Catalyst Calendar: A Sovereign Roadmap

February 2011
Charles Mounts
203-930-7279
cmounts@knight.com

Brian Yelvington
203-930-7281
byelvington@knight.com

Please see analyst's certification and important disclosures in Appendix A of this report.
 Latent and Active Catalysts – Three Threats

Sovereign Debt Crisis

Central Bank
Policy
Missteps

Slowdown in
Chinese Demand

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 Slowdown in Chinese Demand
Chinese Loan and GDP Growth (% Change YoY) • NYT article 2/2/2011 stating China is
25 poised to hike rates within one month
23 Loan Growth
21
19 GDP Growth • Mixed PMI data recently; new 5M low
17
15
and second consecutive decline for
13 January
11
9
7
• Chinese press reported 2/1/2011 that
5 the PBOC may implement price controls
Mar-94

Mar-97

Mar-00

Mar-03

Mar-06

Mar-09
Dec-94

Dec-97

Dec-00

Dec-03
Sep-95
Jun-96

Sep-98
Jun-99

Sep-01
Jun-02

Sep-04
Jun-05

Dec-06
Sep-07
Jun-08

Dec-09
Sep-10
to stabilize inflation

• PBOC may be backing away from

differentiated RRR in 2011 as liquidity is
Chinese Required Reserve Ratio for Major Banks tight (around New Year)
19
• Salient Questions:
17
15 – Is China like Japan in that it absorbs
13 more global growth than it
11 Chinese Required provides?
Reserve Ratio
9
– How much will the RE and banking
7
sectors be shielded from a
Mar-07

Mar-08

Mar-09

Mar-10
Dec-06

Dec-08
Jun-06
Sep-06

Jun-07
Sep-07
Dec-07

Jun-08
Sep-08

Jun-09
Sep-09
Dec-09

Jun-10
Sep-10
Dec-10

slowdown?

– Is it a normal cycle or a bubble?

Source: The People’s Bank of China; Bloomberg; Knight Research

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 Central Bank Policy Missteps – Inflation and Credit Problems
vs. Job Growth
U.S. Inflation and Credit Eurozone Unemployment (%)
300 10.5
Income/Expenditure
Differential 10
250
Commodity Prices 9.5
200 9
150 8.5
8
100
7.5
50 7
J-90

J-97

J-04
J-89

J-91
J-92
J-93
J-94
J-95
J-96

J-98
J-99
J-00
J-01
J-02
J-03

J-05
J-06
J-07
J-08
J-09
J-10

M-09
S-09
J-10
J-05
M-05
S-05
J-06
M-06
S-06
J-07
M-07
S-07
J-08
M-08
S-08
J-09

M-10
S-10
Source: Eurostat; Bloomberg; Knight Research

SOVXWE
230
Income/Expenditure
210 250
Differential
190 Commodity Prices
200
170
150 150
130
100
110
90 50
S-05

S-06

S-07

S-08

S-09

S-10
J-05
M-05

J-06
M-06

J-07
M-07

J-08
M-08

J-09
M-09

J-10
M-10

N-10
N-09
D-09
J-10

J-10
J-10

D-10
J-11
O-09

F-10

O-10

F-11
M-10
A-10
M-10

A-10
S-10
Source: Bureau of Economic Analysis; NYBOT; Bloomberg; Knight Research Source: Marklt; Bloomberg; Knight Research

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 Makeup of European Spreads
Non-Externally Supported Spreads

• Reflects
• Reflects

Eurozone Membership Mitigant

• Belief in fiscal unity
• High levels of
indebtedness • Possibility of
central treasury
• Aging population

Observed Markets
• Continued bailout
• Higher market
efforts
sensitivity to
sovereign risks
• Global
indebtedness - =
• Banking system risk
• Reflect Combination
of Both Cases

• Market expectations are dependent on the prevailing belief in both the risks inherent in sovereigns on a stand-alone basis
and the mitigants associated with Eurozone membership. Both are moving targets, with the stand-alone spread defining
process being iterative in information and the risk mitigant factors subject to numerous political factors. Understanding the
catalysts that move these factors is key to understanding European sovereign risks.

