Investment Research — General Market Conditions

23 July 2010

Weekly Credit Update

Summary
iTraxx Europe (5Y CDS)
 Limited activity in the credit markets 250
bp

 Moody’s harsh on Danish subordinated debt 200

 EU stress tests to be published tonight 150

100

Market comment
50

With most retail and institutional investors on holiday, not much has happened during the
0
past week. CDS indices have traded sideways during the past week but today markets jul-07 jan-08 jul-08 jan-09 jul-09 jan-10 jul-10

have started with a positive tone. The iTraxx Main investment grade index is currently Source: Markit

trading a bit tighter than last week (2bp) at 113bp while the crossover index is trading at
509bp (some 15bp tighter than last week). All eyes are now on the release later today of
the bank stress tests (see below). The results will probably get more attention than they iTraxx Crossover (5Y CDS)
1.400
deserve. bp

1.200

Primary activity is lacklustre. BBVA reopened the Spanish covered bond issuance by 1.000

offering a Jumbo EUR2bn issue. But everything comes at a price, and BBVA had to pay 800

record high ASW +195bp for a 3Y note. In the senior unsecured space, issuance has been 600

very modest. With limited primary issuance, street generally being low on inventory and 400

more corporates beating expectations than not, cash spreads in the secondary markets 200

have tightened (IBOXX Non-Financial index has tightened 7bp to 111bp and IBOXX 0
jul-07 jan-08 jul-08 jan-09 jul-09 jan-10 jul-10
Financial index has tightened 9bp to 209).
Source: Markit
Moody’s harsh on Danish subordinated debt
On Tuesday, Moody’s downgraded a structured security (a CDO) referencing junior
subordinated loans to Danish commercial and savings banks named Scandinotes V. While
that may be of limited interest to most readers, it is more interesting that Moody’s stated:
“The deterioration of the portfolio (CDO) has been driven by the negative performance of
the Danish Banking Sector in the context of the global financial crisis. In response to the
financial crisis, the Danish government created two bank packages that have been
providing support to the banks. Bank Package I is due to expire on 30 September 2010,
which Moody’s expects will have a negative impact for Danish banks, in particular for
weaker institutions which may see some depositors withdraw their funds in favour of
stronger banks. Whilst this may be mitigated by Bank Package II, which offers
government guarantees on senior debt for up to three years, the subordinated debt of
Danish banks remains likely to suffer large losses in the event of insolvency.”

A harsh tone from Moody’s.

Chief Analyst
Thomas Hovard
+45 25424209
thomas.hovard@danskebank.dk

www.danskeresearch.com
Weekly Credit Update

Upcoming EU bank stress tests

Later today at 18:00 the long-awaited results of the EU bank stress tests will be released
by the Committee of European Banking Supervisors (CEBS) both on an aggregated and
bank-by-bank basis.

The motivation behind the bank stress tests is simple. Investors are worried about bank
capitalisations and bank robustness in case of either another European recession or a
further escalation of the sovereign debt crisis or perhaps more likely, the two combined.
The key to success, in our view, is that the set of stress scenarios is realistic in the eyes of
investors and that a credible plan for increasing capital in failed banks is put forward as
well.

Achieving these outcomes is probably easier said than done. From the media we have
heard about sovereign haircuts in the PIIGS in the range between 17-23% in Greece, 8%
in Portugal and Ireland, and 5% in Spain and Italy. Further, it appears that only holdings
in trading books will be stressed and not holdings in “hold to maturity” portfolios.

Should recapitalisation for failing banks be needed, most governments will be able to
finance this on their own. Yet, for some of the weaker countries, this might not be a
possibility and perhaps alternative financing will be available through the European
Financial Stability Facility (EFSF). However, at the time of writing, it is very unclear
how the details of this would work. Given that the IMF is involved in the EFSF, a
capitalisation by the EFSF would probably require a high degree of conditionality from
the IMF’s side.

The market impact by the release of EU bank stress tests is more or less completely
dependent on how investors perceive the stress scenarios as tough enough (we are not that
optimistic on the strictness of the tests). If too few banks fail the tests, it will be a credit
non-event or investors may react negatively and risky assets should underperform. It is
not just a question of how many banks fail the tests. It is more importantly that the level
of disclosure is appropriate. More details mean higher likelihood of success.

Further, if a country has an over-representation of failed banks, this will increase the
likelihood of government recapitalisation of banks, which will hamper government
budgets, increase debt ratios and increase supply pressure.

