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					U.S. CREDIT PERSPECTIVES




   Picking the Winners
                                                                                          Mark
                                                                                          Kiesel
   January 2010

                           What will be the investment winners in 2010? A number
                           of corporate bonds are likely to be winners: They should
                           outperform Treasuries in 2010 due to improving credit
                           fundamentals and strongly supportive credit market
                           technicals, in which demand should exceed supply, causing
                           credit spreads for many higher-quality corporate bonds to
   tighten versus Treasuries. Within the credit market, select banking and financial
   sector bonds stand out as potential winners due to an improved outlook for asset
   quality and profits; healthier balance sheets; continued government, policy and
   regulatory support and attractive relative valuations.

   The search for yield, which we claimed would lead to strong relative performance
   in the credit market in 2009 (see the December 2008 U.S. Credit Perspectives:
   “Credit Now, Equities Later”), will likely continue to influence investment returns
   in 2010. While investments in the credit market have performed well in the past
   year, corporate bonds, particularly those in certain banks and financials, remain
   attractive relative to other fixed income sectors such as mortgages and Treasuries.

   The corporate sector has demonstrated remarkable discipline, cutting costs and
   spending to increase free cash flow while strengthening balance sheets by terming
   out near-term debt maturities with longer-maturity new bond issues and by
   raising new equity capital. Credit fundamentals should improve as the economy
   gradually recovers, and market technicals appear highly supportive for corporate
   bonds, particularly relative to Treasuries.


   Credit Fundamentals Improving
   Corporate credit fundamentals have improved with the return of private capital
   and management’s desire for less aggressive business and financial profiles. Rising
   cash balances, stronger balance sheets, an improving economy and easier credit
   conditions are all helping to support corporations.

   One reason corporate fundamentals and balance sheets are improving is the
   return of animal spirits and private sector risk capital in both the equity and debt
U.S. CREDIT PERSPECTIVES




    markets. Low short-term interest rates combined                                                                                                      Corporate executives’ confidence has increased
    with a gradual economic recovery have caused                                                                                                         with the improvements in balance sheets, credit
    investors to venture farther out the risk spectrum                                                                                                   availability and credit fundamentals, along with
    over the past year. According to a December report                                                                                                   the gradual strengthening of the global economy.

    from JPMorgan, U.S. companies in 2009 were able                                                                                                      Nevertheless, management remains conservative

    to raise $529 billion of new equity: a 42% increase                                                                                                  on the outlook for sustainable economic growth,

    over 2008’s total of $372 billion.                                                                                                                   as government and monetary stimulus may
                                                                                                                                                         fade throughout 2010. The longer-term economic
    In addition to raising equity capital, investment                                                                                                    outlook remains unclear, causing management to
    grade and high yield companies raised $1.18 trillion                                                                                                 remain highly cautious about hiring and capital
    through the new issue corporate bond market                                                                                                          spending. This explains why companies are
    in 2009, according to CreditSights. Amazingly,                                                                                                       hoarding cash: According to JPMorgan, non-
    issuance increased significantly across all rating                                                                                                   financial corporations, which from 2004–2008
    categories from AAA-rated to CCC-rated credits,                                                                                                      held roughly $500 billion of cash on their balance
    allowing both high-quality and low-quality                                                                                                           sheets, increased their total cash holdings to

    companies to refinance near-term debt maturities                                                                                                     $708 billion by the end of the third quarter of 2009.

    with longer-maturity debt, push out the average                                                                                                      Although corporations remain conservatively
    maturity profile, reduce liquidity risk and                                                                                                          managed, corporate profits are increasing with the
    strengthen balance sheets.                                                                                                                           moderate economic recovery (Chart 2). And, because

    This improvement in corporate credit fundamentals                                                                                                                                            U.S. Corporate Pro ts Improving
                                                                                                                                                                               1600
    has materially improved the outlook for default                                                                                                                                                  Non-financial and Financial Corporate Profits
                                                                                                                                                                               1400

    risk, particularly in the high yield market, and                                                                                                                           1200                  Non-financial
                                                                                                                                                         Billions of Dollars




