Barcap US Credit Alpha - 13 Aug 2010

CREDIT RESEARCH U.S. Credit Alpha | 13 August 2010

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 31

U.S. CREDIT ALPHA Fatter Tails

Overview ..................................................................................................................................... 2

Risky assets took a hit this week as concerns about macroeconomic fundamentals continued to mount. We interpret this week’s sell-off and Fed comments as indicative of widespread acceptance that the recovery has stalled somewhat; indeed, several forecasters, including Barclays Capital, have revised downward their predictions for 3Q growth. Given the tight levels of many non-financial sectors compared with pre-crisis tights, we believe there are opportunities to create tail risk hedges against the possibility that growth will slow enough to have a meaningful effect on credit.

Focus: Supply Side Performance Boost in 2010 .................................................................. 4

New issues have outperformed the U.S. High Yield Very Liquid Index by a par-weighted average of 1.57% so far in 2010. Slightly more than half of this outperformance occurs on the first day of post-break trading. BB and B rated new issues have outperformed their respective quality benchmarks significantly, while CCC and lower rated issues have underperformed on average. We encourage investors to pay particular attention to any new issue that offers a yield concession at the upper end of the 25-50bp range.

Investment Grade: Putting on Your (Cyclical) Shorts....................................................... 16

Given the uncertain macroeconomic environment, highlighted by Tuesday’s Fed announcement and continuing lackluster economic data, investors who are looking to decrease exposure to risky assets and/or hedge against the tail risk of a double dip can get short certain cyclical sectors. We highlight the technology, transportation services, pipelines, and metals sectors as potential cyclical shorts.

High Yield: Toggles Get PIK’ed Off ....................................................................................... 21

The number of issuers still exercising the PIK option on their toggle notes is dwindling. With the primary market open and significant amounts of liquidity on high yield balance sheets, issuers appear comfortable with their ability to access capital markets if needed.

Leveraged Loans & CLOs: Take Out..................................................................................... 24

Issuers continue to take advantage of the stability in earnings to opportunistically access the primary markets, extend loan maturities, and get covenant relief. In our view, even in the absence of primary CLO issuance, higher quality companies should be able to repay, refinance, and amend and extend their maturities within the confines of the loan and bond markets, provided they remain open to new deals and amenable to extensions.

Options & Tranches: Selling the Tails .................................................................................. 28

Investors looking for a low-cost macro tail hedge should consider buying IG9 7y 10-15% tranche protection and offsetting some of the cost by selling an equal notional of IG9 10y 15-30% tranche protection.

Jeffrey Meli

+1 212 412 2127

[email protected]

Bradley Rogoff, CFA

+1 212 412 7921

[email protected]

Michael Anderson, CFA

+1 212 412 7936

[email protected]

www.barcap.com

Barclays Capital | U.S. Credit Alpha

13 August 2010 2

OVERVIEW

Fatter Tails Risky assets took a hit this week as concerns about macroeconomic fundamentals continued to mount. As of midday on Thursday, IG14 was 7bp wider on the week, trading just above 111bp. HY14 was down about 1.25pt since last Friday, trading around 97. As expected in a week with sharp moves, the cash indices outperformed the weakness in CDS. The U.S. Credit Index was 3bp wider, although we expect it to catch up over the next few trading sessions. Equities were similarly weak. The S&P500 has dropped 3.4% since last Friday. Although the day-to-day correlations between stocks and CDS were choppy (equities outperformed early in the week and then underperformed on Wednesday and Thursday following the Fed announcement), the weekly moves are in line with the relationship we have seen over the past several months. With a beta of 10%, a 7bp move in the IG14 index should correspond to a 3.2% drop in stocks, meaning that on a week-to-week basis the relationship between the two markets has been stable for some time.

Obviously, the major event in the market this week was the announcement by the Federal Reserve that it will reinvest the proceeds from prepayments of its mortgage portfolio in 2-10y Treasuries. Originally, the Fed planned to allow the portfolio to run down. Importantly, this does not represent new stimulus, but rather maintains a neutral stance whereby existing stimulus will not be withdrawn. Although the initial reaction was positive, with the stock market reversing some of its early losses on Tuesday, the markets clearly faded later in the week. The higher-than-expected jobless claims number on Thursday morning further exacerbated macroeconomic concerns – claims climbed to their highest level in five months.

There are several positive takeaways from the Fed announcement. First, it shows that the central bank is willing to adjust policy further in response to macro developments, which should be reassuring for investors who believe the economy will continue to deteriorate. Second, regarding credit in particular, this announcement is likely to keep Treasury rates and, thus, all-in yields across fixed income at lower levels. Indeed, rates were lower in

Figure 1: Weekly Index Changes

Figure 2: Fixed-Rate Weekly Issuance ($bn)

Wednesday

Close

Last Week Close

4-Week Avg

Credit Index (bp) 162 159 162

CDX.IG.14 (bp) 109.5 104.0 105.5

High Yield Index ($ price) 98.56 98.96 98.34

CDX.HY.14 ($ price) 97.25 98.00 97.53

Leveraged Loan Index ($ price) 90.61 90.57 90.21

LCDX.14 ($ price) 96.26 97.00 96.48

0

5

10

15

20

25

30

35

2-Jul 9-Jul 16-Jul 23-Jul 30-Jul 6-Aug 12-Aug

HY IG

Source: Barclays Capital Note: Supply numbers for week of August 12 are as of Wednesday close. Source: Barclays Capital

Jeffrey Meli +1 212 412 2127

[email protected]

Bradley Rogoff, CFA +1 212 412 7921

[email protected]


13 August 2010 3

response to the news. So long as growth remains somewhat positive, even if at low levels, and corporate fundamentals thus remain strong, we believe this would create a positive technical backdrop for spread product in general and credit in particular. We expect that this is true as far down the credit spectrum as BBs – the fundamentals of lower rated credits could suffer if growth slows markedly for an extended period.

These are longer-term issues, and they underpin our more constructive medium-term base case regarding the higher-rated parts of the market. However, the Fed announcement also highlights how much the recovery has faded and signals that policy makers believe that the steps taken to date (such as 0% interest rates) are not working as expected and that additional measures may be needed. We interpret the sell-off this week as indicative of widespread acceptance that the recovery has stalled somewhat; indeed, several forecasters, including Barclays Capital, have revised downward their predictions for 3Q growth.

Given the tight levels of many non-financial sectors compared with pre-crisis tights, we believe there are opportunities to create tail risk hedges against the possibility that growth will slow enough to have a meaningful effect on credit. In the Investment Grade section, we discuss specific cyclical sectors and single-name credits that are trading at relatively tight spreads and continue to exhibit high betas versus the rest of the market. In the Tranches and Options section, we compare several hedging strategies using index products.

Finally, despite the poor performance this week, the new issue market remained robust in both investment grade and high yield (Figure 2). More than $13bn of investment grade debt priced through Wednesday, resulting in over $45bn in issuance month-to-date. This was the largest week on record for high yield, with more than $12bn of supply, not including the $3.9bn from ILFC (which is a 5B credit). Most of the high yield issuance has been BB and B.

We examine high yield supply in more detail in this week’s focus article. New issues have outperformed the U.S. High Yield Very Liquid Index by a par-weighted average of 1.57% so far in 2010. Slightly more than half of this outperformance occurs on the first day of post-break trading. However, performance dynamics have not been uniformly distributed, as BB and B rated new issues have outperformed their respective quality benchmarks significantly, while CCC and lower rated issues have underperformed on average. New issue concessions have generally been 25-50bp. We encourage investors to consider any new issue that offers a yield concession at the upper end of this range as a potential source of significant outperformance.


13 August 2010 4

FOCUS

Supply Side Performance Boost in 2010 New issues have outperformed the U.S. High Yield Very Liquid Index by a par-weighted average of 1.57% so far in 2010. Slightly more than half of this outperformance occurs on the first day of post-break trading. However, performance dynamics have not been uniformly distributed, as BB and B rated new issues have outperformed their respective quality benchmarks significantly, while CCC and lower rated issues have underperformed on average. New issue concessions have generally been 25-50bp. We encourage investors to consider any new issue offering a yield concession at the upper end of this range as a potential source of significant outperformance.

Activity in the high yield primary market has waxed and waned in 2010, largely in response to secondary market fluctuations (Figure 1). New issuance was strong in the first four months of the year as spreads continued to tighten from 2009 levels. However, the May sell-off sent issuers to the sidelines, resulting in a 10-week period from early May to mid-July during which gross supply averaged only $1.6bn per week and net supply was negative. The July rally brought issuers and investors back to the table, with volumes increasing sequentially in each of the past four weeks (Figure 2). Despite the influx of new supply, recent deals have generally continued to price on the tight side of talk, often upsizing and trading solidly on the break.

In several important ways, the new issue market has continued to follow trends that were established in 2009, including the following:

After many years of supporting the credit-fueled M&A and LBO boom, the primary market has turned overwhelmingly toward refinancing as the primary use of proceeds. Bonds issued to repay outstanding debt have accounted for 61.2% of all issuance year-to-date, compared with 17.7% for strategic use and 16.7% for general corporate purposes (Figure 3). While in recent weeks there has been an uptick in bond deals used to fund shareholder distributions, such deals account for only 3.6% of 2010 issuance thus far.

Michael Kessler +1 212 412 3031

[email protected]


[email protected]

Michael Anderson, CFA +1 212 412 7936

[email protected]

Eric Gross +1 212 412 7997

[email protected]

Figure 1: U.S. High Yield Very Liquid Index YTD Total Return Figure 2: 2010 U.S. High Yield Gross Issuance

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

4-Jan 16-Feb 31-Mar 13-May 25-Jun 7-Aug

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

8-Jan 19-Feb 2-Apr 14-May 25-Jun 6-Aug

$bn

Source: Barclays Capital Source: Barclays Capital


13 August 2010 5

After having comprised no more than 19.7% of high yield issuance in any year for the past two decades, secured bonds shot up to 39.7% of the total in 2009. That trend has persisted in 2010, as secured debt represents 32.1% of high yield issuance thus far. Much of the increase in secured debt as a percentage of the total can be traced to the loan market. After accounting for less than a third of the leveraged loan refinancing market during the last few years of the credit boom, the high yield market absorbed substantially all loan refinancings in 2009 and has accounted for nearly two-thirds in 2010 (Figure 4). Roughly half of all bonds issued to take out loans in 2009 and 2010 have been secured. As a result, secured debt now represents 22% of all high yield debt outstanding, after averaging around 10% of the outstanding total from 2005 to 2008.

