Research Quarterly, 2Q 2010

Research REPORT second quarter 2010

Research quarterly 2Q 2010

Volume V No. 12

New York n Washington

TABLE OF CONTENTS

Table of Contents ...... 1 Capital Markets Overview ...... 2 Municipal Bond Market ...... 3 Treasury Market ...... 5 Federal Agency Debt Market ...... 7 Funding and Money Market Instruments ...... 8 Mortgage-Related Securities ...... 10 Asset-Backed Securities and CDO Market ...... 12 Corporate Bond Market ...... 13 Equity and Other Markets ...... 14 Derivatives ...... 17 Primary Loan Market ...... 18 SIFMA RESEARCH QUARTERLY

SIFMA Research Quarterly, Q2 2010 | Page 1

CAPITAL MARKETS OVERVIEW

Capital Market Issuance Down 11.6 Percent off issuances of agency mortgage portfolios in May to $1.6 Trillion in Second Quarter 2010 and June of 2009. Markets have been preoccupied for much of the past Corporate bond issuance fell significantly to a total of year with the progress and shape of financial regulatory $162.7 billion in the second quarter, down 43 percent reform. Shortly after the end of the second quarter, the from 1Q’10 and 36 percent from 2Q’09. Investment Dodd-Frank Wall Street Reform and Consumer Protec- grade corporate issuance decreased more than high tion Act (“Dodd-Frank Act”) was passed and signed yield issuance. Refinancing pressures remain high in into law by President Obama. Dodd-Frank touches al- the U.S. While there was a decline in corporate de- most every aspect of the U.S. financial system, expand- faults during the second quarter, this was oversha- ing regulatory oversight, creating new regulators, and dowed by worries over the possibility of an increase of mandating changes in business practice, among many defaults in over the next few years. other provisions. Equity market issuance rose again, totaling $47.9 bil- There are hundreds mandated regulatory actions that lion in 2Q’10, a decline of 22.6 percent y-o-y. Al- must be competed and regulations that must be imple- though there was a significant increase in IPO activity mented over the next several years. While largely sup- y-o-y from the doldrums experienced in early 2009, portive of the need for some fundamental regulatory secondary market issuance decreased significantly y-o- overhauls, there is broad industry concern revolving y, although both were up compared to 1Q’10. around the continued constriction of credit availability, Issuance of U.S. Capital Markets anemic economic recovery and stagnant employment 2009:Q2 YTD vs 2010:Q2 YTD growth, all which will be further impacted by the im- 1400 $ Billions 2009:Q2 YTD plementations of many areas of regulatory reform. 1200 2010:Q2 YTD

During the second quarter, $1.6 trillion in securities 1000

were issued, a decline of 11.6 percent from $1.8 trillion 800 in 1Q’10 and down 23.7 percent year-over-year (y-o-y) from $2.0 trillion in 2Q’09. 600 400 Municipal issuance totaled $100.2 billion in the second quarter, a decline of 9.8 percent from 2Q’09. The taxa- 200 ble share of issuance edged up to 32.8 percent from 0 Treasury(1) Federal Agency(1) Municipal(1) Mortgage-Related Asset-Backed Corporate(1) Equity

32.6 percent in Q1’10, in part due to steady BABs is- (1)Includes long-term issuance only suance as well as a moderate increase in the non-BAB Source: Thomson Reuters, U.S. Treasury, U.S. Federal Agencies taxable share due to the authorization direct payment Issuance Highlights

SIFMA RESEARCH QUARTERLY options on certain bonds in Q1’10, such as lean renew- Y-o-Y % able energy bonds (CREBs). $ Billions 2010:Q2 2009:Q2 Change 2010:Q2 YTD Treasury (1) 588.6 533.5 10.3% 1,211.7 Federal Agency (1) 232.7 313.8 -25.8% 540.3 While net treasury issuance fell 5.5 percent to $588.6 Municipal (1) 100.2 111.1 -9.8% 204.2 Mortgage-Related 356.5 656.1 -45.7% 745.7 billion in 2Q’10 from $623.1 billion last quarter, Asse t-Ba cke d 32.1 50.1 -35.9% 64.9 2Q’10 issuance is 10.3 percent above 2Q’09 issuance Global CDO 0.8 1.3 -39.1% 3.2 Corporate (1) 162.7 255.0 -36.2% 453.7 of $533.5 billion, partly due to Treasury’s Supplemen- Equity 47.9 114.8 -58.3% 88.9 * Percent change between 2010:Q2 and 2009:Q2 tary Financing Program (SFP). The SIFMA Govern- (1) Includes long-term issuance only ment Forecast Survey predicts net treasury issuance will rise again in 3Q’10. Federal agency debt issuance totaled $232.7 billion in 2Q’10, down from $307.6 billion in 1Q’10, and was down almost 26 percent y-o-y. The two largest agencies, Fannie Mae and Freddie Mac, were recently de- listed from the NYSE stock exchange at the end of 2Q’10. Total mortgage-related issuance decreased significantly to $356.5 billion in 2Q’10, a 45.7 percent decrease y-o- y from $656.1 billion. The large decrease in mortgage- related issuance, or more accurately, the unusual increase of issuance in 2Q’09 was chiefly due to the one-

Research Quarterly 2Q 2010 | Page 2

MUNICIPAL BOND MARKET

Short-1 and Long-Term Municipal Issuance Municipal GO AAA and 10-Yr Treasury Ratio 2001 - 2010:Q2 Jun. 2003 - Jun. 2010 500 $ Billions 1.80 % Yield 450 Short‐Term

400 Long‐Term 1.60

350

300 1.40

250

200 1.20

150

100 1.00

50 0.80 0 2009 2010 0.60 2001 2002 2003 2004 2005 2006 2007 2008 2009 Q2 YTD Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 1Includes maturities of 13 months or less Source: Bloomberg, MMA. Source: Thomson Reuters

Long-Term Municipal Issuance by Enhancement Status1 Average Daily Trading Volume of Municipal Securities1 2001 - 2010:Q1 2006:Q2 -2010:Q2 500 $ Billions 30 $ Billions Unenhanced 450 Enhanced 400 25

350 20 300

250 15 200

150 10 100

50 5 0 2009 2010 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 Q2 YTD 06:Q2 06:Q4 07:Q2 07:Q4 08:Q2 08:Q4 09:Q2 09:Q4 10:Q2 1Includes maturities of 13 months or more 1Includes both dealer-to-dealer and customer-to-dealer transactions. Source: Thomson Reuters Source: Municipal Securities Rulemaking Board

Build America Bond Issuance Taxable vs. Tax-Exempt Issuance 2010:Q2 (YTD) 2000-2010:Q2 600 $ Billions 35% BAB Build America Bonds Taxable 30% $51.8B 500 AMT 26% Tax‐Exempt Taxable Percentage of Municipal Issuance (right) 25% 400 20% 300 15% 200 10% SIFMA RESEARCH QUARTERLY 100 5%

Long-term Municipal 0 0% Issuance (non-BAB) $150.7B 2009 2010 74% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Q2 YTD Sources: Bloomberg,Thomson Reuters, SIFMA Source: Thomson Reuters, SIFMA According to Thomson Reuters, long-term municipal BAB taxable bonds were issued following the enact- issuance volume, including both taxable and tax- ment of the Hiring Incentives to Restore Employment exempt issuance, totaled $100.2 billion in the second Act (HIRE Act). quarter of 2010, down 3.6 percent from $104.0 billion Tax-exempt issuance continued to lose ground to tax- in 1Q’10 and 9.7 percent below that in 2Q’09. Exclud- ables in the second quarter, with issuance of $66.3 bil- ing taxables, tax-exempt issuance totaled $72.7 billion, lion, a decline of 3.2 percent from 1Q’10 and 23.9 per- an increase of 6.1 and a decline of 16.6 percent, respec- cent from 2Q’09. The decline stands in stark contrast to tively, from 1Q’10 and 2Q’09. tax-exempt fund inflows, which remained strong Taxable issuance modestly gained additional market throughout 2Q’10; according to Investment Company share in 2Q’10, claiming 32.8 percent of all municipal Institute (ICI), inflows for the first half of 2010 into issuance compared with 32.5 percent and 20.8 percent, tax-exempt municipal funds have totaled $19 billion, a respectively, in 1Q’10 and 2Q’09. While Build Ameri- rise from $13 billion in 1Q’10 and $17.0 billion in ca Bonds (BABs) have accounted for the majority of 2Q’09.1 taxable municipal issuance (76.7 percent of all taxables issued in 2Q’10), approximately $2.4 billion in non- 1 Investment Company Institute, Long-Term Mutual Fund Flows

