Banks Diversified Financials by jennyyingdi

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									How will regulation reshape the banking system?



                       Yasmine de Bray
                       11/05/2012
Summary




     01 New regulation is putting pressure on the size of the banking
        system…
     02 …but the risk of an abrupt shrinkage has more to do with the
        current sovereign crisis
     03 Regulation should be instrumental in avoiding future liquidity
        crisis but should not overshoot




                                       How will new regulation reshape the banking system? - 26/07/2012 - page 2
 1/ New regulation is putting pressure on the size of the banking system

 Regulators require banks to hold more
  capital
    – The switch from Basel 2 to Basel 3 is
      reducing the average common equity ratio
      of the top 100 global banks by 3% points
      from 10.2% at June-end 2012 to 7.1% as
      per the latest QIS published by the Basel
      Committee on April 12th.
    – In practice, European regulators are
      requesting their domestic banks to hold
      common equity ratios of at least 9%.

 More than €500bn has been raised so
  far in Europe: 55% of which has been
  provided by governments and 45% by
  private investors. European banks’
  core tier 1 ratios have improved from                                                                       Source: Goldman Sachs
  6.5% in 2008 to 10% in 2011.
 Ability to raise further capital is limited given governments’ over-indebtedness and the lack of investors’
  appetite for bank stocks due to poor risk-adjusted returns (cf Unicredit’s difficult capital increase in early
  January which required a 40% discount to TERP).
 The other way for banks to release capital is to reduce their balance sheets…




                                                            How will new regulation reshape the banking system? - 26/07/2012 - page 3
   1/ New regulation is putting pressure on the size of the banking system
 Regulation is to structurally reduce the size of the                             Assets/loans
                                                                                                                                                                            Lending as a %

  senior debt market:                                                              Legacy assets
                                                                                                     CIB/
                                                                                                    markets     Lending     CEE
                                                                                                                                      Greece /
                                                                                                                                      Ireland
                                                                                                                                                    Total
                                                                                                                                                 deleverage
                                                                                                                                                               % of total
                                                                                                                                                                assets
                                                                                                                                                                            of deleveraging
                                                                                                                                                                                  plan
                                                                      UCG                  19 000                 61 500     7 000                    87 500      9%                        78%
– The European commission recently issued a consultation paper        ISP                                         15 700     5 000                    20 700      3%                  100%
  suggesting that regulators should be able to impose losses on       Medio                                       3 600                               3 600       6%                  100%
                                                                      BMPS                                        16 000                              16 000      7%                  100%
  bank creditors before the bank become insolvent potentially         BP                                          18 894                              18 894     14%                  100%
  based on a trigger mechanism. The key is whether it will be a low   UBI                                          7 000                               7 000      5%                  100%

  or high trigger.                                                    PMI                                            500                                500       1%                  100%
                                                                      Other                                        40 000                             40 000      2%                  100%
                                                                      Italy               19 000         -       163 194    12 000         -        194 194       5%                   90%
– Term senior unsecured debt would become more “capital” than         Soc Gen               2000            0      34 300     2 053        250        38 603      3%                  94%
  “funding” in nature, and would become more expensive. This could




                                                                                                                                                                                            1
                                                                                                                                                                              1bp




                                                                      BNP                  22800            0      47 000       406                   70 206      4%          1,2

                                                                                                                                                                                      68%
                                                                      CASA                 11524        7 000      10 000        60      5 460        34 044      2%                  30%
  lead to a structural reduction in banks’ unsecured debt funding     Natixis              19300        8 400                                         27 700      6%                   0%
  reliance, only partially offset by growing covered bond issuance.   France
                                                                      KBC
                                                                                          55 624
                                                                                           6 300
                                                                                                      15 400      91 300
                                                                                                                   7 545
                                                                                                                             2 520
                                                                                                                             5 400
                                                                                                                                        5 710
                                                                                                                                        9 800
                                                                                                                                                    170 554
                                                                                                                                                     29 045
                                                                                                                                                                  3%
                                                                                                                                                                 10%
                                                                                                                                                                              1bp

                                                                                                                                                                                  1
                                                                                                                                                                                       55%
                                                                                                                                                                                      45%
                                                                      ING

