Mortgage-Backed Securities Has Been Significantly Influenced by the Reduction in Activity by Private-Label Issuers

SEPTEMBER 2008

Volume III No. 8 Research September 2008 Quarterly Issuance in the U.S. Capital Markets Capital Market Issuance Reaches $3.12 Trillion, Trails 2007:1H vs 2008:1H 1200 First-Half 2007 $ Billions g 2007:1H g 2008:1H 1050

Securities issuance in the first half of 2008 reached $3.12 trillion, a modest 900 decrease from the $3.76 trillion issued in the first half of last year. The sharpest declines in new issuance volume were seen in the sectors most vulnerable to the 750 current credit and interest rate environment. Issuance of corporate debt faltered 600 in the first half, a result of a dismal first quarter, but rebounded in the second 450 half. Underwriting in the equity market was behind the first half of 2007, how- 300 ever underwriting activity made a significant recovery in the second quarter as 150 the backlog of offerings began to clear and demand for technology, media and 0 communication stocks increased. Declines in the subprime mortgage and home Mortgage- Corporate(1) Asset- Federal Treasury(1) Municipal(1) Equity Related Backed Agency(1) Sources: Thomson Financial, U.S. Treasury, U.S. Federal Agencies U.S. Federal Treasury, Thomson Financial, U.S. Sources: equity loan sectors led to a significant drop in issuance of asset-backed securi- (1) Includes long-term issuance only ties. Similarly, the market for mortgage-backed securities has been significantly influenced by the reduction in activity by private-label issuers. Agency MBS volume has helped to prop up the sector as tighter underwriting standards and U.S. Capital Markets Outstanding the effect of several microeconomic drivers have negatively influenced issuance. As of June 30, 2008 (1) Asset-backed securities issuance increased on a quarterly basis, but year-to-date Treasury $4.7 T Federal Agency $3.1 T volume still lags far behind the volume of the same period a year ago. Federal 9.0% 6.0% agency debt issuance has surged on stagnation in the private-label market. In the Municipal* $2.7 T 5.2% first half of 2008, Treasury issuance increased as the federal government sought Equity to meet the expected budget shortfall. Likewise, municipal government’s fund- $21.2 T 40.6% 14.5% Mortgage-Related* raising in the capital markets is on pace to break last year’s record. $7.6 T

As we progress through the second half of the year, the pace of U.S. economic 4.8% 11.8% 8.2% Asset-Backed* growth is expected to be subdued, picking up in 2009. The FOMC held the $2.5 T federal funds rate at 2.00 percent at its latest meetings and is not expected to Money Market* Corporate* (2) $4.3 T raise the rate until late this year or into next year as the committee looks to Total: $52.2 Trillion $6.2 T (2) balance the risk of inflation with that of a stagnant economy. With the Federal Total Debt: $31.0 Trillion Sources: Federal Reserve, U.S. Treasury, Federal Agencies, Bloomberg, Thomson Financial Agencies, Bloomberg, Federal Treasury, Sources: Federal Reserve, U.S. (1) Includes marketable public debt Housing Finance Agency placing Fannie Mae and Freddie Mac into conser- (2) Figures may not add due to rounding vatorship, turbulence in the housing market is expected to settle down. With *SIFMA estimates economic growth risk diminishing later in the year and core inflation steady, the economic outlook for the coming year is subdued, but promising. The 10-year Treasury note is expected to yield 4.10 percent, driven by inflation, inflationary expectations, investor risk appetite and Fed policy.

Contributors Issuance Highlights Kyle Brandon [email protected] $ Billions 2008:Q2 only 2007:1H 2008:1H % Change Charles Bartlett [email protected] Municipal1 145.3 231.2 229.1 -0.9% Tiffany Coln [email protected] Treasury1 219.8 372.9 423.6 13.6% Sarvanu Datta intern

Federal Agency1 387.9 499.5 817.4 63.6% Paul Rainy [email protected] Sharon Sung [email protected] Mortgage- 429.5 1168.6 816.2 -30.2% Related Eric Vidal intern Asset-Backed 65.4 652.3 123.4 -81.1%

Global CDO 17.3 36.8 11.7 -68.2%

Corporate1 350.8 701.1 567.7 -19.0% New York n Washington n London n Hong Kong Equity 96.1 134.5 147.2 9.4%

Short- and Long-Term Municipal Issuance Municipal Volume Matches 2007’s Record Pace, ARS 2001–2008:1H 550 $ Billions g Long-Term g Short-Term (1)

Crisis Fuels Refundings 500 Short- and long-term municipal issuance totaled $250.0 billion in the 450 first half of 2008, essentially unchanged from the $250.9 billion issued in 400 the same period of last year. Total second-quarter issuance increased 82.1 350 percent on a linked-quarter basis, to $161.7 billion, compared to the $88.8 300 Jan-Jun 250 billion issued in the first quarter, a result of an increase in refunding activity 200 as issuers restructured outstanding auction-rate securities (ARS) into vari- 150 able rate debt and responded to a tightened credit environment. The first 100 quarter was marked by turmoil in the bond insurance industry and disloca- 50 tions in the ARS market, both helping to curtail new deals. Issuance in the 0 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’07 ’08 Thomson Financial Source: second quarter received a boost as the conversion to variable-rate debt took (1) hold and previously postponed deals went to market. Improving yields and Includes maturities of 13 months or less increased refunding activity have helped keep the year’s issuance on pace to meet or surpass the record $429.1 billion issued in 2007. Municipal GO AAA and 10-Yr Treasury Ratio Jan. 2002–Jun. 2008 Long-term municipal issuance volume was $145.3 billion in the second quarter, surpassing the record $123.7 billion issued in the same period last 1.15 % Yield year, and the $83.8 billion issued in the first quarter. Record volume in April 1.10 of $52.5 billion helped to boost issuance totals. New short-term issuance was 1.05 $16.3 billion, up from $13.4 billion in the second quarter of last year. The 1.00 ratio of the 10-year AAA-rated general obligation municipal yield to that 0.95 of Treasury securities of similar maturity ended the second quarter at 101 0.90 percent, compared to the historically high 111 percent at the end of March. 0.85 The increase reflects investor “flight-to-safety” amid the volatile credit market 0.80 0.75 1/02 7/02 1/03 7/03 1/04 7/04 1/05 7/05 1/06 7/06 1/07 9/07 6/08

conditions, as well as improved retail demand due to higher, more attrac- Source: Bloomberg tive yields. As of August 19, the yields on 10-year municipal securities have increased to 3.78 percent, with the ratio to comparable maturity Treasuries standing at 99 percent. Long-Term1 Municipal Issuance by Enhancement Status 2001–2008:1H New Money Volume Drops; Refundings Surge in Second Quarter 500 $ Billions g Enhanced g Unenhanced

New capital issuance totaled $118.4 billion in the first half of 2008, 9.4 450 percent less than the $130.8 billion issued in the first half of last year. New 400 capital volume was behind the record 2007, pace as many issues were 350 sidelined by the monoline insurer situation earlier this year. The larger 300 Jan-Jun use-of-proceeds sectors saw a decline from the first half of 2007, with edu- 250 cation-related issuance totaling $30.4 billion, compared to $36.6 billion. 200 The general government sector issued $30.2 billion, a 12.6 percent decline 150 from the $34.6 billion issued in the first half of 2007. New money volume is 100 expected to strengthen as sidelined deals from the first half of the year are 50 brought to market in the second half, and municipal issuers look to issue 0 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’07 ’08 Thomson Financial Source: debt to meet project financing needs and budget shortfalls. (1) Includes maturities of 13 months or more Refunding activity totaled $110.7 billion in the first half, ahead of the $100.3 billion issued in the first half a year ago. Refunding volume increased Average Daily Trading Volume of Municipal Securities* as municipal issuers sought to restructure outstanding ARS into credit- 2006:Q1–2008:Q2 enhanced variable-rate securities. Issuance volume was down across many of 30 $ Billions the larger sectors. Education-related issuance fell 9.7 percent, to $23.3 billion from $25.8 billion in the first half of 2007. The general government sector 25 also saw a decline to $17.1 billion in the first half of the year, from $25.1 bil- 20 lion in the same year-earlier period. In contrast, healthcare-related issuance increased to $21.6 billion from $17.0 billion. While the displacement of the 15 ARS market helped to fuel refunding volume, second-half activity will remain constrained until municipal-to-Treasury yield ratios return to their long- 10 term average of below 100 percent. 5

