Investing in High Yield and
Distressed Debt
A growing asset class in difficult times
LIUC
April 2009
1
AGENDA

Basics of Credit Investing

Investing in HY and Distress

Strategies and Trading Technicals

Current situation

Appendix
2
Basics of Credit Investing
A Focus on
High Yield Bonds and
Leverage Loans
3
Credit Investing

Lending to corporations


a direct private financing contract (loan)
underwriting newly issued corporate bonds


vs.
public offerings
Secondary market investing in corporate bond


private placement
Publicly listed debt
vs.
OTC transactions
Return on credit investments

periodic interest payments until maturity


vs.
payment-in-kind (PIK loans)
Repayment of the principal (end of the game)



in cash
entirely at maturity (bonds, bullet loans)
according to a scheduled amortization (most loans)
Capped return on the investment
4
Example of a PIK
The KDG Case

“Structurally” subordinated
to the operating assets






Euro 400m Floating Rate Senior PIK Notes due
2014 of Kabel Deutschland Holding GmbH & Co.
KG, issued on December 2004
Issue price: 99%
Book runners: GS and DB
“Interest will be payable of additional notes, or
cash if we so elect…”  in case the company
elects to pay-in-kind (PIK), all the cash will be
received at maturity by the noteholders
“The Notes will be senior obligations of the
Issuer and will rank equal with all existing and
future debt of the Issuer” (as a matter of fact,
the notes are structurally subordinated to the
operating assets)”
“We might redeem all or part of the Notes on
December 2005” – technically called Non-Call 1
“If we experience a Change of Control, we will
be required to offer to repurchase the Notes at
101%”
Assets Traded
Type of Assets
Asset Characteristic
Typical Investors
Senior secured, 1st lien and
2nd lien bank debt, DIP
facilities, bridge financings,
mezzanine debt, LCDS
Greater security, stricter
covenants, more rights.
Assets are generally less
volatile
Bonds
Secured bonds, unsecured
bonds, subordinated bonds,
convertible bonds, CDS
Commonly traded
High yield funds, CDOs and
instruments with high
credit funds
market correlation. Typically
little covenant protection and
limited rights in a workout
Higher threshold for losses
relative to bank debt investors.
Low expertise in workouts. CDOs
may be forced sellers in
defaulted situations
Trade Claims
and Other Debt
Trade claims, pension
deficit claims, vendor notes,
intercompany claims,
litigation claims
Less liquid. Often possible
to create claims at discount
to market. Often provides a
different or unique angle
Trade suppliers, unions,
employee pension trustees,
vendors, insolvency
practitioners
Generally unsophisticated, or
unable to exercise full rights.
Look for liquidity
Public securities have highest
volatility of all assets. Private
situations or structured deals
are low volatility. Potential for
new money deals
Equity funds, special
situation funds, private
equity, families,
governments, other equity
investors
More sophisticated, particularly if
private equity. Relationships
remain key. Event driven or
special situation funds focused
on opportunistic investing
Bank Debt
Special Situation
Equity
Public and private equity,
impaired equity, post
reorganisation equity,
convertible preferred or
preferred equity, options
Only Distress / Special Situation funds
Commercial banks, CLOs,
credit funds, mezzanine
funds
Investor Characteristic
Low threshold for losses. As
investor base shifts from
traditional investors to CLOs and
general credit funds, level of
workout expertise is decreasing
6
High Yield Bonds and Leverage Loans
Leverage Loans
High Yield (HY) Bonds






Bond / note / other securities

Sub-investment grade - Junk
(mostly B- through CCC rating)

Typically 7-10 year maturity

Yield at issuance  8%-12%
(Libor + 500/700 bps)
Mostly issued in the context of a
leverage buyout (LBO) executed by
a private equity firm
Usually unsecured and
subordinated




Contract form
Arranged by banks and mostly
syndicated to the market
Maturity typically 6, 7 and 8 years
(1° lien tranche A, B, C, or 2° lien)
Spreads range from 200bps to
400bps
Most of times underwritten in LBOs,
as high yield bonds
Security over assets
Can be first lien or second lien on
assets
7
Where Do High-Yield, Distress Bonds
& Loans Sit in the Capital Structure?
Senior Secured Loans:
• private instrument / contract (typically negotiated by
banks and then syndicated to the credit investors)
• first priority in reimbursement in case of liquidation
• rights typically protected by security over hard assets
Senior Unsecured Bonds:
• publicly listed instrument / note or bonds (typically
underwritten by banks and then syndicated to the credit
investors)
Subordinated debt
•subordinated to senior credit loans or bonds, but senior
to equity, in reimbursement in case of liquidation
• rights typically protected by a general guarantee of the
issuer (no direct claim on the assets)
CAPITAL STRUCTURE “WATERFALL”
8
Credit Investing Risk-Reward Profile
REWARD / IRR
Indicative spreads to
Risk-free rate:
15%-25%
Alitalia
Geox
4%-15%
1%-4%
0%-1%
Risk-free rate
TI
IT Holding Equities and
Seat
Distressed Debt
Corporate Debt
High Yield / Junk
Italy
Corporate Debt
US
Investment Grade
Enel
Government Debt
• High yield debt becomes distressed when it trades in the
secondary market below 70-80% of face value
• This is the main focus of today‘s lecture !
RISK
[Risk can be defined as VAR,
volatility, illiquidity, tail risk, gap
risk,...]
9
Risk / Reward:
Cutting To The Core
Risk premium line
REWARD / IRR
Attractive Risk / Reward
Unattractive Risk / Reward
riskfree
RISK
10
Treasury Yield Curve
11
Credit Spreads
Default Rates
Historical Max
Previous peak
points
Long-term Avg
Ratings & Default Rates
Risk Event: Migration
Default Rates vs. High Yield Spreads
(US)
16
Default Rate vs. Leveraged Loan
Spread
Estimated Recovery Rate
Final Recovery Rate
Recovery Rates (US)
Default Rates & Recovery Rates
Default Loss
Corporate Credit Spreads’ Indexes
• The latest release of the HY
index is the Itraxx S9 Xover
(maturity March 2013)
•The Itraxx Europe index is
a reference for investment
grade companies
The Itraxx Finl Sen and
Sub represent senior and
subordinated credit risk of
financial institutions
• Itraxx Generic represents a
blend of the various series’
releases (indexes roll every 6
months into a new release with
new constituents)
23
Itraxx Generic Xover Index
24
Liquid vs Illiquid Investments /
Trades
LIQUID




