NYU Stern School of Business How Risky are Private Equity Sponsored LBOs Dr. Edward Altman NYU Stern School of Business MacQuarie University Sydney, Australia November 09, 2015 1 1 1 1

Research Objectives To assess the default and loss rate on PE-Sponsored LBOs To analyze the default risk of PE-Sponsored LBOs compared to comparably rated corporate bonds Null Hypothesis: That the LBO mortality (Default) Rate is the same as the rate on comparably rated corporate bonds The first study to utilize the mortality rate concept to analyze the Leveraged Buy-Out market over the last 20 years; no migration bias The study utilizes two unique databases: (1) an institutional loan-based LBO database; (2) a comprehensive loan and bond default database matched to the LBO sample Source of LBO transaction data: S&P LCD; Source of default data: NYU Salomon Center Master Default, Chapter 11 Filings & Defaulted Securities Pricing Databases In addition to LBO default rate estimates, we also explore investor loss estimates; Investor returns not available

Sample Characteristics Sample of U.S. Dollar LBOs includes only those large, highly-leveraged financed transactions that involve institutional loan issuance A total of 747 individual PE-sponsored LBOs analyzed, consisting of 980 loan issues Involving LBOs from December 1994 through April 2012 Involving 862 observations stratified by their implied bond rating (IBR) or by their original S&P loan rating (OLR) (it’s possible that a single issuer had multiple loans at different implied & original ratings) Total dollar amount of loan issuance equaled $592 billion Mean loan size $604 million; median loan size $270 million IBR based on a 2-notch reduction from the original loan rating Default incidence Defaults include bankruptcies, missed interest payments, & distressed exchanges Total number of individual LBO defaults equals 126 Total number of defaults by IBR equals 145 Total loan dollar amount of defaults equals $150 billion Largest defaulters: TXU, Clear Channel, Caesars and Tribune

Mortality Rate Methodology

Marginal and Cumulative Mortality Rate Actuarial Approach total value of defaulting debt from rating (r) in year (t) total value of the population at the start of the year (t) MMR(r,t) = MMR = Marginal Mortality Rate 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, CMR(r,t) = 1 -  SR(r,t) , t = 1 N r = AAA CCC here CMR (r,t) = Cumulative Mortality Rate of (r) in (t), SR (r,t) = Survival Rate in (r,t) , 1 - MMR (r,t)

Mortality Rate Concept (Illustrative Calculation) For BB Rated Issues Security Issued Year 1 Year 2 No. Amount Default Call SF Default Call SF 1 50 -- -- 5 -- -- 5 2 50 50 -- -- NE NE NE 3 100 -- 100 -- NE NE NE 4 100 -- -- -- 100 -- -- 5 150 -- -- -- -- -- 15 6 150 -- -- -- -- -- -- 7 200 -- -- 20 -- -- 20 8 200 -- -- -- -- 200 -- 9 250 -- -- -- -- -- -- 10 250 -- -- -- -- -- -- Total 1,500 50 100 25 100 200 40 Amount Start of 1,500 175 1,325 340 985 Period - - - = Year 1 Year 2 Marginal Mortality 50/1,500 = 3.3% 100/1,325 = 7.5% Rate 1 - (SR1 x SR2 ) = CMR2 Cumulative Rate 3.3% 1 - (96.7% x 92.5%) = 10.55% NE = No longer in existence SF = Sinking fund

Mortality Rates by Original Rating All Rated Corporate Bonds* 1971-2014 Years After Issuance *Rated by S&P at Issuance Based on 2,847 issues Source: Standard & Poor's (New York) and Author's Compilation 7

Mortality Losses by Original Rating All Rated Corporate Bonds* 1971-2014 Years After Issuance *Rated by S&P at Issuance Based on 2,354 issues Source: Standard & Poor's (New York) and Author's Compilation 8

Empirical Findings

Number of Issuers BB 230 B 547 CCC/CC 84 Total 861 BB 15 B 539 CCC/CC By Original Loan Rating (OLR) BB 230 B 547 CCC/CC 84 Total 861 By Implied Bond Rating (IBR) BB 15 B 539 CCC/CC 308 Total 862

Number of Defaulted Issuers by Years After Issuance By Implied Bond Rating (IBR) Years After Issuance to Default 1 2 3 4 5 6 7 8 9 10 Totals BB B 17 16 13 11 90 CCC/CC 12 54 28 26 25 14 145 By Original Loan Rating (OLR) Years After Issuance to Default 1 2 3 4 5 6 7 8 9 10 Totals BB 33 B 21 19 99 CCC/CC 18 15 31 27 30 14 16 150

