September 10, 2004

Evolution of the Fixed Income MarketFinance 472: Trading & Markets

Deutsche Bank Securities Inc., a subsidiary of Deutsche Bank AG, conducts investment banking and securities activities in the United States.

2

Contents

Section

1 Unsecured Debt and Swap Market

2 Development of Mortgage and Asset Backed Securities

3 Issuer Case Study: Capital One

Section 1

Unsecured Debt and Swap Market

4

“Neither a borrower,

nor a lender be. . . ”

--Polonius, to his son Laertes, in Hamlet

5

n Envision the corporate balance sheet. Specialist bankers are responsible for covering each component of a corporate balance sheet. In addition to delivering their own specialties, these bankers also work together to deliver multi-disciplinary solutions that encompass more than one section of the balance sheet.

Assets = Liabilities + Shareholders’ Equity

n The debt originators are responsible for underwriting transactions with their client base in a broad range of currencies: USD, EUR, GBP, JPY and AUD, as well as smaller ones.

n The risk marketers -- all highly specialized -- focus separately on interest rate, currency, commodity and credit risk

What is Debt Capital Markets?

The bankers within DCM focus principally

on the Liabilities component of the

balance sheet. While definitions can vary by firm, at DB all of

the corporate-facing debt originators and

risk marketers are within DCM

M&A and corporate finance bankers

Debt originators and derivative marketers

Equity capital markets and corporate finance bankers

6

Key Players in the Origination, Sales and Trading of Corporate Debt

The Capital Markets process of matching

investors with issuers requires intricate

coordination between various parts of an

investment bank

Issuers Syndicate Sales Investors

Debt originators

Derivative marketers

DCM

Cash bond traders

Credit default swap traders

Credit Trading

Interest rate swap traders

Treasury traders

Interest Rate Trading

Credit Research

7

0%

1%

2%

3%

4%

5%

6%

Treasury Yield Curve

1yr 5yr 10yr 20yr 30yr15yr 25yr

Yield Curve as of 9/7/04

3 month 1.62%6 month 1.88%1 year 2.11%2 year 2.56%3 year 2.89%5 year 3.46%10 year 4.24%30 year 5.01%

Yield Curve as of 9/7/04

3 month 1.62%6 month 1.88%1 year 2.11%2 year 2.56%3 year 2.89%5 year 3.46%10 year 4.24%30 year 5.01%

Normal Curve

Flat Curve

Inverted Curve

Steep Curve

8

Treasury Yield CurveLast 20 years

Interest rates have fallen dramatically

over the last 20 years

The principal reason for this secular

decline in rates has been a precipitous decline in inflation

In recent years a decline to new low in

rates has been driven by the 2001-2002

recession and accommodating Fed

monetary policy

US Treasury Yield Curve

0%

2%

4%

6%

8%

10%

12%

14%

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

2yr 5yr 10yr 30yr

Flat yield curve

Steep yield curve

Inverted yield curve

9

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Credit Spreads Relative to Treasuries

1yr 5yr 10yr 30yr

Boeing: A3/A ( +65)

GECC: Aaa/AAA ( +52)

GECC: Aaa/AAA ( +34)

Comcast: Baa3/BBB ( +42)

GM: Baa1/BBB ( +229)

Disney: Baa1/BBB+ ( +45)

Georgia Pacific: Ba1/BB+ ( +158)

Capital One Fin.: Baa3/BB+ ( +130)

Ford: A3/BBB- ( +199)

Xerox: Ba2/BB- ( +233)

Capital One Fin.: Baa3/BB+ ( +85)

AT&T: Ba1/BB+ ( +281)

Comcast: Baa3/BBB ( +95)

High-quality corporate bonds are

quoted as basis point spreads to Treasuries.

The basis point spreads equate to

incremental yield for the greater credit risk

of a corporate bond versus a Treasury

bond

Corporate credit spreads are

theoretically driven by the probability of

default (failure by the borrower to pay

principal or interest) and the anticipated

recovery of principal (as a % of par) if there

is a default

Dow Chemical: A3/A- ( +126)

GlaxoSmithKline: Aa2/AA ( +69)

10

Corporate Yield = Treasury Yield + Corporate Spread (bps)

= Treasury Yield + (Amortization of implicit premium generated by writing puts on the equity of the specific company)

n Corporate bond investor accepts risks that equity cushion (SE = Assets minus Liabilities) will decline or even become negative (leading to an event of default)

n Equity volatility (both company-specific and in index form, as expressed by the VIX) influences corporate spreads as well. Low volatility translates into low implicit option premium and tight corporate spreads. Conversely, high volatility leads to high premium and wide spreads.

n Capital structure arbitrageurs look to profit from discrepancies in valuation of different layers of a given company’s capital structure.