Not surprisingly, the proportion of the new issue market rated CCC or lower declined as a result of the financial crisis, from a peak of 25.2% in 2007 to 10.2% in 2009. That figure has rebounded slightly, to 13.0%, thus far in 2010. Importantly, the trough for this cycle (so far) is nowhere near the lows reached in 2001 and 2002, when barely more than 3% of all high yield issuance carried a CCC rating.

Early July brought a period of relative strength in the high yield secondary market, seemingly whetting investor appetite for new issuance. However, most issuers remained on the sidelines as earnings season approached and yields remained above the April lows. The resulting supply/demand imbalance led to a period of outstanding deal performance, with numerous upsized issues and strong post-break trading. The price mechanism ensures that such imbalances do not last long in the marketplace, and as we have been expecting for several weeks, issuers are now stepping forward in droves, despite what would normally be a seasonally quiet period in August. With a robust deal calendar that only seems to grow larger by the day, this is an opportune time to examine what set of factors best explains new issue performance in 2010.

Figure 3: Annual High Yield Issuance by Use of Proceeds Figure 4: Sources of Loan Refinancing

0%10%20%30%40%50%

60%70%80%90%

100%

2002 2003 2004 2005 2006 2007 2008 2009 2010

M&A / LBO Refinancing GCP/CAPEX Other

0

20

40

60

80

2005 2006 2007 2008 2009 2010

$bn Unsecured BondsSecured BondsLoans

Note: Refinancing includes bond and loan takeouts funded by high yield issuance. Source: Barclays Capital Leveraged Finance Syndicate

Sources: S&P LCD, Barclays Capital


13 August 2010 6

High Yield New Issue Performance

New Issue Concession It is not surprising that new issues often outperform the broader market over the remainder of the year in which they are issued. Deals generally price with a new issue concession, as issuers who are tapping the market for the first time must compensate investors for their unfamiliarity, while repeat issuers offer new debt at a discount to existing bonds with comparable maturities to ensure adequate participation. This new issue concession has recently been 25-50bp. We encourage investors to consider the new issue concession in the context of the +1.57% average new issue outperformance thus far in 2010. A typical 8y maturity with a 4y non-call provision will usually have an option-adjusted duration of 5-6 years. A new issue yield concession of 25bp realized annually over 5-6 years should result in 1.25-1.50% of outperformance relative to a comparable existing bond. Given that new issues have outperformed by an average of 1.57% thus far in 2010, it appears that investors are capturing substantially all of the lifetime value of the new issue concession within the first year following issuance. When such concessions begin to creep closer to 50bp with the same duration expectation, an investor is likely to have above-average outperformance in year one and beyond.

For example, Goodyear Tire & Rubber recently placed $900mn of 8.25% senior notes due in 2020. The issue priced at 99.163 for an 8.375% YTW, despite an existing issue of the same maturity with weaker covenants trading at a yield of 7.56%. With a duration of about 7, the new issue concession of ~80bp should lead to substantial outperformance over time.

Potential Performance Drivers We break down new issue outperformance in two ways in an attempt to find the specific set of factors that best explain it. First, we note that approximately half of new issue outperformance occurs on the very first day of trading. Relative to the U.S. High Yield Very Liquid Index (VLI),1 2010 new issues have outperformed on a par-weighted basis by 0.84% on Day 1 and 1.57% year-to-date. Second, we consider two broad sets of factors that may influence new issue performance over one-day and year-to-date horizons. The first set of potential drivers can be summarized as market based, including:

Overall secondary market strength on the day of issuance.

Amount of high yield supply during the week of issuance.

Fund flows into or out of high yield mutual funds immediately prior to issuance.

The second set is deal-specific and includes the following:

Credit rating.

Use of proceeds.

Seasoned versus first-time issuer.

Registered bonds versus 144a-for-life issues.

Secured versus unsecured.

1 We use the VLI as a proxy for market performance, because new issues are very liquid and tend to trade actively in the months immediately following issuance. The VLI is therefore a better benchmark than the full U.S. High Yield Index.


13 August 2010 7

Level of original issuer discount.

Transaction type: road show, drive-by, private placement, or add-on.

First Day Performance The two factors that are the strongest drivers of first day new issue performance in 2010 have been the credit rating of the issuer and the overall secondary market tone on the date of issuance. Higher-rated issues have consistently found a strong opening bid regardless of overall market tone, as they have not only outperformed the VLI in post-break trading, but more importantly have also outperformed their respective quality subcomponents (Figure 5).

Figure 5: First Day Trading Relative Performance by Credit Rating

Credit Rating vs. VLI vs. Quality Std Dev of

Rtns Par Amt

($bn) % of Ttl

Issuance

BB +1.05% +1.08% 1.20% 41.2 33.4%

B +0.83% +0.83% 1.02% 63.6 51.5%

CCC +0.44% +0.42% 1.37% 17.9 14.5%

CC +0.00% +0.00% n/a 0.8 0.6%

Totals +0.84% +0.85% 1.24% 123.5 100.0%

Source: Barclays Capital

It is no surprise that new issues tend to perform better in absolute terms on Day 1 if they are fortunate enough to catch the market on a strong day. What is less immediately intuitive is that they have outperformed strong markets to a greater extent than new issues that come to market on weak trading days. As Figure 6 demonstrates, bonds issued on strong or very strong days have outperformed their respective quality indices by more than 1% on the first day of trading. Bonds issued into weak and very weak markets have still outperformed on Day 1, but to a significantly lesser degree.2

Figure 6: First Day Trading Relative Performance by Secondary Market Tone

Issue Date Market Tone vs. VLI vs. Quality Std Dev of

Rtns Par Amt

($bn) % of Ttl

Issuance

Very Strong +0.92% +1.04% 1.51% 28.5 23.1%

Strong +0.93% +0.97% 1.10% 53.7 43.5%

Weak +0.76% +0.70% 1.02% 31.0 25.1%

Very Weak +0.37% +0.20% 1.28% 10.3 8.3%

Totals +0.84% +0.85% 1.24% 115.8 100.0%


Several other factors appear to moderately influence first day relative performance, although in many cases the relationship is less systematic or consistent. High yield mutual fund flows appear to have little influence, except when the most recent weekly outflow has been greater than $250mn. Drive-by offerings have tended to have weaker first day performance than road shows, which is unsurprising given the divergent nature of the marketing and pricing surrounding these deal types. Finally, issuers offering a significant OID, in the 96/97 range, have generally had their deals trade up significantly on the break, implying perhaps a bit too much value left on the table. Sample size is relatively small at 2 For the purpose of this analysis, we define very strong secondary markets as having a daily total return of greater than 0.25%, strong markets as having a return of 0-0.25%, weak markets as those with a return between -0.25% and 0%, and very weak markets as those with a daily total return lower than -0.25%.


13 August 2010 8

these discount levels, however, so the result may reflect idiosyncratic, rather than systematic, issues. See Figure 13 in the Technical Appendix for a full data table, including Day 1 absolute and relative performance across all factors.

Isolating Day 1 Performance Effects – Multivariate Regression Results Intuitively, a high level of mutual fund inflows should create excess cash that investors must put to work. Similarly, a low level of new high yield issuance should theoretically create a constrained supply environment. One might expect either of these two factors in isolation to affect post-break trading performance positively. Certainly, both of them in combination would be expected to do so. However, we have already seen that the single most dominant factor in determining Day 1 new issue performance is the strength of the overall secondary market. Given that high yield index returns tend to be positively correlated with mutual fund flows and new issue supply (the direction of causation is debatable), we thought it wise to control for returns when determining if fund flows or supply have significant explanatory power. We therefore ran a series of multivariate regressions using Day 1 new issue absolute performance as the dependent variable and the following independent variables:

Day 1 VLI Index total return

High yield mutual fund flows in the week prior to issuance

Total high yield supply brought to market during the week of issuance.

Our baseline clearly demonstrates that secondary market strength, as reflected in the Day 1 VLI Index total return, is a statistically significant driver of new issue trading performance on the issue date. The t-stat on the slope coefficient in the regression in Figure 7 is 4.23.

Figure 7: New Issue Day 1 Absolute Performance vs. VLI Index Daily Total Return

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

-1.5% -1.0% -0.5% 0.0% 0.5% 1.0%

y = 1.1059x + 0.0081R^2 = 0.0708


Adding high yield mutual fund flows and total supply as additional independent variables, either alone or in combination, does not add significant explanatory power to the regression results. In fact, as Figure 8 demonstrates, adding these variables actually reduces the adjusted R-squared, and none of the added coefficients is significant beyond an 80% confidence level in any of the regression results. We therefore conclude that the effects of constrained supply or strong mutual fund inflows are already reflected in secondary market performance and do not need to be considered separately as performance drivers.


13 August 2010 9

Figure 8. Multivariate Regressions Using Day 1 VLI, Supply, and Fund Flows

Day 1 VLI and Supply Day 1 VLI and Fund Flows Day 1 VLI, Supply, and Fund Flows

Day 1 VLI Supply Intercept Day 1 VLI Flows Intercept Day 1 VLI Supply Flows Intercept

Coeff 1.086 0.000 0.007 1.046 0.000 0.008 1.044 0.000 0.000 0.007

Std Err 0.263 0.000 0.002 0.265 0.000 0.001 0.266 0.000 0.000 0.002

T-stat 4.132 0.761 3.375 3.947 1.285 8.185 3.930 0.251 1.062 3.506

P-Value 0.000 0.448 0.001 0.000 0.200 0.000 0.000 0.802 0.289 0.001

Adj R^2 0.065 0.069 0.066


Year-to-Date Performance Breakdown Credit rating continues to play a dominant role in explaining new issue relative performance when the time horizon is expanded beyond the first day of trading, although the relationship has been less linear. Generally speaking, BB and B rated issues have continued to outperform both the VLI and their respective quality indices as the issue date fades into the past, while CCC and lower-rated paper has underperformed (Figure 9). Under normal circumstances, we would expect CCC new issuance to outperform the broader CCC market due to selection bias, as only the best CCC rated companies can access the primary market at all. However, CCC new issue performance in 2010 has varied significantly from credit to credit, as investors have become concerned about the slower pace of U.S. growth in the second half. New issues from CCC rated credits including Beazer Homes, ATP Oil & Gas, Maxim Crane Works, Radnet, Sitel, Catalyst Paper, and NewPage Corp have all underperformed the VLI by 5% or more (with several significantly into double-digit territory), bringing down the average considerably. This performance dispersion is evident in the standard deviation of returns, which is much higher for lower-rated 2010 new issues.

