1 moody’s 2002 corporate finance credit outlook investor briefing the marriott marquis new york...
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Moody’s 2002 Corporate Finance Credit Outlook
Investor Briefing
The Marriott Marquis
New York
January 15, 2002
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Liquidity Ratings
Michael Rowan, MD
Leverage Finance
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• Basis for differentiating issuers
• Deconstruction of established ratings
• Short term rating scale for speculative grade/non-prime issuers
• Independent opinion on a core fundamental credit issue
Market Benefits
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What do we mean by “Deconstruction “?
EXPECTED PROBABILTY SEVERITY OF
CREDIT LOSS = OF DEFAULT X LOSS IN DEFAULT
LIQUIDITY
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What Is A LIQUIDITY RATING?
Moody’s Liquidity ratings are opinions of an issuer’s relative ability to generate cash from internal resources and the availability of external sources of committed financing, in relation to its cash obligations over the coming 12 months.
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Rating Scale
L-1
L-2
L-3
L-4
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L-1L-1
Issuers rated L-1 possess good liquidity:
• Highly likely to meet their obligations through internal resources
• Do not rely on external sources of committed financing
• Are expected to maintain orderly access to committed financing
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Issuers rated L-2 possess moderateliquidity: • Are likely to meet their obligations through
internal resources• May rely on external sources of committed
financing • The issuer’s ability to access committed
sources of financing is highly likely based on Moody’s evaluation of near term covenant compliance
L-2
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L-3
Issuers rated L-3 possess adequateliquidity:• Are expected to rely on external sources of
committed financing• Moody’s believes the company will be in
compliance with covenants, but the cushion is modest
• The issuer may require covenant relief to maintain orderly access to funding lines
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L-4
Issuers rated L-4 possess weak liquidity: • They rely on external sources of financing • The availability of that financing is in Moody’s
opinion highly uncertain
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Analytical Considerations
• Does the company generate free cash flow from operations before/after capex ?
• Does the company have a liquidity facility that is largely undrawn or used primarily for seasonal purposes ?
• What is the forecasted compliance with bank covenants ?
• Are the company’s assets unencumbered ?• Does the company have alternatives to raise cash –
could sell a product line or assets- would that impact operations, or impair enterprise value ?
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What additional information does a liquidity rating provide ?
• Time horizon is shorter than a bond rating
• Independent opinion on a key default variable
• Issuer level opinion not tied to a single issue
• Provides a basis for differentiating among
issuers with equivalent issue ratings
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Roger B. Arner, MDGlobal Coordinator
Liquidity Risk Assessments
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Important Market Developments
• Market turbulence -- Asia, LTCM, Enron underscore fallacy of unlimited market access
• Increased systemic risk, structural changes
• Liquidity squeeze -- General American, Mercury Finance, Xerox, Finova, Lucent, California utilities
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Liquidity Remains A Primary Concern
Events of the past eighteen months have drawn
investors to those issuers with a demonstrated
ability to exit confidence sensitive public
markets in an orderly fashion.
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Moody’s Announces LRA’s
Liquidity Risk Assessments or LRA’s
• Critical need for additional information• Research driven response • Focused on ability of an issuer to conduct orderly exit
of confidence sensitive public markets.