Corporate Credit SpreadsCloser Look

11

Historical Credit Spreads

Historical Credit Spreads Over 10yr Treasuries

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

AA A BBB

Asian crisis

Russian debt default/LTCM

Stock market bubble bursts, economy goes into recession, default frequency

accelerates

US economy begins to

recover; assets reflate

Spread Compression

Spread DecompressionPeriods of low volatility are typically

accompanied by small spread increments for

differing levels of credit risk

Periods of high volatility typically see much greater spread

increments for the same differences in

risk

12

Historical Issuance Volume

Rates

Issuance Volume

Issuance volume has multiplied as funding cost became cheaper

Historical US Investment Grade and High Yield Issuance

-

100

200

300

400

500

600

700

800

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

YTD

$ B

illio

ns

0%

2%

4%

6%

8%

10%

12%

14%

Inv. Grade (LHS)

High Yield (LHS)

10y Treasury Note (RHS)

13

$0

$20

$40

$60

$80

$100

$120

$140

$160

$180

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Volu

me

(US$

Bill

ions

)

0

20

40

60

80

100

120

140

160

180

200

Defa

ult C

ount

s

Volume (US$ Billions) (LHS)

Default Count (RHS)

Historical Default Rates

Source: Moody’s Investor Services

Global Corporate Bond Default Counts & Dollar Volumes, 1982-2003

Oops! Corporate bonds actually do carry principal risk!

Recessions lead to sharp increases in

default frequencies

After prolonged periods of economic

growth, lax underwriting

standards and/or investor avarice can

exacerbate the pressures of

economic weakness

14

Historical Default Migration

Average One-Year Ratings Transition Matrix: 1920-2002

Source: Moody’s Investor Services

1yr 2yr 3yr 4yr 5yrAaa - - - - 0.03%Aa - 0.00% 0.03% 0.08% 0.14%

A 0.01% 0.05% 0.14% 0.24% 0.34%Baa 0.15% 0.40% 0.69% 1.13% 1.55%Ba 0.88% 2.50% 4.49% 6.56% 8.59%

B 4.19% 9.75% 15.12% 20.37% 25.27%Caa-Ca 17.14% 30.91% 44.84% 55.91% 66.80%

Average Cumulative Credit Loss Rates from 1 – 5 years (1982 – 2003)

Aaa Aa A Baa Ba B Caa-C Default WRAaa 88.37% 6.31% 0.96% 0.20% 0.01% 0.00% 0.00% 0.00% 4.15%Aa 1.17% 86.99% 5.75% 0.63% 0.15% 0.02% 0.00% 0.07% 5.21%A 0.07% 2.36% 86.09% 4.78% 0.62% 0.10% 0.02% 0.12% 5.82%

Baa 0.04% 0.25% 3.92% 82.66% 4.72% 0.65% 0.09% 0.29% 7.38%Ba 0.01% 0.08% 0.42% 4.76% 78.41% 5.38% 0.50% 1.11% 9.33%B 0.00% 0.04% 0.14% 0.56% 5.86% 75.99% 3.22% 3.67% 10.52%

Caa-C 0.00% 0.02% 0.03% 0.32% 1.21% 4.59% 71.72% 13.27% 8.84%

Ratin

gs F

rom

Ratings To:Default migration studies measure how

badly and how quickly credit can deteriorate

Default frequenciesfor B and Caa-Ca

illustrate the term “junk bond”

In bond market parlance, an NCAA

champion is a bond that defaults before

the first semi-annual coupon is paid –

“no coupon at all”

15

Insurance

10%

Captive

Finance12%

REIT13%

Broker/Dealer

22%

Domestic Bank25% Specialty

Finance9%

Foreign Bank9%

Financial63%

Healthcare5%

Energy/Power13%

TMT5%Other

2%

Autos1%

Industrial8%

Consumer/Retail3%

Corporate Debt Issuance—Sellers (“Issuers”)

Auto (Captive Finance)Ford Motor Co.General MotorsAmerican Honda

Telecom/Media/TechnologyAT&TMotorolaIBM

Consumer/RetailAnheuser-BuschWal-MartProcter & Gamble

FinancialsCitigroupWashington Mutual BankAllstate

IndustrialGeneral ElectricCaterpillarJohn Deere

HealthcareGlaxoSmithKlinePfizer

Energy/PowerCon Edison of New YorkPacific Gas and Electric

OtherFedExBerkshire Hathaway

Sovereign/SupranationalsRepublic of PhilippinesInternational Finance Corp.

Examples

Financials

16

Sample Buyers of Corporate Debt

n Asset Managers: Blackrock, PIMCO, WAMCO, etc.

n Banks: Bank of New York, Citibank, HSBC, etc.

n Corporates: Caterpillar Investment Management, Fannie Mae, Microsoft, etc.

n Hedge funds: BlueBay, SAC Capital, Solent, etc.

n Insurance Companies: Aegon, AIG, Northwestern Mutual Life, etc.

n Mutual Funds: Dreyfus, Fidelity, Vanguard, etc.

n Pension Funds: General Electric Pension Fund, Teachers Insurance & Annuity Assoc., etc.

n Retail (“mom-and-pop”): Muriel Finkelstein in Boca Raton, FL, plus hundreds ofthousands of others.

n State Fund: Alabama State Fund, California PERS, Maryland State Retirement and Pension System, etc.

