CDR Monthly Strategy Call July 2008

Global Strategic and
Tactical Credit Outlook
Tim Backshall - Chief Strategist

Dave Klein – Indices & CSA
Byron Douglass - Tranches
July 2008
© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.
Agenda – 30 Mins!
• Market Summary 3 Mins
• Top-Down Outlook Update 8 Mins
• Segment Performance, Trends, and Themes 5 Mins
• Investment Themes (Systemic) 7 Mins
• Bottom-Up Trading Ideas (Idiosyncratic) 5 Mins
• Conclusion 2 Mins

Big Picture Recap
• Our approach is working – performance remains solid.
• Outlook remains for ongoing gradual decompression in
credit spreads with HY (high beta) underperforming.
• High Commodity Prices (Consumer-Spending) and
troubled financials remains prescient.
• Idiosyncratic and Systemic Risk are not ‘capped’.
• Overseas Strength mixed blessing (inflation vs.
earnings).
• Time (sentiment) not money (reflation) more likely the
cure for housing.
• Fundamentals (liquidity) will be driver of next leg.
• Volatility to drop short-term but rise H2.
Recent Summary
• Financial Fears and Credit Contraction, margin
relief as Commodity Price Declines, write-downs,
and bailouts set the scene for the month.
• Volatility in Financials shrinks risk appetite.
• Non-Financials mixed as dispersion rises.
• Summer-led Profit-taking (Longs & Shorts).
• Short-covering driving market activity as volumes
remain light in CDS and worse in cash.
• New Issues Stagnant as minimal supply and
indifferent demand.
• Idiosyncratic risk down but still elevated as
systemic risk falls sparking opportunities.
Where to Next?
• Base Case Scenario is steady spread widening with
IG-HY decompression.
• Spread Tightening / • Rapid Spread Widening

Compression Scenarios Scenarios
• Substantial and • Major Financial
sustained correction in Company Failure
oil prices • Fed Tightening
• Housing PRICE • Major Spike in Oil prices
bottoming. (War/Weather?)

A Busy Month for All…
• GSE Bailout – Senior-Sub decompression, short TSY-Long
FNM/FRE Seniors.
• SEC Naked Short Selling Rule – Much ado about nothing
– Sentiment helped but no asymmetric differential in
CDS/Equity/Vol.
• Housing Bill – too little too late (ex GSE bailout) but
Keynesians will like it (Govt leveraging up).
• Oil Prices Fall – Ongoing media/govt scapegoat hunt for
manipulators and bank/hedge fund capital raising (still in
range vs. Gold).
• FDIC – 3 bank failures, warnings of more to come, reserves
draining quickly, watch regionals (SKF).

A Busy Month for All…more
• Covered Bond Push – nice non-agency idea (maybe 2-3
years early), EUR mkt shut currently, stresses bank balance
sheets further, implicit govt guarantee?
• BIS II Trading Book Adjustments – BIS delays
implementation of new (more accurate) guidelines for
counterparty risk reserves in trading book (delays
inevitable reality check as risk is 5x hist.).
• FASB 157 Delay – 5-0 vote to delay a critical accounting
change to standardize Level 3 asset accounting.
• TAF/TSLF/PDCF Extension – Fed (unsurprisingly)
extends their temporary emergency-only lending facilities
amid the worst TAF and TSLF results since inception.

IG-HY Decompression Increases as
Dispersion drops thanks to Monolines
‐120 ‐100 ‐80 ‐60 ‐40 ‐20 0 20 40
CDX10 IG
CDX10 IG (FV)
CDX10 IG Dispersion
High Beta
Low Beta
CDX10 HVOL
CDX10 HVOL (FV)
CDX10 ExHVOL
CDX10 ExHVOL (FV)
CDX10 XO
CDX10 XO (FV)
CDX HY10
CDX HY10 (FV)
CDX9
XOver9
ITRX9
CPTY
Aussie
Asia

Low Beta Outperforms as ExHVOL
trades Richer
‐35% ‐30% ‐25% ‐20% ‐15% ‐10% ‐5% 0% 5%
CDX10 IG
CDX10 IG (FV)
CDX10 IG Dispersion
High Beta
Low Beta
CDX10 HVOL
CDX10 HVOL (FV)
CDX10 ExHVOL
CDX10 ExHVOL (FV)
CDX10 XO
CDX10 XO (FV)
CDX HY10
CDX HY10 (FV)
CDX9
XOver9
ITRX9
CPTY
Aussie
Asia

Credit Outperformed (ex TMT) as FINL
Dispersion Fell and TMT rose.
30%
20% Stock
5Y CDS
CDS Dispersion
10%
0%
CONS ENRG FINL INDU TMT
‐10%
‐20%
‐30%
‐40%

