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

CFA Hawaii Institutional Investor Conference

July 14, 2009

Aaron Prince Thomas V. McMahon

1

Government Liquidity Programs Extended

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 AMLF ABCP Money Market Investor Funding Facility Banks borrow from the Fed to purchase ABCP from money market funds at amortized cost and zero risk-weighting. 30-Jan-09 1-Feb-10 152 16 Term Sercurities Lending Facility (Schedule 1) Primary dealers obtain Treasuries against collateral including agency debt and agency-gtd MBS. 30-Jan-09 13-Jul-09 Term Sercurities Lending Facility (Schedule 2) Primary dealers obtain Treasuries against collateral including IG corporates, municipal, MBS and ABS. 30-Jan-09 1-Feb-10 MMIFF Money Market Investor Funding Facility Fed buys CP, bank notes and CDs less than 90 days to maturity from money markets. 30-Apr-09 31-Oct-09 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 Temporary Guarantee Program for Mmkt. Funds Guarantees money held in participating money market funds on September 19, 2008 against breaking the buck. 29-Dec-08 18-Sep-09

• TALF

Term Asset-Backed Securities Loan Facility Fed leverages $20 billion of TARP money to provide $200 billion in loans against consumer and SBA ABS5. 31-Dec-09 31-Dec-09 25 25 TAF Term Auction Facility Loan facility that provides 28 and 84-day funding against full range of discount window collateral. n/a1 n/a1 493 283 TLGP Temporary Liquidity Guarantee Program FDIC guarantees new issuance by financial companies maturing prior to June 30, 2012. 30-Jun-09 30-Oct-09 336 335² TAG Transaction Account Guarantee FDIC guarantees qualified non-interest bearing transaction accounts above what is already guaranteed under the regular deposit insurance program. 30-Jun-09 31-Dec-093

• GSE Debt & MBS Purchase Program

Fed buys Fannie, Freddie and Home Loan debentures and Agency MBS. 30-Jun-094 31-Dec-094 564 564 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

1The TAF has no expiration date. 2As of May 31, 2009 from the FDIC TLGP monthly report. 3May be extended by the FDIC to June 30, 2010. 4Purchases of GSE debt & MBS to be completed in "several quarters". MBS purchases expected to be completed by the end of 2009. 5TALF was extended to include CMBS on May 18, 2009.

TSLF 236 7 Expiration Date Usage Acronym Name Description

2

The Fed to the Rescue

The Monetary Base (Size of Fed΄s Balance Sheet) Monetary Base Level (left scale) Monetary Base 6-Month Annualized Growth Scale (right scale) 500 700 900 1100 1300 1500 1700 1900 2100 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 USD (billions)

• 50

50 100 150 200 250 300 350 Percent/Year

Source: Federal Reserve Board. As of 30 Jun 09

9/11 Y2K

3

1930s Depression

Velocity of Money Around 1930s Depression 1st "Leg"of Depression Narrowly Defined Money Broadly Defined Money 1.0 1.5 2.0 2.5 3.0 3.5 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 Times/Year

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

2nd "Leg" of Depression Money Stock Around 1930s Depression 1st "Leg" of Depression Narrowly Defined Money Broadly Defined Money 10 20 30 40 50 60 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 USD (billions)

Source: Milton Friedman and Anna J. Schwartz, A Monetary History Of The United States, 1857-1960

2nd "Leg" of Depression

4

2-Year Swap Spreads

20 40 60 80 100 120 140 160 180 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Basis Points

Source: Bloomberg. As of 30 Jun 09

5

Financial Crisis

1987 Stock Crash 1990 Thrift Collapse Asian/LTCM Crises Enron Crisis Subprime Crisis 0.0 1.0 2.0 3.0 4.0 5.0 6.0 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Eurodollar Rates over T-Bill Rates (%)

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.

The TED Spread 0.0 1.0 2.0 3.0 4.0 5.0 6.0 Eurodollar Rates over T-Bill Rates (%) Oct 08-June 09

6

Investment Grade Spreads Have Narrowed, However, Remain Extremely Elevated

Barclays Capital U.S Corporate Index 100 200 300 400 500 600 700 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 OAS (basis points)

Source: Barclays Capital. As of 30 Jun 09 Periods of recession highlighted in yellow.

