M EMORANDUM To: Board of Trustees, Fresno Country Employees - - PDF document

SLIDE 1

W U R T S A S S O C I A T E S

Institutional Investment Consultants Seattle and Los Angeles

MEMORANDUM

To: Board of Trustees, Fresno Country Employees’ Retirement Association From: Jeffrey MacLean, Wurts & Associates Date: May 1, 2008 Re: Counterparty Risk In light of the recent problems confronting Bear Stearns, the FCERA Board of Trustees directed Wurts & Associates to inquire about the counterparty exposures within the fixed income portfolios. A memorandum was sent to Western Asset Management Company (“WAMCO”), Blackrock, Loomis Sayles, Bradford & Marzec, and GMO to provide the following:

• Detailed list of all counterparty exposures in the portfolio
• Information about the initial due diligence process and on-going review procedures of all

counterparties

• An opinion about the current status of counterparty risk given the current market conditions.

While Wurts & Associates cannot provide an opinion on the relative security of any of the counterparty positions within the portfolio nor can we say for sure that an adverse event will never

• ccur, we believe the managers employed by FCERA understand the risks associated with these

investments and are qualified to prudently manage these securities. We have compiled each manager’s response for easy reference. Please feel free to call me anytime at 310.297.1777 should you have any questions. Otherwise, I look forward to discussing this issue at the May 7th meeting.

SLIDE 2

Fresno County Employees’ Retirement Association

Counterparty Risk Exposure

May 7, 2008

999 Third Avenue, Suite 3650 Seattle, Washington 98104 206.622.3700 2321 Rosecrans Avenue, Suite 2250 El Segundo, California 90245 310.297.1777

SLIDE 3

Western Asset Management Company (WAMCO).…………………………….Tab I BlackRock………………………………………...…………………………….Tab II Loomis, Sayles & Company…………………………………………………….Tab III Bradford & Marzec……….…………………………………………………….Tab IV GMO…………………………………………..……………………………….Tab V

Counterparty Risk Exposure Table of Contents

Wurts & Associates

SLIDE 4

I. WAMCO

SLIDE 5

Mkt Val % of Pf Mkt Val % of Pf Bank of America

• 3,281

0.00% Barclays

• 284,637
• 0.14%

2,438 0.00% Credit Suisse

• 367,171
• 0.18%

26,360 0.01% Deutsche Bank 299,067 0.14% Goldman Sachs

• 107,785
• 0.05%

JPMorgan

• 4,950

0.00% Lehman 3,000 0.00% Merrill Lynch 82,033 0.04% Swap TBA

Western Asset Management Company Summary of SWAP & TBA Positions

SLIDE 6

Asset ID Holdings Security Description Notional Market Price Market Value Duration Broker

0WP056112

• 1,500.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.8 Yr Zero Leg
• 1,500,000.00

100.0000

• 1,500,000.00

0.00000 Barclays Capital Inc (PAS) 0WP056195

• 1,000.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.8 Yr Zero Leg
• 1,000,000.00

100.0000

• 1,000,000.00

0.00000 Barclays Capital Inc (PAS) 0WP056872

• 400.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.8 Yr Zero Leg
• 400,000.00

100.0000

• 400,000.00

0.00000 Barclays Capital Inc (PAS) 0WR056110 1,500.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.8 Yr 1,500,000.00 90.1599 1,352,773.80 0.00000 Barclays Capital Inc (PAS) 0WR056193 1,000.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.8 Yr 1,000,000.00 90.1599 901,849.20 0.00000 Barclays Capital Inc (PAS) 0WR056870 400.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.8 Yr 400,000.00 90.1599 360,739.68 0.00000 Barclays Capital Inc (PAS) 0WP077837

• 2,998.31 CDS-ABX @ 18 bps 37.4 Yr Zero Leg VTG# 06-1
• 2,998,310.51

100.0000

• 2,998,310.51

0.00000 Credit Suisse First Boston Inc (PAS) 0WP077936

• 499.72 CDS-ABX @ 18 bps 37.4 Yr Zero Leg VTG# 06-1
• 499,718.42

100.0000

• 499,718.42

0.00000 Credit Suisse First Boston Inc (PAS) 0WR077835 2,998.31 CDS-ABX @ 18 bps 37.4 Yr VTG# 06-1 2,998,310.51 89.5000 2,683,592.85 0.00000 Credit Suisse First Boston Inc (PAS) 0WR077934 499.72 CDS-ABX @ 18 bps 37.4 Yr VTG# 06-1 499,718.42 89.5000 447,265.48 0.00000 Credit Suisse First Boston Inc (PAS) 0WP054273

• 4,500.00 IR Swap 3MO LIBOR
• 4,500,000.00

100.0527

• 4,515,117.30
• 0.00328 Deutsche Bank Securities Inc (PAS)

0WP077811

• 699.61 CDS-ABX @ 18 bps 37.4 Yr Zero Leg VTG# 06-1
• 699,605.79

100.0000

• 699,605.79

0.00000 Deutsche Bank Securities Inc (PAS) 0WP077852

• 500.00 CDS-ABX @ 11 bps 38.2 Yr Zero Leg VTG# 06-2
• 500,000.00

100.0000

• 500,000.00

0.00000 Deutsche Bank Securities Inc (PAS) 0WP077951

• 299.83 CDS-ABX @ 18 bps 37.4 Yr Zero Leg VTG# 06-1
• 299,831.05

100.0000

• 299,831.05

0.00000 Deutsche Bank Securities Inc (PAS) 0WP079015

• 9,400.00 IR Swap 3.8% Fixed
• 9,400,000.00

98.6468

• 9,272,798.26
• 0.32164 Deutsche Bank Securities Inc (PAS)

