Red Flags for Corporate Bond Investors

1
Red Flags for Corporate Bond Investors

• Robert J. Grossman, Group Managing Director

2
Rating Mix Trend (12/31/00-6/30/02)
A
BBB
AA
AAA
B
BB
CCC-C
3
Companies with Senior Debt Median Ratios Ratings
of A as of 12/31/99 (174 Companies)
12/31/99
12/31/01
Debt/EBITDA
1.80x
2.33x
EBITDA/Interest Expense
8.11x
6.31x
EBITDA-Cap Ex/Interest Expense
4.52x
2.93x
Total Debt/Market Cap.
29
34
(Op Cash Flow CAPEX-Dividends)/Total Debt
7
5
4
Upgrades/Downgrades
2001Q4
2002Q1
2002Q2
2002Q3
Down
Up
Down
Up
Down
Up
Down
Up
Quarterly Totals
grades
grades
grades
grades
grades
grades
grades
grades
73
24
52
17
59
46
76
21
Fin'l Institutions
88
11
99
11
109
4
74
16
Corporates
161
35
151
28
168
50
150
37
All Corporate Finance
As of 9/25/02
5
Historic Credit Spreads to Treasuries 1988-2002
6
Red Flags

• Traditional
• Decrease in free cash flow (including CAPEX
  dividends)
• Increase in short-term debt
• Excessive growth in a negative business climate
• Non-traditional
• Credit default swap spreads
• Bond price anomalies
• Equity market deterioration, absolute/relative to
  industry/short interest
• Increased presence in CDO portfolios

7
Free Cash Flow
Free Cash Flow (operating cash flow - CAPEX -
cash dividends) divided by total debt
12/31/01 Median

• AA senior debt issuers
• A senior debt issuers
• BBB senior debt issuers
• BB senior debt issuers
• B senior debt issuers

11 8 5 4 3
8
Free Cash Flow/Total Debt BBB Issuers
(12/31/01)

• Top
• (Highest FCF/TD Ratio)
• Textiles Furniture
• Consumer Products
• Leisure Entertainment
• Healthcare Pharmaceutical

• Bottom
• (Lowest FCF/TD Ratio)
• Telecommunication
• Utilities
• Cable
• Paper Forest Products
• Energy

9
Free Cash Flow/Total Debt BBB Rated Issuers
(operating cash flow-CAPEX-cash dividends)/total
debt
12/31/01 Median
Consumer Products 34.0 Utilities -6.4
10
Utility Spreads by Rating
B
BB
BBB
A
AA
AAA
Sep-18-2002
Source Reuters
11
Short-Term Debt Usage

(short-term debt current portion long-term
debt)/total debt
12/31/01 Median
AA rated issuers 23 A rated
issuers 15 BBB rated issuers 10 BB
rated issuers 5 B rated issuers 2
12
Short-Term Debt Usage BBB Rated Issuers
(short-term debt current portion long-term
debt)/total debt
12/31/01 Median
Gaming, Lodging Restaurants 1.5 Utilities 19.6

13
Excessive Growth in a Negative Business
Environment

• Revenue growth significantly in excess of
  industry or GDP
• Income growth significantly in excess of industry
  or GDP
• Segment analysis Do the pieces add up?

14
Credit Default Swap Spreads/Bond Price Anomalies

• Review spread movements by industry and country
• Review individual outliers/relative to industry
• Investors use of market based indicators

15
Credit Default Swap Spreads
Last Week's Worst Performing Assets (Week Ending
9/6/02)
Last Week's
Prior Week's
Spread
Asset
Country
Term
Avg Spread
Change
Currency
Industry
Avg Spread
Asset 1
United States
5y 0m
350
225
125
USD
Supermarkets Drug Stores
Asset 2
Japan
5y 0m
225
130
95
USD
Banking Finance
Asset 3
United States
5y 0m
190
110
80
USD
Energy
Asset 4
France
5y 0m
800
725
75
EUR
Transportation
Asset 5
Japan
5y 0m
168
95
73
USD
Banking Finance
Asset 6
Turkey
3y 0m
1092
1020
72
EUR
Sovereign
Asset 7
United States
5y 0m
344
275
69
USD
Building Materials
Asset 8
United States
5y 0m
450
385
65
USD
Chemical
Asset 9
United States
5y 0m
350
286
64
USD
Broadcasting Media
Asset 10
Turkey
5y 0m
1127
1070
57
EUR
Sovereign
16
Credit Default Swap Spreads
Last Week's Best Performing Assets (Week Ending
9/6/02)
Last Week's
Prior Week's
Spread
Asset
Country
Term
Avg Spread
Avg Spread
Change
Currency
Industry
Asset 1
Canada
5y 0m
450
521
-71
USD
Chemical
Asset 2
Japan
5y 0m
135
205
-70
JPY
Banking Finance
Asset 3
Brazil
2y 0m
2600
2660
-60
USD
Sovereign
Asset 4
Russian Federation
2y 0m
375
400
-25
EUR
Sovereign
Asset 5
United States
5y 0m
800
825
-25
USD
Computers Electronics
Asset 6
Colombia
1y 0m
608
633
-24
USD
Sovereign
Asset 7
Switzerland
5y 0m
204
225
-21
EUR
Building Materials
Asset 8
Germany
5y 0m
30
49
-19
EUR
Chemical
Asset 9
Korea, South
3y 0m
90
108
-18
USD
Telecommunication
Asset 10
United States
5y 0m
118
135
-18
USD
Banking Finance
17
Equity Market Indicators

• Price movements by industry and issuer
• Short interest

18
Increased Presence in CDO Portfolios

• Stock and flow analysis
• Sophisticated lenders hedge risk
• Not always an indicator

19
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