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2 Notch Differential Analysis The differences between agency ratings and CDS IRs can be categorized by the number of notches apart the CDS IR is from the agency rating on a traditional ratings scale. For example, if the CDS IR for company X is A-, while the AR is BBB-, the notch differential, or, is +3 notches. On the other hand, if the CDS IR for Company Y is BBB- while the AR is A-, the is then -3 notches. The matrix below provides a visual illustration of notch differentials. Agency Rating A- 0 1 notch 2 notch BBB+ BBB A- BBB+ BBB BBB- BBB- -1 notch -2 notch -3 notch 0 1 notch -1 notch -2 notch 0-1 notch 3 notch 2 notch 1 notch 0 Using the notch categorization outlined above, we next calculate the notch differentials for each entity in the CDS IR universe. For this analysis we re interested in determining the rate of upgrades, downgrades and no changes from the first instance of the notch being observed over 1 year and 3 year time horizons. By observing the rate of agency actions from the first instance of each notch differential across all entities we can then determine the probability of upgrade, downgrade and no change for each CDS IR movement. The analysis was performed on rating actions observed between January 2001 and July Results: A Strong Direct Relationship Between Gaps and Future Rating Actions The charts below show the rate of agency actions by each notch differential category over a 1 year and 3 year horizon. The analysis demonstrates a strong direct relationship between the CDS IR level and future Agency Rating action. At the 0 notch differential level we observe nearly random agency actions, while the rate of actual agency downgrades steadily increases as the negative notch differential (CDS IR worse than AR) increases. Similarly, the rate of upgrades greatly increases as the notch differentials become more positive. These same trends are even more pronounced within the 3 year horizon.

3 Looking at the individual notch results, we can infer that once a -3 notch is established (e.g. the CDS IR is 3 notches lower than the AR), there is a 51% chance that an entity will experience a downgrade within 1 year. When we perform the same analysis within a three year window, we find that 67% of entities with a -3 notch are downgraded within 3 years. We also find that at a -2 notch differential, we see a nearly 48% chance of a firm being downgraded within one year. On the positive side, when observing a +3 notch (e.g. the CDS IR is 3 notches higher that the AR), we see that over 45% of entities receive an upgrade within one year. Again, looking at a 3 year horizon, we find that nearly 70% of the entities with a +3 notch experience an agency rating upgrade.

4 Case Studies In order to illustrate how the results of the study have played out in recent history, we examine two cases where s successfully predicted agency rating actions. In the chart above, we see that UBS had sustained a negative one notch for at least two months before being rapidly downgraded three times by the CDS IR model in November 2007, resulting in a -4 notch. As we would expect, UBS was consequently downgraded by Fitch Ratings on December 12th, Despite the rating action, the lingering -3 notch, suggested a better than 50% chance of a future downgrade. True to this prediction, and after experiencing two more CDS IR downgrades to widen the to -5 notches, UBS was downgraded by Fitch, S&P and Moody s on April 1st.

5 Hess Corporation exemplifies where positive s, reflecting perceived credit strengthening in the CDS market, accurately predicted an agency rating upgrade within one year. Hess showed a +2 notch, signaling a 43% probability of an upgrade, in September 2007, nearly 8 months before both Fitch and Moody s upgraded the entity. In this case, the CDS IR signaling quality was further improved upon as Hess Corporation s positive increased to +3 a little over a month prior to the Fitch upgrade. Implications for investors By providing the ability to better anticipate future agency rating actions, the CDS IR model can be utilized as an investment screening, portfolio monitoring and risk management tool. This is especially true of investors targeting a specific portfolio credit quality profile. While no model is perfectly accurate, when appropriately harnessed and interpreted, the signals provided by the CDS market can improve an investor s ability to anticipate events among portfolio entities. By enhancing the ability to anticipate future rating actions, portfolio managers can improve their decisions on whether to increase, decrease or maintain exposure to specific names and therefore better meet investment objectives. Companies on Alert The table below lists ten companies with CDS IRs three or more notches away from their Agency Ratings. The first five corporations are experiencing a positive three notch, implying a 45% chance of an agency rating upgrade within one year and a 69% chance within three years of the date on which the first instance of the occurred. The remaining five names, in shaded rows, are potential candidates for agency rating downgrades, showing -3 and -4 notch s.

6 Companies on Alert The table below lists ten companies with CDS IRs three or more notches away from their Agency Ratings. The first five corporations are experiencing a positive three notch, implying a 45% chance of an agency rating upgrade within one year and a 69% chance within three years of the date on which the first instance of the occurred. The remaining five names, in shaded rows, are potential candidates for agency rating downgrades, showing -3 and -4 notch s. Rohm & Haas Company A+ BBB+ 3 8/21/08 13 Oracle Corporation AA A 3 7/16/08 39 Motorola BB BBB -3 8/19/08 15 Toll Brothers, Inc. BB BBB -3 4/18/ Societe Generale A- AA- -3 7/15/08 40 IKB Deutsche Bank AG BB- BBB- -3 9/1/08 6 JP Morgan Chase BBB+ AA /27/ Source: Fitch Solutions CDS IR CDS IR Alert List AR Gap Gap since Gap duration (business days) Hasbro, Inc. A BBB 3 8/8/08 22 Loew's Corporation AA A 3 4/21/ Sony Corporation AA- A- 3 5/30/08 72

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