Convertible Bond Trader Notes

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
All about converts This blog will discuss all topics pertaining to convertible bonds including credit analysis, indenture analysis and convertible arbitrage trade ideas. About the Site This site contains analysis and trade ideas from the experience that I have accumulated over the past 12 years as an investment analyst for four different convertible arbitrage hedge funds. While convertible arbitrage is the main focus on this site, there are entries for distressed credit, event driven and other special situations as well. The links on the right are sorted by Reference Materials, which explains the basics of convertible bonds, convertible arbitrage and indenture analysis, Credit Analysis, which includes credit and indenture analysis, Convertible Topics, which are posts that talk about trade ideas, Fixed Income Topics, which are posts on fixed income securities including high yield and distressed securities, and Special Situations, which covers other arbitrage topics.

Reference Materials

Convertible Arbitrage Traditionally, convertible arbitrage is the investment strategy that involves owning the convertible bond while shorting the underlying stock. Because the convertible bond exhibits positive gamma characteristics, the convert will move up more than the stock to the upside but move down less to the downside on a delta neutral hedge. This allows the position to be profitable if the stock has larger moves than implied by the warrant embedded in the convertible bond. The key to convertible arbitrage is to isolate the cheapness (or richness) in the security. The four main components of a convertible bond are stock price, credit spread, interest rates, and volatility. If you can hedge out three of the four variables, you can determine whether the final variable is cheap (or rich). In some cases of convert market distress, you and hedge out all four and make a riskless return. Convertible Accounting Convert Accounting Beginning on Jan 1, 2009, convertibles with net share settled features were subject to the new bifurcation accounting rule that would more accurately reflect the value of the underlying embedded convert equity option and capture the related dilution. This change resulted in a larger amount of interest expense recorded on the convert than had been recorded under previous accounting rules. This is due to the interest expense being recorded by the issuer will include a combination of the coupon interest and the accretion of the discount as opposed to just the coupon interest under current rules. Consequently, net income and earnings per share for issuers of these securities will be lower and thus could discourage new issuances. Barclays published a research note that detailed this accounting rule titled, “Accounting for convertibles – a primer” on October 1, 2009 that does a good job of explaining the concepts. Most of this post is taken from the report.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
The accounting treatment depends on the settlement upon conversion. For share settled converts the if-converted method is used and for net share settled converts the new bifurcation method is used. Share Settled Convert Accounting – If-Converted Method The accounting for this method of settlement is fairly straight forward. If a convert is fully share settled the convert is recorded on the balanced sheet as 100% debt at issue. There is no accretion through the life of the security. The fully diluted EPS is taken to be the more dilutive of 1) the basic EPS and 2) the EPS wherein the tax adjusted interest expense is added back and the shares underlying the convert are added to the total share count. Typically, the higher the net income relative to interest expense, the more likely the second option will be more dilutive. Net-Share Settled Bifurcation Convert Accounting Balance Sheet Impact The par amount of the convert is broken down into an Original Issue Discount (OID) debt component and an equity (option) component and recorded on the balance sheet at inception. The value of the debt component is calculated first, and the remainder is attributed to Equity (APIC and Deferred Tax Liability if there is no call spread and only APIC if there is a call spread). The OID value of the convert can be calculated by discounting the cash flows of the convert at a comparable straight debt equivalent rate (higher than the coupon on the convert). The OID debt component accretes to par using the expected life of the security (usually the shorter of the first put or maturity). In the case of a plain-vanilla net-share settled convert with no call spread the equity is divided between APIC and a deferred tax liability since the additional OID (non-cash) interest expense is not tax deductible. Where there is a call spread the entire interest expense (cash + OID non-cash) is tax deductible and there will be no deferred tax liability account. An example discussed later will help clarify this concept. Income Statement Impact The total interest expense is the sum of the actual cash interest on the convert and the OID non-cash interest expense. The total interest is typically significantly higher than the actual coupon rate of the convertible thus reducing the total income and lowering basic EPS. Tax treatment: for GAAP statements the total interest is assumed to be tax-deductible on the income statement. However for tax-accounting only the cash interest amount is tax deductible in cases where the convert is net-share settled and does not have a related call spread. If there is a callspread the entire interest amount (cash + OID non-cash) is tax deductible. Dilution/Share Count Net share settled convert without a call spread: If the stock price is above the convert strike price the share count is increased by the additional in-the money shares underlying the convert. Example: For a $100 million face convert with a strike of $50, 2 million shares underlying the convert. If the stock is at $75 then the in-the money value of the convert = ($75-$50) * 2 million shares = $50 million. And the in-the money shares = $50 million / $75 = 0.67 million shares. Net share settled convert with a call spread: If the stock price is above the convert strike price the share count is increased by the additional in-the money shares underlying the convert. And if the stock is above the high strike of the call spread the additional shares related to the high strike of the call spread are added to the share count as well. For GAAP accounting the effect of the low strike of the call spread is ignored because it is anti-dilutive. In other words the share count will not be lowered despite the issuer having bought calls at the lower strike. Example: Continuing with the previous example, in addition to the 0.67 million shares due to the convert the additional shares

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
attributed to the high strike of the call spread need to be added as well. Let’s assume the high strike on the call spread at issue was set $10 above the convert strike (low strike of the call) at $60. If stock is at $75, the dilution due to the high strike leg of the call will be = (($75-$60)*2 million)/$75 = 0.4 million shares. If the stock were lower than $60 then there would be no additional shares due to the call spread Convertible Arbitrage Strategies Convertible Arbitrage Trades There are many types of convertible arbitrage trades but I will highlight the most common types here. Many of the concepts on this post were taken from Morgan Stanley’s research report, “Convertible Arbitrage: Bend Your Way to Profitability” from May 8, 2002.       Synthetic puts Gamma trades Vega trades Defensive trades Credit trades Cash flow trades

Synethic Puts Synthetic puts are highly equity sensitive convertibles that are in the money, trading with conversion premiums of less than 10%. In other words, these are convertibles with high delta, reasonable credit quality, and a solid bond floor.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Synthetic put strategies primarily are designed to profit from expansion of conversion premium (curvature) in case of a stock price decline. The secondary source of income is the static return, net of premium or theta (time value) decay. Static return is simply the net cash inflow generated by holding the position for the horizon, assuming no “trading” profits/losses. Positive cash inflow is earned from the convertible’s coupon / dividend and rebate from short common stock. Negative cash outflow, or cost of carry, occurs as a result of dividends paid on the short common stock and financing cost of the position. The difference ( net cash inflow) is known as net position cash flow. Ideally, you want positive net position cash flow to pay for some of the premium of the convert. Risks. The principal risk for this strategy is premium erosion or theta (time value) decay , in which the conversion premium does not hold or increase as the stock price goes down. Other risks associated with the “net position cost” are low coupon/dividend on the convertible and high levels of dividends on underlying stock. Gamma/Vega trades These are high gamma/high vega, middle-of-the-road convertibles with typically lower implied volatilities as compared to the high option/historical stock volatilites. In other words, the convertibles trade within the “sweet spot” of the trading curve. These are generally classified as convertibles trading with delta levels between 20% and 70%, with significant gamma/vega. Gamma Trades Opportunities for gamma trading arise by establishing a delta-neutral, or in some cases a biased, position involving a convertible security with reasonable credit quality, and simultaneous short sale of the underlying common stock. Due to the inherent volatility of underlying stock movements, this strategy requires careful monitoring by dynamically hedging the position, in other words continuously buying/selling shares of the underlying common stock. Risks. This strategy is primarily based on undervaluation of the convertible on an implied-volatility basis as compared to the historical stock volatility. The key risk lies in the importance of determining an appropriate credit spread to arrive at a realizable level of implied volatility. Another risk stems from the transaction costs of continued hedging (due to the constant buying and selling of shares of underlying stock). As discussed above, the inherent volatility of the stock requires continual buying and selling of shares of underlying common stock in order to maintain delta neutrality of the position. Vega Trades Vega trades (or volatility trades) arise by establishing a long position in the convertible and selling appropriately matched call options on the underlying stocks that are trading at higher levels of implied volatility. Again, careful monitoring of the positions involving listed call options requires that the call option strike price and expiration is matched as close as possible to the convertible’s terms. Some stocks have longer -dated call options, called LEAPS (Long Term Equity Anticipation Securities), with expiration between nine months and three years, that offer higher flexibility for convertible hedge investors. Risks. The key risks to this strategy are the mismatches between the convertible’s call protection or maturity and call option expiration as well as between the convertible’s conversion price and call option strike price. Defensive Trades These are “out of the money” convertibles that have strong actual or implied investment grade/s plit rating. These securities have high bond floor, high conversion premiums, and low theoretical delta. In other words, these convertibles have low premium over bond floor, enabling investors to acquire the call option embedded in the convertible security at a very low price.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
A common strategy is to be long the convertible and swap out the credit in the form of an asset swap (or hedge with CDS), to result in a low-cost call option. Another strategy is to be long the convertible security and short a very small number of shares of underlying stock, i.e., being on a very light hedge. The goal of such a strategy is to provide a bullish bias, in case the stock shows strong upward movement. Risks. Key risks we see for defensive credit bets are: 1) Implied volatility on the long call position continues to decline. The credit spread of the long convertible position widens. 2) Credit risk can be quantified by omicron, which denotes the sensitivity of convertibles to increase in credit spreads. Convertible-hedge investors can mitigate the credit risk by either swapping out the credit in the form of an asset swap, or by entering into a default swap. Since these convertibles tend to have very short maturities, they primarily have short-term interest rate and creditrisk exposure. However, those convertibles that have longer maturity, but high bond floor due to high rating, typically are susceptible to long-term interest rate risk, or “rho” risk. Investors can attempt to hedge out the interestrate risk by using treasury futures, total-return swaps for a comparable corporate bond index, or interest-rate swaps. Credit Sensitive Convertibles These convertibles tend to trade deep out of the money and have an explicit or implied sub-investment grade rating. The key feature to note in these securities is that investment value (or bond floor) is difficult to determine, and it is possible that the issuer may not be able to meet its debt obligations. These securities have high conversion premiums and low theoretical delta. However, the actual delta for these securities tends to be much higher than theoretical delta. Continued weakness in the stock price tends to reduce the equity cushion available to the debt holder, causing the credit spread for the convertible to increase, resulting in the security behaving like stock. Consequently, these convertibles have a tendency to exhibit “negative gamma” i.e., declining at a rate faster than theoretical delta and in some cases faster than the underlying stock. Because credit-sensitive convertible securities lack firm bond floor, one way to access “delta” is to consider the securities as long-dated mandatory securities rather than as a convertible bond. While a convertible bond assumes a bond floor and suggests a “delta,” a long -dated mandatory has very little bond floor and has a high delta. One of the arbitrage strategies that some investors employ to distressed situations is called “ dollar hedging.” In this strategy, the long convertible position is matched dollar for dollar (i.e., equivalent dollar amount) by short stock position, resulting in substantial overhedging well beyond the theoretical delta. The excess short over and above the theoretical delta is intended as a source of credit protection. Another, less frequently employed method is to short a subordinated security (debt, preferred, etc.) of the issuer against the long convertible position (capital-structure arbitrage). If there are credit concerns surrounding the issuing company, it is highly likely that the credit spreads on the subordinated security of the company widen. By shorting the subordinated debt, the investor can offset the losses on the convertible with the profits on the short position on the straight debt. The key risk we see for this strategy is the high cost of carry for the short subordinated position from higher coupon of the short security. Risks. Credit risk, which means that the credit spread may widen, tends to be the most important risk for investors in credit sensitive convertibles. Apart from credit risk, investors should be aware of the following risks: Weak protection or lack of change-of-control put clause in case of a “change of control.” Most convertible bonds have a provision under which the holders can “put” the bonds back to the issuer for par (100%) in case of a “change of control” in the issuing company. The terms of this clause can be found in the convertible’s prospectus and vary for each security. Changes-of-control put clauses are typically triggered in case of acquisitions wherein a company is acquired for cash or non-stock consideration, instead of stock. Since these convertibles typically trade at very low prices, the change-of-control clause can cause very high returns for the investor. Due to the reasons explained above, weak protection or absence of a change-of-control put clause can be a risk to investors of creditsensitive convertibles, whereas strong change-of-control protection could prevent the issuer from being taken over. Expensive stock borrow. The short position is established by borrowing shares of underlying stock. When the company is in distress, the borrow ability of its shares tends to come under pressure, causing the borrowing cost to

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
increase. Since most prime brokers tend to deduct the borrowing cost from the rebate offered for the short proceeds, the increase in borrowing cost hurts the short rebate. This decrease in short rebate negatively affects the profitability of the strategy. Low convertible coupon income. Profitability for the overall strategy is also dependent on the coupon/dividend income earned on the convertible, especially in a rising interest rate environment. Credit-sensitive convertibles that offer a low coupon/dividend are particularly risk-prone, since the net position cost is high, which could reduce profits. In summary, investment in these convertibles as credit bets requires careful evaluation of various factors. These include the issuing company’s ability to meet its debt obligations, and the coupon, maturity, issue size, and type of seniority or relative position of the convertible in the company’s capital structure. Other important considerations include the following:    Funding cost of the long position, Leverage of the transaction, and Short-selling rules.

Cash flow trades This strategy focuses on convertible securities with reasonable coupon or dividend income relative to the underlying common stock dividend and conversion premium. This strategy offers profitable trading alternatives where coupon or dividend earned and rebate received from the short position offset the premium decay over time, financing costs of the long convertible position and any dividends that may be payable on the short common stock. For each position, calculate cash flows from:     Coupon of the convertible bond Long financing costs Short rabate Dividend payout for short stock

In some cases, especially for deep in the money, long dated converts, the cash flow from the position more than offsets the premium of the convertible bond, which means you are getting paid to own a put option. These trades are rare but do exist and are more common today due to fewer convertible hedge funds in the market. Risks. The key risk for this strategy can be due to possible large net position cost, arising from low coupon on the convertible, or high/increasing dividend and/or borrowing cost on the underlying stock. A rise in the level of interest rates also affects the profitability of the strategy as it increases the borrowing cost for the long position in the convertible security. Convertible Bond Basics Convertible Bond Basics The bulk of material in this section is taken from the BAC primer on convertible bonds. The report does a great job of explaining difficult concepts so there’s no reason to reinvent the wheel. A convertible security is traditionally defined as any investment instrument which is not currently common stock, but which can be converted into common stock at the holders’ option. This includes commonly known securities such as convertible bonds and preferreds but also extends to more exotic securities. Convertibles are hybrid

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
securities that combine both equity and debt features. Through convertible securities, the investor participates in an equity price appreciation with a more limited downside risk, generally provided by the debt feature. The debt feature of a convertible bond is derived from the convertible’s stated coupon and claim to principal. As such, its price is subject to changes in interest rates and credit worthiness of the issuer. The debt feature protects the convertible from a full decline in the price of the equity. The equity feature is derived through the call option, or warrant, embedded in the bond and enables the convertible bond to participate in an equity price appreciation. Accordingly, the value of the warrant is tied to factors affecting the underlying stock price. The value of the embedded option is significantly affected by the volatility of the underlying stock. As volatility rises, the potential appreciation in the stock price increases, resulting in a higher convertible value. Conversely, an increase in common stock dividends decreases the value of the convertible as it diminishes its relative value compared to the stock (the alternative investment). The longer the amount of time left on the warrant, the higher its value. Convertibles exhibit hybrid behavior The two main determinants of a convertible’s behavior are its yield and its conversion premium. Generally, convertibles can be characterized into one of three categories: (1) yield instrument/straight debt alternatives, (2) total return instruments, or (3) equity alternatives. To illustrate the pricing dynamics of convertibles and these categories, we have constructed a theoretical price curve in Chart 2 below. The underlying common stock price is reflected along the horizontal axis, while the convertible’s value is depicted along the vertical axis. Yield instrument/straight debt alternative – Convertibles in this category are characterized by relatively high yields and high conversion premiums. Given that the equity option is so far out of the money, the security behaves almost like a pure debt instrument with little regard given to the option value. Also called a “busted” convertible. This type of convertible is illustrated in the left-hand side of Chart 2 below. Total return instrument – Convertibles in this category exhibit ideal characteristics of a convertible investment. Characterized by moderate yields/conversion premiums and a good level of equity sensitivity. This type of convertible is illustrated in middle section of Chart 2 below. Equity alternative – Convertibles in this category behave very close to a pure equity investment. Characterized by lower yields/conversion premiums and a high degree of equity sensitivity. This type of convertible is illustrated in the right-hand side of Chart 2 below.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
The investment value (i.e., straight bond value ignoring the conversion feature) is independent of the price of the underlying stock and hence appears as a flat line in the graph. It provides a theoretical floor below which the bond should not trade, given an unchanged interest rate and credit environment. In practice, the fixed income component is not an absolute floor, because it will shift in relation to the general level of interest rates and the company’s cre dit quality (like, the record credit spread widening in 2008). For very low values of equity, the convertible price drops with the equity because such low equity levels are associated with sharply worsening credit quality and a reduced probability of corporate survival. As the underlying equity price increases, the parity (conversion value) of the bond also increases because parity is directly proportional to the price of the underlying equity. The “sweet spot” of convertible investing is the Total Return region. Here, the convertible offers a compelling risk/reward profile, enjoying greater participation with the equity on the upside than it suffers if the equity drops. Provided the convertible bond is not about to be called by the issuer or the common does not out-yield the convertible, the convertible price lies above the greater of parity and straight bond value. A bondholder can always get parity by converting the bond to equity. In the event of a fall in the stock price, the convertible price is supported by the investment value of the bond, which is illustrated by the convertible price curve in Chart 2. The Greeks In convertible arbitrage, traders rely on models to determine the fair value of the convertible bond. There are only a few variables that determine the value of the converts. These are underlying stock price, volatility of the underlying stock, credit spread, risk free rate, time to put/maturity, and dividend of the underlying stock. Each of these variables have greeks associated with that measures the rate of change of the convertible fair value (CFV) for each unit move of the variable.       Delta (Δ) = change in CFV per unit change in underlying stock price Vega (v) = change in CFV for a 1% change in the underlying stock’s implied volatility Theta (Θ) = change in CFV for a 1 day change in the number of days to expiry Rho (ρ) = change in CFV for a 10 bps change in interest rates Omnicron (ο) = change in CFV for a 10 bps change in credit spread Phi (Φ) = change in CFV with respect to the underlying stock dividend yield

and finally,  Gamma (Γ) = the second derivative of CFV with respect to change in underlying stock price.

Many of the concepts here were taken from the book, Convertible Aribitrage by Nick Calamos (2003), a highly recommended book for those interested in convertible arbitrage. Delta Delta measures the change in the convertible’s price with respect to the change in the underlying common stock price. The delta measures the convertible equity’s sensitivity for very small stock -price changes. In a convertible arbitrage position, the trader will own the convertible bond and short an amount of stock that is equal to the delta of the convertible bond. The graph below show a visualization of a convertible’s delta. The delta is the slope of the line that is tangent to the convertible’s fair value line at a particular stock price. A convertible bond has a particular delta at point A. A convert that is hedged on that delta will move to point B as the stock moves up. Since point B is below the convert’s fair value line, the convert price will then appreciate in price to point C in an efficient world.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas

For a typical convertible bond, delta increases as the underlying stock price increases and approaches 1.0 as the convertible moves deep in the money. The price of a convertible that is deep in the money will see a percentage change very close to the price of the underlying stock. On the other end of the spectrum, delta will approach 0 as the convertible moves out of the money. The price of an out of the money convertible will behave like fixed income and only change at a fraction of the change in the underlying stock price. Gamma Gamma is the second-order partial derivative of the convertible’s price with respect to changes in the underlying stock. Gamma is also the change in delta with respect to the change in the underlying stock price. Gamma is highest with the underlying stock price at the conversion price. At that point, the delta of the convertible changes the most rapidly. Convertibles that are deep in the money or out of the money have low gammas. Gamma is also higher for shorter dated converts all else being equal. With a convertible arbitrage position hedged at a specific delta, positive gamma means the price of the convert will increase more than the short stock position on the way up and decrease less than the short stock position on the way down. Traders can “capture” this gamma by re-hedging to the new delta when the stock moves. Typically, traders will re-hedge for every 1% move in stock price. In the best scenario, a stock will gap up or down by more than 10%, thus allowing a significant amount of gamma capture.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas

Vega Vega measures the change in the convertible’s price to changes in implied volatility. Increases in volatility raises the value of a convertible while decreases in volatility lowers the value of a convertible. Traders will own a convertible position where the implied volatility is below its expected volatility. Traders will hold the position until the implied volatility rebounds to the level that they expect. The vega risk measure quickly indicates the upside capture from a move in the volatility back to the expected volatility level or the reverse. The vega curve is similar to the gamma curve in that convertibles in the money or out of the money demonstrate lower vegas. The best way to visualize vega is that a convertible with a higher vega has a fair value curve that is higher than a convert with a lower vega, all else being equal.

Theta

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Theta measures the change in the convertible’s price with respect to changes in time. The time premium decay of a convertible is complicated to some degree by the realization that the option portion of the convertible is subject not only to a maturity date but also to variations in call probabilities. Like an option, convertibles nearing maturity or the end of their call protection trade with a higher degree of theta risk. Unlike an option, a convertible that is slightly out of the money with no call protection remaining but with a low coupon payment on the issue will most likely remain outstanding. However, a reduction in interest rates to levels that may make the convertible issuer likely to call the issue in order to refinance at a lower rate has the effect of increasing the theta risk of the issue. To visualize theta, picture convertible fair value curves declining as time passes.

Rho Rho measures the change in the convertible’s price with respect to a change in interest rates. Higher interest rates result in lower convertible values. Convertibles will have a different interest rate sensitivity than straight bonds because the option component of the convertible moves in tandem with rate changes, slightly offsetting the interest rates impact on the convertible. Convertibles have negative rho at most points along the convertible price track. The negative rho exists because as interest rates increase, the investment value decreases. A deep in the money convert will exhibit a rho near zero. To visualize Rho, imagine the entire convert fair value curve shifting down as interest rates increase. As you can see, the convertible fair value has the greatest change when the convert is deep out of the money and the smallest change when the covert is deep in the money.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas

Omnicron Omnicron measures the change in the convertible’s price with respect to the change in credit spread. An out of the money convertible is generally more sensitive to changes in credit spreads than any other variable. In general, as credit spreads narrow, a convertible’s value increases and as spreads widen, the convertible’s value decreases. Convertibles that are deep in the money have a very low sensitivity to credit spread changes. Omnicron is one of the most important risk measures for convertible arbitrageurs hedging low-grade issues that are trading near or below their exercise price.

Upsilon Upsilon measures the change in the convertible’s price with respect to a change in the credit recovery rate. The credit recovery rate is an estimation of the principal amount recovered in the event of default on the security.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Recovery rates depend on many factors including the seniority of claims on the borrower’s assets and the quality of the collateral. As the stock price declines, the convertible bond becomes distressed and trades near recovery value, as investors see a high risk of bankruptcy. Upsilson becomes very high as the convert trades on expected recovery value.

Phi Phi measures the change in the convertible’s price with respect to a change in the underlying stock dividend. A convertible’s fair value moves inversely to changes in the underlying stock dividend. The valuation of any convertible considers the present value of the convertible’s income minus the present value of the underlying stock dividend over the expected life of the security. The option value decreases with higher dividend yields because the option buyer does not receive the dividends. Glossary of Convertible Bond Terms 144a Indicates that the convertible security was issued under SEC rule 144a and was not registered by the SEC. 144a securities can only be purchased by Qualified Institutional Buyers (QIBs) Accreted value OID and premium redemption convertibles ‘accrete’ over their life from issue price to redemption price. The prospectus sometime lays down a straight line appreciation but more often one that maintains the bond on its issue redemption yield. Accrued interest This is the value of the accrued portion of the coupon on a convertible bond. Most Eurobonds adopt a 360 day convention. American-style option

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
This type of option allows the holder to exercise into the underlying asset at any time during the life of the option. Anti-dilution provisions These provide for an adjustment in the conversion terms in the event of special stock dividends, stock splits or other corporate events that can result in the dilution of the underlying share price. At-the-money A convertible is said to be at-the-money if the current share price is close to the conversion price. Balanced convertible A balanced convertible is a convertible that trades at a price where it is neither a pure equity substitute nor trading on its bond floor, but is balanced between the two. Binomial tree A binomial tree option-pricing model estimates the theoretical value for an option. Adaptations of the approach are commonly applied to convertible bonds. They take account of events such as puts and calls that take place during the life of the instrument. Black-Scholes option pricing model The option pricing model derived by Fischer Black and Myron Scholes is used to estimate the theoretical fair value of European options based on a range of inputs and assumptions. Bond floor (or investment value) The bond floor is the value of the fixed income element of the convertible if rights of conversion are ignored. Bond with/cum warrant This is a straight bond issued with a long maturity call option attached. The bond and warrant can typically be traded separately in the secondary market. Breakeven The breakeven calculation for a convertible measures the time taken for the b ond’s income advantage to offset the conversion premium. It is a simple measure that takes no account of dividend growth projections or discounting for present value. Call feature (or call option) A call feature gives a convertible issuer the right to redeem a convertible bond prior to maturity at a price determined at issue. Holders of convertibles who receive a call notice will generally have time to exercise their rights of conversion before repayment takes place; thus a call option can frequently be interpreted as required early conversion. (see also ‘trigger’) Clean price

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
The clean price is the price of a convertible bond quoted excluding accrued interest. Most convertibles are quoted this way. Clean-up call If an issuer is entitled to call any remaining bonds when a certainpercentage of the bond issue has already been converted into shares, or otherwise extinguished, it is termed a ‘clean -up call’. The percentage is often set at around 90% of the convertible issue size. Contingent conversion A contingent conversion feature makes a convertible investor’s ability convert contingent upon the share price attaining a specified level. Contingent interest payment Contingent interest payment features allow the payment of a small amount of interest to the convertible bondholder if the average market price of the convertible falls to a specified level in a specified time frame. Conversion premium See premium. Conversion price At issue, the conversion price is the price at which shares are effectively bought’ upon conversion, if the convertible is purchased at the issue price. It is calculated by dividing the issue price of the bond by the conversion ratio. It is market convention to define conversion price at maturity for a single currency bond as the principal amount divided by the conversion ratio, even for even for bond with above par redemption. Conversion price = Par Value/Conversion ratio Conversion ratio The conversion ratio is the number of shares into which each bond can be converted. Conversion ratio = Par Value/Conversion Price Convertible preferreds Convertibles issued in the form of preferred shares. They pay a fixed ‘dividend’, equivalent to a coupon, and are sometimes issued in perpetual form. Convertible price This is the price at which the convertible is traded in the market. It is generally quoted as a percentage of par. Coupon The coupon is the interest payment per bond. It is normally quoted as a percentage of the face value.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Credit spread The credit spread is the spread over the swaps curve (or sometimes Government bond curve) at which the issuer is assumed able to issue a straight bond that is otherwise identical to the convertible. Cross currency convertible A convertible that is denominated in a different currency to that of the underlying shares. Current (or running) yield Current yield is the income per unit of currency invested. It is calculated by dividing the coupon by the current convertible price. Cushion The excess of parity over the call price that an issuer requires before issuing a call notice. DECs DECS stands for Dividend Enhanced Convertible Securities or Debt Exchangeable for Common Stock. DECs are mandatory convertibles, typically issued as preferred stock paying quarterly fixed dividends. Delta Delta is a measure of the sensitivity of the convertible bond price to share price movements. It is defined as the expected change in the convertible price for a small absolute change in parity. Dirty price The dirty price is the clean price of a convertible bond plus its accrued interest. It is the actual price an investor will pay for a bond. Dividend yield The dividend yield is an indication of the income generated by each share. It is calculated by dividing the annual dividend per share by the share price. European option This type of option gives the holder the right to exercise only on the maturity date. Exchangeable bond This is a convertible bond issued by one company that can be converted into the shares of a different company. Gamma