The Biggest Impacts were…
• The names having the largest impact on IG are MBIA
Insurance Corporation (-1457.2bps) pushing IG 7.43bps
tighter, and Washington Mutual Inc. (+343.6bps) adding
2.06bps to IG.
• HVOL is more sensitive with MBIA Insurance Corporation
pushing it 33.66bps tighter, and Washington Mutual Inc.
adding 9.33bps to HVOL's change this month.
• The less volatile ExHVOL's move this month is driven by
both International Paper Co. (-51.75bps) pushing the index
0.52bps tighter, and Newell Rubbermaid Inc. (+37.5bps)
adding 0.39bps to ExHVOL.
• The CDR Counterparty Risk was dominated by Lehman
Brothers (+53bps) as the worst performer this month and
Credit Suisse (-34bps) and Deutsche Bank (-31.43%) best.

Tighteners Outpace Wideners but
ranges remain extreme in both
100%
% Range
80%
% Change
60%
40%
20%
0%
‐20%
‐40%
‐60%

Longs and Shorts Took Profits as
Winners and Losers Swap Place
100%
Close Range Position
90%
Open Range Position
80%
70%
60%
50%
40%
30%
20%
10%
0%

Spreads End Unchanged Amid High
Volatility and Multi-Month Wides.
700
NAIG NAHY EUIG
600
EUXO Asia AUS
Global CRI
500
400
300
200
100
0
Jun‐07 Jul‐07 Aug‐07 Sep‐07 Oct‐07 Nov‐07 Dec‐07 Jan‐08 Feb‐08 Mar‐08 Apr‐08 May‐08 Jun‐08 Jul‐08

Counterparty Risk Remains Elevated
but Volatility is Extreme
250
FNM/FRE
Bailout,
Bear Stearns Debacle WFC/Citi/BAC
Earnings, and
200 SEC Short
Squeeze
Lehman Rumors,
IndyMac Failure, and
FNM/FRE Solvency Fears
150
Monolines Blowout
US Brokers Report Huge
Losses and Writedowns
100
50 Monolines
Bear Stearns Hedge Funds Failure Further Downgrade
Writedowns,
Initial Subprime Concerns Appear Rights Issues,
and Lehman
Fed Cuts Rates 50bps Fears.
0
01/05/06 04/05/06 07/05/06 10/05/06 01/05/07 04/05/07 07/05/07 10/05/07 01/05/08 04/05/08 07/05/08
Copyright © 2008 Credit Derivatives Research LLC. All Rights Reserved

Broad Market Volatility is trending
down as we head into Summer
30% 35
Daily Range (% of Open)
Daily Range (bps) 30
25%
25
20%
20
15%
15
10%
10
5%
5
0% 0
9/20/2006 12/20/2006 3/20/2007 6/20/2007 9/20/2007 12/20/2007 3/20/2008 6/20/2008

IG10 Weekly Chart Show Wide
Ranges but 3 of 4 Weeks Tighter
190
170
150
130
110
90
70
50
30
3/30/2007 6/8/2007 8/17/2007 10/26/2007 1/4/2008 3/14/2008 5/23/2008 8/1/2008

IG10 Daily Consolidating in 125-135bps
range (as predicted) with trend tighter
185
165
145
125
105
85
65
45
25

IG10 Hourly Trend Tighter but vol and
strength fading as rally falters
200
190
180
170
160
150
140
130
120
110
100
90
80

Corporate Bond Spreads
Underperformed CDS and legged wider
600
500
Moody's Baa ‐ Aaa corporate bond spread (bps)
400
300
200
100
J‐06
J‐03
J‐00
J‐97
J‐94
J‐91
J‐88
J‐85
J‐82
J‐79
J‐76
J‐73
J‐70
J‐67
J‐64
J‐61
J‐58
J‐55
J‐52
J‐49
J‐46
J‐43
J‐40
J‐37
J‐34
J‐31
J‐28
J‐25
J‐22
J‐19

Corporates remain attractive versus
TSYs but liquidity may be misleading
30%
Spread return as a percentage of full corporate bond return (%) 280
BBB‐AAA Corporate Bond Spread (bps)
25%
230
20%
180
15%
130
10% 80
5% 30
J‐07
J‐05
J‐95
F‐97
M‐99
A‐01
M‐03
N‐92
J‐84
A‐86
S‐88
O‐90
J‐82
J‐72
F‐74
M‐76
A‐78
M‐80
N‐69
J‐61
A‐63
S‐65
O‐67
J‐59
J‐49
F‐51
M‐53
A‐55
M‐57

LCDX Outperforms as HY and XO
Underperform
800
750
CDX HY 5Y OTR Spread
700 CDX XO 5Y OTR Spread
650 LCDX 5Y OTR Spread
600 CDX HVOL 5Y OTR Spread
550 CDX IG 5Y OTR Spread
500
450
400
350
300
250
200
150
100
50
0
Dec‐03 Jun‐04 Dec‐04 Jun‐05 Dec‐05 Jun‐06 Dec‐06 Jun‐07 Dec‐07 Jun‐08

