l kedran garrison panageas eand co fixed income...

F E B R U A R Y 2 5 , 2 0 0 9

T H E D E C L I N E A N D F A L L O F T H E S E C U R I T I Z A T I O N M A R K E T S

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Kedran Garrison PanageasFixed Income Strategy: CDOs / Interest Rate Derivativeskedran g panageas@jpmchase com

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(212) 270-0137

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This presentation was prepared exclusively for the benefit and internal use of the JPMorgan client to whom it is directly addressed and delivered (including such client’s subsidiaries, the “Company”) in order to assist the Company in evaluating, on a preliminary basis, the feasibility of a possible transaction or transactions and does not carry any right of publication or disclosure, in whole or in part, to any other party. This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither thisonly and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be disclosed or used for any other purpose without the prior written consent of JPMorgan.

The information in this presentation is based upon any management forecasts supplied to us and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. JPMorgan’s opinions and estimates constitute JPMorgan’s judgment and should be regarded as indicative, preliminary and for illustrative purposes only. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was otherwise reviewed by us In addition our analyses are not and do not purport to be appraisals of the assets stock or business of the Company or any

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otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of the Company or anyother entity. JPMorgan makes no representations as to the actual value which may be received in connection with a transaction nor the legal, tax or accounting effects of consummating a transaction. Unless expressly contemplated hereby, the information in this presentation does not take into account the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation and other effects.

Notwithstanding anything herein to the contrary, the Company and each of its employees, representatives or other agents may disclose to any and all ith t li it ti f ki d th U S f d l d t t i t t t t d th U S f d l d t t i t t t f th

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persons, without limitation of any kind, the U.S. federal and state income tax treatment and the U.S. federal and state income tax structure of the transactions contemplated hereby and all materials of any kind (including opinions or other tax analyses) that are provided to the Company relating to such tax treatment and tax structure insofar as such treatment and/or structure relates to a U.S. federal or state income tax strategy provided to the Company by JPMorgan.

JPMorgan’s policies prohibit employees from offering, directly or indirectly, a favorable research rating or specific price target, or offering to change a rating or price target, to a subject company as consideration or inducement for the receipt of business or for compensation. JPMorgan also prohibits its T

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research analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to benefit investors.

JPMorgan is a marketing name for investment banking businesses of JPMorgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan arranging, financial advisory and other investment banking activities are performed by a combination of J.P. Morgan Securities Inc., J.P. Morgan plc, J.P. Morgan Securities Ltd. and the appropriately licensed subsidiaries of JPMorgan Chase & Co. in Asia-Pacific, and lending, derivatives and other commercial banking activities are performed by JPMorgan Chase Bank, N.A. JPMorgan deal team members may be employees of any of the foregoing D

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g p y g , g y p y y g gentities.

This presentation does not constitute a commitment by any JPMorgan entity to underwrite, subscribe for or place any securities or to extend or arrange credit or to provide any other services.

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OverviewOverview

The global ‘liquidity glut’ sought out yield and ‘Fed’ the housing bubbleThe global liquidity glut sought out yield and Fed the housing bubble.

Risk-based capital requirements and off-balance sheet accounting led to an explosion of securitization.

CDO ff d di ifi ti d dit t hi b t k d i i l

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CDOs offered diversification and credit tranching but repackaged increasingly levered securities; correlation was massively underestimated.

Subprime and CDO losses triggered a system-wide de-leveraging process; securitization (the unregulated banking system) is in peril FinancialI

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securitization (the unregulated banking system) is in peril. Financial disclosure, accounting and regulatory capital rules will be revised.

A broad-based recapitalization of banks, guarantors, and conduits is required (halfway completed) Earlier negative returns and the spectre ofT

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(halfway completed). Earlier negative returns and the spectre of nationalization discourages private investment.

Spillover into markets such as Alt-A, HELOCs, credit cards, auto loans, student loans and commercial mortgages. Corporate lending is down as well. D

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AgendaAgenda

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Drivers of Securitization

Credit Expansion 2

9

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The role of CDOs

Subprime: the first domino 14

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The credit crunch is not contained

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Household leverage increased massively over time

Debt outstanding as percent of nominal GDP

Household leverage increased massively over time

98

7680

100Government Household Non-Financial Business

5260

40

0

20

ON

Source: Federal Reserve. As of 2008 Q2.

