Eurozone Debt Crisis Recap Markets Signal Investors Fear a Collapse

1. Eurozone Debt Crisis RecapMarkets Signal Investors Fear a Collapse September 14th 2011

2. Debt crisis intensifies, • European leaders scrambled to reassure financial markets over the last week that they were taking more decisive action to deal with the worsening debt crisis, as default threatens Greece again. • The Greek economy is in a tailspin, bondholders are in revolt, and voters in Europe’s creditor countries are increasingly calling on their leaders to cut Athens loose. • Increasing signals that Germany is losing patience with the current process after its executive board member, Jürgen Stark, quit the European Central Bank and its economy minister said “an organized bankruptcy” of Greece should no longer be a taboo. • The risk of contagion beyond Greece pushed sovereign credit-default swap prices to record highs across the eurozone. European bank debt risk also rose to the highest ever amid speculation. • With the exception of just three days in early 2009, eurozone bank stocks are at their lowest levels in at least seven years.

3. Merkel Quells Speculation on Greece • Conflicting statements this week by German politicians about Greece have added to markets' fear that Greece will default on its debt and might be forced out of the euro. Tensions between Greece and the team of international inspectors charged with overseeing its fiscal overhauls have also hit investors' confidence that Europe can tame the festering debt crisis in parts of the currency zone. • German Chancellor, Angela Merkel, sought on Tuesday to quash talk that cash-strapped Greece might have to declare bankruptcy soon or even leave the euro zone, rebuking her junior coalition partner for fueling market speculation about Greece's fate. • She warned that the future of the euro, and with it the future of Europe, was at stake. • German official made it clear that the institutional instruments do not exist for an “orderly insolvency” for Greece as was suggested in an interview by the German economy minister. The chancellor stressed that Germany remains committed to financing Greece through the euro zone's bailout funds until Greece can repair its own finances through austerity measures. • Ms. Merkel's comments helped to calm jittery markets on Tuesday, and contributed to a sharp rebound in French banking stocks, which have been hammered recently by fears of a chaotic Greek bankruptcy that could inflict painful losses on banks elsewhere in Europe.

4. French banks latest casualty of europe’s debt crisis • French bank shares suffered a fresh sell-off on Monday as concerns about the eurozone sovereign debt crisis intensified despite an attempt by Societe Generale to assuage market concerns by pledging to accelerate asset disposals and cut costs. • These banks are the most exposed in the euro zone to Greek borrowers, including businesses as well as the Athens government, and stand to lose heavily from a Greek financial meltdown. • Nonetheless, French banks stocks rose strongly on Tuesday following Merkel’s comments. Shares in Société Générale SA, France's second-largest bank by market value, rose 15%, BNP Paribas SA shares rose 7.2% and Crédit Agricole SA gained 6.7%. • Société Générale's reprieve comes after a prolonged selloff since Aug 1, in which its stock sank 46%. • Broader eurozone bank shares also suffered early in the week, plunging to depths they only surpassed for three days in early 2009 during the financial crisis. They have now fallen 55% since their peak in February. • Moody's Investors Service said on Wednesday that it downgraded the credit ratings of Société Générale and Credit Agricole, marking the latest in a series of blows to French banks that have recently punished European stocks. • Moody's cut Société Générale’s debt and deposit ratings by one notch to Aa3 from Aa2. For Credit Agricole, Moody's cut its long-term debt and deposit ratings by one notch to Aa2 from Aa1.

5. Time Is Running Out For Greece • Markets are becoming increasingly anxious about the possibility of Athens defaulting. • Trouble started again as international leaders demanded further austerity measures due to Greece failing to meet its targets, leading to a €1.7bn funding shortfall. The year’s budget deficit target was already revised from 7.6% of GDP to 8.1%. • The troika refused to pay the latest €8bn EU-IMF aid tranche, if the Greek government does not commit further. • On Monday figures showed that for the first eight months of the year, the state budget deficit was 22% wider than a year earlier. • The country teeters on the brink of running out of money, as the Greek government stated that it has only enough funds to last until mid-October. • Greek bonds were at panic levels, where yields for 10-year bonds rose to 23.6% and two-year bonds over 75%. Both are trading at prices of 40-50 cents in the euro, indicating that investors are fearful of suffering big losses. • To calm markets, the Greek finance minister outlined a plan to cover a €2bn shortfall with a special property tax. On Monday, reports suggested that Greece’s new measures would be enough to qualify it for its €8bn slice of the first bailout money.