HY Decompression (vs LCDX and IG)
as HVOL shifts away from IG
9 75%
Index Multiples
70%
8
65%
7 60%
55%
6
50%
5 45%
HVOL / IG
HY / IG 40%
4
XO / IG 35%
XO / (IG to HY) (RHS)
3 LCDX / HY (RHS) 30%
25%
2
20%
1 15%
Dec‐03 Jun‐04 Dec‐04 Jun‐05 Dec‐05 Jun‐06 Dec‐06 Jun‐07 Dec‐07 Jun‐08

CDR Liquid 50™ NAIG Matches
Counterparty Risk Index with lower Vol
300
Bear Stearns
Bailout Monoline
250 Madness II
CDR Credit Index

200
Long-run IG
Basis Points
Average Spread Monoline

given Credit Index Madness I
150
100
50
CDR Counterparty Risk Index
0
6/1/07 7/20/07 9/7/07 10/26/07 12/14/07 2/1/08 3/21/08 5/9/08 6/27/08

CDS Outperformed Equity but coming
back into line (Europe CDS Richer)
250
NA 5Y CDS Market
200
150
CDS 5Y Mid
NA 5Y CDS Model EUR 5Y CDS Model
100
50 EUR 5Y CDS Market
0
1/2/08 2/11/08 3/22/08 5/1/08 6/10/08 7/20/08

Credit Outperformed Across All Sectors
(Most in Energy/Utes, Least in NonCycs)
Basic Materials Cheaper
Richer
CDS CDS
Capital Goods (Red) (Green)
Consumer Cyclical
Consumer Noncyclical
Energy
Finance
TMT
Utilities
50 40 30 20 10 0 10 20 30
Number of Companies

Did The SEC ‘Naked-Short Restrictions’
Change Anything? No!
• The SEC’s announcements of restrictions on naked short-
selling clearly sparked a lot of interest but based on our
models, there was no asymmetric risk taking (Vol / CDS /
Equity) post the announcement (CDS outperformed!)
260
SEC Rule
Fair Value CDS
Announced
240 CDS - Equity
Disconnect
220 Reverses
200
180
160 Market CDS CDS & Equity

Reconnects
140
6/30 7/2 7/7 7/9 7/11 7/15 7/17 7/21 7/23 7/25 7/29 7/31

Tranche Performance mixed in US but
25
Europe focused at the lower end. 70
Delta‐Adj Change (Bps)
Delta‐Adj Change (Bps)
20 60
15 CDX 50
5Y 7Y 10Y
10
40
5
30
0
0‐3% 3‐7% 7‐10% 10‐15% 15‐30% 30‐100% 20
iTraxx
‐5
10
‐10
‐15 5Y 7Y 10Y 0
0‐3% 3‐6% 6‐9% 9‐12% 12‐22% 22‐100%
‐20 ‐10

At-the-Money Correlation Reveals EUR
Correlation diverging from US.
80%
ATM Correlation
diff
CDX
60% ITRX
40%
ATM Correlation differential increases to
20% highs
0%
Mar‐08 Apr‐08 May‐08 Jun‐08 Jul‐08
‐20%

CDX Correlation underperformance
driven by over-steepening of skew.
22%
Steep Correlation Skew
19%
16%
13%
10%
Nov‐07 Jan‐08 Mar‐08 May‐08 Jul‐08

Tranche Skews Offer Attractive
Relative-Value Opportunities
16% 120
Carry Position (bps)
difference 100
7‐10% Skew 80 Carry Position
10‐15% Skew
12% 60
Current
40
20
8%
Base Correlation Skew
0
0 50 100 150 200
‐20
4% ‐40
‐60
‐80
0% Index Reference (bps)
‐100
Nov‐07 Jan‐08 Mar‐08 May‐08 Jul‐08

MFCI Continues to Outperform (with
Long and Short winners) 10
Median MFCI Score
• All recent (MFCI-based)
baskets have
outperformed (in both up 5
and down markets) across
IG, XO, and HY.
• HY Basket II – exit with 0
large gain
• Recent Entry in HY
Basket IV ‐5
• Recent Outrights: ‐10

• Long STZ and LUV
• Short IR, HSY, and NWL
‐15

Healthcare and Utilities Richen as
Leisure and Tech Cheapen
450
5Y CDS Spreads
1.50
400
Spread Z‐scores
350
1.00
300
250
0.50 200
150
‐ 100
50
0
(0.50)
(1.00)

Sector-to-Industry Breakdowns
Reveal Opportunities in Retailers
500
Spread (Bps)
Discount Luxury
400
Retailers
300
200
100
0
Jan‐08 Mar‐08 May‐08 Jul‐08

