Sie sind auf Seite 1von 88

Fixed Income Strategies

Fourth Quarter 2010

MetWest is a wholly-owned subsidiary of The TCW Group, Inc.


Table of Contents

I. TCW Overview

II Fixed Income Investment Philosophy

III. Corporate Bond Investment Philosophy and Process

IV. Structured Product Management

V. Outlook and Strategy


- Economic Outlook
- Corporate Market Outlook
- Structured Product Outlook

This publication is for general information purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any security. Any holdings of a particular company or security discussed
herein are under periodic review by the portfolio management group and are subject to change without notice. In addition, TCW manages a number of separate strategies, and portfolio managers in those
strategies may have differing views or analysis with respect to a particular company, security or the economy than the views expressed herein. An investment in the strategy described herein has risks,
including the risk of losing some or all of the invested capital. Before embarking on the described investment program, an investor should carefully consider the risks and suitability of the described strategy
based on their own investment objectives and financial position. Past performance is no guarantee of future results.
The information contained herein may include estimates, projections and other “forward-looking statements.” Due to numerous factors, actual events may differ substantially from those presented herein.
TCW assumes no duty to update any such forwardlooking statements or any other information or opinions in this document. Any information and statistical date contained herein derived from third party
sources are believed to be reliable, but TCW does not represent that they are accurate, and they should not be relied on as such or be the basis for an investment decision.
Any issuers or securities noted in this document are provided as illustrations or examples only, for the limited purpose of analyzing general market or economic conditions, and may not form the basis for an
investment decision. TCW makes no representation as to whether any security (or the security of any issuer) mentioned in this document is now or was ever held in any TCW portfolio. TCW is not
recommending the purchase, sale or holding of any security and is making no representation or indication of its own holdings of any securities. TCW may in fact be currently recommending the purchase of a
security or the sale of a security regardless of any statement made in this document about that security or whether TCW owns it or not. Discussion of securities in this document are strictly for educational
use only and are not intended to serve as investment advice. Any statement made in this document, including any statement or implication drawn from any discussion of individual securities, is subject to
change at any time, without notice.
Copyright TCW 2010

1 PREShgf386 1/19/11
I. TCW Overview
TCW Overview

• Established in 1971 in Los Angeles, California

• The TCW Group (TCW®) entities principally include:


The TCW Group, Inc.
Holding company
Trust Company of the West
An independent trust company chartered by the State of California
TCW Asset Management Company (TAMCO)*
Institutional and private client separate accounts
TCW Investment Management Company (TIMCO)*
Mutual funds and retail managed accounts
Metropolitan West Asset Management, LLC (MetWest)*
Mutual funds, institutional separate accounts and private client separate accounts

• Over $115 billion under management or committed to management as of December 31, 2010

• Approximately 1,300 institutional and private clients

• Over 900,000 retail accounts**

• TCW staff of 614 individuals, including 378 investment and administrative professionals***

• The TCW Group, Inc. is an indirect majority-owned subsidiary of Société Générale, S.A.

• TCW offers strategies that invest in major world equity, fixed income and alternative markets, with offices in Los Angeles and New York

* Investment advisors registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Other registered investment advisor entities are also included in the TCW Group.
** Number reported semi-annually, as of December 31, 2010.
***Assistant Vice President and above.
3 PREShgf386 1/19/11
TCW Assets Under Management – By Products Offered
or Committed to Management as of December 31, 2010

Total Assets: $116.2 Billion U.S. Fixed Income Assets: $64.6 Billion

Core Balanced ($0.5)


High Yield Bonds ($3.6)
International ($9.6)
Bank Loans ($3.2)
Mortgage-Backed
Securities ($20.9)
Alternative
Investments ($16.1) Low/Intermediate/
Long Duration ($9.0)

Government/Corporate
Investments ($1.7)

U.S. Equities ($25.4)

U.S. Fixed Income ($64.6) Core Fixed Income ($26.2)

4 PREShgf386 1/19/11
Fixed Income Products

Traditional Liability Driven Investments (LDI)


Ultra Short Active liquidity management Long Duration High quality vs. Long G/C or Long Credit
Low Duration Relative value 1-3 year duration Overlay Strategies Derivative-based asset/liability
Intermediate Relative value 2-4 year duration investing strategies
Total Return
Core Investment grade; opportunistic, value driven
Core Plus Value driven, up to 20% in high yield International Strategies
Opportunistic Core Plus Value driven, up to 50% in plus sectors Emerging Markets Exploits improving credit fundamentals
Developed Market Non-U.S. $ Dedicated focus on international
opportunities
Mortgage Strategies
MBS Total Return Value-driven vs. MBS Index
Specialized Cash LIBOR plus objective Other Strategies
Opportunistic MBS Non-agency MBS focus Treasury-Only U.S. Treasuries
Strategic MBS Absolute return objective TIPs Treasury Inflation Protected Securities
MBS Alternatives Private Vehicles Secured Fixed Income Multiple-sector, bonds backed by
pledged collateral
Portable Alpha Futures/swaps to gain beta (e.g. S&P
Corporate Credit Strategies
500), fixed income alpha engine
Investment Grade Dedicated investment grade corporate
bond portfolios
High Yield Dedicated credit intensive process

5 PREShgf386 1/19/11
Fixed Income Team History & Evolution

1990 – 1992 1992 – 1996 1996 – 2009


History at PIMCO History at Hotchkis & Wiley Metropolitan West Asset Management
Tad Rivelle, • Team recruited to build fixed • Founded firm in August 1996 TCW/MetWest Today
Laird Landmann, income effort
• Grew from $2 Billion to $30 Billion assets under management
and Stephen Kane • Fixed income assets under December 2009 transaction
• 100% focused on U.S. fixed income management
work together as management grew from brings together two prominent
$200 Million to $2 Billion • Morningstar Fixed Income Manager of the Year for 2005
portfolio managers fixed income teams
• 5 Investment Professionals As of December 2009
• 115 Employees
• 30 Investment Professionals
As of December 31, 2010
• $116.2 Billion Total AUM /
Established in 1971 TCW $64.6 Billion AUM in Fixed
Trust Company of the West As of December 2009 Income products offered

• Robert A. Day founder • Headquartered in Los Angeles, California • 614 Total Employees
• Acquired by Société Générale in 2001 • Grows to $50+ Billion in Fixed Income assets under management • 149 Investment Professionals
• 618 Employees
• 57 Fixed Income Investment
• Fixed Income team established in 1976 • 192 Investment professionals Professionals
• Broad capabilities in mortgage-backed securities, • 76 Fixed Income Investment professionals
government, corporate, emerging markets, and
non-dollar debt

6 PREShgf386 1/19/11
Fixed Income Expertise
As of December 31, 2010

Chief Investment Officer–Fixed Income


Tad Rivelle

Generalist Portfolio Team


Stephen Kane, CFA
Laird Landmann
Barr Segal, CFA, CIC
Ruben Hovhannisyan, CFA, CPA – Analyst

Mortgage-Backed Investment Emerging Markets


Corporate/High Yield Government/Rates Product Management Commodities
Securities Risk Management Debt
Portfolio Investment Team Portfolio Investment Team Portfolio Investment Team Stephen Burns, PhD Patrick Moore Portfolio Investment Team Claude Erb, CFA
Eric Arentsen Jamie Farnham Bret Barker Marcos Gutierrez David Vick, CFA Penny Foley Jay Gerard
Pat Doyle Tammy Karp Lawrence Rhee Joseph Lopez Christina Bau David Robbins Matthijs Randsdorp
Mitch Flack Thomas Lyon, CFA Joyce Pang Javier Segovia
Bryan Whalen, CFA Gino Nucci, CFA Analysts/Traders Melicia Shen
Jeannie Fong Andy Wu Analysts/Traders
Analysts/Traders Analysts/Traders Jeffrey Lee Bing Bing Yu Stephen Keck, CFA
Pat Ahn Rahul Bapna, CFA Katherine Wu Jason Shamaly
Scott Austin, CFA Sinjin Bowron Alex Stanojevic
Harrison Choi Mike Carrion
Beth Clarke Marie Choi
Melissa Conn Nikhil Chopra Sovereign Risk
David Doan RJ Cruz, CFA Research
Philip Dominquez, CFA Joel Shpall
Daniel Dy Kenneth Toshima Blaise Antin
Marcela Meirelles, PhD
Michael Hsu
Brett Rowley
Tony Lee
Jean-Charles Sambor
Lifen Li
Brian Loo, CFA
Sonia Mangelsdorf
Jonathan Marcus
Sagar Parikh
Palak Pathak, CFA
Brian Rosenlund, CFA
Brett Roth, CFA
Charles Tu
Nanlan Ye
Zhao Zhao

7 PREShgf386 1/19/11
Representative Client List
As of September 30, 2010

Corporations Public Funds Foundations, Universities and


ArcelorMittal Steel USA, Inc. Alameda County Employees' Retirement Association Not-For-Profit Organizations
AT&T Inc. California State Teachers' Retirement System Adrian Dominican Sisters
BAE Systems North America City of Tallahassee Pension Plan California State University Risk Management Authority
Briggs & Stratton Corporation Duluth Teachers Retirement Fund Association Catholic Relief Services
CEMEX Employees’ Retirement System of the State of Hawaii Community Funds, Inc.
Cleco Corporation Fire & Police Pension Association of Colorado Cornell University
Grupo Bimbo Illinois State Universities Retirement System Cumberland Presbyterian Church
Hallmark Cards, Inc. Maine Public Employees’ Retirement System Father Flanagan’s Trust Fund
ITT Corporation Michigan Department of Treasury Mississippi United Methodist Foundation
Jack in the Box, Inc. Oklahoma Law Enforcement Retirement System Missouri Baptist Foundation
M Life Insurance Co. Oklahoma Public Employees’ Retirement System New York University
McDonald’s Owner/Operator Ins. Co. Ltd. Sacramento County Employees’ Retirement System The Archdiocese of San Francisco
Navy Federal Credit Union Sacramento Regional Transit District The Bush Foundation
R. H. Donnelley Corporation San Diego City Employees’ Retirement System Twin Cities Public Television
RR Donnelley & Sons Company State of Michigan Retirement System University of Oklahoma Foundation, Inc.
sanofi-aventis South Carolina Retirement Systems U.S. Conference of Catholic Bishops
Smart & Final Tacoma Employees’ Retirement System Virginia Tech Foundation, Inc.
Textron, Inc. Uniform Retirement System for Justices & Judges of the State of Oklahoma
The Schwan Food Company Westmoreland County Employees’ Retirement System
Union Bank Mutual Funds and Subadvisory
Verizon Investment Management Corporation Health Care Absolute Investment Advisers LLC
CGCM Core Bond Fund
Allina Health System
Multiple-Employer/Unions Aria Health
Metropolitan West Funds
Russell Investment Group
Boilermaker-Blacksmith National Pension Trust Bishop Clarkson Memorial Foundation
– Multiple Funds
District 1199J Pension Fund Blue Cross and Blue Shield of Minnesota
SEI Core Fixed Income
Local No. 8 I.B.E.W. Retirement Plan Cedars-Sinai Medical Center
SEI Long Duration Fund
Media Guild Retirement Plan Hackensack University Medical Center
Pictet & Co.
New Jersey Transit Iowa Health System
– U.S. High Yield Fund
Painting Industry of Hawaii Annuity Fund Medica
Producer-Writers Guild of America Pension Plan Methodist Le Bonheur Healthcare
San Diego County Cement Masons PeaceHealth
San Diego County Construction Laborers Rush University Medical Center
Screen Actors Guild - Producers Pension Plan Trinity Health
Teamsters Negotiated Pension Plan Via Christi Health System
Welborn Baptist Foundation