                                                                                                                                                                               1000                  Financial
    increased balance sheet strength and financial                                                                                                                             800
                                                                                                                                                                               600
    flexibility for corporations. As a result, Standard &
                                                                                                                                                                               400
    Poor’s is now upgrading more companies than it is                                                                                                                          200
                                                                                                                                                                                 0
    downgrading (Chart 1).
                                                                                                                                                                                                                 1Q 03


                                                                                                                                                                                                                          1Q 04
                                                                                                                                                                                                        1Q 02




                                                                                                                                                                                                                                  1Q 05


                                                                                                                                                                                                                                          1Q 06




                                                                                                                                                                                                                                                          1Q 08


                                                                                                                                                                                                                                                                  1Q 09
                                                                                                                                                                                     1Q 00




                                                                                                                                                                                                                                                  1Q 07
                                                                                                                                                                                             1Q 01




                                                             Credit Fundamentals Continue to Improve                                                                                   Source: Bureau of Economic Analysis
   (Investment Grade and High Yield Corporate Bonds)




                                                       1.4
                                                                                                                                                                                                                         Chart 2
                                                                                S&P Upgrade to Downgrade Ratio
                                                       1.2
           Ratio of Upgrades to Downgrades




                                                       1.0                                                                                               hiring and capital spending are restrained, U.S.
                                                       0.8
                                                                                                                                                         corporate free cash flow is improving significantly.
                                                       0.6

                                                       0.4                                                                                               As a result of cost cutting and aggressive expense
                                                       0.2
                                                                                                                                                         control, non-financial corporations are now
                                                       0.0
                                                                                                                                                         generating free cash flow equal to 29% of EBITDA
                                                             Q1 99

                                                                     Q1 00




                                                                                     Q1 02

                                                                                             Q1 03

                                                                                                     Q1 04

                                                                                                             Q1 05

                                                                                                                     Q1 06

                                                                                                                             Q1 07

                                                                                                                                     Q1 08

                                                                                                                                             Q1 09
                                                                             Q1 01




                                                             Source: Standard and Poor’s
                                                                                                                                                         (earnings before interest, taxes, depreciation and
                                                                                             Chart 1                                                     amortization), the highest level in a decade


                                                                                                                                                     2
according to a December report from Goldman                                                                                                                                            cash on corporate balance sheets may be directed
Sachs. In addition, corporate profits should                                                                                                                                           toward more shareholder-friendly initiatives such
continue to improve as credit conditions ease                                                                                                                                          as increased dividends or share buybacks. Mergers
(Chart 3). A December global survey by McKinsey                                                                                                                                        and acquisitions (M&A) will likely rise in 2010,
                                                                                                                                                                                       and bondholders will need to be on the lookout
                                                    Corporate Pro ts Should Improve
                                                                                                                                                                                       for management teams who appear likely to make
                                                       as Credit Conditions Ease
Non-financial Profits, Year-Over-Year % Change




                                                 60%
                                                                                    Pro ts vs. Lending
                                                                                                                                     -50%                                              changes to benefit shareholders.
                                                 50%




                                                                                                                                            % of Banks Tightening Commercial
                                                                                                                                     -25%




                                                                                                                                             and Industrial Loans (Inverted)
                                                 40%
                                                 30%                                                                                  0%                                               Corporate Bond Market Technicals
                                                 20%
                                                 10%
                                                                                                                                     25%                                               Supportive
                                                  0%                                                                                 50%
                                                 -10%                                                                                                                                  Both financial and non-financial debt growth is
                                                                                                                                     75%
                                                 -20%       Non-financial Profits
                                                            Banks’ Willingness to Lend                                                                                                 now declining on a year-over-year basis, while the
                                                 -30%                                                                                100%
                                                    1Q 90

