2012 convertibles outlook

EQUITY LINKED STRATEGIES | CONVERTIBLES RESEARCH January 06, 2012

V K i h CFA

US Convertibles Outlook 2012

Venu Krishna, CFA+1 212 526 7328

[email protected]

Manoj Shivdasani, CFA

Dusting off from a Stumble+1 212 526 5995

[email protected]

Piyush Anchliya+1 212 526 8432

[email protected]

Barclays Capital does and seeks to do business with companies covered in its 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.Investors should consider this report as only a single factor in making their investment decision.PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 46

Agenda

• Performance • Primary Market Outlook2011

• Technicals Recap

• Economic Outlook • Equity Outlook

MACRO OUTLOOK• Credit Outlook • Volatility Outlook

• Valuations Attractive

MACRO OUTLOOK

• Market Technicals Broadly Supportive• Market Composition Balanced• Setting the Stage

CONVERTS OUTLOOK

• Expected Returns• Recommended Positioning• Opportunities & Risks

RECOMMENDED POSITIONING

January 6, 20122

Performance Recap

2011 US Convertibles Returns – UnderperformanceAsset Class Underperforms

15.61520 %

2.1 1.5

-0.8

5.08.4

(5)0 5

10 15

Source: Barclays Capital.

-5.3(10)US Convert Composite

S&P 500 Russell 1000 NASDAQ BarCap US High Yield

BarCap US Credit 7-10yr Treasury

2011 YTD

Hedged Returns

(5)

0 %

-3.3

-8.1

-19.1

-3.0-5.0 -5.1

-2.6 -3.9

(20)

(15)

(10)

(5)

19.1(25)

HFRX Convertible Arbitrage

HFRX Distressed Securities

HFRX Equity Hedge

HFRX Equity Market Neutral

HFRX Event Driven

HFRX Macro HFRX Merger Arbitrage

HFRX Relative Value Arbitrage

2011 YTD

January 6, 20124


US Converts: Industrials, Transports and Consumer Cyclicals Underperform

Sector Performance

10%

(6.7)

(1.5)

1.5 1.5

(0.4)

4.4

(74)-10

-5

0

5

10

(16.7)

( )

(18.7)(16.5)

(29 6)

(7.4)

-30

-25

-20

-15

(29.6)-35

Basi

c In

dust

ry

Cap

Goo

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unic

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umer

Cyc

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oncy

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Ener

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Tech

nolo

gy

Tran

spor

t

dust

rial

Oth

er

Util

ities

ce In

stitu

tions

B

Com

Con

s

Con

sum

e

Ind

Fina

nc


2011 YTD Return

January 6, 20125

Equity Sensitive, Lower Grade & Mandatories Underperform

Returns by Market CapitalizationReturns by Structure1.1

0

5-10

-3.8

-9.2

-20

-15

-10

-5

-4.6

-2.4

7-6-5-4-3-2

Source: Barclays Capital.Source: Barclays Capital.

-22.4-25Cash Pay

BondsZero Cpn/OID Preferreds Mandatories

2011 YTD Return

-7.2-8-7

Small Cap Mid Cap Large Cap

2011 YTD Return

Returns by ProfileReturns by Credit Quality

-3 6-0.8

-5

0

10.010

15

-3.6

-15.3

-8.3

20

-15

-10

-2.7 -2.3-5

0

5

10

-20Investment

GradeIntermediate

GradeLower Grade Non-Rated

2011 YTD Return

-7.1-10Typical Equity

SensitiveBusted Distressed

2011 YTD Return

January 6, 20126


Widening Spreads, Idiosyncratic Risk & Valuation Cheapening Impacted Convert Returns

Excess Returns in the Debt MarketsExcess Returns in the Convert Market

15%Total Return = 8.35% Total Return = 4.98%0.03%

0%

1%

11.97%7.38%

5%

10%

15%-0.70%

-3.63%-2.20%

-2.22%

-2.62%4%

-3%

-2%

-1%

0%

T t l R t 7.38%

-3.62% -2.40%

-5%

0%

IG HY

-6%

-5%

-4%

IG Non-IG NR

Total Return = -2.92%




Widening Spreads and Idiosyncratic Equity Declines Affected Convert Performance

Rates Excess ReturnSpread and Rates Excess Return

Although a rally in rates drove credit market returns, it contributed little to convert performance