 Regulation is likely to reduce the velocity of money                Benelux
                                                                      SAN
                                                                                            6 300        -         7 545
                                                                                                                  19 962
                                                                                                                             5 400      9 800        29 045
                                                                                                                                                     19 962
                                                                                                                                                                  4%
                                                                                                                                                                  2%
                                                                                                                                                                                       45%
                                                                                                                                                                                      100%

– Growing scrutiny on re-hypothecation.                               BBVA                                        14 678                             14 678       3%                  100%
                                                                                                                                                                              1bp
                                                                                                                                                                              0,8


                                                                                                                                                                              1




                                                                      Caixa                                        5 256                              5 256       2%                  100%
– Higher risk weights for credit exposure to large regulated banks    Pop
                                                                      BTO
                                                                                                                   6 810
                                                                                                                   7 069
                                                                                                                                                      6 810
                                                                                                                                                      7 069
                                                                                                                                                                  5%
                                                                                                                                                                  7%
                                                                                                                                                                                      100%
                                                                                                                                                                                      100%
  (>100bn asset).                                                     SAB                                          3 177                              3 177       3%          1bp
                                                                                                                                                                              0,6
                                                                                                                                                                                      100%
                                                                      BKT                                          5 678                              5 678       9%                  100%
                                                                      BCIV                                         4 180                              4 180       6%                  100%
 We estimate the total deleveraging effort to be close               Other                                       60 000                             60 000       6%                  100%

  to €1.3 trillion of assets (5.7% of total assets) over
                                                                      Spain                  -           -       126 809       -           -        126 809       5%          0,4
                                                                                                                                                                              0bp
                                                                                                                                                                                      100%
                                                                      CBK                 15 164                 216 624    25 981                  257 769      37%                  94%
                                                                      Deutsche                        24 333                                         24 333       1%                   0%
  the next 3 years for European listed banks, which                   Germany             15 164      24 333     216 624    25 981         -        282 102       9%                   86%

  could release €50bn of capital.
                                                                      UBS                 22 648      32 520                                         55 168       5%          0,2
                                                                                                                                                                              0bp
                                                                                                                                                                                       0%
                                                                      CS                   5 405      48 103                                         53 508       6%                   0%
                                                                      Switz               28 053      80 623         -         -          -         108 676       5%                   0%
– Under the IMF base-case scenario for a sample of 58 large EU        RBS                 12 195      85 366      48 171                5 488       151 220       8%                  32%
  banks, the reduction of bank assets would be €1.6bn over the next   Lloy                28 049                  70 976                9 146       108 171       9%              0
                                                                                                                                                                                      66%




                                                                                                                                                                                            1
                                                                                                                                                                              0bp




                                                                      Barc                20 122                                                     20 122       1%                   0%
  two years, €2.5bn under their worst-case scenario.                  HSBC                60 000                                        3 846        63 846       3%              0
                                                                                                                                                                                       0%
                                                                                                                                                                                      0,5       1   1,5




                                                                      UK                 120 366      85 366     119 146       -       18 480       343 358       5%                   35%
                                                                      BOI                                         36 000                             36 000      23%                  100%
 This should help close an estimated capital shortfall               AIB
                                                                      Ireland                -
                                                                                                       3 360
                                                                                                       3 360
                                                                                                                  13 440
                                                                                                                  49 440       -           -
                                                                                                                                                     16 800
                                                                                                                                                     52 800
                                                                                                                                                                 13%
                                                                                                                                                                 19%
                                                                                                                                                                                      80%
                                                                                                                                                                                       94%
  of around €80bn in Europe and help manage down                      Erste
                                                                      RI
                                                                                           1 385
                                                                                          12 800
                                                                                                                             7 140
                                                                                                                             6 717
                                                                                                                                                      8 524
                                                                                                                                                     19 517
                                                                                                                                                                  4%
                                                                                                                                                                 14%
                                                                                                                                                                                      84%
                                                                                                                                                                                      34%
  the stock of senior debt funding (€730bn maturities                 Austria
                                                                      Total
                                                                                          14 185
                                                                                         258 691
                                                                                                         -
                                                                                                     209 082
                                                                                                                     -
                                                                                                                 774 059
                                                                                                                            13 857
                                                                                                                            59 757
                                                                                                                                          -
                                                                                                                                       33 990
                                                                                                                                                     28 041
                                                                                                                                                  1 335 580
                                                                                                                                                                  8%
                                                                                                                                                                 5,7%
                                                                                                                                                                                       49%
                                                                                                                                                                                       62%
  in 2012-2014).                                                      % of Total             19%         16%         58%        4%         3%          100%
                                                                                                                                                                Source: Amundi, Morgan Stanley

