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US S Sovereign R ti D i Rating Downgrade d

Capital Markets Implications

August 7, 2011
Strictly Private and Confidential

Situation Overview
On August 5th, S&P lowered the US long-term sovereign credit rating from AAA to AA+ due to the US debt burden and uncertainty that long-term deficit reduction is achievable in the current political environment.
S&P's action lowered the US long-term credit rating to AA+ with negative outlook The US short term sovereign rating of A-1+ was affirmed S&P removed the CreditWatch negative designation from the US sovereign rating based on its view that the August 2nd Budget Control Act Amendment of 2011 ( h D b C ili A A d f (the Debt Ceiling Amendment) eliminated the risk of near-term d f l d ) li i d h i k f default S&P based its downgrade on its view of the trajectory of the US public debt burden over the next decade and its view of greater policymaking uncertainty in addressing US fiscal challenges S&P noted that the fiscal consolidation plan announced August 2nd falls short of the amount necessary to stabilize the government debt burden Prior commentary by S&P had telegraphed a probable downgrade if the Debt Ceiling Amendment generated less than $4 trillion in spending cuts (vs $2 4 trillion announced) (vs. $2.4 S&P commented specifically on the volatile and unpredictable legislative environment as a key driver of its downgrade, as detailed on the following page S&P suggested that policymaking risks to resolving the US debt burden outweighed the underlying US fundamentals, noting that the rating agency's view of the USs other economic, external, and monetary credit attributes, which are the basis of the sovereign rating, are unchanged S&P also noted the possibility for further downgrade of the US sovereign rating to AA within the next 2 years if: Spending reductions turn out to be lower than levels announced in the August 2nd agreement; Interest rates rise, increasing the cost of servicing the national debt; or New fiscal pressures" result in higher government debt Moody s Moodys and Fitch affirmed their Aaa / AAA US sovereign ratings on August 2nd following announcement of the Debt Ceiling Amendment although Amendment, Moodys maintains a negative outlook S&P generated US public debt projections for the coming decade across three scenarios, with resulting debt-to-GDP ratios for each scenario, which are detailed in the Appendix

Highlights of S&P and Joint Regulatory Releases from August 5

Key Highlights from S&P Release
On Aug. 5, 2011, Standard & Poor's Ratings Services lowered its long-term sovereign credit rating on the United States of America to 'AA+' from 'AAA. The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. believed The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures It appears that for now, new revenues have dropped down on the menu of policy options. the plan envisions only minor policy changes on Medicare and little change in other entitlements, entitlements the containment of which we and most other independent observers regard as key to long-term fiscal sustainability. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade. Our i i i th t l t d ffi i l O opinion is that elected officials remain wary of t kli the structural i i f tackling th t t l issues required t effectively i d to ff ti l address the rising US public debt burden in a manner consistent with a 'AAA' rating and with 'AAA' rated sovereign peers. our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place.

Joint Release from the Fed, Fed FDIC, NCUA and OCC
US government issued a joint release on Friday addressing the action by S&P to help alleviate market concerns and provide g guidance to banking organizations g g The risk weights for Treasury and other securities issued / guaranteed by the US or government-sponsored entities will not change The t t Th treatment of Treasury and other t fT d th securities issued / guaranteed by the US or government-sponsored entities under other federal banking agency regulations will also be unaffected

On Monday, August 8th, S&P will issue separate releases concerning affected ratings in the funds, government-related entities, financial institutions, insurance, public finance, and structured finance sectors.

