State of the U.S. loan market Meredith Coffey SVP – Research & Analysis LSTA www.lsta.org mcoffey@lsta.org

Presentation outline

Definitions and history of the U.S. loan market Current state of the loan market

Volatility Low prices

Pressure points Deleveraging Defaults Devil in details Borrower access to capital

Outlook for the loan market Volatility Issuance Spreads

Syndicated loans

Loans to corporations Large (at least $20 million; often more than $500 million) Syndicated (held by at least three banks or non-bank institutions)

4 key U.S. large corporate loan market segments

Investment grade loan market Loans to companies rated >= BBB-/Baa3 AND with a relatively low LIBOR spread 2007 issuance: $658 billion 2008 issuance: $319 billion

Leveraged loan market Loans to companies rated < BBB-/Baa3 or unrated & with a spread >= LIB+150 bps Divided into bank (pro rata) and institutional segments 2007 issuance: $689 billion 2008 issuance: $294 billion

Institutional loan market Leveraged loans structured to be sold to institutional investors (which include mutual funds, CLOs, insurance companies, hedge funds, etc) 2007 issuance: $426 billion 2008 issuance: $69.6 billion

Secondary loan market Market in which loans trade following the close of primary syndication Most U.S. loan trading involves leveraged loans 2007 trading: $442 billion

Source: Reuters LPC for primary issuance; LSTA for secondary trading

U.S. high yield bond vs. leveraged loan characteristics

Sr. or subordinated Unsecured Incurrence covenants Mostly fixed rate Call protections, premiums Investors Low, variable More downside volatility More upside volatility

Senior Secured Maintenance covenants Mostly floating rate Minimal call protection Banks, investors Higher, more consistent Less downside volatility Less upside volatility

Seniority Security Covenants Pricing Callability Lenders Recovery (RGD) Trading (downside) Trading (upside)

Characteristic High yield bonds Leveraged loans

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Sr, sec’dLoan

SubUnsec’d

Bond

Equity

Tota

l cap

ital s

truct

ure

($M

ils.)

Hypothetical leveraged company capital structure

Banktranches(RC/TLA)

Institutionaltranches(TLB,C,D)

MostSenior

LeastSenior

Historical context: Leveraged loan prices very stable Bi

d (%

of p

ar)

Source: Reuters LPC Merrill Lynch; LSTA/LPC MTM Pricing

Historically, institutional loan prices are very stable In turn, loans can be put into leveraged vehicles

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U.S. institutional loan and HY bond bids

US HY bonds

US inst loans

Money comes into the asset class…

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Cumulative loan mutual fund flows

Cumulative CLOs issued

Loan assets under management soared New investors came on line, including CLOs, Loan mutual funds, Hedge funds, Institutional accounts, TRS programs

Cumulative CLO issuance, fund flows

Issu

ance

/flow

s ($

Bils

.)

Source: J.P. Morgan, Lipper

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1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Institutional Pro Rata HY Bonds

More leveraged finance comes from loans (1)

Source: S&P/LCD and Merrill Lynch Global High Yield Strategy

Total Bank Debt and High-Yield Bond Volume in the Leveraged Finance Market

Volu

me

($B

ils.)

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500

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Institutional Pro Rata High-Yield

Source: S&P/LCD and Merrill Lynch Global High Yield Strategy

More leveraged finance comes from loans (2)

Total Bank Debt and High-Yield Bond Volume in the Leveraged Finance Market

Volu

me

($B

ils.)

In LTM, loan prices nearly as volatile as HY bond prices Bi

d (%

of p

ar)

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Source: Reuters LPC Merrill Lynch; LSTA/LPC MTM Pricing

US HY bonds US inst loans

In last 12 months, institutional loan prices have been nearly as volatile as HY bond prices Puts considerable stress on vehicles (like TRS) structured for a low-volatility asset class

U.S. institutional loan and HY bond bids

Loan prices fall before defaults climb

Institutional loan bid

Bid

(% o

f par

)

Source: LSTA/LPC MTM Pricing, Standard & Poor’s LCD

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Default rate (count)

Default rate ($)

Leveraged loan default rate

Def

ault

rate

(%)

Default rates have climbed, but remain well below peak of last cycle Loan prices well below last downturn This dichotomy initially represented a deleveraging, not defaults However, default rates are increasing materially

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average bid

median bid

Secondary market spreads vastly outstrip primary spreads, limiting issuance

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BB LoansB Loans

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Straight Spread Amort upfront fee

Secondary yields Primary yields (BB rated loans)

Dis

c sp

read

(bps

)

Spre

ad (b

ps)

Source: Standard and Poor’s LCD and S&P/LSTA Leveraged Loan Index

Secondary yields are at record highs Before primary shut down, yields were high Until secondary stabilizes, primary market will not be able to compete

Overall loan issuance contracts materially

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1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Other ($Bils.)IG ($Bils.)Lev. ($Bils.)

