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November 2007

November 2007. Overview of Collateralized Loan Obligations. Table of Contents. The CDO Market The CDO Structure Current Opportunities. The CDO Market 2004-2006. Where are we now?. Where are we now?. Overview of CDOs.

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November 2007

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  1. November 2007 Overview of Collateralized Loan Obligations

  2. Table of Contents • The CDO Market • The CDO Structure • Current Opportunities

  3. The CDO Market 2004-2006

  4. Where are we now?

  5. Where are we now?

  6. Overview of CDOs • Collateralized Debt Obligations (“CDOs”) are securities issued to finance a diversified pool of credits. • The portfolio of securitized assets in a CDO is typically financed by a credit-tiered capital structure, consisting of both investment grade and non-investment grade tranches of debt, supported by an equity tranche. • The majority of the financing for a CDO is usually provided by a large AAA rated tranche of debt, thereby making the weighted average cost of capital significantly cheaper than the return on the portfolio of assets. • Below the rated debt tranches in the structure of a CDO is a tranche of Equity. This tranche is the beneficiary of the spread differential between the returns on the portfolio of assets and the weighted average cost of financing. What are CDOs?

  7. The CDO Market Growth of the Global CDO Market ($Billions) • Global issuance since 1997 has totaled $2.68 trillion Source: Bear Stearns CDO Research; as of September 2007. Issuance figures are as of closing date, and are subject to change as more information becomes available.

  8. The CDO Market CDO Issuance by Sector – U.S. (MM) Source: Bear Stearns CDO Research; funded issuance. * As of August 31, 2007.

  9. Not All CDOs Are Created Equal Diversity in CDOs US Mezz ABS CDO US CLO

  10. Not All CDOs Are Created Equal RMBS vs Leveraged Loans Leveraged Loan Default Rates Subprime 60+ Delinquencies by Vintage RMBS Source: LPS Loan Source: S&P’s LCD

  11. Liabilities 74.4%Of TotalAssets $372 mm Aaa / AAA LIBOR+0.26% $33 mm Aa2 / AA LIBOR+0.40% 6.6% $31 mm A2 / A LIBOR+0.70% 6.2% $20 mm Baa2 / BBB LIBOR+1.65% 4.0% $20 mm Ba2 / BB LIBOR+3.75% 4.0% Preferred Shares $40 mm 8.0% The CDO Structure Assets Debt Service LIBOR+0.50% And Expenses 0.60% ----------------- LIBOR+1.10% $500 mm US Corporate Senior Secured Bank Loans Weighted Average Yield: LIBOR+2.30% Total Costs = CDO Special Purpose Vehicle Remaining Net Spread 1.20% • Capital structure modeled as of 7/2/2007

  12. The CDO Structure Illustrative Sensitivity Analysis of Rated Debt Tranches1 • Defaults begin 2 periods after collateral is purchased, and are the indicated rate thereafter. The call rate of the loans is assumed to be 25% per annum, beginning after 1 period. Assumes a reinvestment spread of 2.40% in year 1, 2.50% in year 2 and 2.60% thereafter. Forward LIBOR used.

  13. The CDO Structure Illustrative Preferred Share Returns1,2 Immediate Recovery at 75% upon Default • Defaults begin 2 periods after collateral is purchased, and are the indicated rate thereafter. The call rate of the loans is assumed to be 25% per annum, beginning after 1 period. Assumes a reinvestment spread of 2.40% in year 1, 2.50% in year 2 and 2.60% thereafter. Forward LIBOR used. • Returns modeled as of 7/2/2007

  14. The CDO Structure Hypothetical CDO Equity Cash Flows ( expected IRR: 12-15%) • Assumes transaction is called after 8.2 years, 3% Annual CDR, and Immediate Recovery at 75% upon default. • Defaults begin 2 periods after collateral is purchased, and are the indicated rate thereafter. The call rate of the loans is assumed to be 25% per annum, beginning after 1 period. Assumes a reinvestment spread of 2.40% in year 1, 2.50% in year 2 and 2.60% thereafter. Forward LIBOR used.

  15. The CDO Structure New Issue Liability Spreads Source: Bear Stearns CDO Research. Simple average of monthly liability spreads for the given year.

  16. Current Opportunities Opportunities for AAA investors • CLO spreads have moved with defaults in previous credit cycles. Because of the current market dislocation, spreads have increased significantly while defaults have remained low AAA CLO Liability Spreads and Leveraged Loan Default Rate through September 20071,2,3 Loan Source: S&P/LCD CLO Liability Spread Source: Bear Stearns CDO Research 1. 12-month lagging leveraged loan default rate by number of issuers. 2. S&P occasionally revises its published historical default rate data, and so the values shown are subject to change. 3. Source: Leveraged Loan Index 12-month lagging leveraged loan default rate by number of issuers.

  17. Current Opportunities Opportunities for BBB & BB investors • CLO spreads have moved with defaults in previous credit cycles. Because of the current market dislocation, spreads have increased significantly while defaults have remained low BBB and BB CLO Liability Spreads and Leveraged Loan Default Rate through September 20071,2,3 Loan Source: S&P/LCD CLO Liability Spread Source: Bear Stearns CDO Research 1. 12-month lagging leveraged loan default rate by number of issuers. 2. S&P occasionally revises its published historical default rate data, and so the values shown are subject to change. 3. Source: Leveraged Loan Index 12-month lagging leveraged loan default rate by number of issuers.

  18. Current Opportunities Risk: Historical Average One Year Downgrade Risk • CLO liabilities have experienced significantly less downgrades than comparably rated corporates Downgrade Source: Moody’s Investor Services, “Credit Migration of CDO Notes, 1996 - 2006, for US and European Transactions” February 28, 2007 1. Baa3 and Ba3 ratings are deemphasized as debt rated at these levels is no longer commonly issued. Additionally, there were only 194 and 212 observations at the Baa3 and Ba3 levels, respectively, while there were 1230, 417, 684, and 363 observations for the Aaa, Aa2, Baa2, and Ba2 ratings, respectively. 2. Figures are from "theoretical" corporate transition matrix. Moody’s weighted each year’s one-year corporate transition rates by the number of CDO ratings outstanding at each rating level at the beginning of the year.

  19. Current Opportunities • CLOs allow investors to access the corporate credit markets • CLO performance is not directly tied to Residential Mortgage Backed Securities • The CLO structure allows investors to participate across the capital structure based on their preference for risk • Uncertainty in the credit markets have caused CLO spreads to widen significantly In Conclusion

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