Figure 9: Year-to-Date Relative Performance by Credit Rating

Credit Rating vs. VLI vs. Quality Std Dev of

Rtns Par Amt

($bn) % of Ttl

Issuance

BB +2.31% +1.50% 4.20% 41.2 33.4%

B +1.93% +2.08% 3.94% 63.6 51.5%

CCC -1.29% +0.02% 7.82% 17.9 14.5%

CC -1.33% -1.32% n/a 0.8 0.6%

Totals +1.57% +1.57% 4.95% 123.5 100.0%


Secondary market tone, whether on a day-of-issuance or trailing 5-day basis, appears to have less bearing on longer-term relative performance than on first day trading. But a factor that has clearly affected year-to-date relative performance in 2010 is the use of proceeds (Figure 10). Bonds issued in support of M&A, LBOs, and shareholder distributions (the three most aggressive transaction types) are the three best performers relative to the quality indices. It is important to note, however, that these represent only about 21.5% of the 2010 calendar. We believe refinancing will continue to be the most common use of proceeds through year-end and that investors who participate in more aggressive deal types will continue to require disproportionate compensation for doing so.


13 August 2010 10

Figure 10: Year-to-Date Relative Performance by Use of Proceeds

Use of Proceeds vs. VLI vs. Quality Std Dev of

Rtns Par Amt

($bn) % of Ttl

Issuance

M&A 4.65% 4.50% 4.10% 17,207 13.93%

LBO 1.93% 2.76% 3.15% 4,680 3.79%

Refinance Bonds 1.52% 1.35% 4.93% 27,605 22.34%

Refinance Loans 0.25% 0.50% 5.41% 36,733 29.73%

Refinance Both 1.35% 1.43% 4.44% 11,295 9.14%

Shareholder Dist 1.99% 2.06% 3.02% 4,485 3.63%

GCP 1.39% 1.06% 5.34% 20,635 16.70%

Totals +1.57% +1.57% 4.95% 17,207 13.93%


Several other deal-specific factors have also played important roles in determining 2010 year-to-date new issue performance. Bonds with maturities of 8 years or more have outperformed those with shorter durations, relative to both the VLI and the quality indices. Unsecured new issues have outperformed new secured debt. Investors have generally been inclined to hold less duration and wanted greater asset coverage, so issuers have had to offer higher yields on longer duration and unsecured debt. As spreads have tightened over the course of the year, investors holding longer maturity, unsecured new issues have realized greater returns.

A final factor that appears to have influenced new issue relative performance is the issuer’s seasoning in terms of prior access to the high yield debt market. As a group, bonds from first-time issuers have somewhat surprisingly underperformed the VLI and the quality indices. Investors typically demand that first-time issuers offer a higher initial yield to compensate for their unfamiliarity. In a favorable credit environment such as the one thus far in 2010, one might expect this initial discount to lead to subsequent strong performance. However, the record of first-time issuers in 2010 is decidedly mixed. The median first-time issuer has outperformed the VLI by 1.82% and the quality indices by 1.81%. However, mean relative performance is strongly influenced by the presence of significant downside outliers. On a par-weighted average basis, first-time issuers have been essentially flat relative to the VLI and beaten the quality indices by only 0.56% year-to-date. Those that have encountered difficulty in 2010 include ATP Oil & Gas, Nationstar Mortgage, Sitel, RadNet, and especially Sorenson Communications, which trades at $47-49 after having issued at 98.10 in mid-January. As was the case with CCC credits, the downside skew for first-time issuers underscores the critical nature of individual credit selection for this group.

Effect of Day 1 on Reported High Yield Index Performance One concern we occasionally hear from investors is that the reported performance of the U.S. High Yield Index, against which many high yield managers are benchmarked, can differ slightly from underlying market performance, due to a variety of factors. One is short-term new issue performance. As a reminder, our index returns universe is rebalanced only at the beginning of each month, and thus does not capture new issue post-break trading outperformance. To quantify the potential effect on reported index performance, we contextualize new issue Day 1 performance by comparing monthly issuance amounts with the total amount of outstanding bonds in the U.S. High Yield Index. As Figure 11 clearly demonstrates, although Day 1 outperformance has been strong, the amount of gross issuance relative to total high yield debt outstanding is sufficiently small that the foregone potential effect on index performance is minimal (12.5bp year to date and no more than


13 August 2010 11

4.4bp in any individual month). Investors who seek to use new issues as a source of short-term outperformance will therefore need to overweight new bonds in their portfolio substantially in order to achieve a meaningful boost relative to index performance.

Figure 11: Hypothetical Performance Effect of New Issuance on U.S. HY Index

Period Day 1 Perf.

vs. VLI Issuance Amt

($Bn) HY Avg

Amt Outst. Issuance as %

of Ttl Performance Impact (bps)

January +1.07% 10.7 775.2 1.36% 1.5

February +1.02% 11.2 787.5 1.41% 1.4

March +1.11% 32.7 799.3 3.93% 4.4

April +0.63% 28.6 822.3 3.37% 2.1

May +0.30% 6.1 834.6 0.73% 0.2

June +0.26% 6.7 828.4 0.80% 0.2

July +0.99% 13.6 829.3 1.62% 1.6

August +0.69% 13.8 837.1 1.63% 1.1

Year-to-Date +0.95% 123.5 812.9 1.86% 12.5


Lack of new issue inclusion is only one of several factors that may cause reported index performance to deviate from underlying market fundamentals. For example, when new issues enter the index at the beginning of the following month, they are initially marked at the ask side, to reflect the fact that the primary market is essentially one-sided. Subsequent marks are at the bid side, creating another relative drag on index performance. However, these issuance-related performance drags are offset by the handling of transaction costs and the month-end sweep of cash balances, both of which modestly raise index performance relative to what a real-world investor is likely to achieve, given the same credit exposures. These effects tend to offset each other, making index performance a good representation of the overall market even as it fails to capture post-break new issue gains. The salient point is that investors can reasonably expect new issues to be a consistent source of short-term modest outperformance, to the extent that they are inclined and able to participate.

2009 New Issuance – A Different Story As investors no doubt recall, new issue relative performance was very different during most of 2009, largely due to the historically wide spreads prevalent in the secondary market early in the year. With the high yield market trading below 70 through late April, issuers were forced to offer significant OID concessions, frequently bringing deals to the market at 95 or 96 and sometimes even lower. These steep new-issue price discounts were still well above secondary prices, thereby implying that new deals had less attractive convexity profiles. As the secondary market rallied from below 70 to the mid-90s by the end of 2009, most new issues would have had to reach 120 or higher to keep pace. Investors were understandably reluctant to bid new issues up to such heights, particularly with market-wide default rates elevated and recoveries correspondingly depressed. The result was systematic new issue underperformance that lasted almost all year. As Figure 12 demonstrates, it was most pronounced relative to the VLI and the quality indices in the early months, getting within hailing distance of flat on a quality-adjusted basis starting in June before finally turning positive in October. We believe 2009 new issue performance further illustrates our point regarding the usefulness of new issue concession calculation as a tool for estimating new issue outperformance potential. Investors should always be mindful of new issue pricing relative to the secondary market when calibrating new issue performance expectations.


13 August 2010 12

Figure 12: 2009 Relative Performance through Year-End by Issuance Month

Month vs. VLI vs. Quality Par Amt ($bn) % of Ttl Issuance

December -0.07% -1.01% 15,510 11.09%

November 0.32% 0.95% 13,193 9.43%

October 0.54% 1.66% 14,439 10.32%

September -1.26% -0.09% 18,426 13.17%

August -3.21% -0.44% 9,744 6.97%

July -6.44% -0.50% 13,170 9.41%

June -6.85% -0.45% 15,038 10.75%

May -11.58% -3.51% 22,254 15.91%

April -24.67% -11.76% 7,911 5.66%

March -32.74% -9.90% 1,665 1.19%

February -31.39% -12.49% 3,662 2.62%

January -28.16% -14.34% 4,874 3.48%

Totals -7.09% -2.16% 139,886 100.00%


Please see Figure 14 for a full table of 2009 new issue relative and absolute performance by category.


13 August 2010 13

Technical Appendix

Figure 13: 2010 Master Data Chart YTD Rel. Perf. Day 1 Rel. Perf. Absolute Performance Par Amt % of Ttl vs. VLI vs. Qual vs. VLI vs. Qual Day 1 Post D1 Total

By Rating BB 41,205 33.35% 2.31% 1.50% 1.05% 1.08% 1.20% 4.23% 5.43% B 63,645 51.52% 1.93% 2.08% 0.83% 0.83% 0.89% 4.70% 5.59% CCC 17,940 14.52% -1.29% 0.02% 0.44% 0.42% 0.47% 1.07% 1.54% CC 750 0.61% -1.33% -1.32% 0.00% 0.00% 0.00% 1.06% 1.06%

By Maturity Up to 7 Yrs 47,815 38.70% 1.23% 1.22% 0.81% 0.81% 0.86% 3.79% 4.64% 8+ Yrs 75,725 61.30% 1.78% 1.79% 0.83% 0.88% 0.97% 4.12% 5.09%

By Month August 13,845 11.21% 0.32% 0.20% 0.69% 0.73% 0.79% -0.85% -0.06% July 13,645 11.04% 1.31% 1.29% 0.99% 1.03% 1.24% 1.54% 2.78% June 6,695 5.42% 2.30% 2.79% 0.26% 0.20% 0.16% 6.60% 6.76% May 6,138 4.97% 1.72% 2.06% 0.30% 0.29% 0.28% 4.91% 5.19% April 28,642 23.18% 1.07% 0.91% 0.63% 0.65% 0.72% 2.25% 2.97% March 32,685 26.46% 2.52% 2.29% 1.11% 1.16% 1.27% 5.65% 6.92% February 11,235 9.09% 1.12% 2.23% 1.02% 0.98% 0.94% 8.10% 9.04% January 10,655 8.62% 1.86% 1.51% 1.07% 0.99% 1.07% 6.53% 7.59%

