Carmel Presentation

8/2/2019 Carmel Presentation

1/54

Investment Focus:

The Pain in Spain


2/54

2

Five Reasons Why Spains Problems Are

Worse than the Market Anticipates

1. Spains national debt is 50% greater than the headline numbers

Spains debt-to-GDP balloons from 60% to 90% of GDP with regional and other debts

2. Spains housing prices will fall by an additional 35%

Spain built one house for every additional person added to the population during thepast two decades; the fall will decrease GDP by ~2% each of the next two years

3. Spain has zombie banks with massive loans to developers and to

homeowners Banks have not begun to realize losses and are vastly undercapitalized

4. Spains economy has not stabilized and will continue to deteriorate

Spain has the highest unemployment in the developed world, one of the highest overalldebt loads, and the most uncompetitive labor market in Europe

5. The EU will not have the firepower or political will to bail out Spain

Rescue fund headline numbers are misleading and count capital that is not yetcommitted


3/54

The Market Will Question Spains Solvency

as Its Problems Compound Each Other

3

Housing devaluation

These problems will reveal themselves in the next12 months

Spains true debt burden will pass the 90%

tipping point identified by Rogoff andReinhart

Housing prices will fall further and faster thananticipated (consensus is 15%; CAMestimate is 35%)

Banks underestimate the residential realestate loan defaults (consensus estimate is

2.8% vs. CAM estimate of 11%)

Expected housing price depreciation andloan defaults will deepen Spains recession(additional 2% contraction in 2012 and 2013)

Spain will need to refinance 186.1 Billion in2012 alone

10-year Credit Default Swap (CDS) on theKingdom of Spain will move higher as thesesurprises are announced


4/54

Spains Credit Default Will Widen More than

Other Peripheral European Countries

4


5/54

Spains National Debt Is 50% Greater than

the Headline Numbers

5

0

50

100

150

200

250

Percen

tage

DebttoGDP(AsofYE'11)Source:IMF

0100200300400500600700800900

1,000

SovereignDebt RegionalDebt BankGuaranteed Debt

OtherSovereignGtd.Debt

Localgovernmentdebt

TotalDebt

Spain'sDettoGDPiscloserto90%than60%

Sources:BankofSpainStatisticalBulletinforNational,RegionalandLocalDebt;BloombergforSoveriegnGuaranteeddebt


6/54

Spains Housing Prices Will Fall by an

Additional 35%

6


7/54

Spain Has Zombie Banks with Massive

Loans to Developers and to Homeowners

7

21.8

143.2

382.0

98.5

298.3

656.5

37.7

99.5

1.4

7.7

17.9

17.4

62.4

18.3

2.2

7.2

Total LoansBillions of Euro YE 2011

Doubtful LoansBillions of Euro YE 2011

Agriculture Industry

ServicesOtherThanRealEstate Construction

RealEstate Services PersonalMortages

ConsumerDurable ConsumerOther

6.5%5.4% 4.7%

17.7%

20.9%

2.8%

5.8%7.3%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

PercentageofDoubtfulLoans


8/54

Spains Economy Has Not Stabilized and Will

Continue to Deteriorate

8

1 in 4 Spaniards is out of work. Youth unemployment is 50%.


9/54

Europe Will Not Have the Firepower or

Political Will to Bail Out Spain

9

Numbers as high as 940bn have been touted for the combined European StabilityMechanism (ESM) and European Financial Stability Fund (EFSF)

Germany would increase from 211bn to 401bn This has not yet been approved by the Bundestag or the Constitutional Court

both barely approved the initial allocation

The ESM relies not only on unapproved financing from Germany, but calls initialcapital from Portugal, Ireland and even Greece

The size of the bail out funds is insufficient if Spain and Italy lose access to the debtmarkets

Spain alone would take 60% of the available funds


10/54

10

Summary: CDS on the Kingdom of Spain

Cost / CapitalCommitment

3.5% of notional per annum effectively an option premium on the defaultof Spain during the next 10 years

Rationale

We began buying Spain CDS in Q4 2011 because the country hassignificant structural problems within its economy, a debt load that is

higher than the headline number, and a banking system withunrealized losses

ExpectedReturn

Should the Spanish crisis flare up in 2012 as we expect, we can generatea 300% return on the annual premium

Instrument 10-year CDS on the Kingdom of Spain


11/54

Appendix


12/54

Spains Debt Is 50% Greater than the

Headline Numbers


13/54

Spains Debt-to-GDP Is Higher than Officials

State and Will Likely Continue to Increase

13

A fuller account of Spains debt-to-GDP places the burden at over 92% from theofficial rate of 61%

