Greece: It's getting serious

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1 Jan 1 Jan 2 Jan 3 Jan 4 Jan 5 Jan 6 Jan 7 Jan 8 Jan 9 Jan 1 Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan 16 APRIL 17, 215 ECONOMIC SIT UAT ION AND ST RAT EGY Greece: It's getting serious People refer to "the elephant in the room" when something obvious is being ignored or when no one wants to talk about a pressing issue because it is too awkward. These days, that applies to Greece's possible bankruptcy or even departure from the euro zone, an event that is not desired politically and for which no precedent exists. But to judge from the news, it has again come closer in recent days. Citing sources from the Euro Group, German newspaper Süddeutsche Zeitung reported yesterday "it is out of the question" that an agreement with Greece could be achieved shortly. A breakthrough in the negotiations at the meeting of finance ministers on April 24 in Riga is said to be unlikely. The main object of the negotiations is a list of reforms that the Greek government under Prime Minister Tsipras is to work out. It comprises further austerity measures, reforms, and privatizations and is supposed to replace some of the measures previously set by the troika (EU Commission, ECB, and IMF) to which the new government no longer feels committed. However, the Greek proposals do not yet satisfy the euro partners in important respects. Above all, detailed steps to implement the proposed reforms and reliable figures on their financial consequences are lacking. But an agreement is viewed as a prerequisite for disbursing EUR 15 billion more to Greece under the still ongoing bailout package Greece: Debt to GDP ratio (in %) that will happen, they would keep their hands down. Such indiscreet observations not only violate all diplomatic protocol, but we believe they also crucially diminish the prospects for an agreement in the future. The signs of stress are also growing daily outside the negotiations. On Wednesday, Standard & Poor's (S&P) lowered Greece's credit rating from B- to CCC+, which represents a "considerable risk" of default. The rating agency cites as its reason that the uncertainty is affecting Greece's economy more with each passing day and thus worsening the financial situation. This effect has so far not been very visible in the broad economic data that we follow for Greece. Business confidence in the manufacturing, services, and retail sectors has declined somewhat, but consumer sentiment has even improved lately. However, it does not take much imagination to see that the current government is subjecting businesses to a considerable endurance test. We therefore share S&P's assessment that the government's course will adversely restrict economic activity, and we expect Greece to relapse into recession unless a course correction is quickly made Greece: Sentiment indicator Industrial confidence Consumer confidence Retail confidence Services confidence Given Athens' extremely strained financial situation, the delay of further aid payments may already be considered bad news. But the really unsettling thing is the impression conveyed recently by the mood in the negotiations. The euro states have evidently given up hope that the Greek government might be willing to compromise. High-ranking representatives of the euro zone have told the Süddeutsche Zeitung that it is "simply impossible" to find a competent person to talk to in the Greek government; experienced civil servants have reportedly lost their positions under the new government. The newspaper has also learned that if one asks the 27 EU commissioners and the president who would help Greece and want to keep it in the euro zone, "everyone would raise their hands." But if asked whether Possibly the greatest pressure is now weighing on the Greek banking sector, which has come under fire from practically all sides. More and more loans are proving to be bad, the protection of homeowners announced by the government threatens to undermine the payment behavior of debtors, and depositors are withdrawing more savings every month. As a result, prices of Greek bank stocks have declined dramatically (since the beginning of the year as of yesterday's close: National Bank of Greece: -27.9%; Alpha Bank: -53.2%; Bank of Piraeus: -71.4%; Eurobank Ergasias: -52.6%), and three of the four largest banks listed on the stock exchange now have prices below 3 cents per share. Since the greatest trouble threatens to arise immediately in the banking sector, it is worthwhile to look at the individual negative factors at work there now. In the third quarter of 214, the ratio of bad to total loans in the books of Greek banks stood at about 34% (December 213: about 32%). More recent figures are available in some cases, but they do not indicate that the situation has improved. For example, Bank of Piraeus has reported its bad loan ratio was 38.8% 1

