1. 13 January 2009 1 Alexander Batchvarov, CFA +44 20 7995 8649 alexander_batchvarov@ml.com Ludwig Clement +44 20 7995 0432 ludwig_clement@ml.com Caspar Cook, CFA +44 131 473 1055 caspar_cook@ml.com Altynay Davletova, CFA +44 20 7995 3968 altynay_davletova@ml.com James Martin +44 20 7995 0110 james_martin@ml.com Furquan Kidwai +44 20 7996 2536 furquan_kidwai@ml.com Sabine Winkler +44 20 7995 4756 sabine_winkler@ml.com European Structured Finance 2008-09 Product ID 13 January 2009 What Drives European Credit Spreads - 2009

2. 13 January 2009 2008-09: In search of a strong footing

3. 13 January 2009 3 2008 - an exceptional year in every respect Rated new issuance exceded Eur700bn, much higher than in previous years Public placement - maybe less than 2.5% of new issuance Main primary market investor- the central banks Secondary market - main focus of remaining investors Spreads - wide across stack, asset classes and geographies CDS on ABS - a viable investment instrument for the cash strapped investor; volatile basis Spread volatility - not a surprise, but how much is driven by fundamentals and how much by technicals US and European ABS - mutually re-enhanced relationship in secondary spreads

4. 13 January 2009 4 2008 - an exceptional year in every respect Performance of European structured finance bonds deteriorating, but the majority of the European structured finance transactions perform according to initial expectations Rating agencies changes in methodology and/or assumptions adding to market instability - an event risk rather than credit risk Deteriorating credit performance - is the actual deterioration within expectations or beyond expectations? MtM sensitivity - unnecessary for structured, illiquid and difficult to value positions - drove traditional investors away from the market and converted buyers into forced sellers Reputational issues - media frenzy and financial institutions reputation - better lose one’s shirt in equity than a shirt’s button in structured finance! Wider markets’ lack of understanding of the structured finance world Events that were never meant to happen - demise of the monolines, hitting a MT NAT test (who gave that advise?!), collapse of the commercial paper market, rise and fall of the systemic bank risk, decline of covered bonds liquidity and collapse of related market-making mechanism, multi- notch downgrades due to radical changes in rating methodology - a squadron of blcak swans!

5. 13 January 2009 5 The demise of the parallel banking system Banks and finance companies actively originate loans in the expectation that they can off-load them to long-term investors Securitisation is the transformation mechanism by which pools of loans are converted into bonds with different risk profile Securitisation bonds are sold to investors with different risk appetite - investors of the senior part of 70-90% of each transaction play a key part in the placement Investors base for the senior and bulkiest part of the securtisation bonds comprise banks, SIVs, ABCP conduits and hedge funds - all rely on short-term funding and/or leverage The parallel banking system replicated the traditional gap (short-term funding / long-term investing) of traditional banking system without the benefit of CB aid A run on the parallel banking system occurred when the short-term markets shut down, bringing the main players of the parallel banking system to their knees The parallel banking system provided credit to the tune of USD1.5-1.8trl p.a. globally in the preceding five years (Western Europe E350-500bn p.a. from securitisation plus E150-200bn p.a. from covered bonds) The elimination of credit flows from the parallel banking system without a replacement provider of that credit in the near team is having a devastating effect on the markets and the economies of many countries around the world

6. 13 January 2009 6 Government actions Actions associated with providing liquidity to the markets Repo facilities and repo eligibility (categories II, III, IV, V) Actions meant to stimulate new lending Guarantee for financing of new lending (the UK) Actions to support borrowers facing debt service difficulties Spain and Italy, so far Actions to prop up the banks and stimulate new debt issuance Government guarantees for bank debt (many countries for 3 or 5 years), covered bonds (Sweden, Ireland, UK), RMBS (UK) Creating a multiple-tier bond market: government guaranteed (GG) bank debt, GG covered bonds, GG MBS, regular (non-GG) bank debt, legacy covered bonds, legacy ABS and MBS Loan modifications - self-interest or moral suasion Additional actions required - social housing, first time buyers, new investors

7. 13 January 2009 7 From one to two markets for structured finance Government related markets for structured finance bonds Repo facilities - new issuance price to repo, not priced to market Potential implementation of government guarantees to RMBS and covered bonds (UK) Government-guaranteed covered bonds vs. covered bonds from government supported banks Legacy markets for structured finance products Secondary markets for ABS and MBS Secondary markets for covered bonds Wide spreads for liquidity or credit reasons, or both Interaction among the different primary markets in the presence of government guarantee GG bank debt - most attractive pricing but limited maturity (3 or 5 yrs) and size per government support packages (on balance sheet debt) Covered bonds - attractive pricing for the guaranteed covered bonds but admin cost not justifiable, hence covered bonds attractive for maturities beyond 3/5 years (on balance sheet debt with encumbrance, investor acceptance in light of product disparity) Securitisation - attractive due to clear asset/liability matching and maturity/ cash flow profile(regulatory issues about retention and capital treatment, structures and asset investor acceptance) Short-term and long-term distortions and their cure