Monthly Historical Average: 126 bps

7

Default Rates, Investment-Grade Corporates 10 20 30 40 1924 1934 1944 1954 1964 1974 1984 1994 2004 Percent 5-Year Default Rate Implied by Market Pricing 30 Jun 09 (20.6%)*

Source: Moody's, Barclays Capital, Bloomberg

5-Year Cumulative Rate of Historical Defaults, Investment-Grade Corporates

Market Implied Annual and Cumulative Default Rates

$99.31 306 bps 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

Yield to Worst: Investment Grade OAS: Investment Grade Avg Price:

8

Market Implied Annual and Cumulative Default Rates

$80.29 945 bps 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

Yield to Worst: High-Yield OAS: High-Yield Avg Price: Default Rates, Speculative-Grade Bonds 10 20 30 40 50 60 1924 1934 1944 1954 1964 1974 1984 1994 2004 Percent

5-Year Default Rate Based on 20% recovery implied by Market Pricing 30 Jun 09 (46.4% )

Source: Moody's, Barclays Capital, Bloomberg. As of 30 Jun 09

5-Year Cumulative Rate of Historical Defaults, Speculative-Grade Bonds Moody’s US Pessimistic 5-year Cumulative Default Forecast: 28.69% Moody’s US Baseline 5-year Cumulative Default Forecast: 22.32%

9

Investment Grade Credit Fundamentals

Through 1Q 2009

Leverage 1.5 2.0 2.5 3.0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Debt/EBITDA Ratio (x)

Source: Morgan Stanley. As of 31 Mar 09

Total Cash/Total Debt 5 10 15 20 25 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Total Cash/Total Debt (%)

Source: Morgan Stanley. As of 31 Mar 09

Interest Coverage 5.0 7.0 9.0 11.0 13.0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 EBITDA/Interest (x)

Source: Morgan Stanley. As of 31 Mar 09

10

50 100 150 200 250 300 350 400 450 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 USD (billions) Broker/Dealer Holdings

Source: Federal Reserve Bank's Flow of Funds Statement. As of 31 Dec 08

Deleveraging at Broker/Dealers Has Been Massive – Result Has Been Reduced Liquidity

11

Net Purchases of U.S. Corporate Bonds by Foreign Entities

• 20000
• 10000

10000 20000 30000 40000 50000 60000 70000 80000 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 USD (billions) Monthly Net Purchases 12-Month Rolling Average

Source: Department of Treasury. As of 30 Apr 09

12

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 $877bn Total Supply $650bn

Source:JP Morgan *Estimates:JPMorgan

13

Sell-offs Have Historically Been Followed by Rallies in the Credit Sector

• 25
• 20
• 15
• 10
• 5

5 10 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Corporate Index 12-Month Rolling Excess Returns

Source: Barclays Capital. As of 30 Apr 09

14

Sell-offs Have Historically Been Followed by Rallies in the High Yield Sector

• 50
• 40
• 30
• 20
• 10

10 20 30 40 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 High Yield Index 12-Month Rolling Excess Returns

Source: Barclays Capital. As of 30 Apr 09

15

Note: Western Asset experience reflects current position title and hire date.

Biographies

AARON PRINCE

21 Years Experience

– Western Asset Management Company – Client Service Executive, 2007- – AFL-CIO Investment Trusts – Western Regional Director, General Manager, 1996-2007 – CS First Boston – Fixed Income Arbitrage Associate, 1994-1995 – Bear Stearns – Fixed Income Vice President, 1992-1994 – Boston Redevelopment Authority – Acting Chief of Staff, Special Assistant, 1986-1992 – Mass. Institute of Technology, Sloan School of Management, M.B.A. – University of Pennsylvania, B.A. THOMAS V. McMAHON

30 Years Experience

– Western Asset Management Company – Product Specialist, 2001- – Credit Suisse First Boston – Vice President, Corporate Bond Specialist, 1996-2001 – J.P. Morgan Securities – Vice President, Fixed Income Sales, 1992-1996 – Donaldson, Lufkin & Jenrette – Vice President, Fixed Income Sales, 1983-1992 – E.F. Hutton – Fixed Income Sales Executive, 1979-1983 – University of Richmond, B.A.