6. Greece on the brink of default • The amount of aid Athens needs to run its day-to-day operations for the next three years is estimated to be around €172bn. Someone – Greek taxpayers, international lenders or private investors – will need to come up with enough cash to fill that hole or Greece will go through a potentially disorganized default. • Athens has been forced to admit its economy is shrinking even faster than expected. On Sunday, it said GDP would contract 5.3% this year; international lenders had estimated just under 4%. Tax receipts, already thin, will grow thinner. • Regardless, when the July deal was struck, officials believed they could fill the €172bn hole from four sources: the remaining cash from Greece’s first bail-out; new loans from the second rescue package; the privatization programme; and bond swaps and roll-overs. All four sources now look increasingly at risk. If any falls through, the bail-out must be reconstructed – or Greece risks defaulting.

7. The most complicated part of the new bailout is a series of debt swaps and rollovers meant to delay Greek bond redemptions for up to 30 years. • In a deal struck between eurozone officials and a group of leading international banks, Greece would erase from the books €54bn in bond repayments scheduled to be met by mid-2014 – as long as 90% of holders of its bonds agree to participate in the swap programme. • But it looks increasingly unlikely that the target will be reached. Bankers and senior EU officials said last week that the current participation rate is just 70-75%. • Many predict Athens will reach 80%. But that would make it unlikely all of the €54bn would be wiped off the books, undermining the assumptions of the July deal. The difference must be made up from somewhere, probably more EU and IMF loans. • Athens is still relying on its old €110bn bailout from the EU and IMF to finance daily operations. When the deal was struck in July for Greece’s second bailout, around €57bn remained from the original bailout to be disbursed. • The €12bn tranche was released in July only after the Greek parliament narrowly approved €28bn in austerity measures. Meanwhile, amongst a worsening economic outlook, the government is now looking to impose a two year property tax in order to raise €2bn this year, closing a €1.7bn budget gap the EU and IMF said must be resolved before releasing the latest €8bn aid tranche. • Without it, Athens says, it cannot pay next month’s salaries and pension. It is likely default would follow. • The EU also wants €4bn of spending cuts and tax rises for next year. The finance ministry is resisting, but it is a condition for release of the €8bn tranche. • If this tranche was released history suggests that the same dance will be repeated at the next installment date, as Greece is likely to fall short of its promises. The problem is that the government is running out of options. • Of the €109bn in the new bailout fund, only €34bn is traditional low-interest loans to finance Athens’ regular operations. But even that has run into trouble as a result of an unorthodox Finnish demand. The new anti euro-centric Finnish parliament agreed to be part of any bailouts only if the government received collateral in return for the fresh loans. • After Greece agreed to this, other countries called foul, and asked for a similar deal. This is leading for increased pressure on the new bailout. • The €50bn privatization plan agreed between the EU and Athens has been a much hyped part of the second bail-out. Lenders went so far as to publish a detailed list of assets and a timetable of when they will be sold between now and 2015, with €28bn to be raised during the three years covered by the July deal. • Already the schedule has slipped. None of the deals planned for completion in the third quarter are likely to be closed on time. In fact, only one sale has been completed: a 10% stake in Hellenic Telecom to Deutsche Telekom for €390m. • A senior Greek official says this year’s €5bn target will be missed – but insisted there were hopes of raising close to €4bn. Source: Financial Times

8. And the contagion moves to Italy • Troubles increased for Italy after its closely watched auction of government bonds met with tepid demand and the country had to fork out higher yields to lure buyers, on concern that Europe’s debt crisis will worsen amid Greece’s struggle against default. • Italy's’ funding costs have recently surged again and 10-year bonds stabilized above 5%, despite steady buying by the ECB, widely seen as the only major buyer of Italian bonds present. • Italy has found itself in the spotlight in recent weeks as its fractious parliament attempts to structure a series of budget cuts, market reform and tax increases. Markets have worried over the Italian government’s ability to push though austerity measures. • Italy could also see its credit rating trimmed by Moody’s Investors Service as the rating firm’s three-month review period end on Saturday.

