SVB Asset Management Economic ReportThird Quarter 2012
2
Table of Contents Thoughts from our CIO pg 3
Overview pg 4
GDP pg 5
Employment pg 6
The Housing Market pg 8
Consumption pg 10
Inflation pg 12
Consumer Credit pg 14
Monetary Policy pg 15
Fiscal Cliff pg 17
Investment Performance pg 18
Yields pg 19
Banking Sector pg 20
Industrial Sector pg 23
Public Debt pg 24
Global GDP pg 25
Euro Zone Debt Crisis pg 26
Central Banks pg 32
FX pg 33
FDIC Insurance pg 34
Regulatory Environment pg 35
Thoughts from our CIO pg 3
Overview pg 4
GDP pg 5
Employment pg 6
The Housing Market pg 8
Consumption pg 10
Inflation pg12
Consumer Credit pg 14
Monetary Policy pg 15
Fiscal Cliff pg 17
Investment Performance pg 18
Yields pg 19
BankingSector pg20
IndustrialSector pg23
PublicDebt pg24
GlobalGDP pg25
EuroZoneDebtCrisis pg26
CentralBanks pg32
FX pg 33
FDIC Insurance pg 34
Regulatory Environment pg 35
3
Thoughts from our CIO Green 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 then the 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 have dubbed 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 dropped below 8 percent, employment growth has remained steady, home prices seem to have stabilized recently, and corporate cash stockpiles have grown, providing potential 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 using communication — one of the Fed’s time-honored tools — in attempt to manage the economy. In 2009, market participants were in desperate need of confidence and 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 and amount 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
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.
5
GDP Struggling to Pick-Up GDP1
Source: 1Bloomberg, SVB Asset Management,2BEA,3.CBO Note: 1GDP values shown in legend are % change vs. prior quarter annualized.
Components of GDP2 Gross Domestic Investment3
• Chairman Bernanke’s September 13 FOMC statement was intended to propel growth by keeping rates low through mid- 2015 if necessary and initiating a monthly program to purchase mortgage-backed securities for an unlimited period
• Corporate sector has been hesitant to spend given uncertainties regarding the fiscal cliff and the implication to taxes and government spending cuts
• Domestic business has shown improvement while international business remains weak
-10.0% -8.0% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0%
10.0%
$0.0
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
Trill
ions
Domestic business Households and institutions Federal State and local
-50.0%
0.0%
50.0%
100.0%
150.0%
Consumption Government spending Investment ex-housing Residential Net exports
6
Employment Need for Consistency Employment Landscape1
Source: 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 and have looked for work sometime in the past 12 months.
Full-Time Employment2
Long Term Unemployment3
• The unemployment rate dropped to 7.8% in September, the lowest rate since President Obama took office
• 582K more people are working part-time rather than full-time, the highest level seen since February 2009
• More people decided to move from full-time to part-time 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
-15.0%
-5.0%
5.0%
15.0%
-1,000.0
-500.0
0.0
500.0
1,000.0
Thou
sand
s
Non-Farm Payroll (LHS) Unemployment Rate (RHS) U-6 (RHS)
0.0
5,000.0
10,000.0
100,000.0 105,000.0 110,000.0 115,000.0 120,000.0 125,000.0
Thou
sand
s
Thou
sand
s
Full Time Employment (LHS) Part Time for Economic Reasons (RHS)
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
Recession Period Unemployed 27 Weeks and Over
7
Employment Need for Consistency Labor Productivity - Output per Hour
Source: Bloomberg, SVB Asset Management.
Wages & U.S. Average Weekly Hours
Initial Jobless Claims
• Productivity rebounded robustly in Q2 following a slowdown. A global slowdown prompted employers to operate more efficiently
• Wage growth has been flat. We need to see improvement in order to drive consumption component of GDP
• Initial claims and continuing claims have experienced very slow improvement and illustrate the long-term challenge facing job growth
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
33.0
33.5
34.0
34.5
35.0
-4.0%
-2.0%
0.0%
2.0%
4.0%
Hou
rs
Wages U.S .Average Weekly Hours All employees
0.0
2,000.0
4,000.0
6,000.0
8,000.0
-100.0
100.0
300.0
500.0
700.0
Thou
sand
s
Thou
sand
s
Initial Claims Continuing Claims
8
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0
3.0 4.0 5.0 6.0 7.0 8.0 9.0
Hom
e S
uppl
y (m
onth
s)
Hom
e S
ales
(Mill
ions
) The Housing Market Gaining Traction Home Sales & Supply
Source: Bloomberg, SVB Asset Management.
