SVB Asset Management Economic Book Q3 2012


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SVB Asset Management is pleased to announce the release of the Q3 2012 Economic Booklet as a research piece summarizing the macro-economic and sector trends in the global market. The Economic Booklet is our reference tool for clients. Displaying graph and chart views of the global economy, this piece guides clients through factors that impact their business.

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SVB Asset Management Economic Book Q3 2012

  1. 1. SVB Asset Management Economic ReportThird Quarter 2012
  2. 2. Table of ContentsThoughts from our CIOThoughts from our CIO pg 3 pgOverview Overview pg 4 pgGDP GDP pg 5Employment Employment pg 6The Housing MarketThe Market pg 8 pgConsumption Consumption pg 10Inflation Inflation pg 12Consumer CreditConsumer Credit pg 14Monetary PolicyMonetary Policy pg 15Fiscal Cliff Fiscal Cliff pg 17Investment PerformanceInvestment Performance pg 18Yields Yields pg 19Banking SectorBanking Sector pg 20 pgIndustrial SectorIndustrial Sector pg 23 pgPublic Debt Public Debt pg 24 pgGlobal GDPGlobal GDP pg 25 pgEuro Zone Debt CrisisEuro Zone Debt Crisis pg 26 pg 26Central BanksCentral Banks pg 32 pg 32FX FX pg 33 pg 33FDIC Insurance FDIC Insurance pg 34 pg 34Regulatory EnvironmentRegulatory Environment pg 35 pg 35 2
  3. 3. Thoughts from our CIOGreen Shoots Again?On March 15, 2009, Federal Reserve Chairman Ben Bernanke told “60 Minutes” that “green shoots” were already evident in the economy. However, since thenthe Fed has primarily acted to further boost economic activity rather than address any inflationary concerns from potential excessive growth.Specifically, they have completed QE1 and QE2 totaling an expansion of their balance sheet to nearly $3 trillion from under $1 trillion; instituted “Operation Twist”in attempt to drive down long-term rates; and most recently instituted QE3 which is an open-ended plan to continue expanding the balance sheet. Some havedubbed QE3 “QEternity.”But the green shoots we see today are much stronger than those recognized by Bernanke 3 ½ years ago. In particular, the unemployment rate has droppedbelow 8 percent, employment growth has remained steady, home prices seem to have stabilized recently, and corporate cash stockpiles have grown, providingpotential for future investment.So why isn’t the Fed talking up the economy today as they were in early 2009 when the outlook was much worse? In my opinion, Bernanke was simply usingcommunication — one of the Fed’s time-honored tools — in attempt to manage the economy. In 2009, market participants were in desperate need of confidenceand Bernanke was simply trying to provide some by pointing out the very few positives of the day.In contrast, today the Fed has longer-term concerns about economic growth and is using the only tool they have — monetary policy — to reduce the cost andamount of funds for use by market participants.The lesson? Focus on Fed activity vs. Fed rhetoric. The Fed’s communication tool can be useful at times, but often it is a contraindicator.Joe Morgan, Chief Investment Officer 3
  4. 4. Overview• GDP growth continued to disappoint in the second quarter as economic participants continue to look for the next catalyst for sustained growth.• There has been a split in the employment data with the unemployment rate falling beneath 8 percent while actual job growth remains stuck well below 200,000 per month. Many jobs being filled are part-time, indicating a possible structural shift in the country’s employment make-up.• Perhaps surprisingly, the housing market has provided a “green shoot” in the form of stabilization and even growth of activity during the summer.• The homeownership rate has continued to fall and is now below 66 percent after peaking at an unsustainable level north of 69 percent. Finding the right long-term balance between owners and renters will help provide a base for housing growth in the future.• Consumption growth has remained positive since 2009, confirming that Americans’ desire to consume has not been reversed despite the economic challenges of recent years. From this vantage, American consumerism continues to drive the global economy.• Unfortunately, lackluster income growth and a continuing debility for the mortgage market to function without government guarantees will limit consumer desires in the near future.