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 Risk Pricing in Peripheral Europe – A Return to Normal

Deterioration of Periphery Maastricht Treaty Indicators Max EMU Member Spread to Bund (10Y, bp)
Since Euro Formation 1200
Greece Ireland Italy Portugal Spain Maastricht Treaty

Maastricht Treaty
1000
Budget Deficit -11.1 -2.9 -8.6 -4.1 -3.5 Euro Launch
Debt/GDP 87.8 92.5 108.1 54.4 46.8
EMU Launch 800
Budget Deficit -3.3 2.7 -1.7 -2.8 -1.4 Max Spread to Germany
(bp)
Debt/GDP 94 48.5 113.7 51.4 62.3 600
Current
Budget Deficit -13.6 -14.4 -5.3 -9.3 -11.1
Debt/GDP 115.1 65.5 116 76.1 53.2 400

Since Maastricht Treaty

Budget Deficit -2.5 -11.5 3.3 -5.2 -7.6 200
Debt/GDP 27.3 -27 7.9 21.7 6.4
Since EMU Launch 0
Budget Deficit -10.3 -17.1 -3.6 -6.5 -9.7 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Debt/GDP 21.1 17 2.3 24.7 -9.1

Source: EuroStat; OECD; Knight Research As of 2/7/11

Source: Bloomberg; Knight Research

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 Europe Faces Rising Debt Burdens and Limited Fiscal Flexibility
European Tax Revenues vs. Interest Expense
Global Debt Rankings (USD)
18%
Country Debt (MM)
Bubble Size Represents Debt
1) Japan 10,744,088 16% to 2011 Projected GDP
2) United States 8,998,373
14%

Interest Expense (% of GDP) *

3) Italy 2,122,356
4) France 1,684,882 Ireland
12%
5) Germany 1,656,882 Greece
6) United Kingdom 1,653,165 10% Spain
7) Spain 835,838 Italy
8) Canada 605,947
8% Belgium
9) Greece 444,142
Portugal
6% US
10) Belgium 423,532
4%
Japan

2%

• Italy and Spain are the largest debtors in the 0%

periphery
-2%
• Italy is more heavily indebted with more 10% 15% 20% 25% 30% 35% 40% 45% 50%
onerous rollover requirements More Fiscal Less Fiscal
Flexibility Flexibility
• Italy, Belgium, and Portugal have a high Tax Revenue (% of GDP)
sensitivity to funding costs * Represents interest expense if total debt were priced at current levels.

European Debt Burdens

Greece Italy Ireland Portugal Spain Belgium US Japan

GDP € 233,046 € 1,520,870 € 159,646 € 168,046 € 1,053,914 € 339,162 $ 14,119,000 $ 5,069
Debt € 293,755 € 1,557,670 € 94,975 € 137,696 € 607,956 € 310,873 $ 8,890,643 $ 10,458
Average Rate Debt Burden % GDP 14.44% 4.19% 4.92% 5.23% 2.58% 3.19% 1.39% 1.40%
Stressed Scenario 12.46% 10.13% 5.88% 8.10% 5.70% 9.06% 3.15% 8.25%
As of 1/4/2011, Stressed Scenario: +700 over current bunds for Euro Periphery, 5% for US, and 4% for Japan

Source: Eurostat; World Bank; Bloomberg; Knight Research

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 Growth Projections Seem Predicated on Fiscal
Responsibility Not Being Contractionary

Economic Growth Forecasts (YoY, % change)

Difference fro m
Octo ber 2010 WEO
P ro jectio ns P ro jectio ns

2009 2 0 10 2 0 11 2 0 12 2 0 11 2 0 12

United States –2.6 2.8 3.0 2.7 0.7 –0.3

Germany –4.7 3.6 2.2 2.0 0.2 0.0
France –2.5 1.6 1.6 1.8 0.0 0.0
Italy –5.0 1.0 1.0 1.3 0.0 –0.1
Spain –3.7 –0.2 0.6 1.5 –0.1 –0.3
Japan –6.3 4.3 1.6 1.8 0.1 –0.2
United Kingdom –4.9 1.7 2.0 2.3 0.0 0.0
Canada –2.5 2.9 2.3 2.7 –0.4 0.0

Source: WEO Update, January 2011; Knight Research

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 EFSF – CDO Solution, Quasi-Treasury, or Debt Spiral?
Difficult
Drawdown of
Funding
EFSF • IMF/Int’l Loans
Environment
• Domestic Bank
Senior Deposits

More Difficult
• EFSF Loans
Market for
Less EFSF • Sovereign Bonds
Funding
Sovereign
Available
Issuance

• Bank Capital
Borrowings
• Offshore Bank
Junior Deposits
New More
Hierarchy of IMF/Int’l
Debt Involvement

