Economic Outlook

Dean Maki
Head of US Economics Research
April 2010

PLEASE SEE ANALYST CERTIFICATION(S) AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 21
 The labor market is improving, boosting household income

3m chg, pp 3m % chg 3m/3m % chg, saar

-0.8 1.0 10 Payroll proxy (agg wkly hrs * avg hrly earnings)

8
-0.4 0.5
6

4
0.0 0.0
2

0.4 -0.5 0

-2
0.8 -1.0
-4

Unemployment rate (lhs, inverted) -6

1.2 -1.5
Nonfarm payrolls (rhs)
-8

1.6 -2.0 -10

00 01 02 03 04 05 06 07 08 09 10 05 06 07 08 09 10

Note: Shading indicates recession. Source: BLS, Haver Analytics, Barclays Capital

2
Consumers are spending the additional income they are earning

% y/y, quarterly data % 3m/3m, saar

20
6

5
10
4

0 3

2
-10 1

0
-20
-1

-2
-30
-3

-40 -4
00 01 02 03 04 05 06 07 08 09 10 00 01 02 03 04 05 06 07 08 09 10
Light vehicle sales Real non-auto consumption

Note: Shading indicates recession. Source: BEA, Autodata, Haver Analytics, Barclays Capital

3
 US households more exposed to equities, but less exposed to real estate

% Stock market holdings as a % of disposable income % Household real estate as a % of disposable income
220
500

US 450
180 UK
Euro area US
400
UK

140 350

300

100
250

200
60
150

20 100
90 92 94 96 98 00 02 04 06 08 90 92 94 96 98 00 02 04 06 08

Note: Stock market data exclude holdings by defined benefit plans and life insurance companies as well as unquoted equities. 2009 real estate observation for UK is
estimated using house price changes. Source: Federal Reserve, Eurostat, ONS, FTSE, Haver Analytics, Barclays Capital

4
 ISM inventories and exports are popping higher

Index, sa Index, sa
75 65

70
60
65

60 55
55
50
50

45
45
40

35 40
ISM manufacturing composite
30
ISM manufacturing: new orders 35 ISM manufacturing: inventories
25
ISM manufacturing: new export orders
20 30
00 01 02 03 04 05 06 07 08 09 10 00 01 02 03 04 05 06 07 08 09 10

Note: Shading indicates recession. Source: ISM, Haver Analytics, Barclays Capital

5
 Global manufacturing confidence is at a cyclical peak

3m/3m % chg, saar SD from mean Index PMI export indices

20 1.5 65

1.0
60
10
0.5
55
0 0.0
50
-0.5
-10 45
-1.0
40 US
-20 -1.5 UK
Euro area
35
-2.0
-30
Global manufacturing output (lhs) 30
-2.5
Global manufacturing confidence (rhs)
-40 -3.0 25
98 00 02 04 06 08 10 07 08 09 10

Source: Datastream, Markit, ISM, Haver Analytics, Barclays Capital

6
US Rates Outlook

Ajay Rajadhyaksha, Head of US Fixed Income and Securitized Products Strategy

Anshul Pradhan, US Fixed Income Strategy

April 2010
Macro Views at the Start of 2010…

ƒ Rate sell-off in Dec 2009 will take a breather in Q1…

ƒ …before rates start rising again by the end of Q1, and over Q2-Q4
ƒ 2s/10s should remain steeper than the forwards, and stay at record-steep levels
ƒ 5s/30s is a good way to put on steepeners, especially going into bond auctions
ƒ Swap spreads should tighten, and 10-year swap spreads turn negative…
ƒ …driven by massive Treasury issuance as well as a deteriorating fiscal situation
ƒ Sell gamma – low realized vol and range-bound rates in Q1, supply, and a weak mortgage option
ƒ …while we expected longer expiries to hold up better
ƒ End of the Fed’s asset purchase program would not be an ‘event’ for MBS spreads…
ƒ …though 15-20 bp of spread widening likely
ƒ Housing and securitized markets pose far lower systemic risk…
ƒ …but home prices have very limited upside for several years

8
…and Macro Views Going Forward

ƒ Rate sell-off should continue, though in a contained fashion…

ƒ …and the curve should stay steeper than the forwards for several months
ƒ Especially with the latest payroll report taking away a major part of the bond bulls’ argument
ƒ Fair value for 10-year swap spreads is still negative…
ƒ …though the near-term widening is not a surprise after the sharp move 2 weeks ago
ƒ Gamma has little further downside – the focus should shift to intermediate expiries
ƒ The vol curve is too steep – sell 2y*10y hedged with 3M*10y
ƒ Supply of vol should continue to be a factor pressuring all options lower
ƒ There should be little MBS spread widening left – and we turn Overweight on the basis now
ƒ Limited home price declines, especially as the latest HAMP program increases bottlenecks
ƒ We still like many of the trades recommended at the start of the year, but a lot has already been realized
ƒ So conviction on trades is that much lower