8. 13 January 2009 8 In Search of New Investors and New Asset Allocation Remaining traditional investors Banks - the MtM issue, overload, reinvesting amortisation, tight liquidity, delevering Insurance companies - 2012 and capital requirement rules Pension funds - different degree of past involvement Government guaranteed paper - the SSA investor Distressed investors Fixed income funds, alternative credit funds Timing the entry, sizing the return ‘Price Distressed’ bonds vs ‘Credit Distressed’ bonds Challenges in sizing the distressed debt market in Europe Cross-over investors Natural fit - private equity investors and CLOs; property investors and CMBS Tenuous fit - bank equity investors and RMBS/ ABS Developments and returns on the traditional market of a given investor in comparison with availability and return of structured finance instruments - dividend yield&capital return vs. coupon&principal return

9. 13 January 2009 9 The Asset Allocation Questions Preferred part of the distressed universe - price vs credit distressed Fit into the existing allocation guidelines or need to modify guidelines Availability of the necessary skill set in the organisation Allocation to fixed income / alternatives / distressed in traditional equity portfolios Realistic assumptions about equity returns Ability to use derivatives to hedge or take exposure Ability to hold investments to maturity

10. 13 January 2009 10 The future of Structured Finance Pros The need for credit and the inability of banks to provide it from wholesale and deposits Demographics demand fixed income instruments Investors preference for secured investment instruments Availability of skilled structured finance professionals displaced by the upheaval in investment banking Securitisation as a truly match-funded funding mechanism Attractive relative value of securitisation and covered bonds post dislocation Cons Regulatory zeal/ hyperactivity - BIS2.2 and the X% rule Insufficient investor base Ambiguity of rating agencies role Negative publicity surrounding structured finance Crowding out effect of government guaranteed debt and ‘nationalisation’ of the banks

11. 13 January 2009 11 Expectations for 2009 De-leveraging and re-capitalisation of banks Stabilisation or at least sizing the trough of the residential and commercial real estate markets Sizing the depth of the economic turn in Europe Reduction of systemic risk in the banking system Clarity as to the range of measures the governments are prepared to take to support the economies, consumer and corporate sectors, market liquidity and funding availability Accepting a scenario-based risk-reward approach to investing Differentiating between price distressed and credit distressed bonds, new and legacy bonds

12. 13 January 2009 Islamic finance

13. 13 January 2009 13 Sukuk market in picture Global Sukuk issuance (US$bn)GCC Sukuk issuance (US$bn) 5yr FLT, Corporate Sukuk spreads (bps) What Drives European Credit Spreads - 2009 Source: Zawya, Merrill Lynch, IFIS

14. 13 January 2009 14 Sukuk market in picture (contd.) Sukuk issuance by country (US$bn)2007 vs 2008 Sukuk issuance (US$bn) Source: Zawya, Merrill Lynch, IFIS

15. 13 January 2009 15 Sukuk spreads widened and issuance declined Sukuk spreads widened 2-3 times; Corporate sukuk priced in the range of 115 – 275bps; Saudi spread declined on GSE issuance Widening attributed to shariah ruling on asset buy-back in sukuks, contagion from the global economic slow down and uncertainty regarding the peg issue Issuance declined 58% y-o-y; only Bahraini market kept up with last year’s numbers – local money market instruments in demand Malaysian local currency sukuk dominated the market with US$5.3bn issuance Indonesia a new market entrant: US$677mn vs US$44mn (in 2007); fixed rate Issuance predominantly in local currency Shariah-compliant syndicated lending continues as an alternate debt supplier

16. 13 January 2009 16 The sukuk controversy Purchase price guarantee in Musharaka, Mudaraba and Wakala structure declared non-compliant shariah; effectively eliminating principle guarantee Equity/ownership or securitisation structures preferred Ijara (sale and lease-back) structure exempted from this restriction Musharaka and Mudaraba sukuks down to 17% and 5% respectively from 43% to 21% last year; Ijara sukuks up to 54% from 30% in 2007 YoY structural shift in sukuk issuance

17. 13 January 2009 17 Islamic Securitisation First land securitization in Abu Dhabi and the UAE: Sun Finance Limited First 100% local currency ABS; true sale with title transfer for asset isolation Rated Aa3/A3/Baa3 and pricing in at 200/250/350bps over EIBOR Some of the transaction features include: Low WA LTV (49%), 42% over-collateralisation, short WA life (21 months) & pre-funded reserve accounts Strong state participation in Abu Dhabi’s development, registered land ownership & high-rated backup servicer, positive real estate outlook in Abu Dhabi for short-medium term Source: Moody’s

18. 13 January 2009 18 GCC Securitisation: any chance? Fundamentals: weakening economy and real estate markets; Saudi relatively better Credit growth: credit growing rapidly, banks’ loan to deposit growth (100% in Qatar, 65% KSA), over-exposure to the real estate sector – need to offload in the capital market Collateral performance: low non-performing loan ratio supported by strong economic growth; consumer loans exposed to local stock markets (esp. KSA) and real estate; deterioration of assets likely especially the UAE Demand: local investors and banks; shariah-compliant securitisation to attract Islamic banks; however real estate exposure to be taken with a pinch of salt Legal issues: untested and evolving legal system; two-tier SPV used so far; free-zones more reliable, replicate English law Expectations: GCC securitisation to continue; UAE the most developed markets in the GCC; Qatar and Saudi picking up; post-downturn origination to slow down

