JANUARY 2 0 0 4 RESTRUCTURING - EVOLUTION OF A CREDIT EVENT S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A LS T R I C T L Y P R I V A T E A.

JANUARY  2 0 0 4

RESTRUCTURING - EVOLUTION OF A CREDIT EVENT

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ConsecoBank debt restructured (compensated maturity extension)Significant price disparity between short-dated bank debt and longer-dated bondsPotential moral hazards and significant value in cheapest-to-deliver option led to debate about the proper form of restructuring as a credit event

National PowerDe-merger resulted in two entities of very different credit quality (Innogy and International Power)“Successor” unclear under 1999 definitions, inspired “Successor Supplement”

Railtrack PLCRaised issue of whether convertible bonds are “Not contingent.”Led to publication of “Convertible and Exchangeable Supplement”

Ratings agencies’ concerns regarding credit events

Some events prompting re-examination of 1999 Definitions

Some events prompting re-examination of 1999 Definitions

Restructuring in Historical Context

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Addendum to the 1991 ISDA definitions required that the terms of an obligation become “materially less favorable” to its holders

Highlighted the desirability of “materiality tests” under the “long form” contract

Asian crisis (Indonesia, Korean issuers) in 1997 and default of Russia on local paper and Paris Club debt in 1998 demonstrated subjectivity and contractual uncertainty of definition

1991 Definition of Restructuring1991 Definition of Restructuring

Evolution of “Restructuring”: 1991-1999R

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1999 Definition of Restructuring1999 Definition of Restructuring

The 1999 definition provided more objectivity by listing specific events that would constitute “restructuring” in a credit default swap contract a reduction in the rate or amount of interest payable a reduction in the amount of principal, a postponement of payment (interest or principal), a change in ranking of priority (subordination), a change in the currency of composition of any payment

To allow for negotiation of changes in interest rates or maturity extensions on bank loans under circumstances falling well short of severity of bankruptcy or payment default, ISDA drafting committee introduced exception to definition the aforementioned events would not be considered a Restructuring if the event did

not “directly or indirectly result from a deterioration in the creditworthiness or financial condition of the Reference Entity.”

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Stock price plunged after a $350mm charge in 2000 and announcement of intent to sell Green Tree, which Conseco had acquired in 1998

Conseco debt downgraded several notches after effectively losing access to the CP market and having to draw on bank backstop facilities

Over the summer of 2000, Conseco accumulated $450mm in cash through improved operations and sale of non-strategic assets, but had used all its bank borrowing capacity to repay maturing debt and was facing repayment of bank lines

Bankers chose to extend maturity of Conseco’s loans instead of demanding timely repayment and likely pushing them into bankruptcy Conseco would repay $450mm of an outstanding credit line in full Maturity of the remaining $900mm in debt would be extended by roughly 15 months,

interest rate would rise from L+50 to L+250, and bank lenders would achieve a form of collateralization

A Restructuring Event had clearly occurred, but - Bonds maturing essentially at the same time as the bank facility were repaid in full The restructured 15 month loan was trading at around 92% of face value Banks who triggered credit derivatives protection were able to receive par for delivery of

long-dated senior unsecured bonds that they had sourced from the secondary market at around 68% of face value

Outstanding notionals of CDS referencing Conseco exceeded $350mm and protection sellers lost over $60mm, but not a single contract was litigated in court - a successful test for the CDS markets, but highlighted need for refining the contract to better avoid perverse outcomes

Conseco - a case study in RestructuringConseco - a case study in Restructuring

Restructuring in Historical ContextR

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Addressing market participants’ needs Bank hedgers did not need any meaningful delivery optionality since bank forebearance

in the US seldom exceeds more than 18 months Protection sellers strongly wanted the maturity of Deliverable Obligations to be capped

in a Restructuring event Dealer community wanted to minimize mismatches on its books

By incorporating the provisions of the Restructuring Supplement (May 2001) and checking the “Restructuring Maturity Limitation Applicable” box in the standard confirmation - If protection buyer triggers after a Restructuring credit event only, the maximum

maturity of deliverables must be no later than the longer of:1) Scheduled termination of the CDS contract; and2) the shorter of;

a) 30 months (in the case of all Deliverable Obligations) after legally effective Restructuring date, orb) latest final maturity date of any Restructured Bond or Loan (provided that this maximum maturity can never be less than the remaining tenor of the triggered contract)

Deliverable obligation must be “fully transferable” (consent not required) to “eligible tranferee” (wide range of institutional market participants)

Restructuring credit event can only be triggered for Obligations that 1) have more than 3 holders in the case of a Bond or a Loan, and 2) in the case of loans only, require at least a 2/3 majority to implement a Restructuring

Restructuring of bilateral loans are not triggers, though they are still deliverable if they otherwise meet Deliverable Obligation definitions

Modified Restructuring fine-tunes triggers and limits deliverables

Modified Restructuring fine-tunes triggers and limits deliverables

Move toward Modified RestructuringR

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From Autumn 2000 to the adoption of the Restructuring Supplement, the US market traded many reference names in two forms - with 1999 Restructuring, and without Restructuring

Obtaining a price for the inclusion of Restructuring in a disciplined derivatives framework is difficult because the probability of Restructuring is not an observable or hedgeable parameter, though it is possible to determine rough pricing boundaries and direction/magnitude of sensitivities of the price given factors such as tenor, credit spread, and recovery rate assumptions.