• Even with all the stimulus in recent years, inflationary indicators remain calm. Though commodity prices are a continuing challenge, it seems every spike is followed by either a backfill of supply (where possible) or consumer substitution which tempers price growth. Countries who have pegged their currency to the dollar, however, are suffering from higher food prices after currency adjustments.• The “fiscal cliff” to be faced in the next two quarters will likely end in another “kick-the-can” solution, though a period of post-election cooperation that drives toward long-term solutions in Washington remains a possibility.• European troubles are long-term and structural in nature. Most of the “positive” news that emanates from the Old World consists of short-term solutions to long-term problems. 4
  5. 5. GDP Struggling to Pick-UpGDP1 10.0% • Chairman Bernanke’s September 13 FOMC statement was 8.0% 6.0% intended to propel growth by keeping rates low through mid- 4.0% 2015 if necessary and initiating a monthly program to purchase 2.0% mortgage-backed securities for an unlimited period 0.0% -2.0% • Corporate sector has been hesitant to spend given uncertainties -4.0% regarding the fiscal cliff and the implication to taxes and -6.0% government spending cuts -8.0% -10.0% • Domestic business has shown improvement while international business remains weakComponents of GDP2 Gross Domestic Investment3 $3.0 150.0% $2.5 100.0% $2.0 Trillions $1.5 50.0% $1.0 0.0% $0.5 $0.0 -50.0% Domestic business Households and institutions Federal State and local Consumption Government spending Investment ex-housing Residential Net exportsSource: 1Bloomberg, SVB Asset Management,2BEA,3.CBONote: 1GDP values shown in legend are % change vs. prior quarter annualized. 5
  6. 6. Employment Need for ConsistencyEmployment Landscape1 Full-Time Employment2 1,000.0 125,000.0 10,000.0 15.0% 500.0 120,000.0 Thousands Thousands Thousands 5.0% 115,000.0 0.0 5,000.0 110,000.0 -500.0 -5.0% 105,000.0 -1,000.0 -15.0% 100,000.0 0.0 Non-Farm Payroll (LHS) Unemployment Rate (RHS) U-6 (RHS) Full Time Employment (LHS) Part Time for Economic Reasons (RHS)Long Term Unemployment3 50.0% • The unemployment rate dropped to 7.8% in September, the 40.0% lowest rate since President Obama took office 30.0% • 582K more people are working part-time rather than full-time, 20.0% the highest level seen since February 2009 10.0% • More people decided to move from full-time to part-time 0.0% voluntarily, increasing the number of part-time workers to 18.6M from 16.9M. This could be due to seasonal activities such as students moving to part-time jobs at the end of the summer Recession Period Unemployed 27 Weeks and OverSource: 1,2,3Bloomberg, SVB Asset Management, 3NBER.Note: The underemployment rate U6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate that they want and are available for a job andhave looked for work sometime in the past 12 months. 6
  7. 7. Employment Need for ConsistencyLabor Productivity - Output per Hour Wages & U.S. Average Weekly Hours 4.0% 35.0 15.0% 2.0% 34.5 Hours 10.0% 0.0% 34.0 5.0% -2.0% 33.5 0.0% -4.0% 33.0 -5.0% -10.0% Wages U.S .Average Weekly Hours All employeesInitial Jobless Claims 700.0 8,000.0 • Productivity rebounded robustly in Q2 following a slowdown. A global slowdown prompted employers to operate more 500.0 6,000.0 efficiently Thousands Thousands 300.0 4,000.0 • Wage growth has been flat. We need to see improvement in order to drive consumption component of GDP 100.0 2,000.0 • Initial claims and continuing claims have experienced very slow -100.0 0.0 improvement and illustrate the long-term challenge facing job growth Initial Claims Continuing ClaimsSource: Bloomberg, SVB Asset Management. 7
  8. 8. The Housing Market Gaining TractionHome Sales & Supply 9.0 14.0 • The Fed’s open-ended policy to buy mortgage securities should further anchor mortgage rates, thus lifting affordability Home Sales (Millions) Home Supply (months) 8.0 12.0 10.0 7.0 • Purchases continue to show signs of improvement although, 8.0 6.0 6.0 more importantly, home price stability could spur consumer 5.0 4.0 confidence 4.0 2.0 • Foreclosures have slowed this year due to processing 3.0 0.0 challenges and unsolved Attorney General settlements Total Sales (new & existing) Existing Home SupplyHousing Starts Home Prices - Indexed to 100 170 2.5 150 2.0 130 Millions 1.5 1.0 110 0.5 90 0.0 Case Shiller 20-City FHFA Purchase Median Home PriceSource: Bloomberg, SVB Asset Management. 8
