13 january 2009 1 alexander batchvarov, cfa +44 20 7995 8649 ludwig clement +44 20 7995 0432 caspar...

13 January 2009

1

Alexander Batchvarov, CFA +44 20 7995 [email protected]

Ludwig Clement +44 20 7995 [email protected]

Caspar Cook, CFA +44 131 473 [email protected]

Altynay Davletova, CFA +44 20 7995 [email protected]

James Martin +44 20 7995 [email protected]

Furquan Kidwai +44 20 7996 [email protected]

Sabine Winkler +44 20 7995 [email protected]

European Structured Finance 2008-09

Product ID

13 January 2009

What Drives European Credit Spreads - 2009

13 January 2009

2008-09: In search of a strong footing

13 January 2009

3

2008 - an exceptional year in every respect

Rated new issuance exceded Eur700bn, much higher than in previous yearsPublic placement - maybe less than 2.5% of new issuanceMain primary market investor- the central banksSecondary market - main focus of remaining investorsSpreads - wide across stack, asset classes and geographiesCDS on ABS - a viable investment instrument for the cash strapped investor; volatile basisSpread volatility - not a surprise, but how much is driven by fundamentals and how much by technicalsUS and European ABS - mutually re-enhanced relationship in secondary spreads

13 January 2009

4

2008 - an exceptional year in every respect

Performance of European structured finance bonds deteriorating, but the majority of the European structured finance transactions perform according to initial expectationsRating agencies changes in methodology and/or assumptions adding to market instability - an event risk rather than credit riskDeteriorating credit performance - is the actual deterioration within expectations or beyond expectations?MtM sensitivity - unnecessary for structured, illiquid and difficult to value positions - drove traditional investors away from the market and converted buyers into forced sellersReputational issues - media frenzy and financial institutions reputation - better lose one’s shirt in equity than a shirt’s button in structured finance!Wider markets’ lack of understanding of the structured finance worldEvents that were never meant to happen - demise of the monolines, hitting a MT NAT test (who gave that advise?!), collapse of the commercial paper market, rise and fall of the systemic bank risk, decline of covered bonds liquidity and collapse of related market-making mechanism, multi-notch downgrades due to radical changes in rating methodology - a squadron of blcak swans!

13 January 2009

5

The demise of the parallel banking system

Banks and finance companies actively originate loans in the expectation that they can off-load them to long-term investorsSecuritisation is the transformation mechanism by which pools of loans are converted into bonds with different risk profile Securitisation bonds are sold to investors with different risk appetite - investors of the senior part of 70-90% of each transaction play a key part in the placementInvestors base for the senior and bulkiest part of the securtisation bonds comprise banks, SIVs, ABCP conduits and hedge funds - all rely on short-term funding and/or leverageThe parallel banking system replicated the traditional gap (short-term funding / long-term investing) of traditional banking system without the benefit of CB aidA run on the parallel banking system occurred when the short-term markets shut down, bringing the main players of the parallel banking system to their kneesThe parallel banking system provided credit to the tune of USD1.5-1.8trl p.a. globally in the preceding five years (Western Europe E350-500bn p.a. from securitisation plus E150-200bn p.a. from covered bonds)The elimination of credit flows from the parallel banking system without a replacement provider of that credit in the near team is having a devastating effect on the markets and the economies of many countries around the world

13 January 2009

6

Government actions

Actions associated with providing liquidity to the marketsRepo facilities and repo eligibility (categories II, III, IV, V)

Actions meant to stimulate new lendingGuarantee for financing of new lending (the UK)

Actions to support borrowers facing debt service difficultiesSpain and Italy, so far

Actions to prop up the banks and stimulate new debt issuanceGovernment guarantees for bank debt (many countries for 3 or 5 years), covered bonds (Sweden, Ireland, UK), RMBS (UK)

Creating a multiple-tier bond market: government guaranteed (GG) bank debt, GG covered bonds, GG MBS, regular (non-GG) bank debt, legacy covered bonds, legacy ABS and MBS

Loan modifications - self-interest or moral suasionAdditional actions required - social housing, first time buyers, new investors

13 January 2009

7

From one to two markets for structured finance

Government related markets for structured finance bondsRepo facilities - new issuance price to repo, not priced to marketPotential implementation of government guarantees to RMBS and covered bonds (UK)Government-guaranteed covered bonds vs. covered bonds from government supported banks

Legacy markets for structured finance productsSecondary markets for ABS and MBSSecondary markets for covered bondsWide spreads for liquidity or credit reasons, or both

Interaction among the different primary markets in the presence of government guaranteeGG bank debt - most attractive pricing but limited maturity (3 or 5 yrs) and size per government support packages (on balance sheet debt)Covered bonds - attractive pricing for the guaranteed covered bonds but admin cost not justifiable, hence covered bonds attractive for maturities beyond 3/5 years (on balance sheet debt with encumbrance, investor acceptance in light of product disparity)Securitisation - attractive due to clear asset/liability matching and maturity/ cash flow profile(regulatory issues about retention and capital treatment, structures and asset investor acceptance)

Short-term and long-term distortions and their cure

13 January 2009

8

In Search of New Investors and New Asset Allocation

Remaining traditional investorsBanks - the MtM issue, overload, reinvesting amortisation, tight liquidity, deleveringInsurance companies - 2012 and capital requirement rulesPension funds - different degree of past involvementGovernment guaranteed paper - the SSA investor

Distressed investorsFixed income funds, alternative credit fundsTiming the entry, sizing the return‘Price Distressed’ bonds vs ‘Credit Distressed’ bondsChallenges in sizing the distressed debt market in Europe

Cross-over investorsNatural fit - private equity investors and CLOs; property investors and CMBSTenuous fit - bank equity investors and RMBS/ ABSDevelopments and returns on the traditional market of a given investor in comparison with availability and return of structured finance instruments - dividend yield&capital return vs. coupon&principal return

13 January 2009

9

The Asset Allocation QuestionsPreferred part of the distressed universe - price vs credit distressedFit into the existing allocation guidelines or need to modify guidelinesAvailability of the necessary skill set in the organisationAllocation to fixed income / alternatives / distressed in traditional equity portfoliosRealistic assumptions about equity returnsAbility to use derivatives to hedge or take exposureAbility to hold investments to maturity

13 January 2009

10

The future of Structured Finance

ProsThe need for credit and the inability of banks to provide it from wholesale and depositsDemographics demand fixed income instrumentsInvestors preference for secured investment instrumentsAvailability of skilled structured finance professionals displaced by the upheaval in investment bankingSecuritisation as a truly match-funded funding mechanismAttractive relative value of securitisation and covered bonds post dislocation

ConsRegulatory zeal/ hyperactivity - BIS2.2 and the X% ruleInsufficient investor baseAmbiguity of rating agencies roleNegative publicity surrounding structured financeCrowding out effect of government guaranteed debt and ‘nationalisation’ of the banks

13 January 2009

11

Expectations for 2009De-leveraging and re-capitalisation of banksStabilisation or at least sizing the trough of the residential and commercial real estate marketsSizing the depth of the economic turn in EuropeReduction of systemic risk in the banking systemClarity as to the range of measures the governments are prepared to take to support the economies, consumer and corporate sectors, market liquidity and funding availabilityAccepting a scenario-based risk-reward approach to investingDifferentiating between price distressed and credit distressed bonds, new and legacy bonds

13 January 2009

Islamic finance

13 January 2009

13

Sukuk market in picture

Global Sukuk issuance (US$bn) GCC Sukuk issuance (US$bn)

5yr FLT, Corporate Sukuk spreads (bps)

050

100150200250300

2005 2006 2007 2008

Bahrain Kuwait Qatar Saudi Arabia UAE

0

2

4

6

8

10

12

14

16

18

20

2005

2006

2007

2008

0

5

10

15

20

25

30

35

2001 2002 2003 2004 2005 2006 2007 2008


Source: Zawya, Merrill Lynch, IFIS



13 January 2009

14

Sukuk market in picture (contd.)