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Gamma measures the sensitivity of the convertible bond’s delta to share price movements. It is the change in delta for a one-point change in parity. Greenshoe The greenshoe is an over-allotment option that allows an underwriter to increase the number of bonds issued, typically by 10%-15%, when there is strong demand for an initial offering. Hard call protection A period of time during which the issuer may not call the bond from the investor. Denomination This is the minimum size in which the bond can be traded Hedge ratio A convertible bond’s hedge ratio is also referred to as ‘delta’. The hedge ratio shows the equity sensitivity of a convertible bond and enables an investor to calculate how many shares he would need to sell to hedge the equity exposure. Implied volatility Implied volatility is the convertible pricing model volatility input that brings the fair value of a convertible into line with its market price. In-the-money A convertible is said to be in-the-money if the current share price is greater than the conversion price. Issue price The issue price is the price at which convertible bonds are sold to investors at issue. Mandatory convertible This is a convertible in which the bondholder is obliged to convert into the underlying equity. Maturity The maturity date is the final redemption date of the bond. Nominal value This is the face value of the bond. It is often 1,000 of the relevant currency in the Euroconvertible market and ¥1,000,000 in the Japanese and Euroyen markets. The current price, issue price and redemption price of most convertibles are expressed as a percentage of the nominal value. Original issue discount (OID)

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
A convertible issued at a discount to par is termed an original issue discount convertible. Out-of-the-money A convertible is said to be out-of-the-money if the current share price is below the conversion price. Par Par is the face value of a bond. Parity Parity is the market value of the shares into which the bond may be converted. It is calculated by multiplying the conversion ratio by the current share price expressed in bond currency terms. It is normally expressed as a percentage of a bond’s nominal value. PERCs PERCs stands for Preferred Equity Redemption Cumulative Stock. PERCs are a mandatory convertible bond structure that caps upside participation in a stock’s performanc e. Premium A convertible’s premium is the percentage by which the market price of the convertible bond exceeds parity. It represents the extra cost an investor must pay to buy the shares a bond converts into via a convertible. It is calculated by subtracting parity from the convertible price and is expressed as a percentage of parity. Premium redemption structure This describes a convertible bond that is issued at par but redeems at a premium to par. Put feature A put gives investors the option to sell back the convertible bond to the issuer at a fixed price on a given date or dates. Ratchet In some convertibles there is a ratchet mechanism in which the conversion ratio is adjusted by a specified amount if a takeover takes place within a given time frame. Parity Parity is the market value of the shares into which the bond may be converted. It is calculated by multiplying the conversion ratio by the current share price expressed in bond currency terms. It is normally expressed as a percentage of a bond’s nominal value. PERCs PERCs stands for Preferred Equity Redemption Cumulative Stock. PERCs are a mandatory convertible bond structure that caps upside participation in a stock’s performance.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Premium A convertible’s premium is the percentage by which the market p rice of the convertible bond exceeds parity. It represents the extra cost an investor must pay to buy the shares a bond converts into via a convertible. It is calculated by subtracting parity from the convertible price and is expressed as a percentage of parity. Premium redemption structure This describes a convertible bond that is issued at par but redeems at a premium to par. Put feature A put gives investors the option to sell back the convertible bond to the issuer at a fixed price on a given date or dates. Ratchet In some convertibles there is a ratchet mechanism in which the conversion ratio is adjusted by a specified amount if a takeover takes place within a given time frame. Reset date The date on which a change of conversion terms takes place on a reset convertible is termed the reset date. Reset features Reset features allow for a change in the conversion price of a convertible in the event of share price depreciation (downward reset) or appreciation (upward reset) on certain specified dates. Reset floor The limit below which the conversion price on a reset convertible cannot fall. Reset period In most reset convertibles, the share price upon which the new conversion price is based is calculated by reference to the average share price observed in a specified reset period. Rho Rho measures the sensitivity of the convertible price to movements in interest rates. It is expressed as the change in the convertible price for a one basis point move in interest rates (a parallel shift in the yield curve). Risk premium The risk premium is the difference between the convertible price and the bond floor expressed as a percentage of the bond floor. Soft call (or provisional call)

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
This is a period of time during which the issuer may only call the bond if the share price has traded above a predetermined level for a set period of time. Step-up coupon This is where the coupon level increases at a future date. This can be a contingent event on for instance, a credit rating downgrade. Theta Theta is the change in the convertible value with the passage of time. It is expressed as the change in the convertible price for the passing of on day, other things being equal. Trigger The threshold above which a share must trade before the issuer can dispatch a call notice. It is normally expressed as a percentage of the conversion price. Thus a 130% trigger means the share price must trade, for a specified period, at 130% of the conversion price. With dual currency convertibles the trigger is sometimes expressed in relation to the share price expressed in domestic currency terms and sometimes in the currency of the bond. Vega Vega is the sensitivity of the convertible price to changes in the volatility of the underlying stock. Vega is the change in the fair value of the convertible for a one percentage point change in the assumption for stock volatility. Volatility Share price volatility is a measure of the dispersion of share price returns. It is defined as the annualised standard deviation of returns. The extent to which the underlying share price has fluctuated over a certain period determines the historical or observed volatility. The assumption for future share price volatility is an input for convertible valuation. Yield advantage The yield advantage is the difference between the current yield on the convertible bond and the stock dividend yield. Yield to maturity Yield to maturity (YTM) is the discount rate that equates the current market price of a straight bond to the present value of its future cash flows. Types of Convertible Bonds The ‘vanilla’ structure As with other bonds‚ a convertible typically pays coupons and carries the promise of cash redemption at maturity. A convertible differs from straight debt in that the holder has the right to exchange the bond, usually at any time, for a predetermined number of the company’s ordinary shares, without any extra payment. On conversion, the investor renounces title to the corporate bond and any future income streams from it in favour of ownership of the predetermined number of shares. A convertible with just this simple structure, with no complications, is sometimes referred to as ‘vanilla’.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Over time, issuers have incorporated other features into the vanilla convertible including       Call features Put features Dividend protection Takeover protection Contingent convertibles (CoCo) Contingent payment convertibles (CoPa)

Check for topics listed under Convertible Indenture Analysis for more details about the twists and wrinkles that bankers have added to the vanilla convertible bond over the years. Mandatory Convertibles

Mandatory convertibles are different from normal convertible bonds because at maturity they automatically convert into a given quantity of shares. Unlike standard convertibles, mandatory convertibles do not have a cash redemption at maturity and therefore provide little downside protection beyond the income stream. Mandatory convertibles can go by as many names as there are investment banks, but in general, the structures share the same basic characteristics. These include DECS, PRIDES, PEPS or ACES Typical buyers of mandatory convertibles include both outright and arbitrage investors. Equity Income and Outright Convertible Funds are attracted to mandatory convertibles because of the higher yield offered relative to common stock and standard convertible bonds. The loss of upside is theoretically offset by the enhanced yield of the mandatory. Arbitrage investors are drawn to mandatories because they allow them to gain specific volatility exposure (long with stock near the upper strike and short when stock near the lower strike) that can offset other volatility positions in convertible bonds. Hedge funds also buy mandatory conve rtibles as ‘cash flow’ trades when the security is either deep in or deep out of the money. Finally, distressed investors buy ‘busted’ mandatory convertibles that have corporate bonds underlying the structure as a recovery value trade. Original Issue Discount (OID) Convertibles

21

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
OID convertible bonds have below market (usually zero coupon) coupon levels and are offered at a steep discount to par (or face) value, and they gradually accrete to their face value at maturity. Yield to maturity is achieved by means of an issue price below final redemption value. Zero-coupon convertibles were popularized in the US in the mideighties by Merrill Lynch, which introduced the acronym LYONs (Liquid Yield Option Notes). The traditional Lyons structure has a maturity of 15 to 20 years, but the bond will contain rolling puts, often every five years, and generally is callable by the issuer from the fifth year onwards. Consequently, it is highly probably that either the put or the call will be exercised in the fifth year, as under practically all circumstances, it would be optimal for either the issuer or the investor to exercise their option. Therefore, investors can consider the first put and call date to be maturity. (Given the put, the bond cannot be worth less than this). When an investor converts a zero-coupon bond, the accreted interest is lost. Consequently, the effective conversion price will accrete over the life of the bond and the maturity payoff diagram shows that the return on the bond will remain constant unless the share price rises very significantly by maturity. The difference between the conversion price based on the issue price and the conversion price based on the final redemption price is the disadvantage (from an investor’s point of view) inherent in zeros, though investors should remember that this is taken into account in arbitrage valuations. Structurally, zeros are the most bond-like and hence most defensive among all convertible categories while offering the least amount of equity sensitivity. During their traded life however, zeros, like cash coupon convertible bonds, acquire different degrees of equity sensitivity driven by the performance of the underlying common stock and the credit of the issuer. Though the maturity of zeros is typically long (20 years), the existence of earlier puts effectively reduces that maturity horizon. This makes zeros less sensitive to interest rates because with a zeros’ price typically being closer to its bond floor, its downside support is likely to strengthen should short term rates decline and/or spreads contract. There have been virtually no new pure OID convertibles issued since 2004. Convertible preferred Instead of the traditional convertible structure of a long bond with an embedded equity option, the convertible preferred is structured as a traditional preferred stock with an embedded option. In practice, convertible preferred stock behaves similarly to traditional convertible bonds with a long-term maturity. Since preferred stock is lower in the capital structure in regards to claim on assets in the event of default, the credit risk is higher than all other debt holders. Because of the lower seniority and long term to maturity – if any, the convertible preferred will offer a higher yield than an equivalent convertible bond. The convertible preferred market has traditionally been a mainstay in the convertible universe, representing about 15% to 30% of the outstanding market. In the past, most convertible preferred did not offer an obligation to pay principal value at any time in the future but many of the trust-structured convertible preferred now offer a maturity date and principal payment at maturity. Contingent Payable Converts Contingent Payable Converts Contingent interest payment (CoPa) features were introduced in 2001. The first security to carry this feature was the $829m Danaher 0% due 2021 senior note that was issued in January 2001. Holders of the converts would receive an incremental interest payment if the underlying stock reached a predetermined level (usually 120% of conversion price).

22

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Incorporating the CoPa feature allows the issuer to treat the convertible as a Contingent Payment Debt Instrument (CPDI) for tax purposes. Any debt instrument whose payments are uncertain in the amount or timing being dependent in another event can be classified as CPDI. By treating the security as a CPDI, the issuer gets substantial tax benefits. This feature has been rare in new converts, but still exists in older ones. Lehman published a report titled, “Grappling with call risk in CoPa converts” on 3/18/04 that does a good job of explaining the concept. Some of that material is incorporated into this post. The benefits result from the fact that, for tax purposes, the issuer gets to accrue interest expense at a comparable (non-contingent) straight debt rate (i.e., with similar ratings, ranking, maturity, and the like) rather than the stated yield to maturity (YTM) rate of the convertible with the CoPa feature. Since the comparable rate is, in almost all cases, greater than the stated yield of the convertible, it results in tax shield benefits to the issuer. Clearly, the issuer maximizes the value of the tax shield when the spread between the stated YTM of the convertible and the CPDI rate is the widest. Assuming that the convertible remains outstanding through maturity, and principal is repaid at maturity, the issuer would be required to reverse the additional/incremental tax shield benefit the issuer received throughout the life of the security. The additional/incremental tax shield benefit essentially accumulates as a deferred tax liability on the issuer’s balance sheet. The primary benefit for the issuer lies in the present value or timing impact of the tax shield cash flows. Assuming the convertible remains outstanding and principal is repaid at maturity, the issuer receives a higher tax shield during the life of the security, but reverses it only at maturity. It is this present value effect of the incremental tax shield that creates enormous value for the issuer. Based on Lehman’s understanding, the following are the guidelines that determine the conditions in which a tax shield recapture would occur when a CoPa convertible is called: Scenario 1: If parity is greater than the tax accreted price of the CoPa convertible (as of the effective date of the call), the issuer does not incur any recapture. In this situation, convertible holders convert their security into common stock. Scenario 2: If parity is greater than the call price, but less than the tax-accreted price of the CoPa convertible, the recapture amount equals the tax shield on the difference between the tax-accreted price of the convertible and parity. In this case, also, convertible holders convert the security to the underlying common stock. Scenario 3: If parity is less than the call price and the tax-accreted price of the convertible, the recapture amount is the tax shield on the difference between the tax- accreted price of the convertible and the call price. In this case, investors would find it economical to take the call price rather than converting. Based on the preceding scenarios, it is clear that the issuer of a CoPa convertible is likely to incur the highest recapture costs in scenario 3, followed by scenario 2, and no zero recapture costs in scenario 1. The magnitude of the recapture will depend on 1) the size of the security, and 2) the size of the tax shield benefits that the issuer has reaped. The size of the tax shield benefits are, in turn, a function of, 1) the spread between the YTM of the convertible and the comparable rate used with the CPDI classification of the security, 2) the corporate tax rate of the issuer, and 3) the convertible’s structure (i.e., zero coupon versus cash pay versus par zero bond). The greater the spread between the convert’s yield and the comparable rate used for tax purposes, the larger will be the tax shield benefit to the issuer.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
  All else being equal, zero coupon structures provide higher tax shield benefits relative to cash-pay bond structures. The higher the corporate tax rate, the greater will be the value of the tax shield.

Where to find information In older coverts, look at Paragraph 1 in the Annex under Interest. For example in LIFE 1.5% converts, In addition, the Company shall pay contingent interest (“Contingent Interest”) to the Holders during any six-month period (a “Contingent Interest Period”) from February 15 to August 14 and from August 15 to February 14, commencing with the six-month period beginning February 15, 2012, if the average Market Price of a Note for the five Trading Day period ending on the third Trading Day immediately preceding the relevant Contingent Interest Period equals $1,200 (120% of the principal amount of a Note) or more per $1,000 principal amount of the Note. Regarding tax treatment, look under Article 12 Tax Treatment under comparable yield and projected payment schedule (1) for United States federal income tax purposes, the Company shall accrue interest with respect to outstanding Securities as original issue discount according to the “non-contingent bond method,” as set forth in Treasury Regulation section 1.1275-4(b) using a comparable yield of 6.375%, compounded semiannually and the projected payment schedule attached as Annex 1 to Indenture; Will the issuer call these bonds or put sweetener Some issuers do not want to repay the tax recapture so they will give a put sweetener to keep the bonds outstanding. One issuer that is known for put sweeteners is OMC, which uses this strategy to manage converts so that is essentially pays a short term interest rate on a long term instrument. According to OMC’s treasurer, there is a limitation on the number of times that put sweeteners can be used. The Copa recapture also discourages the issuer from calling the bond unless the stock is above a certain price so that there is no recapture. To find this out, you must construct a spreadsheet that determines how much the issuer has already benefited from deducting higher taxes. The longer the convert has stayed outstanding, the higher the threshold price to avoid recapture. American Recovery and Reinvestment Act of 2009 The following is taken from BAC’s report titled, “Tax benefits inspires convertible exchanges” on 10/29/09. This act provides benefits for applicable convertible bond exchanges and we see recent transactions from WCC, AMMD and BGC partially driven by such tax benefits. By exchanging a newly issued Contingent Payment (CoPa) convertible bond for their existing convertibles, these companies would generate a gain from debt retirement, which can be excluded from taxable income for 5 years and then be amortized over the following 5-taxable-year period. In addition, these companies are allowed to deduct the interest cost on the newly issued converts at a so-called Comparable Yield, which is much higher than the nominal coupon carried on these convertibles. Convertible Indenture Analysis Who is the issuer? The first thing you want to look for in the indenture is the issuer.

24

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
It seems very straight forward to find the issuer of a convertible bond. However, in certain cases, it can be very deceiving who the issuer is. For example, some companies have a holding company structure where the convert is issued out of the holding company so even though it is a senior bond, it maybe structurally subordinated to other senior debt of the company. For example, HTZ 5.25% 06/01/2014 convertible bonds are senior notes but they are structurally subordinated to all other senior debt of Hertz which is issued from the operating company. HTZ could have allowed the operating company to guarantee the convertible debt but it chose not to and thus is structurally subordinated. Ranking Look in the rankings section of the prospectus. In this section, the issuer will clearly state where the converts rank relative to other debt in the capital structure and whether the converts are structurally subordinated to other debt. Many times, the issuer will detail specifically the debt issues and amounts rank ahead, pari passu, or behind the convertible bonds. Guarantees In the case of PCX 3.25% 05/31/13, the converts are senior bonds that are pari passu with the subsequently issued 8.25% senior notes due 2018 straight bonds. However, the straight bonds are guaranteed by operating subsidiaries while that converts do not have guarantees. This puts the PCX 3.25% convert in a structurally subordinate position. Check the Subordination Analysis page. The table of contents for a convertible indenture is typically as follows: Article 1: Definitions Article 2: Issue, Description, Execution, Registration and Exchange of Notes Article 3: Satisfaction and Discharge Article 4: Particular covenants of the company Article 5: List of Holders Article 6: Defaults and Remedies Article 7: Concerning the Trustee Article 8: Concerning the Holders Article 9: Holders Meetings Article 10: Supplemental Indentures Article 11: Consolidation, Merger, Sale , Conveyance and Lease Article 12: Immunity of incorporators, Stockholders, Officers, and Directors Article 13: Conversion of Notes Article 14: Repurchase of Notes and the option of holders Article 15: Redemption Article 17: Miscellaneous Provisions

In older indentures, there could be an Annex section or Exhibit A that contains important payment schedules. So if you don’t find something in the body of the indenture, look for the Annex in the back. These are usually grouped by paragraphs such as the following: 1) 2) 3) 4) 5) 6) Interest Method of Payment Paying Agent, Registrar Indenture. Limitations Optional Redemption Notice of Redemption

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
7) 8) Purchase of notes at option of holder Conversion

Callable Features Callable bonds Many convertibles allow the issuer to call the bond before the maturity date. But of course if the convertible is “in the money” investors will convert rather than accept the cash redemption. This call can sometimes be subject to a trigger, such as parity needing to be 120% or 130% before the call is activated. Hard Call – Most convertible bonds are issued with a period of call protection during which the issuer may not redeem (call) the bonds early. “Hard” call protection is the period during which the bonds cannot be called under any circumstances. Soft Call – “Provisional” protection is when the bonds can be called subject to the share price being above a certain level. Call protection is important for investors as it guarantees the optionality of the convertible and whatever yield advantage it has over the underlying shares for a fixed period of time. The longer the call protection, the greater the benefit for investors. Make-whole clause – A typical convertible has call protection in the early years of the security’s life. Some issues have built in the option to force conversion immediately if the stock has had a strong run. Issuers paid for this privilege with the “make-whole” payment, which requires them to compensate the holder for this early redemption. Make-whole payments have fallen into two categories: (1) premium or (2) forgone income (coupon). A “premium” make-whole compensates the holder for the premium paid at issuance. This premium payment is stepped down over time, deducting dividends/coupons as they are paid. A “dividend/coupon” make -whole compensates the holder for the foregone future cash flows he would have received under a hard call scenario, generally three to five years. As in the case of a premium make-whole, the payment is reduced over time to reflect coupons received. Use make-whole takeout matrix for soft call (TRW 3.5% 12/01/15) Under Article 3 Redemption and Repurchases Section 3.01h, With respect to any Notes that are exchanged following a notice of redemption, the Company will increase the Exchange Rate for the Notes so surrendered for exchange by a number of Additional Shares, if any, pursuant to Section 11.03. Present value of remaining coupons (MU 4.25% 10/15/13) Under Article 11 Redemption (b) The redemption price at which the Notes are redeemable (the “Redemption Price”)shall be equal to (i) 100% of the principal of Notes to be redeemed, plus (ii) accrued and unpaid interest (including Additional Interest), if any, to, but excluding, the Redemption Date, plus (iii) the Make-Whole Premium; provided, however, that if the Redemption Date is after a Regular Record Date and prior to the Interest Payment Date to which it relates, then the accrued and unpaid interest, if any, to, but excluding, the Redemption Date, shall be paid on such Interest Payment Date to the holders of record of such Notes on the applicable Regular Record Date instead of the holders surrendering such Notes for redemption on the Redemption Date (and in this circumstance, the Make-Whole Premium shall be calculated based on the present values of the remaining scheduled payments of interest on such Notes, starting with the next Interest Payment Date for which interest has not been provided for herein). The Trustee shall have no duty to determine or calculate the Make-Whole Premium, which shall be determined by the Company

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
in accordance with the provisions of this Indenture, and the Trustee shall not be under any responsibility to determine the correctness of any such determination and/or calculation and may conclusively rely on the correctness thereof. The Make-whole amount is under Defined Terms, “Make-Whole Premium” means, with respect to each $1,000 in principal amount of Notes, a payment in Cash, shares of Common Stock or a combination of Cash and shares of Common Stock, equal to the present values of the remaining scheduled payments of interest on the Notes to be redeemed from the Redemption Date to October 15, 2013 (excluding interest accrued to, but excluding, such Redemption Date, which is otherwise paid pursuant to clause (ii) of the definition of Redemption Price), computed using a discount rate equal to 2.5%. Conversion For convertible bonds, the meat of the indenture is in Article 14 Conversion of Notes. This states the terms of the conversion including when a bond can be converted. For contingent conversion bonds (CoCos), these are typically the conditions: 1. 2. 3. 4. Bonds can be converted in the 3 month period prior to the maturity. If the common stock trades above 130% of the conversion price for a 20 day period prior to the end of the preceding quarter. If the convert trades at 98% or less of parity. If there is a fundamental change.

Conversion procedure; settlement upon conversion Convertible bonds can be settled in several ways 1. Stock settled – the company must give holders a number of shares equal to the conversion ratio upon conversion. For arbs, this is the most straight forward settlement. Upon conversion, the shares received will net off against the shorts shares on the position. Cash settled (instrument A) – The company will give holders cash equal to the conversion value of the convert usually based on the average conversion value over a set period of trading days. In this case, the arb has to buy back a fixed number of shares over the observation period. It is important for the arb to check with the back office regarding the exact observation period and whether if it is based on VWAP or closing price. Net share settled – The company could 1) settle in cash for up to par and the reminder in stock (instrument C) or 2) settle in either stock or cash (instrument B). In both of these cases, the final conversion will be based on the average over an observation period. The arb must determine the exact date when the observation period starts and ends.

2.

3.

Companies put in the net share settlement language into the indentures in 2004 to replace contingent convertibles following the accounting rule change pertaining to CoCos (in late 2004) that eliminated the EPS benefits of Cocos. Prior to 2004, FASB said that companies can ignore the impact of the conversion feature whenever the convertibility depends on some contingency. Converts would not count in dilution unless the stock traded above the contingent level. Initially, net share settled converts allowed companies to only dilute EPS if the stock traded over the conversion price. The entire amount of the convert was classified as debt. In 2004, many companies provided sweeteners so holders would change CoCos to net share settle bonds.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
However, effective 1/1/2009, convertibles with net share steeled features are subject to the new bifurcation accounting rule. FASB’s reasoning for changing net -share settled convert accounting was purportedly to accurately reflect the value of the underlying embedded convert equity option and capture the related dilution. In MCP 3.25% 06/15/16, the issuer has a choice to settle in cash or stock Subject to this Section 14.02, Section 14.03(b) and Section 14.07(a), upon conversion of any Note, the Company shall pay or deliver, as the case may be, to the converting Holder, in respect of each $1,000 principal amount of Notes being converted, cash (“Cash Settlement”), shares of Common Stock, together with cash, if applicable, in lieu of any fractional share of Common Stock in accordance with subsection (j) of this Section 14.02 (“ Physical Settlement”) or a combination of cash and shares of Common Stock, together with cash, if applicable, in lieu of any fractional share of Common Stock in accordance with subsection (j) of this Section 14.02 (“ Combination Settlement”), at its election, as set forth in this Section 14.02. Some converts such as LRCX 0.5% 5/15/16 are fully cash settled. In a cash settlement, the company will pay a cash amount equal to the sum of the Daily Settlement Amounts for each of the 25 trading days during the observation period. “Daily Settlement Amount,” for each of the 25 consecutive Trading Days during the Observation Period, shall consist of: (a) cash in an amount equal to the lesser of (i) $40 and (ii) the Daily Conversion Value on such Trading Day; and (b) if the Daily Conversion Value on such Trading Day exceeds $40, a number of shares of Common Stock equal to (i) the difference between the Daily Conversion Value and $40, divided by (ii) the Daily VWAP for such Trading Day. “Observation Period” with respect to any Note surrendered for conversion mean s: (i) if the relevant Conversion Date occurs prior to February 15, 2016, the 25 consecutive Trading Day period beginning on, and including, the second Trading Day after such Conversion Date; and (ii) if the relevant Conversion Date occurs on or after February 15, 2016, the 25 consecutive Trading Days beginning on, and including, the 27th Scheduled Trading Day immediately preceding the Maturity Date. Usually, there is language that says upon conversion, a holder shall not receive any separate cash payment for accrued and unpaid interest. This spells out whether you get the last coupon. Check Last Coupon Before Converting. Make-whole conversion rate increase In a takeout that is also a fundamental change, the issuer will often have a matrix that determine the number of additional shares the issuer will give to holders to compensate them for lost premium value in a takeout. Check Takeover Protection. Adjustment of conversion rate for dividends and other events Many convertible bonds are protected for either all dividends or dividends above a set threshold. In these cases, the conversion ratio is adjusted upward to compensate holders for a dividend payment on the stock. Check Dividend Protection. Adjustment for spin-off In a spin-off scenario, shareholders of the issuer ends up owning shares in both the issuer and the spun-off company. In most newer convert issues, holders would see a conversion ratio adjustment to compensate for the drop in the issuer’s stock price post-spin. In earlier issues, the convert would be convertible into a basket of stock in the issuer

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
and stock of the spun-off company. This usually results in a volatility dampening effect since the two stocks will have a correlation of less than 1. This language will be located under Article 14 Conversion under conversion ratio adjustment. With respect to an adjustment pursuant to this Section 14.04(c) where there has been a payment of a dividend or other distribution on the Common Stock of shares of Capital Stock of any class or series, or similar equity interest, of or relating to a Subsidiary or other business unit of the Company, that are, or, when issued, will be, listed or admitted for trading on a U.S. national securities exchange (a “ Spin-Off”), the Conversion Rate shall be increased based on the following formula: CR’ = CR0 x (FMV0+MP0/MP0 ) where,

CR0 CR’

= the Conversion Rate in effect immediately prior to the end of the Valuation Period; = the Conversion Rate in effect immediately after the end of the Valuation Period;

FMV0 = the average of the Last Reported Sale Prices of the Capital Stock or similar equity interest distributed to holders of the Common Stock applicable to one share of the Common Stock (determined by reference to the definition of Last Reported Sale Price as set forth in Section 1.01 as if references therein to Common Stock were to such Capital Stock or similar equity interest) over the first 10 consecutive Trading Day period after, and including, the Ex-Dividend Date of the Spin-Off (the “Valuation Period”); and MP0 = the average of the Last Reported Sale Prices of the Common Stock over the Valuation Period.

