SEB analysis: The pain in Spain

Likely to need a bailoutThe pain in Spain but unlikely to defaultjohan.javeus@seb.se

Tensions rising in Spain Likely to need a bailout but unlikely to default Over the last two months Spanish CDS prices have surpassed the all time highs from November 2011 The growth outlook for Spain has deteriorated and latest consensus estimate predicts a recession (-1.4% of GDP) for 2012. Further downward revisions are likely The government has been forced to revise its budget deficit forecast for 2012 higher (5.3% of GDP) and growth forecast lower (-1.7%). Risks are for an even larger deficit The CDS market is currently pricing a 70% risk of a 20% haircut on Spanish government debt within the next five years Conclusions It is likely that Spain will need some form of bail out arrangement this year possibly alongside with continued partial funding in the private market. For this to be possible the market needs to see steady progress on deficit reduction and structural reforms Given that the Spanish debt level is still not alarmingly high (69% of GDP in 2011) the country still has some time to fix its problems on its own. The relatively low debt level is the best insurance that a Greek-style default can be avoided The biggest risks are 1) problems for Spanish banks and falling property prices, 2) difficulties to control excessive spending in its autonomous regions, 3) a poor growth outlook with rising unemployment2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 2

CDS market is already pricing a high probability of sovereign default within the next 5 years Spain 500 8.0 The CDS current pricing* indicates a default probability within the next five years of: 400 7.0 70% when assuming a 20% haircut (same as 300 6.0 original proposal for Greece) 200 5.0 38% when assuming a 50% haircut (same as 2nd proposal for Greece) 100 4.0 29% when assuming a 70% haircut (same as 0 3.0 08 09 10 11 12 the likely final deal for Greece) CDS 10Y Government 10Y Above calculations are based on a 5 year CDS. By comparison the equivalent probabilities for France are:20% haircut: 36%, 50% haircut: 16%, 70% haircut: 12% Contrary to the CDS market the Spanish government yield curve shows no tendencies of becoming inverted which is the classical sign of default expectations2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 3

The LTRO’s did great things for Spain and Italy but the positive effects are fading 10 year government yieldsNet purchases of Gov bonds by the 10.0 10.0banking system (EUR bn) 9.0 9.0Dec 2011 – Jan 2012 (BIS) Yield level where Greece, Ireland & Portugal 8.0 were cut off from private funding 8.0 7.0 7.0 6.0 6.0 5.0 5.0 4.0 LTRO 4.0 1&2 3.0 3.0 2.0 2.0 1.0 1.0 Spanish and Italian banks were jan mar maj jul sep nov jan mar large net buyers of government 11 12 bonds after LTRO:s Spain Italy Germany 2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 4

The case for a soft bailout in Spain It Spain is unsuccessful in regaining enough market confidence for its deficit reduction plans to bring down borrowing costs it will need assistance The help could come from either the ECB through its currently dormant Securities Market Program (SMP) or through the introduction of new LTROs Neither of these measures are likely to provide a long term solution and thus a formal bailout arrangement would be the next logical step to calm markets There are several reasons to why a bailout for Spain is likely to be less extensive than the ones in Greece, Ireland and Portugal 1) The current bailout funds EFSF/ESM/IMF are not large enough to fully fund Spain for several years and also (if necessary) take care of Italy. Thus offering Spain a full bailout may destabilize the situation rather than calm things down 2) If Spain is fully funded by official creditors (EU/IMF) that view themselves as prioritized over private creditors the risk of a future default on privately held bonds increases as the EU/IMF take on a growing share of the total Spanish government debt 3) A full bailout would mean that Spain would drop out as a guarantor for outstanding EFSF bonds thus increasing the burden of the other EU countries2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 5