19. 13 January 2009 19 Consumer & mortgage lending Total loans (% of GDP): UAE (103%), Qatar (69%), Bahrain (64%), KSA (42%), Egypt (48%) Consumer Deposits (% of GDP): UAE (103%) and Bahrain (96%) leading, position boosted by offshore financial centres Retails loans: Highest retail loans in Qatar and Bahrain, UAE lagging (6% of GDP) Private consumption rising; credit card market growing – UAE accounts for 50% Mortgage Mortgage penetration low across the board; UAE (8%) and Kuwait (10%) top the list Increasing housing costs to support mortgage growth Legal infrastructure needs clarity

20. 13 January 2009 Covered bonds 2008-09

21. 13 January 2009 21 Market in numbers Jumbo market at the end of 2008 compared with the end of 2007 Annual gross supply: €90bn versus €152bn Share of special-law-based covered bonds17% versus 37% Share of mortgage covered bonds 64% versus 66% Total volume outstanding:€823bn versus €821bn Share of special-law-based covered bonds20% versus 23% Share of mortgage covered bonds60% versus 56% Number of Jumbos issued: 66 versus 99 Number of Jumbo issuers:97 versus 80 Number of products issued in Jumbo format:24 versus 21 New special covered bond laws:2 versus 4 Jumbo redemptions:€87bn versus €80bn Initial maturities of new Jumbos: up to 5 years89% versus 50% 6 to 10 years11% versus 35% over 10 years0% versus 18%

22. 13 January 2009 22 Market in numbers Germany remains the largest Jumbo market Source: Merrill Lynch Germany dominates the 2008 Jumbo primary market Source: Merrill Lynch Special-law-based covered bonds in vogue Source: Merrill Lynch Broken trend Source: Merrill Lynch

23. 13 January 2009 23 Market in numbers Investor appetite for mortgage covered bonds subdued Source: Merrill Lynch, Annual gross supply of Jumbo covered bonds. Covered bonds as mortgage finance instrument Source: Merrill Lynch, Outstanding volume of Jumbo covered bonds. Initial terms of new Jumbos have become shorter Source: Merrill Lynch Significant redemptions expected near-term Source: Merrill Lynch

24. 13 January 2009 24 Challenges What place do covered bonds have in a bank’s overall funding mix? Banks adjust their balance sheets and refinancing strategies Originate-to-retain and originate-to-repo process is in vogue Secured funding implies structural subordination Term funding has to gain importance over time How will the investor base develop and grow? The development of a domestic investor base becomes crucial The risk assessment of covered bonds has become more complex How will the pricing of covered bonds develop? From a ‘rates plus’ product to a ‘credit minus’ product to an in-between product Exceptional competition from government-guaranteed bank debt

25. 13 January 2009 25 Challenges Will the spread differentiation by country and issuer stay? Covered bonds have suffered from a sharp liquidity decline and widening spreads Spread differentiation between countries and issuers has reached all-time wides Spread differentiation and risk aversion go hand-in-hand Flight-to-safety and flight-to-liquidity flows to put upward pressure on spreads Potential issuer downgrades negatively affect the Jumbo spread performance Subdued gross supply and €100bn in redemptions should support Jumbo spreads Spread differentiation by country and issuer to stay Gradual spread contraction in the longer term

26. 13 January 2009 26 Challenges Secondary spreads of 5-year €-denominated Jumbos Source: Merrill Lynch Newer Jumbo markets lack domestic investor base Source: Merrill Lynch Public versus mortgage covered bonds Source: Merrill Lynch General versus special-law-based covered bonds Source: Merrill Lynch

27. 13 January 2009 27 Comeback The 2009 comeback of covered bonds Exceptional market conditions have stemmed the flow of new Jumbo issuance Financing markets have to stabilise and investor risk aversion needs to ease Banks need a variety of funding instruments and matched refinancing Banks have to wean themselves off current exceptional government support The covered bond market dynamics are not fully divorced from the credit market The reception of a covered bond depends on an issuer’s reputation with investors An overhaul of the market-making system to restore investor confidence Combined efforts from the different covered bond market stakeholders

28. 13 January 2009 UK RMBS

29. 13 January 2009 29 UK house prices continue south UK house prices implied by property derivatives Source: Merrill Lynch UK House price index, YOY change Source: Halifax, Nationwide, Land Registry, Merrill Lynch

30. 13 January 2009 30 House sales and mortgage approvals drop Volume of UK house sales Source: Land Registry UK Mortgage approvals (000s) Source: Datastream

31. 13 January 2009 31 Net lending at depressed levels UK Gross mortgage lending by purpose of loan, £mn Source: CML UK Net and gross mortgage lending (£mn) Source: Datastream