The adjustment to the Conversion Rate under the preceding paragraph shall occur on the last Trading Day of the Valuation Period; provided that in respect of any conversion during the Valuation Period, references in the portion of this Section 14.04(c) related to Spin-Offs to 10 Trading Days shall be deemed to be replaced with such lesser number of Trading Days as have elapsed between the Ex-Dividend Date of such Spin-Off and the Conversion Date in determining the Conversion Rate. Merger event Most converitble bonds have some type of protection against a cash takeover. In a cash takeover, the premium for the convertible bond disappears as the cash takeover basically shortens the life of the embedded warrant. To protect investors, convertible bond indentures usually have some type of make-whole payment to holders in the event of a takeout. See more in Takeover Protection. Incremental share factor In 2003, a new structure appeared in converts called incremental share factor, which represents a number of additional shares received upon conversion, so long as the stock has passed through a defined threshold. In practice, it is as if some out-of the money warrants have been embedded within the convertible. Traditionally, the number of shares received upon conversion of a convertible security is fixed at the time of issue and remains constant, independent of stock price. The incremental share factor adds additional shares to the conversion ratio as the stock price rises. So why would an issuer be willing to add shares to the conversion mechanism given a rising share price? We think the answer lies in issuers’ desire to sell stock at high conversion premiums, which in the deals priced to date have been significantly higher than in traditional convertible structures. The average premium on the five securities issued with incremental share factors has been 91%, significantly above

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
the average premium of 43% for convertible bonds issued through April. Normally, a high coupon would be needed to issue a bond with a high conversion premium. With the conversion option so far out-of-the-money, the incremental share factor has been used to add value to the security, effectively reducing the coupon needed to price the structure. Effectively, the conversion ratio as it relates to par has been decoupled. Traditionally, a convertible’s issue price, conversion ratio, and conversion price were interrelated. With the incremental share factor, that relationship breaks down and valuation of the option to convert takes on another dimension. You will need to look at the defined terms to find the formulas for calculating the extra number of shares. The incremental share factor only comes into place when the stock is higher than the base conversion price. Daily Conversion Rate Fraction” means, in respect of any conversion of Notes, a number of shares of Common Stock for each Trading Day during the relevant Cash Settlement Averaging Period determined as follows: (a) if the Applicable Stock Price of the Common Stock on such Trading Day is less than or equal to the Base Conversion Price, the Daily Conversion Rate Fraction for such Trading Day shall be equal to 1/20th of the Base Conversion Rate; and (b) if the Applicable Stock Price of the Common Stock on such Trading Day is greater than the Base Conversion Price, the Daily Conversion Rate Fraction for such Trading Day shall be equal to 1/20th of the following:

Notwithstanding the foregoing, if the Daily Conversion Rate Fraction for any Trading Day in the relevant Cash Settlement Averaging Period would otherwise be greater than the Daily Share Cap, the Daily Conversion Rate Fraction for such Trading Day shall be equal to the Daily Share Cap. “Incremental Share Factor” means initially 8.9532 shares of Common Stock, subject to the same proportional adjustment as the Base Conversion Rate as set forth herein. “Base Conversion Price” on any day means a dollar amount (initially, approximately $72.60) equal to $1,000 divided by the Base Conversion Rate in effect on such day. “Base Conversion Rate” is initially 13.7741 shares of Common Stock, subject to adjustment as set forth herein. Dividend Protection Dividend Protection Prior to 2003, not many convertible bonds had dividend protection language. At best, they protected for only special dividends of over 10%. However, in 2003, the dividend taxation rules changed to favor stock dividends. To the

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
extent that companies decided to increase dividends, this would negatively affect the valuations of most convertible securities. To respond to these changes and their potentially negative impact, investment banks have structured dividend protection language as a means to offer protection against the value-deterioration. Dividend protection is almost always provided by an adjustment to the conversion price or conversion ratio to convey the value of the distribution through the parity value of the bond. There are some instances where such protection could be provided simply passing through those dividend payments directly to bondholders in the form of cash. Where to find the language: Under Article Conversion, section Adjustment to Conversion Rate This section will state the situations when an adjustment to the conversion rate will occur. These usually include: 1) 2) 3) Company issues a stock dividend or splits its stock Company distributes warrants or rights to stock holders (anti dilution provision) Company distributes assets or property to stock holders

4) Company distributes a cash dividend (usually will only adjust for dividend above a certain threshold (typically the cash dividend at the time of issue) Most of the time, there is a clause that says the adjustment will only be made if it is more than 1% in the conversion rate. If the adjustment is less than 1%, the dividend is carried forward to either conversion or the next adjustment period. CSFB published a report on 8/26/03 titled, “Dividend Protection and Convertible Bonds” that explains this concept and is incorporated into this post. CSFB believes the delivery of value through parity adjustment is more valuable than a simple cash pass-through. From the issuer’s standpoint, it saves them the cash outlay on the additional shares associated with the convert and should allow them the ability to garner a higher premium at issue. From the investor’s s tandpoint, the delivery of additional shares is a delivery of more optionality. Theoretically, the bond becomes more valuable as the strike price on the convert is lowered which is offset by the expected fall in stock price. This works toward maintaining the value of the convertible bond investor’s position. We’d also point out that the majority of the existing protection language is asymmetrical—rewarding investors for dividend increases but having no effect on dividend decreases. CSFB makes the following points: • Conversion price versus conversion ratio. Really no surprises here but the language in the indentures of all dividend protected convertibles specifies a change to one of these two items. This is stylistic and should not represent a deterrent to any investor. Regardless of choice, the provision should have an expected impact, to either raise the conversion ratio or decrease the conversion price in the event of a dividend increase.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
• The “fraction.” This is the actual multiplier used to calculate the change in either rate or price. This is typically some application of the market price of the stock and the dividend paid per share. • Market price. Determination of the market price used to adjust the conversion ratio or price is important. It is usually an averaging period of varying length and typically on the closing sale price. The period for evaluation typically ends on the day prior to the record date for the distribution. Timing can affect the adjustment’s effect if the stock price moves materially ahead of the dividend record date. Some provisions afford management the ability to choose the period, giving a slight advantage to the issuer. •Distribution calculation. Some protection language specifies that the cash distribution to be considered is s imply the most recent payment. Others require the holder to utilize the trailing 12 months of distributions. Some use the total distribution. Others take only an amount exceeding a pre-defined level. These will affect your fraction and, ultimately, your adjustment. This is typically where protection language can be “diluted” to the extent that it allows the issuer to avoid having to make any adjustment on dividends that fail to meet the defined threshold. • Overall thresholds. It is possible, although unlikely, that a particular distribution would pass the dividend threshold levels and not pass the overall test for conversion rate adjustment. The likely scenario where this could happen would be on dividend-paying stocks that will only adjust on excess amounts. However, it certainly is possible and this can further delay delivery of value to investors. Most conversion rate adjustment language requires at least a 1% change in the conversion price (conversion ratio) to be met to effect an adjustment. In most instances of dividendprotection language, distributions that fail to meet this larger test are “carried forward” to the next possible adjustment. • Maximum or minimum adjustments. Some deals are structured such that the conversion rate cannot rise above a specified level or the conversion price cannot fall below a specified level. That level is usually the stock price at issue (adjusted for splits, etc.). This is usually a consideration made for the beneficial conversion option, which handles the scenario in which the effective conversion price makes the security appear as if it was issued in-themoney. Events of Default Every convertible bond indenture has a list of things that the issuer cannot do or else would constitute a default. These usually include: 1) Default in payment of interest for a period of 30 days

2) Default in payment of principal when due and payable on the maturity date, upon any required repurchase, upon declaration of acceleration or otherwise 3) 4) Failure to comply with its obligation to convert the Notes Failure to issue a Fundamental Change Notice

And several others. Failure to comply would accelerate the maturity of the notes. Technical default The following contains excerpts from BAC’s report titled, “Technical Default Language Demystified” published 07/14/06.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
In 2006, due to Sarbanes-Oxley and backdating employee options accounting, several convert issuers were put into technical default because they were not able to file their 10Qs and 10ks on time. In most indentures, under Article Holders Lists and Reports by Trustee and the Company, there is a requirement that the company file timely reports to the trustee. The first such case in 2006 was MERQ 0% converts with the following language. Section 7.04. Reports By Company. The Company shall file with the Trustee and the Commission, and transmit to Holders, such information, documents and other reports, and such summaries thereof, as may be required pursuant to the Trust Indenture Act at the times and in the manner provided pursuant to such Act; provided that any such information, documents or reports required to be filed with the Commission pursuant to Section 13 or 15(d) of the Exchange Act shall be filed with the Trustee within 15 days after the same is so required to be filed with the Commission. In the event the Company is not subject to Section 13 or 15(d) of the Exchange Act, it shall file with the Trustee upon request the information required to be delivered pursuant to Rule 144A(d)(4) under the Securities Act. Delivery of such reports, information and documents to the Trustee is for informational purposes only and the Trustee’s receipt of such shall not constitute constructive notice of any information contained therein or determinable from information contained therein, including the Company’s compliance with any of its covenants hereunder (as to which the Trustee is entitled to rely exclusively on Officers’ Certificates). It is expressly understood that materials transmitted electronically by the Company to the Trustee shall be deemed filed with the Trustee for purposes of this Section 7.04. In Article 5 Remedies, Events of Default stated that (d) default in the performance of any covenant, agreement or condition of the Company in this Indenture or the Securities (other than a default specified in (a) or (b) above), and continuance of such default for a period of 60 days after there has been given, by registered or certified mail, to the Company by the Trustee or to the Company and the Trustee by the Holders of at least 25% in aggregate Principal Amount of the Outstanding Securities a written notice specifying such default and requiring it to be remedied and stating that such notice is a “Notice of Default” hereunder; Companies that were late in filing reports were then in default and would be forced to accelerate the maturity. This was a huge benefit to converts that traded below par. BAC had a report that described the weakest, moderate and strongest reporting covenants. Weakest reporting covenant This covenant directly promises only to provide copies of the filed reports, and usually reads as follows: “The Company shall file with the Trustee, within 15 days after it files such annual and quarterly reports, information, documents and other reports with the SEC, copies of its annual report and of the information, documents and other reports (or copies of such portions of any of the foregoing as the SEC may by rules and regulations prescribe) which the Company is required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act… The Company also shall comply with the other provisions of TIA Section 314(a).” Recent examples of the convertible securities with such or very similar language include: BE, CYBX, NT, OPWV, PRX, SNRR, VTSS and WG. Moderate reporting covenant This covenant directly promises to file the required reports with the SEC, although it omits a variation on the word “time”, and usually reads as follows: “The Company shall file all reports and other information and documents which it is requ ired to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act, and within 15 days after it files them with the SEC, the

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Company shall file copies of all such reports, information and other documents with the Trustee ; … The Company also shall comply with the provisions of TIA Section 314(a).” Recent examples of the convertible securities with such or very similar language include: BRKS, NAV, SFNT, SKS, TERN, and UTSI. Strongest reporting covenant This covenant directly promises to timely file the reports with the SEC, and usually reads as follows: “The Company shall file with the Trustee (and the Commission if at any time after the Indenture becomes qualified under the Trust Indenture Act), and transmit to holders of Notes, such information, documents and other reports and such summaries thereof, as may be required pursuant to the Trust Indenture Act at the times and in the manner provided pursuant to such Act, whether or not the Notes are governed by such Act; provided that any such information, documents or reports required to be filed with the Commission pursuant to Section 13 or 15(d) of the Exchange Act shall be filed with the Trustee within fifteen (15) days after the same is so required to be filed with the Commission…” Recent examples of the convertible securities with such or very similar language include: BRCD, CNET, CNCT, CAO, FLYR, IPXL, MERQ, RSTN, and TKLC Weakest covenant created most controversy Holders of convertibles with the strongest or moderate reporting covenants have been largely successful to date in eliciting issuers’ agreement about when a technical default has been triggered, or at least in forcing a default -waiver consent solicitation with a sweetener. On the other hand, the weakest covenant wording does leave room for an issuer to take the position that they have not breached a covenant, with bondholders’ default claims being vigorously disputed in most cases. While virtually every single indenture we looked at contains a close variation on the words “reports, which the Company is required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act,” we find the weakest reporting covenant to be unclear as to the extent of bondholders’ protection in cases of delayed filings with the SEC. Although we believe that the intent of all indenture covenants is to protect the interests of the bondholders, we wait to see if the ongoing BearingPoint court case will set a clear precedent one way or another. Technical default trigger process Technical default usually does not take place automatically, when a company announces a possibility for restatement or any other reason for delaying the financial reporting. Generally, (1) a company has to miss the filing deadline first; then, (2) after 15 days (most common time period we have seen), a written notice of such failure has to be given to the company by the trustee or by the holders of at least twenty-five percent (25%) in aggregate principal amount of the convertible notes outstanding at the time. (3) The company usually has 60 (sometimes, 90) days to cure such failure, before the event of default and subsequent acceleration of notes’ maturity finally occur. New Language Most recently, issuers have removed filing of reports from events of default but have instead up tit under Article 4 Particular Covenants of the Company such as LRCX 0.5% 05/15/16 which says, (d) If, at any time during the six-month period beginning on, and including, the date that is six months after the last date of original issuance of the Notes, the Company fails to timely file any document or report that it is required to file with the Commission pursuant to Section 13 or 15(d) of the Exchange Act, as applicable (after giving effect to all applicable grace periods thereunder and other than reports on Form 8-K), or the Notes are not otherwise freely

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
tradable by Holders other than the Company’s Affiliates (as a result of restrictions pursuant to U.S. securities law or the terms of this Indenture or the Notes), the Company shall pay Additional Interest on the Notes. Such Additional Interest shall accrue on the Notes at the rate of 0.50% per annum of the principal amount of the Notes outstanding for each day during such period for which the Company’s failure to file has occurred and is continuing. As used in this Section 4.06(d), documents or reports that the Company is required to “file” with the Commission pursuant to Section 13 or 15(d) of the Exchange Act does not include documents or reports that the Company furnishes to the Commission pursuant to Section 13 or 15(d) of the Exchange Act. Last Coupon Before Converting For convertible arbitrage, it is very important to determine whether holders get the last coupon prior to being called. In almost all cases, if you decide to convert in between interest payment dates, you don’t get the income accrued since the last payment. Look under Article 12 Conversion. Under conversion procedure, there will be a clause that says whether you get the coupon. The indenture will state as follows, Upon conversion, a Holder will not receive any separate cash payment for accrued and unpaid interest …. As a result, accrued and unpaid interest to, but not including, the Conversion Date shall be deemed to be paid in full rather than cancelled, extinguished or forfeited. In the case where you convert after the record date but before the interest payment date, you will normally have to pay back (upon conversion) the interest you receive as a result of being a record date holder. If Securities are converted after the close of business on a record date, Holders of such Securities as of the close of business on the record date will receive the interest payable on such Securities on the corresponding Interest Payment Date notwithstanding the conversion. Securities surrendered for conversion during the period from the close of business on any Regular Record Date to the opening of business on the corresponding Interest Payment Date must be accompanied by payment of an amount equal to the interest payable on the Securities so converted; There may be some exceptions to this clause. The main exception is upon a call-forced conversion (that is, when the issuer calls a convertible whose parity is above the call price and holders are forced to convert to get the higher value) during the period between the record and payment dates for the interest. This is for convertibles that have call dates prior to maturity dates. The other exception is if a change of control date falls in between the record and payment dates. You will find a clause similar to the following, provided, however, that no such payment need be made (1) if the Company has specified a Fundamental Change Repurchase Date that is after a record date and on or prior to the corresponding Interest Payment Date, (2) for conversions following the Regular Record Date immediately preceding the final Interest Payment Date for the Securities, (3) if the Company has called the Securities for redemption or (4) to the extent of any overdue interest or Additional Interest, if any, existing at the time of conversion with respect to such Security. Except as described above, no payment or adjustment will be made for accrued interest on converted Securities. For converts that are in-the-money at maturity, the situation is a bit cloudy. Some indentures will allow you to keep the last coupon while others will not. For example, in the case of EMC, you get the last coupon prior to maturity.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
(i) Upon conversion, a Holder will not receive any separate cash payment for accrued and unpaid interest except as set forth below. The Company’s settlement of the Conversion Obligations as described above shall be deemed to satisfy its obligation to pay the principal amount of the Security and accrued and unpaid interest to, but not including, the Conversion Date. As a result, accrued and unpaid interest to, but not including, the Conversion Date shall be deemed to be paid in full rather than cancelled, extinguished or forfeited. Notwithstanding the preceding sentence, if Securities are converted after the close of business on a record date, Holders of such Securities as of the close of business on the record date will receive the interest payable on such Securities on the corresponding Interest Payment Date notwithstanding the conversion. Securities surrendered for conversion during the period from the close of business on any Regular Record Date to the opening of business on the corresponding Interest Payment Date must be accompanied by payment of an amount equal to the interest payable on the Securities so converted; provided, however, that no such payment need be made (i) if the Company has specified a Designated Event Purchase Date that is after a Record Date and on or prior to the corresponding Interest Payment Date; (ii) to the extent of any overdue interest existing at the time of conversion with respect to such Security; or (iii) with respect to any Conversion Date that occurs during the period from the close of business on the Regular Record Date immediately preceding Stated Maturity to Stated Maturity. Except as described above, no payment or adjustment will be made for accrued interest on converted Securities. In the case of FCN, the indenture (Article 8 Conversion, section 8.03), the indenture says the only exception is the fundamental change and does not mention the call or maturity. (b) Each Definitive Note surrendered (in whole or in part), or beneficial interest in any Global Note surrendered to the Conversion Agent, for conversion during the Record Date Period shall be accompanied by payment in same-day funds or other funds acceptable to the Company of an amount equal to the interest payable on such Interest Payment Date on the principal amount of such Note (or part thereof, as the case may be) being surrendered for conversion; provided, however, that no such payment need be made in the case of any Note or portion thereof that is subject to repurchase following a Fundamental Change on a Fundamental Change Repurchase Date occurring during the Record Date Period (or if such interest payment date is not a Business Day, the second Business Day after the interest payment date) and, as a result, the right to convert such Note would otherwise terminate in such Record Date Period if not exercised. The interest so payable on such Interest Payment Date with respect to any Note (or portion thereof, if applicable) that is surrendered for conversion during the Record Date Period shall be paid to the Holder of such Note as of such Regular Record Date in an amount equal to the interest that would have been payable on such Note if such Note had been converted as of the close of business on such Interest Payment Date. Interest payable on any Interest Payment Date in respect of any Note surrendered for conversion on or after such Interest Payment Date shall be paid to the Holder of such Note as of the Regular Record Date immediately preceding such Interest Payment Date, notwithstanding the exercise of the right of conversion. Takeover Protection Some material in this post was taken from BAC’s report titled, “Cash Takeover Protection’ published o n 4/16/05. Since convertibles lose all their option value in a cash takeover, and hedged investors get hurt on their short positions in the underlying stock, convertible investors started to demand cash takeover protection from new convertible issuers beginning in 2004. The most common protection gives convert holders additional shares (increase conversion ratio) based on a matrix of prices and dates that are pre-determined at issue on a credit spread, volatility, and interest rates assumptions prevalent at the time. Over time, the convert could richen or cheapen so holders could still make or lose money on a cash takeout. In order to qualify for the matrix, the takeover must satisfy certain conditions. These vary by indenture so you must read the fine print carefully. These could include.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
1) Cash takeover must be at least 10% cash.

2) The acquirer is not a public company. Public acquirer clauses were more popular at the beginning. This gives the acquiring company the right to refuse the matrix and keep the convert outstanding which would then convert into the acquirer’s shares. Fundamental Change It is important to read carefully what constitutes a fundamental change. This term is usually defined in the Defined Terms section of the indenture. This usually states that a transaction is a fundamental change if it meets any of the following criteria: 1) 2) 3) A person or group obtains more than 50% of the voting interest A recapitalization that results in existing holders owning less than before the transaction. Delisting from a stock exchange

Provided that the transaction is not a fundamental change if the takeover consists of at least 90% stock consideration. Change of control put provision – Various forms of “poison puts” are a common feature. The goal of these provisions is to allow the investor to exit a position at par in the event of mergers that are potentially harmful to the conversion option. There are several variations. Generally, poison puts are triggered by a “Change of Control”, in which a third party obtains a defined level of voting control of the company. Some simply provide for a cash put at par plus accrued interest; others aim to adjust the ratio so that parity will equal par. Not all mergers will qualify (e.g., most all-stock mergers do not trigger the put) and the terms of issues can be unique, thus each issue needs to be looked at individually. While the change in control put benefits out-of-themoney convertibles trading below par, for convertibles trading at-the-money or in-the money this put option is worthless. Moreover, these convertibles get hurt the most from the loss of their option value associated with an allcash or mostly-cash merger. Since the second half of 2004, virtually all new convertible bonds include some form of cash takeover protection as described in more detail below. Make Whole matrix BAC convert primer 7/7/11 – Cash takeover protection provision – Since convertibles lose all their option value in a cash takeover, and hedged investors can experience severe losses on short positions in the underlying stock, convertible investors have demanded cash takeover protection (“CTP”) from new convertible issues. The most common type of cash takeover protection is the ‘additional shares’ one. Additional Shares protection method is most common and calls for an increase in the conversion ratio over a limited period of time, based on a matrix of prices and dates. The price-date matrix contains stock share amounts equivalent to a hypothetical premium over parity that would be lost at a future time at a given takeover offer price. The price-date matrix values for the Additional Shares protection method are generally predetermined at the convertible issue date, based on spread, volatility and interest rate assumptions prevalent at that time. This protection virtually always expires by the first call date. Cash takeover protection language includes other features besides protection type, which can affect a convertible’s ability to qualify for compensation, like protection triggering actions (most require conversion), protection triggering forms of merger consideration (only cash vs. any non-stock consideration), minimum triggering non-stock portion (most allow “10% or more” non -stock), protection expiration (most expire after the first call date), and presence of a “public acquiror” clause (this clause effectively transforms a non-stock merger into a stock-for-stock merger form the convertible bondholder’s view). Like other terms, cash

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
takeover protection is subject to change with market conditions. Beware of very stringent non-stock portion requirements in older convertibles, like 100% in Cash. Timing of make-whole matrix In order to receive the extra shares from the make-whole matrix, the holder must convert the bond in connection with a Fundamental Change, which is usually a short time period after the close of the merger. There is a multi-step process to determine this period. 1) 2) 3) Determine whether the transaction qualifies as a Fundamental Change Determine when the company must issue a Fundamental Change Notice Usually, the Fundamental Change Notice will have to specify the Fundamental Change Purchase Date

4) Check if there is language that allows holders to keep the interest if the Fundamental Change Purchase date falls between a record and payment date. In the case of Sybase, the company agreed to be acquired by SAP on 5/17/10 with an expected close in July. The next coupon payment date is 8/15/10 so we need to figure out if you will get that coupon. Section 3.7 says Sybase has up to 20 days after the deal to put out a fundamental change notice. In this notice, they must announce a day for the repurchase of the bonds which is between 20-35 calendar days later. The tender offer, which trigged the fundamental change, was completed on 7/26/10. The company put out the fundamental change notice on 7/27/10, which stated that bonds submitted for conversion before 8/17/10 (Fundamental Change Purchase Date) would get the make-whole. This also allowed convert holders to receive the final coupon payment. Additionally, section 4.2 says that no payment need to be repaid if the company has specified a Fundamental Change Purchase Date that is after a Regular Record Date and on or prior to the corresponding Interest Payment date. So the holder should have been able to receive the make-whole and the final coupon as long as the Fundamental Change was between 8/2/11 and 8/15/11. In the case of OSIP, the indenture stated that the Fundamental Change Purchase Date would be 30 business days after the fundamental change has occurred. Stock mergers When a takeover qualifies as a stock merger, the acquirer takes responsibility of the convertible bond. This is usually spelled out in the section called Merger Treatment or Recapitalizations under Article Conversions. The trick part is if the target shareholders get a choice of cash or stock. In the 2005 TEVA takeout of IVX, IVX convert holders lost out because convert holders received the consideration that non-electing shareholders get. Case Studies: Teva acquires Ivax whereby Ivax shareholders will have a choice of $26 cash or 0.8471 Teva stock, subject to proration so that no more than one-half of such elections are for cash and no more than one half are for Teva stock. IVA convertible bonds will become convertible into whatever consideration non-electing IVX shareholders will end up getting. Therefore, if TEVA stock price stays above $30.69 before the compensation election deadline, and all

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
electing IVX shareholders choose all stock, the non-electing shareholders would end up with an all-cash merger consideration. In other indentures such as LRCX 0.5% due 05/15/16, the indenture states that If the Merger Event causes the Common Stock to be converted into, or exchanged for, the right to receive more than a single type of consideration (determined based in part upon any form of stockholder election), then (i) the Reference Property into which the Notes will be convertible shall be deemed to be the weighted average of the types and amounts of consideration received by the holders of Common Stock that affirmatively make such an election. Public acquirer clause test In older converts, there is a public acquirer clause that says if a publicly traded company acquires the company for cash, it can elect to keep the convert outstanding whereby the bond would convert into the acquiror’s common stock. This could be detrimental to the convert holder since the acquirer likely has a lower volatility and deprives the holder of receiving additional shares through the matrix. In this case, the language will specify how the new ratio is calculated and when holders will be notified, Section 12.04 . Exchange After a Public Acquirer Change of Control. (a) In the event of a Public Acquirer Change of Control, the Company may, in lieu of increasing the Exchange Rate by Additional Shares pursuant to Section 12.03 above and in lieu of application of Section 12.05, elect to adjust the Exchange Rate and the related Exchange Obligation such that from and after the Effective Date of such Public Acquirer Change of Control, Holders shall be entitled to exchange their Securities, subject to the conditions in Section 12.01(a) or (b), into cash and/or a number of shares of Public Acquirer Common Stock, if applicable, in accordance with procedures and elections contemplated by Section 12.01. The adjusted Exchange Rate shall be the Exchange Rate in effect immediately before the Public Acquirer Change of Control by multiplying it by a fraction: (i) the numerator of which will be the average of the Daily VWAP of the Common Stock for the five consecutive VWAP Trading Days prior to but excluding the Effective Date of such Public Acquirer Change of Control, and (ii) the denominator of which will be the average of Daily VWAP of the Public Acquirer Common Stock (determined in a manner consistent with the method used with respect to the Common Stock) for the five consecutive VWAP Trading Days commencing on the VWAP Trading Day next succeeding the Effective Date of such Public Acquirer Change of Control. (b) In order to make the election pursuant to this Section 12.04, the Parent, the Company and the issuer of the Public Acquirer Common Stock shall execute with the Trustee a supplemental indenture providing that each Security shall be exchangeable into Public Acquirer Common Stock and execute an amendment to the Registration Rights Agreement (to the extent any Registrable Securities (as defined therein) remain outstanding) to make the provisions thereof apply to the Public Acquirer Common Stock. Such supplemental indenture shall provide for provisions and adjustments which shall be as nearly equivalent as may be practicable to the provisions and adjustments provided for in this Article 12 as determined in good faith by the Board of Directors of the Parent or such issuer (which shall be conclusive). (c) At least 35 Scheduled Trading Days prior to the expected Effective Date of a Fundamental Change that is also a Public Acquirer Change of Control, the Company will provide a notice to all Holders, the Trustee and the Paying Agent stating whether the Company (i) elects to adjust the Exchange Rate and the related Exchange Obligation as set forth in this Section 12.04 or (ii) does not elect to so adjust the Exchange Rate and the related Exchange Obligation, in which case the Holders will have the right to exchange Securities and, if applicable, receive Additional Shares as set forth in Section 12.03. In addition, upon a Public Acquirer Change of Control, in lieu of exchanging the Securities, the Holders can, subject to the conditions set forth therein, require the Company to repurchase all or a portion of the Securities pursuant to Section 11.02.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas

Credit Analysis Credit Analysis The goal of credit analysis is to access the probability that the bonds or loans in question will be repaid at maturity. When making a decision to buy a bond, the analyst must decide if the bonds are trading at a high enough yield to compensate for the risk of holding the bond. But the primary goal is to select credits that have a high degree of confidence of being repaid at maturity because if a company defaults, there usually isn’t a yield high enough to compensate for the loss. These are the steps to take for credit analysis. Industry analysis Many industries have disappeared over the years such as the horse carriage and buggy whip industries and more recently telephone directories and typewriter makers. Other industries have shrunk in size and have struggled to maintain profitability including newspaper publishing and video rentals. A credit analyst must be aware of the industry structure and trends and be able to make an assessment about the future of the industry. See Industry Analysis. Company analysis It is imperative to understand what the company sells and how it generates cash. The best way to obtain this information is by reading the company’s 10K and annual report. These documents can be found on the SEC website and are good sources of information. Once you understand the company’s business, determine how the company fits within the industry compared to competitors and whether the company has a competitive advantage. See Company Analysis. Financial analysis A good credit analysis should be forward looking since the ability of a company to repay its bonds will depend on future performance. However, analyzing historical financials will provide a good idea of how the company performs over different economic cycles and industry changes. It would be helpful to obtain the compnay’s last 10 years (or at least 5) of financial statements and observe how different financial metrics have changed over time. Next, based on your views of the industry, company and historical financials, forecast longer term performance for the company and determine the risk of the company’s ability to repay the bonds. See Financial Analysis. Structure and maturity schedule analysis A company usually has many different credit obligations within its capital structure. Determine where the bond in question fits within the capital structure. How much debt is senior to the bond? How much debt is scheduled to mature before the bond? Are these bonds structurally subordinated? See Structure and Maturity Schedule. Indenture analysis Credit analysts should be familiar with not only the indenture of the bond being analyzed but also the indentures or credit agreements of the company’s other debts. Understanding this information will help you unders tand how well protected the bond is from management and corporate actions. See Indenture Analysis. Putting it all together

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Based on your credit analysis, try to assign a credit rating for the debt. This rating may or may not agree with the ratings of S&P or Moody’s but it will give you a good assessment of the credit risk. Particularly with convertible bonds, there may not be an agency rating issued. Once you determine the overall rating, you can measure it against other companies with the same rating and determine whether the security is cheap or rich by looking at the following chart.