0WR054271 4,500.00 IR Swap 5.27% Fixed 4,500,000.00 108.8570 4,979,589.45 0.09911 Deutsche Bank Securities Inc (PAS) 0WR077819 699.61 CDS-ABX @ 18 bps 37.4 Yr VTG# 06-1 699,605.79 89.5000 626,171.67 0.00000 Deutsche Bank Securities Inc (PAS) 0WR077850 500.00 CDS-ABX @ 11 bps 38.2 Yr VTG# 06-2 500,000.00 75.2300 376,160.69 0.00000 Deutsche Bank Securities Inc (PAS) 0WR077959 299.83 CDS-ABX @ 18 bps 37.4 Yr VTG# 06-1 299,831.05 89.5000 268,359.28 0.00000 Deutsche Bank Securities Inc (PAS) 0WR079013 9,400.00 IR Swap 3MO LIBOR 9,400,000.00 99.3206 9,336,138.28 0.01126 Deutsche Bank Securities Inc (PAS) 0WP055957

• 1,600.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 5 Yr Zero Leg
• 1,600,000.00

100.0000

• 1,600,000.00

0.00000 Goldman Sachs Group Inc (PAS) 0WP056534

• 800.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 5 Yr Zero Leg
• 800,000.00

100.0000

• 800,000.00

0.00000 Goldman Sachs Group Inc (PAS) 0WP060239

• 900.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.9 Yr Zero Leg
• 900,000.00

100.0000

• 900,000.00

0.00000 Goldman Sachs Group Inc (PAS) 0WP067614

• 7,410.00 CDS-CDX.NA.IG.8 @ 35 bps 4.7 Yr Zero Leg
• 7,410,000.00

100.0000

• 7,410,000.00

0.00000 Goldman Sachs Group Inc (PAS) 0WP067630

• 4,450.00 CDS-CDX.NA.IG.8 @ 60 bps 9.7 Yr
• 4,450,000.00

93.8076

• 4,175,327.31

0.00000 Goldman Sachs Group Inc (PAS) 0WR055955 1,600.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 5 Yr 1,600,000.00 90.1599 1,442,958.72 0.00000 Goldman Sachs Group Inc (PAS) 0WR056532 800.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 5 Yr 800,000.00 90.1599 721,479.36 0.00000 Goldman Sachs Group Inc (PAS) 0WR060237 900.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.9 Yr 900,000.00 90.1599 811,664.28 0.00000 Goldman Sachs Group Inc (PAS) 0WR067612 7,410.00 CDS-CDX.NA.IG.8 @ 35 bps 4.7 Yr 7,410,000.00 95.1495 7,051,440.23 0.00000 Goldman Sachs Group Inc (PAS) 0WR067638 4,450.00 CDS-CDX.NA.IG.8 @ 60 bps 9.7 Yr Zero Leg 4,450,000.00 100.0000 4,450,000.00 0.00000 Goldman Sachs Group Inc (PAS) COLLATERAL 300,000.00 Goldman Sachs Group Inc (PAS) 0WP056856

• 900.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.8 Yr Zero Leg
• 900,000.00

100.0000

• 900,000.00

0.00000 JP Morgan Securities Inc (PAS) 0WP071152

• 8,320.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.6 Yr Zero Leg
• 8,320,000.00

100.0000

• 8,320,000.00

0.00000 JP Morgan Securities Inc (PAS) 0WR056854 900.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.8 Yr 900,000.00 90.1599 811,664.28 0.00000 JP Morgan Securities Inc (PAS) 0WR071150 8,320.00 CDS-CDX.NA.IG.HVOL.8 @ 75 bps 4.6 Yr 8,320,000.00 90.1599 7,503,385.34 0.00000 JP Morgan Securities Inc (PAS) COLLATERAL 900,000.00 JP Morgan Securities Inc (PAS)

SWAP Positions

SLIDE 7

CUSIP COUPON SECURITY_NAME ORIG TRANSACTION_TYPE BROKER_NAME TRADE_DATE SETTLE_DATE PRICE PRINCIPAL 02R060647 6 FHLMC - GOLD 30YR APR FWD 700000 BUY BA SECURITIES INC 2/20/2008 4/14/2008 100.75000000 705250 02R060647 6 FHLMC - GOLD 30YR APR FWD

• 700000 SELL

BA SECURITIES INC 2/21/2008 4/14/2008 101.21875000

• 708531.25

CUSIP COUPON SECURITY_NAME ORIG REMAINPAR BROKER_NAME TRADE_DATE SETTLE_DATE PRICE NET $ 01F052649 5.5 FNMA 30YR 200000 200000 BARCLAYS US FUNDING CORP 3/4/2008 4/14/2008 99.71875 2437.5 01F050643 5 FNMA 30YR 1400000 1400000 FIRST BOSTON 2/21/2008 4/14/2008 97.0859375 26360.075 01F060444 6 FNMA 15YR 480000 480000 LEHMAN BROTHERS 3/7/2008 4/17/2008 102.28125 2999.76 01F050643 5 FNMA 30YR 2500000 2500000 MERRILL LYNCH 2/25/2008 4/14/2008 95.6875 82032.5

TBA Positions

SLIDE 8

Counterparty Risk Management

Certain transactions that Western Asset enters into on behalf of clients expose their assets to a risk that the counterparty in the transaction may default before the transaction is concluded. This counterparty risk must be identified, measured and monitored. Outlined below are Western Asset’s policies and guidelines for counterparty exposure and limits in our client portfolios. This paper outlines the criteria necessary for a dealer to be considered as a counterparty for Western Asset client transactions. In addition, we describe the calculation of counterparty credit risk by transaction type and how credit risk is aggregated across the total portfolio. Counterparty Criteria Western Asset’s Brokerage Review Committee (“the Committee”) maintains an Approved List of counterparties for client transactions. For counterparty tracking purposes the Approved List is further broken down into two lists. The first list includes those counterparties approved for transactions that contain more than deminimus counterparty credit risk exposure. Such transactions may include: swaps, foreign exchange forwards and options, repurchase agreements, mortgage TBAs and OTC options (“List A”). The second list includes all brokers approved for client transactions where the exposure to counterparty credit risk is viewed as minimal. These transactions include regular way settlement transactions (non-derivative trades that settle within three business days) and exchange traded derivatives contracts (the exchange is in effect the counterparty for these transactions) (“List B”). Each counterparty is reviewed by members of Western Asset’s credit group prior to approval. Credit review includes analysis of the counterparty’s capital adequacy, profitability, liquidity and

• ther factors as may be appropriate. The credit group assigns a rating to the counterparty

indicating whether they are approved for List A transactions and/or List B transactions. In addition to the credit review, counterparties are evaluated on execution capability, pricing, responsiveness, specialist credentials, research and back-office capabilities. The Committee reviews additions to the Approved Lists quarterly with a thorough re-evaluation

• f all counterparties annually.