The Credit Cycle is Bifurcating as
Banks De-lever and Corps Turn down
RECOVERY (2003-2005) CREDIT REPAIR (2002-2003)
Equity and Credit UP Credit better than equity
Restructuring efforts boost cash-flow. Balance sheet repair, pay back
debt, focus on cash generation and
Margin expansion, positive FCF.
survival
Banks
4
1 3 Corporates
Margins declining, FCF turns Sharper global slowdown. Vol
negative, leverage starts to rise. up sharply, defaults rise gradually
Equity better than Credit Equity and Credit Down

2
EXPANSION (2006-2007) DOWNTURN (2007-2009)

Stocks and Spreads More in Line with
Cycle but FINLs ahead in credit
190
USD Investment Grade Spread (bps)
1999
170 2000
2001
150 2002
3 2003
130 4 2004
2005
110 2006
2007
90 2008
70
2
50
30 S&P 500 Index 1

700 800 900 1000 1100 1200 1300 1400 1500 1600

Risk Dropping but Idiosyncratic
Remains Elevated (Systemic too tight).
3
3 Idiosyncratic
Systemic
2
0
9/24/2007 10/24/2007 11/24/2007 12/24/2007 1/24/2008 2/24/2008 3/24/2008 4/24/2008 5/24/2008 6/24/2008 7/24/2008
‐1
‐1
‐2
‐2
‐3

Housing Still Showing No Signs of a
Bottom
• Inventories stabilizing at 25 year highs is hardly a sign of
strength. Prices have further to fall.
16
Existing Homes Sales Supply (Months)
14
New Home Sales Supply (Months)
12
10
0
6/1/1982 6/1/1987 6/1/1992 6/1/1997 6/1/2002 6/1/2007

Credit contracting relative to GDP but
Home Values have long way to go yet.
$22,500 0%
$20,000 ‐5%
$17,500 ‐10%
$15,000
US Home Value ($bn)
‐15%
$12,500 US GDP ($bn) ‐20%
$10,000
‐25%
$7,500
‐30%
$5,000 Case‐Shiller
‐35% Current Index
$2,500 Data
‐40%
Case‐Shiller
$0
‐45% Futures
Dec‐51
Dec‐56
Dec‐61
Dec‐66
Dec‐71
Dec‐76
Dec‐81
Dec‐86
Dec‐91
Dec‐96
Dec‐01
Dec‐06
Contract
‐50%

One More Housing Reality Check –
Japan took 15 years to bottom.
350
Nikkei 225 Japan Land Index (Big 6 Cities)
Bubble Burst
300 Peak at 38,957 US Case Shiller 10‐City Composite Index (starts 1996)
NASDAQ
250 Tech Bubble
Burst
Nikkei 225
200 Bottoms at 7603
150
100 Dow/Subprime
Bubble Burst
50
0
3/1/1984 3/1/1987 3/1/1990 3/1/1993 3/1/1996 3/1/1999 3/1/2002 3/1/2005 3/1/20

Total Debt continues to grow as
Marginal GDP growth slides
4.0 $1.00
Total US Credit / Nominal GDP $0.90
3.5 Rise in GDP per unit rise in Total Debt
1933 peak at 2.87x ‐ GSEs, $0.80
3.0 ABS and lower interest rates
facilitated the growth BUT $0.70
hitting a wall now
2.5
$0.60
2.0 $0.50
$0.40
1.5
$0.30
1.0
$0.20
0.5
$0.10
0.0 $0.00

Bank Credit IS Contracting - Redux!
• Headlines point to Bank Loans growing indicating credit
remains expansive and positive BUT ABCP is dragging…
2500 100%
ABCP Market Size ($bn) (RHS)
90%
C&I Loans ($bn) (RHS)
Total C&I Loans plus ABCP (RHS) 80%
2000
YoY Growth in C&I Loans (LHS)
70%
Real Growth in Bank Credit (LHS)
60%
1500 50%
40%
1000 30%
20%
10%
500
0%
‐10%
0 ‐20%
1/3/2001 1/3/2002 1/3/2003 1/3/2004 1/3/2005 1/3/2006 1/3/2007 1/3/2008

Has The Fed Lost Control of The Short-
End and the curve? FINLs say Yes
2800
5
2600
4 2400
2200
3
2000
2 1800
2Y TSY Yield (LHS) 1600
1
S&P 500 Financials (Mkt Cap $bn (RHS))
1400
0 1200

Global Economy Slowing? (or Olympics
Impact as Containers Pile Up?)
12000
10000
Baltic Dry Index
8000
6000
4000
2000
0
J‐90 J‐95 J‐00 J‐05