                                                                              How will new regulation reshape the banking system? - 26/07/2012 - page 4
 2/ New regulation is putting pressure on the size of CIB activities

 The deleveraging effort is focusing on corporate and investment banking
    – European banks announced risk-weighted asset reduction plans of €700bn since 2009 in their CIB business, 37% of
      which has been completed so far.
    – 35% of the remaining deleveraging efforts will focus on CIB activities.
    – CIB activities can be downsized faster.
    – CIB is very competitive and will become less profitable under Basel 3 (CVA, greater capital requirement for market risks
      etc..).
    – Example of explicit regulatory/political pressure: RBS requested to specifically downsize its investment bank.

                                                     RWA Reduction                 RWA Reduction
                               EUR bn                                 % Target
                                                        done so far                       Target
                               UBS                              14       18%                  78
                               CS                               38       48%                  80
                               Deutsche Bank                    30       25%                120
                               CASA                             36      120%                  30
                               BNP                              26       58%                  45
                               Soc Gen                          16       40%                  40
                               Natixis                            3      30%                  10
                               RBS                              94       32%                292
                               TOTAL                           257       37%                694




 Regulation will lead to a polarisation in the investment banking industry
    – Scale will be a competitive advantage given the sector’s high operational leverage (elevated fixed cost base)
    – Heavy technological investments will be required, with the FICC business likely to move to electronic platform trading
      business.




                                                                        How will new regulation reshape the banking system? - 26/07/2012 - page 5
 3/ New regulation is putting pressure on cross-border lending
 Regulators are increasingly requesting liquidity to be ring-fenced
        – The UK independent commission for banking (“ICB”) is requesting the UK ring-fenced entity to be subject to minimum
          liquidity ratios on its own
        – The Austrian regulator recommended that Austrian banks’ foreign subsidiaries do not issue new loans in excess of 110%
          of available local funding.
        – Hungary, Romania and Bulgaria particularly at risk.

 Foreign subsidiaries’ compliance with the Basel 3 NSFR will also put pressure on intra-group funding
  and lending growth given the yet limited size of local debt capital markets.
                                                                                CEE countries will be most impacted…
 200%                                                                                           100%   Reduction in credit supply by European banks under the three IMF
                                                                                                               deleveraging scenarios (in % of total bank credit)


 150%                                                                                           75%




 100%                                                                                           50%




  50%                                                                                           25%




  0%                                                                                            0%
                                                                           SA


                                                                                  SLK
                  SLO


                         SRB




                                        RO


                                               BG


                                                      PL




                                                                                           CZ
         UKR




                                HU




                                                             RU


                                                                    TR




               Sector loan-to-deposits (LHS)   Assets controlled by European banks (RHS)




 Basel 3 creates a capital shortage: banks will seek to better optimize capital utilization by favouring
  multiproduct relationships over lending-only relationships, which tend to favour domestic clients.
        – Banks will however not stop funding their core clients’ off-shore projects.
                                                                                                        How will new regulation reshape the banking system? - 26/07/2012 - page 6
 4/ Basel 3 will reduce the amount of stable funding to the economy

 Banks will favour short-term lending over long-term lending to meet Basel 3 liquidity ratio.
 Banks will seek to gain large corporate (investment-grade) exposures through corporate bonds
  rather than lending.
                           Asset weighting        New                               Liability weighting                         New
          Asset                                             Liability
                           as per first draft   weighting                            as per first draft                       weighting
Cash                             0%                         All other liabilities            0%
Short-term unsecured <1Y         0%                         Wholesale funding 1Y-            50%
Repos                            0%                         Retail and SME deposits       70-85%                                  80-90%
Sovereign                        5%                         Wholesale funding 1Y+           100%
Corporate bonds AA+, >1Y         20%                        Tier 1 & Tier 2 capital         100%
Corporate bonds A-               50%
Corporate lending <1Y            50%
Retail loans <1Y                 85%
Mortgages                       100%              65%
All other assets                100%
Credit facilities                10%               5%