32. 13 January 2009 32 UK economy entering recession UK forecasts (shaded regions) Q1 08Q2 08Q3 08Q4 08Q1 09Q2 09Q3 09Q4 092007200820092010 GDP0.30.0-0.5-0.9-0.5-0.30.00.23.00.7-1.61.5 Consumption0.9-0.1-0.6-0.7-0.5-0.3-0.13.01.6-2.30.4 Investment-2.0-2.8-1.9-2.1-1.6-1.1-0.6-0.17.1-3.8-5.90.5 Government1.00.50.30.50.6 0.51.82.1 Domestic Demand0.0-0.1-0.4-1.2-0.7-0.5-0.20.03.60.6-2.20.8 Exports0.70.00.70.20.40.60.70.8-4.51.81.93.7 Imports-0.3-0.51.0-0.8-0.4-0.10.10.2-1.91.4-0.61.4 Net Exports †0.30.2-0.10.30.2 -0.70.10.70.6 Average Earnings**4.03.53.3 3.93.53.33.5 HICP**2.43.44.84.13.32.01.01.22.33.60.92.3 RPI**4.04.44.93.20.9-0.4-1.3-0.74.34.1-0.42.5 Industrial Production**-0.5-0.7-1.1-2.0-1.2-0.6-0.20.20.4-1.7-3.91.2 Unemployment Rate, %5.25.45.86.46.87.27.47.75.45.77.37.9 BoE Rate (period end)***5.255.00 2.001.00 5.502.001.003.00 Source: ML Economics, ONS. Quarterly figures are quarter-on-quarter changes (not annualized), except where marked by **, which are year-on-year changes. †percentage point contribution to GDP growth.

33. 13 January 2009 33 UK RMBS volumes at record high, on paper UK RMBS issuance by sector, EURbn Source: Merrill Lynch

34. 13 January 2009 34 UK RMBS secondary market gets more distressed UK AAA Prime RMBS basis UK NCF RMBS indicative secondary spreads UK Prime and BTL RMBS indicative secondary spreads Source: Merrill Lynch

35. 13 January 2009 35 UK prime RMBS performance Table 3: Recent performance summary of selected UK RMBS master trusts 1M CPR90+180+REORepossessions*Losses Avg 3Qarrears 3Q 081H 082H 071H 071-3Q 08 ARKLE.25%0.63%0.19%0.08%0.03% 0.01%0.00%0 Aire Valley7%2.65%1.09%0.13%0.07%0.20%0.12%0.16%0.03% FOSSE25%0.20%0.08%0.00% 0.01%0.00% 0 Gracechurch31%0.60%0.23%0.01%0.00% 0 GRANITE39%1.82%0.46%n/a0.23%0.34%0.21%0.17%0.04% HOLMES38%0.69%0.20%0.07%0.10%0.14%0.13%0.03%0.01% LOTHIAN27%0.46%0.21%0.08%0.01%0.04%0.01% 0 MOUND32%4.22%2.30%0.25%0.11%0.18%0.11%0.08%0.07% PERMM30%1.33%0.69%0.14%0.03%0.04%0.03%0.00%0.02% Pendeford33%0.92%0.43%0.13%0.00% 0 UK (CML data)na1.33%0.58%0.16%na0.16%0.11% na Source: ABSXchange, Merrill Lynch, CML *Based on count for Mound and PERMM

36. 13 January 2009 36 UK Prime RMBS 90+ arrears 90+ arrears before and in 2008, against pool seasoning Source: ABSXchange, Merrill Lynch

37. 13 January 2009 37 UK prime RMBS outlook negative Macro outlook suggests more pain ahead Unemployment to reach 8% by 2010 Losses may reach 2% Downside risk, but UK government initiatives may be a significant supporting factor Divergence in performance across master trusts likely to remain Extension risk rising Weaker housing market= lower CPR Step-up calls: not that punitive anymore Reputational considerations getting weaker

38. 13 January 2009 38 UK buy-to-let market BTL gross and net lending YOY change in number of new tenancies (not renewals) signed up in the last 3 months Source: CML, ARLA Surveys % BTL investor respondents expecting to buy more properties in the next 12 months Is there more properties or tenants (% respondents)?

39. 13 January 2009 39 UK BTL rental yields Average rental return on houses, by region Source: ARLA Surveys Average rental return on flats, by region Source: ARLA Surveys

40. 13 January 2009 40 UK BTL arrears rising BTL sector performance Source: CML UK BTL 90+ arrears by deal, Oct-08 vs Dec-07 Source: ABSXchange, Merrill Lynch

41. 13 January 2009 41 while CPRs slowing UK BTL CPR, Oct-08 vs Dec-07 Source: ABSXchange, Merrill Lynch Aire Valley 90+ arrears, before 2008 versus 1-3Q08 Source: Merrill Lynch

42. 13 January 2009 42 UK BTL risk exposure vary across deals UK BTL current indexed* LTV Source: ABSXchange, Merrill Lynch *As reported in investor reports, using Halifax index UK BTL share of fixed-rate mortgages and below 120% ICR Source: ABSXchange, Merrill Lynch

43. 13 January 2009 43 UK non-conforming RMBS arrears UK NCF 90+ arrears Source: Merrill Lynch, ABSXchange UK NCF 180+ arrears Source: Merrill Lynch, ABSXchange

44. 13 January 2009 44 UK NCF RMBS repossessions UK NCF REO, % current balance Source: Merrill Lynch, ABSXchange UK NCF quarterly repossession rate, % current balance Source: Merrill Lynch, ABSXchange, investor reports

45. 13 January 2009 45 UK NCF RMBS losses UK NCF cumulative losses, % original balance Source: Merrill Lynch, ABSXchange UK NCF deals with 2009 resets*, % original balance Source: Merrill Lynch, ABSXchange, investor reports *Excludes deals where the amount of resets is less than 10% of original balance