Credit spread widening was a headwind in the convert market and Convert marketCredit spread widening was a headwind in the convert market and Convert market cheapened relative to straight debt market

Idiosyncratic risk negatively impacted overall index returns (MF Global, Cemex, Ford, GM American Airlines Citigroup Solar sector)

January 6, 20127

GM, American Airlines, Citigroup, Solar sector)

Yet Long Term Risk-Adjusted Returns Remain Competitive

Monthly Returns Sharpe Ratios

0 63

0.79

0 7

0.8

0.9

0.63

0.45

0.61

0 4

0.5

0.6

0.7

0.2

0.3

0.4

0.0

0.1

Cvts S&P 500 HY IG


January 6, 20128

Primary Market Outlook

Primary Market Disappoints, Yet AgainEquity Issuance Steady as WellStraight Debt Primary Market Robust

$383400

500$bn

300$bn

$240

$383

$296$335

$50

$153

$263$224

100

200

300

400

222255

209181

100

150

200

250


$

02008 2009 2010 2011

US IG US HY 0

50

2008 2009 2010 2011

Leading to Negative $26bn Organic GrowthHowever Convert Issuance Down

20

30$bn

70$bn

$23.4

-$11.0-$19.9

-$5.2

-$25.6-10

0

10

20$61.6

$39.7$35.1

2030405060

$

-30

-20

2007 2008 2009 2010 2011

$24.5

01020

2008 2009 2010 2011

January 6, 201210


Despite Low Issuance, New Issue Pricing Attractive

New Issue Cheapness (Monthly)

11.4012%

2.24 2.50 1.743.09 3.11 2.73

4.57

1.942468

10

0.35 0.00 0.1602

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecCheapness

New Issue Cheapness (Annual)

5%

4.102 51 2.92

2 06 2 303.25

4.012 48 2 571

2

3

4

2.511.69 2.06 2.30

1.17 1.762.48 2.57

0

1

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011% Issue Cheapness

January 6, 201211


Primary Market Outlook: Lacking a Catalyst, For Now

Lackluster primary issuance in the last three years due to

Low interest rates

No Near-Term Catalyst for Ramp-Up in New Issuance

Low interest rates

Deleveraging by corporations; Lack of demand for growth/restructuring capital in the current environment

D it i ifi t t d d f th t l d ’t t l t fDespite significant pent-up demand for the asset class, we don’t see a catalyst for ramp-up in new issuance in the near-term as

High equity risk premiums remain high; Low rates environment likely to persist

But Absorption Capacity Remains High

2025$bn $45B $42B

05

101520


0

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es

Like

ly to

be

Put

Like

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be

Cal

led

Inco

me

Buyb

acks

/ T

ende

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Org

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R

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ery

Org

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Ex

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ion

January 6, 201212

Technicals Held Up in 2011; Just About

Short-Term Valuation Held Up

Expansion/Declines in Pts (Top 20 TRACE Names)

1.00

-0.50

0.00

0.50


-1.001/14 2/11 3/11 4/8 5/6 6/3 7/1 7/29 8/26 9/23 10/21 11/18

Median Change

Expansion/Declines Ratio (Top 20 TRACE Names)

20

5

10

15

01/14 2/11 3/11 4/8 5/6 6/3 7/1 7/29 8/26 9/23 10/21 11/18

Expansion Decline

January 6, 201214


Fund Flows Remain Muted

Convert Arb Fund Flow ($B)Convertible Arb AUM ($B)

46$bn

50$bn

4.1

-2.0

-9.5

1.40.7

6-4-2024

4030 35 41 40

10

20

30

40

Source: Barclays Capital HFRXSource: Barclays Capital HFRX

-12-10-8-6

2007 2008 2009 2010 2011

0

10

2007 2008 2009 2010 2011AUM

Source: Barclays Capital, HFRX.Source: Barclays Capital, HFRX.

SPDR Barclays Capital Convertible Composite ETF Growth

100025mn units $mn

200

400

600

800

5

10

15

20

0

200

0

5

2009 2010 2011Number of Units (LHS) AUM (RHS)

January 6, 201215

Source: Barclays Capital, Bloomberg.