By Use of Proceeds M&A 17,207 13.93% 4.65% 4.50% 1.57% 1.60% 1.67% 6.41% 8.08% LBO 4,680 3.79% 1.93% 2.76% 0.27% 0.23% 0.11% 5.52% 5.64% Refi Bonds 27,605 22.34% 1.52% 1.35% 0.64% 0.66% 0.80% 3.38% 4.17% Refi Loans 36,733 29.73% 0.25% 0.50% 0.49% 0.51% 0.59% 3.06% 3.65% Refi Both 11,295 9.14% 1.35% 1.43% 0.55% 0.52% 0.51% 4.58% 5.10% Shareholder Dist 4,485 3.63% 1.99% 2.06% 1.55% 1.60% 1.68% 3.74% 5.43% GCP 20,635 16.70% 1.39% 1.06% 1.17% 1.17% 1.26% 4.12% 5.37%

By 144a / Public Status 144a For Life 21,620 17.50% 1.33% 1.50% 0.32% 0.33% 0.43% 4.57% 5.00% Public 101,920 82.50% 1.62% 1.58% 0.95% 0.96% 1.03% 3.87% 4.90%

By First Time / Repeat Issuer First Time Issuer 23,590 19.09% 0.02% 0.56% 0.72% 0.76% 0.85% 2.77% 3.62% Repeat Issuer 99,750 80.74% 1.94% 1.81% 0.87% 0.87% 0.95% 4.28% 5.23%

By Secured / Unsecured Secured 39,675 32.11% 0.71% 1.01% 0.66% 0.68% 0.73% 3.65% 4.38%Unsecured 83,865 67.89% 1.98% 1.83% 0.93% 0.93% 1.02% 4.16% 5.18%

By Transaction Type Roadshow 61,578 49.84% 1.91% 2.09% 1.03% 1.04% 1.08% 4.44% 5.51% Drive-By 51,955 42.06% 1.04% 0.93% 0.56% 0.57% 0.69% 3.27% 3.96% Private Placement 520 0.42% 2.23% 2.80% 1.55% 1.63% 1.85% 6.55% 8.40% Add-On 9,487 7.68% 2.21% 1.63% 1.12% 1.13% 1.22% 4.91% 6.13%

By OID Handle <=95 1,165 0.94% 6.63% 7.46% 0.12% 0.05% 0.16% 11.30% 11.46% 96 1,495 1.21% 0.11% 0.21% 2.80% 2.82% 2.94% -1.48% 1.46% 97 8,240 6.67% 1.78% 1.86% 1.64% 1.64% 1.69% 4.24% 5.93% 98 23,613 19.11% 1.79% 1.94% 0.57% 0.57% 0.66% 5.03% 5.69% 99 27,835 22.53% 0.36% 0.45% 0.77% 0.76% 0.81% 3.33% 4.14% 100 59,570 48.22% 1.97% 1.85% 0.84% 0.87% 0.96% 3.90% 4.85% >=101 1,622 1.31% 1.01% 0.59% 0.55% 0.52% 0.55% 2.32% 2.87%

By Issue Date Market Tone Very Strong 28,533 23.10% 1.93% 1.82% 0.92% 1.04% 1.31% 4.50% 5.81% Strong 53,727 43.49% 2.07% 1.92% 0.93% 0.97% 1.06% 3.70% 4.76% Weak 31,020 25.11% 0.46% 0.51% 0.76% 0.70% 0.67% 2.85% 3.53% Very Weak 10,260 8.30% 1.26% 2.26% 0.37% 0.20% -0.09% 7.56% 7.47%

By Issue Week Market Tone Very Strong 29,625 23.98% 1.81% 1.80% 0.67% 0.74% 0.97% 4.71% 5.68% Strong 45,615 36.92% 1.13% 1.00% 1.09% 1.12% 1.21% 2.52% 3.72% Weak 34,325 27.78% 2.04% 1.95% 0.73% 0.71% 0.75% 3.95% 4.70% Very Weak 13,975 11.31% 1.33% 2.01% 0.65% 0.52% 0.38% 7.38% 7.76%

By Trailing 5-Day Market Tone Very Strong 26,575 21.51% 1.67% 1.67% 0.91% 0.94% 1.13% 4.41% 5.54% Strong 56,952 46.10% 1.14% 0.95% 0.84% 0.87% 0.97% 2.47% 3.44% Weak 29,088 23.55% 2.25% 2.28% 0.93% 0.93% 0.94% 5.20% 6.14% Very Weak 10,925 8.84% 1.75% 2.64% 0.42% 0.33% 0.18% 7.70% 7.88%

By Fund Flows Very Strong 20,660 16.72% 1.68% 1.52% 0.98% 0.97% 1.11% 2.39% 3.50% Strong 61,632 49.89% 1.46% 1.26% 0.88% 0.89% 0.99% 3.72% 4.70% Weak 21,750 17.61% 2.51% 2.80% 0.94% 0.99% 1.03% 6.43% 7.46% Very Weak 11,543 9.34% 1.17% 2.03% 0.45% 0.40% 0.33% 7.11% 7.44%

By Amount of New Supply ($bn) <=6.5 58,433 47.30% 1.35% 1.55% 0.70% 0.71% 0.79% 4.48% 5.27% >6.5 65,107 52.70% 1.77% 1.58% 0.96% 0.98% 1.05% 3.56% 4.61%

All 123,540 100.00% 1.57% 1.57% 0.84% 0.85% 0.93% 3.99% 4.92%



13 August 2010 14

Figure 14: 2009 Master Data Chart YTD Rel. Perf. Day 1 Rel. Perf. Absolute Performance Par Amt % of Ttl vs. VLI vs. Qual vs. VLI vs. Qual Day 1 Post D1 Total

By Rating BB 45,494 32.52% -11.25% -3.04% 0.29% 0.37% 0.40% 9.92% 10.32% B 80,942 57.86% -5.38% -0.69% 0.36% 0.39% 0.42% 9.05% 9.46% CCC 13,450 9.62% -3.29% -7.99% 0.00% -0.08% 0.05% 6.39% 6.44%

By Maturity Up to 7 Yrs 78,459 56.09% -8.22% -2.51% 0.49% 0.54% 0.65% 12.45% 13.09% 8+ Yrs 61,426 43.91% -5.64% -1.71% 0.20% 0.09% 0.17% 9.95% 10.12%

By Month December 15,510 11.09% -0.07% -1.01% 0.03% 0.11% 0.18% 1.83% 2.01% November 13,193 9.43% 0.32% 0.95% 0.25% 0.18% 0.28% 4.45% 4.73% October 14,439 10.32% 0.54% 1.66% -0.05% -0.05% 0.00% 5.69% 5.69% September 18,426 13.17% -1.26% -0.09% 0.37% 0.42% 0.58% 6.83% 7.41% August 9,744 6.97% -3.21% -0.44% -0.08% -0.07% -0.02% 9.19% 9.18% July 13,170 9.41% -6.44% -0.50% 0.55% 0.62% 0.76% 12.74% 13.50% June 15,038 10.75% -6.85% -0.45% 0.37% 0.40% 0.54% 15.95% 16.49% May 22,254 15.91% -11.58% -3.51% 0.47% 0.47% 0.53% 18.42% 18.96% April 7,911 5.66% -24.67% -11.76% -0.16% 0.10% 0.31% 18.35% 18.66% March 1,665 1.19% -32.74% -9.90% 0.74% 0.78% 0.51% 28.76% 29.27% February 3,662 2.62% -31.39% -12.49% 0.66% 0.67% 0.75% 21.22% 21.97% January 4,874 3.48% -28.16% -14.34% 1.52% 1.54% 1.66% 23.57% 25.23%

By Use of Proceeds M&A 12,266 8.77% -2.99% 2.06% -0.78% -0.79% -0.75% 14.90% 14.15% LBO 0 0.00% n/a n/a n/a n/a n/a n/a n/a Refi Bonds 21,152 15.12% -7.43% -2.21% -0.05% 0.00% 0.14% 11.51% 11.65% Refi Loans 64,421 46.05% -6.66% -2.47% 0.70% 0.72% 0.79% 9.98% 10.77% Refi Both 18,065 12.91% -10.27% -3.48% 0.30% 0.30% 0.32% 13.22% 13.54% Shareholder Dist 2,457 1.76% -0.61% -0.11% 0.01% -0.03% 0.00% 3.04% 3.03% GCP 21,525 15.39% -8.44% -2.70% 0.10% 0.24% 0.49% 12.66% 13.15%

By 144a / Public Status 144a For Life 23,960 17.13% -3.70% -0.64% 0.35% 0.35% 0.47% 8.83% 9.30% Public 115,925 82.87% -7.79% -2.47% 0.29% 0.34% 0.43% 11.87% 12.30%

By First Time / Repeat Issuer First Time Issuer 23,879 17.07% -3.45% -0.88% 0.42% 0.44% 0.52% 7.20% 7.72% Repeat Issuer 116,006 82.93% -7.83% -2.42% 0.28% 0.32% 0.42% 12.21% 12.63%

By Secured / Unsecured Secured 54,763 39.15% -4.75% -1.02% 0.10% 0.12% 0.20% 11.73% 11.93% Unsecured 85,122 60.85% -8.59% -2.89% 0.43% 0.48% 0.59% 11.11% 11.70%

By OID Handle <=95 37,485 26.80% -11.47% -2.69% 0.59% 0.62% 0.74% 19.20% 19.94% 96 16,826 12.03% -12.69% -6.41% 0.61% 0.69% 0.76% 12.34% 13.10% 97 33,327 23.82% -6.37% -1.52% 0.59% 0.60% 0.69% 10.79% 11.47% 98 34,538 24.69% -2.93% -0.64% -0.33% -0.27% -0.15% 6.53% 6.38% 99 10,704 7.65% -2.07% -0.74% 0.06% 0.05% 0.13% 4.20% 4.33% 100 5,821 4.16% -1.57% -2.06% 0.37% 0.35% 0.39% 3.83% 4.22% >=101 1,186 0.85% -2.50% -0.38% -0.91% -0.86% -0.76% 7.11% 6.36%