Sukuk issuance by country (US$bn) 2007 vs 2008 Sukuk issuance (US$bn)


0

5

10

15

20

25

30

35

2001

2002

2003

2004

2005

2006

2007

2008

Bahrain Brunei Gambia Germany Indonesia Kuwait Malaysia PakistanQatar Saudi Arabia Sudan UK UAE USA Supranational

0

2

4

6

8

10

12

14

Bahrain Brunei Indonesia Kuwait Malaysia Pakistan Qatar SaudiArabia

UAE

2007 2008

13 January 2009

15

Sukuk spreads widened and issuance declined

Sukuk spreads widened 2-3 times; Corporate sukuk priced in the range of 115 – 275bps; Saudi spread declined on GSE issuance Widening attributed to shariah ruling on asset buy-back in sukuks, contagion from the global economic slow down and uncertainty regarding the peg issue

Issuance declined 58% y-o-y; only Bahraini market kept up with last year’s numbers – local money market instruments in demandMalaysian local currency sukuk dominated the market with US$5.3bn issuanceIndonesia a new market entrant: US$677mn vs US$44mn (in 2007); fixed rateIssuance predominantly in local currencyShariah-compliant syndicated lending continues as an alternate debt supplier

13 January 2009

16

The sukuk controversy

Purchase price guarantee in Musharaka, Mudaraba and Wakala structure declared non-compliant shariah; effectively eliminating principle guaranteeEquity/ownership or securitisation structures preferred Ijara (sale and lease-back) structure exempted from this restrictionMusharaka and Mudaraba sukuks down to 17% and 5% respectively from 43% to 21% last year; Ijara sukuks up to 54% from 30% in 2007

0%

10%

20%

30%

40%

50%

60%

Musharaka Mudaraba Ijara

2007 2008

YoY structural shift in sukuk issuance

13 January 2009

17

Islamic Securitisation

First land securitization in Abu Dhabi and the UAE: Sun Finance LimitedFirst 100% local currency ABS; true sale with title transfer for asset isolationRated Aa3/A3/Baa3 and pricing in at 200/250/350bps over EIBORSome of the transaction features include:

Low WA LTV (49%), 42% over-collateralisation, short WA life (21 months) & pre-funded reserve accounts Strong state participation in Abu Dhabi’s development, registered land ownership & high-rated backup servicer, positive real estate outlook in Abu Dhabi for short-medium term

Source: Moody’s

13 January 2009

18

GCC Securitisation: any chance?

Fundamentals: weakening economy and real estate markets; Saudi relatively better Credit growth: credit growing rapidly, banks’ loan to deposit growth (100% in Qatar, 65% KSA), over-exposure to the real estate sector – need to offload in the capital market

Collateral performance: low non-performing loan ratio supported by strong economic growth; consumer loans exposed to local stock markets (esp. KSA) and real estate; deterioration of assets likely especially the UAE

Demand: local investors and banks; shariah-compliant securitisation to attract Islamic banks; however real estate exposure to be taken with a pinch of salt Legal issues: untested and evolving legal system; two-tier SPV used so far; free-zones more reliable, replicate English law

Expectations: GCC securitisation to continue; UAE the most developed markets in the GCC; Qatar and Saudi picking up; post-downturn origination to slow down

13 January 2009

19

Consumer & mortgage lending

Total loans (% of GDP): UAE (103%), Qatar (69%), Bahrain (64%), KSA (42%), Egypt (48%)

ConsumerDeposits (% of GDP): UAE (103%) and Bahrain (96%) leading, position boosted by offshore financial centres

Retails loans: Highest retail loans in Qatar and Bahrain, UAE lagging (6% of GDP)Private consumption rising; credit card market growing – UAE accounts for 50%

MortgageMortgage penetration low across the board; UAE (8%) and Kuwait (10%) top the listIncreasing housing costs to support mortgage growthLegal infrastructure needs clarity

13 January 2009

Covered bonds 2008-09

13 January 2009

21

Market in numbers

Jumbo market at the end of 2008 compared with the end of 2007Annual gross supply: €90bn versus €152bn

Share of special-law-based covered bonds 17% versus 37%Share of mortgage covered bonds 64% versus 66%

Total volume outstanding: €823bn versus €821bnShare of special-law-based covered bonds 20% versus 23%Share of mortgage covered bonds 60% versus 56%

Number of Jumbos issued: 66 versus 99Number of Jumbo issuers: 97 versus 80Number of products issued in Jumbo format: 24 versus 21New special covered bond laws: 2 versus 4Jumbo redemptions: €87bn versus €80bnInitial maturities of new Jumbos:

up to 5 years 89% versus 50%6 to 10 years 11% versus 35%over 10 years 0% versus 18%

13 January 2009

22

Market in numbersGermany remains the largest Jumbo market

Source: Merrill Lynch

Germany dominates the 2008 Jumbo primary market


Special-law-based covered bonds in vogue


Broken trend


0

50

100

150

200

2000 2001 2002 2003 2004 2005 2006 2007 2008

Spain Germany United KingdomFrance Ireland NordicsNorth America Benelux others

€bn

0

300

600

900

2000 2001 2002 2003 2004 2005 2006 2007 2008

Spain Germany United KingdomFrance Ireland NordicsNorth America Benelux others

€bn

0%

20%

40%

60%

80%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008

Special-law -based cov ered bonds General-law -based cov ered bonds

0%

20%

40%

60%

80%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008

Special-law -based cov ered bonds General-law -based cov ered bonds

13 January 2009

23

Market in numbersInvestor appetite for mortgage covered bonds subdued

Source: Merrill Lynch, Annual gross supply of Jumbo covered bonds.

Covered bonds as mortgage finance instrument

Source: Merrill Lynch, Outstanding volume of Jumbo covered bonds.

Initial terms of new Jumbos have become shorter


Significant redemptions expected near-term


0%

20%

40%

60%

80%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008

Mortgage loans Mix ed cov er pool Public debt Ship loans

0%

20%

40%

60%

80%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008

Mortgage loans Mix ed cov er pool Public debt Ship loans

0

8

16

24

32

2-y r 3-y r 4-y r 5-y r 6-y r 7-y r 8-y r 10-y r >10-y r

2008 2007€bn

0

25

50

75

Ger

man

y

Fran

ce

Spai

n

UK

Irela

nd

Italy

Swed

en

Aust

ria

N. A

mer

ica

othe

rs

2009E 2010E€bn

13 January 2009

24

Challenges

What place do covered bonds have in a bank’s overall funding mix?Banks adjust their balance sheets and refinancing strategiesOriginate-to-retain and originate-to-repo process is in vogue Secured funding implies structural subordinationTerm funding has to gain importance over time

How will the investor base develop and grow?The development of a domestic investor base becomes crucialThe risk assessment of covered bonds has become more complex

How will the pricing of covered bonds develop?From a ‘rates plus’ product to a ‘credit minus’ product to an in-between productExceptional competition from government-guaranteed bank debt

13 January 2009

25

Challenges

Will the spread differentiation by country and issuer stay?Covered bonds have suffered from a sharp liquidity decline and widening spreadsSpread differentiation between countries and issuers has reached all-time wides Spread differentiation and risk aversion go hand-in-handFlight-to-safety and flight-to-liquidity flows to put upward pressure on spreadsPotential issuer downgrades negatively affect the Jumbo spread performance Subdued gross supply and €100bn in redemptions should support Jumbo spreadsSpread differentiation by country and issuer to stayGradual spread contraction in the longer term

13 January 2009

26

ChallengesSecondary spreads of 5-year €-denominated Jumbos


Newer Jumbo markets lack domestic investor base


Public versus mortgage covered bonds


General versus special-law-based covered bonds


-10

60

130

200

270

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

US cov ered bondsUK cov ered bondsIrish credit cov ered securitiesSpanish CédulasFrench Obligations FoncièresSw edish cov ered bondsGerman Pfandbriefe

bp

-20

0

20

40

60

80

100

7/03 7/04 7/05 7/06 7/07 7/08

-50

-40

-30

-20

-10

0

Mortgage cov ered bonds (lhs)Public cov ered bonds (lhs)

Spread betw een mortgage and public

cov ered bonds

bp bp

-40

0

40

80

120

160

200

7/03 7/04 7/05 7/06 7/07 7/08

-90

-70

-50

-30

-10

10

Special-law based cov ered bonds (lhs)General-law based cov ered bonds (lhs)

Spread betw een special and general-

law -based cov ered bonds

bp bp

35%

14%

11%11%

9%

3%

8%

2%3%

1%

3%

Germany /Austria

Nordics

France

Ireland/UK

Benelux

Iberia

others

Asia

Sw itzerland

Italy

North America

13 January 2009

27

Comeback

The 2009 comeback of covered bondsExceptional market conditions have stemmed the flow of new Jumbo issuanceFinancing markets have to stabilise and investor risk aversion needs to easeBanks need a variety of funding instruments and matched refinancingBanks have to wean themselves off current exceptional government supportThe covered bond market dynamics are not fully divorced from the credit marketThe reception of a covered bond depends on an issuer’s reputation with investorsAn overhaul of the market-making system to restore investor confidenceCombined efforts from the different covered bond market stakeholders