Hedge Fund Data as of Q3, 2011

Liquidity Held Up but Remains Key Investor ConcernMonthly TRACE volumes vs. Index Returns (2011)Monthly TRACE Volumes ($bn)

3035$bn

$25.2B $24.1B3035

6%8%

05

10152025

$22.5B2.2% 2.6%

0.5%2.0%

-0.7%-1.9%-2.3%

-5.8%-5.5%

6.3%

-5.6%

510152025

6%-4%-2%0%2%4%


01/09 07/09 01/10 07/10 01/11 07/11Monthly TRACE Vol Median '09

Median '10 Median '11

05

-8%-6%

01/11 03/11 05/11 07/11 09/11 11/11Index Return TRACE Volumes (RHS)

Liquidity Key Concern for Investors

Liquidity held up through the various market gyrations this year

Average monthly TRACE volumes were $24 1bn for 2011Average monthly TRACE volumes were $24.1bn for 2011

That said, market did witness choppiness and subdued volumes during intermittent periods

Sharp decline in liquidity in corporate bond markets and increased regulatory uncertainty facing broker dealers suggests that liquidity will remain a key concern for investors; Lack of supply puts additional pressure

January 6, 201216


TRACE data as of November 2011

Macro Backdrop 2012

Economic Outlook: Moderate Growth but Risks RemainBaseline Forecast: 2.5% GDP growth; 8% unemployment rate by the end of 2012

EU debt crisis major risk to outlook with non-extension of payroll tax cut key domestic riskrisk

Inflationary Pressures Building Up – Core inflation likely to reach 2.5% by the end of 2012

Yet if financial conditions deteriorate sharply, the Fed may embark upon another round of QE


Unemployment falling faster than in last cycleUS Consumer Spending Picking Up

4603m/3m % chg saar 3m/3m % chg saar

-2412m % chg 12m diff

1

2

3

-20

0

20

402

0

2

4

66

-4

-2

0

2

4


0-40Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11

Vehicle retail sales Personal consumption

6-600 01 02 03 04 05 06 07 08 09 10 11

Nonfarm employment (lhs) Unemployment rate, inverted (rhs)

January 6, 201218Summary of the views of Barclays Capital Economists Dean Maki, and Julian Callow

Recent Macro Data in the US better than ExpectedIndustrial production has picked up… …and housing starts are better than expected…

0.70%0.8%Industrial

Production635

658628

685700 Housing Starts in

000s

0.20%

0.40%

0.10%0.20%

-0 2%

0.0%

0.2%

0.4%

0.6%

590610

635628

600

along with improving consumer sentiment d l di i i di t

-0.20%-0.4%

0.2%

SEP OCT NOVSurvey Actual

500SEP OCT NOV

Survey Actual

…along with improving consumer sentiment… …and leading economic indicators

64 568 69.9

70

80Univ of

Michigan Confidence S ti t 0 60%

0.90%

0.8%

1.0% Leading Indicators

58

64.560.9

64.1

50

60

70 Sentiment

0.20%

0.60%

0.30%0.20%

0.50%

0.2%

0.4%

0.6%

Source: Bloomberg

40OCT NOV DEC

Survey Actual

0.0%SEP OCT NOV

Survey Actual

19

Source: Bloomberg

January 6, 2012

But earnings growth rates have continued to taper off and companies remain defensively positioned

Recovery in corporate profits have been stronger than revenue, but the growth rate has tapered off…

…and consensus EPS growth rates have been trending down…

20%

30%

YoY Change

18.0%18.5%

EBITDA Margin

60%

80%

Annual % change in EPS

-20%

-10%

0%

10%

20%

14 5%15.0%

15.5%16.0%16.5%17.0%

17.5%

40%

-20%

0%

20%

40%

60%

Capex has been increasing but is low relative to Return of cash to shareholders has been increasing but

-30%3/31/2006 3/30/2007 3/31/2008 3/31/2009 3/31/2010 3/31/2011

14.0%14.5%

YoY Change in Revenue YoY Change in EBITDA EBITDA Margin

-60%

-40%

1/31/2002 9/30/2003 5/31/2005 1/31/2007 9/30/2008 5/31/2010

Actual SPX EPS(TTM Lagged Fwd) 12M FWD EPS

gability of companies to invest

e u o cas o s a e o de s as bee c eas g bucompanies have so far been conservative relative to history