By Issue Date Market Tone Very Strong 61,788 44.17% -8.56% -2.75% 0.18% 0.31% 0.49% 13.11% 13.60% Strong 44,769 32.00% -4.32% -0.77% 0.63% 0.62% 0.70% 8.76% 9.46% Weak 18,522 13.24% -6.14% -2.32% 0.28% 0.21% 0.23% 7.92% 8.15% Very Weak 14,807 10.58% -10.51% -3.66% -0.13% -0.23% -0.31% 16.13% 15.81%

By Issue Week Market Tone Very Strong 70,085 50.10% -7.01% -1.80% 0.29% 0.38% 0.55% 11.45% 12.00% Strong 29,069 20.78% -5.79% -2.31% 0.51% 0.52% 0.59% 10.24% 10.82% Weak 17,230 12.32% -5.58% -1.93% -0.37% -0.43% -0.37% 9.24% 8.87% Very Weak 23,501 16.80% -10.03% -3.20% 0.59% 0.54% 0.50% 13.98% 14.48%

By Trailing 5-Day Market Tone Very Strong 86,906 62.13% -7.54% -2.24% 0.29% 0.36% 0.49% 11.76% 12.25% Strong 22,098 15.80% -4.46% -2.16% 0.40% 0.42% 0.51% 7.36% 7.87% Weak 18,724 13.39% -3.44% -0.20% -0.45% -0.46% -0.41% 10.09% 9.67% Very Weak 12,158 8.69% -14.23% -4.57% 1.34% 1.29% 1.21% 17.66% 18.87%

By Fund Flows Very Strong 50,497 36.10% -12.49% -4.27% 0.34% 0.36% 0.44% 16.72% 17.17% Strong 79,211 56.63% -3.69% -0.90% 0.27% 0.32% 0.44% 7.85% 8.30% Weak 9,655 6.90% -4.83% -0.69% 0.23% 0.23% 0.27% 11.19% 11.46% Very Weak 522 0.37% -40.83% -14.94% 2.36% 2.50% 1.62% 25.39% 27.01%

By Amount of New Supply ($bn) <=6.5 105,479 75.40% -9.06% -2.62% 0.41% 0.45% 0.55% 13.49% 14.04% >6.5 34,407 24.60% -1.04% -0.74% -0.03% 0.00% 0.10% 4.80% 4.90%

All 139,886 100.00% -7.09% -2.16% 0.30% 0.34% 0.44% 11.35% 11.79%



13 August 2010 15

Note on Relative Performance Calculations We use two benchmarks against which we measure the relative performance of 2010 and 2009 new issues: the U.S. High Yield Very Liquid Index (VLI), and the Credit Quality Indices (BB, B, CCC, and CC or lower). We use the VLI as our broad market proxy rather than the full High Yield Index for two reasons. First, new issues tend to be more actively traded than the overall market in the first few months following the issue date. Second, the VLI is limited to one bond per issuer and, thus, is less affected by idiosyncratic event risk (for example, M&A) that can cause all bonds for a single issuer to move simultaneously.

Calculating relative performance across each dimension in the master data charts is a two-step process. First, we compare individual issue returns with the relevant benchmark return from the date of issuance to the present (or to year-end for 2009 issuance), to get the issue-specific relative performance. We then group issues by category and calculate the par-weighted average of the issue-specific relative performance values. For example, consider the following hypothetical case in which only four bonds have been issued in 2010, and index returns have been as follows:

Index Rtn Since January 1 Rtn Since April 1

VLI 6% 4%

BB 7% 5%

B 5% 3%

The four hypothetical bonds have the following characteristics:

Company Issue DatePar

Amount Credit Rating

Secured vs Unsec

Total Return

Rel. Perf. vs. VLI

Rel. Perf. vs. Qual

Issuer A 1/1/10 $500m BB Sec 7% +1% +0%

Issuer B 4/1/10 $250m BB Unsec 6% +2% +1%

Issuer C 1/1/10 $1b B Unsec 6% +0% +1%

Issuer D 4/1/10 $500m B Sec 5% +1% +2%

In this example, the two BB credits have outperformed the VLI by a par-weighted average of 1.33%, but have outperformed their quality index by only 0.33%. The two B credits have barely outperformed the VLI, by a par-weighted average of 0.33%, but have solidly outperformed their quality index by 1.33%. Secured bonds have outperformed the VLI by 1%, while unsecured bonds have outperformed the VLI by 0.4%.

The performance calculation of secured and unsecured bonds relative to the quality indices merits some explanation, as this measure forms the basis of much of our analysis in this piece. The two unsecured bonds in this hypothetical example have outperformed their respective quality indices by a par-weighted average of 1%. Indeed, each has individually outperformed its quality index by exactly this amount since issuance, despite the fact that the bonds are being compared with different quality indices (one against the BB Index, the other against the B Index) and across different periods (one was issued in January, the other in April). Our relative return metrics are not time-weighted; rather, they strictly compare year-to-date returns since issuance. Extending this methodology to the secured bonds in our hypothetical example, we see that they have also outperformed their respective quality indices by a par-weighted average of 1% (individually by 0% and 2%, with equal weighting due to the identical par amounts).


13 August 2010 16

INVESTMENT GRADE

Putting on Your (Cyclical) Shorts In addition to another round of weak macro data, the FOMC’s comments on Tuesday about slower economic growth and the Fed’s decision to keep its holdings of securities at the current level to “help support the economic recovery” exacerbated investors’ doubts about the pace of the recovery in the U.S. Continuing weakness on the macro front has even stoked concerns about deflation. While our interest rates strategists consider that a low-probability event (see Market Strategy Americas, August 6, 2010), we view the underlying issue – a continued slowdown in growth – as a viable tail risk with potential implications for credit. Given the extent to which many non-financial sectors have rallied from their wides, we believe reducing risk in and/or getting short certain cyclical sectors is an attractive way to limit exposure to a protracted economic deterioration.

Combining the method for assessing the defensiveness of a sector that we described in our 2009 U.S. Credit Outlook with current valuations, the sector’s beta versus the market, and our credit analysts’ fundamental views, we screen for several non-financial sectors that may be especially vulnerable to a substantial faltering in economic growth (Figure 1).3 The sectors in Figure 1 are sorted based on their defensiveness, with the least defensive (most cyclical) at the top. We also compare the current valuation of each sector with its historical trading range. We consider a sector “tight” if its current spread relative

3 The “defensiveness indicator” in the 2009 U.S. Credit Outlook is calculated using historical sector correlations with quarterly U.S. real GDP growth and the sector’s standard deviation of returns.

Jeffrey Meli +1 212 412 2127

[email protected]

Shobhit Gupta +1 212 412 2056

[email protected]

Alex Gennis +1 212 412 1370

[email protected]

Ryan Preclaw +1 212 526 3083

[email protected]

Figure 1: Select More-Cyclical Sectors (Most Cyclical on the Top)

16-Week Beta

Sector Analyst Rating

Current OAS (bp)

OAS Rank vs Range Apr-07 Current Change

Automotive Not Rated 146 Tight 0.57 0.49 -0.07

Restaurants Not Rated 111 Tight 0.44 0.43 -0.01

Technology Market Weight 118 Tight 0.11 0.76 0.64

Airlines Not Rated 335 Average 0.75 1.54 0.79

Building Materials Not Rated 241 Average 1.29 1.34 0.05

Pipelines Market Weight 199 Average 1.55 1.84 0.29

Oil Field Services Overweight 240 Wide 0.47 3.40 2.93

Wireless Market Weight 137 Tight 1.21 0.91 -0.31

Transportation Services Not Rated 120 Tight 0.10 0.39 0.30

Independent Energy Market Weight 175 Average 0.87 2.04 1.16

Refining Overweight 260 Wide 0.72 1.86 1.14

Tobacco Market Weight 212 Wide 0.35 1.68 1.33

Wirelines Market Weight 180 Average 1.37 1.40 0.03

Integrated Energy Market Weight 129 Average 0.59 2.19 1.60

Metals and Mining Market Weight 202 Average 1.38 1.49 0.11

Electric Market Weight 145 Average 0.78 0.71 -0.07

Retailers Market Weight 121 Tight 0.94 0.55 -0.39


https://live.barcap.com/go/research/content?contentPubID=FC1623728�



13 August 2010 17

to historical levels is tighter than the average among all non-financial sectors. Sectors whose spreads relative to historical levels are wider than their peer group are classified as “wide.” We also calculate a 16-week rolling beta for each sector versus the non-financial component of the U.S. Corporate Index and show how the beta of each sector has changed from April 2007 to today. Sectors with higher betas are more likely to underperform during periods of growth concerns. Cyclical sectors that have become higher beta and are trading toward their historical tights are attractive short candidates for investors who are concerned about future growth prospects, in our view.

Based on these considerations, we consider the technology, transportation services, pipelines, and metals sectors most compelling as potential cyclical shorts (highlighted in Figure 1). We include the transportation services sector despite its low beta because it contains companies such as UPS and FedEx, both economic bellwethers that are likely to be significantly affected by a slowdown in growth. Within the technology sector, we view the lower-rated names as more attractive cyclical shorts, given that the higher quality single-A credits in the sector tend to have larger cash balances that make them more resilient to economic downturns. The cyclical nature of the pipeline sector primarily reflects the sensitivity of MLPs – which make up a large part of the sector – to cyclical capital market conditions, since these credits are cash flow negative and depend on continued access to equity and debt markets. (We leave out the two sectors at the top of the list – automotive and restaurants – because of their low betas.)

Sectors with rich valuations are more compelling candidates because of their asymmetric risk profiles. Figure 2 highlights several of the more-cyclical, tighter-spread sectors and shows that they have substantial room to widen if the aforementioned tail risks materialize, while their potential tightening is limited, based on their historical trading ranges. For example, the technology and transportation services sectors are only 36bp and 32bp away from their pre-crisis tights, respectively.

