Stephen Chang Head of Fixed Income, Pacific Regional Group December 2004

1. Searching for Returns in Fixed Income Markets- A Discussion of Asians Bonds Development and Opportunities in Structured Securities Stephen Chang Head of Fixed Income, Pacific Regional Group December 2004

2. Agenda • Investment Outlook • A Case for Asian Bonds • Asian bonds outlook • Alpha potential • Status of Asian bond market development • Benchmark selection • JPMF Asian bond presence • Opportunities in Structured Securities • Introduction to Mortgage Backed Securities (MBS) • Introduction to Asset Backed Securities (ABS) • Risk Implication for portfolio management • Prepayment and structure risk • Pricing and relative value

3. Investment Outlook

4. Investment Outlook: Key Themes • Range trading in US Treasuries has persisted with no real trends • US economic data has been strong but sustainability is questionable • Asia has been experiencing strong economic growth, outpacing those in US and in Europe • Asian currencies are arguably undervalued with central bank FX reserves building up rapidly from trade surplus and foreign investment • Twin Deficits in the US are a structural problem where a correction should lead to USD declining further • Liquidity is aplenty in US and Asian countries with capital inflow, and lack of lending growth

5. US Treasuries: Range Bound Environment Source:Bloomberg

6. US Economy: Payroll Growth Sustainability Source:Bloomberg

7. US Economy: Borrowing for Consumption Source:Bloomberg

8. US Budget: Deficits Financing Growth Source:Bloomberg

9. Investment Outlook Implications • Structural bearish USD environment:  Exposure to Asian fixed income securities • Range-bound yield environment:  Considerations for Structured Securities

10. A Case for Asian Bonds

11. Asian Bond Outlook: Changing Dynamics How would the current situation evolve? Our central scenario: Situation/Development Investment Implication Current status High growth, inflation rising Long Asian FX Pegged currency/intervention Long Asian Equities Low real interest rates Long Asian Credits Central banks following fed action Long local short end bonds 1-2y horizon Asia moves to floating regime Long Asian Credit Central banks raise rates Long Asian FX Growth rate begins to moderate Neutral Bonds Longer term outlook High rates reining in inflation Neutral FX Interest rate peaks/growth slows Long Asian local bonds

12. Growing Demand for Asian Bonds • Asian increasing need for moderate risk assets • Changing demographics • Barbelling portfolio between cash and equities • Liability matching • Too much US dollar as reserves? • Increasing integrated in trade activities • Active management opportunities • Uneven growth and inflation trends • Central Banks’ dilemma and varying response • Lack of cross-border investor

13. Alpha Potential in Asian Bonds • Range of Instruments • 11 Asian countries with local currency debt market • US Dollar, Japanese Yen and Euro issuance from Asian Sovereigns and Corporations • Credit play from AAA rated governments to high yield issuers • Currency Exposure • Appreciation against USD and other major currencies • Protection against inflation risk • Upgrade potential • Strength of Asian economies from strong growth and exports • Reduction of country/sovereign risk • Positive ratings outlook

14. Alpha Potential: FX volatility and Yield Correlation

15. Status of Asian Bond Market: USD Issuance Statistics • USD bonds has been the issuance of choice for Asian Issuers • Sovereign and Corporate names • Issuance share are dominated by a few names (Hutch, Korea and Philippines sovereigns) US Dollar Bonds issued by Asian borrowers, 1985-2003 (US$ bn) US Dollar Bonds issued by Asian borrowers, 1980-2003 (US$ bn) Source: Bondware, Citigroup

16. Status of Asian Bond Market: JPY Issuance Statistics • Very limited JPY issuance post 1998 • High profile downgrade has deterred Japanese Investors • Korea high grade are the lone exception • Credit enhancement required for lower credit ratings issuers Yen denominated Bond issuance by Asian issuers (US$ mil) Yen Bond issuance by nationality of issuer (Yen bn) Source: Bondware, Citigroup