Credit Risk Exposures The majority of Western Asset’s trades involve very little counterparty credit risk. Once a trade is done and settled our exposure to the broker is over. As described before, counterparty credit risk is only created when we rely on the broker to make future payments or forward settle a trade beyond the normal period. While this is obvious for multi-year swaps transactions, there are other transactions that also create counterparty credit risk. When aggregating Western Asset’s total credit exposure to each counterparty it is important to also take into account all of these transactions. The types of transactions where Western Asset potentially takes on counterparty risk can be broken down as follows:

• Repurchase Transactions
• Mortgage TBAs
• Interest Rate Swaps/Swaptions

SLIDE 9

• Credit Default and Index Swaps
• OTC Options
• Foreign Exchange (FX) forwards/options

What is Western’s credit exposure in these trades? We have relied on the standards set forth by the Bank of International Settlements (“BIS”) which states: “The treatment of forwards, swaps, purchased options and similar derivative contracts needs special attention because banks are not exposed to credit risk for the full face amount of their contracts, but only to the potential cost of replacing the cash flow (on contracts showing positive value) if the counterparty defaults.” In other words, since these trades do not involve the exchange of principal at the outset, our risk is not that we would lose our original investment but that we may not be able to realize the mark- to-market gain on an outstanding contract. (Obviously, if our position is at a loss and a counterparty defaults it does not affect us.) The one special case where we must be concerned with principal invested is when we own any of a dealer’s debt securities. This must be treated like any other corporate credit and monitored as part of Western’s corporate credit review process. In general, current credit exposure for a transaction is calculated as follows:

• Plus (+) principal paid/received for a security/contract.
• Plus (+) the change in the mark-to market value of the security contract from the trade

date in which it was purchased or sold. In addition one should include a factor to estimate projected future exposure. Western Asset utilizes add-ons for future credit risk based on the BIS’s estimates. These add-ons are intended to capture the volatility of each underlying instrument based the instrument type and its term to

• maturity. For any outstanding transaction the factor is multiplied by the full notional value of the

trade to determine the additional amount of potential future credit exposure.

BIS Future Risk Factors Based on Residual Maturity and Applied to Notional Value Residual Maturity Interest Rate Exchange Rate & Gold Equity Precious Metals Except Gold Other Commodities One Year or Less 0.00% 1.00% 6.00% 7.00% 10.00% Over 1 Yr Up to 5 Yrs 0.50% 5.00% 8.00% 7.00% 12.00% Over 5 Yrs 1.50% 7.50% 10.00% 8.00% 15.00%

Applying the above formula and risk factor table to each type of transaction results in the following:

• 1. Repurchase Transactions- With few exceptions, Western Asset only enters into overnight

repurchase agreements of high quality collateral at 102% of the market value. Western Asset client accounts take delivery of these securities so that if the counterparty was to default the client has the legal right to liquidate the collateral and retain the proceeds.

SLIDE 10

Because of these two factors the credit exposure is zero. In cases where Western Asset utilizes term repurchase agreements any exposure to the counterparty in excess of collateral held would be viewed as credit exposure.

• 2. Mortgage TBA’s- Mortgage TBAs are forward-settling trades where generally no

collateralization is required. Most TBA trades settle every month; with Western Asset’s settlement period normally not longer than three months. Although the risk factor table does not specifically list TBA mortgages, Western Asset views them as forward interest rate contracts of less than one year in maturity. The credit exposure is therefore the current mark-to-market of the position and no add-on is required for future credit risk.

• 3. Interest Rate Swaps/Swaptions- Interest rate swaps and swaptions fall under the

governance of the International Swaps and Derivatives Association, Inc. (ISDA) master agreement that contains procedures for collateralization and strict definitions of termination events in case of credit problems by either counterparty. Interest rate swaps executed at the current market rate do not involve any exchange of principal. Western Asset’s swaps will generally be marked to market or rolled forward and the market values reset to zero semiannually. The counterparty credit exposure is then calculated as the sum

• f any initial mark paid, the current mark-to-market value of the swap, and an add-on for

future risk equal to 0.5% of the notional value. Any collateral held by Western Asset is then subtracted from this exposure. For swaptions, the initial premium paid/received is substituted for the initial mark.

• 4. Index and Credit Default Swaps- Index and credit default swaps also fall under the

governance of an ISDA master agreement. The counterparty credit risk in these transactions is the same as for interest rate swaps except that in the risk factor table these swaps should be considered as equity. This means that index or credit default swaps are subject to a minimum 6% risk factor provided that their maturity or reset date is less than

• ne year.
• 5. OTC Options- OTC options may or may not fall under an ISDA master agreement and
• ften contain language regarding collateralization. For any OTC options not covered by

an ISDA agreement, the counterparty credit exposure for OTC options is the sum of the premium paid/received plus any current mark-to-market plus any add-on that is dependent on the underlying asset. OTC options covered under an ISDA which have collateral held by Western Asset would have that collateral subtracted from their

• exposure. For example, options on agency securities would be considered as interest rate

contracts but options on an equity index would be considered equity.

• 6. Foreign Exchange (FX) forwards/options- Western Asset uses FX forwards and options

to hedge the currency exposure of bonds held in the portfolio. These transactions generally have maturities of less than one year. Although once a purely OTC market, these contracts are now becoming subject to ISDA rules which may allow for

• collateralization. In these instances the procedure is the same as for swaps. The calculated

counterparty credit exposure in a currency forward of one year or less (not subject to an ISDA) is the current mark-to-market value of the forward plus 1.0% of the notional value.

