Global Credit
Market Outlook
FinReg Final
In mid-July, President Obama signed into law the Dodd-
Frank Wall Street Reform and Consumer Protection Act,
the legal underpinnings of what many market partici-
pants have referred to as FinReg Reform. At a high
level, the changes initiated by US regulators, along with
proposals from international regulators under Basel III,
will require more capital and liquidity at many financial
institutions and result in less volatile earnings and more
transparency, all of which are good for bank creditors.
The new rules will also potentially have a material effect
on bank profitability and could have some negative
secondary effects on capital markets liquidity. Even
though the Act was a lengthy 2000-plus pages, it
provides only the broad constructs of reform; codifica-
tion of the regulation will occur over the next one to two
years. Nevertheless, understanding the interplay of the
competing outcomes of new law and regulations and
developing a view on the broad impact to the market
and the narrower effects on financial institution business
models and bank bond valuations is the next challenge
for fixed income investors. Below we identify and
discuss three main themes that have emerged following
the enactment of Dodd-Frank: 1) banks will be less prof-
itable but be required to hold more capital; 2) resolution
authority addresses the concept of ‘too big to fail’ but
brings with it additional uncertainties for creditors; and
3) bank bonds are still trading wide to industrials on a
spread basis, but broad-based sector spread tightening
is likely to take some time.
AUGUST 2010
THEME 1: FEWER PROFITS, MORE CAPITAL
The US changes excluding Basel III will end up costing banks
significant revenue. Predictions for earnings impacts are varied,
running from 5% to a hit approaching 25%. The biggest impacts
are expected to be felt by the large universal banks at around
20% because of the breadth of their businesses and the not-so-
subtle intention of Congress to punish the Wall Street players. US
regional banks may be affected less—in the 5–10% range. The
largest impacts come from new credit card rules, restrictions on
overdraft fees and debit card interchange, derivatives income
and, to a lesser degree, the ban on proprietary trading. The
overall impact to profitability could have been worse, in our view,
as there is currently no plan for a tax on wholesale funding (TARP
tax) that President Obama proposed early in the year. Looking
out to the rest of 2010 and beyond, global banking rules under
the auspices of Basel III will change how regulatory capital is
calculated and the amount of liquidity banks are required to hold.
As we discussed in our April 2010 edition of Global Credit Market
Outlook, while lower profitability may not be music to the ears of
equity investors, the corresponding increases in capital require-
ments should be a benefit for bondholders.
Chart 1: Financials v. Industrials OAS
400
300
200
100
0
-100 1/90 1/94 1/98 1/02 1/06 1/10
Source: Barclays Capital. Chart depicts the US Investment Grade Financials less Industrials
option adjusted spread, in basis points, for the period January 1, 1990 through August 18, 2010.
GLOBAL CREDIT MARKET OUTLOOK

THEME 2: RESOLUTION AUTHORIT Y DOESN’T RESOLVE advantage pre-2008 now carry significant disadvantages given
CREDITORS’ CONCERNS
the new focus on consumer protection, while those with signifi-
The main focus for fixed income investors among all the cant foreign operations could benefit in the future.
changes is on what has been generically termed ‘resolu-
From a market perspective, bank spreads rallied after the
tion authority’. New rules give regulators the ability to seize a
passage of Dodd-Frank and then again on the Goldman Sachs
systemically important troubled financial institution and wind
settlement and on diminishing European sovereign concerns,
it down instead of providing exceptional support as in the
but spreads remain far wider than would normally be expected
case of Citigroup and AIG and avoid the kind of global disrup-
at this point in an economic recovery. As Chart 1 shows, the
tion caused by the Lehman Brothers bankruptcy. Resolution
US banking sector currently trades 75 basis points wide to
authority adds uncertainty for creditors because it potentially
the industrial sector, whereas in the 18-year period ended
removes the ‘too big to fail’ label many bank investors had
December 31, 2007, bank spreads traded, on average, 30 basis
relied upon. In addition, it potentially changes the rules for
points through industrials. Note that the wide mark of the basis
secured lenders so that they may not have perfected liens on
was reached at the peak of the liquidity crisis in March 2009,
their collateral. Since repo lending is the backbone of a bank/
when the spread briefly touched 370 basis points. While the
broker’s short term funding, changes here could have a signifi-
available time series is shorter for European investment grade
cant impact on a bank’s liquidity when under stress. Perversely,
bonds, the trend is consistent (and, in fact, the bank-industrial
it could hasten a bank’s fall if short term lenders pull secured
relationship is more pronounced). The current spread premium
lines because they are worried they may not recover 100%. In
of both US and European banks, in our view, reflects market
addition, the ratings agencies are expected to downgrade some
uncertainty over what the average bank will look like two years
of the largest banks based on lower expected levels of govern-
hence once all the new rules are in place. For spreads to
ment support. These downgrades could further impair the
approach their pre-crisis relationship to industrials, the market
banks’ funding costs by removing the short term ratings.
needs to get comfortable with many of the new regulatory
THEME 3: DECLINE IN THE BANK-INDUSTRIAL BASIS WILL LIKELY changes as well as the trajectory of global growth—and this is
TAKE TIME likely to take some time.
With this overhang associated with the resolution authority and
secured lending, it is no wonder why investment grade finan- Investment Strategy
cial sector spreads continue to trade wide to industrials. The Following little adjustment to our risk positions associated with
challenge for investors is to select the companies that are best credit—maintained at a low-to-moderate level—in June, we
positioned to succeed in the new environment. Some banks increased risk exposures across a number of accounts in July.
went into the financial crisis with strong balance sheets and Last month, European governments made progress in addressing
are proving to be the winners as we exit. Others have made sovereign and bank liquidity risks, concerns about immediate
significant repairs to their balance sheets but may have legacy sovereign financial crises receded, and as the US government
issues that will be a drag on earnings for years. In other cases, enacted legislation aimed at reforming the US financial markets,
US consumer-focused business models that may have been an

