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Debt Research Cross Product January 2, 2009 Cross-Product

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Situation Room
The Bailout Guide Research Analyst Contributors
Jeffrey Rosenberg
(646) 855 7927

Mike Cho
(646) 855 6302

Hans Mikkelsen
(646) 855 6468

Economists
Gary Bigg
(646) 855 1980

Peter Kretzmer
(646) 855 1046

Mickey Levy

(646) 855 1045

The Bailout Guide. We provide an updated version of our bailout guide summarizing the panoply of government intervention efforts to date in one single spot. The economic consequence of these combined actions, we estimate, is that they provide more than 70% government support of bank liabilities in addition to the $315 billion capital in the form of preferred stock. Jeffrey Rosenberg, Hans Mikkelsen, Mike Cho.......................................................................................... (Page 5) Equities and Credit Gain Over Last Two Weeks. On the first trading day of the new year, equities gained as the S&P 500 closed up 3.2% to 932. Credit was largely unchanged, with the CDX IG remaining at 198 and CDX HY up slightly at 80 . Week over week, the S&P 500 has rallied nearly 7% while CDX IG has tightened 5 bps and CDX HY is up 1 pt. Since Friday, December 19, the S&P 500 has climbed 5% while CDX IG has tightened 15 bps and CDX HY is up 3 pts. Mike Cho.......................................................................................................... (Page 3) Record Low Confidence, More Housing Declines but Hope for Spending? 2008 ended with the U.S. in severe recession. With labor market conditions dismal, Conference Board consumer confidence hit an all-time record low in December. The long fall in housing also continued late in the year, as sales plummeted and home price declines reaccelerated. However, five months of decline in inflation-adjusted consumer spending ended in November, a sign that the huge declines in energy costs are providing some consumer relief and the worst of the adjustment to large wealth declines may be past. But we do not expect a quick consumer-led recovery. Peter Kretzmer, Mickey Levy, Gary Bigg ............................................................................................................................ (Page 33) The factory recession continued to worsen in December, as the ISM manufacturing index recorded a 5th consecutive below-50 reading. The composite index fell to 32.4, while new orders fell at a record-setting pace. Export orders also continued to weaken at an accelerating pace last month as did input prices. Peter Kretzmer ........................................................................ (Page 34)

This report has been prepared by Banc of America Securities LLC (BAS), member FINRA and SIPC. BAS is a subsidiary of Bank of America Corporation. This report is intended for sophisticated institutional investors and equivalent professionals in the fixed income market only. Please see the analyst certification and important disclosures on page 37 of this report. BAS and its affiliates do and seek to do business with companies mentioned in their research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Should investors consider this report as a factor in making an investment decision, it must be considered as a single factor only. Any portion of this report that has been prepared by a desk strategist or an economist is NOT a product of the debt research department and is NOT covered by the research analyst certification provided on page 37. For additional information concerning the role of trading desk strategists and economists, please see the important conflicts disclosures beginning at page 36 of this report.

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Table of Contents
Research Overview The Situation .................................................................................................................................... 3 Equities and Credit Gain Over Last Two Weeks .................................................................................................................. 3 Credit Strategy ........................................................................................................................................................................ 4 The Bailout Guide ................................................................................................................................................................. 5 Congressional Interventions: EESA and HERA ................................................................................................................... 5 Emergency Economic Stabilization Act (EESA) of 2008................................................................................................. 5 Housing and Economic Recovery Act (HERA) of 2008................................................................................................... 5 Hope for Homeowners ...................................................................................................................................................... 6 Treasury Interventions .......................................................................................................................................................... 8 FDIC Deposit Insurance Limit Increase............................................................................................................................ 8 Temporary Liquidity Guarantee Program (TLGP)............................................................................................................ 9 Guaranteed Performance..................................................................................................................................................... 10 Guarantee Program for Money Market Funds................................................................................................................. 11 Troubled Asset Relief Program (TARP) ......................................................................................................................... 12 Treasury Programs Under TARP .................................................................................................................................... 13 The Heart of Financial Market UncertaintyInsolvency ............................................................................................... 13 The Expanding Safety TARP .......................................................................................................................................... 14 Toward a Final Version of TARP ................................................................................................................................... 15 Company Specific Bailouts ............................................................................................................................................. 17 The Citi Bailout............................................................................................................................................................... 17 The AIG Bailout.............................................................................................................................................................. 18 Auto Bailout .................................................................................................................................................................... 19 DIPping Into the TARP................................................................................................................................................... 19 GMAC Bailout ................................................................................................................................................................ 20 Three Steps to Complement Fannie/Freddie Conservatorship ........................................................................................ 21 What Is a Conservatorship?............................................................................................................................................. 21 Federal Reserve Interventions: Supporting Funding........................................................................................................... 22 Funding From the Fed ..................................................................................................................................................... 25 Asset Backed Commercial Paper Money Market Fund Liquidity Facility (AMLF)....................................................... 26 Commercial Paper Funding Facility (CPFF)................................................................................................................... 26 The CPFF in Short........................................................................................................................................................... 27 Money Market Investor Funding Facility (MMIFF) ....................................................................................................... 28 Term Asset-Backed Securities Loan Facility (TALF) .................................................................................................... 29 Clarification on TALF..................................................................................................................................................... 29 Leveraging the TARP...................................................................................................................................................... 30 GSE Direct Obligation & MBS Purchase Program......................................................................................................... 31 Fed Liquidity Facilities ................................................................................................................................................... 32 Economics .............................................................................................................................................................................. 33 Record Low Confidence, More Housing Declines but Hope for Spending? ...................................................................... 33 Manufacturing Recession Continued to Worsen in December ........................................................................................... 34

Recent Publications
Title
Electric Utilities & Power: Credit Ratings Card Telecommunications High Yield Weekly: Market Update BAS IG Consumer & Retail Earnings and Event Calendar For more information visit http://bofa.com/research/

Authors
Peter Quinn Ana Goshko, Jhanvi Lakhani, Raj Atri Todd Duvick, Thomas Truxillo

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Research Overview The Situation
Equities and Credit Gain Over Last Two Weeks

Mike Cho (646) 855 6302

On the first trading day of the new year, equities gained as the S&P 500 closed up 3.2% to 932. Credit was largely unchanged with the CDX IG remaining at 198 and CDX HY up slightly at 80 . Week over week, the S&P 500 has rallied nearly 7% while CDX IG has tightened 5 bps and CDX HY is up 1 pt. Since Friday, December 19, the S&P 500 has climbed 5% while CDX IG has tightened 15 bps and CDX HY is up 3 pts.
Figure 2. as Did Credit
CDX IG 217 CDX IG Index (bps) 213 209 205 201 197 193
19 -D e 22 c-0 -D 8 e 23 c-0 -D 8 e 24 c-0 -D 8 e 26 c-0 -D 8 e 29 c-0 -D 8 e 30 c-0 -D 8 e 31 c-0 -D 8 ec 2- -0 8 Ja n09

Figure 1. Equities Gained Over the Last Two Weeks


S&P 500 940 930 920 S&P 500 910 900 890 880 870 860
De c08 De c 23 -0 8 -D ec 24 -0 8 -D ec 26 -0 8 -D ec 29 -0 8 -D ec 30 -0 8 -D ec 31 -0 8 -D ec -0 8 2Ja n09

CDX HY 80.9 80.4 79.9 79.4 78.9 78.4 77.9 77.4 76.9 CDX HY Index (pts)

19 -

Source: Bloomberg.

22 -

Source: Banc of America Securities LLC.

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Credit Strategy
The Bailout Guide
Acronym Date Ann. Name AIG 10-Nov-08 AIG Bailout AMLF 19-Sep-08 Asset Backed Commercial Paper Money Market Fund Liquidity Facility Autos 19-Dec-08 Auto Bailout Citi 23-Nov-08 Citi Bailout CPFF 7-Oct-08 Commercial Paper Funding Facility EESA 3-Oct-08 Emergency Economic Stability Act Creates the Troubled Asset Relief Program (TARP). Congress 5 MMIF 21-Oct-08 FDIC Deposits 3-Oct-08 FDIC Deposit Insurance Limit Increase Increases account limit to $250,000 from $100,000. Treasury 8 PDCF 16-Mar-08

Description

Banks borrow from the Fed to Treasury purchases $40 bn in new pfd Purchase ABCP from money stock, with 10% coupon from AIG. market funds at amortized cost and zero risk-weighting. Treasury 18 Foreign Crncy Swaps 18-Sep-08 Foreign Currency Swaps Federal Reserve 26 FNM/FRE Conservatorship 7-Sep-08 FNM/FRE Conservatorship

Guarantees $306 bn in RMBS Congress provides & CMBS in exchange for $7 bn $13.4bn in short term The Fed buys 3-month commercial in pfd stock. Also buys $20 bn loans to GM and $4bn paper from Tier 1 issuers. in pfd stocks and receives to Chrysler. warrants. Congress 19 GSE Debt & MBS Purchase Program 25-Nov-08 GSE Debt & MBS Purchase Program Treasury 17 Guarantee Program for MMkt Funds 19-Sep-08 Federal Reserve 27 HERA 30-Jul-08

Source Page Acronym Date Ann. Name

Guarantee Program for Money Housing and Economic Recovery Act Market Funds Allows homeowners to refinance into FHA loans with principal writedown. Guarantees funds held in Federal Housing Finance Regulatory participating money market Reform Act establishes a new stronger funds on September 19 against regulator of the GSEs. Created the breaking the buck. Federal Housing Finance Agency (FHFA) Treasury 11 TSLF 11-Mar-08 Term Securities Lending Facility Congress 5 TARP 28-Sep-08 Troubled Asset Relief Program

Money Market Investor Primary Dealer Credit Funding Facility Facility

Description

Senior Preferred Stock Purchase Agreement, Unlimited currency swaps with foreign Government Sponsored central banks including the ECB. Enterprise Credit Facilit, GSE Mortgage Backed Securities Purchase Program. Federal Reserve 26 TLGP 14-Oct-08 Temporary Liquidity Guarantee Program Treasury 21

Fed buys Fannie, Freddie & Home Loan debentures and Agency MBS.

Fed buys CP, bank notes and CDs to 90 days maturity from money market funds.

Overnight loan facility that provides funding in exchange for a range of eligibile collateral.

Source Page Acronym Date Ann. Name

Federal Reserve 31

Federal Reserve 28

Federal Reserve 32

TALF TAF 25-Nov-08 12-Dec-07 Term Asset-Backed Securities Term Auction Facility Loan Facility

Description

FDIC guarantees newly issued Senior unsecured debt of banks, thrifts and Fed provides $200 billion in certain holding companies. Unlimited loans to lend against AAAFDIC Insurance coverage on nonrated ABS. interest bearing deposit accounts. Treasury 9 Treasury 29

TARP Capital Purchase Program to buy up to $250 billion pfd shares in Provides loans over a 1-month Overnight loan facility U.S. controlled banks and thrifts. Other term against eligible general that provides funding . planned programs including to collateral. purchase "Troubled Assets" from financial institutions. Federal Reserve 32 Federal Reserve 32 Treasury 12

Source Page

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The Bailout Guide 1


Jeffrey Rosenberg (646) 855 7927 Hans Mikkelsen (646) 855 6468 Mike Cho (646) 855 6302

We provide an updated version of our bailout guide summarizing the panoply of government intervention efforts to date in one single spot. The economic consequence of these combined actions, we estimate, is that they provide more than 70% government support of bank liabilities in addition to the $315 billion capital in the form of preferred stock.

Congressional Interventions: EESA and HERA


Emergency Economic Stabilization Act (EESA) of 2008
The EESA, which was signed into law by President Bush on October 3, 2008, established the Troubled Assets Relief Program (TARP) administered by the Treasury. Please see the TARP section under Treasury Interventions later in this bailout guide.