17. Status of Asian Bond Market: Local Currency Bonds Development • Non-Japan Asia Local currency bond market has doubled from 1997 to 2002 • Account of GDP 47% at end of 2003 (vs. 20% in 1995) • Bond share of total financing raised to 19% (vs. 11% in 1995) • EMEAP (Executives’ Meeting of East Asia and Pacific Central Banks) initiative: • Bilateral swap agreement totally >36B on foreign currency reserves to pool mutual support • Asian bond fund: 1st series launched with 1B USD invested in USD debt on EMEAP countries • Asian bond fund: 2nd series will be launched in early 2005 • Expected to increase turnover in Asian bond markets • Increase public awareness of bonds as alternative instruments

18. Status of Asian Bond Market: Local Currency Bond Issuance Statistics • Makeup of local bond issuers varies quite widely • Local currency bonds provide diversification against US Treasury Asia’s local currency Bond market Return comparison of local Bonds vs US Treasury (Jan 01 – Mar 04) Source: HSBC, BIS

19. Status of Asian Bond Market: Local Currency Bonds Impediments • Capital Control Issues • Differing rates between onshore and offshore rates • Convertibility • Withholding tax issues • Asian Corporations issuing in USD to achieve wider investor base • Relatively low transparency in price quotations, wide bid-ask spreads • Turnover remains generally low

20. Benchmarking Selection: Available Indices • USD credit index: HSBC ADBI, JPM JACI, iTraxx Asian series • Local currency index: HSBC ALBI, JPM ELMI+ • iTraxx Asian Series • Merger of TRAC-X and iBoxx in June 2004 • Equal weight basket of credit default swaps (CDS) • Highly liquid • HSBC ALBI • Historical data since 2001 • Country weights based on HSBC Impediment Index • Varying selection criteria for country indices • Duration instability across different countries • JPM ELMI+ • Inception since 1997 • Basket of tradable local money market bonds or non-deliverable forwards

21. Benchmarking Selection: Dilemma • Bond inclusion difficulty: • Size of issuance small • Credit rating limit varies • Country weights • Driven by country budget situation, e.g. Japan • Market capitalization can change quickly between countries • Duration between countries indices vary significantly • Replicability: • Bid-ask spreads generally wide • Certain issues see small turnover from buy and hold investor • Total return approach, focus on alpha generation

22. JPMF Asian Bond Presence: Our Capabilities • One of the world’s leading asset management companies with over US$730B* under management • 167* fixed income investment professionals manage over US$380B* fixed income mandates globally, with over US$12B* in Asian fixed income and balanced portfolios • Dedication to Asia with over 90* investment professionals and over US$56B* under management • Regional product offering and market coverage includes: • Pacific and Global Balanced Funds • China Balanced Fund** • Bond and money market funds in HKD, TWD, THB*** • Asian Credit Research • Asian Convertible Bonds • Plus customized institutional mandates * As of 30 September, 2004 ** via JV China International Fund Management *** via JV Ayudhya JF Asset Management

23. Opportunities in Structured Securities

24. MBS and ABS securities offer attractive return enhancement Excess return of market sectors over Gov’t 1-3yr index, unadjusted for duration Source: J P Morgan Corp and MBS data 1990 -2004. ABS data 1992 - 2004

25. YTD 2004 in the Lehman Aggregate MBS and ABS securities offer attractive return enhancement YTD Excess Returns to Treasuries (Duration Neutral) Source: Lehman Brothers

26. Introduction to Mortgage Backed Securities

27. How does a US mortgage work? American Homeowner 2 Mortgage from local bank • Key features: • Usually fixed rate • Prepayable with low costs • Redeemed if mortgage holder moves to a new home Mortgage from local bank American Homeowner Investor buys AAA MBS security Agencies combine mortgages 6% 5.75% 5.50% American Homeowner 3 Mortgage from local bank

28. Agencies are considered ‘AAA+' credit quality with actual or implied U.S. Government guarantees GNMA • Backed by the full faith and credit of the U.S. Government • Government-sponsored entities which, given their position in the marketplace and their explicit mandates for housing finance, carry an implicit U.S. Government guarantee • Both entities have a direct line of credit to the U.S. Treasury FNMA & FHLMC