17

Evolution of the European Corporate Credit Market

Arrival of Monetary Union created a

single-currency euro-denominated credit

market to rival the US market

Recent issuance growth among

European A/BBB rated entities have outpaced AAA/AA

rated issuers

The “institutionalization” of European money

management has turned credit into an

asset class

Historical European Investment Grade and High Yield Issuance

-

100

200

300

400

500

600

700

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

YTD

Year

$ Bi

llion

s

AAA/AA A/BBB High Yield

“Belgian dentist” buys individual bonds from highly-rated, highly

recognized companies like Siemens, BT, GE, and Ford

18

Largest Debt Transactions in History

Deals in bold indicate Deutsche Bank served as Bookrunner

The largest capital-raising initiatives ever

have occurred in the unsecured debt

market

Rank Date Issuer Size Currencies1 June 2003 General Motors/GMAC $17.5 Bn US$, Euro, GBP2 March 2001 France Telecom $16.4 Bn US$, Euro, GBP3 June 2000 Deutsche Telecom $14.6 Bn US$, Euro, GBP, JPY4 May 2001 WorldCom $11.9 Bn US$, Euro, GBP5 March 2002 General Electric Capital Corp. (GECC) $11.0 Bn US$6 November 2001 AT&T $10.1 Bn US$, Euro7 December 2000 British Telecom $10.0 Bn US$8 October 2001 Ford/Ford Motor Credit $9.4 Bn US$, Euro9 January 2001 Ford Motor Credit $9.3 Bn US$, Euro

10 July 1999 Ford/Ford Motor Credit $8.6 Bn US$

19

Innovations in US Corporate Bond Market

Ø Swaps to create funding efficiencies and foster cross-currency funding opportunities

Ø Deep and liquid high-yield market (“junk bonds”)

Ø Puttable bonds

Ø 100-year bonds (“Century Bonds”)

Ø Tax-deductible preferred stock (equity credit at a debt cost)

Ø Issuance in new currencies (e.g., CZK, DKK, HUF, NOK, SGD, ZAR)

Ø Retail investor-targeted debt ($25 par baby bonds, MTNs)

Ø Synthetic put bonds (derivatives market-enhanced optionality for issuers)

Ø Inflation-linked debt

Ø GIC-backed notes

Ø Evolution of European credit market

Ø Extendible notes (expand 2a7 money fund capacity at status quo backstop bank facility capacity)

Ø Credit default swaps as a risk management tool

n Early ‘80s

n Early/mid ’80s

n Late ’80s

n 1993

n 1993

n Continuous

n 1995

n 1996-1997

n 1997

n 1997

n Late ’90s

n 2000

n Early ’00s

20

LIBOR Forwards vs. Swap Rate

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

5.00%

5.50%

3/05 9/05 3/06 9/06 3/07 9/07 3/08 9/08 3/09 9/09

Interest Rate Swaps

n An interest rate swap is an agreement between two counterparties to exchange a set of cashflows over an agreed time period in the future.

n An interest rate swap is essentially a PV-weighted average of expected future LIBOR rates.

LIBOR, reset semi-annually

5yr Swap Rate = 3.92%

5yr Interest Rate Swap Diagram

Client

Intuition Behind Pricing Illustrative Cashflow

LIBOR Fwd Curve

5yr Swap Rate = 3.92%

Beg of period

End of Period

Discount Factor Coupon PV Pmt LIBOR PV Pmt

9/9/04 3/9/05 0.9896 3.92% 1.94 2.08% 1.04 3/9/05 9/9/05 0.9761 3.92% 1.91 2.72% 1.36 9/9/05 3/9/06 0.9605 3.92% 1.88 3.22% 1.56 3/9/06 9/11/06 0.9429 3.92% 1.85 3.63% 1.77

9/11/06 3/9/07 0.9246 3.92% 1.81 3.98% 1.83 3/9/07 9/10/07 0.9047 3.92% 1.77 4.28% 1.99

9/10/07 3/10/08 0.8845 3.92% 1.73 4.51% 2.02 3/10/08 9/9/08 0.8637 3.92% 1.69 4.74% 2.08 9/9/08 3/9/09 0.8428 3.92% 1.65 4.93% 2.09 3/9/09 9/9/09 0.8214 3.92% 1.61 5.11% 2.14

NPV 17.86 NPV 17.86

Fixed Leg Floating Leg

21

Interest Rate Swaps: Who Uses and Why?