13 January 2009

UK RMBS

13 January 2009

29

UK house prices continue south

UK house prices implied by property derivatives


UK House price index, YOY change

Source: Halifax, Nationwide, Land Registry, Merrill Lynch

50

60

70

80

90

100

110

0 1 2 3 4 5Years into Correction

Nom

inal

UK

Hou

se P

rice

Implied

1990 correction

Correction to date

-20%

-10%

0%

10%

20%

30%

40%

May

-89

Jan-

90

Sep-

90M

ay-9

1

Jan-

92Se

p-92

May

-93

Jan-

94

Sep-

94M

ay-9

5

Jan-

96Se

p-96

May

-97

Jan-

98Se

p-98

May

-99

Jan-

00

Sep-

00M

ay-0

1

Jan-

02Se

p-02

May

-03

Jan-

04Se

p-04

May

-05

Jan-

06

Sep-

06M

ay-0

7

Jan-

08Se

p-08

Halifax Nationwide Land Registry

13 January 2009

30

House sales and mortgage approvals drop

Volume of UK house sales

Source: Land Registry

UK Mortgage approvals (000s)

Source: Datastream

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

Jan-

1995

Jul-1

995

Jan-

1996

Jul-1

996

Jan-

1997

Jul-1

997

Jan-

1998

Jul-1

998

Jan-

1999

Jul-1

999

Jan-

2000

Jul-2

000

Jan-

2001

Jul-2

001

Jan-

2002

Jul-2

002

Jan-

2003

Jul-2

003

Jan-

2004

Jul-2

004

Jan-

2005

Jul-2

005

Jan-

2006

Jul-2

006

Jan-

2007

Jul-2

007

Jan-

2008

Jul-2

008

0102030405060708090

100110120130140

Oct

-97

Mar

-98

Aug-

98Ja

n-99

Jun-

99N

ov-9

9Ap

r-00

Sep-

00Fe

b-01

Jul-0

1D

ec-0

1M

ay-0

2O

ct-0

2M

ar-0

3Au

g-03

Jan-

04Ju

n-04

Nov

-04

Apr-0

5Se

p-05

Feb-

06Ju

l-06

Dec

-06

May

-07

Oct

-07

Mar

-08

Aug-

08

House purchase

Remortgaging

13 January 2009

31

Net lending at depressed levels

UK Gross mortgage lending by purpose of loan, £mn

Source: CML

UK Net and gross mortgage lending (£mn)

Source: Datastream

4,500

6,000

7,500

9,000

10,500

12,000

13,500

15,000

16,500

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Loans for remortgage GBPm Loans for house purchase GBPm

-1000

1000

3000

5000

7000

9000

11000

13000

15000

Jan-

98Ju

l-98

Jan-

99

Jul-9

9Ja

n-00

Jul-0

0Ja

n-01

Jul-0

1Ja

n-02

Jul-0

2Ja

n-03

Jul-0

3Ja

n-04

Jul-0

4Ja

n-05

Jul-0

5Ja

n-06

Jul-0

6Ja

n-07

Jul-0

7

Jan-

08Ju

l-08

5000

10000

15000

20000

25000

30000

35000

40000

Net lending, LHS Gross lending, RHS

13 January 2009

32

UK economy entering recession

UK forecasts (shaded regions)

Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 2007 2008 2009 2010

GDP 0.3 0.0 -0.5 -0.9 -0.5 -0.3 0.0 0.2 3.0 0.7 -1.6 1.5

Consumption 0.9 -0.1 -0.6 -1.0 -0.7 -0.5 -0.3 -0.1 3.0 1.6 -2.3 0.4

Investment -2.0 -2.8 -1.9 -2.1 -1.6 -1.1 -0.6 -0.1 7.1 -3.8 -5.9 0.5

Government 1.0 0.5 0.3 0.5 0.6 0.6 0.6 0.5 1.8 2.1 2.1 2.1

Domestic Demand 0.0 -0.1 -0.4 -1.2 -0.7 -0.5 -0.2 0.0 3.6 0.6 -2.2 0.8

Exports 0.7 0.0 0.7 0.2 0.4 0.6 0.7 0.8 -4.5 1.8 1.9 3.7

Imports -0.3 -0.5 1.0 -0.8 -0.4 -0.1 0.1 0.2 -1.9 1.4 -0.6 1.4

Net Exports † 0.3 0.2 -0.1 0.3 0.2 0.2 0.2 0.2 -0.7 0.1 0.7 0.6

Average Earnings** 4.0 3.5 3.3 3.3 3.3 3.3 3.3 3.3 3.9 3.5 3.3 3.5

HICP** 2.4 3.4 4.8 4.1 3.3 2.0 1.0 1.2 2.3 3.6 0.9 2.3

RPI** 4.0 4.4 4.9 3.2 0.9 -0.4 -1.3 -0.7 4.3 4.1 -0.4 2.5

Industrial Production** -0.5 -0.7 -1.1 -2.0 -1.2 -0.6 -0.2 0.2 0.4 -1.7 -3.9 1.2

Unemployment Rate, % 5.2 5.4 5.8 6.4 6.8 7.2 7.4 7.7 5.4 5.7 7.3 7.9

BoE Rate (period end)*** 5.25 5.00 5.00 2.00 1.00 1.00 1.00 1.00 5.50 2.00 1.00 3.00

Source: ML Economics, ONS. Quarterly figures are quarter-on-quarter changes (not annualized), except where marked by **, which are year-on-year changes. †percentage point contribution to GDP growth.

13 January 2009

33

UK RMBS volumes at record high, on paper

UK RMBS issuance by sector, EURbn


13 19 20 35 45 52

100

220

3 0 11

8 5

9 13

6

6 6 711

16 18

27 25

11

104

0

50

100

150

200

250

2000 2001 2002 2003 2004 2005 2006 2007 2008

PRM BTL NCF

13 January 2009

34

UK RMBS secondary market gets more distressed

UK AAA Prime RMBS basis

UK NCF RMBS indicative secondary spreads

0

50

100

150

200

250

300

350

400

450

Nov

-08

Oct

-08

Sep-

08

Aug-

08

Aug-

08

Jul-0

8

Jun-

08

May

-08

Apr-0

8

Mar

-08

Feb-

08

Jan-

08

-80

-60

-40

-20

0

20

40

60

80

100

Cash Basis

0

500

1000

1500

2000

2500

3000

21/1

1/08

10/1

0/08

29/8

/08

18/7

/08

6/6/

08

25/4

/08

14/3

/08

1/2/

08

21/1

2/07

9/11

/07

28/9

/07

17/8

/07

6/7/

07

25/5

/07

13/4

/07

2/3/

07

19/1

/07

UK NCF BBB UK NCF A UK NCF AAA

UK Prime and BTL RMBS indicative secondary spreads


0

200

400

600

800

1000

1200

1400

1600

1800

Nov

-08

Oct

-08

Sep-

08

Aug-

08

Jul-0

8

May

-08

Apr-0

8

Mar

-08

Feb-

08

Jan-

08

Dec

-07

Nov

-07

Sep-

07

Aug-

07

Jul-0

7

Jun-

07

May

-07

Mar

-07

Jan-

07

Prime AAA Prime A Prime BBB BTL A BTL AAA

13 January 2009

35

UK prime RMBS performance

Table 3: Recent performance summary of selected UK RMBS master trusts

1M CPR 90+ 180+ REO Repossessions* Losses

Avg 3Q arrears arrears 3Q 08 1H 08 2H 07 1H 07 1-3Q 08

ARKLE. 25% 0.63% 0.19% 0.08% 0.03% 0.03% 0.01% 0.00% 0

Aire Valley 7% 2.65% 1.09% 0.13% 0.07% 0.20% 0.12% 0.16% 0.03%

FOSSE 25% 0.20% 0.08% 0.00% 0.00% 0.01% 0.00% 0.00% 0

Gracechurch 31% 0.60% 0.23% 0.01% 0.00% 0.00% 0.00% 0.00% 0

GRANITE 39% 1.82% 0.46% n/a 0.23% 0.34% 0.21% 0.17% 0.04%

HOLMES 38% 0.69% 0.20% 0.07% 0.10% 0.14% 0.13% 0.03% 0.01%

LOTHIAN 27% 0.46% 0.21% 0.08% 0.01% 0.04% 0.01% 0.01% 0

MOUND 32% 4.22% 2.30% 0.25% 0.11% 0.18% 0.11% 0.08% 0.07%

PERMM 30% 1.33% 0.69% 0.14% 0.03% 0.04% 0.03% 0.00% 0.02%

Pendeford 33% 0.92% 0.43% 0.13% 0.00% 0.00% 0.00% 0.00% 0

UK (CML data) na 1.33% 0.58% 0.16% na 0.16% 0.11% 0.11% na

Source: ABSXchange, Merrill Lynch, CML*Based on count for Mound and PERMM

13 January 2009

36

UK Prime RMBS 90+ arrears

90+ arrears before and in 2008, against pool seasoning

Source: ABSXchange, Merrill Lynch

Granite

PendefordGracechurch

Arkle

Fosse

Holmes

Lothian

Permanent

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50

Seasoning, months

13 January 2009

37

UK prime RMBS outlook negative

Macro outlook suggests more pain aheadUnemployment to reach 8% by 2010Losses may reach 2%Downside risk, but UK government initiatives may be a significant supporting factorDivergence in performance across master trusts likely to remain

Extension risk risingWeaker housing market= lower CPRStep-up calls: not that punitive anymoreReputational considerations getting weaker

13 January 2009

38

UK buy-to-let marketBTL gross and net lending

0

2,000

4,000

6,000

8,000

10,000

12,000

4Q 06 1Q 07 2Q 07 3Q 07 4Q 07 1Q 08 2Q 08 3Q 08

BTL gross lending for house purchase, £mn BTL gross lending for remortgaging, £mn

BTL net lending,LHS, £mn

YOY change in number of new tenancies (not renewals) signed up in the last 3 months

Source: CML, ARLA Surveys

-15%

-10%

-5%

0%

5%

10%

15%

20%

Q2.