Official projected budget deficit levels of 5.3% in 12 and 3.0% in 13 are unlikely tobe met

Admitted deficits would add 8.3% of GDP to the debt by YE 13

Levels are likely to be missed so additional debt is likely to higher by morethan 10%

GDP itself is likely to be lower than official forecasts as a vicious combination ofincreased austerity, falling asset prices and high unemployment take hold

IMF forecasts a fall of 1.7% in 12 and 0.3% in 13

Given a negative wealth effect for rapidly falling housing prices, we expectGDP to be lower ~3% in 12 and ~1% in 13

By YE 13 debt-to-GDP will be close to 110%


14/54

14

There are several sources of

additional debt

Spain and the regionalgovernments have 87.5bn ofunpaid bills

There are state corporationswith explicitly guaranteed debtof 55.9bn

Debt held by the social securityfund equals 56.6bn

In total these would bring debt-to-GDP to 90%

Spain Hides Debts at Regional Level, State

Corporations, and Social Security


15/54

15

There are agencies and banks that have beenexplicitly guaranteed by the Kingdom of Spain

The ICO (Insituto de Credito Ofical) is a state backedlender no maximum draw

FROB (Fondo de Reestructuracion Ordenada Bancaria) isa fund for the restructuring of banks - maximum drawcould be 27bn

FADE is the (Fundo de Amortizacion del Deficit Electrico),which covers the amount by which Spain fails to coverelectricity costs Maximum draw 22bn

The banks are getting guarantees so that they can postthis funding to the ECB no maximum draw

AIF (Administrador de Infraestructuras Ferroviarias)operates the rail network in Spain

At these current draw amounts, debt-to-GDP

would increase by 14.8%

Cumulatively Spain approaches 100% debt-to-GDP

Debt Increases Further When Contingent

Liabilities Are Added

Banks, 59.3

FROB, 10.9

FADE, 12.9

ICO, 75.7

AIF, 0.2

DebtGuaranteedbytheKingdomofSpainSource:Bloomberg(Units Bn)


16/54

Spains Surplus in the 2000s Coincided with

a Building Boom

16

Spain budget balance as a percentage of GDP


17/54

Only the Rosiest Projections Reach the 3%

Deficit Goal for 2013

17

The Government had agreed with

the European Union to meet a2012 deficit of 4.4%

On March 2nd , thegovernment adjusted thetarget to 5.8%

It has since agreed to 5.3%

Even this looks aggressive

9

8

7

6

5

4

3

2

1

0

2011 2012 2013

Percenta

geofGDP

SpainBudgetDeficit

A ctu al Tar ge t Bloo mb er gFor ecast JPMForecast

EUBudgetDeficitTargets


18/54

Even the IMF Does Not Foresee Spain Getting

to a Primary Surplus Any Time Soon

18

IMF Cyclically adjusted primary government balance - Spain


19/54

Controlling Costs Is Difficult Because of

Regional Government Spending

19

Autonomous and local governments havetheir own politics and are often at oddswith the central government

This makes getting their deficitsdown prone to regional politics

Recently, the central government agreedto pay 35bn of local and regional debt


20/54

Regional Government Debt Is Not Counted in

the Countrys Overall Debt-to-GDP

20

As opposed to almost all other Europeancountries, Spains healthcare is paid by

the regions, with limited centralgovernment interference

As the population ages and healthcarecosts escalate, the fiscal pressure on theregions will become more intense

Some regions have started to look to thecentral government to fund healthcaredirectly


21/54

Spains Housing Prices Will Fall by an

Additional 35%


22/54

Compared to the US, the Housing Bubble in

Spain Was Extreme

22


23/54

Housing Prices Have Outstripped Wages

23


24/54

Spain Has Overbuilt its Housing Stock

Relative to its Growth in Population

24

Demographic changes such as fewerpeople per dwelling and more recentsecond home buyers will compound the

problem Implies that Spain has significant excess

housing

Source: Center for European Policy Studies

1.750

1.850

1.950

2.050

2.150

2.250

2.350

2.450

2.550

1 99 9 2 00 0 2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 0

Totalpopulation/totaldwelling

s

PeopleperDwellingSource:EuropeanMortgageFederation,IMF,MinistryofInternal Affairsand

Communications(Japan years'09&'10Estimated)

