Barclays Quanto Credit Rpt

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CREDIT RESEARCH U.S. Credit Alpha | 23 April 20

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 27

U.S. CREDIT ALPHA

Negative Headlines Obscure StrongFundamentals

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

US credit underperformed equities but outperformed European credit as negative

headlines concerning financials and Greece counterbalanced strong earnings and

generally positive economics news.

Focus: Hedging FX Risk with Cross-currency Swaps ......................................................... 4

For credit investors access to markets in different geographies often allows attractiverelative value opportunities, but such cross-border trades also have their own set of

risk issues, especially related to hedging peripheral risks such as interest rate and FX

risk. We show how cross-currency basis swaps can be used to hedge these risks and go

through the mechanics of the swaps.

Investment Grade: Euro Credit at All-time Wides to Dollar Credit .................................12

A combination of secular and cyclical trends has cheapened European credit versus US

credit, while the EUR-USD cross-currency swap remains dislocated and should benefit

investors swapping EUR cash flows into USD. Investors can pick-up 20bp to 77bp of

yield by buying EUR-denominated bonds and switching them into dollars.

High Yield: Sentenced to 144a-for-Life...............................................................................17

144a-for-life issuance is considerably higher this year relative to the index average, and

we believe this feature will remain prominent. 144a-for-life industrials have

outperformed the rest of the HY industrials space by about 100bp year-to-date.

Leveraged Loans: Exit Loans for CLOs ................................................................................20

As the calendar for bankruptcy emergences becomes more visible, we expect exit

financing to be a major component of 2010 loan Issuance. On average, spread on exit

loans have been more than 150bp wide of the general loan new issue, making them

attractive candidates for secondary CLOs.

Structured Credit and Volatility: Costless LCDX Option on Short-term Defaults........22The increased ability of issuers to refinance and term out debt in the current improved

macro environment has caused default expectations to dip significantly in the short

term. In particular, our default outlook for the LCDX.10 index is fairly benign except for

a few names in the portfolio. Therefore, we recommend that investors get long 8-12%

and short 5-8% in the 3y tenor.

Ashish Shah

+1 212 412 7931

[email protected]

Jeffrey Meli

+1 212 412 2127

[email protected]

Bradley Rogoff

+1 212 412 7921

[email protected]

Michael Anderson

+1 212 412 7936

[email protected]

Matthew Mish

+1 212 412 2183

[email protected]

www.barcap.com



Barclays Capital | U.S. Credit Alpha

23 April 2010 2

OVERVIEW

Negative Headlines Obscure Strong Fundamentals

Credit underperformed equities as the CDX.IG14 index widened 2bp, to 89bp (after gapping

5bp wider last Friday), and the CDX.HY14 rose ¼ point, to $100.75, as negative headlinessurrounding financials and sovereigns took a disproportionate toll on credit. However, US

credit continued to outperform European credit, as the iTraxx Main and Xover indices were

6bp and 8bp weaker, respectively.

Financials were front and center, with large money center banks (e.g., Citigroup, Bank of

America) reporting generally solid results amid robust capital markets activity and lower

loss provisions. Regional banks sounded more conservative, but affirmed similar themes

about credit quality and loss provisions. However, concerns about the negative rating

implications of the proposed U.S. regulatory reform legislation (i.e., without the assumption

of potential extraordinary government support, certain large financial institution ratings

would be two to three notches lower) moved sector spreads wider, given the potential

forced selling from rating-constrained investors. Lingering anxiety about the strength andscope of the SEC’s investigation into Goldman Sachs and more litigation headlines/potential

spillover effects to other banks also weighed on spreads.

Greece spreads were under pressure following Moody’s downgrade to A3, on review for

further downgrade (from A2 negative outlook), with Greece CDS breaching 600bp intra-

week from 435bp at the start of the week. The agency cited significant risk that the debt

may stabilize only at a higher and more costly level than previously estimated, a somewhat

discernable shift relative to what the agency outlined as the rationale for the A2 rating back

in December (i.e., the proposal/execution of its fiscal initiatives, its low liquidity risk profile,

and forthcoming conditional support from the EU/IMF). While investor inquiry about

potential scenarios for Greece increased notably this week, credit markets in the US and

Europe proved very resilient, with the correlation between Greece CDS and CDX.IG (and

iTraxx Main) continuing to decline (Figure 1).

Ashish Shah

+1 212 412 [email protected]

Weekly Index Changes Figure 1: One-Month Rolling Correlations Between CDX.IGand Greece/SovX/Banks-Brokers

Thursday

Close

Last

Week

Close

4-week

Average

Credit Index (bp) 128 128 132

CDX.IG.14 (bp) 89.0 87.0 86.1

High-Yield Index ($ price) 99.24 99.29 98.40

CDX.HY.14 ($ price) 100.75 100.50 99.63*

Leveraged Loan Index ($ price) 92.18 92.38 91.92

LCDX.14 ($ price) 99.75 100.38 99.20*

-20%

0%

20%

40%

60%

80%

100%

Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10

Greece/IG SovX/IGBanks-Brokers/ IG

Note: *Since Series 14 began trading. Source: Barclays Capital Source: S&P LCD, Barclays Capital




23 April 2010 3

Very strong corporate earnings provided sizeable support for the market, with an

overwhelming 83% of S&P500 companies to-date beating expectations, versus 9% missing

(at this point last quarter, 80% bested estimates, 13% missed). Top-line growth is surprising

to the upside, with 53% of firms reporting sales above estimates, versus 30% in line and 17%

below views. The positive bias is heavily geared toward cyclicals, with consumer discretionary,

financials, industrials and tech posting some of the largest revenue beat-to-miss ratios.

M&A activity continues to ramp up. Sectors more ripe for consolidation, e.g., telecoms,

airlines, were lively as CenturyTel bid for Qwest Corp. to gain scale and US Airways dropped

talks with United Airlines as the carrier is said to favor a combination with Continental

Airlines.1 The return of animal spirits among executives was evident across earnings calls, e.g.

Terex’s CEO DeFeo noted the company is definitely looking for larger transactions. This theme

is also bolstering high yield firms looking to increase value via monetizing assets and/or

obtaining cheaper financing; e.g., Blackstone is reported to be considering restructuring Equity

Office Property’s debt, and several bidders are emerging for Extended Stay.

We remain constructive on credit longer term and believe fundamentals justify notably

tighter levels absent financial/sovereign concerns. In our view, financial spreads have re-

priced to largely reflect these risks, and the sector should outperform over the long run once

we get more clarity on financial reform and ratings risk.

Finally, as investment themes become increasingly global, investors have shown increasing

interest in cross-border opportunities but are wary of the risks associated with buying

foreign-currency denominated credit. In the second of a two-part series, we show how

cross-currency swaps can be used to hedge these risks. We focus on the mechanics of the

trades and explain the cause of the basis between currencies. We also explain how investors

can structure trades to take advantage of relative value across currencies.

For this week’s U.S. Credit - On Deck, please click here.

1 “US Air Said to See UAL Favoring Continental Merger”, Bloomberg, dated April 22, 2010.

https://live.barcap.com/go/research/content?contentPubID=FC1590316





23 April 2010 4

FOCUS: MANAGING FX RISK IN CORPORATE BONDS

Hedging FX Risk with Cross-currency Swaps

For credit investors access to markets in different geographies often allows attractive

relative value opportunities, but such cross-border trades also have their own set of riskissues, especially related to hedging peripheral risks like interest rate and FX risk. Bond

investors are not only exposed to currency risk on the fixed coupon and principal cash

flows, but in case of default are also faced with quanto risk on the recovery. Cross-

currency basis swaps are a powerful tool for modifying cash flows both across currencies

and between fixed and floating formats. In fact, these swaps are a natural extension of the

term structure of FX instruments available for hedging, with maturities of up to 30 years in

liquid currencies.

Cross currency basis swaps

As the name suggests, cross-currency swaps have interest rate payments in the two legs

set in two different currencies. To eliminate FX risk on the principal amounts these swapsalso incorporate an actual exchange of notionals in the different currencies (usually at

maturity, sometimes also at inception). The notionals in the two currency legs are usually

set in a ratio equal to the spot FX rate at inception.