Housing and Economic Recovery Act (HERA) of 2008


The HERA was signed into law by the president on July 30, 2008, and contains three separate acts, including the establishment of the Federal Housing Finance Agency (FHFA) as a stronger regulator for the GSEs. These new regulatory powers were used to place Fannie Mae and Freddie Mac under conservatorship on September 7, 2008. Please see the section, Three Steps to Complement Fannie/Freddie Conservatorship under Treasury Interventions later in this bailout guide for details on the three programs initiated by the Fed to complement the FHFAs action on Fannie Mae and Freddie Mac. The other key part of the HERA is the HOPE for Homeowners program to refinance distressed mortgages with significant principal writedowns. We reprint below our summary of the HOPE for Homeowners program.
Figure 3. Key Aspects of the Housing and Recovery Act (HERA) of 2008
Housing and Economic Recovery Act (HERA) of 2008 Federal Housing Finance Regulatory Reform Act of 2008 - New stronger regulator for Fannie Mae, Freddie Mac and the Federal Home Loan Banks (FHFA) - Raising conforming loan limit in areas with high home prices by as much as 50% to as much as $625,000 HOPE for Homeowners Act of 2008 - Refinancing distressed loans into FHA insured mortgages with significant write downs Foreclosure Prevention Act of 2008 - Increasing FHA Loan limits - $3.92 billion to assist communities devastated by foreclosures
Source: U.S. Senate.

Updated version of our US Bailout Guide which we last published in the November 26, 2008 Credit Market Strategist.

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Hope for Homeowners 2

HOPE provides refinancing through the FHA with principal writedown

The Bush administration announced the launch of the HOPE for Homeowners program and provided detailed guidance on its usage. Recall, this was the centerpiece of what we previously called the Frank-Dodd bailout for homeowners that provided 3 refinancing options for homeowners through the FHA. As we previously commented , the ultimate language in this plan showed marked improvement with regard to protecting against moral hazard as the massive potential subsidy through principal reduction comes at the cost of sharing all future appreciation (as well as equity created) with the government. The guidance also helps to clarify how the implementation will attempt to overcome one of the key issues in a wider adoption: securing the subordinate lien holders approval. The bill initially called for a subordinated holder to receive 9 or 12% of claims after the sale of the home, but was revised on November 19 to an immediate payment after origination of the new loan. Relative to current marks of cents on the dollar, that may be enough to ease this restriction and open this avenue of refinancing to borrowers, though gaining the acceptance of the large writedowns required by first lien holders remains. The HOPE for Homeowners program, as described above, retains the distinction between the equity created as a result of the restructuring of the loan and any appreciation that may be achieved due to future increase in the price of the house above the appraisal value at the time of restructuring. While the percentage of equity that FHA takes from the homeowners decreases with the immediate payment to subordinate lienholders, the appreciation is split 50-50 regardless of the timing of sale. Importantly, refinancing prior to a sale does not relieve the homeowner from the obligation to share current and future appreciation with the FHA. For a detailed explanation of the profit-sharing mechanism, please see Figure 5 below. In addtion to revising payments to subordinate lienholders, the Department of Housing and Urban Development (HUD) made several other changes on November 19, 2008, including increasing the loan-to-value (LTV) and adjusting debt-to-income (DTI) ratios. These changes will reduce the program costs for consumers and lenders alike while also expanding eligibility by driving down the borrowers monthly mortgage payments according to HUD. Figure 6 summarizes the key changes.

Excerpted from the October 1, 2008 Situation Room. Notice that since that issue was published after midnight, it has an October 2 date. We also published a regular (and different) October 2, 2008 issue with that date. 3 Please see the September 21, 2008 Situation Room.

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Figure 4. Key Aspects of the HOPE for Homeowners Program


I. HOPE for Homeowners Act of 2008 (previously referred to as the "Frank-Dodd" bill)
How does it Work? In guarantees from FHA, up to $300 billion to refinance distressed loans for borrowers at significant discounts Establishes Board of Directors made up of HUD, Treasury, FDIC, and the Federal Reserve to establish additional program standards Voluntary - process initiated when borrower or loan servicer contacts an FHA approved lender Original lender must accept losses at a level to be set by the Board Program starts October 1, 2008 and ends September 30, 2011 Estimated to help approximately 400k borrowers Eligibility Requirements Owner-occupied 1-unit primary residences only; borrower must not have ownership interest in any other residential real estate Originated on or before January 1, 2008; must have made at least 6 payments Mortgage debt-to-income > 31% Under the EESA legislation, this definition was expanded to mean a DTI ratio > to 31% after taking into consideration the terms of the mortgage refinance New Loan < 90% of property current appraised value Note this provision was modified under EESA legislation to give discretion to the Board to set a higher percentage as the Board determines at their discretion 1) including a 3% upfront mortgage insurance premium for the FHA and closing costs 2) An additional annual 1.5% premium paid by the borrower of the remaining balance Underwriting Criteria Fully documented and verified income with the IRS Only refinanced if borrower can reasonably be expected to pay new terms New loan must extinguish all subordinate liens New loan will have a fixed interest rate and a minimum maturity of 30 years New loan cannot exceed 132% of the 2007 GSE loan limit (132% of $417k=$550k) Safeguards Against Misuse - Equity & Appreciation Sharing Distinguish between 1) Equity created as result of the loan restructuring (i.e. min 10% of appraised value) and 2) Future home appreciation after loan restructuring. 1) 5 Year Phase In - upon selling or refinancing of the property the borrower pays: 100% of the created equity in year 1 following restructuring of the loan, 90% in year 2, 80% in year 3, 70% in year 4, 60% in year 5 and 50% thereafter 2) Any realized appreciation in value (difference between future sale price and original appraised value) is shared 50-50 between the government and the borrower Limiting Risks to the Regular FHA Program The program will be paid for using part of the Affordable Housing Trust Fund The GSE bill will provide a further $2 billion cushion by establishing a reserve fund New loans will be permitted to be sold through GNMA
Source: FHA.

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Figure 5. Profit-Sharing Under HOPE for Homeowners

An example of how profits are shared under HOPE for Homeowners


At Time of FHA Mortgage Origination Appraised Value of Home = $150,000 FHA Mortgage Amount = $135,000 Equity because of loan restructuring = 150,000 - 135,000 = $15,000 If sold or refinanced: During Year 1 During Year 2 DuringYear 3 During Year 4 During Year 5 After Year 5 FHA Receives 100%, or $15,000 90%, or $13,500 80%, or $12,000 70%, or $10,500 60%, or $9,000 50%, or $7,500 Homeowner Receives 0%, or $0 10%, or $1,500 20%, or $3,000 30%, or $4,500 40%, or $6,000 50%, or $7,500

Appreciation is realized and shared, if sold Suppose, Selling Price = $170,000 Appreciation = 170,000 - 150,000 = $20,000 Regardless of holding period, Homeowner receives 50% appreciation, or $10,000 FHA receives 50% appreciation, or $10,000 but FHA has to provide upfront payments to subordinate lien holders
Source: FHA.

Figure 6. Highlights of Modifications to Hope for Homeowners Program


Modifications Made on November 18, 2008
Modifications to Hope for Homeowners Program - Loan-to-value (LTV) increases to 96.5% for loans where: * mortgage payment is less than or equal to 31% of monthly gross income and, * household debt payments are no more than 43% of monthly gross income * Continue to offer 90% LTV with ratios of 38% and 50%, respectively - Paying subordinate lien holders immediately to remove liens * Under previous rules would have to wait for the eventual sale of the home - Allowing the extension of maturities to 40 years * Up from previously 30 years - reducing monthly payments
Source: U.S. Department of Housing and Urban Development.

Treasury Interventions
FDIC Deposit Insurance Limit Increase
Treasury interventions include the TARP and the guarantee program for money market funds.

The Emergency Economic Stabilization Act (EESA) of 2008 authorized an increase in FDIC provided insurance of bank accounts to $250,000 from $100,000. That increases the volume of insured bank accounts to $5.1 trillion from $4.5 trillion, thus injecting extra stability into this important part of bank liabilities, reducing the likelihood of

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bank runs. The increase in the insured limit is only temporary and after the end of 2009 the insurance limit is scheduled to again drop back to $100,000. While this insurance program is backed by the FDICs own deposit insurance fund, the Treasury effectively backstops the program.

Temporary Liquidity Guarantee Program (TLGP)


This expansion of U.S. government intervention announced October 14, 2008 underscores the two critical issues of the credit crisis: funding and liquidity. The FDICs Temporary Liquidity Guarantee Program (TLGP) provides FDIC-insured US Bank Holding Cos and US S&Ls a three-year guarantee on newly issued, senior unsecured debt issued before June 30, 2009, and unlimited guarantees on non-interestbearing deposit accounts through December 31, 2009. An October 14 FDIC technical briefing estimated the amount of senior debt and non-interest bearing accounts eligible for the TLGP program to be $1.4 trillion and $400-500 billion, respectively. On November 21, 2008, the FDIC held a board meeting to approve several revisions to the TLGP, including guarantees of timely payment of principal and interest, backing by the full faith and credit of the United States, and cost of participation. As of January 2, TLGP issuance totaled close to $115 billion.
Figure 7. Key Changes to the TLGP on November 21
Temporary Liquidity Guarantee Program (Final Rule) -Backed by the full faith and credit of the United States -Guarantees timely payment of principal and interest -20% risk-weighting applied to debt guaranteed by the FDIC -Excludes debt with a maturity of 30 days or less -Cost of participation is 50 bps for debt maturing in 180 days or less (excl. overnight debt), 75 bps for 181-364 days, 100 bps for 365 days or greater
Source: FDIC.

Figure 8. Key Aspects of the FDIC TLGP Program


Temporary Liquidity Guarantee Program -FDIC guaranteeing newly issued senior unsecured debt of banks, thrifts and certain holding companies -Backed by the full faith and credit of the United States -Issued prior to June 30, 2009 -Includes commercial paper and interbank funding, among others -Excludes debt with a maturity of 30 days or less -Coverage ends June 30, 2012 -Guarantees timely payment of principal and interest -20% risk-weighting applied to debt guaranteed by the FDIC -Cost of participation is 50 bps for debt maturing in 180 days or less (excl. overnight debt), 75 bps for 181-364 days, 100 bps for 365 days or greater -Coverage is automatic for 30 days free of charge, then institutions can opt out -Guarantee will only cover up to 125% of debt outstanding as of Sep 30, 2008 and maturing before June 30, 2009 -Unlimited insurance coverage of noninterest baring transaction accounts. -Coverage ends December 31, 2009 -Cost of participating is a 10 bps surcharge -Coverage is automatic for 30 days free of charge, then institutions can opt out
Source: FDIC.

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Guaranteed Performance 4
TLGP appears successful in bringing down term financing costs for financial issuers. We expect this program to absorb much of financial issuance requirements in 2009.

TLGP issuance appears successful in its intent: bringing down term financing costs for financials

As banks continue to issue FDIC-guaranteed debt under the TLGP, taking advantage of the availability of cheap funding, the guaranteed bonds have tightened about 120 bps to Treasuries since issuance, outperforming agencies recently. The availability of term funding for banks sharply reduces the probability of default at shorter horizons, which has resulted in tightening in non-guaranteed short-dated financial paper as well, making it attractive at higher yields.
Figure 9. FDIC-Guaranteed Bonds Have Tightened About 120 bps to Treasuries Since Issuance, Outperforming Agencies Recently
3 year TLGP
TLGP & Agencies Spread (bps) 210 190 170 150 130 110 90 70 50

3 year Agencies

1-5 year Bank debt


720 710 700 690 680 670 660 650 640 630 Bank Spread (bps)

De c08

De c08

De c08

3D

5D

9D

De c08

15 -

Note: TLGP spread includes average of MS 3.25 11, JPM 3.125 11, C 2.875 11, GS 3.25 12, BAC 3.125 12. Source: Banc of America Securities LLC.

Based on the December 17, 2008 Credit Market Strategist.

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11 -

17 -

19 -

23 -

26 -

De c08

De c08

08 ec -

08

ec -

ec -

08

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Figure 10. TLGP Issuance Now Totals $115 billion
TLGP Issuance 12 TLGP Issuance ($ bn) 10 8 6 4 2 0
-0 8 1De c08 3De c08 5De c08 9De c08 11 -D ec -0 8 15 -D ec -0 8 17 -D ec -0 8 19 -D ec -0 8 25 -N ov

Cumulative 120 Cumulative ($ bn) 100 80 60 40 20 0

Source: Banc of America Securities LLC.

