CFA Hawaii Institutional Investor Conference July 14, 2009 Thomas - PowerPoint PPT Presentation

CFA Hawaii Institutional Investor Conference July 14, 2009 Thomas V. McMahon Aaron Prince

Government Liquidity Programs Extended Expiration Date Usage Acronym Name Description Original Current Peak ($bn) Current ($bn) PDCF Primary Dealer Credit Facility Primary dealers obtain funds against groad range of collateral. 30-Jan-09 1-Feb-10 147 0 Banks borrow from the Fed to purchase ABCP from money AMLF ABCP Money Market Investor Funding Facility 30-Jan-09 1-Feb-10 152 16 market funds at amortized cost and zero risk-weighting. Primary dealers obtain Treasuries against collateral including Term Sercurities Lending Facility (Schedule 1) 30-Jan-09 13-Jul-09 agency debt and agency-gtd MBS. TSLF 236 7 Primary dealers obtain Treasuries against collateral including IG Term Sercurities Lending Facility (Schedule 2) 30-Jan-09 1-Feb-10 corporates, municipal, MBS and ABS. Fed buys CP, bank notes and CDs less than 90 days to maturity MMIFF Money Market Investor Funding Facility 30-Apr-09 31-Oct-09 0 0 from money markets. CPFF Commercial Paper Funding Facility Fed buys 3-month commercial paper from Tier 1 issuers. 30-Apr-09 1-Feb-10 351 124 Currency Swap Lines with 13 Central Banks Fed provides dollar liquidity to foreign central banks. 30-Apr-09 1-Feb-10 466 119 Guarantees money held in participating money market funds on Temporary Guarantee Program for Mmkt. Funds 29-Dec-08 18-Sep-09 - - September 19, 2008 against breaking the buck. Fed leverages $20 billion of TARP money to provide $200 billion TALF Term Asset-Backed Securities Loan Facility 31-Dec-09 31-Dec-09 25 25 in loans against consumer and SBA ABS 5 . Loan facility that provides 28 and 84-day funding against full n/a 1 n/a 1 TAF Term Auction Facility 493 283 range of discount window collateral. FDIC guarantees new issuance by financial companies maturing TLGP Temporary Liquidity Guarantee Program 30-Jun-09 30-Oct-09 336 335² prior to June 30, 2012. FDIC guarantees qualified non-interest bearing transaction 31-Dec-09 3 TAG Transaction Account Guarantee accounts above what is already guaranteed under the regular 30-Jun-09 - - deposit insurance program. Fed buys Fannie, Freddie and Home Loan debentures and 30-Jun-09 4 31-Dec-09 4 GSE Debt & MBS Purchase Program 564 564 Agency MBS. Treasury Purchase Program Fed buys $300 billion of Treasuries. 18-Mar-09 Sep-09 180 180 Source: Federal Reserve, Treasury, FDIC. As of 24 Jun 09 1 The TAF has no expiration date. 2 As of May 31, 2009 from the FDIC TLGP monthly report. 3 May be extended by the FDIC to June 30, 2010. 4 Purchases of GSE debt & MBS to be completed in "several quarters". MBS purchases expected to be completed by the end of 2009. 5 TALF was extended to include CMBS on May 18, 2009. 1

The Fed to the Rescue The Monetary Base (Size of Fed ΄ s Balance Sheet) 2100 350 1900 300 1700 250 1500 200 USD (billions) Percent/Year 1300 150 Monetary Base 6-Month 1100 100 Annualized Growth Scale Monetary Base Level (right scale) (left scale) 900 50 Y2K 9/11 700 0 500 -50 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Federal Reserve Board. As of 30 Jun 09 2

1930s Depression Money Stock Around 1930s Depression Velocity of Money Around 1930s Depression 60 3.5 50 3.0 Narrowly Defined Broadly Defined Money 2.5 USD (billions) 40 Money Times/Year 2.0 30 Narrowly Defined Money Broadly Defined Money 1.5 20 2nd "Leg" of 1st "Leg"of 1st "Leg" of 2nd "Leg" of Depression Depression Depression Depression 1.0 10 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 Source: Milton Friedman and Anna J. Schwartz, A Monetary History Of The United States, 1857-1960 Source: Milton Friedman and Anna J. Schwartz, A Monetary History Of The United States, 1857-1960 Velocity of money: Ratio of nominal income to money stock 3

2-Year Swap Spreads 180 160 140 120 Basis Points 100 80 60 40 20 0 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Source: Bloomberg. As of 30 Jun 09 4

Financial Crisis The TED Spread 6.0 6.0 1987 Stock Crash Enron Crisis 1990 Thrift Collapse Asian/LTCM Crises Subprime Crisis 5.0 5.0 Eurodollar Rates over T-Bill Rates (%) Eurodollar Rates over T-Bill Rates (%) 4.0 4.0 3.0 3.0 2.0 2.0 1.0 1.0 0.0 0.0 Oct 08-June 09 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Source: Federal Reserve Board. As of 30 Jun 09 TED Spread: Spread of 3-Month Euro$ Yields over 3-Month T-Bill Yields, using last month of quarter data. 5