Housing Starts Home Prices - Indexed to 100
• The Fed’s open-ended policy to buy mortgage securities should further anchor mortgage rates, thus lifting affordability
• Purchases continue to show signs of improvement although, more importantly, home price stability could spur consumer confidence
• Foreclosures have slowed this year due to processing challenges and unsolved Attorney General settlements
0.0
0.5
1.0
1.5
2.0
2.5
Mill
ions
Existing Home Supply Total Sales (new & existing)
90
110
130
150
170
Case Shiller 20-City FHFA Purchase Median Home Price
9
The Housing Market Gaining Traction Homeownership Rate
Source: Bloomberg, SVB Asset Management.
Housing Affordability Composite Index
Home Foreclosures - % of Total Loans
• Homeownership has continued to trend down and has remained at 65.6% for the past two quarters
• Historically low mortgage rates have been driving record-high housing affordability numbers, which indicates that a family earning the median income is more likely to be able to afford the median-priced house
• Home foreclosures remain high; however ,we have not seen much effect from the shadow inventory of foreclosures filtering through the system
62.0% 63.0% 64.0% 65.0% 66.0% 67.0% 68.0% 69.0% 70.0%
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0%
0.0
50.0
100.0
150.0
200.0
Mor
tgag
e R
ates
Affo
rdab
ility
Inde
x
30 Year Mortgage Rates Affordability Index
0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0%
10
Consumption Glass Half Full Consumer Sentiment - University of Michigan
Source: Bloomberg, SVB Asset Management
Retail & Food Services Sales Personal Consumption - % Change
• Consumer confidence indicators have been mixed, with the University of Michigan indicator showing some improvement in September. The index rose to 78.3, but is still below the 30-year average
• Retail sales have risen due to strong demand for automobiles. Sales at retailers have been sluggish in recent months
• Personal consumption slowed to 1.5% in the second quarter compared to 2.4% in the first quarter
40.0 50.0 60.0 70.0 80.0 90.0
100.0 110.0 120.0
Average
-6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0%
Vehicle Sales Ex Autos
$5.0
$10.0
$15.0
$20.0
$25.0
$250.0
$300.0
$350.0
$400.0
$450.0
Vehi
cle
Sal
es (M
illio
ns)
Ret
ail &
Foo
d S
ervi
ces
Sal
es (B
illio
ns)
11
Consumption Glass Half Full Personal Savings as a % of Disposable Income
Source: Bloomberg, SVB Asset Management.
Personal Income
Household Debt Payments vs. Debt Outstanding
• Personal incomes have not rebounded, creating a squeeze on consumers’ wallets as commodity prices rise
• This squeeze hampers the ability to save, as evidenced by a declining savings rate
• Consumer credit outstanding unexpectedly fell for the first time in almost 12 months driven by a decline in credit card spending. Non-revolving debt , including student and auto loans, was not as robust as we’ve seen in prior quarters
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
-1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5%
Mon
thly
Per
cent
age
Cha
nge
Debt Outstanding Debt Service Payments
-5.0%
0.0%
5.0%
10.0%
15.0%
8.0%
11.0%
14.0%
17.0%
12
Inflation Within the Boundaries Component Distribution 2012
Source: Bloomberg, SVB Asset Management.
