Markit Credit Research

05/04/2012

Markit Sovereign Report March 2012

Greece on the backburner for now Core eurozone spreads diverging, peripherals converging Political risk will be an issue in months ahead
Overall, it was a relatively strong month for sovereign credit. Tightening names outnumbered widening credits by about three to one. Two of the best performers were Norway and Sweden, which also happen to be the two strongest sovereign credits in Europe. Apart from being in Scandinavia, the two countries also have something else important in common: they are outside the eurozone. Even the most robust credits within the currency bloc have struggled to rally in recent weeks. Take Germany, for example. Its unemployment rate fell for the fifth consecutive month in March and is now 6.7%, the lowest in the post-reunification era. It is one of the eurozones surplus countries and has no problems selling debt. Yet its spreads tightened by just 4bps, or 5%, during March. Its exposure institutional and economic - to the regions laggards has clearly placed a risk premium on the country, albeit a small one.

March 2012 will be noted in the history books as the month when the first Western European sovereign triggered a CDS credit event. Or will it? In reality, the credit event auction that settled the Greek CDS was something of a non-event; the mechanism worked according to the documentation, though the latter may need some improvement around the issue of collective action clauses. Greece is on the backburner for now but only the most optimistic would think that its troubles wont flare up again. The eurozone crisis was dormant for some time but it is certainly not dead. The other peripheral countries Spain, in particular face enormous challenges in returning to fiscal normality.

Sovereign outperformers
Top-10: best performing sovereign CDS (ranked by % change over month)
Name Norway USA Japan Vietnam Sweden Peru Dubai Abu Dhabi Colombia Saudi Arabia 5Y Change Spread 23 31 99 288 44 120 337 117 108 119 -9 -6 -17 -49 -7 -16 -46 -13 -12 -13 % Change -28% -17% -15% -15% -13% -12% -12% -10% -10% -10% Net Notional (USD) 1,148,456,849 5,081,728,185 9,965,286,701 675,128,186 2,965,342,278 1,764,552,086 514,318,652 1,382,161,869 1,602,521,363 476,050,000

Fig.1 Source: Markit But Germanys performance looks stellar in comparison to another core eurozone country: Netherlands. The two nations have always shared similar economic philosophies and have been united in castigating the more profligate members of the currency club. However, the Netherlands fiscal position has come under increasing scrutiny, and its status as a core country has even been doubted in some quarters. Its budget deficit is forecast to hit 4.6% of GDP in 2013 and its public debt rose to 65.2% in

Sources: Markit, DTCC

Markit Credit Research

2011; not quite in the same league as most of the peripherals but still bound to place pressure on its coveted AAA rating if action isnt taken. The Netherlands spreads widened by 24% over March, making it the worst performer over the month.

on spreads will continue and bailout speculation will build. The CDS differential between Spain and Ireland (a bailout recipient), at 108bps, is the lowest since September 2010.

Sovereign underperformers
Bottom-10: worst performing sovereign CDS (ranked by % change over month)
Name Netherlands Australia Spain Guatemala New Zealand Ukraine Hungary Italy Argentina South Africa 5Y Change Spread 115 74 428 207 79 859 546 389 809 160 22 12 55 26 9 101 50 30 32 6 % Change 24% 20% Net Notional (USD) 3,420,073,396 1,354,477,181

15% 14,608,858,156 14% 13% 13% 10% N/A

Fig. 2
588,206,277 840,811,255 N/A

8% 21,511,789,636 4% 4% 2,454,265,577 2,346,040,587

Sources: Markit, DTCC Netherlands aside, the table of worst performing sovereigns for March includes some more familiar names. Spain and Italy both widened significantly over the month, and the pressure mounted towards the end of the period. Spain, in fact, has been the catalyst for a reversal in sentiment that has caused risky assets to sell-off through the beginning of April. The government recently unveiled a budget that underlined how difficult it will be to get its fiscal house in order. The budget deficit was 8.5% of GDP last year; it intends to get this down to 5.3% this year and to 3% in 2013. This is a big ask given the reluctance of the regions to cut their budgets thus far. If they fail again then yet more austerity will have to be inflicted at the federal level, which any government would find difficult to implement with the unemployment rate at over 23%. A weak bond auction on April 4 demonstrated confidence is dwindling in the sovereign and further central bank liquidity measures may be needed down the line The government may find its targets are beyond its reach in an age of austerity. If so, pressure

The renewed focus on Spain has had a knock-on effect on Italy, which has its own problems. Mario Monti, the Italian prime minister, is finding it hard to push through much-needed labour market reforms. The technocratic government that Monti heads has been well-received by the markets and any development that puts its viability in question could put upward pressure on spreads. Political risk will also be a factor elsewhere in the eurozone with elections due in France and Greece over the coming weeks.