9
Macro Effects of the New Housing/Mortgage Programs

ƒ HAMP program – 20-40% of all HAMP modifications

ƒ …but 3-4MM modified loans will still be very difficult
ƒ FHA Refi program – 88bn in possible agency refis / 51bn in possible non-agency refis
ƒ Realistically, 50-60% of this universe of 140bn will end up refinancing
ƒ FHA supply should pick up by 50-100bn but impact on agency speeds is muted
ƒ Housing – further slowdown in foreclosure to REO roll rates
ƒ Home price declines might be even more muted than our 4-5% forecast
ƒ Banks – Losses should be 25-30bn lower on residential loan books
ƒ …led by lower losses on first liens, but the change is not huge given future bank losses of 800+bn
ƒ Many operational challenges remain, and many questions are not yet answered…
ƒ …while debt forgiveness could increase moral hazard risk

10
10y Spreads Should Trade in Negative Territory

ƒ 10y spreads are still trading quite tight relative Main Driver: Budget Deficit Expectations
to history 160 8
140 6

ƒ Forward-looking budget deficit expectations

120 4
100
2
are the main driver 80
0
60
-2
40
ƒ 10y spreads should be trading in negative 20 -4

territory to reflect persistent deficits. 0 -6

-20 -8
Apr-90 Apr-94 Apr-98 Apr-02 Apr-06 Apr-10

10y Spreads, bp, LHS

Fair Value, bp
Average Deficit/GDP %, 5yr forward, RHS

10y spreads: A Historical Perspective 10y Spreads Should be Negative

30
160 20
140 20 16
120 10 15
9 0
100 0
80 -10 -17
60 -20 -10
40 -30
20 -31
-40
0 0
2s 5s 10s 30s
-20
Apr-94 Apr-97 Apr-00 Apr-03 Apr-06 Apr-09 Market, bp Fair Value - CBO Adjusted Deficit Projections

10y Matched Maturity Swap Spreads, bp

Source: CBO, Barclays Capital

11
Government Debt: A Global Concern
UK Experience: A Risk
ƒ Spreads are trading at historically tight levels 110 -40
across the globe. 100
UK 10y Sovereign CDS, LHS
-30
10y UK Swap Spreads, RHS (inverted scale)

ƒ Countries where government debt is perceived 90

-20

to be riskier have tighter spreads

-10
80
0
70
ƒ Spread tightening in UK as sovereign CDS 10

spreads widened highlights the risk

60
20
50 30

40 40
Sep-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10

30y Spreads and Sovereign CDS 10y Spreads and Sovereign CDS
0Holland Germany
20
-20Germany US 10
30y Swap Spread, bp

10y Swap Spread, bp

0 US
-40 France UK
Belguim -10 Holland

-60 -20 France UK

Belguim
-30
-80
-40
Spain -50
-100 Spain
Italy
-60 Italy
-120
-70
25 50 75 100 125
25 50 75 100 125
10y Sovereign CDS
10y Sovereign CDS

Source: Barclays Capital

12
What happened two weeks ago?
A Rise in Financial Issuance
ƒ An increase in swapped issuance activity; 30
however, not far from recent experience 25

ƒ Increased concerns about government debt - 20

sovereign CDS spreads widened and 15

government yield curves steepened 10

5
ƒ Investors were forced to unwind crowded 0
spread widener positions Feb-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10

Weekly Swapped Issuance, $bn 4 week Moving Average

Sovereign CDS Spreads Widened… …and Yield Curves Steepened Globally

12 16
10 14
12
8
10
6 8
4 6
2 4
2
0
0
-2 -2
Belgium

France

UK
Finland
Germany

US

Avg (Non-
Netherlands
Austria

Belgium

France

UK
Germany

Finland

US

Avg (Non-
Netherlands
Austria
US)

US)
Tightening in 10y Spreads, bp Increase in Sovereign CDS, bp Tightening in 10y Spreads, bp Change in 2s10s Tsy Curve, bp

Source: Barclays Capital.

13
US MBS/Residential Credit Outlook

Sandeep Bordia
Head of US Residential Credit Strategy
April 2010
Agency MBS OAS has widened
Current Coupon L-OAS and T-OAS has widened MBS remain rich to other assets
200
20 Treasury OAS (bp)
Agency OAS (bp)
15 150
Nominal spread of Mortgages vs. AAA Industrial 10y (bp)
10 100

5
50
0
0
-5
-10 -50

-15 -100

-20
-150
Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-02 Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09

L - OAS (bp) T - OAS (bp)

ƒ Treasury and Libor OAS have diverged recently on account of rapid tightening of swap spreads
last week
ƒ OAS widening over the past couple of weeks comes as the Fed ends its MBS purchase program
ƒ Despite this however, we believe agency mortgages are still trading rich as spreads to Treasury,
agency debt and credit are still below historical averages
___________________________
Source: Barclays Capital

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The coupon-by-coupon Fannie cleanup scenario

FN 30y prepayment forecast

ƒ Fannie Mae announced clarifications
regarding its buyout timeline on March 18, Coupon Vintage
Actual CPR
Mar
Projected FNMA (reporting month)
Apr May Jun
2010 5 2008 15.7 20.6 18.2 33.9
2007 17.6 22.6 20.6 53.8
ƒ The announcement confirmed that buyouts 2006 18.2 21.8 21.2 52.6
would occur coupon by coupon, with 6.5s 5.5 2008 21.9 27.2 25.4 48.9
bought out in the April report, 6.0s in May, 2007 24.0 30.3 28.1 65.5

and 5.5s and 5.0s in the June report 2006 23.1 29.1 27.1 65.5
6.0 2008 26.1 33.3 68.7 27.3