These assessments are an important supplement to Moody’s Short Term ratings
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Moody’s Short-term Ratings Reflect
• Fundamental credit quality• Vulnerability to “shock risk”• Reliance on confidence sensitive (hot) funding• Quality & Adequacy of on-balance sheet liquidity• Quality & Adequacy of alternate liquidity
Credit and liquidity are substitutable, but only to a certain extent
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LRA’s Supplement The ST Rating
• Important deconstruction of ST rating methodology• Two step process highlighting
- Qualitative evaluation
- Qualitative assessment
LRA not intended to be modifier to ST rating
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Qualitative Evaluation
• Refined analytic approach based on published methodology
• Deliberately qualitative and not formulaic
• Highly transparent with issuers in framework and approach
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Qualitative Assessment
• Deconstruction of ST analysis highlights
- Credit fundamentals
- Stress scenario as lack of market access
• Assessment on continuum
• Published opinion citing details
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Key Points About LRA’s
• Extension of existing methodology• Ratings unlikely to change• Not intended as a rating modifier• Qualitative evaluation, assessment
Liquidity is not well understood as it is episodic
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Richard Stephan - Committee ChairpersonMD, Chemicals/Healthcare/Paper
Bruce Clark, SVP
Diana Lee, VP/SCO
Christophe Razaire, VP/SCO
Kendra Smith, VP/SCO
Rating CommitteeSuperior Sporting Goods
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Objectives of the Rating Committee Process
• Consistency of Rating System (A2 = A2 = A2)
• Thoroughness, Fairness, and Balance
• Responding to Needs of Investors (Timeliness)
• Accuracy
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Company Forecasts 1998 1999 2000 2001 2002 2003 2004
Income Statement
SuperiorSales Growth 3.0% 3.1% 3.0% 2.9% 0.0% 4.0% 5.0%Margins 11.0% 11.0% 11.5% 9.5% 7.0% 11.0% 11.8%
SportsKrazeSales Growth 14.0% 16.7% 14.3% 12.5% 0.0% 15.0% 14.0%Margins 15.0% 15.0% 15.0% 5.0% 5.0% 14.0% 17.0%
Sales 3,200 3,300 3,400 4,400 4,400 4,675 5,002Operating Income 352 363 391 378 290 545 652Net Income 170 173 191 148 91 262 336
Debt & Interest
Average Debt 1,200 1,300 1,300 2,000 2,000 1,900 1,800Interest 90 98 98 150 150 143 135
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Company Forecasts
1998 1999 2000 2001 2002 2003 2004Cash Flow
Gross Cash Flow 320 323 341 398 341 512 586Working Capital 0 0 (50) (150) 0 0 0 Cash From Operations 320 323 291 248 341 512 586
Capex (125) (125) (150) (250) (250) (300) (350)Dividends (100) (100) (100) (100) (100) (100) (100) Free Cash Flow 95 98 41 (102) (9) 112 136
Treasury Stock (125) (125) (125) (75) 0 0 0
Cash Generation (Borrowing Requirements) (30) (27) (84) (177) (9) 112 136
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Company Forecasts
1998 1999 2000 2001 2002 2003 2004
Ratios
EBIT/Interest 3.9 3.7 4.0 2.5 1.9 3.8 4.8
Retained Cash Flow 220 223 241 298 241 412 486
RCF/Debt 18.4% 17.1% 18.5% 14.9% 12.1% 21.7% 27.0%
EBITDA 502 513 541 653 565 820 927
Debt/EBITDA 2.4 2.5 2.4 3.1 3.5 2.3 1.9
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Adjustments2002 2003 2004
Sensitivity
SuperiorMargins SSG 7.0% 11.0% Moody's 6.5% 9.0%
SportsKrazeSales Growth SSG 0.0% 15.0% Moody's -5.6% 12.0%Margins SSG 14.0% 17.0% Moody's 12.0% 15.0%
Cash FlowWorking Capital SSG 0 0 Moody's (50) (50)
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SSG/Moody’s Comparisons1998 1999 2000 2001 2002 2003 2004
Operating Income SSG 352 363 391 378 290 545 652 Moody's 352 363 391 378 270 442 614
Free Cash Flow SSG 95 98 41 (102) (9) 112 136 Moody's 95 98 41 (102) (77) (15) 101
Debt SSG 1200 1300 1300 2000 2000 1900 1800 Moody's 1200 1300 1300 2000 2100 2100 2000
Interest Expense SSG 90 98 98 150 150 143 135 Moody's 90 98 98 150 158 158 150
EBIT/Interest SSG 3.9 3.7 4.0 2.5 1.9 3.8 4.8 Moody's 3.9 3.7 4.0 2.5 1.7 2.8 4.1
RCF/Debt SSG 18.4% 17.1% 18.5% 14.9% 12.1% 21.7% 27.0% Moody's 18.4% 17.1% 18.5% 14.9% 10.6% 15.9% 22.6%
Debt/EBITDA SSG 2.4 2.5 2.4 3.1 3.5 2.3 1.9 Moody's 2.4 2.5 2.4 3.1 3.9 2.9 2.3
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Peer ComparisonsInterest
Debt/Revenues Margins
CoverageRCF/Debt
EBITDA
Consumer Products - Baa3 Average 5,000 7.00% 3.6x 20% 2.8x
Superior Sporting Goods - Baa3*2003 5492 9.6% 2.8 15.9% 2.9*2002 4350 6.2% 1.7 10.6% 3.9*2001 4400 8.6% 2.5 14.9% 3.12000 3400 11.5% 4.0 18.5% 2.41999 3300 11.0% 3.5 17.1% 2.5
Outdoorsman: Ba2 Stable*2002 1400 6.1% 2.3 14.0% 3.1*2001 1400 6.0% 2.3 12.9% 3.11999 1300 6.5% 2.5 13.0% 3.0
