This is a description of what is evolving in the distressed debt market, due to the meltdown in the housing and structured finance markets.

1. That Was Then, But This is Now:
The Evolution of Distressed Debt &
Turnaround Investing
iiBIG’s “2007 Distressed & Turnaround
Investment Forum”
September 24-25, 2007
The Flamingo in Las Vegas, NV.
Track A: Issues in the Financial/Capital Markets

2. Water Tower Capital, LLC
Water Tower Capital, LLC is a specialty investment banking firm that
provides advise to clients in the areas of Corporate Recovery Services,
Valuations, Fairness Opinions, Litigation Consulting and M&A.
Examples of recent Water Tower Capital corporate recovery assignments
are listed below:
2

3. F. John Stark, III, Managing Principal
• John Stark, has been both an investor and an advisor in the distressed debt
market for the past two decades. He has been Managing Principal of Water
Tower Capital since 2001.
• From 1990 to 2000, Mr. Stark was an Executive Vice President and
General Counsel of the Special Investments Group of PPM America, where
he managed $900 million in three distressed securities funds, a $1.5 Billion
Commercial Finance Portfolio, and a $1 Billion workout portfolio.
• Mr. Stark has an AB from Wabash College and a JD from Vanderbilt
University School of Law.
3

4. I. That Was Then

5. I. That Was Then:
Defining Distressed Debt
Traditional Definitions
• Debt that trades at > 1,000 bps yield to worst;
• Debt that is trading flat, i.e., w/o coupon;
• Debt that is in default.
Distressed Debt Strategies
• Trading vs. Control
• Hedge Fund vs. Private Equity
• Domestic vs. International
5

6. I. That Was Then:
Defining Distressed Debt
• As shown below, the two most significant peaks in the distressed market occurred
within 12 months of the years 1990 and 2000;
• The distressed market continues to evolve, but the central issue is still, “when we
will see the next significant peak in defaults?”
6

7. I. That Was Then: 1990
Liquidity, Market Factors & CDOs
Liquidity Drivers CDO / Structured Product Evolution
•Asset-Liability mismatch caused • CDOs, CBOs, CMOs, and CLOs
S&L’s to be forced sellers of High were structured very conservatively.
Yield/Junk Bonds & HLT’s; • Leverage was low;
•Demise of Drexel;
• Permitted CDO Collateral Consisted
•Few Distressed Debt Funds
of:
•No Term B Lenders;
Market Factors
•Repatriation of Kuwait ended the
shooting war with Iraq;
Bank Loans
•Interest rates were relatively high;
High Yield
•Relatively Strong $;
•Oil Prices were $30/barrel;
•Unemployment was high;
•Good Companies with Bad Balance
7
Sheets.

8. I. That Was Then: 2000
Liquidity, Market Factors & CDOs
Liquidity Drivers CDO / Structured Product Evolution
•Implosion of the .com and telecom • CDOs, CBOs, CMOs, and CLOs
credits; were structured much more
•9/11 paralyzed the consumer and aggressively.
spawned “interest free’ auto loans; • Leverage increased significantly;
•Proliferation of Distressed Debt Funds
• Permitted Collateral Consisted of:
and CDOs as “buyers;”
2000
•Emergence of the Term B Lenders;
Bank Loans
Market Factors vs. 1990 1990
High Yield
Bank Loans
•Shooting war with Iraq had no
Distressed Debt
High Yield
discernable end in sight;
ABS, MBS
•Interest rates were lower; Emerging Mkts
• $ was weaker; Mezz.
•Oil Prices were higher; Equity
•Unemployment was lower;
8
•Bad Companies & Balance Sheets.

9. II. This is Now.

10. II. This is Now: 2007
Liquidity, Market Factors & CDOs
Liquidity Drivers CDOs begat SFOCs SIVs, & SIV-lites
•“Interest free” auto loans lead to the
demise of the auto suppliers;
2007
•Term B Lenders postponed the Sub Prime
inevitable spike in defaults; CDOs of CDOs
•Distressed Debt Funds remain buyers, RMBS, CMBS
but the Sub Prime crisis has frozen the Bank Loans
High Yield
new issue CDO market.
Distressed Debt
Market Factors vs. 1990 & 2000
ABS, MBS
•Shooting war with Iraq has no
Emerging Mkts
discernable end in sight;
Mezz.
•Inverted Yield curve is the “norm”; Equity
• $ is weaker;
•Oil Prices are even higher;
•Unemployment is lower;
10
•Bad Companies & Balance Sheets.