Typically a bond or a loan which is
traded by brokers
Bid / Ask spread ranging from 0.25% to
2%
Broker willing to trade a size of at least
Euro 2mln to Euro 10mln
Many market participants focus on
liquid investments due to:

mandate they have from their
investors

Capability to “exit”

Lower gap risk

Capability to improve returns by
“trading around positions”, hence
benefitting from volatility
ILLIQUID





Typically “forgotten” bonds or loans by
brokers, small sized deals, whose
syndication went to just a few market
participants, or directly sourced
investments (where there isn’t a
standard process by which banks first
underwrite the deals)
No market making by brokers
Trading might happen based on
individual negotiations
Impossibility to “exit”, to “trade
around”, etc
Typically only funds which have a lockup period and who target a return
premium for the illiquidity
25
The Extra Premium for Illiquidity
Extra spread demanded by deals smaller than $500
million (proxy of definition of illiquidity)
26
Credit Derivatives (CDS or LCDS)
27
Importance of Derivatives for the
Asset Class

Hedging




If you are “long” a single name credit risk, you can hedge the
trade without going through the process of selling the underlying
cash asset buying a CDS on that name
If you are “long” market credit risk, you may buy credit index
protection to hedge the exposure to the market (i.e. Itraxx)
Capability to have additional liquidity in the market
Capability to deploy curve and basis trades
 relative value
 market neutral
28
Invest in HY and Distress
Evolving Asset Class by the Day
2929
Investing in HY is Cyclical
Cyclicals Returns
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
EUR
-7,0%
-2,1%
9,5%
3,0%
14,0%
18,6%
2,2%
11,7%
-2,2%
14,8%
USD
-4,6%
0,6%
12,2%
0,7%
11,7%
22,4%
8,8%
9,9%
-4,8%
0,7%
25%
USD
1998
1997
1996
1995
1,6%
11,8%
14,3%
18,1%
EUR
20%
20%
15%
15%
10%
10%
5%
5%
0%
0%
-5%
-5%
-10%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
-10%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
30
The Difference Between a Trade and
an Investment
TRADE



Short Term
Potentially look at arbitrage
opportunities
Trade based on trading
technicals
INVESTMENT



Medium-Long Term
Take a view on
market/sector/company
Investment based mostly on
analysis and macro view
31
Investment Process Overview
MANAGING
POSITIONS
IDEA GENERATION
SCREENING ANALYSIS
STRUCTURING
• Identify investment
opportunities internally and
from other sources
• Identify the edge
• Focus on capital preservation • Monitor all positions for
and low volatility
news, data and events in real
time
• Identify opportunities with
down side of debt and upside of • Mark positions monthly
equity
based on bid-ask market
• Monitor “stressed credits”,
industry sector trends, news
and research reports
• Monitor market trends and
review deals in the credit and
equity markets
• Active dialogue with desks,
investment management
community, restructuring
professionals, industry experts
and other relationships
• Maintain key relationships
with funds, desks and
professionals and industrial
players
• Conduct full financial analysis,
including valuation, debt capacity
and liquidity analysis
• Evaluate process risk by
analysing legal issues, jurisdiction, • Assess and understand
capital structure, indentures, legal liquidity of the investment and
agreements, stakeholder
exit
interests, etc
• Review the entire capital
• talk to key players –
structure to determine where to
management, existing investors,
invest and identify intra capital
professional advisors, and
structure plays
interested investors and buyers
• Determine opportunities to
• Conduct industry and sector
create / offer a new security
analysis
• Understand which security
• Perform scenario analysis to
has negotiating leverage, and
determine upside/downside cases assess stakeholder interests
• Identify events and timing to
events
• Determine size, liquidity and
overall fit with portfolio
• Sell discipline focused on
exit: sell when event
happens; sell on price
appreciation; sell if situation
or event changes negatively
• Talk continuously to key
players and contacts to keep
ahead of the information flow
• Review all positions weekly
• Revisit scenarios constantly
• Advisory panel input during
portfolio review process
• Structure hedges
32
Managing the Process
(Special Situations)
From identifying an opportunity to executing on it, we closely manage the process every step
INITIAL ASSESSMENT
REACHING AGREEMENT
• Opportunity assessed against our
investment criteria
• Key commercial issues identified and put • Experienced structuring team dedicated
on the table
delivering the agreed deal
• Immediate feedback – we will only work • Meet and develop relationship with
on deals we believe we can execute
management
• Experienced analyst allocated to
complete financial analysis
EXECUTION
• Creative deal structuring using both
financial, legal and industry angles
• Streamlined documentation
requirements, borne out of years of
• Flexible and pragmatic approach to other
experience of what is key in distressed and
• Founding partners involved from the
stakeholders
special situations
outset to make an assessment of the
• Ongoing honest feedback provided
risk/reward dynamics
• Founding Partners involved throughout –
throughout
leveraging their relationships to bring other
• Information request provided focusing on
• Upside/downside scenario analysis
stakeholders on board
the key facts we need to make an
investment decision
• Timeline to completion established
24/48 hours
• Initial terms proposed and negotiated
2-5 days
5+ days
33
Managing the Trade
Distressed and special situations require early identification, efficient trading and quick, decisive decision
making. For this reason, our founding partners are involved in every stage of the investment process to
ensure we can take full advantage of the different stages of a company’s restructuring and turnaround
Price
(% of Par)
Refine understanding of
the investment rationale,
build the position, drive
the process
100
75
50
25
Early identification of
potential opportunities.
Identify capital structure
weak points and likely
outcome of inter-creditor
negotiations
Constantly reassess
investment rationale,
valuation parameters, and
trading flows throughout
the restructuring process
Efficiently trade
throughout the
restructuring period, have
the best information, look
to create the trade in
other ways
Maximise value
through recovery
and turnaround
phase
0
Time
34
Risk return profile for an HY
manager



Target return: 15%-20% IRR
10%-15% volatility
Key risk measures:

DIV01 = change of the underlying security value to a change of
1bps in credit curve; also indicative of the duration of a security.

Example: For a bond with 5y duration, if the credit curve widens by
20bps, its value decreases by 1% (20bps * duration of 5).