                                                                                                    Sources of corporate debt

 Corporate balance sheets might be weakened                   100%

                                                                90%
  (reduced availability of long-term funding for SMEs           80%                                      Borrowed from
  and greater reliance on volatile market funding for           70%
                                                                                                         banks

  large corporates).                                            60%                                      Obtained
                                                                                                         directly from the
                                                                50%                                      bond market
 This is already visible in the ECB banking surveys:           40%
  “Some further tightening is expected to affect large          30%

  firms (8%) rather than SMEs (2%), as well as                  20%

  primarily long-term loans”, April 2012.                       10%

                                                                 0%
                                                                        US Corporates       US All                           UK       Eurozone   Europe
                                                                                        Incorporations


                                                                   How will new regulation reshape the banking system? - 26/07/2012 - page 7
Domestic credit will also be impacted

 Smaller investment banking and international, activities, together with growing disintermediation for
  corporate funding will help reduce the size of the European banking system…




 900%
                            Banking system assets as a % of GDP                                                                                                                                              Loan to deposit ratios by region
 800%

 700%
                                                                                                                                                                                           120%
 600%
                                                                                                                                                                                           110%
 500%                                                                                                                                                                                                                                         Europe    Other regions
                                                                                                                                                                                           100%




                                                                                                                                                                                LDR 2011
 400%                                                                                                                        With a European
                                                                                                                             sized corporate
 300%                                                                                                                          bond market                                                 90%
                                                                                                                                                  Adding
                                                                                                                                                Mortgages
 200%                                                                                                                                          held in GSEs                                80%

 100%                                                                                                                                                                                      70%

  0%                                                                                                                                                                                       60%
                                     Denmark




                                                                                        Germany
                  UK




                                                                                                                                          US
                                                                                                  Belgium
        Ireland




                                               France




                                                                                                                                                        Canada
                                                                                                                     Italy
                                                        Netherlands

                                                                      Spain

                                                                              Austria




                                                                                                                              Australia




                                                                                                                                               Norway
                                                                                                            Sweden
                       Switzerland




                                                                                                                                                                 South Africa




                                                                                                                                                                                                  EUROPE      LatAm   Europe- with   Africa        US          Asia      Japan
                                                                                                                                                                                                                       a US sized                            ex Japan
                                                                                                                                                                                                                        corporate
                                                                                                                                                                                                                      bond market




                                                                                                                                                                                                                                                           Source: Barclays


                                                                                                                                                                                              How will new regulation reshape the banking system? - 26/07/2012 - page 8
 Domestic credit will also be impacted
 But closing the customer gap will still be needed through:
1. Re-intermediation of off-balance sheet assets, although this could be partially crowed out by State
   borrowing
– Italian banks selling their own retail bonds and term deposits instead of third-party bonds. Introduction of a more favorable fiscal
  regime for government bonds vs. other savings products.
– French banks trying to repatriate savings on balance-sheets:
        €bn
        60


        50


        40
                                                                                         2009
        30                                                                               2010
                                                                                         2011
        20


        10


         0
                  Net inflows (life insurance)   Net inflows (on-balance sheet savings
                                                                products)
         Source: OEE




2. And real lending deleveraging efforts :
– Key risk to growth is tightening conditions for investment loans.




                                                                                                Dotted lines show the IMF’s three deleveraging scenarios



                                                                                                How will new regulation reshape the banking system? - 26/07/2012 - page 9
 Domestic credit will also be impacted
2. And real lending deleveraging efforts :
– Key risk to growth is tightening conditions for investment loans.




                                      Source: IMF
                                      Dotted lines show the IMF’s three deleveraging scenarios




                                                                                  How will new regulation reshape the banking system? - 26/07/2012 - page 10
Summary




     01 New regulation is putting pressure on the size of the banking
        system…
     02 …but the risk of an abrupt shrinkage has more to do with the
        current sovereign crisis
     03 Regulation should be instrumental in avoiding future liquidity
        crisis but should not overshoot




                                      How will new regulation reshape the banking system? - 26/07/2012 - page 11
But what is at stake is the risk of an abrupt credit crunch
 The current risk of credit crunch has more to do with the current crisis.