Research Quarterly 2Q 2010 | Page 3

Eurozone sovereign debt concerns came to a head in in 2Q’09. Insured bond issuance of $7.1 billion, 2Q’10, culminating in a €750 billion rescue package represented 7.1 percent of total enhanced issuance, up aimed at assuaging nervous investors. While the related modestly from 6.3percent in 1Q’10 but down from a “flight to quality” drove Treasury yields down across 9.4 percent share in 2Q’09. the yield curve, municipal yields were not similarly According to a June 2010 Nelson A. Rockefeller Insti- impacted, resulting in widening spreads between the tute of Government report, while two states (New York 10-year AAA G.O. and Treasury yields; the ratio wi- and California) reported growth in collections, 34 dened above 100 percent, ending at 104 percent at the states saw declines in their overall tax collections in end of 2Q’10, a ratio last seen in May 2009. The ratio 1Q’10.4 Additionally, revenue growth was not particu- averaged 91.7 throughout 2Q’10, higher than the 82.6 larly organic, as much of it could be attributed to percent average in 1Q’10, but below the 110.22 aver- enacted tax increases and tax processing changes. age in 2Q’09. The report also noted that after accounting for infla- BAB issuance continued strongly throughout 2Q’10, tion, state tax revenue was at about the same level as with $25.1 billion sold, a modest decrease of 6 percent ten years ago, although the nation’s population has in- from 1Q’10 but still 60.9 percent that in 2Q’09, when creased by approximately 10 percent during that pe- the program officially began. riod. Overall, while positive figures are beginning to Issuance of variable rate demand obligations (VRDOs), trickle in, the road to fiscal recovery remains “bumpy.” long-term municipal bonds with a floating interest rate State tax revenue is driven largely by retail (31 per- that resets daily or weekly and contains a put feature, cent) and income (36 percent) taxes, both correlated to continued to decline, with $4.0 billion issued in 2Q’10, unemployment, which remains stubbornly high; and a 4.3 and 57.6 percent decline from 1Q’10 and 2Q’09, budgetary problems have been pushed out from the respectively. Demand remained weak as investors con- near-term into subsequent fiscal years. Continued rev- tinued to disfavor tax-exempt money market funds for enue weakness will require states to pursue additional more competitive returns elsewhere.2 The SIFMA Mu- measures to close budget gaps. nicipal Swap Index, a 7-day high-grade market index

comprised of tax-exempt VRDOs, ended at 0.25 percent end-June, averaging 0.29 throughout 2Q’10. Government Update On July 21, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. The Act directly impacts the municipal sector, containing provisions relating to financial advisors, municipal derivatives, swaps participation by state and local government, MSRB board composition, SEC divisions, rating

SIFMA RESEARCH QUARTERLY agencies, and others.3 H.R. 5893 was introduced in the House in July, which introduced provisions for: extending the BABs program through 2012; extending the AMT holiday by one year; extending bank-qualified bond limit for 2011; allocating additional funds to RZEDBs ($15 billion) and RZFBs ($10 billion), exempting water and sewer facility bonds from private activity caps; and extending direct payment options for state housing agencies in lieu of tax credits. Credit Quality Trends & Credit Enhance- ment Credit enhancement for municipal bonds continues to wane. Non-enhanced issuance in 2Q’10 comprised 84.8 percent of total issuance, down from the 89.7 percent share in 1Q’10, but above the 82.4 percent share

2 According to ICI, tax-exempt money market funds ended 2Q’10 with $345.9 billion in assets under management (AUM), a decline of $27.5 billion from 1Q’10. Since the beginning of 2009, tax-exempt money market fund AUM has declined by approximately $155.6 billion, or 31 percent. 4 The Nelson A. Rockefeller Institute of Government, Overall State Tax 3 See SIFMA Dodd-Frank Resources for more details. Revenue Is Up, But Losers Still Outnumber Gainers, June 2010.

Research Quarterly 2Q 2010 | Page 4

TREASURY MARKET

Gross Issuance of U.S. Treasury Securities1 Treasury Yields and Fed Fund Rate 2001 - 2010:Q2 Jan. 2002 - Jun. 2010 2,500 $ Billions 6.0 % Yield

2,000 5.0

4.0 1,500

3.0 1,000

2.0 500 2‐yr Trsy 1.0 10‐yr Trsy 0 Fed Funds Target 2009 2010 0.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 Q2 YTD Jan-02 Mar-03 May-04 Aug-05 Oct-06 Jan-08 Mar-09 Jun-10 1Includes only marketable coupon securities Note: Since December 2008, the rate has been 0 - .25% Source: U.S. Treasury Source: Federal Reserve

Average Daily Trading Volume of Treasury Securities1 Quarterly Summary of Bill, Coupon and TIPS Auctions Held by Treasury 2006:Q2 - 2010:Q2 2007:Q1 - 2010:Q2 900.0 800 $ Billions $ Billions

800.0 700 CMBs 4‐week Bills 700.0 13‐week Bills 600 26‐week Bills 600.0 52‐week Bills 500 2‐year Note 500.0 3‐year Note 400 5‐year Note 400.0 7‐year Note 300 10‐year Note 300.0 30‐year Bond 200 TIPS 200.0 100 100.0 0 2006:Q2 2006:Q4 2007:Q2 2007:Q4 2008:Q2 2008:Q4 2009:Q2 2009:Q4 2010:Q2 0.0 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 1Primary dealer activity Source: Federal Reserve Bank of New York Source: U.S. Treasury

Net Issuances of Treasury Marketable Debt 2007:Q1 - 2010:Q2 600 $ Billions

Net Issuance (excluding CMBs) 450 Net Issuance (including CMBs) Net Coupon Issuance (Notes and Bonds only)

300

150 SIFMA RESEARCH QUARTERLY

-150

-300 Jan-07 Apr-07 Jul-07 Nov-07 Feb-08 Jun-08 Sep-08 Jan-09 Apr-09 Aug-09 Nov-09 Mar-10 Jun-10 Source: U.S. Treasury

Jump in Bill Issuance; Concerns Over Cool- pons) quarter-over-quarter, and a 47 percent jump ing Recovery, Shift to Deflation alone in gross bill redemptions over this same time ho- Total second quarter net issuance of U.S. Treasury se- rizon may have partially offset the increase in CMBs. curities was $343.6 billion, down nearly 29 percent Approximately $601.6 billion of Treasury coupons from the prior quarter’s $483.2 billion. Notably, total (notes and bonds) were issued in the second quarter, net issuance excluding cash management bills (CMBs) nearly 13 percent above the $533.3 billion issued in the fell to $(45.4) billion in the second quarter from same year-ago period. Excluding redemptions, coupon 1Q’10’s $353.2 billion. This significant drop in net issuance was $404.5 billion, 6.6 percent below 1Q’10’s issuance reflects the increased use of short-term CMBs $433.2 billion but 9.2 percent above the $370.3 billion in the second quarter, up from approximately 7 percent in the same year-earlier period. of total gross Treasuries issuance in 1Q’10 to 18 percent in 2Q’10. However, there was also a moderate 4.1 Total amount of Treasury securities issued were nearly percent rise in total redemptions (for all bills and cou- $1.8 trillion in the second quarter, roughly in-line with the amount issued in the same year-earlier period.