52Q1 55Q1 58Q1 61Q1 64Q1 67Q1 70Q1 73Q1 76Q1 79Q1 82Q1 85Q1 88Q1 91Q1 94Q1 97Q1 00Q1 03Q1 06Q1

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fed by the global liquidity glut…fed by the global liquidity glut

Trade balance and foreign purchases of agencies. Foreign net purchases of agencies and the US trade balance. 3-month avg.

F i P h f A i T d B l

30

35

es (

$bn)

-70

-60

Foreign Purchase of Agencies Trade Balance

NAFTA implemented

(Jan 1994)

China joined WTO

(Dec 2001)

20

25

of A

genc

y Se

curi

ti

-50

-40

nce

($bn

)

10

15

eign

Net

Pur

chas

e

-30

-20

Trad

e Ba

lan

0

5

Fore

-10

0ON

Source: JPMorgan, US Census, TIC

0

Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08

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The “virtuous credit cycle” kept spreads tight for a long timetime

Credit spreads and household to government debt gap

6000

7000

600

700

800Household minus Government Debt ($ bn, left) AAA Credit Card Spread to Treasuries (bp, right)

4000

5000

400

500

600

3000

4000

200

300

400

1000

2000

0

100

ON

Source: J.P. Morgan, Federal Reserve

Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08

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Securitization drove US credit expansion

Supply ($ Billions)

Securitization drove US credit expansion

Agency MBS Non Agency MBS CMBS ABS CDOs

500

71

210

391

3072,800

3,000

3,200

3,400Agency MBS Non Agency MBS CMBS ABS CDOs

345

78

230402

500

702

874888 529

64126

210 307

1 800

2,000

2,200

2,400

2,600

217

264

404646

67867

52

93

169203

330

702

67

65

203940

773 1213752

1,000

1,200

1,400

1,600

1,800

422

1020

1362

957 913 8561082 1112

1024727267

0

200

400

600

800

ON

* Non-Agency MBS through Nov. 2008Sources: J.P. Morgan, SIFMA

0

2000 2001 2002 2003 2004 2005 2006 2007 2008

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Securitization example: Pooled credit tranched riskSecuritization example: Pooled credit, tranched risk

Cash transactions involve outright purchase (true sale) of assets and funded issuance of notes

A t d i th k t (d l h ) f b l h t f i i tAssets sourced in the market (dealer warehouses) or from balance sheet of originator

Repayment of the ABS is derived from cash flow generated by the underlying assets

Broad theme for structured credit: expanding markets, increasing liquidity, distributing risk

Hedge Counterparties

Class A Notes

Asset

Class B Notes

AssetPortfolio SPV

Class C Notes

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Trustee & Custodian

Equity/First Loss

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How do ABS issued get AAA Ratings?How do ABS issued get AAA Ratings?

Trust Structure Credit Enhancement

Bankruptcy Remote Vehicle

Insulates Investor from

Internal

Excess Spread

Subordination

AAA Rating

Issuer Reserve Fund

Spread Account

Overcollateralization

Payout Events /Performance Triggers

Protects investors from

External

AAA-rated Monoline Insurer

Mortgage Insurance adverse credit developments

g g(Lender Paid)

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AgendaAgenda

C dit E i 2


Credit Expansion 2

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Basel 1 promoted securitization through regulatory arbitragearbitrage

Balance Sheet Post-SecuritizationBalance Sheet Post Securitization

Assets $100 Mortgages $98.50 Notes

Risk weight x 50%x 0% (No capital against sold

tranches)

Capital charge x 8% x 8%$98.5 Notes

Capital charge x 8% x 8%

Capital requirement $ 4.00 $ 0.00

Assets - $1.5 Equity tranche

Capital charge - x 100%

(Sold)

$1 5 Equity (Retained)Capital requirement - $ 1.50

Total Capital requirement $ 4.00 $ 1.50

$1.5 Equity (Retained)

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Capital requirement = flat 8% capital charge * risk-weighted assets (RWA)

Risk weight categories overly broad, capital charge not aligned to underlying economic risk

Basel 1

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Rating agency capital requirement less than regulatory capital charge leads to capital arbitrage via securitization

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Basel II lowered risk weights for highly rated assets, encouraging banks to invest in ABS and increasing the role of rating agencies

700%

Risk weights under Basel II Standardized Approach (%)

For IRB banks, increased reliance on external ratings to determine capital charge (risk weights by rating)

of rating agencies

Resid

650%

600%

700%Senior tranches Basel I

Rating Corporates Securitization

Resid Mortgages (Prime)*

AAA-AA 20 20 35

Single-A 50 50 35

425%400%

500%BBB 100 100 35

BB 100 350 35 Single-B 150 ** 35 Below 150 ** 35

NR 100 ** 35

250%

200%

300%

Source: BIS, June 2004. *Ratings not applicable. *Deduction/Supervisory formula.