0 06:Q1 06:Q2 06:Q3 06:Q4 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 Source: Municipal Securities Rulemaking Board * Includes both dealer-to-dealer and customer-to-dealer transactions

SIFMA Research Quarterly Treasury Market September 2008

Issuance of the U.S. Treasury Securities* Net Treasury Issuance Higher, Yield Curve Steepens 2001–2008:1H as Fed Cuts Rates 900 $ Billions 800

Total net issuance of U.S. Treasury securities, including bills and coupons, 700 was $145.3 billion in the first half of 2008, up significantly from the net pay- 600 down of $12.8 billion in the first half of 2007, a result of a rising budget deficit 500 projection. Net coupon issuance was $88.8 billion in the first half, up 42.5 Jan-Jun 1 400 percent from the $62.3 billion issued in the first half a year ago. Consistent 300 with the results of SIFMA’s recent Government Forecast Survey, the U.S. 200 Treasury announced that it expects to borrow $171 billion of marketable 100 debt in the third quarter of calendar year 2008, compared to a net issuance of 0 $105.3 billion a year ago. In July, the White House Office of Management and '01 '02 '03 '04 '05 '06 '07 '07 '08 Source: U.S. Treasury Source: U.S. Budget announced an expected federal budget deficit of $389 billion for fiscal *Includes only marketable coupon securities year (FY) 2008, compared to the $162 billion budget deficit in FY 2007. The higher deficit projection reflects a forecast of below-trend economic growth Treasury Yields and Fed Fund Rate along with higher inflation. The Congressional Budget Office estimates that Jan. 2002–Jun. 2008 the government will have incurred a budget deficit of $268 billion in the first 6 % Yield g 2-yr Tsy g 10-yr Tsy g Fed Funds Target nine months of the current fiscal year, compared to approximately $148 billion in the same period of FY 2007. The introduction of the 52-week bill by 5 the U.S. Treasury in the second quarter has helped reduce reliance on large 4 cash management bills and provide for sufficient financing to absorb the 3 government’s additional borrowing requirements. 2 Gross coupon issuance volume increased 13.6 percent during the first half 1 of 2008, to $423.6 billion, up from $372.9 billion in the same period of 2007. 0 Gross bill issuance was $2.14 trillion, higher than the $1.79 trillion issued 1/02 1/03 1/04 1/05 1/06 1/07 1/08 6/08 in the first half of 2007. Gross issuance is affected by expected refunding Source: Bloomberg of maturing and callable debt as well as Treasury’s new cash needs. Total marketable Treasury debt outstanding reached $4.68 trillion as of June Primary Dealer Credit Facility 30, 2008, virtually flat compared to the end of the previous quarter. Daily Mar. 2008-Jun. 2008 trading volume of Treasury securities by primary dealers averaged $622.0 40,000 $ Billions billion in the first half, compared to $534.8 billion during the same period 35,000 a year ago. 30,000 In addition to the series of rate cuts that began in September 2007 and low- 25,000 ered the Fed Funds target rate to 2.00 percent from 5.25 percent, the Federal 20,000

Reserve has acted to add liquidity to the credit markets through the forma- 15,000 tion of the Term Auction Facility (TAF), which channels funds to quali- 10,000 fied banks needing assistance in meeting funding requirements, as well as 5,000 the Treasury Security Lending Facility (TSLF) and Primary Dealer Credit Facility (PDCF), which provides funding to primary dealers in exchange for 0 4/2/08 4/9/08 5/7/08 6/4/08 6/11/08 3/19/08 3/26/08 4/16/08 4/23/08 4/30/08 5/14/08 5/21/08 5/28/08 6/18/08 6/25/08 a specified range of collateral. York Source: Federal Reserve Bank of New Treasury securities’ prices continued their rally as credit market disloca- tions and anticipated rate cuts drove the yield curve flatter. Yields across the maturity spectrum remained at relatively low levels as investors continue to Average Daily Trading Volume of Treasury Securities* seek the safety and quality of the Treasury market. The 2-year Treasury yield 2006:Q1–2008:Q2 rose to 2.62 percent at the end of June, higher than the 1.58 percent recorded 700 $ Billions at the end of March, but well below the 4.86 percent recorded at the end of 600 June 2007. The 10-year Treasury yield followed a similar pattern, rising to 3.97 percent at the end of June 2008 from 3.41 percent at the end of March, 500 compared to 4.86 percent at the end of June a year ago. The 2-year to 10-year 400 yield spread tightened to 135 basis points at the end of June, from 183 basis points at the end of the March. The 2- and 10-year yields stand at 2.30 and 300 3.83, respectively, as of August 19. The fragility of the economy and lower 200 crude oil prices have resulted in a pause in the rate hikes by the FOMC. As 100 concerns about inflation have lessened for now, the FOMC has elected to 0 hold the benchmark rate at 2.00 percent. Stability in the financial sector and 06:Q1 06:Q2 06:Q3 06:Q4 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2

a rebound in the housing market are both top issues for the Fed. York Source: Federal Reserve Bank of New * Primary dealer activity

1 The most recent SIFMA Government Forecast can be found at: www.sifma.org/research/pdf/GovForecast0708.pdf

SIFMA Research Quarterly Federal Agency Market September 2008

Long-Term Federal Agency Debt Issuance(1) Agency Issuance Flourishes in Tight Credit Environment 2001–2008:1H 1,400 $ Billions Issuance of federal agency long-term debt totaled $817.6 billion in the first half of 2008, 63.7 percent higher than the $499.4 billion issued in the same 1,200 period of last year. Second-quarter issuance reached $387.9 billion, down 1,000 from the $429.5 billion issued in the first quarter, but higher than the $234.1 Jan-Jun 800 billion issued in the second quarter of 2007. Monthly Government Sponsored Enterprises (GSEs) issuance peaked in February at $158.6 billion, beginning 600 the second quarter with $157.1 billion in new volume, and closing June with 400 $124.0 billion. The issuance growth at each of the five agencies reflects continued stagnation in the private-label market for mortgage-backed securities. 200 As concerns about the larger agencies’ solvency and ability to raise funds 0 '01 '02 '03 '04* '05 '06 '07 '07 '08 in the capital markets rose, the Treasury and Federal Reserve implemented Agencies, Bloomberg Sources: Federal (1) Excludes maturities of one year or less measures to prevent a failure of a GSE to reassure the investment community. * Beginning with 2004, Sallie Mae has been excluded due to privatization In early September, the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac into conservatorship and assumed the power of the Board of Directors and management. The takeover enables the Treasury to acquire U.S. Agency Spreads to Swap $1 billion or preferred shares in each company. The Department has also Jan. 2002–Jun. 2008 2-yr spread 5-yr spread pledged to provide as much as $200 billion in assistance to the companies 30 Basis Points 10-year spread toward the heavy losses on their mortgage defaults. 18 The Federal Home Loan Banks (FHLB) has acted as an important and lower- cost source of liquidity during the prolonged credit crisis for lending and 6 depository institutions. FHLB issuance surged to $384.1 billion in the first -6 half, a result of strong first quarter issuance. Second-quarter issuance fell to $169.6 billion, down from $214.5 billion in the first quarter, possibly reflect- -18 ing improvement in the credit market. Accounting for nearly half of total -30 1/02 9/02 1/03 9/03 1/04 9/04 1/05 9/05 1/06 9/06 1/07 9/07 1/08 6/08 agency debt issuance, the FHLB is expected to continue its strong pace of Source: Bloomberg growth with assistance from the Treasury until the credit markets recover. Freddie Mac’s debt issuance increased 56.3 percent, to $195.0 billion, in the first half of the year, compared to $124.7 billion in the same period of 2007, TED Spread and Libor-OIS 3 Month Spread while Fannie Mae’s debt issuance increased to $171.9 billion from $113.7 bil- Apr. 2007–Jun. 2008 TED spread lion. Long-term issuance by the Farm Credit System increased to $64.5 billion 250 Basis Points Libor-OIS 3 Month in the first half, following issuance of $25.6 billion in the same period last year. The Tennessee Valley Authority’s issuance of long-term debt was $2.1 billion 200 in the first half, compared to $26.5 million in the same period of 2007. 150 Two-year agency spreads to comparable Treasuries rose to 28 basis points at the end of June from 18 basis points at the end of March. On the lon- 100 ger end, spreads between 10-year agency coupons to Treasury coupons of 50 comparable maturity widened to 19 basis points on June 30, compared to 0 13 basis points on March 31. The wider spreads reflect global credit market 4/07 6/07 8/07 10/07 12/07 2/08 4/08 6/08 conditions and investor “flight to safety.” The 10-year agency-to-Treasury Sources: Bloomberg, Federal Reserve, BBA spread stood at 94 basis points as of August 19.

