Credit Markets - Milken Institute...The Nature of Credit 1. Credit is what counts, not leverage. 2. Most loans to real estate are not investment-grade. 3. Interest rates are volatile

David

Malpass

David

MalpassMike

Milken

Mike Milken

Steven Tananbaum

Steven Tananbaum

James Walker

James Walker

Credit MarketsCredit Markets

Stephen Nesbitt

Stephen Nesbitt

Top 10 World

Banks –

1979

Ranked by Assets (US$ Billions)

Top 10 World

Banks –

1979


Source: Bloomberg

BankBank CountryCountry Assets Assets Credit Agricole

France

$105Bank of America

U.S.

$103Citicorp

U.S.

$103Banque

Nationale

de Paris

France

$99Deutsche Bank

Germany

$91Credit Lyonnais

France

$91Societe Generale

France

$85Dresdner Bank

Germany

$70Barclays Group

U.K.

$67Dai-Ichie

Kangyo Bank

Japan

$67

Credit Agricole

France

$105Bank of America

U.S.

$103Citicorp

U.S.

$103Banque

Nationale

de Paris

France

$99Deutsche Bank

Germany

$91Credit Lyonnais

France

$91Societe Generale

France

$85Dresdner Bank

Germany

$70Barclays Group

U.K.

$67Dai-Ichie

Kangyo Bank

Japan

$67

Top 10 World Banks –

1989


Top 10 World Banks –

1989


Source: Bankscope (12/31/01)

BankBank CountryCountry Total AssetsTotal Assets11 Dai-Ichi Kangyo BankDai-Ichi Kangyo Bank JapanJapan 40840822 Sumitomo BankSumitomo Bank JapanJapan 37237233 Fuji BankFuji Bank JapanJapan 36736744 Mitsubishi BankMitsubishi Bank JapanJapan 36436455 Sanwa Bank Sanwa Bank JapanJapan 35835866 Industrial Bank of JapanIndustrial Bank of Japan JapanJapan 26026077 Crédit AgricoleCrédit Agricole FranceFrance 24224288 Banque

Nationale

de ParisBanque

Nationale

de Paris FranceFrance 23123199 Tokai Bank Tokai Bank JapanJapan 230230

1010 Citigroup Citigroup USUS 227227

Top 10 World

Banks –

2008


Top 10 World

Banks –

2008


Source: *The Banker

(July 2008), **Bloomberg (Oct 13., 2008)

BankBank CountryCountry Total Total Assets*Assets*

Market Market Cap**Cap**

11 Royal Bank of ScotlandRoyal Bank of Scotland U.K.U.K. 3,8083,808 202022 Deutsche BankDeutsche Bank GermanyGermany 2,9752,975 262633 2.4942.494 797944 BarclaysBarclays U.K.U.K. 2,4592,459 292955 U.K.U.K. 2,3542,354 16216266

Mitsubishi UFJ Financial GrpMitsubishi UFJ Financial Grp

USAUSA2,2682,268 3737

77Crédit AgricoleCrédit Agricole FranceFrance

2,1872,187 777788 SwitzerlandSwitzerland 2,0192,019 444499 1,8171,817 7878

1010 Bank of America CorpBank of America CorpJapanJapan

1,7161,716 105105

HSBC HoldingsHSBC Holdings

UBSUBS

BNP ParibasBNP Paribas FranceFrance

CitigroupCitigroup

USAUSA

The Nature of CreditThe Nature of Credit

1.

Credit is what counts, not leverage.

2.

Most loans to real estate are not investment-grade.

3.

Interest rates are volatile and unpredictable.

4.

Rating is not credit.

5.

Sovereign debt is historically risky.

6.

Debt values underpin all capital markets

1.


2.


3.


4.


5.


6.


The Nature of CreditThe Nature of Credit

1.


2.


3.


4.


5.


6.


1.


2.


3.


4.


5.


6.


Financial instruments, properly deployed, create socially useful incentives … increasing employment and aggregate wealth.

Financial instruments, properly deployed, create socially useful incentives … increasing employment and aggregate wealth.

Leverage ratios of different financial firms

Leverage ratio, total assets/common equity –

June 2008

Leverage ratios of different financial firms

Leverage ratio, total assets/common equity –

June 2008

Sources:

Federal Deposit Insurance Corporation, Office of Federal Housing Enterprise Oversight, National Credit Union Administration, Bloomberg, Google Finance,

Milken Institute.