• 7. Ownership of dealer issued debt securities- The credit risk of any obligation issued by a

dealer (where exposure is the secured or unsecured credit of the dealer) is the current

SLIDE 11

market value of the security. Dealer issued debt that is backed by other credit such as pools of mortgages or other asset collateral is not counted. Collateralization Banks and securities dealers have learned that trading with relatively risky counterparties without any secured assets behind each trade raises their exposure to loss, particularly when financial markets are volatile. As a result of this experience, exchanging collateral as the transaction’s market value fluctuates is now the norm. Western Asset has adopted a collateral policy governed by executed ISDAs and Credit Support Annexes with each counterparty. Under Western Asset’s executed ISDAs, allowable collateral can generally be in the form of cash, treasury securities or guaranteed agency securities. Aggregating Credit Exposure A portfolio’s aggregate exposure to a counterparty is calculated by summing :

• Net ISDA counterparty exposure less collateral held under a Credit Support Annex (subject

to a minimum amount of zero).

• Plus (+) ownership of dealer issued debt securities (zero if none are owned).
• Plus (+) positive credit exposure of mortgage TBAs (adding only contracts with gains).
• Plus (+) positive credit exposure of any non-ISDA FX or OTC option (adding only

contracts with gains). Counterparty Credit Limits Western Asset treats counterparty exposure as though we were investing in the credit of each

• firm. Since Western Asset has already established issuer limits for each account (generally no

more than 5% of an account’s value can be invested in a single issuer) we treat counterparty credit exposure the same way and impose similar limitations. Specifically, Western Asset’s policy is to have no more than a 3% credit exposure to counterparties who carry an “A” or when not rated who’s parent carries an “A” rating and 5% to counterparties (or their parent) who are rated “AA”. Summary Counterparty risk and exposure are important elements in the management of client portfolios. In

• rder to manage and mitigate risks related to counterparties, Western Asset has established

criteria for the approval of counterparties, has negotiated master agreements to ensure adequate credit and legal protection for our client’s portfolios and has established limits on the aggregate credit exposure to each counterparty.

SLIDE 12

Western Asset Management Company Counterparty Risk Frequently Asked Questions March 25, 2008

• 1. What is your process for approving broker counterparties?

Western Asset maintains an Approved Broker List that is designed to include brokers who demonstrate desk strength, knowledgeable sales coverage, quality research, capital commitment and financial stability. Trades may only be executed with those brokers on the list. Prior to addition to the approved list a broker must be reviewed and approved by the Firm’s Credit Group. Once the Credit Group has approved a broker it may be added to Western’s systems and utilized as a trading

• partner. All changes made to the Approved Broker List are presented for

ratification by the Broker Review Committee at its next meeting. Western Asset’s credit team evaluates all approved counterparties to determine those who will be approved for transactions that involve counterparty risk (e.g. Swaps, FX and TBA trades). Western only approves brokers of high credit quality for these type of transactions.

• 2. What is your process for evaluating and monitoring counterparty risk?

The attached document, Counterparty Risk Management, describes Western Asset’s process for measuring and monitoring counterparty exposure. Aggregate exposures are monitored by portfolio and include the direct debt of the counterparty, mark-to-market of forward settling trades and mark-to-market (less collateral held) for Swaps, OTC Options and Forward exchange contracts. Currently Western Asset limits counterparty exposure to a maximum of 5% for AA rated counterparties and 3% for A rated counterparties.

• 3. Do we have credit exposure to our clearing broker?

Exchange traded futures and options are valued daily. Funds are then moved based

• n the change in market value with a one day lag. E.g. any funds owed today due

to a change in value would be received tomorrow. Therefore, counterparty exposure for exchange traded derivatives is limited to a one day price movement in the derivative positions. Each exchange requires Futures Clearing Members (“FCM”) to post funds with the exchange to mitigate counterparty default risk. This collateral is in the form of securities or cash. In the event of a default by a counterparty, the exchange’s guarantee fund would be utilized to protect customers. In addition, exchanges carry insurance coverage to further protect in the event of a default by an FCM. Client’s initial margin posted with clearing brokers is held in a segregated account for the benefit of each client at a clearing bank. The Commodity Exchange Act and CFTC rules require all FCMs to deposit client margin in segregated accounts and prohibit the use of client assets by the FCM.

SLIDE 13

• 4. What is the process for collateralizing swaps positions?

All of Western Asset’s swaps transactions are executed subject to a master ISDA and Credit Support Annex. These documents define collateral requirements and include threshold levels where collateral may be called. Threshold levels or minimum transfer amounts vary by counterparty and range from $250,000 to $750,000. Western utilizes an internally developed Collateral Asset Tracking System (CATS) to manage the collateral process. Swaps and collateral are valued daily. If the difference between swaps valuation and the collateral held reaches the minimum transfer amount, as outlined in the relevant Credit Support Annex, Western will notify the counterparty of the need for additional collateral. Collateral is due into the collateral account within one business day after both counterparties have agreed upon the call amount. Western currently allows for the pledging of Treasuries and/or cash as the most common forms of collateral for swaps positions.

• 5. Given current market conditions have you taken any steps to alter your

trading relationship with any counterparties? Western has been and continues to monitor the situation regarding trading counterparties very closely. Currently, for swaps, we are restricting new trades with counterparties in potential distress. In addition, we are favoring trades with banks over brokers and generally trading more with higher quality brokers. If possible, we are novating existing swaps trades away from distressed brokers to either a bank or broker in relatively sound condition.

• 6. What is your opinion of Bear Stearns as a Counterparty?

Given the merger agreement and guarantee by JP Morgan (“JPM”), Western currently views the credit of Bear Stearns (“BSC”) on par with JPM. Western is closely monitoring the progress of the merger and will review its assessment of bear Stearns in light of any material developments.

• 7. What does the JP Morgan guaranty provide?