Treasury Market Outlook

Expectations are for a modest sell-off in Treasuries and a potential steepening of the curve early in the week of August 9th with increased volatility in interest rates The US downgrade was broadly anticipated, so the impact should be priced in already for the most part Citi expects an additional increase in yields of 10-20 bps, led by the longer bonds, as there will be some amount of forced selling the impact of this move will be a steepening of the curve Continued high volatility from ongoing European sovereign and bank concerns, and general risk asset weakness has lowered Treasury yields significantly in the last two weeks Potential for P t ti l f a greater sell-off around th T t ll ff d the Treasury auctions thi week if real money i ti this k l investors ( h generally account f h lf of the supply at auctions) back t (who ll t for half f th l t ti )b k away from the market, with estimates as high as a 60 bps sell-off Upcoming Treasury auctions (8/9 - 8/11): 3yr $32bn, 10yr $24bn, 30yr $16bn In the intermediate to long-term, a sell-off of 25-50 bps is expected over the next several years

Perception of US Treasuries as the highest quality instruments available among a set of less attractive alternatives has maintained low rates significantly below long term averages, although in the longer term this logic may come under pressure

Historical Benchmark Rates

Key benchmark rates are well below historical averages (by over 2.40% on average) and rates likely to stay below averages despite any potential sell-off
1yr Swap Rate 0.40% 3.04% 264 bps 3yr Swap Rate 0.81% 3.69% 288 bps

US Treasuries: 2-Week Curve

Treasuries across the curve have benefited from a flight to quality over the past 2 weeks as concerns of a global economic slowdown and the European debt crisis have overwhelmed any concerns about US fiscal health

9.00% 8.00% 7.00% 6.00% 5.00% 4.00%

Current 10 Year Average Difference

2yr UST 0.29% 2.89% 260 bps

5yr UST 1.25% 3.61% 236 bps

10yr UST 2.56% 4.27% 171 bps

1.45% 1.25% 1.20% 0.95%

4.25% 3.85% 3.75%

3.25% 0.70% 0.45% 0.20% 0.49% 0.29% 2.25% 7/22 7/24 7/26 7/28 7/30 2yr UST 3yr UST 8/1 8/3 8/5 7/22 7/24 7/26 7/28 7/30 10yr UST 8/1 8/3 8/5 2.75% 2.56%

3.00% 2.00% 1.00% 1 00% 0.00% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
2yr UST 2yr UST Average 1yr Swap Rate 3yr Swap Rate Average 5yr UST 5yr UST Average 3yr Swap Rate 10yr UST 10yr UST Average 1yr Swap Rate Average

5yr UST

30yr UST

July 22nd July 29th August 5th 2-Week Change

2yr UST 0.39% 0.36% 0.29% 10 bps

3yr UST 0.66% 0.54% 0.49% 17 bps

5yr UST 1.50% 1.36% 1.25% 25 bps

10yr UST 2.96% 2.80% 2.56% 40 bps

30yr UST 4.26% 4.12% 3.85% 41 bps

Treasury Market Outlook (Contd.)

Historical Downgrades
Previous 1-notch downgrades from AAA have caused little market reaction historically On April 18, S&P placed the US on negative outlook. Subsequently, rates sold off, but in the week following the announcement, the 10year yield change was minimal

Muted Impact on Yields of Prior Sovereign Downgrades

10s Country Japan Japan Ratings Change Aaa to Aa1 AAA to AA+ AAA to AA+ AAA to AA AAA to AA+ AAA to AA+ Aaa to Aa1 AAA to AA+ Aaa to Aa1 Date 1D 11/17/1998 02/22/2001 05/06/1998 05/06/1998 05/06/1998 01/19/2009 09/30/2010 03/30/2009 06/02/2009 2 bp 7 bp -1 bp -1 bp -1 bp 1 bp -7 bp 7 bp -7 bp 1W 15 bp -3 bp 3 2 bp 2 bp 3 bp 33 bp -9 bp -18 bp -11 bp 2 bp 1D 3 bp 4 bp 0 bp 0 bp 0 bp -4 bp -3 bp 11 bp 3 bp 2 bp 1W 11 bp 4 bp 7 bp 5 bp 6 bp -43 bp 9 bp 15 bp -11 bp 0 bp 2s/10s