Floating/floating cross currency swaps (also known as cross currency basis swaps ) are

the most basic currency swaps and can be combined with plain vanilla swaps (in single

currencies) to create fixed/floating or fixed/fixed currency swaps. Thus, most market

quotes are for floating/floating (basis) swaps. The market convention is to quote basis

swaps as the spread over Libor paid/received in one currency when receiving/paying Libor

flat in the other currency (the liquidity reference). Figure 1 shows the cash flows for a 5y

swap exchanging 3m USD Libor for 3m EUR Libor. The quote itself was at -23/-19bp,

which means the market maker pays/receives Euribor -23/-19bp versus receiving/payingUSD 3m Libor flat.

Figure 1: Cash flows for 5y EUR-USD cross currency swap, 5 March 2010

2010 2011 2012 2013 2014 2015

EUR cash flows USD cash f lows

Recv 3m Euribor - 23 bps on € 0.73 MM

Pay 3m Usdlibor flat on $ 1 MM

Pay € 0.73 MM; Recv $1 MM

Optional swap of notionals at inception

Pay $1 MM; Recv € 0.73 MM

Mandatory swap of notionals at maturity

Notionals set at spot FX rate of 1.36 on

day of inception

Note: The sizes of the bars are not to scale. Source: Barclays Capital

Arup Ghosh

+44 (0) 20 7773 [email protected]

Matthew Leeming

+44 (0) 20 7773 9320

[email protected]




23 April 2010 5

Understanding the cross-currency basis spread

A floating rate note paying Libor should be priced at (or close to) par in its own currency. This

would imply that a basis swap with notionals on the two legs set in a ratio equal to the spot FX

rate should be priced fairly when both legs pay Libor flat. This would also suggest that market-

quoted basis swaps somehow price in an arbitrage opportunity as one leg pays a spread

above or below Libor. However, the apparent arbitrage vanishes provided the appropriate

swap curve adjusted by the basis is used to discount the cash flows (as is convention). There

are structural reasons for the existence of the cross-currency basis, for example:

Liquidity costs: Cross currency swaps are a powerful way for entities to raise funding in

different currencies. The net balance of demand and supply in the market for funding in

one currency over the other is expressed through the quoted spread, which can be

considered as the liquidity premium charged by the market to convert cash flows

between the currencies. The more negative the basis, the more expensive it is to raise

funding in the currency that is quoted as the liquidity benchmark.

Default concerns: Unlike most other swaps, cross-currency basis swaps involve an

exchange of principal. Thus, systemic concerns about default and counterparty risk in

different currency geographies can also affect the basis. This, however, is probably alesser concern.

Figure 2 shows the current market structure of cross-currency swaps across currencies and

maturities.

For investors who do not have a buy-to-hold view, the mark-to-market on the cross

currency swap also becomes important to consider. Figure 3 plots the time series of basis

for swaps from three currencies to USD over the past three years. The direction of the basis

correlates well with the flight to safer currencies that happened during the credit crunch. Of

course spread changes can lead to either mark-to-market losses or gains for an investor

depending on the direction of the initial swap.

Figure 2: Cross currency market quotes, 26 February 2010

A: Cross currency basis swaps quoted vs USD Libor (flat) B: Term structure of basis swaps

-50

-40

-30

-20

-10

0

10

20

30

40

50

AUD CAD GBP EUR CHF JPY RUB

X

c u r r e n c y b

a s i s ( b p s )

1Y

5Y

10Y

The lower the spread vs USD Libor the

tighter the dollar liquidity in those markets

-40

-30

-20

-10

0

10

20

0 5 10 15 20 25 30Term (years)

X

c u r r e n c y b a s i s ( b p s )

EUR 3m Libor + spread vs USD 3m Libor flatGBP 3m Libor + spread vs USD 3m Libor flatGBP 3m Libor + spread vs EUR 3m Libor flat

Source: Barclays Capital




23 April 2010 6

Figure 3: Cross-currency basis time series; quotes versus USD

-100

-80

-60

-40

-20

0

20

40

60

Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10

X

c u r r e n c y b a s i s ( b p

s )

CAD 5y swap

GBP 5y swap

EUR 5y swap

Source: Bloomberg, Barclays Capital

Cross-border relative value in bonds

From a bond investors’ perspective, the biggest use of cross-currency swaps is in converting

cash flows of foreign currency bonds into local currencies. Since investors are usually most

familiar with domestic issuers, they often charge a premium to hold bonds of foreign

issuers, even when denominated in the domestic currency. Figure 13 highlights this

difference. The chart on the left analyses two sets of single-A issuers: those raising funds in

euros and sterling, as well as those raising funds in euros and dollars. As indicated, entities

raising funds in foreign currencies currently have to pay a credit spread premium (defined

as OAS per unit of duration) of about 20%, which is fairly stable across currency zones and

the term structure. The chart on the right looks at how spreads change across issuers and

currencies for the same universes of bonds as before. As is evident, the spreads of bonds of

different issuers but in the same currency moved more closely together than the spreads of

bonds of the same issuers but in different currencies.

Figure 4: Analysis of non-fin single-A credit spread behaviour in euro, dollar and sterling markets (90 tickers, 927 bonds)

A: Relative credit cost of non-local to local issuers (4 March 2009) B: Relative spread movement; cross issuer and currency (2005-09)

80%

100%

120%

140%

160%

Near (≤4y) Mid (>4y, ≤8y) Far (>8y)

R e l a t i v e c r e d i t c o s t ( n o n l o c a l / l o c a l )

Univ of issuers with EUR & GBP bondsUniv of issuers with EUR & USD bonds

Non-local i ssuers pay around

20% more credit spread than

similarly rated local currency

40%

50%

60%

70%

80%

90%

100%

Issuers with € & £ bonds Issuers with € & $ bonds

A v g c o r r e l a t i o n o f s p

r e a d c h a n g e s

Same issuer, different currencies

Same currency, different issuers

Bonds denominated in the same

currency have higher spread

correlation even when their

isssuers are domiciled in separate

currencies

Note: Here we have defined cost of credit as spread per unit duration. Source: Markit, Barclays Capital




23 April 2010 7

Taken together, the charts indicate that not only do bonds by the same issuer often trade

cheaper in foreign currencies, but cross-border spreads might be more closely tied to the

short-term technicals of a specific market than the long-term credit fundamentals of an

individual issuer. An investor with relevant expertise on issuers with bonds trading across

different currency zones can take advantage of this kind of pricing differential using cross

currency swaps.

Putting the pieces together: Picking up bond spread cross currency

An evaluation of the cash bond curves of France Telecom highlights the cross border trade

applications of asset swaps. Different markets often see demand for different parts of the

curve, as indicated in Figure 5. Many sterling investors, like pension funds, prefer longer-

dated assets to match longer-dated liabilities, while French investors have a preference for

the middle of the curve.

Figure 5: France Telecom cash curves – euro and sterling, 9 March 2010

0

50

100

150

0 2 4 6 8 10 12 14 16 18 20 22 24

Maturity (yrs)

C a s h s p r e a d ( b p s )

Euro bond curve

Sterling bond curve

Demand from French investors

supports the front and middle

end of the Euro curve

Demand from Sterling investors

drives down the far end of the

Sterling curve

Note: Spreads above are ASW over 6m Libor. Source: Markit, Barclays Capital

This creates a pricing differential that can be taken advantage of using cross-currency basis

swaps. Figure 6 highlights the economics of investing in the two sets of bonds marked out

in Figure 5. The spreads indicated are over 3m Libor, for a par-par swap in each case.