  9. 9. The Housing Market Gaining TractionHomeownership Rate Housing Affordability Composite Index 70.0% 200.0 12.0% Affordability Index 69.0% 10.0% Mortgage Rates 150.0 68.0% 8.0% 67.0% 100.0 6.0% 66.0% 65.0% 4.0% 50.0 64.0% 2.0% 63.0% 0.0 0.0% 62.0% Affordability Index 30 Year Mortgage RatesHome Foreclosures - % of Total Loans • Homeownership has continued to trend down and has remained 7.0% at 65.6% for the past two quarters 6.0% 5.0% • Historically low mortgage rates have been driving record-high 4.0% housing affordability numbers, which indicates that a family 3.0% earning the median income is more likely to be able to afford the 2.0% median-priced house 1.0% • Home foreclosures remain high; however ,we have not seen 0.0% much effect from the shadow inventory of foreclosures filtering through the systemSource: Bloomberg, SVB Asset Management. 9
  10. 10. Consumption Glass Half FullConsumer Sentiment - University of Michigan 120.0 • Consumer confidence indicators have been mixed, with the 110.0 University of Michigan indicator showing some improvement in 100.0 September. The index rose to 78.3, but is still below the 30- 90.0 year average 80.0 Average 70.0 • Retail sales have risen due to strong demand for automobiles. 60.0 Sales at retailers have been sluggish in recent months 50.0 40.0 • Personal consumption slowed to 1.5% in the second quarter compared to 2.4% in the first quarterRetail & Food Services Sales Personal Consumption - % Change $450.0 $25.0 8.0% Vehicle Sales (Millions) Retail & Food Services $400.0 $20.0 6.0% Sales (Billions) 4.0% $350.0 $15.0 2.0% $300.0 $10.0 0.0% $250.0 $5.0 -2.0% -4.0% -6.0% Ex Autos Vehicle SalesSource: Bloomberg, SVB Asset Management 10
  11. 11. Consumption Glass Half FullPersonal Savings as a % of Disposable Income Personal Income 10.0% 2.5% 2.0% Monthly Percentage 8.0% 1.5% 1.0% Change 6.0% 0.5% 4.0% 0.0% -0.5% 2.0% -1.0% 0.0% -1.5%Household Debt Payments vs. Debt Outstanding • Personal incomes have not rebounded, creating a squeeze on 17.0% 15.0% consumers’ wallets as commodity prices rise 10.0% 14.0% • This squeeze hampers the ability to save, as evidenced by a 5.0% declining savings rate 11.0% • Consumer credit outstanding unexpectedly fell for the first time 0.0% in almost 12 months driven by a decline in credit card spending. 8.0% -5.0% Non-revolving debt , including student and auto loans, was not as robust as we’ve seen in prior quarters Debt Service Payments Debt OutstandingSource: Bloomberg, SVB Asset Management. 11
  12. 12. Inflation Within the BoundariesComponent Distribution 2012 Core PCE CPI Components 12-month Change Food & Bev. 2.9% 3.5% 3.8% 12.0% 6.0% Housing % change from prior year Housing 1.8% Apparel 4.2% 6.9% Transportation 10.0% Transportation 5.6% Food & Beverages 8.0% Medical Care 3.4% 7.3% 41.0% Recreation 1.0% Medical Care 6.0% Educ. & Comm. 1.9% Education & Communication Other 4.0% Fed Target 1.5% 15.2% Recreation Headline CPI 2.9% 2.0% Less: Apparel less footwear 17.2% 0.0% Energy 7.0% Other Goods & Services Food 3.9% Core CPI 2.2%Consumer Price Index Producer Price Index 15.0% 15.0% % change from prior year 10.0% % change from prior year 10.0% 5.0% 5.0% 0.0% 0.0% -5.0% -5.0% -10.0% CPI Ex Food & Energy CPI PPI Ex Food & Energy PPISource: Bloomberg, SVB Asset Management. 12
  13. 13. Inflation Within the BoundariesWage Growth: Average Hourly Earnings Crude Oil - Spot & Futures 4.0% $160.0 Annual percentage change Price per barrel 3.5% $120.0 3.0% $80.0 2.5% $40.0 2.0% $0.0 1.5% Spot Price Futures PriceUniv. of Michigan Survey of Inflation Expectations 5.5% • Traditional measures point to inflationary pressures being under 4.5% control and effects from rising commodity prices are expected to be only transitory (according to the Fed) 3.5% • Wage growth is needed to spur inflation and we are not seeing 2.5% that yet 1.5% • The Fed continues to state that longer-term inflation expectations remain stable, even as key commodity prices rise 1 Year Ahead 5-10 Year AheadSource: Bloomberg, SVB Asset Management. 13