ƒ We expect speeds on credit-impaired 6.5 2007 26.7 35.7 81.3 29.4

2006 22.8 29.8 75.5 28.3
cohorts to exceed 85 CPR in the April report, 6.5 2008 28.0 85.0 30.5 29.1
and 6.0 cohorts to be exceed 70 CPR in the 2007 29.3 93.3 33.1 32.1
May report. 2006 22.2 87.1 29.9 28.7

___________________________
Source: Barclays Capital

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New initiatives announced
ƒ Bringing debt forbearance to the top of the HAMP waterfall, along with earned
forgiveness
` Targeted at underwater borrowers with MTM LTV > 115
` Effect of lower redefaults overcomes extension to result in moderate upside for senior
securities

ƒ FHA short refinancing program for non-FHA current borrowers

` Underwater current borrowers have part of debt forgiven and are refinanced into new FHA
loan, second lien resubordinated subject to CLTV < 115
` Given stringent eligibility criteria (full FHA underwriting) few borrowers expected to qualify

ƒ Other updates to HAMP and HAFA

` Greater scrutiny about offering HAMP to borrower before foreclosure
` New payment reduction scheme for unemployed borrowers
` Increase incentives in HAFA to encourage foreclosure alternatives
` Will hold up the foreclosure to REO process

17
 Implications for the housing market
ƒ The slowdown in the HAMP foreclosures and modifications will delay near-term distressed supply –
effect to be visible in 3-6 months
ƒ Increases likelihood of limited or no additional declines in 2010 at cost of long drawn recovery –
bolsters our view that government will do whatever it takes

REO influx rate will remain contained REO stock will remain high for a long time
160 1,000
Optimistic
Base

REO Inventory (000s)

120 800
Stress

80 600

400
40
200
0
Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10
-
REO Outflux REO Influx Nov-09 Nov-10 Nov-11 Nov-12
___________________________
Source: NAR, MBA, LoanPerformance, Barclays Capital

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 Overall banks losses will come down slightly
ƒ 1st lien refi likely to help banks by slightly lowering overall losses
ƒ More front-ended losses from HAMP but lower overall losses for both 1st and 2nd liens
ƒ Resi loan losses will be lower by about 5-10%

Bank 1st and 2nd lien losses

Current loans Delinquent Loans REO Total

Assets
Prev. Loss New Loss Prev. Loss New Loss Loss Prev. Loss New Loss
Loans secured by
1-4 family first 1741 138 123 92 86 6 230 209
liens
Loans secured by
1-4 family junior 188 26 25 9 8 0 35 33
liens
Home equity
667 71 65 17 16 0 88 80
loans

Total 2596 236 212 118 96 0 354 322

___________________________
Source: FDIC, Barclays Capital

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 Current non-agency trade recommendations
Type Trade Rationale
● Higher yields than other risky assets
●Favorable on prices ● Muted supply, strong demand and cheap leverage
Overall View
● Systematic risk premium widening can be hedged out using
CDX.HY

● 2H06 Subprime PAAAs and LCF AAAs ● Outright best yields by 2-3% vs. other non-agy sectors
Outright Long ● Alt-A ARM SSNR 2006/07 ● Pickup yield, reset risk is overstated.
● 2005 OA SSNRs ● Yield pickup in cleaner collateral, recast risk overblown

Levered Long ● Jumbo /alt-A Fixed SSNR ● Stable profiles with high levered yields

Recovery ● ABX 07-2 LCF vs. 1.12x ABX 06-2 PAAA ● Downside hedged out with option like upside profile
Trade ● Long 2007 Subprime LCF/PAAAs outright ● Best price pickup in a recovery

● PrimeX ARM could be a good substitute ● Rate Modification risks decreased. However, final structure/cash-
PrimeX for cash synthetic basis will determine viability

Reremics ● Long Sr Mezz ● Attractive risk-reward profile

20
 CMBSN SSNRs rally despite continued credit deterioration
ƒ Impressive rally in March and spreads tightened over 65bp
ƒ Mounting credit pressure
Impressive Rally over the Month Special Serviced Loans Continue to Rise

Bp 12 SS-current
1,600 LCF Dupers - 2005+ all 30+d delq
GSMS 07-GG10 A4 10
1,400

1,200
Spreads dipped below 8 30+ day delinquency rate = 7.8%
1,000 pre-Lehman bankruptcy Specially serviced current = 3.4%
level Total = 11.2%

%
6
800
600 4
400
2
200

0 0
Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 00 01 02 03 04 05 06 07 08 09 10

___________________________
Fixed rate conduit / fusion universe only. Source: Barclays Capital

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Reg AC and Important Disclosures
Analyst Certification(s)
We, Dean Maki, Ajay Rajadhyaksha, Anshul Pradhan and Sandeep Bordia, 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.
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