Receive Floating;Pay Fixed

Pay Floating;Receive Fixed

Banks Match assets with liabilities;Leverage balance sheet

CorporatesHedging interest rate exposure (mostly converting fixed debt to floating)

Hedgefunds

Relative value / Yield enhancement / Yield curveriding / leverage asset base

Agencies/Mortgage

Convexity hedging /Manage prepayment risk

Fund managers Relative value / Yield

enhancement

Match assets with liabilities

Convexity hedging / Manage average life extension risk

Relative value /Yield enhancement

Relative value / Yield enhancement

Hedge anticipated fixed-rate issuance or swap floating-rate bank debt to fixed

22

3m LIBOR Forwards

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Sep '04 Mar '05 Sep '05 Mar '06 Sep '06 Mar '07 Sep '07 Mar '08 Sep '08 Mar '09 Sep '09

Floating Interest Rates – Forward Curve

Current 3mL (9/7/04) 1.86%

Forward LIBORsSept ’04 1.86% (+0bps)Dec ’04 2.29% (+43bps)Mar ’05 2.59% (+73bps)Jun ’05 2.86% (+100bps)Dec ’05 3.27% (+141bps)Dec ’06 3.99% (+213bps)Dec ’07 4.51% (+265bps)

Current 3mL (9/7/04) 1.86%

Forward LIBORsSept ’04 1.86% (+0bps)Dec ’04 2.29% (+43bps)Mar ’05 2.59% (+73bps)Jun ’05 2.86% (+100bps)Dec ’05 3.27% (+141bps)Dec ’06 3.99% (+213bps)Dec ’07 4.51% (+265bps)

In a steep yield curve environment, such as

the current one, forward rates suggest a rapid near-term rise

in rates

Many market participants will elect

to “bet” against this by overweighting

fixed-rate assets or floating-rate liabilities,

or both.

Current Swap Rates (9/7/04)

1-Year 2.42%2-Year 2.95%3-Year 2.34%4-Year 3.66%5-Year 3.92%

Current Swap Rates (9/7/04)

1-Year 2.42%2-Year 2.95%3-Year 2.34%4-Year 3.66%5-Year 3.92%

23

Overprediction of LIBOR Forward Curves

The “hair chart” illustrates that

forward curves have nearly systematically

overpredicted the eventual path of

LIBOR

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

11.00%

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Actual LIBORHistorical LIBOR forward curves

Current LIBOR forward curve

24

Cross-Currency Swaps

n A cross-currency swap can be used to convert interest and principal denominated in one currency into another currency (e.g., from the foreign currency into a company’s functional, or local, currency)

n Euro Fixed/Floating Swap: The Euro LIBOR leg is eventually crossed out by the Euro LIBOR leg from the Basis swap

n Basis swap: Adjusts floating-rates across different currencies: in this example between US$ LIBOR and Euro LIBOR

n USD Fixed/Floating Swap: The US$ LIBOR leg crosses out the US$ LIBOR leg from the Basis swap

Euro/USD Cross-Currency Swap

Euro Fixed

Euro LIBOR

Client

Euro LIBOR

US$ LIBOR + Spread

Client

US$ LIBOR + Spread

US$ Fixed

Client

Euro Fixed

US$ Fixed

Client

Components of a Euro/USD Cross Currency Swap

A cross-currency swap, in essence is

an aggregate of multiple swap

positions

Cross-Currency Issuance Case Study:SLM Corporation (A2/A) in Australian Dollars

n This transaction represents SLM’s inaugural offering in the Australian market, and at a total size of A$600mm, this was the largest single-A kangaroo bond ever issued in the Australian market

n With total annual unsecured debt issuance needs of $10+ billion, SLM looks to maximize investor diversification by issuing in multiple currencies and regions. Investor diversification leads to increased demand for SLM’s paper and ultimately more attractive debt pricing

n As such, Deutsche Bank recommended an Australian transaction, providing SLM with access to a completely new investor base. Being a new issuer in the Australian market, SLM was able to achieve attractive pricing as investors looked to include a new US credit in their portfolios

n As the US Dollar is SLM’s functional currency, the entire deal was swapped to US$. The attractive basis swap between A$ and US$allowed SLM to meet its funding targets

n This transaction met SLM’s goals of investor diversification and issuance at levels slightly better than US$ levels (2 to 3 bps)

n With such a successful transaction, SLM has positioned itself well to be a regular and well-received issuer in the domestic Aussie market