Research Quarterly 2Q 2010 | Page 5

SIFMA’s recently completed quarterly Government primary dealers averaged $528.5 billion in the second Forecast survey of U.S. primary dealers5 projected to- quarter, 12.1 percent greater than 1Q’10’s $471.5 bil- tal net issuance of $399.0 billion for the upcoming lion and nearly 32 percent higher than 2Q’09’s $400.6 third quarter, compared with the net $343.6 billion is- billion average volume recorded. sued in the second quarter and $392.5 billion issued in 3Q’09. Economic Recovery Slowing; Fed Exit on Hold; Regulatory Reform Creates New Challenges The expected increase in total debt issuance projected for 3Q’10 may partly reflect increasing worries regard- The Federal Reserve began offering term deposits ing stagnant employment growth, a cooling economic through its Term Deposit Facility (TDF) in the second recovery, deflationary pressures, and the potential need quarter, through which certain institutions would earn for additional stimulatory measures by the U.S. gov- interest on such reserve balances held at the Fed. How- ernment. ever, sentiment has largely shifted from considering the potential implementation of exit strategies to waiting Total 2Q’10 net issuance of $343.6 billion was in-line and watching for signs of continued economic growth. with Treasury’s May marketable borrowing estimate of A number of key factors have led to increased econom- $340 billion. Cash management bills accounted for ic uncertainty: the unemployment rate still hovers near nearly 18 percent of total gross issuance in the second 10 percent;, the housing market has seen lulls in new quarter (as opposed to the approximate 7 percent in starts and actual deterioration in some instances; Euro- 1Q’10), which may be partly due to the increase in the pean sovereign debt worries have driven up market Supplementary Financing Program (SFP) from $5 bil- volatility and investor hesitation; and record-high defi- lion to $200 billion in late February of this year. Regu- cits. Previously incipient inflationary expectations, lar series bills, notes and bonds all fell as a percentage however, have begun to shift to deflationary concerns. of total gross issuance quarter-over-quarter (q/q). The 2-year Treasury yield was 0.61 percent at the end Treasury had also estimated an end-of-June cash bal- of the second quarter, down 41 basis points (bps) from ance of $280 billion (included $200 billion for the 1.02 percent at the end of 1Q’10. The 10-year Treasury SFP). Looking ahead, Treasury’s estimates for 3Q’10 yield fell 87 bps to 2.97 percent at the end of the include $376 billion in net issuance of marketable debt second quarter from end-1Q’10’s 3.84 percent. As a and an end-September cash balance of $270 billion result, the 2-year to 10-year yield spread narrowed by (including $200 billion for the SFP again). SIFMA’s 46 bps to 236 bps from 282 bps at end-1Q’10 . 1 Government Forecast survey forecast that Treasury 1 will finish the third quarter with a cash position of Survey respondents expected yields to rise and $272.5 billion (including the SFP increase). TIPS is- spreads to widen during the third quarter and remainder suance have continued to increase, from $18.4 billion of 2010. However, the increases predicted are from the in 1Q’10 (and $14.4 billion in 2Q’09) to $19.8 billion historically low levels reached during the second quar- for the second quarter this year. Treasury announced in ter. These lower yields were driven by a combination

SIFMA RESEARCH QUARTERLY its May refunding statement that it plans to increase the of factors such as European sovereign debt worries, frequency of TIPS auctions as well as decrease the siz- deterioration in some housing markets and stubbornly es of longer-term coupon auctions going forward. high unemployment rates, which contributed to rising demand for relatively safe-haven Treasury debt. Second quarter gross coupon issuance volume increased 12.8 percent year over year (y/y) from 2Q’09’s $533.3 billion, but declined 3.4 percent from 1Q’10’s $623.1 billion. Gross redemptions of coupons increased nearly 4 percent q/q and 21 percent y/y to $197.1 billion in 2Q’10. Gross issuance of T-bills fell 3.7 percent from $1.64 trillion in 2Q’09 to $1.58 trillion in 2Q’10, including cash management balances, but jumped more than 36 percent from 1Q’10’s $1.16 trillion. Gross issuance of CMBs alone jumped nearly 200 percent q/q. Gross redemptions of T-bills, however, also grew approximately 47 percent q/q to $1.6 trillion from 1Q’10’s $1.1 trillion. Daily trading volume of Treasury securities by the

5 SIFMA Government Forecast, July 29, 2010

Research Quarterly 2Q 2010 | Page 6

FEDERAL AGENCY DEBT MARKET

Average Daily Trading Volume of Federal Agency Securities1 Long-Term Federal Agency Debt Issuance1 2001 - 2010:Q2 2001 - 2010:Q2 120 $ Billions 1,400 $ Billions Coupons 1,200 100 Discount Notes

1,000 80

800 60 600 40 400

20 200

0 0 2009 2010 2009 2010

2001 2002 2003 2004 2005 2006 2007 2008 2009 Q2 YTD 2001 2002 2003 2004 2005 2006 2007 2008 2009 Q2 YTD

1 Excludes maturities of one year or less 1 * Beginning in 2004, Sallie Mae has been excluded due to privatization Primary dealer activity Sources: FHLB, FNMA, FHLMC, SLMA, TVA, FCS Sources: FRBNY

Agency LT Debt Issuance Continues to Drop; $860.8 billion as of the end of 2Q’10, of which $256.3 Treasury Report on GSEs in 2011 billion was short-term and $604.4 billion was long- term, compared to the $207.8 billion in LTD and Federal agency long-term debt (LTD) issuance was $576.3 billion in STD outstanding at the end of the first $232.7 billion in the second quarter, a decrease of near- quarter. ly 26 percent from the $313.8 billion issued in the Freddie Mac’s second quarter gross debt issuance to- same year-ago period. As of June 30, overall average taled $198.2 billion, a 23.4 percent drop from 1Q’10’s daily trading volume of agency securities (coupons and $258.8 billion gross issued. Total debt outstanding fell discount notes) by the primary dealers was approx- slightly to $809.3 billion at end-June from $833.4 bil- imately $70.7 billion for 2Q’10, a decrease of 15.9 per- lion at end-March. cent from end-2Q’09’s average daily trading volume of $84.1 billion. Total bond issuance by the Farm Credit System, the oldest GSE, which was created to fund loans to those Federal Home Loan Banks (FHLBs) second quarter in the farming and agricultural businesses, totaled bond issuance was $143.6 billion, 3.3 percent below $29.5 billion in the second quarter, 27.6 percent above 1Q’10’s $148.4 billion issued. Total FHLB bonds out- 1Q’10’s $23.1 billion in bonds issued. The Tennessee standing were $665 billion as of June 30, approximate- Valley Authority (TVA) filed their first quarter results ly 2.6 percent below the $682.7 billion outstanding at with the SEC as of April 30, in which it reported short- end-1Q’10. FHLB global debt issuance (bonds sepa- term debt outstanding of $2.2 billion and long-term 7 SIFMA RESEARCH QUARTERLY rately issued under the Global Debt Program, which debt outstanding of $20.8 billion . was initiated in 1994 to specifically target the foreign Primary dealers polled by SIFMA for the Government investor pool) totaled $69.3 billion, nearly 25 percent 8 lower than then $92.3 billion issued in 1Q’10. Total Forecast survey expected gross coupon issuance le- FHLB global debt outstanding at the end of the second vels by the four largest agencies to increase 41 percent quarter was $348.4 billion, little changed from the to $327 billion in 3Q’10 from the $232.1 billion rec- $342.3 billion outstanding at the end of 1Q’10. orded in 2Q’10.