This chart only serves as a guideline. For example, while the average BB credit spread is 532, there are many BB credits that trade above or below that spread for good reasons. Review your credit analysis and determine how much above or below the credit should trade compared to the rating category. Industry Analysis Industry risk is the risk of losing revenue or market share or incurring an overall financial decline as a result of industry changes, business cycles, product obsolescence, changes in consumer preferences, changes in technology, reduction in barriers to entry, or an increase in competition. The credit analyst must understand industry dynamics and trends in order to accurately assess the risk. In the early 1900s, the horse carriage making industry was thriving. However, even the best horse carriage maker would go out of business because the automobile made the industry obsolete. A more recent example is the telecommunication services industry in the late 1990s. As Internet usage grew at astonishing rates, capital flowed to start-ups that built new telecom networks throughout the US. Although Internet traffic continued to grow at high rates, the barriers to entry were low, and thus too many companies entered the market and drove prices down due to overcapacity. Many of these companies were not able to make any money and eventually folded. We cannot analyze every industry here but will provide a framework for conducting your own industry analysis. Industries that are considered better credit risks are those with:          Low cyclical sectors whose cash flow do not have big swings Low barriers to entry which could be due to regulations, technology or other reasons Longer business cycles that allow companies to plan longer-term Few established (and rational) market participants with stable market shares Low rate of technological change Favorable and consistent growth outlook Naturally recurring revenues Low capital expenditures requirements Low fixed costs

Based on the above characteristics, certain industries are inherently more risky than others as see in the following table:

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This table only serves as a guideline since industry structures change all the time based on the economic and competitive environment. In the late 1990s, many retailers went out of business because the country was over-stored with too many shopping malls appearing throughout the country. The fierce competition drove prices down and pressured the retailers already thin margins. Only the most efficient or best positioned retailers escaped bankruptcy. In the early 2000′s, the highest risk industry was telecom service providers. As internet usage grew, capital flowed into start-ups to construct new networks. Although internet usage grew at high rates, network capacity grew at even higher rates and eventually pressured pricing. Most of these start-up networks did not survive. In contrast, retailers performed well during that recession because retail square footage had been taken out and low interest rates and rising home prices kept the consumer spending. In the current 2008-2011 downturn, financials, autos, and home builders have felt the greatest stress due to the bursting of the housing bubble. We have seen Lehman Brothers, Washington Mutual, CIT and MF Global all go bankrupt. In autos, General Motors, Lear and a host of other auto suppliers filed for bankruptcy. Michael Porter’s Five Forces Another industry analysis framework is Michael Porter’s five forces model. The Competitive Forces analysis is made by the identification of 5 fundamental competitive forces:      The entry of competitors (how easy or difficult is it for new entrants to start to compete, which barriers do exist) The threat of substitutes (how easy can our product or service be substituted, especially cheaper) The bargaining power of buyers (how strong is the position of buyers, can they work together to order large volumes) The bargaining power of suppliers (how strong is the position of sellers, are there many or only few potential suppliers, is there a monopoly) The rivalry among the existing players (is there a strong competition between the existing players, is one player very dominant or all equal in strength/size)

Using this framework to analyze the industry, you can assess the industry’s health by examining the potential threats and structural changes. This can be helpful in determining the company’s credit risk.

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Company Analysis In order to analyze a company’s business risk, start by understanding what the company sells and how it generates cash. The best starting off point its to read the company’s 10K . The company must file this document once a year within 60 days of its fiscal year end. There is a section titled, “Description of our business” that discusses the company’s products, customers, competitors, market share, industry dynamics, suppliers, own ed properties and much more. Once you understand the company’s business, the next step is to identify the company’s competitive advantage. This is crucial to the company’s credit risk because a company with weak or unsustainable competitive advantage will likely face profit pressures in the near future. Sustainable competitive advantage could be due to the following:    Low cost producer due to economies of scale, technology or other Highly differentiated product due to innovation or brand recognition Focus on a niche product

Sometimes, a competitive advantage can last a very long time such as some branded consumer products like Coke. Other times, the competitive advantage only last short time such as AOL due to technological and industry structure changes. The job of the credit analyst is to determine how sustainable the competitive advantage is and how long it can last. Other favorable factors for companies include the following:      Consistent or increasing market share The ability for pricing power Diversification by products, geography or types of customers Consistent sales or recurring revenues Long product cycles

Another framework to use for company specific risk analysis is to use SWOT analysis, which analyzes the strengths, weaknesses, opportunities and threats for a specific company. Financial Analysis A starting point for financial risk analysis look at the last 10 years (or at least the last 5) of financial statements for the compamy and look for trends includng the following: Profitability trends: Is the company consistently profitable or are earnings cyclical Working capital usage: Is the company working capital intensive? How has working capital changed over the years? Is working capital cyclical or seasonal? Capital expenditures: How capital intensive is the business? What is maintenance capex vs performance based capex? Is capex lumpy or consistent? Free cash flows: Does the company consistently generate free cash flow? Is there a big difference between operating income and operating cash flow? These are just some of the questions credit analysts need to ask to assess the company’s financials. Depending on the company and industry, there are many more questions that need to asked and answered in order to understand the company’s risk.

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Combined with industry and company analysis, historical financial analysis should allow the credit analyst to forecast future cash flows and asses the company’s ability to repay the bonds. The following are some key financial ratios that credit analysts look at and where it places the company compared to the averages for each rating group. This is a useful guideline for the financial strength of the company since these ratios have been used for credit analysis over many years and have fairly good predictability for credit risk. Several of these ratios are also the basis of financial covenants used by most credit agreements and bond indentures.

The above chart only serves as a guideline for determining a company’s rating. For example, the average BB rated company has an EBITDA interest coverage ratio of 3.5 but there are many BB rated companies with higher or lower ratios. A company operating in a favorable industry and has a sustainable competitive advantage should have a higher rating than its ratios imply. Conversely, a company operating in an unfavorable industry should have a lower rating. Other considerations Beyond the simple financial ratio calculations and comparisons, it is important to focus on the balance sheet, profitability, cash generation and financial flexibility. The balance sheet identifies the company’s financial obligations and the asset quality that support those obligations. Analyzing just the debt/equity structure is not sufficient to determine credit quality, but comparing all debt obligations, including those off the balance sheet, with the cash generation ability of the assets is vital.

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Things to look for include post retirement and pension obligations, operating leases, securitized receivables, joint ventures and unconsolidated subsidiaries, and unusually large changes in working capital. Profitability is a good measure of the viability, the volatility, the value, and the performance of the business, especially versus competitors. Ratios to consider include operating and net margins, returns on equity and total assets, and revenue and income growth. The actual ratios are important but the trends and forecasts of these ratios are even more important. Cash generation is important because cash is used to pay financial obligations. Comparing the ability to generate cash with the need for cash, including its use in repaying obligations, is the most critical component of financial risk analysis. The credit market is obsessed with EBITDA but a better approach is to look at the generation of free cash flow. EBITDA has some weaknesses that include    Ignores changes in working capital and overstates cash flow in periods of working capital growth Does not consider the amount of required reinvestment Can be manipulated by changing accounting policies

Financial flexibility recognizes the entity’s ability to withstand fluctuations in business activity. Accessing cash and mitigating obligations is critical when the business environment shifts, especially for weak credits. Analysts should consider situations where liquidity may be needed. These could include:     A gradual deterioration in operating performance A dramatic setback in the business caused by a crisis in customer confidence A large adverse litigation judgment An unforeseen event that affects the entire industry

In these cases, the company may need access to liquidity that could come from the following:       Cash and marketable securities Access to credit lines Cash from operations Asset sales Dividend cuts Capital spending cuts

Structure and Maturity Schedule Structural analysis involves identifying where the debt resides within the capital structure. First it is necessary to determine the corporate structure. Some companies have a straight forward corporate structure where all the debt is issued from the same entity as where the operating assets reside. Other companies will have a holding company / operating company structure. Still others may have financing subsidiaries or international operations that also issue debt. The goal of structural analysis is to determine what assets back your bond and how much debt have priority claims. One way to find out the corporate structure along with the amount of debt for each entity is the CAST function on Bloomberg. Below is the corporate structure and debt amounts for United Rentals (URI). Also see Subordination Analysis.

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As you can see, the unsecured bonds of URI sit behind $1.8B of first lien secured loans but ahead of $772m of subordinated bonds. A credit analyst should take this into account. On average, subordinate bonds have a credit spread that is 150-200 bps higher than the senior bond. You can also see that the URI has a holding company/operating company structure with most of the debt issued out of the operating company. Maturity Schedule Analysis It is also important to identify the amount of debt that matures before and after the bond in question. In general the credit curve is positively sloping, meaning that shorter maturities of the same company have lower credit spreads. On Bloomberg, the DDIS function shows the company’s maturity schedule. Below is the maturity schedule of URI.

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Indenture/Credit Agreement Components of a bond indenture/credit agreement A bond indenture is a contract between the issuer and bond holder that governs the terms of the bond. For loans, it is the credit agreement. These are written by lawyers and are not easy to read. However, most of these documents are similar because they basically use the same underlying template with minor variations. If the loan is secured, you will also need to read the security and collateral agreement to learn which assets secure the claim. The most important part of the indenture/credit agreement is the covenant section. There are slight differences between the credit agreement and indenture but both have similar structures. Title page – name of borrower, guarantors, trustee, closing date of loan, agent banks on the loan. It is important to determine who the issuer is for purposes of structural subordination. Table of contents - list of articles or sections in the indenture/credit agreement. Recitals – tells you the reason for the loan and a bit of history of transactions leading up to this one. Article 1: Definitions and incorporation by reference

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Every capitalized term in the document is usually defined in this section. Important defined terms include the definition of Total Debt, Fixed Charges and EBITDA for purposes of calculating the negative covenants. Generally, the issuer wants EBITDA to be defined as broadly as possible and fixed charges to be as narrow as possible so that EBITDA/Fixed charges can be high. Article 2: Terms of the loan (Credit Agreement)/The Notes (Indenture) See Terms of the Loan Article 3: Conditions precedent (Credit Agreement Only) The conditions precedent in a credit agreement are a simplified closing list of things that have to be in place before the loan gets funded. The conditions specify what documents the borrower must deliver to the lenders, what actions it must take, and what other circumstances must exist in order for credit to be available. Signing versus closing – most credit agreements are signed and closed on the same day. However, some credit agreements including LBOs and non-US borrowers may be signed in advanced of the effective date. MAC clause – Lenders usually insist that the credit agreement conditions protect against the borrower’s suffering what is called a Material Adverse Change clause. Perfection of Collateral If a facility is to be secured, the conditions precedent normally require evidence of two things: first, that each lien granted to the lenders has been perfected and second that it has the agreed upon priority over other liens on the property. Perfection means that steps have been taken to give public notice of the security interest and to make it enforceable against other creditors of the borrower. Lenders will also insist that lien searches be conducted to ensure that the lien is first in priority. Appraisals Appraisals are not commonly required as a condition to the extension of credit under an agreement with 2 exceptions 1) asset based lending and 2) loans are made against the security of real property. Solvency A reason why there is a clause in the credit agreement stating the borrower is solvent is to give lenders independent confirmation that they could show later to a court to demonstrate that borrower’s financial condition at the time of the loan closing and show that it was solvent. This is to determine whether fraudulent conveyance has occurred. Other checks for the lender include environmental due diligence, insurance, patriot act, and the catchall. Effectiveness A credit agreement becomes effective as a contract when all parties have executed and delivered counterparts. However, the obligation of the lenders to extend credit does not become effective until the borrower satisfies all of the effectiveness date conditions. Article 4: Representations and warranties (Credit Agreement Only)

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The organization in existence representation tells the lenders 4 things about the borrower 1) that it is organized, 2) that it exists, 3) that it has certain powers and 4) that it is qualified to do business where required. Other representations needed from the borrower include financial statements, litigation, licenses, capitalization, subsidiaries, real property, existing debt and liens, etc. Article 5: Covenants See page on Covenants Article 6: Events of default See Events of Default Article 7: The agent Article 8: Amendments, supplements and waivers Bank Agreements The agent may waive certain technical defaults or restructure non-material terms on behalf of the lending group. A majority or super-majority needed for material modifications including:       Forgiveness of interest or principal Extension of maturity or other payment dates Adjustment of voting requirements for admendments, waivers and responsive actions Release of collateral or guarantee Change in seniority or subordination Modification of mandatory redemption provision

Bond indentures     Voting levels are usually 100% for material changes and 50% for other amendments and waivers. Bondholder retains individual right to sue for payment of interest and principal when due Other rights including acceleration, subject to vote requiring minimum threshold (usually 25%), creates demand of action upon Trustee; acceleration makes notes immediately due and payable Restructure to avoid default and accerleration can often be effected in spite of non-compliant noteholders, through coercive tender offer.

Article 9: Guarantees Guarantee – Credit agreement guarantees vary in length from a few lines to many pages. When more than one guarantor guarantees an obligation the undertaking is generally expressed as “joint and several”. Each guarantor is independently obligated for the full amount. For JVs, it is not unusual for each JV partner to be severally obligated to its percentage ownership. Many guarantees state expressly that the guarantor is obligated to pay interest accruing on the loan after commencement of a bankruptcy or insolvency proceeding.

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Guarantees are almost always guarantees of payment rather than guaranteed of collection. In guarantee of payment, the guarantor becomes obligated to make the payment on the obligation. In guarantee of collection, the lender is required to exhaust all remedies before it can make a claim. Waivers – At common law, guarantors are favored over the beneficiaries of guarantees. Therefore, many credit agreements include waivers of common law defenses. Subrogation – When a guarantor pays off the lender, it assumes the obligation so the borrower now owes the guarantor. This is called subrogation and happens at the time of payment. Some credit agreements states subrogation happens only after the lender gets repaid. Reinstatement – Under bankruptcy code, if a borrower pays a lender within three months of bankruptcy, the bankrupt estate may be able to get that payment back. The credit agreement may state that the guarantor is reinstated if that were to happen. Guarantees can be 1) upstream (when a sub guarantees a parent), 2) Cross-stream (one sub guarantees another sub) or 3) downstream (when a parent guarantees a sub). For upstream guarantees, it could be challenged under fraudulent conveyance because the sub could be seen as insolvent at the time of the guarantee if the amount of the guarantee is greater than its book value. This is even more troublesome for foreign subs. Deemed dividends A loan to a US borrower that is guaranteed by a non-US subsidiary may raise the so called deemed dividend problem. Under section 956 of the US IRS code, a guarantee from a non-US subsidiary controlled by a US company is generally deemed to be a dividend by the subsidiary to its US parent of the earnings and profits of the subsidiary. As a consequence, most guarantees of debt of a US borrower are restricted to its US subsidiaries. The deemed dividend problem can also surface if a US borrower pledges the equity of a non-US subsidiary. A pledge of more than 66.67% of the total combined voting power of the non-US subsidiary is deemed to be a dividend to the same degree as a guarantee by the subsidiary. To avoid this, security agreements customarily limit the percentage of equity pledge to 65%. Also, customarily the carve out above 65 percent applies to all equity capital of the non-US subsidiary. See more on Guarantees Article 10: Miscellaneous Covenants There are two types of covenants:   Affirmative covenants Negative covenants

Affirmative covenants state what the borrower must do. Negative covenants state what the borrower may not do. Negative covenants usually include financial covenants that state the issuer cannot have a leverage ratio above a set limit or an interest coverage ratio below a set limit.

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Many credit agreements or indentures create a separate section or article for each category but frequently financial covenants are treated as negative covenants. In general, credit agreements are more strict than bond indentures, partly because it is easier to get a waiver on a credit agreement from a loan group. The purpose and goal of negative covenants are: A) Constrain the borrower – prohibit actions and activities detrimental to lenders B) Accelerate the debt, if all else fails – give the lenders ability to terminate committments and accelerate maturity of loans C) Must be realistic – what restrictions is the borrower capable of meeting in the ordinary course D) Must be flexible – give the borrower some wiggle room to reflect ordinary ups and downs E) Breaches must be material for lenders to act – immaterial breaches cannot be basis of material action by the lenders Subsidiaries The covenants in most credit agreements apply not only to the borrower but to the borrower and its subsidiaries, the theory being that the financial strength of the borrower is only as good as the strength of the entire group of companies of which the borrower is the parent. The company and its restricted subsidiaries are subject to the covenants, even if the company is the only signatory to the indenture.

In a credit agreement with both restricted and unrestricted subsidiaries, the restricted subsidiaries are subject to all of the representations, covenants and defaults, while unrestricted subsidiaries are typically subject to none of these. However, unrestricted subsidiary earnings are not used in the financial covenant calculations. To be unrestricted, a subsidiary may not have debt or other liabilities guaranteed in any way by the borrower. Similarly, the unrestricted subsidiary may not have any outstanding debt or other liabilities that will be accelerated upon a default under the credit agreement. Significant subsidiaries – any subsidiary that has 10 percent or more of the assets or 10 percent or more of the income of the borrower’s consolidated group. The insolvency of a subsidiary gives rise to an event of default only i f the subsidiary is significant. This is so that lenders need not be concerned about events at the borrower’s subsidiary unless it is significant.

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Affirmative covenants These are things the borrower must do to remain in compliance with the agreement. These could include filing quarterly and annual statement filings within a certain amount of days after a quarter or year end. It could also include maintaining property , holding insurance, buying interest rate protection to guard against swings in interest rates, and making sure that the use of proceeds of the loan be used for the purposes it specified. Negative covenants Negative covenants tell the borrower what it may not do. When looking at these limitations, it is important to look for carve-outs that permit the issuer to get past the limitation. Negative covenants can be grouped into two major categories:   Limitations on what the issuer can do Financial tests that the issuer must pass

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Limitation on indebtedness Purpose – prevents borrower from issuing excessive additional debt Permitted exceptions – examples 1) Existing debt 2) Intra-company debt 3) Purchased M&A debt 4) Debt to be refinanced – new debt permitted to refinance or replace existing debt 5) Ratio debt basket (more frequent in bond indentures) – permits additional debt as long as it meets debt incurrance tests 6) True baskets – permits the borrower to issue additional, “undedicated” debt. Typically dollar capped. Limitation on subsidiary debt The limitation on subsidiary debt is relevant in the absence of upstream guarantees and is an important constraint on consolidation leverage and subordination. In Moody’s view, there should be no borrowing unless it is permitted under the debt incurrence ratio test. See limitation on liens Limitations on liens/negative pledge Purpose- prohibits or limits debt/other obligations secured by collateral, which would improve other lenders prospects and recovery in default or insolvency Permited exceptions – examples 1) Pari passu/junior; intercreditor agreements allows limited secured debt with equal or junior claim to same assets. Intercreditor agreement governs inter-relationship of competing claims in same collateral. A negative pledge covenant prevents the issuer from raising secured debt unless it provides security “ratably”, thereby limiting subordination. Limitation on liens constrain a company’s ability to create secured debt ahead of the existing security. Carve-outs include 15% of net tangible assets or working capital, vendor financing, and bank debt. Negative Negative Pledge – limits the ability of a borrower to enter into negative pledges with third parties. The main reason why the lending syndicate wants a negative negative pledge is to ensure that the borrower is free to grant security to the syndicate in the future without having to obtain consent from any third party. Since a borrower can be expected to be subject to many lien restrictions in the ordinary course of its business, a negative negative pledge covenant normally contemplates a long list of exclusions. Limitations on asset sales Purpose – limits risk to lenders when the borrower shrinks

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Permitted exceptions – examples 1) Consolidation – goal is to get fair market value for assets sold and as much cash as possible 2) Application of proceeds – ideally term loans are prepaid out of asset sales proceeds Restrictions on asset sales should limit the issuer’s ability to sell an asset without using the proceeds to reduce debt or re-invest in the remaining operations, explicitly fixed assets. For re-investments, this covenant could require the proceeds be in cash or marketable securities until an investment can be found. Issuers are usually required to find an investment within 12 months (tight) or 12 to 24 months (loose). Typical conditions include 1) Cannot exceed $250m or 10% net tangible assets, whichever is greater 2) Assets to be sold at fair market value 3) 75% of proceeds in cash 4) Mandatory prepayments 5) Any sales above $20m needs to be aggregated into a total amount 6) Comply with financial covenants Limitation on sale/leaseback This restricts the issuer from selling assets and then leasing them back. Such a shift creates a debt burden in the form of leases, as well as increasing fixed charges and reducing the asset pool available to bondholders. Many sale/leaseback transactions occur when a company is in need of liquidity. Limitation on dividends/payments (restricted payments) Purpose – limits most problematic use of cash – payments OUT with little or no chance to recover Permitted exceptions – examples 1) Overhead/tax payments to parent – dividends to holding company-type parent to fund the parent’s ordinary expenses, pay taxes, etc 2) Regular dividends/interest on sub debt – addresses reality of paying dividends on public equity and servicing public debt 3) Special dividends – allows a sponsor to cash out its investment. Typically, when included, the principle purpose of the financing 4) Management fees – compensates sponsor for services, without doing an “end run” around general dividend restrictions A restricted payment covenant typically restricts an issuer’s ability to

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1. 2. 3. make distributions, whether in the form of cash, assets or securities repurchase equity or provide dividends to shareholders to redeem subordinated debt

The definition of a “restricted payment” should include all three of these payment and distribution categories. Such a covenant also constrains an issuer’s ability to make “restricted investments.” These are investments in “unrestricted subsidiaries” – that is, subsidiaries not subject to the indenture covenants (and thus not part of the indenture’s credit group) as well as other investments that are not permitted investments, such as joint ventures and minority investments. It is not typical for even the most restrictive covenants to absolutely forbid dividends, nor is this desirable. For low growth, high cash flow companies, an absolute prohibition on dividends may be impractical because issuing dividends may become more rational than reinvestment. Restricted payments covenants are typically crafted in two parts. The first is a general basket that usually builds as a percentage of consolidated net income of the issuer and its restricted subsidiaries. The second part of the covenant is a list of specific baskets for defined purposes and in specific amounts. The general basket is designed to be a function of a company’s profitability over the entire period since issuance of the bonds. It is cumulative and may be used for distributions subject to the absence of any pending event of default on the bonds and compliance with financial covenants. The general basket is the sum of a number of different components: one is 50% of consolidated net income minus 100% of consolidated net losses. Other typical components of the general basket are the following:     equity contributions conversions of debt to common stock the value or amount of investments in an entity that had been previously designated as an unrestricted subsidiary, but that has been re-designated as a restricted subsidiary the amount received from dispositions of other restricted investments tha are not “permitted investments’.

Common specific baskets include:    redemptions of subordinated debt out of proceeds from sale of equity employee stock purchases dividends.

Limitation on investments Purpose – protects lenders against imprudent investments Permitted exceptions – examples 1) Permitted acquisition – limits size, nature, financial impact and other characteristics/results of an acquisition. For example, pro-forma financials may have to meet a tougher standard, may have to be in the same line of business, may have to be in the US, etc 2) Build-up basket – rewards borrower for good operating results and othe rpositive events by permitting borrower to invest, spend, distribute cash. This is sometimes referred to as a “slush fund”. Borrowers would like the basket to be based on consolidated net income while lenders would like the basket to be based on excess cash flow.

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This is the covenant that gets the most discretion and flexibility. Permitted acquisitions are heavily negotiated. Limitations on pre-payments of debt Purpose – middle ground between investments and restricted payments. Allows limited prepayments on debt below lenders. Balances excessive outflows of cash against reduction in debt service costs. Permitted exceptions – examples 1) “Equal fo equal” or ‘junior for senior” – refinancing that does not improve the position of refinanced debt 2) Special financing – when included, often primary purpose od lenders loans. Akin to a special dividend Restrictions on mergers/sales of all or most assets Merger restrictions intend to limit an issuer’s ability to substantially merger or consol idate with another corporation or sell most of its assets. Currently, this covenant rarely offers significant protection because of large carve-outs and important exceptions. The prohibition usually does not apply if the surviving corporation assumes the debt and there is no immediate event of default. While the actual percentage that equals substantially all is subjective it has been addressed in case law and can be triggered at less than 90% and is likely to be more than 50%. Limitations on transactions with affiliates Purpose – protects lenders against “sweetheart” deals, which disproportionately benefits affiliates and disproportionately penalizes borrower (and therefore lenders) Permitted exceptions – examples 1) Arm’s length – affiliates do not exploit their control over borrower 2) Board approval/fairness opinion – blessing from disinterested persons Limitations on being acquired (change of control) A change of control is designed to protect bondholders most directly from leveraged buyouts as well as from other situations where a change in ownership could damage credit quality. The covenant generally gives bondholders the opportunity to put their bonds back to the issuer upon a change of control at 100% or 101%. Bond indentures usually allow this as long as there is no default, the acquirer is a US entity, and the survivor assumes all indentures. Other common Limitations could include guarantees, capital expenditures, contingent obligations and several others. Limitation on layering (anti-layering) This clause prevents the isuer from layering debt between the senior and subordinated debt. It is only used in senior subordinate deals to ensure that subordinated debt occupies the second class slot (and not the third or fourth). Financial covenants

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Definitions of Debt and EBITDA will vary by indenture/credit agreement because these definitions are negotiated. For debt, the definition could be total debt, net debt, secured debt or another variation. EBITDA is typically Consolidated net income plus interest, taxes, depreciation and amortization but could include other add backs. LBO sponsors often will have cure rights to put in cash that could make the company comply with financial covenants. Incurrence test Most often seen in bond indentures, an incurrence test is a one-time restriction. A debt covenant that is an incurrence test might state that a company is prohibited from borrowing or issuing debt securities if the ratio of debt to EBITDA exceeds 5.00 to 1. The most common are fixed charge coverage ratio and leverage ratio. Within that constraint, the company can take on debt without limit. But if it borrows up to the maximum permitted amount and in subsequent fiscal periods EBITDA declines sharply, so that the new ratio is 20 to 1, it would not be in default; the covenant is tested only when new debt is take on and not continually. The purpose of the ratio test is to allow the company to incur more debt as the credit improves. Maintenance test A maintenance covenant would mandate that the ratio of debt to EBITDA be maintained so that it never exceeds an agreed level. If EBITDA plummets the borrower would be in default regardless of whether this is the result of a voluntary action on its part. There are three types of financial covenants.    Date specific (net worth or current ratio covenant) Performance over one or more fiscal periods (fixed charge or interest coverage covenant) Hybrid of date specific and performance (debt ratio)

Date specific covenants are typically balance sheet related and therefore are not performance related. The other two are performance covenants that generally detect deteriorations in credit quality sooner than capital covenants because they are based on current performance ratios rather than the stock of past profits and net capital contributions. Date specific covenants Net worth The excess of the borrower’s assets over its liabilities. More often, the definition is built up from paid in capital and retained earnings less treasury stock. The covenant prevents the borrower from paying a large dividend to its shareholders that has the effect of reducing its capital below the agreed number. Tangible net worth Measures only tangible assets – tangible liabilities. This ratio is more often used. Leverage ratio Ratio of total liabilities to tangible net worth. The objective is to test whether the borrower has sufficient equity capital to support the liabilities carried on the balance sheet. Although at one time the leverage ratio was popular, it