Figure 6: France Telecom – euro versus sterling ASW spreads, 10 March 2010

Bond Maturity Clean price Spread over native

currency

Spread over Euro

(including basis)

Bond maturity ~ 8 years

£ Frtel 8 Dec 17 7.8 yrs £122 138 bp 130 bp€ Frtel 5 5/8 May 18 8.2 yrs €114 73 bp 73 bp

Bond maturity ~ 6.5 years

£ Frtel 5 May 16 6.2 yrs £104 120 bp 109 bp

€ Frtel 4 3/4 Feb 17 6.9 yrs €108 71 bp 71 bp

Note: prices/spreads are indicative as of the date mentioned. Spreads are calculated off 3m Libor in all cases.Source: Markit, Barclays Capital




23 April 2010 8

As indicated, an investor buying a sterling bond with a cross-currency swap actually picks

up 40-60bp more (above swaps) than a euro bond of slightly longer maturity.

A yield perspective; swapping between fixed coupons across currencies

Cross-currency swaps can also be used to modify bond cash flows to pay fixed coupons in a

different currency. This might be useful for investors looking to meet yield targets and are

indifferent to the benchmark swap rate. Also, investors with an outright view that rates will

be slower to rise than the yield curve implies, might choose to implement this view by

locking in the implied forward rate through a fixed coupon bond. These trades can be

structured in both ‘par’ or ‘market’ formats, with the investor investing par or the bond

price, respectively (see European Credit Alpha, 16 April 2010). A third format – a ‘coupon

swap’ – is also attractive in some cases. In this structure, the swap is set up so that only the

coupon is swapped instead of the full yield of the underlying bond. In effect, this means

there is no exchange of the “100 – price” amount as in the par and market structures. This

leads to much lower counterparty exposure between the buyer and seller and is often

attractive for cash rich investors. Figure 7 shows the cash flows in the par and coupon

formats for the France Telecom Sterling 8%, 2017 bond, and compares this to the Euro 55

/8%, 2016 bond.

Figure 7: France Telecom – euro vs sterling yields, 10 March 2010

Bond Dirty price Coupon Redemption Yield

£ Frtel 8 Dec 17

£ bond cash flows £124 8% £100 4.52%

€ par ASW cash flows €111 (= £100) 4.25% €111 (= £100) 4.39%

€ coupon ASW cash flows €136 (= £124) 7.59% €111 (= £100) 4.19%

€ Frtel 5 5/8 May 18

€ bond cash flows €118 5.625% €100 3.62%

Note: Prices/yields are indicative as of the date mentioned. Coupons are paid on the redemption value.Source: Markit, Barclays Capital

In this case by swapping cash flows from sterling to euros we believe it is possible to pick up

60-75bp more of yield compared to a euro denominated bond of similar maturity.

It is important to note that in the par (and market) format the higher counterparty exposure

leads to higher collateral posting requirements where CSAs are applicable. For cash-rich

investors it might make sense to analyse the trade by including the collateral-related cash

flows. In such case, the funding costs of this collateral will have a drag on the swapped net

yields indicated above. For example, in the par swap, the buyer will have to post £24

(=€26.4) points worth of collateral at trade inception. This collateral will be paid back to the

buyer over the life of the trade, amortising to zero at maturity. Through the trade the buyer

will earn Eonia on the amount of collateral posted at any given time. If these collateral cashflows are included in the accounting of the trade, the net yield on the par swap comes down

to around 3.9% from 4.39% (assuming Eonia levels stay unchanged, and the collateral

amortises linearly). In effect, instead of investing £124 in the credit, the buyer is investing

£100 in the underlying credit and £24 in a swap counterparty credit. In this case, as the

swap counterparty is better quality, the overall yield is reduced versus the outright bond

investment. This still leaves a pick-up of around 30bp over the comparable euro bond. For

the coupon swap, the net value of the collateral posted will be very small, and the effect on

the net yield of these cash flows will be much smaller.

Coupon swaps allow the investor

to swap just the fixed coupon

instead of the full

yield of the bond






23 April 2010 9

Clean asset swaps for cross-currency trades

When using cross-currency swaps to invest in non-local currency bonds, the investor is left

with three risks: 1) credit risk on the underlying; 2) mark-to-market on the swap in case of

default; 3) quanto risk on the recovery payment in case of default. It is possible to eliminate

such risk completely using swaps that extinguish in case of a credit event. These are called

clean asset swaps, and the swap component of the trade cancels, with zero mark-to-market

in case of a credit event. In effect, the swap leg becomes a credit-linked swap and takes into

account not only the direction and likelihood of rate and FX changes in the future, but also

the probability of default of the underlying credit. In this case, the seller of the swap absorbs

the potential mark-to-market in case of default of the underlying, and also pays the investor

recovery in the swapped currency as a percentage of notional. Thus the spread paid on

such a swap will be different from a normal swap package. It will typically depend on the

following factors among others: 1) the credit quality of the underlying name; 2) both swap

curves; 3) interest rate volatility in both currencies; 4) correlation between rates in the two

currencies; 5) FX rate volatility; as well as 6) correlations between the two interest rate

curves, FX rates and the default risk of the underlying.

Clean asset swaps are suitable

for investors looking to eliminate

all interest rate and FX exposure,

even that arising in case of a

default of the underlying bond




23 April 2010 10

Appendix: Pricing cross currency swaps

Cross-currency swaps are priced exactly the same way as vanilla single-currency swaps,

with one crucial difference; the discounting of future cash flows is done off swap curves

that incorporate the full term structure of the cross-currency basis. Figure 8 presents the

cash flows of different asset swap formats, single and double currency; and fixed to floating.

Figure 8: Cash flows for different asset swap formats

Bond cash flows in native currency Bond cash flows after par swap Swap cash flows

100

100

A

Buyer can choose both:

1. currency of final cash flows

2. format of coupon A (fixed/floating)

100-P

A

C

Swap is designed to have PV = 100-P, when cash

flows of both legs are di scounted off the respective

swap curves including the basis. The PV of the

foreign leg is converted using the spot FX ra te.100

100

Bond cash flows after market swap Swap cash flows

P

P

M



2. format of coupon M (fixed/floating)

M

C

P

100

Swap is designed to have PV = 0, when cash flows of

both legs a re discounted off the respective swa p

curves including the basis. The PV of the foreign leg is

converted using the spot FX rate.

Bond cash flows after coupon swap Swap cash flows

P

100

C

P = bond dirty price

C = bond coupon (fixed/floating)

100 = bond face value

P

100

Cu



2. format of coupon Cu (fixed/floating)

This swap is when the buyer wants exposure to the

bond in a different currency or coupon format from the

original bond, but in a non par or price structure

Cu

C

100

100

Swap is designed to have PV = 0, when cash flows of

both legs are discounted off the respective swap

curves including the basis. The PV of the foreign leg is

converted using the spot FX rate.


Bond investors can use the Bloomberg ASW function to price fixed – floating cross currencyswaps as indicated in Figure 9.




23 April 2010 11

Figure 9: Using ASW to price cross currency swaps on £ France Telecom 8, 2017

A: Swapping currencies on ASW B: ASW page 2; swapped spreads across currencies

Change reporting currency to get

swapped spread in that currency

Cross currency basis

N e t s w a p p e d s p r e a d i n

d i f f e r e n t c u r r e n c i e s


This function is straightforward to use, and an easy way to look up cross currency spreads.

It does however suffer from a few drawbacks, namely: 1) it uses single points on the basis

curve, instead of the full curve to price the swapped spread; and 2) it is not easy to change

the benchmark rate to 3m Libor, which is what the market uses to price and quote. For

these reasons, we recommend using the SWPM function to arrive at a more representative

spread for a cross-currency swap. Figure 10 shows how a fixed-float swap can be set up in

SWPM to solve for asset swap spreads in different currencies.

Figure 10 Using SWPM to price cross currency swaps on £ France Telecom 8, 2017

Match fixed leg characteristics to

bond (maturity, coupon etc.)

Solve for "Spread" on floating leg, such that

mark et value of the swap = (Clean price - 100)

ASW spread in

specified currency

Coupon frequency


SWPM can also be used in a similar fashion to calculate the fixed coupon on a par-par swap

in any currency. In this case the calculation of the currency swapped spread takes into

account the term structure of both swap curves as well as the full basis swap curve.