The clients listed are invested in one or more investment strategies and are selected either because of their inclusion in the 2010 Money Market Directory or with express written consent by the client. Inclusion on this list
should not be considered an endorsement of the investment advisor or services rendered.
8 PREShgf386 1/19/11
II. Fixed Income Investment Philosophy
U.S. Fixed Income Investment Philosophy

Consistent outperformance can be achieved through:


• Implementation of multiple fixed income strategies
• Focus on sector management and issue selection
• Application of fundamental value-driven research process

Philosophical Tenets:
• Fixed income markets/securities are mean reverting
• Technical factors can temporarily drive pricing away from fundamentals
• Persistent inefficiencies in fixed income market can be exploited through disciplined research and bottom-up
issue selection

10 PREShgf386 1/19/11
Investment Process

Long-Term Quarterly
Economic Outlook

Mean reversion
Patience
• Duration Management Monthly
Discipline
• Yield Curve Management
Understanding of macro risks
• Sector Management

Portfolio Structure Client


• Diversified
Objectives
• Optimized
and Guidelines
• Controlled Risk

Intensive search for value • Security Selection


Understanding of micro risks • Buy/Sell Execution Daily

11 PREShgf386 1/19/11
Duration Management

Long-Term Investment Outlook


Financial Market Conditions Monetary Policy Fiscal Policy
Credit Spreads Real Fed Funds Budgetary Initiatives
Slope of Yield Curve Fed Objectives Tax Policies
Corporate Profitability Inflation Deficit / Surplus Conditions
Consumer Delinquency Rates

Duration Strategy
Defensive Outlook Index Positive Outlook
Fast Growth Trend Growth Slow Growth
Higher Rates Rates Stable Declining Rates

Duration Range + / - 1 year

• Long-term outlook is primary driver of long-term duration strategy


• Duration/maturity shifts are held to one-year around client benchmark
• Duration is only one of five tools to add value
• Duration is “dollar cost averaged” over the interest rate cycle

12 PREShgf386 1/19/11
Yield Curve Management

• Yield curve strategy based upon: Unchanging Scenario


8% Bullet
– Fundamental outlook for Fed policy and inflation Return
Bullet 6.87%
7%

Yield
– Expectations versus forward curve
Barbell
6%
– Yield versus convexity trade-off Return
Barbell 6.17%
– Total return analysis 5%
Maturity

Flattening Scenario
8% Bullet
Current Return
7% 7.39%

Yield
One Year
Barbell
6%
Return
7.97%
5%
Maturity

Steepening Scenario
8% Bullet
One Year
Return
7%
Current 7.39%
Yield

6%
Barbell
5% Return
5.49%
4%
Maturity

Scenarios presented do not represent current conditions and are illustrative only.

13 PREShgf386 1/19/11
Sector Management

Average Annual Return by Investment Horizon Average Annual Return by Investment Horizon
(Looking Back from 2008) (Looking Back from 2009)
15% 13.74% 60% 58.21%

10% 8.52% 7.71% 50%


6.35% 6.26% 6.57% 1.43
5% 4.09%
2.31%
6.28%
14.12% 7.15% 4.26% 40%
0% 2.17%
-0.80%
-5% 39.89% 30% 61.78%
-5.59%
-10% 20%
-15% 8.70%
10% 6.14% 6.46% 6.72% 7.57%
1.01% 1.91%
-20% 0.16% 1.61% 0.57%
5.98% 6.15% 6.56% 6.79%
4.85%
-25% 0%
-26.16% -3.57%
-30% -10%
1-Year 3-Year 5-Year 10-Year 15-Year 20-Year 1-Year 3-Year 5-Year 10-Year 15-Year 20-Year

Treasuries High Yield Treasuries High Yield

Source: Barclays Capital Live Fixed Income Indices as of 12/31/08 Source: Barclays Capital Live Fixed Income Indices as of 12/31/09

“Investors should be greedy when others are fearful and fearful when others are greedy.”
– Warren Buffett

• Sector Allocation Philosophy

– Diversify across all allowed investment classes to reduce volatility

– Returns of each sector can be highly divergent in the short-term but revert to the mean in the long-term

– Overweight most attractive sectors to achieve higher risk adjusted returns

14 PREShgf386 1/19/11
Issue Selection: Treasuries

• Live pricing feeds to analytical models TCW/MetWest Proprietary Treasury Model

• Constructs fair value curve

– Identifies rich/cheap Treasury securities

– Compares valuations to historical averages

• Simulate total returns

– Steepen/flatten yield curve

– Measures roll-downs

– Values convexity/volatility

• Trading done via electronic systems (TradeWeb) Source: MetWest


to foster best execution

15 PREShgf386 1/19/11
Issue Selection: Corporates

• TCW/MetWest employs a “belts and suspenders” approach


to corporate bond investing

– Cash flow analysis

– Asset quantification

• Customized corporate valuation models screen relative


value of various credits

• Comprehensive credit analysis

– Rating agency / management interviews

– Capital structure / organizational structure

– Liquidity forecast Traditional Sub-Sectors Structured Sub-Sectors


– Covenant analysis • Industrial • Callable Corporates
• Finance • Putable Corporates
• Utilities • Refundable Bonds
• Yankees • Floating Rate Notes
• Euro Bonds • Sinking Fund Bonds
• Taxable Munis • Asset-Backed

16 PREShgf386 1/19/11
Issue Selection: Mortgage-Backed and Asset-Backed Securities
Shown is a print screen from our loan level database, which aggregates information on all of the loans backing this particular deal
and compares it against the average for the cohort.
1 Deal Information – Basic information about the deal structure
2 Geographic Distribution – Aggregated from zip code data
1 3 Loan Characteristics – Average loan details, and a breakdown
of loans by type (fixed, adjustable, interest only, etc.)
4 Income Documentation – Loans to borrowers with
documented income are less likely to default
5 Loan-To-Value Ratios – Measure of the size of the loan relative to the
value of the property; higher LTVs generally translate to higher loan delin-
3 5 10 14 16 quency. Two methodologies are used to enhance our understanding of
the impact of distressed markets
6 FICO Scores – Limited importance to security analysis in today’s
environment
7 Servicer – Each servicer is independently rated based upon
a proprietary scoring system
6
13 8 Current Loan Performance – Current Credit Enhancement, delinquency,
default, and prepayment rates allow us to
compare this bond to similar bonds in the same cohort
9 Servicing Metrics – In addition to a broad servicer level score, servicing
metrics such as cash flow velocity, advancing, cure rates, severities and
15 8 timelines are tracked at the bond level and compared to the cohort averages
10 Modifications and Recidivism – We track the percentage of the bond level
collateral that has been modified and compare these to the cohort. We
4 9 also break out the modification type and measure what percentage of
seasoned modifications re-default through the recidivism metric.
11 Negative Amortization – For those loans that allow negative amorti-
11 zation, we track what percentage of each negam sleeve
is current and the percentage of each sleeve approaching the negam cap
12 Subsequent Performance of Serious Delinquent Loans – Tracks the
number of payments made by loans that were seriously delinquent 3
months prior and have yet to liquidate. Good indicator of future transi-
12 tions from serious delinquency to default.
13 Current Consumer Credit Data – Knowledge of current borrower credit
2 activities helps forecast delinquencies, defaults and severities as well as
7 shifts in the overall credit quality of the pool.
14 Alpha/Negative Alpha Pricing – Using the TCW loan level default, severity
and prepayment models, the price at which the bond is likely to
outperform (Alpha Px) or underperform (Neg Alpha Px) versus it’s peers.
15 Roll Rates – Tracks the trend of previously current loans transitioning to
the delinquency pipeline.
Result: There is a wealth of information that is gathered, organized, and analyzed 16 Delinquency Analytics – Detailed delinquency statistics covering all
stages of delinquency and default for both the primary pool backing the
through the proprietary loan database. This information has been critical in bond as well as any cross collateralized pools. Additional metrics provide
navigating the difficult environment of the last two years. information on loans that have never been delinquent or are reper-
forming giving an even more detailed view of the health of the pool.
17 PREShgf386 1/19/11
III. Corporate Bond Investment Philosophy and Process
Corporate Bond Investment Philosophy

• Add value throughout the credit cycle via multiple strategies • Take advantage of modest asset base

– Adjust the overall corporate exposure (basis) – Nimbly trade into/out of issuers and sectors
as valuations change over the credit cycle
– Position sizes are not limited by size of market
– Implement intensive credit research process
– Make use of relatively small, but often compelling
to identify undervalued securities
areas of the corporate bond market
– Make modest duration and yield curve shifts
• Project debt
st
• 1 mortgage debt
• Control risk through
• Secured bank debt
– Limited basis when spreads are tight
• SPVs, e.g. EETCs
– Intensive credit analysis that focuses on asset
coverage/downside protection
• Look for value across
– Emphasis on companies with proven management
and strong balance sheets – Capital structure
– Diversification by industry and issuer – Term structure

19 PREShgf386 1/19/11
Credit Research
U.S. Fixed Income Resources

Credit Committee Systems Used for Analysis:


• Generalist Portfolio Managers • Credit Sights • Aviation Specialists, Avitas, etc.
• Jamie Farnham – Director of Credit Research • Covenant Review • Bloomberg
• Gino Nucci, CFA – Corporate Trader • SNL • Barclays Live
• Tammy Karp – Corporate Trader • Markets.com • TCW/MetWest’s proprietary
• CallStreet Securities Management
Credit Research Team • Bond Hub System (SMS)
• Jamie Farnham – Director of Credit Research; Utilities • Capital IQ • TCW/MetWest’s proprietary
• Gino Nucci, CFA – Corporate Trader • Power Finance & Risk Credit Trading System
• Mike Carrion – Corporate Trader • Intra Links • SyndTrak
• Tammy Karp – Corporate Trader
• Joel Shpall – Credit Analyst; Transportation, Autos, REITs
• Marie Choi – Credit Analyst; Healthcare, Food/Beverage,
Consumer Products, Retail
• Rahul Bapna, CFA – Credit Analyst; Insurance, Banks, Finance,
Chemicals, Diversified Manufacturing
• Sinjin Bowron – Credit Analyst; Telecom, Media, Technology,
Homebuilders/Materials, Municipals
• RJ Cruz, CFA – Credit Analyst; Energy, Metals/Mining
• Ken Toshima – Credit Analyst; Industrials, Paper/Packaging,
Gaming/Lodging
• Nikhil Chopra – Credit Analyst; Utilities, Municipals
20 PREShgf386 1/19/11
TCW/MetWest Corporate Credit Team, Resources, Interactions
Corporate Credit Committee
CIO
Generalists / Jamie Farnham / Gino Nucci, CFA / Tammy Karp
Risk Management/Credit Analysts