NR 100 35

Basel I 100 100 50

N

100%

60%

35%20%12%10%8%7%

0%

100%

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AAA AA A+ A A- BBB+ BBB BBB- BB+ BB BB-

Source: BIS, June 2004.

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As allowable leverage increased, AAA spreads narrowed (and non-bank investors were priced out)

Lower capital requirement => much higher leverage on AAA ABS/CDO => very attractive Return on Equity

out)

140%

160%

180% 7% risk weight (IRB banks)

20% risk weight (Standardized Banks)

100% risk weight (Basel 1)

80%

100%

120%

n Ti

er 1

Cap

ital

AAA CLO, 2004

40%

60%

80%

Retu

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N

0%

20%

0.15% 0.20% 0.25% 0.30% 0.35% 0.40% 0.45% 0.50% 0.55% 0.60% 0.65% 0.70% 0.75% 0.80%

AAA CLO, 2006

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Source: JPMorgan. Returns assume bank capital structure of 90% senior debt, 4% Tier II capital, and 6% Tier I capital. Cost of funding: 12.5 bp spread to Libor on senior debt and 20bp spread to Libor on Tier II capital (average from June 2005-June 2007).

AAA CLO Spread over Libor

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CP markets offered non-term financing at cheap rates, aided by regulatory treatment of liquidity facilities (0% risk weighting)

CP outstanding ($ billions)

risk weighting)

1,800

2,000

2,200Asset-Backed Commercial Paper

Commercial Paper

1,200

1,400

1,600

600

800

1,000

N

0

200

400

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Jan-91 Apr-92 Jul-93 Oct-94 Jan-96 Apr-97 Jul-98 Oct-99 Jan-01 Apr-02 Jul-03 Oct-04 Jan-06 Apr-07 Jul-08

Sources: Federal Reserve

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AgendaAgenda

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Credit Expansion 2

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ABS product types

Global ABS issuance by collateral type ($bn)

ABS product types

250

300 Student LoansOther

Non US RMBSManufactured Housing

Home Eq (subprime)E i

150

200

Equipment

Credit CardsAutos

100

150

NO

0

50

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Source: JPMorgan, MCM, Bloomberg, CreditFlux, IFR, Moody’s, S&P, Fitch

Jan-00 Oct-00 Jul-01 Apr-02 Jan-03 Oct-03 Jul-04 Apr-05 Jan-06 Oct-06 Jul-07 Apr-08

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Types of Home Equity LoansTypes of Home Equity Loans

2nd Lien 1st Lien

Types of Mortgage Loans

Borrower

2nd Lien 1st Lien

2nd Lien/ High LTV

Home Equity Line of Credit

Subprime B&C Alt-B Alt-A

PrimeJumboA

Prime Near Prime

Prime Credit Impaired

Near Prime Prime Documentation

Prime

Lien

LTV

Property Type 2nd 2nd 1st

1st 1st 1st

2nd: 90% HLTV: 115%

90%-100% 80%-85% 80%-85% 75% 70%

WAC

FICO

HLTV: 115%

2nd: 8%-10%HLTV: 12%

6% 7%-8%

6.5%-7.5% 6.5% 6.25%

690-715 715 600-625 650-700 715 725

NO

Originators CountrywideCSFB (HEMT)

GMAC RFC (RFMS2)

CountrywideGreenPoint RFC (RFMS2)

Wachovia

Ameriquest Countrywide Option One

RFC

Ameriquest Impac

RFC (RAMP)

CountrywideIndyMac

RFC (RALI)

Chase CountrywideWells Fargo

WaMu

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Asset BackedHome Equity

MortgageBacked

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Fuel for the fire: declining credit standards, increased reliance on refi and a burst of the real estate bubble

36%

Increases in 2nd’s and low documentationSubprime and Alt-A delinquencies on the rise (60+ del as % current balance)

reliance on refi, and a burst of the real estate bubble

28%

32%

36%Subprime Alt-A Prime Jumbo

30%

40%

16%

20%

24%

Dec 200610%

20%

8%

12%

16%

-10%

0%

NO

0%

4%

Jan- Apr- Jul- Oct- Jan- Apr- Jul- Oct- Jan- Apr- Jul- Oct- Jan-

-20%2000 2001 2002 2003 2004 2005 2006 2007

Silent 2nds % Stated Doc %FI

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93 94 95 96 98 99 00 01 03 04 05 06 08Silent 2nds % Stated Doc %National 12m HPA (Dec)

Source: JPMorgan, National Mortgage News, FARES, LoanPerfromance. Source: JPMorgan, Loan Performance.