Expansion to Bond Purchases Raises More Questions than Answers:

• Price sensitivity of sellers
• Potential sellers considering price sensitivity
• Voters realize this is debt transfer/subsidization
• Direct issuance an ever clearer signal to voters
• Legal and ratings issues
• <€440B available versus >€3.2T periphery debt load (treasury level only)

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 Advanced Economies’ Projected Path is Unsustainable
General Government Net Debt Scenario Under 2010 Policies
(In percent of GDP)

Source: IMF
•Public debt has increased to unprecedented levels, rising from a postwar low of 34% in 1974 to a projected record high of 110%
by YE2010
•Unprecedented adjustments are required across the G-7
•The status quo is not an option

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 Unprecedented Fiscal Imbalance Creates Policy Conundrum

Indebted Countries’ Contribution to World GDP • Nearly a dozen countries require fiscal
16% adjustments, representing approximately
54% of global GDP.
Bubble size indicates
14% magnitude of GDP
contribution
Required Adjustment Between 2010

• Policies that promote near term economic

12%
growth are mutually exclusive to policies
that are fiscally responsible.
and 2020 *

10%

8% • Policy choices are affected by election

cycles.
6%

• This elevates monetary, fiscal and

4%
2000
4000
6000
010000
8000
12000
14000
16000
18000
20000
22000
24000
26000
28000
30000
32000
34000
36000
38000
40000
42000
44000
46000
48000
50000
52000
54000
56000
58000
60000
62000
64000
66000
68000
70000
72000
74000
76000
78000
80000
82000
84000
86000
88000
90000
92000
94000
96000
100000
98000
102000
104000
106000
108000
110000
112000
114000
116000
118000
120000
122000
124000
126000
128000
130000
132000
134000
136000
138000
140000
142000
144000
146000
148000
150000
152000
154000
156000
158000
160000
162000
164000
166000
168000
170000
172000
174000
176000
178000
180000
182000
184000
186000
188000
190000
192000
194000
196000
198000
200000
202000
204000
206000
208000
210000
212000
214000
216000
218000
220000
regulatory policy risk to new levels, which
Greece Ireland
Japan United States in turn affects economic growth prospects.
United Kingdom Spain
Portugal France
Belgium Austria
Netherlands

* Reflects fiscal adjustment needed to reduce a country’s debt/GDP

2009 Gross domestic product in constant 2000 U.S. dollars Sources: IMF; WEO; WDI
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 Die Deutsche Frage – A Difficult Balancing Act

European Banking Exposure to GIIPS nations (% of Common Tier 1 Capital)

350%

300%
(% of Tier 1 Common Capital)

German Banks
250%
Exposure to GIIPS

200% French Banks

150%

U.K. Banks Spanish Banks

100%

50%
Italian Banks
0%
0.5 0.7 0.9 1.1 1.3 1.5 1.7

Core ROA

Sources: BIS; SNL; Knight Research

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 March Madness - Political Risk Is High and Rising
• Funny thing about democracies is the feedback loop
between electorates and national policy
• Policy risk remains tethered to national, and even
regional political risk across the European Union
– Higher risk within coalition governments
– Breakdown of coalition (i.e. Ireland) can lead
to snap elections and uncertainty around
policy action
• Two primary sources of political risk as it relates to the
Euro sovereign crisis
– Stressed states (periphery Europe) lose the
electoral support to carry out reforms, trim
deficits, and curtail debt
– Core Europe or payer states (e.g. Germany)
lose electoral support to bail out Peripheral
Europe or debtor states
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Eurozone Political Sound Bites:
“We believe that Ireland may be left with no option, in
the absence of a renegotiated deal, but to write down
the value of the bonds in the Irish banks or face the
prospect of a hugely damaging sovereign default”
Fine Gael, Irish Opposition Party, February 2, 2011
“62% of [German] voters oppose further bail-outs of
weak euro members….”
The Economist, January 13, 2010
“49% of Germans would like to have a return of the D
Mark”
YouGov Insitute, December 26, 2010
It may be “useful for the €440 billion European
Financial Stability Facility to buy government bonds”
Jean-Claude Trichet, January 26, 2011
13
 March Madness – German Regional Elections Will Signal
Voter Sentiment Toward Bailouts •German federal election in 2013
•Irish national election on February 25,
2011
•First national election spawned by
crisis
•Fine Gael positioned to form
coalition government with Labour
•Election one year ahead of
requirement
•Spanish national election due in March
2012
•13 autonomous regions hold
elections in 2011
•Portugal national election late 2013
•Italian national elections due in April 2013
•Early election could materialize in
Spring 2011
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•7 regional elections in 2011
•Four elections in February and
March
•In 3 of those elections the CDU
(Angela Merkel’s party) is in the
ruling coalition
•Losses in the states will reduce the
ruling parties’ representation in the
Bundesrat, the upper house at the
national level
•French national election June 2012
•Greece national election due in 2013
Image Courtesy of www.expansys-usa.com
14
 March Madness – Debt Maturities Heavily Loaded in March