Long-Term Federal Agency Debt Issuance Average Daily Trading Volume of Federal Agency Securities(1) 2001–2008:1H 140 $ Billions g Coupons g Discount Notes $ Billions 2007 2007:1H 2008:1H % Change* $ Change*

120 FHLB1 495.2 235.4 384.1 63.2% 148.7 100 Freddie Mac 191.1 124.7 195.0 56.4% 70.3

Fannie Mae 190.8 113.7 171.9 51.2% 58.2 80

FCS2 64.6 25.6 64.5 152.0% 38.9 60

TVA3 1.1 0.03 2.1 11064.3% 2.1 40

Totals 942.8 499.4 817.6 63.7% 318.2 20 Sources: Bloomberg and Federal Agencies *Percent and amount change between 2007:1H and 2008:1H 0 1 Federal Home Loan Bank System '01 '02 '03 '04 '05 '06 '07 '07 '08 2 Farm Credit System York Source: Federal Reserve Bank of New (1) Primary dealer activity 3 Tennessee Valley Authority

SIFMA Research Quarterly Mortgage-Related Market September 2008

Issuance of Mortgage-Related Securities Agency MBS Issuance Strong; Housing Bill Expected 2001–2008:1H to Add Stability to Markets 3,500 $ Billions g Agency MBS/CMO g Private-Label MBS 3,000 Issuance of mortgage-related securities, including agency and non-agency pass-throughs and collateralized mortgage obligations (CMO), totaled $816.2 2,500 billion in the first half of 2008, compared to $1,168.9 billion in the first half of 2,000 last year. The drop in year-over-year volume can be attributed to the dissolu- 1,500 tion of the private-label market and tighter mortgage underwriting standards. Jan-Jun

Issuance of mortgage-related securities reached $429.5 billion in the second 1,000 Thomson Financial, Bloomberg quarter, ahead of the $386.7 billion issued in the first quarter, but well below 500 the $628.5 billion issued in the second quarter of 2007. Agencies, 0 The market for mortgage-related securities has proven to be vulnerable '01 '02 '03 '04 '05 '06 '07 '07 '08 to several microeconomic factors, driving the decline in issuance volume. Sources: Fed. Rising delinquencies and foreclosures, continued declines in home prices and tighter underwriting standards by mortgage lenders, combined with Issuance of Agency Mortgage-Backed Securities 2001–2008:1H tightened liquidity and overall turbulence in the global credit markets has g g g 2,400 $ Billions FHLMC FNMA GNMA prompted the recent passing of the housing bill by Congress designed to add stability and confidence in the markets. More mortgage financing could 2,100 become available as several large banks have committed to issuing covered 1,800 bonds, on-balance sheet instruments that are backed by a pool of high-quality 1,500 mortgages that must meet certain criteria. In addition to supporting the issu- 1,200 ance of covered bonds, the U.S. Treasury has announced a plan that would 900 overhaul supervision of the housing-related GSEs and allow the government Jan-Jun to insure refinanced mortgages. Recognizing the important role GSEs play in 600 the stability and credibility of the housing market, and overall global financial 300 markets, the Federal Housing Finance Agency and Treasury intervened and 0 has taken the two housing GSEs under conservatorship in a move to stabilize '01 '02 '03 '04 '05 '06 '07 '07 '08 Sources: GNMA, FNMA, FHLMC and return investor confidence to the MBS market. Treasury’s support of GSE debt reinforces its status and strengthens the implicit guarantee on the Agencies’ outstanding debt. Issuance of Non-Agency Mortgage-Backed Securities 2001–2008:1H g CMBS g RMBS Agency Issuance Compensates for Private-Label Decline 900 $ Billions Issuance of agency mortgage-backed pass-throughs totaled $687.5 billion 800 in the first half of 2008, an increase of 25.2 percent from the same period 700 last year. Agency CMO issuance decreased to $93.5 billion in the first six 600 Jan-Jun months, a decline of 37.5 percent compared to the $149.8 billion issued a 500 year earlier. The higher agency issuance levels reflect the interest rate spread 400 between agency and non-agency securities and the expanded capacity of the 300 GSEs under the recently passed housing bill. Agency issuance accounted for roughly 96 percent of total residential mortgage-related security issuance in 200 the first half of 2008. 100

0 Thomson Financial Source: The private-label market turmoil has engulfed higher-quality as well as sub- '01 '02 '03 '04 '05 '06 '07 '07 '08 prime product sectors. Private-label issuance includes both jumbo mortgages that exceed conforming loan size limits and higher-credit-risk mortgages Average Daily Trading Volume of Agency that do not meet underwriting guidelines. Non-agency residential mortgage- Mortgage-Backed Securities(1) 2001–2008:1H backed securities (RMBS) new issue volume decreased to $22.0 billion in 450 $ Billions the first half, a fraction of the $322.1 billion issued in the same period of last 400 year. RMBS issuance totaled $10.1 billion, in the second quarter, compared Jan-Jun 350 to $11.9 billion in the first quarter and $155.4 billion in the second quarter of 2007. 300 250

Commercial mortgage-backed securities (CMBS) issuance totaled $13.2 bil- 200 lion in the first six months of 2008, down dramatically from the $149.0 billion issued in the same period a year ago. Approximately $6.6 billion in new 150 CMBS was issued in the second quarter, flat compared to the first quarter, 100 but well below the $91.5 billion issued in the second quarter of 2007. The 50 0 CMBS sector has suffered from tighter financing conditions and weakened '01 '02 '03 '04 '05 '06 '07 '07 '08

economic growth resulting from slowed real estate activity and constrained York Source: Federal Reserve Bank of New (1) retail sales. Primary dealer activity

SIFMA Research Quarterly Asset-Backed Market September 2008

Issuance of Asset-Backed Securities Total ABS Issuance Rises; Home Equity ABS 2001–2008:1H Issuance Continues to Head Lower, But Credit Cards 1400 $ Billions and Student Loans Rise 1200 Asset-backed securities (ABS) issuance increased to $66.0 billion in the 1000 second quarter, up 13.7 percent from the historically low previous quarter’s 800 Jan-Jun volume of $58.0 billion and 80.2 percent less than second quarter 2007 600 volume of $333.0 billion. Total issuance for the first half of 2008 was $124.0 billion, significantly below the $657.4 billion issued in the first half of 2007. 400