Leverage

VAR
Making an Investment
Recommendation

Market screening

Building an investment idea

Sector analysis

Company analysis

Equity and credit comps

Assessing risk-reward profile

Degree of conviction

The investment recommendation
36
Market Screening

Scouting for companies with traded debt securities


Take a look at sectors we deem to be attractive
Take a look at bonds/loans deeply discounted to par value

A HY investor restrict himself to names offering a
potential levered return of at least Libor+600 bps

Brokers or research analysts might suggest ideas,
companies and situations to look at

Who is focused on distressed looks at firms with an
important credit event (imminently due or just past)


bankruptcy process, like Alitalia or Lehman Brothers
downgrades
37
Market Screening: example #1
38
Market Screening: example #2
39
Building an Investment Idea



Choose the right sector
Choose a company with a very good
management team in that sector
Pick cheap debt securities of that
company in relative value terms
40
(1) Sector Analysis


Most of our actual return on capital depends on the sector we invest in
A deep understanding of all the challenges faced by the companies in
the sector are facing is then of paramount importance


To gain an educated view on the company sector condition and outlook



e.g. raw material price increases, price pressure, intense competition,…
look at the competitors/peers in terms of their operating and financial stats
(sales growth, EBITDA margin, leverage, cashflow conversion, etc)
when a listed competitor / peer reports its quarterly numbers, we might find
a lot of information from its reports and subsequent brokers’ analysis
In the current context (recession) we


favor sectors like utilities, telecom, healthcare, aerospace, niche
technologies (“defensive” sectors, uncorrelated with economic cycles)
avoid retail, fashion and luxury, financials, automotive and related, airlines,
consumer goods (“cyclical” sector, highly correlated with the economic
environment)
41
(2) Company Analysis

Review of


Financial accounts (annual reports, quarterly financials statements)
Sell side research (equity and credit analyst research)

Interviews to suppliers, customers, peers, etc.

Aim to gain a deep knowledge of:




firm’s business model and business plan
firm’s financial structure
firm’s traded debt securities or loans
The end product is an excel-based output, including a granular
operating and financial model of the company
42
(3) Equity and Credit Comps


Need to understand if the debt securities we are considering
investing in are “cheap” or “expensive” - compared to the
securities of other companies in the same sector or with similar
leverage
Especially true if we are trying to deploy a relative value
investment strategy to isolate the “ALFA”


One of the key features to make money over time is to invest in
cheap securities
Often we find better investment opportunities (better
risk/reward and better companies) in comps/peers we look at

By analyzing comps’ securities as well, we might find a better way
to express our views by combining together various trades
43
Equity and Credit Comps: Example #1
Selected equity automotive components trading multiples
Price
Mkt Cap
Net debt/
FV/sales
FV/EBITDA
EBITDA margin
FV/EBIT
EBIT margin
P/E
Local ccs
€mm
Autoliv
58
3,495
1.4x
0.95x
0.91x
0.88x
7.0x
6.8x
6.1x 13.7%
13.4%
14.3%
10.8x
10.9x
9.3x
8.8%
8.3%
9.4%
15.1x
14.1x
11.8x
BorgWarner
76
3,379
1.8x
1.28x
1.19x
1.05x
8.9x
8.1x
7.2x 14.4%
14.6%
14.6%
12.7x
10.9x
9.5x 10.1%
10.9%
11.0%
16.0x
14.0x
12.2x
Brembo
10
680
1.2x
1.03x
0.96x
0.90x
6.9x
5.9x
5.2x 14.9%
16.4%
17.2%
10.3x
8.7x
7.3x 10.0%
11.0%
12.4%
16.1x
13.9x
10.5x
Continental
96
14,139
1.2x
1.18x
1.07x
1.02x
7.0x
6.5x
5.9x 16.9%
16.5%
17.1%
9.6x
8.9x
8.2x 12.2%
12.0%
12.4%
13.4x
11.7x
10.7x
Faurecia
53
1,289
2.3x
0.28x
0.27x
0.27x
3.7x
5.8x
5.3x
7.4%
4.7%
5.1%
8.9x
13.4x
10.7x
3.1%
2.0%
2.5%
neg.
neg.
neg.
GKN
mkt cap 2006A 2007E 2008E 2006A 2007E 2008E 2006A 2007E 2008E 2006A 2007E 2008E 2006A 2007E 2008E 2006A 2007E 2008E
4
3,925
2.3x
0.94x
0.90x
0.88x
10.0x
8.6x
7.9x
9.4%
10.5%
11.1%
17.7x
14.0x
12.5x
5.3%
6.4%
7.0%
22.6x
16.8x
14.6x
94
14,329
2.1x
0.74x
0.69x
0.88x
9.9x
8.9x
10.9x
7.4%
7.8%
8.1%
13.8x
12.1x
14.5x
5.3%
5.7%
6.1%
14.3x
13.9x
16.1x
Lear
36
2,093
3.6x
0.32x
0.36x
0.38x
7.0x
6.5x
5.9x
4.6%
5.5%
6.3%
13.3x
10.2x
8.6x
2.4%
3.5%
4.4%
NM
18.9x
10.9x
SKF
140
6,815
0.5x
1.29x
1.22x
1.19x
7.6x
7.4x
6.9x 17.0%
16.5%
17.3%
9.5x
9.3x
8.6x 13.6%
13.1%
13.9%
14.8x
15.0x
13.4x
7
831
1.2x
1.02x
0.99x
0.96x
6.7x
6.4x
6.1x 15.2%
15.6%
15.8%
11.9x
10.8x
10.1x
8.6%
9.2%
9.6%
16.5x
14.9x
13.4x
Superior Industries
21
424
(2.7x)
0.64x
0.63x
0.60x
18.4x
8.2x
6.7x
3.5%
7.8%
8.9%
-37.4x
29.9x
18.7x
(1.7%)
2.1%
3.2%
neg.
48.3x
24.1x
Tenneco
26
948
3.9x
0.65x
0.53x
0.49x
6.8x
6.2x
5.9x
9.5%
8.6%
8.3%
11.7x
10.0x
9.4x
5.5%
5.3%
5.2%
19.2x
13.7x
11.8x
Johnson Controls
SOGEFI
Tomkins
3
3,340
1.2x
0.93x
1.00x
0.98x
6.9x
7.5x
7.3x 13.5%
13.3%
13.4%
9.7x
10.9x
10.3x
9.6%
9.2%
9.5%
12.2x
15.9x
14.0x
178
1,715
3.8x
0.98x
0.90x
0.87x
9.8x
8.5x
7.8x 10.0%
10.6%
11.2%
13.9x
11.8x
10.5x
7.0%
7.6%
8.3%
16.3x
12.4x
11.1x
TRW
35
2,717
3.5x
0.59x
0.57x
0.55x
6.8x
6.5x
6.1x
8.7%
8.7%
9.0%
12.2x
11.7x
10.7x
4.8%
4.9%
5.2%
17.9x
15.5x
13.2x
Valeo
44
3,389
1.8x
0.52x
0.51x
0.49x
5.3x
5.1x
4.5x
9.8%
9.9%
10.8%
14.4x
12.2x
9.2x
3.6%
4.2%
5.3%
17.2x
19.5x
12.4x
Median
1.8x
0.93x
0.90x
0.88x
7.0x
6.7x
6.1x
9.9%
10.6%
11.1%
11.8x
10.9x
9.8x
6.3%
7.0%
7.6%
16.2x
14.9x
12.4x
Average
1.8x
0.83x
0.79x
0.77x
8.0x
7.1x
6.6x
11.0%
11.3%
11.8%
8.9x
12.2x
10.5x
6.8%
7.2%
7.8%
32.4x
17.2x
13.3x
Trelleborg
Looking at equity comps is the most immediate - and frequently the most
effective - way to form a view on the Enterprise Value of our target company
44
Example (yes / no)
KAMPS: NO – too much leverage due to
operating underperformance
Q1 2006 Capital Structure
Cash
Bank Loans
Barilla's Credit Line
New Financing for 2006
Total Net Senior Debt
HY Bond
Total Net Debt
Receivables Sold
Adjusted Net Debt
GROHE: YES – quite leveraged, but high
potential for cost savings and plenty of
liquidity
Q1 2006 Capital Structure
Face Value
€mm
(16.7)
4.0
93.3
100.0
180.6
326.8
507.4
x LTM
EBITDA
(0.4x)
0.1x
2.1x
2.3x
4.2x
7.5x
11.7x
Mkt Value
€mm
(16.7)
4.0
93.3
100.0
180.6
284.3
464.9
x LTM
EBITDA
(0.4x)
0.1x
2.1x
2.3x
4.2x
6.5x
10.7x
96.0
603.4
2.2x
13.9x
96.0
560.9
2.2x
12.9x
Bank Debt / Revolver / Restructuring
Other Financial Indebtness
Total Senior Debt
HY
Total Debt
Cash
Net Debt
Available Revolver
Available Restructuring Facility
€mm
815.0
25.0
840.0
340.0
1,180.0
(31.0)
1,149.0
65.0
70.0
2006E
EBITDA EBITDA-C
4.7x
5.6x
0.1x
0.2x
4.8x
5.8x
1.9x
2.4x
6.8x
8.2x
(0.2x)
(0.2x)
6.6x
8.0x
Equity and Credit Comps: Example # 2
46
Assessing Risk-Reward