45%

50%

55%

6 5%

7.0%

7.5%

25%

30%

35%

40%

4 5%

5.0%

5.5%

6.0%

6.5%

Source: Bloomberg

25%12/30/2005 12/29/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010

Buybacks+Dividends/EBITDA Capex/EBITDA

4.5%12/30/2005 12/29/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010

Cash/Assets Capex/Net Assets

20

Source: Bloomberg

January 6, 2012

Risk Aversion faded to a certain extent in December in the US

But equities retained some of their defensive biaswith health care and staples being the best performers Risk Assets Outperformed in December

Abs Returns6%

1M Returns

1.0%

1.5%

2.0%

2.5%

3.0%

-4%

-2%

0%

2%

4%

6%

-0.5%

0.0%

0.5%

LQD* JNK* DXY CWB PFF* TLT* CRY

Last 1M

-10%

-8%

-6%

XLV XLP XLY XLF XLI XLK XLU XLE XME

Absolute Beta Adjusted

Equity indices globally had positive absolute returns ..and precious metals underperformed

6%Returns

10%

Abs Returns

-6%

-4%

-2%

0%

2%

4%

-10%

-5%

0%

5%

Source: Bloomberg, Barclays CapitalNote: Start date for return calculations is Nov 23rd * TLT: Treasury Bond ETF; LQD: IG Corporate Bond ETF; PFF: Preferred Stock ETF;JNK HY Corporate Bond ETF; CWB:Convertible Bond ETF

-10%

-8%

6%

.HSI. SPX RTY SX5E EEMAbsolute Beta Adjusted

-15%Agri Brent Oil Industrial Metals Gold Silver

Last 1M

21

TLT: Treasury Bond ETF; LQD: IG Corporate Bond ETF; PFF: Preferred Stock ETF;JNK HY Corporate Bond ETF; CWB:Convertible Bond ETF

January 6, 2012

Equity Outlook: ‘Muddle Through’ 2012 with Difficult 1H122012 Year End S&P Target of 1330 based on 12.9x multiple on ‘12E Earnings of $103

Risks to the range of economic outlook are asymmetric with few prospects of acceleration but significant downside risksacceleration but significant downside risks

S&P multiple to remain low at 12.9x given y/y earnings growth deceleration & heightened uncertainty surrounding public and financial sector deleveraging

Range-bound market despite optically attractive valuation; 1H likely to remain challenging but equities should fare better in second half as EU crisis fallout dissipates

Recommend scaling back aggressive sector exposure in anticipation of a difficult 1H12

Full-Year ForecastSource: Barclays Capital.

S&P 500 Level y/y Level y/y Level y/yOperating EPS* $84 48% $97 15% $103 6%P/E 15x 7% 13x -13% 12.9x -1%

Full Year 2010 Full Year 2011e Full Year 2012e

S C

Index 1258 23% 1260 0% 1330 6%*Trailing four quarter EPS. Source: Barclays Capital Equity Research

January 6, 201222Summary of the views of Barclays Capital Equity Strategy Team


Equity ValuationsValuation reflects lingering uncertainty

Equity valuations relative to Fixed Income appear compelling but the argument might be flawed due to the Fed distorting the interest rate curveg

Moreover, stocks screen only modestly inexpensive under models of economic uncertainty. B/S metrics (price/book, price to sales) and metrics that incorporate debt (EV/EBITDA or EV/Sales) are still not compelling for stocks

Valuation Relative to Fixed Income might be flawed due to Fed distorting the interest rate curve

January 6, 201223

Source: Factset, Barclays Capital.

M&A deal activity declined in 2H11

…and sector distribution was largely unchanged…The level of new M&A deal activity and announced equity value fell in the second half of 2011

100 20Communications

Basic Materials6.2%

Utilities

40

60

80

8

12

16

Communications8.2%

Consumer, Cyclical

0.9%

25.7%

Technology6.4%

0

20

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec0

4

Deal Equity Value ($ bn - left axis) # of Announced Deals (right axis)

Consumer, Non-Cyclical23.4%

Financial10.1%

Industrial10.6%

Energy14.6%

…the median risk arb spread remained relatively steady through the end of 2011

…and breakeven probabilities were in line with historic averages.

All Deals

20%

Risk Arb SpreadBreak-Even Probability

100%

Break Even %

5%

10%

15%

85%

90%

95%

Source: Bloomberg Barclays Capital

0%6/8/11 7/6/11 8/3/11 8/31/11 9/28/11 10/26/11 11/23/11 12/21/11

Average Median Historical Median

80%6/8/11 7/6/11 8/3/11 8/31/11 9/28/11 10/26/11 11/23/11 12/21/11

Average Median Historical Median

24

Source: Bloomberg, Barclays Capital.