Transaction Highlights and Motivation

Announcement Date: May 5, 2004

Maturity Date: May 18, 2009

Size: A$375mm

Launch Spread: Mid Swaps + 40 bps

Bookrunners: Deutsche Bank, UBS

Co-Managers: CBA, Citigroup, NAB, RBC

Fixed-Rate Notes

Announcement Date: May 5, 2004

Maturity Date: May 18, 2009

Size: A$225mm

Launch Spread: Bank Bills + 40 bps

Bookrunners: Deutsche Bank, UBS

Co-Managers: CBA, Citigroup, NAB, RBC

Floating-Rate NotesStudent lender SLM

Corp. used cross-currency swaps to

capture a window in the “kangaroo” market to raise

A$600m swapped back into US$

($438.3m) at a cost savings versus US

issuance while generating substantial

investor diversification

26

Evolution of the Interest Rate and Currency Swap Market

Historical Interest Rate and Currency Swap Notionals

Source: International Swap and Derivatives Association

-

20

40

60

80

100

120

140

160

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Year

$ Tr

illio

nsThe near exponential

growth of the swap market has been

driven by a broader awareness of and comfort with this

technology’s ability to mitigate risk,

transform cash flows and generate returns

Section 2

Development of Mortgage and Asset Backed Securities

28

Agency CMO's

25%

Agency MBS62%Non-Agency

CMO's13%

Development of the Mortgage Backed Securities Market

§ Total Size of U.S. Mortgage Market: $7.5 Trillion

§ Roughly $4.0 Trillion in MBS outstanding

§ $3.5 Trillion in Agency MBS outstanding

§ $2.5 Trillion in Agency MBS§ $1.5 Trillion FNMA§ $0.6 Trillion FHLMC§ $0.4 Trillion GNMA

§ $1.0 Trillion in Agency CMOs§ $0.5 Trillion FHLMC§ $0.4 Trillion FNMA§ $0.1 Trillion GNMA

§ Roughly $0.5 Trillion in Non-Agency CMOs

Size of the Mortgage Backed Securities (“MBS”) Market

Source: Bond Market Association Statistics (March 31, 2004), Deutsche Bank Securities

29

Mortgage-Backed SecuritiesSecuritization: Turning Loans into Securities

Birth of Mortgage-Backed Securities

BANK

8% 30 Year Mortgage Obligation, with house pledged as collateral

Borrows Money

$100,000

INDIVIDUAL HOMEOWNER

30

Mortgage-Backed Securities (continued)

Mortgages Swapped to become Mortgage-Backed Securities

BANK

FNMA

8% 30 Year Mortgage Obligation, with house pledged as collateral

Borrows Money

$100,000

Bank swaps a pool of ten $100,000 8% interest rate

mortgages

Pays insurance premium 0.25%

INDIVIDUAL HOMEOWNER

$1 million 7.5% FNMA Certificate backed by ‘Full

Faith and Credit’ of U.S. Government Continues to receive

Servicing Fee 0.25%

With possession of FNMA instead of Mortgages, Bank can:1. Sell FNMA into liquid __market2. Borrow against it __efficiently3. Keep it on balance __sheet with less __capital

(“Federal National Mortgage Association”)

31

Typical Bank Balance Sheet

Assets Liabilities

FNMA

Certificates

Single-Family

Mortgages

Student Loans

Auto Loans

Credit Card Loans

More Liquid

Less Liquid

Deposits

Term Notes

Preferred Stock

Equity

Senior

Subordinated

32

Collateralized Mortgage Obligations

§ CMO’s allowed cash flows of 30 year mortgages to be cut up and tailored to suit investor preferences.

Tranching of Cash Flows

Investment Horizon: Short Term Intermediate Term Intermediate/Long Term Long Term

Average Life: 2 years 5 years 10 years 20 years

Amortization Window:

4 years 4 years 8 years 14 years

Investor Type: Banks Banks/Insurance Insurance Insurance/Pension Funds

FNMA 7.5% CASH FLOW (12 YEAR AVERAGE LIFE, 30 YEAR AMORTIZATION)

33

Impact of CMO’s on Mortgage Costs

30 Year Mortgage Benchmark vs. 30 Year Treasury Benchmark

Source: Freddie Mac & Bloomberg

Average Spread After CMO's: 134 bps

Average Spread Before CMO's: 286 bps

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Spread to 30 Year Treasury Benchmark 30 Year Mortgage Benchmark 30 Year Treasury Benchmark

Advent of Early CMO's

34

ABS Market Overview

ABS Market Continues Growth Trajectory

* Data annualized.

