Is There More Upside in High Yield?

DC Finance Institutional Investor Conference

May 24, 2010

2

Global Credit Strategy

● Par is not a ceiling

● The key is what happens to the default rate

● Economic trend favors a lower default rate

● Diverse approaches point to a default rate decline

● “Wall of Maturities”: An overstated problem

3

Par Is Not a Ceiling

4

After This Big a Rally, Can We Expect Good Performance?

All-Time High (28 Feb 2005)

Average (1998 - 2009)

All-Time Low ( 12 December 2008)

PAR

50

60

70

80

90

100

110

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

2009 2010

Pri

ce o

f G

lob

al H

igh

Yie

ld I

nd

ex

Source: BofA Merrill Lynch Global Research.

5

There Is Upside from 100

U.S. High Yield Year Index Beginning Price

1997 99.483

2004

Income

Price Gain

Total Return

Key:

Source: BofA Merrill Lynch Global Research.

Total Return for the Year

9.12%

4.15%

7.00%

2.60%

7.77%

2.62%

High Yield Government Investment GradeCorporates

13.27%

9.60%10.39%

8.46%

2.41%

4.36%

-0.94%

5.95%

-0.53%

High Yield Government Investment GradeCorporates

10.87%

3.42%

5.42%

102.621

6

The Key Is What Happens to the Default Rate

7

Change in Default Rate versus High Yield Price Return

-3.32

3.95

-5

-4

-3

-2

-1

0

1

2

3

4

5

Rising Default Rate Declining Default Rate

Mea

n P

rice

Ret

urn

(%

)

1987 – 2009, Annually

Sources; BofA Merrill Lynch Global Research, Moody’s Investors Service.

In 17 out of 23 years, the default rate and the high yield index price moved in opposite directions

8

Economic Trend Favors a Lower Default Rate

9

Real Growth in GDP – Germany

2008 – 2010, Quarterly

Sources; Bloomberg.

-8

-6

-4

-2

0

2

4

6

1 2 3 4 1 2 3 4 1 2 3 4

2008 2009 2010Ch

ang

e o

ver

Pre

ced

ing

Per

iod

- A

nn

ual

Rat

e (%

)

Historical Projected

10

Real Growth in GDP – U.S.

2008 – 2010, Quarterly

Sources; Bloomberg.

-8

-6

-4

-2

0

2

4

6

8

10

1 2 3 4 1 2 3 4 1 2 3 4

2008 2009 2010Ch

ang

e o

ver

Pre

ced

ing

Per

iod

- A

nn

ual

Rat

e (%

)

Historical Projected

11

Real Growth in GDP – U.K.

2008 – 2010, Quarterly

Sources; Bloomberg.

-8

-6

-4

-2

0

2

4

6

8

1 2 3 4 1 2 3 4 1 2 3 4

2008 2009 2010Ch

ang

e o

ver

Pre

ced

ing

Per

iod

- A

nn

ual

Rat

e (%

)

Historical Projected

12

Diverse Approaches Point to a Default Rate Decline

13

Global Default Rate

1985-2010, Quarterly

Sources: BNP Global Credit, Moody’s Investors Service. - - - Moody’s projection

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1Q

85

1Q

86

1Q

87

1Q

88

1Q

89

1Q

90

1Q

91

1Q

92

1Q

93

1Q

94

1Q

95

1Q

96

1Q

97

1Q

98

1Q

99

1Q

00

1Q

01

1Q

02

1Q

03

1Q

04

1Q

05

1Q

06

1Q

07

1Q

08

1Q

09

1Q

10

Qu

arte

rly

Rat

e (%

)

3.78%

Projected April 2011: 0.50%

Mean = 1.24%

Moody;s employs atime-tested econo-metric model

14

Liquidity Correlates with Default Rate

0

10

20

30

40

50

60

1 2 3 4

Speculative - Grade Liquidity Rating

One

-Yea

r D

efau

lt R

ate

(%)

M

arch

200

9 to

Mar

ch 2

010

Source: Moody's Investors Service.

The least liquidcompanies defaultat a much higher ratethan the others

15

Liquidity Improvement Points to Default Rate Decline

0

5

10

15

20

25

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

2007 2008 2009 2010

SG

L-4

as P

erce

nt o

f All

SG

L R

atin

gs

Source: Moody's Investors Service.

The number of highlyilliquid companies hasfallen dramatically

16

Market-Based Default Rate Forecast

Source: BofA Merrill Lynch Global Research.

As of May 6, 2010

The proportion of companieswith spreads greater than +1,000basis points has declined from apeak of 84% in December 2008

Distribution Annualof High Yield Default WeightedUniverse (%) Rate (%) Average (%)

Distressed 9.87% x 23.53% = 2.32%Non-distressed + 90.13% x 1.23% = 1.11%Cyclical Adjustment Factor + -0.75% = -0.75%

Default Rate Forecast = 2.68%

17

“Wall of Maturities”: An Overstated Problem

18

Distribution of U.S. Debt Maturities

2010-2020, Annually

0

50

100

150

200

250

300

350

400

450

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

$ B

illio

n

High Yield Bonds Leveraged Loans

Source: BofA Merrill Lynch Global Securities.

Maturing debt is not a significant problem in 2010-2011

19

Projected Resolution of 2010-2014

$770 Billion Leveraged Loan Maturities

Source: Fitch Ratings.

$425 Billion Loan Refinancing

$75 Billion Other

$55 Billion Mandatory

Prepayments

$86 Billion Bond- for-Loan Takeouts

$135 Billion Amend + Extend

Agreements Fitch sees 90% of maturities being resolved before taking into account equity issuance oracquisitions

20

Fitch’s Key Assumptions

● Loan issuance at 1998-2003 level (before CLO boom)

● Only modest CLO new issuance

● 45% of loan issuance used to refinance loan maturities

● $125 billion annual high yield issuance – below peak levels, which are considered unsustainable

● Non-refinancing uses of high yield issuance at levels consistent with historical experience

21

Conclusion

We cannot travel backward in time to buy the high yield market at 54,

But among the opportunities available today, high yield remains attractive.

High Yield should outperform conventional fixed income over the next 12 months.