The reduced volume is largely due to declines in the subprime mortgage 200 and home equity loan (HEL) sectors. The ABS market faces two major chal- 0 lenges from oil price rises and bank writedowns: with oil prices relatively '01 '02 '03 '04 '05 '06 '07 '07 '08 high, gas prices will weaken consumer credit performance as discretionary Thomson Financial Sources: income is squeezed; in addition, while bank writedowns now total over $400 billion, with $300 billion in capital raised, this process can still be considered to be in the early stages. Both factors will, in turn, slow economic Asset Backed Swap Spreads Aug. 2007-Jun. 2008 growth and soften the labor market; while these issues have been recog- nized by the market, the likelihood exists that higher commodity prices, 540 Basis Points 480 additional writedowns and more expensive capital will trickle down in the — 3-Year Home Equit 420 ABS markets, triggering another bout of selling. — 2-Year Prime Auto 360 — 3-Year Credit Card Leading ABS Sectors 300 240 Auto loan ABS was the largest issuing ABS sector, with a second-quarter 180 issuance of $21.0 billion, a 132.8 percent increase from the previous quarter, 120 but a 15.9 percent decrease from the second quarter of 2007. According to 60 0 industry experts, auto lease ABS deals were placed on negative watch by 8/07 9/07 10/07 11/07 12/07 1/08 2/08 3/08 4/08 5/08 6/08 S&P, citing softer consumer demand for trucks, sport-utility and crossover- Morgan Securities Inc. Source: JP utility vehicles as well as the subsequent “unprecedented and rapid” decline in used vehicle prices. Credit card ABS was the second-largest issuing sector in the second quarter, ABX.HE Credit Spreads Jun. 2008–Jul. 2008 at $19.2 billion, a decrease of 29.7 percent from the previous quarter and — AAA 2007 19.4 percent below second-quarter 2007. Delinquency rates have remained 60 Basis Points — BBB 2007 relatively flat due to more aggressive collection efforts. Moody’s and S&P 50 placed the ratings of all Washington Mutual Master Trust and Washington 40 Mutual Master Note Trust classes on negative watch, citing the elevated 30 charge-off rates. 20 Student loan ABS issuance increased to $14.4 billion in the second quarter, a 76.1 percent increase over the previous quarter’s $8.2 billion and a 35.4 10 increase over second-quarter 2007 issuance of $10.6 billion. 0 6/2/08 6/6/08 6/16/08 6/23/08 6/30/08 7/7/08 7/14/08 7/21/08 7/28/08 The HEL ABS and mortgage ABS primary markets virtually closed down Source: Markit Group in the second quarter. HEL ABS issuance volume was only $0.6 billion, an 80.4 percent decrease from the previous quarter and a stark contrast to the $87.5 billion in issuance during the second quarter of 2007. Similarly, ABS Outstanding by Major Types of Credit* As of June 30, 2008 mortgage ABS, including non-jumbo transactions comprising first-lien Credit Card Receivables mortgage loans with weighted average FICO credit scores of less than 674 $356.3 B and subprime mortgages, remained at $0.12 billion in the second quarter, 14.3% Home Equity up marginally by 5.4 percent from the first quarter, when only $0.11 billion $585.7 B was issued. Non-agency mortgage-related sectors will continue to suffer 23.4% from low issuance volumes. Manufactured Other Housing 41.3% $1,031.4 B $26.6 B 1.1% 1.7% Equipment Leases 10.3% $43.6 B 8.0% Student Loans $256.3 B Automobile Loans Total: $2,498.9 Billion $199.0 B Sources: Thomson Financial, Bloomberg, SIFMA Thomson Financial, Bloomberg, SIFMA Sources: *Percentages may not add due to rounding.

SIFMA Research Quarterly 7 Global CDO Markets September 2008

Global CDO Issuance by Transaction Structure 2006:Q1–2008:Q2 Global CDO Issuance Drops on Weak Liquidity, g Market Value 200 $ Billions g Synthetic Funded Subprime Deterioration g Cash Flow & Hybrid Global collateralized debt obligation (CDO) issuance fell for the fifth consecutive quarter as diminished liquidity, de-leveraging, subprime mortgage 150 deterioration and valuation uncertainties continued. Global funded CDO volume fell to $17.3 billion in the second quarter of 2008, compared to 100 $19.5 billion in the previous quarter and $175.9 billion in the second quarter of 2007. For the first half of 2008, $36.8 billion was issued, a significant 50 drop from the $362.4 billion issued in the first half of 2007. Cash flow and hybrid CDO volume totaled $14.3 billion in the second quarter, an 0 increase of 19.5 percent from the first-quarter issuance of $11.9 billion, but 06:Q1 06:Q2 06:Q3 06:Q4 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 a decrease of 89.4 percent from the same period a year ago. The synthetic Thomson Financial Source: funded CDO primary market continued to be virtually closed, with only $0.7 billion issued second-quarter 2008, compared to $8.4 billion in the previous quarter. Market-value CDO volume declined to $2.4 billion in Global CDO Issuance by Underlying Collateral the second quarter of 2008, down from $7.0 billion in the previous quarter. 2008:1H

Based on CDO purpose segmentation, arbitrage CDOs represented 62 per- Structured Finance cent of global volume during the second quarter of 2008, despite declining 29.8% by 40.7 percent from the previous quarter and dropping 93 percent below the $153.6 billion issued in the second quarter a year ago.

IG Bonds Collateral and Currency Sectors 22.9% Although the structured finance (SF) collateral group encompasses a wide range of collateral types, the group is dominated by mortgage-related HY Loans (largely subprime) and home equity loan collateral. Credit quality deterio- 47.3% ration, diminished liquidity and weak housing market trends have brought

SF CDO issuance to a virtual halt in 2008, with $5.0 billion issued in the Total: $36.8 Billion second quarter following $6.0 billion in the first quarter, compared to the Thomson Financial Source: $98.7 billion in the second quarter a year ago. CDOs backed by high-yield loans, or collateralized loan obligations (CLO), were the highest-collateral CDO issuance sector in the second quarter, at $11.3 billion, an 85.1 percent increase over the previous quarter. Global CDO Issuance by Currency 2008:1H In 2007, the dollar-denominated segment of CDO issuance accounted for Euro more than 50 percent of global issuance, but by the second quarter of 2008 48.5% Yen the euro-denominated segment dominated at 48.5 percent, a 20.8 percent 0.4% increase from the previous quarter, to $9.8 billion, though nowhere near Sterling the levels from the second quarter of 2007, when $32.5 billion was issued. 4.6% U.S. CDO volume ranked second, at $6.2 billion, down 29.7 percent from Other the previous quarter. 5.9% Downgrades Continue Following the downgrades of Ambac, MBIA, CIFG, FGIC, TCPL and XL U.S. Dollar Capital Assurance, CDO rating downgrades dominated the landscape, and 40.5% most of the downgrades were ABS or SF CDOs. As of July 10, year-to-date, Total: $36.8 Billion there were 1,224 rating actions taken on various ABS RMBS and CDOs Thomson Financial Source: affecting $276 billion, according to Moody’s. On the SF CDOs side, S&P has reported 202 SF CDOs experiencing events of defaults totaling over $220 billion as of June 30. Nearly one quarter of the entire Events of Default (EOD) asset pool have fallen into liquidation.

SIFMA Research Quarterly 8 Funding and Money Market Instruments September 2008

Financing by U.S. Government Securities Dealers Repo Average Daily Amount Outstanding Increases Average Daily Amount Outstanding 2001–2008:1H 8,000 $ Billions in the First Quarter g Repurchases Jan-Jun 7,000 g Reverse Repurchases The average daily volume of total outstanding repurchase (repo) and reverse repo agreement contracts was $7.11 trillion in the second quarter, 6,000 a 9.7 percent increase from the $6.38 trillion average in the previous quar- 5,000 ter. Daily outstanding reverse repo agreements averaged $2.79 trillion, 1.2 4,000 percent above the previous quarter’s $2.76 trillion. Average outstanding 3,000 repo decreased by 2.11 percent, totaling $4.21 trillion in the second quarter, compared to $4.31 trillion the quarter before. The data represent financ- 2,000 ing activities of primary dealers reporting to the Federal Reserve Bank of 1,000

