Barclays Tuesday Credit Call

No Independence from Rates

Jeffrey Meli Jigar Patel Alex Gennis July 9, 2013

Please see analyst certifications and important disclosures starting after slide 15.

Agenda
Credit Strategy

Conference Call Information Tuesday, 7:45am (EDT) Conference ID: 77122048 Dial-in: +1-866-394-9718 +1-706-634-9973 Replay: Live.barcap.com Credit Conference Calls

Jeffrey Melis Piece

Other Speakers
Corporate Bonds/CDS Trading

Finbar Cooke European Bank CDS Ryan Johnstin Financials Cash Yoni Gorelov Yankee Credit

Yana Bouchkanets Barclays Live

After hitting new YTD wides/lows on June 24, IG and HY CDX have rallied sharply over the past two weeks. Cash spreads are also modestly tighter over the same period
CDX IG OTR (bp)
99 94 89 84 79 74 69
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13

US Corporate Index OAS and YTW

155 150 145 140 135 130 125
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13

Chg from 6/21 7/5: -8bp Yesterday (7/8): -4bp

OAS Last 2wks: -1bp YTD: +7bp

YTW +13bp +79bp

3.5 3.3 3.1 2.9 2.7 2.5

US IG Corp YTW (rhs, %)

US IG Corp OAS (lhs, bp)

CDX HY OTR ($)

108 107 106 105 104 103 102 101 100 520 500 480 460 440 420 400
Jan-13 Jul-13

US HY Index OAS and YTW

OAS Last 2wks: -10bp YTD: -35bp YTW +5bp +54bp
7.4 6.9 6.4 5.9 5.4 4.9
Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13

Chg from 6/21 7/5: Price +$1.30; Spread -31bp Yesterday (7/8): Price +$1.00; Spread -22bp
Feb-13 Mar-13 Apr-13 May-13 Jun-13

Jan-13

US HY Corp YTW (rhs, %)

US HY Corp OAS (lhs, bp)

___________________________ Source: Bloomberg, Barclays Research

The main news on the macro front was Fridays better-than-expected payrolls report. Treasury yields spiked, and CDX spreads widened in reaction. However, CDX managed to retrace all of the widening by yesterdays close
Change in Nonfarm Payrolls (m/m, sa)
Job creation exceeded estimates for the third consecutive month

350k 300k 250k 200k 150k 100k 50k

10y Treasury Yield Intraday (Jul 5 8, %)

2.75 2.70 2.65 2.60 2.55 Jul-05 07:00
Payroll announcement

10y yields rose 23bp on Friday, but declined 10bp yesterday

0k Jan-11

Jun-11

Nov-11
Survey

Apr-12

Sep-12

Feb-13

Latest

6 Month Rolling Average

Jul-05 10:00

Jul-05 13:00

Jul-05 16:00

Jul-08 09:30

Jul-08 12:30

Jul-08 15:30

CDX IG and HY Intraday (Jul 5 8, bp)

435 430 425 420 415 410 Jul-05 07:00 Jul-05 10:00 Jul-05 13:00 Jul-08 09:15 Jul-08 12:15 Jul-08 15:15
CDX indices managed to retrace Fridays move wider 88

S&P 500 Futures Intraday (Jul 5 8)

89 87 86 85 84 83 82 1,640 1,635 1,630 1,625 1,620 1,615 1,610 Jul-05 07:00 Jul-05 10:00 Jul-05 13:00 Jul-05 16:00 Jul-08 09:45 Jul-08 12:45 Jul-08 15:45

CDX IG (rhs)

CDX HY

___________________________ Source: BLS, Bloomberg, Barclays Research

So far, despite a significant selloff in fixed-income markets, there has been little evidence of a great rotation away from credit and into equities, as the selloff and fund outflows have occurred across most risky assets
Mutual Fund Flows ($bn)*
20

Equity Markets May-June Peak to Trough (%)

0% -5%

15

10

but, more recently, outflows occurred across risky assets

-10% -15% -20%

-25%
S&P 500 Nasdaq Eurostoxx EEM Nikkei

Credit May-June Peak to Trough Spd Moves (bp)