Euro12

Spain

USA

Japan

IncomparisontotheUS

25.0%overbuilt=

6.45mm units

IncomparisontoJapan

17.1%%overbuilt=

4.42mm units

IncomparisontoEurope

9.4%overbuilt=

2.44mm units

18.0

19.0

20.0

21.0

22.0

23.0

24.0

25.0

26.0

27.0

38.0

39.0

40.0

41.0

42.0

43.0

44.0

45.0

46.0

47.0

Homes(Unitsinmillions)

Population(Unitsinmillions)

Spainadded

one

home

per

person

for

almost

two

decadesSources:IMF,Ministerio deFomento,Asociacion Hipotecaria Espanola

Population(L HS) Houses(RHS)


25/54

Housing Has Been a Great Investment in

Spain, but It Is Not Affordable Now

25


26/54

Strong Investment Returns on Housing Have

Boosted Home Ownership Rates

26

Source: IMF

Germany

Denmark

Netherlands

France

Japan

Sweden

UnitedStates UnitedKingdom

Australia

Ireland

Portugal

Belgium

Italy

Spain

0

200

400

600

800

1000

1200

40 50 60 70 80 90

YE2011C

DS

Levels

HomeOwnershipRate

CDSLevelsvsHomeownershipRates

High investment returns tend to drawpeople in

Thus creating a bubble and diminishing returns

Also encouraging speculative borrowing

High rates of homeownership can also reducelabor mobility

Over time housing excesses diminish the

credit quality of the country itself


27/54

Retirees Will have to Sell their Houses but

There Are No Obvious Buyers

27

Already at homeownership age, with few buyers behindthem


28/54

Prices Will Have to Drop Further Before

Homes Become Affordable

28

US homes are far more affordable after the crisis

Source: National Association of Realtors

MoreAffor

dable

More

Affordable

Spanish homes are 30% LESS affordable than99

Source: Bank of Spain


29/54

A Fall in Housing Prices Will Reduce GDP

29

If prices were to fall to match US - ~35%

To match Spanish income growth -~30%

Including a fall in wages to bring in line with Euro labor costs -~45% To match 99 affordability -~30%

To match affordability in US -~55%

Contributing factors

Possible increase in homeownership rate? NO most already own

New buyers? NO aging population and the need to convert homes to fund retirement

Tight inventory? NO there are as much as 20% excess houses

Conclusion housing prices have to drop at least 1/3 from current levels

We believe that this will take place over 2-3 years as housing generally does not devaluefaster than ~15% per annum

The Bank of Spain estimates that the Wealth Effect is about a 0.03 reduction inconsumption for a 1 fall in housing prices1

1 Housing boom and burst as seen from the Spanish Survey of Household Finances, Olympia Bover

A 15% decline in housing should reduce GDP by ~2% in both 2012 and 2013


30/54

Spain Has Zombie Banks with Massive

Loans to Developers and to Homeowners


31/54

Banks in Spain Are Holding Devastating Real

Estate Losses

31

We estimate that Spanish banks may need 200bn of additional capital nearly 20%of GDP

Given the losses experienced in the last housing crash of 93-94, we would expectlosses to be much higher than the banks have admitted

This bubble was larger in scope and scale, yet mortgage losses are 50% what they were then they shouldbe much higher

Spain has likely 50% of GDP in commercial real estate assets, many of these are todistressed builders and developers, with minimal recovery value likely

Problem Loans are still below what was experienced in the early 90s while corporatebankruptcies are 10x that period

The LTRO has given Spanish banks some new financing, which they seem to haveput into Spain sovereign debt

If prices on this debt falls even by 0.5%, the banks will be asked for additional collateral this was a similar

situation to MF global

Banks government holdings are now 33% greater then their tangible equity

While banks can be more profitable by adding additional leverage, they would still lose money on theircurrent asset base


32/54

Mortgages Default Rates Will Rise Dramatically

32

During the last housing boom mortgage defaultrates peaked about 5.5%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

Mar07

Jun07

Sep07

Dec07

Mar08

Jun08

Sep08

Dec08

Mar09

Jun09

Sep09

Dec09

Mar10

Jun10

Sep10

Dec10

Mar11

Jun11

Sep11

Dec11

DefaultRates

Current

CrisisSource:AsociacionHipotecariaEspanola

Given the enormous jump in housing prices andunemployment, default rates could double or more


33/54

Spanish Banks Hold Large Exposures to

Commercial Real Estate

33

Not only do German banks have 2/3 theCRE exposure, Germanys economy is2.5x times bigger than Spain