Guarantee Program for Money Market Funds 5


The Treasury on September 29, 2008, released updated details regarding the guarantee program for money market funds (originally announced on September 19, 2008). The program guarantees the share price of any publicly eligible money market fund that participates, if the funds NAV breaks the buck. New details include eligibility requirements, including a minimum net asset value of $0.995 and a 11.5 bp upfront fee for participation. The program initially will last three months, after which the Treasury will review needs and possibly extend until September 18, 2009. On November 24, 2008, the Treasury extended the program to April 30, 2009 from December. Funds could elect to continue coverage and pay a fee by December 5. Funds not currently participating were precluded from signing up. The program covers approximately $3 trillion of assets.

Based on the September 29, 2008 Credit Market Strategist.

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Figure 11. Updated Details on the Guarantee Program for Money Market Funds
Temporary Guarantee Program for Money Market Funds - Guarantees the share price of any publicly offered eligible money market mutual fund that participates - Guarantee triggered if the participating fund's NAV falls below $0.995 (breaks the buck) - Provides coverage for amounts held in participating money market funds as of the close of Sept 19, 2008, or the current amount, whichever is less - Program covers approximately $3 trillion of assets - Will initially exist for 3 months, after which the Treasury will review needs and possibly extend - The Treasury has the option to renew the program up to Sept 18, 2009 - Extended to April 30, 2009 from December - To participate, money market funds with a NAV greater or equal to $0.9975 as of Sept 19, 2008 will pay a 1 bp up - Money market funds with a NAV between $0.995 and $0.9975 as of Sept 19, 2008 will pay a 1.5 bp upfront fee - Funds with a NAV below $0.995 as of Sept 19, 2008 are ineligible - Fees will only cover the first three months of the program
Source: U.S. Department of Treasury.

Troubled Asset Relief Program (TARP)


TARP now includes up to $310 billion in capital injections via preferred stock

Interim Assistant Secretary for Financial Stability, Neel Kashkari, updated on October 13 the structure of TARP implementation. We republish below our thoughts on the TARP program from the September 28, 2008 Situation Room. Secretary Paulson on November 12, 2008 effectively put on hold the initial intent of the TARP to purchase illiquid mortgage assets directly from financial institutions. The Term Asset-Backed Securities Loan Facility (TALF) represents another use of TARP initially with a $20 billion guarantee, see Figure 33.

Figure 12. Update on TARP Implementation by the Treasury Department on October 13, 2008
Structure of TARP Implementation 1) Mortgage-backed securities purchase program - Identifying which troubled assets to purchase, from whom and pricing mechanism 2) Whole loan purchase program aimed particularly at regional banks. - Identifying which troubled assets to purchase first and pricing mechanism 3) Insurance program for troubled assets - Mortgage-backed securities and whole loans - Public request for comment issued on October 10 requiring responses with ideas for program within 14 days 4) Equity purchase program targeting broad array of financial institutions - Voluntary with attractive terms to encourage participation from healthy institutions. - Encourage complementary private capital raising 5) Homeownership preservation - Help homeowners when purchasing mortgages and mortgage-backed securities while protecting taxpayers 6) Executive compensation - Specifying requirements on executive compensation for firms that participate in the TARP - Will differ depending on the method of troubled asset purchases 7) Compliance - Establishing Oversight and Compliance structures
Source: U.S. Department of Treasury and Banc of America Securities LLC.

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Treasury Programs Under TARP
The Treasury has released program descriptions for four programs under TARP: 1) Capital Purchase Program, 2) Systematically Significant Failing Institutions Program, 3) Automotive Industry Financing Program and 4) Targeted Investment 6 Program. While the last three have been used for company specific bailouts (AIG, the autos and Citi, respectively) we provide more details about the more broadly applicable Capital Purchase Program below.

Figure 13. Summary of Treasury Programs Under the Economic Stabilization Act.
1. Capital Purchase Program - Treasury purchases up to $250bn in senior pfd stock from qualifying US controlled banks, savings associations and certain bank and savings & loan holding co's (see below table for full details) 2. Systemically Significant Failing Institutions Program - Treasury purchases any financial instrument including debt, equity or warrants from systemically significant institutions - Participation requires issuing warrants to Treasury and executive compensation limits - Eligibility determined on a case-by-case basis and no deadline for participation 3. Automotive Industry Financing Program - Treasury purchases any financial instrument including debt, equity or warrants that are determind to be troubled from the automotive industry - Participation requires issuing warrants to Treasury and executive compensation limits - Eligibility determined on a case-by-case basis and no deadline for participation 4. Targeted Investment Program - Treasury purchases any financial instrument including debt, equity or warrants that are determind to be troubled - Participation requires issuing warrants to Treasury and executive compensation limits - Eligibility determined on a case-by-case basis and no deadline for participation
Source: U.S. Department of Treasury and Banc of America Securities LLC.

The Heart of Financial Market UncertaintyInsolvency


Treasurys expansion of TARP to include purchases of preferred stock through the Capital Purchase Program (CPP) dramatically expands the initial focus of TARP from assets to equity. Such an expansion goes directly to the heart of financial market uncertaintyinsolvency. The key future question will be defining healthybefore or after such capital injections? And for the remaining financial institutions seeking such capital, Treasurys determination of eligibility and allocations becomes an existential event. Finance companies as well face critical strategic decisions as the actions further tip the competitive landscape in favor of regulated banks.

Please see: http://www.treas.gov/initiatives/eesa/program-descriptions

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Figure 14. Key Aspects of the TARP Capital Purchase Program


TARP Capital Purchase Program - Treasury to purchase up to $250 billion of senior preferred shares in qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies - Must elect to participate November 14, 2008. - Size is a minimum 1% of risk-weighted assets. Maximum is the lesser 3% of risk-weighted assets or $25 billion - Senior preferred shares will be funded by the Treasury by year-end 2008; - New preferred stock is non-voting and ranks pari pasu to existing preferred stock except junior preferred stock. - Dividend on new preferred shares is 5% for the first five years, then increasing to 9%. - Treasury receives warrants to purchase 15% of the amount of the senior preferred stock purchase - Participating companies adopt the Treasury's standards for executive compensation and corporate governance
Source: U.S. Department of Treasury and Banc of America Securities LLC.

Figure 15. TARP CPP Participation List (>$330 million)


As of December 29, 2008
Date 2 8 -O ct-0 8 2 8 -O ct-0 8 2 8 -O ct-0 8 2 8 -O ct-0 8 2 8 -O ct-0 8 2 8 -O ct-0 8 2 8 -O ct-0 8 1 4-N o v-0 8 1 4-N o v-0 8 1 4-N o v-0 8 1 4-N o v-0 8 1 4-N o v-0 8 2 8 -O ct-0 8 1 4-N o v-0 8 1 4-N o v-0 8 2 8 -O ct-0 8 Company C itig ro up I nc. JP M o rg an C ha se & C o . W e lls Far go & C o m p an y B a n k o f A m erica C orp or atio n M e rrill L yn ch & C o ., I nc. M o rg an S ta n le y T he G old m a n S a ch s G r ou p, In c. U .S . B an co rp C a pita l O n e Fina n cia l Co rp ora tio n R e gion s F in a ncia l Co rp. S u n Tru st B a n ks, I nc. B B & T C orp . B a n k o f N e w Yo rk Me llo n C orp or atio n K e yCo rp C o m er ica In c. S t at e S t ree t Co rp ora tion Amount ($mm) 2 5 ,0 00 2 5 ,0 00 2 5 ,0 00 1 5 ,0 00 1 0 ,0 00 1 0 ,0 00 1 0 ,0 00 6 ,5 99 3 ,5 55 3 ,5 00 3 ,5 00 3 ,1 34 3 ,0 00 2 ,5 00 2 ,2 50 2 ,0 00
Date 1 4-N o v-0 8 1 4-N o v-0 8 1 4-N o v-0 8 1 4-N o v-0 8 19 -D ec-0 8 5 -D ec-0 8 1 4-N o v-0 8 23 -D ec-0 8 2 1-N o v-0 8 2 1-N o v-0 8 2 1-N o v-0 8 23 -D ec-0 8 1 4-N o v-0 8 5 -D ec-0 8 Company M a rsh all & Ilsley C orp o rat io n N o rth ern T rust C orp o rat io n Z io n s B an co rpo ra tion H u nt in gt on B a n csha re s S yn ovu s Fin an cial C orp . P o p ular, In c. F irst H orizon N a tio n al C o rpo ra tio n M & T B a nk Co rp ora tio n A sso ciat ed B a nc-C o rp C ity Na tio na l C orp ora tio n W e b ste r Fin an cia l C orp o rat io n F ulto n Fina n cia l C orp ora tio n T CF F in an cial C or po rat io n S o u th Fina n cia l G ro u p, In c. O th er T ot al Amount ($mm) 1 ,7 15 1 ,5 76 1 ,4 00 1 ,3 98 9 68 9 35 8 67 6 00 5 25 4 00 4 00 3 77 3 61 3 47 1 0 ,5 55 17 2 ,4 61

Source: Treasury Department.

Source: Treasury Department.

The Expanding Safety TARP 7


The Treasurys safety net for financial markets appears to be expanding. Reports suggesting inclusion of insurance companies mark only the latest episode of expansion of the EESA legislation and the role of government to respond to the financial crisis. 8 We wrote in Engineering the Bottom that the capital purchase plan and Treasurys determination of eligibility and allocations would create an existential event for banks, and the purchase of National City by PNC illustrates exactly such a point. The Treasurys capital determinations and its apparent accelerated pace should go a long way to relieving the uncertainty of solvency currently plaguing financial markets. Despite the volatility for individual institutions, the rapid clarification of these issues should be welcomed for its duration limiting impact on the credit crisis. The extension into insurance companies, especially if those end up including the monoline industry, will further help to reduce systemic risk critically important as banks holding
7 8

Based on the October 24, 2008 Situation Room. Please see the October 14, 2008 Credit Market Strategist.

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commercial-based CDO exposures face writedowns on those, increasing their exposure to monolines in the corporate analog (albeit much less severe) to last years subprimerelated super senior CDO issues.
Figure 16. Breakdown of Monolines Structured Finance Guarantee Portfolios (1) . . Other Other Structured RMBS and Company ABS CDO Other CDO Home Equity ABS (2) Finance (3) ABK 29,195 42,305 46,184 56,577 22,894 (4) AGO 1,255 38,992 16,367 12,301 2,509 FGIC 10,932 17,168 31,361 15,832 95 CIFG 9,400 1,900 FSA 364 72,836 18,772 38,499 MBI 30,600 100,296 33,447 23,265 19,846 SCA 17,996 26,304 8,900 6,067 15,371 Total 99,742 297,901 156,931 152,541 60,715
(1) CDOs include both international and US CDOs. All other exposures are only US. (2) Other includes Student Loans, Commercial MBS, Auto Loan, Credit Card and Non-Specified ABS. (3) Investor owned Utilities, Financial Debt, Direct Corporate Exposure and unspecified structured finance. (4) MBS and HE are comprised of roughly 50% Prime MBS with an average rating of A+. Source: Company reports, Banc of America Securities LLC estimates.

Toward a Final Version of TARP


Funding for the TARP will be tranched with $700bn authorized, but $250bn available for immediate use

Working through the weekend, a final version of the TARP emerged on September 29. That Sunday night, the Treasury hosted a call to go over aspects of the legislation and to field analysts questions. Most of the main provisions from earlier versions remained intact with some critical changes and additions. Funding will now be tranched with $700bn authorized, but $250bn available for immediate use. With presidential certification, an additional $100bn can be accessed and the remaining $350bn subject to Congressional disapproval. As of December 29, 2008, $172bn of the $250bn was allocated through preferred stocks to 208 banks in addition to an extra $20 and $40bn for Citi and AIG, respectively and $6 billion for GMAC and GM (see section below). $20bn has been reserved for the TALF. Regarding both price and conditions, more discretion was granted to the Secretary on both fronts. Both direct purchases and market mechanisms remain with little specificity on how the price determination would be met. The bills language requires program guidelines to be issued within 45 days of passage, providing further details, or within 2 days of the first purchase. Warrants and limits on executive compensation remain in the bill, with some critical easing of the compensation limits relative to earlier versions. Warrants attached to participation remain in the bill, but terms of the warrants governing the degree of dilution now stand at the discretion of the Secretary. Treasury gave further guidance on the call regarding their intent. Direct purchases envision the purchase of assets from failing institutions such as in the case of Bear Stearns or AIG with substantial and punitive equity stakes taken. But for institutions accessing the program through the market mechanism, Treasurys guidance was that in exercising this discretion, the Secretary would look to scale the size of dilution according to participation, say, as a percentage of total liabilities of the institution sold into the fund. The goal is for the warrants to not be punitive so as to not create a disincentive to

Based on the September 28, 2008 Situation Room.