23 April 2010 12

INVESTMENT GRADE: GLOBAL CREDIT - CROSS CURRENCY TRADE IDEAS

Euro Credit at All-time Wides to Dollar Credit

A combination of secular and cyclical trends has cheapened European credit versus US

credit. At the same time, the EUR-USD cross-currency swap remains dislocated andbenefits investors swapping EUR cash flows into USD, as discussed in our focus article

this week (Managing FX risk in corporate bonds ). We screen for attractive switch

opportunities from USD to EUR-denominated bonds issued by the same company with

similar maturities. US-based investors can pick-up 20bp to 77bp yield by buying EUR-

denominated bonds and switching their cashflows into dollars.

EUR credit is cheap to USD credit for the first time

Historically, USD-denominated bonds have traded cheap to EUR-denominated bonds.

This is evident from the spread history of USD and euro bond or CDS indices, although

compositional differences between the two domiciles account for some of the historical

relationship. Even when we control for differences in composition by selecting a basket of issuers with bonds in both currencies at the same maturity, the effect remains. According

to our metric, USD bonds traded 30-50bp cheap (50-100% of the average EUR spread)

before the credit crunch and 50-100bp cheap (30-50% of the average EUR spread)

throughout the volatility of 2007 and 2008 (Figure 1). This discount collapsed during

2009, and today the differential between USD and EUR bonds stands at only 10bp, or 7%

of the average spread level.

At the same time, the spread pick-up for swapping USD for EUR cashflows by entering a

currency basis swap, which (at the 5y tenor) reached extreme levels near -50bp at the

height of the crisis, has failed to normalize and still stands at close to -25bp. In other words,

aside from relative value between USD and EUR bonds, investors continue to get paid for

swapping euro cashflows into dollars.

US

Jeffrey Meli+1 212 412 2127

[email protected]

Alex Gennis

+1 212 412 1370

[email protected]

Europe

Arup Ghosh

+44 (0) 20 7773 6275

[email protected]

Aziz Sunderji

+44 (0) 20 7773 7881

[email protected]

Matthew Leeming

+44 (0) 20 7773 9320

[email protected]

Figure 1: The differential in spreads between USD bonds andEUR bonds – even when matched by issuer and maturity – has collapsed

Figure 2: When the dramatic moves in the USD/EURcurrency swap basis are added, EUR credit stands at all-timecheap levels versus USD credit

0

100

200300

400

500

600

700

2005 2006 2007 2008 2009

4-6y bonds of a selected baset of names in dollars

4-6y bonds of the same basket in Euros

OAS (bp)

-120

-100

-80

-60-40

-20

0

20

40

60

2005 2006 2007 2008 2009

spread pickup for switching from USD to EUR

spread pickup after swapping

bp

Note: Basket based on DT, TELEFO, TITIM, VOD, GE, GS, MCD, MS, PG, andSLMA (bonds issued at least 5y ago in both currencies). Source: Barclays Capital





23 April 2010 13

For US investors, the message is clear: EUR-denominated bonds are at all-time cheap levels;

when the benefit of the currency swap is added, the spread pick-up for switching from USD

to EUR bonds can be substantial. Investors need not take exposure to euros in order to

benefit from the spread pick-up offered by EUR-denominated bonds – they can enter into a

cross-currency basis swap to convert their EUR-denominated coupon payments into USD

cashflows. Given the current cheapness of converting from EUR to USD, this results in even

further spread pick-up (please see this week’s Focus for details on the cross-currency basisswap). Although European investors will not benefit from the currency basis swap, outright

cheap levels for EUR-denominated debt make this an opportune moment to repatriate USD

investments into EUR credit.

Why was USD credit cheap and what has changed?

Structural factors explained the relatively tight spreads on EUR-denominated bonds

Historically, euro-denominated corporate bonds have traded rich to USD bonds. This has

partly been a function of the structure of the two markets. In particular, European

corporates have traditionally relied on bank loans rather than public bonds for funding,

leading to a dearth of liquid bonds and a strong bid for the relatively few benchmark issues.

Retail participation in credit markets has also been stronger in Europe: large domestic

savings bases in Germany and France are channelled via savings banks into primary and

secondary credit markets, underpinning tighter spreads. In the US, domestic savings rates

are lower and retail investors have historically favoured equities.

A reversal of these same dynamic has caused euros to cheapen

We believe a number of factors have caused the USD discount to shrink, most of which are

simply reversals of the same dynamic that caused USD to be cheap for so long. Firstly, the

euro bond market has exploded in terms of issuance, reducing the structural

supply/demand imbalance. One factor behind the increased euro-denominated issuancehas been the shift from loan to bond financing for European corporates, due to the

constraints on bank balance sheets and risk tolerance. Secondly, the retail bid for credit has

been very strong in the US (fund flows attest that the wall of cash in money market funds

went straight into IG credit, skipping US equities entirely). Thirdly, European assets as a

whole have been tainted by sovereign risk. Indiscriminate selling of EUR-based assets has

cheapened them to USD assets — even compared with bonds issued by the same

companies (see US Alpha 26 March 2010, on Yankee Utes). Importantly, the validity of this

last reason as one to shun EUR-based credit is weak.

The issuer angle

The robust pace of Yankee issuance in the US market over the past several months provides

further evidence of the dislocations in the relationship between USD and EUR credit

markets, as well as in the cross-currency swap market. Yankee issuance has accounted for

over half of all investment-grade, fixed rate issuance in the USD market YTD 2010, with a

large portion of Yankees coming from euro issuers. The same calculation that indicates EUR

bonds are cheap relative to USD bonds from an investor’s perspective leads issuers to prefer

tapping the US primary market.






23 April 2010 14

Risks

The obvious risks regarding credit deterioration and interest rate volatility that apply to a

USD issue also apply to EUR issues swapped into USD. In addition, movements in the cross-

currency swap will affect the MTM of the trades we recommend. Although (as discussed in

the Focus article this week) the swap remains dislocated versus pre-crisis levels, there is a

risk that the swap becomes more negative, causing MTM losses. In addition, many of the

drivers of the divergence between the US and European credit markets are long-term in

nature and could dislocate further before reverting.

Trade recommendations

Figure 5 and Figure 6 list our most attractive switches for European and US names, in all

cases switching from a US denominated issue to a comparable euro one. All comparisons

are done from the perspective of a dollar investor, and the euro bonds are currencyswapped into dollars. The investor not only picks up spread by moving into a cheaper bond,

but also picks up the basis on the cross-currency swap, which is in their favour. In all cases

the asset swapped spread has been calculated off the 3 month Libor curve, and all bond

prices include bid-offer costs.

Figure 5: Cross currency switches (Yankee)

Ticker Description Maturity Price*

ASW spd in

local curr.

ASW spd in USD

after basis swap

Spread

pick-up

BHP EUR 4.75 04/2012 105.69 52 78 49

USD 5.125 03/2012 107.01 29 29

BRITEL EUR 5.25 01/2013 106.03 146 171 39

USD 5.15 01/2013 105.91 132 132

GSK EUR 5.625 12/2017 115.66 59 78 55

USD 5.65 05/2018 114.24 23 23

LGFP EUR 4.25 03/2016 99.52 188 208 34

USD 6.5 07/2016 109.76 174 174

MTNA EUR 8.25 06/2013 115.31 151 176 44

USD 5.375 06/2013 106.73 132 132

TELEFO EUR 3.406 03/2015 100.48 111 130 50

USD 5.855 02/2013 109.26 80 80

Note: *Accounting for bid/offer. Prices and spreads as of 22 April 2010. Source: Bloomberg, Barclays Capital

Figure 3: The surge in European issuance has diminished the

structural supply/demand imbalance

Figure 4: US mutual fund flows have been out of money

markets and into USD corporate credit

0

50

100

150

200

250

300

350

1994 1997 2000 2003 2006 2009

€bn non financial issuance

-100

-50

0

50

100

150

200

250

300

2001 2002 2003 2004 2005 2006 2007 2008 2009

U S D B

i l l i o n s

Fund flows to USD high grade bonds Fund flows to equities

Source: Dealogic Source: Lipper




23 April 2010 15

Figure 6: Cross currency switches (US issuers)

Ticker Bond Maturity Price*

ASW spd in

local curr.