04

Q3.

04

Q4.

04

Q1.

05

Q2.

05

Q3.

05

Q4.

05

Q1.

06

Q2.

06

Q3.

06

Q4.

06

Q1.

07

Q2.

07

Q3.

07

Q4.

07

Q1.

08

Q2.

08

Q3.

08

Prime Central London South East Rest of UK All

% BTL investor respondents expecting to buy more properties in the next 12 months

0

10

20

30

40

50

60

70

80

90

100

Yes No Don't know

Is there more properties or tenants (% respondents)?

0

10

20

30

40

50

60

70

80

90

100

Q2.

02

Q4.

02

Q2.

03

Q4.

03

Q2.

04

Q4.

04

Q2.

05

Q4.

05

Q2.

06

Q4.

06

Q2.

07

Q4.

07

Q2.

08

More tenants More properties Equal nos of props & tenants

13 January 2009

39

UK BTL rental yields

Average rental return on houses, by region

Source: ARLA Surveys

4.5

4.6

4.7

4.8

4.9

5

5.1

5.2

5.3

5.4

5.5

5.6

5.7

Q3.03 Q1.04 Q3.04 Q1.05 Q3.05 Q1.06 Q3.06 Q1.07 Q3.07 Q1.08 Q3.08

Prime Central London South East Rest of UK All (w eighted)

Average rental return on flats, by region

Source: ARLA Surveys

4.5

4.6

4.7

4.8

4.9

5

5.1

5.2

5.3

5.4

5.5

5.6

5.7

Q3.03 Q1.04 Q3.04 Q1.05 Q3.05 Q1.06 Q3.06 Q1.07 Q3.07 Q1.08 Q3.08

Prime Central London South East Rest of UK All (w eighted)

13 January 2009

40

UK BTL arrears rising

BTL sector performance

Source: CML

UK BTL 90+ arrears by deal, Oct-08 vs Dec-07


0.54 0.53 0.55 0.58 0.560.68

0.811.01

1.46

0.05 0.05 0.05 0.05 0.050.05

0.08

0.09

0.13

0.07 0.06 0.07 0.08 0.100.12

0.15

0.21

0.22

0.00.10.20.30.40.50.60.70.80.91.01.11.21.31.41.51.61.71.81.9

3Q 06 4Q 06 1Q 07 2Q 07 3Q 07 4Q 07 1Q 08 2Q 08 3Q 08

90+ arrears (ex cl receiv er of rent) 90+ arrears w ith LPA receiv er of rent REO

2.65%

0.12%

0.33%

0.03%

0.06%

0.10%

0.19%

0.06%

0.06%

0.92%

0.06%

0.07%

0.06%

0.06%

0.08%

0.04%

0.04%

0.04%

0.00% 0.50% 1.00% 1.50% 2.00% 2.50%

Aire Valley

PARAGON 10

PARAGON 11

PARAGON 12

PARAGON 13

PARAGON 14

PARAGON 7

PARAGON 8

PARAGON 9

Oct-08 Dec-07

13 January 2009

41

while CPRs slowing

UK BTL CPR, Oct-08 vs Dec-07


Aire Valley 90+ arrears, before 2008 versus 1-3Q08


0.60%

1.10%

1.60%

2.10%

2.60%

30 33 34 35 36 37 38 39 40 41

Seasoning, Months

Aire Valley, 2008

Aire Valley, before 2008

5.1%

5.7%

3.0%

10.0%

4.3%

2.1%

3.3%

4.0%

6.7%

9.9%

14.8%

2.6%

2.3%

3.2%

2.3%

8.7%

8.9%

10.5%

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0%

Aire Valley

PARAGON 10

PARAGON 11

PARAGON 12

PARAGON 13

PARAGON 14

PARAGON 7

PARAGON 8

PARAGON 9

Oct-08 Dec-07

13 January 2009

42

UK BTL risk exposure vary across deals

UK BTL current indexed* LTV

Source: ABSXchange, Merrill Lynch*As reported in investor reports, using Halifax index

UK BTL share of fixed-rate mortgages and below 120% ICR


4.8%

4.5%1.4%

5.6%1.3%

1.3%4.2%

10.0%

8.4%2.2%

8.6%1.8%

2.1%9.8%

5.6%0.9%0.6% 2.1%

0% 2% 4% 6% 8% 10% 12% 14% 16%

Aire ValleyPARAGON 7

PARAGON 8PARAGON 9

PARAGON 10

PARAGON 11PARAGON 12

PARAGON 13PARAGON 14

Above 95% 90-95%

64.3

48.8

61.0

66.0

44.5

38.240.0

37.7

64.0

3.7 2.9

7.43.5

6.7

24.4

8.0

0.6

0

10

20

30

40

50

60

70

Paragon14

Paragon13

Paragon12

Paragon11

Paragon10

Paragon 9 Paragon 8 Paragon 7 AireValley

Fixed ICR <1.2

13 January 2009

43

UK non-conforming RMBS arrears

UK NCF 90+ arrears

Source: Merrill Lynch, ABSXchange

UK NCF 180+ arrears


0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

43413937353331292725232119171513119753

Months since closing2005 2006 2007

0%

5%

10%

15%

20%

43413937353331292725232119171513119753


13 January 2009

44

UK NCF RMBS repossessions

UK NCF REO, % current balance


UK NCF quarterly repossession rate, % current balance

Source: Merrill Lynch, ABSXchange, investor reports

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

43413937353331292725232119171513119753


0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

19181716151413121110987654321

Quarters since closing

2003-04 2007 2006 2005

13 January 2009

45

UK NCF RMBS losses

UK NCF cumulative losses, % original balance


UK NCF deals with 2009 resets*, % original balance

Source: Merrill Lynch, ABSXchange, investor reports*Excludes deals where the amount of resets is less than 10% of original balance

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%

0.8%

0.9%

1.0%

41383532292623201714118522005 2006 2007

0

10

20

30

40

50

60

70

80

90

100

ALBA

200

6-1

ALBA

200

6-2

ALBA

200

7-1

BLST

200

7-1

ESAI

L 20

06-1

XES

AIL

2006

-2X

ESAI

L 20

06-3

XES

AIL

2006

-4X

ESAI

L 20

07-1

XES

AIL

2007

-2X

ESAI

L 20

07-3

XES

AIL

2007

-4X

GH

M 2

007-

1GH

M 2

007-

2XKM

S 20

07-1

XLE

EK 1

8XLE

EK 1

9XLM

S 2

MAN

SD 2

007-

2XM

PS 3

XM

PS 4

XNG

ATE

2006

-2N

GATE

200

6-3X

NG

ATE

2007

-1X

NG

ATE

2007

-2X

RM

ACS

2006

-NS4

XR

MAC

S 20

07-N

S1X

RMS

22X

Discounted Fixed

13 January 2009

46

UK non-conforming RMBS series

UK NCF 90+ arrears and repossessions versus risk factors, by vintage and series*

13 January 2009

47

UK NCF RMBS CPRs

UK NCF CPR


Gap between 3M Libor and BBR (%)

Source: Bloomberg

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

4139373533312927252321191715131197531

2005 2006 2007

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Nov

-02

May

-03

Nov

-03

May

-04

Nov

-04

May

-05

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

13 January 2009

48

UK NCF RMBS: Sizing losses under a stress scenario

Table 9: UK NCF average loss estimates and assumptions

2005 Vintage 2006 Vintage 2007 Vintage

Average CPR 19% 16% 7%

Average severity 20% 30% 40%

Average losses 5% 10% 20%

CE

AAA 36% 31% 23%

AA 21% 16% 12%

A 12% 10% 8%

BBB 5.2% 4.7% 3%


13 January 2009

European RMBS

13 January 2009

50

European GDP and unemployment

Quarterly GDP growth 2000-Q3 08 (YoY%)