Credit Outlook: High YieldBase Case: 5-7% Total Returns & 5-7% excess returns as well

Given an uncertain macro outlook and an expectation of modest increase in interest rates 2012 is likely to another below coupon year for total returnsrates, 2012 is likely to another below coupon year for total returns

Default rate likely to remain low at 2-3% due to lower leverage across most cyclical sectors driven by corporate discipline

Continue to favor high quality due to a) high quality shows resilience in a slow growth environment b) higher quality spreads already price-in more bad news c) no-default loss compensation is more robust for higher quality

Li idit i k i t t t l d li l f t t l

2012 Total Return Scenarios

Liquidity remains a key investor concern: structural and cyclical factors at playSource: Barclays Capital.

Expected Year End Values Base Case

Current Values

Faster Recovery

Mild Recession

Financial Crisis

10y Treasury 2.5% 2.0% 3.0% 1.8% 1.5%US HY OAS (bp) 730 750 550 900 1400US HY YTW 9.2% 9.0% 7.8% 10.3% 15.1%US HY Price 94 75 95 5 101 90 68 75

S C

US HY Price 94.75 95.5 101 90 68.75Price Return -0.8% 0.0% 5.5% -5.7% -25.2%Default Loss -1.7% -1.7% -1.7% -3.4% -6.9%Coupon Return 8.7% 8.7% 8.7% 8.7% 8.7%Year-end total return 6.1% 6.9% 12.5% -0.5% -23.4%

January 6, 201225


Credit Outlook: Investment GradeBase Case: 4.25% Total Returns and 20 bps spread tightening

1) Base case: EU sovereigns return to a stable path and spreads tighten by 40bps as they start to reflect the underlying fundamentals; however a challenging liquiditythey start to reflect the underlying fundamentals; however, a challenging liquidity environment for bonds and large-scale deleveraging by EU banks will likely persist even if EU stabilizes 2) In a much less probable outcome, a further deterioration of the situation in EU could cause a severe selloff in risky assets.

Operating fundamentals strong by historical standards and estimates for ‘12 reasonable. But capital expenditure, M&A, and share repurchases likely to put upward pressure on aggregate leverage.

Model Forecast SpreadsSource: Barclays Capital.

Non-Financials Financials US Credit Corp CDX.IGp

Current Values 192 353 245 141Modeled Value 187 321 232 141Model/real basis -5 -32 -13 0

Modeled Spreads

S C

Modeled SpreadsBase Case 162 292 205 108Downside Case 484 681 549 295Interim Expected Trading Range 170-221 302-358 214-267 111-156

January 6, 201226


Volatility Outlook: Expect to Remain High

Base Case : Realized Volatility 21% (Stress Case: 29%)

Volatility to stay high over the course of 2012, with developments in Europe being the key driver baseline forecast 21% and stress case 29% (SPX realized volatility)key driver – baseline forecast 21% and stress case 29% (SPX realized volatility)

Concerns about US double dip abated, corporate profitability encouraging and Fed’s support should limit downside. However, US not immune to significant deterioration in EuropeEurope.

SPX short dated skew is trading at pre-crisis July 2011 levels, yet high relative to long-term and pre-2008 averages

…and SPX skew still high vs. long term and pre-08 averagesSPX Term Structure has been quite volatile


201 6

5

10

15

0.40.60.81.01.21.41.6

S CS C

0Dec-09 Jun-10 Dec-10 Jun-11 Dec-11

SPX SX5E HSI VIX

0.00.2

Jun-02 Dec-03 Jun-05 Jan-07 Jul-08 Feb-10 Aug-113M Rolling 12M/3M Term Structure VolatilityMean Term Structure Volatility

January 6, 201227Summary of the views of Barclays Capital Equity Derivative Strategy Team


Volatility Outlook Contd.