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participation. The bills language includes a provision excluding warrants for the first $100m of participation. Executive compensation limits scaled back. Relative to earlier bills, executive compensation limits have been scaled back again to lessen the punitive nature and disincentive toward participation. The most stringent limits now only apply to use of the fund under the direct purchases method. For purchases made under Auctions, executive compensation limits only apply to participation of greater than $300m, and those limits only include limitations of No Golden Parachutes under the events of termination, bankruptcy, or receivership and would apply only to top 5 executives and only during the 2-year period of the fund (subject to a 1-year extension by the president). This clearly represents an attempt to encourage usage of the program, at a minimum in small size, by reducing the punitive nature of the executive compensation limits present in earlier versions of the bill. Not intended to bail out failing institutions. Note as well that the bill includes language stipulating the Secretary take into consideration the long-term viability of the institution before purchasing the assets. Further clarification on the call indicated the intent is not to put funds into failing institutions, but to help healthy institutions get liquidity for the troubled assets and for that liquidity to make its way back into the system. In what appears a political concession, the House Republican proposal for the establishment of an insurance fund as an alternative mechanism appears in the bill. Treasury stated that their thought process on this program was further behind that of the purchase program and as such they were unable to provide many details on how it would work. Provisions in terms of size and equity warrants appear to apply to this portion. Critical to evaluating this alternative will again be the determination of price. The draft legislation stipulates pricing should create reserves necessary to protect taxpayers. This appears an even less well thought through provision, and its inclusion is for political rather than economic sense. On the pricing issue, for example, the insurance premium must be set equal to the consideration given under the purchases method; otherwise, sellers into the fund will choose the more advantaged pricing scheme. Furthermore, premium-based payments for insurance create potential issues as, for example, the Treasury will be severely informationally disadvantaged in determining the risk of the asset being insured relative to the financial institution seeking the insurance. The same issue exists under direct purchases, but under insurance the problem is exacerbated by the fact that premiums received, if they are spread out over the expected life of the asset, may end up falling well short of the realized loss. Overall, this version makes some critical revisions relative to earlier versions. The new version gives substantial discretion to the Secretary in regards to the attachment of warrants to usage of the program. The guidance on the call clearly suggests that Treasury envisions the Auction process as a way to bring liquidity to the market, and intends in this version, through lessening the punitive nature of both warrants and executive compensation under that form of usage, to encourage its use. For small sizes, this clearly appears to be the case. However, for most institutions, exposures to the troubled assets far exceed these limits, and therefore a broader usage of the program would expose them to not only these scaled-down executive compensation limits, but also to an as-yet undefined amount of future equity dilution. The issue of price as well remains unclear, and any decision to use the program will first and foremost depend on how Treasury sets price. As we have discussed, the use of reverse auctions to set prices likely limits participation to institutions carrying assets at the lowest levels as they will

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be able to offer troubled assets at the lowest levels with no additional capital hit required. This version of the bill appears to extend benefits to those using it for relatively small sizes (below the trigger thresholds for executive compensation and warrants). For the rest in between, it remains to be seen how Treasury determines price in balancing the competing priorities to stabilize financial markets while at the same time protecting taxpayers before the longer-term impact will be clear. Near term, however, passage of the bill will likely be treated as lowering systemic risks, easing the credit crisis with tighter spreads and higher stock prices a result.

Company Specific Bailouts


In addition to the government intervention and programs addressed above, Citi and AIG received company-specific bailout packages on November 23 and November 10, 10 respectively. The Citi investment falls under the Targeted Investment Program as part of EESA and the AIG investment is classified under the Systemically Significant 11 Failing Institutions Program . While several government agencies are involved we categorize these under Treasury Interventions as both received TARP capital injections and review the bailouts for Citi and AIG below.

The Citi Bailout 12


The US Treasury, Federal Deposit Insurance Corporation (FDIC), and Federal Reserve Board on November 23, 2008 issued a joint statement announcing an agreement with Citigroup to guarantee specific residential and commercial real estate-based assets valued at $306 billion in exchange for $7 billion in preferred stock. Besides the asset guarantee, the Treasury also buys $20 billion in preferred stock under the Capital Purchase Plan (CPP) and receives warrants with exercise value of $2.7 billion.
Figure 17. US Government Announced Bailout for Citigroup
Citigroup Bailout Summary Asset Guarantee: - $306 bn of loans and securities backed by residential and commercial real estate to be guaranteed - Assets to remain on Citi's books and get 20% risk weighting - Guarantee is in place for 10 years on residential and 5 years on non-residential assets - Citi takes the first $29bn in losses; thereafter losses shared 90% by US govt , 10% by Citi - The 90% US govt share of losses is split as follows: * Treasury takes second loss (after Citi's first loss) up to $5bn * FDIC takes third loss up to $10bn * Fed funds the remaining pool of assets, if required, with a non-recourse loan at OIS + 300bps - Treasury to get $4bn of preferred stock with 8% dividend rate; FDIC $3bn - Citi is prohibited from paying common stock dividends of more than $0.01 per share for three years TARP Capital Purchase Plan: - Treasury to buy $20 bn of perpetual preferred stock paying cumulative dividend of 8% per annum - Treasury also gets 10 year warrants for exercise value of $2.7 bn at strike of $10.61 per share
Source: Treasury, FDIC, Federal Reserve.

10 11

See: http://www.treas.gov/initiatives/eesa/program-descriptions/tip.html Please see: http://www.treas.gov/initiatives/eesa/program-descriptions/ssfip.shtml 12 Based on the November 24, 2008 Situation Room.

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The AIG Bailout 13
In what may form a template for other bailouts, including for the bond insurers, the government announced a restructured support package for AIG. Highlighting the broadening scope of TARPs Capital Purchase Program (CPP), the Treasury is purchasing $40 billion in new preferred stock, with 10% coupon from AIG. The existing $85 billion credit facility with the Fed is restructured, dramatically reducing the interest rate and commitment fees, as well as extending the maturity to five years. Finally, the Fed is committing loan financing to two limited liability companies (LLC) designed to purchase troubled assets from AIG. One $23.5 billion LLC will purchase RMBS from the companys U.S. securities lending program, while the other $35 billion program is set to acquire ABS CDOs on which AIGFP has written CDS protection. AIG provides a $1 billion first loss piece for the former and $5 billion for the latter. We note that the package does not address AIGs $237 billion exposure to corporate CDOs, where performance is sensitive to the developing default cycle.

Figure 18. Key Aspects of the New AIG Rescue Package


New November 10, 2008 AIG Rescue Package - Treasury to purchase $40 billion in preferred shares under TARP * 10% Coupon * Includes 10-year warrant for 2% of AIG common stock - Restructuring of existing credit facility with the Fed * Size reduced to $60 billion from $85 billion * Maturity of facility extended to 5 years from 2 * Interest rate on drawn funds reduced to L+300 from L+850 bps * Commitment fee for undrawn funds reduced to 75 bps from 850 - $23.5 billion residential Mortgage-Backed Securities Facility * Limited liability company to purchase RMBS from AIG's U.S. securities lending program * Funded with a $22.5 billion loan from the New York Fed and $1 billion subordinated loan from AIG * $37.8 billion existing securities lending facility with the Fed will be repaid and terminated - $35 billion Collateralized Debt Obligations Facility * Limited liability company to purchase multi-sector CDOs on which AIGFP has written CDS contracts * Funded with a $30 billion loan from the New York Fed and $5 billion subordinated loan from AIG * Counterparties to unwind the related CDS transactions
Source: Federal Reserve and AIG.

13

Based on the November 10, 2008 Situation Room.

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Figure 19. Summary Statistics for Super Senior Credit Derivatives
As of September 30, 2008

Asset Class Regulatory Capital Relief Transactions Corporate Residential Mortgages Other Arbitrage Transactions Multi Sector CDO w/Subprime Multi Sector CDOs w/No Subprime Corporate debt/CLOs Total
Source: AIG I3Q investor Presentation.

Notional Amount ($mm) 170.0 143.6 3.6 76.5 32.0 67.1 492.8

Auto Bailout
On December 19, 2008 GM and Chrysler announced they will receive secured bridge 14 loans facilities utilizing TARP in the amounts of $13.4 and $4bn, respectively . As announced on December 29, 2008 the Treasury separately will purchase $5bn in preferred stock from GMAC, using TARP funds as well as lend $1bn to GM to participate in a rights offering at GMAC in supporting the companys transition as a 15 16 bank holding company . We republish our original thoughts below.

DIPping Into the TARP 17


GM and Chrysler obtain a bridge loan to a restructuring that converts to a DIP loan if negotiations are unsuccessful

The Administration announced utilizing the TARP to fund effectively a Debtor-InPossession (DIP) loan to GM and Chrysler. Unlike regular DIP financing, however, terms on the loan give the companies through first quarter 2009 to complete a restructuring outside of bankruptcy before triggering a default. Terms of the loan mirror those in the failed Senate bill including the Corker amendment, but with those provisions stated as Targets rather than hard requirements. The focus of auto uncertainty now shifts to required stakeholder concessions by February 17 before the final March 31 deadline certifying long term viability ..[and]..achievement by the company of positive net present value. Failure by this date (or after one extension of 30 days) by the Presidents Designee to certify plan completion will result in the loan amounts becoming due and payable in 30 days. Absent another source of financing, such an action would precipitate a bankruptcy filing, upon which these government loans may be converted into a true DIP facility.

As part of the Automotive Industry Financing Program under EESA: 15 Please see the press release: http://www.treasury.gov/press/releases/hp1335.htm 16 The Federal Reserve announced its conditional approval of GMAC as a bank holding company in a December 24, 2008 press release: http://www.federalreserve.gov/newsevents/press/orders/20081224a.htm 17 Based on the December 19, 2008 Situation Room.

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Figure 20. Highlights from the General Motors and Chrysler Secured Bridge Loan Facilities
General Motors and Chrysler Secured Bridge Loan Facilities - Term loan to Dec 29, 2011 (if in compliance with conditions of agreement) with full recourse financed using TARP funds * Secured by first lien on unencumbered assets or junior lien on encumbered assets * GM loan amount up to $13.4 bn. $4 bn on Dec 29, $5.4 bn on Jan 16 and $4.0 bn on Feb 17 (last payment needs approval by Congress). * Chrysler loan amount up to $4.0 billion. - Cost is L+300 bps though spread increases to 800 bps in the event of default. LIBOR floor is 2.00% - Except for mandatory repayments under existing secured loans, 100% proceeds from asset sales and capital raisings directed to loan repayment - Subject to executive privileges and compensation limitations in the EESA - President's Designee need to approve any special business transaction exceeding $100 million. - Companies submit long-term plan (including term sheet signed by all relevant parties) to President's Designee by Feb 17, 2009 including plans for * Repayment of the government * Complying with Federal fuel efficiency and emissions requirements and commencing production of advanced technology vehicles * Providing positive net present value, rationalizing costs, restructuring existing debt and a competitive product mix - Restructuring targets (carried over from "Corker Amendment") * debt-to-equity swaps amounting to at least 2/3 of existing debt * Average compensation levels per labor hour and work rules must be similar toUS operations of Nissan, Toyota and Honda by Dec 31, 2009 * Elimination of benefits to employees that have been fired, laid-off, furloughed or idled (other than customary severance) * No less than half of contributions made to the voluntary employees beneficiary organization to be made in stock - Progress report to be submitted to Congress by March 31, 2009 - Loan facilities may be converted into DIP financing in the event of bankruptcy at lender's option - Treasury receives warrants for 20% of the maximum loan amount up to 20% of common shares
Source: Treasury Department.