2 Apr. Apr. 2 Apr. 4 Apr. 6 Apr. 8 Apr. 1 Apr. 12 Apr. 14 ECONOMIC SITUATION AND STRATEGY in the fourth quarter of 214 and thus only slightly below the preceding quarter's 39.1%. 3 Stock prices Greek banks Greece: Deposits of corporations and private households at Greek banks (bln. EUR) NATIONAL BK.OF GREECE BANK OF PIRAEUS ALPHA BANK EUROBANK ERGASIAS This remarkably strained situation could worsen, if the Greek government is serious about a proposed new law that would more strongly protect homeowners from foreclosure. The proposal basically provides that real estate valued up to EUR 3, no longer be subject to foreclosure, if the owner's total assets amount to less than EUR 5, or the owner's annual income is less than EUR 5,. These relatively high hurdles to foreclosure are viewed critically not only by the ECB, which fears increased strategic misconduct on the part of debtors. We also fear that the area of real estate loans, which still accounts for about 3% of Greek banks' total loans, could come under heavier pressure again. In September 214, the ratio of bad loans in the real estate sector was about 28%. At the same time, more and more Greeks are playing it safe and withdrawing their deposits from domestic banks. Customers withdrew funds totaling more than EUR 7.5 billion in February alone, and outflows in the last three months add up to almost EUR 24 billion. This trend is not new, and investors have been withdrawing deposits from the Greek banking system for several years. Deposits have thus decreased by almost EUR 1 billion since the beginning of 21. However, over this period, they have never been withdrawn as quickly as in the last few months. We firmly expect this money will not be brought back to Greek banks for the time being. Greek households and businesses that have withdrawn money as a precaution will only revise that decision when it is clear that the danger of another sovereign bankruptcy will remain averted in the medium term. On the other hand, a temporary easing of tension, e.g., resulting from another payment of aid money, is not likely to bring decisive improvement. Since Greek government bonds have no longer been eligible as security with the ECB since February 11, Greek banks must increasingly seek refinancing by way of emergency loans at the Greek central bank. The plight of the banks is reflected in the need to raise the upper limit on such emergency liquidity assistance (ELA) already several times. Emergency loans taken out in February totaled EUR 65.6 billion, but the number increased in March to EUR 68.5 billion. According to agency reports, it has risen again and now stands at about EUR 7 billion. The upper limit on emergency loans set by the ECB was raised by EUR 1.2 billion last week and has been increased again by EUR 8 million this week and now stands at EUR 74 billion. That leaves Greece maneuvering room of EUR 4 billion. It is a prerequisite for financing the banking sector by means of emergency loans that commercial banks are generally solvent. The ECB regards that condition as fulfilled now. But in an environment with considerable political and economic uncertainty, falling deposits, a high ratio of bad loans, extremely limited possibilities for increasing capital, and a possible Greek default, a time could come when the ECB judges this state of affairs differently. A critical point will be reached then, in our view, because political leaders will finally have to make a fundamental decision. To keep Greece in the euro zone, the Greek banking sector would have to be restructured by the euro partners and outfitted with fresh capital. Even this would only work if the Greek government cooperates and such a financial feat can be politically legitimized by the euro partners. Neither of those conditions is certain at present. Although we still consider it in Greece's interest to remain in the euro zone, the Tsipras government has lately done all it could not to achieve that goal. Whether that is due to political convictions or internal difficulties in the SYRIZA party or the governing coalitions is unclear to us. The political price of obtaining majorities for another bailout of Greece is also constantly rising in many countries. In Germany, there were several dissenters from the ranks of the governing parties in the last vote taken on loans to Greece. Reporting on the negotiations with Greece and on the topic of reparation demands might have also 2