ASW spd in USD

after basis swap

Spread

pick-up

DE EUR 7.5 01/2014 117.1 92 121 77

USD 6.95 04/2014 116.5 44 44

ABIBB EUR 7.375 01/2013 113.3 92 124 59

USD 2.5 03/2013 100.4 65 65

VZW EUR 8.75 12/2015 129.1 88 118 49

USD 5.55 02/2014 109.9 68 68

FO EUR 4 01/2013 102.1 169 200 48

USD 6.375 06/2014 110.0 152 152

GE EUR 4.25 02/2014 105.4 91 119 43

USD 3.75 11/2014 102.1 76 76

JPM EUR 6.125 04/2014 112.8 83 111 43

USD 4.65 06/2014 106.6 69 69

WFC EUR 6 05/2013 110.5 86 116 38

USD 4.375 01/2013 105.3 78 78

PG EUR 4.5 05/2014 108.6 35 63 37

USD 4.95 08/2014 109.6 26 26

PM EUR 5.875 09/2015 114.9 62 90 20

USD 6.875 03/2014 115.0 70 70

Note: *Accounting for bid/offer. Prices and spreads as of 22 April 2010. Source: Barclays Capital




23 April 2010 16

YTD2010 Fixed IG Supply ($bn) CDX.IG Curve

Govt.

Guaranteed,

$9.5, 3%

Finance,

$119.7, 37%

Utility,

$15.1, 5%

Industrial,

$79.6, 25%

NonCorp.,$96.1, 30%

-60

-50

-40

-30

-20

-10

0

10

20

30

Jul-08 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10

bp

-40

-35-30

-25

-20

-15-10

-50

510

15

bp

5s10s (LHS) 5s7s (RHS)

Note: All levels on this page as of Thursday 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

30

70

110

150

190

230

270

310

Jun-08 Oct-08 Feb-09 Jun-09 Oct-09 Feb-10

0

10

20

30

40

50

60

70

80

90

CD X. IG 5. 0 Mk t (L HS, bp) VIX (RHS, %)

60

140

220

300

380

460

540

620

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

bp

-400

-350

-300

-250

-200

-150

-100

-50

0

bp

Credi t OAS (LHS, bp) Basi s (RHS, bp)

Note: A portion of the significant tightening in CDX.IG on March 20, 2009, isattributable 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 Mkt versus Intrinsic Par Downgrade/Upgrade Ratio

70

80

90

100

110

120

130

Aug-09 Oct-09 Dec-09 Feb-10 Apr-10

bp

CDX IG12 Mkt

CDX IG12 Intr

CDX IG13 Mkt

CDX IG13 Intr

0

5

10

15

20

25

30

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

Moody's S&PDG/UG Ratio

Source: Barclays Capital Note: S&P had a par downgrade/upgrade ratio of 91.4 in January 2010. Moody’sratio was 0.4; however, Moody’s downgraded only three companies andupgraded seven companies in January 2010. Source: Barclays Capital




23 April 2010 17

HIGH YIELD

Sentenced to 144a-for-Life

High yield was mostly unchanged through Thursday, despite increased volatility induced by

SEC charges of Goldman Sachs and renewed fears around Greece. Nevertheless, derivativesoutperformed cash, with HY14 advancing $0.25 to $100.75. Cash was $0.05 lower through

Thursday, ending at $99.24. The CDX index has also been outperforming Europe, with the

spread between HY14 and iTraxx XO compressing 53bp since the roll.

High yield companies are beginning to report first quarter earnings and, thus far, the

positive reports outnumber the negative. For most, the positive surprises remain cost-

driven, though there are some signs of better-than-expected top-line growth as well. On

Monday, Rexnord reported preliminary revenues and EBITDA well ahead of expectations.

Hanesbrands also reported a significant 1Q10 beat, driven by a combination volumes

growth and improved operating margins, and Complete Production was also ahead of

consensus on sales and EBITDA. Community Health was in line for the quarter, as was

Massey Energy, although the latter reduced guidance for the year. On the services front,United Rentals was a beat on EBITDA as used equipment margins improved, and Westcorp

beat despite lower revenues. Terex earnings were disappointing, though the company is

looking to make use of its $1.8bn cash balance and $500mn revolver to grow its machinery

and industrial products businesses via acquisitions. Standard Pacific was also weaker,

reporting its first quarterly loss in a few quarters despite no charges or impairments.

Freescale’s 1Q10 numbers were in line with the company’s pre-announcement, and the

outlook is for solid, broad-based end-demand growth.

On the M&A front, CenturyTel (CTL) has agreed to acquire Qwest Communications (QUS).

The $10.6bn all-stock deal values Qwest at about $22.4bn, including $11.8bn in debt to be

assumed by CenturyTel. The combined company will have annual revenues of nearly $20bn.

Currently, CTL represents 21bp of the U.S. Credit Index by market value, with $6.3bn in

index-eligible par outstanding. Meanwhile, QUS represents 23bp with $7.1bn, and has

another $3.5bn in the U.S. High Yield Index, or 43bp by market value. However, all three

major ratings agencies have put Qwest (Ba3/BB/BB+) on watch positive; likewise, all three

have either put CenturyTel (Baa3/BBB-/BBB-) on watch negative or negative outlook.

Should QUS move to IG, the index-eligible total of $16.2bn would represent 52bp by market

Bradley Rogoff, CFA


Michael Anderson, CFA

+1 212 412 7936

[email protected]

Gautam Kakodkar

+1 212 412 7937

[email protected]

Eric Gross


Figure 1: Cash and CDS Movers Figure 2: HY Industrials Index Statistics

High Yield Cash

Best Px Chg Worst Px Chg

RDN 5.375 '15 85.50 +6.5 AIG 8.125 '46 93.13 -3.9

MBI 4.65 '18 55.94 +6.2 VRS 11.375 '16 92.75 -3.5

SAPSJ 7.5 '32 77.00 +6.0 SFI 5.7 '14 76.50 -3.0

High Yield CDS

Best 5y Chg Worst 5y Chg

RDN 5.0 pts -7.5 pts AKS 433 bp +34 bp

QUS_CAP 186 bp -100 bp AMR 19.5 pts +1.5 pts

HOV 8.0 pts -4.3 pts TSO 471 bp +28 bp

SEC

Registered

144a with

Reg Rights

144a for

Life

# of Issues 999 185 213

Par ($bn) 458 91 97

Price 100.60 104.00 102.00

Coupon (%) 8.26 9.20 9.60

Yield to Worst (%) 7.60 8.00 8.80

OAS (bp) 506 499 614

YTD Total Return 5.59% 5.22% 6.67%

Source: Barclays Capital Source: Barclays Capital




23 April 2010 18

value. However, given these ratings actions, it appears more likely that CenturyTel slips to

HY. In that case, the combined entity would have $17.2bn in index-eligible debt,

representing 2.14% of the HY index by market value, and would unseat Sprint as the fifth-

largest issuer by par.

The services sector also experienced some M&A activity, as The Geo Group agreed to

acquire Cornell Companies in an all-stock transaction valued at $685mn including theassumption of Cornell debt.

In another sign of the loosening of the credit markets, 144a-for-life issuance has comprised

22% of the calendar since the beginning of March. This represents a considerable increase

over the High Yield Index's 13.7% weighting on February 26. Not all 144a-for-life deals are

created equally, however, as some are issued by public companies (US and non-US issuers).

The feature will likely remain prominent, even when the strength of the primary market

fades because of the necessary refinancing of upcoming loan maturities, which include

many small private issuers.

Not surprisingly, since the beginning of the year, 144a-for-life industrials have

outperformed the rest of high yield industrials by roughly 100bp (6.67% for 144a's with no

registration rights versus 5.70% for the High Yield Industrial Index). Although 144a's for life

have roughly the same duration and issue size (~$450mn) as registered bonds, they yield

120bp more. Nonetheless, their larger coupon leads them to be priced $1.40 higher on

average (Figure 2).