  14. 14. Consumer Credit Shift to Education Debt BalanceStudent loan debt is rising at a time $2,500.0when other debt is flat or evendeclining. From Q4 2011 to Q22012, the nation’s loan balance $2,000.0grew 4.6%, from $874 billion to$914 billion. $1,500.0The College Cost Reduction and BillionsAccess Act, a measure from 2007that, among other things, lowered $1,000.0the interest rate on federal studentloans from 6.8% to 3.4%, wasextended at the end of June. $500.0The House and Senate bills willboth increase direct spending for $0.0student loans by more than $6billion over the 2012–2022 period.Nearly all of the outlays will occurin 2012 and 2013. Auto Loan Credit Card Student Loan Source: Bloomberg. 14
  15. 15. Monetary Policy Stimulus TimelineFinancial Crises and Timeline Timeline The U.S. Treasury seized U.S. President Barack The FDIC adopted a rule As previously announced, the U.S. President The FOMC announced control of mortgage giants Obama signed $787 that requires banks to pay Fed concluded its $600B bond Barack Obama an extension to the Twist Fannie Mae and Freddie Mac billion stimulus package, at the end of 2009 the purchasing program. signed 2010 Tax program by adding $267 and pledged a $200 billion entitled the American amount they would owe the QE2 was conducted at an even Bill Into Law – Tax billion, thereby cash injection Recovery and FDIC for insurance pace, and the end date was Cuts Extended extending it throughout The government bailed out Reinvestment Act premiums over the next telegraphed from the start of the Until 2012. 2012. AIG, with $85 billion. (ARRA) of 2009. three years. program. Oct-08 May-09 Mar-10 Mar-11 Sep-11 Sep-12 Sep-08 Feb-09 Nov-09 Dec-10 Jun-11 Jun-12 As part of the Helping Families Save The quantitative Enacted the Emergency The Fed continued to The FOMC announced the The Fed Their Homes Act, Congress approved a easing program Economic Stabilization reinvest payments on implementation of Reserve permanent increase of the FDICs line of (QE1), concluded in Act of 2008 authorizing securities purchased Operation Twist, a plan to announced QE3 credit with the Treasury from $30 billion Q1 2010, with a total the U.S Secretary of the during the QE1 program. purchase $400 billion of to aid U.S. to $100 billion. In addition, the bill allows of $1.25 trillion in Treasury to spend up to In addition, it began the bonds with maturities of recovery, entails the FDIC to draw up to $500 billion until purchases of MBS $700 billion to purchase purchase of $600 billion six to 30 years and to sell buying $40 Dec-10 if allowed by FDIC Chairman, and $175 billion of mortgage-backed of longer-term Treasury bonds with maturities less billion in MBS Fed Chairman, and Secretary of the agency debt securities (MBS). securities. than three years. each month. Treasury. purchases.Deliberate efforts to stimulate the U.S. economy through government fiscal policy have been a formal part of the political economy for more thaneighty years.Source: Federal Reserve, FOMC, FDIC, 15
  16. 16. Monetary Policy Continuous Stimulus Timing of Monetary PolicyThe Fed in September 2012 Q.E. Q.E. Continuous Stimulus: Operation Twist,announced that it would buy $40 1.0 2.0 Extension of Operationbillion a month in mortgage-backed Twist and Q.E. 3.0securities for the foreseeable 15,000.0 4,000.0future. The plan has been dubbedQ.E. 3.0 since it is the central 13,500.0 3,500.0banks third round of quantitative 12,000.0easing. 3,000.0 10,500.0 2,500.0 9,000.0The Fed hopes that by pumpingmoney into the economy, thereby 7,500.0 2,000.0lowering mortgage rates, Q.E. 3.0 6,000.0could lead to an increase in 1,500.0consumer spending and more 4,500.0 1,000.0hiring by businesses. 3,000.0 500.0 1,500.0This program could last until themiddle of 2015 and eventually 0.0 0.0reach $2 trillion, including thebuying of long-term Treasuriesplanned by the Fed under an Monetary Policy Dow Jones (LHS) S&P 500 (RHS) Nasdaq (RHS)extension of "Operation Twist.” Source: Federal Reserve 16
  17. 17. Fiscal Cliff Deeper Dive The Deficit in 2013 Compared with 2012 under two scenarios Federal Budget Deficit in 2013The Congressional Budget Officeprojects that under current law a Baseline Deficit in Baseline Deficit insharp reduction in the federal 2013 ($641 billion) 2013budget deficit between 2012 and Deficit in 2012: US$1,037 Deficit in 2012:2013 will cause the economy to $1,128 billion billion $1,128 billioncontract. But this will also put Extend Tax Cuts*federal debt on a path more likely $487 billion Prevent Spending Reduction in the Deficit in 2013 comparedto be sustainable over time. with 2012 Cuts* $91 billion The Economy in 2013To illustrate the