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Basecase collateral loss estimates were around 4-5%Basecase collateral loss estimates were around 4-5%

Typical HEL ABS Structure HEL ABS ARM cumulative losses by loan age (months)

7%

8%

9% 2000 2001 2002 2003

2004 2005 2006 2007

AAA: 21-100%

5%

6%

7%

AA: 12-21%

3%

4%

5%

NO

Single-A: 7-12%

BBB+ : 6-7% BBB: 5-6%

BBB- : 4-5% 1%

2%

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First-Loss: 0-2%

Source: JPMorgan

BB+: 3-4%BB- : 2-3% 0%

1 9 17 25 33 41 49 57 65 73 81 89 97 105

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AgendaAgenda

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Credit Expansion 2

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What is a CDO?

Basic Accounting

What is a CDO?

A CDO is a tranched investment fund

CDO Balance Sheet

A CDO is a tranched investment fund

Comparable to a finance companyBorrows money (liabilities)Invests in collateral (assets)Has residual value (equity)

Equity represents an ownership stake and first loss position

Typically managed by a seasoned assetAssets

Liabilities

CDO Typically managed by a seasoned asset manager with a strong track record in the respective asset class

Repayment of liabilities relies on the performance of the underlying collateral

CDO collateral

pool

Senior & Mezz Debt

p y g

Credit enhancement and tranching created different rating levels, allowing involvement of a wide investor base

Equity investors look for monetization ofCDO Equity

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Equity investors look for monetization of illiquidity premia and ratings arbitrage

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Indicative CDO timeline

Event

Indicative CDO timeline

5-7 weeks

7-10 weeks

8-14 weeks

Structuring

Draft Documents

Warehouse Assets 8-14 weeks

4-8 weeks

3-5 weeks

Warehouse Assets

Equity Marketing

Debt Marketing

Pricing

Closing and Funding

3-6 monthsRamp-up Period

Non-Call Period 3-5 years

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5-7 yearsReinvestment Period

Note: The information presented above is indicative and subject to change. The timeline of an actual CDO may vary significantly from the information set forth above.

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The CDO market boom (and bust) cycle

Global issuance by collateral type ($bn)

The CDO market boom (and bust) cycle

600

700

800HY Loans IG* / HY Debt Mezzanine ABS, CRE High Grade ABS Other, CDO^2, EM

400

500

600

200

300

400

0

100

OS

Source: JPMorgan, MCM, Bloomberg, CreditFlux, IFR, Moody’s, S&P, Fitch.*Excludes unfunded IG corporate exposure

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

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ABS CDOs hold other Asset-Backed Securities

Mezz ABS collateral by sector (x-axis: vintage)

ABS CDOs hold other Asset-Backed Securities

Mezz ABS collateral by rating (x-axis: vintage)

20%

40%

60%

80%

100%

20%

40%

60%

80%

100%

0%

20%

2003 2004 2005 2006 2007

AAA AA A BBB <=BB

0%

20%

2003 2004 2005 2006 2007

HEL RMBS CDO CMBS Other ABS

High Grade ABS collateral by rating (x-axis: vintage)

60%

80%

100%

High Grade ABS collateral by sector (x-axis: vintage)

60%

80%

100%

0%

20%

40%

2003 2004 2005 2006 2007

0%

20%

40%

60%

2003 2004 2005 2006 2007

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Source: Intex, JPMorgan

HEL RMBS CDO CMBS Other AAA AA A BBB <=BB

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Higher rated assets allow higher leverageHigher rated assets allow higher leverage

Typical Mezzanine ABS CDO Structure Typical High Grade ABS CDO Structure

Sr. AAA: 38 100%38-100%

(Unfunded)Sr. AAA: 17-100%

(Term funded or CP)

Jr. AAA: 23-38%

AA: 15-23%AA: 15-23%

A: 10-15%

BBB: 5-10%

Jr. AAA: 7-17%

AA: 3.5-7%

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BB/Equity: 0-5%

BBB: 5 10%

BB/Equity: 0-1%

A: 2-3.5%

BBB: 1-2%

Source: JPMorgan

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Securitization can be “synthetic”Securitization can be synthetic