Several of the more-cyclical sectors in our list have changed fundamentally since we ranked their cyclical/defensive nature at the end of 2008. For example, we do not consider the wireline sector an attractive cyclical short despite its higher beta. AT&T and Verizon, which comprise a substantial part of the sector, have deleveraged and now have substantial balance sheet flexibility to withstand an economic downturn. However, we note that event risk remains an issue for some of the credits in the sector and may account for its somewhat wide spreads.

Figure 2: OAS of More-Cyclical Sectors: Current versus Historical Range (bp)

0

100

200

300

400

500

600

700

800

900

Tech Transport Services Pipelines Metals



13 August 2010 18

We also do not consider the retail sector to be a compelling cyclical short, despite its tight spreads. Since 2007 retailers have repaired their balance sheets and reduced leverage. The sector’s beta has also nearly halved during the period, in large part because some of the more cyclical names, such as JC Penney and Macy’s, have been downgraded to high yield and dropped out of the investment grade index.4 In fact, several of the large retailers, such as Costco and Wal-Mart, are actually counter-cyclical plays that can benefit from consumers’ trading down during times of economic weakness. From the standpoint of selecting cyclical shorts, high yield retailers may have higher sensitivity to macro developments than the credits that remain in the investment grade retail index. Furthermore, the wide trading levels of several of the sectors in our list have reduced their attractiveness as cyclical shorts. Analyst Harry Mateer has recently upgraded the oil field services sector to Overweight, in part as a result of substantial widening on the back of the Macondo well incident, which he views as overdone (please see Sector Recommendations: Energy, Pipelines, and Basic Industries, August 11, 2010, for details).

Investors who are concerned about a double-dip tail risk can implement low-cost shorts by buying the CDS of select tighter-trading names in more-cyclical sectors. Figure 3 highlights credits with CDS trading at or near its tights for the year that our analysts are Underweight or Market Weight. We believe that these names are at risk of underperforming in case of a protracted growth slowdown. Furthermore, the risk-reward in these names is attractive, in our view, given that most of these companies have tight CDS spread levels and are trading toward this year’s tights. We also include credits from sectors that we did not highlight above but that we view as particularly exposed to renewed macroeconomic pressures, such as Temple-Inland and CBS.

Figure 3: Select More-Cyclical Credits Trading Close to Year-to-Date Tights

5y CDS Spread (bp)

Ticker Sector Analyst Rating Apr 15, 2010 Current Change

OLN Chemicals NR 125 120 -5

CBS Media Non-Cable MW 113 123 10

NUE Metals UW 70 87 17

TIN Paper MW 137 154 16

CSX Railroads MW 50 51 1

DELL Technology UW 79 92 13

MOT Technology MW 107 76 -31

AVT Technology MW 147 147 0

ARW Technology MW 128 139 12

FDX Transport. Services NR 85 93 8

UPS Transport. Services NR 36 43 8

R Transport. Services NR 135 149 14


In addition to potential cyclical shorts, we highlight several more-defensive sectors for more bullish investors looking for a lower-beta long to leverage the economic recovery (Figure 4). This list is also ranked in the order of our defensiveness indicator, with the most defensive

4 In addition, the performance of the retail sector is highly seasonal. Spreads tend to lag in the fall ahead of anticipation of holiday shopping results but typically recover after the winter holidays once concerns about holiday shopping trends fade.




13 August 2010 19

sectors at the bottom. Sectors that are particularly attractive, in our view, are home construction, supermarkets, and consumer products. The beta of the home construction sectors has almost halved (in large part because several higher-beta names have dropped down to the high yield index), its companies have reduced leverage and stockpiled cash, yet it is still among the widest investment grade sectors in the index. While supermarkets and consumer products are two other more-defensive sectors that are likely to outperform the market in times of economic weakness, we recommend that more bullish investors approach potential longs in the sector with caution, given the sector’s limited tightening potential.

Figure 4: Select More-Defensive Sectors (Most Defensive on the Bottom)

16-Week Beta

Sector Analyst Rating Current OAS

(bp) OAS Rank vs Range Apr-07 Current Change

Home Construction Market Weight 357 Wide 3.33 1.70 -1.63

Aerospace/Defense Market Weight 98 Tight 0.59 0.23 -0.35

Chemicals Underweight 143 Average 0.57 0.90 0.33

Food and Beverage Market Weight 111 Tight 0.64 0.58 -0.06

Supermarkets Market Weight 141 Tight 0.97 0.42 -0.55

Consumer Products Not Rated 115 Tight 0.28 0.55 0.28

Constr. Machinery Not Rated 90 Tight 0.47 0.49 0.02

Industrial Other Not Rated 85 Tight -0.24 0.43 0.67

Healthcare Market Weight 116 Tight 1.06 0.46 -0.60



13 August 2010 20

Year-to-Date 2010 Fixed Investment Grade Supply ($bn) CDX.IG Curve

NonCorp., $164.7,

30%

Industrial, $156.8,

28%

Utility, $28.7, 5%

Finance, $199.6,

35%

Govt. Guaranteed, $14.3, 3%

-60

-45

-30

-15

0

15

30

Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10

bp

-40

-30

-20

-10

0

10

20

bp

5s10s (LHS) 5s7s (RHS)

Note: All levels on this page as of Wednesday close. Source: Barclays Capital Note: A portion of the significant steepening in CDX.IG curve levels on March 20, 2009, is attributable to the roll from Series 11 to Series 12. Source: Barclays Capital

CDX.IG versus VIX Basis

70

80

90

100

110

120

130

140

Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-1015

20

25

30

35

40

45

50

CDX.IG 5.0 Mkt (LHS, bp) VIX (RHS, %)

50

125

200

275

350

425

500

575

Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10

bp

-375

-325

-275

-225

-175

-125

-75

-25

bp

Credit OAS (LHS, bp) Basis (RHS, bp)

Note: A portion of the significant tightening in CDX.IG on March 20, 2009, is attributable to the roll from Series 11 to Series 12. Source: Markit, Barclays Capital

Note: Basis defined as CDX.IG spread – corporate Libor OAS. Source: Barclays Capital

CDX.IG OTR Market versus Intrinsic (bp) Par Downgrade/Upgrade Ratio

70

80

90

100

110

120

130

140

Jan-10 Mar-10 May-10 Jul-10CDX IG OTR Intr CDX IG OTR Mkt

0

5

10

15

20

25

30

J F M A M J J A S O N D J F M A M J J

Moody'sS&P

DG/UG Ratio

Source: Barclays Capital Note: S&P had a par downgrade/upgrade ratio of 91.4 in January 2010. Moody’s

ratio was 0.4; however, Moody’s downgraded only three companies and upgraded seven companies in January 2010. Source: Barclays Capital


13 August 2010 21

HIGH YIELD

Toggles Get PIK’ed Off High yield product lost some ground this week as the market generally pulled back from risky assets on global recovery concerns. Through Wednesday, derivatives led cash down, with HY14 losing $1.00 and the Barclays Capital High Yield Index falling only $0.40.

While the cash market has retreated this week, it has held up remarkably well considering the record amount of new supply that high yield issuers have priced. Through midday Thursday, new issuance stands at $12.9bn, surpassing the previous weekly record of $11.7bn set in late March of this year. Issuers, particularly at the higher end of the quality spectrum, have taken advantage of the lower yield environment and open primary market to come to market, with 87% of the issuance coming as an add-on or drive-by. The opportunistic issuance was used primarily for refinancing, as companies used 43% of proceeds to repay bank debt and 27% to repay bonds. Notable issuers included Chesapeake ($2bn), Ally Financial ($1.75bn), Goodyear ($900mn), Peabody ($650mn), and Rite Aid ($650mn).

Second-quarter earnings season is still in full swing, and the reports remain mixed overall. On the positive side, issuers including Sequa, Tyson, Georgia-Pacific, Visant, and Education Management reported strong quarters, with some beating expectations on both revenues and EBITDA. On the other hand, several names reported on the softer side of estimates, but the majority came generally in line. While cyclical names seem to have rebounded off their lows, earnings reports and management teams are sending mixed signals about the pace of end-market recovery.

The number of issuers still exercising the PIK option on their toggle notes is dwindling. With the primary market open and significant amounts of liquidity on high yield balance sheets, issuers appear comfortable with their ability to access capital markets if needed. Earlier this year, Surgical Care Affiliates, Hawker Beechcraft, Avaya, Momentive, and Freescale elected to pay cash interest. This week, Clear Channel announced that it will also switch to cash pay, despite significant 2011-14 maturities. The company will begin making AHYDO payments in 2013, which may have weighed into the decision. Also this week, Intelsat elected to pay its next interest payment as 50% cash, 50% PIK. While most toggles issued during the 2005-07 bull market allow for the 50/50 option (in addition to 100% PIK and 100% cash pay


[email protected]


[email protected]

Gautam Kakodkar +1 212 412 7937

[email protected]

Eric Gross +1 212 412 7997

[email protected]

Michael Kessler +1 212 412 3031

[email protected]

Figure 1: Cash and CDS Movers

Figure 2: Yield to Worst of the U.S. High Yield Index

High Yield Cash

Best Px Chg Worst Px Chg

MBI 6.4 '22 73.79 +9.0 SOLOC 8.5 '14 85.50 -4.5

CCK 7.625 '17 106.50 +7.3 OPCCN 7.875 '14 82.50 -4.1

CMZB 8.151 '31 84.67 +4.1 AIG 7.57 '45 83.00 -4.0

High Yield CDS

Best 5y Chg Worst 5y Chg

FFHCN 154 bp -26 bp NLC 432 bp +77 bp

AVIS 4.7 pts -0.7 pts FSL 21.5 pts +3.5 pts

INTEL 4.7 pts -0.2 pts AMR 24.0 pts +3.0 pts

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.0

11.5

12.0

Aug-09 Nov-09 Feb-10 May-10

%



13 August 2010 22

alternatives), this is the first time an issuer has chosen that route. In addition, the Intelsat PIK option should be more valuable to the company than for most other issuers, as it expires in 2013, while many other toggle options expire in 2011 or early 2012.

Four notable names remain among those still PIK’ing: First Data, Realogy, Claire’s Stores, and Univision. History tells us that issuers have used the PIK option to preserve liquidity when the primary market becomes unreliable. Therefore, unless continued heavy issuance leads to a spike in risk aversion, we expect more issuers to toggle back to cash pay, even if economic growth slows.