The top 10
Top 10 Sovereign CDS ranked by spread at endMarch 2012
Name Norway USA Sweden UK Finland Germany Australia New Zealand Chile Japan 5Y Change Spread 23 31 44 64 65 73 74 79 93 99 -9 -6 -7 -3 1 -4 12 9 0 -17 % Change Feb ranking

-28% 1 (0) -17% 2 (0) -13% 3 (0) -4% 6 (+2) 1% 5 (0) -5% 8 (+2) 20% 4 (-3) 13% 7 (-1) 0% 10 (+1) -15% 14 (+4)

Source: Markit
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Markit Credit Research

The top three occupy their usual slots in the table of the tightest sovereigns and all of them performed strongly over the month. The UK also rose up the table; the latest Markit PMIs indicate that the country might not be in a technical recession after all. Australia and New Zealand have dropped a few places amid speculation that the Chinese economy is heading for a hard landing. This remains an outside possibility; the government has amplef policy tools it can implement swiftly. Chinas sovereign CDS actually tightened 3% over the month, suggesting that the concerns arent serious, at least for now.

Eurozone rankings*
Name Finland Germany Estonia Netherlands Austria France Slovakia Belgium Slovenia Italy 5Y Change Spread 66 78 95 122 160 173 237 256 366 378 382 608 1075 1183 1 -8 -5 -5 -10 1 8 -22 13 -15 -5 4 -90 4 % Change Feb ranking

1% 1(0) -9% 2(0) -5% 4(+1) -4% 3(-1) -6% 5(0) 1% 6(0) 3% 8(+1) -8% 7(-1) 4% 11(+2) -4% 11(0) -1% 9(-2) 1% 12(0) -8% 13(0) 0% N/A

The bottom 10
Bottom 10 Sovereign CDS ranked by spread at end-March 2012
Name Cyprus Portugal Ukraine Argentina Venezuela Ireland Hungary Egypt Lebanon Spain 5Y Change Spread 1183 1075 859 809 712 572 546 544 459 428 4 -90 101 32 -13 -27 50 -52 -17 55 % Change 0% -8% 13% 4% -2% -5% 10% -9% -4% 15% Feb ranking

Spain N/A 2 (0) 4 (+1) 3 (-1) 5 (0) 6 (0) 8 (+1) 7 (-1) 9 (0) 16 (+6) Name France Italy Germany Brazil Ireland Portugal Cyprus

*Luxembourg and Malta rarely trade in the CDS market

CDS Liquidity
5Y % Spread Change 166 389 73 121 428 64 99 112 117 229 Net Notional (USD) % Change -2% -5% -2% -1% 1% -6% 4% 1% -3% 4%

-1% 21,993,407,004 8% 21,511,789,636 -5% 19,170,537,726 -8% 18,311,130,383 15% 14,608,858,156 -4% 11,278,794,678 -15% -3% -8% 0% 9,965,286,701 9,022,194,012 8,137,649,835 5,953,125,273

Source: Markit Cyprus enters the bottom 10 table at the top. The sovereign was thinly traded up until recently for reasons discussed in the liquidity section below. Apart from that it is the usual collection of Latin American, MENA, Eastern European and peripheral eurozone names. Spains recent deterioration has seen it enter th the table in 10 place.

Spain UK Japan China Mexico Turkey

Sources: Markit, DTCC

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Markit Credit Research

Fig. 3 It was a mixed bag in March for the top 10 CDS by net notional. Six of the names saw decreases while four saw the amounts increase. Volumes remain thin overall in the sovereign CDS market, as they do across most asset classes. Perhaps the most interesting development was the advent of Cyprus as a sovereign CDS name. It had been very thinly traded in the past, with few, if any quotes on a daily basis. But its inclusion in the Markit iTraxx SovX Western Europe Series 7 has seen a surge of interest. It now averages around 50 quotes per day, according to Markit Liquidity Metrics, and about eight dealers quote it regularly. As such it now has the highest Markit Liquidity Score of One, when previously it had a poor Four. This shows the impact of index membership.

Gavan Nolan
Credit Analyst Markit Tel: +44 20 7260 2232 Email: gavan.nolan@markit.com For further information, please visit www.markit.com

05/04/2012