Dr. Edward Altman NYU Stern School of Business Defaults and Returns in the Corporate Bond Market and the Outlook for Defaults and the Distressed Debt Market Size in 2004/2005 TMA Luncheon Address Union League Club, NYC February 5, 2004

2 Straight Bonds Only Excluding Defaulted Issues From Par Value Outstanding, 1971 – 2003 (US$ millions) Historical Default Rates Par ValuePar ValueDefault YearOutstanding a DefaultsRates (%) 2002 $757,000$96, $649,000$63, $597,200$30, $567,400$23, $465,500$7, $335,400$4, $271,000$3, $240,000$4, $235,000$3, $206,907$2, $163,000$5, $183,600$18, $181,000$18, $189,258$8, $148,187$3, $129,557$7, $90,243$3, $58,088$ $40,939$ $27,492$ $18,109$ $17,115$ a As of mid-year b Weighted by par value of amount outstanding for each year. Source: Author’s compilation and Salomon Smith Barney Par ValuePar ValueDefault YearOutstanding a DefaultsRates (%) 1980$14,935$ $10,356$ $8,946$ $8,157$ $7,735$ $7,471$ $10,894$ $7,824$ $6,928$ $6,602$ Standard Deviation (%) Arithmetic Average Default Rate 1971 to % 3.161% 1978 to %3.394% 1985 to % 3.515% Weighted Average Default Rate b 1971 to % 1978 to % 1985 to % Median Annual Default Rate 1971 to % 2003 $825,000 $38,

3 Historical Default Rates QUARTERLY DEFAULT RATE AND FOUR QUARTER MOVING AVERAGE 1992 –2003

4 Filings for Chapter 11 Number of Filings and Pre-petition Liabilities of Public Companies filings and pre- petition liabilities of $337.5 billion filings and pre- petition liabilities of $110.4 billion Note: Minimum $100 million in liabilities Source: NYU Salomon Center Bankruptcy Filings Database

5 Public deals only. Source: Citigroup Estimates. Distressed And Defaulted Debt as a Percentage of Total High Yield Debt Market

6 Estimated Face And Market Values Of Defaulted And Distressed Debt (1) Calculated using: (2002 defaulted population) + (2003 defaults) - (2003 Emergences) (2) For 12/31/02 and 12/31/03, we use a private/public ratio of Source: Edward Altman, NYU Salomon Center, Stern School of Business

7 Source: E. Altman, NYU Salomon Center. Size of Defaulted And Distressed Debt Market ($ Billions) (1990 – 2003) 9/15/2002

8 Historical Default Rates and Recession Periods in the U.S. Periods of Recession: 11/73 - 3/75, 1/80 - 7/80, 7/ /82, 7/90 - 3/91, 4/01 – 12/01 Source: Figure 1, Appendix B & National Bureau of Economic Research Data HIGH YIELD BOND MARKET 1972 –2003

9 Unadjusted for Only FallenAll exceptPrice Adjusted for Fallen AngelsAngelsFallen Angels BACKGROUND DATA AVERAGE DEFAULT RATE, %5.873%3.957%4.844% AVERAGE PRICE AT DEFAULT (a)45.503%56.951%35.618%45.492% AVERAGE PRICE AT DOWNGRADE (a)61.781% AVERAGE RECOVERY45.503%92.183%35.618%66.003% AVERAGE LOSS OF PRINCIPAL54.497%7.817%64.382%33.997% AVERAGE COUPON PAYMENT9.554%8.200%10.720%9.554% DEFAULT LOSS COMPUTATION DEFAULT RATE4.661%5.873%3.957%4.844% X LOSS OF PRINCIPAL54.497%7.817%64.382%33.997% DEFAULT LOSS OF PRINCIPAL2.540%0.459%2.547%1.647% DEFAULT RATE4.661%5.873%3.957%4.844% X LOSS OF 1/2 COUPON4.777%4.100%5.360%4.777% DEFAULT LOSS OF COUPON0.223%0.241%0.212%0.231% DEFAULT LOSS OF PRINCIPAL AND COUPON2.763%0.700%2.760%1.878% (a) If default date price is not available, end-of-month price is used. Source: Author's Compilations and various dealer quotes Default Loss Rate

10 Default Rates and Losses a 1978 – 2003 Par Value Outstanding a Of Default Default Weighted PriceWeightedDefault Year ($MM)($MMs)Rate (%)After DefaultCoupon (%)Loss (%) 2003 $825,000$ 38, %$ %2.76% 2002 $757,000$96, %$ %10.15% 2001$649,000$63, $ $597,200$30, $ $567,400$23, $ $465,500$7, $ $335,400$4, $ $271,000$3, $ $240,000$4, $ $235,000$3, $ $206,907$2, $ $163,000$5, $ $183,600$18, $ $181,000$18, $ $189,258$8, $ $148,187$3, $ $129,557$7, $ $90,243$3, $ $58,088$ $ $40,939$ $ $27,492$ $ $18,109$ $ $17,115$270.16$ $14,935$ $ $10,356$200.19$ $8,946$ $ Arithmetic Average :3.66%$ %2.52% Weighted Average :5.38% 3.93% a Excludes defaulted issues. Source: Authors’ compilations and various dealer price quotes.