180 160 140 120 100 80 60 40 20 0
12-Jun IG Bonds HY Bonds 3-Jul
CDX.IG US Corp OAS CDX.HY US HY OAS iTraxx Main Euro Corp OAS iTraxx Xover PE HY OAS

(5)

(10) Initially, equity funds

(15)

saw inflows despite outflows from fixed income funds

1-May

22-May Equities

___________________________ *Note: Monthly and weekly reporters including ETFs. Source: Lipper/Thomson Reuters, Bloomberg, Barclays Research

The recent volatility in credit markets has drawn additional scrutiny to fund flows. While HY flows appear to have value as a contemporaneous indicator of returns, the utility of IG fund flow data is limited
US HY Flows vs US HY Index Total Returns1
2 1 0 -1 -2 -3
-5 -4 -3 -2 -1 0 1 2 3

Assets of Lipper Corp IG Fund Category2

Munis Mortgage IG Corp Bonds
(35%)

Total Returns (%)

R2 = 50%

Treasuries Cash & Other HY Corp Bonds

Fund Flows ($bn)

Most IG assets within mutual funds are in total return/agg funds rather than dedicated IG corporate bond funds

US IG Flows vs US Corp Index Excess Returns1

Excess Returns (%)

Limited Information Contained in IG Fund Flows

2 1 0 -1
-3 -2 -1 0 1 2 3 4

While HY fund flows are important to understanding prices moves in HY credit, in our view, IG fund flows are less useful for understanding spread moves in the IG market There is a fairly strong contemporaneous relationship between HY fund flows and HY returns, but almost no relationship between IG flows and IG returns Fund flows are less meaningful for the IG market because retail investors are a smaller part of the buyer base in IG than in HY and because most IG mutual fund assets are in total return/agg funds rather than dedicated IG corporate bond funds. In fact, only 35% of the main IG corporate bond fund Lipper category is IG corporate bonds

R2 = 6%

___________________________ 1. Regressions based on weekly flows and returns (Wednesday to Wednesday periods) for the past 52 weeks. Flows are for weekly-only reporters including ETFs. 2. Weekly-only reporters including ETFs Source: Lipper / Thomson Reuters, Barclays Research

Fund Flows ($bn)

We expect spreads to tighten in the near term once interest rates stabilize and fund outflows abate. However, in the longer term, we are mindful of the risk of QE withdrawal without accompanying improvements in economic data
Volatility Spiked When Fed Was Not in the Market
1000 900 800 700 600 500 400 300 200 100 0 40

Near-Term View

90 80

We continue to believe that credit spreads are likely to retrace the recent widening once rates stabilize, as the asset class becomes more attractive at higher yield levels and fund outflows abate In fact, high yield flows have turned positive recently and spreads have already moved away from their recent wides As a result, certain parts of the market that have lagged present buying opportunities, in our view

70

60 50

In HY, short-duration bonds have underperformed and now appear attractive. In IG, we maintain our constructive view on financials, which have also lagged

Medium- to Longer-Term View

In the medium to longer term, however, we will continue to closely monitor commentary from the Fed and changes in underlying economic data While we expect the pace of removal of Fed stimulus to be linked to the pace of the economic recovery, we are mindful of the risk that QE is withdrawn without significant improvement in economic data A scenario in which the Fed withdraws stimulus but economic data remain weak exposes the market to an external risk flare-up that could lead to a spike in volatility similar to selloffs in the spring/summer 2010 and summer 2011, when the Fed withdrew stimulus

30 20 10 0

Sep-08

Jun-09

Mar-10

Dec-10

Sep-11

Jun-12

Mar-13

Fed Not in the Market

___________________________ Source: Barclays Research

Credit Index OAS (bp, lhs)

VIX Index (rhs)

Not surprisingly, banks, which have been higher beta over the past several years, underperformed in the recent selloff. We remain positive on the sector and would use the recent selloff as an opportunity to increase exposure
US Corporate Index: Fins vs Non-Fins (OAS, bp)
165 20

5y Bank CDS minus 5y CDX.IG Spread (bp)

100

160 15 155

80

CDS spreads of U.S. banks have underperformed the CDX index recently, with MS and GS lagging the most

150

The financial-industrial basis has widened during the recent selloff, after compressing to zero earlier in the year