effects of fiscal -0.5% Change in inflation-adjusted GDP, 4th +1.7%tightening, CBO compared its quarter 2012 to 4th quarter 2013projections under current law (the"baseline" projections) with A Broad Spectrum of Fiscal Policy Choicesprojections under an alternative set Decisions for 2013of policies — two scenarios in a More Fiscal Tightening Less Fiscal Tighteningbroad spectrum of choices. Allow changes scheduled under Shrink deficit from 2012 by less than $487 Seek to stimulate the economy by current law to occur or take other billion by extending some of the expiring tax cutting taxes, increasing spending, steps to shrink the deficit from cuts, curbing the spending cuts, or adopting or doing both, thereby running a 2012 by $487 billion or more. other combinations of policies. larger deficit in 2013 than in 2012. Implications for Future Policy Decisions Reductions in taxes or increase in spending in 2013, relative to what would occur under current law, would have near-term economic benefits but would add to the already large accumulation of govt. debt. Because current policies would ultimately lead to an unsustainable level of federal debt, policymakers will need – at some point – to adopt policies that will require people to pay significantly more in taxes, accept substantially less Source: CBO in govt. benefits and services, or both. 17
  18. 18. Investment Performance Value in the Long EndBenchmark Performance Ticker Q3 2012 2011 2010 2009 2008 2007 Short Benchmarks 3-Month Treasury Bill G0O1 0.034 0.103 0.126 0.207 2.057 5.004 3-Month Citi/Salomon CD SBMMCD3 0.050 0.289 0.310 0.822 3.442 5.448 6-Month Treasury Bill G0O2 0.059 0.268 0.365 0.579 3.582 5.607 6-Month Cit/Salomon CD SBMMCD6 0.078 0.389 0.437 1.611 3.756 5.459 1-yr Treasury Bill G0O3 0.106 0.496 0.792 0.813 4.746 5.948 Treasury 1-3 yr Treasury G1O2 0.256 1.554 2.348 0.785 6.609 7.317 3-5 yr Treasury G2O2 0.758 6.229 5.695 -0.672 12.153 9.836 Corporate/Govt (A Rated and Above) 1-3 yr Corp/Govt B110 0.477 1.527 2.641 2.766 5.184 6.981 3-5 yr Corp/Govt B210 1.226 5.479 5.925 2.958 6.174 8.324 Agencies 1-3 yr Agencies UAG1 0.250 1.536 2.338 2.189 7.034 6.735 3-5 yr Agencies UAG2 0.876 5.290 4.900 3.223 8.971 8.261 Municipals - Tax Exempt 1-3 yr Prere U1AF 0.233 0.629 0.923 3.189 5.875 4.710 3-7 yr Prere U2AF 0.596 1.923 2.087 5.345 7.992 5.390 Auto Asset Backed Securities 1.4 yr duration - Fixed Rate R0U0 0.628 0.661 3.077 14.845 -0.682 5.723 Dow Jones Industrial Average INDU 6.483 5.544 11.023 3.116 -33.762 6.432 S&P 500 SPX 7.454 2.110 12.783 23.454 -38.486 3.530 NASD CCMP 5.605 -1.799 16.910 43.888 -40.541 9.812 MSCI World Index MXWO 7.765 -7.615 9.262 27.283 -42.081 7.093 CRB Index (Commodities) CRY 7.096 -8.264 15.430 23.563 -39.450 16.679*Periodic return.Source: Bloomberg, Bk of America/ML, Morgan Stanley. 18
  19. 19. Yields Longer End TighteningYield Curve comparison Q2 versus Q3 1.0% 2.5% 2.0% 1.5% 0.5% 1.0% 0.5% 0.0% 0.0% U.S. Treasury Bill /Notes (Q2) U.S. Agency DN/Bonds (Q2) A-1/P-1 CP (Q2) Ind Bonds - A Rated (Q2) Fin Bonds - A Rated (Q2) A-1/P-1 CP (Q3) U.S. Treasury Bill /Notes (Q3) U.S. Agency DN/Bonds (Q3) Ind Bonds - A Rated (Q3) Fin Bonds - A Rated (Q3)Source: SVB Asset Management, Bloomberg 19
  20. 20. Banking Sector Stabilizing RecoveryFDIC Quarterly Bank Net Income / (Loss) $40,000.0 $30,000.0 $20,000.0 $10,000.0 Millions $0.0 -$10,000.0 -$20,000.0 -$30,000.0 -$40,000.0U.S. banks’ performance continues to stabilize and is supported by a decline in loss provisions, albeit in a persistently low interest rateenvironment.Source: FDIC. 20
  21. 21. Banking Sector Stabilizing RecoveryLending Standards Delinquency Rates Net percent of banks reporting tighter lending standards 14.0% 120.0% 12.0% 100.0% Conservative All banks, seasonally adjusted 10.0% 80.0% 60.0% 8.0% 40.0% 6.0% 20.0% 4.0% Relaxed 0.0% -20.0% 2.0% -40.0% 0.0% Commercial & Industrial loans Commercial Real Estate Loans Residential Consumer Loans Residential Mortgage Loans Prime Commercial and Industrial Loans Commercial Sub-Prime Non TraditionalSource: Bloomberg. Source: Federal Reserve. 21
  22. 22. Banking Sector On WatchRating Agencies’ U.S. Financials Upgrades and Downgrades 3,000 2,500 2,000 1,500 1,000 500 0 Upgrades Downgrades2012 Financial sector downgrades are expected to outpace upgrades, but number of rating actions from S&P, Moody’s and Fitchshould be moderate compared to 2009.Source: S&P, Moody’s, Fitch & Bloomberg, October 3, 2012 22