GMAC Bailout
The Treasury announced on December 29, 2008 that it will purchase from GMAC $5bn in senior preferred stock using TARP funds. The preferred stock will have an 8% dividend and warrants will be issued to Treasury in the form of additional preferred equity, equal to 5% of the preferred stock purchase, which will pay a 9% dividend if exercised. In addition, the Treasury will lend up to $1bn to GM to help the company support GMACs transition to a bank holding co. The GM loan will be exchangeable at any time at the Treasurys option, into equity interests in GMAC acquired by GM in a rights offering.
Figure 21. Highlights in the GMAC Investment

TARP Investment in GMAC


-Tre a sury w ill p urch a se $5 b n in p re fe rred st ock with a n 8 % divid e nd -W a rran ts will b e issu e d to Tre a sury in th e fo rm of a dd it io n al p fd st ock, e qu a l to 5% o f t he p fd st ock pu rch ase w ith a 9% d ivid en d if e xe rcise d -Tre a sury w ill len d G M $ 1 bn t o he lp G M su pp o rt G M A C's tra ns itio n to a B HC w it h te rm s s ub sta nt ia lly th e sa m e a s th e $1 3 .4 bn cre d it fa cility (se e ab o ve ), exc ep t se cure d b y G M A C eq u ity
Source: Treasury.

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Three Steps to Complement Fannie/Freddie Conservatorship 18

Senior Preferred Stock Purchase Agreement Government-Sponsored Enterprise Credit Facility -- GSE Mortgage-Backed Securities Purchase Program

The Federal Housing Finance Agency (FHFA) on September 7, 2008 placed Fannie Mae and Freddie Mac under Conservatorship. This state, as defined below, means the FHFA establishes control and oversight of the GSEs to put them in a sound and solvent condition and thus closely resembles bankruptcy. Simultaneously, the Treasury Department announced three steps to complement the FHFA decision. The Treasury will purchase senior preferred stock as needed to maintain positive net worth at Fannie and Freddie up to $100 billion each. The Treasury also announced the Government Sponsored Enterprise Credit Facility (GSECF) to provide secured funding to Fannie Mae, Freddie Mac and the Federal Home Loan Banks. The final step by the Treasury Department involves direct purchases of agency MBS designed to complement modest increases in GSE retained portfolios until December 31, 2009 (without regards to capital requirements) to directly support the mortgage market. While the above-described measures are designed to provide temporary support for the mortgage market as the Treasury Departments authority expires December 31, 2009, it is up to Congress to define the structure and roles of the GSEs over the longer term. The Senior Preferred Stock Purchase Agreement calls for a gradual 10% annual reduction in Fannie Mae and Freddie Macs retained portfolios from as much as $850 billion each as of December 31, 2009 to $250 billion.

What Is a Conservatorship?
A Conservatorship is the legal process in which a person or entity is appointed to establish control and oversight of a Company to put it in a sound and solvent condition. In a conservatorship, the powers of the Companys directors, officers, and shareholders are transferred to the designated Conservator. from www.ofheo.gov/media/PDF/FHFACONSERVQA.pdf The FHFA will act as the conservator.
Figure 22. GSE Capital Structure Outline
Treasury Has Agreed To Inject Capital Into Fannie Mae and Freddie Mac as Needed at the Senior Preferred Stock Level
S enior D ebt S ubordinated D ebt T reasury to inject up to $100 billion into each agency as needed to ensure positiv e net w orth S ubordinated to new preferred stock and div idends elim inated T reasury receiv es warrants for 79.9% of com m on stock and div idends elim inated

N ew 10% S enior P referred S tock

E x isting P referred S tock

C om m on S tock
Source: U.S. Department of Treasury.

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Based on the September 7, 2008 Situation Room.

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Figure 23. Three Steps Taken by the Treasury To Complement the FHFAs Decision To Place Fannie Mae and Freddie Mac Into Conservatorship
Senior Preferred Stock Purchase Agreement - Treasury to buy senior preffered stock to ensure that each Agency maintains positive net worth - Up to $100 billion for each agency - 10% coupon on the senior preferred stock - may increase to 12% for a period if dividends are not paid in cash - Treasury receives immediately from each GSE $1 billion of sr. preferred stock and Warrants to purchase 79.9% of common stock - Beginning March 31, 2008 the Treasury is paid a quarterly commitment fee in cash or sr. pref. stock - GSEs subject to several covenants restricting their abilities to pay dividends and increase debt beyond 110% of June 30, 2008 levels, among other things - Caps each GSEs retained portfolio to $850 billion as of Dec 31, 2009 after which the portfolios shall decline by 10% each year until it reaches $250 billion Government Sponsored Enterprise Credit Facility (GSECF) - Provide secured funding to the Fannie Mae, Freddie Mac and the Federal Home Loan Banks (FHLB) on an as needed basis - Funded by the Treasury's general fund and expires Dec 31, 2009 - Collateral limited to agency MBS and advances made by the FHLBs - Federal Reserve Bank of New York will act as agent - Short term loans expected to be less than one month but at least one week based on individual requests - Maturing loans can be replaced with new loans - Can be pre-paid with two days notice - Interest rate is set by the Treasury, initially LIBOR+50 bps GSE Mortgage Backed Securities Purchase Program - Treasury to invest in agency MBS in the open market at the discretion of the Treasury Secretary - Scale determined by developments in the markets - Authority expires on December 31, 2009 - Independent asset managers to purchase and manage the portfolios under guidelines from the Treasury - Subject to statutory debt limit - The Treasury purchased $5 billion of GSE MBS in September and $20.5 billion in October
Source: U.S. Department of Treasury.

Federal Reserve Interventions: Supporting Funding 19


Treasury and the Fed, we estimate, now combine to support directly or indirectly more than 70% of banking system liabilities

Step one in combating systemic risk lies in securing funding markets. The accumulated efforts of the Treasury and the Fed, we estimate, now combine to support directly or indirectly more than 70% of banking system liabilities. Those efforts include expansion of FDIC guarantees by the Treasury, the CPFF, FHLB advances, TAF and Discount Window borrowings From the Fed. The one large remaining area that could benefit from backstop liquidity is the Bank CD market, so potentially BCDLF (Bank Certificate of Deposit Liquidity Facility) could be next, although the Money Market Investor Funding Facility (MMIFF) provides support for a small portion of CDs. The combined efforts so far should eventually reduce systemic bank funding risk, giving time for step two, dealing with the root cause of the financial crisisthe uncertain asset values and solvency issues they raisethe time it needs to proceed.

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Based on the October 8, 2008 Situation Room.

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In Figure 24 below, we estimate the combined US Bank and Thrift assets and liabilities. The notes to the tables detail our methodology. In Figure 13, we associate Bank and Thrift liabilities to their support sources. Note that in this table we make several assumptions; please see detailed notes accompanying the table.
Figure 24. US Bank and Thrift Assets and Liabilities
Assets Cash or Near Cash Total Bank Credit Securities Loans Bank Loans Mortgages Consumer Credit Misc. Assets
(1)

$bn Liabilities 147 Deposits 10,895 2,749 2,184 4,778 903 2,469 Checkable and Small Time/Savings Non-Interest Bearing Deposits Large Time Deposits Short Term Borrowing Commercial Paper
(2)

$bn 7,889 4,447 1,104 2,338 2,791 2,427 850


(3) (2)

8,146 Short Term Liabilities

Other ST Borrowings

1,578

Other ST Liabilities Long term Liabilities Total Assets 13,511 Total Liabilities

(2)

364 1,456 12,136

Note: Created using Table L.109 Commercial Banking and L.114 Savings Institutions of the Fed Flow of Funds Accounts Z.1 release for Second Quarter 2008. (1) Includes Vault Cash, Reserves at Federal Reserve, Checkable Deposits, Time and Saving Deposits, and Fed Funds and Security RPs. (2) Estimated using liabilities' composition for a smaller sample of banks. To create the aggregate balance sheet, we begin with the data in the Flow of Funds release from the Federal Reserve, which provides us the Banks and Savings levels separately. For simplicity of presentation, we collapse the details therein into high-level balance sheet accounts. However, this release does not provide the break-up of liabilities by credit instruments (commercial paper, etc.) or maturity (short term, long term), which is important for our purposes. To estimate these details for the aggregate data we calculate the weighted average compositions of liabilities for a sample of 10 banks with the highest total outstanding liabilities and apply that to the aggregate data. (3) Other Short Term Borrowings include repos, Federal Funds and other interbank lending.

Source: Federal Reserve, company filings, Banc of America Securities LLC estimates.

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Figure 25. Treasury and the Fed We Estimate Now Combine To Support Directly or Indirectly More Than 70% of Banking System Liabilities
Liabilities Deposits Checkable and Small Time/Savings Non-Interest Bearing Deposits Large Time Deposits Short Term Liabilities Short Term Borrowing(2) Commercial Paper(2) Other ST Borrowings
(3)

$bn Support Sources 7,889 4,447 FDIC(4) 1,104 TLGP(5) 2,338 MMIFF(9) 2,791 2,427 850 CPFF(6) 1,578 Programs Listed Below FHLB (Short term portion) TAF, Discount Window TLGP
(5) (9) (8) (7)

$bn 5,100 450 180

850 1,578 356 950 700 420 558 8,716 (72%)

MMIFF Other ST Liabilities Long term Liabilities Total Liabilities


(2)

364 1,456 FHLB (Long term portion)(7) 12,136 Total Support Sources

Note: Created using Table L.109 Commercial Banking and L.114 Savings Institutions of the Fed Flow of Funds Accounts Z.1 release for Second Quarter 2008. (2) Estimated using liabilities' composition for a smaller sample of banks. To create the aggregate balance sheet, we begin with the data in the Flow of Funds release from the Federal Reserve, which provides us the Banks and Savings levels separately. For simplicity of presentation, we collapse the details therein into high-level balance sheet accounts. However, this release does not provide the break-up of liabilities by credit instruments (commercial paper, etc.) or maturity (short term, long term), which is important for our purposes. To estimate these details for the aggregate data we calculate the weighted average compositions of liabilities for a sample of 10 banks with the highest total outstanding liabilities and apply that to the aggregate data. (3) Other Short Term Borrowings include repos, Federal Funds and other interbank lending. (4) An October 1, 2008 Congressional Budget Office report estimated that raising the limit for FDIC insured deposits to $250,000 from $100,000 would raise the amount of FDIC insured deposits to $5.1 trillion from $4.4 trillion. The first $250,000 of large time deposits are also insured but we do not separate out the $5,100 billion FDIC insured amount. (5) The FDIC estimated in an October 14, 2008 technical briefing that $400-500 billion in non-interest bearing bank accounts would be covered under the Temporary Liquidity Guarantee Program (TLGP). Additionally the FDIC estimated that $1.4 trillion in unsecured debt is eligible for refinancing under the TLGP. Because there is overlap in coverage between the various government funding programs, for example the CPFF and the TLGP, we use in this analysis half of the potential size, i.e., $700 billion. (6) Because most banks are Tier 1 we assume for simplicity that all outstanding bank commercial paper is eligible for the Commercial Paper Funding Facility (CPFF). (7) Bank advances from the Federal Home Loan Banks (FHLB) totaled $914 billion as of June 30, 2008. We classify the 39% of advances with maturities less than one year as short term borrowings and the remaining $61% as long term liabilities. (8) We used the peak potential size of the Term Auction Facility (TAF) over year-end of $900 billion and $50 billion in Discount Window borrowing consistent with the most recent reported numbers as of October 1, 2008. (9) We assume that 30% of the $600 billion under the MMIF program is used to support CDs. The rest is available to support other short term liabilities.

Source: Federal Reserve, company filings, Banc of America Securities LLC estimates.

Figures on the TAF and Discount window usage are peak numbers possible toward the end of the year. As of December 29, actual usage was $535 billion.

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Funding From the Fed

The Fed provides a variety of liquidity facilities including the CPFF and the TAF

We review below the AMLF and CPFF, the two commercial paper funding facilities set up by the Fed to support that market. In addition the Fed provides access to emergency funding through a variety of programs including the Term Auction Facility (TAF), the Primary Dealer Credit Facility (PDCF) and the Term Securities Lending Facility (TSLF). Figure 36 on page 32 provides a summary of these and other Fed liquidity facilities. The AMLF, CPFF, and PDCF were extended to April 30, 2009 on December 2, 2008. The Fed also funds the originally $30 billion Maiden Lane portfolio of 20 assets from Bear Stearns as well as extends credit lines to AIG (see Figure 26 below for current usage). Finally, the Fed provides unlimited amounts of dollars in currency swap arrangements with nine foreign central banks from the Bank of Japan to the ECB. These swaps provide dollars for foreign central banks to distribute while the Fed does not distribute the foreign currency.