Core PCE
Consumer Price Index Producer Price Index
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
% c
hang
e fro
m p
rior y
ear
Fed Target
-5.0%
0.0%
5.0%
10.0%
15.0%
% c
hang
e fro
m p
rior y
ear
CPI Ex Food & Energy CPI
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
% c
hang
e fro
m p
rior y
ear
PPI Ex Food & Energy PPI
41.0%
17.2%
15.2%
7.3%
6.9%
6.0% 2.9% 3.5%
Housing
Transportation
Food & Beverages
Medical Care
Education & Communication
Recreation
Apparel less footwear
Other Goods & Services
CPI Components 12-month Change Food & Bev. 3.8% Housing 1.8% Apparel 4.2% Transportation 5.6% Medical Care 3.4% Recreation 1.0% Educ. & Comm. 1.9% Other 1.5% Headline CPI 2.9% Less:
Energy 7.0% Food 3.9%
Core CPI 2.2%
13
Inflation Within the Boundaries Wage Growth: Average Hourly Earnings
Source: Bloomberg, SVB Asset Management.
Crude Oil - Spot & Futures
Univ. of Michigan Survey of Inflation Expectations
• Traditional measures point to inflationary pressures being under control and effects from rising commodity prices are expected to be only transitory (according to the Fed)
• Wage growth is needed to spur inflation and we are not seeing that yet
• The Fed continues to state that longer-term inflation expectations remain stable, even as key commodity prices rise
$0.0
$40.0
$80.0
$120.0
$160.0
Pric
e pe
r bar
rel
1.5%
2.5%
3.5%
4.5%
5.5%
1 Year Ahead 5-10 Year Ahead
Futures Price Spot Price
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
Ann
ual p
erce
ntag
e ch
ange
14
Consumer Credit Shift to Education
Student loan debt is rising at a time when other debt is flat or even declining. From Q4 2011 to Q2 2012, the nation’s loan balance grew 4.6%, from $874 billion to $914 billion. The College Cost Reduction and Access Act, a measure from 2007 that, among other things, lowered the interest rate on federal student loans from 6.8% to 3.4%, was extended at the end of June. The House and Senate bills will both increase direct spending for student loans by more than $6 billion over the 2012–2022 period. Nearly all of the outlays will occur in 2012 and 2013.
Source: Bloomberg.
Debt Balance
Bill
ions
$0.0
$500.0
$1,000.0
$1,500.0
$2,000.0
$2,500.0
Auto Loan Credit Card Student Loan
15
Monetary Policy Stimulus Timeline
Source: Federal Reserve, FOMC, FDIC, Treasury.gov
Financial Crises and Timeline
Deliberate efforts to stimulate the U.S. economy through government fiscal policy have been a formal part of the political economy for more than eighty years.
Timeline
Sep-08
The Fed continued to reinvest payments on securities purchased
during the QE1 program. In addition, it began the purchase of $600 billion of longer-term Treasury
securities.
Enacted the Emergency Economic Stabilization Act of 2008 authorizing the U.S Secretary of the Treasury to spend up to $700 billion to purchase
mortgage-backed securities (MBS).
As part of the Helping Families Save Their Homes Act, Congress approved a permanent increase of the FDIC's line of credit with the Treasury from $30 billion to $100 billion. In addition, the bill allows the FDIC to draw up to $500 billion until Dec-10 if allowed by FDIC Chairman, Fed Chairman, and Secretary of the
Treasury.
The quantitative easing program
(QE1), concluded in Q1 2010, with a total
of $1.25 trillion in purchases of MBS and $175 billion of
agency debt purchases.
The Fed Reserve
announced QE3 to aid U.S.
recovery, entails buying $40
billion in MBS each month.
U.S. President Barack Obama
signed 2010 Tax Bill Into Law – Tax
Cuts Extended Until 2012.
The U.S. Treasury seized control of mortgage giants
Fannie Mae and Freddie Mac and pledged a $200 billion
cash injection The government bailed out
AIG, with $85 billion.
U.S. President Barack Obama signed $787
billion stimulus package, entitled the American
Recovery and Reinvestment Act (ARRA) of 2009.
The FDIC adopted a rule that requires banks to pay
at the end of 2009 the amount they would owe the
FDIC for insurance premiums over the next
three years.
The FOMC announced an extension to the Twist program by adding $267
billion, thereby extending it throughout
2012.
