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Toward A Bottom-Up Approach in Assessing Sovereign Default Risk

NYU Stern Alumni Conference

London

June 03, 2011

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June 01, 2007 – May 6, 2011

Source: Citigroup Yieldbook Index Data

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,200

6/1/2007

7/13/2007

8/24/2007

10/5/2007

11/16/2007

12/31/2007

2/12/2008

3/25/2008

5/6/2008

6/17/2008

7/29/2008

9/9/2008

10/21/2008

12/2/2008

1/15/2009

2/26/2009

4/9/2009

5/21/2009

7/2/2009

8/13/2009

9/24/2009

11/5/2009

12/17/2009

2/1/2010

3/15/2010

4/26/2010

6/7/2010

7/19/2010

8/30/2010

10/11/2010

11/22/2010

1/3/2011

2/14/2011

3/28/2011

6/12/07 (260bp)

4/26/10 (442bp)

05/06/11 (408bp)

12/16/08 (2,046bp)

YTM Spread Between High Yield Markets & 10 Year Treasury Notes

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Major Risks Going Forward (For 2011)

Real Economy – Primarily U.S. (Double-Dip?): Impact on Default Rates & Credit Availability

Sovereign Debt Crisis – Europe

Contagion Between Markets – Debt and Equity

Maturity Schedule On Private and Public Debt

Inflation and Rise in Interest Rates

Municipal Bond Market Troubles

Uncertainties (non-quantifiable)

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Sovereign Ratings Actions2009 - Present

GreeceRa

ting

s

A1 A2 A3

Ba1B1

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PortugalRa

ting

s

Aa2A1 A3

Baa1

Sovereign Ratings Actions2009 - Present

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IrelandRa

ting

s

AAA Aa2

Baa1Baa3

Aa1

Sovereign Ratings Actions2009 - Present

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SpainRa

ting

s

AAA

Aa2

Aa1

Sovereign Ratings Actions2009 - Present

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(Z-Metrics PD Estimates and Implied PDs from CDS Spreads)

*Assuming a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R))

Sources: RiskMetrics Group (MSCI), Markit, Compustat.

Z-Metrics PD Esimates: Five-Year Public Model

ListedCompanie

sY/E 2010

Median PDY/E 2009

Median PDY/E 2008

Median PD

Five-Year Implied PDFrom CDS Spread*

Country 2010 2009 2008

Netherlands 85 3.56% 3.33% 5.62% 2.03% 2.83% 6.06%

U.S.A. 2226 3.65% 3.93% 6.97% 3.79% 3.28% 4.47%

Sweden 245 3.71% 5.31% 6.74% 2.25% 4.60% 6.33%

Ireland 29 3.72% 6.45% 7.46% 41.44% 12.20% 17.00%

Belgium 69 3.85% 5.90% 5.89% 11.12% 4.58% 5.53%

U.K. 507 4.28% 3.62% 5.75% 4.73% 6.52% 8.13%

France 351 4.36% 5.51% 7.22% 4.51% 3.75% 4.05%

Germany 348 4.63% 5.54% 7.34% 2.50% 2.67% 3.66%

Italy 174 7.29% 7.99% 10.51% 9.16% 8.69% 11.20%

Spain 91 7.39% 6.44% 7.39% 14.80% 9.39% 8.07%

Portugal 33 10.67% 9.36% 12.07% 41.00% 10.90% 7.39%

Greece 93 15.28% 10.60% 11.57% 70.66% 24.10% 13.22%

Financial Health of the Corporate, Non-Financial Sector: Selected European Countries and U.S.A. in 2008-2010

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Weighted Average Median 5-Year PD for Listed Non-Financial1

and Banking Firms2 (Europe & US): 2009

1 Based on Z-Metrics Default Probability Model.2 Based on Altman-Rijken Model (Preliminary)

Non-Financial Firms Banking Firms

Country PD (%) Weight PD (%) WeightWeighted Average

(%)

Rank

CDS Spread PD (%)