Luxury International: Baa3 Negative*2002 3000 7.2% 2.9 16.0% 3.2*2001 3100 7.2% 2.9 15.5% 3.01999 2900 7.5% 3.4 16.0% 2.6
U.S. Recreation: Ba1 Stable*2002 2500 6.9% 2.9 14.9% 3.0*2001 2500 7.0% 2.7 14.7% 3.11999 2400 6.9% 2.7 14.5% 3.0
Fonstab AG: Baa2 Stable*2002 6,000 12.5% 3.9 21.5% 2.4*2001 6200 12.4% 4.0 22.0% 2.31999 6000 12.5% 3.6 21.0% 2.5
*Moody's Estimates
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Q & A
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Objectives of the Rating Committee Process
• Consistency of Rating System (A2 = A2 = A2)
• Thoroughness, Fairness, and Balance
• Responding to Needs of Investors (Timeliness)
• Accuracy
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Members of Committee
Lead Analyst – Extensive credit background but only 2 Years with Moody’s
Team MD (or SVP) – Long relationship with SSG
Leveraged Finance Analyst – Crossover rating placement
Retail/Consumer Goods Analyst - Industry expertise
Resorts/Leisure Analyst - Industry expertise
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Company Under Discussion
Superior Sporting Goods Inc.•Global manufacturer of sporting goods with presence in recreation
•Revenue - $3.5 billion
•Strong franchise - 30 year history
•Rated Baa3 since 1992
•Moody’s confirmed ratings after $500 million acquisition of SportsKraze USA
•Fictitious company - any resemblance to any other company, either currently in existence or not, is purely coincidental
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Sequence of Recent Events
Sept. 2000: Confirmed Baa3; changed Outlook to Negative
Sept. 1, 2001: Rating placed on review for downgrade.
Discussion of Agenda/Key Factors in Review
Oct. 10, 2001: Met with issuer Review of Presentation
Communication of Critical Issues
Oct. 25, 2001: Rating Committee Meets
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Current Ratings and Capital Structure
Capital Resources Current Ratings
$1,000 Mil. Public Debt Baa3
$600 Mil. in 5-Year Acquisition-Related Debt Baa3
$400 Mil Unused Revolving Credit Facility Baa3
$400 Mil. ABS Facility Aa
$1,900 Mil. Common Equity
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Recommendation
Ratings Actions
Senior Implied Rating: Assign Ba1 - Stable
Senior Unsecured Rating: Lower Baa3 to Ba1 - Stable
Bank Credit Facility: Lower Baa3 to Ba1 - Stable
Note: No Differentiation between Senior Implied and Senior Unsecured
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Fundamentals
• Positives•Highly competitive business position•Strong/well-managed brands•Extensive product and geographic diversification•Solid position with retailers•Competitive level of operating efficiency
• Negatives•Fraud at SportsKraze•Markets for SSG are slowing •Potential pushback of inventory
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Strong & Well-Managed Brands
• Leading market share positions
• Consumer survey data – brand recognition
• Marketing/Advertising spend
• Intense, deep-rooted focus on brand management
• Strong returns, equity value, market transaction value of brands
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Good Position With Retailers
• Company focus
• Confirmation from Moody’s retail analyst
Retailers make good margins
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SportsKraze Acquisition
Fully discussed prior to Sept. 2000
Rationale for transactionFit with core image - sports, health, branding, etc.Vehicle for growth
Moody’s viewModerately high priceStretching scope of core strategyGrowing investment requirements
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SportsKraze Acquisition
2000 Proforma
SSG SportsKrazeRevenues $3,400 Mil. $800
81% 19%
Op. Income $391 Mil. $120 Mil.77% 23%
Moody’s changed Outlook to Negative
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SportsKraze’s Current Problems
Sellers discounted extended memberships
Program was not disclosed
SSG discovered and disclosed the problemRedoing forecasts‘01 and ‘02 performance will be below expectations
Business has been disrupted - some customerdissatisfaction
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Management Credibility
• MD, Moody’s relationship and company emphasis
• Good dialogue Communication of strategy
• Delivering results
• SportsKraze – Fully discussed in advance
• Commitment to build financial flexibility– Reduce debt/ Acquisitions off until 2003
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Management Change
Chairman and CEO to Retire at end of 2002:
Built portfolio of brands
Forged company’s brand culture
Stayed ahead of curve on international expansion and cost control
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Track Record - Operating Efficiency
• Working capital management