Illustrative synthetic ABS CDO structure

Credit Default Swap Portfolio

P i P t ti

Issuing Trust

Trustee

Asset Manager

Contingent Collateral Account:

Designated Aaa/AAA

Premium Protection

Cash

Security

Senior AAA

Notes (unfunded)

Junior AAA Notes

Subordinate

Notes

Preferred

Shares

Asset ManagerSecurity Cash

Aaa/AAAABS assetsPremium Protection

Notes (unfunded) (funded) (funded) (funded)

Collateral amortization and interest payments

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Source: JPMorgan

Collateral losses and contingent payments

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Synthetics facilitated the growth of ABS CDOs beyond the cash market

% of US Mezz ABS CDO issuance in synthetic formatTotal Mezz ABS CDO volume* vs US BBB/BB HEL ABS issuance ($ billions)

cash market

80%

90%

100%

Cash Synthetic

50

60HEL issuance HEL issuance inside CDOs

60%

70%

80%

30

40

30%

40%

50%

20

30

0%

10%

20%

0

10

OS

2001 2002 2003 2004 2005 2006 2007

Source: JPMorgan, MCM, Bloomberg, CreditFlux, IFR, Moody’s, S&P, Fitch. Source: JPMorgan, MCM, Bloomberg, CreditFlux, IFR, Moody’s, S&P, Fitch. *ABS CDO volume scaled by typical HEL share of portfolio.

2000 2001 2002 2003 2004 2005 2006 2007

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Who bought CDOs?

Estimated Supersenior ABS CDO investors by type Estimated Jr. AAA to BBB ABS CDO investors by type

Who bought CDOs?

Hedge funds

/ managers

20 0%

Bank

12.5%

Conduits &

SIVs

1%

Hedge funds

/ managers

Insurance

10%

Bank

5%

20.0%10%

Dealer

CDOs

55.0%

Insurance

7.5%Negative

Basis

24%

Dealer

50%

5.0%

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Source: JPMorgan Source: JPMorgan

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ABX and TABX: new benchmarks for ABS and CDOs

Each TABX series composed of 40 underlying reference obligations (06-2 = 20 of ABX 06-2 and 20 of ABX 06-1)

ABX and TABX: new benchmarks for ABS and CDOs

Reference Obligations ABX Ref Obs Standardized

TranchesMortgage Portfolio

AA

AAA

25-40%

40-100%BBB- 1

BBB- 3

BBB- 2

Subprime Mortgages A

BBB

BBB

15-25%

10-15%

5 10%

BBB- 4

BBB- 5

BBBBBB-

Residual 0-5%

5-10%BBB- …

BBB- 40

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Liquid synthetic benchmarks helped to re-price risk quickly

ABX 06-2 index prices

quickly

TABX BBB- 06-2/06-1 index prices

80

90

100AAA AA A BBB

80

90

100 10-15 (BBB/BB)

15-25 (A)

25-40 (AA)

40-100 (AAA)

50

60

70

50

60

70

30

40

50

30

40

50

0

10

20

0

10

20

OS

Source: JPMorgan, Markit

2/15/07 8/2/07 1/17/08 6/19/08 10/30/08

Source: JPMorgan, Markit

2/16/07 7/20/07 12/27/07 5/29/08 10/30/08

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Turmoil in the short-term markets implies balance sheet squeeze even liquidation

ABCP outstandings ($bn) Bank borrowing costs (%)

squeeze, even liquidation

5.5

6

6.5

1,000

1,200 Other Asset-backed

4

4.5

5

600

800

ED

3

3.5

4

400

600

TC

ON

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2

2.5

Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-080

200

0 8 1 0 1 0 1 1 0 1 0 1 0 9NC

HI

SN

OT

1M Libor 1M EuriborABCP 30 Day Fed Funds1/

30

2/28

3/3

4/3 0

5/3

6/30

7/3

8/3

9/30

10/3

11/3

0

12/3 1/30

2/29

Source: Federal Reserve Board Source: JPMorgan

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Off-balance sheet assets weren’t far enough off balance sheetsheet

15 largest global liquidity providers (as of 2007 Q1)

I $

Estimated putable HG ABS CDO ABCP exposure (as of 08/2007)

Put provider O di ($ )Issuer $mnABN AMRO Bank N.V. 103,075Citibank, N.A. 90,798Bank of America Corp. 84,637JPMorgan Chase Bank N.A 73,342Morgan Stanley 64 764