11 Defaults by Original Rating Source: Authors' Compilations from S&P and Moody's records.

12 Fallen Angels companies 2003

13 Fallen Angel(FA) Vs Original Issue & All High Yield Default Rates : (Issuer Based)

14 Fallen Angels: an Analysis of Recovery Rates and Loss Rate on Default ( )

15 Weighted Average Recovery Rates On Defaulted Debt by Seniority Per $100 Face Amount 1978 – 2003 YearNo.$No.$No.$No.$No.$No.$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $18.370$0.0037$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $60.00 Total/Average229 $ $ $ $ $21.091,926 $34.46 Median $54.63 $42.27 $32.35 $31.96 $18.25 $40.05 SeniorSeniorSeniorDiscount andAll DefaultSecuredUnsecuredSubordinatedSubordinatedZero CouponSeniorities

16 Recovery at Default* on Public Corporate Bonds ( ) and Bank Loans (1989-Q3-2003) Loan/Bond Seniorityof Issues Median Mean % Deviation Senior Secured Loans Senior Unsecured Loans Senior Secured Bonds Senior Unsecured Bonds Senior Subordinated Bonds Subordinated Bonds Discount Bonds Total Sample Bonds1, *Based on prices just after default on bonds and 30 days after default on loans. Source: K. Emery (Moody’s), 2003 (Bank Loans) and Altman & Fanjul, 2004 (Bonds).

17 Investment Grade vs. Non-Investment Grade (Original Rating) Prices at Default on Public Bonds ( ) Number of Median Average WeightedStandard Bond Seniority Issues Price %Price % Price %Deviation % Senior Secured Investment Grade Non-Investment Grade Senior Unsecured Investment Grade * 44.05* Non-Investment Grade Senior Subordinated Investment Grade Non-Investment Grade Subordinated Investment Grade Non-Investment Grade Discount Investment Grade Non-investment Grade Total Sample2, Notes: (*) Including WorldCom, the Average and Weighted Average were 43.53% and 30.45% Non-rated issues were considered as non-investment grade

18 Ultimate Recovery Rates on Bank Loan Defaults, Nominal and Discounted Values (1988-2Q 2003) Ultimate Ultimate Nominal Discounted Standard Observations Recovery Recovery Deviation Senior Bank Debt % 78.8% 29.7% Senior Secured Notes % 65.1% 32.4% Senior Unsecured Notes % 46.4% 36.3% Senior Subordinated Notes % 31.6% 32.6% Subordinated Notes % 29.4% 34.1% Source: Keisman, 2003, from Standard & Poor’s LossStats™ Database, 2084 defaulted loans and bond issues that defaulted between Recoveries are discounted at each instruments’ pre-default interest rate.

19 Bank Loan Ultimate Recovery Rates are Declining Source: Standard & Poor’s.

20 Recovery Rate/Default Rate Association Altman Defaulted Bonds Data Set ( ) Dollar Weighted Average Recovery Rates to Dollar Weighted Average Default Rates Source: E. Altman, et. al., “The Link Between Default and Recovery Rates”, NYU Salomon Center, S

21 Recovery Rates for Telecommunications and E-Commerce Industries* Source: Authors’ compilation from Various Dealer Quotes – 2003 * Includes Wireless Equipment and Satellite Telecommunication companies in addition to Telecommunication Service companies. ** Dealer quotes not available for Energis PLC, Mpower Holding, Corp. and ITC DeltaCom, Inc.

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

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

24 All Rated Corporate Bonds a Mortality Rates by Original Rating (a) Rated by S&P at Issuance Based on 1,719 issues Source: Standard & Poor's (New York) and Author's Compilation

25 All Rated Corporate Bonds a Mortality Losses by Original Rating (a) Rated by S&P at Issuance Based on 1,535issues Source: Standard & Poor's (New York) and Author's Compilation

(5.68)14.45(20.13) (8.41) (8.73) (1.18) (2.55)(8.29) (8.46)6.88(15.34) (14.74) (2.67) (7.58) (5.46) (6.32) (9.63) (1.00)(2.96) (0.86) (1.11) Arithmetic Annual Average Compound Annual Average a End-of-year yields. Source:Salomon Smith Barney and author’s compilations (1.53) (16.19) Annual Returns Yields and Spreads on 10-Year Treasury (Treas) and High Yield (HY) Bonds Return (%)Promised Yield (%) a YearHYTreasSpreadHYTreasSpread

27 Forecasting Defaults and the Default Rate

28 Forecasting Defaults and the Default Rate MODEL DRIVERS Mortality Rate Estimates: = f {bond rating, age, redemptions, defaults} Historical New Issuance over last 10 years by credit quality Bond-ratings Z-score Bond-equivalent ratings New Defaults and Default Rate in 2004 Estimate high yield market growth in 2004 New Defaults and Default Rate in 2005

29 Z’’ Score Model for Manufacturers, Non-Manufacturer Industrials, & Emerging Market Credits Z’’ = 6.56X X X X 4 X 1 = Current Assets - Current Liabilities Total Assets X 2 = Retained Earnings Total Assets X 3 = Earnings Before Interest and Taxes Total Assets X 4 = Book Value of EquityZ’’ > “Safe” Zone Total Liabilities 1.1 < Z’’ < “Grey” Zone Z ” < “Distress” Zone

30 US Bond Rating Equivalent Based on Adjusted Z” Score Model US Equivalent RatingAverage Z” ScoreSample Size AAA8.158 AA+7.6- AA7.318 AA-715 A A A BBB BBB BBB BB BB BB B B B CCC CCC2.510 CCC D014

31 Forecasted High Yield Market Size, Defaults and Default Rates for 2004 and 2005

32 Forecasted Face and Market Values of Defaulted and Distressed Debt 2004 – 2005 (US$billions) (1) Calculated using: (2003 defaulted population) + (2004 defaults) - (2005 Emergences), same for 2005 (2) Based on 5.0% of size of high yield market (in 2004, $994 billion); 7.5% of market in 2005 ($1,041 billion) (3) For 12/31/04 and 12/31/05, we use a private/public ratio of Source: Edward Altman, NYU Salomon Center, Stern School of Business

33 Source: E. Altman, NYU Salomon Center. Size of Defaulted And Distressed Debt Market ($ Billions) (1990 – 2005)