Spain public finances outlook General government gross debts % of GDP (OECD estimates) 211% The budget deficit for 2011 came in at 8.4% of GDP (vs a target of 6%) The Government plans to cut the budget 165% deficit to 5.3% of GDP 2012 (vs. original target of 4.4% of GDP) 127% 113%112% Despite further austerity measures recently 98% 98% 90% announced to save another €27bn (2.5% of 84% 74% GDP) the risk is still for a larger deficit 2012 61% 56% 56% The goal is still to cut the budget deficit to 46% 3% of GDP in 2013 a task which would require additional austerity measures or a rapid improvement in economic growth a rk l d any nd Ital y UK Spa in n USA ce ce en ga While deficits are not likely to fall as quickly ay J apa Irelan Finl a Fra n G ree Denm Portu Swed Nor w G erm as predicted the debt level is nevertheless unlikely to spiral out of control Note: the deficits of Spains autonomous regions and its municipalities are included in the general government debt Consensus (March) expects a budget deficit numbers of 5.7% in 2012 and 3.9 % in 20132012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 6

Spain still has a lower public debt than Germany(Each data point represents one year. 2011-13 are ECFIN forecasts) Eurozone public finances outlook (ECFIN) 0 Germany 0 2009 -3% good 2012 fc Government budget balance (% of GDP) -5 -5 Italy Belgium 2009 France 2009 2009 -10 Spain -10 2009 Portugal 2009 Ireland -15 2009 -15 Greece 2009 -20 -20 -25 -25 -30 -30 bad -35 -35 40 50 60% 70 60 80 90 100 110 120 130 140 150 160 170 180 190 Government debt (% of GDP)2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 7

€140bn of government debt matures in 2012 Spain faces large bond redemptions in April, July and October Total redemptions and coupon payments amount to €140bn in 2012 (12% of GDP) On the positive side 1) the average maturity of the central government debt is still relatively long – currently 6.40 years (down from 6.54 years one year ago) 2) Spain has front loaded its financing for 2012 so far having secured almost half of its full year medium to long term financing A M J J A S O N D2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 8

Risk 1 – Spanish banks The Spanish banking system is relatively large compared to other countries. Assets of about 340% of GDP vs an average of 200% On the positive side Spain’s biggest banks are among the best capitalized and well diversified in Europe The banking sectors problems are concentrated to the remaining 17 regional savings banks (the Cajas) While the overall situation for the Spanish banking system remains problematic it is still unlikely that the government will face an Irish style scenario with massive bank bail outs2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 9

Higher unemployment + falling house prices rising NPL The total stock of non performing Spain loans has risen sharply to €140bn in 110 8 January 2012 equivalent to 8% of total loans 100 7 Continued house price declines and 90 6 unemployment increases will fuel a further rise in non performing loans 80 5 (NPL) 70 4 60 3 50 2 40 1 30 0 02 04 06 08 10 12 NPL as % of total lending Real Estate Market Index2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 10

Restructuring the banking sector Government has gone from good to better The government has taken several steps to solve the problems in the banking sector 2009: Creation of the Fund for Orderly Bank Restructuring (FROB). Its initial capital of €9bn can be leveraged up to 10 times creating a total fire power of €99bn 2010: Initiated reforms for the savings banks (Cajas) reducing their numbers through shotgun marriages from 45 to currently 17 2011: Increased core capital ratio requirements to 10% 2012: Forcing banks to make additional provisions of €50bn for NPL of the banks total €323bn exposure to the real estate sector. As growth continues to deteriorate and house prices falls the credit losses of banks will rise. The aim of the restructuring is to limit the burden for tax payers as much as possible. Banks will have to deal with credit losses through - Provisions and future profits to help plug the holes - FROB (so far €15bn has been committed) - Private sector involvement (PSI): private investors taking losses on bank debt 1) The general impression is that so far the government (current & previous) has done a good job in handling the banking crisis 2) Spain’s ability to consolidate and restructure its banking sector will ultimately decide if the Spanish government will remain solvent or not2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 11

Spanish banks financing A large deposit base make Spanish banks less dependent on issuing bank debt. Financing through ECB via the Target 2 euro system has risen sharply Spanish banks liabilities Target 2 funding 4500 4500 4000 4000 3500 3500 3000 3000 2500 2500 2000 2000 1500 1500 1000 1000 500 500 0 0 00 01 02 03 04 05 06 07 08 09 10 11 Eurosystem borrowing Equity & reserves Deposits Other Debt securities2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 12