60

10

40

145
20

140

5
0

135 0 130
-20

125 2-Jan

-5 31-Jan 1-Mar 29-Mar 26-Apr 24-May 24-Jun

-40 2-Jan BAC

30-Jan C

27-Feb

27-Mar GS

24-Apr JPM

22-May MS

19-Jun WFC

Diff (rhs)
___________________________ Source: Barclays Research

Fins

Non-Fins

The sector continues to be in the spotlight as the TBTF1 debate intensifies. While estimates of the TBTF subsidy vary wildly, we believe the higher estimates apply too large a spread subsidy to too broad a borrowing base
Subsidy Estimates Vary Wildly: $0-83bn

News outlets and academics have estimated that the SIFIs benefit from an aggregate subsidy as great as $83bn per year2

Most of a Large Banks Liabilities Would Not Reflect TBTF Perceptions

100% 90% 80%

We believe these estimates apply too large a spread subsidy to too broad a borrowing base

6% 11% 15%

7% 10% 15% 6% 12% 25% 26%

8% 9% 17% 5% 10% 23% 22%

4% 11% 10%

Others have argued that the big banks borrow no cheaper than they would on a standalone basis and, consequently, that there is no subsidy

70% 60% 50% 40% 30%

8%

9%

2% 3%

We believe these estimates do not appropriately account for business model and risk differences between regional and money center banks

6% 11%

Repo funding (~10%) repo rates approach govt funding rates and are primarily based on the quality of the collateral, rather than the borrower Trading liabilities (~5%) similar to repo, have costs more related to the underlying securities than the credit quality of the bank Other category - primarily consists of timing differences and customer payables, which do not bear credit-sensitive interest

Some Liabilities Clearly Do Not Benefit

16% 50% 50% 18% 8%

BAC C GS JPM

16% 50%

70%

20% 10% 0%

20%

10%
MS WFC

Only a subset of wholesale debt would fall within the scope of TBTF senior unsecured debt, commercial paper, sub debt, and trust preferred securities, which together represent $1.2trn in debt, or ~ 13% of these six banks total assets ___________________________

Deposits

Repo

Trading Liab

Whsale Debt

Equity

Other

1. Too-big-to-fail 2. Why Should Taxpayers Give Big Banks $83 Billion a Year? Bloomberg View. February 20, 2013. Note: For details, please see TBTF: The $83bn Question, July 1, 2013. Source: Company reports, SNL, Barclays Research

While the impact of TBTF status on deposits is less clear, we believe they are unlikely to be any cheaper because of TBTF
Deposits: Unlikely to be Cheaper Due to TBTF
At $4.4trn, deposits represent the largest single liability on the money center banks aggregate balance sheet Deposit balance naturally divides into two distinct categories:

Cum. Chg in Acct Bal >250k since 4Q11 (%)1

Uninsured depositors have appeared largely indifferent 20% to a banks size 15%
25% 10% 5% 0% -5%
4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

Insured Deposits: with insured deposits, depositors have little incentive to consider the credit quality of their banks Uninsured Deposits: these deposits could display some credit sensitivity; however, in practice, they have shown little sensitivity to a banks systemic importance

Moneycenters

All Others

When the FDICs expanded Transaction Account Guarantee (TAG) expired at the end of 2012, money-center banks experienced a 1% decline in previously guaranteed account balances the opposite of what we would expect if TBTF were a major depositor consideration Even if an uninsured depositor were to leave funds at a failing bank, developments in bank resolution practices minimize the chance of experiencing a loss Collectively, this very low likelihood of bearing a loss explains uninsured depositors minimal credit sensitivity

Resolutions to Protect Uninsured Deposits (05-)

100% 80% 60% 40% 20% 0%
>$0.5bn $0.5-1bn $1-10bn $10-100bn >$100bn

94%

87%

88%

86%

100%
*Only Wash. Mutual

___________________________ 1. The All Others category excludes the three major trust banks (BK, STT, and NTRS), as these banks have experienced much more volatile deposit flows over the past two years than either the money centers or the other regional banks. Note: For details, please see TBTF: The $83bn Question, July 1, 2013. Source: FDIC, Barclays Research

Uninsured Deposits Protected

Uninsured Deposits Not Protected

On the low end, those estimating no TBTF subsidy have focused on bond market funding costs, where a comparison of credit spreads shows no benefit to size. However, we believe this type of analysis oversimplifies the issue
10y IG Bank Holdco OAS vs Total Assets1
OAS 300