New York, which includes repurchase and reverse repurchase agreements 0 York Source: Federal Reserve Bank of New '01 '02 '03 '04 '05 '06 '07 '07 '08 involving U.S. government, federal agency, agency mortgage-backed, and corporate securities. The Fixed Income Clearing Corporation’s Government Securities Division Repo Trades Submitted to the GSD (GSD), an SEC-registered clearing agency, facilitates orderly settlements 2008:1H in the U.S. Government securities market and tracks repo trades settled Other* through its system by product type. Over $281.4 trillion in repo trades were Federal Agency submitted by GSD participants through the second quarter of 2008, with an 9.1% average daily volume of approximately $2.3 trillion. Transactions involving Treasury Bonds 8.8% Treasury notes accounted for the largest share of GSD’s repo activity, rep- 7.2% resenting $191.4 trillion, or 68.0 percent of total volume. Repos involving Treasury Bills 68.0% Treasury bills accounted for an estimated $19.0 trillion, or 6.8 percent of 6.8% the total, and those involving Treasury bonds accounted for $20.4 trillion of Treasury Notes the activity for the period. Transactions involving federal agency non-mortgage securities accounted for $24.9 trillion, or 8.8 percent of 2008’s volume through the second quarter. Total: $281.4 Trillion Source: Fixed Income Clearing Corporation CP Outstanding Declines in the Second Quarter; Money Market * Includes Discount Agency, Forward Starting Generic Repo Trades, STRIPs, TIPS Bonds, TIPS Notes Outstanding Rises The outstanding volume of total money market instruments, inclusive of Outstanding Money Market Instruments commercial paper (CP) and large time deposits, totaled more than $4.25 2001–2008:1H* 4500 $ Billions trillion at the end of June 2008, a slight increase from the $4.20 trillion outstanding at the end of March. CP outstanding totaled $1.74 trillion at 4000 the end of June 2008, a modest 2 percent decrease from the $1.78 trillion at 3500 Commercial Paper the end of March 2008. 3000 2500 Financial CP outstanding decreased 2.1 percent to $817.6 billion, from the $835.3 billion total at the end of the first quarter. Non-financial CP out- 2000 standing declined to $165.1 billion at the end of June, down 4.91 percent 1500 1000 from the previous quarter end total of $173.6 billion and down 8.8 percent Large Time Deposits* from the $181.1 billion total at the end of May. Weak economic growth 500 has slowed investment spending and thus the demand for more traditional 0 '01 '02 '03 '04 '05 '06 '07 '08:Q2* commercial paper has stabilized. Asset-backed commercial paper (ABCP) Source: Federal Reserve System * SIFMA estimates outstanding declined by 6.7 percent, to $758.2 billion, from the $812.5 billion accumulated at the end of March, due in part to a slower mortgage sector, the presence of more assets on company balance sheets, and slower Commercial Paper Discount Rates - Yield Curves financial company growth. As of June 30, 2008 A2/P2 Nonfinancial AA Nonfinancial % Yield 3.5 AA Financial AA Asset-Backed

3.0

2.5

2.0 1-day 7-day 15-day 30-day 60-day 90-day Days to Maturity Source: Federal Reserve System

SIFMA Research Quarterly Corporate Bond Market September 2008 Corporate Bond Issuance Recovers from Feeble First Corporate Bond Issuance* 2001– 2008:1H g Investment-Grade g High-Yield Quarter Start 1,200 $ Billions

After a feeble start in the first quarter of this year, corporate bond issuance 1,000 staged an impressive recovery. The uncertainty in credit markets, increased volatility, reduced profit trend, and widening corporate bond spreads are 800 Jan.–Jun. among the main reasons for an anemic first quarter, but they failed to hin- 600 der corporate bond issuance in the second quarter. Total corporate bond issuance rose to $331.4 billion in the second quarter of 2008, reflecting a 400 57.5 percent increase from the previous quarter and was only 4.6 percent below the very strong results in the same year-earlier period. Despite the 200 dramatic volume increase from the first quarter, it remains unlikely to con- 0 tinue and issuance levels are expected to moderate. The support provided '01 '02 '03 '04 '05 '06 '07 '07 '08 Source: Thomson Financial Source: * Includes all nonconvertable debt, MTNs and Yankee bonds, but excludes all issues with maturities of one by the Federal Reserve’s liquidity actions has inspired an increase in inves- year or less, CDs, and federal agency debt tor risk appetite for corporate bonds. In regard to corporate spreads, the stunning spread widening in the first quarter, notably in the financial sector, has been alleviated somewhat as financial institutions have undertaken Corporate Debt Outstanding — Financial Sectors* significant recapitalization programs. As of June 30, 2008 REITs The first half of 2008 witnessed dismal issuance totals in the high-yield sec- Funding Corporation $238.5 B $411.3 B tor, the lowest since the first half of 2000. According to S&P Global Fixed Brokers & Dealers Income Research, high-yield issuance will most likely continue on this path 17.8% 10.3% $80.4 B 3.5% Savings because of stricter lending standards and the reduced likelihood of under- 0.5% Institutions $10.7 B writers taking on higher risk.

Credit Quality Stagnant at Weak Levels; Spreads Shrink in Second 31.3% 36.7% Quarter Commercial Banking $723.9 B Corporate credit quality has been declining in aggregate over the past year Finance Companies and credit quality is expected to remain relatively poor in the second half $847.9 B of the year. The amount and pace of downgrades was elevated in the first Total: $2,312.7 Billion half of the year, and is expected to continue through the remainder of the Sources: Federal Reserve System, SIFMA *SIFMA estimates year. Volatility within the credit markets contributes to the overall increase in downgrades. S&P’s downgrade/upgrade ratio is at 1.32 percent, more than double the rate of a year ago. Consumer-dependent sectors such as the U.S. Corporate Spreads to U.S. Treasury — 10-Year retail, entertainment and auto industries are considered most vulnerable to Jan. 2002–Jun. 2008 downturns in inflation-rattled consumer spending. 250 Basis Points — AAA — BBB+ Default rates have continued to rise from historically low rates through 200 the first half of 2008. According to S&P’s Global Fixed Income Research, 150 the 20 companies that accounted for the entire global default total were all quartered in the U.S., of which twelve were publicly rated and eight were 100 confidentially rated. As of the end of June 2008, the S&P speculative grade 50 default rate for the U.S. was 1.92 percent, a substantial increase from the 0.97 percent default rate posted at the end of 2007. The S&P baseline fore- 0 1/02 9/02 5/03 1/04 9/04 5/05 1/06 9/06 5/06 1/07 9/07 1/08 cast for a 4.7 percent default rate a year from now remains unchanged. Source: Bloomberg According to a JPMorgan Credit Quality report, corporate spreads remain under duress due to lower earnings forecasts and higher commodity prices. U.S. Corporate: AAA Industrial — Yield Curves Corporate spreads continued to widen in the second quarter and through

July. As of June 30, the JP Morgan JULI Investment-Grade Index spread was 6.0 % Yield 251 basis points (bps) over Treasuries. The Merrill Lynch High-Yield Index 5.5 spread tightened 86 bps, to 735 bps at the end of June, from 821 bps at the 5.0 end of March. The credit derivative swap market followed a similar pattern; 4.5 4.0 the CDX.NA.HY spreads tightened to 670 basis points, down 14 bps from 3.5 — 3/31/08 3.0 the end of March. — 6/30/08 2.5 — 6/30/07 2.0 1.5 1.0 1 2 3 5 7 10 20