2011 Total Eurozone Monthly Debt Maturities: Sovereign and Financial (€, MMs)
350,000
Sovereign Debt Financial Sector Debt
300,000

250,000

200,000

150,000

100,000

50,000

0
J F M A M J J A S O N D

- Irish National Election - German Regional Election

- German Regional Election - Spanish Regional Election - 2 German Regional Elections

- 3 German Regional Elections

Source: Bloomberg; Knight Research
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 Risk Premiums

Italian Sovereign vs. Financials (5Y CDS) Spanish Sovereign vs. Financials (5Y CDS)
300 400
350
250
300
200 250
150 200
150
100
Italian Sovereign 100 Spanish Sovereign
50 UniCredit Santander
50
Intesa Sanpaolo BBVA
0 0
Feb-10 May-10 Aug-10 Nov-10 Feb-10 May-10 Aug-10 Nov-10

Portuguese Sovereign vs. Financials (5Y CDS) Irish Sovereign vs. Financials (5Y CDS)
1000 1400
Poturguese Sovereign Irish Sovereign
900
Banco Espirito Santo 1200 Bank of Ireland
800
700 BCP 1000 AIB
600 800
500
400 600
300 400
200
100 200
0 0
Feb-10 May-10 Aug-10 Nov-10 Feb-10 May-10 Aug-10 Nov-10

Source: Bloomberg; Knight Research

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 Volatility in Non-Externally Supported Nations
France (Deviations from 2Y Mean) Germany (Deviations from 2Y Mean)

Bearish Bullish Bearish Bullish

BNP Paribas Commerz Bank
Societe Generale
Deutsche Bank
Credit Agricole

French Sovereign/ CAC 40 German Sovereign/ DAX

3 2 1 0 1 2 3 3 2 1 0 1 2 3
Standard Deviations Standard Deviations

U.K. (Deviations from 2Y Mean) Japan (Deviations from 2Y Mean)

Bearish Bullish Bearish Bullish

HSBC Nomura Holdings
Standard Chartered
Lloyds Sumitomo Mitsui
Barclays
Japanese Sovereign/ Nikkei-225
U.K. Sovereign/ FTSE 100
3 2 1 0 1 2 3 3 2 1 0 1 2 3
Standard Deviations Standard Deviations

U.S. (Deviations from 2Y Mean)

Bearish Bullish
KBW Bank Index
Equity Wells Fargo
CDS JPMorgan
Citigroup
Bank of America
U.S. Sovereign/ S&P 500
3 2 1 0 1 2 3
Standard Deviations Source: Bloomberg; Knight Research
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 Volatility in Externally Supported Nations
Italy (Deviations from 2Y Mean) Spain (Deviations from 2Y Mean)

Bearish Bullish Bearish Bullish

Intesa Sanpaolo BBVA

UniCredit Santander

Italian Sovereign/ FTSE MIB Spanish Sovereign/ IBEX 35

3 2 1 0 1 2 3 Equity 3 2 1 0 1 2 3 Equity
Standard Deviations CDS Standard Deviations CDS

Portugal (Deviations from 2Y Mean) Ireland (Deviations from 2Y Mean)

Bearish Bullish Bearish Bullish

BCP AIB

Banco Espirito Santo Bank of Ireland

Portuguese Sovereign/ PSI-20 Irish Sovereign/ ISEQ

3 2 1 0 1 2 3 Equity 3 2 1 0 1 2 3 Equity
Standard Deviations CDS Standard Deviations CDS
Source: Bloomberg; Knight Research
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 Total Divergence
Equity/ CDS Differential by Standard Deviation (2Y Mean Basis)
U.S. Sovereign/ S&P 500
German Sovereign/ DAX
French Sovereign/ CAC 40
Sovereigns/ Irish Sovereign/ ISEQ
Equity Market Portuguese Sovereign/ PSI-20
Index Japanese Sovereign/ Nikkei-225
Italian Sovereign/ FTSE MIB
Spanish Sovereign/ IBEX 35
U.K. Sovereign/ FTSE 100