                                                            1Q 92

                                                                    1Q 94

                                                                            1Q 96

                                                                                    1Q 98

                                                                                             1Q 00

                                                                                                     1Q 02

                                                                                                             1Q 04

                                                                                                                     1Q 06

                                                                                                                             1Q 08




                                                                                                                                                                                       federal government’s debt growth is rising by 30%
                                                        Source: Bureau of Economic Analysis and Federal Reserve                                                                        year-over-year (Chart 4). Non-financial corporates
                                                                                            Chart 3
                                                                                                                                                                                                                     Corporate Sector Delevers While
suggests that increased availability of credit is                                                                                                                                                                   the Federal Government Re-levers
                                                                                                                                                                                                             40%                                                                                                         40%
                                                                                                                                                                                                                           Non-financial, Financial and Federal Government Debt
leading to a more bullish outlook and greater                                                                                                                                                                35%                                                                                                         35%
                                                                                                                                                                                                             30%                                                                                                         30%
                                                                                                                                                                                   Year-Over-Year % Change




                                                                                                                                                                                                                                                                                                                                Year-Over-Year % Change
                                                                                                                                                                                                                                        Non-financial Corporate
confidence in companies’ strategic planning and                                                                                                                                                                                         Financial Corporate
                                                                                                                                                                                                             25%                                                                                                         25%
                                                                                                                                                                                                                                        Federal Government
budgeting processes. If so, increased hiring and                                                                                                                                                             20%                                                                                                         20%
                                                                                                                                                                                                             15%                                                                                                         15%
spending may be on the horizon, which could                                                                                                                                                                  10%                                                                                                         10%
                                                                                                                                                                                                              5%                                                                                                          5%
help improve the outlook for a sustainable
                                                                                                                                                                                                              0%                                                                                                          0%
economic recovery and a continued improve-                                                                                                                                                                   -5%                                                                                                         -5%
                                                                                                                                                                                                             -10%                                                                                                        -10%
ment in credit fundamentals.
                                                                                                                                                                                                                        1Q 87

                                                                                                                                                                                                                                1Q 89

                                                                                                                                                                                                                                         1Q 91




                                                                                                                                                                                                                                                                         1Q 99

                                                                                                                                                                                                                                                                                 1Q 01

                                                                                                                                                                                                                                                                                         1Q 03

                                                                                                                                                                                                                                                                                                 1Q 05
                                                                                                                                                                                                                1Q 85




                                                                                                                                                                                                                                                         1Q 95




                                                                                                                                                                                                                                                                                                                 1Q 09
                                                                                                                                                                                                                                                 1Q 93




                                                                                                                                                                                                                                                                                                         1Q 07
                                                                                                                                                                                                                                                                 1Q 97




The outlook for positive credit fundamentals is not                                                                                                                                                             Source: Federal Reserve

                                                                                                                                                                                                                                                           Chart 4
without risks. The economy is highly dependant on
monetary and fiscal stimulus, as both consumers                                                                                                                                        need less capital because cash on their balance
and businesses are continuing to delever. Private                                                                                                                                      sheets is rising: According to JPMorgan, their cash
sector final demand needs to strengthen before                                                                                                                                         levels increased by $113 billion in the third
a sustainable recovery can establish itself. While                                                                                                                                     quarter of 2009, as cash flow significantly exceeded
near-term inflationary pressure appears under                                                                                                                                          capital spending. As the corporate sector delevers
control, the Federal Reserve may have to tighten                                                                                                                                       while the federal government re-levers, bond
monetary policy should inflationary expectations                                                                                                                                       market technicals should increasingly turn
rise. Aggressive Fed tightening would slow                                                                                                                                             positive for corporate bonds and negative for
economic growth and be a negative for risk assets,                                                                                                                                     Treasuries. This will probably be the single largest
including investment grade corporate bonds, high                                                                                                                                       factor in credit spreads tightening this year for a lot
yield bonds and equities. Finally, the surge in                                                                                                                                        of companies.