10y IG Bank HoldCo OAS vs Composite Rating2

OAS 300
*Bubble size denotes total assets

250

250

200

200

150

R = 0.0084

150

100

100

50

50

1. Asset size as of 1Q13. 2. Composite rating reflects median of Moodys, S&P, and Fitch senior holding company issuer ratings. Note: For details, please see TBTF: The $83bn Question, July 1, 2013. Source: Barclays Research

$1,000 $1,500 $2,000 Asset Size ($bn) Small Regional Money Center ___________________________

$0

$500

$2,500

3 AA-

4 A+

6 7 8 ABBB+ BBB Composite Standalone Ratings Money Center Regional Small

5 A

9 BBB-

10 BB+

10

A simple spread comparison is incorrect because the largest banks differ in their business mix from regional banks and from each other
Money Center vs Regional Banks
Retail Banking Money Center Banks Regional Banks Yes Yes Commercial Banking Yes Yes Credit Cards Yes Sometimes Trade Finance Yes Sometimes Debt & Equity Capital Markets Yes Minimal Securities Trading Yes Minimal Asset Management Yes Sometimes

Money Center Banks Risk-Weighted Asset Mix1

100% 20% 80% 60% 40% 20% 22% 0% Bank of America (BAC) Citigroup Inc. ( C ) Goldman Sachs (GS)
Retail & Commercial Banking

6% 24% 30% 68% 84% 76% 70% 32%

78% 80%

JPMorgan Chase (JPM)

Morgan Stanley (MS)

___________________________ 1. Risk-weighted assets as of 1Q13. Note: For details, please see TBTF: The $83bn Question, July 1, 2013. Source: Company reports, SNL, Barclays Research

Investment Banking

Wells Fargo & Company (WFC)

11

Instead, comparing each banks credit spread to a weighted-average spread corresponding to its asset mix better addresses the money center risk profile. Utilizing such a framework, we estimate an annual subsidy of $2-6bn
Bank Credit Spreads vs Risk-Weighted Asset Mix1
A simple analysis suggests a subsidy of 9-32bp for four of the six largest banks

OAS 300 250 200 150 100 0%

Average Spread for Pure Investment Banks

BAC WFC 10% 20%

MS JPM

GS

Average Spread for Pure Retail & Commercial Banks

OAS 250 200 150 100

Refined RWA Analysis

A more refined analysis suggests a subsidy of 5-15bp for only three banks

30% 40% 50% 60% 70% Est. Investment Banking RWAs % Total RWAs

+ 11bp

80%

90%

100%

15-50bp x $1.2 trillion of credit-sensitive debt of six banks = $2-6 billion Even this estimate may be too high

$2-6 Billion Annual Subsidy

+ 24bp

+ 13bp

Money center bank debt is far more liquid Money center banks average Tier 1 Common Ratio is 9.14% compared with 8.26% for a sample of large regionals1 Low-risk businesses, such as asset management and trust/custodial, are not considered

- 7bp
-15bp

- 6bp BAC C GS JPM MS WFC

Actual 10y Spread Predicted 10y Spread ___________________________ 1. Retail & commercial bank average includes COF, PNC, USB, and FITB. Investment bank average includes JEF, LAZ, and RJF. Note: RWA breakdown as of 1Q13. For details, please see TBTF: The $83bn Question, July 1, 2013. Source: Barclays Research

12

Our recent institutional investor survey confirmed that the perception of TBTF is widespread and that regulators have much work to do in improving the credibility of their new resolution powers
Investor Survey: TBTF Subsidy Estimate
40% 30% 20% 10% 0% No Spread Subsidy 1-25 bp 26-50 bp 51-100 bp Over 100 bp Because the 6 largest U.S. banks might be bailed out in a future crisis, the market-demanded spread for senior U.S. SIFI credit is __ bp lower than it would be otherwise.