Commerz Bank
AIB
Societe Generale
Bank of Ireland
Intesa Sanpaolo
BNP Paribas
Santander
Lloyds
UniCredit
Nomura Holdings
BBVA
Banks
Credit Agricole
HSBC
Wells Fargo
BCP
Banco Espirito Santo
Citigroup
JPMorgan
Barclays
Standard Chartered
Deutsche Bank
Bank of America
Sumitomo Mitsui

Source: Bloomberg; Knight Research 0 0.5 1 1.5 2 2.5 3

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 Key Takeaways
• Primary catalytic events revolve around two key themes
– Slippage on fiscal reform in the GIIPS
– Popular (read voter) revolt in both the adjusting countries (e.g. GIIPS) and/or the
paying countries (e.g. Germany)

• Volatility should remain a defining market characteristic in the coming year

as policy action attempts to simultaneously address
– A sluggish economic recovery
– High unemployment
– Record levels of fiscal imbalance

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 Notes
• Notes to Slide 10, “Advanced Economies’ Projected Path is Unsustainable”: Weighted average by PPP-
GDP. The debt scenario assumes that the cyclically adjusted primary balance, corrected for fiscal
stimulus measures, remains constant at the 2010 level (in percent of GDP). Nominal GDP is assumed
to grow by 3 percent per year. The interest rate–growth differential (r-g) is assumed to equal zero until
2014 and 1 percentage point afterwards. Moreover, the scenario accounts for the estimated increase in
aging-related spending.
• Note to Slide 11, “Unprecedented Fiscal Imbalance Creates Policy Conundrum”: Countries included
need at least a 5% change in fiscal policy to bring debt/GDP to 60%. Diagram excludes Cyprus, which
also requires a fiscal adjustment greater than 5% of GDP.

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 Acknowledgements
• Slide 10, “Advanced Economies’ Projected Path is Unsustainable”: Graph entitled “General Government Net
Debt Scenario Under 2010 Policies” from IMF Staff Position Note: “Long-Term Trends in Public Finances in the
G-7 Economies” by Carlo Cottarelli and Andrea Scheachter, September 2010.

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 Appendix A: Disclosures
Data as of February 4, 2011
DISCLOSURE STATEMENT: This information and opinions in this report have been prepared by Knight Capital Americas, L.P. and may be distributed by
Knight Capital Americas, L.P. or its affiliates (collectively, “Knight”). Any recommendation contained in this report may not be suitable for all investors.
Moreover, although the information contained herein has been obtained from sources believed to be reliable, its accuracy and completeness cannot be
guaranteed. Knight has no obligation to tell you when opinions or information in the report change.

Analyst Certification
I, Brian Yelvington, hereby certify that (1) the views expressed in this report accurately reflect our personal views about the subject issuers and the
securities of those issuers and (2) that no compensation, direct or indirect, is related to providing a specific recommendation or view in this report.
I, Charles Mounts, hereby certify that (1) the views expressed in this report accurately reflect our personal views about the subject issuers and the
securities of those issuers and (2) that no compensation, direct or indirect, is related to providing a specific recommendation or view in this report.

Important Disclosures
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total revenue of Knight, a portion of which is generated by investment banking business. They do not receive compensation from any specific
investment banking transaction.

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 Appendix A: Disclosures (cont’d)
Knight Research Disclosure for United Kingdom and European Union
This report is approved for distribution in any European Union jurisdiction by Knight Capital Europe Limited (KCEL) and is only suitable for an investment
firm or investment professional. KCEL does not itself act as a market maker in any of the securities discussed in this report. Research analysts
employed by Knight Capital Americas, L.P. who wrote or who were involved in writing this report are not compensated by KCEL.
Knight Capital Europe Limited is Authorised and Regulated by the Financial Services Authority and a member of the London Stock Exchange.
Registered Address: City Place House, 55 Basinghall Street, London, EC2V 5DU United Kingdom.
Other Disclosures
This “Catalyst Calendar: a Sovereign Roadmap” is as of February 7, 2011.
This research presentation was prepared for the institutional clients of Knight. This presentation was not prepared for any individual client or prospective
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