Figure 26. Fed Lending in Cash to Banks and Brokers Has Reached $1.1 Trillion
As of December 29, 2008

Figure 27. a $36 Billion Increase From the End of November


Change In December as of December 29, 2008

Maiden Lane, 28 AIG, 87 AMLF, 24 PDCF, 38 CPFF, 332

AIG, 9 AMLF, -25

CPFF, 28

Discount Window, 85

Repos, 80

PDCF, -17 TAF, 44


TAF, 450

Discount Window, 3
Source: Federal Reserve.

Source: Federal Reserve.

20

Notice that the Fed has written down this portfolio by nearly 10% due to deteriorating asset values, please see the October 23, 2008 Situation Room for details.

Situation Room

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Figure 28. $620 Billion in Emergency Dollar Currency Swap Arrangements With the Fed
Currency Swap Arrangements With the Fed Banco Central do Brazil Banco de Mexico Bank of Canada Bank of England Bank of Japan Bank of Korea Danmarks National Bank ECB Monetary Authority of Singapore Norges Bank Reserve Bank of Australia Reserve Bank of New Zealand Sveriges Riksbank Swiss National Bank Total
Source: Federal Reserve and Banc of America Securities LLC.

($ billions) 30 30 30 Unlimited Unlimited 30 15 Unlimited 30 15 30 15 30 Unlimited Unlimited

Asset Backed Commercial Paper Money Market Fund Liquidity Facility (AMLF) 21
The Federal Reserve announced September 21, 2008, the Asset Backed Commercial Paper Money Market Fund Liquidity Facility (AMLF). The program allows banks to borrow from the Boston Fed to fund purchases of ABCP from money market funds at amortized cost. The Fed bears all credit risk and banks get 0% risk weighing and amounts will be excluded from leveraged capital purposes. This effectively gives Money Market Funds key motivations of capital (amortized cost means no principal at risk) and liquidity (the Fed ensures a ready buyer for ABCP) to keep money market funds invested in ABCP. The Fed disclosed $24 billion of loans had been made under the program as of December 29, 2008, though the peak was $152 billion in October.

Commercial Paper Funding Facility (CPFF) 22


The CPFF began October 27 and provides 3-month financing to Tier 1 issuers

The Fed announced October 7, 2008, the formulation of the CPFFCommercial Paper Funding Facilityadding to the alphabet soup of liquidity backstops. These actions signal the expansion of previously announced Guarantee Program for Money Market Funds and AMLF (Asset Backed Commercial Paper Liquidity Facility) efforts to stem the panic in wholesale funding markets. These quiet bailouts have helped to stem the pace of outflows in Prime funds and, as evidenced by the $140bn increase in Prime fund assets since inception, are helping to relieve the systemic risk of a funding breakdown. Expanding those programs to the CP market benefits mainly Tier 1 bank issuers, but with subsidiary benefits to corporate issuers helping to alleviate any potential bank draw risks. The program excludes A2/P2 issuers, but indirectly they may still benefit from reduced funding costs in the Tier 1 market. As of December 29 the CPFF program $332 billion outstanding according to the H.4.1. statistical release.

21 22

Based on the September 29, 2008, Credit Market Strategist. Based on the October 7, 2008, Situation Room.

Situation Room

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Figure 29. Description of the New Commercial Paper Funding Facility


Commercial Paper Funding Facility - Federal Reserve to set up an SPV to Purchase Commercial Paper Until April 30, 2009 - Program Began October 27, 2008 - The Fed Lends to the SPV at the target Fed Funds rate - SPV purchases 3-month commercial paper directly from issuers - Pricing is 3-month OIS +100 bps and +300 for unsecured and asset-backed commercial paper, respectively - 100 bps surcharge on unsecured lending - Still unclear what collateral is acceptable for secured lending - Initial fee of 10 bps on maximum amount of commercial paper the SPV may own - Size of program: Up to $1.3 trillion - Only U.S. issuers (includes U.S. domiciled subsidiaries of foreign issuers) may use the program - CPFF will purchase paper rated Tier 1 by one of the three rating agencies or at least two if rated by multiple agen - For a single issuer the maximum amount of purchases by the CPFF is CP outstanding in August 2008, less CP held by investors other than the CPFF
Source: Federal Reserve.

The CPFF in Short


The Fed sets up an SPV to purchase from issuers 3-month CP, set at a level of OIS plus 100 bps plus as unsecured credit surcharge of 100 bps. ABCP is set at 3-month OIS + 300 bps. Limits per issuer will be set at the amount outstanding as of August 2008, which by our figures for Tier 1 domestic CP programs totalled $1.3 trillion. As a backstop facility, the intent is by providing a guarantee of liquidity, private market participants will be more willing to extend term financing and that only a small fraction of this amount would actually need to be used. The Fed will meet its secured lending requirement through one of an upfront fee, guarantee, or collateral satisfactory to the Fed.
Figure 30. Current Commercial Paper Market and What Is Eligible for the CPFF (estimated)
Outstanding as of December 31 Represents the Total CP Market Tier 1 Commercial Paper Issued by a US Issuer Outstanding as of August Is Eligible for the CPFF

CP Category
Domestic Nonfinancial Foreign Nonfinancial Domestic Financial, U.S. Owned Domestic Financial, Foreign Bank Parent Domestic Financial, Foreign Nonbank Pare Foreign Financial Other Financial Asset-backed TOTAL

Outstanding Eligible for as of Dec 31 ($bn) CPFF ($bn, est)


132 50 243 277 46 147 1 704 1,600 146 0 251 205 41 0 0 633 1,276

Note: We estimate commercial paper eligible for the CPFF from the August 27, 2008 (we do not know the precise date in August used by the Fed) total amount outstanding in the commercial paper market except foreign non-financial and financial, as we assume for simplicity that these have no US subsidiary. As of August 27, $1,492 of $1,758 billion outstanding commercial paper, or 85%, was tier 1. For simplicity we assume that 85% of commercial paper in each category in this table is Tier 1. Source: Federal Reserve and Banc of America Securities LLC.

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Money Market Investor Funding Facility (MMIFF) 23

The new MMIF provides support for CP, bank notes and large CDs with less than 90 days to maturity.

The Federal Reserve announced another liquidity program. The MMIFF should further contribute to a decline in funding costs and suggests extending liquidity support beyond money market funds to over time include other money market investors. That brings our estimate of government support for banking system liabilities) to more than 70%. Investors will be able to sell Tier 1 rated CDs, bank notes and commercial paper with maturities of 90 days or less into a private sector PSPV, receiving in return 90% cash funded by the Federal Reserve Bank of New York (FRBNY) and 10% Asset-Backed Commercial Paper (ABCP). That ABCP is a first-loss piece in the PSPV structure as it is subordinated the FRBNY funding. What this means is that the investor will end up holding a piece of the PSPV structure designed to absorb the first 10% of losses in the 24 entire PSPV. For example, if the underlying issuers have expected loss rates of 1% the 1% expected loss on the entire PSPV structure needs to be absorbed by only 10% of its capital structure. While not entirely true because of complications related to correlation between issuers, one might intuitively think about an expected loss rate for the ABCP in this example of 10%. Whatever a more realistic expected loss rate is for the first loss ABCP piece, presumably the Federal Reserve has cleared with the rating agencies that this is consistent with the required Tier 1 rating as otherwise 2a-7 funds 25 may not be able to hold it. Based on merely the limited information we have, and given the relative lack of diversification in the PSPV, we would not be able to make that determination. The Federal Reserve plans on setting up five PSPVs, totaling up to $600 billion of 26 assets and with each structure containing short term money market instruments issued by ten issuers. Key to the importance of the MMIFF for supporting bank liabilities is the ability to sell bank CDs into the program, as large time deposits remains the one large portion of banking system liabilities until now unsupported by the government.
Figure 31. PSPV Structure Relies on Getting Tier 1 Rating for First Loss Piece
CDs, Bank Notes & CP Issuer 1 Issuer 2 Issuer 3 . . . . . . Issuer 10
Source: Federal Reserve and Banc of America Securities LLC.

PSPV Up to $120 Billion

90% Senior Piece Funded by the Federal Reserve Bank of New York

10% First Loss Piece: ABCP

23 24

Based on the October 21, 2008 Situation Room. For example, a 2% default probability and a 50% expected recovery rate. 25 2a-7 funds may only hold up to 5% Tier 2 rated paper. 26 According to Bloomberg.

Situation Room

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Figure 32. Key Aspects of the Money Market Investor Funding Facility (MMIFF)
Money Market Investor Funding Facility (MMIFF) - Establishes five private sector PSPVs to buy money market instruments from eligible investors - Eligible investors include money market funds initially. May be expanded to include other money market investors over time - Each PSPV will buy up to $120 billion in US dollar denominated CP, bank notes and CDs with Less than 90 days to maturity - Each PSPV buys paper issued by 10 different Tier 1 issuers - Concencentration limit of 15% for each issuer - Investors will receive 90% in cash and 10% in ABCP - ABCP is a 10% first loss piece - Price is amortized cost which means par - Federal Reserve Bank of New York lends 90% of purchase price to PSPV senior to the ABCP - Program runs until April 30, 2009 unless extended
Source: Federal Reserve.

Term Asset-Backed Securities Loan Facility (TALF)


TALF program provides $200 billion in loans to lend against AAA-rated consumer ABS.

The Federal Reserve announced the Term Asset-Backed Securities Loan Facility (TALF) on November 25. The program will provide $200 billion in loans to lend against AAA rated cash ABS backed by auto loans, student loans, and SBA guaranteed small business loans. On December 19, the Federal Reserve released additional details on the TALF. Figure 33 below shows the highlights.

Clarification on TALF
The Federal Reserve put out clarification on the TALF program addressing most of the questions we had originally in a manner that may make the program highly effective. Loan maturities were extended from 1 to 3 years and auctions were abandoned in lieu of specified loans. Haircuts, however, remain to be specified, but they did provide clarity they would be based on both the riskiness of the collateral and its maturity. The Fed clarified key uncertainties regarding loan terms, in both pricing and allocation. The original proposed auction process meant potential bidders would not know their loan amounts, making it difficult to commit to purchasing the underlying collateral for the loan. In the revised approach, loan amounts will be requested by the borrower and proceeds will be distributed in a loan vs. collateral fashion. That relieves uncertainty as to receipt of financing, but may still require for leverage users some intermediate 27 leverage provider. Eligible ABS criteria were also further clarified and eligible borrower definition was limited to corporations and a minimum loan size of $10M narrowed the borrower definition from the original proposal. Figure 33 below summarizes the new terms. Note that the eligible ABS collateral for a particular borrower must not be backed by loans originated or securitized by the borrower or by an affiliate of the borrower. This criteria is designed to limit banks from originating deals and placing them on their own balance sheet. However, this does not preclude another bank (a non-originating bank)
For example, in order to access the Fed loans, the borrower must first secure the assets. In order to do that another intermediate lender may be required. The intermediate lender would then be paid off by the TALF loans upon receipt of those proceeds. Simultaneous settlement of both the asset purchase and the TALF loan could effectively eliminate the requirement of an intermediate lender.
27

Situation Room

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35
from purchasing ABS assets and borrowing from the TALF against these assets. As we highlighted in our original summary announcements (portions of which we repeat below), the non-recourse nature of the loans coupled with no mark-to-market or remargining requirements means after accounting for the haircut, assets associated with the TALF loan could be treated with a zero risk weight for risk weighted assets purposes and could be excluded from leveraged capital purposes as was the treatment in the case of AMLF. However, the release did not provide this guidance and this remains an open area. We also reprint parts of our original summary analysis from the announcement date.

Figure 33. Key Terms in the TALF


Term Asset-Backed Securities Loan Facility (TALF) - The NY Fed provides $200bn in loans to lend against AAA rated (by at least two agencies) cash ABS - The Treasury will provide $20bn in credit protection to the Fed using TARP funds (10% 1st loss piece) - Eligible collateral includes auto loans, credit cards and student loans * Only U.S. dollar-denominated ABS originated after January 1, 2009 * Substantially all underlying exposures must be U.S. domiciled * Underlying auto loans issued after Oct 1, 2007, SBA guaranteed loans after Jan, 2008 and student loans after May 1, 2007 * Eligible credit card ABS must be issued to refinance existing credit card ABS maturing in 2009 * May be expanded later to include commercial mortgages, non-Agency residential mortgages or other asset classes - Eligible borrowers under the TALF include all U.S. companies (including those that have a non-US. parent company) - TALF loans will have a 3 year term, with non-recourse to the borrower - Not subject to mark-to-market or re-margining requirements - Haircuts to be established by the New York Fed for each class of eligible collateral based on riskiness - Loans ($10 million min size) will be allocated at the discretion of the New York Fed * Contingent on delivery of the eligible ABS collateral - Borrowers must use a primary dealer as agent - Sponsor of ABS must comply with executive compensation requirements of the EESA
Source: Federal Reserve, Treasury, Banc of America Securities LLC.