11. II. This is Now: 2007
Liquidity, Market Factors & CDOs
Market Factors {What is a SFOC, SIV, or SIV-lite and why should we care?}
•Structured Investment Vehicles “{SIV’s”} are a subset of the structured
financial operating companies in the credit arbitrage market;
•Moody’s and S&P have rated SIV structures that have >$350 billion in
assets under management;
•“SIV-lites” focus on residential mortgage backed securities {“RMBS”} and
they are estimated to hold as much as $12 billion in RMBS paper, comprising
>90% of their holdings, versus a SIV with <25% exposure.
•The SIV-lite structure permits higher advance rates and greater leverage
than a SIV or a CDO would have.
11

12. II. This is Now: 2007
Liquidity, Market Factors & CDOs
12

13. II. This is Now: 2007
Liquidity, Market Factors & CDOs
Long-Dead, Cash Flow CDOs Can Continue to Live On, See circa 2000 CDO
13

14. II. This is Now: 2007
Liquidity, Market Factors & CDOs
Long-Dead, Cash Flow CDOs Can Continue to Live On, See circa 2000 CDO
14

15. II. This is Now: 2007
Liquidity, Market Factors & CDOs
In contrast, the $1trillion of “market value” CDOs, SIVs and SIV-lites may be
forced to start selling collateral.
•On August 28th, Rhinebridge SIV announced that it had sold $176 million of
securities, or around 7%, to meet liquidity requirements;
•Not since the “1998 Russian Flu,” has a 'conventional' SIV admitted that asset
sales have been necessary in order to manage liquidity;
•SIV triggers normally work in the following order: Restricted Investment;
Restricted Funding; and Enforcement and the fall from grace can be very quick,
usually only 3 to 5 business days are given to cure a breach at each stage.
•Rhinebridge is only 6 months old and was built on a capital model that allowed
for investment in riskier paper, as Moody's itself acknowledged in its new issue
report earlier this year.
15

16. II. This is Now: 2007
Liquidity, Market Factors & CDOs
In contrast, the $1trillion of “market value” CDOs, SIVs and SIV-lites may be
forced to start selling collateral.
• Two Additional traditional ABCP conduits have had problems with
rolling CP: Titan Securitization & CentreStar
• One Additional SIV has announced its intention to liquidate
Cheyne Finance breached its capital loss test and entered
Enforcement.
• One Additional SIV/SIV-Lite
Kestrel Funding has entered into Restricted Operations stage implying
it can not purchase further assets.
16

17. III. Conclusions

18. III. Conclusions
Market Factors vs. 1990 & 2000
•With the CP market in gridlock and structured finance & bank paper
trading at sub-par prices, more SIVs are likely to come under pressure.
•According to a recent Deutsche Bank research report, given the
financing squeeze for almost any type of structured finance investor,
the demand backdrop for asset-backed product will remain
extremely weak for the foreseeable future.
•Secondary prices seem to reflect this shrinkage in the investor base,
with for example AAA UK prime mortgages trading at spreads of
30 bps and BBB non-conforming RMBS at spreads> 200 bps.
•Spreads are therefore firmly back to 2001 levels, as is arguably the
depth of the investor base.
18

19. III. Conclusions
Market Factors vs. 1990 and 2000
•A significant percentage of structured products’ buyers have been
leveraging illiquidity risk through the repo and ABS CP markets, which
could result in an asset / liability mismatch similar to the 1990 era S&L’s
•The lack of new CDO issuance will spill over in to the leveraged loan
market as there will be fewer buyers;
•If the $1 trillion of “market value” CDOs become “forced sellers,” this
will adversely affect all debt markets and create buying opportunities.
•The presence of structured vehicles in corporate workouts will
complicate the process as their options for conversion of debt to equity
are limited.
19

20. III. Conclusions
The amount of $’s allocated to Distressed Debt continues to rise.
20

21. III. Conclusions
That was Then This is Now
Category 1990 2000 2007
Precipitant S&L implosion Telcom & 9/11 Sub Prime?
Type of BK Free Fall Pre Arranged Pre Arranged
2nd Lien Debt
Fulcrum Security Bonds Bank Debt
% Recovery on 60% 15% ?
Bonds
Capital Structure Very simple Simple/CDOs Complex/SFOCs
of Issuer
# of $’s allocated Few Many Too many?
to Dist. Debt
21

22. Panelists
F. John Stark III, Managing Principal,
Water Tower Capital, LLC, Chicago, IL, Phone: 312-373-8001,
Email: john@watertowercapital.com
David Yu, Director - Distressed Investments Unit
MetLife, NY, NY, Phone: 973-355-4581,
Email: dyu@metlife.com
Robert A. Guy, Jr. Waller Lansden Dortch & Davis, LLP
Nashville, TN Phone: 615 850-8933
E-mail: bobby.guy@wallerlaw.com 22