3 ECONOMIC SITUATION AND STRATEGY done something to reduce public approval of aid to Greece again. There seems to be hardly any or ever less sympathy for Greece's position in many other countries as well. In particular, politicians in eastern European states have noted with concern that Tsipras has intensified relations with Moscow. Moreover, payments to Greece are hard to explain to those countries' citizens, since average incomes in Latvia, Estonia, and Lithuania are still lower than in Greece. This list could be lengthened at will, but ultimately we conclude that the Greek government now has practically no support in the euro zone for its position. The time for concrete negotiation results is pressing. We have examined the maturity structure of Greece's obligations, and the next payments for three short-dated government bonds in April and May add up to EUR 3.8 billion. IMF tranches totaling EUR 1.1 billion are coming due at the beginning of June. More payments amounting to EUR 9 million must be made to the IMF in mid-june, and short-dated government bonds will be rolled over in the amount of EUR 3.6 billion. In regard to commercial paper, Greece has maintained its ability to place paper on the market. If that should continue in the future, the repayments of IMF loans on June 5, 12, and 16 are the next critical dates. Of course, one can still argue that Greece is pursuing an extremely tough negotiating tactic and betting on achieving a possibly advantageous agreement for itself by offensively threatening a sovereign bankruptcy. And the opposing party, the other euro member states, is seeking for its part to increase the pressure by means of indiscreet comments and (possibly) feigned resignation. But if that is the case, this tactic will become riskier from day to day. In the banking sector, the situation with respect to public opinion and on the capital market does not always worsen at a relatively constant pace. It could eventually reach a point where circumstances suddenly change and dynamic processes that may resist control are set in motion. If negotiations continue with the same somnambulatory dynamic, that point may be reached relatively soon. An exit as accident (a "Graccident") might ultimately be the consequence. 3

4 Dez. 8 Jun. 9 Dez. 9 Jun. 1 Dez. 1 Jun. 11 Dez. 11 Jun. 12 Dez. 12 Jun. 13 Dez. 13 Jun. 14 Dez. 14 Jun. 15 ECONOMIC SITUATION AND STRATEGY Weekly outlook for April 2-24, 215 Nov. Dec. Jan. Feb. Mar. Apr. Release DE: Producer prices, m/m.% -.7% -.6%.1% -.1% April 2 DE: Producer prices, y/y -.9% -1.7% -2.2% -2.1% -2.3% April 2 DE: ZEW expectations April 21 DE: ZEW current conditions April 21 DE: GfK consumer climate April 23 DE: PMI, manufacturing April 23 DE: PMI, services April 23 DE: Ifo business climate index, sa April 24 EUR19: Consumer confidence April 22 EUR19: PMI, manufacturing April 23 EUR19: PMI, manufacturing April 23 MMWB estimates in red Chart of the Week: Yield on 1-year government bonds soon negative? 1-year government bond yields in different European countries (in %) A A -5 Germany France Italy Portugal Greece (r.h.s.) At the ECB's press conference yesterday, President Mario Draghi announced, as expected, that the key interest rate is being left unchanged at a record low level of.5%. The bond purchase program that began in March with a monthly total of EUR 6 billion may already be showing first signs of success. According to Eurostat, the euro zone's industrial sector surprised in February with a sharp rise of new orders (+1.1% m/m). The IMF has raised its forecasts of GDP growth in the euro zone from 1.2% to 1.5% for this year and from 1.4% to 1.6% for 216. Despite now better economic prospects, the ECB intends to continue its bond purchase program as planned until the inflation rate target of near 2% is reached. Draghi has thus countered speculation that the ECB might taper off its program early. However, in its spring forecast, the IMF has warned at the same time of the negative effects of the ECB's expansionary monetary policy on European and especially German life insurance companies. Large financial intermediaries such as life insurance companies, for example, invest their customers' money mainly in high-rated government bonds, partly because regulations require them to do so. But yields on such bonds are very low due to the ECB's expansionary monetary policy. For example, 1-year German government bonds (Bunds) are now yielding only.1%, and yields on 8-year maturities have fallen this week into negative territory. The guaranteed interest rates promised for the long term by life insurers have therefore become a heavy burden. According to the IMF, stress tests show that one-fourth of insurers would not be able to meet their capital requirements in a longer phase of lower interest rates. The insurance sector reportedly has an investment portfolio of EUR 4.4 trillion in the EU alone, and the interconnectedness of the financial sector is increasing, which makes the danger of contagion to other financial market participants likely in a crisis. 4