Source: Deutsche Bank, Thomson Financial Securities Data

$12.9 $17.1 $24.9 $25.8 $19.1 $30.5 $36.4 $37.8 $40.2 $49.6 $69.8 $75.9 $83.6 $77.7 $82.4$22.6 $21.9 $17.4 $19.6 $32.1 $47.4 $49.4 $41.0 $42.8 $41.4$57.6 $68.4 $70.2 $64.9 $54.4

$11.1$16.1

$38.7 $70.7$87.5 $73.8

$77.2$103.0

$188.9

$310.2

$465.4

$2.7 $6.9 $9.4$19.5

$19.5 $42.5

$69.5

$100.7 $109.1

$109.3$96.6

$91.9

$128.5

$161.6

$8.0$1.0 $9.8 $6.4 $5.8$11.0

$8.3$6.7$10.3

$5.2$2.2

$6.9

$2.8$3.2$2.2

$2.7$0.2$0.2

$0$50

$100$150$200$250$300$350$400$450$500$550$600$650$700$750

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04*

billio

ns

Automobile Credit Card Home Equity Other

$1.2 $63.1$55.9$52.1$10.0 $9.1 $14.9 $24.4 $43.4 $81.8

$113.5

$167.0

$219.0

$271.2 $273.9

$313.9 $343.9

$434.7

$581.3

$763.8

§ Wall Street starts to turn its attention to securitization of other asset categories:

– 1985: Auto Loans, 1987: Credit Cards, 1988: Home Equity Loans, 1993: Student Loans

35

Mortgage Related, $5.4 trillion, 23.5%

Corporate, $4.6 trillion, 20.0%

US Treasury, $3.8 trillion, 16.5%

Fed Agencies, $2.8 trillion, 12.1%

Money Market, $2.6 trillion, 11.6%

Municipal, $2.0 trillion, 8.6%

Asset Backed, $1.8 trillion, 7.8%

ABS Market Overview (continued)

Estimated Outstandings of U.S. Fixed Income Securities – $22.8 Trillion

As of Q2 2004

Source: Bond Market Association

36

The Forces Driving Asset Securitization

– Capital efficiency

– Funding diversification

– Asset-liability management

– Accounting gain on sale

– Manage portfolio growth

Investor IncentivesIssuer Incentives

– Attractive nominal yield andbetter credit relative to corporates for similar ratings

– Generally low payment variability relative to MBS

– Excellent liquidity in most sectors

37

Some Top Clients

38

League Tables: Total ABS Market

2003 (Excluding Self-Funded Issues & Shelf Issues)

2004 Year to Date (2)

(Excluding Self-Funded Issues & Shelf Issues)

Lead Manager Principal (mm) (1) Market Share (%) Lead Manager Principal (mm) (1) Market Share (%) 1 Citigroup $45,555.2 11.8 1 Citigroup $32,328.0 12.5

2 Deutsche Bank Securities 40,502.0 10.5 2 Deutsche Bank Securities 25,211.0 9.7

3 JP Morgan 36,735.2 9.5 3 JPMorgan 23,385.7 9.0

4 Credit Suisse First Boston 34,849.9 9.1 4 Greenwich Capital 21,724.4 8.4

5 Banc of America Securities 30,473.5 7.9 5 Credit Suisse First Boston 21,191.1 8.2

6 Morgan Stanley 29,261.3 7.6 6 Merrill Lynch 21,109.3 8.2

7 Lehman Brothers 25,878.6 6.7 7 Banc of America Securities 17,967.2 6.9

8 Greenwich Capital 25,160.0 6.5 8 Lehman Brothers 16,750.9 6.5

9 Merrill Lynch 20,865.0 5.4 9 Morgan Stanley 15,575.9 6.0

10 Bear Stearns 19,314.2 5.0 10 UBS 14,746.7 5.7

Total of top 10 Managers $308,594.9 80.2% Total of top 10 Managers $209,990.2 81.1%

Industry Total $384,944.3 100.0% Industry Total $258,987.8 100.0%

Source: Thomson Financial Securities Data (SDC) and Deutsche Bank Securities 1) In U.S. dollar equivalents based on exchange rate as of pricing date. 2) As of July, 2004

39

Case Study: Capital One

§ As the ABS Market has grown to rival corporate market, an increasing number of major corporations have used securitization as a principal means of financing their business:

Capital One: Alternative Funding

On-Balance Sheet Funding Off-Balance Sheet Securitization Funding – Liability Structure

AAA-BBB avg = L+ 70 bps vs. AAA-BBB avg = L+ 19 bps

Prime Autos

97.55%

2.45%

AAA

A

Sub-Prime Autos

87.0% AAA

13.0% O/C

Credit Cards

A(L+36)

BBB(L+83)

AAA

(L+11)

81.25%

10.0%

7.25%

1.5% O/C

Assets

Autos

Credit Cards

International8.0% Equity

92.0% Corporate

DebtBBB

(L+70)

Liabilities

History of ABS – An Issuer’s PerspectiveSteve Linehan, SVP & Treasurer, Capital One Financial Corporation

41

42

Capital One is:

3434thth largest largest depository institution depository institution

in the U.S.in the U.S.

