JANUARY 2 0 0 4
S T R I C T LY
P R I VAT E
AN D
C O N FI D EN TI AL
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
Restructuring in Historical Context
Some events prompting re-examination of 1999 Definitions
Conseco
Bank debt restructured (compensated maturity extension)
Significant price disparity between short-dated bank debt and longer-dated bonds
Potential moral hazards and significant value in cheapest-to-deliver option led to debate about
the proper form of restructuring as a credit event
National Power
De-merger resulted in two entities of very different credit quality (Innogy and International
Power)
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
“Successor” unclear under 1999 definitions, inspired “Successor Supplement”
Railtrack PLC
Raised issue of whether convertible bonds are “Not contingent.”
Led to publication of “Convertible and Exchangeable Supplement”
Ratings agencies’ concerns regarding credit events
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Evolution of “Restructuring”: 1991-1999
1991 Definition of Restructuring
 Addendum to the 1991 ISDA definitions required that the terms of an obligation become
“materially less favorable” to its holders
 Highlighted the desirability of “materiality tests” under the “long form” contract
 Asian crisis (Indonesia, Korean issuers) in 1997 and default of Russia on local paper and Paris Club
debt in 1998 demonstrated subjectivity and contractual uncertainty of definition
1999 Definition of Restructuring
 The 1999 definition provided more objectivity by listing specific events that would constitute
“restructuring” in a credit default swap contract
 a reduction in the rate or amount of interest payable
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
 a reduction in the amount of principal,
 a postponement of payment (interest or principal),
 a change in ranking of priority (subordination),
 a change in the currency of composition of any payment
 To allow for negotiation of changes in interest rates or maturity extensions on bank loans under
circumstances falling well short of severity of bankruptcy or payment default, ISDA drafting
committee introduced exception to definition
 the aforementioned events would not be considered a Restructuring if the event did not
“directly or indirectly result from a deterioration in the creditworthiness or financial condition
of the Reference Entity.”
2
Restructuring in Historical Context
Conseco - a case study in Restructuring
 Stock price plunged after a $350mm charge in 2000 and announcement of intent to sell Green
Tree, which Conseco had acquired in 1998
 Conseco debt downgraded several notches after effectively losing access to the CP market and
having to draw on bank backstop facilities
 Over the summer of 2000, Conseco accumulated $450mm in cash through improved operations
and sale of non-strategic assets, but had used all its bank borrowing capacity to repay maturing
debt and was facing repayment of bank lines
 Bankers chose to extend maturity of Conseco’s loans instead of demanding timely repayment and
likely pushing them into bankruptcy
 Conseco would repay $450mm of an outstanding credit line in full
 Maturity of the remaining $900mm in debt would be extended by roughly 15 months, interest
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
rate would rise from L+50 to L+250, and bank lenders would achieve a form of collateralization
 A Restructuring Event had clearly occurred, but  Bonds maturing essentially at the same time as the bank facility were repaid in full
 The restructured 15 month loan was trading at around 92% of face value
 Banks who triggered credit derivatives protection were able to receive par for delivery of long-
dated senior unsecured bonds that they had sourced from the secondary market at around 68%
of face value
 Outstanding notionals of CDS referencing Conseco exceeded $350mm and protection sellers lost
over $60mm, but not a single contract was litigated in court - a successful test for the CDS
markets, but highlighted need for refining the contract to better avoid perverse outcomes
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Move toward Modified Restructuring
Modified Restructuring fine-tunes triggers and limits deliverables
 Addressing market participants’ needs
 Bank hedgers did not need any meaningful delivery optionality since bank forebearance in the
US seldom exceeds more than 18 months
 Protection sellers strongly wanted the maturity of Deliverable Obligations to be capped in a
Restructuring event
 Dealer community wanted to minimize mismatches on its books
 By incorporating the provisions of the Restructuring Supplement (May 2001) and checking the
“Restructuring Maturity Limitation Applicable” box in the standard confirmation -
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
 If protection buyer triggers after a Restructuring credit event only, the maximum maturity of
deliverables must be no later than the longer of:
1) Scheduled termination of the CDS contract; and
2) the shorter of;
a) 30 months (in the case of all Deliverable Obligations) after legally effective Restructuring
date, or
b) latest final maturity date of any Restructured Bond or Loan (provided that this maximum
maturity can never be less than the remaining tenor of the triggered contract)
 Deliverable obligation must be “fully transferable” (consent not required) to “eligible
tranferee” (wide range of institutional market participants)
 Restructuring credit event can only be triggered for Obligations that 1) have more than 3
holders in the case of a Bond or a Loan, and 2) in the case of loans only, require at least a 2/3
majority to implement a Restructuring
 Restructuring of bilateral loans are not triggers, though they are still deliverable if they
otherwise meet Deliverable Obligation definitions
4
Move toward Modified Restructuring - continued
Multiplicity of curves post-Conseco
 From Autumn 2000 to the adoption of the Restructuring Supplement, the US market traded many reference names
in two forms - with 1999 Restructuring, and without Restructuring
 Obtaining a price for the inclusion of Restructuring in a disciplined derivatives framework is difficult because the
probability of Restructuring is not an observable or hedgeable parameter, though it is possible to determine rough
pricing boundaries and direction/magnitude of sensitivities of the price given factors such as tenor, credit spread,
and recovery rate assumptions.