As previously announced, the Fed concluded its $600B bond
purchasing program. QE2 was conducted at an even
pace, and the end date was telegraphed from the start of the
program.
The FOMC announced the implementation of
Operation Twist, a plan to purchase $400 billion of bonds with maturities of
six to 30 years and to sell bonds with maturities less
than three years.
Feb-09 Nov-09 Dec-10 Jun-11 Jun-12
Oct-08 May-09 Mar-10 Mar-11 Sep-11 Sep-12
16
Monetary Policy Continuous Stimulus
The Fed in September 2012 announced that it would buy $40 billion a month in mortgage-backed securities for the foreseeable future. The plan has been dubbed Q.E. 3.0 since it is the central bank's third round of quantitative easing. The Fed hopes that by pumping money into the economy, thereby lowering mortgage rates, Q.E. 3.0 could lead to an increase in consumer spending and more hiring by businesses. This program could last until the middle of 2015 and eventually reach $2 trillion, including the buying of long-term Treasuries planned by the Fed under an extension of "Operation Twist.”
Source: Federal Reserve
Timing of Monetary Policy
Q.E. 1.0
Q.E. 2.0
Continuous Stimulus: Operation Twist,
Extension of Operation Twist and Q.E. 3.0
0.0
500.0
1,000.0
1,500.0
2,000.0
2,500.0
3,000.0
3,500.0
4,000.0
0.0
1,500.0
3,000.0
4,500.0
6,000.0
7,500.0
9,000.0
10,500.0
12,000.0
13,500.0
15,000.0
Monetary Policy Dow Jones (LHS) S&P 500 (RHS) Nasdaq (RHS)
17
Fiscal Cliff Deeper Dive
The Congressional Budget Office projects that under current law a sharp reduction in the federal budget deficit between 2012 and 2013 will cause the economy to contract. But this will also put federal debt on a path more likely to be sustainable over time. To illustrate the effects of fiscal tightening, CBO compared its projections under current law (the "baseline" projections) with projections under an alternative set of policies — two scenarios in a broad spectrum of choices.
Baseline Deficit in 2013 ($641 billion)
$487 billion
Deficit in 2012: $1,128 billion
Reduction in the Deficit in 2013 compared with 2012
Baseline Deficit in 2013
Extend Tax Cuts*
Prevent Spending Cuts*
US$1,037 billion
$91 billion
Deficit in 2012: $1,128 billion
The Economy in 2013
Change in inflation-adjusted GDP, 4th quarter 2012 to 4th quarter 2013
Decisions for 2013
Implications for Future Policy Decisions
Allow changes scheduled under current law to occur or take other
steps to shrink the deficit from 2012 by $487 billion or more.
Shrink deficit from 2012 by less than $487 billion by extending some of the expiring tax cuts, curbing the spending cuts, or adopting
other combinations of policies.
Seek to stimulate the economy by cutting taxes, increasing spending,
or doing both, thereby running a larger deficit in 2013 than in 2012.
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 in govt. benefits and services, or both.
More Fiscal Tightening Less Fiscal Tightening
Federal Budget Deficit in 2013
-0.5% +1.7%
A Broad Spectrum of Fiscal Policy Choices
Source: CBO
The Deficit in 2013 Compared with 2012 under two scenarios
18
Investment Performance Value in the Long End
Source: Bloomberg, Bk of America/ML, Morgan Stanley.
Benchmark Performance
Ticker Q3 2012 2011 2010 2009 2008 2007Short 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.
19
Yields Longer End Tightening
Source: SVB Asset Management, Bloomberg
Yield Curve comparison Q2 versus Q3
0.0%
0.5%
1.0%
U.S. Treasury Bill /Notes (Q2) U.S. Agency DN/Bonds (Q2)
U.S. Treasury Bill /Notes (Q3) U.S. Agency DN/Bonds (Q3)
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
A-1/P-1 CP (Q2) Ind Bonds - A Rated (Q2)
Fin Bonds - A Rated (Q2) A-1/P-1 CP (Q3)
Ind Bonds - A Rated (Q3) Fin Bonds - A Rated (Q3)
20
Banking Sector Stabilizing Recovery
Source: FDIC.