Years to Maturity Source: Bloomberg

SIFMA Research Quarterly 10 Corporate Bond Market continued from page 10 September 2008 Investment-Grade Issuance Recovered in Second Quarter; Surges U.S. Corporate: BB Industrial — Yield Curves Ahead of Year-Ago Levels — 3/31/08 11.0 % Yield — 6/30/08 — 6/30/07 Non-convertible investment-grade issuance increased 49.8 percent, to 10.0 $306.1 billion, from last quarter’s $204.4 billion and moved 5.3 percent above issuance in the second quarter last year. Consistent with the financial 9.0 sector’s capital raising strategies, financials remain the dominant invest- 8.0 ment-grade issuing sector, with commercial banks, investment banks and 7.0 other credit institutions accounting for nearly 60 percent of investment- 6.0 grade volume in the second quarter. Dating back to the first quarter of 5.0 2007, the financial sector has maintained an overwhelming majority in 1 2 3 5 7 10 20 30 investment-grade issuance. Credit strategy suggests that the looming fear of Years to Maturity Source: Bloomberg inflation, a vulnerable economy, and interest rates were the reasons why the first half of 2008 was so heavily front loaded with new issues. High-Yield Issuance Rose in Q2 S&P Corporate Composite Spreads Non-convertible high-yield debt issuance rose to $25.3 billion in the second Jan. 2004–Jun. 2008 — High-Yield Basis Points quarter of 2008, a tremendous 328.8 percent increase from the $5.9 billion 900 — Investment-Grade issued in the first quarter. The increase shows a remarkable rebound from 800 the previous quarter, but high-yield issuance totals are still down 55.5 per- 700 600 cent compared to the second quarter of 2007. The energy and power sector 500 was by far the largest sector accounting for 33 percent of the total high-yield 400 issuance, with the industrial sector in second place at 16 percent. 300 200 Convertible Issuance, Medium-Term Note Issuance Rose in Second 100 0 Quarter 1/04 1/05 1/06 1/07 9/07 12/07 6/08 Source: Standard & Poor’s Convertible issuance (investment-grade and high-yield) increased during the second quarter to $19.4 billion, a 198.5 percent increase from the dismal $6.5 billion recorded in the first quarter. Although a substantial recovery was made, the second-quarter 2008 total was 31.4 percent below the $28.3 Credit Default Swap Spread billion issued in the second quarter of 2007. Jun. 2005–Jun. 2008 — DJ CDX.NA.IG 5Yr CDS Spread Medium-term note (MTN) issuance increased to $230.3 billion, up 11.8 250 Basis Points — DJ CDX.NA.HY 5Yr CDS Spread 900 percent from the first-quarter total of $206 billion and 30.7 percent above 800 200 the $176.2 billion issued in the second quarter of 2007. 700 600 150 Trading Volume Decreased Slightly in the Second Quarter 500 100 400 According to the FINRA’s TRACE System, estimated total investment-grade 300 average daily trading volume increased in the second quarter to $8.6 billion, 50 200 2.2 percent above that in the first quarter, but 8.2 percent below the second 100 0 0 quarter 2007 average. The second-quarter high-yield average daily trading 6/05 8/05 11/05 2/06 5/06 8/06 11/06 2/07 4/07 10/07 1/08 4/08 volume of $4.1 billion marked a 6.5 percent decrease from the previous Morgan Source: JP quarter, but was 3.9 percent higher than the average in the same year-earlier period. The slight decrease in overall average daily trading volume, inclusive of both investment-grade and high-yield trading volume, reflects the rela- TRACE Average Daily Trading Volume tively unchanged market between the first and second quarters of 2008. Jan. 2007– Jun. 2008 20 $ Billions g Investment-Grade g High-Yield

1/07 2/07 3/07 4/07 5/07 6/07 7/07 8/07 9/07 10/07 11/07 12/07 1/08 2/08 3/08 6/08 Source: FINRA

SIFMA Research Quarterly 11 Equity September 2008

Daily Closing Stock Prices Jan. 2003–Jun. 2008 Preferred Stock Underwritings Set New Record; — S&P 500 Trading Volume Slows; Short Interest Soars 3,000 NASDAQ Composite The Dow Jones Industrial Average (DJIA) and S&P 500 joined the NASDAQ 2,500

Composite Index in bear territory on July 2 and July 9, respectively, when 2,000 they declined 20 percent from their peak levels. The UK, Germany, France, Hong Kong, Shanghai and India were other major markets that crossed 1,500 the bear market threshold in 2008. While rising energy prices have created 1,000 pressure in the markets, soaring food and other commodity price increases 500 have also exerted their influence, contributing to an estimated global infla- 0 tion rate of 5.5 percent, up from 3.5 percent at the beginning of the year. For 1/03 1/04 1/05 1/06 1/07 1/08 3/08 6/08 Sources: NASDAQ. S&P the quarter, the DJIA and S&P 500 declined by 7.4 percent and 3.2 percent, respectively, while the NASDAQ rose 0.6 percent. Compared to the end of the first half in 2007, the major U.S. indices closed first-half 2008 down 15.4 NYSE and NASDAQ Average Daily Share Volume percent (DJIA), 14.9 percent (S&P 500) and 11.9 percent (NASDAQ). 2003:Q1–2008:Q2 g g 6,000 Millions of shares NASDAQ NYSE Share Trading Volume Catches Breath 5,000 The New York Stock Exchange’s (NYSE) second-quarter average daily share volume was 2.4 billion shares, a decline of 15.4 percent from the previous 4,000 quarter, while NASDAQ average volume was 2.4 billion shares, down 14.2 percent. Compared to the second quarter a year ago, NYSE volume rose 3,000

10.1 percent and NASDAQ rose by 0.4 percent. While falling in the second 2,000 quarter, NYSE and NASDAQ average share trading volumes are still on pace for another record year due to record highs in the first quarter. 1,000

The NYSE’s average daily dollar trading value reached $81.4 billion in the 0 second quarter, down 14.1 percent from the previous quarter but still above 03:Q1 03:Q3 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 07:Q3 08:Q2 the $80 billion level for the sixth consecutive quarter. Average daily dollar Sources: NASDAQ, NYSE trading value on the NASDAQ reached $66.1 billion, down 7.3 percent from the previous quarter. Compared to the second quarter a year ago, NYSE dollar volume fell by a modest 2.5 percent, while NASDAQ rose by Equity Quarterly Average Daily Trading Volume 19.9 percent. 2003:Q1–2008:Q2 g NASDAQ g NYSE 180 $ Billions

Short Interest Sets Record in Second Quarter 160

NYSE short interest volume rose to 18.13 billion shares, which represents 140 4.3 percent of the total outstanding shares on the NYSE for the June 30 120 quarter end reporting period, increasing by over 2.5 billion shares, or 16.3 100 percent, from the previous quarter, and 5.38 billion shares above the level 80 at the start of the year. The impact of the SEC’s mid-July emergency order 60 addressing concerns over abusive short selling may be seen in short interest 40 data in future periods. 20

0 Total Corporate Issuance 03:Q1 03:Q3 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 07:Q3 08:Q2

Second quarter total corporate underwriting volume, including straight and Sources: NYSE, NASDAQ convertible debt, asset-backed and non-agency mortgage-backed securities, and equity, was $538.5 billion on 643 deals, up 52.9 percent from $349.0 bil- NYSE Short Interest lion on 574 deals in the first quarter but 47.7 percent below the volume in the Jan. 2003–Jun. 2008 second quarter 2007. While underwriting is still relatively soft, the backlog 20 Billions of Shares of offerings is beginning to clear. Equity underwriting made a significant 18 recovery in the second quarter due to higher demand for technology, media 16 and communication stocks; debt issuance, however, fell due to steep declines 14 of mortgage-backed securities and high-yield bond issuance. 12 Preferred stock underwriting grew at a record-setting pace in the second 10 quarter, pushing first-half volume to $73.1 billion, surpassing the $60 bil- 8 lion 2007 full-year record. Second-quarter preferred stock issuance totaled 6 4 $40.2 billion on 32 deals, up 22.1 percent from the previous quarter and up 1/03 7/03 1/04 7/04 1/05 7/05 1/06 7/06 1/07 7/07 1/08 3/08 6/08 487.1 percent from the second quarter of 2007. Of the 32 preferred issues Source: NYSE in the second quarter, 11 were by bank or bank holding companies, com-

SIFMA Research Quarterly 12 Equity continued from page 12 September 2008 Total Equity Underwriting pared to 18 deals reported in the first quarter, of which 12 were by bank or 2003:Q1–2008:Q2 bank holding companies. Closed-end-fund offerings dropped in the second 100 $ Billions quarter to $0.2 billion on 2 transactions, a dramatic decline from the $3.4 billion on 12 deals recorded in the previous quarter and the $14.3 billion 80 on 39 deals in the same year-earlier period. Approximately 75 percent of closed-end-fund second-quarter underwriting volume occurred in June, 60 with none in April. 40 Combining corporate debt (straight bonds and securitizations) and equity underwriting, the securities industry raised $526.7 billion in the second 20 quarter of 2008, an increase of 52.9 percent from the previous quarter, but down 47.4 percent from the same year-earlier quarter, when a record-set- 0

03:Q1 03:Q3 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 07:Q3 08:Q2 Thomson Financial Source: ting $1 trillion was raised. The linked-quarter increase can be attributed to straight corporate debt (up 56.7 percent), preferred stock (up 22.2 percent) and follow-on stock offerings (up 272.5 percent). Total IPOs and “True IPO” Markets Rise Quarterly “True” IPO - Excluding Closed-End Funds 2003:Q1–2008:Q2 U.S. initial public offerings (IPOs) raised $5.1 billion in the second quar- g $ Billions $ Billions ter, up 12.5 percent from the previous quarter, but down 83.3 percent 20 # of Deals 90 80 from the second quarter 2007. “True IPOs,” which exclude closed-end- 16 70 fund IPOs, totaled $4.8 billion, a more than fourfold increase from the 60 12 previous quarter but 69.1 percent below the level in the second quarter- 50 2007. The IPO backlog declined in dollar terms for the third straight 40 8 month, to $21.6 billion, on 114 deals, down $15.4 billion, or 41.6 percent, 30 from the previous quarter. 4 20 10 Second-Quarter Secondary Offerings Set Record 0 0