 But, as observed for most US names, 1999 Restructuring commanded about 10% more spread than protection
without Restructuring during that period
 Since the adoption of the Restructuring Supplement, Modified Restructuring (MR) in US names has tended to trade
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
at about a 5% premium to protection without Restructuring (NR)
5
Modified Modified Restructuring
History
 Though Modified Restructuring has been used for trades on US, Autralian and New Zealand
Reference entities since the Supplement was published, MR was not adopted as a market
standard for European, Japanese, and other Asian Reference Entities
 An alternative version of Modified Restructuring was introduced and adopted within the 2003
Definitions to cover European Reference Entities
MMR - the specifics
 Where (a) Modified Restructuring Maturity Limitation and Conditionally Transferable Obligation
are specified as applicable in the Confirmation and (b) the Buyer of protection triggers the
contract in respect of which the only Credit Event is Restructuring then:
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
 the Deliverable Obligation will have a maximum maturity no later than the longer of:
1) Scheduled Termination Date of the CDS contract; and
2) 60 months (in the case of Restructured Bonds or Loans) or 30 months (in the case of all other
Deliverable Obligations) following the legally effective date of the Restructuring
 the Deliverable Obligation has to be transferable to any bank, financial institution, or other
entity which is regularly engaged in or established for the purpose of making, purchasing or
investing in loans, securities or other financial assets either (I) without consent or (ii) with
consent of the Reference Entity, not to be unreasonably withheld
 Differences to MR and why  MMR provides for longer maturity cap for Restructured Bonds and Loans than MR (30 months)
because it may be more common to see longer maturity extensions in the European market
 More common for borrowers in Europe to restrict transferability of debt instruments to banks
and financial institutions
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Modified Modified Restructuring (2)
 In 2003, a customer buys 5 year protection on EnergyCo
 June 2004, EnergyCo enters legally binding agreement to restructure certain of its
bonds
 You can deliver (1) restructured bonds maturing before mid 2009 and (2) non
restructured bonds maturing before 2008
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
30 month
Maturity
Cap
2003
Effective
2004
2005
Legally effective
date of
Restructuring
2006
2007
Maturity
Floor
2008
60 month
Maturity Cap
2009
2010
STD
7
Modified Modified Restructuring (3)
(Europe and US)
Feature:
MR (US standard)
MMR (European Standard)
Maturity Cap:
30 month cap
 30 month cap for non restructured
Floored at STD
obligations
 60 month cap for restructured
obligations
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
 Floored at STD
Transferability:
Must be transferable to extensive Must be transferable to entities
list of entities without consent
regularly engaged in loan and securities
markets with consent not to be
unreasonably withheld
Obligations covered:
At least three holders and
requires a 2/3 majority to
implement restructuring
At least three holders and in the case of
a Loan, requires a 2/3 majority to
implement restructuring
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Valuing Restructuring - Grasping for a model framework
Restructuring Premium in the Japanese CDS market
 Since the adoption of the 2003 Definitions, there are four choices regarding Restructuring as a
Credit Event - Restructuring, MR, MMR, and NR
 Japanese CDS markets have continued to adhere to three credit events (Bankruptcy, Failure to
Pay, and Restructuring) as a market standard despite 1) the large proportion of the Japanese
credit markets being comprised of bilateral loans, and 2) indications that MR or even NR CDS are
acceptable to Japanese banks as hedges for regulatory capital purposes
 Because of rampant moral hazard and the relatively high likelihood of Restructuring being a
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
Credit Event, the Japanese CDS market provides fertile ground for thinking about the
Restructuring Premium
 Worth noting that, unlike other markets, the Japanese CDS market has never experienced a
Credit Event on an actively-traded name with material CDS contracts outstanding, so remains an
untested market
 Intuitively, the value of Restructuring in a CDS contract will be a function of the likelihood that
Restructuring will be the trigger Credit Event, as well as the Recovery Rate upon Restructuring
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Valuing Restructuring (2)
Estimating the Relative Likelihood of Restructuring and Recovery Rates
 We assume that three factors are the most important for determining the relative likelihood of
Restructuring as a Credit Event for Japanese corporate reference entities
 Size of debt
— larger companies with higher debt levels are more likely to receive financial support in
“debt forgiveness” form than being forced into bankruptcy
 Size of overseas operations (ratio of overseas sales used as proxy)
— The larger the proportion of overseas operations, the higher the likelihood of debt
restructuring, as bankruptcy rehabilitation plans will more likely involve foreign creditors
 Level of excess capacity in the sector
— larger industry excess capacity will tend to decrease likelihood of debt restructuring, as a
function of doubts concerning ongoing viability
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
 We then assign scores (1 to 5) for each of the factors, with a lower score corresponding to a
higher probability of restructuring. The scores are added (3 lowest, 15 highest, but with 1 to
2points added for technology, 1 to 2 points subtracted for infrastructure sectors), and we assume
that a total score of 12 suggests a 50% chance that Restructuring will be the CE
Size of
debt
over 1 tril.
up to 1 tril.
up to 500bil
up to 200bil
below100 bil.