Cumulative Mortality (Default) Rates by Dollar Amount (U. S Cumulative Mortality (Default) Rates by Dollar Amount (U.S.) Based on IBR For LBOs by Implied Bond Rating (IBR) at Issuance (1995-2014) – Mortality Rates 1 2 3 4 5 6 7 8 9 10 BB 0.00% 22.99%* 22.99% B 1.86% 5.52% 14.27% 15.65% 16.69% 17.65% 17.83% 21.25% 22.42% 22.58% CCC/CC 11.82% 18.82% 24.91% 27.31% 30.21% 30.56% 34.03% 34.81% 35.91% *from 1 large Distressed Exchange by Freescale Semiconductor. For High-Yield Bonds by Original Bond Rating at Issuance (1971-2014)** - Mortality Rates 1 2 3 4 5 6 7 8 9 10 BB 0.95% 2.96% 6.75% 8.58% 10.73% 12.10% 13.39% 14.37% 15.61% 18.27% B 2.86% 10.38% 17.42% 23.87% 28.22% 31.42% 33.86% 35.24% 36.39% 36.87% CCC 8.15% 19.58% 33.99% 44.78% 47.37% 53.43% 55.97% 58.11% 58.40% 60.19% **from: E. Altman and B. Kuehne “Defaults and Returns in the High-Yield Bond and Distressed Debt Market: The Year 2014 in Review and Outlook”, Paulson and Co. and the NYU Salomon Center, January 30, 2015.

Cumulative Mortality (Default) Rates by Number of Issuers (U. S Cumulative Mortality (Default) Rates by Number of Issuers (U.S.) Based on IBR For LBOs by Implied Bond Rating (IBR) at Issuance (1995-2014) – Mortality Rates 1 2 3 4 5 6 7 8 9 10 BB 0.00% 6.67% B 0.37% 2.23% 5.45% 8.59% 11.23% 13.56% 14.21% 16.22% 17.81% 18.27% CCC/CC 0.65% 2.60% 5.96% 9.39% 13.61% 14.70% 15.82% 18.47% 18.85% For High-Yield Bonds by Bond Rating (1981-2013)* - Default Rates 1 2 3 4 5 6 7 8 9 10 BB 0.87% 2.69% 4.90% 6.98% 8.83% 10.65% 12.18% 13.56% 14.84% 15.96% B 4.23% 9.62% 14.26% 17.91% 20.73% 23.03% 24.94% 26.45% 27.76% 29.01% CCC/C 27.98% 38.53% 44.43% 48.25% 51.25% 52.52% 53.76% 54.67% 55.82% 56.58% *from: “Default, Transition, and Recovery: 2013 Annual Global Corporate Default Study and Rating Transitions”, Standard & Poors Ratings Direct, March 19, 2014.

Cumulative Mortality Rates for LBOs Based on OLR at Issuance (U.S.) By Dollars 1 2 3 4 5 6 7 8 9 10 BB 3.10% 4.19% 8.96% 9.80% 10.31% 11.07% 11.22% 15.78% 16.61% 16.75% B 5.36% 12.27% 23.70% 25.78% 27.79% 28.61% 30.23% 31.45% 32.83% 32.93% CCC/CC 0.00% 0.90% 4.85% 7.82% 13.77% 15.08% 17.23% By Number of Issuers 1 2 3 4 5 6 7 8 9 10 BB 0.43% 2.17% 4.87% 6.72% 8.15% 10.09% 11.07% 13.56% 15.09% 15.60% B 0.55% 2.38% 6.31% 10.00% 13.80% 15.90% 16.56% 18.35% 19.47% 19.70% CCC 0.00% 1.19% 6.13% 11.20% 17.83% 19.22% 23.40%

Cumulative Mortality Losses by Dollar Amount For LBOs by Implied Bond Rating (IBR) at Issuance 1 2 3 4 5 6 7 8 9 10 BB 0.00% 19.65%* 19.65% B 0.12% 1.54% 5.50% 6.63% 7.48% 7.80% 7.98% 9.71% 10.44% 10.52% CCC/CC 5.18% 12.02% 15.71% 17.39% 18.71% 18.74% 20.92% 21.44% *from 1 large Distressed Exchange by Freescale Semiconductor. For High-Yield Bonds by Original Bond Rating at Issuance (1971-2014)* 1 2 3 4 5 6 7 8 9 10 BB 0.56% 1.73% 3.99% 5.07% 6.33% 7.02% 7.75% 8.20% 8.88% 9.89% B 1.92% 7.23% 12.18% 16.76% 19.90% 21.86% 23.68% 24.56% 25.26% 25.65% CCC 5.38% 13.61% 24.45% 33.14% 35.36% 40.95% 43.36% 45.28% 45.51% 47.01% *from: E. Altman and B. Kuehne “Defaults and Returns in the High-Yield Bond and Distressed Debt Market: The Year 2014 in Review and Outlook”, Paulson and Co. and the NYU Salomon Center, January 30, 2015.

Cumulative Default Rates by Number of Issuers (Europe) For High-Yield Bonds by Bond Rating (1981-2013)* 1 2 3 4 5 6 7 BB 0.57% 1.76% 2.93% 3.69% 4.63% 5.68% 6.73% B 3.30% 8.26% 12.28% 14.81% 16.62% 17.81% 18.26% CCC/C 31.76% 38.10% 40.01% 41.16% 42.84% 44.96% *from: “Default, Transition, and Recovery: 2013 Annual Global Corporate Default Study and Rating Transitions”, Standard & Poors Ratings Direct, March 19, 2014.