A copy of the JP Morgan Guarantee Agreement is attached. Within this agreement, JPM unconditionally guaranties the due and punctual payment of all Covered Liabilities of Covered Bear Stearns Companies Entities. Details of Covered Liabilities and Entities may be found in the agreement and include liabilities from repurchase agreements, swap agreements, options or other derivatives, settlement

• r clearing contracts, margin loan agreements or other similar contracts or
• transactions. The guaranty is effective through either the closing of the merger or

the termination of the merger agreement. The guaranty does not cover direct debt of Bear Stearns. However, once the acquisition is complete, it is expected (and JPM management has alluded to this) that BSC debt will be wrapped into the JPM capital structure and provided for

• perationally. S&P's upgrade of BSC ratings to AA- (equal to JPM) reflects that

expectation.

SLIDE 14

• II. BlackRock

SLIDE 15

SLIDE 16

Managing Counterparty Credit Risk BlackRock’ s philosophy is to manage counterparty credit risk conservatively. As such, the firm actively and aggressively monitors counterparty credit risk exposures globally and evaluates counterparty credit quality on a continuous basis. We believe our policies and procedures for counterparty risk management are robust and thorough, and recent market events have not required us to revise our approach. In 2005, BlackRock established the Counterparty Credit Risk Management Group, a dedicated team of professionals worldwide that leads the process for managing counterparty risk. The Group is responsible for managing credit risk in all trading relationships with counterparties and to that end coordinates with credit research, portfolio management, operations, and data integrity functions across the organization. The Group monitors and assesses counterparty exposures from a wide range of instruments that include derivatives, mortgage TBAs, foreign exchange, financing trades (repo), equities, and ot her forward-settling transactions. On a daily basis, a report is generated to show aggregate risk exposures by counterparty and by portfolio. The Counterparty Credit Risk Management Group developed the firmwide Counterparty Credit Policy and Procedures, and is responsible for implementing, updating and enforcing it, as follows: (1) assess prospective counterparty creditworthiness and approving counterparties, (2) measure and monitor credit exposure to each counterparty by portfolio, broken out by asset classes, (3) monitor financial performance of counterparties in order to establish, confirm, or adj ust exposures, as needed, (4) monitor levels of exposure by product, by tenor, and by counterparty, and provide feedback to portfolio management when aggregate firmwide exposures warrant, and (5) provide guidance and supervision of credit issues for IS DA and other derivatives documentation. We require our swap counterparties to be rated at least A. BlackRock’s Counterparty Approval Process BlackRock focuses primarily on counterparty credit risk and counterparty reputation risk. Counterparty credit risk is the potential loss that BlackRock or our clients’ accounts could incur if an issuer or counterparty is unable to perform on its trading commitments. Reputation risk is defined as the risk to earnings or capital arising from negative public opinion. The process by which we select broker/ dealer counterparties for transaction purposes is outlined below. Determine the nature of the proposed transaction activity: What are the securities to be traded? What is the expected volume by security? Determine the settlement and delivery procedure: How are we going to receive monetary compensation in exchange for delivering the particular security in question? If we are going to receive securities, how is the counterparty going to deliver those securities? Is settlement through DTC and Fed only or is there also a physical settlement? From a delivery risk perspective, we view DTC and Fed settlement to be of limited

• risk. We view settlement via other methodologies as bearing potentially significant risk, and

generally limit it to only those counterparties who have had investment grade debt ratings (for senior unsecured debt) for an extended period of time. Determine if the proposed counterparty settles “directly” or uses a correspondent: Most “ agency” counterparties utilize correspondents to clear securities for them. If they do so, whom are they using? On what basis are they clearing (fully disclosed or otherwise)? BlackRock will only accept clearing correspondents that are well-capitalized, well-established, and possess a favorable reputation in the marketplace (investment grade in most cases). S ettlement risk tolerance levels: BlackRock has established tolerance levels for our exposure to settlement risk (defined as a credit balance on all trades outstanding but not settled). The level reflects our settlement risk 1

SLIDE 17

tolerance per counterparties and is monitored by BlackRock’ s Counterparty Credit Risk Management Group, Operations, and Compliance personnel on a daily basis. If the limit is exceeded, the trade details are reviewed in concert with the counterparty’ s financial strength in order to determine if any intervention is required. Financial review: Our view is that the level and trend of excess regulatory capital (required under S EC Rule 15c3-1), as shown in the financial information, is the principal barometer of the financial strength of our counterparty. Most brokerage firms are required to calculate and report this figure to regulatory authorities on a periodic basis. We are directly interested in ensuring that the process is maintained. Therefore, investment grade counterparties are monitored as part of our ongoing credit research process, which includes daily corporate bond morning meetings and monthly watch list meetings. Our credit research analysts review financial statements on a quarterly basis. As previously stated, non-investment grade counterparties are required to clear through investment grade clearing correspondents and are limited to short settlement trades. Current GAAP and regulatory financial filings are reviewed on an ongoing basis. Counterparty Monitoring To monitor post-trade counterparty risk, BlackRock has a strong technological infrastructure and proprietary internal review processes in place. In 2002, BlackRock built DECO, our derivatives collateral management system. DECO automates daily monitoring of collateral requirements for all derivative instruments, including futures, swaps (including forward FX trades as applicable), and OTC options governed by master agreements. DECO is incorporated into our firmwide Aladdin trading system. BlackRock prefers to have multiple counterparties to ensure sufficient liquidity, risk management, and best execution. The counterparties with which we trade must have broad market coverage. In terms of swaps, notional exposure to each counterparty is monitored, and agreements are diversified to minimize exposure to individual counterparties. Each day our positions are marked-to-market. The threshold limits negotiated in each agreement is zero. Margin calls are made on a dealer-by-dealer basis for each portfolio, with minimum transfer amounts of $500,000. BlackRock also has a number of reporting tools that allow us to manage our counterparty exposure, balancing net exposures to our different derivative counterparties. Where necessary, credit risk exposure to each counterparty can quickly be adj usted, both at the individual portfolio level and at the aggregate firmwide level. 2

SLIDE 18

BlackRock’s Fully Integrated Collateral Management System BlackRock’ s Collateral Management Group, part of the Global Operations & Administration Department, is responsible for the management of derivatives collateral and uses DECO to move and monitor cash and securities (used as collateral) to and from futures commission merchants (FCMs) and dealers. The Group also uses DECO to review daily exposure and collateral valuation by counterparty, determine eligible collateral, and view master agreement