Risk 2 – Excessive regional spending Spain has 17 autonomous regions (state General government debt governments) which together account 800 800 for about 11% of the total public sector debt 700 700 In addition local authorities have debt of 600 600 about 3% of GDP EUR (billions) The central government has had a 500 500 billions difficult time restricting spending at the 400 400 state level The government has recently introduced 300 300 new legislation aimed at excerpt better 200 200 control over regional spending. We still need to wait to see how effective this will 100 100 be For markets confidence in Spain it is 0 0 00 02 04 06 08 10 vital that the central government is able to regain control of regional Central government spending/deficits State government Local government2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 13

Risk 3 – Deteriorating growth outlook Consensus sees -1.4% GDP growth in 2012 and 0.1% in 2013. Further downward revisions likely in coming months Consensus GDP forecasts for 2012 each point represents the month the forecast for 2012 was made 2.0 1.0 0.6 Germany 0.0 0.2 France -1.0 Spain -1.4 Italy -2.0 -1.6 Portugal -3.0 Greece -3.7 -4.0 -5.0 -5.6 -6.0 Jul Aug Sep Oct Nov Dec Jan Feb Mar 2011 20122012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 14

The Spanish economy in brief Surging unemployment and plummeting consumer confidence2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 15

Spanish export sector may be a way out of crisis Spanish exports relatively geographically Spain Exports 2010 diversified with limited dependence on GIPS 9.1% 0.9% Spanish export sector is slightly larger than France/Italy 47.4% Export, goods and services, % of GDP 50 50 45 Greece Portugal 45 France Germany 42.5% 40 Italy Sweden 40 Spain 35 35 30 30 25 25 Total ex EMU Portugal 20 20 EMU ex Greece/Portugal Greece 15 15 Source: IMF 10 10 5 5 0 0 Source: OECD2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 16

Spain has a very large net debt to foreigners International net investment position. % of GDP. SEB estimates 80 60 75 40 55 20 43 37 75 10 4 12 0 -10 -13 -13 -17 -24 -20 -59 -40 Sweden: 50% in early 1990s -60 -100 -80 -100-100 -107 -100-120 Ita ly G IIP S US N o rw a y E U -1 7 C h in a UK Po rtu g a l S p a in Japan F in la n d G e rm a n y F ra n c e D e n m a rk Ire la n d Sw ed en G re e c e2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 17

Disclaimer Important: This statement affects your rights The information in this document has been compiled by SEB Merchant Banking, a division of Skandinaviska Enskilda Banken AB (publ) (“SEB”). It is produced for private information of recipients and SEB is not soliciting any action based upon it. All information has been compiled in good faith from sources believed to be reliable. However, no representation or war- ranty, expressed or implied, is made with respect to the completeness or accuracy of its contents and the information is not to be relied upon as authoritative. Recipients are urged to base any investment decisions upon such investigations as they deem necessary. To the extent permitted by applicable law, no liability whatsoever is accepted for any direct or consequential loss arising from use of this document or its contents. Any presented performance data is un audited. Your attention is drawn to the fact that SEB, a member of, or any entity associated with, SEB or its affiliates, officers, directors, employees or shareholders of such members may from time to time have holdings in the securities mentioned herein. THIS INFORMATION IS NOT INTENDED TO BE PUBLISHED OR DIST- RIBUTED IN THE UNITED STATES. SEB is incorporated in Stockholm, Sweden, with limited liability. SEB is regulated by Finansinspektionen (the Swedish Financial Supervisory Authority). Confidentiality Notice: This information is confidential and may not be reproduced or redistributed to any person.2012-04-13 | THE PAIN IN SPAIN – LIKELY BAILOUT BUT UNLIKELY DEFAULT 18

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SEB analysis: The pain in Spain

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