                                                                                                                                                                               3
U.S. CREDIT PERSPECTIVES




   Who’s buying Treasuries? Despite rising issuance,                                                                          Finally, corporate America’s rising cash balances
   almost half of the increase in Treasury supply                                                                             and diminished leverage should support credit
   of $1.89 trillion over the past 12 months, or                                                                              technicals due to lower corporate issuance needs,
   $889 billion, was purchased by non-U.S. investors.                                                                         helping to tighten credit spreads versus Treasuries
   Will foreign investment continue to support                                                                                for the stronger companies this year.
   the Treasury market to the same degree in
   2010 in the face of rising issuance? The answer                                                                            Bank Bonds Likely to Be
   remains unclear, particularly given the low                                                                                Winners in 2010
   level of Treasury yields and upcoming surge in                                                                             Within the credit market, the banking sector stands
   government borrowing.                                                                                                      out as a likely winner. Banks should see a gradual
                                                                                                                              slowing in the growth of problem loans as well
   Net fixed-rate Treasury issuance this year should
                                                                                                                              as improving balance sheet strength and profit
   approach 10% of nominal GDP. By comparison,
                                                                                                                              growth. Banks are delevering their balance sheets,
   net non-financial corporate bond issuance will                                                                             raising more loss-absorbing equity capital and
   likely be less than 1% of nominal GDP (Chart 5).                                                                           facing increasing regulatory oversight. In addition,
   The amount of Treasury issuance is rising sharply                                                                          bank and financial companies should benefit
   as the government levers up its balance sheet,                                                                             from reduced issuance needs in the bond market,
   while the amount of non-financial corporate                                                                                providing for supportive market technicals. All
   debt issuance is falling as companies delever.                                                                             these factors should support bondholders and lead
   The Treasury is also set to lengthen the maturity                                                                          to strong relative performance.
   profile of its debt. Rising deficits are causing
                                                                                                                              Banks’ asset quality, while still deteriorating, is
   heightened concern over the sovereign credit
                                                                                                                              benefiting from government efforts to support
   risk of the U.S. government. These trends should
                                                                                                                              housing. While commercial real estate likely has
   support corporate bonds relative to Treasuries in
                                                                                                                              more downside risk, there is increasing evidence
   2010, particularly given that the Federal Reserve
                                                                                                                              that lower-priced housing is starting to stabilize
   is set to end its quantitative-easing Treasury
                                                                                                                              due to low mortgage rates, government efforts to
   and mortgage purchase program in March 2010.
                                                                                                                              increase credit availability to homebuyers and
                                                               Technicals Favor Corporate                                     improved affordability. As residential real estate
                                                                 Bonds Over Treasuries                                        prices stabilize and other asset price declines
   Net Fixed-Rate Issuance % Nominal GDP




                                           12%
                                                                     Treasury vs. Corporate Supply
                                           10%                                                                                moderate, the pace of write-downs on banks’
                                           8%               Treasury/GDP
                                           6%               Corporate/GDP
                                                                                                                              balance sheets should slow. This will likely
                                           4%                                                                                 improve bank asset quality and earnings and
                                           2%
                                                                                                                              lessen the need for banks to raise more capital.
                                           0%

                                           -2%

                                           -4%
                                                                                                                              Banks’ balance sheet strength and equity
                                                 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10F
                                                                                                                              capitalization have improved significantly over
                                                 Source: Barclays and PIMCO
                                                 Net fixed-rate issuance is gross fixed-rate issuance minus maturities.
                                                 Corporate net issuance is non-financials.
                                                                                                                              the past year. The Troubled Asset Relief Program
                                                                             Chart 5                                          (TARP) allowed banks to raise equity capital