Reviews relative value, sets risk budgets, industry concentration,


conducts credit reviews

Portfolio Construction/Credit Trading


Tammy Karp Mike Carrion Gino Nucci, CFA

• Idea Generation • Implementation


• Portfolio Construction

Proprietary Technology Credit Research Risk Management


• Quantitative Risk Tiering Model Jamie Farnham, Director Marcos Gutierrez
• Corporate Index Tracking Model Andy Wu, FRM
• Attribution Analysis Joel Shpall Rahul Bapna, CFA Joyce Pang
• Credit Tracking System Kenneth Toshima RJ Cruz, CFA Melicia Shen
• Securities Management System (SMS) Marie Choi Sinjin Bowron Ruben Hovhannisyan, CPA
Nikhil Chopra Stephen Burns, PhD
Vladimir Goldenberg

Information Services

• SEC Filings • Consultants


• Economic Data • Wall Street Analysts
• Industry Data Sources • Independent Analysts
• Management Reviews/ • Legal Professionals
Company Visits • Rating Agency Analysts

21 PREShgf386 1/19/11
Credit Research
Fixed Income Roles, Responsibilities & Process

Follow up
questions

Brief Credit
Some Fundamental Review Credit Some
Investment Investment Ideas Committee Ideas Investment
Idea Advance Analysis Analysis Advance
Discussion Discussion

Responsibility • Trader(s) • Director of Credit • • Analyst(s)


Analyst(s) • Director of Credit • Director of Credit • Trader(s)
• Director of Credit • Trader(s) • Analyst(s) • Analyst(s) • Analyst(s)
• Analyst(s) • Analyst(s) • Trader(s)
• Generalist(s) • Generalist(s)

Process • Trader(s) continually • Director of Credit, • Industry & • Analyst(s) presents • Evaluate investment • Trader(s) implement
monitor real-time trader(s) and competitive initial analysis/opinion merits Investment axe
relative value analyst(s) initially dynamics to Director of Credit
• Trader(s) present • Analyst(s) conduct
discuss investment
• Analyst(s) • Financial analysis • Evaluate whether relative value vs. ongoing credit
merits
periodically review & projections idea merits credit opportunity set monitoring
comparable • Evaluate relative committee discussion
• Liquidity review • Identify further credit
universe value to decide if full
• Analyst(s) prepares questions for follow-up
credit review • Read indenture &
• Generalist(s) also analysis for credit
analysis is credit agreements • If approved, develop
evaluate relative committee discussion
appropriate use of trading axe targets
value across fixed • Asset value analysis
resources & parameters
income sectors
• Discussions with
management &
rating agency

22 PREShgf386 1/19/11
Credit Research Evaluation
• TCW/MetWest’s credit analysts conduct rigorous fundamental assessments to evaluate tangible asset value, claim structure and
management quality

Credit Opportunity

Assets/Cash Flow Liquidity Liability/Capital Structure

• Tangible asset valuation • Cash and undrawn credit facilities • Capital structure
• Cash flow assessment/forecast • Two year quarterly forecast • Organizational structure
• Industry trends • Restrictive covenants • Restrictive covenants
• Economic trends • Unencumbered assets/value • Management’s ability to execute
• Management skill of growing • History of liquidity management within restrictive capital structure
business/cash flow • Bondholder friendliness history

Credit Opinion
Merits vs. Risks

23 PREShgf386 1/19/11
Credit Process
Anchored in Asset Value

• “Two Ways Out” allows flexibility across market cycles

Cash Flow/Liquidity at Maturity Distressed Liquidity/


Recovery (most conservative)

• Asset “coverage” measured both on the face value and market value basis.

Example – Asset Coverage Valuation Methods


Debt at Face Debt at Market Distressed recovery

Asset Value
Less: Debt
$800m
$1b
$800m
$300m1
Critical
Asset sale value } Most relevant
in times of
market stress

Asset Coverage 0.8x 2.7x DCF analysis


Asset Coverage (Discounted)2 0.6x 2.0x Important
FCF analysis

1 Assumes debt trades at 30 cents on dollar


Relevant EBITDA multiple
2 Assumes chapter 11 bankruptcy. Discounts at 20% for 1.5 Years

• Lower bond prices improves asset coverage

24 PREShgf386 1/19/11
Critical Credit Research Aspects
What Are They & Why They Are Important?

Credit Research Analyst Tasks Why is it important?


Industry Analysis • Traces short/long-term industry trends • Identify potential investment candidates
Coverage

• Understand competitive dynamics of companies, • Highlight industry trends that may include
Sector

suppliers & customers important economic signals for generalist


macroeconomic view point

Cash Flow Generation • Identify business model drivers and forecast future • Can business internally generate cash via
expected cash flows business operations?
• Distill accounting “gimmicks” to identify actual cash • If not, business is dependent on external sources
generation and long-term viability could be in question

Claim Structure Priority • Detailed examination of legal/organizational • In a downside, recoveries result from asset value
structure and associated claims (debt) attributed to claim pool. Higher priority claims
• Identify structural and/or claim priority seniority have more favorable recoveries

Asset Valuation • Conduct various valuation approaches including cash • Abundant asset value and unencumbered assets
flow multiple, discounted cash flow percent of could be a potential source of cash
Credit Evaluation

replacement cost, required IRR, etc.


• Determine enterprise valuation of assets

Covenant Analysis • Identify and understand various covenants across • Are there limitations on management flexibility
capital structure via tight covenants?
• Loose covenants could indicate leveraging
potential via value shift to equity owners

Liquidity Assessment • Identify cash and undrawn credit facilities available • Defaults occur when external liquidity
• Detailed quarterly forecast of cash sources/uses for disappears. Can the company manage within
the next two years internal liquidity during a crisis?

Management Interaction • Evaluation of senior management via historical track • Does management have history and flexibility
record and regular interviews to expect leveraging?
• Assess bondholder friendliness and incentives to • How strong is management?
favor shareholders

25 PREShgf386 1/19/11
Credit Research
Other Current Considerations

• Bankruptcy Scenario
– Would a priming debtor in possession loan be necessary? If so, How much?
– Potential for undisclosed liabilities
– Implied recovery using claim priority
• Capital Structure Considerations
– Organizational structure and claim priority analysis
– Pressure of intercompany loans
• Supply Chain Considerations
– Sector excess capacity
– Ability to pass through commodity cost
– Customer concentration/health
• Pension/OPEB Obligations
– Funding requirements
– In downside, what priority and how large would claim be?
• Environmental Liabilities
– Potential capital requirements or demand response of carbon emissions regulation
– Asbestos liability
– Decommissioning liability

This list is not exhaustive but is designed to be indicative of the types of issues analyzed when researching credits.

26 PREShgf386 1/19/11
Credit Portfolio Tracking
Proprietary Credit/Index Monitoring System

• Real-time portfolio monitoring vs. Index using proprietary system

• Idea generation

– Both buy and sell using historical trading relationships

• Credit tracking system keeps record of key analyst notes

Source: TCW/MetWest

27 PREShgf386 1/19/11
Credit Monitoring

28 PREShgf386 1/19/11
Credit Research Example
Telecommunications Firm A

• Large U.S. wireless carrier with valuable spectrum positions, Parent Telecommunications Corporation

Revolver $0 0.1x
customer relationships, and long-haul wireless assets. Export Development Canada $750 0.1x
6.000% Senior Notes 2016 $2,000 3.4x
8.375% Senior Notes 2017 $1,300 3.4x
• Fallen angel that entered high yield universe due to operational 9.250% Debentures 2022
TowerCo Sale-Leaseback
$200
$697
3.4x
3.4x
Subtotal $4,947 3.4x
challenges from integration that caused subscriber losses. Total Subsidiary Debt $15,115 3.4x
Other Debt $239 3.4x
Consolidated Debt $20,301 3.4x
• This coincided with market deleveraging with irrational fears of
an impending default despite generating sizable free cash flow Holding Corporation Holding Corporation
Co-borrower under credit facility
while having substantial liquidity and moderate (~3.0x) 7.625% Senior Notes 2011* $1,650 3.4x 6.875% Senior Notes 2013** $1,473 3.4x
8.375% Senior Notes 2012* $2,000 3.4x 5.950% Senior Notes 2014** $1,170 3.4x
leverage. 6.900% Senior Notes 2019*
6.875% Senior Notes 2028*
$1,729
$2,475
3.4x
3.4x
7.375% Senior Notes 2015**
Total
$2,137
$4,780
3.4x
3.4x
8.750% Senior Notes 2032* $2,000 3.4x ** Guaranteed by Parent but can be waived
Total $9,854 3.4x in certain asset sale circumstances
• During crisis, fears of a split were overblown, in our opinion, * Unconditionally guaranteed by Parent
Other Subsidiary 1
causing over 30 points of price disparity between bonds. Other Subsidiary A

Subsidiary bonds traded as low as the 30s but still trade at a 5 Other Subsidiary 2
Other Subsidiary B
to 10 point discount to parent bonds.
Other Subsidiary 3
Recent Developments: Other Subsidiary C

Other Subsidiary 4
• The operational turn-around is now gaining traction with lower Other Subsidiary D

subscriber churn, and liquidity is still strong. Other Subsidiary 5


54% Voting Interest 1st Lien L+212.5 FRN 2013* $300 3.4x
Parent Telecommunications Corporation B 2nd Lien L+325 FRN PIK 2014* $181 3.4x
• Company recently contributed assets and funding to next Total $481 3.4x
* Unconditionally guaranteed by Parent
generation wireless network operator in exchange for majority 56% Economic Interest
Holding Corporation B
ownership, which represents an additional high yield 12.00% Secured Notes 2015 $2,772 N/A

investment opportunity. Vendor Financing Notes 2014


Total
$33
$2,805
N/A
N/A

• Distinct credit but strategically aligned requiring dual credit


analysis.