                     Net % of banks contributing to tightening their credit standards, ECB
                                                                                                               Credit standards
                                                                                                               have tightened in
                                                                                                               H1 2012 with the
                                                                                                               worsening of the
                                                                                                               sovereign crisis.
                                                                                                               Recent relief in Q1
                                                                                                               is due the easing
                                                                                                               of banks and
                                                                                                               governments’
                                                                                                               funding access in
                                                                                                               the wake of the
                                                                                                               two LTROs (Dec
                                                                                                               and Feb).




                                                                  How will new regulation reshape the banking system? - 26/07/2012 - page 12
But what is at stake is the risk of an abrupt credit crunch
 Credit tightening has more to do with sovereign-related liquidity and capital issues rather than
  regulations.
         – Credit conditions for corporates: a net 87.5% of Italian banks reported tighter standards in Q4 vs 35% of
           European banks in the Q4 2011 ECB survey (25% vs. 9% respectively in the Q1 2012 survey)
         – Credit conditions for households: a net 87.5% of Italian banks reported tighter standards in Q4 vs 29% of
           European banks in the Q4 2011 ECB survey (37.5% vs. 17% respectively in the Q1 2012 survey)


Difficult wholesale funding access based on sovereign risk                                      Capital shortfall driven by net unrealized losses on bonds
                                         5 YR CDS spreads
                                                                                                              Country split of EBA's €106bn european banks capital shortfall
              SPAIN              ITALY              FRANCE       GERMANY            NORDICS
 800                                                                                                                              SWEDEN   NORWAY SLOVENIA
                                                                                                                           AUSTRIA 1%                0%
                                                                                                                                             1%
 700                                                                                                                         3%                        DENMARK
                                                                                                                            CYPRUS                        0%
 600                                                                                                                   BELGIUM3%
                                                                                                                         4%                                  GREECE
 500                                                                                                                                                          29%
                                                                                                                      GERMANY
                                                                                                                         5%
 400                                                                                                                  PORTUGAL
                                                                                                                         7%
 300

 200
                                                                                                                        FRANCE
                                                                                                                          8%
 100

   0
                                                                                           en




                                                                                                                                 ITALY                    SPAIN
Sa ter

   B B ll




                                                                           ed
                      n




                                                  P




                                                                  BK
                                     P




                                                                                    ls ea
                            BP



                                      I




                                                                                an No B
                                                 N
                           PS




                                                              Z
      VA




                                                  A
      de




                                   C
                    Sa




                                                             M
                                              BN
                                  IS




                                                                                N
                                               AS
                                                G




                                                                                        nk
     in




                                 U




                                                                       Sw



                                                                                  de rd




                                                                                                                                  14%                      25%
                                                                  D
                          M




                                                                            D
   ba




                                                             C
                                             SO
  nk




                                                                                      ba
                                             C
Ba




                                                                                H




                                                                                                Source: EBA

As at end of April 2012




                                                                                                    How will new regulation reshape the banking system? - 26/07/2012 - page 13
 …driven by market forces and a previous lack of regulation
Banks’ market funding costs were extrememly low…                                  $tr    Total market funding issued by European banks p.a.
                                                                        3 500


                                                                        3 000


                                                                        2 500


                                                                        2 000


                                                                        1 500


                                                                        1 000


                                                                            500


                                                                              0
                                                                                        2000   2001    2002   2003   2004   2005    2006   2007     2008     2009   2010   2011   2012
                                                                                                                                                                                  YTD
… creating a strong incentive for banks to leverage their balance sheets.
                                                                                  150%
                                                                                                      L/D Ratio European System

                                                                                  145%


                                                                                  140%


                                                                                  135%


                                                                                  130%


                                                                                  125%


                                                                                  120%
                                                                                    Jan-1999           Jan-2001      Jan-2003      Jan-2005       Jan-2007      Jan-2009     Jan-2011
                                                                                                                                                                            Source: ECB

                                                                            How will new regulation reshape the banking system? - 26/07/2012 - page 14
Monetary authorities are trying to smooth the process
 Authorities are seeking to avoid a severe credit crunch:
     – In Dec 2011 and Feb 2012 the ECB provided €530bn of net additional funding to European banks (LTROs
       take up less MRO transfers), equivalent to the amount of senior and covered bonds maturing over the next 12
       months.
     – Spanish and Italian banks have covered their 2012 maturities and invested in short-term government bonds.

