Global Credit Markets - Current Crisis and Outlook for Defaults and Distressed Debt January 24, 2008 New York Ed Altman NYU Stern School of Business

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Council Member Biography Edward I. Altman is the Max L. Heine Professor of Finance at the New York University Stern School of Business. He is the Director of Research in Credit and Debt Markets at the NYU Salomon Center for the Study of Financial Institutions. Prior to serving in his present position, Professor Altman chaired the Stern School's MBA Program for 12 years. Dr. Altman has an international reputation as an expert on corporate bankruptcy, high yield bonds, distressed debt and credit risk analysis. In 2005, Prof. Altman was named one of the 100 Most Influential People in Finance by the Treasury & Risk Management magazine. Professor Altman is one of the founders and an Executive Editor of the international publication, the Journal of Banking and Finance. Dr. Altman's primary areas of research include bankruptcy analysis and prediction, credit and lending policies, risk management and regulation in banking, corporate finance and capital markets.

Topics A review of defaults, related values, and recoveries for 2007 Forecasting 2008/2009 defaults Leverage buyout financial analysis and earnings implications The relevance of historical based models in today's market

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8 Dr. Edward Altman NYU Stern School of Business Current Conditions in Global Credit Markets A New Paradigm or The Great Credit Bubble? GLGi Seminar New York January 24, 2008

9 Changes in the Credit Environment: Are Historical Default and Recovery Estimates Still Relevant? Default and Recovery Forecasting Models Macro-Economic Models: Default Probabilities Mortality Rate Models: Default Probabilities Recovery Rate Models: Loss-Given-Default Distressed Debt Market Size Estimate

10 Factors Affecting the Transformation of Credit Markets in Last Few Years Massive Global Liquidity –Petrodollars, Foreign Governments, Financial Institutions, Global Money Supply Expansion, etc. Explosion of Hedge Fund Activity Frenetic Activity in M&A/LBO transactions Growth of the Institutional Loan Market, esp. Leveraged Loans Easy Credit Standards by both Bank and Non-Bank Lenders Record Low Required Yield Spreads in a Higher Credit Risk Profile Environment until September 07 –Third Quarter 2007 Spread Volatility

11 Factors Affecting the Transformation of Credit Markets in Last Few Years Rapid Growth in Derivatives and Synthetics, esp. CDOs Historically Low Default Rates and High Recoveries Extremely Low Equity and Debt Volatility until Summer 07 Escalating Leverage Throughout the Credit Markets in Search of Alpha Recession in 2008/2009? –Hard Landing Default Rate –Soft Landing Default Rate

12 Are Historical Default and Recovery Estimates Still Relevant? Increased Creditor Influences and Lower Default Rates Rescue Financing Restructurings (Privatization of Bankruptcy) Pre-Petition Credit Facilities Distressed Debt Control Investing DIP Financings, Exit Financing

– 2007 (Mid-year US$ billions) Size of the US High-Yield Bond Market

14 Par ValuePar ValueDefault YearOutstanding a DefaultsRates (%) 2006$993,600$7, $1,073,000$36, $933,100$11, $856,000 $38, $757,000$96, $649,000$63, $597,200$30, $567,400$23, $465,500$7, $335,400$4, $271,000$3, $240,000$4, $235,000$3, $206,907$2, $163,000$5, $183,600$18, $181,000$18, $189,258$8, $148,187$3, $129,557$7, $90,243$3, $58,088$ $40,939$ $27,492$ $18,109$ b Weighted by par value of amount outstanding for each year. Source: Authors compilation and Salomon Smith Barney 2007 $1075,400 $5, % Straight Bonds Only Excluding Defaulted Issues From Par Value Outstanding, 1971 – 2007 (US$ millions) Historical Default Rates Par ValuePar ValueDefault YearOutstanding a DefaultsRates (%) 1981$17,115$ $14,935$ $10,356$ $8,946$ $8,157$ $7,735$ $7,471$ $10,894$ $7,824$ $6,928$ $6,602$ Standard Deviation (%) Arithmetic Average Default Rate 1971 to % 3.061% 1978 to %3.272% 1985 to % 3.435% Weighted Average Default Rate b 1971 to % 1978 to % 1985 to % Median Annual Default Rate 1971 to %

15 Historical Default Rates QUARTERLY DEFAULT RATE AND FOUR QUARTER MOVING AVERAGE 1991 – 2007

16 Historical Default Rates and Recession Periods in the U.S. Periods of Recession: 11/73 - 3/75, 1/80 - 7/80, 7/ /82, 7/90 - 3/91, 4/01 – 12/01 Source: E. Altman (NYU Salomon Center) & National Bureau of Economic Research HIGH YIELD BOND MARKET 1972 – 2007

17 Filings for Chapter 11 Number of Filings and Pre-petition Liabilities of Public Companies 1989 – 2007 Note: Minimum $100 million in liabilities Source: NYU Salomon Center Bankruptcy Filings Database filings and liabilities of $23.2 billion filings and liabilities of $72.65 billion

18 Credit Statistics Trends and Leveraged Market Activity

19 New Issues Rated B- or Below as Percentage of all New Issues (1993 – 2007 Q3) Source: Standard & Poors Global Fixed Income Research

20 Source: Standard and Poors LCD Purchase Price Multiple excluding Fees for LBO Transactions Purchase Price Multiples

21 Average Total Debt Leverage Ratio for LBOs: Europe and US with EBITDA of /$50M or More Leverage Continues to Increase Current European and U.S. Environments Source: Standard & Poors LCD

22 Average Equity Contribution to Leveraged Buyouts 1987 – 4Q07 Equity includes common equity and preferred stock as well as holding company debt and seller note proceeds downstreamed to the operating company as common equity; Rollover Equity prior to 1996 is not available; There were too few deals in 1991 to form a meaningful sample. Source: Standard & Poors LCD