46. 13 January 2009 46 UK non-conforming RMBS series UK NCF 90+ arrears and repossessions versus risk factors, by vintage and series*

47. 13 January 2009 47 UK NCF RMBS CPRs UK NCF CPR Source: Merrill Lynch, ABSXchange Gap between 3M Libor and BBR (%) Source: Bloomberg

48. 13 January 2009 48 UK NCF RMBS: Sizing losses under a stress scenario Table 9: UK NCF average loss estimates and assumptions 2005 Vintage2006 Vintage2007 Vintage Average CPR 19%16%7% Average severity 20%30%40% Average losses 5%10%20% CE AAA 36%31%23% AA 21%16%12% A 10%8% BBB 5.2%4.7%3% Source: Merrill Lynch

49. 13 January 2009 European RMBS

50. 13 January 2009 50 European GDP and unemployment Quarterly GDP growth 2000-Q3 08 (YoY%) Source: Datastream Quarterly unemployment rates 2000-Q3 08 (%) Source: Datastream

51. 13 January 2009 51 Spanish house prices and lending Nominal house price growth YOY Source: European Mortgage Federation, national statistics, Eurostat, INE Net lending: Housing loans* and loans for house purchases Source: AHE *including loans for improvement, development/construction, land

52. 13 January 2009 52 Spanish RMBS volumes and spreads Spanish issuance volumes (€mn) Source: Merrill Lynch Spanish RMBS indicative secondary spreads Source: Merrill Lynch

53. 13 January 2009 53 Spanish RMBS arrears and CPR 60+ day delinquencies, by vintage, by month Source: ABSXchange, Merrill Lynch CPR rate, by vintage, by month Source: ABSXchange, Merrill Lynch

54. 13 January 2009 54 Dutch RMBS residential lending Dutch monthly gross lending and 12M rolling, EURmn Source: DNB Dutch resi loans outstanding and net monthly lending, EURmn Source: EMF, national central banks, national statistics offices, Eurostat, Merrill Lynch Real GDP growth (rhs) and house price growth, (%) Source: NVM, Datastream, Merrill Lynch

55. 13 January 2009 55 Dutch RMBS issuance and spreads Funded Dutch RMBS issuance (EURmn) Source: Merrill Lynch Dutch RMBS indicative secondary spreads (bp) Source: Merrill Lynch

56. 13 January 2009 56 Dutch RMBS arrears and foreclosures Dutch monthly foreclosures and 12M rolling (RHS) Source: Kadaster Dutch RMBS 90+ arrears by vintage (Quarters since closing) Source: Merrill Lynch, ABSXchange

57. 13 January 2009 57 Dutch RMBS arrears and CPR Dutch non-NHG RMBS 90+ arrears by series (Quarters since closing) Source: Merrill Lynch, ABSXchange Dutch RMBS CPR by vintage, (Quarters since closing) Source: Merrill Lynch, ABSXchange

58. 13 January 2009 58 German residential lending and house prices Total outstanding residential loans (€bn) Source: Deutsche Bundesbank, Merrill Lynch Real and nominal house price YoY growth (%) Source: OECD

59. 13 January 2009 59 German RMBS issuance and spreads Secondary spreads until Nov 08 (bp) Source: Merrill Lynch German funded issuance EURmn200620072008 Cash1,20657027,749 Synthetic53104,732 Total1,73757032,481 Source: Merrill Lynch

60. 13 January 2009 60 German insolvencies and foreclosures 3-month rolling average of individual insolvencies (by month) Source: FSO, Merrill Lynch Number (000s) and value (€bn) of foreclosure auctions Source: Argetra GmbH, Merrill Lynch

61. 13 January 2009 61 German RMBS prepayments German CPR rates by source, by date Source: ABSXchange, Fitch, Moody’s, Merrill Lynch German CPR rates by vintage, quarter since launch Source: Fitch, Moody’s, Merrill Lynch

62. 13 January 2009 62 German RMBS credit events and losses Credit events (% of outstanding balance), quarter since launch Source: S&P, Merrill Lynch Cumulative losses (% of original balance), quarter since launch Source: ABSXchange, Merrill Lynch

63. 13 January 2009 63 Italian macro outlook Italian nominal and real house price YoY growth, 1984-Q12008 Source: OECD, Merrill Lynch ML Global macroeconomic forecasts (in %) 2007 2008F2009F20010F Italy GDP1.4-0.40.8 CPI2.03.61.61.7 Unemployment6.27.08.18.5 Euro area GDP2.61-0.61.1 CPI2.13.41.31.8 Unemployment7.47.58.69.0 Source: Merrill Lynch

64. 13 January 2009 64 Italian RMBS issuance and spreads Italian RMBS indicative secondary spreads Source: Merrill Lynch Italian funded issuance, EURmn 20062007 2008 (Nov) Total16,81921,05953,589 Source: Merrill Lynch

65. 13 January 2009 65 Italian RMBS arrears Italian 90+-day delinquencies by vintage Source: ABSXchange, Merrill Lynch Italian RMBS 90+-day arrears, quarters since closing Source: ABSXchange, Merrill Lynch