To measure the risk/reward we need to look
at the unit of reward we are getting for a
unit of risk we are undertaking
One possible risk-reward measure can be
spread / leverage turns
Example:

A debt security which yields 1000bps over
Euribor and “sits” at 5x EBITDA leverage, has a
ratio of “spread per turn of leverage” equal to
200bps – the higher the ratio, the higher their
are paying us for a unit of risk, where the proxy
for the unit of risk is the EBITDA leverage
An investment in a senior secured loan
purchased at discount (80-85 cents) where
there is a likely event of refinancing in 1-2 years
and an almost nil probability of default
potentially represents a good risk/reward
investment (low default risk of senior secured
loans and 15-20% equity-like potential return
over the investment horizon)
47
Risk / Reward Moving Up and Down
the Capital Structure
Example Intra Capital Structure: Moving Lower – from Senior to
Subordinated – Risk is More and More Rewarded with Extra Spreads
Spread / Leverage (Sub Debt)
Spread / Leverage (Senior Debt)
A
B
C
D
A/C
Incremental Spread / Leverage
per additional leverage to go
from Senior to Sub
B/D
(B-A) /
(D-C)
48
Degree of Conviction


The degree of conviction represents how
comfortable we are in the numbers and in the
judgment calls at the basis of our analysis
Having a high degree of conviction in high
yield and distress investing is of paramount
importance since


the loss can be huge
Exit may be difficult
49
Degree of Conviction: Examples

Situations where we might have a high degree of
conviction:





We have been studying the company for a long time and we have had the
chance to verify that our financial model works well in terms of forecasting
We have a good relationship with the CEO or CFO of the target company and
we feel we have a better understanding of their body language
We know the sector well because we have been investing in it for a long time
We have already invested in the company
Situations where we might NOT have a high degree of
conviction:




It is the first time we are looking at the sector of our target company
We have little historical financial information on the target company
Earnings have historically proven to be very volatile
The sector is going through a transformational period
50
A Crucial Pair: Risk/Reward Measure
& Degree of Conviction
REWARD / RISK
Attractive Investments
Unattractive Investments
DEGREE OF
CONVICTION
51
The Investment Recommendation

Following the investment analysis, an investment idea (if reached)
must be proposed in a one-pager


Additional recommendation detail: “trading on a scale”


“Buy/Sell the security X at the price Y in this size”.
“If the price goes up by Z amount, unwind the trade, while buy K more
if the price goes down by a W amount, assuming the investment thesis
l holds true”
Additional recommendation detail: “stop loss”

“If the price goes down by Z amount, unwind the trade, while buy K
more if the price goes up by a W amount
52
Trading on a Scale: Example
• It averages down the purchase price of our investment if market conditions
worsen
• It secures the profits if market conditions improve
• Since each bond price implies a Yield to Maturity -YTM, if the investment
thesis holds true, you invest more in that debt security whenever returns
become more attractive (prices go down only due to market conditions)
Price
YTM
YTC
YT '08 takeout
>= 90
10.7%
13.9%
20.9%
92
10.3%
13.1%
19.4%
94
9.9%
12.3%
18.0%
96
9.5%
11.5%
16.6%
98
9.2%
10.7%
15.2%
100
8.8%
10.0%
13.9%
>100
Position Size
% of Total Bond
80
24%
60
18%
40
12%
25
7%
15
4%
10
3%
0
0%
“Trading on a Scale” – Mean
Reverting, High Conviction Trades

The importance of trading on a scale in credit investing is due to the
“mean reverting” aspect of the strategy


While in equities a stock can be cheap but it can get cheaper and stay there forever, in
credit there is an event (the repayment at par value) which allow to verify if the initial
investment thesis was correct (assuming you go long a credit at discount)
Assuming the company will be able to repay at par the debt security we have invested
in, then a scenario of high volatility allows a good trader to make more profits
throughout the way
TOTAL P&L: CARRY INTEREST + CAPITAL GAIN
sell
sell
Par value: 100
price
buy
buy
buy
54
Strategies and Trading
Technicals
The Devil is in the Detail
5555
Detailed Company Fundamentals