• terms. Once a threshold limit (governed by the swap agreement) is reached, the Collateral

Management Group contacts the swap dealer to arrange for next day receipt or delivery of collateral based on the last night’ s close. Via DECO, the Group monitors collateral movement and daily exposure versus the collateral and pre-set limit. Each FCM calculates the initial margin using S PAN (S tandardized Portfolio ANalysis of risk), the world's leading margin system, in accordance with the exchange and guidelines of the Commodity Futures Trading Commission (CFTC). BlackRock posts the initial margin in the form

• f cash or acceptable securities to the FCM and all subsequent daily variation margins are

settled with the FCM in cash. BlackRock monitors all derivative portfolios on a daily basis and moves collateral in accordance with the IS DA/ CS A to ensure all accounts are properly collateralized. All margining is done via the DECO system, a module fully integrated within our trading platform. For all derivative positions we have no unsecured thresholds, and we have no direct exposure to hedge funds or to monoline insurers. 3

SLIDE 19

BlackRock

Opinion on Current Market Environment Managing counterparty risk has always been a very important function at BlackRock that receives the highest level of attention at the firm. As described in response to question 2

• f this request, BlackRock makes every effort to carefully evaluate and monitor

counterparty exposure to each individual institution. Recent events in the credit markets have created a very fluid and challenging situation in the marketplace that BlackRock is carefully monitoring through ongoing dialogue with the Street, utilization of proprietary technology and strict adherence to our outlined process. While a broad statement on the condition of the counterparty environment is difficult to make at this time, we are confident that our process is designed to mitigate, but not totally eliminate, risks. We are happy to answer questions about the current counterparty market environment with a call

• r meeting at your convenience

SLIDE 20

• III. Loomis, Sayles & Co.

SLIDE 21

PENDING TRADES USD Trade Settle Security ID Description Code Quantity Settle Amount Broker/ Counterparty Trade Price Price 3/ 27/ 08 Exposure Side Exposed 03/ 26/ 2008 03/ 31/ 2008 620076BA6 MOTOROLA INC SR NTS B 10,000.00

• 8,218.64 Morgan Stanley

79.426 78.404 $102.20 Broker 03/ 26/ 2008 03/ 31/ 2008 35687MAP2 FREESCALE SEMICONDUCTOR B 2,000.00

• 1,469.63 Goldman Sachs

70.5 69.5 $20.00 Broker 03/ 25/ 2008 04/ 01/ 2008 38141GFM1 GOLDMAN SACHS GROUP INC B 975,000.00

• 973,206.00 Goldman Sachs

99.816 98.606 $11,797.50 Broker 03/ 27/ 2008 04/ 01/ 2008 125581AW8 CIT GROUP INC B 20,000.00

• 15,533.00 Credit Suisse

76.75 78.632

• $376.40

Client 03/ 27/ 2008 04/ 01/ 2008 620076AP4 MOTOROLA INC DEB B 5,000.00

• 4,012.78 B B & T Capital Mkts

77.8 78.599

• $39.95

Client 03/ 24/ 2008 04/ 14/ 2008 31408DZL1 FNMA POOL 848647 S 356,171.91 358,882.78 Goldman Sachs 100.5625 100.604 $147.81 Broker 03/ 24/ 2008 04/ 14/ 2008 31410UHR6 FNMA POOL 897640 S 2,802,828.48 2,824,161.12 Goldman Sachs 100.5625 100.556

• $182.18

Client 03/ 24/ 2008 04/ 14/ 2008 3128M4K69 FHLMC GOLD POOL G02717 S 3,027,195.01 3,048,816.33 UBS Securities 100.51562 100.587 $2,160.81 Broker PENDING TRADES TBA 03/ 11/ 2008 04/ 14/ 2008 01F042640 FNMA TBA POOL APR 30YR 4.5% B 3,250,000.00

• 3,030,320.31 Greenwich Cap Mkts

93.07812 95.656

• $83,781.10

Client 03/ 18/ 2008 04/ 14/ 2008 01F042640 FNMA TBA POOL APR 30YR 4.5% SHS 3,250,000.00 3,161,843.75 Bank of Amer Securities 97.125 95.656

• $47,742. 50

Client 03/ 24/ 2008 04/ 21/ 2008 01N052640 GNMA TBA POOL 30 YR 5.5 B 1,700,000.00

• 1,734,147.57 JPMorgan Securities

101.70312 101.4375 $4,515.54 Broker 03/ 24/ 2008 04/ 21/ 2008 01N052640 GNMA TBA POOL 30 YR 5.5 B 2,085,000.00

• 2,125,903.64 Morgan Stanley

101.65625 101.4375 $4,560.94 Broker 03/ 24/ 2008 04/ 21/ 2008 01N050644 GNMA TBA POOL 30 YR 5% B 2,270,000.00

• 2,269,211.81 Lehman Brothers

99.6875 99.3438 $7,801.99 Broker 03/ 24/ 2008 04/ 21/ 2008 01N050644 GNMA TBA POOL 30 YR 5% B 1,700,000.00

• 1,698,878.47 Bank of Amer Securities

99.65625 99.3438 $5,311.65 Broker Amount Credit Suisse

• $376.40

B B & T Capital Mkts

• $39.95

Goldman Sachs

• $182.18

Greenwich Cap Mkts

• $83,781.10

Bank of Amer Securities

• $47,742.50

Grand Total

• $132,122.13

Exposure Summary by Broker/ Counterparty

Loomis, Sayles & Co.

Summary of USD &TBA Positions

SLIDE 22

Loomis, Sayles & Co.