9.1

9.8

9.4

31.6

23.7

21.5

67.9

Credit unionsCredit unions

Commercial banksCommercial banks

Savings institutionsSavings institutions

Brokers/hedge fundsBrokers/hedge funds

Federal Home Loan BanksFederal Home Loan Banks

Fannie MaeFannie Mae

Freddie MacFreddie Mac

Sources: Freddie Mac, Fannie Mae, FDIC, Milken Institute.

Fannie Mae and Freddie Mac: Highly LeveragedFannie Mae and Freddie Mac: Highly Leveraged

60x60x 56x56x 48x48x 55x55x60x60x 58x58x 52x52x 57x57x64x64x81x81x

56x56x

167x167x

65x65x

244x244x

59x59x

00

5050

100100

150150

200200

250250

300300

Core capitalCore capital Fair valueFair value Core capitalCore capital Fair valueFair value

20052005 20062006 20072007 2008Q22008Q2

Mortgage book of business over capital measuresMortgage book of business over capital measures

Fannie MaeFannie Mae Freddie MacFreddie Mac

-393x-393x

19901990

The latest run-up of home prices

was extraordinary

The latest run-up of home prices

was extraordinary

Sources: Robert Shiller, Milken Institute (Annualized growth rate of nominal home index: 3.4%)

18901890 19001900 19101910 19201920 19301930 19401940 19501950 19601960 19701970 19801980 20002000 20102010

WWIWWI WWIIWWIIGreat

Depression

Great

Depression70’s

Boom

70’s

Boom80’s

Boom

80’s

Boom

Latest

Boom

Latest

Boom250250

200200

150150

100100

5050

Index: 2000 = 100

Long-term

trend line

Long-term

trend line

19901990

Home prices don’t go up forever

Change in home prices in 100-plus years

Home prices don’t go up forever

Change in home prices in 100-plus years

Sources: Robert Shiller, Milken Institute.

18901890 19001900 19101910 19201920 19301930 19401940 19501950 19601960 19701970 19801980 20002000 20102010

WWIWWI WWIIWWIIGreat

Depression

Great

Depression70’s

Boom

70’s

Boom80’s

Boom

80’s

BoomLatest

Boom

Latest

Boom30%30%

20%20%

10%10%

0%0%

-10%-10%

-20%-20%

First RepublicBank CorporationFirst RepublicBank Corporation

Most Texas Banks were AAA in the 1980sMost Texas Banks were AAA in the 1980s

The prices of residential estate in Houston (in real terms) declined 40% from 1983-1988.

-

OFEHO Housing Index / FRB study

The prices of residential estate in Houston (in real terms) declined 40% from 1983-1988.

-

OFEHO Housing Index / FRB study

Foreclosures in HoustonForeclosures in Houston

30,00030,000

20,00020,000

19801980

10,00010,000

1,0001,00019861986 19921992

Source: Harris County Foreclosure Listing ServiceSource: Harris County Foreclosure Listing Service

•

1970: “In the first 70 years of the 20th

century, AA-rated railroads have had more than double the default rate of single-B rated industrials.”

•

Today: Many AAA-rated mortgage portfolios will have a higher default rate than single-B rated industrials.

•

1970: “In the first 70 years of the 20th

century, AA-rated railroads have had more than double the default rate of single-B rated industrials.”

•

Today: Many AAA-rated mortgage portfolios will have a higher default rate than single-B rated industrials.

•

Microsoft•

ADP•

Exxon-Mobil•

Johnson &

Johnson

•

Microsoft•

ADP•

Exxon-Mobil•

Johnson &

Johnson

AAA-rated Industrial Companies in the U.S.AAA-rated Industrial Companies in the U.S.

AAA

16,907AA+

240AA

2,098AA-

3,414A 2,602A-

2,027BBB+

903BBB

1,371BBB-

1,359

AAA

16,907AA+

240AA

2,098AA-

3,414A 2,602A-

2,027BBB+

903BBB

1,371BBB-

1,359

BB+

238BB

313BB-

331B+

339B

330B-

1,189CCC+

293CCC

214CCC-

104CC

36C 11

BB+

238BB

313BB-

331B+

339B

330B-

1,189CCC+

293CCC

214CCC-

104CC

36C 11

Investment-Grade SecuritiesInvestment-Grade Securities Non-investment Grade SecuritiesNon-investment Grade Securities

Source: Bloomberg 11/6/08

Standard &

Poor’s Ratings

New Issues: 1/1/2000 to 9/30/2008

Standard &

Poor’s Ratings

New Issues: 1/1/2000 to 9/30/2008

2%BB-Unrated3%BBB4%A11%AA80%AAA

1%Unrated1%BBB2%A3%AA5%Junior AAA88%Senior AAA

Mortgage bondsMortgage bonds

Mortgage loansMortgage loans

High-grade structured-finance CDOHigh-grade structured-finance CDO



Mezzanine structured-finance CDOMezzanine structured-finance CDO CDO-SquaredCDO-Squared

Source: International Monetary Fund.