23 April 2010 19

High Yield 2010—Supply by Sector Top On-the-Run CDX Index Names by Net CDS Outstanding

Nat Res

Industrial

Financial

Telecom

Technology

Healthcare

Chemicals

Others

Media

Consumer

YTD - $86.5bn

Notional

Outstanding ($bn)

Change –

Week Ending

4/16/10 ($mn)

Gross Net Gross Net

Radian Group 43.5 3.1 329.8 28.7

ILFC 37.1 2.9 252.6 67.3

GMAC 57.0 2.9 536.6 77.8

Sprint Nextel 32.8 2.3 91.4 (40.1)

Macy's 30.5 2.2 134.8 (71.6)

Lennar 38.6 2.2 221.7 (10.2)

Limited Brands 32.3 2.1 239.3 17.0

MBIA Inc 36.2 2.1 169.8 18.7

Weyerhaeuser 23.7 2.1 83.3 (150.4)

Temple-Inland 25.2 2.0 27.1 (7.6)

Source: Barclays Capital Source: DTCC

High Yield Average Institutional Trade Volume OTR HYCDX versus U.S. High Yield Index

01

2

3

4

5

6

7

8

9

10

Dec-09 Jan-10 Feb-10 Mar-10 Apr-10

$bn Daily Volume

Rolling 1-Week Average

50

60

70

80

90

100

110

Nov-08 F eb-09 May-09 Aug-09 Nov-09 F eb-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

5

10

15

20

25

30

35

40

< 2 0 0

2 0 0 - 4 0 0

4 0 0 - 6 0 0

6 0 0 - 8 0 0

8 0 0 - 1 0 0 0

> 1 0 0 0

% Last Month

Current

0

5

10

15

20

25

30

35

40

45

50

55

< 4 0

4 0 - 5 0

5 0 - 6 0

6 0 - 7 0

7 0 - 8 0

8 0 - 9 0

9 0 - 1 0 0

1 0 0 - 1 1 0

1 1 0 - 1 2 0

> = 1 2 0

%Last Month

Current





23 April 2010 20

LEVERAGED LOANS

Exit Loans for CLOs

As the calendar for bankruptcy emergences becomes more visible, we expect exit financing

will be a major component of 2010 loan issuance. We have seen a number of large issuersemerge in the past few months, including Lear, Idearc, RH Donnelley and Charter. This week

Six Flags’ $770mn first- and second- lien loans allocated and traded well in the secondary

market. The $400mn first-lien has a L+400bp coupon, 2% Libor floor and a 101 soft call

premium, while the $250mn second-lien has a L+725 coupon, 2.5% Libor floor and

103,102, 101 call premiums. While the $19bn current forward calendar does not reflect the

potential exit pipeline, we expect the 2010 calendar could include Hawaiian Telcom,

Fairpoint, Smurfit Stone, WR Grace, Tronox, Chemtura, Lyondell, AbitibiBowater, Tribune,

Visteon, and Young Broadcasting. On average, spreads on exit loans have been more than

150bp wide of the general loan new issue market (Figure 2), making them attractive

candidates for secondary CLOs. On the primary CLO front, we are beginning to see some

green shoots, with Apollo testing the waters with a new $300mn vehicle with arranger

Citibank. Interestingly, we have seen shorter re-investment periods in the small sample of new deals, to make the senior tranche more attractive to investors.

Covenant amendments and maturity extensions continue to flow. HIT Entertainment

completed a credit facility amendment allowing for the total leverage covenant to be

replaced by a new first-lien leverage covenant. In exchange, the company paid a fee of

295bp and the coupon was increased from L+225bp to L+525bp. The revolver was also

downsized from $77mn to $52mn, with the balance being termed out. Meanwhile, ILFC

amended two of its revolvers (totaling $4.5bn) to allow for the extension of their maturities.

On the M&A front, Calpine’s exit term loan softened 1pt after the company announced that it

was acquiring the Conectiv fleet (4.5GW) from Pepco Holdings for $1.65bn The company

expects to fund the acquisition with new bonds, a $1.3bn 7y term loan, and cash on hand.

The purchase gives Calpine access to the eastern Pennsylvania/Jersey/Maryland market, the

one attractive area in which it did not have a foothold. Also, Reynolds Group is in the market

seeking an amendment to allow for the issuance of a $750mn add-on term loan. The loan,

together with a $1bn bond offering, will finance the acquisition of Evergreen Packaging.

Figure 1: Exit Financing Volume Figure 2: Exit Financing Spreads

0

5

10

15

20

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

Deal Size New Money

($bn)

200

400

600

800

1,000

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

Pro Rata Institutional

(bp)

Note: Institutional plus pro-rata volume. Source: Barclays Capital, S&P LCD Source: Barclays Capital, S&P LCD

Bradley Rogoff, CFA


Michael Anderson, CFA

+1 212 412 7936

[email protected]

Gautam Kakodkar

+1 212 412 7937

[email protected]

Eric Gross





23 April 2010 21

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

Leveraged Loan

No. of

Deals

Amt

($mn)

Trailing 1m Launches 49 23,050

Forward Calendar 44 19,190

Year-to-Date 126 48,890

0

2

4

6

8

10

12

17-Apr 12-Jun 7-Aug 2-Oct 27-Nov 22-Jan 19-Mar

$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

1,400

1,600

1,800

Jun-08 Oct-08 Feb-09 Jun-09 Nov-09 Mar-10

bp

60

65

70

75

80

85

90

95

100

105

110

Oct-08 Jan-09 May-09 Aug-09 Dec-09 Mar-10

$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

50

60

70

80

90

100

110

Jul-08 Nov-08 Feb-09 Jun-09 Sep-09 Jan-10

$HY Loans Index

LCDX

0

10

20

30

40

50

< 6 0

6 0 - 7 0

7 0 - 8 0

8 0 - 8 5

8 5 - 9 0

9 0 - 9 5

9 5 - 1 0 0

> 1 0 0

% Current

Last Month





23 April 2010 22

STRUCTURED CREDIT & VOLATILITY

Costless LCDX Option on Short-term Defaults

The increased ability of issuers to refinance and term out debt in the current improved

macro environment has caused default expectations to dip significantly in the short term. Inparticular, our default outlook for the LCDX.10 index is fairly benign except for a few names

in the portfolio. Therefore, we believe short-dated junior LCDX.10 tranches offer attractive

P&L profiles. Except for the equity tranche, we think that all have enough cushion against a

few surprise defaults until the maturity date.

Sell $10mn 5-8% at 62pts, Buy $11.4mn 8-12% at 96.25pts (3y LCDX.10)

We recommend that investors get long the 3y LCDX.10 8-12% tranche by buying $11.4mn at

96.25pts and enhance the P&L profile of the tranche by shorting the 3y LCDX.10 5-8% tranche

by selling $10mn at 62pts. Both tranches have 14 months to maturity on June 20, 2011.

We choose the notionals of both legs of the trade such that the net PV of all the cash flows

to maturity would be zero. In other words, the trade is constructed to be costless toinvestors if the LCDX.10 index avoids any defaults in the next 14 months.

The LCDX.10 index has experienced 21 credit events to date. This includes 16 defaults and

5 cancellations. The 5-8% and 8-12% tranches are currently 0.00-1.13% and 1.13-6.20%

tranches of the current 79-name LCDX.10 portfolio. The 5-8% tranche currently has a

factor of 0.2983.

The 5-8% tranche trades in all-upfront form. The 8-12% tranche trades in upfront plus 500bp

annual running coupon. The annual payment is based on the full notional of the tranche but

could decrease if the tranche has a principal loss due to defaults. At the trade’s inception,

investors would pay $1.13mn upfront for selling the $10mn 5-8% tranche. They would

receive $0.43mn upfront and $0.57mn annually for buying the $11.4mn 8-12% tranche.

Figure 1 shows the trade’s potential P&L profile under various loss scenarios for the LCDX.10

index by June 20, 2011. Investors would neither make nor lose money if no defaults occur in

the portfolio. The trade starts losing money only if more than 2.45% losses occur. Assuming a

Batur Bicer


Figure 1: Performance of the Recommended Trade

-5

-4

-3

-2

-1

0

1

2

3

0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5%

Cumulative Losses in LCDX.10

Net 8-12% 5-8%PV of Cash Flows ($mn)





23 April 2010 23

60% recovery rate, which is in line with the average recovery rate of 55.6% for the previously

defaulted 16 names in the portfolio, this means that more than 5 names need to default in the

next 14 months for the trade to lose money. In our view, this is unlikely.