Source: Datastream

Quarterly unemployment rates 2000-Q3 08 (%)

Source: Datastream

-2

-1

0

1

2

3

4

5

6

Q2

00

Q1

01

Q4

01

Q3

02

Q2

03

Q1

04

Q4

04

Q3

05

Q2

06

Q1

07

Q4

07

Q3

08

UK ITA GER SPA NED EU

0

2

4

6

8

10

12

Q1

00

Q3

00

Q1

01

Q3

01

Q1

02

Q3

02

Q1

03

Q3

03

Q1

04

Q3

04

Q1

05

Q3

05

Q1

06

Q3

06

Q1

07

Q3

07

Q1

08

Q3

08

UK ITA GER SPA NED EU

13 January 2009

51

Spanish house prices and lending

Nominal house price growth YOY

Source: European Mortgage Federation, national statistics, Eurostat, INE

Net lending: Housing loans* and loans for house purchases

Source: AHE*including loans for improvement, development/construction, land

-10

-5

0

5

10

15

20

25

30

35

40

45

Q1

1984

Q4

1985

Q3

1987

Q2

1989

Q1

1991

Q4

1992

Q3

1994

Q2

1996

Q1

1998

Q4

1999

Q3

2001

Q2

2003

Q1

2005

Q4

2006

0

20

40

60

80

100

120

140

160

180

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Sep-

08

Housing loans Loans for house purchase

EUR bn

13 January 2009

52

Spanish RMBS volumes and spreads

Spanish issuance volumes (€mn)


Spanish RMBS indicative secondary spreads


3 3

10

16 16

28

38

60 58

0

10

20

30

40

50

60

70

2000 2001 2002 2003 2004 2005 2006 2007 2008

(Nov )

0

200

400

600

800

1000

1200

1400

Nov

-08

Oct-

08

Sep-

08

Aug-

08

Jul-0

8

May

-08

Apr-

08

Mar

-08

Feb-

08

Jan-

08

Dec

-07

Nov

-07

Sep-

07

Aug-

07

Jul-0

7

Jun-

07

May

-07

Mar

-07

Jan-

07

Spanish RMBS AAA Spanish RMBS A

13 January 2009

53

Spanish RMBS arrears and CPR

60+ day delinquencies, by vintage, by month


CPR rate, by vintage, by month


0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77

2002 2003 2004 2005 2006 2007

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77

2002 2003 2004 2005 2006 2007

13 January 2009

54

Dutch RMBS residential lending

Dutch monthly gross lending and 12M rolling, EURmn

Source: DNB

Dutch resi loans outstanding and net monthly lending, EURmn

Source: EMF, national central banks, national statistics offices, Eurostat, Merrill Lynch

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

May

-03

Oct

-03

Mar

-04

Aug-

04

Jan-

05

Jun-

05

Nov

-05

Apr-

06

Sep-

06

Feb-

07

Jul-0

7

Dec

-07

May

-08

Oct

-08

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

Total loans for house purchase Sum of previous 12mths (RHS)

-6,000

-4,000

-2,000

0

2,000

4,000

6,000

8,000

10,000

Jan-

07Fe

b-07

Mar

-07

Apr-0

7M

ay-0

7Ju

n-07

Jul-0

7Au

g-07

Sep-

07O

ct-0

7N

ov-0

7D

ec-0

7Ja

n-08

Feb-

08M

ar-0

8Ap

r-08

May

-08

Jun-

08Ju

l-08

Aug-

08Se

p-08

Oct

-08

370,000

375,000

380,000

385,000

390,000

395,000

400,000

405,000

410,000

Net monthly lending Outstanding, RHS

Real GDP growth (rhs) and house price growth, (%)

Source: NVM, Datastream, Merrill Lynch

-3

0

3

6

9

12

15

18

21

Q3

86Q

3 87

Q3

88Q

3 89

Q3

90Q

3 91

Q3

92Q

3 93

Q3

94Q

3 95

Q3

96Q

3 97

Q3

98Q

3 99

Q3

00Q

3 01

Q3

02Q

3 03

Q3

04Q

3 05

Q3

06Q

3 07

Q3

08

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

House prices change GDP change (RHS)

13 January 2009

55

Dutch RMBS issuance and spreads

Funded Dutch RMBS issuance (EURmn)


Dutch RMBS indicative secondary spreads (bp)


69

1823

15

26

38

68

28

0

10

20

30

40

50

60

70

80

2000 2001 2002 2003 2004 2005 2006 2007 2008

(Nov )

0

100

200

300

400

500

600

700

Nov

-08

Oct

-08

Sep-

08

Aug-

08

Jul-0

8

May

-08

Apr-

08

Mar

-08

Feb-

08

Jan-

08

Dec

-07

Nov

-07

Sep-

07

Aug-

07

Jul-0

7

Jun-

07

May

-07

Mar

-07

Jan-

07Dutch RMBS AAA Dutch RMBS A

13 January 2009

56

Dutch RMBS arrears and foreclosures

Dutch monthly foreclosures and 12M rolling (RHS)

Source: Kadaster

Dutch RMBS 90+ arrears by vintage (Quarters since closing)


0

50

100

150

200

250

Dec

-02

Jun-

03

Dec

-03

Jun-

04

Dec

-04

Jun-

05

Dec

-05

Jun-

06

Dec

-06

Jun-

07

Dec

-07

Jun-

08

0

500

1000

1500

2000

2500

Monthly (lhs) 12 Month Total (rhs)

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%

0.8%

0.9%

1.0%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

2002 2003 2004 2005 2006 2007 Average

13 January 2009

57

Dutch RMBS arrears and CPR

Dutch non-NHG RMBS 90+ arrears by series (Quarters since closing)


Dutch RMBS CPR by vintage, (Quarters since closing)


0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1 2 3 4 5 6 7 8 9 10 11 12 13 14

Arena Candide Delphinus DMPL Dutch MBS

EMAC Hermes Saecure Storm Average

0%

5%

10%

15%

20%

25%

30%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

2002 2003 2004 2005 2006 2007 Average

13 January 2009

58

German residential lending and house prices

Total outstanding residential loans (€bn)

Source: Deutsche Bundesbank, Merrill Lynch

Real and nominal house price YoY growth (%)

Source: OECD

980

1000

1020

1040

1060

1080

1100

1120

1140

2000

Q1

2000

Q3

2001

Q1

2001

Q3

2002

Q1

2002

Q3

2003

Q1

2003

Q3

2004

Q1

2004

Q3

2005

Q1

2005

Q3

2006

Q1

2006

Q3

2007

Q1

2007

Q3

2008

Q1

2008

Q3

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

Q2

1991

Q4

1992

Q2

1994

Q4

1995

Q2

1997

Q4

1998

Q2

2000

Q4

2001

Q2

2003

Q4

2004

Q2

2006

Q4

2007

Nominal HP growth Real HP growth

13 January 2009

59

German RMBS issuance and spreads

Secondary spreads until Nov 08 (bp)


German funded issuance EURmn 2006 2007 2008

Cash 1,206 570 27,749

Synthetic 531 0 4,732

Total 1,737 570 32,481


0

200

400

600

800

1000

1200

1400

06/07/07 06/11/07 06/03/08 06/07/08 06/11/08

AAA A

13 January 2009

60

German insolvencies and foreclosures

3-month rolling average of individual insolvencies (by month)

Source: FSO, Merrill Lynch

Number (000s) and value (€bn) of foreclosure auctions

Source: Argetra GmbH, Merrill Lynch

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

Aug-

02

Dec-

02Ap

r-03

Aug-

03De

c-03

Apr-

04

Aug-

04De

c-04

Apr-

05Au

g-05

Dec

-05

Apr-

06Au

g-06

Dec-

06Ap

r-07

Aug-

07

Dec

-07

Apr-

08

Aug-

08

0

10

20

30

40

50

60

70

80

90

100

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 20070

5

10

15

20

25

30

Number of Auctions Value (RHS)

