Eurozone Governments (December 2009)

900 $849
BIS data shows Holdings of Eurozone Government Debt
that French- Loans to Euro Governments
based banks 700 $622
have $75 billion 600
of exposure to
USD billion

Greek debt, and 500

German banks 400 $329
have $45 billion
488 $185 $173
200 242
271 112
100 158
87 61
0 27
German Banks French Banks Italian Banks Spanish Banks Belgian Banks Dutch Banks

Source: Autonomous, February 8, 2010. Based on Euro Exchange Rate of 1.36 47

Less Exposure for U.S. Banks
Implications for U.S. Banks
Direct exposure of
the U.S. banking  Direct Losses from Lending / Derivatives: limited, especially compared to European banks
system to over-  The U.S. banking system relies very little on overseas earnings (< 20%)
indebted European
 Tier 1 capital is well in excess of direct exposures
sovereign credits
is reasonably
limited…  However, indirect impact of an escalating crisis could be significant:
 Bank spreads are particularly vulnerable to exogenous shocks in the global financial system
…but the indirect
impact of  Negative impact on lending and bank facilities
“contagion”  Contagion through increased systemic risk
effects on a  Heightens focus on financial regulation (with upward pressure on capital, and downward pressure on
vulnerable global earnings)
financial system
could be
substantive Claims on Sovereigns Held by U.S. Banks (1) Aggregate U.S. Bank Exposure vs. Top 10 U.S.
(September 2009) Bank Capital
90 $82 900 $850
80 Total: $178 billion 800
70 700
60 600
USD bn

USD bn
50 500
40 400
30 300
$18 $178
20 200
10 100

0 0
Ireland Spain Greece Portugal Aggregate exposure to Top 10 US bank
Greece, Ireland, Portugal, Tier 1 capital
Ireland Spain Greece Portugal and Spain

Source: Federal Financial Institutions Examination Council.

(1) Claims consist of cross-border loans, claims from derivatives, and foreign office claims on local residents 48
Implications for Foreign Exchange
The ultimate impact Euro Declines to 9 Month Low
on Eur/USD, and
related capital  Euro: More downward pressure (pre-sovereign crisis, DB view that Euro is already over-valued on
flows, will fundamentals and so has room to fall)
ultimately depend
on the depth and  Euro as Reserve Currency: Could slip on a trend basis with potential benefit to USD, JPY, CAD and Gold
volatility of the
 Euro Government bond market as rival to U.S. Government bond market is still someway off
 Euro sovereigns are clearly still 16 separate markets with their own distinct credit risk and liquidity profiles
…but the impact
could be
 USD: strong upward pressure to rally vis-à-vis Euro, though will depend on depth and volatility of the sovereign
credit crisis; strong move expected into USD assets (equities and bonds)

Euro / US$ Spot (1999 - Present) Euro / US$ Spot (May, 2009 – Present )
DB 2010 EUR/ USD 1.55
Forecast: 1.35 1.6

1.5 1.50

1.3 1.45
Euro / US$

Euro / US$

1.0 1.35

0.8 1.30

Source: Bloomberg






l -0

t- 0










Implications for Commodities
A stronger USD Implications for Commodities of the Sovereign Credit Crisis
downward  Impact of Stronger USD: extent of USD rally will be linked to depth of crisis and is likely to reinforce downward
pressure on nearly pressure on nearly all commodity asset classes, especially oil
all commodities,
especially oil…  Impact of Economic Weakness: will depend on depth of crisis and potential contagion effects; weaker industrial
capacity will negatively impact commodity pricing
…Gold may be the
 Impact may be exacerbated by an already vulnerable financial system and global economic recovery outlook
exception to the
extent volatility  In addition, could reinforce 2009 downward pressure on refining margins, negatively impacting profitability,
spikes sharply if and potentially increasing prospect of sales and/ or shutdowns
the sovereign
crisis escalates
 Flight to Quality (Risk-aversion): to the extent the crisis spikes sharply, Gold prices would be the exception to
the generally downward pressure on commodity prices

DB 2010 Gold (oz)

Forecast: $1,175 Gold (Feb 2009 - Apr 2010) Oil (Feb 2009 – Apr 2010)
1,200 100

1,150 90
DB 2010 Oil (bbl)
Forecast: $70 1,100 80

1,050 70
$ per troy oz

$ per bbl
1,000 60

950 50

900 40

850 30

800 20
Source: Bloomberg Feb-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Feb-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10