Investment Grade Spreads Have Narrowed, However, Remain Extremely Elevated Barclays Capital U.S Corporate Index 700 600 500 OAS (basis points) 400 300 200 Monthly Historical Average: 126 bps 100 0 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Source: Barclays Capital. As of 30 Jun 09 Periods of recession highlighted in yellow. 6

Market Implied Annual and Cumulative Default Rates Investment Grade Avg Price: $99.31 Investment Grade OAS: 306 bps Yield to Worst: 5.98% 30% Recovery Year 1 Year 2 Year 3 Year 4 Year 5 Annual Default Rate 5.3% 5.3% 5.3% 5.3% 5.3% Cumulative Default Rate 5.3% 9.4% 13.3% 17.0% 20.6% 40% Recovery Year 1 Year 2 Year 3 Year 4 Year 5 Annual Default Rate 6.1% 6.1% 6.1% 6.1% 6.1% Cumulative Default Rate 6.1% 10.8% 15.3% 19.6% 23.6% Source: Barclays Capital, Bloomberg. As of 30 Jun 09 Default Rates, Investment-Grade Corporates 40 30 5-Year Default Rate Implied by Market Pricing 30 Jun 09 (20.6%)* Percent 20 5-Year Cumulative Rate of Historical Defaults, 10 Investment-Grade Corporates 0 1924 1934 1944 1954 1964 1974 1984 1994 2004 Source: Moody's, Barclays Capital, Bloomberg 7

Market Implied Annual and Cumulative Default Rates High-Yield Avg Price: $80.29 High-Yield OAS: 945 bps Yield to Worst: 12.28% 20% Recovery Year 1 Year 2 Year 3 Year 4 Year 5 Annual Default Rate 13.6% 13.6% 13.6% 13.6% 13.6% Cumulative Default Rate 13.6% 23.3% 32.0% 39.6% 46.4% 30% Recovery Year 1 Year 2 Year 3 Year 4 Year 5 Annual Default Rate 15.4% 15.4% 15.4% 15.4% 15.4% Cumulative Default Rate 15.4% 26.2% 35.6% 43.8% 51.0% 40% Recovery Year 1 Year 2 Year 3 Year 4 Year 5 Annual Default Rate 17.7% 17.7% 17.7% 17.7% 17.7% Cumulative Default Rate 17.7% 29.8% 40.2% 49.0% 56.5% Source: Western Asset. 30 Jun 09 closing levels for Barclays and 5-year swap rate Default Rates, Speculative-Grade Bonds 60 50 5-Year Cumulative Rate of Historical 5-Year Default Rate Based on 20% recovery implied by Defaults, Speculative-Grade Bonds Market Pricing 30 Jun 09 (46.4% ) 40 Percent Moody’s US Pessimistic 5-year Cumulative Default Forecast: 28.69% 30 20 Moody’s US Baseline 5-year Cumulative Default Forecast: 22.32% 10 0 1924 1934 1944 1954 1964 1974 1984 1994 2004 Source: Moody's, Barclays Capital, Bloomberg. As of 30 Jun 09 8

Investment Grade Credit Fundamentals Through 1Q 2009 Leverage 3.0 Debt/EBITDA Ratio (x) 2.5 2.0 1.5 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Source: Morgan Stanley. As of 31 Mar 09 Interest Coverage 13.0 EBITDA/Interest (x) 11.0 9.0 7.0 5.0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Source: Morgan Stanley. As of 31 Mar 09 Total Cash/Total Debt Total Cash/Total Debt (%) 25 20 15 10 5 0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Source: Morgan Stanley. As of 31 Mar 09 9

Deleveraging at Broker/Dealers Has Been Massive – Result Has Been Reduced Liquidity Broker/Dealer Holdings 450 400 350 300 USD (billions) 250 200 150 100 50 0 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 Source: Federal Reserve Bank's Flow of Funds Statement. As of 31 Dec 08 10

Net Purchases of U.S. Corporate Bonds by Foreign Entities Monthly Net Purchases 12-Month Rolling Average 80000 70000 60000 50000 40000 USD (billions) 30000 20000 10000 0 -10000 -20000 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Department of Treasury. As of 30 Apr 09 11

Possible Shortage of Investment Grade Corporate Bonds Should Support Spread Narrowing DEMAND for Investment Grade Corporate Bonds *SUPPLY of Investment Grade Corporqate Bonds Redemptions Non- Financial Issuance $500bn Financials $500bn Non-Financials $155bn Financial Issuance $150bn ex-gov't guaranteed Market Growth $222bn assume conservative 5% New Demand from non-traditional investors ? Total Demand Total Supply $877bn $650bn Source:JP Morgan *Estimates:JPMorgan 12

Sell-offs Have Historically Been Followed by Rallies in the Credit Sector Corporate Index 12-Month Rolling Excess Returns 10 5 0 -5 -10 -15 -20 -25 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: Barclays Capital. As of 30 Apr 09 13

Sell-offs Have Historically Been Followed by Rallies in the High Yield Sector High Yield Index 12-Month Rolling Excess Returns 40 30 20 10 0 -10 -20 -30 -40 -50 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source: Barclays Capital. As of 30 Apr 09 14