Because the left hand graph does not include non-EBAbanks, It understates the size of the exposure by 60%


34/54

16% of Euro CMBS Is in Special Servicing

34

Funding risk

CRER

isk


35/54

Current Crisis Is Much Worse than 93-94,

but Loan Delinquencies Are Lower (So Far)

35

Corporate bankruptcies are 8x the amount duringthe 93-94 crisis and 20% more than 09

We are likely not even near the peak ofdelinquencies and therefore defaults and losses


36/54

CAM Estimates that Bank Losses are Sizeable

With Even a Modestly Poor Economic Outlook

36

Rationale

TotalLoans Defaultrate LossonDefault LossEuroBn DefaultRate LossonDefault

RealEstateServices 298.3 40% 75% 89 2xcurrent"Doubtful" Effectivelyunsecuredloanstobusinesses

ServicesOtherThanRealEstate 382.0 15% 75% 43 Reflectionofgreatlyincreasedbankruptcyrate EffectivelyunsecuredloanstobusinessesPersonalMortages 656.5 11% 50% 36 2x'93'94defaultrates Lossesmitigatedbyrecourse toborrower

Construction 98.5 40% 75% 30 2xcurrent"Doubtful" ConsiderationtoRealEstatealreadyownedbybanks

ConsumerOther 99.5 10% 75% 7 Increasereflectiveofunemployment Unsecuredloanstoconsumers

Industry 143.2 10% 40% 6 Reflectiveofweakeningeconomyandausterity Reflectiveofmix ofsecuredandunsecuredloans

ConsumerDurable 37.7 10% 50% 2 Increasereflectiveofunemployment Securedloanstoconsumers

Agriculture

21.8 10% 50%

1 Modest

increase

to

current

default

rates Estimate

Total 214

%ofGDP 19.97%


37/54

LTRO Has Relieved Funding Pressure, but

Spreads Are Rising Again

37

CDS spreads on domestically focused Spanish banks


38/54

Banks Have Greatly Increased Exposure to

Sovereign, Likely Via Leverage

38

When the market discovered how much exposure MF Global had to European Sovereigns, a de factobank run occurred. Could the whole system be doing the same now?!?!


39/54

LTRO Allows Banks to Add New Assets

Profitably, but Not Against Current Assets

39

0.4

0.5

0.6

0.7

0.8

0.9

1

1.1

1.2

12/1/2005

3/1/2006

6/1/2006

9/1/2006

12/1/2006

3/1/2007

6/1/2007

9/1/2007

12/1/2007

3/1/2008

6/1/2008

9/1/2008

12/1/2008

3/1/2009

6/1/2009

9/1/2009

12/1/2009

3/1/2010

6/1/2010

9/1/2010

12/1/2010

3/1/2011

6/1/2011

Perce

nt

Versusthebankscurrentassets,LTROimplies"negativecarry"

IMFRoAEst

ECBRoAEst

LTRO

0

1

2

3

4

5

6

7

LTROallowsbankstoearn"carry"onadditionalassets

3YrSpanishGovtBondYield LTROFundingRate

Currentspreadis223bps


40/54

Spains Economy Has Not Stabilized and

Will Continue to Deteriorate


41/54

Spains Economy Has Intractable Problems

41


42/54

Spains Labor Is Expensive

42

Unit Labor Costs since the introduction of the Euro Source OECD


43/54

Spain Has the Worst Labor Restrictions

43


44/54

Construction Jobs Are Not Coming Back

44

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

13.0%

14.0%

%ofWorkforceInvolvedinConstruction

Spain US

Source: Bloomberg


45/54

Exports Are Vulnerable to a European Slowdown

45

i i h d


46/54

Spains Exports Are Getting Cheaper and Its

Imports More Expensive

46

( 50,000)

( 40,000)

( 30,000)

( 20,000)

( 10,000)

0

10,000

MINERALPRODUCTS

MACHINESA

NDAPPARATUS,

ELECTRICALMATERIAL

PRODUCTSFROM

CHEMICALINDUSTRIESAND

TEXTILEMATERIALSANDTHEIRPRODUCTS

CO

MMONMETALSANDTHEIRPRODUCTS

OPTICS,

PHOTOGRAPHYANDFILM.