66. 13 January 2009 66 Italian RMBS arrears by series Italian RMBS 90+-arrears as of 3Q08, by vintage and series Series200220032004200520062007 Apulia 0.0140.017 Argo 2 2.1%* Asti Finance 1 1.20% Berica 10.50% 3.90% Bipielle 1 2.00% BP Mortgage 2 0.9%* BP Mortgage 3 1.5%* Capital mortgages 1 1.50% Cordusio 0.30%0.90%0.50% FE Mortgages 1.7%* 3.4%* Giotto 2 2.70% Intesa 0.50% 0.60% Marche Mutui 0.8%* 0.70% Media Finance 1.20% Orio 30.60% Sestante 3.20%3.30%3.10%3.2%* Siena3.50% 2.80% Vela ABS 2.00% Vela Home 0.0060.0150.0272.20% Source: ABSXchange, Merrill Lynch

67. 13 January 2009 67 Italian RMBS defautls and CPR Cumulative defaults by vintage (% of original balance), quarters since closing Source: ABSXchange, Merrill Lynch Italian CPR by vintage Source: ABSXchange, Merrill Lynch

68. 13 January 2009 European CMBS & property derivatives – stressed or distressed?

69. 13 January 2009 69 Property Derivatives Trading resilient Despite credit crisis, trading in property derivatives remains resilient A focus on risk management and liquidity has seen volumes increase, running 10% above 2007 levels Derivatives also provide transparency in an illiquid property market – about where prices are expected to go, or perhaps have already reached European IPD Commercial Property derivative trading volumes Source: IPD

70. 13 January 2009 70 Property Derivatives UK Commercial UK commercial real estate is down 30% from peak according to valuers Property derivatives imply a further 39% decline – 57% peak to trough Yields expected to peak at 10.5% UK commercial property downturns compared Source: IPD, ML UK Peak to trough decline - implied and realised

71. 13 January 2009 71 Property Derivatives European Commercial Germany derivatives imply a further 18% decline between 2008 and 2011 for commercial real estate – with yields moving 130bp wider to 7.3% French office a larger decline of 31% from the peak at the end of 2007 is implied, with gross initial yields expected to move from 5.5% to 8.0% German All Property capital values - historic & implied Source: IPD, ML French Office capital values - historic & implied

72. 13 January 2009 72 Property Derivatives House Prices UK house prices down 19% from peak. Further 35% decline implied for a peak to trough decline of 47% French house prices expected to decline 10% over next 5 years UK house prices in 1990 downturn and implied Source: HBOS, ML Implied decline in UK house prices from peak to trough

73. 13 January 2009 73 Property Derivatives 2009 Developments Property derivatives to be used more strategically Shorted dated investment strategy has outperformed by a large margin Interest growing in structured products Portfolio management in direct portfolios and alpha generation Managing liquidity, particularly for open-ended funds CMBS hedging or arbitrage becoming easier Increasing links between valuations and transactions Forward index prices represent current sale prices Valuers increasing aware of property derivative prices Increasing links between REITs and property derivatives Listing of property derivatives on Eurex to go live in Q1

74. 13 January 2009 74 CMBS in distress What Drives European Credit Spreads - 2009 Servicer to behave like a trustee in not exercising discretion, this will slow the recovery or workout process significantly. Vacant possession value falls of 80%+ are likely to be repeated for some secondary assets. Secondary spreads could gap out further if forced asset sales become the norm and banks offload CRE loans into ‘bad’ bank structures

75. 13 January 2009 75 Who is the marginal buyer for CRE? What Drives European Credit Spreads - 2009 REIT buyer...high single digit yields for prime assets, lower leverage does not affect post tax returns, rights issues/partial asset sales Sovereign wealth funds…still provide a source of capital for super prime assets but are not going to be as dominant given declining oil prices Private equity buyer and hedge fund buyer aiming for returns of 20%+…CMBS potentially provides their route…falling libor/euribor with constant absolute return expectations from this buyer base points to declining CMBS prices Corporate buyer…reversing the trend of sale and leasebacks, the corporate buyer could provide a bid for some of the secondary property in CMBS but they are likely to look for a short payback period

76. 13 January 2009 76 Special Servicer is going to minimise litigation risk Enforcement is going to be difficult due to the need to get noteholders to indemnify the servicer. Maximising recovery is likely to result from working loans out rather than enforcement on non trophy or prime assets. Without indemnification the servicer will minimise litigation by trying to behave as a prudent lender. This could be done by following the action that bank lenders and other servicers are taking. At the moment the newsflow points to prudent lenders opting to workout.