Having a bottom-up granular operating and financial model allows to forecast
quarterly developments of the financials of the company,
You can potentially understand if covenants will be triggered or other events
will unfold and act immediately on this expectations



should prices of raw materials price increase, you may immediately run your
model to assess changes in the profitability (i.e. EBITDA) of the company without
the need to wait for the next quarterly financial release to understand what the
numbers are
we can act sooner on our investment (exiting or adding more) before the vast
majority of investors who lack a precise and detailed operating and financial model
Credit investors have a much more sophisticated bottom-up approach than
equity investors since forecasting cashflows in detail is their core business

in equity investing you will very rarely find people who have detailed operating and
financial models on companies under analysis
56
Approach to Company Fundamentals
Disciplined approach to analysis and investment decisions.
Process includes an iterative approach to analysis and structuring
FINANCIAL ANALYSIS
PROCESS ANALYSIS
Industry and Competition
Process Environment
• Competition, customers, suppliers
• Jurisdictional and legal issues, including
• Comparables (multiples, M&A comps)
Valuation
• Business plan and scenario analysis
• DCF, multiples, sum of parts
• Liquidation and break-up analysis
Continuous discussions
with analysts, managers,
industry experts, advisors,
other investors, etc
Debt Capacity
Liquidity Analysis
• Debt service, capex, w/c impact
through restructuring process
• Cash, borrowing capacity, headroom
Situation Assessment
• Capital structure, review of indentures,
covenants, security and inter-creditors
agreements
• Shareholders’ and other agreements
Scenario Analysis
• Leverage comparables and ratings
• Focus on coverage ratios: debt,
interest, free cash flow, capex
relevant bankruptcy processes
• Identify various process alternatives
• Identify the edge in a trade
• Identify players involved
• Upside/downside scenarios
• Know events & timing
• Understand exit in illiquid
situations
• Take process or business risk
(not both)
• Assess stakeholder interests &
negotiating leverage
• Timing of events and map out possible
scenarios
• Understand upside/downside, risk and
reward
57
Company Fundamentals: Example I/IV
[SEE ATTACHMENT]
58
Company Fundamentals: Example – II/IV
2004
2000
2001
2002
2003
Q1
Q2
Q3
Q4
2004
Q1
Q2
245.4
225.9
(7.9%)
215.4
(4.7%)
50.7
53.0
49.1
46.5
199.3
(7.4%)
47.6
(6.2%)
39.4
47.9
(9.5%)
39.4
(11.0%)
2.4%
(8.1%)
0.6%
(3.2%)
0.0%
Sales
2005
Q3
Sale of AQUA
Rotter in Sep-05
Q4
2005
41.0
(12.0%)
181.6
(8.9%)
€ Sales
Germany
Growth %
German Sales Excl. Aqua Rotter
LFL for Sale of Aqua Rotter
Out of Which, Volume %
Out of Which, Price %
45.1
(8.2%)
38.2
(6.0%)
(3.1%)
Economic Data from the Federal Statistical Office (www.destatis.de):
GDP Growth %
2.5%
1.5%
Construction Capital Growth %
(4.6%)
(6.1%)
Housing Growth %
(6.2%)
(6.0%)
Gross Value Added in Construction Industry Growth %
(4.9%)
(3.6%)
[See spreadsheet "German Construction" to see running pick-up in Construction Dwellings]
0.9%
(1.6%)
(1.0%)
(4.3%)
Benelux
Growth %
Out of Which, Volume %
Out of Which, Price %
106.2
105.1
(1.0%)
(3.8%)
2.9%
105.6
0.4%
(2.9%)
2.0%
30.5
30.7
21.2
26.8
109.2
3.4%
25.5
(16.3%)
25.8
(16.1%)
22.1
4.2%
24.2
(9.7%)
97.6
(10.6%)
France
Growth %
Out of Which, Volume %
Out of Which, Price %
88.8
93.8
5.5%
2.7%
2.8%
98.0
4.5%
2.3%
2.2%
26.6
28.6
23.3
19.2
97.7
(0.4%)
24.2
(9.1%)
22.7
(20.6%)
21.8
(6.3%)
19.8
3.3%
88.5
(9.4%)
52.5
0.4%
(0.4%)
0.9%
54.2
3.2%
