CONFIDENTIAL 1 A Look at the Credit Markets


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CONFIDENTIAL 1 A Look at the Credit Markets

  1. 1. A Look at the Credit Markets
  2. 2. Disclaimer The information contained herein is confidential and may not be reproduced in whole or in part. This presentation is for informational purposes only and is being furnished on a confidential basis to a limited number of eligible investors. By accepting this information, the recipient agrees that it will use and it will cause its directors, partners, officers, employees and representatives to use the information only to evaluate its potential interest in any investment described herein and for no other purpose and will not divulge such information to any other party. Any reproduction of this information, in whole or in part, is prohibited. This presentation is not an offer to sell, or a solicitation of an offer to buy, any security. Any such offering may be made only by an offering circular and the information contained herein will be superseded in its entirety by such offering circular (including the information therein as to conflicts and risks) prior to making an investment decision. Investors must rely upon their own examination of the terms of any investment described herein and upon their own representatives and professional advisors, including legal counsel and accountants, as to the accounting and tax treatment, suitability for such investor, and the legal and other aspects of any investment. This presentation is based on information that is believed to be reliable. No representation is made that it is accurate or complete. Institutional Credit Partners LLC, The Bank of New York Company Inc. and/or its affiliates may have positions in, or may effect transactions in securities and instruments of, issuers mentioned herein and may also provide significant advice or investments services, including investment banking, to the issuers of such securities and instruments. Additional information is available on request. ICP Securities LLC is a member of the NASD and SIPC. SIPC protects securities customers of its members up to $500,000 (including $100,000 for claims for cash). Explanatory brochure is available upon request or at Hypothetical Illustrations and Prior Investment Results This presentation may contain statements that are not purely historical in nature but are hypothetical illustrations of such things as income or return, sample or pro forma portfolio structures or portfolio composition, scenario analysis and proposed or pro forma levels of diversification or sector investment. These hypothetical illustrations may illustrate a range of potential outcomes and are based on certain assumptions. Such outcomes are not a prediction of the performance of any investments described herein. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that illustrated returns will be realized or that actual returns or results will not be materially lower than those presented. All statements included are based on information on the date hereof, and Institutional Credit Partners LLC, The Bank of New York Company Inc. and/or its affiliates assumes no duty to update any such statement. Any prior investment results or returns are presented for illustrative purposes only and are not indicative of any future returns in any investment described herein.
  3. 3. <ul><li>Section </li></ul><ul><li> </li></ul><ul><li>Credit Markets Today – Where are We? </li></ul><ul><li>Factors Behind the Market – Why is the Market Where it is? </li></ul><ul><li>Outlook - What Happens from Here? </li></ul><ul><li>Opportunities - What Strategies Can be Implemented? </li></ul>Table of Contents
  4. 4. Credit Markets Today – Where are We?
  5. 5. The Market Today – A Leveraged Environment <ul><li>Today’s credit market is marked by high levels of corporate and consumer leverage. </li></ul><ul><li>Consumer borrowing has increased by approximately 72% since 2001 </li></ul><ul><li>Average total corporate debt / EBITDA has increased by approximately 15% over the same period </li></ul>Source: 1 MacroMavens 2 Standard and Poor’s
  6. 6. The Market Today – Historically Tight Spreads <ul><li>Corporate and Emerging Market spreads are currently at historically tight levels </li></ul><ul><li>In addition, certain Emerging Markets currently have deficit current account balances which will have to be funded in the near term, positioning them for a future widening in spreads </li></ul>Source: 1 Standard & Poor’s 2 Bloomberg, as of 4/21/2006 3 International Monetary Fund, as of 12/31/2005 1 -6% 13 Portugal -1.3% 19 Italy -3% 24 Greece -8% 57 Hungary 2% 34 Korea 1% 55 Thailand -5% 5 Spain -11% 26 Iceland Current Account as % of GDP 3 10 Year CDS Spreads 2 Country
  7. 7. Factors Behind the Market – Why is the Market Where it is?