77. 13 January 2009 77 Performance: delinquencies are a lagged indicator Delinquencies are likely to follow the direction of corporate insolvencies Rating action is likely to accelerate in spite of some remarks by S&P in Sep 2008 that the AAA rating on CMBS is robust Source: National Statistics Office

78. 13 January 2009 78 Tighter underwriting standards for CRE loans; New CRE lending to be restricted to max LTV between 50 to 65% after allowing for 50% peak to trough declines; assets with significant reletting and operating risks to be stressed harshly and not valued into perpetuity Demand / supply balance continues to exist in CMBS combined with uncertain outlook points to limited issuance over the medium term (most retained) Source: Merrill LynchSource: Bank of England, Merrill Lynch

79. 13 January 2009 79 CMBS secondary only in 2009 Secondary market: at risk from (1) significant rise in supply of distressed CRE loans from bad bank structures; (2) enforcement on defaulting loans; & (3) further falls in Libor / Euribor Lehman’s insolvency took us to a new level: counterparty risk, protection bought became worthless, security agents ineffective etc Source: Merrill Lynch

80. 13 January 2009 80 European Office Supply Source: Jones Lang Lasalle

81. 13 January 2009 81 European Rental Growth Source: Jones Lang Lasalle

82. 13 January 2009 82 Business & Consumer Confidence Collapses Source: Datastream, Merrill Lynch Source: IFO Institute Source: European Commission Spanish Retail Sales Source: ISTAT

83. 13 January 2009 83 Corporate Securitisation Corporate Securitisation to continue to exist from utilities, project finance and social housing Listed equity is likely to think twice about doing whole business securitisations eg M&B and Punch The success of the secured structure is likely to come under scrutiny in 2009. More specifically the ability of the noteholders to appoint an administrative receiver. Leaky restricted payment conditions in the pub sector is also a cause for concern Source: Merrill Lynch

84. 13 January 2009 84 Pubs – an eventful year in prospect Globe to enter default, Punch proactive in managing its debt, beer volumes to continue falling, the role of the monolines, rating action on the back of leaky restricted payment conditions Source: Merrill Lynch, Offering Circulars

85. 13 January 2009 85 Infrastructure Deflation: most project finance deals have 100% index linked debt, water deals 50%, gas 25% and BAA 10%. With deflation principal due may actually fall. Water regulatory review likely to put pressure on Post Maintenance Interest Cover Ratios…overall though expect a pragmatic approach from the regulator BAA to continue to suffer from the large overhang of debt, hefty capital spend, retail risk and the forced sale process No change on THPA: poor outlook due to concentration of revenues in steel and oil, construction of post panamax facility, amortisation picks up in 2011 resulting in an RPC breach, car revenue to come under pressure. Carehomes are under pressure from local authority fees and contraction in private payer wealth. Over-levered carehome securitisations may prompt local authorities to prefer less levered competitors.

86. 13 January 2009 86 Corporate Securitisation Corporate Securitisation to continue to exist from utilities, project finance and social housing Listed equity is likely to think twice about doing whole business securitisations eg M&B and Punch The success of the secured structure is likely to come under scrutiny in 2009. More specifically the ability of the noteholders to appoint an administrative receiver. Leaky restricted payment conditions in the pub sector is also a cause for concern

87. 13 January 2009 87 Corporate Securitisation Corporate Securitisation to continue to exist from utilities, project finance and social housing Listed equity is likely to think twice about doing whole business securitisations eg M&B and Punch The success of the secured structure is likely to come under scrutiny in 2009. More specifically the ability of the noteholders to appoint an administrative receiver. Leaky restricted payment conditions in the pub sector is also a cause for concern

88. 13 January 2009 European CDOs

89. 13 January 2009 89 Global CDO trends Sharp reversal in issuance and spread trends Activity concentrated on the secondary side of the market What Drives European Credit Spreads - 2009 Source: Merrill Lynch, Creditflux CLO issuance stalls while spreads soarSynthetic issuance comes to a halt too

90. 13 January 2009 90 Global CDO trends (2) Credits trends deteriorating at a fast pace Source: Moody’s, S&P Negative IG corp rating actions as a % of total IG corp rating actions US loan default rate

91. 13 January 2009 91 Global CDO trends (3) Withdrawal of leverage continues unabated At the underlying, structure and investor level Supply and demand dynamics favour buyers CDO of ABS R.I.P Lessons learned Liquidity drives credit drives liquidity Diversification, structures, counterparty risk matter Source: Merrill Lynch CDO of ABS R.I.P

92. 13 January 2009 92 Migration rates take a nosedive Credit stability rates plunged in 2008 Aggregate statistics don’t tell the whole story … Weakness was mainly concentrated in US SF CDO and US CDO² … but the credit quality deterioration is becoming increasingly broad based Global CDO migration rates since inception (original-to-current ratings) December 2007November 2008 Default %*Downgrade %Default %*Downgrade % AAA 0.088.61.0225.9 AA 0.2311.81.7432.9 A 0.2912.42.5631.2 BBB 0.5213.93.2733.9 BB 1.3412.02.6124.0 B 3.5213.42.5648.3 Source: S&P, default rate is the rate of migration to D

93. 13 January 2009 93 Synthetic CDO of corporates – three-step deterioration process First, it was the mark to market … … then came the negative migration What Drives European Credit Spreads - 2009 Source: Merrill Lynch, assuming not tranche credit migration Illustrative corporate synthetics MtM path* – the decline accelerated in H2 2008

94. 13 January 2009 94 Synthetic CDO of corporates – three-step deterioration process (2) … followed by a unprecedented wave of underlying defaults Financial defaults, number of tranches impacted per region, and total concentration in the overall synthetic market FNMFRELEHWMGLBIRLANISLKAUP US 958866994803348350444 Europe 93690813641047405421514 Asia Pacific 9792119154949598 Japan 150138157155656991 Total58.48%54.74%71.95%58.97%24.91%25.54%31.33% Recovery*91.51%94.00%8.63%57.00%3.00%1.25%6.63% Source: S&P, Merrill Lynch estimates * recovery data for the GSEs and the Icelandic refers to the senior debt recovery rate