Call overwriting likely to be a good strategy given the outlook for range-bound markets

Base Case : Realized Volatility 21% (Stress Case: 29%)

g y g gy g g

Realized and Implied correlations remain high on an absolute basis and after adjusting for the higher level of current volatility

Position for outperformance of U S vs European Equities using Put spreads rather

..but its secular increase across assets limits downsideCorrelation elevated relative to volatility

Position for outperformance of U.S. vs. European Equities using Put spreads rather than cash/futures; however not immune to significant deterioration in Europe

40

50

60

70

60%70%80%90%

100%

30%40%50%60%70%80%

Pairwise Correlations

0

10

20

30

10%20%30%40%50%

Dec-01 Dec-04 Dec-07 Dec-103M R l d C 3M I l d C 3M I V l (RHS)

0%10%20%30%

Dec-96 Dec-01 Dec-06 Dec-11Commodities Global Equity IndicesUSD FX crosses US Stocks


3M Realized Corr 3M Implied Corr 3M Imp Vol (RHS) USD FX crosses US Stocks

January 6, 201228Summary of the views of Barclays Capital Equity Derivative Strategy Team

Credit vs. Equity: Relatively Synchronized moves in Credit & Equity Volatility Broke Down in the U.S. Recently

While 12M SPX implied volatility dropped sharply in December, credit spreads tightened modestly

Credit spreads in the U.S. now appear wide relative to equity-implied volatility; HY p pp q y p yspreads widest relative to SPX implied vol since 2008

Positive macro views better expressed via long credit vs selling equity implied vol; on the other hand SPX implied volatility is a cheaper hedge than selling credit

Credit Spreads Wide Relative to Equity Implied Volatility

4

-2

0

2

-6

-4

06 07 08 09 10

S C

BarCap IG OAS vs SPX 12M Wtd Avg IV BarCap HY OAS vs SPX 12M Wtd Avg IV

January 6, 201229


Summary of the views of Barclays Capital Equity Derivative Strategy Team

Convertibles: Modest Expectations for 2012

Signs of Relative Value Beginning to Appear in Non-IG spreads; Aggregate Valuations have Improved

Absolute Spreads have also widenedNon-IGs have cheapened relative to HY

800682800

1000bps

100

150

556 506

682

200

400

600

800

-50

0

50


0non-IG Cvts HY 'B' Index

12/31/2010 12/30/2011

Jan 11 Apr 11 Jul 11 Oct 11

Non-IG Cvts vs. HY B Index (RHS)

Aggregate Valuations AttractiveIG Implied Vol in Line with Listed Vol

33.1 31.730.337.6

32.83540%

1.52

%

24.017.8

30.323.4

05

101520253035

1-0.5

00.5

1

heap

R

ich

0Cvt IG Implied

Vol90D Realized

VolOption Surface

VolVIX Index

12/31/2010 12/30/2011-2

-1.5-1

Jan-11 Apr-11 Jul-11 Oct-11

Ch

January 6, 201231


Market Technicals Broadly SupportivePrice DistributionTerms Attractive

120

140

160Effective Equity

Exposure US Equity

0

20

40

60

80

100

120

40%60%80%

100%Exposure US Equity

US Cvts


0

30 -4

040

-50

50 -6

060

-70

70 -8

080

-90

90 -1

0010

0 -11

011

0 -12

012

0 -13

013

0 -14

014

0 -15

015

0 -16

016

0 -17

017

0 -18

018

0 -19

019

0 -20

020

0 -21

021

0 -22

022

0 -23

023

0 -24

024

0 -25

0

Current Year End 2010

0%20%

0.0% 2.0% 4.0% 6.0% 8.0% 10.0%Yield

US HY

Fund Flows into Equities and Taxable BondsHealthy Ownership Mix Between HFs and Outright

281300 $bn

70

148

0

100

200

48%

74%52%

-19(100)

2010 2011Equity Bonds

26%48%

2008Q2 2011Q3Outright

January 6, 201232


Market Profile has Improved Market Value by Market CapMarket Value by Structure

13 Zero Coupon/

OID

30 Mand.9%

60 Pref.11%

OIDs2% 95 Large Cap

40%

363 Small

111 Mid Cap26%


466 Cash Pay Bonds78%

11%Cap34%

Market Value by ProfileMarket Value by Credit Quality

153 Eq

42 Distressed2%80 IG

27%

51 Junk6%

153 Eq. Sensitive

36%147 Busted24%

27%

275 NR36%

227 Typical38%

163 Inter. G31%

January 6, 201233


2012 Convert Outlook: Setting the Stage

Valuations attractive with market trading ~1.5% cheap

Non-IGs trading cheaper relative to HY market; spreadsV l i have also widened on an absolute basis

Low HF participation & low leverage deployed reducesprobability of liquidity driven valuation pullback

Valuations

We find technicals broadly supportive

Balanced buyer baseTechnicals Supportive

Market composition and price distribution attractive

If macro conditions stabilize corporate actions are likely to

Supportive

If macro conditions stabilize, corporate actions are likely toresume

Corporate actions generally positive but a double edgedsword for arbitrage investors

Corporate Actions Positive

sword for arbitrage investors


January 6, 201234

Expected Returns

Key Macro ForecastsEconomics: 2.5% GDP growth, and continuation of easy monetary policy.