Global Economy is Slowing but ‘Real’
Oil Remains under pressure.
0.17
8/30/2005 Peak at 0.162oz of gold
per barrel of oil
0.15 Hurrican Katrina ‐ $70 /barrel
9/20/2000 Peak at 0.138oz of
gold per barrel of oil
0.13
Bush‐Gore Election ‐ $37/barrel
10/16/1990 Peak at 0.107oz
0.11 of gold per barrel of oil
First Gulf War $40/barrel
0.09
0.07
0.05
Oil (oz of Gold)
0.03
7/1/1986 7/1/1989 7/1/1992 7/1/1995 7/1/1998 7/1/2001 7/1/2004 7/1/2007

Energy CDS Outperformed CDX as Oil
Sold off – Macro hedge?
80 $150
Oil & Energy Performance vs. CDX
75 Utility Performance vs CDX
$145
Spot Crude Oil Price ($)
70
$140
65
$135
60
55 $130
50
$125
45
$120
40
$115
35
30 $110
5/1/2008 5/15/2008 5/29/2008 6/12/2008 6/26/2008 7/10/2008 7/24/2008

TAF/TSLF Worst Ever as Stress Remains
in Term Lending as OIS stabilizes
1 5.5
0.9 5 1M OIS
0.8
4.5 Eurodollar Deposit Rate
0.7 Fed Funds ‐ Libor
Spread (Dec08) 1M Libor
4
0.6
3.5 TAF Stop‐Out Rate
0.5
0.4 3
0.3
2.5
0.2
2
0.1
1.5
0

Fed Extending TAF was Necessary as
Bid-to-Cover Maxes Out!
2.5
TSLF Schedule 1
2
TSLF Schedule 2
1.5
0.5
0
3/13/2008 4/2/2008 4/22/2008 5/12/2008 6/1/2008 6/21/2008 7/11/2008 7/31/2008 8/20/2008

Write-downs Will Continue – US worse
than Europe but Europe CDS overdone Actual
1Y Default 5Y Default Asset Value Expected Loss Expected Loss Writedowns
Risk (%) Risk (%) ($bn) (1Y) ($bn) (5Y) ($bn) ($bn)
US Brokers
Bear Stearns Companies Inc. $0.0 $0.0 $3.2
Goldman Sachs Group Inc 5.05% 18.43% $245.6 $12.4 $45.3 $3.8
Lehman Brothers Holdings Inc. $0.0 $0.0 $8.2
Merrill Lynch & Co., Inc. 13.69% 40.52% $217.6 $29.8 $88.2 $51.8
Morgan Stanley 7.22% 22.01% $182.6 $13.2 $40.2 $14.4
$55.4 $173.6 $81.4
US Banks
Bank of America Corp. 2.06% 15.96% $419.4 $8.6 $66.9 $21.2
Citigroup Inc 5.14% 19.38% $413.9 $21.3 $80.2 $54.6
Capital One Bank 5.54% 25.26% $30.5 $1.7 $7.7
JP Morgan Chase & Co. 2.10% 13.15% $345.8 $7.3 $45.5 $12.8
Wachovia Corp. 11.83% 40.18% $176.5 $20.9 $70.9 $22.0
Wells Fargo & Company 1.65% 13.39% $234.5 $3.9 $31.4 $10.0
Washington Mutual Inc. 61.27% 99.13% $49.2 $30.2 $48.8 $14.8
$93.7 $351.4 $135.4
US Consumer Finance names
American Express Company 4.18% 17.53% $88.7 $3.7 $15.5
CIT Group Inc 54.85% 98.13% $35.1 $19.2 $34.4
General Electric Capital Corp 1.60% 7.60% $655.0 $10.5 $49.8
Block Financial LLC 0.52% 4.08% $8.5 $0.0 $0.3
iStar Financial Inc. 25.72% 77.42% $7.1 $1.8 $5.5
SLM Corp 21.16% 37.36% $101.4 $21.5 $37.9
$56.8 $143.4
European Banks
BNP Paribas 1.49% 5.37% $172.6 $2.6 $9.3 $2.7
Barclays Bank Plc 2.28% 6.93% $125.8 $2.9 $8.7 $6.4
Credit Suisse Group 1.52% 8.55% $102.9 $1.6 $8.8 $9.5
Deutsche Bank AG 2.55% 5.99% $150.3 $3.8 $9.0 $11.2
HSBC Bank PLC 1.41% 5.29% $270.0 $3.8 $14.3 $19.5
UBS AG 6.43% 16.55% $220.7 $14.2 $36.5 $38.2
$28.8 $86.6 $87.5