                                                                                                                          4
when the capital markets were frozen in autumn                                                 likely to ensure banks maintain adequate levels
2008. However, starting in the fourth quarter of                                               of loss-absorbing equity capital. This is positive
2008, private investors gradually became more                                                  for bonds, which are at the top of the capital
comfortable taking both subordinated debt and                                                  structure, but less so for equity, which potentially
equity risk in banks and financial companies.                                                  could see further dilution if economic growth
JPMorgan, Goldman Sachs, Bank of America and                                                   and asset prices deteriorate, leading to loan
Wells Fargo have all been able to sell stock to the                                            losses and additional write-downs. However,
private sector to help raise money to pay back the                                             should the economy continue to improve, banks’
government. Just two weeks ago, Citigroup was                                                  profit growth could rebound more sharply than
able to raise $17 billion in common equity.                                                    expected. Finally, the steep yield curve is a positive

The return of private capital has been a significant                                           for economic growth and specifically for banks

positive for the sector. Today, over half of the                                               (Chart 7), as net interest margins tend to widen,

government’s $245 billion TARP capital has been                                                which helps boost banks’ profits.

repaid with private sector capital, and in the past
                                                                                                                                   A Steep Yield Curve Is Positive for Banks
15 months, the over $1 trillion raised across the                                                                                 500                                                                                                       500
                                                                                               10-Year Treasury - Fed Funds (%)




                                                                                                                                                                    Yield Curve vs. Bank Stocks




                                                                                                                                                                                                                                                  S&P 500 Commercial Bank Index
                                                                                                                                                                                                                                            450
                                                                                                                                  400
worldwide financial system has significantly                                                                                                                                                                                                400
                                                                                                                                  300                                                                                                       350
exceeded write downs or losses of $743 billion
                                                                                                         Yield Curve




                                                                                                                                  200                                                                                                       300
                                                                                                                                                                                                                                            250
(Chart 6), according to Bloomberg. As a result of                                                                                 100
                                                                                                                                                                                                                                            200
                                                                                                                                   0                                                                                                        150

                               The Financial Sector is Re-capitalizing                                                            -100
                                                                                                                                                                                                          Yield Curve
                                                                                                                                                                                                                                            100
                                                                                                                                                                                                                                            50
                      500                                                                                                                                                                                 Bank Stocks
                                    Worldwide Financial System Losses and Capital Raised                                          -200                                                                                                      0
                      450
                                                                                                                                         Jan-90

                                                                                                                                                  Jan-92




                                                                                                                                                                             Jan-98

                                                                                                                                                                                      Jan-00




                                                                                                                                                                                                                          Jan-08

                                                                                                                                                                                                                                   Dec-09
                                                                                                                                                                                                                 Jan-06
                                                                                                                                                           Jan-94




                                                                                                                                                                                               Jan-02
                                                                                                                                                                    Jan-96




                                                                                                                                                                                                        Jan-04
                      400           Losses
                      350           Capital Raised
Billions of Dollars




                                                                                                                                       Source: Bloomberg and S&P
                      300
                      250
                                                                                                                                                                               Chart 7
                      200
                      150                                                                      Bank bonds continue to offer attractive relative
                      100
                      50
                                                                                               value (Chart 8) within the overall corporate bond
                       0
                            3Q 07 4Q 07 1Q 08 2Q 08 3Q 08 4Q 08 1Q 09 2Q 09 3Q 09 4Q 09*
                                                                                               market. In addition to attractive valuations, bank
                            Source: Bloomberg
                            *Capital raised and losses announced quarter to date.              bonds benefit from considerably strengthened
                                                     Chart 6                                   balance sheets, the increase in loss-absorbing
recent equity issuance, several of the largest U.S.                                            common equity, and regulatory efforts to help
financial firms saw their Tier 1 common equity                                                 cushion balance sheets and protect bondholders
ratios recently climb above 7%, according to                                                   from potential asset quality deterioration.
PIMCO credit research.
                                                                                               Finally, and most importantly, governments and

Increased regulation in the banking industry                                                   policymakers remain committed to supporting key
will likely mean less leverage and lower returns                                               banks and financial companies, in order to enable
on equity. Policymakers and regulators are                                                     a sustainable economic recovery.


