A Look at the Credit Markets

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Disclaimer

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Section

I. Credit Markets Today – Where are We?

II. Factors Behind the Market – Why is the Market Where it is?

III. Outlook - What Happens from Here?

IV. Opportunities - What Strategies Can be Implemented?

Table of Contents

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Credit Markets Today – Where are We?

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The Market Today – A Leveraged Environment

Today’s credit market is marked by high levels of corporate and consumer leverage.

Consumer borrowing has increased by approximately 72% since 2001

Average total corporate debt / EBITDA has increased by approximately 15% over the same period

Source: 1 MacroMavens 2 Standard and Poor’s

Consumer Borrowing per $1 Spent

$0.00

$0.01

$0.02

$0.03

$0.04

$0.05

$0.06

$0.07

$0.08

$0.09

$0.10

$0.11

$0.12

$0.13

$0.14

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Source= BEA, Federal Reserve: Flow of Funds

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The Market Today – Historically Tight Spreads

Corporate and Emerging Market spreads are currently at historically tight levels

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

Source: 1 Standard & Poor’s 2 Bloomberg, as of 4/21/2006 3 International Monetary Fund, as of 12/31/2005

Country10 Year CDS

Spreads2

Current Account as % of GDP3

Korea 34 2%

Italy 19 -1.3%

Thailand 55 1%

Iceland 26 -11%

Portugal 13 -6%

Hungary 57 -8%

Greece 24 -3%

Spain 5 -5%

1

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Factors Behind the Market – Why is the Market Where it is?

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Liquidity in the Market – Transaction Volume Growth

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

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

The total rated volume of U.S. CDO transactions in 2005 was more than 73% larger than transaction volume in 2004.2

ABS issuance increased by 34% to a record $537 billion in 2005.3

Source: 1 MacroMavens 2,3 Moody’s Investors Service

Issuance of Home Equity ABS

Corporate Debt Outstandingy/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

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Liquidity in the Market – The Growth of Money Supply

Expanding money supply is a primary source of the liquidity in the market

Despite Fed’s recent tightening efforts through the raising of rates, liquidity is concurrently being pumped into the market.

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

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

M1, M2, M3: 1995 - March 2006 (Seasonally Adjusted)

0

2000

4000

6000

8000

10000

12000

Jan-95Jul-95Jan-96Jul-96Jan-97Jul-97Jan-98Jul-98Jan-99Jul-99Jan-00Jul-00Jan-01Jul-01Jan-02Jul-02Jan-03Jul-03Jan-04Jul-04Jan-05Jul-05Jan-06

0

500

1000

1500

2000

2500

3000

3500

4000M3

M2

M1

Dotted Line -- Non-M2, M3 (Right Axis)

M1, M2, M3

Non-M2, M3

Source: 1 Federal Reserve

M 1 M 2 M 3 Non M 2 M 3

Jan 1995 - Present 20.2% 93.4% 134.4% 297.6%Apr 98 - Apr 00 3.8% 13.5% 17.7% 29.1%Mar 04 - Mar 06 4.1% 9.8% 13.4% 21.8%

Growth Rate Dec to Dec12-Month to Feb 2006 0.5% 4.7% 8.0% 15.1%

2005 -0.2% 4.0% 7.6% 15.5%2004 5.2% 5.6% 6.3% 7.8%2003 7.0% 4.8% 3.6% 0.9%2002 8.7% 10.5% 12.9% 18.2%2001 -3.2% 6.1% 8.6% 14.9%2000 2.6% 6.0% 8.3% 14.1%

Growth Rates in Monetary Aggregates

M1 Currency in Circulation, Demand Deposits, Other Checkable Deposits

M2 M1 + Savings Deposits, Time Deposits < $100K, Retail MMKT

M3 M2 + Institutional MMKT Funds, Time Deposits > $100K, RPs, Eurodollars

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Liquidity in the Market – Foreign Investing

Increased foreign buying has also contributed to the market’s liquidity

Foreign investment in US financial assets has exhibit continuous positive growth over the past 15 years.

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

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

Source: 1 Federal Reserve, Flow of Funds 2 National Bank Financial

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Outlook – What Happens from Here?

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Historically, the end of Fed tightening periods has prompted wider spreads in the credit markets

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

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

BAA Corporate Spreads

100

150

200

250

300

350

400

450

1985 1988 1991 1994 1997 2000 2003 2006

Source: 1 MacroMavens 2 Comstock Partners, Inc.

*MBS Spread

60

80

100

120

140

160

180

200

220

240

260

1985 1988 1991 1994 1997 2000 2003 2006

*FNMA 30-Year minus 10yr. Treasury

260

240

220

200

180

160

140

120

100

80

60100

150

200

250

300

350

400

450

1985 1988 1991 1994 1997 2000 2003 2006

Market Outlook – A Widening Spread Environment

Market Trends During Periods of Fed Tightening (Shaded)

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Opportunities – What Strategies Can be Implemented?

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Source: 1 Credit Suisse

MBS are at 5-year cheaps vs. corporates1

Opportunities in the Current Credit Markets – Defensive Strategies

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.

Many sectors of corporate and consumer credit are overpriced and offer “short” opportunities.

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.

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Opportunities in the Current Credit Markets – “Credit Neutral” Approach

Expect current sub-prime production to mirror that of 2000-2001.

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.

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.

Source: 1 Fitch

Prime Cumulative Loss by Age

0.00%0.05%

0.10%0.15%

0.20%0.25%

0.30%0.35%

0.40%0.45%

0.50%

0 6 12 18 24 30 36 42 48 54 60 66 72

Subprime Cumulative Loss by Age

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

0 6 12 18 24 30 36 42 48 54 60 66 72

Alt-A Cumulative Loss by Age

0.00%0.10%

0.20%0.30%0.40%0.50%

0.60%0.70%0.80%

0.90%1.00%

0 6 12 18 24 30 36 42 48 54 60 66 72

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