9. Italy Still A Cause For Concern • The Rome-based Treasury sold €3.9bn, on Tuesday, of a new benchmark five-year bond at an average yield of 5.60%, compared with 4.93% at a previous similar auction on July 14. Demand was 1.28 times the amount on offer, compared with 1.93 times at the previous sale. • On Monday, investors charged Italy 4.153% on a one-year bill auction, up from 2.959% a month ago. • London-based traders noted that the ECB had bought Italian bonds ahead of the auction and the central bank reportedly also stepped in after the sale. • Italian bonds continued to be hammered after the auction, with the spread over 10 year Italian-German yields climbing to 4.03 percentage points. The 10-year Italian bond yield rose 0.19 percentage points to 5.74%, its highest level in a month. • The auction came after Monday’s news that Italy’s finance minister held talks with China’s sovereign-wealth fund and other Chinese officials in a bid to persuade Beijing to buy large amounts of Italian bonds. However, recent reports are suggesting that China is reluctant to buy Italian government bonds.

10. Italy Still A Cause For Concern • The auction came after Monday’s news that Italy’s finance minister held talks with China’s sovereign-wealth fund and other Chinese officials in a bid to persuade Beijing to buy large amounts of Italian bonds. • A debt of €1900bn, more than Spain, Greece, Ireland and Portugal combined, leaves Italy vulnerable to any advance in yields costs as it refinances maturing debt. While Italy has completed more than 70% of its financing this year, it must still sell more than €60bn of bonds by year-end to cover its budget deficit and redemptions. • The case will likely be similar for Spain, which is bracing for a sale of up to €4bn in bonds Thursday. Although Spanish yields are trading below those of Italy across, the results of Italy’s auctions fuelled concern that the Spanish sale will also prove a hard sell.

11. European Leaders Face A Fork In The Road • It seems more than not that eurozone leaders will have to come to a decision with regards to the future of the euro. Suggestions for Greece to exit the single currency continue to surface, or a break-up where Germany and other creditworthy economies like the Netherlands set up a new currency. • Equity markets have been clobbered this week. Germany’s Dax 30 index declined by 27% since the start of July. Italy’s benchmark index is down by 29%, France by 23%. Such falls have surpassed the US where the S&P 500 has lost 11% over the same period. • The potential loss that European banks face on their holding of sovereign debt is on the forefront of markets concerns. Credit default swaps on European banks are above the levels they reached in late 2008. • In running from some markets, investors have overwhelmed what they perceived as safe havens. Demand for German Bunds is at its highest, whose 10-year yields fell to a record low of 1.72%

12. European Leaders Face A Fork In The Road • The eurozone is facing a harder battle in the fight against its debt crisis, as economic growth seems to stall in the face of budget tightening. The eurozone grew by a marginal 0.2% in the second quarter, fueling concerns that the currency area is on the verge of entering a recession. • Uncertainty is abundant for European markets. The eurozone is seen as lacking unified political leadership. European leaders seem to consistently fall short on carrying out their promises. • Market fears are centered on the inadequacy of the bailout arsenal, the European Financial Stability Facility. Continuing to rely on the ECB to hold the fort with its Securities Markets Programme is unsustainable, especially with the ongoing tension between Germany and the ECB. • Moreover, troubled countries do not seem to be fully committed to take control over their financial woes. Berlusconi’s government continues to flip-flop in pushing through austerity measures. • Confidence in European leaders and the ECB seems to be on a declining trend.