5 ECONOMIC SITUATION AND STRATEGY As of Change versus Stock markets 13:3-1 week -1 month -3 month YTD Dow Jones 1816,3%,7% 3,4% 1,6% S&P 5 215,1% 1,1% 4,2% 2,2% Nasdaq 58,2% 1,6% 8,1% 5,7% DAX ,% -1,4% 18,% 22,4% MDAX ,3% 1,% 2,7% 26,% TecDAX ,3% -1,1% 14,9% 2,6% EuroStoxx ,7% 1,2% 17,2% 19,2% Stoxx ,3% 3,6% 15,% 18,7% SMI (Swiss Market Index) ,8% 1,7% 19,% 4,6% Nikkei ,1% 3,3% 17,9% 14,% BOVESPA 54674,8% 11,9% 11,5% 9,3% RTS 162 6,2% 3,6% 37,9% 34,3% BSE ,7%,8% 1,9% 4,2% China Shanghai Composite ,% 21,6% 24,2% 29,7% MSCI Welt (in ) ,9% 1,2% 15,4% 18,4% MSCI Emerging Markets (in ) 152,4% 1,3% 18,9% 24,7% Bond markets 3 months $ Libor, year US Treasuries 1, year Bunds, year JGB, US Treas 1Y Performance 575,75,7% 2,2% -,1% 3,2% Bund 1Y Performance 65,37,7% 1,9% 3,5% 4,8% REX Performance Index 477,15,2%,6%,7% 1,1% US mortgage rate 3, IBOXX AA,, IBOXX BBB, 1, ML US High Yield 6, JPM EMBI+, Index 717 -,2% 4,4% 4,% 3,7% Convertible Bonds, Exane ,% 1,9% 7,1% 9,1% Commodities CRB Index 426,83 1,7% 3,6% -4,% -4,6% MG Base Metal Index 295,57 1,5% 4,3% 4,2% -2,7% Crude oil Brent 6,4 7,3% 8,2% 26,7% 5,4% Gold 1197,96 -,8% 3,9% -6,% 1,% Freight rates Baltic Dry Index 593 2,2% 5,1% -2,% -24,2% Currencies EUR/ USD 1,7 1,3% 1,5% -7,6% -11,8% EUR/ GBP,72-1,%,5% -5,6% -7,5% EUR/ JPY 127,64,3% -,3% -5,5% -12,1% EUR/ CHF 1,3 -,6% -2,7% 2,% -14,1% USD/ JPY 119,1-1,% -1,9% 1,2% -,6% Carsten Klude cklude@mmwarburg.com Dr. Christian Jasperneite cjasperneite@mmwarburg.com Matthias Thiel mthiel@mmwarburg.com Martin Hasse mhasse@mmwarburg.com Rebekka Haller rhaller@mmwarburg.com This report does not constitute and shall not be construed as an offer or an invitation to make an offer. It may only be used as guidance and to illustrate potential business activities. No claim is made as to the exhaustiveness of the information contained in this report, and it is therefore non-binding. The opinions expressed here may change at any time without notice. Any statements made about prices or interest rates or any other indications that are given relate exclusively to the time that the report was produced and do not contain any statements about future trends or, in particular, about future profits or losses. In addition, this report does not constitute and shall not be construed as advice or a recommendation and is not a substitute for obtaining client- and product-specific advice. This report is confidential and is intended solely for the addressee designated herein. Any use beyond that of the addressee without our consent is prohibited. That applies in particular to copies, translations, microfilming, storage and processing in electronic media, and any other publication of the content whether wholly or in part. 5

Mounting signs of capital market stress

Mounting signs of capital market stress Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jan 94 Jan 96 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10 Jan 12 Jan 14 Jan 16 JANUARY