A majorA majorcredit card playercredit card player

A diversified A diversified consumer financial consumer financial services companyservices company

A significant capital A significant capital markets issuermarkets issuer

• 5th Largest Visa/Mastercard issuer• $45.3 managed U.S. credit card assets

• 2003: $1.1B net income, ROA 1.52%, ROE 23.4% • $71.8 B in managed loans• 37% of assets are outside of U.S. Card• 18% of Q1 2004 profits are non U.S. Card

• $23.6B in deposits• Direct Retail Deposits• Brokered Deposits

• Over $20.2B of Capital Markets issuance in 2003• ABS programs include U.S. credit card,

non-prime and prime auto, U.K. credit card• Unsecured programs include senior and

subordinate debt • Ratings: BB+/BBB- Baa3/Baa2

43

$5.60 - $5.901

$4.85

$0.48 $0.64 $0.77$0.93

$1.32$1.72

$2.24

$2.91

$3.93

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E

Growth Rate 33% 21% 21% 42% 30% 30% 30% 35% 23% 15-22%

Capital One continues to deliver strong earnings

Earnings Per Share

1) As of July 21, 2004.

One of three companies to earn > 20% EPS growth for 10 consecutive years

44

World Class World Class People & People & AnalyticsAnalytics

Scientific Scientific LaboratoryLaboratory

One of the One of the Largest Largest

Databases in the Databases in the WorldWorld

Massive Massive InnovationInnovation

MicroMicro--segmentation/segmentation/

Mass Mass CustomizationCustomization

Quantum Quantum Advance in Risk Advance in Risk

ManagementManagement

Capital One’s Killer App: The Information Based Strategy- IBS

45

We are using IBS to diversify our assets

GFS($18.7B)

Auto($9.4B)

Diversified Managed Outstandings

62%

25%

13%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1997 1998 1999 2000 2001 2002 2003 Q204

Card($45.2B)

46

Funding Mix – Securitization is important to Capital One

Total Managed Liabilities and Capital

43%

8%

9%

27%

5%8%

0%

20%

40%

60%

80%

100%

1998 1999 2000 2001 2002 2003 Q2 2004

Off-Balance Sheet Securitizations

Auto Securitizations

Senior Notes

Deposits

Other Liabilities*Capital

* Includes repos, Fed Funds, trust preferred securities, various payables and other liabilities

47

The Rationale for Securitization

Funding CostFunding Cost

Funding,Funding,Diversification,Diversification,

& Liquidity& Liquidity

Accounting &Accounting &Regulatory CapitalRegulatory Capital

RequirementsRequirements

AssetAssetLiabilityLiability

ManagementManagement

• Allows lower-rated companies to fund at approximately AA levels

• Transactions may represent risk transfer and qualify as sales

– Issuers don’t need to hold capital against securitized assets for regulatory capital requirements

– Issuers don’t need to reserve against loan losses on securitized assets

• The higher ratings on issuer’s securitization “debt” vs. its unsecured debt broadens its investor base and enhances its liquidity

• Securitization transactions are an effective tool for asset liability management, including maturity, currency, and basis (fixed vs. floating) management

48

LOW

HIGH

Securitization benefit increases during times of market disruptions

AAA AA A BBB BB B C D

AVAILABILITY COST

MOST COMMERCIAL

BANKSAND FINANCE COMPANIES

COB COFC

Securitization enables us to access deeper investor bases at lower costs

49

Credit Card securitization involves the issuance of securities secured by a designated pool of asset receivables “sold” to a bankruptcy remote entity

Capital OneMaster TrustCapital One Bank

(originator of assets)Investors

Asset BackedSecurities

Receivables onAccounts

Proceeds from ABS Issuance

50

The financial engineering of cash flows creates credit rating efficiency

As unsecured revolving debt obligations, credit card receivables offer limited recovery in the event of cardholder default.

To achieve investment-grade ratings, credit enhancement is needed to protect investors from changes in loss performance.

Credit enhancement is provided through:– Subordination (Class B and C tranches)

• Interest and principal payments are made to subordinate tranches only after all senior payments have been made.

– Excess spread is the net income of a securitization trust that flows back to the issuer.

– Spread or reserve accounts• A mechanism to capture excess spread if performance begins to deteriorate.

Class A81.25%(“AAA”)

Class C7.25% (“BBB”)

Class B10% (“A”)

Excess Spread

Spread Account

Capital One Subordination Structure

Class D1.50% (“BB”)

Sen

ior

Su

bo

rdin

ate

Cre

dit

E

nh

ance

men

t

Su

bo

rdin

atio

n

Excess spread is function of: Trust revenue

Gross portfolio yield 20.00%Trust expenses

Investor coupon -5.00%Servicing fee -2.00%

Charge offs -6.00%

Trust net incomeExcess spread 7.00%

51

Credit Card ABS have bullet maturities just like corporate unsecured bonds making them attractive to a broad investor base

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

1 2 3 4 5 6 7 8 9 10 1 1 12 13 1 4 15 16 1 7 18 19 20 21 22 23 24 25 26 27 28 29 3 0 31 32 3 3 34 35 3 6