Rank

Netherlands 3.33 0.968 18.8 0.032 3.82 1 2.83 2

U.K. 3.62 0.965 20.4 0.035 4.21 2 6.52 7

U.S.A. 3.93 0.821 16.9 0.179 6.25 5 3.28 3

France 5.51 0.931 19.2 0.069 6.45 7 3.75 4

Germany 5.54 0.938 15.1 0.062 6.13 4 2.67 1

Sweden 5.31 0.984 12.8 0.016 5.43 3 4.60 6

Ireland 6.45 0.848 53.5 0.152 13.60 12 12.20 11

Italy 7.99 0.876 18.1 0.124 9.24 9 8.69 8

Belgium 5.90 0.957 12.4 0.043 6.18 6 4.58 5

Spain 6.44 0.882 11.7 0.118 7.06 8 9.39 9

Portugal 9.36 0.857 16.2 0.143 10.34 10 10.90 10

Greece 10.60 0.868 24.9 0.132 12.49 11 24.10 12

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Weighted Average Median 5-Year PD for Listed Non-Financial1 and Banking Firms2 (Europe & US): 2010

1 Based on Z-Metrics Default Probability Model.2 Based on Altman-Rijken Model (Preliminary)* PD based on CDS Spread as of 4/26/2011

Non-Financial Firms Banking Firms

Country PD (%) Weight PD (%) WeightWeighted

Average (%)Ran

k

CDS Spread PD

(%)*Rank

Netherlands

3.56 0.977 11.1 0.023 3.73 1 2.03 1

U.K. 4.28 0.977 15.5 0.023 4.54 5 4.73 6

U.S.A. 3.65 0.837 13.8 0.163 5.30 7 3.79 4

France 4.36 0.986 14.0 0.014 4.49 4 4.51 5

Germany 4.63 0.983 13.1 0.017 4.77 6 2.50 3

Sweden 3.71 0.984 17.3 0.016 3.93 2 2.25 2

Ireland 3.72 0.906 77.6 0.094 10.65 10 41.44 11

Italy 7.29 0.906 20.0 0.094 8.48 9 9.16 7

Belgium 3.85 0.972 12.4 0.028 4.21 3 11.12 8

Spain 7.39 0.948 10.9 0.052 7.57 8 14.80 9

Portugal 10.67 0.971 12.1 0.029 10.71 11 41.00 10

Greece 15.28 0.921 30.1 0.079 16.45 12 70.66 12

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Five Year Implied Probabilities of Default (PD) From Capital Market CDS Spreads*Greece, Jan. 2009 – Apr. 2011

*Assumes 40% Recovery Rate.Source: Markit

11

01020304050607080

01-J

AN

-09

06-F

EB-0

916

-MA

R-09

21-A

PR-0

927

-MA

Y-09

02-J

UL-

0907

-AU

G-0

914

-SEP

-09

20-O

CT-0

925

-NO

V-09

31-D

EC-0

905

-FEB

-10

15-M

AR-

1020

-APR

-10

26-M

AY-

1001

-JU

L-10

06-A

UG

-10

13-S

EP-1

019

-OCT

-10

24-N

OV-

1030

-DEC

-10

04-F

EB-1

114

-MA

R-11

19-A

PR-1

1

Def

ault

Pro

babi

lity

(As

%)

Greece

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Five Year Implied Probabilities of Default (PD) From Capital Market CDS Spreads*Portugal, Jan. 2009 – Apr. 2011

*Assumes 40% Recovery Rate.Source: Markit 12

05

1015202530354045

01-J

AN

-09

06-F

EB-0

916

-MA

R-09

21-A

PR-0

927

-MA

Y-09

02-J

UL-

0907

-AU

G-0

914

-SEP

-09

20-O

CT-0

925

-NO

V-09

31-D

EC-0

905

-FEB

-10

15-M

AR-

1020

-APR

-10

26-M

AY-

1001

-JU

L-10

06-A

UG

-10

13-S

EP-1

019

-OCT

-10

24-N

OV-

1030

-DEC

-10

04-F

EB-1

114

-MA

R-11

19-A

PR-1

1

Def

ault

Pro

babi

lity

(As

%)

Portugal

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Recent Five-Year Probability of Default (PD) Implied From Capital Market CDS Spreads

Sources: Author Calculations from MSCI Group, Compustat Data

Country

Five Year Implied

PD from Capital

Market CDS

Spreads

(12/15/10)

Five Year Implied

PD from Capital

Market CDS

Spreads

(04/26/11)

Netherlands 3.66% 2.03%

United Kingdom 4.68% 4.73%

USA 2.27% 3.79%

France 6.65% 4.51%

Germany 3.19% 2.50%

Spain 19.45% 14.80%

Ireland 33.67% 41.44%

Italy 11.63% 9.16%

Portugal 26.40% 41.00%

Greece 51.79% 70.66%

(December 15, 2010 & April 26, 2011 Results)