Put provider Outstandings ($mn)

Citi $18,968 Barclays $18,805 Soc Gen $5,855 West LB $5,777 BOA $4,600 Morgan Stanley 64,764

Wachovia Bank N.A. 51,282Barclays Bank PLC 49,866Deutsche Bank AG 42,594Bank of Scotland 42,121Rabobank Nederland 41 669

$ , Credit Suisse $4,022 Calyon $4,020 Goldman Sachs $3,865

Bear Stearns $3,600 Wachovia $2,293

ED

Rabobank Nederland 41,669Societe Generale 38,450Lloyds TSB Bank PLC 32,583Royal Bank of Scotland PLC 32,269WestLB AG 30,390Fortis Bank 29,201

UBS $1,672 JPMorgan $880

Rabobank $880 AIG $737 Merrill $624 Morgan Stanley $174T

CO

NT

AI

NE

Source: Standard & Poors.

,Total 807,041

Morgan Stanley $174

Total $76,771 Source: JPMorgan, Moody’s, S&P, Fitch, Bloomberg, MCM.

NC

HI

SN

OT

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Into the vortex: declining asset prices pull equity prices ever downwardsever downwards

ABX.07-1 AAA versus BKX* index prices

100

120

90

100

BKX (left) ABX.07-1 AAA (right)

80

60

70

80

ED

60

40

50

60

TC

ON

TA

IN

E

20

40

20

30

40

NC

HI

SN

OT

Source: J.P. Morgan, Markit, Bloomberg. *KBW bank stock index.

20

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09

20

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Structured Finance writedowns necessitate capital infusions across the bank and guarantor community

Financial writedowns and credit losses - $1.1tn and counting ($bn)

infusions across the bank and guarantor community

Share of losses taken worldwide by investor type

250

300Americas Europe Asia

GSEs

10%

Insurers

15%

150

200Banks/

Brokers

75%

ED

100

150

400

500 Worldwide

Financial capital raised - $1tn so far ($bn)

TC

ON

TA

IN

E

0

50

0

100

200

300

NC

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Source: Bloomberg. Does not include trading losses.

4Q08 3Q08 2Q08 1Q08 4Q07 3Q07 Prior 1Q09 4Q08 3Q08 2Q08 1Q08 4Q07 3Q07

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A decent chunk of banks’ capital holes have been plugged, but $750 1000b i$750-1000bn remains

Estimates of financial sector potential losses as of October 2008 (in billions of US dollars)

Breakdown of Losses

Out-

standing

Estimated Losses on Loan & Mark-to-

market Losses on Securities Banks Insurance

Pensions/ Savings

GSEs & Government

Other (Hedge

Funds, etc.)

Unsecuritized Loans

Subprime 300 90 Alt-A 600 100 Prime 3,800 100 Commercial real estate 2,400 60 Consumer loans 1,400 40 Corporate loans 3 700 75E

D

Corporate loans 3,700 75 Leveraged loans 170 20

Total for loans 12,370 485 215-280 20-40 20-40 60-100 80-100

Securities ABS 1,100 300 ABS CDOs 400 300

TC

ON

TA

IN

E

Prime MBS 3,800 150 CMBS 940 300 Consumer ABS 650 25 High-grade corporate 3,000 50 High-yield corporate 600 50 CLOs 350 50N

CH

IS

NO

T

Source: J.P. Morgan

CLOs 350 50 Total for securities 10,840 1225 615-690 170-200 175-220 70-160 125-270

Total for loans & securities 23,210 1,710 800-1,000 190-235 160-290 125-250 200-360

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The credit crunch remains in full swing

Net percentage of domestic respondents tightening lending standards

The credit crunch remains in full swing

70

80

90

100 Resi Mortgage Loans Credit Cards CRE Loans

40

50

60

ED

0

10

20

30

TC

ON

TA

IN

E

-30

-20

-10

0

NC

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Source: Federal Reserve Board (Senior Loan Officer Survey)

Sep-90 Mar-92 Sep-93 Mar-95 Sep-96 Mar-98 Sep-99 Mar-01 Sep-02 Mar-04 Sep-05 Mar-07 Sep-08

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Danger of overshooting on the way down

1987 t 1997

S&P/Case-Shiller home price index (composite-10)

