Monthly Income Fund Update

September Quarter 2008

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Market outlook September was an extraordinary month in terms of the scale of credit events but almost equally extraordinary were the lengths that governments around the world went to in order to restore stability to the financial system. Measures ranged from direct liquidity and capital injections to provision of loans, arranged marriages that under normal circumstances would not have been permitted on anti competitive grounds and a $700bn facility to acquire troubled mortgage assets in the US. Whilst that has in part become a political issue the world is now firmly focused on the stability of the financial system and its necessity to the global economy. Whilst we believe that there is still some way to go before we are out of the woods, our view remains that large money centre banks, that are the core of their economies, will continue to be ring fenced and protected in situations of distress. This is by and large how things have transpired over the month but we remain alert to unfolding developments and will seek to dispose of any potentially problematic assets where we can.

Composition may not total 100% due to rounding.

• The two largest mortgage lenders in the US, Fannie Mae and Freddie Mac, were bailed out by the US Federal Reserve and Treasury, as was the largest US insurer AIG.
• The largest UK mortgage lender HBOS was placed in a hastily arranged marriage with Lloyds as its share price plummeted whilst a number of European banks including Fortis, Dexia and Hypo Real Estate were given capital injections from their respective governments to stave off a run on those banks.
• Meanwhile the largest ever financial bankruptcy occurred with Lehman Brothers and the investment banking landscape was dramatically changed with the remaining three major US investment banks either being folded into a bank (Merrill Lynch into Bank of America) or becoming a bank (Goldman Sachs and Morgan Stanley).
• Unprecedented moves were witnessed in financial markets as fear spread through risk assets and these developments clearly had adverse consequences for the performance of credit bonds in general and the BlackRock Monthly Income Fund.
• The Fund’s credit duration closed the month 200 basis points wider at 612 basis points.

• Following months of speculation, the US Treasury introduced a four part plan to bailout Freddie Mac (FRE) & Fannie Mae (FNM) in an effort to support the availability of mortgage finance in the US as well as provide stability to the broader financial markets.
• Lehman Brothers, once the fourth largest investment bank in the US, filed for bankruptcy after its shares plummeted on concern that the firm could not raise enough capital to compensate for its mortgage losses. Lehman had estimated debts of $613bn as at 31 May. Just prior to Lehman’s filing for bankruptcy the Fund had an exposure of 0.25% to Lehman’s. This has subsequently been marked down to 0.02%.
• With the market casting around for the next victim of the credit crunch a hasty marriage between Bank of America and Merrill Lynch was arranged on the same weekend as Lehman’s bankruptcy. The Bank of America announced it had agreed to acquire Merrill in a USD50bn all-stock transaction. Final approval is required from both companies shareholders, but has already had approval from Directors of both companies. The Fund has 0.33% exposure to Merrill Lynch and 0.85% exposure to Bank of America.
• With increasing pressure on it due to loss of confidence, AIG, the largest US insurer was cast a life line by the US Federal Reserve in the form of an $85bn lending facility. The loan is a fully secured revolving credit facility that has a 2 year term. Whilst the Federal Reserve had determined that Lehman’s was not too big to fail, their assessment in the case of AIG was that “a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance”. Assets that have been mooted to be up for sale include the aircraft leasing company ILFC, real estate and private equity investments. The Fund has exposure of 0.31% to AIG of which 0.26% is exposed to ILFC.
• A week after the exit of Lehman Bros and Merrill Lynch, the final two large US investment banks Morgan Stanley and Goldman Sachs announced that they had received regulatory approval to become Bank Holding Companies, ending the era of the large independent US investment bank. By becoming Bank Holding Companies each will be subjected to the Federal Reserve’s minimum capital thresholds, but will also gain access to the discount window, a source of liquidity.
• Financial market strain was not confined to the US with the UK’s largest mortgage bank HBOS coming under intense pressure as confidence in their ability to meet their funding requirements saw their share price plummet to a low of over 50% from previous month end. With the apparent support of the regulators, Bank of England and the UK Government, Lloyds agreed to acquire HBOS in an all equity transaction equating to an initial offer of roughly 232p per share, a discount of 44% to HBOS tangible common equity. The Fund has 3.38% exposure to HBOS and 0.86% exposure to Lloyds.
• In Europe, troubled banks benefited from capital injections from their governments with Fortis Bank receiving EUR11.2bn from the governments of Belgium, Luxembourg and the Netherlands, Dexia receiving EUR6.4bn from the governments of Belgium, France and Luxembourg and German bank Hypo Real Estate bank becoming the beneficiary of EUR35bn of funding from a consortium of German banks and the Bundesbank. The Fund has 0.55% exposure to Fortis Bank, 0.38% to Dexia and 0.19% exposure to Hypo Real Estate Bank.
• Two large US regional banks also left the financial landscape during the month after being placed under the control of the FDIC following concerns about damage to their franchise from a run on deposits. The deposits, assets and certain liabilities of Washington Mutual were acquired by JP Morgan for a payment of USD1.9bn to the FDIC. The bulk of the assets and liabilities of Wachovia were acquired by Citigroup. Citigroup entered a loss sharing agreement on the loans of Wachovia with the FDIC that will cap Citigroup’s losses to USD42bn. The Fund had no exposure to Washington Mutual and sold its Wachovia exposure during the month.
• In the UK, Santander added to their acquisitions of UK banks with the acquisition of the retail deposit base and branch network of Bradford & Bingley following it being nationalised by the UK government. In a positive move for Irish banks, the Irish government provided a two year guarantee over their deposits and debt including senior debt, covered bonds and dated subordinated debt restoring confidence in their banking system following the sharp drop in the share prices of Irish banks. The Fund had no exposure to Bradford & Bingley, 1.48% exposure to Santander, 3.54% exposure to Allied Irish Bank and 0.58% exposure to Anglo Irish Bank.

• The Fund distributed 0.62 cpu for the month of September.
• The running yield as at 30 September 2008 was approx 13.5%.
• The Fund managed approximately $1.25 billion in assets at the end of September.

• Are looking to receive high, consistent monthly income from their non-transactional cash balances.
• Might be considering investing in mortgage or bond funds.