Maximum potential upside is almost $3mn (more than four times the upfront amount of

$0.70mn paid by investors) if cumulative losses reach 1.1% by the maturity date. This

corresponds to the best-case scenario in which the 5-8% tranche is totally wiped out whilelosses do not cause principal loss to the 8-12% tranche.

Market Recap: Synthetic Tranches and Credit Options

The IG.9 ref levels remained unchanged in 5y and increased 2bp and 4bp in 7y and 10y

tenors, respectively. The delta-adjusted changes in tranches were muted compared with

previous weeks. The biggest mover of the week was the 10y 7-10% tranche with a w/w

delta-hedged P&L of 1.5%.

The HY.10 ref levels remained unchanged in 3y and decreased 0.5pts in 5y and 7y tenors.

The significant outperformance of the short-dated 3y 10-15% equity tranche continued this

week as the tranche rallied 3.2% w/w on both an absolute and delta-adjusted basis. Theabsolute tranche price increased 19.5pts m/m.

The LCDX.10 index ref levels remained unchanged in 3y and decreased 0.25pts in the 5y

tenor. The delta-adjusted changes in tranches were muted across the capital structure

except the 5y 15-100% tranche, which generated a w/w delta-hedged P&L of 1.9%.

During the past week in IG index options, 3m implied volatility increased 2.0%, to 52.8%,

while 3m realized volatility declined 1.3%, to 39.2%. The risk premium, which we define as

the basis between the implied and realized volatility levels, increased 3.3%, to 13.6%. The

term structure of implied volatility flattened significantly, with the 3m-1m implied volatility

basis decreasing to 2.6% from 6.3%. The implied volatility skew steepened slightly. The

implied volatility basis between 115% and 85% normalized strikes (assuming that the ATM

strike is 100%) increase to 2.6% from 2.0%.




23 April 2010 24

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

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) 2.26 0.10 2.36

Total Par ($bn) 80.23 3.50 83.73

Cash Percent 2.82% 2.83% 2.82%

Europe

Cash (€bn) 0.58 0.05 0.63

Total Par (€bn) 24.81 3.16 27.97

Cash Percent 2.35% 1.58% 2.27%

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




23 April 2010 25

Tranche Bid Offer DeltaLevel

Change

Delta

Adjusted

Return

Level

Change

Delta

Adjusted

Return

Index 89 0 -7

0-3% 37.875 38.375 8.2 -0.94 1.0% -9.63 8.0%

3-7% 1.625 2.125 7.0 1.25 -1.3% -2.50 1.2%

7-10% -7.875 -7.625 3.7 -0.25 0.2% -0.50 -0.2%

10-15% -0.625 -0.375 1.8 -0.13 0.1% -0.13 -0.2%

15-30% -1.97 -1.89 0.7 0.04 0.0% 0.07 -0.2%

30-100% -2.33 -2.25 0.4 -0.05 0.1% 0.13 -0.2%

Index 111 2 -4

0-3% 57 57.5 4.7 -0.25 0.8% -7.75 6.9%

3-7% 9 9.5 5.8 0.38 0.1% -7.13 6.1%

7-10% -8.5 -8 3.7 -0.13 0.4% -3.13 2.4%

10-15% 1.375 1.625 1.9 -0.13 0.3% -0.75 0.4%

15-30% -1.87 -1.77 0.9 0.25 -0.2% 0.53 -0.6%

30-100% -3.16 -3.06 0.5 0.05 0.0% 0.31 -0.4%

Index 123 4 -1

0-3% 66.875 67.375 2.7 0.63 0.2% -5.63 5.5%

3-7% 19 19.5 4.8 0.44 0.8% -8.00 7.7%

7-10% -2 -1.5 4.2 -0.50 1.5% -4.50 4.1%

10-15% 5.625 5.875 2.2 -0.38 0.9% -2.50 2.3%

15-30% -1.8 -1.64 1.1 0.22 0.0% 0.28 -0.4%30-100% -4.14 -3.98 0.6 0.19 0.0% 0.54 -0.5%

Index 104.5 0 0.75

0-10%

10-15% 76 77 10.8 3.13 3.2% 19.50 10.1%

15-25% 102.875 103.25 3.5 -0.19 -0.2% 2.06 -0.5%

25-35% 105.5 106 0.3 0.00 0.0% 0.00 -0.4%

35-100% 105.5 106 0.1 0 0.0% -1 -0.7%

Index 105 -0.5 1

0-10%

10-15% 34 34.5 2.3 1.75 3.2% 8.50 6.8%

15-25% 79.5 80.5 3.3 -1.00 0.5% 5.75 2.8%

25-35% 101.875 102.875 1.9 -0.88 -0.1% 1.38 -0.5%

35-100% 112.25 113.25 0.5 0 -0.2% 0 -0.6%

Index 102 -0.5 1.5

0-10%10-15% 13.5 15.5 0.9 0.25 0.9% 3.25 2.0%

15-25% 58.5 60 2.3 0.00 1.1% 4.00 1.3%

25-35% 90.75 91.75 1.9 -0.50 0.4% 2.88 0.4%

35-100% 114.75 115.75 0.8 -1 -0.2% 1 0.0%

Index 102 0 0.25

0-5%

5-8% 62.25 63 7.1 -0.13 -0.1% 11.38 6.8%

8-12% 95.25 96.25 11.0 -0.75 -0.8% 0.38 -1.5%

12-15% 103.5 104.25 2.9 -0.13 -0.1% -0.38 -0.9%

15-100% 105.25 105.625 0.4 0.00 0.0% -0.19 -0.3%

Index 102.25 -0.25 0.25

0-5%

5-8% 25.75 26.75 1.2 -0.75 0.0% 4.50 3.9%

8-12% 63.375 64.375 5.8 -0.63 0.5% 2.38 1.3%

12-15% 92.5 93.5 4.3 -0.88 0.0% 0.50 -0.3%15-100% 110.75 115.5 0.8 1.75 1.9% 1.88 1.7%

Strike Type Price Imp Vol Strike Type Price Imp Vol

80 REC 10 48.9% 70 REC 9 49.4%

85 REC 18 50.4% 80 REC 20 50.2%

90 REC 29 51.8% 90 REC 39 51.9%

90 PAY 40 51.8% 90 PAY 73 51.9%

95 PAY 30 52.6% 100 PAY 53 52.1%

100 PAY 23 54.5% 110 PAY 38 53.4%105 PAY 17 55.3% 120 PAY 29 55.4%

Normalized Volatility Skew of 3m On-the-run IG Options

3m ATM On-the-run IG Realized vs Implied Volatility

Term Structure of Implied Volatility for ATM IG Options

5 y C

D X . I G . 9

7 y C D X . I G . 9

1 0 y C D X . I G . 9

3 y C D X . H Y . 1 0

5 y C D X . H Y . 1 0

Weekly Monthly

S w a p t i o n S e p - 1 0

I G . 1 4 R e f = 8 9 . 5

7 y C D X . H Y . 1

0

3 y L C D X . 1 0

5 y

L C D X . 1 0

S w a p t i o n J u n - 1 0

I G . 1 4 R e f = 8 9 . 5

10%

30%

50%

70%

90%

110%

130%

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

Jan

10

Realized Volatility

Implied Volatility

49%

50%

51%

52%

53%

54%

55%

80% 90% 100% 110% 120%Normalized Strikes

22-Apr

15-Apr

25-Mar

40%

42%

44%

46%

48%

50%

52%

54%

56%

0 1 2 3 4 5 6 7Months to Maturity

22-Apr

15-Apr25-Mar

Note: W/w changes constitute the difference in market closing levels between April 15 and April 22, 2010. M/m changes constitute the difference in levels betweenMarch 25, and April 22, 2010. Calculations ignore carry and defaults. Source: Barclays Capital