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
is used less frequently today since most lenders believe a debt ratio covenant that measures debt to EBITDA is a more accurate predictor of future performance. Current Ratio and Working Capital The purpose is to ensure that the borrower has sufficient liquid assets to cover liabilities that will come due in the next 12 months. Current ratio =current assets/current liabilities. Working capital = current assets – current liabilities. An agreement rarely has both covenants and the frequency of those covenants has declined considerably in recent years as lenders focus increasingly upon a borrower’s cash flow rather than assets. Performance based financial covenants Interest coverage ratio (EBITDA/Interest expense) This ratio is designed to ensure that the borrower has sufficient available cash to pay interest on its outstanding debt. Interest expense is normally defined to include only cash interest ; pay in kind interest and capitalized interest charges are excluded. Also, interest expense reflects interest hedging. Fixed Charges Coverage Ratio (EBITDA/Debt Service + Cap ex + taxes + preferred dividends). The purpose is to test the ability of the borrower to generate sufficient cash during a period to service all of its non-operating cash needs during the period. Hybrid financial covenants Debt Ratio (Debt/EBITDA) Debt ratios measures the firm’s ability to repay debt. Events of Default Default of payment For credit agreements, a default in the payment of interest often enjoys a grace period of 2 to 3 business days. In contrast to credit agreements, the typical bond indenture has a payment-default grace period (whether for principal or interest) of 30 days. The longer grace period for bonds reflects the practical reality that, if a default occurs, there is greater difficulty in first locating and then obtaining waivers from a disparate and anonymous bondholder group than from lenders under a credit agreement. Inaccuracy of representations Whenever a representation proves to have been false in any material aspect, it constitutes an event of default. Bond indentures rarely include a default based on a breach of representations. Bond indentures are always accompanied by a detailed offering circular and bonds are a security for SEC purposes. A bank information memorandum tends to be much less detailed and normally provides only high level view of the borrower. Breach of covenants Bond indentures usually have 30 or 60 day grace periods and require that notice be given before the grace period commences. There are no immediate events of default based on covenant breaches. There is no uniform approach to credit agreements. It could be immediate while others require notice.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Cross default The cross default is one of the most misunderstood provisions but also one of the most powerful. Borrowers have 3 concerns 1) borrower has credit related problems 2) risk of other debt being accelerated 3) borrower can get a waiver from other lenders or restructure to disadvantage other creditors such as granting collateral security. Cross default refers more accurately to a provision that allows the credit agreement to be accelerated whenever a default or event of default occurs in another instrument, whether or not the debt under that other instrument has been or may be accelerated. Judgment default Texaco in 1984 faced a $11B judgment against it for allegedly interfering with Pennziol’s acquisition of Getty Oil. Texaco, which thought it had good grounds to appeal, could not obtain a bond of that size without breaching its debt agreements. It was forced to file for bankruptcy to gain the benefit o f the Bankruptcy Code’s automatic stay and thereby capture the time it needed to appeal. In the end, after a four year saga that included its filing for bankruptcy, Texaco settled with Pennzoil for $3B. Change of control In contrast to bond indentures, in which changes of control are almost universally mandatory redemption or repurchase events, credit agreements often treat a change of control as a default rather than as a mandatory redemption or repurchase events, credit agreements often treat a change of control as a default rather than as a mandatory prepayment. Material Adverse Change In rare cases, particularly in asset based lending transactions, a credit agreement includes an event of default upon a MAC. Remedies When an event of default occurs, lenders are faced with difficult choices. The best course of action may not be to force a default but to renegotiation terms. Subordination Analysis A very important concept of credit analysis is subordination. Subordination is always:   With respect to some issue In relation to some other item in the capital structure

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Two types of subordination

Contractual Subordination Contractual subordination indicates an explicit agreement from the subordinated debt holders that more senior debt does exist or may exist. This can be achieved either though an indenture or an inter-creditor deed that governs priority of claims. Two basic forms of contractual subordination   Subordination in assets – or liquidation preference Subordination in right of payment (venture lenders, z tranche bonds)

First-out provisions: Debt (usually working capital revolver financing) having priority payment position in documented Application of Funds of credit agreements; first receipt of all distributions in bankruptcy, including post-petition interest, even though pari-passu in seniority to long-term debt with respect to asset claims. E.g. Telcordia – senior secured notes = B2, senior secured first-out revolver = Ba1. Subordination in assets recognizes that the holders of more senior debt would recover more in the event of a default. There is a hierarchy of debt in a capital structure that looks similar to the following:

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas

Subordination in right of payment is considered a going-concern subordination, which says that holders of subordinated debt will be paid interest only after the holders of more senior debt have been paid. They cannot call a default until more senior debt holders have been repaid. Various mechanisms exist to defer interest payments on the outstanding debt in the event of nonpayment. Security Security/liens grant a creditor the right to sell the secured assets and be repaid from the sale proceeds. If all the shares of a company are pledged as security, this also provides a mechanism by which the secured creditor can sell the company outright. Bank loans are usually secured by assets while corporate bonds are typically unsecured although some are secured on s second lien basis (behind bank debt). Structural Subordination In a corporate structure with a holding company and subsidiaries where each entity has its own balance sheet with its own debt, investors need to be able to differentiate where in the structure the debt lies and what assets it has claims on. In a holding company/subsidiary structure, the holding company owns the equity of the subsidiaries and therefore has the lowest claim on the subsidiary assets behind the debt of he subsidiary. For example, in a bankruptcy, debt of subsidiary A would have senior claims of the assets of subsidiary A. There is a question of whether upstream guarantees or inter-company loans stand up in bankruptcy court. A judge could enforce equity subordination in these cases and rule that the actions are not legal. Guarantees

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Issuers are conscious of structural subordination issues and the additional funding costs that come with them. Some market participants have developed structures that may mitigate or even cancel out the subordination. These include upstream guarantees and inter-company loans.      A guarantee is a commitment (usually by a subsidiary or parent) to meet an obligation, if that obligation cannot be met by the debtor. A guarantee can be secured, senior, sr subordinated, unsubordinated A guarantee is effectively a security, which allows the bondholder to claim directly against the guarantor entity Operating company guarantees are effective because they enable the creditor of a holding company to claim against a company, or group of companies, with assets that could be sold to satisfy the claim Guarantees are usually “joint and several”, meaning th at each guarantor is liable for the full amount of the obligation it guarantees; however; Sometimes local law requires guarantee amounts to be capped (corporate benefit). In Europe, senior banks usually require that guarantees (if any) fall away upon certain events or default scenarios, thereby allowing the sale of the business free and clear of outstanding debt.

With an upstream guarantee, the OpCo acts as a guarantor to the Holdco. In the event of a default, the assets of both the Holdco and the OpCo would probably be lumped together to satisfy both the guarantor and the beneficiary. As a result of the guarantee, the debt obligations of both entities would share the same level of seniority and would rank pari passu. The pari passu clause is very common in credit agreements of all kinds and simply indicated that there is no subordination of any type between two classes of debt. For various reasons, firms with international operations tend to incur debt locally. In order to mitigate structural subordination, the foreign subs will guarantee the debt of the holding company on a senior basis. Inter-company loans Another way of overcoming structural subordination involves the use of inter-company loans from the Holdco to the OpCo. When the Holdco extends a loan to the OpCo, it becomes both a creditor and a shareholder of the OpCo. This loan could also rank pari passu with other obligations of the subsidiary, thereby eliminating structural risk. Contractual versus Structural Contractual subordination implies a seat at the table for all creditors at that company. In the event of a restructuring, highly negotiated position between banks, bondholders and equity. In the event of a sale of assets/liquidation/sale of company, the courts usually allocate proceeds according to priority. Structural subordination implies no seat at the table for subordinated creditors (creditors of a different company). Structurally senior bank debt has a clear preference. In the event of a restructuring, the negotiations could be between the bondholders and the equity as long as the bank debt is un-impaired. In the event of a sale of assets, proceeds will flow to bondholders only after the banks have been paid out, either through loans or through equity. The following chart shows the typical investment grade and high yield corporate structures.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas

When a company loses an investment grade rating or becomes distresssed, creditors try to act in the following manner: Banks      Get closer to the assets Desire for security Desire for guarantees Refinance senior to bondholders Forced asset sales vs protracted negotiations

Bondholders    Maintain status quo Threaten acceleration/liquidation Lawsuits/injunctions

While the company that is in distress tried to go the following:      Maintain liquidity Avoid insolvency other than in US Keep banks unsecured if possible Drawdown facilities to create “cash hoard” Asset sales

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
 Protect shareholders and/or creditors

Security Interests Creditors are secured when they benefit from security or collateral in support of a debt instrument. There is usually a separate Security Agreement that stipulates the exact collateral backing the debt. Types of Collateral Financial Cash/bank accounts – The most liquid form of collateral. Traded securities – Very liquid if investments are short-term fixed income instruments. Receivables – Generally liquid because of their self-liquidating nature. Analysts must consider the quality of the receivables. Physical Inventories – Less liquid form of collateral. Finished stocks and raw materials should be differentiated. Equipment – Less liquid form of collateral. Includes a wide range of assets. Intangibles Rights and patents – Less liquid for of collateral. Could include copyrights for print, music, and images and patents for pharmacveuticals, technology, etc. Contracts and concessions – Less liquid for of collateral. Include business agreements, contracts, etc. Intangible assets – Least liquid form of collateral. Include goodwill and brands. Granting and Perfecting Collateral Borrowers and creditors need to document by contract that the security interest was created and granted to the secured counterparty, normally a financial institution, or a trustee, collateral agent, depository, or fiduciary. In the offering circular, the description of the securities should include the word “secured.” There should be a “granting” clause in the clauses that start with whereas in Recitals. There should be a separate security agreement in addition to the offering circular and indenture. Perfection of Collateral Creditors must verify that the borrower has stated that the beneficiary of the collateral has prior rights to the pledged collateral. An interest in a real estate property is recorded with the Registrar of Deeds in the US.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Financial assets are perfected by contract, which will confirm the identity of the ultimate beneficiary of such assets. Because contracts remain a private nature, it will be difficult for creditors to be absolutely certain that there will be no competing claims Terms of the Loan This section include the amount of the facility as well as the amount of each tranche of the facility. If a facility has a revolving credit and a term loan, it has 2 tranches. It will also include the amortization schedule of the facility, the amount of letters of credit that are permitted to issue and other items. The most important parts here are the mandatory and voluntary prepayments. The mandatory section will state whether the issuer has to pay back the loan if it sells assets for cash, issues equity, or has excess cash flow. Interest rate Most commonly, the interest rate under a credit agreement will be floating and normally is expressed as the sum of 1) base component that is reset from time to time (LIBOR or prime) and 2) a margin (spread) that is either fixed or subject to change based on pre-agreed criteria. Applicable margin – the applicable margin for LIBOR loans is always higher than the applicable margin for base rate (prime) loans in order to bring the two rates closer to parity. The difference has historically been 100 basis points. The spread may be dependent on the credit rating and/or a financial test of the borrower. There rates are set forth in the credit agreement in the form of a grid that varies by type of loan. When grid pricing is based on leverage, the relevant date on which to test leverage is usually the end of the borrower’s most recent fiscal quarter. However, changes do not take place at the end of the quarter but rather when they borrower delivers to the administrative agent financial information. Fees Commitment fee – compensation for the lenders contractual commitments to make loans. Typicaly, they are charged on revolving credit commitments, usually based on the daily average of the unused portion of each lender’s outstanding revolving credit commitment. The rate is either flat or subject to grid pricing. Facility fee – based on both used and unused commitments. Commitment fees and facility fees are mutually exclusive – the same revolving credit facility would not provide for both. Utilization fee – additional fee if utilization is higher than a specified level. Letter of credit fee – fee paid to the letter of credit issuer to compensate for additional risk in case one of the other lenders in the group fails to meet its obligation. Breakfunding clause – If the lender suffers a loss due to a borrower repaying the loan in the middle of an interest period or asking for a loan but does not draw it down. Amortization and Maturity Payments

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Credit agreements stipulate that loans must be advanced to the borrower (and payments to the lenders) in funds that are immediately available. Payment by check is generally not in immediately available funds. Real time funding can be accomplished by 1) For advances of funds to the borrower, the lenders normally send money through the Federal Reserve’s wire transfer system to the administrative agent. 2) Payments by a borrower to the lenders are effected in the same way if funds come to the administrative agent from another bank. More frequently, the borrower maintains a deposit account at the administrative agent and instructs the agent to debit the account in the required amount whenever payment is to be made. Time of payment Credit agreements almost uniformly require that payments be made by a particular time on a specified date. Under New York Law, if a payment is due on a day that is not a business day, then the due date is automatically extended to the next succeeding business day, but no interest is payable for the period of the extension. Accordion feature To confuse things, bankers also use the term accordion to describe a quite different feature whereby the maturity date for a loan is advanced because of an intervening bond maturity or other event. Lenders might want a borrower to refinance a subordinated debt that is due before the maturity of the loan. TO ensure that the borrower completes the refinancing in a timely fashion, the credit agreement may provide that, if the bonds are outstanding on the agreed date, the maturity date for the loans is automatically advanced to that date. 364 day facilities One type of loan commitment is entitled to reduced capital requirements (for a bank)- loans with commitment of less than one year. Therefore banks would rather make a 364 day loan to the borrower. Repayment Credit agreements with limited exceptions, do not restrict prepayments or impose prepayment premiums. The ability to repay a loan facility is one of the big advantages of credit agreements over bond indentures. In the case of the prepayment of a loan that is otherwise payable in installments, the prepayment provision addresses how the prepayment is to be applied to the installments. Mandatory prepayments Clean downs – In a revolving credit facility, a clean down requirement forces the borrower, typically for a period of 30 days, during each calendar year, to have no outstanding under the revolving credit commitments. This type of mandatory prepayment requirement is customarily applied to a borrower with a seasonal business. Borrowing base – this is the amount of collateral backing the loan. For highly leverages borrowers, the syndicate may want to implement a borrowing base structure in which the availability of loans is tied to an agreed valuation of the collateral security. Borrowing bases are used primarily in “asset backed” transactions. Normally, the credit facility is secured by the assets including accounts receivables and inventory. The borrowing base is usually calculated as the sum of an agreed percentage (the advance rate) of each class of assets included in the collateral security. When the borrowing base declines, part of the loan must be repaid. Asset sales sweep – Depending on the strength of the borrower’s credit, lenders can be sensitive to a borrower’s sale of assets, particularly if the sale is material. Usually the credit agreement will give a specified time period for the borrower to reinvest those funds.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Casualty events – A casualty event is akin to an involuntary sale of an asset 1) Act of God – a factory burns down 2) condemnation – government act. Equity or debt issuance sweep – issuance of equity is rarely restricted by the covenants in a credit agreement. In contrast, issuance of additional debt is routinely constrained by debt covenants or leverage ratios. However, mandatory repayments from equity or debt issues are common. The login is that any cash coming in should go to repay the loans. Since the lenders always view the credit agreement as sitting at the top of the capital food chain, they expect the loans to have first claim on that unexpected cash. Some credit agreements are bridge facilities, which is to say that the borrowing of the loans is an interim measure bridging to a more permanent issuance of debt or equity. In this circumstance, the mandatory prepayment is simply designed to ensure that the credit facility functions as a short term agreement. Equity carve outs are often seen where only a portion of the proceeds of the issuance is applied to the prepayment of the loans. Excess cash sweep – the prepayment provision typically stipulates that some percentage of the borrower’s excess cash flow for an agreed accounting period is applied to prepay outstanding term loans. Change of control – One of the fundamental principles of sound banking is the know your customer rule. This principle is the genesis of the change of control provision. The credit agreement customarily provides that all term loans must be paid in full before any reduction of the revolving credit commitments occurs. Convertible Topics Convert New Issue Analysis Convertible bonds new issues usually drive-by deals whereas most new high yield and loan issues go through a 1-2 week road show. This is becuase a large part of a convertible bond’s valuation is equity and requires less credit/indenture analysis. Most convertible bonds do not have financial covenants. Once a deal is announced, investors have a short amount of time (usually 1 day or less) to perform a quick and dirty analysis on the deal. Daiwa does a good job of this type of analysis and I have documented most of it here. Exceptions are clearly stated. 04-11-13 RTI International Metals (RTI) $250m (+37.5m) sen unsec cb coming tonight from BARC/CITI. Terms: 6.5 yrs, 1.625%-2.125% up 30-35%, pctns. UOP = gcp/cap ex/potential 3% buy back. Existing 3% trades rich 2 model due to outright ownership. -2.8% up 32% @116 vs cls = L+165 (30%), theo=110.65. Small but solid B credit w/good liquidity. Aerospace = 55% of rev w/exp growth this yr (demand for fuel efficient aircraft), defense= 20% rev which has some political risk. 3yr $150m undrawn sec/rev = L+200, we’d use L+400 for 6.5 yr. ADV = 315k so hard to realize vol, no leaps, brw a ? on way down, we’ll cap vol at 30. Theo = 104.3. History does repeat itself in our market so look at 3%. Clear l/only demand, stk -5%. This is a STEEL. Producer of titanium mill products, fabricated titanium and specialty metal components. RTI is a small titanium producer w/customers in aerospace, defense, energy, & medical device markets. Acq Rennele 2/12 for $183m cash, provider of eng service to same sectors, will provide some diversification. Aerospace 55% of rev, expect growth 2013 driven by demand for fuel-efficient aircraft. Defense about 20% revenues, some risk of cuts via sequestration. Liquidity good w/$150m secured rev undrawn (L+200, matures 2/17)

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Our assigned spread L+400 At the mids, L+600, 35v, 50bps borrow, new issue models 1.5-2pts cheap. RTI primarily a metals processor, so we compared it to KALU, X, DCO (specialty aerospace materials), ATI, and AA. Both X and AA are vertically integrated in steel and aluminum, so companies reflect commensurately higher leverage and earnings volatility. Meanwhile, pro forma leverage looks to be 33% of total cap, 1x LTM EBITDA, assuming no immediate buyback of 2015 converts. For comparison, other materials processors (KALU, ATI, DCO) average 39% debt/debt+mkt cap, 3x LTM EBITDA. Business profile should position company well for growth as overall industrial economy improves. Our only complaint is that company not a great cash generator and apparently has no cost pass-through on its long-term supply contracts, which could result in periodic risk to operating margin. Over time, we’d like to see co. look to build some add’l cash balances to hedge this risk. However, in the meantime, our credit estimate builds in some compensation for this potential volatility. 04-04-13 Colony Capital (CLNY) $150m (22.5m) sen unsec cb coming tonight from GS/MER. Terms: 10y 4.75-5.25% up 10-15%, s/c 7y @1120% (cpn/make whole), full pctns. UOP = acq. Quasi reverse enquiry w/ xover but we’ll still run exercise. Commercial RE inv REIT w/small subsidiary specializing in single family rental market. $143m undrawn sec/bank loan amended in Sept @ L+375, expires 8/13 (converts into 1y loan). PF Cash = 548m (232m raised in 01/13 stock replacement), LTM ebitda = 79m, fcf = 71m, lev = 3.3x. We’d assume L+500. ADV = 450k, no leaps, we’d cap 10 yr vol at 20%. Theo = 101.2 w/oput stock down. Stk down to $21 = 100. Hearing STWD type investor interest who know sector will. Little pressure on stock given small h/f allocations, small deal – skewed by demand and not valuation. We’ll leave it to the experts. 04-03-13 LINTA (TWX/TWC) $825m sen unsec exch coming tonight from BNP/MER. Terms: 30 yr, 0.5-0.75% up 10%, s/c 5-10 yr @120%, put & h/call 10 yr, full dvd p/thru. UOP = retire some 3.125% 21. Theory vs. reality: exchangeable w/zero ring fense so don’t use standard model (tail risk = credit in bankruptcy w/parity @ 120) –ve basis in str8/cds mkt but 10y CDS indicated 350, we’ll cap vol at 20%. T heo = 99. Now to reality: 3.25% (cpn + pass thru) up 10% @par in media space which is sparse w/obvious index inclusion = attractive to long only (despite 84 SBV). At this pt in cycle, mkt will assume table dvi 4 10 yrs (try reducing p/thru over 10y in model), zero default risk. The purpose here is highlight theory vs reality = this is not model cheap but profile/history gets it done. 03-20-13 US Steel (X) $250m (37.5m) sen cb coming tonight from JPM/NARC/GS/MS. Terms: 6yr, 2.5-3 up 27.5-32.5, nc-4, prov call @130% after, full pctns. UOP = repay debt/gcp. Concurrent $250m 8y str8 del. Co’s recovery very gradual. Exposed to fluctuation in US & Euro markets. Imports from china have increased, putting pressure on other markets. However, liquidity NOT an issue at moment. We’re aware of where existing straights trade but with 6yr CDS 680/720, we’ll use L+700. 90d 50/10 ile, vol = 49.7/40.2. 2 yr 90d real = 36.5. We’ll use 35. Stk brw -1.5%. Theo = 97.75. Stock has been beaten up and slow to bounce. X4 traded rich for a long time, so no reason this won’t as well. Need to see o/r demand in order to make this work bc even on cheaps, this certainly not a STEEL. Integrated steel producer X has seen gradual improvement last few years. Have benefited from improvement in auto industrial and strong demand for oil country tubular goods. But steel market conditions remain depressed w/global econ cond remaining challenging & cont oversupply. Slowing growth in China has led to mfgs to ship more to the US, adding to the

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
oversupply issues. Industry cond remain fragile. Liquidity is good w/full $875m secured rev available, $625m A?R sec facility avail, & $300m of European credit fac available. Our assigned spread L+700 03/12/13 iStar (SFI) On the mids, we think customers should consider buying the new SFI preferred deal. With no common dividend, the yearly cash flow is quite substantial and more than compensates for the premium. The positive cash flow also allows for heavy delta which handles the credit risk. We think there may be room for this security to trade up particularly as customers are still starved for yield. 03-12-13 Salesforce.com (CRM) $1b (+150m) sen unsec cb coming Tue night from MS/BOAML. Terms: 5yr, 0-0.25% up 47-52%, full pctns. UOP note hedge/acq/gcp. CB shud appeal to o/r’s with HF struggling with mode & optics. 6x leverage. Olds came 0.75 up 25 for $500m deal, we used 250/32 then, now we’ll use 200/30 (some suggest 150/32) Theo = 98.01. Stock on high, +149% from last issue. Apart from lousy optics, model that struggles, no obvious equity switch and low coupon, it’s great. You’ll hear index, technicals (so much IG rolls off next 6 months), o/r wall of money, quasi IG, PCLN precedent, etc . Should be cheaps but balanced (48% delta & 87.2 floor) so don’t let model Cramp your style. Customer relationship management application via the internet or cloud. CRM offerings include sales, service, marketing & salesforce platform for apps. They sell globally to cos of all sizes w/70% rev from Americas, 18% Europe, & 12% A?P, strong growth w/rev up 35% yoy driven by acq. Compl 8 acq FY13 w/$580m cash, Buddy largest to date $73m ($498m cash). Significant cash and FCF provide liquidity. More acq to come. Possible patent infringement litigation adds uncertainty. Our assigned spread L+200 03-12-13 Iconix (ICON) :**** DAIWA NEW ISSUE COLOR: ICON ********************* $350m (+50m) sen sub cb coming tonite from BARC.Terms:5y,1¼-1¾up 27½-32½%, full pctns. UOP=$75m stk buyback/hedge/acq/gcp.Co owns/manages 20 brands, most recently acquiring Umbro from Nike in 12/12 for $225m. Solid credit; low capex, high margin, strong c/flow & good liq (600m t/loan in 12/12, undrawn 100m revolver & 150m sec rev due 11/13). See CREDIT COLOR. Existing pari 2.5% CB came 05/11 2.5% up 32.5% w/stk 20cents away ($23.21). These are ~108.5 w/42% premo & x/par +71% (O/R’s clearly like this name). We’d assume L+400 & 28vol (2yr 90d 10/50%ile still 24/41 despite recent dampened vol.ADV=684k).Theo=100.2/102.2/104.2.We’d prefer 2 WEAR this on MIDS but again at mercy of l/only demand.Balanced CB’s on good credits harder 2 find in 2cndry >BUY<(Cofiling/bbg) Brand management co w/20 brands including Candie’s, Mudd, Joe Boxer, London Fog, OP, Voyal Velvet, & Sharper Image Icon owns & manages brands. Biz has limited assets & not cap intensive. Licensing model benefits from predictable royalty inc, high margins, & strong FCF. Co acq w/most recent Umbro from Nike for $225m cash. $600m sec term loan issued 12/12 + $100m var funding revolver (undrawn currently) avail. Add’l liqui dity from $150m sec rev due 11/13. Both converts senior sub & rank behind other debt. Buying back stock.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Our assigned spread L+400 03-11-13 Blucora (BCOR) $150m (22.5m) sen unsec cb coming tonight from MER. Terms: 6yr, 4-4.5% up 35-40%, H/C 4 yrs, no puts, full pctns. UOP = acq/gcp ¾ of FY12 rev came from google (search engine advertising) so co wants to diversify going forward (bought Tax Act in 2012). We’d assume B rating and L+600. ADV = 337, no leps, 2yr 90d 10/50ile = 34/42, we’d discount to 35 vol. Th eo = 102.75. Another very doable small deal but we do not like hard call component. 675m mkt cap/low ADV/v tight credit mkt = model trap 4 h/fs. Nice coupon vs zero div so may see some x/over demand. Have seen a lot of recent value destruction w/skewed demand in order books. This one not so obvious but mkt wants credit. Internet search business & online tax preparation business (formerly Infospace) BCOR is on a mission to expand beyond their search business. Early 2012 they acq Tax act for $288m cash, using avail cash and bank line. Bank line has $10m rev (nothing currently out) & $74m remaining on term loan due 2017 (L+300 to 450, secured by tax biz). Tax biz very seasonal, but profitable, 15% of HY 12 rev. Search biz growing, but hightly concentrated with Google accounting for 77% of FY12 revenue. Looking for add’l tech or internet related acq. Approved $50m stock buyback last month L+600 03-06-13 Invesco Mortgage Capital (IVR) $250m (+37.5m) sen unsec cb coming tonight from CS. Terms: 5yr, 5-5.5% up 10-15%, full pctns. UOP = acq assets/maintain REIT status. Portfolio = 20/80 commercial/residential (res 50:50 agency: non agency) Housing recovery has increased IVRs demand 4 riskier non agency. PF Debt = skewed by s/term repurchase agreements (cb only 1/term debt), cash = 889m, LTM ebitda = 574m, FCF = 428m. We’d assume B+ & L+500 ADV = 1.6m, no leaps, 2yr 90d 10/50 ile = 18/25, we’ll cap @20%. Theo = 101.25. Long only demand for res/mortgage exposure is trumping any valuation call. Any recent mortgage related name has traded to fv and thru: RDN, RWT, MHO, STWD, BKCC. This I am sure will follow suit but at some point this greater fool game will end and we do not want to be holding the keys. IVR invests in both agency and non agency RMBS and CMBS. Have been shifting assets to non-agency from agency in recent quarters. As market fundamentals improve in housing market they expect trend to continue. CMBS also growing. YE12 agency accounted for 49% of equity, non-agency 29%, CMBS 21% – compared to 52%, 27% & 19% prev year. Inv port grew from $14B to $18B yoy. Proceeds from Jan equity offering & conv will fund add’l growth. Convert only long term debt, everything else short term repo agreements. L+500 02-26-13 Radian (RDN) $200m (+30m) sen unsec cb coming weds from MS/GS. Terms: 6yr, 3-3.5% up 25-30%, 4yr s/c @130%, pctns. Concurrent 30m (+4.5m) stock offering UOP=gcp. Stk up 4x since 05/12 low, 5yr CDS 2300 bp tighter (150bp on last night’s announcement) & existing 3% cb up 1.5 pts (2.9% up 54% x/par +65%, using L+500/7 5bp brw 33iv). Co has done a good job pushing out maturities (leaves only $55m due 2015 b4 existing CB (see credit color). 5yr CDS 530/560 & 6yr CDS 545/585. Brw is off top (-0.5 to -1 range) w/expectation that placement will help ADV=4.2m, no leaps, 2 yr 50/10ile = 64/42 however unless you set up vs. CDS (esp given move) we are going to cap vol at 35%, use L+585 & 75bp brw. Theo = 107.5/105.5 mid/rich. Cheap no question Given move some CDS protection is advisable however BUY