1.7%
1.5%
15.4
14.4
11.6
12.9
54.2
0.1%
16.1
4.9%
13.3
(7.6%)
8.5
(26.7%)
9.6
(25.4%)
47.5
(12.4%)
Italy
Growth %
Out of Which, Volume %
Out of Which, Price %
1.2%
3.1%
2.2%
2.1%
52.3
1.3%
(0.1%)
2.4%
(1.1%)
(0.3%)
(2.1%)
1.3%
(2.4%)
(2.6%)
(5.6%)
59
Company Fundamentals: Example III/IV
2004
2000
2001
2002
2003
Q1
Q2
Q3
Q4
2004
Q1
Q2
Q4
2005
(159.5)
(163.3)
2.4%
(18.6%)
(162.5)
(0.5%)
(18.0%)
(161.6)
(0.6%)
(18.2%)
(40.0)
(41.0)
(36.5)
(40.1)
(18.0%)
(16.9%)
(16.3%)
(17.9%)
(157.6)
(2.5%)
(17.3%)
(40.0)
0.0%
(18.1%)
(41.5)
1.2%
(18.6%)
(38.4)
5.3%
(18.4%)
(33.3)
(16.9%)
(15.6%)
(159.0)
0.9%
(18.4%)
(336.1)
(0.5%)
(37.3%)
(328.0)
(2.4%)
(36.9%)
(83.1)
(92.0)
(85.2)
(86.0)
(39.1%)
(337.6)
1.4%
(38.4%)
(37.5%)
(38.0%)
(38.0%)
(38.5%)
(346.3)
5.6%
(38.0%)
(86.2)
3.8%
(39.0%)
(85.8)
(6.7%)
(38.5%)
(80.5)
(5.4%)
(38.5%)
(83.2)
(3.3%)
(38.8%)
(335.8)
(3.0%)
(38.8%)
358.4
42.1%
378.0
43.0%
403.1
44.7%
399.5
44.9%
98.5
44.5%
109.1
45.1%
102.4
45.7%
97.4
43.6%
407.4
44.7%
94.9
42.9%
95.6
42.9%
90.2
43.1%
97.6
45.6%
370.6
42.8%
Cost of Sales
Fixed Costs
Growth %
As % of Sales
Variable Costs
Growth %
As % of Sales
Gross Profit
Margin %
(18.8%)
(332.9)
2005
Q3
Sale of AQUA
of AQUA Rotter]
Original TPG Plan
Margin %
430
44.5%
Other Costs
R&D Costs
Growth %
As % of Sales
Selling Expenses
Growth %
As % of Sales
A&G Expenses
Growth %
As % of Sales
Other, Net
Operational EBITA
Margin %
D&A
Operational EBITDA
Margin %
Original TPG Plan
Margin %
(20.9)
(20.0)
(4.3%)
(2.3%)
(24.2)
21.0%
(2.7%)
(25.9)
7.0%
(2.9%)
(194.6)
0.7%
(22.1%)
(198.7)
2.1%
(22.0%)
(192.2)
(3.3%)
(21.6%)
(3.2%)
(30.8)
11.6%
(3.5%)
(29.3)
(4.9%)
(3.2%)
(31.9)
8.9%
(3.6%)
(0.4)
2.3
(3.5)
116.3
13.7%
134.9
15.3%
39.5
155.8
18.3%
(2.5%)
(193.2)
(22.7%)
(27.6)
(6.4)
(7.1)
(7.4)
(8.6)
(29.5)
14.1%
(3.2%)
(7.0)
8.9%
(3.2%)
(7.7)
8.4%
(3.5%)
(9.0)
22.5%
(4.3%)
(8.6)
(0.8%)
(4.0%)
(32.3)
9.3%
(3.7%)
(2.9%)
(2.9%)
(3.3%)
(3.9%)
(48.4)
(51.9)
(50.5)
(50.2)
(201.0)
4.6%
(22.1%)
(49.5)
2.4%
(22.4%)
(48.9)
(5.8%)
(21.9%)
(45.7)
(9.5%)
(21.8%)
(49.1)
(2.3%)
(22.9%)
(193.1)
(3.9%)
(22.3%)
(21.8%)
(21.4%)
(22.5%)
(22.5%)
(7.6)
(7.9)
(8.1)
(7.0)
(3.1%)
(30.6)
(4.0%)
(3.4%)
(7.2)
(5.2%)
(3.3%)
(7.0)
(11.3%)
(3.2%)
(7.1)
(12.3%)
(3.4%)
(7.0)
0.3%
(3.3%)
(28.4)
(7.4%)
(3.3%)
(3.4%)
(3.3%)
(3.6%)
(1.8)
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
147.4
16.3%
147.7
16.6%
36.1
16.3%
42.1
17.4%
36.5
16.3%
31.5
14.1%
146.3
16.1%
31.2
14.1%
31.9
14.3%
28.4
13.6%
32.9
15.4%
116.8
13.5%
36.3
38.3
38.6
10.0
10.0
10.0
10.0
40.0
10.0
10.0
10.0
10.0
40.0
171.2
19.5%
185.7
20.6%
186.3
21.0%
46.1
20.8%
52.1
21.5%
46.5
20.8%
41.5
18.6%
186.3
20.4%
41.2
18.6%
41.9
18.8%
38.4
18.4%
42.9
20.1%
156.8
18.1%
200
20.7%
60
Company Fundamentals: Example IV/IV
2002
Cost of Sales
Actuals
Estimation
Difference
Absolute
2003
2004
2005
2006
Q1 '02
Q2 '02
Q3 '02
Q4 '02
Q1 '03
Q2 '03
Q3 '03
Q4 '03
Q1 '04
Q2 '04
Q3 '04
Q4 '04
Q1 '05
Q2 '05
Q3 '05
Q4 '05
Q1 '06
48.6
48.0
0.6
0.6
49.2
49.2
(0.0)
0.0
42.9
43.7
(0.8)
0.8
43.7
43.7
(0.0)
0.0
45.6
45.2
0.4
0.4
46.8
45.6
1.2
1.2
44.5
44.8
(0.3)
0.3
45.1
45.0
0.1
0.1
46.5
46.9
(0.4)
0.4
49.0
49.3
(0.3)
0.3
44.9
44.9
(0.0)
0.0
44.5
43.6
0.9
0.9
44.5
45.4
(0.9)
0.9
50.2
50.3
(0.1)
0.1
47.0
46.8
0.2
0.2
46.5
46.2
0.3
0.3
50.3
50.1
0.2
0.2
Fixed Costs
Unit Cost / Unit Revenue
Q2 '06
Q3 '06
Q4 '06
50.5
46.4
44.9
6.7
6.6
70%
Cost of Sales - Actuals vs Estimation by Quarter
£ 52.0
£ 50.0
£ 48.0
£ 46.0
£ 44.0
£ 42.0
£ 40.0
Q1 '02
Q2 '02
Q3 '02
Q4 '02
Q1 '03
Q2 '03
Q3 '03
Q4 '03
Q1 '04
Q2 '04
Q3 '04
Q4 '04
Q1 '05
Q2 '05
Q3 '05
Q4 '05
Q1 '06
Q2 '06
Q3 '06
Q4 '06
61
Company Capital Structure: Example I/II
62
Company Capital Structure: Example II/II