Expected Investor Reactions

Recent feedback from investors is that a downgrade would not necessarily prompt selling of Treasuries, although in a downside scenario significant selling by one or more major market participants would likely prompt others to follow quickly The largest holders of US government debt, the foreign central banks, are unlikely to adjust their US Treasury holdings due to the liquidity and depth of the US Treasury market Insurance companies are unlikely to be forced to sell as the NAIC has recently deemphasized ratings for regulatory capital q requirements Asset managers retain significant flexibility The Federal Reserve has issued a guideline noting no change in risk weights for US banks

Belgium Italy Spain Spain Spain Ireland Ireland

Average 0 bp

Major Holders of US Treasuries

US Treasury Owner Households Corporations, Businesses, GSEs, ABS Issuers & Dealers State & Local Governments US Federal Reserve Banks, S&Ls, Credit Unions, Insurance Cos. Pension & Retirement Funds Mutual Funds, Closed end Funds, ETFs Money-Market Funds Non-US Private Investors Non-US Central Banks & Sovereign Wealth Funds Total $BN 959 271 506 1,340 578 826 359 338 1,287 3,158 9,621

USD Considerations
Potential for knee-jerk USD weakening on the Asia open, but Citi does not expect this to be maintained General move towards risk reduction could be USD positive

Foreign buyers could potentially shift their holdings away from USD through th US T th h the Treasury market, h k t however th current risk appetite the t i k tit and the status of the of the USD as the worlds reserve currency will likely mitigate selling pressure Less favorable capital flows could weigh on USD in the medium-term

Investment Grade Market Outlook

Citi expects that the US sovereign downgrade will primarily impact financial spreads and have a modest impact on corporate spreads.
Prior to S&Ps announcement of a downgrade of the US sovereign credit rating to AA+, the threat of potential action contributed to a movement into high-quality investment grade corporate paper Investor positioning on sectors that are dependent on the US government and the overall state of the economy, coupled with portfolio allocations that may need to shift in accordance to rating guidelines for holdings, may affect unsecured credit spreads Despite the negative headlines, we do not expect a decline in new issuance this week In fact, numerous high-quality corporates are considering accessing the market to take advantage of the current low interest rate environment Financial issuance could be impacted in the near-term due to widening spreads and reduced investor appetite

The municipal market had anticipated the downgrade. Citi expects that tax-exempt bonds from states that are more closely linked to the federal government (healthcare bonds, housing revenue bonds, federal highway grant anticipation bonds) will see the greatest impact. Revenue bonds that have standalone ratings and are not reliant on the US for support should be less affected

Citis Expectations
Financials Citi expects that financial spreads will experience gradual widening as a result of the downgrade FIG entities viewed as being supported will be impacted in the event of a downgrade, including select US insurance and bank issuers Potential investor rebalancing away from systemically-supported US financial institutions given their implicit linkage with the sovereign, particularly the money centers Main focus will be on US financial institutions that lie at the lower end of each rating band (AAand A-) as any downgrade could force rebalancing based on investment criteria A) The unlikely scenario of a downgrade on banks below the A-1 rating currently received would certainly impact access to money market funding. However, most US banks have diversified away from CP for funding post-credit crisis Corporates Citi expects that higher-quality corporate spreads will largely remain unaffected, while BBB rated credits might see modest spread widening Current expectation is that highly rated corporates in the US which do not benefit from government highly-rated US, support, will not see any modifications to current ratings The rating agencies have suggested that it is possible for corporate bonds to receive a higher rating than their sovereigns 5 Higher-rated credits could benefit from the downgrade as investors may look to switch out from higher-beta financial bonds into lower-beta corporate bonds
Spread (bps)

Relative Spread Performance

225 215 205 195 185 175 165 155 145 135 125 04/01 Corporate Index Financial Index






Source: Yield book

Equity Capital Markets Outlook

Elevated Volatility
1,400 S&P 500 Index 1,350 1,300 1,250 1,200 1,150 1 150 6/30 7/7 7/14 7/21 7/28 VIX Index 8/4
Q4 '10 Q1 '11 Q2 '11 Q3 '11 IPO Filed Backlog Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '10 Q1 '11 Q2 '11 Q3 '11

New Issue Pull Back

35% 30% 25% 20% 15% 10% Volatility (%)

$28 $25 Proceeds ($BN)

$56 $45 Proceeds ($BN) $45

Proceeds ($BN) $13


$15 $11

$5 $ $3



S&P 500 Index

Source: Factset as of 08/05/11.