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
* Leading provider of private mortgage insurance. * Gradual housing mkt recovery & reduced FHA competing insurance is +ve for mort insurers, but mkt remains difficult. Losses expected to continue as they work thru legacy book. RDN has been focused on preserving cap & pushing out debt maturities. All ’13 debt repaid. Exch offer on ’15 debt has pushed most out to ’17, leaving only $55mm due in ’15. Proceeds from conv & stk offering provide liquidity to fund new biz & provide add’l cap to subs if risk-to-cap ratios require injection. * Our assigned spread —>L+600<— Src: Co Filings, Bloomberg 02-20-13 Post (POST) $175m (26.25m) pep/prfd coming tonight from MS/WFC/CS. Terms: 3.75-4.25% up 20-25%, s/c 5yr @130%, Partial pctns. UOP = repay t/loan & gcp. This one we do not get; Perp pfd w/poor t/over pctn, static b/even > call & withholding tax issues (will not be listed). 7.375% 22 str8 OAS 410 (credit color to follow). We’ll use L+625 (1.5x) ADV = meager 245k, no leaps, 2y 90d50/10 ile = 31/24. We’ll cap vol at 22 given structure & no adv. Theo = 103.5. Model schmodel, try monetizing the vol. To upside, would need to run theo light 2 get b/e b4 call & will trade badly to a material downside move. One positive = right sector which may bring the long only’s 2 the table (excuse the pun). We don’t like too much hair in our cereal, so we’d AVOID unless cheaps. 02-20-13 Forstar (FOR) $110 (+15m) sen unsec cb coming Wednesday from GS. Terms: 7y 3.5-4% up 32.5-7.5%, full pctns. UOP = repay line of credit/gcp, Co tried coming to market in June 2011 w/concurrent HY deal. HY deal struggled and both deals got pulled. CB terms on mids in 2011 were 3.75% up 25, now 3.75 up 35. Co recently amended rev and term loan (9/12) @ L+400. We’ll use L+700 for unsecured CBs. 2 yr 50/10 ile real vol = 37.8/31.4. No leaps, ADV = 144k. We’ll discount to 27 vol. Theo = 102.125. Once again, a small deal that serves as enhanced equity trade w/possible xover interest. As has been the case with these small deals, it will get done, but we’d prefer to buy on mids or better. Real estate invest inc single-family res lots & mixed use comm., oil & gas e&p, and fiber resources Involves in 3 different biz, real estate 69% of revenues followed byoil & ga 26%, & fiber 5%. All biz neg impacted by downturn, but have improved more recently. R/E primarily TX and Atlanta. Acq Credo Petrol in Sept for $155m cash, boost oil exposure to 57% of proved res. YE est proved res of 5.6mm boe. Also acquired r/e projects. Amended rev/term loan 9/12, secured paying L+400. $200m revolver now fully available boosting liquidity. Our assigned spread = L+700 02-13-13 Blackrock Kelso Capital (BKCC) $100m sen unsec cb coming overnight from CS/CITI/MER/DB. Terms: 5y 4.625-5.125% up 10-15%, full pctns. UOP = repay debt/gcp. Will be relatively quick: positives = potential BBB- rating, yield scramble will mean long only bond funds who can’t buy 9% up 0% stock will buy 4.875% up 12.5% w/theo SBV of 97.5 (PSEC/ARCC/STWD/NLY all cash in point), small issue (key is be small w/good long only demand or hit the $500m index inclusion threshold). Negative = not cheap in model (L=475/17vol/stock unch = 99/100.4/101). STWD surprised us today by magnitude of move (+1.5 points o/swap) demonstrating again that the model is increasingly academic within this tape. We know this will get done & most likely off the CHEAP end but we’d avoid unless on cheaps. Blackrock Kelso Capital (BKCC) announced an overnight $100mm 5yr senior convert. Px talk 4 5/8- 5 1/8s up 1015. BKCC is structured as a business development company. Without putting a lot of reliance on the underlying

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Blackrock name, bond pricing looks aggressive. Using L+600 at mid-range of px talk, bonds imply 23% vol, which puts it square on top of 180d and 260d realized vols. Using L+600/18v, bonds model to a TV of 97. Compare with ARCC ($6bn AUM) 2018 notes at L+450/23 impl vol, PSEC ($3bn AUM) 2019s at L+600/18 IV and recent TICC ($538mm AUM) 2017 deal which priced L+850/18.5 IV. For this deal to be worth more than par at the mids, you need to believe credit is L+450 (18v), in line w/ ARCC, which is 5x bigger. Common stock pays a 9.8% dividend and stock is valued in line w/ comps at 1.1x 2013E book value. Company has 6.5% senior secured notes outstanding, issued in 2011, though no pricing is available on those, though we note that BB-rated credit has tightened a net 50bps since Jan 2011, while BBB- credit has remained flat. Purely on the numbers, we would put fair value on the credit in range of L+600-625, reflecting its rather small portfolio size ($1.1bn) and $385mm of secured debt and bank loans ahead of the proposed converts. That said, we concede convert size is small. If portfolio value drops 30% (currenty booked at avg of 102% of face), converts should still be covered by just over 3.5x net of secured debt, which should provide a reasonable margin of safety for bondholders. BKCC’s portfolio composition consists of 75% senior secured loans and 2/3 of the portfolio was underwritten in 2010-2011. While we cannot speak directly to the margin of safety of these loans given a resumption of loan term slippage since 2010, at the very least it should reduce the near term risk of reduced income from loans being refinanced at lower rates. Avg portfolio yield was 12.2% at 3Q12, consisting of 11.6% on the senior secured loan book and 13.5% on all other loans and debt. Company’s funds $310mm via its TL and revolver at L+300 -325bps and has $175mm of sr sec’d notes at ~6.5%. At 3Q12, its largest industry exposures were to Personal Services (ex. fitness) at 12.5%, Healthcare (12%), Business Services (10.2%) and Manufacturing (10.1%). Avg exposure size is $21.6mm, with largest exposure of $50mm and top 5 exposures representing 21% of the portfolio. 02-11-13 Starwood Financial (STWD) ***************** DAIWA NEW ISSUE COLOR: STWD ****************** $450m (+67.5m) sen unsec cb coming tonight from DB/BOA/C/CS/GS. TERMS:5y, 4.15-4.65% up 10%, full pctns. UOP=origination/purch of commercial mort. loans/gcp/potential funding of LNR purchase. STWD originates and invests in commercial mort. loans&other comm. real estate investments. LNR acq. should help compliment biz, but they are taking on ~70bn in assets via acq. We’ll use L+475. 2y, 50/10%ile real vol=17.9/14.6. We’ll use 15. Theo=97 15/16/98⅞ / 99⅝. If shoe exercised, could go into o/r index (sigh). Why own this @ 4.4 up 10% when you could own IG-rated PSEC 5.8 up 8? We see Grey, but this deal dooesn’t do it for us. If you feel compelled to own, push for CHEAPS. Calendar warmin g up, might be better to come. Unless cheap, we’d AVOID {SRCE:bbg & Co.Filings) **** STWD New Deal Summary **** Announcing a $450mm 5-yr bullet senior convert. Px talk 4.15-4.65s up 10%. Proceeds to be used to fund LNR Property acquisition and/or investme nt in additional comm’l RE loans. STWD currently manages $3.8bn of assets, including $3.5bn of earning assets, funded via $1.4bn of secured debt. Assets This will be co’s first unsecured debt. Co. is structured as a REIT, so can use SFI, NLY and NRF as comps. SFI 5yr CDS currently 500bps, NLY models around L+400/24v and NRF around L+850/15v. Credit spread of L+500 implies 12.6vol. L+500/15v indicates FV of 101.67. While STWD does own a decent chunk of subordinated and mezz exposure, the balance sheet is less levered vs. its peers (unencumbered assets ~3.3x converts vs. SFI at 1.5x and NRF at 3.5x). Largest sector concentration is hospitality sector at 49%, followed by office properties at 18%. Geographically, portfolio is 26% exposed to the Western US, while Northeast represents 20% and the South 18%. Portfolio consists of 78% whole loans and 24.5%

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
in CMB and RMB securities. Loan book is a barbell of 51% first mortgage loans and 32% mezz debt (B-Notes), with the balance in sub notes. For the LTM, net investment totaled $1.4bn, primarily new whole loans. For the LTM, portfolio generated $265mm of NOI, or an asset yield of 7.6%. Dividend yield on the stock is 6.8% vs. 12% for NLY and 7.8% for NRF. Stock priced at 1.3x 2014 consensus book value vs. 1.1x for NRF, 0.9x for NLY, and 1.1x for SFI. 02-11-13 Molina (MOH) New issue color: Molina (MOH) $325m (50m) sen unsec cb coming tonight from JPM/MER. Terms: 7 yr 1.125-1.625% up 27.5-32.5%, full protections. UOP hedge/$50m stock buy back/CB repurchase. $1.4B Medicaid player which w/benefit from rev growth & Medicaid expansion going forward. Finally seeing rate increases in TX, CA, FL , MI which was reflected in a much better Q4 LTM EBITDA = 114m, FCF = 266m, PF Cash = 1.364B, debt = 562m. We’d assume B+ & L+500. ADV = 734k, no leaps, 2y 90d 50/10ile = 54/36%, we’d assume 33% for 7 yr paper (3.75% CB in 1 pt today, using L+200 = 35 iv). Theo = 102.3. The recent trend of lone VWAPs at maturity continues with 80 days here (no obvious benefit to anyone so why?) Right sector, right $ px, obv o/r demand which will skew pricing. Would prefer mids but then woke up, don’t miss, BUY. Medicaid related health plans in CA, FL, MI, NM, OH, TX, UT Also provide business proc, IT and admin to states Narrow focus on Medicaid plans. FY12 difficult yr/with issues in TX and CA but have recently received rate incr in both along with FL and MI. Co should benefit from Medicaid expansion over next few years. Have won several new contracts in recent months. Expect significant rev growth over the next few years. Liquidity okay w/$160m available on rev after paydown w/prcceeds (sec L+250). Funding cuts and reimbursement rate compression are key risks. L+500 01-24-13 Molycorp (MCP) ———-> Daiwa New Issue Credit Color: Molycorp <———— * Owner/operator of world’s largest rare earth deposit outside China. * Liquidity concerns are back as co announced 1H13 rev & cf much lower than exp due to delays in ramping Ph I prod at Mountain Pass & continued weak pricing for rare earth elements. Expect 6 mth delay in prod ramp & will need add’l cap-ex funding. Co estimates short ~$250mm. Liquidity still looks tight after stk & convert offering. Significant execution & integration risks remain. Converts rank behind $650mm senior secured notes. * Our assigned spread —>L+1400<— Src: Bloomberg, Co Filings Molycorp MCP, our HY analyst/desk remains negative…. equity/convert offering due to co announcing that 4Q results below expectations, 1H13 production will be less than expected, and capex programs over budget. $300MM capital raise will just about cover $250MM expected cash shortfall in 2013, but recall co did big capital raise in August to “cover shortfall” and that didn’t happen – things have just gotten worse since then, CEO blown out and co under SEC investigation. We think the company looking to raise equity when the price is close to an all-time low is a not a great sign. We remain negative on name.

73

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
01-23-13 KB Homes (KBH) ******************** DAIWA NEW ISSUE COLOR: KBH **************** $150m (+17.5m) sen unsec cb coming tonite from CITI/CS/MER/DB. Terms: 6y, 1⅜-1⅞% up 45-50%, NC 5.75yrs, full pctns. Concrnt $100m (+15m) stk plcmnt.UOP=gcp.TOL & MTH came 09/12. TOL ½% up 50% (better credit) & MTH 1⅞% up 47½% (good comp w/CITI lead left as well).Stk +158% from 06/12 low w/5y CDS ~390 & 7y ~450. We’d use L+415 for 6y. ADV=6m, 01/15 60d calls ~38-43, w/out CDS how well does 1⅝ up 47½% on a $1.4bn home builder hold on way down? We’ll use 35%. Theo=97½/99½/101½.Like MTH, a model trap unless u set up vs CDS. Right $px (only MTH/TOL ~par) & will do ok whilst mkt believes in housing recovery (MTH +4pt o/swap from 09/12). We DO NOT want to be long w/out CDS if/when music stops Optic rich/model fair. AVOID unless CHEAP (bbg/co filing KBH New Issue Color- Buy it for a flip The optics of the bond aren’t great. Low coupon and high premium but that’s what we’ve come to expect in the homebuilder space. The bond doesn’t model that cheaply either. Around 35.5 on the mids puts it right in line with SPF and more expensive than TOL, RYL and LEN. Arguably KBH is a more volatile stock, (more like SPF), but with credit roughly double the other homebuilders, this is less likely than others to hold in a downturn (if it comes). Also homebuilder vol is currently declining and some of the other names are under pressure. And vol names in general are under pressure. All that being said, homebuilders bonds have done well on issue and given the small deal size, we suspect that this won’t be an exception. But it’s not an attractive long -term hold. 01-17-13 Theravance (THRX) DAIWA NEW ISSUE COLOR: THRX $250m (+37.5m) sub cb cmoing tonight from MER. Terms: 10y,2-2½% up 27½-32½%, full pctns. UOP=GSK milestone payments/repay debt 05/13=FDA approval on Relvar/Breo, filed for approval on Anoro (both respiratory drugs & partnered w/Glaxo). 3rd GSK partnered drug P3 in ’13. Others in Pipeline=5xP2 & 2xP1. Pari 3% cb ~L210 (35vol) w/1.7y exp life. We’d use L+650 (see CREDIT COLOR). 10y sub cb on a CCC credit w/low SBV would normally signal trouble on a large move lower but for Glaxo’s 27% stake.This is why we’d use 35 vs 30vol 4 model.Brw=50bp.Theo=97½/100¼/103⅛ Enhanced eqty yield trade, not a hedge trade. We like story but structure does not take our breath away. Understanding eqty x/over demand is key. We’d only play at CHEAP w/out them (Co filing/bbg) * Biotech focus on respiratory, bacterial infections, & central nervous system/pain. * THRX filed for FDA approval of 2 drugs Relvar/Breo & Anoro, both COPD (respiratory) treatments partnered with GSK. Expect to hear from FDA in May on first. Would receive royalty on sales. Third GSK partnered drug to start P3 this yr. Pipeline incl 5 other P2 drugs & 2 P1 drugs. Astellas term agreement early ’12, looking at options for Vibativ (inject antibiotic). Two converts are the only debt & both are subordinated. * Our assigned spread —>L+650<— Src: Bloomberg, Co Filings

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
01-16-13 Pacira Pharma (PCRX) PCRX $100m (+110m) sen unsec cb coming tonight from Jeff/Barc. Terms: 6 yr, 3.504% up 27.5-32.5%, 4y s/call@130%, full pctns. UOP=repay sec-facility/fund Exparel. Another enchanced equity play, this time a $600m mkt cap pain mgmt pharma. Co has 1 large drug = Exparel (post surgical mgt) which is the play here. Launched 04/12 it has potential to reach 40m patients & looking 4 a European partner (see credit color). We’ll assume CCC & L+700. ADV= 252k, no leaps but we all know this is not a model trade. We’ll cap vol at 35%, use 2% borrow 2 model just as a sanity check. Theo = 103.3 This has been pre-placed so when you add the obv x/over interest do not expect too much. NUMB yourself for small allocations. BUY Specialty Pharmaceutical company focused on hospital based products for pain management Small pharma w/one marketed product Exparel (post-surgical pain management). Launched 4/12 in the US w/sales slowly ramping. Large market opportunity with 40m potential patients. Looking for an EU partner. Recently signed partnership w/Aratana for animal health. Proceeds will repay 9.75% secured bank loan entered in 2012 & provide additional funding for Exparel ramp incl new manufacturing facility maybe online 4Q13. Pipeline is 2 P2 Exparel trials for nerve block. Our assigned spread L+700 01-15-13 Intermune (ITMN) ****************** DAIWA NEW ISSUE COLOR: ITMN ***************** $85m (+12.75m) sen unsec cb coming tonight from GS/JPM. Terms: 5y, 3⅛-3⅝% up 25-30%, 2.5y S/C @ 130%. Cncrnt 12.5m (+1.875m) stk deal. UOP=repay 5% cb/fund Ascend trial/gcp. $660m mkt cap 1 drug Biotech focussing on pulmonolgy/fibrotic diseases. It’s Esbriet drug is in PIII within US, already used in 10 countries, expected to be in another 6 in ’13 (See CREDIT COLOR). Estimated US launch in ’15 & expected to be a blockbuster. $554m PF cash will help burn until launch. We’d use L+750. ADV=403k, no leaps, we’ll default to our 35vol cap. Theo=102/103.8/104.6. Small deal w/a very interesting equity/credit story. Expect equity x/over interest & those playing stk post placement. If you expect big a llocations, don’t hold your breath. >BUY< (bbg/Co filing) ———> Daiwa New Issue Credit Color: Intermune <———— * Biotech focused on pulmonology and fibrotic diseases. * PF Cash LTM FCF $554mm PF Debt $325mm LTM EBITDA $(176)mm $660mm

$(175)mm Yrs Cash 3.2yrs Mkt Cap

* ITMN has launched Esbriet (IPF treatment) in 9 EU countries & recently in Canada. Expect to launch in Spain & Italy & 4 smaller EU countries this yr. Co nducting 3′rd P3 trial in US, expect results 1H14. Possibly on US mkt ’15 w/potential to be blockbuster in a few yrs. Currently, nothing competing on mkt, but HIH & Boehringer Ingelheim are both conducting P3 trials on treatments, w/ results also expected 2014. Significant cash will cover burn for a few yrs. No other pipeline.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
* Our assigned spread —>L+750<— Src: Bloomberg, Co Filings 01-10-13 Silver Standard (SSRI) Silver Standard (SSRI) $200m (30m) sen unsec cb coming tonight from CITI. Terms: 20 yr, 2.875-3.375% up 37.5-42.5%, puts 7,10,15 s/call 5 yr @130% (m/whole), h/call 7 yr, full pctns. UOP=repay 4.5% cb & gcp. Silver miner w/1 producing mine in Argentina & developmental projects in Mexico & Peru. We’d assume CCC+ & L+700, ADV = 242k, v low OI in LEAPS. Not a vol trade again so we’ll use model as a sanity check. Using 700/35 vol = 100/102.1/104.4 Model output disappointing but the equity/credit story is unique being the only silver play in market. There will be domestic & equity interest which will skew pricing. We like story as well. Push for mids or better Canadian silver miner w/Pirquitas mone in Argentina & dev stage properties in Mexico and peru Piraquitas mine in argentina prod at stable level & generating EBITDA, however mine life < 7 years is short. Proved reserves at FY11 were 58.3m oz silver versus FY12 prod of 8.6m oz. Dev proj in MX (Pitarrilla) promising w/478mm oz prob reserves but nothing proven & it will take years & lots of cash to dev. Dev proj in Peru (San Luis) is quite small currently. Converts are only debt. Cash will fund dev for a while but more needed. L+700 01-09-13 Arcelor Mittal (MT) $1.75B mando sub notes (MCN) coming tonight from GS/Boa/DB. Terms: 3yr, 5.875-6.375% up 20-25%, protected for all divs. Concurrent $1.75B stk placement. L+450 (Euro entity), 2 skew (36/38), 30 bp brw US mando space is depleted. Total mkt cap 19.5B with 8B rolling off in 2013 alone. Within this low rate paradigm, despite being sub, 6% up on sen BB+ credit will still be attractive to market. Not directly comparable to VW given rating but this is a BUY 12-17-12 Prospect Capital (PSEC) $200m (30m) sen unsec cb coming tonight from GS Terms: 01/19 5.875% up 15% (at par) 97.25-07.75 reoffer. Full pctns, UOP = gc/inv profile. Deal 5 in its financial engineering program. 6.25% 107 x/par +12%, 5.5% 102.5 & x/par +19%, 5.375% 102.5 x/par 9.5%, 5.75% 100.75 x/par +14% (came 8/12 @97.75 & struggled initially). We saw CO 12/05 & will send credit color shortly. We’d assume L+625 for 6 yr. All deals have transferre d over to O/R ownership over time incl the recent 5.75%. BRW off top, we’ll use 75bp (delta small so not a big effect) & cap vol @20%, O/R interest will determine stk pressure. Stk -2.5%/5% theo = 97.3/96.88. Not cheap but other 4 have o/r fan club tho may take time to find Boring we’d prefer sub 97.25 Mkt cap = 2.283B Co has been aggressively growing their portfolio & indicated they had many deals to close near term. Funding growth thru combo of equity (share count +54% since June) & debt. Bank line renegotiated March, secured, paying L+275, entire $517m available. > 75% of investments are secured debt (senior and sub) & co has good record. Converts pari with other senior notes. Significant unemcumbered assets provides flexibility Our assigned spread L+625

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
12/14/12 Ares Commercial Re (ACRE) Announcing $50mm of 3yr senior convertible notes. A 10% allocation is earmarked to go to management of the company. Px talk is 7s up 15 at the mids. Very limited borrow on the stock and and company pays a div yield of 6.17%. Looking at the Mortgage REIT convert landscape, we would comp ACRE tighter vs. NRF (+850), but wider to SFI (+400 3yr CDS). Using borrow cost of 2pts and L+750-800 implies vols of 12-14. At L+750/12 vol, TV is 100. Working in favor of the credit is sho rt maturity on the notes, the company’s relatively clean balance sheet and a lack of legacy CRE assets, so could make an argument for L+650-700, which would model at +2pts. ACRE is a commercial REIT formed in Dec 2011 and IPO’ed in May 2012. ACRE is manage d by Ares Management LLC, also the manager of ARCC. Total assets at 3Q12 were $220mm, including $190.5mm BV of real estate loans. Total equity was $167mm and liabilities include $48.8mm of secured revolving credit borrowings. Ostensibly, the proceeds of the convert will go to refresh some of the revolver capacity. Company’s focus appears to be on cash flow lending to mid-market real estate borrowers. Products include “transitional” renovation and enhancement loans, “stretch” senior loans, which typically have higher LTVs vs traditional CRE loans, and subordinated/mez-type structures, including B-notes. Current book includes a heavy mix of apartment collateral in secondary markets (Miami, Denver, Austin, etc). Also has a handful of small office building loans in Boston, Miami, Atlanta and Fort Lauderdale. 12/6/12 Epay (EPAY) $150m (+22.5m) sen unsec cb coming thur night from RBC/RBS, terms : 5yr 1.25-1.75% up 27.5-32.5% full pctns. UOP = gcp/hedge. Biz is growing and co. recently raised rev + eps guidance. PF Cash = $253m, PF Debt = $150m, Lev = 5.7x, LTM FCF = $32m Co has solid liquidity from cash & +FCF. We’ll use L+500. 2yr 90d realized vol = 46. ADV = 200k. Can make argumkent for higher, but we’ll cap vol at 33. Theo = 103.5. There may be some concern over secondary liquidity but improving credit story, small deal size and pre-marketed (we hear) all signal success in mkt starving for balanced paper like this. As the captain says, “the bottom line is” you want to be involved. BUY

Cloud-based payment, invoice and document management solution for corp, fin inst, banks. Small s/w co serving 3 markets: legal spend management, commercial banking, b to b electronic settlement. Benefits from transition to elec-based processes from paper. Has been making small acq to grow biz, recently Intuit’s comm. Bank biz for $20m & Albany software for $32m w/more acq expected. Biz growing & co recentl raised FY13 rev & eps guidance. Recurring rev makes up 71% No revolver, but cash & +FCF provide liquidity. Our assigned apread L+500 UBS *** EPAY New Deal Commentary **** Announces a $150mm senior convert, with talk at 1 1/4 – 3/4 up 27.5-32.5%. Use of proceeds to fund working capital and potential acquisitions. Looks like decent edge in the pricing for credit, no borrow issues and we’re told deal was mainly pre-sounded. Not much in the way of comps out there, but we looked to TRAK at L+475 area, DLLR at ~L+800, and TIBX at L+450 as small/mid-cap convert technology comps geared toward more transactional infrastructure business. Using L+600 implies 31vol in the model and L+650/35 vol (conservative vs. what we’re hearing on guidance) models to a TV of 104.5. Both realized and option vols are in the low/mid 40s, so vol looks reasonably cheap here, too. Co. provides payment, invoice, and document automation services via “the Cloud” (what we used to call the Internet). Primary industry focus is financial services and legal billing.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Fundamentally, an increasing amount of revenue being derived from subscriptions and transactions, but co. also gets a lot from service and maintenance on existing clients. Growth strategy is likely to be centered around smaller, bolton acquisitions going forward. Meanwhile, organic growth has been running at 8-10% recently. Profit margins are decent at a 50-55% gross margin and EBITDA margins around 15%. Company also has been generating positive FCF. Cash at fiscal 1Q13 was $107mm. In the market with a $150mm senior convert; px talk at 1 1/4 – 3/4 up 27.5-32.5%. Use of proceeds to fund working capital and potential acquisitions. Looks like decent edge in the pricing for credit, no borrow issues and we’re told deal was mainly pre-sounded. Not much in the way of comps out there, but we looked to TRAK at L+475-500 area, DLLR at ~L+800, and TIBX at L+450 as small/mid-cap convert technology comps geared toward more transactional infrastructure business. Using L+600 implies 31vol in the model and L+650/35 vol (conservative vs. what we’re hearing on guidance) models to a TV of 103.4. Both realized and option vols are in th e low/mid 40s, so vol looks reasonably cheap here, too. 12/5/12 Seacor (CKH) $350m (52.5m) sen unsec cb coming Tues night from JPM/GS Terms: 5y, 1.75-2.25% up 22.5-27.5%, partial happy meal. Full pctns. UOP = note hedge/buyback up to 50m 2.875% CB/acq/gcp. LTM EBITDA = $47m Although lev high (8.8x), ebitda expected to double over next two years, bringing lev down to more reasonable levels. Pre-deal announcement, existing 2.875% trade L+200 for 3 years. We’ll conservatively use L+500 for 5 year. 90d hist vol last 2 yrs =30, we’ll use that. Theo = 105.5. Hard not to like +equity story and improving credit profile in this sector. Could see an eruption of interest from a wider audience than 1 st deal. Be weary of reprice, but make this a core position. 12/04/12 Volcano (VOLC) $350m (52.5m) sen unsec cb coming Tues night from JPM/GS Terms: 5y, 1.75-2.25% up 22.5-27.5%, partial happy meal. Full pctns. UOP = note hedge/buyback up to 50m 2.875% CB/acq/gcp. LTM EBITDA = $47m Although lev high (8.8x), ebitda expected to double over next two years, bringing lev down to more reasonable levels. Pre-deal announcement, existing 2.875% trade L+200 for 3 years. We’ll conservatively use L+500 for 5 year. 90d hist vol last 2 yrs =30, we’ll use that. Theo = 105.5. Hard not to like +equity story and improving credit profile in this sector. Could see an eruption of interest from a wider audience than 1 st deal. Be weary of reprice, but make this a core position. 11/28/12 Meritor (MTOR)

$150m (22.5m) sen unsec cb coming tonight from BNP/UBS/JPM/RBS. Terms: 14.5 yr, 7.5-8% up 156%, IP=90, put/call 8, full pctns. UOP = repay debt/gcp. 1:1 tender: issue of new cb (co has tripped loan covenant, has to reduce $150m 8.125% str8 & $200m 4.625% cb). Tender/new issue not contingent for holders (ie independent books) but new issue is contingent upon successful tender. 4.625% w/03-16 put ~88 pre-event ~L+825, 10 yr CDS ~24 pts = L+1000, we’ll use L+1000 4 new CB. We’d obv use higher vol if u lock into option w/CDS, o/wise obv discount for a $375m mkt cap (ADC = 1.45m). We’ll use 35%. Theo = 92.24. Let’s say you do hedge w/CDS 45 vol = 96.75 (assumes CDS is deep/reliable enough 2 rehedge on way down). Not an 8yr credit we like PLUS not CHEAP enough. AVOID