EU Insurers to Outperform US
banks/brokers but Asia Exposure High!
iTraxx Europe Main Tranches CDX.NA.IG Tranches
Equity Junior Mezz Senior Mezz Senior Super Senior Equity Junior Mezz Senior Mezz Senior Super Senior
Entity Region 0‐3 3‐6 6‐9 9‐12 12‐22 0‐3 3‐7 7‐10 10‐15 15‐30
ABN Amro Holdins EU XX X XX X X
Barclays EU XX XX X
BNP Paribas EU X X XX X XX
Credit Suisse Group EU X XX XX X
Deutsche Bank EU X XX XX X
HSBC Holdings PLC EU X XX XX X
Royal Bank of Scotland EU XX X XX X
Societe Generale EU XX X X XX
UBS AG EU XX XX X
Bank of America Corp. US XX X X XX
Bear Stearns Co. US XX XX X
Citigroup Inc. US X XX X XX
Goldman Sachs US XX X X XX
JP Morgan US X XX X XX
Lehman Brothers US XX XX XX
Merrill Lynch US XX X X XX
Morgan Stanley US XX X X XX
Aegon EU X XX X XX
Fortis EU X XX X X XX
ING Groep NV EU XX X X XX
KBC Group EU XX X XX
Munich Re EU XX X XX X
AIG US XX XX XX XX
AXA US XX X XX X
Hartford Financial Servcies US XX X X XX
MetLife US XX X XX X
Prudential Financial Inc. US XX X X XX
Sompo Japan Insurance JP XX X XX X
Sumitomo Mitsui Financial JP XX X XX X
Sumitomo Trust & Banking Co. JP XX X XX X

Inflation or Low Margins – Pick Your
Poison
0.5
0.4
PPI Output vs. Input
0.3
Input‐Output Inflation Gap Trend
0.2
0.1
0
Apr‐47 Apr‐52 Apr‐57 Apr‐62 Apr‐67 Apr‐72 Apr‐77 Apr‐82 Apr‐87 Apr‐92 Apr‐97 Apr‐02 Apr‐07
‐0.1
‐0.2
‐0.3
‐0.4
‐0.5

Defaults are Coming…Soon!
• The link between Lending Standards and HY Defaults is very
strong and standards are rising very quickly
12.0% 40
Moody's Default Rate (%) (HY)
30
Senior Loan Officer Survey (% of Respondents
10.0%
Tightening Lending Standards) (4Q average)
20
8.0% 10
0
6.0%
‐10
4.0% ‐20
‐30
2.0%
‐40
0.0% ‐50
1965 1970 1975 1980 1985 1990 1995 2000 2005

Default Risk Forecast Edging Higher as
Vol rises and Equities stall
18%
16%
14%
Average 5Y Default Risk (%)
12%
10%
8%
6%
4%
2%
0%
D-01 J-02 D-02 J-03 D-03 J-04 D-04 J-05 D-05 J-06 D-06 J-07 D-07 J-08

Spreads Still Rich to Default Premium
80
Spread Per unit of Default risk (bps/%)
70
Average 5Y Sread Per unit of
Default risk (bps/%)
60
50
40
30
20
10
0
D-01 J-02 D-02 J-03 D-03 J-04 D-04 J-05 D-05 J-06 D-06 J-07 D-07 J-08

HY Default Risk Accelerating Faster
Than IG
HY/IG default risk flat for last six months, we
35%
expect HY to underperform 10
IG Average Default Risk
30%
HY Average Default Risk 9
Multiple
8
25%
7
20%
6
15%
5
10%
4
5%
3
0% 2
1/1/2006 7/1/2006 1/1/2007 7/1/2007 1/1/2008 7/1/2008

IG Rich to Recessionary Expectations
300
50% Recovery
40% Recovery
250 30% Recovery
20% Recovery
10% Recovery
200
150
100
50
0
1965 1970 1975 1980 1985 1990 1995 2000

HY at ‘Economic’ Recessionary
Expectations
900
800
700
600
50% Recovery
40% Recovery
500
30% Recovery
20% Recovery
400 10% Recovery
300
200
100
0
1965 1970 1975 1980 1985 1990 1995 2000

Investment Themes
• Short ExHVOL (Again!)

• HY-IG Decompression
• FINL CSA Trades
• Short EUR FINLs vs. Main
• HY Butterfly –Medium-Term Short
• Industry Short baskets
• CDX Tranche Skew Flattener
• Swing Trade IG
Theme 1
STAY! Short ExHVOL10 (or IG10)
200
• Low beta continues to
CDX IG 5Y OTR Spread
under-perform in every 150
sell-off. CDX ExHVOL 5Y OTR Spread
• Preference for ExHVOL 100
over IG as a short 50
• ExHVOL 10 most rich to
intrinsics. 0
D‐03 J‐04 D‐04 J‐05 D‐05 J‐06 D‐06 J‐07 D‐07 J‐08
• ExHVOL is best systemic 80% 80
short. 75% ExHVOL / IG (%) (LHS) 70
70%
IG ‐ ExHVOL (bps) (RHS) 60
• Rich to recessionary peak 65%
50
default rates. 60%
40
• Fundamentals point to 55%
30
50%
further deterioration in 45% 20
low-beta credits as 40% 10
recession hits.

