From the Investment Desk

Highlights From a credit perspective, encouraging signs of a pick-up in two-way activity emerged at the end of fourth quarter 2008, as investors became more willing to reenter the market and purchase longer-dated paper. We are currently in the process of revalidating clients’ individual reinvestment guidelines to explore viable areas of opportunity, in order to capture incremental earnings amidst the still-turbulent market environment. We saw a significant drop in LIBOR rates this quarter, as investors piled into names with maturities as far out as 6-months. Investors demonstrated broad acceptance of the recently released FDIC guaranteed paper, which has been primarily 2- and 3-year issuance. Due to our focus on shorter dated paper, J.P. Morgan has not yet ventured into this area of the market, but will continue to assess its viability.

Jim Wilson Global Head Investment Management

Market Update
It will come as no surprise to clients that generally difficult conditions dominated the fourth quarter of 2008. From an economic perspective, we saw weakness on virtually all fronts, from labor to housing and even consumer spending, which contracted noticeably during the 2008 holiday spending season. Unemployment rose, as the corporate sector grappled with falling revenues. Uncertainty in the housing market, which has diminished consumers’ wealth, weighed heavily on consumers’ personal financing decisions, as well.

During December 2008, the Federal Open Market Committee (FOMC) cut its target for the fed funds rate to a range of 0 to 25 basis points, stating that it “anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.” With the Federal Reserve (Fed) now functionally close to operating a zero interest-rate policy, the central bank’s focus going forward will likely be its unconventional policy tools. Specifically, during the quarter the Fed has hinted at evaluating the potential benefits of purchasing longer-term Treasuries, and that it may buy Government Sponsored Enterprise (GSE) mortgage-related obligations beyond the $600 billion amount already announced. It is also important to note that the Fed’s decision to move to a target “range” rather than a target point is also very telling of economic conditions and expectations thereof.

Year-end 2008 was largely a non-event, with the fed funds rate opening as low as 0.04%, a historic low. Meanwhile, various Treasury programs continue to provide significant support to 6-month and shorter-maturity investments. On the positive side, the quarter ended with signs that activity overall was picking up, with investors showing interest in longer-dated paper, although this trend helped drive LIBOR rates down.

In an effort to strengthen investor confidence and encourage liquidity in the banking system, the FDIC created a temporary guarantee liquidity program wherein it provided FDIC guarantees for newly issued, senior unsecured debt of banks, thrifts and certain holding companies, and by providing full coverage of non-interest bearing deposit transaction accounts, regardless of their dollar amount. Investors broadly accepted this new FDIC guaranteed paper, which was comprised of 2- and 3-year issuance. While our focus on much shorter-dated paper currently dominates our purchases, we are conducting intensive due diligence on the FDIC offerings as possibly acceptable repo collateral.

Strategies and Opportunities
Given current and recent market conditions, we continue to focus our purchases on fixed rate investments in the 3- to 6-month range, where we believe value is most prolific from a credit perspective. Currently, we own very little asset-backed commercial paper, due to its relatively low yields, which is due in part to competition in the form of the Fed’s unprecedented liquidity programs.

Our Outlook: An Ideal Time to Revalidate Reinvestment Guidelines
We expect rates to continue to hover at or near zero percent for most of 2009. For lending clients, this will likely translate into continued spread compression, particularly as the Treasury begins to issue a significant amount of new debt to fund existing obligations.

We believe credit spreads are poised to narrow in 2009, although they are not likely to return to pre-August 2007 levels. However, as buyers’ quest for yield sharpens, and if sellers remain in short supply, as we expect they will, investors should continue putting more and more money to work, and this should bode well for names that have been trading at distressed levels but that remain fundamentally sound. Finally, our activity in money market funds has increased, as a way of offsetting the swift decline in short-term rates.

A zero-percent interest rate environment obviously creates challenges for lending clients and the business as a whole. From a proactive stance, we believe this represents an ideal time to revalidate the risk within your reinvestment guidelines. By doing so, together we can explore areas of potential opportunity, and in turn, create incremental earnings within this challenging environment.