Due Diligence Process Considerations When Selecting Broker-Dealers Except in those circumstances where discretion is limited by a client, Trading Personnel have sole discretion in selecting broker-dealers from the Active Broker-Dealer Lists when seeking the best execution of transactions in client accounts. Trading Personnel who wish to place a trade with a broker-dealer who is not currently on the Active Broker-Dealer List, must seek approval prior to placing such trade. In determining whether to include a new broker-dealer on the Active Broker-Dealer List, the relevant Head Trader may consider, but is not limited to, the following:

• A broker-dealer’s overall competitiveness, financial soundness, reputation

and integrity or specialized expertise

• The flow of information from the broker-dealer including idea and

research generation

• Portfolio Manager and Research Analysis input and the results of the most

recent Broker-Dealer Vote (Equity only)

• The fact that the particular broker-dealer is a market maker in the

securities to be traded

• A broker-dealer’s willingness to enter into a difficult transaction (e.g.

putting their own capital at risk, the size of the order, etc.)

• The facilities that a broker-dealer makes available such as trading

networks, access to multiple floor brokers and markets, and significant resources for positioning as principal

• A broker-dealer’s ability to effect difficult trades in less liquid, smaller

capitalized, and more closely held issues

• The commission rate or spread the broker-dealer will charge for the

transaction

• The quality of the broker-dealer’s back office (ability to settle the

transaction in a timely fashion) Thereafter, on a quarterly basis, the relevant Head Trader will review the then current Active Broker-Dealer List from the Charles River Trading System to ensure that the appropriate approvals were obtained for any broker-dealer appearing on the list and/or that broker-dealers are removed from such list if appropriate. The Head Trader will report any significant developments that may occur with a particular broker-dealer to the Trading Oversight Committee on a quarterly or as needed basis. If a Head Trader learns of circumstances which suggest that the firm should cease to trade with a particular broker-dealer, the Head Trader should either discuss potential removal or suspension with the Trading Oversight Committee at its next meeting or, if the Head Trader feels appropriate, immediately remove or suspend such broker-dealer

SLIDE 23

from the Active Broker-Dealer List and communicate the change to all relevant Trading Personnel and the Chief Compliance Officer. Trading Personnel will only select those broker-dealers which appear on the Active Broker-Dealer List and will consider those factors described above when making their

• selections. When possible and the situation warrants, Traders will attempt to solicit

multiple bids when in competitive biding situations, unless, in the judgment of the Trader, competitive bidding is either not likely to result in, or is not necessary to achieve best execution. Derivative Counterparty Policy In addition to the above procedures, Loomis Sayles' Derivatives Counterparty Procedures require that any counterparty used by Loomis Sayles to execute derivative transactions must have a minimum credit rating of A3, A-, or C- according to Moody’s, S&P or Loomis Sayles. Due to the recent downgrade of Bear Stearns from A2/A to Baa1/BBB, Bear Stearns has been taken off of the approved derivatives counterparty list as of March 18, 2008. Opinion on Current Market Environment We define counterparty exposure as any unsettled obligation where we expect a future payment from a counterparty. Examples would be unsettled TBA trades, unsettled forward contracts, and derivative instruments. For a short time, there is a slight settlement risk for any normal settlement trades (T+3). However, since most trades settle DVP/RVP (Deliver or Receive versus Payment), the real risk is unrealized gain or loss on the security between trade and settlement date. The firm's overall position on counterparty risk is cautious. With the recent Fed action related to Bear Stearns, there is increased confidence that they are effectively managing systemic risk. The line in the sand seems to be large notional derivative exposure. The primary concern now is non-US CounterParties. One could potentially see problems with commodity related exposure, foreign exchange as well as continued issues with reinsurance companies (FGIC, XL, Radian, Ambac). The positive news is that with the International Swap Dealers Association (ISDA) collateral support, annex managers should be able to manage counterparty exposure within very tight tolerances.

SLIDE 24

• IV. Bradford & Marzec

SLIDE 25

SLIDE 26

Bradford & Marzec

Due Diligence Process Prior to a trading with a broker/dealer, Bradford & Marzec LLC performs a background check through several areas of the firm. Specifically, the research department reviews financials, the Compliance Department performs a FINRA check, and the Portfolio Management Team confirms their request to trade with the specific dealer for specific services/markets they

• ffer.

Additionally, on a semi-annual basis, Bradford & Marzec evaluates the quality and cost of services received from all broker/dealers with whom client orders are placed. As a part of this evaluation, Bradford & Marzec considers the quality and cost of services available from alternative broker/dealers, market makers, and market centers. Bradford & Marzec recognizes that the analysis of execution quality involves a number of factors, both qualitative and quantitative. The research department also reviews the credits of all counterparties on a semi-annual basis

• r more often if needed.

Opinion on Current Market Environment Our opinion is that counterparty risk is still high. However, we believe that this risk, which peaked at the time of the Bear Stearns/JPMorgan/Fed transaction, has been falling and will continue to fall for two key reasons: 1) significantly reduced balance sheet risk among the large banks/brokers, and 2) unprecedented action by the Fed has significantly improved the liquidity for, and confidence in, these counterparties. Balance sheet risk continues to be a big concern, which is ultimately why counterparty risk is still high. Bank/broker balance sheets have been saddled with hundreds of billions of LBO, SIV, and leveraged fund lending, and subprime ABS and CDO debt securities. One major risk has been that falling prices on risky assets would lead to the insolvency of a major bank/broker. We don’t believe this will be the case as managements have been very aggressive in reducing balance sheet risks, while increasing transparency to the investment

• community. It was only a few months ago that the street was sitting on over $400 billion of

high yield and leveraged loan securities. Now, their exposure is around $100 billion and decreasing rapidly. It was only a few months ago that most of them were left with billions in exposure to subprime ABS and related CDOs when the credit crunch hit. Now, through sales, hedges, and write-offs, these exposures have become much more manageable. Also, it was

• nly a year ago these bank/brokers were loosely lending to leveraged investors. Now, they

have demanded lower leverage, better transparency, and much tighter collateral demands of these fund managers. Also, better balance sheet management hasn’t just been on the asset side of the equation. Just in the last few months, the street has issued tens of billions of equity capital to shore up balance sheets which have been stressed by increased leverage and billions in write-offs. Federal Reserve actions have also aided tremendously in the reduction in counterparty risk. For instance, the Term Securities Lending Facility alone allows the Fed to lend up to $200 billion to primary dealers (which includese the major counterparties), and allows for greater flexibility on what assets may be pledged as collateral. These actions by the Fed effectively means that the Fed will backstop any potential liquidity crisis (in other words, a run on a bank

SLIDE 27

is much less possible now). If this facility, and the Primary Dealer Credit Facility, had been in place before fears of a Bear Stearns liquidity crisis hit a fevered pitch, then Bear Stearns may not have needed a white-knight. In other words, what happened to Bear Stearns was a classic “run on a bank,” that likely wouldn’t have occurred if these facilities had been in

• place. As a further note, Bear Stearns was the only larger broker/dealer which had more

short-term liabilities than short-term assets. Will there be some large write-offs to come? Probably, but they should be manageable as equity capital has been largely restored, risky assets have been largely dealt with, the government has proven its strong desire to see order restored in the capital markets, and liquidity is in strong supply. In other words, confidence is being restored to the markets.