• Offshore manufacturing
• Operating margins
• Good focus on cost without sacrificing critical capex or brand-support investments
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Current Debt Protection Measures
• Historic ratios consistent with Ba1
• Financial Strategy: SSG consistently ran near the edge - EVA benefit
• Concerns/risks offset by business strengths
• Slowing economies in U.S. and Europe are depressing sales and margins of SSG
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Other Concerns
Would have violated covenants in $800 Mil.Revolver
Banks wanted security, but negative pledgeblocked
Facility split - $400 Mil. Revolver & $400 Mil.Receivable sale. Ample covenant headroom
Debt protection measures will be inconsistent withBaa3 until 2003, at earliest
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SSG Assumptions and Forecasts
Market demand by product and geographic region
Process/strategy for fixing SportsKraze
Pricing environment
Cost expectations
Working capital and capex
Margins
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Financial Analysis Conclusion
Debt protection measures marginal for Baa3Debt protection measures marginal for Baa3
Performance in ‘01 and ‘02 will be consistent with Ba2Performance in ‘01 and ‘02 will be consistent with Ba2
If operations are as SSG plans, performance is marginal forIf operations are as SSG plans, performance is marginal forBaa3Baa3
There is no cushion for downside deviation from planThere is no cushion for downside deviation from plan
More aggressive financial policies in ‘03 and beyond?More aggressive financial policies in ‘03 and beyond?
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Security Position of Banks
Banks wanted security
Will have $400 million in receivables
Total debt of $2,000 Mil.Total assets of $4,500 Mil.Equity of $1,900 Mil.Net tangible assets $1,500 Mil.
Security is a negative, but not overwhelming.
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Notching Issues
Senior Implied
Overall enterprise credit quality
Ignores security, structural subordination
Cases of security:Notch secured up from senior impliedNotch unsecured down from senior
implied
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52
Rating Options
Senior implied & senior unsecured now Baa3
a) Confirm Senior Unsecured @ Baa3 - Negative
b) Assign Senior Implied Baa3 - StableLower Senior Unsecured to Ba1 - Stable (notch)
b) Assign Senior Implied Ba1- StableLower Senior Unsecured to Ba1- Stable
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53
Liquidity & Debt Maturity
• Covenant violation caused problem
• New covenants provide a lot of head-room
• $400 Revolver affords ample capacity for:– Refunding of $300 Mil. bond maturity in June ‘02– Unforeseen events ($100 Mil.)
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54
Recommendation
Assign Senior Implied of Ba1 - StableLower Senior Unsecured to Ba1- Stable
Rationale:• Ba2 financial performance for ‘01 and ‘02• Marginal Baa3 performance in ‘03• Good possibility Ba1 performance until ‘04• EPS growth will pressure financial strategy• Covenant violation and bank security• Permanently running on the edge - tolerance for financial risk• Chairman/CEO retirement
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55
Appendix
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56
Product Diversification
SwimwearSki
Golf equipmentTennis
FootwearBicycles
Outdoor/camping Exercise
equipment Skating
Health, Fun, Youth, Quality, Excitement
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57
North America
60%
Europe40%
Geographic Diversification
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58
Trends For Syndicated Bank Loans
Dan Gates, SVP
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59
New Issuance Collapsed InThe Third and Fourth Quarters
0
50
100
150
200
250
300
350
400
450
2000q1 2000q2 2000q3 2000q4 2001q1 2001q2 2001q3 2001q4
$ B
illi
on
s
Inv. Grade LeveragedSource: LPC, Moody's
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60
Moody’s Loan Ratings Continue To Grow In A Weak Market In 2001
0
100
200
300
400
500
600
700
800
900
Jun1997
Dec1997
Jun1998
Dec1998
Jun1999
Dec1999
Jun2000
Dec2000
Dec2001
Ra
ted
Vo
lum
e -
$ B
illi
on
s
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61
Comparative Rating Coverage
Number of Issuers with Rated Loans
0 200 400 600 800 1,000 1,200
Fitch
S&P
Moody's
Source: Companies' Web sites, Moody's Database
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Credit Availability Problems Are Very Different For Investment Grade and Non-IG
• Investment Grade - Strong market access, but a shrinking pro-rata investor base and increased relationship selectivity are making it more difficult to syndicate revolving credit facilities.
