Business Finance: Lending and Job Creation in the 21st Century

Fall 2010

Industrial and commercial loans by all depository institutions declined in 2009

-120

-80

-40

0

40

80

120

2007 Q1

2007 Q2

2007 Q3

2007 Q4

2008 Q1

2008 Q2

2008 Q3

2008 Q4

2009 Q1

2009 Q2

2009 Q3

2009 Q4

Quarterly change, US$ billions

Source: FDIC. 2

Bank lending continues to decline, while businesses and individuals draw upon existing credit lines

4.0

5.0

6.0

7.0

8.0

9.0

2003 Q1

2003 Q3

2004 Q1

2004 Q3

2005 Q1

2005 Q3

2006 Q1

2006 Q3

2007 Q1

2007 Q3

2008 Q1

2008 Q3

2009 Q1

2009 Q3

US$ trillions

Net loans and leases

Unused commitments

Sources: FDIC, Milken Institute.

3

Companies raised $3 trillion worldwide in 2009 via corporate bond issuance

4

Source: Dealogic.

0

500

1,000

1,500

2,000

2,500

3,000

3,500

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

US$ billions

2009: $3 trillion

U.S. companies raised $883 billion from corporate bond issuance in 2009

5

Source: Dealogic.

0

100

200

300

400

500

600

700

800

900

1,000

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

Th

ou

san

ds

US$ billions 2009: $883 billion

Companies worldwide raised $809 billion on equity markets in 2009

6

Source: Dealogic.

0

100

200

300

400

500

600

700

800

900

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

US$ billions

IPO

Follow-on offering

Loan issuance in the United States Quarterly, Q1 2004 to Q1 2010

7

Source: Dealogic.

0

100

200

300

400

500

600

700

800

900

2004 2005 2006 2007 2008 2009 2010

Investment grade

Leveraged

Highly leveraged

US$ billions

$625 billion high yield bonds and $1.9 trillionleveraged loans are scheduled to mature by 2015

8

0

100

200

300

400

500

600

2010 2011 2012 2013 2014 2015 >2015

US$ billions

Leveraged loans

High yield bonds

Source: Dealogic.

Leveraged loans scheduled to mature between now and 2015

9

0

100

200

300

400

500

600

2010 2011 2012 2013 2014 2015 >2015

US$ billions

Others

Term loan

Revolving credit

Source: Dealogic.

Medium term note (MTN)

Traditional vs. shadow banking system

10

Traditional banks

Investors

•Money market funds

Shadow banking system

- Bank conduits

- Special investment vehicles (SIVs) and limited purpose finance companies (LPFCs)

- Securitizations (ABS, RMBS, CMBS, auto loans)

- CLOs, CBOs and CDOs

- Special credit managers

•Securities lenders

•Investment managers

•Under-exposed banks

•Pension companies and insurance companies

Commercial paper (CP)

CP, MTN and capital

Capital

Capital, Debt

CD, CP, bank equity

Borrowers

-Corporate borrowers

- Individual borrowers

Loans

Cash Products

Source: Gary Gorton (2010).

Despite market value Haircuts, CLO event of default levels at their trough maintained 15%+ cushion levels

Sources: Moody’s, S&P/LSTA, Wells Fargo.

90

95

100

105

110

115

120

125

130

135

Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

(%)

2003 CLOs - Senior O/C ratio 2004 CLOs - Senior O/C ratio 2005 CLOs - Senior O/C ratio2006 CLOs - Senior O/C ratio 2007 CLOs - Senior O/C ratio 2003 CLOs - EOD O/C trigger2004 CLOs - EOD O/C trigger 2005 CLOs - EOD O/C trigger 2006 CLOs - EOD O/C trigger2007 CLOs - EOD O/C trigger

U.S. Corporate CLO EOD Index

11

12

Securitization contributed to economic growth by providing cheap financing and stimulating consumption

Economic growth

Securitization

ConsumptionCheap

financing

13

Total private credit market debt/US GDP 1916 to 2009

Sources: Federal Reserve, Historical Statistics of the United States, Bureau of Labor Statistics, Milken Institute.

0

50

100

150

200

250

300

350

1920 1930 1940 1950 1960 1970 1980 1990 2000

Percent

Great Depression

Today

14

Leveraged loan and high yield spread Q1 1998 to Q4 2009

0

400

800

1,200

1,600

2,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Basis points

Average straight spread of B+/B institutional loans to LIBOR

Average high yield spread to Treasuries

No risk premium

Source: S&P/LSTA, Merrill Lynch

15

Subprime: Defaults & losses lead to uncertainty & loss

of confidence

SIVs & Conduits:Loss of confidence results in disappearance of short term funding/ABCP market forcing

some SIVs holding LT portfolios into default and liquidations

Banks:Illiquidity and disappearance of lenders

leads to overhang of loans on bank books causing markdowns and secondary price

decline

CLOs:Bank warehousing

lines frozen, AAA lender disappears, closes ABS

market

Hedge funds:Marked-to-market losses,

conditions to equity withdrawals and liquidations

Leveraged loan market:Minimal capital available to

loan market from Hedge Funds, CLOs, Banks

LiquidityCrisis

LiquidityCrisis

A liquidity crisis

U.S. leveraged loans outstanding 2000 to 2009

16

Sources: Credit Suisse.

0

200

400

600

800

1000

1200

1400

1600

1800

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

US$ billions

Non-syndicated loans

Syndicated loans

17

Active institutional loan investor groups 1996 to 2009

Sources: Credit Suisse Leveraged Loan Index, S&P LCD Quarterly Leveraging Lending Review.