95. 13 January 2009 95 Synthetics on the brink As credit quality tumbles … … the capital implications of holding CSO paper become dearer and dearer What Drives European Credit Spreads - 2009 Reg capital gains (-) and losses (+) from credit rating migration - RBA* From / ToAAAAAABBBBB B and below AAA0.0%0.6%1.0%5.4%33.4%99.4% AA-0.6%0.0%0.4%4.8%32.8%98.8% A-1.0%-0.4%0.0%4.4%32.4%98.4% BBB-5.4%-4.8%-4.4%0.0%28.0%94.0% * assuming the AAA tranche is the most senior outstanding, which may not always be the case Source: S&P, Merrill Lynch

96. 13 January 2009 96 Tracks for 2009 – safety is the new cheap Volumes to stay depressed, driven by poor investor demand But also limited appetite from the arranging side Credits quality to deteriorate further The cycle of defaults and especially downgrades far from over The combination of adverse selection, thin cushions and poor diversification is likely to continue to weigh on performance, barring restructurings However, fundamental investment rationale for the product still holds We continue to favour - short ended, - highly cushioned, - senior tranches Reversing the 2005-07 rush for adverse selection theme is another area of opportunity What Drives European Credit Spreads - 2009 Source: Merrill Lynch Credit curves favour the short end

97. 13 January 2009 97 Leveraged loan CLO – all eyes on secondary trading Issuance in the doldrums Narrowing investor base Soaring cost of debt tranches Ample secondary supply, as paper moves out of leveraged hands Focus very much on secondary trading Where spreads soared to and beyond historical highs European CLO generic spreadsUS CLO generic spreads Source: Merrill Lynch

98. 13 January 2009 98 Leveraged loan CLO – reversal of credit trends orderly … so far US loan default rate up to 3.76% in Nov 2008 Up from 3.59% in October And a 350bp pickup year-on-year So far, remains roughly in line with long run averages European default rate still sub-2% Lagging, not decoupling, in our view Source: S&P US 12mth trailing loan default rate – increasing slowly but steadily

99. 13 January 2009 99 CLO – credit deterioration to pick up significantly in 2009 Defaults The combination of ever strengthening lending standards, very poor refinancing outlook, and collapsing economic data across the board will bring default rates above those of the previous cycle We expect double digit default rate in 2009 Recoveries Weak covenants, large institutional market share, and a proliferation of loan-only issuers likely to drive recoveries much lower Dispersion to be very pronounced, especially across loan sub types. Look for 2 nd lien / mezzanine to behave like sub debt upon default Repayments Near-zero repayments to persist for a while … … preventing reinvestments in newer vintage, stronger collateral

100. 13 January 2009 100 Tracks for 2009 – value amid the landmines Compelling value at the top of the capital structure We like AAA/AA at current valuations AAA/AA principal impairment risk is remote and well compensated, in our view CLO breakeven default rates (50% recovery, 10% prepayment rate) RatingTranche spreadCADR to first $ of lossCADR to interest deferral*Timing of interest deferral* AAA2513%16%YR7 AA4010%12%YR10 A659%10%YR5 BBB1607% YR3 BB4506%5%YR2 Source: Merrill Lynch, Interest deferral on AAA/AA tranches usually triggers an event of default Junior debt outlook gloomy, default timing will be key As a result of rapidly deteriorating pool performance, we look for interest deferrals to kick in throughout the year for equity and junior debt tranches

101. 13 January 2009 101 Main risks: downgrades, recovery surprises, and structural headwinds AAA notes to stand the test of recovery rates CLO breakeven default rates under various loan recovery assumptions Structural headwinds the main risks to our core view Discounted obligations: limits and OC penalties CCC buckets rapidly ballooning In 2008, the sector experienced its first downgrades in nearly 4 years We look for downgrade activity to intensify First BBB/BB tranches, but increasingly the entire cap structure is at risk Source: Merrill Lynch

102. 13 January 2009 102 CCCs on the rise CCC risk for leveraged loan CLO is two fold First it the high cyclicality of CCC default rates indicates further defaults to come Second CCC concentrations have strong implications for OC tests beyond a pred- defined level (usually in the 5-7.5% range) OC weakness is a net short-term negative for junior debt and equity Longer-term, EoD risk affects the entire structure, with senior pay AAA the only tranche with any chance to recover some principal at current loan prices Steady rise of CCC concentrations Source: Moody’s, trustee reports

103. 13 January 2009 103 Year ahead: the road to reform This is not 2002-2003 CDO problems – and structured credit in general – are much more widespread than the HY CBO issues of 2002-03. We expect reforms will need to be much deeper, and the time to recovery much longer, before any sustainable comeback is possible Focus on portfolio composition Positive portfolio selection, as well as a greater focus on structures, technical factors and liquidity, should prevail. Differentiation eventually gets to take centre stage. Withdrawal of leverage – in its many forms Borrower leverage Structural leverage Investor leverage 2009 Outlook Demand: the quest for a renewed AAA investor base Supply: secondary to continue outweigh primary Credit: challenges to intensify Spreads: bottom not reached, but downside to most-senior tranches is reducing