Source: Dealogic. Includes U.S. domiciled offerings $25 mm.

Defensive Rotation
Market Indices Consumer Staples Telecom Utilities Information Technology Healthcare Consumer Discretionary Industrials Financials (2) Materials Energy
Source: Factset as of 08/05/11. (1) S&P 500 peak (04/29/11). (2) Includes Real Estate.

Last Week (2.5%) (2.9) (3.8) (6.2) (6.8) (8.1) (8.3) (9.2) (9.5) (10.0)

2011 YTD 1.9% (5.4) 1.5 (3.2) 0.8 (2.6) (8.9) (15.8) (10.3) 0.0

Peak To Date(1) (4.7%) (9.2) (3.8) (8.9) (9.8) (10.2) (18.0) (18.0) (15.5) (15.3)

Investor Selectivity
Median Follow-On File/Offer Performance ed a o o O e/O e e o a ce
Q4 '10 Fo ollow-On File to Offer Q1 '11 Q2 '11 Q3 '11




( 9%) (7.9%)

Source: Dealogic. Includes U.S. domiciled offerings $25 mm.

Advice To Issuers
Markets Last weeks pressure in expectation of rating downgrade European overhang; anticipate continued defensive rotation p g; p Issuance Observe markets and launch on stable footing; windows open and close rapidly Choose underwriters with global differentiated distribution capabilities IPOs Flexibility on size and price range - fine tune prior to launch Assess opportunity for pre-sounding including cornerstone/anchor investments Follow-Ons Minimize market exposure and launch smaller - increase through oversubscription Equity Linked Convertible market underpenetrated Sell equity at premium; replacement to widening fixed income rates Share re-purchase strategies (open market / ASR / levered)

Investors Re-Calibrating Growth

Real GDP (QoQ at Annual Rate)
3.7% 3.1% 2.6% 1.7% 2.3% 1.5%

Q1 '10
Source: Citi Research.

Q2 '10

Q3 '10

Q4 '10

Q1 '11

Q2 '11

Q3 '11

Leveraged Finance Market Outlook

Near Term Outlook
Market expectation is that the high yield market will remain open, at wider levels, post the downgrade announcement The forward calendar for August is already light, so the new issue market will not fully resume activity until after the Labor Day As the dust settles, high quality BB rated issuers should continue to have good access to the market Weaker, stressed names reliant on strong GDP growth and / or equity market performance will be more challenged, although the market should still be available at wider levels

The market will benefit from relatively modest supply of "must-go" issuance in the near term, a different dynamic from mid 2007 to early 2009, where pent up supply from committed LBO issuance, corporate short term maturities, and a greatly reduced bank loan market led to unfavorable supply / demand technicals y y Key takeaways for the near-term issue market 1. 2. 3. Market characterized by windows of opportunity as economic data and European debt crisis headlines drive fluctuations between risk on and risk off Negative bias around issuers with high vulnerability to either a US double dip recessionary scenario (particularly those in cyclical sectors with weaker balance sheets) or reductions in government spending (government contractors, companies subject to reimbursement risk) Positive bias for issuers in non-cyclical industries and large companies with international exposure (non-PIIG) who can take advantage of economic diversification and a potential weakening of the USD

Near to Medium Term Outlook

Over the near to medium term, retail fund flows and economic data will drive the new issue market Biggest risk to the high yield market is a retail overreaction to economic conditions and a pull back in retail demand Dealers are unlikely to provide much balance sheet to support prices should retail demand diminish, putting pressure on yields Some support to the market would be provided by high levels of cash on the sidelines, which would be expected to be put to work as investors who have been priced out of the market begin to participate at wider levels

