AAM Corporate Credit View

July 2009

AAM continues to be cautiously optimistic about Corporate bonds. Corporate credit spreads have tightened materially this year, generating 13.49% excess returns year to date as of July 10, 2009. The tightening has been broad based across industries, all benefiting from the improvement in confidence in the financial sector and economy. Except for financials and most deep cyclical industries, spreads have returned to their 3 year average in the intermediate to long end of the curve. New issue concessions have tightened over the year as demand for Corporate bonds, especially those that are higher quality, has increased. Therefore, unlike in 2007-2008 when the technical driver was an exodus from Corporates to safe-haven Treasuries, the technical driver has been positive this year.

AAM Corp Credit 7-09 1

Source: Moody’s Economy.com

We enter the earnings season with spreads over 200 basis points tighter and signs of stabilization from an economic standpoint. Our expectation for unemployment to peak between 10-11% in the first half of next year is consistent with the markets’ and should allow Industrial and Utility companies to maintain their second half forecasts for 2009. Financial firms are expected to report dismal earnings the remainder of the year due to the elevated provision costs as late stage loans such as commercial & industrial and commercial real estate become a bigger problem. We are watching three main areas in the bank sector over the near term: (1) the trajectory and magnitude of loan losses (2) foreclosure mitigation (3) rate of change in loan balances. As long as these track within expectations, bank spreads should remain range bound with technicals possibly placing pressure on them in the latter part of the year as the Fed’s Temporary Liquidity Guarantee Program (TLGP) expires and banks resume funding in the unsecured market.AAM Corp Credit 7-09 2

Since late 2008, AAM has been buying Corporate bonds from issuers that will withstand a period of prolonged single-digit economic growth. We need more than “green shoots” and “stress tests” to get more bullish and invest in the broader financial and deep cyclical sectors. We remain cautiously optimistic as we enter this very important earnings season.

AAM Corp Credit 7-09 3

Source: AAM, FDIC, Federal Reserve
Note: 4Q’09 reflects SCAP stressed case assumptions

AAM refers to Asset Allocation & Management Company, LLC, an SEC registered investment advisor specializing in insurance investment management. This report does not constitute an offer to any person to provide investment management services in any jurisdiction where unlawful or unauthorized. AAM only provides products or services to qualified investors.

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