23 April 2010 26

ANALYST RATING CHANGES

Last four weeks

HG/HY Sector Issuer From To Date Changed

HG European Utilities Thames Water Utilities Underweight Market Weight 4/22/2010HG TMT Time Warner Cable Overweight Market Weight 4/19/2010

HY Gaming MGM Mirage (unsecured notes)

Overweight Market Weight 4/19/2010

HG TMT Bertelsmann Market Weight Overweight 4/9/2010

HG Technology Oracle Corp Overweight Market Weight 3/26/2010

HG European Basic Industries Evonik Industries Initiating Coverage Overweight 3/25/2010

HG Energy, Pipelines & Basics Chemicals Metals & Mining Oil Field Services Eastman Chemical

Market Weight

Overweight

Overweight

Overweight

Underweight

Market Weight

Market Weight

Market Weight

3/23/2010

3/23/2010

3/23/2010

3/23/2010

HY Industrials CNH 7.75% Notes Market Weight Overweight 3/22/2010

HG European Utilities Enel SpA $US Paper Market Weight Overweight 3/22/2010


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23 April 2010 27

U.S. CREDIT STRATEGY

Global

Ashish Shah

[email protected]

+1 212 412 7931

Investment Grade

Jeff Meli

[email protected]

+1 212 412 2127

Shobhit Gupta

[email protected]

+1 212 412 2056

Hari Manappattil

[email protected]

+1 212 412 7922

Alex Gennis

[email protected]

+1 212 412 1370

Matthew Mish, CFA

[email protected]

+1 212 412 2183

Praveen Korapaty

[email protected]

+1 212 526 0680

High Yield & Leveraged Loan

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

Structured Credit & Volatility

Batur Bicer

[email protected]

+1 212 412 3697



Analyst Certification(s) We, Ashish Shah, Jeffrey Meli, Bradley Rogoff, Michael H Anderson, Matthew Mish, Alex Gennis, Eric Gross, Shobhit Gupta, Batur Bicer, Hari Manappattil,

Gautam Kakodkar, Yana Bouchkanets and Joanie Genirs, hereby certify (1) that the views expressed in this research report accurately reflect our personalviews 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 orindirectly 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 CapitalResearch 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 Capitalmay have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/oran affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debtsecurities 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 permittedand subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel todetermine 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 potentialinterest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing informationwas obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads arehistorical 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 researchproducts, whether as a result of differing time horizons, methodologies, or otherwise.

Company-specific DisclosuresBarclays Capital is acting as financial advisor to CenturyTel Inc. (CTL) in the potential acquisition of Qwest Communications International Inc. (Q).

The rating on Qwest Communications has been temporarily suspended due to Barclays Capital's role. The estimates in this report do not incorporate

this potential transaction. Barclays Capital is acting as financial advisor to The Geo Group (GEO) in the potential acquisition of Cornell CompaniesInc. (CRN). The rating and price target on The Geo Group have been temporarily suspended due to Barclays Capital's role. The estimates in this report

do not incorporate this potential transaction.



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 orPan-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 orPan-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-eligiblecorporate debt securities to the Barclays Capital U.S. Credit Index, the Pan-European Credit Index or the EM Asia USD High Grade Credit Index, asapplicable.Overweight: The analyst expects the issuer's index-eligible corporate bonds to provide positive excess returns relative to the Barclays Capital U.S. CreditIndex, 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. CreditIndex, 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 applicableregulations and/or firm policies in certain circumstances including where Barclays Capital is acting in an advisory capacity in a merger or strategictransaction 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% IssuerCapped 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% IssuerCapped 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 eithersome 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 theBarclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or theEM 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 totalreturn of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excludingFinancials, 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, orthe 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 applicableregulations and/or firm policies in certain circumstances including where Barclays Capital is acting in an advisory capacity in a merger or strategictransaction involving the company.



This publication has been prepared by Barclays Capital, the investment banking division of Barclays Bank PLC, and/or one or more of its affiliates asprovided below. This publication is provided to you for information purposes only. Prices shown in this publication are indicative and Barclays Capital isnot offering to buy or sell or soliciting offers to buy or sell any financial instrument. Other than disclosures relating to Barclays Capital, the information

contained in this publication has been obtained from sources that Barclays Capital believes to be reliable, but Barclays Capital does not represent orwarrant that it is accurate or complete. The views in this publication are those of Barclays Capital and are subject to change, and Barclays Capital has noobligation to update its opinions or the information in this publication. Barclays Capital and its affiliates and their respective officers, directors, partners andemployees, including persons involved in the preparation or issuance of this document, may from time to time act as manager, co-manager orunderwriter of a public offering or otherwise, in the capacity of principal or agent, deal in, hold or act as market-makers or advisors, brokers or commercialand/or investment bankers in relation to the securities or related derivatives which are the subject of this publication.The analyst recommendations in this report reflect solely and exclusively those of the author(s), and such opinions were prepared independently of anyother interests, including those of Barclays Capital and/or its affiliates.Neither Barclays Capital, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for anydirect or consequential loss arising from any use of this publication or its contents. The securities discussed in this publication may not be suitable for allinvestors. Barclays Capital recommends that investors independently evaluate each issuer, security or instrument discussed in this publication and consultany independent advisors they believe necessary. The value of and income from any investment may fluctuate from day to day as a result of changes inrelevant economic markets (including changes in market liquidity). The information in this publication is not intended to predict actual results, which maydiffer substantially from those reflected. Past performance is not necessarily indicative of future results.This communication is being made available in the UK and Europe to persons who are investment professionals as that term is defined in Article 19 of theFinancial Services and Markets Act 2000 (Financial Promotion Order) 2005. It is directed at, and therefore should only be relied upon by, persons whohave professional experience in matters relating to investments. The investments to which it relates are available only to such persons and will be enteredinto only with such persons. Barclays Capital is authorized and regulated by the Financial Services Authority ('FSA') and member of the London Stock

Exchange.Barclays Capital Inc., US registered broker/dealer and member of FINRA (www.finra.org), is distributing this material in the United States and, inconnection therewith accepts responsibility for its contents. Any U.S. person wishing to effect a transaction in any security discussed herein should do soonly by contacting a representative of Barclays Capital Inc. in the U.S. at 745 Seventh Avenue, New York, New York 10019.Subject to the conditions of this publication as set out above, Absa Capital, the Investment Banking Division of Absa Bank Limited, an authorised financialservices provider (Registration No.: 1986/004794/06), is distributing this material in South Africa. Absa Bank Limited is regulated by the South AfricanReserve Bank. This publication is not, nor is it intended to be, advice as defined and/or contemplated in the (South African) Financial Advisory andIntermediary Services Act, 37 of 2002, or any other financial, investment, trading, tax, legal, accounting, retirement, actuarial or other professional adviceor service whatsoever. Any South African person or entity wishing to effect a transaction in any security discussed herein should do so only by contactinga representative of Absa Capital in South Africa, 15 Alice Lane, Sandton, Johannesburg, Gauteng 2196. Absa Capital is an affiliate of Barclays Capital.Non-U.S. persons should contact and execute transactions through a Barclays Bank PLC branch or affiliate in their home jurisdiction unless localregulations permit otherwise.In Japan, foreign exchange research reports are prepared and distributed by Barclays Bank PLC Tokyo Branch. Other research reports are distributed toinstitutional investors in Japan by Barclays Capital Japan Limited. Barclays Capital Japan Limited is a joint-stock company incorporated in Japan withregistered office of 6-10-1 Roppongi, Minato-ku, Tokyo 106-6131, Japan. It is a subsidiary of Barclays Bank PLC and a registered financial instruments firmregulated by the Financial Services Agency of Japan. Registered Number: Kanto Zaimukyokucho (kinsho) No. 143.Barclays Bank PLC Frankfurt Branch is distributing this material in Germany under the supervision of Bundesanstalt fuer Finanzdienstleistungsaufsicht(BaFin). This material is distributed in Malaysia by Barclays Capital Markets Malaysia Sdn Bhd.

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