23 European Initial/Secondary Buyouts: Volume Deal Count: 51 * Deal Count counts First and Second Lien portions of a single transaction as one event; Deal Count also excludes any amendments. Reflects total sources of funding of initial or secondary buyout by a private equity firm (excludes recaps, refinancings, etc) Annual Senior Loan VolumeLBO Transaction Volume Source: Standard & Poors LCD Deal Count: 152 Volume: H 70.7B 2007:96.62B 2007: 55.66B 2007 Total Funding from All Sources : B

24 Below Investment Grade Debt Maturity Schedule (U.S.) ($Bil.) Includes Term Loans, Revolvers, and Other Loans; Assumes Revolvers are Fully Drawn. Source: DealLogic, Fitch Ratings.

25 Recovery Rate Analysis

26 Default Rates and Losses a 1978 – 2007 Par Value Outstanding a Of Default Default Weighted PriceWeightedDefault Year $MM)($MMs)Rate (%)After DefaultCoupon (%)Loss (%) 2007 $1,075,400$5, $ $993,600$7, $ $1,073,000$36, $ $933,100$11, $ $825,000$ 38, $ $757,000$96, $ $649,000$63, $ $597,200$30, $ $567,400$23, $ $465,500$7, $ $335,400$4, $ $271,000$3, $ $240,000$4, $ $235,000$3, $ $206,907$2, $ $163,000$5, $ $183,600$18, $ $181,000$18, $ $189,258$8, $ $148,187$3, $ $129,557$7, $ $90,243$3, $ $58,088$ $ $40,939$ $ $27,492$ $ $18,109$ $ $17,115$270.16$ $14,935$ $ $10,356$200.19$ $8,946$ $ Arithmetic Average :3.37$ Weighted Average : a Excludes defaulted issues. Source: Authors compilations and various dealer price quotes.

27 Source: E. Altman, et. al., The Link Between Default and Recovery Rates, NYU Salomon Center, S-03-4.

(5.68)14.45(20.13) (8.41) (8.73) (1.18) (2.55)(8.29) (8.46)6.88(15.34) (14.74) (2.67) (7.58) (5.46) (6.32) (9.63) (1.00)(2.96) (0.86) (1.11) Arithmetic Annual Average Compound Annual Average a End-of-year yields. Source: Citigroups High Yield Composite Index (7.95) (1.53) (16.19) Annual Returns Yields and Spreads on 10-Year Treasury (Treas) and High Yield (HY) Bonds 1978 – 2007 Return (%)Promised Yield (%) a YearHYTreasSpreadHYTreasSpread

29 YTM Spread Between High Yield Markets & 10 Year Treasury Notes June 1 – December 31, 2007

30 Size of Distressed Debt Market

31 Public deals only. Source: Citigroup Estimates. Distressed And Defaulted Debt as a Percentage of High Yield And Defaulted Debt Markets 1990 – 2007

32 Estimated Face And Market Values Of Defaulted And Distressed Debt ($billion)

33 Size Of The US Defaulted And Distressed Debt Market ($ Billions) 1990 – 2007

34 Returns and Correlations of the Defaulted Debt Markets

35 Defaulted Debt Indexes: Market-to-Face Value Ratios (1987 – 2007) Source: Altman-NYU Salomon Center Defaulted Debt Indexes Loans Median Market-to-Face value is 0.69 and Average Market-to-Face value is 0.68 Bonds Median Market-to-Face value is 0.46 and Average Market-to-Face value is 0.43

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39 U.S. Distressed Debt Managers 2007

40 U.S. Distressed Debt Managers 2007

41 U.S. Distressed Debt Managers 2007

42 U.S. Distressed Debt Managers 2007

43 U.S. Distressed Funds with European Offices European Distressed Debt Managers (Home Grown)

44 Distressed Active/Control Investors

45 Investment Styles and Target Returns in Distressed Debt Investing

46 Forecasting Defaults and the Default Rate

47 Forecasting Defaults and the Default Rate MODEL DRIVERS Mortality Rate Estimates: = f {bond rating, age, redemptions, defaults} Historical New Issuance over last 10 years by credit quality Bond-ratings Z-score Bond-equivalent ratings New Defaults and Default Rate in 2006 Estimate high yield market growth in 2007 New Defaults and Default Rate in 2007, 2008

48 Marginal and Cumulative Mortality Rate Equation One can measure the cumulative mortality rate (CMR) over a specific time period (1,2,…, T years) by subtracting the product of the surviving populations of each of the previous years from one (1.0), that is, MMR (t) = Total value of defaulting debt in year (t) total value of the population at the start of the year (t) MMR = Marginal Mortality Rate CMR (t) = 1 - SR (t), t = 1 hereCMR (t) = Cumulative Mortality Rate in (t), SR (t) = Survival Rate in (t), 1 - MMR (t)

49 Mortality Rate Concept (Illustrative Calculation) For BB Rated Issues SecurityIssuedYear 1Year 2 No.AmountDefaultCallSFDefaultCallSF NENENE NENENE Total1, Amount Start of 1, , Period ---=---= Year 1Year 2 Marginal Mortality50/1,500 = 3.3%100/1,325 = 7.5% Rate 1 - (SR1 x SR2 ) = CMR2 Cumulative Rate3.3%1 - (96.7% x 92.5%) = 10.55% NE = No longer in existence SF = Sinking fund

50 All Rated Corporate Bonds* Mortality Rates by Original Rating *Rated by S&P at Issuance Based on 1,990 issues Source: Standard & Poor's (New York) and Author's Compilation

51 Forecasted High Yield Market Size, Defaults and Default Rates for