CDOs In The Heartland Middle Market Commercial Loan Securitization (Middle Market CLOs) March 2003

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CDOs In The HeartlandMiddle Market Commercial
Loan Securitization(Middle Market CLOs)March
2003
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Middle Market CLOs
Panel Presentation

• Moderator
• Bill Brown - Director of Structured Credit
  Products, Wachovia Securities
• Panelists
• Elizabeth Russotto - Senior Director, Fitch
  Ratings
• Darric Brambora - Managing Director, Banc One
  Capital Markets, Inc.
• David Schmuck - CFO, Antares Capital Corporation
• John Timperio - Partner, Mayer, Brown, Rowe Maw

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Middle Market CLOs
Macro Trends

• Bank consolidation
• Number of banks has declined from 15,000 in 1990
  to less than 9,000 in 2001
• Forced migration to high volume businesses, e.g.,
  large syndicated loans
• Tightening credit environment
• Total volume of non-investment grade loans is
  down 45 since 1998
• Senior debt-to-EBITDA multiples declined to
  2.25x, down from 2.6x during the last recession
• Looming regulatory changes
• Implementation of Basel projected for 2005
• FASB pronouncement on treatment of SPEs

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Middle Market CLOs
Credit Trends

• Banks scrutinize
• Credit quality
• Liquidity
• Fee income potential (relationship banking)
• Regulatory capital and mark-to-market (Basel)
• Capital markets application for portfolio risk
  management
• Single name credit default swaps
• CLOs to manage balance sheet risk

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Middle Market CLOs
Middle Market Sector

• Major banks have exited the market
• Bank consolidation
• Lack resources or relationships
• Historical mispricing
• Capital concerns (Basel related)
• Focus on fee opportunities (larger syndicated
  loans 50 million EBITDA)
• Non-bank lenders unwilling to take underwriting
  risk
• Absence of traditional bank lenders has returned
  loan pricing to risk-based levels
• Demand for debt capital has significantly
  outpaced supply
• Priced without expectation of capital markets fee
  income
• Formation of specialty lenders insufficient to
  meet demand

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Middle Market CLOs
Capital Influx

• Middle market (MM) segment of leveraged loan
  market not adequately served by new entrants
• Continued exodus of traditional bank lenders,
  e.g., Fleet, LaSalle, and Wachovia
• Large portion of market exceeds hold levels for
  new entrants
• Underwriting strategy requires infrastructure and
  significant equity exposure
• Specialty lenders and funds lack balance sheet of
  traditional bank lenders
• Optimal debt financing encourages smaller hold
  levels
• Influx of debt capital characterized by two (2)
  main groups
• Full service platforms (specialty lenders)
• Independent, i.e., committed equity
• Strategic partnerships, i.e., Antares Capital and
  Mass Mutual
• Participants (investment funds)
• Investment funds represent the largest influx of
  capital to the middle market sector

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Middle Market CLOs
Participant Groups
Albion Alliance GSC Partners Guggenheim
Antares Capital (Mass Mutual) Highbridge/Zwirn
CDC IXIS CMNA (CDC) J.H. Whitney Denali Capital
(Bass Family) Ramius Capital Madison Capital
(New York Life) Windjammer Capital STRATEGIC
PARTNERSHIPS OPPORTUNITY FUNDS
FIRM COMMITMENT
EQUITY CAPITAL
FLUID COMMITMENT
SPECIALTY FINANCE 4 DEBT FUNDS 1
BILLION Allied Capital AbleCo Finance
(Cerberus) American Capital Dymas Capital
(Cerberus) CapitalSource Finance GE
(Heller) Gladstone Capital MCG
Capital Merrill Lynch Capital Group
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Middle Market CLOs
Middle Market Loan Types
ASSET-BASED
TRADITIONAL BANK LENDING
LEVERAGED LENDING
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Middle Market CLOs
Defining The Market