29 PREShgf386 1/19/11
IV. Structured Product Management
Structured Products – Team, Resources, Interactions
Structured Product Working Group
(Sector Allocations/Risk Weightings)
CIO
Generalist Portfolio Managers/Structured Product Specialists
Structured Product Analysts
Reviews relative value, risk budgets, sets trading targets and
approves new structures/trading programs

Structured Product Portfolio Managers


Proprietary Technology (Implementation) Additional Technology
• Loan level database over 30 million loans • INTEX
• Idea generation • Reporting
• Default, prepayment and severity models • Trepp
• Implementation • Analysis Review
• Deal level tracking • Yield Book
• Supervision
• Deal/collateral tracking • Bloomberg
• Servicer/originator reviews • Loan Performance 1010 Data
• Securities Management System (SMS)
Structured Products Analysts • Derivative Solutions
• BWIC Browser • Idea generation • Prepayment analysis • Charles River Investment Management System
• Security Analyzer • Price discovery • Servicer reviews • FactSet
• WIP (Collaborative Trading Tool) • Relative value analysis • Risk monitoring • Equifax
• Portfolio Surveillance • Delinquency trends/forecasts • Stress testing • Altos
• Originator tracking

Global Capital Market Resources


Other factors requiring cross-sector perspectives are
quickly assessed through internal collaboration with TCW
specialists in:
• Developed and Emerging Markets
• U.S. High Yield Fixed Income
• U.S. High Grade Fixed Income
• U.S. Equities and Convertibles
• Commodities

The processes described herein are illustrative only and subject to adaptation in any particular context.
31 PREShgf386 1/19/11
Non-Agency MBS Agency MBS
The unprecedented housing and sector dislocation has created the Persistent inefficiencies in the agency mortgage market can be exploited
opportunity for high loss-adjusted yields through a disciplined asset through disciplined research and bottoms-up issue selection.
selection process using: • Minimal credit risk of agency MBS
• Top-Down Analysis • Few competing high quality assets with yield advantage
– Regional and local property trends • Agency MBS cash flows modeled over a range of scenarios
– Local employment conditions for prepayments, interest rates, volatility and home prices
– National loan modification initiatives • Combine fundamental OAS and spread regression with technical
– Differentiating mortgage servicers methods market trends
• Bottom-Up Deal Analysis • Dedicated team seeking relative value opportunities
– Detailed collateral analysis
– In-depth structural analysis
– On-going surveillance of investments, strategies, and trends Structured Products
• Negative home equity is of particular focus
Philosophy and
Valuation Process

CMBS ABS
Historically wide credit spreads and stable cash flows can be captured Complex structures, esoteric assets, and unique idiosyncratic risks limit
through continuous evaluation of: investor participation but can also lead to cheap risk-adjusted investments.
• Systematic Factors: • Hard asset or receivables valuation is the basis for which other forms
– Property Types and Geographic Region of credit protection can be evaluated

– Modification and Liquidation Trends • How these assets or receivables fit within the lessee or borrower’s
business model help us evaluate sponsorship and cash flow timing
– Availability of Financing in both Loan and Securities Markets
• Structural protections need to fill the “credit” gaps and anticipate how
– Transaction Volumes and Subsequent Price Discovery and where performance deterioration will impact bondholders
• Idiosyncratic Factors: • Any level of liquidity constraints are considered when determining the
– Close attention to Tenants and Occupancy proper cusip and portfolio exposure
– Payment Shocks can affect the borrower’s Ability to Pay
– Individual Loan Covenants such as Lockboxes can affect Cash Flows
to the trust
Ultimately our goal is to establish the projected Debt Service
Coverage Ratio
32 PREShgf386 1/19/11
RMBS Proprietary Research and Analytical Tools

Our systems allow us to understand the risks and opportunities of every MBS we purchase on behalf of our clients

Loan Level Database


30+ Million Loans Research & Analytics Outputs
• Combination of proprietary loan database • Delinquency roll rates (deal level) • Vintage Rankings
and third-party loan data • Prepayment rates (deal level) • Alt A vs. Subprime vs. Prime vs. Option
• Original/current loan characteristics • REO sales index (zip code level) Arm comparative analysis
updated monthly by 10 trustees • Absolute and relative rankings at the deal
• Mark-to-Market LTV (loan level)
• Loan information received quickly and level as well as the security level.
• Identify loans with/without positive equity
generally accessible 30-45 days before Approximately 65,000 individual securities
(loan level-current/projected)
third-party systems are currently ranked
• Default behavior coefficient by
• Original information provided includes • Market analysis/insight
Mark-to-Market LTV
LTV, zip code, property type, • Pricing
documentation, loan type, FICO score etc. • Inventory to sales ratios (zip code level)
• Current information updated monthly • Projected home price stabilization
includes payment status, modification (MSA, city and zip code level)
details, loss amounts, prepayments and • Probability of delinquency vs.
liquidation amounts necessary for us to unemployment rates
estimate information and REO sale prices • Recidivism rates (vintage)
• Filters allow for cohort comparative • Actual servicing timeline performance net
analysis of moratoriums and other regulatory
action (respective servicers)
• Projected loss severities based on
servicing non-performing loan model
(loan level)

The processes described herein are illustrative only and subject to adaptation in any particular context.
33 PREShgf386 1/19/11
TCW Proprietary RMBS Analytics
Shown is a print screen from our loan level database, which aggregates information on all of the loans backing this particular deal
and compares it against the average for the cohort.
1 Deal Information – Basic information about the deal structure
2 Geographic Distribution – Aggregated from zip code data
1 3 Loan Characteristics – Average loan details, and a breakdown
of loans by type (fixed, adjustable, interest only, etc.)
4 Income Documentation – Loans to borrowers with
documented income are less likely to default
5 Loan-To-Value Ratios – Measure of the size of the loan relative to the
value of the property; higher LTVs generally translate to higher loan delin-
3 5 10 14 16 quency. Two methodologies are used to enhance our understanding of
the impact of distressed markets
6 FICO Scores – Limited importance to security analysis in today’s
environment
7 Servicer – Each servicer is independently rated based upon
a proprietary scoring system
6
13 8 Current Loan Performance – Current Credit Enhancement, delinquency,
default, and prepayment rates allow us to
compare this bond to similar bonds in the same cohort
9 Servicing Metrics – In addition to a broad servicer level score, servicing
metrics such as cash flow velocity, advancing, cure rates, severities and
15 8 timelines are tracked at the bond level and compared to the cohort averages
10 Modifications and Recidivism – We track the percentage of the bond level
collateral that has been modified and compare these to the cohort. We
4 9 also break out the modification type and measure what percentage of
seasoned modifications re-default through the recidivism metric
11 Negative Amortization – For those loans that allow negative amorti-
11 zation, we track what percentage of each negam sleeve
is current and the percentage of each sleeve approaching the negam cap
12 Subsequent Performance of Serious Delinquent Loans – Tracks the
number of payments made by loans that were seriously delinquent 3
months prior and have yet to liquidate. Good indicator of future transi-
12 tions from serious delinquency to default
13 Current Consumer Credit Data – Knowledge of current borrower credit
2 activities helps forecast delinquencies, defaults and severities as well as
7 shifts in the overall credit quality of the pool
14 Alpha/Negative Alpha Pricing – Using the TCW loan level default, severity
and prepayment models, the price at which the bond is likely to
outperform (Alpha Px) or underperform (Neg Alpha Px) versus it’s peers
15 Roll Rates – Tracks the trend of previously current loans transitioning to
the delinquency pipeline
Result: There is a wealth of information that is gathered, organized, and analyzed 16 Delinquency Analytics – Detailed delinquency statistics covering all
stages of delinquency and default for both the primary pool backing the
through the proprietary loan database. This information has been critical in bond as well as any cross collateralized pools. Additional metrics provide
navigating the difficult environment of the last two years. information on loans that have never been delinquent or are reper-
forming giving an even more detailed view of the health of the pool
34 PREShgf386 1/19/11
TCW RMBS Cash Flow Models

Proprietary Default, Severity and Prepayment Model

Using logistical regression, TCW models defaults


and prepayments from over 15 different variables
such as combined loan-to-value, refinancing
incentive, and home price changes which are
forward looking estimates of where home prices will
stabilize at the MSA and certain zip code levels

Following a servicer timeline and liquidation costs


model, TCW projects loan level severities from over
10 variables including foreclosure timelines and
legal fees

Deal cash flows are influenced by deal specific


TCW home price and unemployment vectors

The processes described herein are illustrative only and subject to adaptation in any particular context.

35 PREShgf386 1/19/11
Proprietary CMBS Research and Analytical Tools
Our systems allow us to understand the risks and opportunities of every CMBS we purchase on behalf of our clients.

