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Fixed Income Research

J.P. Morgan Securities Inc.
New York
December 1, 2004

ABS and CDOs: Record Performance Continues

Chris FlanaganAC
(1-212) 260-6515
christopher.t.flanagan@jpmorgan.com
The certifying analyst(s) is indicated by a superscript AC. See last page of the report for analyst
certification and important legal and regulatory disclosures.

www.morganmarkets.com
US Fixed Income Markets

2005 Outlook
ABS and CDOs:
Record Performance Continues
Chris Flanagan
christopher.t.flanagan@jpmorgan.com
212-260-6515

December 1, 2004
2005 key points – ABS and CDOs

„ Multi-year tight spread environment, the result of extremely accommodative monetary policy of
past few years, enters year 2.
„ Record year for US ABS in 2004, with close to $600 billion in issuance. Spreads are at historic
tights.
„ Repeating 2004, home equities should continue to dominate. $375 billion in issuance anticipated
for 2005 – down slightly from 2004’s $400 billion pace.
„ Heavy issuance and excessive concerns about housing bubble continue to create some spread
volatility for home equities – and one of the best relative value opportunities in fixed income
market, especially seniors. New rating agency Libor stress scenarios provide additional
conservatism and support for home equities.
„ Former benchmark ABS sectors, credit cards and autos, remain at historically tight spreads with
minimal volatility. The same holds for Student Loan ABS and Global RMBS.
„ 2004 was an unequivocally positive year for the CDO market, with increased supply and tightening
spreads.
„ CDOs continued their transformation into a core asset class in the fixed income market.
US Fixed Income Markets 2005 Outlook

„ More spread tightening likely, best value in mezzanine cash and “second senior” synthetic
paper.
„ Global structured credit bid for assets will remain huge.
„ Close to $115 billion in cash CDO issuance anticipated for 2005 (85/15 US/European asset split,
50/50 Corporate/ABS split).
„ $600+ billion estimated synthetic “issuance” in 2004 growing to close to $800 billion in 2005
(50/50 US/European, 90/10 Corporate/ABS).

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US ABS supply

US public ABS supply
US public ABS supply
2002 2003 2004 YTD 2005 Projected
% $
Collateral $ Billions % Floating $ Billions Floating Billions % Floating $ Billions
Credit Cards 65.8 84% 64.8 76% 45.7 78% 55
Autos 88.2 23% 77.2 19% 59.8 5% 75
Home Equity 159.0 76% 220.3 85% 365.9 90% 375
Dealer Floorplan 3.0 100% 8.9 100% 12.9 100% 10
Equipment 5.5 28% 6.8 33% 5.1 34% 5
Student Loans 19.5 98% 30.7 98% 41.2 100% 40
Global RMBS 18.9 96% 31.7 100% 34.8 100% 35
Other 9.4 32% 3.8 20% 4.6 24% 5
Total $367.9 65% $444.2 73% $573.3 81% $600
US Fixed Income Markets 2005 Outlook

Note: Other includes deals backed by Manufactured Hpousing, Stranded Asset, RV, Boat, Consumer, EETC, Aircraft Leases and Small Business Loans. Global RMBS, backed by
non-US collateral, are registered and sold in the US public markets.
Source: JPMS, MCM CorporateWatch, Bloomberg.

2
ABS spreads – AAA and BBB
3
3 year
year AAA
AAA spreads
spreads
Spread
Spread to
to LIBOR
LIBOR (bps)
(bps)

60 Cards (3-year) Auto (3-year) HEL ARMS (3-year) Global RMBS (3-year)

40
29
20
9
0 2
11/98 6/99 1/00 8/00 3/01 10/01 5/02 12/02 7/03 2/04 9/04

5
5 year
year BBB
BBB spreads
spreads
Spread
Spread to
to LIBOR
LIBOR (bps)
(bps)

350 Credit Card ABS HEL ABS UK RMBS
300
250
200 175
150
US Fixed Income Markets 2005 Outlook

100
50 60
0 50
11/98 6/99 1/00 8/00 3/01 10/01 5/02 12/02 7/03 2/04 9/04
Source: JPMS.