Conclusions Summary Default Statistics for PE-Sponsored LBOs from 1995-2014 (Leveraged Loan Transactions): Number of Individual LBO Defaults: 126 Number of Issuer Defaults by Original Loan Rating: 150 Dollar Amount of Defaults: $150 billion Default Statistics Within 5 Years of Original Transaction Date 11.2% of Individual LBOs Defaulted 12.1% (13.6% ,including exits) of the Number of LBO Loan Issues Defaulted 11.5% (12.9%, including exits) of all LBOs defaulted by Implied Bond Ratings 20.1% (21.2% , including exits) of all LBOs defaulted by Loan Dollar Amount Private Equity Sponsored LBOs had Significantly Lower Cumulative Mortality (Default) Rates than did Comparably Rated Corporate Bonds over the Last Two Decades Similar Results for Default Losses

Remarks Possible Positive Reasons for Lower Default Rates, and Losses, on PE-Sponsored LBOs compared to Comparably Rated Corporate Bonds: Greater Access to Capital by PE-Sponsored LBOs Greater Funds to Support Ailing Companies Better Portfolio Management and Management Support Techniques than Stand-Alone Companies Better and Cheaper Access to Traditional and “Shadow Banking” Funds LBO Management More Heavily Invested in Success; More “Skin in the Game” Private Firm versus Public Firm Flexibility Rating Agency Bias in Rating LBOs? Possible Negative Reasons for Higher Default Rates and Losses: Asset Stripping (Crown Jewels) to Repay Debt (Could Work Both Ways) Subsequent Debt Issuance to Pay-out Dividends to Owners

Current Lbo and Default statistics

Historical H.Y. Bond Default Rates Straight Bonds Only Excluding Defaulted Issues From Par Value Outstanding, (US$ millions), 1971 – 2015 (10/15)) Year Par Value Outstandinga ($) Par Value Defaults ($) Default Rates (%) 2014 1,496,814 31,589 2.110 2013 1,392,212 14,539 1.044 2012 1,212,362 19,647 1.621 2011 1,354,649 17,963 1.326 2010 1,221,569 13,809 1.130 2009 1,152,952 123,878 10.744 2008 1,091,000 50,763 4.653 2007 1,075,400 5,473 0.509 2006 993,600 7,559 0.761 2005 1,073,000 36,209 3.375 2004 933,100 11,657 1.249 2003 825,000 38,451 4.661 2002 757,000 96,855 12.795 2001 649,000 63,609 9.801 2000 597,200 30,295 5.073 1999 567,400 23,532 4.147 1998 465,500 7,464 1.603 1997 335,400 4,200 1.252 1996 271,000 3,336 1.231 1995 240,000 4,551 1.896 1994 235,000 3,418 1.454 1993 206,907 2,287 1.105 1992 163,000 5,545 3.402 1991 183,600 18,862 10.273 1990 181,000 18,354 10.140 1989 189,258 8,110 4.285 1988 148,187 3,944 2.662 Year Par Value Outstanding* ($) Par Value Defaults ($) Default Rates (%) 1987 129,557 7,486 5.778 1986 90.243 3,156 3.497 1985 58,088 992 1.708 1984 40,939 344 0.840 1983 27,492 301 1.095 1982 18,109 577 3.186 1981 17,115 27 0.158 1980 14,935 224 1.500 1979 10,356 20 0.193 1978 8,946 119 1.330 1977 8,157 381 4.671 1976 7,735 30 0.388 1975 7,471 204 2.731 1974 10,894 123 1.129 1973 7,824 49 0.626 1972 6,928 193 2.786 1971 6,602 82 1.242 Standard Deviation (%) Arithmetic Average Default Rate (%) 1971 to 2014 3.117 3.097 1978 to 2014 3.340 3.273 1985 to 2014 3.843 3.416 Weighted Average Default Rate (%)* 3.491 3.496 3.513 Median Annual Default Rate (%) 1.664 2015 (10/15) 1,595,839 35,414 2.219 Source: Author’s compilation and Citigroup/Credit Suisse estimates a Weighted by par value of amount outstanding for each year. 20

Quarterly Default Rate and Four-Quarter Moving Average Default Rates on High-Yield Bonds Quarterly Default Rate and Four-Quarter Moving Average 1989 – 2015 (3Q - Preliminary) Source: Author’s Compilations 21

Historical Default Rates and Recession Periods in the U.S. High-Yield Bond Market (1972 – 2015 (3Q - Preliminary)) Periods of Recession: 11/73 - 3/75, 1/80 - 7/80, 7/81 - 11/82, 7/90 - 3/91, 4/01 – 12/01, 12/07 - 6/09 *All rates annual, except 3Q 2015 which is the LTM. Source: E. Altman (NYU Salomon Center) & National Bureau of Economic Research

Purchase Price Multiple excluding Fees for LBO Transactions Purchase Price Multiples Purchase Price Multiple excluding Fees for LBO Transactions N/A N/A (# obs.) Source: S&P Capital IQ LCD

Average Total Debt Leverage Ratio for LBO’s: Europe and US with EBITDA of €/$50M or More Source: S&P Capital IQ LCD

Maturity Profile of Leveraged Debt – As of 12/31/14 Source: S&P Capital IQ LCD