  23. 23. Industrial Sector Steady PaceRating Agencies’ U.S. Industrials Upgrades and Downgrades 400 350 300 250 200 150 100 50 0 Upgrades Downgrades2012 Industrial sector upgrades to remain at the same pace as downgrades, as healthy industrials face uncertain economicconditions.Source: S&P, Moody’s, Fitch & Bloomberg, October 3, 2012 23
  24. 24. Public Debt Watching the Bubbles Public Debt - % of GDPGovernment debt at the end of 2011 6.0%was above 100% of GDP in Greece,Ireland, Italy and Portugal and budget 4.0%deficits have been most swollen onthe southern and western rim of the Australia Japaneuro area. 2.0% U.S. Canada Germany FranceBy contrast, German government debt 0.0%was around 80% of GDP and its U.K. GDP YoY % Spain Irelandbudget balance was only mildly in the -2.0%red last year. Italy Portugal -4.0% Greece -6.0% -8.0% 0% 50% 100% 150% 200% 250% Debt to GDP Ratio Source: Bloomberg as of October 3, 2012. Note: Bubble size represents borrowing costs. 24
  25. 25. Global GDP Slowdown Real GDP Growth - % per yearDue to the recessionary 6.0% 5.4%environment, future global growth 5.2% 5.3% 5.1%will be revised downwards for 5.0% 4.7% 4.5%several years. Currently, the 4.0% 4.0% 4.0% 4.1%4.2% 3.9%consensus scenario is still one of 4.0% 3.6% 3.5%3.4%quite robust global growth in 2012 2.8% 2.9%and even more so in 2013. 3.0% 2.6% 2.0% 1.5%The recessionary environment hasnot only hit the developed market, 1.0%but also the developing markets.This is clearly evident from the 0.0% -0.6%global GDP being dragged down.However, 2012 is expected to close -1.0% -1.2%lower then 2011 mainly due tocontinued pressure on developed -2.0% -2.4%markets and slowing down ofemerging economies (BRIC etc). -3.0% Actuals IMF Forecast OECD Forecast Source: Bloomberg, IMF, OECD. 25
  26. 26. Euro Zone Debt Crisis Reasons Behind the SupportEuropean Banks’ Foreign Exposure • Due to the global nature of their operations, French and German $600.0 banks remain heavily exposed to credits in Greece, Ireland, Italy, Portugal and Spain $500.0 • Comparatively, U.S. banks’ exposure to the GIIPS countries is relatively lower and more manageable. This is because U.S. $400.0 banks are generally more U.S.-centric compared to the French and German banks Billions $300.0 • Similarly, Spanish banks have relatively lower foreign exposure $200.0 to the GIIP countries as they are inward focused and international exposures are in Latin America and the rest of the $100.0 world • With their skin in the game, the French and German $0.0 governments, through their representation in European Union and ECB, would be incentivized to continue their support for the GIIPS Italy Spain Ireland Portugal GreeceSource: BIS 26
  27. 27. Euro Zone Debt Crisis Lack of UnityDo the Metrics Support the Ratings? National Debt Debt as a % Country GDP YoY % S&P Moody’s 10 -Year Yield (billions) of GDP Greece $370.94 165.30% -5.50% CCC C 18.80% Portugal $226.99 107.80% -3.30% BB Ba3 8.62% Spain $963.14 68.50% -1.30% BBB+ Baa3 5.67% Italy $2,108.84 120.10% -2.60% BBB+ Baa2 4.96% Ireland $183.72 108.20% -1.10% BBB+ Ba1 4.86% Australia $256.18 26.80% 3.70% AAA Aaa 2.92% France $1,781.44 85.80% 0.30% AA+ Aaa 2.18% Canada $876.95 87.40% 1.90% AAA Aaa 1.72% United Kingdom $1,971.31 85.70% -0.50% AAA Aaa 1.69% United States $10,922.02 67.70% 2.10% AA+ -- 1.61% Germany $1,433.29 81.20% 1.00% AAA Aaa 1.46% Japan $11,799.87 211.70% 3.20% AA- -- 0.76%Source: Bloomberg ,SVB Asset Management as of October 3, 2012. 27
  28. 28. Euro Zone Debt Crisis Ongoing SupportEuro/USD 11/30 - U.S. Fed 2/29 - ECB’s second 3/09 - Greece closes its 9/06 – ECB $1.45 adjusts its dollar LTRO operation resulted restructuring deal with 4/25 - Spains 4/27 – Spain is announced a new plan liquidity swaps in €529 billion in loans to creditors and ISDA Bankia seeks a for unlimited bond downgraded to BBB+ making it easier for 800 banks, bringing the declares that it €19B bailout from purchases from by S&P European banks to total liquidity injection to constitutes a credit event the government Eurozone countries $1.40 raise capital over €1 trillion and payouts will be made to CDS holders 5/02 – Euro Zone 9/03 - Moodys cuts unemployment rate the outlook on the 4/18 - Italian rises to 10.9%, a EUs Aaa credit $1.35 government cuts 15-year high rating to negative growth forecast for from stable the economy in 2012 