SLIDE 28

• V. GMO

SLIDE 29

Global Bond Fund Market Value $355,412,223 (preliminary) Broker Name3 Swaps & Options1,2 Forwards1,2 Net OTC Derivatives1,2 Futures1,2 Net OTC & Futures1,2,4 ($,000) ($,000) ($,000) (%) ($,000) ($,000) (%) Barclays Bank 23 286 309 0.09% 309 0.09% Bear Stearns

• 3
• 3

0.00% 4,285 4,282 1.20% Citigroup

• 10
• 315
• 325
• 0.09%
• 325
• 0.09%

Deutsche Bank

• 3

21,725 21,723 6.11% 21,723 6.11% Goldman Sachs

• 33
• 33
• 0.01%
• 33
• 0.01%

JP Morgan

• 101
• 49
• 150
• 0.04%
• 150
• 0.04%

Lehman Brothers 4 4 0.00% 4 0.00% Merrill Lynch

• 10
• 10

0.00%

• 10

0.00% Morgan Stanley 89 89 0.03% 89 0.03% UBS

• 263
• 263
• 0.07%
• 263
• 0.07%

Total

• 307

21,647 21,340 6.00% 4,285 25,624 7.21% Definitions:

2 Although certain funds have received collateral, there can be no assurance that realization on the collateral will be 100% of its current

• value. Among the factors that could affect realization levels are: fluctuations in its value prior to disposition; costs of disposition, possible

claims by third parties to the collateral, possible ambiguity in rights under the governing derivatives contracts, legal costs and delays.

3 Broker names shown are any brokers/investment banks with which a GMO sponsored fund or client account has counterparty exposure.

For purposes of this Summary, to the extent a fund or account uses different subsidiaries and other affiliates of a broker/investment bank, they have not been broken out separately, even though the relevant OTC derivative documentation generally does not provide the legal right to net obligations of separate legal entities against each other. This Summary does not include repurchase agreements, which generally involve initial collateral worth 102% of the repurchase amount. There may be other brokers/investment banks through which a Fund or a Separately Managed Account holds and/or transacts in securities positions that are not shown above. Swaps & Options: Net unrealized gain/loss less collateral. Forwards: Net unrealized gain/loss. Net OTC Derviatives: Sum of Swaps & Options and Forwards. Percent is as a percent of the total account market value. Futures: Collateral plus 1 day variation margin.

Counterparty Exposure Summary

as of March 31,2008 Net OTC & Futures: Sum of OTC Derivatives and Futures. Percent is as a percent of the total market value.

1 Exposures have been calculated at the fund level (and underlying fund level, if applicable). All values are shown as the net aggregate of

the applicable individual positions (though individual underlying funds generally do not have the legal right to net obligations against

• bligations of other funds); absolute values of exposures may be substantially larger. Please note that the exposures set forth above do not

and are not intended to represent the client's ownership of the individual securities or positions as all securities and positions are held on an undivided basis for all investors in the fund.

SLIDE 30

GMO

Due Diligence Process The Funds typically only enter into OTC derivatives with counterparties that, at the time they enter into a transaction, have long-term debt ratings of A or higher by S&P or Moody’s (or if unrated, have comparable credit ratings as determined by GMO). The Funds may also enter into short-term derivatives transactions with counterparties that do not have long-term debt ratings if they have short-term debt ratings of A-1 by S&P and/or a comparable rating by Moody’s. In addition to monitoring the credit ratings of counterparties, GMO takes additional steps on behalf of the Funds to minimize the risk of loss for the Funds’ unrealized gains on open derivative positions. On futures positions, the Funds receive or pay variation margin daily, and thus generally have only one day's margin exposure to futures clearing brokers. Swap contracts typically have quarterly, semi-annual or annual reset dates on which the parties exchange payments, thereby limiting the Funds’ credit exposure to counterparties to the accumulated unrealized gain since the most recent reset date. For swaps and options, if the exposure is of sufficient magnitude (e.g., $250k million), the contract will typically require collateral to be posted by the counterparty. Consistent with historical industry practice, collateral is not typically posted with respect to foreign currency forward contracts however, those contracts typically have maturities of only three to six months. GMO also seeks to incorporate contractual mechanisms (e.g., incorporating credit downgrade, netting, set-off and

• ther provisions into master trading agreements) into the Fund’s OTC derivative contracts to

minimize credit exposure on OTC derivative products. The counterparty exposure within the Fund meets with the guidelines as detailed in the Statement of Additional Information. Opinion on Current Market Environment GMO is very comfortable with the counterparty exposures in our Global Bond Fund (and, of course, our other fixed income portfolios). We monitor closely, as the reports show, all of our exposures on a net and gross basis by type of instrument and by counterparty. Our counterparty in bond futures trades is the Board of Trade. We have followed the Bear Stearns situation closely over the past year and have broadened our execution and clearing relationships in anticipation of potential credit rating problems. With the pending purchase of Bear Stearns by J. P. Morgan, our trading with Bear has been smooth. Our sales coverage from Bear Stearns is joining J.P. Morgan so we expect a seamless transition to a higher- quality broker. We have initiated a relationship with Lehman Brothers to diversify our bond futures execution and clearing alternatives. We, too, are very comfortable with our currency and swap counterparties and monitor closely exposures here as well.