Theme 2
HY-IG Decompression
• Spread Multiple
CDX IG (bps)
compressed to near all- 185
CDX OTR 5Y Spread
time lows. (pre s9)
• IG underperformance 165 CDX s9 5Y Spread R² = 0.9689
overdone.
145
• Default Cycle due to pick
up as lending standards 125
tighten.
• HY defaults will rise/spike 105
before IG.
85
• Default Risk differential
almost constant for last 6 65
months – empirically very
different. 45
• Carry at ~3x IG is modest CDX HY (bps)
25
60bps as Tail Risk erupts.
200 300 400 500 600 700 800 900

Theme 3
Financials Capital Structure Trades
300
• Financials have moved 250
Fannie Mae USD‐Senior‐Modified
around the credit cycle Restructuring 5 Year CDS Spread
Fannie Mae USD‐Subordinated‐Modified
200
between downturn and Restructuring 5 Year CDS Spread
150
recovery. Spread Differential
100
• De-levering will hurt
50
equities and hep credit –but
0
outrights in either are M‐06 N‐06 M‐07 N‐07 M‐08
volatile bets.
260
• We prefer Long Credit, Fair Value CDS
SEC Rule
Short Equity trades in select 240 Announced
names. 220
CDS - Equity
Disconnect
• Senior-Sub plays remain 200
prescient but entry levels
must be selective and exits 180
timely. 160 CDS & Equity
Market CDS
140
6/30 7/2 7/7 7/9 7/11 7/15 7/17 7/21 7/23 7/25 7/29 7/31

Theme 4
Short EUR FINLs vs. Main
• Buy ITRX SEN FINLs 180 60
Protection, Sell ITRX Main 160

Itraxx Europe 5Y On The Run Spread
Protection. Itraxx Financials 5Y On The Run Spread
50
• FINLs – Non-FINLs in Main 140

Differential
differential is at wides. 120
40
• Stress remains prescient 30

in EUR FINLs indicated by 100
Libor-FF spreads and 80 20

lower write-downs.
• Spread versus dispersion 60
10
indicates relative richness 40
in FINLs.
0
• Beta should be 0.75x 20
FINLs for pos carry and 0 ‐10
historical precedent along
with solid upside.

Theme 5
HY Butterfly – Cheap Medium-Term Short
• From our 2008 Outlook, 1000
CDS Spread (bps)
we see default rates 900
rising.
• Historically, the cycle has 800
forced short-term 700

marginal risks
considerably higher. 600
• HY Curves will invert 500

further (very flat now).
• 3s5s7s Butterfly has 400
better economics than 300
3s5s flattener outright.
• Butterfly has lower carry 200
2+ Notch Downgrade 1 Notch Downgrade
than outright short. 100 Current Ratings‐Implied Current
• Butterfly is ‘hedged’ and 1 Notch Upgrade Tightest in HY9
Tightest in HY8 Tightest in HY7
positively exposed in the 0
event of default. 3Y CDS 5Y CDS 7Y CDS

Theme 6a
Builder Basket Shorts
• Fundamentally, the 550
bottom is not in for
builders.
450
• Even MDC is struggling.
• Creative shorts are best –
success with CSA, Curve 350
Basis, and Pairs trades.
• Use MFCI to select
builder basket and cover 250 Diff
with XO10. Homebuilder Basket
• Build carry-neutral 150
basket short builders, XO 9
long building materials.
• Construct possible 50
long/short basket of pure
builders.
1‐Oct 1‐Nov 1‐Dec 1‐Jan 1‐Feb 1‐Mar 1‐Apr
‐50

Theme 6b
Retailer Basket Shorts
• Retailers have been hit 500
Spread (Bps)
hard during the sell-off in Discount
credit.
Luxury
• MFCI indicates that in 400
Retailers
general consumer cyclical
credits are fair but
retailers are rich. 300
• Discounters have
massively outperformed
Luxury and Mid-range 200
retailers.
• Personal Bankruptcies
rising, delinquencies 100
rising, margins under
pressure, credit card
exposures – WMT, TGT, 0
COST, TJX (marginal). Jan‐08 Mar‐08 May‐08 Jul‐08

Theme 6c
Energy Basket Shorts
• Utilities have 140
Oil & Gas Energy
$150
outperformed in the oil

sell-off but Energy names 120 Utilities $140
are considerably rich Energy vs Utilties Differential
relative to utilities. 100 (bps)
$130
Crude Oil ($) (RHS)
• As oil sold off, energy
outperformed CDX holding 80
$120
onto its gains.
60
• Oil prices are volatile but
we feel energy basket (call $110
for names) are 40
idiosyncratically rich. $100