13 January 2009

61

German RMBS prepayments

German CPR rates by source, by date

Source: ABSXchange, Fitch, Moody’s, Merrill Lynch

German CPR rates by vintage, quarter since launch

Source: Fitch, Moody’s, Merrill Lynch

0%

2%

4%

6%

8%

10%

12%

14%

Q1

03

Q3

03

Q1

04

Q3

04

Q1

05

Q3

05

Q1

06

Q3

06

Q1

07

Q3

07

Q1

08

Q3

08

Rating agencies ABSxchange

0%

2%

4%

6%

8%

10%

12%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

2002 2003-2004 2005 2006 Average

13 January 2009

62

German RMBS credit events and losses

Credit events (% of outstanding balance), quarter since launch

Source: S&P, Merrill Lynch

Cumulative losses (% of original balance), quarter since launch


0.00%

0.02%

0.04%

0.06%

0.08%

0.10%

0.12%

0.14%

8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 240.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

Pr A 03-1 Pr A 04-1 Pr A 05-1

Pr A 06-1 Pr Blue 02-1 Pr Blue 05-1

Pr Blue 05-2 BAUHAUS (RHS) Pr VR 02-1 (RHS)

Pr VR 03-1 (RHS) Pr VR 04-1 (RHS) Average (RHS)

0.00.51.01.52.02.53.03.54.04.55.0

1 3 5 7 9 11 13 15 17 19 21 23 25

Bauhaus Pr A 03-1 Pr A 04-1Pr A 06-1 Pr Blue 02-1 Pr Blue 05-1Pr Blue 05-2 Pr VR 02-1 Pr VR 03-1Pr VR 04-1 PB Dom Average

13 January 2009

63

Italian macro outlook

Italian nominal and real house price YoY growth, 1984-Q12008

Source: OECD, Merrill Lynch

ML Global macroeconomic forecasts

(in %) 2007 2008F 2009F 20010F

Italy

GDP 1.4 -0.4 -1.0 0.8

CPI 2.0 3.6 1.6 1.7

Unemployment 6.2 7.0 8.1 8.5

Euro area

GDP 2.6 1 -0.6 1.1

CPI 2.1 3.4 1.3 1.8

Unemployment 7.4 7.5 8.6 9.0


-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

Q1

1984

Q1

1986

Q1

1988

Q1

1990

Q1

1992

Q1

1994

Q1

1996

Q1

1998

Q1

2000

Q1

2002

Q1

2004

Q1

2006

Q1

2008

Nominal HP growth Real HP growth

13 January 2009

64

Italian RMBS issuance and spreads

Italian RMBS indicative secondary spreads


Italian funded issuance, EURmn

2006 20072008 (Nov)

Total 16,819 21,059 53,589


0

200

400

600

800

1000

1200

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-

07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

AAA A

13 January 2009

65

Italian RMBS arrears

Italian 90+-day delinquencies by vintage


Italian RMBS 90+-day arrears, quarters since closing


0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

Mar

-03

Sep-

03

Mar

-04

Sep-

04

Mar

-05

Sep-

05

Mar

-06

Sep-

06

Mar

-07

Sep-

07

Mar

-08

Sep-

08

2002 2003 2004 2005 2006 2007 Average

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

2002 2003 2004 2005 2006 2007 Average

13 January 2009

66

Italian RMBS arrears by series

Italian RMBS 90+-arrears as of 3Q08 , by vintage and series

Series 2002 2003 2004 2005 2006 2007

Apulia 0.014 0.017

Argo 2 2.1%*

Asti Finance 1 1.20%

Berica 10.50% 3.90%

Bipielle 1 2.00%

BP Mortgage 2 0.9%*

BP Mortgage 3 1.5%*

Capital mortgages 1 1.50%

Cordusio 0.30% 0.90% 0.50%

FE Mortgages 1.7%* 3.4%*

Giotto 2 2.70%

Intesa 0.50% 0.60%

Marche Mutui 0.8%* 0.70%

Media Finance 1.20%

Orio 3 0.60%

Sestante 3.20% 3.30% 3.10% 3.2%*

Siena 3.50% 2.80%

Vela ABS 2.00%

Vela Home 0.006 0.015 0.027 2.20%


13 January 2009

67

Italian RMBS defautls and CPR

Cumulative defaults by vintage (% of original balance), quarters since closing


Italian CPR by vintage


0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

2002 2003 2004 2005 2006 2007 Average

0%

2%

4%

6%

8%

10%12%

14%

16%

18%

20%

Sep-

03

Jan-

04

May

-04

Sep-

04

Jan-

05

May

-05

Sep-

05

Jan-

06

May

-06

Sep-

06

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

2002 2003 2004 2005 2006 2007 Average

13 January 2009

European CMBS & property derivatives – stressed or distressed?

13 January 2009

69

Property DerivativesTrading resilient

Despite credit crisis, trading in property derivatives remains resilientA focus on risk management and liquidity has seen volumes increase, running 10% above 2007 levelsDerivatives also provide transparency in an illiquid property market – about where prices are expected to go, or perhaps have already reached

0

1

2

3

4

2005

Q1

06

Q2

06

Q3

06

Q4

06

Q1

07

Q2

07

Q3

07

Q4

07

Q1

08

Q2

08

Q3

08

UK France Germany

European IPD Commercial Property derivative trading volumes

Source: IPD

13 January 2009

70

40

50

60

70

80

90

100

0 1 2 3 4 5

Years into downturn

Cap

ital V

alue

1990 correction

Correction to date

Implied

Property DerivativesUK Commercial

UK commercial real estate is down 30% from peak according to valuers

Property derivatives imply a further 39% decline – 57% peak to trough

Yields expected to peak at 10.5%

UK commercial property downturns compared

Source: IPD, ML

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

Jan-07 May -07 Sep-07 Jan-08 May -08 Sep-08

Peak

to tr

ough

dec

line

(%)

Implied decline

Realised decline

UK Peak to trough decline - implied and realised

13 January 2009

71

Property DerivativesEuropean Commercial

Germany derivatives imply a further 18% decline between 2008 and 2011 for commercial real estate – with yields moving 130bp wider to 7.3%

French office a larger decline of 31% from the peak at the end of 2007 is implied, with gross initial yields expected to move from 5.5% to 8.0%

German All Property capital values - historic & implied

Source: IPD, ML

60

70

80

90

100

110

1995 1997 1999 2001 2003 2005 2007 2009 2011

Historic capital v alue Implied capital v alue

50

100

150

200

1997 1999 2001 2003 2005 2007 2009 2011

Historic capital v alue Implied capital v alue

French Office capital values - historic & implied

13 January 2009

72

Property DerivativesHouse Prices

UK house prices down 19% from peak. Further 35% decline implied for a peak to trough decline of 47%

French house prices expected to decline 10% over next 5 years

UK house prices in 1990 downturn and implied

Source: HBOS, ML

Implied decline in UK house prices from peak to trough

-50%

-40%

-30%

-20%

-10%

0%

Aug-07 Nov -07 Feb-08 May -08 Aug-08 Nov -08

Implied decline

Realised decline

50

60

70

80

90

100

110

0 1 2 3 4 5Years into Correction

Nom

inal

UK

Hou

se P

rice

Implied

1990 correction

Correction to date

13 January 2009

73

Property Derivatives2009 Developments

Property derivatives to be used more strategicallyShorted dated investment strategy has outperformed by a large marginInterest growing in structured productsPortfolio management in direct portfolios and alpha generationManaging liquidity, particularly for open-ended funds

CMBS hedging or arbitrage becoming easierIncreasing links between valuations and transactions

Forward index prices represent current sale pricesValuers increasing aware of property derivative prices

Increasing links between REITs and property derivativesListing of property derivatives on Eurex to go live in Q1

13 January 2009

74

CMBS in distress


Servicer to behave like a trustee in not exercising discretion, this will slow the recovery or workout process significantly.

Vacant possession value falls of 80%+ are likely to be repeated for some secondary assets.

Secondary spreads could gap out further if forced asset sales become the norm and banks offload CRE loans into ‘bad’ bank structures

13 January 2009

75

Who is the marginal buyer for CRE?


REIT buyer...high single digit yields for prime assets, lower leverage does not affect post tax returns, rights issues/partial asset sales

Sovereign wealth funds…still provide a source of capital for super prime assets but are not going to be as dominant given declining oil prices

Private equity buyer and hedge fund buyer aiming for returns of 20%+…CMBS potentially provides their route…falling libor/euribor with constant absolute return expectations from this buyer base points to declining CMBS prices

Corporate buyer…reversing the trend of sale and leasebacks, the corporate buyer could provide a bid for some of the secondary property in CMBS but they are likely to look for a short payback period

13 January 2009

76

Special Servicer is going to minimise litigation risk

Enforcement is going to be difficult due to the need to get noteholders to indemnify the servicer.

Maximising recovery is likely to result from working loans out rather than enforcement on non trophy or prime assets.

Without indemnification the servicer will minimise litigation by trying to behave as a prudent lender. This could be done by following the action that bank lenders and other servicers are taking. At the moment the newsflow points to prudent lenders opting to workout.