When is a AAA not a AAA?When is a AAA not a AAA?

Secondary Market Prices of Third-World Debt

Secondary Market Prices of Third-World Debt

2020

3030

4040

5050

6060

7070

8080

100100

19821982 19831983 19841984 19851985 19861986 19871987 19881988 19891989

Cents on the dollarCents on the dollar

U.S. Lending to Third-World Countries

At Face Value

U.S. Lending to Third-World Countries

At Face Value

$700$700

$900$900

$1,100$1,100

$1,300$1,300

$1,500$1,500

19821982 19831983 19841984 19851985 19861986 19871987 19881988 19891989

$ billions$ billions

The most important year

in financial history

since World War II.

The most important year

in financial history

since World War II.

19741974

19741974•

Interest rates double in one year; highest level in recent recorded U.S. history

•

Regulation restricts lending

•

Energy prices skyrocket

•

U.S. stock market plunges 50%

•

Unemployment almost doubles

•

Interest rates double in one year; highest level in recent recorded U.S. history

•

Regulation restricts lending

•

Energy prices skyrocket

•

U.S. stock market plunges 50%

•

Unemployment almost doubles

19741974

RESULT:

Companies with the highest returns on

capital, fastest rates of growth in market share and employment, and greatest

innovation were denied access to equity and debt capital.

RESULT:

Companies with the highest returns on

capital, fastest rates of growth in market share and employment, and greatest

innovation were denied access to equity and debt capital.

19761976197519751974197419731973

11001100

10001000

900900

800800

700700

600600

500500

Index

“I’ll Never Own a Stock Again”

Dow Jones Industrial Average



1052 on 11 Jan. 19731052 on 11 Jan. 1973

578 on 6 Dec. 1974578 on 6 Dec. 1974

19761976197519751974197419731973

11001100

10001000

900900

800800

700700

600600

500500

Index

1052 on 11 Jan. 19731052 on 11 Jan. 1973

578 on 6 Dec. 1974578 on 6 Dec. 1974





2008 -

2009


2008 -

2009


Source: Datastream

4/21/09

65006500

75007500

85008500

95009500

1050010500

1150011500

1250012500

1350013500

Dec

2007

Dec

2007June

2008

June

2008Dec

2008

Dec

2008April

2009

April

2009

David Malpass

slides

For “Video Safe”

slides, all information must be inside this box.

Credit market was providing $400

billion

quarterly, now draining funds (last obs. Q4 2008)

Sources: Haver

Analytics, Encima

Global.

-1000

100200300400500600700800900

1000

1998 2000 2002 2004 2006 2008

Quarterly change, $ billions



Banks loans and leases shrinking

26-week change (last obs. April 1, 2009)

Sources: Haver

Analytics, Encima

Global.

-4%

-2%

0%

2%

4%

6%

8%

10%

1/1/

75

1/1/

77

1/1/

79

1/1/

81

1/1/

83

1/1/

85

1/1/

87

1/1/

89

1/1/

91

1/1/

93

1/1/

95

1/1/

97

1/1/

99

1/1/

01

1/1/

03

1/1/

05

1/1/

07

1/1/

09

26 w

eek

% c

hang

e



New cars loan rate 48 month

(last obs. April 16, 2009)

Sources: Haver

Analytics, WSJ, Encima

Global.

6.0

6.2

6.4

6.6

6.8

7.0

7.2

7.4

7.6

Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09

%

M2 13-week change,

annualized


Sources: Haver

Analytics, Encima

Global.

0%

5%

10%

15%

20%

25%13 week % change, AR

Which way will it break?

Jobless Claims 4 week Avg


Sources: Haver

Analytics, Encima

Global.

0

100

200

300

400

500

600

700

1967 1972 1977 1982 1987 1992 1997 2002 2007

Thousands, seasonally adjusted

Jim Walker slides

Securitization issuance

1%

2%

3%

4%

5%

6%

7%

0

500

1,000

1,500

2,000

2,500

3,000

2000 2001 2002 2003 2004 2005 2006 2007 2008

Tangible EquityIssu

ance

($Bn

)

RMBS ABS CDO Bank Tangible Equity (rhs)Sources: Fir Tree Partners, JPMorgan, Credit Suisse.

The “unregulated”

financial system

•

Lower consumer borrowing rates

•

“Short term”

bank profits: transaction fees and

deal spreads as Principal Issuers

•

US credit markets became most advanced and liquid globally –

art / music royalties?