78

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
11/20/12 Encore Capital (ECPG) $100m (+15m) sen unsec cb coming tonight from MS. Terms: 5yr, 2-25 up 25-30%, full pctns. HAPPY MEAL UOP = $25m buyback/cb hedge/repay debt. Yet another stk+dividend CB play best suited to equity holders. $660 mkt cap portfolio manager of defaulted consumer loan & property liens. Acq TX based Propel for $186m cash in 05/12 to enter prop/tax lien market. All debt is secured & ahead of CB & ranges between L+250 & 375 4 both entities (see credit color). We’ll use 800 for 5yr sen unsec. ADV = 136k, no leaps, s/term pick up in vol but again, try realizing >30 vol on low ADV & downside. Not model trade, it is a directional equity/x/over, not cheap otherwise. We’ll default on this one. If u play, CHEAPs only. Core business is defaulted consumer loans. Existed bankruptcy servicing mkt in May. Entered TX property tax lien mkt w/Propel acq in May $186m cash. All other debt is secured. New corp bank fac announced. $575m secured due 15/17 +$200m accord, L+250-300, tighter than prior. Propel has $160m fac due 2015, paying L+300-375. $75m secured notes due 2017/2019. Authorized $50m stock buyback, will use $25m of proceeds. L+800 11/15/12 AK Steel $125m (+18.75m) sen unsec cb coming tomorrow night from JPM/CS. Terms: 7 yr, 5.25-5.75 up 27.5-32.5, full pctns. Concurrent 25, stock & $350m 6 yr sen sec str8. UOP = repay asset backed debt/gcp. 7.625% 20 OAS about 920, 5yr CDS indicated 1030. We’ll assume B, L+1000. ADV = 1.2m Leaps illiguid, 2 yr 90d 50/10% = 58/44. Brw ~2% (2ndary will help so will use blended 1.5%). Another EQTY+DIV CB so again model really is a sanity check. Brw+credit = -ve gamma/convexity so we will cap vol at 35%. Theo = 103.9/106.1/108.3. Equity HDS + obvious equity switch + potential stock bounce off placement (stock already down 14%) + tight allocations means anything off rich end will be a STEEL. However much you vary the inputs (to a pt) this deal is CHEAP. 11/7/12 iStar (SFI) $100m (+15m) sen unsec cb coming tonight from ML/BARC/JPM. Terms 4yr, 3-3.5% up 37.5-42.5%, full pctns. Concurrent $250m 6yr str8. UOP = repay 6.5/8.625% str8. Illiquid 5.85% 17 OAS ~576bp, 5.875% 16 OAS ~460bp, 5yr CDS ~525, we’ll use L+500. Small 685 mkt cap, ADV = 760k, means we’ll discount vol to 25% & use 50bp brw. Theo: 99.9/101.4/102.9. If you think we should be using higher vol assumption then 28 vol/50bp brw=104.6 on cheaps. It’s the only way we could make it work for a hedger (monetizing close to 30 vol on a 775k ADV is difficult), Counter argument = small deal, may be some equity & o/r interest but optics are not great, model fairish which does not offset optics. Not for us. If play, wish upon istar comes cheap. 10/16/12 Walter Investment Management (WAC) 10/16/12 WAC $265m (+25m) sen sub cb coming weds from CS/MS/MER/BARC. Terms: 7 yr, 4.5-5% up 35%-40%, full pctns. Concurrent 4.5m (+675k) stk offer UOP = acq/repay second lien debt. Stk +132% since 05/12 & @highest pt > 2007 housing crash, issuing down cap/structure to refi makes obv sense 4 co. Current debt secured ($2.2B mortgage backed & $728m t/loan). CB will take out $265m 2 nd lien loan (rated B, L+1100, entered into 07/11). Co wants to refi L+625 1st lien loan as well 7yr this far down cap/structure = CCC & L+1000. ADV = 220k, 50% go to H/F ~8d vol needs 2 be shorted (80d), -ve gamma obvious reality, 90d 50/90 ile = 39/30. Equity + div so model 2ndry. We’ll use 32%. Theo 102.3. Stk +130% = can’t rely on placement bounce esp w/shorting pressure. Too Wacky. Avoid. 10/11/12 Stillwater Mining (SWC) 10/11/12 SWC

79

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
$300m (+45m) sen unsec cb coming tonight from CS/WFC. Terms: 20 yr 1.75-2.25% up 47.5-52.5% (hyper), 7 yr full pctns. UOP=repay 1.875% cb/gcp. $1.4B mkt cap palladium and platinum miner. Bought marathon in 2010 (sold 25% to Mitsubishi) & will need $500m in funding to YE16, bought Altar in 2011 & will need much more capital (see Credit Color). We’d assume B & L+650. ADV = 2.35m, 01/14 & 01/15 leaps > 50iv, 2yr 90d 10/50ile = 48/56%. Hyper delta ~105 provides pctn on way down which negates a lot of –ve gamma w/weaker credits (default 2 zero = 21). Tough call btw 35 or 40 vol assump tion so we’ll use both risky vs bond+option on a 7yr hyper is material so beware (we use blended). 40 evol theo = 107.6. 35evol = 103.1. Lots of variables but one thing is clear – BUY Palladium & platinum miner producing mines in Montana & properties in Canada & Argentina Small US prod of palladium & platinum and recycler of platinum group metals. Auto is primary end market. Plans to diversify. Purchased Marathon, PGM/copper dev proj in Canada in late 2010 & Altar, copper/gold dev Argentina proj, in 2011. Both will need significant dev& capex. Sold 25% marathon to Mitsubishi for $95m 1Q12, will need add’l $400-$500m thru 2016 & much more for Altar. FCF to turn negative & will need more funding. Our assigned spread L+650 10/03/12 Ares Capital (ARCC) 10/03/12 ARCC $200m ($30m) sen unsec cb coming tonight from JPM/GS/DB. Terms: 5.25y, 4.25-4.75 up 17.5-22.5, full pctns. UOP=repay dbt/gcp. 4th sequel in ARCC w/progressively worse cpns; 5.75% +17.5% in 01/11, 5.125% +17.5% in 03/11 & then 4.875% +17.5% in 03/12. Interestingly, all 3 priced off a 16c stk range over 14m period. They have done ok but 5.75% due 2 $575m size (index inclusion & o/r sponshopship) has outperformed. New paradigm = 1 big deal performs better than 3 small serials. 4.875% tap would be better for market but you are up against very efficient financial engineering (co wants 2 swap sen4sub & push out maturities) 4 model, L+475/20 vol. Theo = 99.25. We want new issues, get them in the system but @ moment we prefer more liquid 5.75/5.125. AVOID 10/01/12 Wellpoint (WLP) 10/01/12 Wellpoint (WLP) $1.35B (+150m) sen unsec cb coming tomorrow from CS/MER/UBS. Terms: 30 yr, 2.5-3% up 20-25%, s/c 10 yr @150%, full pctns. UOP = gcp/stk buyback/debt repayment. Happy Meal. After ~950B of str8 IG issuance ytd, we get a shot. Recent A- (S&P) 4.65% ’43 str8 z-spread ~200 (UOP=AGP acq), 7 yr CDS ~155 we’d use L+200 for 30 yr. 01/14 72.5c=26iv bid/same delta=30iv bid. 2 yr 90d 10/50 ile = 20.9/26.3. This is 30 vol, we’d discount to 22 evol. Theo = 103.5. 2013 = big IG roll off, investors need paper eap balanced and around par. Not an obv equity switch (2% up zero vs 2.75% up 22%), not hugely cheap in model ( 3 pts over 30 yrs?) however pure supply/demand technicals will trump all doubts. We’d prefer MIDS but hard to fi ght IG technical. BUY 9/24/12 GTAT 9/24/12 GTAT $175m (15%) sen unsec cb coming tonight from UBS/MER/CS. Terms: 5yr, 3-3.5% up 25-30%, full pctns. UOP = hedge/gcp. Interesting equity story w/the replacement of glass w/sapphire on smart phones/tablets. Cash will be used 2 continue its diversification from solar (45% of CY12 sales coming from LED). We see credit as CCC. PF cash = 502m, debt = 320m, LTM ebitda = 247, fcf -44m. We’d assume L+800. ADV = 730k, no leaps. Sounds like a broken record but model should be used as secondary tool. Volatile stock but attach credit option = -ve gamma/brw issues on a material move lower. We’d cap vol at 35. Brw = 1% (will get better so we’ll use blended 75bps). Theo = 104.3. There may be equity x/over interest, we like story, profile. Like GTAT on Mids.

80

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
GTAT 100% in solar market as recently as CY10. Have been working to diversify & expect 45% CY 12 sales to come from LED. Focused on add’l opportunities for sapphire, virtually shatter proof. Price reduction make it affordable option for smart phones, tablets, and devices. Solar market is weak and diversification will take time. Outstanding debt is $145m secured term loan. $175m rev available. Cash will be used for acq and expansion. Our assigned spread L+800 nvertible bonds including credit analysis, indenture analysis and convertible arbitrage trade ideas. 9/19/12 XPO Logistics (XPO) 9/19/12 XPO Logistics (XPO)

$100m (+15m) sen unsec cb coming tonight from MS/DB/JEF. Terms: 5yr, 4-4.5% up 20-25%, s/c 4yr @130% (m/whole prem), full pctns. UOP = gcp/acq. Bradley Jacob’s equity play (who consolidated waste mgmt & equipment rental industries in 90s). He invested in XPO in 4Q11, currently owns 52% & did a $137m secondary stk offering in 03/12. Plans are to aggressively grow thru a cq/cold starts so more funding will be required. We’d assume CCC+ & L+750. Will say it yet again, this eqty w/div so model is redundant. Brw is v v thin, small @1.5% fee. Anyone owning the stock will want to own CB, anyone wanting to own either will be Jac ob believers. If you don’t believe then get sense of book. Full of long only then play for flip tomorrow. XPO undergoing transformation after $72m inv by Brad Jacobs in 2011. Mr Jacobs is founder of United Waste & United Rentals & 2 other prior ventures. Excellent track record consolidating highly fragmented ind. XPO newest venture. He controls ~52% of stock. Plans significant growth thru acq, cold starts (new locations), & new tech platform. Secondary stock offer brought in $137m earlier this yr. Together w/convert proceeds have funding for the near term, but more will be needed. L+750 9/18/12 Ctrip.com (CTRP) 9/18/12 Ctrip.com (CTRP) $140m (+20m) sen unsec cb coming overnight from JPM. Terms: 5yr, 0-1% up 10-15%, 3yr put, full pctns. UOP=hedge/gcp. Btw reverse merger mess (SDTH, CMED, AOB, TRE, etc) & the performance of HMIN on way down (another Chinese cb into adr) this is a hard sell. Don’t get us wrong, this is a legitimate business like HMIN but you are long equity with no recovery (Cayman listing w/assets in China) 50% hedge then 3m shares needed to hedge (65d), so brw already is off top (we were using -1% blend) & would get worse on way down. How would you define a credit w/zero recovery so we won’t use model +ve = co is buying $40m but not obvious equ ity switch. (low coupon). We need paper but this one is too risky for us. Equity guys may play but a rough hedge set up. 9/18/12 TICC Capital (TICC) $100m (+15m) sen unsec cb coming tonight from BARC. Terms: 5yr, 7-7.5% up 10-15%, full pctns. UOP = gcp/sfv investment. Small $440m tech BDC w/$439 total inv (70% sen/sec, 29% CLO debt/eqty). LTM ebitda = 28, fcf = 38m, PF cash = 256m, debt 321m. Larger PSEC & AINV = comps (although both rated). 5yr PSEC 6.375% L+550, 6 yr 5.75% L+590 & AINV 5.75% L+430 (using 20 vol). We’ll use L+750 for TICC. No gamma in sector & even worse w/TICC as ADV = 95k. Saying this a lot w/these small deals of late; this is not a model trade but we’ll run it anyway. We’ll use 20% & blend 1% brw. Theo = 102.7. PSEC came +10% & xpar +8% & 9% respectively. ARCC & AINV = sector favs with o/r’s Small deal helps but we like PSEC & ARCCC more. AVOID

81

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Very small biz dev co. Investment total $439m & concentrated in tech co. Nearly 70% of portfolio is senior secured debt. Issued $33m of stock & closed $120m CLO trans recently. Together with convert proceeds, added liquidity will allow expansion of portfolio. Rest of debt is a $101m CLO done in 8/11. Have no revolver & debt is not rated. Pay large dividend to maintain RIC status. Our assigned spread L+750 9/12/12 Jarden (JAH) 9/12/12 Jarden (JAH) $450m (50m) sen sub cb coming tonight from BARC/JPM. Terms: 6y, 1.875 up 27.5-32.5. UOP=gcp and share buyback. Happy meal. CEO has SPAC history so savvy (1.875 on 6y sen sub w/credit tight/stk high & levering co to buyback stk all proof). Pari 7.5% 20 OAS = L+310 & 7.5% 17 z-spread = L+320. 02/12 sec t/loan negotiated @ L+300 but credit has rallied a lot. We’ll use L+375. ADV = low 200k 2 yr 90d 50/10 ile = 25/22. We’ll use 20%. Theo = not model cheap but let’s not fool ourselves; try finding a balanced consumer goods cb w/30% prem in mkt. Not about theo value, it is about owning stk w/div. New primary paradigm = closing your eyes as a h/fund watching fair go rich. RISK = if/when credit turns u will get hurt 6y L+375 on B credit w/200k ADV does not hold. 9/12/12 Meritage Homes (MTH) 9/12/12 Meritage Homes (MTH) $100m (15m) sen cb coming tonight from CITI/JPM/DB/BOA. Terms 20 yr 1.375-1.875% up 47.5-52.5%, 5 yr put call. UOP = gcp. Homebuilders in 2012 = REITs in 2007 (the more allocated the more resistance & the more we hear –ve basis. 5yr CDS 300 but illiquid. Both pari 7.731% 2017 and 7.15% 2020 OAS L+500. –ve basis argument like brw facility, if you can buy tight cds or take cheap brw, u would. Just cos 95% of mkt does not use CDS does not change the fact that cheap CDS exists. No leaps, ADV = 640k, 90d 50/10 ile = 47/36. We’ll use 35. Using 300 bp CDS =105. Using L+425 = 101.1. Clearly if u don’t buy CDS then not cheap. This one may be a home builder too far. 50% being worst premo yet on smallest builder not for us. Prefer LEN. SPF, RYL. 9/4/12 Toll Brothers (TOL) Toll (TOL) $250m (37.5m) sen unsec cb coming tonight from DB/Citi. Terms: 20 yr, 0.25-0.75% up 47.5-52.5%, 5.25/5yr put/call, full pctn. UOOP = gcp. Stk +148% since 10/11 low but still 44% off heady housing market of 2005. CDOs may need to make comeback w/lax lending standards before u see this ITM. LEN/DHI cheaper vs listeds but too ITM for o/r’s SPF/RYL more comparable with 109/113 $px. SPF came 0 .25% up 42.5% in 07/12 and RYL 1.625% up 42.5% in 05/12, both lower rated (Fitch BBB- on TOL). We’ll use L+150 (not adding –ve basis) & 30 vol (2 yr 90 day 10/50 ile = 24/37. Listed atm 40 iv but high strikes low 30s. Theo = 102.2 May go in IG index, allow s o/r’s to add a balanced, better rated housing name. Not gonna blow the roof off Push for mids. 8/22/12 Wright Medical (WMGI) 8/22/12 Wright Medical (WMGI) $200m (+30m) sen unsec cb coming tonight from JPM. Terms: 5yr 2.25-2.75% up 22.5-27.5, full pctns. UOP = hedge/buyback debt (incl $29 2014 cb). Small $830m orthopedic device maker w/PF debt = 201m (cb), cash=227m, LTM ebitda=54m, fcf = 31m, lev =3.7x. We’ll assume B & L+550. Small adv (335k), no leaps, 2yr 10/50%ile 28/37. Given size of co & low adv this again is not a model trade so should serve as sanity check. We’ll use 25 vol.

82

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Theo = 102.7. Premos extended in low rate env/technical shortage of paper so a 100 cb w/25 prem is going to be wanted regardless of credit quality ( & this is not a bad one), equity holders should want the 2.5% coupon. Model is less relevant nowadays which changes our mids recommendation to a simple BUY Small orthopaedic device co w/leading pos in foot and ankle. Mkt dominated by large players inc stryker and Zimmer. Working on repositioning – focus on higher growth extremities biz, transitioning to direct sales force for foot ankle, & improved inv mgmt. Sales & margins will continue to be under pressure but cash flow improving. New converts will be only debt. Recently disclosed US attorney subpoena adds uncertainty. Our assigned spread L+550 Molycorp (MCP) 8/16/12 Molycorp (MCP) $300m (+45m) sen unsec cb coming tonight from MS/CS. Terms: 5yr, 5-5-6% up 20-25%, s/c yr 3 @130% full pctns. UOP = w/capex repay Neo/Mat 5% 2017. Concurrent $172.5m stk placement and $138m brw facility. Will need O/R otherwise brw won’t be enough (placing w/help free up rate but not to GC). Capital need for ’12 = $300m, PF debt=1.234B, cash = 576m, ltm ebitda = 81m, fcf = -680m, lev = 15x. 10 yr sen sec str8 ~L+990 (CCC+). 3.25% 16 cb ~L+1200. Not model trade (tuf to short 3.25 $px to hedge credit plus tight brw) but we’ll humor notion (GC brw/1400 bps/35 vol). Theo 101.125/103.125/105.125. Tuf to play w/out outright to relieve brw pressure (hard to get close to 100d), placement dscnt will mitigate shorting pressure. Some will play stk bounce potential but AVOID Liquidity concern as recent results disappointed on lower prices & vols. Made acq of Canadian magnet powders biz june, used $600m cash and triggered coc on 5% sub conv, requires up to $230m for put. Expansion of CA fac continued w/300m needed 2h12, up to $75m could be deferred. Prod to ramp to 40,000 mt 2013. If all comes together, EBITDA could ramp next year, but significant execution & integration risks exist. Our assigned spread 1400 Prospect Capital (PSEC) 8/8/12 Prospect Capital (PSEC) 8/8/12 $200m (+30m) 144a sen unsec cb overnight from BAR. Terms: 5.5 yr bullet, 5.75% up 10%, re-offer at 99. All prtns, UOP=maintain liquidity, investments. PSEC is a small biz development co (BDC) that invests in mid-market privately held co’s. There are three CB’s in existence, IG rates. Co. just did stk offering (July 11). Borrow got better post stk deal but this will retest that, ~3%. For what its worth, model w/600 credit, 20 vol & 3% borrow, worth 98.72. If we use 10.83 (stk) and 99, we see 2.5 pts rich, theo 96.59. All PSEC bonds model rich, and we don’t see it as a model trade. We thought the last one was an AVOID and think these are too, the last one’s have barely budged since issue. A deal too far – Again Hornbeck Offshore (HOS) 8/7/12 Hornbeck Offshore (HOS) 8/7/12 $260m (+40m) 144a convertible sr note from BAR pricing Tues night after close. 7 yr bullet 1.5-2% up 32.5-37.5, all ptcns, UOP, pay for note hedge, retire 1.625% converts and GCP. HOS is a leading provider of marine transport to the offshore oil and gas industry, mainly in the GOM with some limited int’l exposure. They also transport petro products via tugs and barges in NE, USA and PR. The 5.875 % str8s trade 435 ish, we’ll use L+500 for converts, volatile name but 7 yrs, we’ll use 37. GC brw That’s 106.72/104.33/101.99. No small deal excuse here, looks cheap. Some o/r accts might see floor premium & punchy delta & stay with olds, but new one should be shipped in, BUY

83

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
ISIS (ISIS) 8/7/12 ISIS (ISIS) $175m ($26.25m) 144a unsec sr cb pricing TUE nite from GS, JPM, BARCAP. Terms: 7 yr, 3-3.75% up 27.532.5%, nc-4, 130% after, prot. UOP= GCP and repurchase of existing 2.625% converts. ISIS focuses on developing antisense drugs for cardiovascular, inflammatory and metabolic diseases. Co has handful of its pipeline licensed or partnered w/larger pharmas. Has 8 drugs in phase 2 dev and 2 in phase 3. We’re using L+300 for the old ones, will use L+650 for 7 yr. 90d IV 50/10 ile = 41.4/25.3. We’ll use 35 to dscnt for duration. Using 50 bos brw, theo = 102.5/104.625/106.875. 2.625 have been hot recently, sector in favor and with UOP mentioning potential call of old, we’d expect a rotation into the new. Definate reprice potential here as this is as BUY. Exelixis (EXEL) 8/7/12 Exelixis (EXEL) 8/7/12 $225m (+33.75m) REG unsec sen sub cb pricing wed nite from GS. Terms: 7yr, 3.75-4.25% up 25-30%, nc-4, 130% after, prot. UOP = GCP. Concurrent offering of 20m shares. Biotech co focused on developing smallmolecule therapies for cancer treatment. Key drug = CABO. FDA approval likely for thyroid cancer version in Nov, but mkt is small. CRPC version is crucial, but phase 3 trials not expected til 1H2014. Expected cash burn thru 2015 could see some sort of partnership down the road. We’ll use L+1050. Not really a vol trade but for modeling, we’ll use 38 vol. Brw is 150 bps. Theo = 96.5/98.5/100.75. Small deal, hot sector, should be one for strong equity interest, but with lack of short term catalysts we’d be selective and BUY on cheaps. Standard Pacific (SPF) 07/31/12 Standard Pacific (SPF) $250m (+22.5m) REG unsec senior cb pricing tonight from JPM/CS/Citi/Bofa. Terms 1.125%-1.625% up 37.542.5$ p/c yr 5, prot. UOP = GSP. Concurrent 12.5m shares. Homebuilder operating in CA, FL, AZ, NC, SC, TX and CO. 5 yr CDS 345/365. SPF has more checkered past than RYL, DHI, LEN (stk 0.67 at the lows), we’ll add sector basis and use L+500. 90 day 50/10 ile = 56.6/38. If stock heads anywher e close to lows, we doubt you’ll be buying stock back, we’ll dscnt to 35 vol. Stk brw pre deal 50 bps, now out to 150bps, but should settle back post deal (every 50 bps = 1 pt) Using 50 bps, 100.25, Housing is hot, deal is small, market needs primary but be careful getting too close to the sun, buy on cheaps. Beazer Homes (BZH) 7/10/12 BZH- Consider playing the deal and then (probably) flip it On the mids of the price talk and using a 70 and 65 vol and a 1000 over credit spread, the new BZH deals models 4.41% cheap or about 1.5% cheap a year. Theoretical delta is 6.65. As mandatories go, this is reasonable valuation. However, there are a few cautionary notes. Most importantly, the note that is called senior is actually structurally subordinate to the other debt and the CDS that references that debt because it doesn’t have the subsidiaries’ guarantee. Also, borrow is not regular although the fee has been stable in the 100-150 bps range for a while. Further, it is unlikely to substantially richen on a convertible valuation basis for a year or so. Finally, past BZH deals traded 5% cheap a year during the dark days of last fall. However, the technicals of the deal are very positive. The size is small (75mm). Additionally, past deals have been very popular with crossover accounts. Credit Suisse often likes to allocate crossover and outright accounts over convertible hedge funds for internal political reasons and to reduce deal flipping. Further, BZH’s previous two deals were flushed earlier this year and holders made a nice return. Finally, there is an equity deal coming alongside with should help with the stock.

84

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Weighing all of these points, consider playing the deal and then flipping it unless something odd happens and it comes on the cheaps, in which case, it may be better to hold it. Affimetrix (AFFX) 6/19/12 Affimetrix (AFFX) $105m($10m) reg unsec sen cb pricing Tues pm from MS/Citi. Terms: 7yr, 3.25-3.75% up 27.5-32.5, pc-after 5yr@130%, prot. UOP=pending eBioscience acq. (If acq falls through, co may redeem at $1010 + interest +75% of diff, if +, betw redemption & initial conv) Market leader in genotyping. $379m mkt cap. 70% of sales – academic & been weak. Acq to improve growth prospects but had been put on hold due to lack of funding. Post deal, liq=tight w/#44 cash. (see credit color). Inputs academic given structure/credit. We’ll use L+900. Not a vol trade. Given 7 yr, we’ll use 32v. Stk brw varies. Using net 50 bps, theo = 97/99.25/101.5. It’s not in our genes to like a marginally mispriced 7 yr credit name, looks like equity, could behave like it too (80d) AVOID AFFX is mkt leader in gene exp & genotyping but mkt has been in decline in several years & fell 12% 1Q12. Looking to diversify buying eBioscience. Plan amended for lack of funding & lower sales from weak US academic mkt. Price lowered $15m to $315m & secured debt portion lowered. Plan to use $85m dec debt, $105m convert & $125m cash. Adds cell & protein analysis & has better growth prospects. Liquidity tight with only $44m of cash remaining & uncertainties that come with a merger Our assigned spread L+900 Royal Gold (RGLD) 6/14/12 Royal Gold (RGLD) $325m (+$45m) sen unsec cb coming tonight from GS. Terms : 7yr 3.125-3.625% up 30-35%, s-c yr4 @130% (m/whole table), full pctn. UOP = pay down debt, gcp. Mexican, Chilean & Canadian levered gold play. PF Cash = 405m, CB only debt, LTM ebitda = 231m FCF -194m, low lev =1.4x (see credit color). We’d use L+500, ADV = 800k, 0/14 same delta calls = 37 iv bid, we’ll use 35 vol. Theo = 104.2/106.2/108.2 NEM = itm, GG=fat, GSS=balanced but not for all, KGC = no delta so demand for a balanced, pure gold play on a good credit with low country risk is obvious. Oh, we forgot cheap. We’ll keep this short GOLDman for this right so far. BUY RGLD’s royalty portfolio incl 38 prod, 26 dev-stage & 127 exp stage props. Co is very leveraged to gold, which accounts for 2/3 of royalty rev, w/limited exposure to cost inflation. Geo-political risk low w/royalties concentrated in Canada, Chile and Mexico, each accounting for ~25 & balance in US, Australia, & Africa. Liquidity good wboost to cash & full $225m rev avail (L+187 due 2/1/14). New converts are only debt & 7 yr. Our assigned spread L+500 Medicines Co (MDCO) 6/5/12 $200m (+30m) sen unsec cb coming tonight from JPM/Citi/Bac. Terms: 5yr, 1.125-1.625% up 20-25%, pctns. UOP = $50m stk buyback/hedge. Happy meal. $1.2B acute/intensive care pharma. Pfolio = lead drug angiomax (used in 2500 hospitals globally, FY12 net rev expected 2 be 9-11% over FY 11), Cleviprex, Argatroben (US only) then 4 in phase 1-3. Angioma/Angiox sales grow every year w/US sales +10.9% in Q411 alone. Co has $296m cash w/this CB being the only debt. We’ll use L+500. ADV = mere 479k, no leaps, 2y 90d 10/50ile = 27/34 vol. Given lack of ADV, mkt cap & -ve gamma, dscnt to 25v. Theo = 100.25. Pipeline = future catalysts, good equity story 4 long only so expect their interest. Not obvious arb set-up. Acutely aware of recent primary performance. CHEAPs. Ryland (RYL) 5/10/12 Ryland (RYL)

85

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
$150m (+22.5m) sen unsec cb coming tonight from CITI/JPM. Terms: 6yr, 1.625-2.125% up 37.5-42.5%, full pctns. UOP=gcp/debt repayment. Larger LEN has 3.25% which back out L+460 to 11/16, RYL 6 yr CDS is ~320 mid but sector trades with basis (100-150 bps). Z-spread on RYL 6.625% ’20 str8 ~480bp. We’ll use L+450 for 6 yr. 01/13 leaps illiquid but ~42iv, 2yr 90d 10/50%ile = 35/43 vol. We’ll use 35 vol. Theo = 102.15. Have heard some getting 0.25 on brw but most GC. Concerns are; brw & cds mkt disappearing on way down making rehedge difficult plus fat optics. RLY 1.875% up 40 with tight CDS means u can only lock in real model cheapness by actually buying CDS o/wise it is a model trap. However, space is cheap, its small deal and will get done. BUY Annaly (NLY) 5/8/12 Annaly (NLY) $750m (+115m) sen unsec bought cb coming overnight by CS/MS. Terms: 3yr, 5% up 15%, dvd pctn > 55c per qtr. UOP = to buy mbs portfolio & gcp. Not sure where to begin! Existing 4% ’15 backs out L+500. We’ll use L+400 for this and 15 vol. Taking stk down to $16 for slippage (effective 18.3% premo) = 101.83 We are going to keep this brief. Deal size is too big, no obvious substitution from 4% CB or out of equity (15% up 0%), not cheap enough and has risk overnight. Long only funds who can only express their view through CBs may find this attractive but not obvious for anyone else. AVOID Titan Machinery (TITN) 4/18/12 Titan Machinery (TITN) – 4/18/12 $115 144a senior unsec cb pricing tonight from BAML/WFC. Terms: 7 yr, 3.625-4.125% up 30-35%, nc-3y, s-call thereafter @120%, prot. UOP = working capital & gcp (incl repaying portion of floor plan finance). Titan Machinery sells & rents agricultural & construction machinery in Midwest & Europe. $675 mkt cap stk just off all time highs. Recent results have been good given improving env. 6.3x levered, incl floorplan financing. Highly acquisitive. For 7 yr, we think L+650 is right. See credit color. 2y90d 50/10 ile = 63/48, but ADV is thin 360k. We’ll discount to 33iv. Theo = 102. Small deal. Less than stellar credit & cb structure. Will get done, but we’d push for mids FY13 results very impressive driven by favorable ag env. Ag is 85% sales & benefiting from high farm incomes and commodity prices. Construction mkt improving w/good weather, energy inv in bakken shale & ag-related demand. Co very acq completing 45 acq since jan 03. Have presence in Romania & Bulgaria with 12/11 & 3/23 acq. More acq to come. Other debt decured credit fac & floorplan financing w/$400m avail w/proceeds paydown L+650 Wabash (WNC) 4/17/12 4/17/12 Wabash (WNC) $150m sen unsec cb coming tonight from MS/WFC. Terms: 6yr, 3.375-3.875% up 32.5-37.5% full pctns. UOP = fund walker acq/gcp. Note: co has option to pay 101 + 75% parity move (theo delta) + accrued if deal fails. Small $621m truck/trailer manufacturer w/have $450m debt > deal w/$300m secured ahead of CB. Combined EBITDA espected to be 85m w/ sales of $1.5B and 5% gross margins. Deal does not jump out at us. We’ll use 35 vol given usual risk on way down Theo = 103.4. Co has option to redeem, it does not have to. Good to see 2 deals coming tonight but there are just too many unknowns & this deal will disappear. We’d avoid. If you are going for it, steer to cheaps. Tibco (TIBX) 4/17/12 4/17/12 Tibco (TIBX)