FDIC Quarterly Bank Net Income / (Loss)
U.S. banks’ performance continues to stabilize and is supported by a decline in loss provisions, albeit in a persistently low interest rate environment.
-$40,000.0
-$30,000.0
-$20,000.0
-$10,000.0
$0.0
$10,000.0
$20,000.0
$30,000.0
$40,000.0
Mill
ions
21
-40.0%
-20.0%
0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
120.0%
Rel
axed
Con
serv
ativ
e
Commercial & Industrial loans Commercial Real Estate Loans
Residential Mortgage Loans Prime
Sub-Prime Non Traditional
Banking Sector Stabilizing Recovery Delinquency Rates
Source: Federal Reserve.
Lending Standards
Source: Bloomberg.
Net percent of banks reporting tighter lending standards
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
All
bank
s, s
easo
nally
adj
uste
d
Residential Consumer Loans
Commercial and Industrial Loans Commercial
22
Banking Sector On Watch
Source: S&P, Moody’s, Fitch & Bloomberg, October 3, 2012
Rating Agencies’ U.S. Financials Upgrades and Downgrades
2012 Financial sector downgrades are expected to outpace upgrades, but number of rating actions from S&P, Moody’s and Fitch should be moderate compared to 2009.
0
500
1,000
1,500
2,000
2,500
3,000
Upgrades Downgrades
23
Industrial Sector Steady Pace
Source: S&P, Moody’s, Fitch & Bloomberg, October 3, 2012
Rating Agencies’ U.S. Industrials Upgrades and Downgrades
2012 Industrial sector upgrades to remain at the same pace as downgrades, as healthy industrials face uncertain economic conditions.
0
50
100
150
200
250
300
350
400
Upgrades Downgrades
24
Government debt at the end of 2011 was above 100% of GDP in Greece, Ireland, Italy and Portugal and budget deficits have been most swollen on the southern and western rim of the euro area.
By contrast, German government debt was around 80% of GDP and its budget balance was only mildly in the red last year.
Source: Bloomberg as of October 3, 2012. Note: Bubble size represents borrowing costs.
Public Debt Watching the Bubbles Public Debt - % of GDP
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
0% 50% 100% 150% 200% 250%
GD
P Y
oY %
Debt to GDP Ratio
Greece
Italy
Portugal
Ireland Spain
U.S. Canada Australia
Germany France
U.K.
Japan
25
Global GDP Slowdown
Due to the recessionary environment, future global growth will be revised downwards for several years. Currently, the consensus scenario is still one of quite robust global growth in 2012 and even more so in 2013. The recessionary environment has not only hit the developed market, but also the developing markets. This is clearly evident from the global GDP being dragged down. However, 2012 is expected to close lower then 2011 mainly due to continued pressure on developed markets and slowing down of emerging economies (BRIC etc).
Source: Bloomberg, IMF, OECD.
Real GDP Growth - % per year
4.0% 4.0%
1.5%
-2.4%
4.0%
2.9%
5.2% 5.4%
2.8%
-0.6%
5.3%
3.9% 3.5%
4.1%
4.7% 4.5%
2.6%
-1.2%
5.1%
3.6% 3.4%
4.2%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
Actuals IMF Forecast OECD Forecast
26
Euro Zone Debt Crisis Reasons Behind the Support European Banks’ Foreign Exposure
Source: BIS
• Due to the global nature of their operations, French and German banks remain heavily exposed to credits in Greece, Ireland, Italy, Portugal and Spain
• Comparatively, U.S. banks’ exposure to the GIIPS countries is relatively lower and more manageable. This is because U.S. banks are generally more U.S.-centric compared to the French and German banks
• Similarly, Spanish banks have relatively lower foreign exposure to the GIIP countries as they are inward focused and international exposures are in Latin America and the rest of the world
• With their skin in the game, the French and German governments, through their representation in European Union and ECB, would be incentivized to continue their support for the GIIPS
$0.0
$100.0
$200.0
$300.0
$400.0
$500.0
$600.0
Bill
ions
Italy Spain Ireland Portugal Greece
27
Euro Zone Debt Crisis Lack of Unity
Source: Bloomberg ,SVB Asset Management as of October 3, 2012.