Summary of Potential Implications
Markets / Entities Impact Potential Implications (Depending on Crisis Depth)
US$ Bond Market New  Strategic: Pre-funding more important than ever (volatility creates shorter issuance windows)
Issue Conditions  Spreads: Upward pressure on new issue, risk and liquidity premiums
 Treasury yields: Creates downward pressure on rates if volatility and global systemic risk rises

U.S. Economy  Increases risk of double-dip; lower overseas earnings; lower U.S. exports on stronger USD; high
debt levels creates higher inflation over time; contagion effects; higher costs of capital

European Economy  Significant potential drag on recovery: Large exposures for banking system; systemic risk and
contagion; reduced lending; austerity measures to reduce debt; social unrest; coordinating policy;
higher taxes; lower corporate earnings; sharply higher cost of capital; repo eligibility with ECB

U.S. Banks  Limited direct lending and/or derivative losses (especially vis-à-vis capital)
 More indirect impact: bank spreads very vulnerable to exogenous shocks at this time; contagion
effect; higher cost of capital; increases focus on financial regulatory reform

European Banks  Very significant direct bank exposures: In excess of 20% of GDP for France, Germany and many
of the peripheral sovereigns themselves
 Sharply higher costs of capital
 Full range of meaningful indirect impact: already vulnerable; less lending; contagion; Eastern
Central Bank Policy  Generally creates downward pressure on Central Bank tightening and “exit strategies”
 Will vary by region: Little impact on U.S. Fed unless crisis spikes sharply; UK likely to extend
quantitative easing; Significantly increases full range of ECB considerations and variables; China will
continue to tighten as needed; Asia (ex-China) will likely pause on any tightening in current

Bank Facilities  Creates downward pressure on tenor (more focus < 3 years); would take sharp spike in crisis to
bring back down to Financial Crisis peak levels of < 365 days
 Potential negative impact and focus on Risk Weighted Assets (and therefore capital)
 Hedging via CDS becomes more expensive (as CDS widens); creates downward pressure on size,
and upward pressure on cost, of facilities

Summary of Potential Implications
Markets / Entities Impact Potential Implications (Depending on Crisis Depth)
Sovereign Bond Market  Supply: increases already high needs coming out of the financial crisis to fund deficits
New Issue Conditions  Spreads: Sharply wider; higher costs for “Peripherals” to be sure; contagion impact on other regions,
as well as developed European sovereigns (depending on role in potential bail-out and contagion)
 Euro / USD basis could make USD market particularly attractive for European issuance
 CDS: sharply wider for single names in particular; more liquidity in Index product; additional negative
premium for Euro members than U.S. and U.K. due to coordination challenges on EMU policy
 Delays: Creates a heavy pause in what is otherwise expected to be a very high issuance year

Capital Flows  Not very transparent at this time (due to 3 – 6 month lags in high quality data)
 USD Assets: depending on depth of crisis, strong moves into USD assets likely (equities and bonds)
 Strong overseas demand on US$ bond deals already apparent
 Repatriation strategies: increased focus, especially for investors

Foreign Exchange  USD: potential continued rally depending on depth of crisis and volatility
 Euro: Increases downward pressure (currently on 9 month decline versus USD)
 Euro as Reserve Currency: could slip on a trend basis (with potential benefit to USD, CAD, JPY and
gold); Euro sovereigns will clearly be viewed as 16 separate markets with distinct credit risk and
liquidity profiles

Commodities  Price: If crisis escalates, economic drag and USD rally will create downward pressure on virtually all
commodity asset classes, especially oil.
 Gold: Potentially positive benefit depending on depth of crisis and flight to quality; still unclear

Financial Regulatory  Heightens focus on financial regulatory reform (both negatively and positively)
Reform  Increases focus on derivatives (particularly on bank margin requirements for counterparty
exposures, and tighter regulation of certain products)
 Sharply higher focus on systemic risk (more need for international coordination, systemic
regulator, Too Big to Fail, multi-jurisdictional focus, capital flows, leverage limits)

The impact on all of the above markets will ultimately depend on the depth of the crisis, the
effectiveness of the response, and the level of volatility and risk aversion that follows
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