13. Can mutual euro bonds be the magic solution • Calls for a more fundamental step towards a fiscal union have increased. One suggestion was to introduce Eurobonds. • Advocates of Eurobonds point out that the public finances of the eurozone, taken as a whole, compare favorably with other big economies such as the US, whose government is currently able to borrow at record low yields. Benchmark 10-year bonds are trading at 1.9% as of late. Thus, the currency area would be able to benefit from low borrowing costs, helped by the liquidity advantage of creating what would become a vast government bond market. • Nonetheless, critics argue that creating Eurobonds would weaken budget discipline, reducing the incentive for weaker states to get their finances in order.

14. Eurozone: Stuck between integration and defragmentation • European leaders will have two choices, either to take a big leap towards a fiscal union, or a break-up of the single currency. • Moving towards a fiscal union seems unlikely with Germany and France strongly opposed to such suggestions. The underlying problem remains that the single currency includes different economies that work at different speeds and in different directions. • The problem with the idea of countries leaving the euro is that there is no exit mechanism. This complicates the issue of a euro break-up and increases the costs if a member country was to exit the single currency. • Economic cost of disintegration of the euro could be immense for Europe and beyond. A departure could lead to devaluation of the seceding country’s currency by as much as much as 60%. • Moreover, political costs of breaking up the euro, even in part, are probably to high to quantify in cash terms. • This leaves European leaders with its policy of muddling through, as it tries to find common ground. But the problem remains the inability of all members to agree on the next move. • Nonetheless, most leaders have continued to promise that they intend to strongly defend the euro.

15. What to sovereign credit ratings mean… • Credit rating agencies have been a large part of the debate in recent months, especially on the heels of S&P’s downgrade of the US sovereign rating. • Thus it is interesting to see what is the long-term, foreign currency credit ratings assigned to European sovereign borrowers by the three major ratings agencies. • Especially with reports suggesting that Italy might be downgraded by Moody’s.

16. Sources: Moody's, Standard & Poor's, Fitch and the WSJ

17. Disclaimer • The materials of this report may contain inaccuracies and typographical errors. Cairo Amman Bank does not warrant the accuracy or completeness of the materials or the reliability of any advice, opinion, statement or other information displayed or distributed through this report. You acknowledge that any reliance on any such opinion, advice, statement, memorandum, or information shall be at your sole risk. Cairo Amman Bank reserves the right, in its sole discretion, to correct any error or omission in any portion of the report without notice. Cairo Amman Bank may make any other changes to the report, its materials described in the report at any time without notice. • The information and opinions contained in this report have been obtained from public sources believed to be reliable, but no representation or warranty, express or implied, is made that such information is accurate or complete and are provided "As Is" without any representation or warranty and it should not be relied upon as such. This report does not constitute a prospectus or other offering document or an offer or solicitation to buy any securities or other investment and\or to be relied on for any act whatsoever. • Information and opinions contained in the report are published for the assistance of recipients "As Is", but are not to be relied upon as authoritative or taken in substitution for the exercise of judgment by any recipient; they are subject to change without notice and not intended to provide the sole basis of any evaluation of the instruments discussed herein. Any reference to past performance should not be taken as an indication of future performance. Cairo Amman Bank does not accept any liability whatsoever for any direct, indirect, or consequential loss arising from any use of material contained in this report. • All estimates, opinions, analysis and/or any content for whatsoever nature included in this report constitute Cairo Amman Bank’s sole judgments and opinions without any liability and/or representation as of the date of this report and it should not be relied upon as such. • Cairo Amman Bank reserves the right to change any part of this report or this legal Disclaimer at any time without notice. Any changes to this legal Disclaimer shall take effect immediately. Notwithstanding the above, Cairo Amman Bank shall not be obliged to keep this report up to date. • The Recipient agree to defend, indemnify and hold harmless Cairo Amman Bank and its subsidiaries & affiliate companies and their respective officers, directors, employees, agents and representatives from any and all claims arising directly or indirectly out of and in connection of the recipient activities conducted in connection with this report.