But, as observed for most US names, 1999 Restructuring commanded about 10% more spread than protection without Restructuring during that period

Since the adoption of the Restructuring Supplement, Modified Restructuring (MR) in US names has tended to trade at about a 5% premium to protection without Restructuring (NR)

Multiplicity of curves post-ConsecoMultiplicity of curves post-Conseco

Move toward Modified Restructuring - continued

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Though Modified Restructuring has been used for trades on US, Autralian and New Zealand Reference entities since the Supplement was published, MR was not adopted as a market standard for European, Japanese, and other Asian Reference Entities

An alternative version of Modified Restructuring was introduced and adopted within the 2003 Definitions to cover European Reference Entities

HistoryHistory

Modified Modified RestructuringR

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MMR - the specificsMMR - the specifics

Where (a) Modified Restructuring Maturity Limitation and Conditionally Transferable Obligation are specified as applicable in the Confirmation and (b) the Buyer of protection triggers the contract in respect of which the only Credit Event is Restructuring then: the Deliverable Obligation will have a maximum maturity no later than the longer of:

1) Scheduled Termination Date of the CDS contract; and2) 60 months (in the case of Restructured Bonds or Loans) or 30 months (in the case of all

other Deliverable Obligations) following the legally effective date of the Restructuring the Deliverable Obligation has to be transferable to any bank, financial institution, or other

entity which is regularly engaged in or established for the purpose of making, purchasing or investing in loans, securities or other financial assets either (I) without consent or (ii) with consent of the Reference Entity, not to be unreasonably withheld

Differences to MR and why - MMR provides for longer maturity cap for Restructured Bonds and Loans than MR (30

months) because it may be more common to see longer maturity extensions in the European market

More common for borrowers in Europe to restrict transferability of debt instruments to banks and financial institutions

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2003 2004 2005 2006 2007 2008 2009 2010

Effective STD Legally effective date of Restructuring

60 month Maturity

Cap

Maturity

Floor

30 month Maturity

Cap

Modified Modified Restructuring (2)

In 2003, a customer buys 5 year protection on EnergyCo

June 2004, EnergyCo enters legally binding agreement to restructure certain of its bonds

You can deliver (1) restructured bonds maturing before mid 2009 and (2) non restructured bonds maturing before 2008

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At least three holders and in the case of a Loan, requires a 2/3 majority to implement restructuring

At least three holders and requires a 2/3 majority to implement restructuring

Obligations covered:

Must be transferable to entities regularly engaged in loan and securities markets with consent not to be unreasonably withheld

Must be transferable to extensive list of entities without consent

Transferability:

30 month cap for non restructured obligations

60 month cap for restructured obligations

Floored at STD

30 month cap

Floored at STD

Maturity Cap:

MMR (European Standard)MR (US standard)Feature:

Modified Modified Restructuring (3) (Europe and US)

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Since the adoption of the 2003 Definitions, there are four choices regarding Restructuring as a Credit Event - Restructuring, MR, MMR, and NR

Japanese CDS markets have continued to adhere to three credit events (Bankruptcy, Failure to Pay, and Restructuring) as a market standard despite 1) the large proportion of the Japanese credit markets being comprised of bilateral loans, and 2) indications that MR or even NR CDS are acceptable to Japanese banks as hedges for regulatory capital purposes

Because of rampant moral hazard and the relatively high likelihood of Restructuring being a Credit Event, the Japanese CDS market provides fertile ground for thinking about the Restructuring Premium

Worth noting that, unlike other markets, the Japanese CDS market has never experienced a Credit Event on an actively-traded name with material CDS contracts outstanding, so remains an untested market

Intuitively, the value of Restructuring in a CDS contract will be a function of the likelihood that Restructuring will be the trigger Credit Event, as well as the Recovery Rate upon Restructuring

Restructuring Premium in the Japanese CDS marketRestructuring Premium in the Japanese CDS market

Valuing Restructuring - Grasping for a model framework

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Estimating the Relative Likelihood of Restructuring and Recovery Rates

Estimating the Relative Likelihood of Restructuring and Recovery Rates

Valuing Restructuring (2)R

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We assume that three factors are the most important for determining the relative likelihood of Restructuring as a Credit Event for Japanese corporate reference entities Size of debt