Leveraging the TARP 28


The Term ABS Loan Facility (TALF) program effectively leverages the TARP funds, turning $20bn of that into upwards of $200bn of purchasing power. Critically for banks accessing the program, the non-recourse nature of the loan and no re-margining suggest the potential for a zero risk weighting and an exclusion from leverage capital purposes much as in the AMLF. That could remove the balance-sheet constraint a key reason for the freeze in these markets but those conditions and others have not yet been specified. TALF contributes to financial system repair necessary to make QE (quantitative easing) effective. TALF is unique relative to other Fed lending programs in that its benefits extend to any US-domiciled investor [subsequently modified to be limited to US companies]. Assets include auto loans, student loans, credit card loans and small business loans. While commercial and residential mortgage loans have been excluded, the language clearly contemplates expanding the program later to include these assets. That expansion suggests that corporate loans could also eventually be included, providing critical liquidity support for C&I loans though at this point there has been no mention of such an extension to these assets from the Treasury Secretary.
28

Based on the November 25, 2008 Situation Room.

Situation Room

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GSE Direct Obligation & MBS Purchase Program
The Federal Reserve also announced November 25 the GSE Direct Obligation & MBS Purchase Program, which purchases $100 billion of Fannie, Freddie and Home Loan debentures as well as $500 billion of Agency MBS. Here the Fed expands the monetary base, as it continues its program of effective quantitative easing, and at the same time by directing those purchases at agency debt and MBS in lieu of typically using Treasuries will aid in reducing the cost of mortgages. The Fed has purchased $10.4 billion in agency debentures as of December 19, 2008. Additionally on December 30, 2008 the Federal Reserve released further details regarding the MBS Purchase Program including security eligibility, timing and investment strategy. Figure 35 describes the details.
Figure 34. Highlights of the GSE Direct Obligation & MBS Purchase Program

GSE Direct Obligation/MBS Purchase Program -The Fed will purchase up to $100bn of Fannie, Freddie and Home Loan debentures as well as up to $500bn of Agency MBS -GSE direct obligations will be purchased from dealers through an auction process -Purchases of MBS will be conducted by four investment managers and a custodian
Source: Federal Reserve.

Figure 35. $500 Billion Agency MBS Purchase Program Details on December 30, 2008

MBS Purchase Program 1. Security Eligibility -Only fixed rate agency MBS guaranteed by Fannie Mae, Freddie Mac & Ginne Mae -Includes (but not limited to) 30 yr, 20 yr & 15 yr securities -Excludes CMOs, REMICs, Trust IPOs / Trust POs and other mortgage derivatives and cash equiv 2. Timing -Purchases expected to start in early January 2009 -Purchases expected to occur over two quarters, by end of 2Q09 3. Investment Strategy -Will employ passive buy and hold strategies in accordance with guidelines from the Fed -Purchases will be guided by commonly referenced market indicies -Will be financed through creation of additional bank reserves -May involve use of dollar rolls as a supplemental tool (to smooth market supply & demand)
Source: : Federal Reserve.

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Fed Liquidity Facilities


Figure 36. Federal Reserve Liquidity Facilities
Excluding the Maiden Lane Portfolio, the AIG Line of Credit and the Foreign Currency Swap Arrangements
Regular Open Market Operations (Repos and Discount Window Reverse Repos) Announcement Date Term Auction Facility (TAF) December 12, 2007 Primary Dealer Credit Facility (PDCF) March 16, 2008 Securities Lending Term Securities Lending Facility (TSLF) March 11, 2008 ABCP MMF Liquidity Facility (AMLF) September 19, 2008 Depository Institutions, Bank Holding Companies, US Branches of Foreign Banks Funds Commercial Paper Funding Facility (CPFF) October 7, 2008

Who can borrow?

Primary Dealers

Depository Institutions

Primary Credit-Eligible Depository Institutions

Primary Dealers

Primary Dealers Primary Dealers

Primary Dealers, Issuers of CP

What are they borrowing?

Funds

Funds

Funds

Funds

US Treasuries

US Treasuries

Funds

What collateral can US Treasuries, Agencies, Agency MBS be pledged?

Full Range of Discount Full Range of Discount Window Collateral* Window Collateral*

Broadened to include types of collateral that can US Treasuries be pledged in the tri-party repo systems

All IG Debt

First-Tier ABCP

First-Tier CP, including ABCP

Typically Term is overnight-14 days though What is the term of authorized for up to 65 loan? days. New single tranche program is 28 days. How frequently are Once or more daily operations conducted?

Typically overnight but authorized up to several weeks and added the Term 28 or 84 days Discount Window Program (up to 90 days) As requested Every other week

Overnight

Overnight

28 days. Additionally for TSLF options typically 2 weeks or less

Up to 120 days for Depository Institutions, Up to remaining term of financed ABCP for NonDepository Institutions (ranges from overnight to 270 days) Once or more daily

3-month US denominated CP using financing provided by the NY Fed

As requested

Daily

Weekly

As requested Greatest amount outstanding by issuer b/t Jan 1 & Aug 31, 2008 $332 billion

Maximum Allowed -

$900 billion

$150 billion

What is the latest borrowing?

$80 billion**

$85 billion

$450 billion

$38 billion

$5.7 billion

$183 billion***

$24 billion

* Includes US Treasuries, Agencies, State/Political Subdivisions, CMOs, ABS, Corporate Bonds, MM instruments, Residential Real-Estate Loans, Commercial Industrial Agricultural Loans, Commercial Real Estate Loans, Consumer Loans. ** Does not account for reverse repos. *** Exceeds the maximum allowed because the number includes exercised TSLF options that come in addition to the maximum. Source: Federal Reserve.

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Economists: Peter E. Kretzmer (646) 855 1046 Mickey Levy (646) 855 1045 Gary Bigg (646) 855 1980 Published January 2, 2009 for week of January 5, 2009

Economics
Record Low Confidence, More Housing Declines but Hope for Spending? 29
The year 2008 ended with the U.S. in severe recession. With labor market conditions dismal, Conference Board consumer confidence hit an all-time record low in December. The long fall in housing also continued late in the year, as sales plummeted and home price declines reaccelerated. However, five months of decline in inflation-adjusted consumer spending ended in November, a sign that the huge declines in energy costs are providing some consumer relief and the worst of the adjustment to large wealth declines may be past. But we do not expect a quick consumer-led recovery. The Conference Boards consumer confidence index, compiled since February 1967, fell to a 41-year record low of 38.0 in December. While other sentiment indices have improved slightly in the past month or so, the deteriorating labor market, with a prominent place in the Conference Board survey, was behind Decembers surprise decline. The decline was composed of a small drop in consumer expectations in December, which fell to 43.8 but remained well above the record low of 35.7 set in October, and a large drop in the present situation index, which fell to its lowest since April 1992. Prominent in the computation of the present situation index is the closely watched job-market assessment, which deteriorated markedly in December. The share of respondents reporting jobs plentiful fell to 6.2% in December, while the share reporting jobs hard to get rose to 42.0%, both at levels last seen in 4Q 1992. The results point to another dismal employment report for December. We expect the loss of 475,000 jobs and a rise to 7.0% in the unemployment rate. We foresee an 8.1% peak jobless rate in late-2009. The October Case-Shiller Home Price Index, off 18.0% versus its year-ago level, declined at an accelerating pace in the month. On a month-to-month basis, the index fell 2.2%, versus a 1.8% decline in September and only 1.0% in August. For the twenty Case-Shiller regions, sixteen posted larger month-to-month declines in October than in September. For the second consecutive month, none of the twenty Case-Shiller regions posted month-on-month home price increases. In recent months, home price declines have shown the impact of the sharp worsening in recessionary conditions. We expect this trend to continue while recent mortgage rate declines provide limited support. Home sales also worsened in November: after posting a 5.2% decline in October, new home sales fell 2.9% in November, while existing home sales fell 8.6%. The number of homes for sale and under construction fell 7.3% in November, and were down an annualized 43% versus 3Q 2008. After declining 16.1% in 3Q, we project that residential investment fell an annualized 26.0% last quarter. We forecast a decline of 28.1% in 1Q 2009, before any tapering begins.

The Conference Boards consumer confidence index fell to a 41-year record low in December, pointing to another dismal employment report

Home price declines have accelerated in recent months, reflecting the sharp worsening in the recession

The pace of residential construction decline picked up in 4Q and will be maintained this quarter

Highlight from the U.S. Economic Weekly: Record Low Confidence, More Housing Declines but Hope for Spending? published earlier today.

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Aided by the boost to real disposable personal income provided by falling energy prices, inflation-adjusted consumer spending rebounded 0.6% in November, its first monthly gain since May. Durable and service spending rose 0.6% and 0.1% respectively in November, while nondurable consumption jumped 1.5%, following 5 consecutive monthly declines. The break in the downward trend in real spending implies a softer 4Q consumption decline than previously estimated, a bit of solace in a quarter of rapidly falling economic activity. We estimate that consumer spending fell at a 1.8% annualized pace last quarter versus a 3.8% rate of decline in 3Q 2008. Following a roughly 3% pace of decline in the second half of last year, we forecast about a 1% pace of decline in the first half of 2009. The pace of decline should diminish as household spending falls into line with new lower levels of household net worth. However, job cuts and tight credit will continue to constrain spending in 2009. Moreover, high levels of consumer debt point to a prolonged period of below-trend consumption, lasting into 2010.

While consumer spending will remain weak all year, the pace of decline should diminish in 1H 2009 relative to the second half of last year

Manufacturing Recession Continued to Worsen in December 30


No industries showed growth last month; 16 indicated declining economic activity, while 2 indicated no change. Notably, there was no sign in the December report that the pace of decline is yet bottoming. Peter Kretzmer Economist (646) 855 1046

The manufacturing recession continued to worsen in December, as the ISM manufacturing index recorded a 5th consecutive below-50 reading. The composite index fell to 32.4, while new orders fell at a record-setting pace. Export orders also continued to weaken at an accelerating pace last month as did input prices. The ISM manufacturing survey fell to 32.4 in December (versus 36.2 in November), well below the 35.4 median of analysts forecasts (according to Bloomberg). No industries showed growth last month; sixteen industries indicated declining economic activity, while two indicated no change. The new orders index set an all-time record low of 22.7 (versus 27.9 in November). A stunningly low 5% of respondents indicated rising orders in December, while 64% reported declines. Production also continued to plummet, with the index falling to 25.5 in December (versus Novembers 31.5), also an all-time record low. The previous records that were shattered last month had been set during the credit control period of June 1980. The employment index also gapped lower to 29.9 (versus 34.2 in the previous month). The share of respondents indicating lower payrolls hit 50% for the first time since early-1958! Export orders worsened significantly in December, as the index fell to 35.5 at the end of its 21st year of compilation. This result is indicative of the worldwide nature of the current economic decline. The price index fell to 18.0 in December, lowest since June 1949! Only 2% of respondents indicated rising input prices, while 66% reported declines. Notably, there is no sign in the December report that the pace of manufacturing decline is yet bottoming.

30

This U.S. Economic Data and Policy Commentary was published earlier today.

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Figure 37. ISM Manufacturing
ISM Manufactur ing: New Or der s Index
SA, 50+=Incr easing

ISM Manufactur ing: New Expor t Or der s Index


SA, 50+=Incr easing 67. 5 67. 5

60. 0

60. 0

52. 5

52. 5

45. 0

45. 0

37. 5

37. 5

30. 0

30. 0

22. 5 06 07 08

22. 5

Source: Institute for Supply Management /Haver Analytics.