Combining capital structure analysis with the equity and credit comps’ analysis, we are
effectively able to “price” the distress securities
Previous example of Wind Hellas, the Greek telecom operator:



from equity comps’ analysis we have that similar type of assets trade between 6x and 7x
a 6.5x value would then “break through” Wind Hellas’ capital structure, allowing to recover par
value on the subordinated notes (which sit at 6.5x leverage) and nil on the PIK notes (which sit at
7x leverage)
Among Wind Hellas’ securities, subordinated notes currently trade in the 70s while the PIK
notes trade in the 50s implying a return of approx 15-20% on the subordinated notes and
of approx 35-40% on the PIK notes



The market is not pricing the subordinated notes at par while the PIK notes at zero
The company in two to three years might or might not improve its profitability, hence the PIK
notes might get or do not get value
The price of the subordinated notes and the PIK notes tell us that the market on one hand is
pricing the possibility that the company might lower its EBITDA/Valuation (that’s why the
subordinated notes are trading at discount) and on the other hand is pricing the possibility that
the company might improve its EBITDA/Valuation (that’s why the PIK notes have some value)
63
Credit Statistics

There is a set of credit statistics coming out of financial models
which are what most credit investors look at in order to form an
opinion about the credit soundness of the target company
Lack of deleveraging  distress situation
Pro forma

Year 1
Year 2
Year 3
Year 4
The analysis of the credit stats varies according to:



the cash-flow conversion of the company, its earnings’ growth, its
predictability of earnings, etc
new issue or secondary trade;
the sector we are looking at
64
Legal and Structure Analysis

Investing in credit offers a variety of legal rights as outlined in legal
norms and either loan provisions or bond indenture



Being able to identify our own rights as creditor is an important step
of the investment decision process




Basic one: priority be reimbursed vs equity in case of liquidation
That’s why credit return is capped
the priority in the capital structure,
covenants’ protection,
majority clauses to change the contract if loan or the bond indenture if
bond, etc
The legal and structure analysis becomes more and more important
the more distress the situation we are looking at is


When investing in high yield, hopefully we will not get to the point
where we have to worry about liquidation priorities, etc
In distress, instead, the legal and structure analysis is paramount
65
Legal and Structure Analysis

When investing in debt securities, the legal documentation
analysis and the understanding of our own and other
creditors’ rights rights is of paramount importance









Security / collateral (mainly in case of loans, but also bonds sometimes)
Seniority in the capital structure (structural and contractual)
Change of control clause
Super majority clauses (specifically in case of loans)
Covenants and events of default
Application of excess cashflow
…..
……
…..
66
Liquidation Analysis

High yield and distress investors must
understand:

the bankruptcy regime of the country where the
default would take place (Center of Main Interest)




Privileged creditors
Concordato Preventivo vs Fallimento vs Legge Marzano etc
…..
Understanding of treatment of each class of creditors &
waterfall mechanics
67
Legal and Structure Analysis
68
Trading Dynamics and Scale




Given the illiquidity of the product, being able to rightly identify
which broker to deal with in order to build up a position, which
timing to use, etc is a key aspect of investing in high yield and
distress bonds/loans
While stocks can be cheap/expensive but can always get
cheaper/more expansive, credit investing is mean reverting, i.e.
the company will pay you back par value unless it defaults
This feature makes the trading scale strategy crucial
When prices deteriorate because of market conditions, usually
high yield and distress investors who have a high degree of
conviction would tend to add to their positions (technically
called “double down”)
69
Trading Analysis


High yield and distress loans / bonds traded OTC (Over The Counter),
can be very illiquid, meaning that bid/offer spreads are high (1 or 2
percentage points):
E.g. WIND PIK 91.5 – 93.5
2X2
Being able to find the broker “who has paper” is key in order not to
“spoil” the market.

if you go to a broker who is not “axed” (he doesn’t have the paper you are
looking at), he will put out a bid in the inter-dealer broker market, hence
pushing the price up before you buy the targeted bond or loan
Interdealer 1
Broker 1
Client 1
Broker 2
Client 2
Interdealer 2
Broker 3
Client 3
Interdealer 3
Broker 4
Client 4
Broker 5
Client 5
Client 6
70
Which Investments to Place in the
Portfolio?




In a Portfolio Manager’s perspective, it is key to evaluate where an
investment opportunity stands compared to others when added to
his portfolio
Each new investment should fit at the “margin” with the existing
portfolio when considering risk/reward, degree of conviction and
other diversification profiles
This “marginal investment opportunity” needs to be one where the
manager think he has a particular edge (competitive advantage)
Investments can be:


market directional (beta exposure, both positive or negative)
market neutral (long/short credit, curve trades, basis trades, markethedged trades, etc)
71
Which Investments to Place in the
Portfolio: Example I/II
Credit Opportunities Portfolio - Summary of Potential Risk and 1Y P&L
MAXIMUM CAPITAL AT RISK
INVESTED CAPITAL
BASED ON MKT HISTORY
WORST CASE SCENARIO
Face Value
5Y-equivalent
(duration-adj)
Cash Value
5Y-equivalent
(duration-adj)
5,600,000
0
(800,000)
4,800,000
4,868,000
0
(1,596,000)
3,272,000
15.1%
0.0%
(5.0%)
10.2%
1,183,304
148,974
(456,670)
875,608
15.7%
2.0%
(6.1%)
11.6%
1,437,159
173,803
(471,192)
1,139,771
KDG
Directional Sub Risk
3,000,000
3,000,000
9.3%
527,752
7.0%
Sensata
Directional Sub Risk
7,500,000
5,912,500
18.4%
1,277,743
4,800,000
200,000
5,000,000
3,572,000
(600,000)
2,972,000
11.1%
(1.9%)
9.2%
722,683
(289,156)
433,527
Grohe
Directional Sub Risk
Rel Value - Steepener
Rel Value - Basis
Seat Pagine Gialle
Directional Sub Risk
Rel Value - Basis
%
Max Loss if All Defaults
Prob-Weighted
[80% recovery Senior]
[40% recovery Sub]
[10% recovery PIK]
POTENTIAL 1Y P&L
Net Carry
Yield %
Capital Gain
(assume YTW)
/ Rolldown
14.7%
1.8%
(4.8%)
11.6%
679,673
884,600
10,393
1,574,665
14.0%
N.A.
N.A.
48.1%
237,758
497,008
116,928
851,695
917,431
1,381,608
127,320
2,426,360
18.8%
N.A.
N.A.
74.2%
615,710
6.3%
116,000
3.9%
5,358
121,358
4.0%
17.0%
1,606,776
16.4%
401,843
6.8%
147,344
549,187
9.3%
9.6%
(3.8%)
5.8%
932,663
(279,021)
653,642
9.5%
(2.8%)
6.7%
273,717
(73,600)
200,117
7.7%
N.A.
6.7%
200,192
130,539
330,732
473,909
56,939
530,849
13.3%
N.A.
17.9%
%
Max Loss if All Defaults
Prob-Weighted
[70% recovery Senior]
[30% recovery Sub]
[0% recovery PIK]
%
Total Potential
Annual P%L
Yield %
72
Which Investments to Place in the
Portfolio: Example II/II
Credit Opportunities Portfolio - Summary of Credit Exposure by Strategy and by Credit Curve
Blue Colour: Bond
Red Colour: CDS
Green Colour: Assumptions
1Y
Grohe
Directional Sub Risk
Rel Value - Steepener
Rel Value - Basis
2Y
3Y
6,000,000
20,000,000
0
26,000,000
4Y
5Y
6Y
7Y
8Y
9Y
10Y
Face Value
5Y-equivalent
(duration-adj)
Cash Value
5Y-equivalent
(duration-adj)
Purchase
Bond
Prices
4,868,000
0
(1,596,000)
3,272,000
77.125%
(2,000,000)
(1,000,000)
(3,000,000)
5,600,000
0
(800,000)
4,800,000
4,000,000
0
4,000,000
8,000,000
(4,000,000)
(2,000,000)
(6,000,000)
0
0
0
0
75.125%
KDG
Directional Sub Risk
3,000,000
3,000,000
3,000,000
Sensata
Directional Sub Risk
7,500,000
7,500,000
5,912,500
78.833%
(3,000,000)
(3,000,000)
4,800,000
200,000
5,000,000
3,572,000
(600,000)
2,972,000
74.417%
75.000%
Seat Pagine Gialle
Directional Sub Risk
Rel Value - Basis
0
0
0
6,000,000
4,000,000
10,000,000
0
0
0
0
0
73
Directional vs Market Neutral
Investments
DIRECTIONAL