13 January 2009

77

Performance: delinquencies are a lagged indicator

Delinquencies are likely to follow the direction of corporate insolvenciesRating action is likely to accelerate in spite of some remarks by S&P in Sep 2008 that the AAA rating on CMBS is robust

UK companies in difficulty vs GDP

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

2.50

Companies in difficulty UK Quarterly GDP Grow th

% of total loans that are delinquent and defaulted

0.00%

0.10%

0.20%

0.30%

0.40%

0.50%

0.60%

0.70%

0.80%

1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07 1Q08

Source: National Statistics Office

Source: National Statistics Office

13 January 2009

78

Tighter underwriting standards for CRE loans;

New CRE lending to be restricted to max LTV between 50 to 65% after allowing for 50% peak to trough declines; assets with significant reletting and operating risks to be stressed harshly and not valued into perpetuityDemand / supply balance continues to exist in CMBS combined with uncertain outlook points to limited issuance over the medium term (most retained)

European CMBS issuance €mn

0

10,000

20,000

30,000

40,000

50,000

60,000

2000 2001 2002 2003 2004 2005 2006 2007 2008

CON HOA MBR NPL PSR SBR

UK bank lending to CRE £bn

0

50

100

150

200

250

300

Sep-

80D

ec-8

1M

ar-8

3Ju

n-84

Sep-

85D

ec-8

6M

ar-8

8Ju

n-89

Sep-

90D

ec-9

1M

ar-9

3Ju

n-94

Sep-

95D

ec-9

6M

ar-9

8Ju

n-99

Sep-

00D

ec-0

1M

ar-0

3Ju

n-04

Sep-

05D

ec-0

6M

ar-0

8Ju

n-09

Sep-

10D

ec-1

1

Bank lending ex posure Projection 1990s profile

Source: Merrill Lynch Source: Bank of England, Merrill Lynch

13 January 2009

79

CMBS secondary only in 2009

Secondary market: at risk from (1) significant rise in supply of distressed CRE loans from bad bank structures; (2) enforcement on defaulting loans; & (3) further falls in Libor / Euribor Lehman’s insolvency took us to a new level: counterparty risk, protection bought became worthless, security agents ineffective etc

CMBS Secondary Spreads

0

500

1000

1500

2000

2500

Jan-

01

Aug-

01

Mar

-02

Oct

-02

May

-03

Dec

-03

Jul-0

4

Feb-

05

Sep-

05

Apr-0

6

Nov

-06

Jun-

07

Jan-

08

Aug-

08

AAA AA A BBB


13 January 2009

80

European Office Supply

Vacancy Rate + Future S upply

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Vacancy rate 2008 - 2010 supply as % of total space Planned space in 2011 & beyond as % of supply

Source: Jones Lang Lasalle

13 January 2009

81

European Rental Growth

Source: Jones Lang Lasalle

Annual Rental Growth in Europe to Q3 2008

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

Antw

erp

Barc

elon

a

Birm

ingh

am

Buda

pest

Dus

seld

orf

Fran

kfur

t

Ham

burg

Leed

s

Lond

on

Lyon

Man

ches

ter

Mos

cow

Osl

o

Prag

ue

Stoc

khol

m

Utre

cht

Prime office Prime Retail Warehouse

13 January 2009

82

Business & Consumer Confidence Collapses

German IFO Business Climate Index

0

20

40

60

80

100

120

Jan-

91

Jan-

93

Jan-

95

Jan-

97

Jan-

99

Jan-

01

Jan-

03

Jan-

05

Jan-

07

Jan-

09

Diminishing French Consumer & Business Confidence

-30

-20

-10

0

10

20

30

Jan-

92

Jan-

93

Jan-

94

Jan-

95

Jan-

96

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Consumer confidence Business Confidence

I talian Retail Sales

-6

-4

-2

0

2

4

6

8

10

12

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Retail Sales Index Large Stores Sales Index Linear (Retail Sales Index )Source: Datastream, Merrill Lynch

Source: IFO Institute

Source: European CommissionSpanish Retail Sales

Source: ISTAT

13 January 2009

83

Corporate Securitisation

Corporate Securitisation to continue to exist from utilities, project finance and social housing

Listed equity is likely to think twice about doing whole business securitisations eg M&B and Punch

The success of the secured structure is likely to come under scrutiny in 2009. More specifically the ability of the noteholders to appoint an administrative receiver. Leaky restricted payment conditions in the pub sector is also a cause for concern

Corporate Securitisation Issuance €bn

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

2000 2001 2002 2003 2004 2005 2006 2007 2008

Transport Hospital Carehome Mix ed Energy Water Retail Pub Other


13 January 2009

84

Pubs – an eventful year in prospect

Globe to enter default, Punch proactive in managing its debt, beer volumes to continue falling, the role of the monolines, rating action on the back of leaky restricted payment conditions

Securitisation

Yr of Peak debt

serviceCurrent DSCR

Peak debt service

cover ratio RPCHeadroom to RPC (Peak) Default

Headroom to default (peak)

Enterprise - Unique 2011 2.1 1.3 1.8 -41% 1.10 14%

Punch Taverns Finance1 2016 & 2031 1.6 1.3 1.5 -11% 1.25 7%Punch Taverns Finance B 2011 2.2 1.5 1.9 -26% 1.25 15%Spirit Issuer 2014 2.0 1.8 1.3 5%

1.6 1.7 -1% 1.1 35%57% 67%2 -10%

Mitchell & Butler 2021 2.0 1.8 1.3 26% 1.10 37%

Greene King 2009 2.0 1.9 1.5 23% n/a1.7 1.6 1.3 16% 1.1 29%

Marstons 2009 2.1 1.9 1.5 20% n/a1.7 1.7 1.3 24% 1.1 36%

Wellington Pub Company 2009 1.6 1.5 1.3 18% n/a

Globe Pub Issuer 2035 1.4 1.3 1.5 -17% 1.25 3%

Source: Merrill Lynch, Offering Circulars

13 January 2009

85

Infrastructure

Deflation: most project finance deals have 100% index linked debt, water deals 50%, gas 25% and BAA 10%. With deflation principal due may actually fall.

Water regulatory review likely to put pressure on Post Maintenance Interest Cover Ratios…overall though expect a pragmatic approach from the regulator

BAA to continue to suffer from the large overhang of debt, hefty capital spend, retail risk and the forced sale process

No change on THPA: poor outlook due to concentration of revenues in steel and oil, construction of post panamax facility, amortisation picks up in 2011 resulting in an RPC breach, car revenue to come under pressure.

Carehomes are under pressure from local authority fees and contraction in private payer wealth. Over-levered carehome securitisations may prompt local authorities to prefer less levered competitors.

13 January 2009

86






0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

2000 2001 2002 2003 2004 2005 2006 2007 2008


13 January 2009

87






0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

2000 2001 2002 2003 2004 2005 2006 2007 2008


13 January 2009

European CDOs

13 January 2009

89

Global CDO trendsSharp reversal in issuance and spread trends

Activity concentrated on the secondary side of the market


0.00

5.00

10.00

15.00

20.00

25.00

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

0

100

200

300

400

500

600

US (USDbn) Europe (USDbn) Blended US-EUR AAA spreads (bp)

0

50

100

150

200

250

2004

Q1

2004

Q3

2005

Q1

2005

Q3

2006

Q1

2006

Q3

2007

Q1

2007

Q3

2008

Q1

2008

Q3

0

100

200

300

400

500

600

700

800

900

size ($bn, LHS) risk-w eighted ($bn, RHS)

Source: Merrill Lynch, Creditflux

CLO issuance stalls while spreads soar Synthetic issuance comes to a halt too

13 January 2009

90

Global CDO trends (2)Credits trends deteriorating at a fast pace

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Q1-95 Q1-96 Q1-97 Q1-98 Q1-99 Q1-00 Q1-01 Q1-02 Q1-03 Q1-04 Q1-05 Q1-06 Q1-07 Q1-08

total financial

0.00

1.002.00

3.004.00

5.006.00

7.008.00

9.00

12/31/1998 12/31/1999 12/31/2000 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007

US loan 12m trailing default rate Long-run av erageSource: Moody’s, S&P

Negative IG corp rating actions as a % of total IG corp rating actions

US loan default rate

13 January 2009

91

Global CDO trends (3)Withdrawal of leverage continues unabated

At the underlying, structure and investor levelSupply and demand dynamics favour buyersCDO of ABS R.I.PLessons learned

Liquidity drives credit drives liquidityDiversification, structures, counterparty risk matter