                                                                                           5
U.S. CREDIT PERSPECTIVES




                                                 Bank Bonds Continue to                                                                                             will likely result in banks that are less risky
                                               Offer Attractive Relative Value                                                                                      and less leveraged. These secular trends, while
                                     800                                                                                800




                                                                                                                              Option-Adjusted Spread (OAS)
                                                                                                                              vs. Treasuries, in Basis Points
   Option-Adjusted Spread (OAS)
   vs. Treasuries, in Basis Points




                                     700                            Corporate Spreads                                   700                                         likely negative for equity holders, are positive for
                                     600                                                                                600
                                     500                                                                                500
                                                                                                                                                                    bondholders. In fact, both senior and subordinated
                                     400                   Banks
                                                           Corporates
                                                                                                                        400
                                                                                                                                                                    debt and even some Tier 1 bank capital could
                                     300                                                                                300
                                     200                                                                                200                                         benefit – such securities are unlikely to be useful
                                     100                                                                                100
                                      0                                                                                 0                                           for regulators wanting higher loss-absorbing
                                       Q1 00




                                                        Q1 02

                                                                Q1 03

                                                                        Q1 04

                                                                                Q1 05

                                                                                        Q1 06

                                                                                                Q1 07

                                                                                                        Q1 08

                                                                                                                Q1 09
                                                Q1 01




                                                                                                                                                                    capital. The larger equity cushion for bondholders
                                           Source: Barclays (Sub-sectors of the Barclays U.S. Credit Index)
                                                                                                                                                                    would likely help tighten credit spreads for bank
                                                                        Chart 8
                                                                                                                                                                    bonds. Given the current attractiveness of some
   Without a healthy financial sector, capital may not                                                                                                              Tier 1 bank capital credit spreads (Chart 9), a select
   recirculate into the private sector. Governments                                                                                                                 group of these securities could be relative winners
   and central banks will likely want to ensure the                                                                                                                 in 2010.
   banking industry is able to increase lending to the
   private sector, so government support programs                                                                                                                                                                     Tier 1 Bank Capital Remains Attractive




                                                                                                                                                                                                                                                                                                                BofA Merrill Lynch U.S. HY BB-B Index, Option-Adjusted
                                                                                                                                                                    JPMorgan Bank Capital Index, Option-Adjusted




                                                                                                                                                                                                                                                                                                                     Spread (OAS) vs. Treasuries (in Basis Points)
                                                                                                                                                                     Spread (OAS) vs. Treasuries (in Basis Points)




   should remain in place until banks heal. The                                                                                                                                                                      1800                                                                                1800
                                                                                                                                                                                                                                                    Bank Capital vs. High Yield
   Federal Reserve will likely keep monetary policy                                                                                                                                                                  1600                                                                                1600
                                                                                                                                                                                                                     1400                                                                                1400
   highly accommodative to allow banks to increase                                                                                                                                                                   1200                  T1 Index                                                      1200
                                                                                                                                                                                                                     1000                  U.S. HY BB-B index                                            1000
   profits and build equity capital.                                                                                                                                                                                 800                                                                                 800
                                                                                                                                                                                                                     600                                                                                 600

   Investing in banks is not without risks. A weak                                                                                                                                                                   400                                                                                 400
                                                                                                                                                                                                                     200                                                                                 200
   economy or double-dip recession would be highly                                                                                                                                                                     0                                                                                 0
                                                                                                                                                                                                                           Q1 01