10/26 - Banks agree to by 1.2% 7/23 – Moodys reduces $1.30 take a 50% loss on Greek Germanys AAA rating debt, and shortly after, down to negative Euro Zone agrees on a 3/14 – Euro Zone 6/07 – Fitch new plan for Greece agrees to a second downgrades bailout program for Spain three $1.25 1/13 – S&P downgrades notches to BBB Greece in the amount 10/10 - Franco-Belgian nine Euro Zone nations and of €130B in Bank, Dexia, is lowers the EFSF’s credit rating days later conjunction with the nationalized €28B from the IMF 07/04 - ECB lowered its $1.20 6/09 - Spain main lending rate to an 3/02 - ECB’s balance requests up to 6/25 – Moody’s all-time low following a 12/21 - ECB’s first LTRO sheet surges to a record 3/30 - European leaders €100B in aid from downgrades 28 rate cut by Chinas operation was a success € 3.02T after the second commit to a new €500B the EU to shore Spanish banks due central bank and $1.15 with a record take down of tranche of three-year firewall to be added to the up its banking to real estate additional asset €489B in three-year loans by loans current amount of €300B sector exposure and purchases by the BoE European banks Spain’s reduced creditworthiness $1.10Source: CapitalIQ, SVB Asset Management , IMF, EUROPA and ECB. 28
  29. 29. Euro Zone Debt Crisis Confusion ReignsEuropean Banking Crisis Solutions Program Target Countries Objective EU/IMF Greece, Ireland, Portugal Provide funding assistance European Financial Stability Facility 1 All Euro Zone Contingency Funding Program (€750 billion) (EFSF) European Stability Mechanism (ESM) All Euro Zone Permanent Resolution Mechanism (2013) Securities Market Program Distressed Countries Stabilize bond markets EU/IMF Greece, Ireland, Portugal Improved terms to buy time EFSF 2 All Euro Zone Increase capacity and flexibility ECB Long Term Refinancing Operation All Euro Zone Access to liquidity (€489 billion) (LTRO) ECB Long Term Refinancing Operation All Euro Zone Access to liquidity (€529 billion) (LTRO 2)Europeans lack a clear leader. However, the recent ECB has offered temporary liquidity relief to banking sector.Source: SVB Asset Management , IMF, EUROPA and ECB. 29
  30. 30. Euro Zone Debt Crisis The Social Cost of Admission Weekly ECB Bond Purchases• On September 6, 2012, the ECB announced a new plan for buying bonds from Euro Zone countries. If successful, the “Outright Monetary €250.0 €25.0 Transactions” or OMT programme could help limit borrowing costs for some of the weaker economies in Europe. The duration of the previous ECB Securities Markets Program was temporary, while the new OMT €200.0 €20.0 programme has no ex-ante time or size limit. However, to gain access to the OMT, countries must formally apply for an European Financial Stability Facility or European Stability Mechanism programme and must stick to all the conditionality that this brings €150.0 €15.0• Markets responded positively to the ECBs announcement. Hence, Billions Billions analysts believe that it should be seen as progress €100.0 €10.0• Implementation risk remains high; neither Spain and/or Italy are likely to be in any hurry to formally apply for intervention – Spain is fully funded up until a October 19, 2012 bond maturity of €9 €50.0 €5.0 billion• The ECB held monetary policy steady at 0.75%, despite downgrading their growth expectations for both 2012 and 2013 €0.0 €0.0 – Lowered its 2012 ‘growth’ forecast from -0.1% per year to -0.4% per year, while 2013 has been cut to 0.5% per year from 1.0% per year previously SMP Bond Purchases Per Week Cummulative Holdings Source: Bloomberg. 30
  31. 31. Euro Zone Debt Crisis Diverging Options 18.0% 16.0% 14.0% Luxembourg Austria 12.0% Italy 10.0% Belgium 8.0% Spain Finland 6.0% Germany 4.0% Netherlands 2.0% France 0.0%Fund managers have largely exited out of most Euro-area countries except stable core countries such as Germany, France andNetherlands.Source: Crane Data, SVB Asset Management. 31
  32. 32. Central Banks Global Easing Central Bank Assets1Central banks have expanded from $4,000.0just interest rate management andhave adopted new monetary $3,500.0“tools” to support economicgrowth. $3,000.0Quantitative easing and asset $2,500.0 Billionspurchases are now a globalphenomenon, especially among the $2,000.0industrialized nations. Since the $1,500.0liquidity crisis, domestic andforeign central banks have built up $1,000.0their balance sheets in the aim ofsupporting its respective $500.0economies. As a result, the generalborrowing cost of sovereign debt $0.0remain relatively low.The role of the central banks havemorphed from the “lender of last European Central Bank Bank of Japan U.S. Federal Reserveresort” to “buyer of last resort”. Source: Bloomberg 32