29. The US residential mortgage sector is the largest component of the US fixed income market • Mortgage-backed securities make up 35% of the Lehman Aggregate Index • 60% of the US mortgage market is securitized • The market has a diverse lending base • The market has a diverse investor base, with diverse motivations As of October 31, 2004 Lehman Aggregate: Percent by par amount outstanding

30. Benefits of MBS for asset allocation • Highly liquid Low transaction costs • Minimal credit risk • Yield advantage versus U.S. Treasuries • Diversification

31. Prepayment Sensitive (Residential) Mortgages As of September 30, 2004 Current Coupon 30-Year Mortgages • Outlook • Convexity needs of mortgage players will increase in a market rally of 25bps or more as refinancing activity and fixed rate mortgage supply pick up. Implied volatility should increase further and mortgage valuations should appear less attractive. • Sponsorship from banks will continue, but to a much lesser extent than in the past as Fed Funds are at 2% and the yield curve has flattened by 90 basis points in 2/10s. • Mortgage spreads are at the tighter end of the range for the last year. Given current spread levels, uncertainty regarding future GSE portfolio activity, the flatter yield curve, and increased refinancing risk mortgage spreads are vulnerable to widening. • Market Conditions • Mortgage spreads ranged from 138 to 150 bps versus 5/10s treasury blend during the quarter. In September mortgage spreads widened by 8 bps as the yield curve flattened and rates rallied. • Gross fixed rate supply was moderate, as 50% of gross issuance was comprised of Adjustable Rate Mortgages, and net supply of fixed rate mortgages was close to zero. Mortgage rates steadily declined during the quarter from 6% to 5.5% and as a result refinancing activity and supply increased. • Implied volatility was at the lowest levels of the year during July and August. As rates rallied, however, volatility increased as convexity needs of mortgage investors rose.

32. Introduction to Asset Backed Securities

33. What are asset-backed securities? • ABS derive cash flow and credit characteristics from a pool of underlying assets • The goal is to isolate the asset pool from the originator • pool is independent of the originator in the event of bankruptcy • ABS contain credit enhancements • allows the securities to attain a higher rating higher than the originator Issuer motivations • True sale of assets • free up equity and regulatory capital • liquefy assets • asset liability management • Access to capital • attractive funding at “AAA” levels • diversify funding sources

34. Auto loans and leases Credit card receivables Home equity loans Manufactured housing contracts Recreational vehicles Utility stranded costs Dealer floor plan receivables Commercial loans ABS collateral is many and varied... • Aircraft and computer leases • Agricultural and equipment loans • Unsecured consumer loans • Trade receivables • Student loans • Marine receivables • Truck loans • Emerging markets asset classes • Entertainment royalties

35. Asset Backed Securities As of September 30, 2004 Asset Backed Securities are an attractive short duration asset Spread to U.S. Treasury (bps) Agency 3-yr. Debt AAA 3-yr.Corp. Bond AAA 3-yr. Credit Card AAA 3-yr. Auto AAA 3-yr. HEL Note: Spreads are nominal spreads to U.S. Treasuries • Market Conditions • AAA par-priced spreads to swaps/LIBOR tightened in the third quarter on strong demand for short duration assets and limited fixed rate supply. • Two-year and five-year swap spreads tightened 5-8 bps to Treasuries. • Subordinates and off-the-run names tightened as well. • AAA Home Equity floaters were the one area of softness due to heavy supply as interest rates remain low and originations high. • Outlook • Year-to-date issuance volume is up 30% from 2003, led by subprime home equity. Supply may moderate as the Fed lifts rates but will remain robust. • AAA spreads to swaps are still relatively tight and may experience widening at the margin as market participants take a defensive stance in the fourth quarter. • Subordinate spreads are backstopped by strong fundamentals in the competing corporate debt market and by CDO demand.

