Transcript Fixed Income Opportunity

N O R T H E R N T R U S T G L O B A L I N V E S T M E N T S
High Yield Fixed Income Update
June 30, 2008
Edward Casey
Richard Inzunza, CFA
Fund Managers, Northern High Yield Fixed Income Fund
© 2007 Northern Trust Corporation
northerntrust.com
High Yield Update Agenda
2

Review of Current Environment

High Yield Market Outlook
High Yield Fixed Income Management
High Yield Environment Review
3

In 2007 high yield default rates & spreads reached historic lows following strong economic
growth and accommodative credit creation from structured markets ( please see OAS and
default charts)

Problems in the housing market severely impaired structured credit markets and caused
financial markets to cease functioning properly

The systemic disruption culminated in a liquidity crisis that threatened the imminent failure of
Bear Stearns. The Federal Reserve helped to structure the rescue of Bear Stearns by J.P.
Morgan, aided by credit available directly from the Federal Reserve

In response to the financial market turmoil the Federal Reserve lowered the Fed Funds target by
325bps, including a 75bps inter-meeting move. Several liquidity measures were introduced by
the Federal Reserve, ECB and Bank of England to ease market liquidity tensions

Credit market sentiment cautiously recovered early in the second quarter as financial
institutions were able to raise additional capital through the issuance of common equity,
preferred stock and hybrid securities. Bank capitalization remains weaker than before the crisis
and lending standards have tightened considerably (please see C&I lending chart)
High Yield Fixed Income Management
High Yield Environment Review - High Yield Index Spreads
High Yield Market Option-Adjusted Spread (OAS)
1100
1050
March 17th
815bps
1000
950
900
1998 to 2003
645bp
850
800
750
700
20 year avg
475bp
650
10 year avg
517bp
600
550
500
450
400
350
2007 low
231bps
1993 to 1998
avg 326bp
300
250
Source: Lehman Brothers 2% Capped Index, June 2008
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High Yield Fixed Income Management
Oc
t-0
6
Au
g07
Ju
n08
Oc
t-0
1
Au
g02
Ju
n03
Ap
r-0
4
Fe
b05
De
c05
Oc
t-9
6
Au
g97
Ju
n98
Ap
r-9
9
Fe
b00
De
c00
Fe
b90
De
c90
Oc
t-9
1
Au
g92
Ju
n93
Ap
r-9
4
Fe
b95
De
c95
-88
r-8
9
Ap
Ju
n
Au
g87
200
High Yield Environment Review – Moody’s Default Rate
20-year Moody’s Global Default Rate Average 4%
12.0
11.0
10.6
10.4
10.0
10.0
9.0
8.4
8.0
7.0
6.0
6.2
6.1
5.7
5.6
5.0
3.5
4.0
3.9
3.8
4.3
3.6
3.5
3.3
3.0
2.0
5.3
4.9
1.8
1.0
1.9
1.6
1.3
0.4
3.4
3.3
1.6
2.4
2.0
1.7 1.7
1.0
0.7
0.0
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
Source: Moody’s, December 2007
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High Yield Fixed Income Management
1999
2001
2003
2005
2007
High Yield Environment Review – Tightening Lending Standards
Tightening Standards for Commercial & Industrial Loans (Small Companies)
versus High Yield Spreads
1050
75
1000
65
950
900
55
850
800
45
750
700
35
650
600
25
550
500
15
450
400
5
350
300
-5
250
200
-15
150
C&I (RHS)
OAS (LHS)
Source: Federal Reserve Survey, April 2008, Lehman Brothers June 2008
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High Yield Fixed Income Management
-08
Ju
n
Oc
t-0
7
-06
Fe
b-0
7
Ju
n
Oc
t-0
5
Fe
b-0
5
-04
Ju
n
Oc
t-0
3
-02
Fe
b-0
3
Ju
n
Oc
t-0
1
Fe
b-0
1
-00
Ju
n
Oc
t-9
9
-98
Fe
b-9
9
Ju
n
Oc
t-9
7
Fe
b-9
7
-96
Ju
n
Oc
t-9
5
Fe
b-9
5
-94
Ju
n
Oc
t-9
3
Fe
b-9
3
-92
Ju
n
Oc
t-9
1
-25
Fe
b-9
1
100
High Yield Market Outlook
7

The disruptions in the financial and banking system are likely to result in a reduction in the
availability of credit to all areas of the economy

This reduction in credit is expected to have a negative impact on spending in the broader
economy. The reduction in demand will reduce earnings, with HY companies the most at risk

The risks to growth are skewed to the downside given the multitude of headwinds facing the
economy; weak residential market, tightening lending standards, weakening labor market, high
commodities prices and low consumer confidence

The transition from a financial/banking system disruption to a problem in the broader economy
is expected to occur in a two-stage process in which the impact to the broader economy lags the
financial system by 6 to 9 months. Therefore, the impact to the broader economy should
continue through 2008

The safety net of "free money" that had artificially suppressed the default rate over the past few
years is no longer available to support distressed companies
High Yield Fixed Income Management
High Yield Market Outlook (continued)
8

Weaker issuers are expected to breach financial covenants. Lenders are expected to seek
increases in effective interest rates, a floor on LIBOR and waiver fees

The default rate is likely to increase due to the normal seasoning cycle. A further reduction in
credit availability will add pressure to the default rate going forward

The HY index at 689 on June 30 was within the 675-725 six month target range set by Northern
Trust Global Investment’s Credit Strategy Committee. HY portfolio management expects
negative earnings to pressure spreads as the earnings cycle progresses. However, a significant
widening beyond 1,000bps is not expected in the near term due to lower risk of systemic failure
High Yield Fixed Income Management
Important Information
The preceding discussion is general in nature, is intended for informational purposes
only, and is not intended to provide specific advice or recommendations
for any individual or organization. Because the facts and circumstances
surrounding each situation differs, you should consult your attorney, tax advisor
or other professional advisor for advice on your particular situation.
There are risk involved with investing, including possible loss of principal.
The information in this communication has been obtained from sources
considered reliable, but we do not guarantee that it is accurate or complete.
Additional information is available upon request.
The Lehman U.S. Corporate High Yield 2% Issuer cap Index is an unmanaged
index that is not available for direct investment.
Past performance is no guarantee of future results.
NOT FDIC INSURED
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High Yield Fixed Income Management
NO BANK GUARANTEE
MAY LOSE VALUE