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Important Information Concerning Economists


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REG AC ANALYST AND FIRM CERTIFICATION


The research analyst whose name appears on the front page of this research report certifies that: (1) all of the views expressed in this research report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of the research analysts compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst in this research report. To the extent that any of the views expressed in this report have been produced as a result of the application of the Credit OAS quantitative proprietary model, Banc of America Securities LLC (BAS) and its affiliates certify that (1) the views expressed in this report accurately reflect the Credit OAS quantitative model as to the securities and companies mentioned in the report and (2) no part of the firms compensation from any company mentioned in this report was, is or will be, directly or indirectly, related to the views or results produced by the Credit OAS quantitative model. For a description of the Credit OAS proprietary credit evaluation model, including the data input into the model, please see Introduction to Lighthouse: Credit Option Adjusted Spread, Portfolio Analytics and Data Analysis, dated November 24, 2006.

IMPORTANT RESEARCH CONFLICT OF INTEREST DISCLOSURES


The analyst and associates responsible for preparing this research report receive compensation that is based upon various factors. These include (i) the overall profitability of BAS and its affiliates, (ii) the profitability of the fixed income department of BAS and its affiliates and (iii) the profitability of BAS and its affiliates from the fixed income security asset class covered by the analyst or associate. A portion of the profitability of BAS and its affiliates, their fixed income department and each security asset class is generated by investment banking business. Research analysts and associates do not receive compensation based upon revenues generated from any specific investment banking transaction. BAS and affiliate policy prohibits research personnel from disclosing a rating, recommendation or investment thesis for review by an issuer prior to the publication of a research report containing such rating, recommendation or investment thesis. Materials prepared by BAS and affiliate research personnel are based on public information. BAS and its affiliates prohibit analysts, their associates and members of their households from maintaining a financial interest in the securities or options of any company that the analyst covers except in limited circumstances as permitted by BAS and affiliate policy. Any such direct securities ownership by the analyst(s) preparing this report is disclosed above. The absence of any such disclosure means that the analyst(s) preparing this report does(do) not have any such direct securities ownership in his or her covered companies mentioned in this report. Such persons may own diversified mutual funds. BAS and its affiliates are regular issuers of traded financial instruments linked to securities that are mentioned in this report.

BANC OF AMERICA SECURITIES RATINGS DISCLOSURES


BAS High Grade and High Yield Research employ a Buy/Neutral/Sell rating system, and these recommendations carry a time horizon of six months. Buy: Spreads and / or total returns are likely to outperform sector averages over the next six months; the company has improving credit fundamentals and/or it is trading at a notable spread concession relative to bonds of comparable risk within the sector. Neutral: Spreads and / or total returns are likely to perform equal to or near sector averages over the next six months; the company generally has solid credit fundamentals and/or it is trading in line relative to bonds of comparable risk within the sector. Sell: Spreads and / or total returns are likely to underperform sector averages over the next six months; the company may have weakening credit fundamentals and/or it is trading at a notable spread premium relative to bonds of comparable risk within the sector. High Grade and High Yield Research use the following rating system with respect to Credit Default Swaps (CDS). Buy: We recommend that investors buy protection in CDS, therefore going short credit risk; Neutral: We are neutral on CDS and expect performance in line with sector performance; Sell: We recommend that investors sell protection in CDS, therefore going long credit risk. High Grade Research also employs a formal structure to define sector performance, using Overweight/Market Weight/Underweight. The sector recommendation time horizon is determined by the expected performance over the next six months, but sector recommendation changes may occur at any time based upon sector analysis and relative value. Overweight: The sector is expected to outperform excess spread returns of High Grade corporate indices, namely the BAS Broad Market Index (BAS BMI), over the next six months. Market Weight: The sector is expected to perform in line with excess spread returns of High Grade corporate indices, namely the BAS BMI, over the next six months. Underweight: The sector is expected to underperform excess spread returns of High Grade corporate indices, namely the BAS BMI, over the next six months. This report may contain a trading call which highlights a specific identified near-term catalyst or event impacting a security, company, industry sector or the market generally that presents a transaction opportunity, but does not have any impact on the analysts "Buy," "Sell," or "Neutral" rating (which is based on a 6month investment horizon). Trading calls may differ directionally from the analysts rating on a security or company because they reflect the impact of a nearterm catalyst or event.

Rating Distribution*
Coverage Universe Buy Hold Sell Recommendations 241 286 104 Pct. 38 45 16 Investment Banking Clients Buy Hold Sell Recommendations 101 130 68 Pct.** 42 45 65

* For the purposes of this Rating Distribution, Hold is equivalent to our Neutral rating. ** Percentage of recommendations in each rating group that are investment banking clients. As of 12/01/2008.

Further information on any security or financial instrument mentioned herein is available upon request.

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Disclaimers
This document is being provided to you based on the fact that you are a Qualified Institutional Buyer under Rule 144A of the Securities Act of 1933 or equivalent sophisticated institutional investor or professional in the fixed income market. Recipients who are not institutional investors or market professionals should seek the advice of their independent financial advisor before considering information in this report in connection with any investment decision or for a necessary explanation of its contents. This report has been prepared as part of independent research activity or quantitative analytics and not in connection with any proposed offering of securities or as agent of the issuer of any securities. This report has been published independently of any issuer of securities mentioned herein. None of BAS, its affiliates or their analysts (collectively, BofA) have any authority whatsoever to make any representation or warranty on behalf of the issuer(s). This report is provided for information purposes only and is not an offer or a solicitation for the purchase or sale of any financial instrument. Any decision to purchase or subscribe for securities in any offering must be based solely on existing public information on such security or the information in the prospectus or other offering document issued in connection with such offering, and not on this report. BofA, through business units other than Debt Research, may have issued and may in the future issue trading ideas or recommendations that are inconsistent with, and reach different conclusions from, the information presented in this report. Such ideas or recommendations reflect the different time frames, assumptions, views and analytical methods of the persons who prepared them, and BofA is under no obligation to ensure that such other trading ideas or recommendations are brought to the attention of any recipient of this report. Securities recommended, offered or sold by BofA are not insured by the Federal Deposit Insurance Corporation, are not deposits or other obligations of any insured depository institution (including Bank of America, N.A.) and are subject to investment risks, including the possible loss of the principal amount invested. The information contained in this report (with the exception of the information set forth under the captions Regulation AC Certification and Important Disclosures) has been obtained from and is based on sources believed to be reliable, but we do not guarantee its accuracy or completeness and it should not be relied upon as such. All opinions, projections and estimates constitute the judgment of the author as of the date of the report and are subject to change without notice. Prices also are subject to change without notice. BofA is under no obligation to update this report and BofAs ability to publish research on the subject company(ies) in the future is subject to applicable quiet periods. You should therefore assume that BofA will not update any fact, circumstance or opinion contained in this report. Investing in non-U.S. securities may entail certain risks. The securities of non-U.S. issuers may not be registered with, nor be subject to, the reporting requirements of the U.S. Securities and Exchange Commission. There may be limited information available on foreign securities. In general, foreign companies are not subject to uniform audit and reporting standards, practices and requirements comparable to those of U.S. companies. In addition, exchange rate movements may have an adverse effect on the value of an investment in a foreign stock and its corresponding dividend payment for U.S. investors. 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Neither BofA nor any officer or employee of BofA accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents. BofA does not provide tax advice. Accordingly, any statements contained herein as to tax matters were neither written nor intended by the sender or BofA to be used and cannot be used by any taxpayer for the purpose of avoiding tax penalties that may be imposed on such taxpayer. If any person uses or refers to any such tax statement in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement to any taxpayer, then the statement expressed above is being delivered to support the promotion or marketing of the transaction or matter addressed and the recipient should seek advice based on its particular circumstances from an independent tax advisor. Notwithstanding anything herein to the contrary, any party hereto (and any of its employees, representatives and other agents) may disclose to any and all persons, without limitation of any kind the tax treatment or tax structure of this transaction. Materials prepared by BAS and BASL research personnel are based on public information. Facts and views presented in this material have not been reviewed by, and may not reflect information known to, professionals in other business areas of BAS, BASL and their affiliates, including investment banking personnel. BAS and BASL research personnels knowledge of legal proceedings in which BAS, BASL and their affiliates may be plaintiffs, defendants, co-defendants or co-plaintiffs with or involving companies mentioned in this report is based on public information. 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These disclosures should be read in conjunction with the Banc of America Securities Limited general policy statement on the handling of research conflictsavailable upon request. To German Customers: In Germany, this report should be read as though BAS has acted as a member of a consortium that has underwritten the most recent offering of securities during the past five years for companies covered in this report and holds 1% or more of the share capital of such companies. To Canadian Customers: The contents of this report are intended solely for the use of, and only may be issued or passed on to, persons to whom BAS is entitled to distribute this report under applicable Canadian securities laws. In the province of Ontario, any person wishing to effect a transaction should do so with BAS, which is registered as an International Dealer. With few exceptions, BAS only may effect transactions in Ontario with designated institutions in foreign securities as such terms are defined in the Securities Act (Ontario). To Hong Kong Customers: Any Hong Kong person wishing to effect a transaction in any securities discussed in this report should contact Banc of America Securities Asia Limited. To Customers in Other Countries: This report, and the securities discussed herein, may not be eligible for distribution or sale in all countries or to certain categories of investors. In general, this report may be distributed only to professional and institutional investors. This report may not be reproduced or distributed by any person for any purpose without the prior written consent of BAS. Please cite source when quoting. All rights are reserved. 2009 Bank of America Corporation

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Banc of America Securities Debt Research Directory


Credit Strategy Research
Jeffrey A. Rosenberg, CFA Head of Credit Strategy Research

High Grade Research

High Yield Research


Larry Bland Head of High Yield Research Healthcare, Deathcare Andrew Bressler, CFA Washington Healthcare 646.855.6502

646.855.7927 Dennis P. Coleman, CFA 646.855.6220 Head of High Grade Research Michael Contopoulos 646.855.6372 Energy, Pipelines, Master Limited Partnerships Lighthouse Portfolio Strategy & Analytics Michael J. Barry 646.855.7547 Hans Mikkelsen 646.855.6468 Insurance, REITs High Grade Kevin Christiano 646.855.7485 Olivera Radakovic 646.855.3496 Media, Telecommunications Lighthouse Data Analysis & Indices Todd Duvick, CFA 704.388.5053 Glen Taksler 646.855.7559 Consumer, Grocers, Retail Derivatives Strategy Gerardo Fuentes 646.855.6208 Technology Douglas Karson 646.855.7405 Aerospace/Defense, Manufacturing, Autos Marisa B. Moss Transportation, Chemicals David K. Peterson, CFA Healthcare, Leisure Peter D. Quinn, CFA Electric Utilities & Power 646.855.8493 704.386.9419 646.855.8284

202.442.7454

Ana Goshko 646.855.9936 Telecommunications, Towers, Business & Other Services Bo Hunt 646.855.9435 Chemicals, Paper, Packaging, Forest Products Douglas Karson Autos 646.855.7405

James Kayler, CFA 646.855.9223 Gaming, Lodging & Leisure, Restaurants Kelly J. Krenger Energy William M. Reuter Consumer, Retail Peter D. Quinn, CFA Electric Utilities & Power 646.855.6410 646.855.6363 646.855.8284

Daniel Volpi, CFA 646.855.9872 Building Materials, Metals & Mining, Paper, Packaging, Forest Products

Mike Terwilliger 646.855.6270 General Industrials, Metals & Mining, Aero/Defense Eric Toubin, CFA Technology, Food & Beverage 646.855.6498

Stephen Weiss 646.855.7298 Cable/Satellites, Broadcasting/Publishing, Theaters

The persons listed on this directory have the title research analyst. Unless otherwise noted, any other contributors named on the front cover of this report but not indicated above have the title research associate. BAS (United States) Banc of America Securities LLC
One Bryant Park New York, New York 10036 Tel. Contact: 888.583.8900 214 North Tryon Street Charlotte, North Carolina 28255 Tel. Contact: 800.432.1000

All research analysts are employed by Banc of America Securities LLC (BAS) except as noted above.

BASL (United Kingdom) Banc of America Securities Limited


5 Canada Square London E14 5AQ, United Kingdom Tel. Contact: +44 (20) 7174 4000

BASAL (Hong Kong) Banc of America Securities Asia Limited


42 Floor, Two International Finance Centre 8 Finance Street, Central Hong Kong Tel. Contact: +852 2847 5222
nd

Bank of America Singapore Limited (Singapore)


Republic Plaza 9 Raffles Place #18-00, Singapore 048619 Tel +65 6239 3888

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