Danger of overshooting on the way down

No. of borrowers (owner occupied, first lien mortgage) by CLTV

Current CLTV

1.5

1.6 1987 to 1997

2003 to Oct 2008

Projected

Current CLTV

<80% 80-90% 90-100% >100% Borrowers

underwater Alt-A 931,310 478,112 521,972 1,357,584 41% Subprime 1,438,821 715,026 738,104 1,476,263 34% Jumbo 1,069,345 307,495 247,956 383,490 19% A 20 00 000 6 900 000 2 00 000 200 000 %

1.3

1.4 Currently down 25%

from 6/06 peak

10/89 – 12/97: 8 years

Agency 20,100,000 6,900,000 2,100,000 1,200,000 4%Total 23,539,476 8,400,633 3,608,033 4,417,338 11%

State HPA distribution (peak to current HPA, market share)ED

Source: J.P. Morgan, LoanPerformance

1.2 10/89 to 2/94: down

8% peak to trough

10/89 12/97: 8 years

and 2 months

State HPA distribution (peak to current HPA, market share)

-35%-30%-25%-20%-15%

HPA

1: -32% HPA, 32% share

2: -23%, 11%

3: -14%, 10%4: -10%, 12% 0.

1%,

5%0.

02%,

4%

TC

ON

TA

IN

E

1.0

1.1-10% over 12

months

87 88 89 90 91 92 93 94 95 96 97

-10%-5%0%

0% 20% 40% 60% 80% 100%

Subprime Market Share

,5: -5%, 26%

6: -

07:

-0

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Source: J.P. Morgan, S&P/Case-Shiller

87 88 89 90 91 92 93 94 95 96 97 03 04 05 06 07 08 09 10 11 12 13

Group 1: CA, NV, AZ; Group 2: FL; Group 3: RI, MI, MA, NH, HI, OH, MN; Group 4: NY, MD, NJ; Group 5: WY, IL, VA, PA, WA, LA, DC, CT, ME, GA, WI, OR, AL, ND, CO, NE, VT, TN, AK, AR, NC, KY, DE, OK, WV, ID, UT; Group 6: TX; Group 7: NM, SC, IA, IN, KS, MO, MS, MT, SD. As of June 2008Source: J.P.Morgan, LoanPerformance

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Inventory overhang remains; buyers’ marketInventory overhang remains; buyers market

Inventory (mn units)NAR Housing Affordability Index (as of 3Q08)

3Q08 Actual 3Q09 Projected

3.5

4.0

0 5

0.55

0.6Existing (left) New (right)

Excess supply

Excess labor

300

350California

Ohio

Florida

US

3Q08 Actual 3Q09 Projected

92 137

218 323

121 180

151 224

2 5

3.0

0 4

0.45

0.5

200

250

ED

2.0

2.5

0.3

0.35

0.4

100

150

TC

ON

TA

IN

E

1.0

1.5

0.2

0.25

0

50

NC

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1/89 1/92 1/95 1/98 1/01 1/04 1/07

Source: JPMorgan, NAR, Moody’s Economy.com

Mar-79 Mar-84 Mar-89 Mar-94 Mar-99 Mar-04 Mar-09

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Bank funding pressure receding after government supportBank funding pressure receding after government support

TED spread (3-month LIBOR minus 3-month TBills, bp)

500 LIBOR minus Tbills (3-month) Average

400

450

500 LIBOR minus Tbills (3 month) Average

300

350

ED

200

250

150TC

ON

TA

IN

E

50

100

150 150

94

NC

HI

SN

OT

Source: J.P. Morgan, Bloomberg

50

7/31/07 9/30/07 11/30/07 1/31/08 3/31/08 5/31/08 7/31/08 9/30/08 11/30/08 1/31/09

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Foreclosures will get much worse: 2010 explosion in liquidationsForeclosures will get much worse: 2010 explosion in liquidations

Cumulative liquidations (number of loans)Foreclosure inventory (number of loans)

1 500 000

2,000,000Agency

Prime Jumbo

Alt-A

Subprime

6 000 000

7,000,000

8,000,000Agency

Prime Jumbo

Alt-A

Subprime

1 000 000

1,500,000

4 000 000

5,000,000

6,000,000

ED

500,000

1,000,000

2,000,000

3,000,000

4,000,000

TC

ON

TA

IN

E

0

,

0

1,000,000

2,000,000

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Source: J.P. Morgan, LoanPerformance

Nov-08 May-09 Nov-09 May-10 Nov-10 Nov-08 May-09 Nov-09 May-10 Nov-10

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High-yield loan default rate expected to rise to 10% in 2009, base