36. Annual new issuance 1985 — 2004 ABS outstanding exceeds $1.5 trillion $ billion Sources: Various

37. Benefits of ABS for asset allocation • High credit quality: Over 90% issued securities are rated “AAA” • Diversification • Attractive yields • Minimal event risk • Stable average life • Diverse maturities and structures • Liquid secondary market: • over $1.3 trillion of public ABS outstanding • average duration of slightly over 2 years • average deal size of over $500 mm

38. Risk Implications for Portfolio Management

39. Risk implications for investing in MBS and ABS • The primary risk to investing in MBS is prepayment risk • Operationally complex  back office headache! • Collateral and structure risk must be monitored for ABS securities

40. Prepayment risk in MBS • A borrower may prepay all or part of the outstanding principal of his mortgage at his discretion • Prepayment motivations • relocation • access home equity • cheaper finance • Interest rates drive prepayments Interest rate Prepayment MBS Duration

41. Mortgage index duration is volatile Mortgage index duration fluctuation with time • The duration of the mortgage index fluctuates with interest rates • MBS returns are volatile

42. 6.00 5.00 4.00 3.00 2.00 1.00 0.00 -3.00 -2.00 -1.00 0.00 1.00 2.00 3.00 4.00 5.00 -1.00 -2.00 -3.00 -4.00 -5.00 Return profile for MBS Excess returns of MBS to US Treasuries • MBS underperform in major market moves • MBS outperform during stable periods Sector excess returns Increasing USinterest rates Falling US interest rates US Government Bond excess return Underperformancein disaster years MBS 45 Degree Line Poly. (45 Degree Line) Poly. (MBS) Source: Lehman Brothers US MBS Index from February 1989 to April 2003 and JP Morgan US Government Bond Index from February 1989 to April 2003Note: All figures are expressed as monthly excess returns over US 3 month Treasury Bill and normalised to a 5 year duration

43. Extra dimensions of risk management required for MBS

44. A multitude of resources are critical to mortgage investment strategy • Evaluate current conditions and valuations • Forecast changes in the mortgage market trends • Position portfolios to benefit from changing markets In evaluating current mortgage market conditions, the following aspects are considered: • Option adjusted Analytics • Historical based valuations • Gross and Net Mortgage Issuance • Activity of major investment classes • Recent performance vs. other sectors • Dollar Roll • Level of liquidity • CMO Arbitrage

45. Sponsor/Servicer Receivables $ and Seller Interest Master Trust $ $ $ Certs. Certs. Certs. Investor Investor Investor Class A Class A Class A “AAA” Class B Class B Class B “A” Reserve Fund - Trap excess spread Class C Class C Class C “BBB” (Each C Class has a Reserve Fund) Traditional credit card ABS structure

46. Analytical framework for investing in ABS Structured finance investing requires a disciplined credit approach Legal Structure Cash flow characteristics • Initial transfer • Bankruptcy remoteness • Trust owns receivables • Security interest in receivables • Ongoing cash flow structure • Payment priority • Available liquidity • Credit enhancement Main participants Collateral analysis • Originator • Servicer • Credit support provider • Trustee • Swap counterparties • Macro and micro economic analysis • Originator underwriting practices • Servicing expertise • Pool characteristics • Historical credit performance

47. Fixed 5 Year AAA spread to Treasuries Home Equities CMBS Swap Spreads Credit Cards

48. Quantitative and market analytics • Average life • Cash flow timing may be uncertain • Tranching controls cash flow timing • Prepayments • ABS prepayments are less interest rate sensitive than MBS • Home loan ABS must be monitored to predict prepayment trends • Embedded options • Most transactions have servicer call options (i.e., 5 - 10% of original balance) • Pool credit performance triggers may alter cash flows

49. ABS credit enhancement • Unique to the originator and the asset type • Sized to withstand a multiple of future expected losses • Available in several forms: • excess servicing • over-collateralization • subordination • cash reserve • third-party guarantee • Financial models evaluate default frequency, loss severity, prepayments, and interest rates.

50. Transaction monitoring Ongoing monitoring of transaction credit and prepayment performance creates opportunities Ongoing review sessions • Assess the economy/key subsectors/market technicals/regulatory initiatives/relative value Periodic security analysis • Actual security credit performance versus the expected case • Sufficiency of security credit enhancement • Financial condition of key transaction participants Develop a watch list • Key variables/economic data for selected securities/sectors • Make trade recommendations