Loan Level Data – 55,000+ Loans Research & Analytics Outputs


• Third-party loan data applied and • DSCR distribution • Rank of all 55,000 loans by cumulative
customized in a proprietary database – Breakdown of Third Party Vendor defaults and loss severities (rolled up to
• Original/current loan characteristics are Data, TCW’s Prior to Debt Service Deal Level)
updated monthly by trustee data Reset DSCR and TCW’s Post Debt
• Ranking each deal by absolute and relative
Service Reset DSCR
• Live feed via nightly data downloads from loss projections
third-party vendors provide the most up- • Debt Yield Distribution
• Compare seasoned deals vs. recent
to-date data • Delinquency Status and Roll Rates
vintage deals by normalizing the DSCR of
• Original Information includes LTV, NOI, • Projected maturity defaults and payment 06-07’ deals with the projected debt
DSCR, tenant lease information, property defaults using TCW’s proprietary loss vectors
service amount following the end of the
type, amortization type, and previous • Breakdown of implied cap rates at partial Interest-Only period
years’ changes in revenue, expenses, etc. securitization (Loan Level)
• Compare deals within each CMBX series
• Current information includes the latest • % Change in reported NOI on an annual
month’s debt service, modification data, basis • Market Analysis/ Insight
loss amounts, prepayment amounts, • Price and Forecasted Yield Analysis
• Lockbox Status
delinquency status, any change in the
loan’s amortization, and appraisal • Breakdown of Workout Strategy for
reductions to account for updated Modified Loans
property values • Appraisal Reduction Summary (ASERs
• Filters allow TCW to use the latest and ARAs)
available debt service for calculating a • Lease Rollover Summary by Property Type
loan’s DSCR, accounting for changes in a (Loan Level)
loan’s amortization and haircuts for loans • Balloon Analysis – % of loans that were
that have not reported financials for more able to refinance vs. still outstanding
than 12 months (Deal Level)
• Breakout of loans with pro-forma LTVs
and DSCRs at origination (Deal Level)
The processes described herein are illustrative only and subject to adaptation in any particular context.
36 PREShgf386 1/19/11
TCW Proprietary CMBS Analytics
Shown is a print screen from our loan level database, which aggregates information on all of the loans backing this particular deal.
1 Deal Information – Basic Information about the deal structure
2 Collateral Summary – Avg. loan details and the weighted average DSCR prior to and post
the partial interest-only reset date
3 DSCR Distribution – A comparison of Trepp to TCW’s proprietary DSCR distribution,
1 which includes each loan’s most recent financials, and its post-reset debt service
payment
4 TCW NOI Vector – Applying TCW’s NOI and cap rate assumptions to each individual
loan, and projecting deal cumulative defaults as well as loss severities
2 6 11 16 5 Maturity Analysis – The deal’s ability to refinance at the balloon date. The % of loans
outstanding past maturity and the % of loans that were able to successfully refinance
6 Delinquency Roll Dates – Tracking the continual movement of loans that are current
transitioning to the delinquency pipeline
7 7 Amortization Type – Data has shown that loans experiencing the end of their interest
only period and entering into full amortization have shown a higher propensity to default
12 8 DSCR Migration – The transition of the pool’s DSCR buckets over time
18 9 Appraisal Reduction Amount – The % of loans that have had appraisals lower than their
loan balance, allowing the servicer to limit their advances. The % cumulative appraisal
3 8 reduction is the difference between the appraisal amount and the current loan balance
10 Prepayment Protection – Most CMBS loans are structured with prepayment protection,
13 either through a yield maintenance provision or defeasance. The payment protection
19 usually ends a year before the loan’s balloon date
17 11 Financial As of Date – A breakout of the reporting dates for the loans in the pool.
Research has shown that loans that have not reported recent financials have shown to
4 have a higher delinquency %
12 Debt Yield Breakdown – Debt Yield is a loan’s NOI over its current loan balance. Its
9 often used as a measure to estimate a property’s ability to refinance its debt
20 13 % Change in NOI – Year-over-year changes in the loan’s net operating income. A majority
5 10 14 of loans (as of Nov 2010 remittance reports) have reported financials during 2010
14 LTV Breakdown – Collection of LTV’s that were reported at securitization, as well as
15 recent LTV’s for loans that have received appraisals since origination
15 Lease Expiration – The reported lease rolls from different property types. Loans that have
a high % of expiring leases are vulnerable to significant variability in their net cash flow
16 Lockbox Status – Loans are structured with either a hard lockbox (in which cashflows go
directly from the tenants towards paying the property’s debt) or a soft lockbox (in which
the borrowers have discretion to the funds before the debt payment is due) or no
lockbox at all
17 Remaining Term – The pool’s maturity schedule. (to the balloon date)
Result: There is a wealth of information that is gathered, organized, and 18 Special Service Loans- List of the pool’s largest special servicing loans (non-performing
or in special servicing due to lease rollover risk, low DSCR, or borrower bankruptcy)
analyzed through the proprietary loan database. It is not only the 19 Special Service/Watchlist – Loans that have been either added to the Watchlist, are
access to the loan level information but how we use and assimilate the performing special servicing loans or loans that are delinquent. (mutually independent)
20 Pro-Forma Financials – Loans that were underwritten with pro-forma financials (based
pieces of data that provides us with a competitive advantage. on expected future cash-flows) have higher leverage and lower DSCR’s than were in
place at origination
37 PREShgf386 1/19/11
Transportation and Specialized Finance Asset-Backed Securities (ABS)
Our dedicated ABS research and investment team enables us to participate in these less-trafficked but opportunistic asset classes.

Fundamentals Structure Outputs


• Financial aspects • Waterfall • Asset-specific valuation
– Current lease rates and direction – Priority of interest versus principal • Comprehensive portfolio valuation
– Lessee performance, absolute and – Robustness of LTV maintenance
• Comparative statistics between asset
relative to industry requirements
pools
– Utilization/participant portfolio – Performance triggers
• Servicer opinions
growth rates • Ability to cure
• Influence of Servicer • Assessment of market assumptions with
– Revenue stability
regard to asset deployment, cashflow
– Access to capital/broader-picture • External Credit Enhancement
stream and residual value
financing considerations – Class-dedicated Reserve Funds
– Financial guarantor/monoline wrap • Market and current environment opinion
• Tangible assets
• Involvement of Related Parties • Security/asset-specific price-yield analysis
– Plant, property and equipment
– Issuer’s reliance upon securitization
– Current market values
– Role of private equity, takeout
– Lease type/terms
considerations and impact on
– Recourse cashflow
• Expert opinions and forecasts – Servicer’s capacity, with or without
– Servicer involvement and projections achieving consents, to re-deploy or
– Specific company performance dispose of assets
– Overall industry performance

The processes described herein are illustrative only and subject to adaptation in any particular context.
38 PREShgf386 1/19/11
Structured Products: Reporting and Tracking Exposure

Risk Management – Proprietary Risk Exposure Reports


Disciplined risk allocation and position size monitoring

Duration and liquidity positioning are Long term sector targets are set by the Sector construction and individual
constantly evaluated against both Structured Products Committee based security selection is delegated to the
target and current credit exposures. upon relative value against a myriad of Specialists.
economic scenarios.
These reports ensure that sub-sector
targets are achieved and done so with
consistency across similar accounts.

39 PREShgf386 1/19/11
Structured Products: Portfolio Tracking and Reporting Exposure

Risk Management – Proprietary Risk Exposure Reports


Portfolio guidelines, restrictions and risk targets

Allocation of credit related structured products are


Downgrade policies mandated by clients are monitored
dictated by portfolio targets set by Structured Products
daily along with required actions.
Committee and specific client directives.

40 PREShgf386 1/19/11
Structured Products: Portfolio Tracking and Reporting Exposure

Contribution to Duration Report


• MetWest Monitors mortgage contribution to duration (CTD) by account on a daily basis

• Effective durations are run daily using Barclays Point System to compare MetWest Total Return strategy portfolios to the MBS portion
of the Barclays Aggregate Index

The processes described herein are illustrative only and subject to adaptation in any particular context.

41 PREShgf386 1/19/11
V. Outlook and Strategy
Economic Outlook
U.S. Economy Has Suffered An Immense Loss of Wealth

• The “illusion of wealth” effect brought on by the asset price bubble in housing led to:
– Personal net-worths are systematically mis-estimated
– Sharp elevation in consumption, remember “mortgage equity withdrawals”?
– Economic distortions, e.g., an excess of construction activity, too many mortgage brokers, record levels of car sales

• Since the 2006/2007 peak in housing, the U.S. has experienced a dramatic diminution in net worth
– Residential real estate down $7 trillion – some 28% from the 2006 peak
– U.S. equities down over 25% since 10/31/071

Households Owners’ Equity in Real Estate

Owners' Equity as % of Real Estate


25.0 90%
Owners' Equity ($ Trillions)

80%
20.0 70%
60%
15.0
50%
40%
10.0
Households Owners’ Equity in Real Estate 30%
5.0 20%
Owners' Equity as % of Household Real Estate
10%
0.0 0%

51 55 58 61 64 68 71 74 77 81 84 87 90 94 997 000 003 007 010


19 19 19 19 19 19 19 19 19 19 19 19 19 19 1 2 2 2 2
Source: Federal Reserve Board
1
Through 8/31/10
44 PREShgf386 1/19/11
...Which Has Translated Into

• Elevation in savings rate/loss of consumption


• De-leveraging of the American consumer

Savings Rate Consumer Credit Outstanding


7% 3000

6% 2500

5%
2000

Billions ($)
4%
1500
3%
1000
2%

500
1%

0% 0
00 01 02 03 04 05 06 07 08 09 01
0 59 962 965 969 972 976 979 982 986 989 993 996 000 003 006 010
l-20 l-20 l-20 l-20 l-20 l-20 l-20 l-20 l -20 l -20 ul-2 19 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2
Ju Ju Ju Ju Ju Ju Ju Ju Ju Ju J

Source: Bloomberg

45 PREShgf386 1/19/11
Meanwhile, the Rest of the Private Sector Continues to De-Lever

Commercial and Industrial Loans Outstanding Commercial Paper Outstanding: Financial and Asset-Backed

1600 1400

1400 1200

1200

Billions ($)
Billions ($)

1000
1000
800
800
600
600
400
400

200 200
88 89 91 992 94 995 997 999 000 002 003 005 007 008 010 01 001 002 03 04 04 05 6 7 7
00 200 200 -200 200
8 9 10
-19 g-19 r-19 ct-1 y-19 c-1 l-1 -1 -2 -2 -2 -2 -2 -2 r-2 -20 ct-2 ul-2 r -20 n-20 -20 g-20 y-2 - - - -20
n
Ja A u M a O Ma De Ju Feb Sep Apr Nov Jun Jan Aug Ma J a n
O J A p Ja N o v
Au M
a F e b
N ov
S e p
Ju
n
M
a r

Commercial and Industrial Loans at All Commercial Banks Financial Commercial Paper Outstanding (SA)

Commercial and Industrial Loans of Large Commercial Banks Asset-backed Commercial Paper Outstanding (SA)

• Banking Sector • Shadow Banking System

Source: Federal Reserve Bank of St. Louis

46 PREShgf386 1/19/11
Leaving Labor Markets Deeply Stressed
Historical Unemployment (U-3) Historical Unemployment and Underemployment Rate (U-6)
16.0 18.0

14.0
16.0

12.0

U-3 Unemployment Rate (%)


U-3 Unemployment Rate (%)

14.0
10.0

8.0 12.0

6.0
10.0

4.0
8.0
2.0

0.0 6.0
Jan-1948 Mar-1953 May-1958 Jul-1963 Sep-1968 Nov-1973 Jan-1979 Mar-1984 May-1989 Jul-1994 Sep-1999 Nov-2004 Jan-2010 Jan-1994 Jan-1996 Jan-1998 Jan-2000 Jan-2002 Jan-2004 Jan-2006 Jan-2008 Jan-2010

Unemployment Rate (U-3) Recession Unemployment Rate (U-3) Recession

• “Narrow” Measure • “Broad” Measure

Length of Time on Unemployment Rolls – An Indication of Depth of Economic Distortions


Average Weeks of Unemployment Duration

40
35
30
25
20
15
10
5
0
Jan-1985 Oct-1988 Jul-1992 Apr-1996 Jan-2000 Oct-2003 Jul-2007 Jun-2010
Source: Bloomberg

47 PREShgf386 1/19/11
As the Loss of Wealth Was Severe, So Has Been the Economic Retrenchment

6.0%
5.0%

4.0% 3.7%
2.9%

2.0% 1.6%
Gross Domestic Product

0.6%
(Annualized)

0.0%
1.6%
-0.7% -0.7%
-2.0%

-4.0%
-4.0%
-4.9%
-6.0%

-6.8%
-8.0%

Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010

• The technical ending of the Great Recession has not brought economic activity back to where it was pre-recession
• And, with all these negative forces, how has the economy stayed above water?

Source: Bloomberg

48 PREShgf386 1/19/11
America Goes for Broke:
Government “Levers Up” as Private Sector “Levers Down”
GDP = Consumer Spending (C) + Business Investment (I) + Government Outlays (G) + Net Exports (X – M)

• In classic fashion, government is “replacing” the loss of consumption from the private sector by implementing
“borrow and spend” stimulative programs

U.S. Public Debt Outstanding U.S. Total Public Debt Outstanding as a % of GDP
$13.2 Trillion 95%
$12.3 Trillion 8.2
90%

Total Public Debt as a % of GDP


7.3
85%

80%
$8.7 Trillion 5.0 5.1
75%
4.3 4.4
$5.7 Trillion 70%
3.2 65%
2.5
60%

55%

50%
Jan-2000 Jan-2007 Dec-2009 Jun-2010
96 96 97 98 99 99 00 01 02 02 03 04 05 05 06 07 08 08 09 10
19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20 20 20
Marketable Non-Marketable

Source: Bloomberg, U.S. Treasury

49 PREShgf386 1/19/11
Government Spending Providing “Bridge Financing”

Transfer Payments as a Share of Personal Income

20%

18%

16%

14%

12%

10%

8%

6%

4%

• Do the Feds have the willingness and the ability to sustain the stimulus until private sector balance sheets recover
and growth resumes?