Do the Metrics Support the Ratings?
Country National Debt (billions)
Debt as a % of GDP GDP YoY % S&P Moody’s 10 -Year Yield
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%
28
$1.10
$1.15
$1.20
$1.25
$1.30
$1.35
$1.40
$1.45
Euro Zone Debt Crisis Ongoing Support
Source: CapitalIQ, SVB Asset Management , IMF, EUROPA and ECB.
Euro/USD
10/26 - Banks agree to take a 50% loss on Greek debt, and shortly after, Euro Zone agrees on a new plan for Greece
11/30 - U.S. Fed adjusts its dollar liquidity swaps making it easier for European banks to raise capital
12/21 - ECB’s first LTRO operation was a success with a record take down of €489B in three-year loans by European banks
10/10 - Franco-Belgian Bank, Dexia, is nationalized
2/29 - ECB’s second LTRO operation resulted in €529 billion in loans to 800 banks, bringing the total liquidity injection to over €1 trillion
3/02 - ECB’s balance sheet surges to a record € 3.02T after the second tranche of three-year loans
3/30 - European leaders commit to a new €500B firewall to be added to the current amount of €300B
3/14 – Euro Zone agrees to a second bailout program for Greece in the amount of €130B in conjunction with the €28B from the IMF
4/18 - Italian government cuts growth forecast for the economy in 2012 by 1.2%
4/25 - Spain's Bankia seeks a €19B bailout from the government
6/09 - Spain requests up to €100B in aid from the EU to shore up its banking sector
1/13 – S&P downgrades nine Euro Zone nations and lowers the EFSF’s credit rating days later
4/27 – Spain is downgraded to BBB+ by S&P
5/02 – Euro Zone unemployment rate rises to 10.9%, a 15-year high
6/07 – Fitch downgrades Spain three notches to BBB
6/25 – Moody’s downgrades 28 Spanish banks due to real estate exposure and Spain’s reduced creditworthiness
3/09 - Greece closes its restructuring deal with creditors and ISDA declares that it constitutes a credit event and payouts will be made to CDS holders
9/06 – ECB announced a new plan for unlimited bond purchases from Eurozone countries
07/04 - ECB lowered its main lending rate to an all-time low following a rate cut by China's central bank and additional asset purchases by the BoE
9/03 - Moody's cuts the outlook on the EU's Aaa credit rating to negative from stable
7/23 – Moody's reduces Germany's AAA rating down to 'negative
29
Euro Zone Debt Crisis Confusion Reigns
Source: SVB Asset Management , IMF, EUROPA and ECB.
European Banking Crisis Solutions
Program Target Countries Objective
EU/IMF Greece, Ireland, Portugal Provide funding assistance
European Financial Stability Facility 1 (EFSF) All Euro Zone Contingency Funding Program (€750 billion)
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 (LTRO) All Euro Zone Access to liquidity (€489 billion)
ECB Long Term Refinancing Operation (LTRO 2) All Euro Zone Access to liquidity (€529 billion)
Europeans lack a clear leader. However, the recent ECB has offered temporary liquidity relief to banking sector.
30
Euro Zone Debt Crisis The Social Cost of Admission Weekly ECB Bond Purchases
Source: Bloomberg.
• On September 6, 2012, the ECB announced a new plan for buying bonds from Euro Zone countries. If successful, the “Outright Monetary 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 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
• Markets responded positively to the ECBs announcement. Hence, analysts believe that it should be seen as progress
• 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 billion
• The ECB held monetary policy steady at 0.75%, despite downgrading their growth expectations for both 2012 and 2013
– 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
€0.0
€5.0
€10.0
€15.0
€20.0
€25.0
€0.0
€50.0
€100.0
€150.0
€200.0
€250.0
SMP Bond Purchases Per Week Cummulative Holdings
Bill
ions
Bill
ions
31
Euro Zone Debt Crisis Diverging Options
Source: Crane Data, SVB Asset Management.