The high yield market started to price in weakening economic data in July, and will remain very focused on economic releases as a driver of sentiment

Long Term Outlook

Over the long term (2012 and on) Citi is bullish on the state of the leveraged finance market Upcoming maturities remain manageable through 2014 / 2015, and minimal covenant issues and strong levels of liquidity will keep the default rate at historical lows Equity volatility and low benchmark rates will drive demand for high yield

One longer term concern is the performance of over-leveraged LBOs in a potentially low growth environment with a soft equity market High Yield Interest Rate Environment
Despite a recent reversal, the trend in the high yield market over the past 12 months has been progressively lower yields..

Weekly High Yield New Issuance ($ in millions)

LTM Improvement BB Index: 10% B Index: 4%
$16,000 $14,000 $12,000 $10,000

LTM Issuance: $324.1 bn 2011 YTD Secured Issuance: $52.6 bn 2011 YTD Issuance: $183.3 bn

Yield-to-Wo (%) orst

9% 8% 7% 6% 5% 5.891% 7.748% 7 748%

$8,000 $8 000 $6,000 $4,000 $2,000 $0



Oct Nov Jan Citi HY BB Index



Apr May Citi HY B Index














Week Ended

ABS Market Outlook

Market Outlook Post-US Downgrade
Expect continued relative strength for AAA ABS (excluding FFELP Student Loan ABS and other government-linked ABS) as short AAA paper should continue to enjoy a flight to quality bid No impact expected for AAA ABS ratings in all S&P scenarios as US sovereign rating projected to remain AA or better Impact of any Treasury sell-off will be reflected in benchmarks, however recent Treasury rally and relative stability in swap spreads has resulted in compelling ABS issuance environment over the past two weeks despite market volatility Recent rally in the short end of the curve creates sufficient cushion to absorb projected widening in most forecasts Yields in the short end are expected to see less pressure than longer end of Treasury curve even with US downgrade given current macro conditions downgrade, Citi derivatives team expects market technicals from unwind of existing positions to maintain swap spreads at / near current levels The past several weeks have seen numerous on-the-run transactions executed at issuer friendly yields, including a retail auto and a lease ABS deal led by Citi that priced on Thursday, August 4th Citi has led the last 4 benchmark fixed-rate new issues in the ABS market and investor participation, while being more risk adverse was still robust and broad based Tranches on last week transactions were 2-3x oversubscribed despite the weak rally in benchmarks 2 3x Continued investor demand should support the market's key asset classes, as tranches on last weeks transactions were generally 2-3x oversubscribed Expect any pressure on risk assets resulting from market uncertainty on US downgrade to impact off-the-run asset classes such as esoterics / whole business Bank sponsored ABS issuance may also be impacted if the US government downgrade results in S&P downgrades to bank ratings, given the high level of implied government support in the sector Rating agencies have stated that FFELP ABS ratings will move lock-step with ratings of the US which likely drives spreads wider, but government reinsurance should appeal to investors at the right price Investor dialogue will be critical for issuance involving FFELP ABS or other government linked transactions Ultimately, Citi believes that ABS will remain in high demand (perhaps being a boost to demand as it will be a AAA alternative to governments) following an adjustment period

The ABS market has been resilient in the face of broader market volatility resulting from European sovereign debt crisis and the recent US debt ceiling standoff

Pricing Benchmark Snapshot

ABS benchmark indices are expected to remain accommodative for issuers and below historical norms even if there is some widening
6.0% 5.0% 4.0%

2011 YTD All-In AAA Auto ABS Yields

Triple-A auto ABS yields averaged a little over 1% during 2011, with recent prints at approximately 0.9%
1.6% 1.4% 1.2%