Source: Bloomberg

50 PREShgf386 1/19/11
Cost: Federal Debt Interest Payments

Interest-Bearing Debt
Rate*
T-bills 0.24%
Treasury Notes 2.74%
Treasury Bonds 6.23%1
TIPS 2.24%
Other 4.63%
Non-Marketable 4.37%
Total 3.21%

Interest service over $400 Billion per annum

*As of May 31, 2010.


1
Approximate rate on non-marketable Treasury debt.
Source: U.S. Treasury

51 PREShgf386 1/19/11
Central Conundrum

National
Economy Public and
Non-Marketable
(GDP)
Federal Debt

$14.6 Trillion $13.2 Trillion

• Public debt/GDP has risen from 55% to 90% over the ‘00s
– Trend is not sustainable unless private sector begins to grow substantially more rapidly
– Private sector must replenish the demand that will be “lost” when deficit spending moderates

• Once debt/GDP equals 100%...


– GDP must grow as fast as debt service rate or debt/GDP worsens (forever)
– Interest-bearing debt rate of 3.2% suggests that nominal GDP growth rate must sustain itself over this figure

52 PREShgf386 1/19/11
Fundamentally: How Do You Solve a Problem Like a Debt Burden?

1. Depression: Cancel debt via forgiveness/bankruptcy


– Creates vicious cycle of foreclosure and bankruptcy forcing asset sales and still more bankruptcies
– Democratic systems do not voluntarily choose this as the primary solution

2. Inflation: Reduce the debt burden over time via expansion of money and credit
– Allow the real adjustment to be “masked” by a nominal change in price level
– “Socializes” the costs of adjustment

3. Prosperity: Grow your way out: Fix private sector balance sheets
– Re-allocate labor/capital facilitating real GDP growth
– Not directly determined by policy makers in Washington

53 PREShgf386 1/19/11
Prognosis

• Keynesian stimulus will be pulled back – hence, growth will be very muted

– Endogenously: By deficit hawks pre-emptively cutting the budget or raising taxes

– Exogenously: By global financial markets reducing its “preference” for U.S. Treasuries

Prematurely scaling back government spending would set the table for a “double-dip”

• Would the Fed then stand idly by – or would the Fed activate “QE-2” and inflate the economy?

But a “double-dip” might be (mis)-managed, leading to long-term inflation

• Meanwhile, government intervention has impeded economic adjustments – including slowing the re-pricing of the
stock of residential real estate, thereby delaying recovery

54 PREShgf386 1/19/11
Investment Approach in Uncertain Times

Economic Backdrop Investment Opportunities

• Recovery faces deleveraging headwinds • Treasury rates near historical lows (0.5-3%)
• Housing stabilizing • Agency MBS at 3-4%
• Corporate balance sheets improving • Senior non-agency RMBS 5-11%
• Government stimulus will eventually fade • Senior commercial MBS 4-5%
• Heightened risk for deflation (near-term) • IG Corporates 3-5%
and inflation (long-term) • HY Corporates 8-9%
• Equities: Function (GDP, earnings, production, rates)

Conclusions

• Underweight Treasuries, defensive duration


• Agency MBS has attractive carry, good substitute for Treasuries
• Non-agency MBS is still the best risk-adjusted asset with high
single digit loss adjusted yields
• Defensive, highly regulated industries of IG Corp market offer value
• High Yield attractive vs. Treasuries and Equities

55 PREShgf386 1/19/11
Corporate Market Outlook
Barclays Credit Spreads – Index OAS
As of December 31, 2010

900

800

700

600
OAS (bps)

500

400

300

200

100

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Credit Index Non-Corporates Industrials Utilities Financials

Source: Barclays Capital

57 PREShgf386 1/19/11
Current Portfolio Positioning

Objective
• Position portfolio for challenging economic environment, focusing on companies that are:
– Government–sponsored
– Non-cyclical
– Backed by good management and flexible balance sheets
• Achieve corporate basis exposure above market/index

Strategy
• Corporate basis greater than index
• Duration short index
• Overweight/Emphasize
– Senior debt of large money center banks
– Regulated pipeline companies
– Secured project debt
– Well-capitalized telecommunications companies
– Well-managed, asset-rich companies
– Insurance companies (Senior)
– REITs (Healthcare; frontend)
• Underweight
– Industrials
– Retailers
– Technology
– Media
• Opportunistic allocation to Super-Senior CMBS

Opinions expressed are current only as of the time made; are subject to change without notice.
58 PREShgf386 1/19/11
Opportunities in the Corporate Bond Market

Financials:
Financials bonds offer compelling valuation on both absolute and relative basis, trading at nearly 2x the spread of single A-rated
industrials and at nearly 2x historical pre-crisis means.
• Money-center banks – relatively stable funding profile (deposit-heavy) and diversification by business line and geography. Long-term
ramifications of FinReg are credit friendly while balance sheets continue to rehabilitate. Expect financials spread to mean revert over time.
– Large money center bank senior debt @ ~+220-230bps
– Floating rate TRUPs/hybrids – due to FinReg (Collins amendment), regulatory capital credit will phase between 3-5 years from
passage. Likely to cause incentive to call/refinance structures while quasi inflation-hedge. Currently trade in low 70s and yield 7-8%
• Insurance – favor operating company level securities. Well capitalized and generally have lower problematic loan balances than banks.
– Secured paper at ~+200–300bps
– Opco surplus notes @ ~+300–400bps
– Callable hybrid securities @ ~8-9% to likely call
• Real Estate Investment Trusts (REITs) – asset-heavy sector where bonds offer strong covenant protection that limit debt incurrence
ability, both on secured and unsecured basis. Favor healthcare REITs and shorter maturities.

Opinions expressed are current only as of the time made; are subject to change without notice.
59 PREShgf386 1/19/11
Opportunities in the Corporate Bond Market (cont’d)

Regulated Pipeline / Secured debt:


Enhanced Equipment Trust Certificates (EETCs) – secured, bankruptcy-remote debt instruments backed by a diversified pool of aircraft.
Favor senior tranches (top of capital structure) with strong asset coverage, with modern collateral and LTVs in the 65% – 85% range
• Example A tranche EETC: 16 average life: rated Baa2/BBB
– At ~$103.5, trades at nearly 7.5% or ~+530bps, nearly 3x the credit index
– Aircraft: 12 737-800’s (’00 vintage), 3 767-400ers (’00 vintage). Current market value LTV of ~85%
Utility project debt – bonds benefit from power generation collateral and long-term contracts with highly-rated regulated utilities. Strong
asset coverage with contracted cash flows
• Example Alternative Power Project – 7% ‘23 average life. Rated BBB-/BBB-
– At ~$101.5, trades at ~6.8% yld or ~+370bps
– Collateral of 190 wind generation turbines that generate power under long-term contract
– Benefit from ambitious state renewable generation requirements
Regulated natural gas pipeline debt – transports natural gas over long-haul pipelines under long-term contracts with highly-rated
regulated utilities. Strong asset coverage with contracted cash flows
• Example Gas Pipeline Company – 5.45% ’20. Rated Baa2/BBB. ~+220bps
– At ~+220bps, attractive relative value vs. similarly rated electric utilities in mid +100’s
– FERC regulated gas pipeline that provides 70% of Florida’s natural gas supply, Florida’s gas-fired power generation is projected
to grow from 39% in ’08 to 54% in ’17, implying favorable demand for natural gas
– Average contract term is 11 years with main counterparties

Opinions expressed are current only as of the time made; are subject to change without notice.
60 PREShgf386 1/19/11
Opportunities in the Corporate Bond Market (cont’d)

BABs / Underweight Asset-Light Sectors:


Build America Bonds (BABs) – taxable municipal bonds that benefit from federal government subsidy of 35% of the ’09 Congressional
stimulus bill (ARRA). Municipals have ability to adjust both cost structure and revenue structure. Focus on both revenue bonds backed
by specific cash flows from certain tax, utility, or fee revenue cash flows or General Obligation bonds backed by full, faith and credit
of governments
• Example Revenue Bond – 6.263% senior bonds. Rated Aa3/AA. ~+220bps
– Revenue bonds supported by toll cash flows of seven bridges
– Critical to city’s commerce as commuting alternatives are limited
– Solid debt service coverage in excess of 1.5x

Technology/Retail – due to asset-based lending philosophy, tend to be cautious on asset-light sectors and industries where rapid
technological evolution could cause diminution of intellectual property. Underweight both sectors

Opinions expressed are current only as of the time made; are subject to change without notice.
61 PREShgf386 1/19/11
Structured Product Outlook
Treasury Rate & Agency MBS Yield Moves In 4Q 2010

September 30, 2010 December 31, 2010 Difference

2-Year UST 0.42 0.59 +0.17

5-Year UST 1.26 2.00 +0.74

10-Year UST 2.51 3.29 +0.78

2/10 UST curve 2.09 2.70 +0.61

30yr Current Coupon FNMA Yield 3.38 4.13 +0.75

Conclusion: Rates backed up significantly in 4th quarter and the curve steepened.
MBS Agency yields rose 75 bps and average lives extended.

63 PREShgf386 1/19/11
Agency MBS Duration Changes In 4Q 2010

September 30, 2010 December 31, 2010 Difference


Agency MBS In TGLMX
Duration 4.63 5.57 +0.94

Barclays MBS Index


Duration 2.93 4.16 +1.23

Representative Position In TGLMX vs. Cohort


Effective Durations
30-Year Freddie Mac 5% LLB 5.04 5.82 +0.78
30-Year Freddie Mac 5% Cohort 2.88 4.25 +1.37

• While price payups for Loan Balance pools compressed, their more stable durations due to better convexity as well
as higher current yields offset the loss in payups during the rate backup in the 4th quarter

Conclusion: The duration in the Agency MBS in TGLMX extended less


than the duration in the Barclays MBS Index by 0.29 years
due to better convexity characteristics.