The Dodd-Frank Act signed into law by the President on July 21 conspicuously avoided the topic of GSE reform, Treasury Deputy Secretary Neal Wolin in his Keynote Address at SIFMA’s July 15 2010 Regulatory Reform Summit” reported that Treasury will put out a report outline its proposals and recommendations early next year.6 Fannie Mae’s gross short-term debt (STD) issuance was $146.2 billion in the second quarter, while gross long-term debt (LTD) issuance was approximately $101 billion. Fannie Mae’s outstanding debt rested at

6 See http://events.sifma.org/2010/647/RegReform-highlights.html and 7 Second quarter TVA financial results have not been provided yet. http://www.treas.gov/press/releases/tg774.htm 8 SIFMA Government Forecast, July 29, 2010

Research Quarterly 2Q 2010 | Page 7

FUNDING AND MONEY MARKET INSTRUMENTS

Financing by U.S. Government Securities Dealers Outstanding Money Market Instruments Average Daily Amount Outstanding 2001 - 2010:Q2 2001 - 2010:Q2 4,500 $ Billions 8,000 $ Billions 4,000 7,000 Large Time Deposits Reverse Repurchases 3,500 6,000 Commercial Paper Repurchases 3,000 5,000

2,500 4,000

3,000 2,000

2,000 1,500

1,000 1,000

0 500 2009 2010 0 2001* 2002 2003 2004 2005 2006 2007 2008 2009 Q2 YTD 2001 2002 2003 2004 2005 2006 2007 2008 2009 2Q'10 *Beginning in July 2001 corporate securities are included Source: Federal Reserve Bank of NY Sources: Federal Reserve, SIFMA Estimates

T-Bill 3-Month, LIBOR 3-Month, and Overnight Indexed Swaps (OIS) 3-Month Daily Rates Jan. 2006 - June 2010 6.0 Percentage T-Bill 3-Month LIBOR 3-Month 5.0 OIS 3-Month

4.0

3.0

2.0

1.0

0.0 Jan-06 Jul-06 Feb-07 Sep-07 Mar-08 Oct-08 May-09 Dec-09 Jun-10 Sources: Federal Reserve, BBA, Bloomberg Total Repos and Reverse Repos Unchanged Y/Y; also published their final recommendations in the Spreads Widen second quarter for reforming the current tri-party repo infrastructure10. The average daily amount of total outstanding repur- chase (repo) and reverse repo agreement contracts was Money market rates overall rose through the second $4.51 trillion through the first half of this year, roughly quarter, and spreads widened. 3-month LIBOR rates unchanged from the average daily outstanding in the rose to 53.4 basis points (bps) at the end of the second same year-ago period. Daily average outstanding repo quarter from 29.2 bps at the end of 1Q’10. The over- SIFMA RESEARCH QUARTERLY transactions totaled $2.55 trillion year-to-date, down night indexed swaps (OIS) rate, a commonly used 4.2 percent from the $2.66 trillion recorded in the same measure of liquidity and stress, was unchanged quarter year-ago period, while reverse repo agreements aver- over quarter (20 bps at the end of 2Q’10), although it aged $1.96 trillion, up 4.9 percent from the $1.87 tril- rose up to 25 bps intra-quarter. The 3-month Treasury lion daily average outstanding during the same year- bill yield also picked up slightly, rising to 18 bps as of ago period. June 30from 16 bps at end-March. The Federal Reserve Bank of New York (FRBNY) The LIBOR-OIS 3-month spread, an important indica- began testing tri-party reverse repos in late 2009 in tor of liquidity and marketplace lending risk, jumped preparation for their potential use to drain extraordi- significantly to 33.2 bps at end-2Q’10from 8.9 bps at nary reserves from the U.S. banking system when it the end of 1Q’10. The spread between the 3-month T- may be deemed necessary. These repo data represent bill and LIBOR rate, or the TED spread, is another financing activities of the 18 primary dealers reporting measure for liquidity and credit risk in the marketplace, to the FRBNY and includes repos/reverse repos using and more specifically reflects how likely banks may U.S. government, federal agency, agency mortgage- default on loans. The spread also rose to 35.4 bps at the backed, and corporate securities as collateral9. FRBNY end of 2Q’10from 13.2 bps at the end of the first quarter, an indicator of worsening (or assumption for wor- 9 SIFMA Repo Factsheet. As of April 9, 2010, U.S. government securities sening) credit conditions as sovereign debt concerns accounted for approximately 30 percent of the most common collateral types, mortgage-backed securities account for nearly 40 percent, Federal agency and securities of the government sponsored enterprises (for example, Fannie Mae and Freddie Mac) approximately 17.1 percent, corporate 10 Final recommendations of the FRBNY Tri-Party Repo Infrastructure securities 6.7 percent, and other (including equities and money markets) Reform Task Force can be found at this link: account for 7 percent. http://www.newyorkfed.org/prc/report_100517.pdf.

Research Quarterly 2Q 2010 | Page 8

and a slowing recovery may have dragged on market confidence. Total CP Outstanding Continues to Decline The outstanding volume of total money market instruments (MMI), including commercial paper (CP) and large time deposits, totaled over $2.9 trillion as of the end of 2Q’10, 5.1 percent below the $3.08 trillion as of the end of 1Q’10 and 13.5 percent below year-ago vo- lumes. CP outstanding totaled approximately $1.04 trillion at the end of the second quarter, down 4.4 percent from end-1Q’10’s $1.09 trillion recorded and an over 15 percent decline from the outstanding volume for the same year-ago period. Financial CP outstanding declined 9.2 percent to $514 billion at the end of 2Q’10 from $566.2 billion at end-1Q’10. Non-financial CP outstanding rose for the second consecutive quarter to $115.6 billion at quarter end from $108.7 billion at end-1Q’10. SIFMA RESEARCH QUARTERLY

Research Quarterly 2Q 2010 | Page 9

MORTGAGE-RELATED SECURITIES

Issuance of Mortgage-Related Securities Issuance of Agency Mortgage-Backed Securities1 2002 - 2010:Q2 2001 - 2010:Q2 3500 $ Billions 2500 $ Billions Agency ‐ Other GNMA FNMA FHLMC 3000 Agency MBS/CMO 2000 Non‐Agency MBS 2500

1500 2000

1500 1000

1000 500 500

0 0 2009 2010 2009 2010

2001 2002 2003 2004 2005 2006 2007 2008 2009 Q2 YTD 2002 2003 2004 2005 2006 2007 2008 2009 Q2 YTD 1 Sources: Federal Agencies, Thomson Reuters Agency issuance of MBS & CMOs on net exposure. Sources: GNMA, FNMA, FHLMC Issuance of Non-Agency Mortgage-Backed Securities U.S. Non-Agency Securities Outstanding 2002 - 2010:Q2 2002 - 2010 800 $ Billions 3500 $ Billions

700 RMBS CMBS 3000 RMBS CMBS 600 2500 500

400 2000

300 1500

200 1000 100

500 0 2009 2010 0 2002 2003 2004 2005 2006 2007 2008 2009 Q2 YTD 2002 2003 2004 2005 2006 2007 2008 2009 2010 YTD Sources: Bloomberg, Thomson Reuters Sources: Loan Performance, Fitch Ratings, Moody's, S&P, SIFMA, Thomson Reuters Average Daily Trading Volume of Agency Mortgage-Backed New and Existing Home Sales, Seasonally Adjusted Securities2002 - 2010 Jun. 2006 - June. 2010 400 $ Billions 7.0 Units, Millions Units, Millions 1.2

350 6.0 1 300 5.0 250 0.8

200 4.0 0.6 150 3.0

SIFMA RESEARCH QUARTERLY 100 0.4 2.0 50 0.2 1.0 Existing Home Sales (left axis) 0 2009 2010 New Home Sales (right axis) 0.0 0 2002 2003 2004 2005 2006 2007 2008 2009 Q2 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Sources: Federal Reserve Bank of NY Sources: U.S. Census Bureau, National Association of Realtors Mortgage-Related Market tax credit, which expired in April. Similar to the uptick Issuance of mortgage-related securities, including in November 2009 (when the first homebuyer tax cre- agency- and non-agency pass throughs and collatera- dit was scheduled to expire), home sales experienced a lized mortgage obligations (CMOs), totaled $356.5 sharp drop after the expiry as sales were most likely billion in the second quarter of 2010, a decline of 8.4 “frontloaded” from existing expected sales. percent and 45.7 percent, respectively from 1Q’10 and Agency Issuance; Delisting; Tightened Standards 2Q’10. The relatively steep decline in issuance y-o-y in Agency mortgage-related issuance in 2Q’10, including the second quarter stems largely from the one-off is- FDIC securitized transactions, totaled $354.4 billion, suance of MBS collateralized by seasoned mortgages comprising 99.4 percent of all mortgage-related is- from agency portfolios in May and June of 2009, but, suance for the quarter. as in prior quarters, agency issuance continues to do- minate the market. The Federal Reserve, now one of the largest holders of agency MBS, began conducting coupon swaps in the New and existing home sales experienced a small up- end of June in order to facilitate the settlement of out- tick at the beginning of 2Q’10 as homebuyers rushed to standing unsettled trades. complete applications to qualify for the federal housing