3
What bubble? Home prices up, but payments, the key
driver, still very low

Housing
Housing and
and disposable
disposable income
income (Ratio)
(Ratio) Real
Real national
national average
average home
home prices
prices (qoq
(qoq %
% change)
change)

0.95 Monthly payment Purchase price 9.5 8% OFHEO index deflated by CPI
0.90
9.0 6%
0.85
8.5
0.80 4%

0.75 8.0
2%
0.70 7.5
0.65 0%
7.0
0.60
-2%
6.5
0.55
0.50 6.0 -4%
Q1.1983
Q3.1984
Q1.1986
Q3.1987
Q1.1989
Q3.1990
Q1.1992
Q3.1993
Q1.1995
Q3.1996
Q1.1998
Q3.1999
Q1.2001
Q3.2002
Q1.2004

-6%
US Fixed Income Markets 2005 Outlook

Monthly Payment (av erage payment relativ e to -8%

Q1.1983
Q3.1984
Q1.1986
Q3.1987
Q1.1989
Q3.1990
Q1.1992
Q3.1993
Q1.1995
Q3.1996
Q1.1998
Q3.1999
Q1.2001
Q3.2002
Q1.2004
per capita disposable income)
Purchase Price (av erage purchase price
relativ e to per capita disposable income)
Sources: Federal Housing Finance Board, JPMS. Sources: OFHEO, US Dept of Labor, Bureau of Labor Statistics

4
Home builders efficiently responding to demand – for
bigger houses! (Where’s the speculative bubble here?)

Nominalized
Nominalized new
new home
home sales
sales and
and housing
housing starts
starts Ratio
Ratio of
of housing
housing starts
starts to
to new
new home
home sales
sales
(Jan 1963 = 1, 3-month moving average) (3-month moving average)
(Jan 1963 = 1, 3-month moving average) (3-month moving average)

4.0
3.00 New Home 2.00
Sales 3.5
2.75 Housing Starts
3.0
1.75 2.5
2.50
2.0
2.25 1.5
1.50
2.00 63 68 73 78 83 88 93 98 03
Source: US Census Bureau, US Dept of Commerce.
1.75 1.25

Median
1.50 Median price
price of
of new
new homes
homes
1.00 Median Price Size (median Price per sq ft
1.25 Year (2003 dollars) sq ft) (2003 dollars)
1975 161,634 1,535 $105.30
1.00 1980 196,585 1,595 $123.25
US Fixed Income Markets 2005 Outlook

0.75 1983 183,191 1,565 $117.05
0.75 1990 177,046 1,905 $92.94
1992 169,334 1,920 $88.19
1997 174,401 1,975 $88.30
0.50 0.50
2000 182,297 2,079 $87.68
63 68 73 78 83 88 93 98 03 2003 195,000 2,126 $91.72

Source: US Census Bureau, US Dept of Commerce. Source: Joint Center for Housing Studies of Harvard.

5
HEL ABS versus homebuilding index

Spread
Spread differential
differential to
to BBB
BBB HEL
HEL (bp)
(bp)

300
HEL BBB minus Bank BBB

JPM Homebuilding STW (Sw apped) minus HEL BBB
250

200

150

100

50
US Fixed Income Markets 2005 Outlook

0
1/03 4/03 7/03 10/03 1/04 4/04 7/04 10/04

Source: JPMS.

6
HEL ABS cheap – Irrational fears at work

Spread
Spread differentials
differentials to
to AAA
AAA HEL
HEL (bp)
(bp)

40 HEL AAA (3Y) minus FNMA CC 30yr Libor OAS
SF CDO AAA (7-9Y) minus HEL AAA 3Y
30 29
20
10 12
0
-10
10/00 4/01 10/01 4/02 10/02 4/03 10/03 4/04 10/04

Spread differentials
Spread differentials to
to subordinate
subordinate HEL
HEL (bp)
(bp)

300 Single-A HEL ABS (6-year) minus Financial (5-year) BBB HEL ABS minus Financial (5-year)
200 158
100 148
0
US Fixed Income Markets 2005 Outlook

-100
-200
-300
10/00 1/01 4/01 7/01 10/01 1/02 4/02 7/02 10/02 1/03 4/03 7/03 10/03 1/04 4/04 7/04 10/04

Source: JPMS.

7
New rating agency LIBOR stress – Prepared for the worst

LIBOR
LIBOR curves
curves –– BBB
BBB stress
stress

7% S&P Moody's Fitch Forw ard Curv e (11/12)

6%

5%

4%

3%
US Fixed Income Markets 2005 Outlook

2%
11/04 8/05 5/06 2/07 11/07 8/08 5/09 2/10 11/10 8/11 5/12 2/13 11/13

Source: Moody’s, S&P, Fitch, Intex.