Chart 2: Credit Index Performance

Spreads Returns
OAS MTD YTD MTD YTD MTD YTD
7/30/10 Change Change ER ER TR TR
US IG 175 -18 3 1.26 0.23 1.96 7.87
EUR IG 194 -37 19 1.38 0.11 1.22 4.80
US HY 632 -68 15 2.77 2.49 3.56 8.23
EUR HY 634 -116 -72 4.50 5.48 4.26 9.92

Source: Barclays Capital. OAS is option-adjusted spread, in basis points. ER is excess return, in %. TR is total return, in %. MTD is month-to-date. YTD is year-to-date. US IG is US Investment
Grade Corporate Index. EUR IG is Euro Investment Grade Corporate Index. US HY is US High Yield Index. EUR HY is Euro High Yield Index. Index returns are unmanaged and do not reflect the
deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income.

2
GLOBAL CREDIT MARKET OUTLOOK
which removed a fair degree of uncertainty associated with
the regulatory environment. We viewed these developments, in
conjunction with generally good earnings results for companies
reporting thus far for 2Q10, as constructive signs for the corpo-
rate bond valuations. We remain cautiously optimistic with respect
to our orientation toward the credit markets, but are mindful that
a sustained rally in risky assets could be threatened by a weaker
macroeconomic backdrop. We continue to believe that both
investment grade and high yield credit markets offer the potential
for positive risk-adjusted returns over the medium term.
Market Update
Sentiment for risky assets reversed in July and turned decidedly
positive, driven primarily by the release of European bank stress
test results and the passage of legislation in the US aimed at
reforming the regulatory structure of financial markets. While we
would not characterize either the European stress tests or the
US legislation as unmitigated positives, there were clear benefits
from the perspective of many market participants to removing
the uncertainty (and potential downside scenarios) associated
with these two events. During the course of the month, global
equity markets rallied—the S&P 500, for example, was up
nearly 7%—volatility declined meaningfully, and government
bond yields in the US declined slightly and increased modestly
in Germany. The credit markets registered the second strongest
monthly performance in 2010, with excess returns ranging from
1.25% for US investment grade to 4.5% for European high
yield for July. Financial institutions, in particular, posted among
the strongest returns for the month in both the high yield and
investment grade universes. In addition, lower quality credits
outperformed higher quality issues, and longer duration corpo-
rate bonds generally outperformed shorter duration instruments.
3
Economic & Interest Rate Outlook
The theme of deteriorating economic indicators that we high-
lighted in last month’s outlook continued through June, and
what we know about July so far suggests that the economic
backdrop hasn’t gotten much better. June proved to be some-
what of a ‘lost month’ for employment, production, income and
spending, and evidence emerged of an erosion of business
and consumer confidence, along with further weakness in the
US housing sector. Despite the tepid macro environment, July
proved to be a very good month for risky asset returns. The
increased appetite for risk was driven, in our view, not so much
because investors felt better about the economy, but because
corporate earnings have generally continued to be relatively
strong and concerns regarding European sovereigns and banks
receded. Our expectations for a moderation in economic growth
over the near to medium term lead us to the following conclu-
sions: 1) if moderation occurs early in the recovery cycle, it
implies that unemployment will fall more slowly, that deflation
will become a bigger risk, and that the renormalization of policy
interest rates will be further delayed; 2) the ‘early moderation’
scenario significantly increases the likelihood of episodes of
negative price action for risky assets, and 3) an external shock
to the global financial system occurring when growth is slow
is far more dangerous than a shock occurring when growth
is rapid, especially when much of the ammunition that policy
makers have to cushion the system has been used up.
GLOBAL CREDIT MARKET OUTLOOK

For information, please contact:

William H. Cunningham Robert Kania, CFA Ossi Valtanen Jeffrey Megar, CFA
Senior Managing Director Vice President Vice President Vice President
Head of Global Credit Strategies US Investment Grade European Investment Grade High Yield
SSgA SSgA SSgA UK One Lincoln Street/SFC 29
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This material is for your private information. The views expressed in this material are the views of Robert Kania through the period ended August 20, 2010 and are subject to change based on market
and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable, but
its accuracy is not guaranteed. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future
performance and actual results or developments may differ materially from those projected. Past performance is not a guarantee of future results.
In general, fixed income securities carry interest rate risks; the risk of issuer default; and inflation risk. This effect is usually pronounced for longer-term securities. Any fixed income security sold or
redeemed prior to maturity may be subject to a substantial gain or loss. Government bonds and corporate bonds have more moderate short-term price fluctuations than stocks, but provide lower
potential long-term returns. U.S. Treasury Bills maintain a stable value if held to maturity, but returns are generally only slightly above the inflation rate.
Investing in high yield fixed income securities, otherwise known as “junk bonds,” is considered speculative and involves greater risk of loss of principal and interest than investing in investment grade
fixed income securities.

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