Research Quarterly 2Q 2010 | Page 10

On June 16, both Fannie Mae and Freddie Mac notified es designed to provide synthetic exposure to the non- NYSE (as well as the Chicago Stock Exchange for agency RMBS market, previously only available in Fannie Mae) of their intent to delist their common and relatively liquid form for the subprime (ABX) and preferred stock listings.11 While the Dodd-Frank Act is CMBS (CMBX) markets.16 According to DTCC data silent on the future of the two agencies under conserva- at end-June, trading has been active for PrimeX in the torship, outside of a requirement for Treasury to study two months following launch, with more that 350 con- the issue and issue recommendations and a report to tracts based on the PrimeX.ARM indices and nearly Congress, it remains unlikely that the issue will be ad- 500 on PrimeX.FRM for gross notional amounts of dressed in the near-term. $4.8 billion and $9.1 billion respectively ($1.3 billion and $1.4 billion, respectively, on a net basis). At the end of April, Fannie Mae tightened its transaction standards for the purchase and securitization of Dodd-Frank Promises Further Changes to adjustable rate mortgages (ARMs), including interest Mortgage Space only (IOs) and balloon loans, in order to “protect con- The Dodd-Frank Act, passed shortly after the end of sumers from potentially dramatic payment increases the second quarter, mandated numerous studies and and to help ensure that borrowers who hold these types rule-makings relating to financial regulatory reform. of mortgages can sustain them beyond the initial inter- For the mortgage-related market, risk retention re- 12 est rate period.” The move echoes Freddie Mac’s quirements of upwards of 5 percent of credit risk (un- changes in 1Q’10, when they announced their plans to hedged) may be required, although certain carve outs cease purchasing IO-only mortgages after September 1, are available in the mortgage market for “qualified res- 13 2010. At the same time, the agency also announced idential mortgages.”17 increased penalties for strategic defaulters, imposing a seven-year lockout policy on eligibility for a Fannie Mae-backed mortgage loan.14 The FDIC issued $233 million of notes in a single structured securitized transaction through its Structured Sale Guarantee program in the 2nd quarter, comprised of commercial real estate, making the transaction its fourth structured note issuance in 2010.15 Non-Agency Issuance: Commercial, Residential Eleven CMBS deals totaling $3.3 billion were issued in 2Q’10; four were re-REMIC transactions and the balance conduit/fusion or other types of deals. Net issuance continues to remain negative, as approximately $769.1 billion remained outstanding in non-agency

SIFMA RESEARCH QUARTERLY CMBS end-June, a decline of 1.8 percent from 1Q’10 and 11.8 percent from the peak at 4Q’07. The TALF for new CMBS closed quietly at the end of 2Q’10, with the three second quarter auctions attracting no bids for financing. To date, the November 2009 TALF auction remained the only auction with bids for financing new CMBS. In the non-agency RMBS space, the first jumbo RMBS in two years closed at the end of April (Sequoia Mort- gage Trust 2010-H1, “Redwood”), but the market remained otherwise quiet. Notably, Markit launched its PrimeX indices at the end of April, a set of CDS indic-

11 Fannie Mae, Press Release, July 16, 2010, Fannie Mae Notifies NYSE and Chicago Stock Exchange of Intention to Delist ; Freddie Mac, Press Release, July 16, 2010, Freddie Mac Notifies NYSE of Intention to Delist 12 Fannie Mae, April 30, 2010. Fannie Mae Changes Criteria for Purchasing and Securitizing Adjustable-Rate Mortgages (ARMs) 13 Freddie Mac, February 25, 2010. Freddie Mac Announces That It Will Cease Purchases of Interest Only Mortgages 14 Fannie Mae, June 23, 2010, Fannie Mae Increases Penalties for Borrow- ers Who Walk Away 16 Markit PrimeX summary 15 FDIC, Press Release, May 24, 2010. FDIC Closes on Sale of $233 Million 17 For more information and detail, please see SIFMA's Dodd-Frank Infor- of Notes Backed by Commercial Real Estate Loans mation page.

Research Quarterly 2Q 2010 | Page 11

ASSET-BACKED SECURITIES AND CDO MARKET

Issuance of Asset-Backed Securities ABS Issuance by Major Types of Credit 2001 - 2010:Q2 2010:Q2 (YTD) Student Loans, 800 $ Billions $8.30B

700

600 Other, $6.59B

500

400 Manufactured Housing, $0.00B 300

200 Home Equity, $0.37B 100 Automobile, $33.75B 0 Equipment, $4.02B 2009 2010

2001 2002 2003 2004 2005 2006 2007 2008 2009 Q2 YTD Credit Card, $4.80B Source: Thomson Reuters, SIFMA Source: Thomson Reuters, SIFMA Charge-off Rates and Unemployment, SA Global CDO Issuance by Transaction Structure 2006:Q1 - 2010:Q1 2006:Q2 - 2010:Q2 12 Percentage 200 $ Billions

Consumer Loans ‐ All 180 Market Value 10 Consumer ‐ Credit Card Synthetic Funded Consumer ‐ Other 160 Cash Flow & Hybrid Consumer ‐ Leases 8 Unemployment 140

120 6 100

4 80

60 2 40

0 20 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 0 2006 2007 2008 2009 2010 06:Q2 06:Q4 07:Q2 07:Q4 08:Q2 08:Q4 09:Q2 09:Q4 10:Q2 Source: Thomson Reuters Sources: Federal Reserve, BLS

Asset-Backed Market & CDO issuance totaled $819.7 million in 2Q’10, a decline of Asset-backed securities issuance in the second quarter 65.4 percent and 56 percent, respectively, from 1Q’10 of 2010 totaled $57.8 billion, a decline of 21.3 percent and 2Q’09. Two cashflow deals were issued in the and 49.1 percent, respectively from 1Q’10 and 2Q’09. second quarter: one arbitrage deal comprised of high Second quarter issuance, similar to that in the first yield loans, the other a balance sheet deal comprised of quarter, was led by the auto sector ($13.1 billion, or other assets.

SIFMA RESEARCH QUARTERLY 51.1 percent of all issuance), followed by student loans Dodd-Frank Act, Regulation AB Changes ($3.6 billion), other ($3.4 billion), and credit cards The Dodd-Frank Act mandated numerous rule-making ($3.1 billion) procedures and studies relating to the asset-backed Tightened underwriting standards and improved finan- market. In particular, rules regarding risk retention, the cial conditions of issuers, particularly auto finance use of representations and warranties, credit rating companies, may ultimately benefit collateral perfor- agencies, and requirements for reporting, disclosure, mance, although the various new rules, proposed or to and registration are all heightened, which has played be implemented (e.g., FDIC safe harbor rules, SEC’s out to some extent shortly after the bill signing in the Reg AB proposals, the Dodd-Frank Act) will likely ABS primary market19,20. On May 3, the SEC issued a continue to hamper issuance for at least the remaining very significant and lengthy regulatory proposal that half of 2010. However, the performance of the underly- would amend fundamental aspects of Regulation AB, ing collateral in structured finance securities, however, Rule 144A as it relates to MBS and ABS, and many remains correlated to U.S. unemployment, however other securities regulations21. Certain of the provisions temporary or structural it may be, as high unemploy- contained in the Dodd-Frank Act, however, overlap ment generally means “depressed personal income, those in the SEC’s rule proposal, and it remains unclear reduced consumer spending, and, consequently, higher how these will be harmonized. consumer collateral delinquencies and losses.”18

Global funded collateralized debt obligation (CDO) 19 Bloomberg, July 23, 2010. “SEC Grants Six-Month Delay for Ratings Disclosure on Asset-Backed Bonds” 18 Standard and Poor’s, “Elevated Unemployment Remains a Concern for 20 SEC, July 22, 2010. Regulation AB, Item 1120 (no action letter) U.S. Structured Finance Collateral Performance”, April 29, 2010. 21 http://sec.gov/rules/proposed/2010/33-9117fr.pdf