  8. 8. Liquidity in the Market – Transaction Volume Growth <ul><li>There is an unprecedented amount of liquidity in the credit markets despite the rising rate environment. This is evident through the increase in corporate and structured credit transactions in recent years </li></ul><ul><li>Year/year change in corporate debt outstanding has increased from less than 1% in January 2003 to approximately 6% in the end of 2005. 1 </li></ul><ul><li>The total rated volume of U.S. CDO transactions in 2005 was more than 73% larger than transaction volume in 2004. 2 </li></ul><ul><li>ABS issuance increased by 34% to a record $537 billion in 2005. 3 </li></ul>Source: 1 MacroMavens 2,3 Moody’s Investors Service Issuance of Home Equity ABS Corporate Debt Outstanding y/y 0 1 2 3 4 5 6 1/1/03 6/1/03 11/1/03 4/1/04 9/1/04 2/1/05 7/1/05 12/1/05
  9. 9. Liquidity in the Market – The Growth of Money Supply <ul><li>Expanding money supply is a primary source of the liquidity in the market </li></ul><ul><ul><li>Despite Fed’s recent tightening efforts through the raising of rates, liquidity is concurrently being pumped into the market. </li></ul></ul><ul><ul><li>Data shows that while M1 has remained relatively constant and M2 has grown similar to the rate of GDP growth, M3 has shown significant growth rates in recent years. In particular, M3-M2 has grown at a rate of over 15% for each of the past two years. 1 </li></ul></ul><ul><ul><li>Market liquidity has been created through the use of leverage in the form of electronic money (corporate cash, Eurodollars and repurchase agreements) found in the M3 measure of money supply </li></ul></ul>Source: 1 Federal Reserve M3 M2 + Institutional MMKT Funds, Time Deposits > $100K, RPs, Eurodollars M2 M1 + Savings Deposits, Time Deposits < $100K, Retail MMKT M1 Currency in Circulation, Demand Deposits, Other Checkable Deposits
  10. 10. Liquidity in the Market – Foreign Investing <ul><li>Increased foreign buying has also contributed to the market’s liquidity </li></ul><ul><ul><li>Foreign investment in US financial assets has exhibit continuous positive growth over the past 15 years. </li></ul></ul><ul><ul><li>Foreign investing grew by 17.3% in 2004 and 13.4% in 2005 which accounted for approximately 75% of U.S. debt issuance in 2005. 1 </li></ul></ul><ul><ul><li>US Current Account Deficit is running at 7% of GDP (annualized). Foreigners need to put 2.5 billion per day into the US economy to sustain current dollar levels. 2 </li></ul></ul>Source: 1 Federal Reserve, Flow of Funds 2 National Bank Financial
  11. 11. Outlook – What Happens from Here?
  12. 12. <ul><li>Historically, the end of Fed tightening periods has prompted wider spreads in the credit markets </li></ul><ul><li>In the last 3 periods of rate hikes, BAA rated corporate spreads widened by an average of 70 bps and MBS spreads widened by an average of 33 bps within one year after the Fed stopped raising rates. 1 </li></ul><ul><li>In addition, these periods are characterized by declines in the equity markets. In the last 12 periods of rate hikes the market declined 10 times following the last increase with the average decline amounting to 22% over the next 10 months. 2 </li></ul>Market Outlook – A Widening Spread Environment Source: 1 MacroMavens 2 Comstock Partners, Inc. Market Trends During Periods of Fed Tightening (Shaded) 260 240 220 200 180 160 140 120 100 80 60
  13. 13. Opportunities – What Strategies Can be Implemented?
  14. 14. Opportunities in the Current Credit Markets – Defensive Strategies Source: 1 Credit Suisse MBS are at 5-year cheaps vs. corporates 1 <ul><li>Expect pockets of deterioration among sub-prime borrowers poorly positioned for a decline in bank liquidity and an increase in interest rates and borrowing costs. </li></ul><ul><li>Many sectors of corporate and consumer credit are overpriced and offer “short” opportunities. </li></ul><ul><li>The chart below demonstrates the relative overpricing of corporate credit compared to MBS. Opportunity exists to short corporate credits against long positions in low volatility prime borrower backed MBS that are defensively positioned in the current market. </li></ul>
  15. 15. Opportunities in the Current Credit Markets – “Credit Neutral” Approach <ul><li>Expect current sub-prime production to mirror that of 2000-2001. </li></ul><ul><li>The charts below demonstrate that cumulative loss for prime borrower and Alt-A RMBS reaches a maximum of 0.25% and 1% respectively while sub-prime RMBS credits reach loss levels of up to 6% for vintages of 2000 through 2005. </li></ul><ul><li>In light of these conditions, opportunities exist in defensive strategies involving long positions in prime borrower backed RMBS securities and short positions in mezzanine RMBS floaters backed by sub-prime borrowers, investment grade corporates and sovereign credits. </li></ul>Source: 1 Fitch
  16. 16. A CDO of High Yield Securities Managed by Peritus I Asset Management LLC 445 Park Avenue, 12th Floor New York, NY 10022 Main: 212-821-1900 Fax: 212-821-1959