2| 23 July 2010
www.danskeresearch.com
Weekly Credit Update

US investment grade CDS index (CDX) Merrill Lynch US & European high yield cash indices

Source: Ecowin Pro Source: Ecowin Pro

US cash indices 3M LIBOR-OIS spread

Source: Ecowin Pro Source: Ecowin Pro

Nordic banks 5Y CDS spreads Slope of US credit curves (2Y spread – 10Y spread)

300 bp

250

200

150

100

50

0
jul-09 sep-09 nov-09 jan-10 mar-10 maj-10

Danske Bank Nordea DnB NOR

SEB Handelsbanken Swedbank

Source: Danske Markets Source: Ecowin Pro

3| 23 July 2010
www.danskeresearch.com
Weekly Credit Update

Fixed Income Credit Research

Head of Credit Research

Thomas Hovard
+45 45 12 85 05
thomas.hovard

TMT, Utilities & Energy Financials & Strategy Pulp & Paper Industrials

Jakob Magnussen Thomas Hovard Peter Tind Larsen Peter Tind Larsen
+45 45 12 85 03 +45 45 12 85 05 +45 45 12 85 08 +45 45 12 85 08
jakob.magnussen thomas.hovard peter.tind.larsen peter.tind.larsen

Nadia Bendriss Henrik Arnt Asbjørn P. Andersen

+47 8540 7067 +45 45 12 85 04 +45 45 14 88 86
nab@fokus.no henrik.arnt asbjorn.andersen

Nadia Bendriss
+47 8540 7067
nab@fokus.no

email addresses end @danskebank.com

4| 23 July 2010
www.danskeresearch.com
Weekly Credit Update

Disclosure
This research report has been prepared by Danske Research, which is part of Danske Markets, a division of
Danske Bank. Danske Bank is under supervision by the Danish Financial Supervisory Authority. The author of
this research report is Thomas Hovard, Chief Analyst.

Danske Bank research reports are prepared in accordance with the Danish Society of Investment Professionals’
Ethical rules and the Recommendations of the Danish Securities Dealers Association.

Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high
quality research based on research objectivity and independence. These procedures are documented in the Danske
Bank Research Policy. Employees within the Danske Bank Research Departments have been instructed that any
request that might impair the objectivity and independence of research shall be referred to Research Management
and to the Compliance Officer. Danske Bank Research departments are organised independently from and do not
report to other Danske Bank business areas. Research analysts are remunerated in part based on the over-all
profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other
remuneration linked to specific corporate finance or debt capital transactions.

The Equity and Corporate Bonds analysts of Danske Bank and undertakings with which the Equity and Corporate
Bonds analysts have close links are not permitted to invest in securities within the research sector to which the
securities covered by the relevant Equity or Corporate Bonds analyst relate.

Danske Bank is a market maker and may as such hold positions in the financial instruments mentioned in this
research report.

Please go to www.danskebank.com/Research for further disclosures and information.

Disclaimer
This publication has been prepared by Danske Markets for information purposes only. It has been prepared
independently, solely from publicly available information and does not take into account the views of Danske
Bank’s internal credit department. It is not an offer or solicitation of any offer to purchase or sell any financial
instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no
representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from
reliance on it. Danske Bank, its affiliates or staff may perform services for, solicit business from, hold long or
short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned
herein. The Equity and Corporate Bonds analysts are not permitted to invest in securities under coverage in their
research sector. This publication is not intended for retail customers in the UK or any person in the US. Danske
Markets is a division of Danske Bank A/S. Danske Bank A/S is authorized by the Danish Financial Supervisory
Authority and is subject to provisions of relevant regulators in all other jurisdictions where Danske Bank A/S
conducts operations. Moreover Danske Bank A/S is subject to limited regulation by the Financial Services
Authority (UK). Details on the extent of our regulation by the Financial Services Authority are available from us
on request. Copyright (C) Danske Bank A/S. All rights reserved. This publication is protected by copyright and
may not be reproduced in whole or in part without permission.

This publication has been prepared by the correspondent of Auerbach Grayson & Company Incorporated
(“AGC”) named above on the date listed above.

We are distributing this publication in the U.S. and any U.S. person receiving this report and wishing to effect
transactions in any security discussed herein, should do so only with a representative of Auerbach Grayson &
Company Incorporated. Additional information on recommended securities is available on request.

5| 23 July 2010
www.danskeresearch.com