Research Quarterly 2Q 2010 | Page 12

CORPORATE BOND MARKET

Corporate Bond Issuance1 U.S. Corporate Spreads to U.S. Treasury - 10 Year 2001 - 2010 Q2 Jun. 2007 - Jun. 2010 1,200 $ Billions 450 Basis Points High Yield 400 AAA 1,000 Investment Grade BBB+ 350 800 300 600 250

400 200

150 200

100 0 2009 2010 50

2001 2002 2003 2004 2005 2006 2007 2008 2009 Q2YTD 0 1 Includes all nonconvertible debt, MTNs Yankee bonds, and TLGP debt, but excludes all Jun-07 Oct-07 Feb-08 Jun-08 Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 issues with maturities of one year or less, CDs, and federal agency debt Source: Thomson Reuters Source: Bloomberg

U .S. C orporate : AAA Industrial - Yield Curves TRACE Average Daily Trading Volume Jun. 2007 - Jun. 2010 6 % Yield 20 $ Billions High Yield 18 Investment Grade 5 16

14 4

3 10

8 2 6

1 6/30/2009 4

6/30/2010 2 0 Years to Maturity 1234567891011121314151617181920 0 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Source: Bloomberg Source: FINRA

Corporate Bond Issuance Fell in 2Q’10; High tively, compared to 75 and 147 bps end-March and 101 Yield Issuance Soared and 268 bps end-June 2009. Total corporate bond issuance was $154.6 billion in Yields, however, for AAA- and BBB-rated corporate 2Q’10, a 29.3 percent decline from the $218.8 billion bonds continued to fall in 2Q’10, ending at 387 bps issued in 1Q’10, and a 36.5 percent decline from the and 456 bps, respectively, from 459 bps to 531 bps in SIFMA RESEARCH QUARTERLY $243.6 billion in 2Q’09. This decline was concentrated 1Q’10. Yields remain approximately 22 percent lower in investment grade (IG) bonds, which contracted by than the 5-year average for both AAA- and BBB-rated 43.3 percent y-o-y. Year-to-date, however, high yield corporates (490 and 588 bps, respectively). (HY) issuance has doubled compared to same period in 2009 and is on pace for a record breaking year as issu- Credit Metrics Improve Slightly ers took advantage of both low rates and open markets. According to S&P, year-to-date 42 issuers have de- faulted worldwide, 30 of which were from the U.S. According to the NASD’s TRACE data, IG average Distressed exchanges continued to remain one of the daily trading volume decreased to $10.3 billion end- primary reasons for default, with a third of all U.S. de- June from $12.4 billion in end-March and $14.1 billion faults stemming from distressed exchanges. end-June 2009. The HY average daily trading volume fell to $4.2 billion end-June, down from $5.9 billion Downgrades continued to slow slightly in 2Q’10, with end-March and $5.2 billion end-June 2009. the upgrade to downgrade ratio ending at 93/53 in 2Q’10, from 57/62 in 1Q’10. Downgrades by number Spreads Widen In 2Q’10; Yields Below 5- and dollar amount were from consumer-oriented sec- Year Average tors: media and entertainment (10 downgrades, $37.8 Spreads for AAA- and BBB-rated corporates continued billion), followed by retail/restaurants (5 downgrades, to tighten briefly in 2Q’10 until end-April (67 and 138 $22.7 billion). While the 12-month trailing HY default bps, respectively), and then widened due to eurozone rate has declined to 5.99 percent end-June from 9.99 sovereign debt concerns as investors sought safety in percent end-March, S&P noted that the continued Treasuries. Spreads for AAA- and BBB-rated corpo- overhang of leveraged corporate issuers could make rates ended wider at 90 and 159 bps end-June, respec- default risk beyond the one-year horizon increase.

Research Quarterly 2Q 2010 | Page 13

EQUITY AND OTHER MARKETS

Daily Closing Stock Prices NASDAQ and NYSE Average Daily Share Volume Jan. 2003 - Jun. 2010 2005:Q2 - 2010:Q2 3,000 6,000 Millions of Shares NASDAQ Composite S&P 500 NASDAQ NYSE 5,000 2,500

4,000 2,000

3,000

1,500 2,000

1,000 1,000

500 0 2003 2004 2005 2006 2007 2008 2009 2010 05:Q2 06:Q2 07:Q2 08:Q2 09:Q2 10:Q2 Sources: NASDAQ, S&P Sources: NASDAQ, NYSE NASDAQ & NYSE Average Daily Trading Volume NYSE Short Interest 2005:Q2 - 2010:Q2 Jun. 2005 - Jun. 2010 180 $ Billions 20 Billions of Shares NASDAQ 160 NYSE 18 140 16 120

14 100

80 12

60 10

40 8 20

6 0 2005 2006 2007 2008 2009 2010 05:Q2 06:Q2 07:Q2 08:Q2 09:Q2 10:Q2 Sources: NASDAQ, NYSE Source: NYSE

Equity markets fell in the 2Q’10 by an average of 11.2 Market Structure: Circuit Breaker Changes percent from their end-1Q’10 levels. Among the major On May 18, 2010 the U.S. Securities and Exchange indices, the Dow Jones Industrial Average (DJIA) fell Commission (SEC) released the preliminary results 10 percent in the quarter, with the NASDAQ declining from its study of the causes of the May 6 “Flash 12.1 percent and the S&P 500 falling 11.6 percent. Crash,” during which the equities and futures markets NYSE & NASD Daily Share Volume Up plunged five percent in a span of less than ten minutes.

SIFMA RESEARCH QUARTERLY In its report, the SEC alluded to several possible factors The New York Stock Exchange’s (NYSE) 2Q’10 aver- that could have caused the dip and quick recovery: a age daily share volume rose to 2.2 billion shares from lack of liquidity, the common use of “stub quotes,” the last quarter’s 1.7 billion shares, though still below the use of market orders and stop-loss market orders, a link 2.4 billion average daily share trading volume in between the decline of equity indices and the selling 2Q’09. The 2Q’10 increase is significant, however, off of individual securities.22 In response to the “Flash because it marks the return to the 2 billion plus share Crash,” the SEC and FINRA adopted a stock-by-stock level for the first time since 2Q’09. The NYSE’s aver- circuit breaker on June 10, which will temporarily stop age daily dollar trading volume increased to $57.7 bil- trading on any stock in the S&P 500 if its price moved lion from the previous quarter’s $45.5 billion, and was by 10 percent or more in a five minute period.23 On also above the 2Q’09 daily average of $50.0 billion. June 30, the SEC announced that it was also consider- NASDAQ’s average daily share trading volume in- ing expanding the rule to apply to all Russell 1000 increased to 2.5 billion shares in 2Q’10 from 2.3 billion dex securities and certain ETFs.24 shares in 1Q’10 and unchanged y-o-y. NASDAQ’s average daily dollar trading volume increased to $57.7 billion from last quarter’s $50.6 billion, and experienced a 36.7 percent improvement y-o-y. 22 Securities and Exchange Commission (SEC). Preliminary Findings Re- Short Interest Rises garding the Market Events of May 6, 2010, May 18, 2010. 23 Securities and Exchange Commission (SEC). Press Release: SEC Ap- NYSE short interest stood at 14.1 billion shares at the proves New Stock-by-Stock Circuit Breaker Rules. June 10, 2010. end of 2Q’10, a slight increase from last quarter’s 13.9 24 Securities and Exchange Commission (SEC). Press Release: SEC to Publish for Public Comment Proposed Rules Expanding Stock-by-Stock billion, but below 2Q’09’s close of 15.6 billion. Circuit Breakers. June 30, 2010.