Investor Survey: Likelihood of Bail-Out

Over the next 20 years it is likely ( > 50% chance ) that:

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

Multiple US SIFIs will A single US SIFI will A US SIFI failure is face an idiosyncratic unlikely in the next 20 face a connected stand-alone failure years succession of standalone failures

Investor Survey: Likelihood of Bailout

80% 60% 40% 20% 0%

Assuming a SIFI fails in the next 10 years, do you believe Orderly Liquidation Authority (OLA) would be used to resolve the entity?

While the TBTF subsidy is real, its small size suggests

Subsidy Size is Not Constant

only modest power to alter risk-taking behavior market risk

Subsidy is likely to change with perceived broad Subsidy could be large during times of
No, some form of bail- Yes, but only if one Yes, even if multiple out would instead take SIFI were to fail on an SIFIs failed in place idiosyncratic basis relatively quick succession

uncertainty unless regulators address outstanding concerns

___________________________ Note: For details, please see TBTF: The $83bn Question, July 1, 2013. Source: Barclays Research

13

In Summary
Credit spreads rallied over the past two weeks, with CDX outperforming. So far, despite the sharp selloff in fixed income since the May tights, there has been little evidence of a great rotation away from credit and into equities In the near term, we remain positive on credit and expect spreads to tighten once rates stabilize. However, in the medium-to-longer term, we will continue to closely monitor commentary from the Fed and changes in underlying data, being mindful of the risk that QE is withdrawn without significant improvement in economic data The banking sector remains in focus as the TBTF debate has intensified. Estimates of the TBTF subsidy vary wildly, ranging from $0 to $83bn. The high-end estimates apply a subsidy to too broad a borrowing base, while the low-end estimates ignore differences in business mix Our RWA-based approach estimates an annual subsidy of $2-6bn. But perhaps more importantly, our recent investor survey confirmed that the perception of TBTF is widespread and that regulators have much work to do to dispel the notion of TBTF

14

Tip of the Week: Access your TSP folder in CHART

With the launch of the cross-asset charting and curve analysis tool Chart, Time Series Plotter will be retired in the near future. We are mindful that the Time Series Plotter is still widely used, and we want to ensure a smooth transition to Chart. Please review these simple steps that will allow you to move all saved TSP plots to Chart. 1. Make sure your "Settings" are set up properly: When you open CHART, click "Settings" on the top grey menu bar. From the menu, you will see Show open TSP menu with a box. Please make sure this box is checked and click Save 2. Go to "File," then "Open TSP" Once your settings are changed, your "File" menu will show "Open TSP". Select "Open TSP" to access to your saved TSP folder. You should see your saved TSP plots in the folder. 3. Save your TSP Plots in CHART Once you have opened the TSP plot in CHART, you must "Save As" in CHART to access the plot after TSP retirement and to add the plot to your CHART Batch reports. Barclays Live Sales: Americas Yana Bouchkanets +1 212 526 5537 yana.bouchkanets@barclays.com

Julia Brezing +1 212 412 2539 julia.brezing@barclays.com

Jim Martin +1 212 412 7619 jim.martin@barclays.com

15

Analysts Certifications and Important Disclosures

Analyst Certification(s) We, Jeffrey Meli, Jigar Patel and Alex Gennis, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures: Barclays Research is a part of the Corporate and Investment Banking division of Barclays Bank PLC and its affiliates (collectively and each individually, "Barclays"). For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to http://publicresearch.barclays.com or call 212-526-1072. Barclays Capital Inc. and/or one of its affiliates does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays may have a conflict of interest that could affect the objectivity of this report. Barclays Capital Inc. and/or one of its affiliates regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). Barclays trading desks may have either a long and / or short position in such securities, other financial instruments and / or derivatives, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, Barclays fixed income research analysts regularly interact with its trading desk personnel regarding current market conditions and prices. Barclays fixed income research analysts 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, Currencies and Commodities Division and the potential interest of the firms investing clients in research with respect to the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays produces various types of research including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research may differ from recommendations contained in other types of research, whether as a result of differing time horizons, methodologies, or otherwise. Unless otherwise indicated, Barclays trade ideas are provided as of the date of this report and are subject to change without notice due to changes in prices. In order to access Barclays Statement regarding Research Dissemination Policies and Procedures, please refer to https://live.barcap.com/publiccp/RSR/nyfipubs/disclaimer/disclaimer-research-dissemination.html.

16

Disclaimer
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17

Disclaimer (contd)
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