  33. 33. FX Influence of Central BanksThe U.S. Dollar Index Measures the General Value of the USD Volatility in the Euro Persists130 €1.75 €1.65120 €1.55110 €1.45100 €1.35 90 €1.25 €1.15 80 €1.05 70 €0.95 60 €0.85 50 €0.75 The multiple monetary programs may keep the dollar pegged The resilience of the euro has been greatly dependent on the here for several more years. enormous operations by the European governments.Source: Bloomberg, SVB Asset Management . 33
  34. 34. FDIC Insurance What’s NextDodd-Frank Domestic Non-interest-Bearing Transaction Accounts Accounts Greater Than $250,000 $1,800.0 $1,600.0 $1,400.0 $1,200.0 $1,000.0 Billions $800.0 $600.0 $400.0 $200.0 $0.0 Distribution by Banks’ Asset Size Over $100 Billion $50 - $100 Billion $10 - $50 Billion $1 - $10 Billion Less than $1 BillionUnlimited FDIC Insurance under Dodd-Frank Act is set to expire on December 31, 2012. Most transaction account deposits above$250,000 are with the larger banks and should be able to withstand the possible flight of deposits if the insurance expires.Source: FDIC, SVB Asset Management 34
  35. 35. Regulatory Environment Rocky Road AheadPotential MMF Reform Proposals as of 3Q2012• Amendments to SEC 2a-7 rule Floating NAV by • Real-time mark to market level valuation have been in place for more than SEC • Most of the money fund industry is not in favor two years now. Key changes included more restrictive maturity limits, higher credit quality OR standards and establishment of new daily and weekly liquidity Capital Buffer and • Cushion against liquidity and credit risk Redemption • Goal: to minimize the risk or disorderly run requirements. Restriction by • Uncertain about the form or amount of buffer SEC • Could drive further consolidation and work against the investor• The SEC failed to push through a objective of liquidity second round of reforms in OR August 2012. SIFI’s Designation • Inclusion of certain money funds as SIFI* by FSOC • Could be subject to heightened regulation by Federal Reserve• In September 2012, Geithner highlighted that if SEC doesn’t take actions for further reform, FSOC may step in by designating Potential Reforms can be a combination of above measures. certain funds as SIFI. Recommendation is slated to be released in November 2012. *SIFI: Systemically Important Financial InstitutionsSource: SVB Asset Management FSOC: Financial Stability Oversight Council 35
  36. 36. Our Team Our Team Managing Director Head of Portfolio Management Head of Credit Research Jeff Schnitz Ninh Chung Melina Hadiwono, CFA Chief Investment Officer Portfolio Managers Credit and Risk Joe Morgan, CFA Minh Trang, CFA Sook Kuan Loh, CFA Paula Solanes Tim Lee, CFA Renuka Kumar Kyle Balough Jose Sevilla 36
  37. 37. SVB Asset Management555 Mission Street, Suite 900San Francisco, CA 94105This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in partupon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do notrepresent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to berelied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investmentdecision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment orto engage in any other transaction.All material presented, unless specifically indicated otherwise, is under copyright to SVB Asset Management and its affiliates and is for informationalpurposes only. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any otherparty, without the prior express written permission of SVB Asset Management. All trademarks, service marks and logos used in this material aretrademarks or service marks or registered trademarks of SVB Financial Group or one of its affiliates or other entities.©2012 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of FDIC and Federal Reserve System. SVB>, SVB>Find a way,SVB Financial Group, and Silicon Valley Bank are registered trademarks. SVB Asset Management, a registered investment advisor, is a non-bankaffiliate of Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management are not FDIC insured, are notdeposits or other obligations of Silicon Valley Bank, and may lose value. Rev. 10.16.2012 1012-0177