Issuance Strategy Recommendations

Allow the market to digest the US downgrade news and stabilize before approaching with new business Even in a scenario where Treasury yields gap out, a more stable market tone will benefit spreads Lead with most on-the-run alternative if electing between asset classes




Harley Retail 2011-1: 0.92% Hyundai Lease 2011-A: 0.94%

3.0% 2.0% 1.0% 0.0%

1.0% 0.8% 0.6%

1mo 3mo 6mo 1 yr 1.5 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr Current 2 years ago 5 years ago

g p Although we expect the markets will be receptive to new issue almost immediately, pricing tension will be maximized in cleanest asset classes
Feb-11 Apr-11 May-11 Jul-11 All-in Auto AAA Yield Trendline


Maintain preparedness to issue in a volatile market where windows will open and close quickly

Appendix A di

S&Ps U.S. Public Debt Projections

S&P generated US public debt projections for the coming decade across three scenarios, with resulting debt-to-GDP ratios for each scenario as shown in the table below Macro assumptions were based on the US congressional baseline economic assumptions

Base Case Scenario S&Ps Assumptions S&P A ti $2.1 trillion f the $2 1 t illi of th spending di reductions are implemented 2001 and 2003 tax cuts, due to expire in 2012, remain in place GDP growth of 3%, CPI at 2%

Upside Scenario $2.1 trillion f the $2 1 t illi of th spending di reductions are implemented 2001 and 2003 tax cuts for high earners lapse from 2013 onwards GDP growth of 3%, CPI at 2%

Downside Scenario $1.2 trillion in $1 2 t illi i second round of d d f spending cuts does not occur as planned 2001 and 2003 tax cuts, due to expire in 2012, remain in place 50-75 bps rise in funding costs (i.e. 10-year bond yields) 2013 onwards GDP growth of 2.5%, CPI at 1.5%

Debt / GDP 2011 2015 2021 Rating Outcome 74% 79% 85%(1) AA+ with negative long-term outlook 74% 77% 78% AA+ with stable long-term outlook 74% 90% 101% AA long-term rating


On Friday the US Treasury posted on its blog (http://www.treasury.gov/connect/blog/Pages/Just-the-Facts-SPs-2-Trillion-Mistake.aspx) that the debt-to-GDP ratio in this scenario should be 79% rather than 85%, as S&P misread congressional baseline economic assumptions. This discrepancy apparently generated a $2 trillion difference in the calculated debt-to-GDP ratio

Different Concerns: Public vs Private Financial Institutions

Financial Institutions & Insurance
Fannie & Freddie, GSEs and Liquidity Guarantee Programs Supported entities would be negatively impacted U.S. banks held $1.77 trillion of securities issued or guaranteed g by the U.S. treasury as of 3/31/11 Creates risk of meaningful unrealized losses if prices decline would impact recovery in the banking sector Potential disruption of Repo market (U.S. Treasuries are a p primary source of collateral) y ) AAA rated insurance companies have strong levels of capital & liquidity and are not linked to government support Money Market Funds under $1.3 trillion exposure to government securities risk breaking the buck only under significant redemption activity (tail end risk) (tail-end

Banks, TIAA, USAA, and Independent Financial Institutions

No impact expected where p p ratings are based on standalone basis Sovereign rating downgrade could build negative pressure on higher rated b k t d banks

U.S. Non Financial Corporates

AAA corporations resilient to a 1-2 notch sovereign downgrade (ADP, ExxonMobil, Johnson & Johnson, and Microsoft) Rating resiliency based on: Revenues derived from non-government sources with significant international component Robust internal cash flow generation Funding not highly reliant on government or domestic banks

U.S. Public Finance

Munis & Local Governments

No automatic rating impact, but issuers would be capped at 1-2 notches above sovereign Impacted by the rating level of the credit enhancement provider (which could be downgraded)

Credit Enhanced Mortgage Backed Securities/Bonds

Federal Revenue Anticipation Funds

Debt not explicitly supported by a State could be impacted


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