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TMA Houston October 5 Breakfast Meeting

The Panelists. Jay Krasoff

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TMA Houston October 5 Breakfast Meeting

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    1. TMA Houston October 5 Breakfast Meeting Hyper-liquidity and its implications

    2. The Panelists Jay Krasoff – Moderator – Chiron Financial Group Aamir Shah –Senior Secured Lender– Comerica Bank Preston Massey – multi-strategy – Wells Fargo Foothill Matt Whitaker – private equity – Priest River, Ltd. Leon Komkov – hedge fund – Longroad Asset Mgmt.

    3. CURRENT SITUATION Unprecedented Liquidity Aggressive Lenders Hedge Funds Competing for Loan Business Leverage Multiple above 5X for lower middle market companies Second Lien Market has risen from $0 to $20 Billion in five years Rising Proportion of Low-Grade Issues (B- or lower)

    4. Middle-Market Purchase Price Multiples The continuing momentum in the market has been fueled by the accommodating lending market and increasing leverage. Senior leverage in Q1 2005 has reached a level not seen since the mid 1990s (as shown on the previous slide). This has allowed purchase price multiples of the lower middle market to return to the 1998-1999 levels. Additionally, the private equity market is continually looking toward dividend recaps as an alternative to traditional exits strategies. By November of 2004, 46 private equity dividend deals had been completed in the high-yield market, up from 14 in 2003. There were no dividend recap deals done in 2002. Both the increase in multiples and leverage are laying the ground for future credit problems.

    5. Bank Debt to EBITDA ratios As the figure to the right demonstrates, the senior leverage in the first quarter 2005 reached a level not seen since the mid-90s. These leverage multiples have also fueled a steady increase in purchase price multiples, with the average middle market purchase multiple reaching 8.6x - 10.4x in Q1 2005 for the lower middle market. (Thomson Financial)

    6. Average Debt to EBITDA Multiples of Highly Leveraged Loans

    7. Impact on Senior Lenders

    8. Typical Old Leveraged Capital Structure The banks controlled the revolver and Term Loan A, which might be 60% of the total financing.

    9. Typical New Leveraged Capital Structure The revolver and Term Loan A (20%) might be provided by an asset-based lender, and the remainder (80%) might be from institutional parties.

    10. US High-Yield Bond Market New Issuance Volume High-Yield Bond issuance remains very strong. Low default rates combined with investors seeking higher yields allowed otherwise marginal companies to issue CCC rated bonds and lower. This, together with second lien loan growth is a major tool for bankruptcy deferral

    11. What is Liquidity Doing to Lower Middle Market Private Equity? Undisciplined Money Rush to make any investment No More Club Deals --- Poaching pressures The Ratchet-Down Effect: Why are $5B hedge funds chasing $100MM sales cos? Remember: that 25-year old financial rocket scientist has never seen a bust. Matt WhitakerMatt Whitaker

    12. Size of the Second Lien Loan Market In the past three years there has been an explosion of the second lien product. The $21.6 billion in second lien debt issued in 2005 was almost seven times the $3.3 billion of 2003. The 2nd lien product is partially responsible for the lull in bankruptcy filings, as it became the loan of last resort helping companies put “band-aids” over the problems. These instruments are highly leveraged floating rate products with limited covenants and collateral. I (Komkov) believe these loans are the distressed inventory of the future

    13. Distressed Debt Index (Face Value in $ Billions

    14. Industry Breakdown of Distressed Index By number of issues, as of 7-14-06

    15. What is Driving the Hedge Funds? Size: Senior Secured Loan Market – 1.5 Trillion in 2005 Hedge funds $1.3 Trillion under management 2005 2 and 20 Negative Arbitrage

    16. Is Discipline is Old-Fashioned? EBITDA Multiples Appear to be Irrelevant Covenants Are Weak Mezzanine Lenders are out of the market Or calling themselves 2d lien lenders

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