64 PREShgf386 1/19/11
Agency MBS Fundamental Valuations

• Nominal Spreads to Treasuries near long term averages


• Nominal Spreads above averages when removing the 2008 financial crisis period
AgencyMBSSpreadto5/10yrUST
350

2008financialcrisis
300

250
FNMACurrentCouponNominalSpread

200

150

100

Min 103
Max 293
50 Last 146
Average(10yr) 156
Average(5yr) 150

Source:Bloomberg
65 PREShgf386 1/19/11
Agency MBS Fundamental Valuations (cont’d)

• LIBOR option-adjusted spreads (LOAS) slightly above long term averages

AgencyMBSLOAS

100
Min Ͳ41
Max 82
80 Last 15
Average(10yr) Ͳ4
Average(5yr) Ͳ5
60
FNCLCurrentCouponLOAS(bps)

40

20

20
Ͳ20

Ͳ40

Ͳ60

Source:Yieldbook

66 PREShgf386 1/19/11
Agency MBS Fundamental Valuations

Refinancabilityof30yrFixedConventionalUniverse
4.0s 4.5s 5.0s 5.5s 6.0s 6.5s

• Expectations for
400 voluntary prepayments
Marginally Fully remain muted for 2011
350 Refinanceable Refinanceable
=~64% =~42% despite the historically
300 WillingandAble low rate environment,
UnwillingorUnable which will bode well
250
for collecting carry in
<18%ofuniverseisboth
OutstandingBalance($bn)
utstandingBalance($bn)

200 willingANDableto Agency MBS

150
• After accounting for
100
credit, mark-to-market
50
LTVs, and loan balances,
only about 18% of the
0 outstanding Agency
mortgage market is
GrossWACBucket currently “refinanceable”
Willing: Sufficientmortgagerateincentiveonlargeenoughloansize(>$150,000)toovercomeupfrontcostsofrefinance
Ͳ50bpsis"marginallyrefinancable"
Ͳ100bpsis"fullyrefinancable"
Able:Unconstrainedbycredit(LTV<80%,FICO>720)
Source:FTNFinancial
67 PREShgf386 1/19/11
Risks to Fundamental Valuations

• Government policy changes are unpredictable and often a catalyst to higher mortgage spread volatility
• Delivered volatility has recently trended above implied volatility

ImpliedSwaptionVolatilityversusDeliveredVolatility
300

3Yrby10YrImpliedVolatility(bp)

Volof3Yrby10YrSwapRate,20Ͳdayaverage(bp)
250

200

If delivered volatility
remains elevated, implied
150
volatility is likely to rise,
reducing LOAS
100 valuations for Agency
MBS and pressuring
spreads wider
50

Source:Bloomberg

68 PREShgf386 1/19/11
Agency MBS Technical Valuations

Millions
(Existing)
MonthlyHomeSales Millions
(New) • Net supply of Agency MBS will be low
7
ExistingSingleFamilyHomeSales(ls)
1.6 due to:
Buyersrushedtotake

6.5
NewSingleFamilyHomeSales(rs) advantageofexpiring
federal taxcredits 1.4
1. continued low levels of new home
sales (see graph)
6 1.2 2. muted or negative home price
appreciation (HPA)
5.5 1
3. higher mortgage rates
5 0.8 4. tighter underwriting guidelines
5. higher loan fees charged by GSEs
4.5 0.6
(see table below)
4 0.4

3.5 0.2

3 0 Fannie Mae Loan Level Pricing Adjustments


Effective April 1, 2011

Sources: NAR,U.S.CensusBureau LLPAs by LTV Range

Credit Score <= 60% 60 - 70% 70 - 75% 75 - 80% 80 - 85% 85 - 90% 90 - 95% 95 - 97%

=> 740 -0.25% 0.00% 0.00% 0.25% 0.25% 0.25% 0.25% 0.25%
720 - 739 -0.25% 0.00% 0.25% 0.50% 0.50% 0.50% 0.50% 0.50%
700 - 719 -0.25% 0.50% 0.75% 1.00% 1.00% 1.00% 1.00% 1.00%
680 - 699 0.00% 0.50% 1.25% 1.75% 1.50% 1.25% 1.25% 1.00%
660 - 679 0.00% 1.00% 2.00% 2.50% 2.75% 2.25% 2.25% 1.75%
640 - 659 0.50% 1.25% 2.50% 3.00% 3.25% 2.75% 2.75% 2.25%
620 - 639 0.50% 1.50% 3.00% 3.00% 3.25% 3.25% 3.25% 3.00%
< 620 0.50% 1.50% 3.00% 3.00% 3.25% 3.25% 3.25% 3.25%
Source: Fannie Mae

69 PREShgf386 1/19/11
Agency MBS Technical Valuations

• Demand from commercial banks ChangeinCommercialBankHoldings($bn)versusYieldCurveSlope


should remain robust 400 300

– Steep yield curve provides


high net interest margin 300 250
(NIM) and is associated with
growth in bank securities
portfolios mmercialBankHoldings($bn)
ChangeinCommercialBankHoldings($bn) 200 200

– C & I loan issuance remains


anemic as banks remain 100 150

10YrUSTͲ 2YrUST(bps)
cautious on economic
recovery prospects and loan

2YrUST(b
0 100
demand is weak
– Basel III rules favor low risk- Ͳ100 50
weighted, highly liquid asset
allocations
Ͳ200 0

CommercialBankGovtSecuritiesHoldings,$changeYoY(LHS)
Ͳ300 CommercialBankC&ILoans,$changeYoY(LHS) Ͳ50
2Ͳ10Spread(RHS)

Ͳ400 Ͳ100

Source:FederalReserve,Bloomberg

70 PREShgf386 1/19/11
Agency MBS Technical Valuations

• Demand from money managers should be steady as Agency MBS valuations appear attractive
to other high quality assets such as investment grade corporates

MBS Yield Advantage vs High-Grade Corporates


As of 1/7/2011

MBS Index
Sector Duration Yield Yield Pickup
U.S. MBS Index 4.31 3.69 –
Intermediate AAA Corporates 3.54 1.72 197 bps
Intermediate AA Corporates 4.00 2.57 112 bps
Intermediate A Corporates 4.41 3.27 42 bps

71 PREShgf386 1/19/11
Risks to Technical Factors for Agency MBS

• Paydowns from the Federal Reserve’s (Fed’s) Agency


MBS portfolio will not be reinvested in Agency MBS

A lower rate or flatter curve environment would


increase supply to the market from elevated Fed
portfolio paydowns

• Overseas accounts may avoid U.S. dollar investments


in favor of fixed income assets or equities
denominated in alternative currencies

• If government proposals and debates on GSE reform


shy away from continued strong support, further
participation in Agency MBS could be limited by
investor concerns

72 PREShgf386 1/19/11
Non-Agency MBS Review and Outlook

Current State of the Market


• Important to distinguish between loans and securities – total residential mortgage market size is roughly $10.8 trillion

• Loans – roughly $3.7 trillion


– Individual mortgage loans not held in any TCW investment portfolio
– Loans sit on bank balance sheets, and largely have not yet been written down
– Banks want to delay writing them down to allow themselves time to earn their way out of trouble
– Deleveraging has only just begun

• Securities – roughly $1.7 trillion


– Securitized packages of loans that are publicly traded
– Marked-to-market already, deleveraging complete
– Re-leveraging has started
• Aided by pricing of super-senior bonds that are “cheap” relative to fundamental value
• Continued maturation of the re-REMIC* market has broadened the investor base
• Expansion and easing of terms for repo financing
– Prices on super-senior securities should rise further as cash flow projections improve

* Real Estate Mortgage Investment Conduits


73 PREShgf386 1/19/11
Non-Agency MBS Outstanding and Monthly Bid List Volume

3,000,000 30,000

2,500,000 25,000

Monthly Bid List Volume (mm)


Collateral Balance (mm)

2,000,000 20,000

1,500,000 15,000

1,000,000 10,000

500,000 5,000

0 0
Jan-2008 Apr-2008 Aug-2008 Dec-2008 Apr-2009 Aug-2009 Dec-2009 Apr-2010 Aug-2010 Dec-2010

Collateral Balance Monthly Bid List Volume

Source: TCW; bid list volume data provided by Deutsche Bank

74 PREShgf386 1/19/11
Non-Agency MBS Review and Outlook
Loan Fundamentals

• Voluntary Prepayments Historical Voluntary Prepayment Trends


– Subprime and Alt-A
80%
• Running in low single digits and market is
extrapolating this for the life of the loans 70%

• Given large negative equity, loans are unlikely

Conditional Prepayment Rate (CPR)


60%
to be refinanceable in the near future
• The future is difficult to predict, and the market 50%

is assigning a zero probability, so investors


40%
get a “free” option
30%
– Prime 25.3%
20%
• Recent rise into the mid-20s will not be sustained
due to rise in mortage rates 10% 10.2%

• Risk of adverse selection, meaning that those 3.1%


with the most equity refinance first, leaving 0%
1 1 2 2 3 3 4 5 5 6 6 7 8 8 9 9 0 0
00 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 201 201
a weaker set of borrowers in the pool 1/2 1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/
1/ 8 / 3 10 5 12 7 2 9 4 11 6 1 8 3 10 5 12

Prime Alt-A SubPrime

Source: TCW, Intex

75 PREShgf386 1/19/11
Non-Agency MBS Review and Outlook (cont’d)
Loan Fundamentals

• Cumulative Defaults – Primarily a function of both the


ability to pay and equity in the home
– Subprime and Alt-A
50%
• Market assumes most (70% to 90%)
of the remaining loans will default 45% 44.9%

40%
• Delinquencies are between 25% to 50%

60+ Delinquency Rate


35%
• Current pricing generates a relatively high
yield even in near worst case scenarios 30%

– Prime 25% 24.4%

20%
• Market assumes cumulative defaults of
10% to 40% of the remaining loans 15%

• Current delinquencies approaching 10% 10%


8.3%

• Risk that prime loans have lagged subprime 5%

and Alt-A and more delinquencies/defaults 0%


may be coming 93 94 95 95 96 97 98 99 00 00 01 02 03 04 05 05 06 07 08 09 10 10
19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20 20 20
/ 1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/
6 4 2 12 10 8 6 4 2 12 10 8 6 4 2 12 10 8 6 4 2 12

Subprime Alt-A Prime

Source: TCW, LoanPerformance

76 PREShgf386 1/19/11
Non-Agency MBS Review and Outlook (cont’d)
Loan Fundamentals

• Loss Severity
– Largest factor in determining loss severity is the
depreciation of home value 70%
72.2%
• House prices have been stable recently 65%
• Risks to lower home prices remain due to large 60%
shadow inventory of homes 55%
57.7%

• Foreclosure moratoria may simply delay foreclosure 50%


and increase severities

Loss Severity Rate*


45% 44.4%
• Bank/servicers can be conflicted on a 1st lien mortgage 40%
regarding modification and/or foreclosure decisions if 35%
they own the second lien on the property as well 30%

– Subprime and Alt-A 25%

• Prices reflect more margin for error regarding 20%

ultimate severity outcomes 15%

• Lower priced homes have fallen to the level 10%

where rental income can cover mortgage costs 5%

making it profitable for property owners to 0%


00 01 01 02 02 03 03 04 04 05 05 06 06 07 07 08 08 09 09 10 10
buy at current prices and rent homes 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20
/ 1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/ /1/
12 6 12 6 12 6 12 6 12 6 12 6 12 6 12 6 12 6 12 6 12

– Prime Prime Alt-A SubPrime


• Generally narrower band of outcomes for severities
is priced into prime markets
• Still room for downside in prices for higher end homes Source: TCW, LoanPerformance
• Closely tied to employment and wage growth,
both of which are weak
• Tight credit for jumbo loans will hold down demand
and limit refinancing options
77 PREShgf386 1/19/11
Non-Agency MBS Review and Outlook (cont’d)
Non-Agency Mortgage Comparison

• Distressed/Depression-like pricing conditions of late ‘08/early ‘09 have remediated to “stressed” pricing
– Market continues to discount very severe defaults, loss severities, and prepayments:

Actual (12/31/2010)* Market Expectations**


60+ Delinquency Rate Loss Severities Cumulative Default Rate Loss Severities Expected Loss Adjusted Yield

Prime 10.8% 44.9% 10% - 25% 50% 4% - 6%

Alt-A 27.4% 58.2% 40% - 70% 60% - 65% 6% - 8%

Subprime 48.0% 72.2% 80% - 95% 80% - 90% 8% - 10%

⇒ Senior securities present excellent loss adjusted yield

* 2005-2007 vintages. Source: Calculations based on security prices from Bloomberg and major banks.
** Source: TCW Loan Level database and Intex. 2005-2007 vintages.