High-yield Loan Default Rate (%)

case, according to JPMorgan High Yield Strategy; risk is to upside

2009 Estimate, 10% 10%

12%

2009 Estimate, 8%12/31/2000, 8.2%

6%

8%

ED

3.75% as of Dec 31

4.35% as of Dec 314%

6%

TC

ON

TA

IN

E

0%

2%

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Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 2009

Estimate

By Dollar Amount By Issuer Count

Source: S&P LCD, JPMorgan

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AgendaAgenda

C dit E i 2


Credit Expansion 2

9

MA

RK

ET

S

The role of CDOs


19IT

IZ

AT

IO

N


e ole o C Os

30

TH

ES

EC

UR

Appendix 42

DF

AL

LO

FE

CL

IN

EA

ND


ED

Single-Name CDS basics

Single name credit default swaps

Single-Name CDS basics

Reference

Entity

Risk (Notional)

Protection

Seller

Protection

Buyer

Premium

Contingent payment upon a

Credit Event

• Buy CDS• Buy protection• “Short risk”

• Sell CDS• Sell protection• “Long risk”

• Pay periodic payments • Receive periodic payments

Source: JPMS.

Credit risk profile of shorting bond Credit risk profile of owning bond

DI

X

[ C L I E N T N A M E ] 43AP

PE

N

Synthetic Corporate SecuritizationSynthetic Corporate Securitization

Super Senior /

CDS 1

CDS 2 Single name

dit t tiBasket credit

t ti

Asset 1

Asset2

Super Senior / AAA Tranche

SPV Reference portfolio

(Static or

CDS3

…..

Periodic premium

credit protection protection

Periodic premium

Asset 3

…..

Reference Entities

AA/A Tranche

(Managed)CDS

98

CDS 99

Asset 98

Asset 99

BBB/BB Tranche

First loss

CDS 100

Asset 100

DI

X


PE

N

“Pay-as-you-go” credit default swaps specifically designed for ABS securitiesdesigned for ABS securities

Reference Obligation is cusip-specific: performance varies by trust, rating level

Trade notional amortizes with the underlyingTrade notional amortizes with the underlying

After credit events protection buyer has the option to physically settle the contractOption avoids risk of short squeeze – limited universe of deliverable obligationsAvoids reliance on cash valuation in less liquid markets

Otherwise, pay-as-you-go settlement: contingent payments as writedowns and interest shortfalls occur

Term extends to final maturity of the underlying

Pay as you go (PAYG) with physical settle option

Premium

Protection

SellerProtection

BuyerWriteups, Interest Reimbursements

Writedowns, Interest Shortfalls

Buyer

Par

Physical Bond

Source: JPMorgan.DI

X


PE

N

CDO ti b i

Most CDO tranches are rated by at least two, perhaps three, of Moody’s, Standard & Poor’s,

CDO rating basics

Sample tranche loss distribution

6%

7%

and Fitch

Rating agencies examine portfolio characteristics, structural parameters, legal documentation, and the CDO manager’s track

5%

6%record and operational experience

Rating process is to

model the portfolio

generate default distributions

3%

4%

Equity

Mezzanine 10%—20% Super Senior: from 30% up

generate default distributions

run cashflow scenarios based off default assumptions and other factors (interest rates, default timing, etc.)

quantify tranche risk

1%

2%

Equity 0%—10%

quantify tranche risk

All three agencies have moved to a Monte-Carlo approach - assets are modeled with individual

default probabilities

0 503% 6%0%

1%

0% 10% 20% 30% 40% 50% 60%

recovery rates (possibly stochastic)

asset correlation factors to — industry / ABS sector— wider market

i i (ABS/CMBS) (CDO)

DI

X

[ C L I E N T N A M E ]

— originator (ABS/CMBS) or manager (CDO)

46AP

PE

N

Intex is predominant cashflow modeling toolIntex is predominant cashflow modeling toolD

IX


PE

N

Typical debt scenario analysis

200

Typical debt scenario analysis

10% recovery rate (Trust Preferred CDO)

100

150

200AAA, No call

Single-A, No call

50

100

ount

Mar

gin

-50

0

0 0.4 0.8 1.2 1.6 2 2.4 2.8 3.2 3.6 4 4.4 4.8 5.2 5.6 6 6.4 6.8 7.2 7.6 8

Tran

che

Disc

o

-150

-100

-200 Annual Default Rate1

DI

X


PE

N