— larger companies with higher debt levels are more likely to receive financial support in “debt forgiveness” form than being forced into bankruptcy

Size of overseas operations (ratio of overseas sales used as proxy)— The larger the proportion of overseas operations, the higher the likelihood of debt

restructuring, as bankruptcy rehabilitation plans will more likely involve foreign creditors

Level of excess capacity in the sector— larger industry excess capacity will tend to decrease likelihood of debt

restructuring, as a function of doubts concerning ongoing viability

We then assign scores (1 to 5) for each of the factors, with a lower score corresponding to a higher probability of restructuring. The scores are added (3 lowest, 15 highest, but with 1 to 2points added for technology, 1 to 2 points subtracted for infrastructure sectors), and we assume that a total score of 12 suggests a 50% chance that Restructuring will be the CE

Size ofdebt

Score Overseas sales Score Excesscapacity

Score

over 1 tril. 1 Over 75% 1 Short 1up to 1 tril. 2 Up to 75% 2 Fair 2up to 500bil 3 Up to 50% 3 Fairly high 3up to 200bil 4 Up to 25% 4 High 4below100 bil. 5 Below 10% 5 Significant 5

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Estimating the Relative Likelihood of Restructuring and Recovery Rates

Estimating the Relative Likelihood of Restructuring and Recovery Rates

Valuing Restructuring (3)R

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With the lowest score 1 (with adjustment) and the highest 15, we assume a linear increase in likelihood of 2CEs with each increase in score (and have applied the approach to some names):

Estimating the Recovery Rate of Deliverable Obligations for a Japanese corporate reference entity upon Restructuring is quite challenging, given paucity of data

We nevertheless look at some historical data of bond prices following Restructuring events as a guideline for estimating this parameterHaseko 6 (03/1/31)

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Haseko 6 (03/1/31)

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Fujita 12 (01/9/28)

Fujita 13 (02/12/10)

Probability of Likelihood of RTwo Credit relative to

Score Events (TCE) TCE1 0% NM2 5% 21.03 9% 10.04 14% 6.35 18% 4.56 23% 3.47 27% 2.78 32% 2.19 36% 1.8

10 41% 1.411 45% 1.212 50% 1.013 55% 0.814 59% 0.715 64% 0.6

Likelyhood of RExcess Total Final relative to

Debt Score Overseas ScoreCapacity Score Score Adj. Score TCE RemarksNTT 7,309 1 0% 5 2 8 -2 6 3.4 Infrastructure adj.DoCoMo 1,458 1 0% 5 2 8 -2 6 3.4 Infrastructure adj.Toyota 6,853 1 63% 2 3 6 6 3.4Nissan 2,829 1 66% 2 3 6 6 3.4Mazda 667 2 49% 3 3 8 8 2.1Nippon Steel 2,019 1 20% 4 4 9 9 1.8Kobe Steel 1,049 1 20% 4 4 9 9 1.8

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Given an assumption for R2 (expected recovery rate for 2CEs), we can generate a matrix of the par spread ratio between 2CE and 3CE CDS (1-S2/S3), as a function of Relative Likelihood of Restructuring and Recovery Rate upon Restructuring

Important to note that, though the model is extremely assumptions-based, it provides for thinking about the 2CE-3CE basis occasionally observed (or heard) in the markets. Sony 5yr 2CE CDS currently trades at around 75-80% of 5yr 3CE CDS - is this too high?

Determining the theoretical basis between 3CEs and 2CEs

Determining the theoretical basis between 3CEs and 2CEs

Valuing Restructuring (4)R

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Par Spread Discount Table ( 32/1 SS )

%302R M

0.11 0.25 0.33 0.50 1.00 1.50 2.00 3.00 4.0015.00% 12%23%29%38% 55%65%71%78%83%25.00% 11%21%26%35% 52%62%68%76%81%30.00% 10%20%25%33% 50%60%67%75%80%35.00% 9%19%24%32% 48%58%65%74%79%

RR 45.00% 8%16%21%28% 44%54%61%70%76%

55.00% 7%14%18%24% 39%49%56%66%72%65.00% 5%11%14%20% 33%43%50%60%67%75.00% 4% 8%11%15% 26%35%42%52%59%85.00% 2% 5% 7%10% 18%24%30%39%46%

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This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be used for any other purpose without the prior written consent of JPMorgan.

The information in this presentation is based upon management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of the Company or any other entity. JPMorgan makes no representations as to the actual value which may be received in connection with a transaction nor the legal, tax or accounting effects of consummating a transaction.[The information in this presentation does not take into account the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation and other effects.

JPMorgan’s policies prohibit employees from offering, directly or indirectly, a favorable research rating or specific price target, or offering to change a rating or price target, to a subject company as consideration or inducement for the receipt of business or for compensation. JPMorgan also prohibits its research analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to benefit investors.

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