                                                                                                                                                                                                                                   Q1 02


                                                                                                                                                                                                                                            Q1 03


                                                                                                                                                                                                                                                        Q1 04


                                                                                                                                                                                                                                                                 Q1 05


                                                                                                                                                                                                                                                                         Q1 06


                                                                                                                                                                                                                                                                                 Q1 07


                                                                                                                                                                                                                                                                                         Q1 08


                                                                                                                                                                                                                                                                                                 Q1 09
   negative for both residential and commercial real
                                                                                                                                                                                                                             Source: JPMorgan and BofA Merrill Lynch
   estate prices, and thus for banks’ asset quality.
                                                                                                                                                                                                                                                                Chart 9
   Higher short-term interest rates, which could
   result from the Federal Reserve increasing the fed                                                                                                               What do market technicals look like for the
   funds rate to tame inflationary expectations, would                                                                                                              financial sector in 2010? JPMorgan estimates gross
   negatively impact banks’ net interest margins and                                                                                                                issuance in the sector will decline 38% this year
   profitability. Regulatory and legislative actions
                                                                                                                                                                    versus 2009, down to $285 billion; net issuance, or
   could also be negative for bank investments at the
                                                                                                                                                                    gross issuance minus maturities, is estimated to
   bottom of the capital structure; re-regulation and
                                                                                                                                                                    decrease by $17 billion (Chart 10). Why do banks
   the eventual implementation of Basel III and new
                                                                                                                                                                    and financial companies need less money? These
   capital rules by 2012 may cause banks to raise more
                                                                                                                                                                    companies raised substantial equity over the past
   equity capital, lowering the potential returns for
                                                                                                                                                                    year, were able to access the Temporary Liquidity
   existing shareholders.
                                                                                                                                                                    Guarantee Program (TLGP) for funding, have now
   While potentially dilutive for bank shareholders,                                                                                                                delevered their balance sheets, remain cautious on
   re-regulation and increased capital requirements                                                                                                                 new loans and, if needed, can tap into their vast


                                                                                                                                                                6
                             Technicals for the Financial Sector                     policy combined with the likelihood for increased
                                Are Strongly Positive in 2010                        regulation requiring higher equity capital, bond-
                600
                                                   Financial Supply                  holders in a number of key bank and financial
                500
                             Gross                                                   companies should benefit as the economy recovers
                400          Net
                                                                                     and profit growth allows capital to build, causing
$ in Billions




                300

                200
                                                                                     banking and financial sector credit fundamentals

                100
                                                                                     to improve. Given supportive fundamentals and

                 0
                                                                                     a positive technical outlook, investors should
                -100                                                                 consider staying overweight select bank and
                       2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010F

                       Source: JPMorgan
                                                                                     financial bonds and underweight Treasuries in 2010.
                       Net issuance is gross issuance minus maturities.

                                                 Chart 10

deposit bases for cash. The net result is that the                                   Mark Kiesel
supply outlook for banks and financials should                                       Managing Director
be muted this year, providing a positive technical
backdrop for bondholders, particularly given the
likelihood for continued solid demand for high-
quality bonds with attractive relative valuations.


Picking the Winners
The corporate sector is delevering at the same
time the federal government continues to re-
lever. Credit fundamentals are improving
for the corporate sector at the same time
credit fundamentals are deteriorating for the
government. This should lead to tighter credit
spreads, particularly for firms with strong credit
fundamentals, as the beginning of 2010 sees a lack
of high-quality spread alternatives to compete with
corporate bonds.

A number of bank and financial companies
stand out as potential winners this year due to
attractive valuations and an improved outlook for
asset quality and profitability. The banking and
financial sector has been able to recapitalize and
delever its balance sheet by raising private equity
capital. Due to supportive monetary and fiscal


                                                                                 7
Past performance is not a guarantee or a reliable indicator of future performance. Investing in the bond market is subject to certain
risks including market, interest-rate, issuer, credit, and inflation risk. Equities may decline in value due to both real and perceived general market,
economic, and industry conditions. Certain U.S. Government securities are backed by the full faith of the government, obligations of U.S.
Government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government;
portfolios that invest in such securities are not guaranteed and will fluctuate in value. Mortgage and asset-backed securities may be sensitive to
changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor
there is no assurance that the guarantor will meet its obligations. High-yield, lower-rated, securities involve greater risk than higher-rated securities;
portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Derivatives may involve certain
costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous.
Investing in derivatives could lose more than the amount invested.
This material contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice.
This material has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon
proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment
product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be
reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC,
840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2009, PIMCO.




840 Newport Center Drive
Newport Beach, CA 92660
949.720.6000



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