Rates: Fed Funds Rate to remain unchanged The Treasury yield curve is likely toRates: Fed Funds Rate to remain unchanged. The Treasury yield curve is likely toremain unchanged as well, as a result of supportive policy.

C dit IG 4 25% b l t t (20b d ti ht i ) d HY 5% 7% b l tCredit: IG 4.25% absolute return (20bps spread tightening) and HY 5%-7% absolutereturn (2-3% default rate, 20bps spread tightening).

Equity: Expect range-bound S&P 500. The 2012 year-end S&P 500 target of 1330 isbased on an unchanged 12.9x multiple on 2012E earnings of $103 (up 6% from 2011Eearnings of $97).

Volatility: Expect volatility to stay high over the course of 2012, with developments inEurope being the key driver. Baseline and stress case SPX realized volatility for 2012

t d t b b t 21% d 29% (2011 22 5%) ti lexpected to be about 21% and 29% (2011: 22.5%), respectively.


January 6, 201236

Base Case Returns ~ 7% UPSIDE CASE BASE CASE DOWNSIDE CASE

Equities Px Return +15% +6% -15%

Credit SpreadsCredit SpreadsIG 30 bps tighter 20 bps tighter 50 bps widerNon-IG 150 bps tighter 50 bps tighter 200 bps wider

R t U h d U h d U h dRates Unchanged Unchanged Unchanged

Volatility Unchanged Unchanged Unchanged

Default Rate0.7% for HY/NR;

0% for IG0.7% for HY/NR;

0% for IG1.7% for HY/NR;

0% for IG

Total Convert MarketTotal Convert Market Return +12.1% +6.6% -5.7%

Total Equity Return +17% +8% -13%Participation 71% 83% 44%Participation 71% 83% 44%

Using Fair Value Methodology

January 6, 201237


Recommended Positioning

Recommended Portfolio Positioning: Defensive going into 1H’12

Modest Returns to be Earned from Multiple Sources: No Low-Hanging Fruit

I id i l di it it t d t dit d ti ht i &

Portfolio Positioning and Recommendations

Income, mid-single digit equity returns, modest credit spread tightening, &incremental improvement in valuations

Defensive Positioning due to Significant Macro Uncertainty

Bond Structures (over mandatories and preferreds)

Shorter maturities; Prices closer to Par

Defensive sector positioningDefensive sector positioning

Typical and Busted names (over equity sensitive names)

Overweight Non-IGs and Non-Rated, Underweight IGs; Cheapening in Non-IGsprovides greater opportunitiesprovides greater opportunities

January 6, 201239

Recommended Positioning; Overweight Bonds/Non-IGs/MidCap and Typical Converts

Convert Profile Structures8%

11.5%80%

100%

32% 22.0%80%

100%

92%78.0%

20%

40%

60%

12%37.2%

56%

38.7%

0%

20%

40%

60%


0%Rec Portfolio Market

Cash Pay Zero Cpn/OID Preferred Mandatories

12%0%Rec Portfolio Market

Equity Sensitive Typical Busted Distressed

Credit QualityMarket Cap

28% 31.3%80%

100%

36% 37.1%80%

100%

28% 40.4%

44% 26.6%

20%

40%

60%

12% 26.2%

44%31.6%

8% 5.6%

0%

20%

40%

60%


Large Cap Mid Cap Small Cap


Investment Grade Intermediate GradeSpeculative Grade Not Rated

January 6, 201240


Recommended PositioningOverweight Technology & Consumer Discretionary and Underweight Non-REIT Financials, Materials and Healthcare.