Score
1
2
3
4
5
Overseas sales
Over 75%
Up to 75%
Up to 50%
Up to 25%
Below 10%
Score
1
2
3
4
5
Excess
capacity
Short
Fair
Fairly high
High
Significant
Score
1
2
3
4
5
10
Valuing Restructuring (3)
Estimating the Relative Likelihood of Restructuring and Recovery Rates
 With the lowest score 1 (with adjustment) and the highest 15, we assume a linear increase in
likelihood of 2CEs with each increase in score (and have applied the approach to some names):
S core
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
P robability of
Tw o C redit
Events (TC E)
0%
5%
9%
14%
18%
23%
27%
32%
36%
41%
45%
50%
55%
59%
64%
Likelihood of R
relative to
TC E
NM
21.0
10.0
6.3
4.5
3.4
2.7
2.1
1.8
1.4
1.2
1.0
0.8
0.7
0.6
N TT
D oC oM o
Toyota
N issan
M azda
N ippon Steel
Kobe Steel
D ebt Score O verseas
7,309
1
0%
1,458
1
0%
6,853
1
63%
2,829
1
66%
667
2
49%
2,019
1
20%
1,049
1
20%
Likelyhood of R
Excess
Total
Finalrelative to
Score C apacity Score Score Adj. Score TC E
Rem arks
5
2
8 -2
6
3.4 Infrastructure adj.
5
2
8 -2
6
3.4 Infrastructure adj.
2
3
6
6
3.4
2
3
6
6
3.4
3
3
8
8
2.1
4
4
9
9
1.8
4
4
9
9
1.8
 Estimating the Recovery Rate of Deliverable Obligations for a Japanese corporate reference entity
 We nevertheless look at some historical data of bond prices following Restructuring events as a
guideline for estimating this parameter
H aseko 6 (03/1/31)
80
80
70
70
60
60
50
50
H aseko 6 (03/1/31)
40
40
Fujita 12 (01/9/28)
Fujita 13 (02/12/10)
98
/1
2
99
/2
99
/4
99
/6
99
/8
99
/1
0
99
/1
2
00
/2
00
/4
00
/6
00
/8
00
/1
0
00
/1
2
01
/2
01
/4
01
/6
01
/8
01
/1
0
01
/1
2
01
/9
01
/6
01
/3
00
/1
2
00
/9
00
/6
00
/3
99
/1
2
20
99
/9
20
99
/6
30
99
/3
30
98
/1
2
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
upon Restructuring is quite challenging, given paucity of data
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Valuing Restructuring (4)
Determining the theoretical basis between 3CEs and 2CEs
 Given an assumption for R2 (expected recovery rate for 2CEs), we can generate a matrix of the
par spread ratio between 2CE and 3CE CDS (1-S2/S3), as a function of Relative Likelihood of
Restructuring and Recovery Rate upon Restructuring
RESTRUCTURING - EVOLUTION OF A CREDIT EVENT
R2  30%
RR
Par Spread Discount Table (1  S 2 / S 3 )
M
15.00%
25.00%
30.00%
35.00%
45.00%
0.11
12%
11%
10%
9%
8%
0.25
23%
21%
20%
19%
16%
0.33
29%
26%
25%
24%
21%
0.50
38%
35%
33%
32%
28%
1.00
55%
52%
50%
48%
44%
1.50
65%
62%
60%
58%
54%
2.00
71%
68%
67%
65%
61%
3.00
78%
76%
75%
74%
70%
4.00
83%
81%
80%
79%
76%
55.00%
65.00%
75.00%
85.00%
7%
5%
4%
2%
14%
11%
8%
5%
18%
14%
11%
7%
24%
20%
15%
10%
39%
33%
26%
18%
49%
43%
35%
24%
56%
50%
42%
30%
66%
60%
52%
39%
72%
67%
59%
46%
 Important to note that, though the model is extremely assumptions-based, it provides for
thinking about the 2CE-3CE basis occasionally observed (or heard) in the markets. Sony 5yr 2CE
CDS currently trades at around 75-80% of 5yr 3CE CDS - is this too high?
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[P R E S EN T AT I O N
T I T L E ]
This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with,
the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be used for any other purpose without the
prior written consent of JPMorgan.
The information in this presentation is based upon management forecasts and reflects prevailing conditions and our views as of this date, all
of which are accordingly subject to change. In preparing this presentation, we have relied upon and assumed, without independent
verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of
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