Research Quarterly 2Q 2010 | Page 14

Total Equity Underwriting "True" IPO - Excluding Closed-End Funds 2005:Q2 - 2010:Q2 2005:Q2 - 2010:Q2 120 $ Billions # of Deals 350 20 $ Billions # of Deals 90 Volum e Volume ($ Billions) 18 80 300 Deals 100 Deals 16 70 250 14 80 60 12 200 50 60 10 150 40 8 40 30 100 6 20 4 20 50 2 10

0 0 0 0 05:Q2 06:Q2 07:Q2 08:Q2 09:Q2 10:Q2 05:Q2 06:Q2 07:Q2 08:Q2 09:Q2 10:Q2 Source: Thomson Reuters Source: Thomson Reuters Secondary Stock Offerings U.S. Mergers and Acquisitions Announced Deals 2005:Q2 - 2010:Q2 2005:Q2 - 2010:Q2 120 $ Billions # of Deals 300 600 $ Billions # of Deals 3,500 Volum e Volume Deals 3,000 100 Deals 250 500

2,500 80 200 400

2,000 60 150 300 1,500

40 100 200 1,000

20 50 100 500

0 0 0 0 05:Q2 06:Q2 07:Q2 08:Q2 09:Q2 10:Q2 05:Q2 06:Q2 07:Q2 08:Q2 09:Q2 10:Q2 Source: Thomson Reuters Source: Thomson Reuters Equity Underwriting was $191.4 million, up to from last quarter’s $136.3 Total equity underwriting rose slightly in 2Q’10 from million. Secondary issuances were down sharply from 1Q’10 in total volume ($47.9 billion up from $41.1 the 2Q’09’s $108.3 billion total on 256 deals, the high- billion), although it fell by number of deals (249 from est value of the decade. The 2Q’09 total, however, 274). Compared to the record setting issuance volume which resulted from massive capital raising campaigns in 2Q’09, however, total equity underwriting decreased by financial institutions as a result of the Supervisory significantly, down 58.8 percent in dollar volume, but Capital Assessment Program (SCAP), should be only 9 percent in deal number. viewed as an outlier; the decade’s quarterly average is $28.3 billion.

SIFMA RESEARCH QUARTERLY Equity underwriting still remained above the 5-year average in terms of both number of deals and dollar U.S. M&A Increases volume for the fifth consecutive quarter. Total number Announced U.S. mergers and acquisitions (M&A) dol- of deals beat the average by 27 percent while dollar lar volume increased 18 percent to $199.9 billion in volume was slightly above the 5-year average by 3 2Q’10 from $169.4 billion in 1Q’10. Deal volume, percent. however, decreased to 1,767 deals from 1,916 deals. IPO Market Uptick The most active M&A sectors were financials, tele- “True” initial public offerings (IPOs), which exclude phone-integrated, and oil exploration and production, closed-end fund IPOs, rose to $5.1 billion on 39 deals in size order. The largest deal was the acquisition of in 2Q’10 from $4.8 billion on 33 deals in 1Q’10. How- Qwest Communications International by CenturyLink ever, the average deal size again fell quarter-over- Inc for $22.2 billion.25 quarter, this period by 9.4 percent. The trend of significant year-over-year improvement continued, with 226 percent increase in deal value and a tripling in deal number compared to the same quarter last year. Secondary Offerings Also Rises Secondary market issuance increased in 2Q’10, totaling $38.1 billion, up 25 percent from $30.5 billion last quarter, although the number of deals fell to 199 from 224 last quarter. The average deal value for the quarter 25 Bloomberg. MAATUS Index. M&A Transaction Value US.

Research Quarterly 2Q 2010 | Page 15

S&P 500 P/E Ratio NASDAQ and NYSE Share Buybacks Jun. 2005 - Jun. 2010 2005:Q2 - 2010:Q2 24 160 $ Billions

NYSE 140 22 NASDAQ

120 20

100 18 80 16 60

14 40

12 20

10 0 2005 2006 2007 2008 2009 2010 05:Q2 06:Q2 07:Q2 08:Q2 09:Q2 10:Q2

Source: S&P Source: Dealogic

Venture Capital Investments in U.S. Companies SPX Volatility Index (VIX) Close 2005:Q2 - 2010:Q2 Jun. 2005 - Jun. 2010 9,000 $ Millions # of Deals 1,200 70

8,000 60 1,000 7,000

50 6,000 800

40 5,000 600 4,000 30

3,000 400 20 2,000 Investment Deals 200 10 1,000

0 0 0 2005 2006 2007 2008 2009 2010 05:Q2 06:Q2 07:Q2 08:Q2 09:Q2 10:Q2 Source: Chicago Board of Options Exchange Source: Pricewaterhouse/Venture Economics/NVCA MoneyTree Survey

P/E Ratio Falls Slightly age value over the first quarter was 26.25, higher than The S&P 500’s P/E ratio averaged 16.4 in 2Q’10, fall- the previous quarter’s average of 20.15. The VIX did ing 9 percent from the preceding quarter’s average of not come near its credit crisis high of 60.9, but still 18, and still below the inclusive 5-year average of 17. rose continuously for every month of the quarter. Vola- The 2Q’10 ratio is still higher than its 14.4 average a tility rose this past quarter, unsurprisingly, as investors year ago of in 2Q’09. The decline was partly a sign of confronted a sovereign debt crisis in Europe, rising apprehension among equity investors due to high vola- concerns over a double-dip recession in the US, an eq- tility and economic uncertainty throughout the second uity market “flash crash” in early May, and the final drafting and passage of financial reform regulation.

SIFMA RESEARCH QUARTERLY quarter, which drove prices lower. Higher earnings in the quarter put also a downward pressure on the ratio, Venture Capital on the Rise with earnings per share in the S&P 500 index 14 per- Venture capital investment increased significantly in cent higher than in 1Q’10. 2Q’10, bouncing back from a particularly weak first Buybacks Rise on NYSE, Fall on NASDAQ quarter. Total venture capital investments increased 34 The number of corporate share repurchases increased percent to $6.5 billion on 906 deals, the highest level on the NYSE to 112 deals totaling $78.3 billion in since 2Q’08. 2Q’10, compared to the 107 buybacks totaling $89.1 The software and biotechnology industries were the billion in 1Q’10. On the NASDAQ, the value of buy- largest and second largest industries, respectively, in backs substantially rose to $23.8 billion on 88 deals in venture capital investments. In 2Q’10 there were 229 2Q’10 from only $8.9 billion on 93 deals the previous deals in the software industry, generating slightly over quarter. Both NYSE and NASDAQ have seen marked $1.0 billion. The biotechnology industry and medical increases in stock repurchases over the last year, when device and equipment industry, which suffered last the lowest amount of activity in the decade was record- quarter from the uncertainty of the then looming ed in 2Q’09, with only 1 buyback on the NYSE and healthcare reform, recovered strongly in 2Q’10. Total none on the NASDAQ. venture capital investment in biotechnology increased CBOE VIX Rises Sharply 57 percent to $1.3 billion from $824 million last quar- The Chicago Board Options Exchange Index (VIX), a ter, while the medical device and equipment industry popular measure of market volatility, closed the quarter increased 46 percent to $755 million from $517 million at 34.54, nearly double the end-1Q’10 level. The aver- last quarter.

Research Quarterly 2Q 2010 | Page 16

DERIVATIVES

Notional Breakdown: Top 25 Financial Holding Companies27 Notional Breakdown: Top 25 Financial Holding Companies 2008:Q2 - 2010:Q1 2010:Q1 Options 350 $Trillions (Exchange- Traded), $11.21 Futures Futures (Exchange-Traded) Credit Options (Exchange-Traded) (Exchange- 300 Derivatives(OTC), Credit Derivatives(OTC) Traded), $6.64 $23.82 Forwards (OTC) 250 Options (OTC) Swaps (OTC)

200

Forwards (OTC), $45.97 150

Swaps 100 (OTC), $170.53

50 Options (OTC), $34.77 0 Q2:08 Q3:08 Q4:08 Q1:09 Q2:09 Q3:09 Q4:09 Q1:10

Source: OCC Quarterly Report Source: OCC Quarterly Report

Top 10 Sovereign Reference Entitites as of Aug 06, 2010 Top 10 Corporate Reference Entitites as of Aug 06, 2010

Country Gross Notional (USD EQ) Net Notional (USD EQ) Company Gross Notional (USD EQ) Net Notional (USD EQ)