Interest paid to investor Principal paid to investor

Bond cash flow $10,000,000 investment

Investment: Credit card ABS, three-year bullet maturity

Revolving period Accumulation period

6 12 1 8 24 30 36

Col

late

ral b

alan

ce (

$)

Collateral: Credit card accounts, monthly principal and interest receipts

Excess seller interest

Required seller interest

Investor interest

Revolving period Accumulation period

52

Funding costs are lower and less volatile than the company’s corporate debt

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

Jun-02

Jul-02

Aug-02

Sep-02

Oct-02

Nov-02

Dec-02

Jan-03

Feb-03

Mar-03

Apr-03

May-03

Jun-03

Jul-03

Aug-03

Sep-03

Oct-03

Nov-03

Dec-03

Jan-04

Feb-04

Mar-04

Apr-04

May-04

Jun-04

Corporate DebtDepositsCARD ABS*

*ABS represents the weighted avg. cost of funds for 5 year COMET deal including A, B and C tranches

High Low Average Std DevDeposits 6.13% 3.60% 4.72% 0.60%Corporate Debt 11.29% 3.78% 6.66% 1.92%Card ABS 5.95% 3.13% 4.37% 0.76%

Indicative 5 Year Fixed Rate Cost of Funds for Capital One

53

Securitization is an effective capital management tool

0%

2%

4%

6%

8%

10%

12%

With Securitization Without Securitization0%

5%

10%

15%

20%

25%

ROE% of Capital Required

Illustrative Example

54

Securitization markets provide flexibility to meet our asset-liability management objectives

-6%

-4%

-2%

0%

2%

4%

6%

Down 300 Down 200 Down 100 Basecase Up 100 Up 200 Up 300

Limit

Limit

Per

cen

t C

han

ge

in 1

2-M

on

th N

II

7/31/04NII rises 1.4% or $78MM

Deterministic Net Interest Income Sensitivity% Change in 12 Month NII

Programs

• Fixed Rate 3, 5, 7 years• Floating Rate 3, 5, 7 ,10, 15 years• £ Denominated transactions using

US Collateral• € Denomintaed transactions using

US Collateral

• £ denominated transactions using £ collateral

• € denominated transactions using £ collateral

$34B swap book also used to manage interest rate & currency risk

Rate Shock

55

Capital One continues to enjoy success in the capital markets

2003 1H 2004U.S. Card Securitizations Triple-A $5,100 $3,100 Single-A $1,100 $650 Triple-B $1,375 $668 U.K. Card Securitizations (1) $981 $1,249 Auto Loan Securitizations Prime $2,000 $850 Non-Prime $2,125 $1,000 Senior Notes $2,000 $1,000 Subordinated Notes $500 -Total $20,271 $10,279

1) In U.S. dollar equivalents based on exchange rate as of pricing date

56

Capital One expects to remain a lead issuer in the securitization market

US Cards US Autos

2003 2004 YTD 2003 2004 YTD

Issuer Total $ (billions)

(%) Issuer Total $ (billions)

(%) Issuer Total $ (billions)

(%) Issuer Total $ (billions)

(%)

1 Citibank 14.1 21.7 1 Bank One 5.7 18.8 1 GMAC 10.4 13.4 1 GMAC 4.6 9.0

2 Bank One 10.4 16.1 2 MBNA 5.2 17.2 2 Honda 6.1 7.8 2 Ford 4.6 9.0 3 MBNA 9.1 14.0 3 Capital One 4.6 15.1 3 Nissan 5.9 7.6 3 WFS 4.1 8.0

4 Capital One 6.9 10.7 4 Citibank 4.4 14.4 4 WFS 4.8 6.2 4 Daimler Chrysler 4.1 8.0 5 Chase 6.5 10.0 5 Chase 3.4 11.1 5 Ford 4.7 6.0 5 Honda 3.5 7.0

6 Discover 3.6 5.5 6 American Express 3.4 11.0 6 Daimler Chrysler 4.3 5.5 6 USAA 3.0 6.0 7 American Express 3.1 4.8 7 Providian 1.5 4.8 7 Chase 3.6 4.6 7 Nissan 2.5 5.0

8 Gracechurch 3.0 4.6 8 GE 1.0 3.3 8 Capital One 3.5 4.5 8 Capital One 2.5 5.0 9 Household 2.3 3.5 9 Gracechurch 0.8 2.6 9 Americredit 3.3 4.3 9 AmeriCredit 2.0 4.0

10 Advanta 1.5 2.3 10 World Financial Network 0.5 1.7 10 Toyota 2.9 3.7 10 Chase 1.5 3.0 Industry Total 64.9 100.0 Industry Total 30.5 100.0 Industry Total 77.7 100.0 Industry Total 50.8 100.0

Source: Deutsche Bank Securitization Monthly As of July 31, 2004

#3 ABS Issuer in 2003#1 ABS issuer YTD 2004