0%

10%

20%

30%

40%

50%

60%

2000 2001 2002 2003 2004 2005 2006 2007 2008

0

20

40

60

80

100

120

Mezz High Grade % of US CDO issuedSource: Merrill Lynch

CDO of ABS R.I.P

13 January 2009

92

Migration rates take a nosedive

Credit stability rates plunged in 2008Aggregate statistics don’t tell the whole story …

Weakness was mainly concentrated in US SF CDO and US CDO²… but the credit quality deterioration is becoming increasingly broad based

Global CDO migration rates since inception (original-to-current ratings)

December 2007 November 2008

Default %* Downgrade % Default %* Downgrade %

AAA 0.08 8.6 1.02 25.9

AA 0.23 11.8 1.74 32.9

A 0.29 12.4 2.56 31.2

BBB 0.52 13.9 3.27 33.9

BB 1.34 12.0 2.61 24.0

B 3.52 13.4 2.56 48.3

Source: S&P, default rate is the rate of migration to D

13 January 2009

93

Synthetic CDO of corporates –three-step deterioration process

First, it was the mark to market …… then came the negative migration


-0.50

-0.40

-0.30

-0.20

-0.10

0.00

0.10

7/3/2007 9/3/2007 11/3/2007 1/3/2008 3/3/2008 5/3/2008 7/3/2008 9/3/2008 11/3/2008

BBB A AA AAA

Source: Merrill Lynch, assuming not tranche credit migration

Illustrative corporate synthetics MtM path* – the decline accelerated in H2 2008

13 January 2009

94

Synthetic CDO of corporates –three-step deterioration process (2)

… followed by a unprecedented wave of underlying defaults

Financial defaults, number of tranches impacted per region, and total concentration in the overall synthetic market

FNM FRE LEH WM GLBIR LANISL KAUP

US 958 866 994 803 348 350 444

Europe 936 908 1364 1047 405 421 514

Asia Pacific 97 92 119 154 94 95 98

Japan 150 138 157 155 65 69 91

Total 58.48% 54.74% 71.95% 58.97% 24.91% 25.54% 31.33%

Recovery* 91.51% 94.00% 8.63% 57.00% 3.00% 1.25% 6.63%

Source: S&P, Merrill Lynch estimates

* recovery data for the GSEs and the Icelandic refers to the senior debt recovery rate

13 January 2009

95

Synthetics on the brink

As credit quality tumbles …… the capital implications of holding CSO paper become dearer and dearer


0

200

400

600

800

1000

1200

Jan-08 Feb-08 Mar-08 Apr-08 May -08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov -08

Ratings low ered CreditWatch negativ e placements Ratings raised CreditWatch positiv e placements

Reg capital gains (-) and losses (+) from credit rating migration - RBA*

From / To AAA AA A BBB BBB and below

AAA 0.0% 0.6% 1.0% 5.4% 33.4% 99.4%

AA -0.6% 0.0% 0.4% 4.8% 32.8% 98.8%

A -1.0% -0.4% 0.0% 4.4% 32.4% 98.4%

BBB -5.4% -4.8% -4.4% 0.0% 28.0% 94.0%

* assuming the AAA tranche is the most senior outstanding, which may not always be the case

Source: S&P, Merrill Lynch

13 January 2009

96

Tracks for 2009 – safety is the new cheap

Volumes to stay depressed, driven by poor investor demandBut also limited appetite from the arranging side

Credits quality to deteriorate furtherThe cycle of defaults and especially downgrades far from overThe combination of adverse selection, thin cushions and poor diversification is likely to continue to weigh on performance, barring restructurings

However, fundamental investment rationale for the product still holdsWe continue to favour - short ended, - highly cushioned,- senior tranches

Reversing the 2005-07 rush for adverse selection theme is another area of opportunity


-50

0

50

100

150

200

250

300

7/2/2007 10/2/2007 1/2/2008 4/2/2008 7/2/2008 10/2/2008

5-10 Slope Blended CDX-iTrax x 5YR Blended CDX-iTrax x 10YRSource: Merrill Lynch

Credit curves favour the short end

13 January 2009

97

Leveraged loan CLO – all eyes on secondary trading

Issuance in the doldrumsNarrowing investor baseSoaring cost of debt tranchesAmple secondary supply, as paper moves out of leveraged hands

Focus very much on secondary tradingWhere spreads soared to and beyond historical highs

0

300

600

900

1200

1500

1800

Feb-01 Feb-02 Feb-03 Feb-04 Feb-05 Feb-06 Feb-07 Feb-08

US AAA US A US BBB

0

300

600

900

1200

1500

1800

Feb-01 Feb-02 Feb-03 Feb-04 Feb-05 Feb-06 Feb-07 Feb-08

EUR AAA EUR A EUR BBB

European CLO generic spreadsUS CLO generic spreads


13 January 2009

98

Leveraged loan CLO – reversal of credit trends orderly … so far

US loan default rate up to 3.76% in Nov 2008Up from 3.59% in OctoberAnd a 350bp pickup year-on-year

So far, remains roughly in line with long run averagesEuropean default rate still sub-2%

Lagging, not decoupling, in our view

0.00

1.002.00

3.004.00

5.006.00

7.008.00

9.00

12/31/1998 12/31/1999 12/31/2000 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007

US loan 12m trailing default rate Long-run av erageSource: S&P

US 12mth trailing loan default rate – increasing slowly but steadily

13 January 2009

99

CLO – credit deterioration to pick up significantly in 2009

DefaultsThe combination of ever strengthening lending standards, very poor refinancing outlook, and collapsing economic data across the board will bring default rates above those of the previous cycleWe expect double digit default rate in 2009

RecoveriesWeak covenants, large institutional market share, and a proliferation of loan-only issuers likely to drive recoveries much lowerDispersion to be very pronounced, especially across loan sub types.

Look for 2nd lien / mezzanine to behave like sub debt upon default

RepaymentsNear-zero repayments to persist for a while …… preventing reinvestments in newer vintage, stronger collateral

13 January 2009

100

Tracks for 2009 – value amid the landmines

Compelling value at the top of the capital structureWe like AAA/AA at current valuations

AAA/AA principal impairment risk is remote and well compensated, in our view

CLO breakeven default rates (50% recovery, 10% prepayment rate)

Rating Tranche spread CADR to first $ of loss CADR to interest deferral* Timing of interest deferral*

AAA 25 13% 16% YR7

AA 40 10% 12% YR10

A 65 9% 10% YR5

BBB 160 7% 7% YR3

BB 450 6% 5% YR2

Source: Merrill Lynch, Interest deferral on AAA/AA tranches usually triggers an event of default

Junior debt outlook gloomy, default timing will be keyAs a result of rapidly deteriorating pool performance, we look for interest deferrals to kick in throughout the year for equity and junior debt tranches

13 January 2009

101

Main risks: downgrades, recovery surprises, and structural headwinds

AAA notes to stand the test of recovery rates

0%

5%

10%

15%

30% 40% 50% 60%

AAA AA A BBB BB

CLO breakeven default rates under various loan recovery assumptions

Structural headwinds the main risks to our core viewDiscounted obligations: limits and OC penalties CCC buckets rapidly ballooning

In 2008, the sector experienced its first downgrades in nearly 4 yearsWe look for downgrade activity to intensifyFirst BBB/BB tranches, but increasingly the entire cap structure is at risk


13 January 2009

102

CCCs on the rise

CCC risk for leveraged loan CLO is two foldFirst it the high cyclicality of CCC default rates indicates further defaults to comeSecond CCC concentrations have strong implications for OC tests beyond a pred-defined level (usually in the 5-7.5% range)

OC weakness is a net short-term negative for junior debt and equityLonger-term, EoD risk affects the entire structure, with senior pay AAA the only tranche with any chance to recover some principal at current loan prices

0%

1%

2%

3%

4%

5%

6%

7%

juil-07 sept-07 nov -07 janv -08 mars-08 mai-08 juil-08 sept-08

Steady rise of CCC concentrations

Source: Moody’s, trustee reports

13 January 2009

103

Year ahead: the road to reform

This is not 2002-2003CDO problems – and structured credit in general – are much more widespread than the HY CBO issues of 2002-03. We expect reforms will need to be much deeper, and the time to recovery much longer, before any sustainable comeback is possible

Focus on portfolio compositionPositive portfolio selection, as well as a greater focus on structures, technical factors and liquidity, should prevail. Differentiation eventually gets to take centre stage.

Withdrawal of leverage – in its many formsBorrower leverageStructural leverageInvestor leverage

2009 OutlookDemand: the quest for a renewed AAA investor baseSupply: secondary to continue outweigh primaryCredit: challenges to intensifySpreads: bottom not reached, but downside to most-senior tranches is reducing

13 january 2009 1 alexander batchvarov, cfa +44 20 7995 8649 ludwig clement +44 20 7995 0432 caspar...

Documents