• Non-Investment Grade - Market access is limited for lower rated issuers. Tighter credit standards reflect the elevated default rate. Standards may ease after defaults peak in the 1st H of 2002.
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The Investor Shortage in IG:
• On-going consolidation of the banking sector• Retreat by many foreign banks• Greater focus on ROE• Increased use of portfolio tools for balance
sheet management• Revolving credits are under priced but ancillary
business can only be spread so far• Unfunded facilities are not well suited to most
non-bank investors
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64
Changing Investor Base For IG Credit Facilities
0
100
200
300
400
500
600
700
800
900
1000
1995 1996 1997 1998 1999 2000 2001*
Ne
w S
yn
dic
ate
d L
oa
ns
* Projected Source: LPC, Moody's
Non-Bank Share
Bank Share
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The Number Of Active Providers Of Pro-Rata Facilities Continues
To Shrink
Active Investors in Syndicated Loans
1996 130
2001 60
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Changing Investor Base For Non-Investment Grade Loans
0
50
100
150
200
250
300
350
1995 1996 1997 1998 1999 2000 2001
New
Syn
dic
ated
Lo
ans
Source: LPC, Moody's estimates
Non-Bank Share
Bank Share
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67
The Growth Of CDO’s
0
20
40
60
80
100
120
140
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001*
$ B
illio
ns
0
50
100
150
200
250
300
Rated Volume (left scale)
Number of Deals (right scale)
* Estimated
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Trends in Loan Structures
• Less stretch in financial structures and projections
• Better collateral coverage/control
• Easier assignments, more call protection, Libor floors
• More active trading
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69
Trading of Loans Has Grown; And The Distressed Share of Trading Has
Increased
1999
11%
2000
24%
2001
35%
Source: LPC, Moody’s
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Market Outlook
• Investment grade loan market looks fairly strong and will be “refinancing” driven in 2002
• Forward calendar for leveraged loans is quite weak, after 30% volume decline last year
• Leveraged loans fell below 25% of total syndications in 2001, first time since 1997
• Non-investment grade issuer default rate of 9% is highest in 8 years and nearing a peak
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Average Recoveries On Defaulted Loans Are Falling
1999
20002001
0%
20%
40%
60%
80%
100%
1999 2000 2001
Re
co
ve
ry o
n D
efa
ult
ed
Sr.
Se
cu
red
Lo
an
s
Long Term Average 69%
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History Suggests That Credit Will Not Ease Until After Defaults Peak
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
0%
2%
4%
6%
8%
10%
12%
14%
Federal Reserve - Net Tightening Statistics (Left Axis)
Moody's Speculative Grade Default Rate (Right Axis)
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Amid The Gloom, The Stage is Being Set For Eventual Improvement
• Noticeably tighter lending standards since the 3rd quarter of 2000
• Leveraged loans structured with less leverage and better collateral coverage
• Much more market skepticism to projected operational and financial improvements or merger synergies
These factors suggest that new loans should have somewhat higher credit quality
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New Syndications Exhibit Higher Ratings Due to Tighter Lending Standards
Higher Ratings On New Loans in 2001 Compared to Prior Years
0%
5%
10%
15%
20%
25%
30%
35%
Aaa
Aa1 Aa2
Aa3
A1 A2 A3
Baa1
Baa2
Baa3
Ba1 Ba2
Ba3
B1 B2 B3
Caa1
Caa2
Caa3
Bank Loan Ratings Assigned in1999-2000 Bank Loan Ratings Assigned in 2001