03:Q1 03:Q3 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 07:Q3 08:Q2 Thomson Financial Source: Second-quarter secondary underwritings set a new quarterly record of $50.8 billion on 103 deals, eclipsing the previous record of $47.3 billion on 169 deals set in the first quarter of 2000. This represents an increase of 272.5 percent over the first-quarter 2008 level and 54.4 percent above the Quarterly Secondary Stock Offerings second-quarter 2007 level. 2003:Q1–2008:Q2 g $ Billions U.S. M&A Volume Rebounds After Three Quarterly Falls 60 $ Billions # of Deals 200 M&A announced deal volume slipped over the previous three quarters, 50 150 only to surge in the second quarter of 2008 to $427.5 billion, a 180.2 per- 40 cent increase from the previous quarter of $152.5 billion and the third 30 100 highest quarterly total this decade, although 16.9 percent below that in the second quarter 2007. The number of announced M&A deals declined 20 50 9.4 percent from the previous quarter and 24.7 percent from the second 10 quarter in 2007. 0 0 03:Q1 03:Q3 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 07:Q3 08:Q2 P/E Breaches 5-Year Average Thomson Financial Source: The P/E ratio of the S&P 500 stood at 22.2 at the end of June, up 12.7 and 25.5 percent from the previous quarter and the same period last year, respectively. While it was the first quarter to close above the 5-year average U.S. Mergers and Acquisitions Announced Deals of 19.80 in more than three years, the end-second-quarter P/E ratio at the 2003:Q1–2008:Q2 end of the second quarter remained below the 10-year average of 26.91. 600 $ Billions Share Buyback Volume Lower 500 Corporate share repurchases declined for a third straight quarter, with 400 second-quarter buyback volume falling on both the NYSE and NASDAQ 300 by 40.4 percent and 70.3 percent, respectively. Announced buyback volume on the NYSE was $45.4 billion on 36 share repurchase programs, 200 while NASDAQ share buyback volume was $2.8 billion on 13 share repurchase programs. The lower buyback levels in this quarter reflect 100 continuing capital conservation and management strategies as well as a 0 03:Q1 03:Q3 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 07:Q3 08:Q2 downshift in equity prices. Thomson Financial Source:

SIFMA Research Quarterly 13 Equity continued from page 13 September 2008

CBOE Volatility Index Moves Higher S&P P/E Ratio Jan. 2002–Jun. 2008

The Chicago Board Options Exchange Volatility Index (VIX) closed at 70

23.95 at the end of the quarter. June had the highest month-end level 60 of the turbulent second quarter, following 20.79 and 17.83 in April and 50 May month-ends, respectively, and a peak of 24.12 on June 11. The VIX remained above the 5-year average and 10-year averages. Current market 40 conditions suggest that volatility will continue to remain elevated. 30 20 Venture Capital/Private Equity 10

Venture capital investments in the US declined for the second con- 0 1/02 7/02 1/03 7/03 1/04 7/04 1/05 7/05 1/06 7/06 1/07 9/07 12/07 6/08 secutive quarter in second-quarter 2008 but remained above $7 billion Source: Bloomberg for the seventh consecutive quarter. However, capital disbursements declined by 1.5 percent to $7.39 billion from $7.50 billion at the end of the second quarter of 2007. Private equity investments were up slightly NASDAQ and NYSE Share Buybacks by 0.3 percent to $7.39 billion, compared to the $7.36 billion in second 2001:Q1–2008:Q2 quarter of 2007. The number of private equity deals increased to 990, 180,000 $ Millions g NASDAQ g NYSE 160,000

1.3 percent more than the 977 deals recorded in the first quarter. 140,000

120,000

100,000

80,000

60,000

40,000

20,000 0 01:Q1 01:Q3 02:Q1 02:Q3 03:Q1 03:Q3 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 08:Q2 Source: Dealogic

SPX Volatility Index (VIX) Close Jan. 2003–Jun. 2008

0 1/03 7/03 1/04 7/04 1/05 7/05 1/06 7/06 1/07 7/07 6/08 Source: Chicago Board of Options Exchange

Venture Capital Investment in U.S. Companies 2005:Q2-2008:Q2 10,000 $ Millions

8,000

6,000

4,000

2,000

0 05:Q2 05:Q3 05:Q4 06:Q1 06:Q2 06:Q3 06:Q4 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 Sources: Pricewaterhouse/Venture Economics/NVCA MoneyTree Survey MoneyTree Economics/NVCA Sources: Pricewaterhouse/Venture

SIFMA Research Quarterly 14 Leveraged Loans September 2008

Leveraged Loan Issuance Second Quarter 2008: Leveraged Loan Market Review2 2005:Q1–2008:Q2 250 $ Billions Across the broader economy, recession woes have now collided with inflationary fears as food and energy prices have soared while the U.S. dollar remains 200 weak. Whether it was due to the credit crises, the mortgage meltdown or a series of bad decisions, the final result is a weakening U.S. economy; so weak 150 that an estimated 325,000 jobs were lost so far this year. Following the worst performance ever during the three-month period of first -quarter 2008, 100 the syndicated bank loan market rallied back amid the global economic downturn to post record returns. As loan prices rallied off their first-quarter 50 all-time lows, returns were once again quite impressive. During the second 0 quarter, Loan Participation Funds averaged a whopping 4.49 percent return. 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 07:Q3 08:Q2 High-yield bonds and equities, however, did not share such strong results - Source: Reuters LPC/Dealscan bond funds dropped by an average of 0.21 percent, while equities, particularly U.S. bank stocks, fell to their lowest level in years. On the supply side, second-quarter 2008 leveraged loan issuance totaled CLO Issuance $84 billion. Although the figure represents a 39 percent quarter-over- 2005:Q1–2008:Q2 35 $ Billions quarter increase, lending activity has been mired in a slump for the past four quarters. Across the first half 2008, total leveraged loan volume was 30

$144.5 billion, a 66 percent fall from the record $428 billion of the first 25 half of 2007. The silver lining to the drop in leveraged lending is that the diminished supply may help rebalance the supply and demand equation 20 and, in turn, revitalize the market. As a result of the lack of new-issuance 15 volume, arrangers were able to reduce the underwriting overhang of pre- 10 correction paper by an estimated $47 billion during the second quarter. This was accomplished in large part by block sales of these loans at prices in 5 the mid-‘90s, well below their par value. By the end of June, the calendar of 0 unwritten loans shrank to a new low of $64 billion. The calendar, which had 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 07:Q3 08:Q2 peaked last July at $237 billion, compressed to roughly $110 billion during Leveraged Commentary & Data (LCD) Source: S&P the first quarter from $156 billion at year-end.