•

Reduced cost of capital for issuers

Source: Fir Tree Partners.

•

Derivatives market became unregulated global “Casino”

•

Financial institutions became holders of residual risk

•

Tax and accounting code enabled growth of securitized debt

•

Rating agency and bank’s/dealer’s compensation were wrongly incented

•

Banks ”moving companies” led to poor asset quality

New corporate debt issuance

Source: Fir Tree Partners, JPMorgan.

0bp

500bp

1000bp

1500bp

2000bp

0

200

400

600

2004 2005 2006 2007 2008

Spreads (bp)

Issu

ance

($B

n)

Yearly

High Yield Leveraged Loans HY Spread (rhs)

0bp

500bp

1000bp

1500bp

2000bp

0

5

10

Jan‐09 Feb‐09 Mar‐09

Spreads (bp)

Issu

ance

($B

n)

1Q09

High Yield Leveraged Loans HY Spread (rhs)

Various risks to easing of credit markets


Risks?

History of U.S. debt –

public and private

Sources: Fir Tree Partners, Deutsche Bank.

150%

160%

170%

180%

190%

200%

210%

220%

230%

240%

250%

Jan‐84 Jan‐89 Jan‐94 Jan‐99 Jan‐04 Jan‐09

US Debt Outstanding as % of GDP

•

Tangible common equity

•

Steep yield curve

•

Deleveraging through asset sales

•

Debt for equity exchanges

•

Bankruptcies•

Exchange Offers•

Secondary Equity offerings

•

Savings

•

Bankruptcies

•

Debt restructuring

The cure


INFLATE

Corporations Consumer Banks

GoldenTree Asset Management®

Steven A. Tananbaum, CEO & Chief Investment OfficerApril 2009

PastGlobal hunt for return and regulatory changes for banks led to the Creationand Implosion of Shadow Banking Systems–

Asset Based Structures–

Prop Desk–

SIVs–

On/Off Balance Sheet–

Basis Trading Books (Imaginary P&L)

Evolution of Banking Model and Credit Markets is happening Real Time

Credit Technicals are Evident of Market Forces at Work–

Most Liquid Names are Drawing the Most Interest

PresentRebound in Credit, not broad-based–

1st

Lien vs. 2nd

Lien (Wide Spread between Jr. vs. Sr.)–

2nd

Lien vs. High Yield Bonds (Similar level of Capital Structure)–

AAA rated CLO Debt Prices (Create Bank Debt at 30-50% Discount)–

Large EBITDA Issuers of $1 billion+ vs. $100-500 million Issuers–

Other Asset Backed Structures are still Very Dislocated

Retail example

Capital Structure

EBITDA

($ mm) FCFLeverage at Create Price YTM

Smart & Final 2nd

Lien147 5.5% 4.1x 55.0 24.4%

Dollar General Sr. Notes

1,000 7.0% 4.0x 104.0 11.0%

The specific investments noted within this presentation have been included for informational purposes only to illustrate the investment process.

No assurance can be given that similar opportunities will arise

or that the performance of these investments will be typical or representative of any or all future investments associated with GoldenTree.

It should not be assumed that these investments or any investments made in the future will be profitable.

Transactions of the type described herein may involve a high degree of risk, and the value of such instruments may be highly volatile.

The above information represents GoldenTree’s internal assumptions and analysis.

Accordingly, there can be no guarantee as to the results or accuracy of the information noted above.

To that end, investors may lose their entire investment in the Fund.

Past performance is not indicative of future results.

Healthcare exampleCapital Structure

EBITDA ($ mm) FCF

Leverage at Create Price YTM

Generics International 2nd

Lien72 3.0% 5.0x 65.0 20.0%

The TriZetto Group Unsecured Notes

121 3.8% 4.0x 81.1 18.3%

Biomet, Inc. Sr. Sub. Notes

900 3.5% 6.4x 94.5 11.4%

The specific investments noted within this presentation have been included for informational purposes only to illustrate the investment process.

No assurance can be given that similar opportunities will arise

or that the performance of these investments will be typical or representative of any or all future investments associated with GoldenTree.

It should not be assumed that these investments or any investments made in the future will be profitable.

Transactions of the type described herein may involve a high degree of risk, and the value of such instruments may be highly volatile.

The above information represents GoldenTree’s internal assumptions and analysis.

Accordingly, there can be no guarantee as to the results or accuracy of the information noted above.

To that end, investors may lose their entire investment in the Fund.

Past performance is not indicative of future results.

Documents

Credit Markets - Milken Institute...The Nature of Credit 1. Credit is what counts, not leverage. 2. Most loans to real estate are not investment-grade. 3. Interest rates are volatile