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Slide 1: A view on structured credit in 2008 Conan Hales

Slide 2: Contents  How we got to today  Trends in 2008  Some lessons learned  View for the next 12 months on various market sectors  Strategy for structured credit  Biography

Slide 3: 2007 – the sub prime fallout  While a few market participants were aware of the US mortgage market overheating in 2005, it was not until the ABX index shorting sent signals in the market that something was afoot • AIG decided to stop guaranteeing the super senior tranches on Merrill Lynch CDOs as early as 2005 (“Merrill Lynch to post new write downs”, WSJ, April 15th) • Some dealers wanted to short the market so they invented ABSCDS and the ABS indices early in 2006 (06-01 series). Their subsequent shorting caused a huge depreciation of the valuations towards the end of 2006.  By mid 2007, the credit contagion affected other part of the credit markets that had no direct relationship with low quality US mortgages: • Corporate credits and loans • Corporate loans • Commercial property securitizations  Writedowns to date $269bn (Creditflux, April 08)  An estimated total sub prime write down of $1 trillion • (Global Financial Stability Report, IMF, April 08)

Slide 4: 2008 – credit seizure and a scramble for cash  Structured finance issuance has almost stopped in many global markets across all asset classes  Central banks have stepped in with unprecedented liquidity provisions to keep basic credit markets functioning • New York Fed’s $200 bn Term Securities Lending Facility, Primary Dealer Credit Facility • Bank of England’s £50 bn Special Liquidity Scheme  Banks are hoping to recapitalize their balance sheets with record issuances to potential equity investors • RBS $24bn, UBS up to $15bn, ML $6.6bn, HBOS $8bn, etc TED spread - difference between the three month T-bill and the LIBOR interest rate.

Slide 5: Some of the lessons learnt so far  Bubbles can form and burst in any market  Leveraged structured can exhibit extreme volatility  Structures and trading strategies can exhibit skewed pay- offs  Mathematics and structured finance modeling do not replace fundamental credit analysis

Slide 6: View for the coming 12 months – corporate risk  Corporate credit spreads have hit new highs and since then tightened, however, it has yet to be seen what the knock on effect of the financial crisis will have on the knock on the “real” economy • Potential re-widening of credit spreads as some of the weaker corporations default on lack of credit  US Corporate defaults in January 2008 alone roughly equal to the whole of 2007, and it is expected that the losses in Europe could be equally substantial (IMF)  Some banks have already sold leveraged loans at a deep discount on the recent rally of corporate spreads (Citigroup $12bn, DB $5bn), possibly indicating a good time to exit this risk  Regarding corporate credit correlation, the benign credit event situation in the high grade space has let the implied losses drift up the capital structure. As we saw in 2005 in the auto sector, credit correlations tend drop on idiosyncratic events, causing expected loss to move into the subordinate tranches Chart: Relative loss allocation charts indicate how the correlation markets imply how losses are expected to occur in the capital structure

Slide 7: View for the coming 12 months – US CMBS  Securitization has slowed as property price appreciation has waned • Current CMBX spread levels indicate expected losses to be worse than ever before, with some improvement in the last few weeks in the cash sector (see charts)  However, on the positive side • Borrowers are less likely to face payment shocks as most loans are 7 to 10 year fixed rate loans • Borrowers have audited financial statements and therefore fraud is less likely  RMBS typically lags CMBS……..

Slide 8: View for the coming 12 months –RMBS  While lack of confidence in the structured finance area will remain, liquidity spreads may tighten as distressed funds and other specialists come in • Timing is going to be the perceived “bottom” of the credit cycle  The US mortgage market has sophisticated players who look at each underlying mortgage one by one taking into account important information – therefore liquidity could appear here faster due to transparency and sophisticated nature of the market, e.g. • Vintage, FICO, size • ZIP code • Loan to value including second liens  Greater dispersion between borrowers with and without credit access lie ahead • Agency traditional with faster prepayment at lower mortgage rates will perform more favourably  European RMBS vary from country to country, however UK RMBS is perceived to be at risk despite its sophistication • In April 2008, house prices recorded its first annual drop in the 13 year rally (Hometrack) • New mortgages dropped by half in a year despite the BoE cutting its base rate (BBA)

Slide 9: View for the coming 12 months – other US consumer credit  Credit card, student and automobile debt delinquencies have remained resilient so far • Borrowers seem to have stayed current on this credit for 2008  However this sector is expected to weaken as unemployment rises As of 2007, U.S. households held $2.5 trillion in consumer debt in the form of revolving ($900 billion), primarily credit card debt, and non-revolving debt ($1.6 trillion), most of which is auto loans. The securitized market represents roughly $780 billion, spanning a wide range of assets, including credit cards ($343 billion), auto leases ($199 billion), student loans ($236 billion), and other miscellaneous securitized loans. (IMF)

Slide 10: Strategy for structured credit  An environment becoming more positive for unwinding credit positions in the immediate future • Liquidity is being provided either by direct private issuance or by central bank’s liquidity measures to the financial sector • More distressed debt funds are being established in 2008  34 funds in 2008 vs15 funds raising a total of $33bn in 2007 (Lex, FT)  Some credit markets are rallying despite having yet to exhibit default events • e.g. corporate related and potentially some consumer related • It may be an advantage to move quickly  Though there remains uncertainty on when normality will return to the market any time soon • A trade-off between trying to obtain efficient market price and timely sale  Obtain regular tradable and independent valuations • Not ratings-based! • Using fundamental credit analysis, potential losses need to valued bottom-up

Slide 11: Biography  Conan Hales, Vice President, currently works for BlackRock Solutions. He is responsible for business development and portfolio analytics support in the Asia-Pacific and Middle East regions  Prior to joining BlackRock in 2007, Mr. Hales spent five years as a synthetic correlation structuring and marketing professional for Merrill Lynch Securities and JPMorgan Securities in Tokyo. Before this, he was a quantitative counterparty credit analyst for derivatives at Merrill Lynch for 2 years.  Mr. Hales is fluent in Japanese. He earned a BSc. degree with honours in mathematics and statistics from Nottingham University in 1996.  The views expressed here are entirely his and may not bear any relation to any of the above employers’ views, past or present.