Meanwhile, on the demand side, collateralized loan obligation (CLO) issu- Lagging 12-Months Default Rate by Principal Amount ance - long the funding giant of leveraged loans - continued its precipitous Jan. 2005–Jun. 2008 slide. During the second quarter, CLO issuance totaled a measly $3.4 billion 3.5 % Yield

– more than $29 billion less than was reported during the same quarter last 3.0 year. A surprisingly positive trend is that, despite the disappearance of CLO 2.5 issuance, non-traditional accounts have begun to enter the loan market and 2.0 might well prove to be major players in the months ahead. While CLO man- 1.5 agers were left to grapple with historically wide AAA spreads, these non-traditional lenders, such as distressed funds and private equity firms, began to 1.0 take advantage of the attractive yields found both in the primary and second- 0.5 0.0 ary loan markets, and subsequently began to provide much-needed liquidity. 1/05 3/05 1/06 3/06 1/07 3/07 1/08 6/08 These new accounts have begun to replace not only the large funding void left Leveraged Commentary & Data (LCD) Source: S&P behind by the lack of new CLO vehicles but also some highly levered players, such as hedge funds, that were either forced to close shop or simply found the loan asset class no longer attractive, given the massive reduction in the S&P/LSTA Leveraged Loan Index Returns amount of leverage being offered in today’s market. 2007:Q1–2008:Q2 4.94% 4 % Yield Still another positive result in the second quarter was the return of retail 3 money to the asset class. According to AMG data, inflows into daily access 2 1 1.97% 1.43% funds turned positive in May, at $61 million, and expanded to $242 million 0 -1.23% -0.14% in June. Such much-needed inflows represented a dramatic reversal from -1 the $325 million of redemptions during March, and the record $1.3 billion -2 in redemptions during February. Under more balanced supply and demand -3 -5.70% -4 conditions and with the emergence of less levered accounts, the market -5 could stabilize and make a pleasant comeback in the second half of the -6 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 Source: S&P Leveraged Loan Index Source: S&P 2 The author of the Leveraged Loan discussion is Ted Basta, Loan Syndication and Trading Association (LSTA), Vice President of Market Data & Analysis

SIFMA Research Quarterly 15 Leveraged Loan continued from page 15 September 2008 Secondary Market Loan Price year. Factors such as rising oil prices, reduced consumer spending, higher Jun. 2007–Jun. 2008 Mean Secondary Price Mean Bid-Ask Spread (BPS) unemployment rates, rising inflation and the housing market will all influ- 100 250 ence the market’s reemergence. 98 225 Heading into 2008, many loan experts thought that the market would see 96 200 BPS a default rate of about 5 percent for the year. However, during the first % of par 94 175 quarter, 13 institutional loans defaulted, pushing the first-quarter run rate 92 150 to 6.1 percent, well surpassing the market’s estimate and its comfort level. 90 125 Fortunately, during the second quarter, the number of defaults moderated 88 100 considerably, and the 5 percent default figure again appeared reasonable to 86 75 84 50 lenders. After jumping 1.57 percentage points by the end of the first quarter 6/07 3/07 6/07 9/07 1/08 6/08 from an all-time low of 0.26 percent, the loan market’s lagging 12-month MTM Pricing Source: LSTA/LPC default rate by number of issuers moderated somewhat during the second quarter, but still rose to 2.58 percent by the end of June. Nonetheless, given the many options embedded in pre-third-quarter-2007 loan agreements SecondaryDistribution Market of Secondary Breadth Price Volatility (PIK-toggle or Cov-Lite deals) companies should find breathing room Apr.Apr. 2008–Jun. 2008–Jun. 2008 2008 when facing interest payments. When and if they do default, recoveries Decliners 100 $ Billions 60 84% Advancers could fail to match historical norms. Still, the risk-adjusted returns of lev- 90 Apr. 2008 80 50 70% May 2008 eraged loans, which are senior secured and sit atop the capital structure, Jun. 2008 70 40 remain attractive relative to other asset classes, although today’s returns 60 48% not only with a higher level of volatility but also the expectation of rising 50 30 50% default rates. 40 30 20 20 After experiencing a record loss of 5.74 percent during the first quarter, 10 26% 10 the S&P/LSTA Leveraged Loan Index (LLI), the widely used industry 14% 0 0 Worse -1% -.5% -.25% -.001% 001% 25% 5% 1% Greater benchmark, fought back with a vengeance and posted a record gain of 4.49 thanApr. 2008 to to to May. to 2008 to to to toJun. 2008 than Source: LSTA/LPC MTM Pricing Source: LSTA/LPC <-5% > -5% >-1% >-.5% >-.25% <.25% <.5% <1% <5% 5% MTM Pricing Source: LSTA/LPC percent in second-quarter 2008. Following record gains during April, loan prices continued to rally in the secondary market through the third week of June, but then turned decidedly negative as the rally came to an end. Thanks in large part to the last six trading sessions of June, the S&P/LSTA Leveraged Loan Index posted a 3-month-low return of 0.25 percent, follow- Distribution of Secondary Price Volatility ing May’s 0.94 percent and April’s record high of 3.70 percent. This com- Apr. 2008–Jun. 2008 plete reversal of fortune reaffirms the volatile state of the bank loan market. 60 $ Billions Apr. 2008 The volatility of the LLI, as measured by the lagging 12-month standard 50 May 2008 deviation of monthly index returns, skyrocketed to 2.73 percent by the end Jun. 2008 of June 2008, from just 0.53 percent at the end of June 2007. Nonetheless, 40 the recovery of the LLI during the second quarter was extraordinary. 30 The index’s strong second-quarter performance was echoed by the LSTA/ 20 LPC Mark-to-Market pricing (MTM) dataset’s steady price appreciation 10 since the end of first-quarter 2008. The MTM dataset, which comprises U.S. 0 Worse -1% -.5% -.25% -.001% 001% 25% 5% 1% Greater term loans quoted by three or more broker dealers, pulled off a 3.5 percent than to to to to to to to to than <-5% > -5% >-1% >-.5% >-.25% <.25% <.5% <1% <5% 5% MTM Pricing Source: LSTA/LPC surge in average bid level during the second quarter, after succumbing to a 6.3 percent tumble in the first quarter. After sliding to an all-time low of 85.48 during early February of this year, the average price of the MTM dataset has gradually recaptured lost ground, rising above the 90 price bar- rier by July 20, a price level not seen since the beginning of the year. By the Distribution of Secondary Prices g <90 g 90-98 g 98-100 g >100 2007:Q3–2008:Q2 0% 1% end of June, though, the average MTM price fell back to 89.23, as the last 100 4% 2% 4% 8% six trading sessions shaved 75 bps from the market average. After widening 90 22% to a record high level of 222 bps on February 13, the MTM dataset’s bid- 80 39% 46% ask spread, commonly used as a measure of liquidity, tightened to 132 bps 70 62% by June 20, and then proceeded to widen back out to 144 bps by month- 60 end. The last time the bid-ask spread was tighter than 140 bps was back in 50 60% January. Even after June’s month-end plunge, bids still rose by more than 40

30 49% 300 bps while bid-ask spreads tightened by 40 bps. 49% 20 By month-end June, it became clear that the second-quarter secondary 29% 10 16% market rally had come to a halt. For the first time all quarter, monthly 8% 0 market breadth was negative, albeit slightly. During June, advances were 2007:Q3 2007:Q4 2008:Q1 2008:Q2 outnumbered by declines by a ratio of 0.96 to 1, with 48 percent of the MTM Pricing Source: LSTA/LPC

SIFMA Research Quarterly 16 Leveraged Loan continued from page 16 September 2008

MTM dataset reporting gains following the 70 percent and 84 percent figures reported during May and June. MTM price volatility was skewed slightly toward the negative side of the distribution as more loans recorded MTM price losses than price gains. During June, loans that recorded price gains between 1 percent and 5 percent accounted for 15 percent of the entire MTM dataset, while loans reporting gains of greater than 5 percent comprised 5 percent of the dataset. On the negative side of the distribution, loans that recorded price losses between 1 percent and 5 percent accounted for 19 percent of the MTM dataset, while loans reporting losses of greater than 5 percent comprised 5 percent of the MTM dataset. Last month those figures were only 10 percent and 4 percent, respectively. The distribution of secondary prices at month-end June also illustrates the loan market’s second-quarter rally, at least what is left of it by the time this review is published. By the end of the second quarter, roughly 29 percent of all loans in the MTM dataset were priced below 90, compared with the record high 49 percent figure reported at the end of 08:Q1. Those loans previously bid below 90 had migrated up into the 90 to 98 price range, which increased to a record 2008 high of 62 percent by month-end June from the 46 percent figure reported at month-end March.

SIFMA Research Quarterly 17 SIFMA RESEARCH AND POLICY DEPARTMENT

Kyle Brandon Managing Director, Research [email protected]

Washington Staff Switchboard: 202-962-7300

Tiffany Coln: [email protected] Mary Bateman: [email protected]

New York Staff Switchboard: 212-313-1200

Charles Bartlett: [email protected] Paul Rainy: [email protected] Sharon Sung: [email protected]

Surveys Bernard Reichert: [email protected] Nancy Cosentino: [email protected] Samantha Simone: [email protected]