8
The Structured Credit bid for assets will remain significant

Global
Global Cash
Cash CDO
CDO issuance
issuance by
by sector
sector ($bn)
($bn) Total
Total outstanding
outstanding Global
Global Credit
Credit Derivatives
Derivatives volume
volume ($bn)
($bn)

120 6000
SF HY Loans Corp Bonds Other Other Credit Deriv ativ es Structured Credit

100 5000

80 4000

60 3000

40 2000

20 1000
US Fixed Income Markets 2005 Outlook

0 0
1997 1998 1999 2000 2001 2002 2003 2004 1997 1998 1999 2000 2001 2002 2003 2004

Source: JPMS, MCM, IFR Markets, Moody’s, S&P, Fitch, Bloomberg Source: JPMS, CreditFlux, British Banker’s Association, ISDA, McKinsey & Co., Bank for
International Settlements

9
CLO spreads grind to record tights, but premium to Cards
has ended up unchanged

AAA
AAA CLO
CLO Spread
Spread to
to LIBOR
LIBOR (bp) BBB CLO Spread to LIBOR (bp)
(bp) BBB CLO Spread to LIBOR (bp)

65 325
60 300
55
275
50
250
45
40 225

35 200
30 175
10/00 4/01 10/01 4/02 10/02 4/03 10/03 4/04 10/04 10/00 4/01 10/01 4/02 10/02 4/03 10/03 4/04 10/04

AAA CLO
CLO minus
minus AAA
AAA Card
Card Spread
Spread differential
differential (bp) BBB CLO
CLO minus
minus BBB
BBB Card
Card Spread
AAA (bp) BBB Spread differential
differential (bp)
(bp)

35 185

165
30
145
25
US Fixed Income Markets 2005 Outlook

125
20
105
15 85

10 65
10/00 4/01 10/01 4/02 10/02 4/03 10/03 4/04 10/04 10/00 4/01 10/01 4/02 10/02 4/03 10/03 4/04 10/04

Source: JPMS.

10
Despite tightening, CDOs still offer a spread pick-up to like rated
securities

AAA
AAA Spreads
Spreads to
to Swaps/Libor
Swaps/Libor

53
39 33
28 27
18 13 5

5-7 Yr IG Syn 7-12 Yr SF 6-10 Yr HY 10 Yr CMBS 3-5 Yr HEL 10 Yr Floating 5 Yr UK 10 Yr
CDO CDO CLO Cards Sterling RMBS Industrial

BBB
BBB Spreads
Spreads to
to Swaps/Libor
Swaps/Libor

315 300
200 175
82 75 75 49
US Fixed Income Markets 2005 Outlook

7-12 Yr SF 5-7 Yr IG Syn 6-10 Yr HY 3-5 Yr HEL 10 Yr CMBS 5 Yr UK 10 Yr Floating 10 Yr
CDO CDO CLO Sterling RMBS Cards Industrial

As of November 18th, 2004
Source: JPMS.

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average total return of the bonds in the analyst’s (or analyst’s team’s) coverage universe. Neutral. Over the next six to twelve months, we
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Underweight. Over the next six to twelve months, we expect this bond to underperform the average total return of the bonds in the analyst’s
US Fixed Income Markets 2005 Outlook

(or analyst’s team’s) coverage universe.

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This report should not be distributed to others or replicated without prior consent of JPMorgan.

12
Chris Flanagan (1-212) 260-6515 US Fixed Income Research
christopher.t.flanagan@jpmorgan.com 2005 Outlook – Special Report
December 1, 2004

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Revised November 12, 2004

Copyright 2004 JPMorgan Chase & Co. All rights reserved. Additional information available upon request.

JPMorgan uses the following rating system: Overweight (we expect the bond to outperform the average total return of the bonds in the analyst’s (or analyst’s team’s) relevant sector), Neutral (we expect the bond to perform the
same as the average total return of the bonds in the analyst’s (or analyst’s team’s) relevant sector), and Underweight (we expect the bond to underperform the average total return of the bonds in the analyst’s (or analyst’s team’s)
relevant sector).

*JPMSI or an affiliate has managed or co-managed an offering of securities within the past twelve months.
^A senior employee, executive officer, or director of JPMSI and/or its affiliates is a director of the company.