• Debt obligations to commercial companies with
  50-500 million in revenue (5-50 million in
  EBITDA)
• Market estimated at 900 billion (Source The
  Bond Market Association)
• Predominantly comprised of asset-based and cash
  flow loans
• Market historically served by three (3) primary
  groups
• Asset-based lenders
• Specialty lenders
• Traditional bank lenders
• Typical borrower characteristics
• Primarily private companies
• Non-rated or shadow rated
• Repayment of debt through asset liquidation or
  operating cash flow
• Lack recourse to shareholders, i.e., personal
  guarantees are atypical
• Primary loan types
• Asset-based loans
• Cash flow loans, e.g., senior secured, stretch
  senior, last out senior, and mezzanine

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Middle Market CLOs
Loan Types

• Asset-based loans finance working capital
  requirements
• Collateralized by receivables and inventory, may
  have recourse to inventory
• Revolver tied to borrower base
• Expressed in terms of loan to liquidation value
• Pricing L200-350 or P to P150 bps
• Cash flow loans finance needs ranging from
  working capital to private equity group (PEG)
  activities, e.g., leveraged buyouts, recaps, and
  acquisitions
• Include senior secured, stretch senior, last
  out senior, and mezzanine financing
• Traditional bank lenders target established
  companies in stable industries
• Specialty lenders and select bank lenders focus
  on PEG related activity
• Primarily collateralized by operating cash flow
• Underwritten to a multiple of EBITDA or loan to
  enterprise value
• Senior secured L450-800 bps (floating)
  mezzanine 11-12 (fixed) plus deferred interest
  and/or warrants to yield 18-22

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Middle Market CLOs
Leveraged Loan Market
Large Syndicated Loans EBITDA 50 million
Loan Size 200 million - 1 billion
Rating BB- / Ba3 Pricing L300-325 bps Club
Loans EBITDA 25-50 million Loan
Size 50-125 million Rating Shadow Rated (B
/ B1) Pricing L400-600 bps One Stop Loans
EBITDA 5-25 million Loan Size 10-80
million Rating Not Rated (Implied B area)
Pricing L550-800 bps
Large Syndicated Loans
Club Loans
Middle Market Sector
One Stop Loans
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Middle Market CLOs
Cash Flow Loan Types
Senior Secured
Stretch Senior
Mezzanine
Company XYZ
Last Out Senior
0x EBITDA
1x EBITDA
2x EBITDA
3x EBITDA
4x EBITDA
5x EBITDA
70
Relative Recoveries
58
40
0
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Middle Market CLOs
Market Participants

• Significant equity capital
• Conservative operating leverage
• Experienced management teams
• Credit focus
• Originate assets with intent to own the risk
• Rarely purchase loans on a whole loan basis
• Do not originate to a box for capital markets
  execution, e.g., diversity considerations
• Underwriting not dictated by rating agency view
  of credit
• Loans priced on a risk-adjusted basis (no
  expectation of fee income)
• Securitization viewed as a financing rather than
  a vehicle for risk transfer

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Middle Market CLOs
Lenders by Focus

• Senior Secured Lenders
• Ableco
• Antares Capital
• BNP Paribas
• CapitalSource
• CDC IXIS CMNA
• Denali Capital
• Dymas Capital
• GE (Heller)
• Gladstone Capital
• Madison Capital
• MCG Capital
• Merrill Lynch Capital Group
• Ramius Capital
• Royal Bank of Scotland

• Asset-Based Lenders
• CapitalSource
• CIT
• Congress Financial
• Fleet Capital
• Foothill Capital
• GE Capital
• Merrill Lynch Capital Group

• Mezzanine Lenders
• Ableco
• Albion Alliance
• Allied Capital
• American Capital
• Antares Capital
• Capital Resource Partners
• CapitalSource
• CDC IXIS CMNA
• Dymas Capital
• J.H. Whitney
• MCG Capital
• Ramius Capital
• William Blair Co.
• Windjammer Capital