13 August 2010 23

High Yield 2010 – Supply by Sector Top On-the-Run CDX Index Names by Weekly CDS Volume

Industrial18%

Nat Res16%

Financial11%Telecom

9%

Technology8%

Healthcare7%

Consumer7%

Others13%

Chemicals5%

Media6%

YTD - $141.7bn

Notional

Outstanding ($bn)

Change – Week Ending 8/6/10

($mn)

Gross Net Gross

Sprint Nextel 31.7 1.9 653.7 Macy's 30.2 2.2 508.8 Radian Group 44.2 2.2 439.3 First Data 21.3 1.1 414.5 Starwood Hotels 22.1 1.6 404.9 Lennar 37.0 1.7 324.0 Residential Cap. 26.9 1.1 315.3 Limited Brands 32.3 1.9 278.8 Ford Motor Co 25.5 1.6 264.2 ILFC 38.4 2.9 209.8

Source: Barclays Capital Source: DTCC

High Yield Average Institutional Trade Volume

OTR HYCDX versus U.S. High Yield Index

01

23

45

67

89

10

Apr-10 May-10 Jun-10 Jul-10 Aug-10

$bn

Daily Volume Rolling 1-Week Average

70

75

80

85

90

95

100

105

110

Aug-09 Nov-09 Feb-10 May-10 Aug-10

$

US HY - Price HYCDX - Price

Source: Trace, Barclays Capital Source: Barclays Capital

On-the-Run HYCDX Spread Distribution

High Yield Index Price Distribution by Par

0

4

8

12

16

20

<200

200-

300

300-

400

400-

500

500-

600

600-

700

700-

800

800-

900

900-

1000

>100

0

%

Last Month Current

0

5

10

15

20

25

30

35

40

< 70

70-7

5

75-8

0

80-8

5

85-9

0

90-9

5

95-1

00

100-

105

105-

110

>= 1

10%

Last Month Current



13 August 2010 24

LEVERAGED LOANS & CLOS

Take Out The loan market was resilient despite the Fed’s revised expectations for a more modest pace of economic recovery. Issuers continued to take advantage of the stability in earnings to opportunistically access the primary markets, extend loan maturities, and get covenant relief. An estimated $30bn of the S&P/LSTA Institutional Loan Index has been repaid through high yield bond proceeds this year, allowing issuers to push out their 2012-14 maturity walls, which currently amount to $336bn, down from $405bn at year-end 2009. In our view, even in the absence of primary CLO issuance, higher quality companies should be able to repay, refinance, and amend and extend their maturities within the confines of the loan and bond markets, provided that they remain open to new deals and amenable to extensions.

First Data received approval for an amendment that would allow the issuance of bonds to repay its loans, the exclusion of any junior lien debt from its senior secured leverage test, and the extension of its loan maturities in the future. FDC paid a 10bp amendment fee and subsequently issued $500mn in 8.875% first-lien secured notes at 9.125% yield to repay a portion of its $12.5bn loan burden, a quarter of which is held by CLOs. FDC also reported strong 2Q10 free cash flow generation despite soft EBITDA. Net total leverage crept up to 11.0x, up from 10.3x at year-end. While the TLBs trade at fair value ($86.5, 8% yield to maturity) and are a potential amend-and-extend candidate, in our view, the concentration of exposure to CLOs could exacerbate economic headwinds. Rite-Aid announced that it will refinance its $1.175bn 2012 revolver, replacing it with a lower-rate revolver due 2015 with a springing maturity feature. The company will also opportunistic take out its 2015 TL4 with $650mn in first-lien bonds due 2020. In addition, RAD is seeking amendments to provide more flexibility under certain covenants. Toys ‘R’ Us announced plans to issue $1bn in secured loans and bonds to refinance its Delaware loans. Other issuers looking to tap the bond market to repay bank debt include DirecTV, SPX, Tembec, and BMCA. Meanwhile, Pinnacle Foods completed a $400mn 8.25% 7NC3 bond deal priced at par to repay its TLC. This is in conjunction with the newly issued $442mn (L+425, 1.75% Libor floor) TLD, which broke slightly north of par.


[email protected]


[email protected]

Gautam Kakodkar +1 212 412 7937

[email protected]

Eric Gross +1 212 412 7997

[email protected]

Mike Kessler +1 212 412 3031

[email protected]

Figure 1: Estimated Institutional Loan Repayments from High Yield Bond Proceeds

0

2

4

6

8

10

Mar

-09

Apr

-09

May

-09

Jun-

09

Jul-

09

Aug

-09

Sep-

09

Oct

-09

Nov

-09

Dec

-09

Jan-

10

Feb-

10

Mar

-10

Apr

-10

May

-10

Jun-

10

Jul-

10

MTD

Aug

Repayments of Loans from S&P/LSTA Index$bn

Source: Barclays Capital, S&P LCD


13 August 2010 25

On the distressed front, Boston Generating’s first-lien loan soared 9pts, to $96, after Constellation Energy agreed to buy the company's gas fleet in New England. Meanwhile, taking advantage of the flurry of issuance, Chemtura, Visteon, and AbitibiBowater are seeking approvals for their reorganization plans, some of which will be accompanied by loan issuance to exit from bankruptcy.


13 August 2010 26

Institutional Loan New Issue Volume LCDX Weekly New Contract Volume (4w Average)

Leveraged Loan No. of Deals

Amt ($mn)

Trailing 1m Launches 33 11,870

Forward Calendar 41 18,370

Year-to-Date 232 87,430

0

2

4

6

8

10

12

14-Aug 23-Oct 1-Jan 12-Mar 22-May 6-Aug

$bn

Source: S&P LCD and S&P/LSTA Leveraged Loan Index, Barclays Capital Source: DTCC

OTR LCDX Historical On-the-Run Spreads OTR HYCDX versus LCDX

0

200

400

600

800

1,000

1,200


bp

75

80

85

90

95

100

105

110


$HYCDX

LCDX

Note: Current market assumes 55% recovery on LCDX. Source: Barclays Capital


OTR LCDX versus Loan Index Price History Loan Index Price Distribution by Par

70

80

90

100

110


$

HY Loans Index LCDX

0

10

20

30

40

<70

70-7

5

75-8

0

80-8

5

85-9

0

90-9

5

95-1

00

>100

%

Current Last Month



13 August 2010 27

Junior OC Test Cushions for U.S. and European CLOs CCC Bucket Size for U.S. CLOs

0% 10% 20% 30% 40% 50%

> 5%

2.5% to 5%

0% to 2.5%

-2.5% to 0%

-5% to -2.5%

< -5%

Percent of Deals

U.S. Europe

0% 5% 10% 15% 20% 25% 30% 35%

> 20%

17.5% to 20%

15% to 17.5%

12.5% to 15%

10% to 12.5%

7.5% to 10%

5% to 7.5%

2.5% to 5%

0% to 2.5%

Percent of Deals

Weighted Average Life (WAL) Test Cushion for U.S. CLOs CLO Arbitrage (Assets Minus Liabilities)

0% 5% 10% 15% 20% 25% 30% 35% 40%

5 to 6

4 to 5

3 to 4

2 to 3

1 to 2

0 to 1

-1 to 0

-2 to -1

Percent of Deals

0%

2%

4%

6%

8%

10%

12%

14%

16%

Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10

Par minus Liability Value as Percent of Par

U.S. CLO Spread Performance by Rating (bp) Cash Amount for U.S. and European CLOs in Our Sample

0

250

500

750

1000

1250

1500

1750

2000

2250

Feb-03 May-04 Aug-05 Nov-06 Feb-08 May-09

AAA AA A BBB Reinvestment Period

In Post Total

U.S.

Cash ($bn) 1.84 0.15 1.99

Total Par ($bn) 77.72 5.61 83.33

Cash Percent 2.36% 2.70% 2.39%

Europe

Cash (€bn) 0.55 0.06 0.61

Total Par (€bn) 23.08 3.31 26.39

Cash Percent 2.38% 1.74% 2.30%

Note: All figures are as of July 31, 2010, and based on a sample set of 200 U.S. and 80 European CLO deals in our universe. Source: Barclays Capital


13 August 2010 28

OPTIONS & TRANCHES

Selling the Tails With the steady stream of disappointing economic data, investors are focused on the potential implications of growth in the United States heading lower. While we believe growth will remain positive and, thus, investment grade credit should remain well supported, given the current state of balance sheets, we recognize the downside risks to this forecast. As a result, we examine several potential tail risk hedging strategies using index products. We believe an IG9 senior “spread” strategy is attractive, given current valuations. It involves buying a senior tranche and offsetting some of the cost of carry by selling a tranche that is senior to it and has several characteristics that we believe compare favorably with buying protection outright or to buying OTM payer options.

Trade Details The trade involves two legs: buying $100mn IG9 7y 10-15% tranche protection at 3.50pts upfront (ref: 135bp) and selling an equal notional of IG9 10y 15-30% tranche protection at -0.46pts upfront (ref: 143bp). Prices are based on levels on August 11, 2010. The IG9 7y tranche matures in December 2014, and the 10y tranche matures in December 2017. The trade requires an upfront payment 3.96pts, and because the 100bp coupons of the two tranches offset each other, does not have any carry costs until December 2014. The trade requires an upfront payment of 3.96pts and, because the 100bp coupons of the two tranches offset each other, has no carry costs until December 2014. After this time, the trade has a positive carry of 100bp through December 2017 (although we expect it to be unwound before the first leg matures).

Converting all the coupons into upfront terms, the total cost of the trade is only 1.10pts. This is less than half the total (upfront + carry) cost of buying 7y 15-30% protection outright. Figure 1 shows the P&L performance of the trade since September 2007 (inception of IG9) to present. Figure 2 shows the tranche expected losses (EL) since January this year, along with the breakevens.

Praveen Korapaty +1 212 412 7942

[email protected]

Figure 1: P&L (in $mn) of the Trade since September 2007, Assuming Current Cost Structure

-$5

$0

$5

$10

$15

$20

$25

Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10

P&L ($ mn)

The trade has performed very well during periods of macro stress and spread widening

A loss greater than cost has occurred only assuming current cost and 2007 conditions. The trade can be unwound should such normailzation occur



13 August 2010 29

Analysis of Trade Performance Given a 1.10pt cost, the trade would have produced a high P&L of $20.5mn (March 2009) from September 2007 onward. During the sovereign risk flare-up in May/June this year, the maximum P&L would have been $1.6mn. Given that the trade is a hedge against spread widening, we would expect to pay a premium for this insurance. Although there have been lower-cost entry points this year (Figure 3), most were in April, when the growth outlook was considerably better. We believe this payoff profile is an attractive hedge trade, even at current levels. Below, we show that the trade compares favorably with some of the common alternatives.