20
• Possible macro hedge for
short Oil play. $90
0
‐20 $80

Theme 7
Short CDX Mezz (Skew Flattener)
• Most efficient tranche short.
80%
ATM Correlation
diff
• Technically, the skew is very
steep. ATM correlation CDX
60%
remains very high even as ITRX
idiosyncratic risk drops.
40%
• Short Skew and Short
Correlation. ATM Correlation
20% differential
increases to highs
• Divergent from European
correlation performance 0%
Mar‐08 Apr‐08 May‐08 Jun‐08 Jul‐0
• Buy (hedged or outright)
Protection on CDX 10Y 3-7% ‐20%

Theme 8
Swing Trade IG10 against Core Short
• Higher frequency index 200
trading has been (and we 190

forecast will continue to 180
be) very profitable this
year… 170
• Intraday OHLC bars 160

combined with Filtered 150
Adaptive Moving Averages,
Momentum/Trend 140
Oscillators, and Relative 130
Strength Indicators
120
provide entries.
• Parabolic SAR stop-loss. 110
• Pivot Points, Trendlines, 100

and Fibonacci crossing 90
over from Equity trading.
80

What We Are Watching
Long EUR LoVol vs. Short US ExHVOL
• Global Decoupling 140
unlikely. EUR LoVOL
120
US ExHVOL
• US will lead weakness but
LoVOL ‐ ExHVOL
technicals are keeping 100
EUR wide.
80
• Compare Builders.
60
• Convexity trade at these 40

wides.
20
• ExHVOL richer to
intrinsics than LoVol. 0
‐20

Long Main ExFINLs, Short IG ExHVOL
160
• Two portfolios are more
fungible than ExHVOL 140
trades. Main ExFINLs
120
US ExHVOL
• Differential is less volatile
and range-bound. 100
Main ExFINLs ‐ ExHVOL
80
• Somewhat contrarian but
is basically a US 60
underperforms EUR in
non-financials. 40
20
• Differential is at the limit.
0

New Issue-based Negative Basis Trades
• New Issues offer strong 120
Basis Points of Convergence

concessions – especially locked
in versus CDS. 100
• Cheapest Play on Financials 80
Recovery – note recent trend.

60
• CDS technicals helping 40

convergence.
20
• Positive Carry, default hedged,
convexity-based directionality, 0
Dollar Cheapness
and short TSY may be a -2 0 2 4 6 8

preference given current curve. -20
• Long-Maturity Steepeners. -40

Curve Trades
• Flatteners on Weak 50
Credits.
• Steepeners on Strong 0
Credits. 0 100 200 300 400 500 600 700
• Default Intensity Focus is ‐50

around 5Y – curves are
increasingly hump-
shaped. ‐100
Current Curves
Jan1st Curves
• More curves inverted and

some imply very low ‐150
marginal default rates.
‐200

Market Summary
• Base Case continues to be gradual spread widening and IG-HY
decompression.
• Too many uncertainties for Long Financials, Short Corporates – take
alpha from both legs – CSA and baskets respectively.
• Macro – we see credit contracting, lending standards tightening,
default risk rising, and housing prices continuing to drop, and oil
remaining high (no silver lining yet!)
• Financials face further stress (despite Fed floor) as rising loan losses,
inability to lend effectively, business model failure, overhanging
regulation (FAS140/157 and BIS II), and tapped out capital providers.
• Corporates face margin pressures from rising input costs (PPI in/out)
and more than just $20 off oil to fix (oil not so overbought ex-$), rising
leverage, GDP revisions point to consumer-led recession.
• Stick to Themes for beta and use Trading Ideas for Alpha,
• Capital Structure Arbitrage remains viable and profitable (despite
event risk) as risk tends to one way in Financials.

Visit… www.creditresearch.com

CDR Monthly Strategy Call July 2008

Încărcat de

Informații document

Drepturi de autor

Formate disponibile

Partajați acest document

Partajați sau inserați document

Opțiuni de partajare

Vi se pare util acest document?

Este necorespunzător acest conținut?

Drepturi de autor:

Formate disponibile

CDR Monthly Strategy Call July 2008

Încărcat de

Drepturi de autor:

Formate disponibile

Global Strategic and

Tactical Credit Outlook

Tim Backshall - Chief Strategist

• Top-Down Outlook Update 8 Mins

• Segment Performance, Trends, and Themes 5 Mins

• Investment Themes (Systemic) 7 Mins

• Bottom-Up Trading Ideas (Idiosyncratic) 5 Mins

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

• Spread Tightening / • Rapid Spread Widening

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

CDR Credit Index

Average Spread Monoline

CDR Counterparty Risk Index

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

NA 5Y CDS Model EUR 5Y CDS Model

50 EUR 5Y CDS Market

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

160 Market CDS CDS & Equity

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

• Recent Outrights: ‐10

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

Equity better than Credit Equity and Credit Down

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

30 S&P 500 Index 1

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

$12,500 US GDP ($bn) ‐20%

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.

© Copyright 2008 Credit Derivatives Research LLC. All Rights Reserved.