  ECB Lending, Since End-Nov 11
  SPAIN                                                                                                     ITALY
  Source                                          Use                                                       Source                                                         Use
  ECB New Loans                           210 526 2012 debt maturities                         99 734       ECB New Loans                                          116 813 2012 debt maturities      45 764
  LT debt issued in 1Q12                    7 000 Sov Acqn                                     87 748       LT debt issued in 1Q12                                   5 931 Sov Acqn                  80 630
                                                  Balance                                      30 043                                                                      Balance              -     3 650
                                          217 526                                             217 526                                                              122 744                          122 744

  ECB new loans as a % of total assets           6%                                                         ECB new loans as a % of total assets                            3%




                                          1 200                                              ECB lending to commercial banks

                                          1 000

                                               800
                                         €bn




                                               600

                                               400

                                               200

                                                0
                                                     janv 07




                                                                         janv 08




                                                                                                  janv 09




                                                                                                                          janv 10




                                                                                                                                              janv 11




                                                                                                                                                                  janv 12
                                                               juil 07




                                                                                   juil 08




                                                                                                            juil 09




                                                                                                                                    juil 10




                                                                                                                                                        juil 11
                                                                                                                      How will new regulation reshape the banking system? - 26/07/2012 - page 15
Summary




     01 New regulation is putting pressure on the size of the banking
        system…
     02 …but the risk of an abrupt shrinkage has more to do with the
        current sovereign crisis
     03 Regulation should be instrumental in avoiding future liquidity
        crisis but should not overshoot




                                      How will new regulation reshape the banking system? - 26/07/2012 - page 16
                      The cost of financial crises might outweigh that of regulation
                      A survey of the Basel Committee on Banking Supervision (BSBC) estimates that the net present
                       value costs to output from financial crises range between 19% and 163% of annual GDP (with a
                       median estimate of 63%). The same survey estimates that financial crises occur approximately every
                       twenty to twenty-five years. So financial crisis would cost 3% of GDP per year.
                      According to a BIS paper published in 2010, the probability of systemic banking crisis is substantially
                       reduced for systems’ core tier 1 in excess of 9%.
                      The relationship between bank lending growth and GDP growth, although intuitively positive, is not
                       straightforward
                               – 1980s: the introduction of credit cards did not lead to stellar GDP growth
                               – Past periods of deleveraging show varying outcome for underlying economic growth.
                               – Credit crunch induced by banking crises negatively impact investments.


                     8%
                     7%
                     6%
Crisis Probability




                     5%
                     4%
                     3%
                     2%
                     1%
                     0%
                          6%    7%   8%   9%     10%    11%        12%   13%   14%   15%
                                               Core Tier 1 ratio


                                                                                           How will new regulation reshape the banking system? - 26/07/2012 - page 17
 Too much regulation kills regulation? The shadow banking system
 Shadow banking is defined as “the system of credit intermediation that involves entities and activities
  outside the regular banking system“ as per the FSB): insurance companies, asset managers, hedge
  funds, pension funds, non-regulated credit institutions…”
    – Non-rated private securitization placements (with more flexible collateral eligibility criteria)
    – Loans

 Liquidity and credit risks are being transferred to “unregulated” institutions. When regulated,
  regulation plays against this transfer (cf Insurance).
 Non-regulated shadow banking entities could pose systemic risk if connected to the banking system
  (ex: banking affiliates):
    – Risk of moral hazard,
    – Remember that US subprime loans were primarily originated by non banking institutions.

 Banking is a confidence business no matter what: regulators need to be pragmatic when deciding
  upon the final calibrations of the NSFR and LCR ratios (40% cap on level 2 assets, calibration of
  corporate deposit outflows).
                                              Excess return/capital requirement (%) of different asset classes under the draft solvency 2 rules


 The shadow banking
  system is particularly big
  in the US. Globally,
  shadow banking account
  for 25-30% of the financial
  system.


                                                                                                                 Source: Morgan Stanley/Oliver Wyman

                                                                          How will new regulation reshape the banking system? - 26/07/2012 - page 18
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                                                                                                         How will new regulation reshape the banking system? - 26/07/2012 - page 19

								
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