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
Luxembourg
Austria
Italy
Belgium
Spain
Finland
Germany
Netherlands
France
Fund managers have largely exited out of most Euro-area countries except stable core countries such as Germany, France and Netherlands.
32
Central Banks Global Easing
Central banks have expanded from just interest rate management and have adopted new monetary “tools” to support economic growth.
Quantitative easing and asset purchases are now a global phenomenon, especially among the industrialized nations. Since the liquidity crisis, domestic and foreign central banks have built up their balance sheets in the aim of supporting its respective economies. As a result, the general borrowing cost of sovereign debt remain relatively low.
The role of the central banks have morphed from the “lender of last resort” to “buyer of last resort”.
Source: Bloomberg
Central Bank Assets1
$0.0
$500.0
$1,000.0
$1,500.0
$2,000.0
$2,500.0
$3,000.0
$3,500.0
$4,000.0
Bill
ions
European Central Bank Bank of Japan U.S. Federal Reserve
33
FX Influence of Central Banks Volatility in the Euro Persists
The resilience of the euro has been greatly dependent on the enormous operations by the European governments.
The U.S. Dollar Index Measures the General Value of the USD
The multiple monetary programs may keep the dollar pegged here for several more years.
Source: Bloomberg, SVB Asset Management .
50
60
70
80
90
100
110
120
130
€0.75
€0.85
€0.95
€1.05
€1.15
€1.25
€1.35
€1.45
€1.55
€1.65
€1.75
34
FDIC Insurance What’s Next
Source: FDIC, SVB Asset Management
$0.0
$200.0
$400.0
$600.0
$800.0
$1,000.0
$1,200.0
$1,400.0
$1,600.0
$1,800.0
Bill
ions
Distribution by Banks’ Asset Size
Accounts Greater Than $250,000
Over $100 Billion $50 - $100 Billion $10 - $50 Billion $1 - $10 Billion Less than $1 Billion
Unlimited 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.
Dodd-Frank Domestic Non-interest-Bearing Transaction Accounts
35
Regulatory Environment Rocky Road Ahead
Source: SVB Asset Management
• Amendments to SEC 2a-7 rule have been in place for more than two years now. Key changes included more restrictive maturity limits, higher credit quality standards and establishment of new daily and weekly liquidity requirements.
• The SEC failed to push through a second round of reforms in August 2012.
• In September 2012, Geithner highlighted that if SEC doesn’t take actions for further reform, FSOC may step in by designating certain funds as SIFI. Recommendation is slated to be released in November 2012.
Floating NAV by SEC
• Real-time mark to market level valuation • Most of the money fund industry is not in favor
OR
Capital Buffer and Redemption Restriction by SEC
• Cushion against liquidity and credit risk • Goal: to minimize the risk or disorderly run • Uncertain about the form or amount of buffer • Could drive further consolidation and work against the investor
objective of liquidity
OR
SIFI’s Designation by FSOC
• Inclusion of certain money funds as SIFI* • Could be subject to heightened regulation by Federal Reserve
*SIFI: Systemically Important Financial Institutions FSOC: Financial Stability Oversight Council
Potential MMF Reform Proposals as of 3Q2012
Potential Reforms can be a combination of above measures.
36
Our Team
Head of Portfolio Management Ninh Chung [email protected] Portfolio Managers Minh Trang, CFA [email protected] Paula Solanes [email protected] Renuka Kumar [email protected] Jose Sevilla [email protected]
Head of Credit Research Melina Hadiwono, CFA [email protected] Credit and Risk Sook Kuan Loh, CFA [email protected] Tim Lee, CFA [email protected] Kyle Balough [email protected]
Managing Director Jeff Schnitz [email protected] Chief Investment Officer Joe Morgan, CFA [email protected]
Our Team
SVB Asset Management 555 Mission Street, Suite 900 San Francisco, CA 94105
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©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-bank affiliate of Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value. Rev. 10.16.2012 1012-0177