22 2948 54

4264

7698

116

168

218

261

85102

0

50

100

150

200

250

300

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Numberof investor groups that made 10 or more primary commitments each year

18

Syndicated bank loan and high yield bonds maturing in the next five years

$21 $58$95

$215$294

$22$68

$61

$93

$108

0

50

100

150

200

250

300

350

400

450

2010 2011 2012 2013 2014

US$ billions

$43

$126$156

$308

$403

Sources: Credit Suisse Leveraged Loan Index, Merrill Lynch High Yield Master II Index, S&P LCD Quarterly Leveraging Lending Review.

Middle-market loans maturing in the next five years

19

Sources: Thomson Reuters LPC.

71 82109

65

25

817

31

38

26

0

20

40

60

80

100

120

140

160

2010 2011 2012 2013 2014

US$ billions

Sponsored Non-sponsored

99

140

103

52

20

Differentiating CLO’s versus Mortgage CDO’s

CLOs – The Good Mortgage CDOs – The Bad

High quality product No AAA CLO has lost principal

value More suitable leverage Ability to access underlying

collateral

Contributor to lower cost of bank debt CLOs are a “non-bank” bank Provides meaningful benefit to the

U.S. economy

Low quality product Ratings agency did not understand

the correlation risks Imprudent leverage Impossible to access underlying

collateral leading to decreased ability to fix systemic problems associated with the product

Destroyed balance sheets of banks

21

Corporate loan default rates peaked in 2009 at less than half the current mortgage delinquency rate

Sources: Moody’s, Bloomberg. Note: (1) Moody’s trailing twelve month default rate by Issuer; (2) Bloomberg Mortgage Delinquency Rate – includes All Mortgages 90+ Days. Delinquent including REO and Foreclosure as a percentage of loans that provided delinquency figures for the month from Bloomberg’s non-agency database encompassing over 12 million loans.

3/31/10: 10.26%

3/31/10: 25.68%

0%

5%

10%

15%

20%

25%

30%

2005 2006 2007 2008 2009 2010

Percent

Mortgage delinquency rate (2)

Loans default rate (by issuer) (1)

22

CLO’s if properly structured should help reduce the cost of credit to small, medium and large companies

0

10

20

30

40

50

60

70

80

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Q1 2010

Percent of newly issued institutional loans purchased by CLO's

Source: S&P LCD Quarterly Leveraged Lending Review.

23

CLO outstanding reinvestment period

Source: S&P LCD Quarterly Leveraged Lending Review.

-300

-200

-100

0

100

200

300

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Cumulative CLO outstandings in reinvestment period

Cumulative decrease in demand as reinvestment period ends

US$ billions

24

U.S. middle-market loan issuance 2001 to 2009

0

20

40

60

80

100

120

140

160

180

200

2001 2003 2005 2007 2009

Total issuance, US$ billions

0

20

40

60

80

100

120

140

160

2001 2003 2005 2007 2009

Large

Traditional

Large and traditional loan issuance, US$ billions

Source: Thomson Reuters LPC.

25

Importance of BDCs to the middle market

Sources: Thomson Reuters LPC, Stifel Nicolaus Research.

0%

5%

10%

15%

20%

25%

30%

35%

40%

0

10

20

30

40

50

60

2006 2007 2008 2009

Traditional middle-market loan issuance (left axis)

BDC originations (left axis)

BDC originations as % of middle-market volume (right axis)

Loan volume, US$ billions Percent

26

Prognosis for BDCs—Outlook improving

0

5

10

15

20

25

0.0

1.0

2.0

3.0

4.0

5.0

2006 2007 2008 2009 2010 YTD

Equity issuance (left axis)

Number of deals (right axis)

US$ billions

0

4

8

12

16

20

2002 2003 2004 2005 2006 2007 2008 2009

Market capitalization for BDC industry, US$ billions

Sources: Lazard and ECM Analytics as of 3/12/10; SEC filings.

27

Cost of capital for BDCs is normalizing

0

5

10

15

20

25

30

35

40

45

3/30/2005 3/30/2006 3/30/2007 3/30/2008 3/30/2009 3/30/2010

Yield to maturity, percent

BDC dividend yields

Bank of America/Merrill Lynch U.S. high yield B-BB index

Sources: Bank of America/Merrill Lynch, JMP Securities Research

28

Bank failures reached 140 in 2009 Annual: 1934 — 2009

Source: FDIC.*through March 19, 2010

29

Number of “problem institutions” reached 702 in 2009, exceeding $400 billion in assets Annual: 2001 — 2009

Source: FDIC.

FAS 157—Unintended consequences

• FAS 157 was enacted in 2006 (for adoption after November 15, 2007) to address uniformity in accounting standards for fair value measurements

• While BDCs were created to supplement a bank function, they were not granted the same accounting standards for loans ascribed to banks

• While BDCs have always been required to fair value their assets, FAS 157 and subsequent regulatory guidance changed fair value measurement for assets but did not permit them to fair value their existing liabilities in a similar manner

• Unintended consequence: During the credit crisis, the FAS 157 process forced money-good assets to be marked down, skewing statutory leverage ratios and thus diminishing the ability of BDCs to extend capital during a critical period

30Source: Jim Zelter.

FAS 157—Impact on BDC model

An erosion in mark to market asset prices significantly curtails lending activity of BDCs at a critical juncture

Sources: Jim Zelter, Apollo Analysis.

Par Portfolio Down 30%

Portfolio Value $1,500 $1,050

Debt $500 $500

NAV $1,000 $550

Leverage 0.50x 0.91x

Incremental Capacity $500 $50

(US$ millions)

31