Most illiquid investments/trades are
directional

Betting on an individual
company or situation

Very idiosyncratic, low
correlation with the market
“Value” investments, based on a
deep knowledge of the company or
the situation
Degree of conviction needs to be
very high
Most of distress situations are
directional (e.g. Alitalia convertible
bond)
MARKET NEUTRAL





Strategies mostly built up through liquid
investments
Inter-company  long/short credit
Intra-company  long loans / short
bonds or long bonds / short equity
Curve trades  long 2y credit risk /
short 5y credit risk

Possible if credit derivatives exist
(CDS)

Express a view about the shape
of the credit curve (e.g.
steepeners and flatteners)
Basis trades  buy a cash bond and
buy CDS protection, yielding a net
interest income (virtually risk free)
74
Relative Value, Basis & Curve
Trades: Another Way to Express
Investment Views

Buy CDS protection X-year and Sell CDS protection Y-year

Trade can be



Trade can be




DIV01 neutral (ratio to neutralize market risk)
Jump to default neutral (ratio to completely neutralize default risk)
Flattener (to “play” the flattening of the curve), generally a bearish trade
Steepener (to “play” the steepening of the curve), generally a bullish trade
Trade need to be rebalanced quarterly, since with time going by the ratios (to
make the trade DIV01 neutral or jump-to-default neutral) change
If short term credit risk is attractive but a market exposure is not wanted, then
a trade where to go long the short end of the credit curve (i.e. sell CDS
protection) and short the long end of the credit curve (buy CDS protection)
makes sense - specifically if the trade is carry positive and roll-down positive

The roll-down is when a 5y CDS becomes a 4y because 1 year has gone by  roll-down is
positive when 4y spread is lower than 5y spread, hence your contract is in the money after 1y
75
Example of a Curve Trade:
The Steepener
Trade/Investment:

Sell 5mln protection (go long credit
risk) on Grohe 2y CDS at 700bps

Buy 2mln protection (go short credit
risk) on Grohe 10y CDS at 950bps
Carry plus “roll-down”:

Positive carry: 700bps * 5mln = +350k

Negative carry: 950bps * 2mln = (190k)

Net annual carry: +160k

Roll-down effect in 1 year: +200k

From 2y to 1y  400bps * 5mln *
1d = +200k

From 10y to 9y  0bps * 2mln *
5d = 0k

Risk of default: 5mln – 2mln = 3mln
76
Liquidating a Position

Liquidating a position in high yield can be very expensive
(in distress is virtually impossible)

Bid / Ask spread can be up to 5 points in the less liquid names,
and most likely would work in max 2mln size



Once you hit a bid of a broker in 2mln, the next “market” the broker might
offer you can be 1 or 2 points lower
In a market where there is lack of liquidity, e.g. the days after the
Lehman bankruptcy, there is literally no bid for the higher
yielding products
The CDS is much more liquid, however not all the cash
bonds do have CDS protection outstanding (only the
more traded and liquid names)
77
Monitoring Risk

Risk monitoring is done through a portfolio
management tool









Interest rate or currency risk exposure
Breakdown of exposure by sector
Breakdown of exposure by seniority of securities in the capital structure
Analysis of carry interest vs accrual of principal (PIK or capital appreciation
when securities purchased at discount)
Analysis of liquidity of the instruments
Analysis of volatility by instruments
Analysis of estimated tail risk (capital at risk in case of financial shocks)
Risk management performed daily with update of prices
Risk management need to be put into the overall hedge fund
context
78
Hedging Strategies:
Which Risks to Hedge?

Market risk





Tail / Shock market risk



Buying out of the money put options on the reference index
Buying out of the money put options on the listed public equity of the company,
assuming the company is listed
Operating risks



Hedged through shorting the reference index (Itraxx Xover 5y in high yield)
Hedged through shorting basket of comps
Capital structure trades (long loan, short bond)
Curve or basis trades
Assuming the company is highly exposed to a raw material, then short the best proxy
of such raw material or buy out of the money call options
Assuming the company has significant portion of EBITDA in US$, then hedge the
currency risk
Financial risks

Assuming we want to buy a long dated fixed coupon bond, then probably a good idea
would be to hedge the interest rate risk
79
Why is Information so Important?

To refine the company fundamentals analysis



To forecast events that the market is not aware of


Better operating and financial modeling
Better knowledge of suppliers’ and customers’ opinion of
company’s products
M&A or extraordinary finance transactions which might have an
impact on bonds and loans
From a strictly trading perspective, better execution
on buying and selling


Knowing who has the paper
Knowing how many buyers and sellers there are in the market
80
Current Market Conditions
Are You Ready for Distress?
81
Where Are We in the Cycle?
DOES NOT INCLUDE LEHMAN BROTHERS OR ANY RECENT DEVELOPMENT!
[NORTH AMERICAN DATA AS PER END OF AUGUST]
82
Correlation of Spreads with Default Rates
83
Default Rates vs HY Spreads (US)
84
Default Rates vs Leverage Loans
Spreads (US)
85
Historical Recovery Rates (US)
86
More on Recovery Rates (US)
87
HY New Issue Trends (US)
88
Conclusions

Distressed debt is already out there


Spreads are currently on the rise, and there to stay
for 12-24 months


Many private equity funds and other institutional funds are
setting up more and more dedicated funds to this asset class
Carry interest is currently high, looking at historical average,
which makes the asset class already attractive
Default rates will peak in the next 12-24 months

Market prices (hence spreads) anticipate default rates
89