At current levels, the trade has an annual cost of 27.5bp. To evaluate the cost-effectiveness of this hedge, we consider some alternatives:

Buy senior protection outright: The total cost of IG9 7y (December 2014) 15-30% protection is 2.39pts (equivalent annual cost is 60bp) for a maximum payoff of $11.1mn. That is, it costs more than two times the cost of our trade and produces only a little more than half of the payoff at the peak. The 10-15% tranche at the same maturity costs almost 7x the cost of our trade and produces only 1.6x the payoff at the peak.

Buy index protection outright: CDX IG14 5y costs 109bp annually and would have produced a maximum payoff of around $9.33mn (assuming it reaches widest spread level on IG9 5y over the past three years). There is also considerable downside risk in case of a tightening from current levels (as seen earlier this year). However, in the case of a few defaults, holders of index protection will be able to collect realized losses, whereas holders of senior tranches will not.

Buy deep out-of-the-money (OTM) payers: Since most options expire within six months, investors looking for longer-term tail risk hedges will have to roll positions. For example, buying the 120 Dec IG14 payer costs 69.3bp (ref: 107.75). The annualized cost is 207.9bp, which is greater than the cost of the index. The difference in cost, 65bp (=207.9-107.8), stems from the asymmetric nature of option payoffs. Part of the high cost is also due to current implied vol (65%) being somewhat elevated (given recent sovereign credit and growth concerns) compared with its April lows (51%). Unless investors expect significant widening by year-end, options can prove expensive.

Figure 2: Tranche Expected Losses (EL) since January 2010

Figure 3: Entry Cost of Trade since January 2010

5%

6%

7%

8%

9%

10%

11%

4.00% 5.00% 6.00% 7.00% 8.00%IG9 7y10-15% tranche EL (%)

7y10-15% EL (%)

Current

Breakeven

Positive P&L

Negative P&L

-1.0

-0.5

0.0

0.5

1.01.5

2.0

2.5

3.0

3.5

Jan-10 Mar-10 May-10 Jul-10

Entry Cost (pts) Entry costs have

been lower only on a few occasions



13 August 2010 30

ANALYST RATING CHANGES

Past Four Weeks

HG/HY Sector Issuer From To Date Changed

HG Energy Weatherford International Ltd Initiating Coverage Overweight 08/11/10

HG Pipelines Williams Partners LP Overweight Market Weight 08/11/10

HG Pipelines Enterprise Products Partners Overweight Market Weight 08/11/10

HG Pipelines Sector – Pipelines Overweight Market Weight 08/11/10

HG Energy Sector - Oil Field Services Market Weight Overweight 08/11/10

HG Energy Sector -Integrated Energy Underweight Market Weight 08/11/10

HY Oil & Gas Plains E&P Sr Notes Market Weight Overweight 08/10/10

HG Insurance Aon Corp Market Weight Overweight 08/09/10

HG Healthcare Cigna Overweight Market Weight 08/05/10

HY Paper & Pack Catalyst Paper 11% Sr Sec Bonds Market Weight Overweight 08/04/10

HG Insurance XL Group Market Weight Overweight 08/04/10

HG Media & Ent CBS Underweight Market Weight 08/03/10

HG Insurance Marsh & McLennan Underweight Market Weight 08/03/10

HY Industrials Oshkosh 8.5% Senior Notes Market Weight Overweight 08/03/10

HY Industrials Baldor Electric 8.625% Sr Notes Underweight Market Weight 08/03/10

HG Insurance CNA Financial Underweight Overweight 08/02/10

HG Banks & Fin Sector– U.S. Banks Market Weight Overweight 08/02/10

Euro HY Euro Paper & Pack Reynolds 7.75% & 8% 2016 Market Weight Overweight 08/02/10

HY Oil & Gas Tesoro Underweight Market Weight 7/30/10

HY Restaurants Wendy’s Sr Notes Overweight Market Weight 7/29/10

HY Technology GXS Worldwide Initiating Coverage Overweight 7/29/10

HY Autos Valeo EUR13s Market Weight Overweight 7/28/10

HY Gaming Harrah’s 10% Second-Lien Notes Market Weight Overweight 7/27/10

HY Gaming Harrah’s 12.75% Second-Lien Notes Initiating Coverage Overweight 7/27/10

HY Consumer CKE Restaurants Sr Secured Notes Initiating Coverage Market Weight 7/26/10

HY Consumer Michael Foods Senior Notes Initiating Coverage Market Weight 7/26/10

HY Media & Ent LIN Television Initiating Coverage Market Weight 7/26/2010

HY Media & Ent New York Times Overweight Market Weight 7/22/10

HG REITs Prologis Market Weight Underweight 7/22/10

HG Tobacco Philip Morris International Initiating Coverage Market Weight 7/21/10

HG Tobacco Reynolds American Initiating Coverage Market Weight 7/21/10

HG Tobacco Altria Initiating Coverage Market Weight 7/21/10

HG Food & Bev Dr. Pepper Snapple Initiating Coverage Market Weight 7/21/10

HG Food & Bev Anheuser-Busch InBev Initiating Coverage Market Weight 7/21/10

HG Food & Bev Sara Lee Initiating Coverage Underweight 7/21/10

HG Food & Bev Kraft Initiating Coverage Market Weight 7/21/10

HG Food & Bev Heinz Initiating Coverage Market Weight 7/21/10

HG Food & Bev General Mills Initiating Coverage Market Weight 7/21/10

HG Food & Bev ConAgra Initiating Coverage Market Weight 7/21/10

HY Technology NXP 7 7/8% Sr Secured Notes Overweight Market Weight 7/19/2010











































13 August 2010 31

U.S. CREDIT STRATEGY Investment Grade

Jeffrey Meli [email protected] +1 212 412 2127

Shobhit Gupta [email protected] +1 212 412 2056

Praveen Korapaty [email protected] +1 212 412 7942

Hari Manappattil [email protected] +1 212 412 7922

Alex Gennis [email protected] +1 212 412 1370

High Yield & Leveraged Loans

Bradley Rogoff, CFA [email protected] +1 212 412 7921

Michael Anderson, CFA [email protected] +1 212 412 7936

Gautam Kakodkar [email protected] +1 212 412 7937

Eric Gross [email protected] +1 212 412 7997

Michael Kessler [email protected] +1 212 412 3031

Analyst Certification(s) We, Jeffrey Meli, Bradley Rogoff, Michael H Anderson, Gautam Kakodkar, Shobhit Gupta, Praveen Korapaty, Hari Manappattil, Eric Gross, Mike Kessler and Alex Gennis, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgi-bin/all/disclosuresSearch.pl or call 212-526-1072. Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capital may have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/or an affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and / or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel to determine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise.

Explanation of the High Grade Sector Weighting System Overweight: Expected six-month excess return of the sector exceeds the six-month expected excess return of the Barclays Capital U.S. Credit Index or Pan-European Credit Index, as applicable. Market Weight: Expected six-month excess return of the sector is in line with the six-month expected excess return of the Barclays Capital U.S. Credit Index or Pan-European Credit Index, as applicable. Underweight: Expected six-month excess return of the sector is below the six-month expected excess return of the Barclays Capital U.S. Credit Index or Pan-European Credit Index, as applicable. Explanation of the High Grade Research Rating System The High Grade Research rating system is based on the analyst's view of the expected excess returns over a six-month period of the issuer's index-eligible corporate debt securities to the Barclays Capital U.S. Credit Index, the Pan-European Credit Index or the EM Asia USD High Grade Credit Index, as applicable. Overweight: The analyst expects the issuer's index-eligible corporate bonds to provide positive excess returns relative to the Barclays Capital U.S. Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months. Market Weight: The analyst expects the issuer's index-eligible corporate bonds to provide excess returns in line with the Barclays Capital U.S. Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months. Underweight: The analyst expects the issuer's index-eligible corporate bonds to provide negative excess returns relative to the Barclays Capital U.S. Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months. Not Rated (NR): An issuer which has not been assigned a formal rating. Rating Suspended (RS): The rating has been suspended temporarily due to market events that make coverage impracticable or to comply with applicable regulations and/or firm policies in certain circumstances including where Barclays Capital is acting in an advisory capacity in a merger or strategic transaction involving the company. For Japan and Australia issuers, the ratings are relative to the Barclays Capital U.S. Credit Index or Pan-European Credit Index, as applicable. Explanation of the High Yield Sector Weighting System Overweight: Expected six-month total return of the sector exceeds the six-month expected total return of the Barclays Capital U.S. High Yield 2% Issuer Capped Credit Index, or the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, as applicable. Market Weight: Expected six-month total return of the sector is in line with the six-month expected total return of the Barclays Capital U.S. High Yield 2% Issuer Capped Credit Index or the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, as applicable. Underweight: Expected six-month total return of the sector is below the six-month expected total return of the Barclays Capital U.S. High Yield 2% Issuer Capped Credit Index or the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, as applicable. Explanation of the High Yield Research Rating System The High Yield Research team employs a relative return based rating system that, depending on the company under analysis, may be applied to either some or all of the company's debt securities, bank loans, or other instruments. Please review the latest report on a company to ascertain the application of the rating system to that company. Overweight: The analyst expects the six-month total return of the rated debt security or instrument to exceed the six-month expected total return of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Market Weight: The analyst expects the six-month total return of the rated debt security or instrument to be in line with the six-month expected total return of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Underweight: The analyst expects the six-month total return of the rated debt security or instrument to be below the six-month expected total return of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Not Rated (NR): An issuer which has not been assigned a formal rating. Rating Suspended (RS): The rating has been suspended temporarily due to market events that make coverage impracticable or to comply with applicable regulations and/or firm policies in certain circumstances including where Barclays Capital is acting in an advisory capacity in a merger or strategic transaction involving the company.

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Barcap US Credit Alpha - 13 Aug 2010