78 PREShgf386 1/19/11
2010 Non-Agency Sector Return Attribution

12% 6.0% 2.4% 0.8% 21.2%


+ + + = 2010
Price Appreciation Current Yield 8% * .3 7% * .4 * .3
Non-Agency Sector
Annualized Voluntary Prepayments Annualized Defaults Total Return
& Amortization x Recovery
x Market’s Average x Market’s Average
Price Discount to Par Price Discount to Par

Coupon and principal payments alone provide healthy returns


given current market prices

Is there additional price appreciation to be captured?

Source: Return numbers are estimates provided by TCW portfolio management.


79 PREShgf386 1/19/11
4Q 2010 Non-Agency MBS Empirical Duration

Interest Rates 74 bps

Non-Agency MBS Prices +3.5%

-4.7 yr Empirical Duration for 4Q 2010

80 PREShgf386 1/19/11
The Layering of Old and New Metrics on Non-Agency MBS

Price
Old Metrics
Base Case
+ 3 Month
Timeline Extension
55.00 9.83 9.53
56.00 9.51 9.21
57.00 9.20 8.91
58.00 8.90 8.61
59.00 8.61 8.33
60.00 8.33 8.05
61.00 8.06 7.78
62.00 7.79 7.52
63.00 7.53 7.26
64.00 7.28 7.01
65.00
66.00
7.03
6.79
 6.77
6.54
67.00 6.56 6.31
68.00 6.33 6.08
69.00 6.11 5.87
70.00 5.90 5.65
71.00 5.69 5.45
72.00 5.48 5.24
73.00 5.28 5.05
74.00 5.09 4.85
75.00 4.90 4.66
Total Defaults 67% 67%
Voluntary Prepayment Rate 1% 1%
Severity Rate 60% 62.5%

81 PREShgf386 1/19/11
The Layering of Old and New Metrics on Non-Agency MBS (cont’d)

Price
Old Metrics
Base Case
+ 3 Month
Timeline Extension
+ Increasing Interest
Rate Modifications
+ Increasing Stop
Advancing %'s
55.00 9.83 9.53 9.10 8.61
56.00 9.51 9.21 8.79 8.31
57.00 9.20 8.91 8.49 8.01
58.00 8.90 8.61 8.20 7.73
59.00 8.61 8.33 7.92 7.46
60.00 8.33 8.05 7.64 7.19
61.00 8.06 7.78 7.38 6.93
62.00 7.79 7.52 7.12 6.67
63.00 7.53 7.26 6.87 6.43
64.00 7.28 7.01 6.63 6.19
65.00
66.00
7.03
6.79
 6.77
6.54
 6.39
6.16
 5.96
5.73
67.00 6.56 6.31 5.93 5.51
68.00 6.33 6.08 5.71 5.30
69.00 6.11 5.87 5.50 5.09
70.00 5.90 5.65 5.29 4.88
71.00 5.69 5.45 5.09 4.68
72.00 5.48 5.24 4.89 4.49
73.00 5.28 5.05 4.69 4.29
74.00 5.09 4.85 4.50 4.11
75.00 4.90 4.66 4.32 3.93
Total Defaults 67% 67% 67% 68%
Voluntary Prepayment Rate 1% 1% 1% 1%
Severity Rate 60% 62.5% 62.5% 62.5%

82 PREShgf386 1/19/11
The Layering of Old and New Metrics on Non-Agency MBS (cont’d)

Price
Old Metrics
Base Case
+ 3 Month
Timeline Extension
+ Increasing Interest
Rate Modifications
+ Increasing Stop
Advancing %'s
+ Improved Defaults
and Prepayments
55.00 9.83 9.53 9.10 8.61 10.41
56.00 9.51 9.21 8.79 8.31 10.06
57.00 9.20 8.91 8.49 8.01 9.72
58.00 8.90 8.61 8.20 7.73 9.39
59.00 8.61 8.33 7.92 7.46 9.08
60.00 8.33 8.05 7.64 7.19 8.77
61.00 8.06 7.78 7.38 6.93 8.47
62.00 7.79 7.52 7.12 6.67 8.18
63.00 7.53 7.26 6.87 6.43 7.89
64.00 7.28 7.01 6.63 6.19 7.62
65.00
66.00
7.03
6.79
 6.77
6.54
 6.39
6.16
 5.96
5.73
 7.35
7.09
67.00 6.56 6.31 5.93 5.51 6.84
68.00 6.33 6.08 5.71 5.30 6.59
69.00 6.11 5.87 5.50 5.09 6.35
70.00 5.90 5.65 5.29 4.88 6.12
71.00 5.69 5.45 5.09 4.68 5.89
72.00 5.48 5.24 4.89 4.49 5.67
73.00 5.28 5.05 4.69 4.29 5.45
74.00 5.09 4.85 4.50 4.11 5.24
75.00 4.90 4.66 4.32 3.93 5.04
Total Defaults 67% 67% 67% 68% 55%
Voluntary Prepayment Rate 1% 1% 1% 1% 3%
Severity Rate 60% 62.5% 62.5% 62.5% 62.5%

83 PREShgf386 1/19/11
CMBS Review and Outlook
Despite Strong Rally, Opportunity Remains In Super-Senior Tranches

Current State of Market


• Fundamental backdrop is likely to be challenged through • Important to distinguish the securitized commercial real estate
the continued deleveraging process in the economy and market (CMBS) and that which is proprietarily held on bank
financial markets balance sheets as loans
– 80% of the roughly $3.5 trillion in commercial mortgage
• Lease rates and occupancy are down giving rise to potential securities is held by banks as loans
deterioration in debt service coverage
– Commercial real estate deleveraging has to occur largely in
• Excess capacity and property owners struggling in a the loan markets
sluggish economy – Loans, on bank balance sheets as “held to maturity” line
items, are not marked to market
• Despite the considerable rally in CMBS over the past 18 months, – Banks earn significant yields over the cost of the funds,
we remain constructive on the risk-adjusted return opportunities and use this “net interest margin” to write off loan losses
available in super-senior tranches of selected CMBS issues over time
– CMBS have enjoyed no such privilege and are marked to
market daily
• Near the peak of the crisis price declines of CMBS were excessive
relative to fundamentals

• The CRE market has seen prices decline roughly 40% from the
peak of the cycle in October of 2007

• On heels of successful government programs (PPIP & TALF)


private leverage has returned

Opinions expressed are current only as of the time made; are subject to change without notice.
84 PREShgf386 1/19/11
CMBS Review and Outlook (cont’d)
Despite Strong Rally, Opportunity Remains In Super-Senior Tranches

The Opportunity
• Value to be gained in CMBS due to the structural protections of the super-senior tranches

• Best risk-adjusted value in senior last cash flow sequential payers bearing 30% credit enhancement at issuance

• The original credit enhancement of 30% would protect the nominal yield up to a 40% default rate and 75% severity
(or, alternatively 50% default at 60% severity)

• Focused on large, well-diversified pools that are not concentrated in a few large loans

• Emphasizes those CMBS that are expected to hold up even in a process of continued deleveraging

• Avoiding exposure to deals with significant forecasted declines in debt service coverage ratios

• Capital has returned to new issue CRE lending albeit at conservative underwriting standards

Opinions expressed are current only as of the time made; are subject to change without notice.

85 PREShgf386 1/19/11
Asset-Backed Securities (ABS) Review and Outlook

On-the-run Sectors
Credit Cards
• Stricter underwriting standards enacted by issuers over the last two years have resulted in steadily improving master trust metrics
• Several trusts continue to employ the discount option, which will continue to lend stability to excess spread measures
• Chargeoffs and delinquencies continue to decline, although softness in the overall employment situation could challenge this trend

Autos
• Overall better performance in the auto industry has resulted in better execution levels for new issuance, across all pieces of the capital
structure
• The more conservative guidelines prescribed by rating agencies have produced very solid, well-protected structures and historically
active purchasers have returned to provide support to the sector

FFELP Student Loans


• Consolidation has been the story this year, and the combination of a short list of approved servicers as well as smaller issuers’ lack of
ongoing business due to the elimination of FFELP should lead to continued consolidation
• Refinancing, the resumption of ARS clearing, and securitization of loans still on balance sheet will continue to provide activity in the sector

Specialized Sectors
• The low interest rate environment, net decrease in outstanding supply and large amounts of cash to deployed have spurred issuers to
tap the markets
• Transportation stalwarts such as rails and containers have been able to access the markets, aircraft-related securitizations are in the
queue, and even highly-specific revenue streams should be able to issue in the near term
Opinions expressed are current only as of the time made; are subject to change without notice.
86 PREShgf386 1/19/11
Asset-Backed Securities (ABS) Review and Outlook (cont’d)

Spread Yield Outlook Comments


On-the-run Sectors
Credit Card AAA 35 dm 1.4% Marginally tighter Should see the most
spread tightening;
Credit Card BBB 140 dm 2.5% Much tighter represents even spread
to some private label AAA

Auto AAA 30 / swaps 1.5% Marginally tighter

Auto A 80 / swaps 2.6% Much tighter Limited size supports


further tightening

FFELP Student Loan 75 dm 3.0% Tighter

Specialized Sectors
Shipping Container 225 dm 3.25% Tighter Scarcity of assets and
limited new issuance will
continue to drive spreads

Aircraft 375 / maturity 5.3% Marginally tighter Will be affected by overall


10% to refinancing prospects of refinancing
and participants’ access to
unsecured and secured capital

Opinions expressed are current only as of the time made; are subject to change without notice.
87 PREShgf386 1/19/11