PRECISION

ME

RCHANDISEANDDIFFERENTPRODUCTS

LIVEANIMALSANDPRODUCTSOFTHEANIMALKINGDOM

ARTIFICIALP

LASTICMATERIALS,

RUBBERANDTHEIR

FOOD

PRODUCTS,

BEVERAGESANDTOBACCO

WOOD,C

ORKANDTHEIRPRODUCTS

HIDES,

SKINSANDTHEIRPRODUCTS

PAPE

R,

ITSRAW

MATERIALSANDPRODUCTS

FINEPEARLS,

PRESIOUSSTONESANDPRECIOUSMETALS

FOOTWEAR,

HATMAKING,

UMBRELLAS,

ARTIFICIAL

WORKSOFARTFORCOLLECTIONSANDANTIQUES

FATSANDOILS,

PRODUCTSOFTHEIRSEPARATION,

PRODUCTSOFSTONE,

CEMENT,...

CERAMIC,

GLASS

PRODUCTSOFTHEVEGETABLEKINDGOM

TRANSPORTMATERIAL

2008netexports

Foodstuff

Oil

Oil prices rising

Food prices falling

M f i i S i I W k i E


47/54

Manufacturing in Spain Is Weakening Even

Relative to the Rest of Europe

47

Eurozone PMI and GDP Spain PMI and Production

Th IMF P j t S i Will B i R i


48/54

The IMF Projects Spain Will Be in Recession

in 2012 and 2013

48

Only one of twocountries in recessionin 2013

Most severe change ofany nation from the Sept11 WEO to the Jan 12

WEO = World Economic Outlooklast published January 24, 2012

S i H L t C t l f I t t R t d


49/54

Spain Has Lost Control of Interest Rates and

Currency by Being in the Euro

49

Source: Center for Economic Policy Research

Effective interest rates are 4% too high The currency needs to fall 15%

Spain Has Too Much O erall Debt Which Is


50/54

Spain Has Too Much Overall Debt Which Is

Owned by Foreigners

50

0%

20%

40%

60%

80%

100%

120%

Netexternaldebtasa%ofGDP(YE'10)

Source:McKinsey

Global

Institute

&

The

World

Bank

These two countries have control of their own currency


51/54

Europe Will Not Have the Firepower or

Political Will to Bail Out Spain

The Headline Numbers for the European


52/54

The Headline Numbers for the European

Firewall Are Unrealistic and Misleading

52

The headline numbers on the combined European firewall is as large as 940bn

This counts 220bn of funds already committed to Portugal, Ireland and Spain

Germany would owe a total of 401bn they currently only have approval both bythe Bundestag and the Constitutional Court for 211bn

Greece would owe 20bn impressive for a country that just was bailed out

Spain would owe 176bn which is 16% of GDP and 154% of the expected

Government tax revenues for 2012

Obviously if Spain needs to be bailed out the size of the Fund will be much smallerthan the headline


53/54

Details on the Firewall Size Are Uncertain

53

There are two rescue mechanisms

European Financial Stability Facility (EFSF) commitments from members are

undrawn until needed and funds to this point have been lent directly to nationalgovernments

German commitment capped at 211bn which has been approved by the legislature and theConstitutional Court

European Stability Mechanism (ESM) Initial drawn capital has been set at

80bn which will be funded by the members, additional capital can be drawnup to a total of 500bn

Unclear at this point if weak countries will have to pay the initial funding

Initial capital call equals ~0.9% of GDP would this count against the budget deficit? The 9.5bncapital call on Spain equals almost 10% of LTM government revenues

German commitment capped at 190bn which if is part of the 211bn has been approved

If the programs are to run concurrently, would Germany need approval by theBundestag? Would it face another challenge in the Constitutional Court?

If Spain Unravels the Size of the Problem


54/54

If Spain Unravels, the Size of the Problem

Grows and the Rescue Funds Shrink

54

Should all of the GIIPS countries be forced to drop out of ESM and EFSF, roughly1/3 of the commitments would disappear

Should Spain lose complete access to the markets like Greece, Ireland andPortugal have, the worst case funding needs are very large:

MaturingDebt 2012 2013Bills 60.4 21.1

Bonds 45.1 60.4

International bonds 3 1.5ICO 10.4 15.4FROB 3 2.1

FADE 2.1 2.7

Deficit(estimatedbyCITI) 70.1 43.8BankdebtguaranteedbySpain 26.1 5.5

Total 220.2 152.5

Su mfor '12and'13 372.7 In this worst case, Spain would take up nearly 60% of the fully drawn headline

numbers leaving less for Italy, Portugal, Ireland and Greece

Documents

Carmel Presentation