Our underweight in Healthcare and overweight in consumer discretionary is a

Sector Exposure

g g yreflection of the absence of attractive securities/profiles

12 0%

28.0% 28.0%21.8%

15 1%20%25%30% Recommended Portfolio US Convertible Index

12.0%

8.0% 8.0%4.0% 4.0%

0.0%4.0% 4.0%

0.0%

7.6%12.1% 11.7%

8.5% 7.1% 8.4%

2.2%

15.1%

3.0% 2.5%

0%5%

10%15%

TS x- ary

gy IT als

als es are

om es


REI

T

Fina

ncia

ls e

REI

Ts

Con

. D

iscr

etio

n a

Ener

g

Mat

eria

Indu

stri

a

Con

. Sta

pl

Hea

lthc a

Tele

co

Util

iti

January 6, 201241

Recommended Positioning; Shorter Maturities, Prices Closer to Par, and Lower Delta

Distribution by PriceDistribution by Maturity

Number of Securities 8

10 Number of Securities

2

3

4

5

6Securities

02468


0

1

0-1 1-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-10 10+

0-10

10-2

0

20-3

0

30-4

0

40-5

0

50-6

0

60-7

0

70-8

0

80-9

0

90-1

00

100-

110

110-

120

120-

130

Aggregate Terms of the Recommended Portfolio

Recommended Portfolio

US Convertible IndexPortfolio Index

# of Securities 25 567Current Yield (%) 3.8 3.7CY / YTP / YTM (%) 5.4 4.9Premium (%) 59 42( )Delta (%) 42 55Years to Put/Maturity 4.3 5.0Call Protection (yrs) 2.6 2.4

January 6, 201242


Single Name Themes & Risks

Single-Name Themes

• Though Spreads have normalized, we think there are still opportunities• SFI Floater, CX 4.875s, MGM 4.25s, ILMN 0.25s

Opportunities in Credit

• High Current Income, Higher in the Cap Structure, Downside Protection via Cheap Puts

• WCC, NTAP, SBAC, CRM, ADS Equity Swaps

• M&A Activity, Binary Events• WebMD, Risk-Arb situations

Event-Based Trades

• Complex Structures, Technical supply-demand trends• Cheap Embedded Puts in Deep ITM Converts

Overlooked Situations/Valuation Plays

January 6, 201244


Risks: Macro Front and Center

EU debt crisis & US fiscal concerns remain key issues

EU recession

US fiscal issues and policy uncertainty going into the election year

Macro

Though valuations have cheapened

Performance likely a function of policy actions, economic outlook and associated performance of credit equity andValuations outlook and associated performance of credit, equity and rates

Expect correlations to remain high

Valuations

Liquidity remains a key investor concern: structural and temporary factors at play

Low HF participation, regulations

Liquidity

High volatility, lack of supply


January 6, 201245

Analyst Certifications and Important DisclosuresAnalyst Certification:

We, Manoj Shivdasani and Venu Krishna, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.

Important Disclosures

For current important disclosures, including, where relevant, price target charts, regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to http://publicresearch.barcap.com or call 1-212-526-1072.

The analysts responsible for preparing this research report have received compensation based upon various factors including the firm's total

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Risk Disclosure(s):

The convertible valuations are based on Barclays Capital proprietary convertible valuation model, under which key assumptions relate to credit spread and equity l tilit t i M t i l h i f th i bl h i ifi t i t l ti U id /d id l i t k i t id tivolatility metrics. Material changes in any of these variables can have a significant impact on valuation. Upside/downside analysis takes into consideration

likely future valuation and expected trading patterns, among others. It is based on a total return participation of the convertible relative to a +/‐ 25% (unless otherwise specified) change in the common stock’s price over a one-year investment horizon. A material change in the company’s financial situation can significantly alter this assessment.

Mentioned Stocks:

Wesco International (WCC, 04-Jan-2012, USD 53.87)( , , )

NetApp Inc. (NTAP, 04-Jan-2012, USD 35.64)

SBA Communications (SBAC, 04-Jan-2012, USD 43.16)

Salesforce.com Inc. (CRM, 04-Jan-2012, USD 97.48)

Alliance Data Systems Corp. (ADS, 04-Jan-2012, USD 100.94)

W bMD H lth C (WBMD 04 J 2012 USD 37 97)

46

WebMD Health Corp. (WBMD, 04-Jan-2012, USD 37.97)

January 6, 2012

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47 January 6, 2012

Important Disclosures (continued)Seoul

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50 January 6, 2012

2012 convertibles outlook

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