On annualized basis, all loan issuance is down materially Issuance ($764B) is lowest year since 1994 In 2009, only issuers that must tap market (necessary refinancings, DIPs, exits, some M&A) likely to emerge

Loan

issu

ance

($B

ils.)

Source: Reuters LPC

U.S. loan issuance

Looking forward

Credit quality Ability to refinance Supply & Demand Ability to lend Where do spreads, fees go? Where does issuance go? What does the asset class look like?

Credit markets rally back (a bit) in late December

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US liquid loans ML HY Bond Index LCDX10

CDX HY 10 CDX HY11-1 CDX HY11-2

Bids on credit asset classes

Bid

(% o

f par

)

Credit assets suffer sharpest drop on record Slight recovery at year-end 2008, first days of January 2009

Source: Thomson Reuters LPC Merrill Lynch; LSTA/LPC MTM Pricing

Thomson Reuters LPC Lender Survey Has the loan market reached a bottom?

0% 10% 20% 30% 40% 50% 60% 70% 80%

Yes - the worst is over

No - there is more badnews to come

% of respondents

Leverage unwind continues Recession is in the early innings Need to get through defaults which have not yet peaked; covenant violations will increase CLO problems are just beginning; more BWICs expected; no new vehicles are being raised

Source: Thomson Reuters LPC Quarterly Lender Survey

39%

27%28%

5%

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45%

Big bank bankruptcy Frozen credit markets Deleveraging Economy/defaults/credit

LSTA conference audience poll: What’s the biggest risk to the loan market today?

Biggest concern for LSTA conference audience was the economy, defaults and credit

% o

f res

pond

ents

Source: LSTA Conference Audience Poll – Oct 2008

LSTA conference audience poll: Where will default rates go in 2009?

20%

43%

34%

3%

0%

10%

20%

30%

40%

50%

3-5% 6-8% 9-11% 12%+

LSTA conference audience expected default rates to increase considerably More than 60% expect to see defaults above 9% in 2009

% o

f res

pond

ents

Source: LSTA Conference Audience Poll – Oct 2008

Default rates are climbing

Source: LSTA/LPC MTM Pricing, Standard & Poor’s LCD

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Default rate (count)

Default rate ($)

Leveraged loan default rate

Def

ault

rate

(%)

Initially defaults were defined by small companies Defaults becoming materially larger Amendments are becoming more difficult Loss given default could worsen Moody’s estimates 10% YE 2009 default rate

Refinancing pressures may emerge Distribution of institutional loan maturities

0%

5%

10%

15%

20%

25%

30%

35%

2009 2010 2011 2012 2013 2014 2015 2016

TLBRC

Maturity profile on RCs, TLBs for active institutional loans*

Source: LSTA, Thomson Reuters LPC

% o

f sam

ple

*Includes only credit agreements filed with SEC

TLB maturities peak in 2014 RC maturities peak in 2011 Most RCs “should” be refinanced in 2010 – which may lead to pressure

Traditional “supply” declines materially U.S. institutional pipeline

Source: Thomson Reuters LPC

020406080

100120140160

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arA

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ay Jul

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The new issue market has shrunk dramatically However, other forms of supply – like portfolio sales – increased materially Demand remains lacking

Pipe

line

($B

ils.)

2006 2007 2008

Thomson Reuters LPC Lender Survey

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% o

f res

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ents

Source: Thomson Reuters LPC Quarterly Lender Survey

Where will you be active in early 2009?

When will you start lending actively again?

Is this a cyclical downturn or has the loan market permanently changed?

Amendments

Debt restructurings/ DIPs

Lending only to key relationships

6 to 12 months

Wait and see

3 to 6 months

12 to 18 months

Permanent

Cyclical

LSTA conference audience poll: What will the leveraged loan market look like in 2 yrs?

Like 1H07: Low volatility, low correlation, high issuance, low

spreads, 13%

Like HY: High volatility, high correlation, low er issuance, high

spreads, 46%

Middle path: Moderate volatility, low er issuance, high(ish)

spreads, 21%

Like 1995: Low volatility, low correlation, low issuance, moderate spreads, 20%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

M i ddl e pat h: M oderate vol at i l i t y, l ow er i ssuance, hi gh( i sh) spreads

Nearly half of LSTA audience believes loan market continues to behave like HY bonds

Source: LSTA Conference Audience Poll – Oct 2008

Presentation recap

Loan market is dislocated Secondary market

Prices are volatile and depressed Depressed prices are a function of deleveraging, lack of buyers – and increasingly defaults Though dislocated, secondary loan market continues to function Once a bottom is established, investors expected may come in

Trouble spots Defaults Access to capital for refinancing, DIPs, exit financings Structures that rely on outdated conventional wisdom

Outlook Non-traditional investors see considerable value – assuming they can find a bottom As long as secondary prices are low, structuring new deals remains difficult – and borrower demand for loans may be limited Defaults are rising, and DIP financing is becoming more difficult – impact on recovery given default Loan market will probably remain more volatile than it has been historically – which leads to wider spreads, lower issuance, tighter structures New standards are being developed to mitigate foreseen and unforeseen risks