1 Italy 236,318,006,131 23,276,925,939 1 GE Capital 91,633,147,457 10,962,587,240

2 Brazil 150,603,562,079 13,722,065,246 2 JPMorgan Chase 85,264,510,524 5,370,139,806

3 Turkey 142,482,613,203 6,146,955,124 3 Bank of America 80,051,644,112 5,960,243,785

4 Spain 112,794,758,251 14,738,325,793 4 Gazprom 71,985,251,381 3,147,461,604

5 Mexico 110,298,934,074 6,512,848,868 5 Morgan Stanley 70,986,086,793 5,325,157,562

6 Russia 99,842,358,611 3,987,995,386 6 Goldman Sachs 66,972,831,436 5,942,832,231

7 Germany 81,854,096,663 15,328,773,197 7 Deutsche Bank 66,940,802,150 5,713,758,245

8 Greece 79,348,095,588 7,035,401,937 8 Telecom Italia 65,787,911,296 2,743,905,499

9 Philippines 69,837,529,512 2,238,618,101 9 MBIA Insurance 65,092,387,355 5,903,315,080

10 Korea 68,459,594,661 3,529,022,010 10 France Telecom 64,725,535,785 2,563,947,645 Derivatives in the Second Quarter26 2008 to 2009 by $300 billion as the value of other cre- Derivatives gross notional outstanding at the top 25 dit derivatives (credit default index and tranche) fell.28 U.S. financial holding companies remained unchanged The increase in single name CDS contracts and the in 1Q’10 at $293.0 trillion; the five largest financial gross notional value of outstanding single name CDS is holding companies accounted for slightly over 95 per- due in part to debt concerns of eurozone sovereigns: cent of that total. On a y-o-y basis, gross notional out- gross notional outstanding for sovereign single name standing has remained virtually unchanged, increasing CDS increased over 1Q’10 in absolute terms, as well as slightly from $291.5 trillion in 1Q’09.27 relative to total gross notional outstanding for CDS.

SIFMA RESEARCH QUARTERLY Notional Value Breakdown Dodd-Frank Act Derivatives Impact Interest rate swaps continue to be the largest derivative The recently signed Dodd-Frank Act contains many category, at $170.7 trillion or 58 percent of all deriva- provisions impacting the derivatives markets. Although tives on a gross notional basis, while forwards, options, the specific application of the derivatives section of the futures, and credit derivatives making up significantly Dodd-Frank Act has been left mainly to the SEC and smaller subsets. Interest rate and foreign exchange (fo- CFTC, there are a number of provisions that are ex- rex) swaps have recently taken a larger share since pected to have profound impacts on these markets.29 lows at the end of 2008, while credit and equity-linked This section was written by William Beshears and Jo- swaps have shrunk in relative proportion. nathan White. Credit Derivatives In the wake of the financial crisis, the credit derivatives market experienced a steep downturn in the gross notional outstanding of credit default indices and a no- minal decrease in the gross notional value of credit default tranches. However, the gross notional outstanding of single name credit defaults swaps (CDS) rose from

26 This quarter marks the introduction of a derivatives section in the SIFMA Research Quarterly. Statistics and commentary will be added over the coming quarter. 27 The jump in outstanding amounts between 2008 and 2009 is primarily 28 DTCC Derivatives CDS Warehouse due to the four major broker-dealers converting or consolidating into bank- 29 Please see SIFMA's regulatory actions database for a list of derivatives- holding companies. related regulatory actions (category “Derivatives”).

Research Quarterly 2Q 2010 | Page 17

PRIMARY LOAN MARKET

Primary Loan Market: Second Quarter Re- Primary Investment Grade Loan Market Volume 30 2008:Q2 - 2010:Q2 view 700 $ Billions 45% 40% Primary loan market volume reached a total of $1.26 600 35% trillion during the first half of 2010, up 36 percent 500 30% compared to the $976.1 billion raised during first half 400 25% of 2009. Much of this growth took place during the 300 20%

second quarter with volume having climbed 52 percent 15% 200 to $723.3 billion from $476.9 billion in 2Q’09. 10% Volum e 100 Though a long way from its pre-credit crisis high, leve- Refinancing % (right axis) 5% 0 0% raged loans recorded their third consecutive quarterly 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q increase in 2Q’10 ($178.6bn). Companies looking to 2008 2009 2010 refinance their pre-existing debt accounted for 42 per- Source: Dealogic cent ($74.5 billion) of leveraged loan volume, the highest proportion on record. Eight out of the 10 largest sectors by leveraged refinancing volume saw in- Bank and financial borrowers continued their re- creases of at least 29 percent versus 2Q’09 levels. The entrance into the credit markets having taken out a total oil & gas sector led the way having captured 13 percent $99.2 billion in syndicated loans in 2Q’10. It was the of all leverage refinancing in 2Q’10, up substantially fourth straight quarterly increase which began in from only 3 percent in 1Q’10. 2Q’09, at which time volume stood at $33.8 billion. Corporate borrowing also saw substantial expansion Primary Leveraged Loan Market Volume 2008:Q2 - 2010:Q2 during this same period, up 45 percent to $602.8 billion 300 $ Billions 45% from $415.8 billion. 40% 250 35% Outstanding Syndicated Loan Volume 2010 200 30% 1,000 $ Billions

25% 900 2nd Half 150 1st Half 20% 800

100 15% 700

10% 600 50 Volum e 500 Refinancing % (right axis) 5%

0 0% 400 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 300 2008 2009 2010 200 Source: Dealogic 100 SIFMA RESEARCH QUARTERLY Refinancing facilities also played a vital role in the in- 0 2010 2011 2012 2013 2014

vestment grade market with volume having reached Source: Dealogic $232.2 billion in 2Q’10, up 282 percent from just $60.7 billion in 2Q’09. This marked the second highest Pricing on syndicated facilities continued to inch its quarterly volume on record and accounted for 43 per- way lower with leveraged loans averaging 394 bps in cent of total investment grade loan volume. This ad- 2Q’10, down from 416 bps in 1Q’10. It was the first vance however was not seen in all parts of the globe. time margins on leveraged loans fell below the 400 bps Europe and North America for example saw volume mark since 4Q’08 (339 bps). Investment grade pricing rise 188 percent and 275 percent respectively, while also fell to 184 bps from 203bps during this same pe- Japan’s investment grade refinancing loan volume fell riod. 78 percent to $1.9 billion, the lowest level recorded As of the end of 2Q’10, and excluding revolver facili- since 2002. ties, there is an expected $362.5 billion in syndicated primary market loans due to mature by the end of this year and $829.3 billion due to mature by the end of 2011. Volume for maturing loans is expected to hit a peak level of $934.6 billion in 2013.

30 The author of the Primary Loan discussion is Anthony Castillo, Dealogic. For any questions, please email [email protected].

Research Quarterly 2Q 2010 | Page 18

SIFMA RESEARCH Kyle Brandon Managing Director, Director of Research [email protected]

RESEARCH Charles Bartlett Vice President and Director, Statistics [email protected]

Sharon Sung – Research Analyst [email protected]

Maria Victoria Barba – Research Analyst [email protected]

CAPITAL MARKETS X. Lily Hao - Analyst [email protected]

Jeremy Simon – Analyst [email protected]

INTERNS William Beshears – Research Matthew Restaino – Capital Markets Scott Roth – Capital Markets Jonathan White – Research

SIFMA RESEARCH QUARTERLY The Securities Industry and Financial Markets Association (SIFMA) prepared this material for informational purposes only. SIFMA obtained this information from multiple sources believed to be reliable as of the date of publication; SIFMA, however, makes no representations as to the accuracy or completeness of such third party information. SIFMA has no obligation to update, modify or amend this information or to otherwise noti- fy a reader thereof in the event that any such information becomes outdated, inaccurate, or incomplete.

The Securities Industry and Financial Markets Association (SIFMA) brings together the shared in- terests of hundreds of securities firms, banks and asset managers. SIFMA's mission is to support a strong financial industry, investor opportunity, capital formation, job creation and economic growth, while building trust and confidence in the financial markets. SIFMA, with offices in New York and Washington, D.C., is the U.S. regional member of the Global Financial Markets Associ- ation (GFMA). For more information, visit www.sifma.org.

Research Quarterly 2Q 2010 | Page 19