86

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
$500m (+75m) 144a sen cb pricing tonight from MS/JPM/C/BAML. Terms: 20 yr, 2.25%-2.75% up 47.5-52.5, 5yr put/call, prot. UOP = $150m stock buyback, $150m credit facility & gcp. Partial Happy Meal. TIBCA Software provides infrastructure software products to link internal operations & customer channels in real time. $5.4B mkt cap. 2.5x lev, consistent FCF generator. IBM.Oracle, & SAP are all competitors. Co has been acquisitive. We think L+450. 2 yr 90d 50/10ile = 41/34. We’ll use 35v. Theo = 102.75. Model trap for hedgies as 2.5 up 50% optics are stretched. Outrights may like the story deapite stk at an all time high. Mkt deserves a good deal so push for MIDS or better. Will get done easily. TIBCA is competing against some much larger s/w cos incl IBM, Oracle & SAP Co has been very acq, most recent log logic for $130m cash closed last week. Additional acq are likely. Also using cash for stock buybacks w/$200m each of last 2 FYs & $150m of deal proceeds. Liquidity is good w/large cash balance & full $250m revolver avail (matures 12/16 L+125 to 200). Co consistent +FCF generator. Only other debt is $38m mortgage. Micron (MU) 4/11/12 4/11/12 Micron added S/C make whole protection on both bonds. $870m (+130m) sen unsec CB coming Thurs night from MS/JPM. Terms C 20y, 1.875-2.375% up 37.5-42.5%, s/c 4 yr @130 put H/C yr (D) 20 yr, 2.625-3.125% up 42.5-47.5%, s/c 5yr @130 put & H/C 9y. full pctns. UOP = gcp/hedge. Similarly structured 2 tranche deal came 07/11 w/stk @7.6. 7yr <A> came 1.5 up 25% & 9yr <B> 1.875% up 25%. Big difference is no S?C make whole on this deal. Currently, 6 <A> backs out L+475 & is 1 pt cheap (425/40) whilst 8yr <B> backs out L+51- & is 1 pt cheap (475/40). We’ll use L+450 for 7 yr & L+500 for 9 yr <D> 40 vol for both. Theo = 103.9, 103.2. <A> and <B> premo crunched horribly last sept on way down. These wont be different. AVOID unless cheaps. DFC Global (DLLR) 4/9/12 DFC Global DLLR 4/9/12 $200m (+30m) unsec cb coming tonight from BARC. Terms: 5yr, 2.75-3.25% up 27.5-32.5, full pctns. UOP = hedge/repay debt/gcp. Happy meal for the minority. Structurally sen 10.375% 16 str8 OSA 570 bps 3% cb (put/call 04/15) backed out L+590 pre-news (using 32 vol). We’ll back 5 yr spread to L+750. Again, not a model trade but if we were to guestimate we’d have to discount vol (ADV= mere 360k, no leaps & -ve gamma on big moves down). We’d use 32v. Theo = 102.1 FACT: $4B US CB issuance ytd, $14B globally & $120B us HY ytd. $360m combined debt post deal vs. $770 mkt cap doesn’t instill comfort but w/existing cb followers, potential equity mkt interest, this small issue wi ll get done. Salix Pharmaceuticals (SLXP) 3/13/12 3/13/12 Salix Pharmaceuticals $500m ($75m) snr unsecured CB coming o/night from Bofa. Terms, 7 yr bullet, 1.5-1.75 up 35%, full pctns, happy meal. UOP include buying back 5.5%/2028 CBs and $50m of stock. Existing 2.75% of 2015 is a $345m deal, back out L+213 (35 vol). Hear 45/350 being suggested for modeling, those that follow our new issue color know we’ll struggle north of 35. We’ll go with 33/425, which means Theo = 102.43. Profile OK (mids), 1.625 up 35, theo delta 69%, 0.53% gamma, floor 76.18. Room for credit tightening. Co is a specialist in gastrointestinal disorders, well liked, even after stk run, outrights will be mindful of both. We can stomach these – prefer mids or better. We look forward to putting these on the runs – BUY Ares Capital (ARCC) 3/8/12 Ares Capital (ARCC)

87

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
$150m (+22.5m) sen unsec cb coming tonight from WFC, MER, JPM, MS. Terms: 5yr, 4.375-4.875% up 17.5-20%, full pctns (div > 0.37). UOP = gcp, debt repayment. $575 deal came 5.75 up 17.5% (01/11), $230m cb came 5.75 up 17.5% (01/11) $230m cb came 5.125 up 17.5% (03/11), both priced off $16.28 (stk now $16.57). 5.75% back out L+525 & 5.125% L+575 (23 vol). We’ll use 23 vol (where the 2 existing imply). Theo = 99.5. There is not much to do here, no switch (no puck up on delta, why swap slightly cheaper 4 yr into 5 yr), no index inclusion (due to issue size). Again, we all want to see more paper but not sure what the trade is here. Small enough to get done but we prefer the existing. Serial issuer, no switch trade – AVOID. ARCC has good track record & held up well during downturn. Portfolio skewed toward more senior issues & well diversified by ind sector (less cyclical) & geography. Increased liquidity w/Jan equity & notes offering used to pay down rev. Most of $810mm secured revolver available & some avail on funding facility. <25% of debt secured, leaving significant unencumbered assets for added flexibility. Our assigned spread L+550 Priceline (PCLN) 3/6/12 Price line (PCLN) $875m (+125m sen unsec cb coming tonight from GS. Terms: 6yr, 1% up 50%, reoffered 98.5-99.5, full pctns. UOP=$200 stk buy back/gcp. Happy Meal for those who want. Put this into perspective; stk up 35% ytd, up 270% from 03/2010 1.25% issue and this will be struck up another 50%. The model likes it; using L+200 for 6 yr BBB+ (bonds apparently will be rated 2 notches > than 1.25% issue). We’ll use 32% (2yr 90d 10/50 ile = 27/40). Them = 102.5 & so ¾ pts cheap over 6 years. Not exactly exciting but decent SBV (87.5 using L+200 and 90 using L+150), limited IG options plus dynamic of index means that these will trade well over time despite optics/strike and historic stk performance. We’d prefer 98.5 to 99 but are realistic. Stone Energy (SGY) 3/1/12 Daiwa new issue SGY Stone Energy $250m (+25m) 144a cb pricing tonight from BARC/MER. Terms: 5 yr bullet, 1.5-1.75% up 30-35%, prot UOP= warrant trans & gcp. Stone Energy is a small oil & gas e&p focused on Gulf Coast Basin. $1.5B mkt cap. Low lev of 1.5x and good liquidity; though cash burn to continue in 2012. Pari 8.625% trade ~600 over, so we’ll use L+650 here. Vol is trickier – 50/10 ile is 60/42. Normally, we’d cap vol at 35 (esp given credit quality). But the aggressive repricing (orig 1.75-2.25 up 25-30%) leads up to believe others will use as high as 40. Using 40v = 101. TRAK & 2ndary valuations stand this deal in good stead, tho with credits like this we prefer to leave some room in the model in case it gets rocky. Prefers mids BUY Small oil & gas e&p co concentrated in GOM shelf region. Have been expanding w/onshore oil & gas shale properties recently. Proved res 602Bcfe, up 27% yoy w/prod replacement of 265%. Res & prod now more focused on liquids w/both ~50% for 2012, +w/favorable outlook for crude prices. Liquidity good with $303 avail on $400m secured rev (limit $700m, adj 2x ann for reserve value). Acquiring props & drilling aggressively leading to cash burn, which may continue for 2012. Our assigned spread L+650 There was a dispute about whether convert guarantees are the same as the straight. Underwriter says it will have the same guarantees.

88

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Dealer Trak (TRAK) new issue 2/28/12 2/28/12 Daiwa Color: Dealer Trak (TRAK) $150m (+22.5m) 144a senior cb pricing tonight from BARC/WFC/JPM. Terms: 5yr bullet, 1.5-2% up 30-35%, prots. DealerTrack provides software to the retail automotive industry. Numbers have been improving with improving auto sales and availability of credit. This cb will be only debt (full $125m secured rev available at L+225). PF Cash = $224m, PF debt = $1 61m, 2.5 lev, LTM FCF +35m. We’ll use L+500 (See credit color). 90d 50/10 vol = 36/31. ADV is thin at 272k. If 75% go to hedgies on a 62d, 1.8m shares need to be shorted. We’ll use 32 vol. Theo = 99.25/101/103. Optics do nothing for us, but this is a small deal and has a new car smell. We’d expect it to do well enough on mids or better. Co is largest on-line credit appl proc network in US& Canada, but w/in DMS compete against ADP & Reynolds & Reynolds, who control market. Sales & margins impacted by recession, but has been improving w/better auto sales & avail of credit. Focused on expanding # dealers & lender relationships. Liquidity good w/full $125m secured rev avail (L+225, matures 4/15). Co has been acquisitive closing 2 trans in FY 11 w/more likely to come. Our assigned spread L+500 Lennar (LEN) new issue 11/22/11 $300m (+45m) sen unsec cb coming tonight from JPM/CITI Terms: 10yr, 5yr put/call, full pctns. UOP=debt repurchase/gcp. 2 existing CBs; 2% (01/12/13), 2.75% (20/12/15). Latter = 2.6% +34% x/par +41% 5yr CDS = 425/450. We’ll use L+400 for 4 yr 2.75% = 26 iv. 01/14 25c indicated 46iv bid, 2 yr 50/10%ile = 42/29%. We’ll use 35v on both. Theo= 104.6/106.4/108.3 vs 2.75%=5.25 points cheap. Both are cheap but both are model traps. A lot of mkt won’t buy CDS, nor will they get long LEN credit at this level. Both valuations are on top of each other so little reason to own 1 yr longer duration. Now, if the NEW comes on cheaps, add the more liquid on the run 5yr CDS into equation, then we see a BOND vs CDS set up cheaper than 2.75%. We think the book should be built on the cheaps. Air Lease (AL) 11/15/11 $300m (+45m) 144a senior unsec cb tonight from JPM/NOM/BARC/C. Terms: 7yr bullet, 2.875%-3.375% up 33.538.5, prot. UOP = acq of commercial aircraft & gcp. Aircraft leasing company, launched in 2010 and IPO’d April 2011. 7.5 levered w/,ore debt to fund acq committments expected (239 planes for $11.7B). $1.3B of debt is secured (~62%) w/balance incl converts. Given their biz & 7 yr structure, we believe L+750 is appropriate. Stk brw is not normal: ~neg 1.5%, which may get worse b4 btr (when IPO shrs unlocked, gc brw adds 3 pts to bond value). Using 35v, theo = 97.375. Global macro worries, high lev & a cb mkt that exhibits no gamma 2 downside, we can not get onboard. AVOID Co started 2010 w/IPO 4/11. Growing rapidly w/79 planes & plans for 101 YE11 &146 YE12. Committments for 239 planes for $11.7B. Lease for all 67 committed thru YE12. $1.3B debt secured (~62%) w/bal incl convert unsecured. Nearly $600m avail on fac, most secured. Cash provides add’l liquidity, but will keep adding debt to fund acq committments. Fleet young avg age 3.6 yrs & >6 yrs on lease, but volatile ind w/global macro uncertainty & high fuel prices are key concerns. Our assigned spread L+750 Take Two (TTWO) new issue 11/10/11 $200m (+30m) sen unsec cb coming 2nite from JPM/BARC. Terms: 5yr bullet, 1.25-1.75% up 30-35%, pctns. UOP=gcp. Existing cb came 4.375% up 25 in 2009. We saw co in May; +ves=revised 5/12 revolver to 2016, profitable fcf+ even in yr w/o GTA release. Emerging mkt partnerships will come 2 fruition in 2013; exp proftiable thru FY13. Assume B rating & L+700. ADV=188k, 2y 90d 10/50ile = 29/38, 1/13 20c=39iv bid (low OI). We’ll use 35 vol. Hard to use model on a 1.3B B credit but fo those who disagree: THEO = 98. Even if we use Tight L+600=102 on cheap. Improving credit/interesting story, stk is up 81% since 2009 issue. Old to new cb switch given s/call & ability to re-strike? Terms are ambitious but sign of the times. We’d take two on cheaps or take none otherwise.

89

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas

Co has been able to generate +FCF last 2 yrs w/out a grand theft auto release. Have built up their catalog w/releases such as Red Dead Redemption, LA Noire, & more recently digital sales. Launched first social gaming experience in May, except to do more & focus on growing Asia Pacific exposure. Amended revolver Oct 2011, max $100m secured, rate reduced to L+250 to 300, nothing drawn, $62m avail. Liquidity good. Our assigned spread = L+700 Human Genome (HGSI) new issue 11/02/11 $400m (60m) sen unssec cb coming this morning from Citi. Terms: 7yr bullet, 3% up 30%, full pctns. UOP = 2.25% 12 reupurchase/hedge/gcp. Will keep this short. Pls dont rely upon model, rely upon the track record of 7yr structures on credit names; MU A, ILMN, CX, BKD. Actually, look at 5yr credit names of late; JRCC, DNDN, REGN etc. Common theme=nuke down on heavy delta & zero stk bought back. Buy this co u like equity story (Benlysta) not cuz model likes it. However, for those who will model we’ll assume L+750 (B-) & 35 vol (2 yr 90d 10/50%ile = 32/40, ADV = 4m, listed = 60 iv +). We’ll take stk to 9.86. Theo = 101. May be some equity interest but this is the wrong mkt to bring this credit/strucutre. Mkt needs paper but this is not it. AVOID Nuance (NUAN) new issue 10/18/11 $600m (+90m) sen unsec cb coming tonight from MS. Terms: 20 yr, 2.5%-3% up 35-40%, call 6y, puts 6,10,15y. Full pctns. UOP=stk buy back/gcp. Good equity story/decent credit. Existing 2.75% cb (BB-) is big o/r name. Came in ’06 +22.5%, now trading 133 w/15% premium so o/r effect clear 2 see on way up. NUAN siri t/nlgy in iphone 4s. Voice recognition is en vogue + EMR mkt will be firm going forward. We’ll use L+550. ADV = 2.5m, 0/1/14 same delta 43iv bid 1/13 47 iv. Given credit = greater confidence in model therefore ability to buy stk on way down. We’ll assume 35 vol. THeo = 104.6. A lot of premo but model likes it. o/r will like equity story (proven by 2.75% HDS, good size & mkt needs this typoe of paper. BUY Regeneron (REGN) new issue 10/17/11 $400m ($60m) 144a senior convert pricing overnight from GS. Terms: 5yr bullet, 1.375-1.875% up 30%, prot. UOP=warrant trans & gcp. $5.8B mkt cap w/one drug on mkt ($5m/qtr rev). Another awaiting approval in Nov which will have Roche competition. PF Cash = $915m, debt=$560m. Neg EBITDA & cash burn expected to continue thru 2012. We’ll use L+650 (could argue wider) & cap vol @35v. Taking stk cown to $61.5 (closed $64.63), on best terms, theo=98.25. But is not a model trade. It’s stk dependent & there is loads to be shorted. If only 25% of deal goes to hedgies on a 70d, that is almost a day’s worth of volume to be shorted. Like we recently saw w/DNDN, negative gamma burns. we don’t need or like the o/n stk risk. Wait til cheaper. AVOID United Therapeutics (UTHR) new issue 10/11/11 $210 (+40m) sen unsec cb coming tonight from DB. Terms: 5yr bullet, 0.5-1% up 20-25%, full pctns. UOP = hedge/$212m stk buy back. Mktd to hedgers on swap/traders. Stock has nearly halved since April & fell 18% alone in Aug when Remodulin trial failed. 2.2B mkt cap now but a good credit; PF Cash = 1.13B, Debt = 720m, lev = 2x LTM FCF=231m, EBITDA = 241m. We’d assume L+500 (see credit color). No leaps, ADV = 1.25B, 2y 90d 50/10ile = 20/29. Striping out short dated vol spike 32 vol is plenty generous. Theo = 99.1/101.3/103.5. Not sure 2 points cheapness over 5 yrs does it for us given some secondary cheapness out there. UTHeR than the hope o/r’s will buy in secondary (esp given where stk is) hard to see the catalyst. We want to like new deals but for that reason we’d push 4 cheaps. UTHR shares fell lower in late august on news of the second failed trial for oral Remodulin. Little hope exsts for an impact to valuation until 2013. Largest drivers to current valuation are traditional Remodulin and Tyvaso franchises & to a lesser extent, Adcirca. Cash on balance sheet is deceptive, as company has been stocking up to take out old converts. Growth slowing in traditional Remodulin adn Tyvaso. Challenges in hypertension market persist. No clinical catalysts on horizon.

90

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Intermune (ITMN) new issue 9/13/11 $100m (+15m) sen unsec cb coming tonight from JPM/GS Terms: 7yr, 3.25-3.75% up 27.5-32.1% s/c ? 4yr @130%, pctns Concurrent 4m stk UOP= r&d, gcp Pulmonology/fibrotic disease specialist w/EU approval of its Esbriet (will be exclusive treatment for 2yr). Hopes to complete US Phase III within 2yr to resumbit for approval. A one-drug to riches play (sold hepatology rights for $175m in 2010 & only have one small drug in mkt). If u believe in +ve binary outcome, u buy (&will tell us our credit is wide). Model isn’t important here but for those who think it is, we’ll use L+800 & 40%. Theo = 101.9/104/106.3. Stock placement a lot harder to play given macro. Dont like 7 yr but small deak w/plenty of stk believers. Set up heavy & wait 4 +ve Esbriet outcome. ITMN has approval for Esbriet (IPF treatment) in EU & about to launch in Germany w/others following though 2013. No treatment exists & will be exclusive for several yrs. Have kicked off add’l pipe line. Sold hepatology rights to Roche in 2010 for $175m cash. Esbriet could be blockbuster in a few yrs, but w/any emerging biotech there are many risks Our assigned spread L+800 MF Global (MF) new issue 7/28/11 $300m (+45m) 144a senior unsec cb pxing tonight from GS/Citi. erms: 7 yr bullet, 2.875%-3.375% up 32.5-37.5, prot, UOP = repurchase $109m 9% cb, hedge. Since bringing 1.875% ’16 in Feb, co burning cash and drew down on revolver (will have $322m avail thru 6/14) PF cash = 809m, PF debt = 1.046b, LTM FCF -474m, LTM EBITRA = 162. Post deal, using 30 vol, 1.875% ~L+550. Use L+575 for 7 yr. ADV = 2.1m 2 yr 90d 50/10ile = 40/31. Will keep vol @30 for 7 yr. 1.875% came up 27.5%, now xpar up 30.5 with weakness post deal announcement. Using gc brw, theo = 101.5. Need to be compensated for extending maturity, esp considering current tape, so don’t be an MF and push for cheaps. Chart Industries (GTLS) new issue 07/28/11 $230m (+34.5m) sen sub cb pricing tonight from JPM/MS. Terms: 7yr bullet, 1.75-2.25% up 27.5-32.5% prot. UOP = up to $175m to redeem straights & cb hedge & gcp. Chart Insutries makes cryogenic & low temperature products for a variety of apps (gas, chemical, biomed). $1.7B mkt cap. Majority of Rev from energy segment, but they are diversifying. Have been acq butliquidity ok. PF Cash = 200m, debt = 289m, 3x levered. We’ll use L+500 (see credit color). This stk can move: 2 yr 90d = 55/50. Capping vol at 35, theo = 102. As we’re all aware, if you can’t captivate an o/r, you are pricing off model and tape, so we’ll be cool if you go in on cheaps on this one. GTLS has seen recovery over last yr, benefit from shift toward nat gas. Most rev still from energy, but has diversified, 25% biomedical & intl growing w/ops in czech rep & china. Have been acq & have announced #39m acq of EU mobile LNG. Co typically generates +FCF for full yr & has focused on reducing debt, no divs or stock repurchase has helped. OKay liquidity w/$109 avail rev. Conv rank behind secured rev & term loan. Out assigned spread L+500 Fidelity National Financial (FNF) new issue 07/27/11 $300m (+45m) 144a senior cb pricing tonight from Boa/JPM. Terms: 7 yr bullet, 3.75-4.25% up 32.5-37.5, prot, UOP = pay down credit fac & buy back stock HAPPY MEAL. FNF is first in US tital insurance, Stk was up 5.7% yesterday on earnings. Stk not seen this level since Fall 09. Straight trade around 300 over. ORI ’18s a decent comp which also trades 300 over but is rated 2 notches higher. So we’ll use L+350 (See credit color), Stk is not very volatile. 2 yr 90d 50/10ile = 28/18. For 7 yr credit, we’ll discount to 20v. Theo = 99.5. Exp a low IG rating too. Model (& tape) says ” mids”, we see profile appeal but we see stock and premo too. Jusr cuz its new, doesn’t mean it has to trade at a premo to this tape.

91

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
FNF is largest US title ins co w/~38% share accounts for 2/3 rev. Rev & eaarnings under pressure recent yrs due to strong correlation to housing mkt, but co has performed well due to disciplined underwriting & cost cutting focus. Co willingness to cut divs helped w/liquidity. Amended rev 3/10 extending mat to 3/13 w/total line $951m w/$750m available after conv deal. Investment portfolio is high quality & liquid w/80% cash & invgrade bonds. Selling flood ins biz for #210m Our assigned spread = L+350 BGCP new issue 7/25/11 $125m (18.75m) 144a sen cb pricing tonight from ML/DB/CNTR. Terms: 5 yr bullet, 4.25-4.75% up 17.5-22.5%, prot. UOP = capped call & possible M&A. $2.2B mkt cap. Street broker specializing in OTC products; was originally part of Cantor Fitz which still holds large stake. Low leverage, +FCF, decent liquidity. Recently signed new revolver at L+300, unsec 2 yrs. Exp BBB-/Ba1 on convert. MF which is smaller mt cap at $1.2B trades at L+500. We’ll use L+450 here. 2 yr 50/10ile vol has been 40/32 but ADV low (600k per day). We’ll dsct for 5 yr to 27v. Stk brw not normal. Using 100bps, theo = 101.5 Small deal, usual dynamics apply. Try for cheaps. BGCP one of five larger inter-dealer brokers. Originally part of Cantor Fitzgerald & They remain strategic holding w/large voting interest. Ops down during 08/09 but have recovered. FCF remains positive & liquidity good w/cash & new $300m rev (unsec, L+300, 2 yrs). Announced plans to acquire Newmark, corp real estate advisory, new businsee (terms unknown). Could be looking for more acq. Co expects to use more cash for divs, share repurchase & unit redemptions. Leverage low. Our assigned apread L+450 Endeavour International (END) new issue 07/20/11 $100m (+15m) sen unsec cb coming tonight from CITI. Terms: 5yr, 5.25-5.75% up 20-25%, full pctns. UOP = Acq of Marcellus Shale assets & gcp. %540m indy E&P co. HY mkt turned away recent $250m deal which woould have taken out 11.5/12% str8s. Capex high on 3 UK/US projects as it strives for 10k boe per day (currently 3k). LTM fcf -98m, ebitda = 36m, PF cash = 687m, debt = 374m. Unlike HY route, > CB there will be 2 o/standing str8s plus expanding t/loan (75m). We’ll assume CCC & L+900. See credit color. Vol less material to your decision process but those modelling, assume 30% (ADV = 290k w/little gamma on way down). Brw = 75bps. Theo = 106.375 on rich (say no more) small deal, not great timing & w/be illiquid but if you like story, it is cheap. END is an independent oil & natural gas e&p with operations in North Sea region of UK and the US. Small e&p with 1Q11 avg daily vol 3k boe & proved reserves 3.5m Most assets not operational. Spending heavily to dev 3 UK proj & expand US precense, 1st to begin prod late 2011. Co goal increase daily prod to 10k, but target has been elusive. 2011 cap-ex plan $150k, will lead to more cash burn. $250m HY deal to take out high rate 13/14 maturities, but did not fly. Buying more US assets, expanding term loan $75m to fund development L+900 MU new issue 7/20/11 $600m (+90m) sen unsec cb coming tonight from MS. Terms A:300m, 20 yr, 1.5-2% up 20-25%, s/c btw 3-5 yr@130% (cpn m/whole to 5yr), H?C > 5y, put 7y. B:300m, 20 yr, 1.875%-2.375% up 20-25%, s/c btw 46y@130% (cpn m/whole to 6 yr), H?C > 6 yr, put 9y. pctns. UOOP=gcp/stk buy back/hedge. B4 news, smaller $175m exch 1.875% ’27 x/par 1.875% up 55% w/call 4yr, ICS=147bps (35%). In 3 pts not. MU 1.875% 14 becomes cash proxy (-1/8 after news). ICS=L+320 (35%). We’ll use 35 vol. Theo A= 100, B = 98.375. Pure equity (70 bf/130 call). Dont like stucture (said re: FCE/A b4 price) however, name has always been popular. 1x $600m deal would preform better. Stick to A if poss, o/r w/skew technicals but push 4 mids. Semi memory is very volatile, currently on strong upswing. MU has rampe up cap spending from $616m FY10, planning to spend $2.9B FY11 & $2B FY12. Generating strong +FCF last 2 years but industry is prone to

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
overexpansion w/large price declines & FCF can quicklytuen negative. Entry into NOR w/2010 acquisition of Numonyx has added diversity & some stability, which will help. Liquidity good w/large cash balance & no significant debt due until 2014. Seven years is a long time in the semi memory biz. Our assigned spread L+500/550 Forest City (FCE/A) new issue analysis 07/15/11 Daiwa color $250m ($46.9m) sen sec cb coming tonight from GS/BARC. Terms: 7yr 3.75%-4.25% up 20-25%, call 4life @130% w/NO cpn make whole (*** A coupon make-whole was added to the deal at the end ***) UOP = repay sec debt. $3B RE co which operated in high barrier to entry mkt in 27 states. Portfolio is 90% secured (co taps $450m sec bank line then the # increased). Has sold equity & assets to survive downturn but bulk of mortgage debt comes due in YE 12. LTM ebitda = 531m FCF = -372m, PF debt = 7.57B cash = 3.2b. We’d assume B - and L+600. Fact: only reits that trade >20iv are in index (SLG to OFC to KRC) ie the whole spectrum trade < 20iv. Well assume 20 vol. Theo = 99.8785 We are a starving asset class but a 7yr structure. callable is not the answer AVOID

FCE has a diversified portfolio in high barrier to entry mkts. Have weathered downturn okay by selling assets & equity and curtailing dev. Able to eliminate div in late 2008 since they are not a REIT. Portfolio is fully encumbered w/secured debt nearly 90% of total. Significant mortgage debt due thru late 2012 ~2.5b. 4 dev projs yet to complete, most financing done, new secured bank line w/$450m due 2014 most available. Our assigned spread L+600 Electronic Arts new issue color 07/15/11 Daiwa New issue Color $550m (+82.5m) 144a sen cb pricing tonight from MS/JPM/UBS. Terms: 5 yr bullet, 1-1.5% up 30-35% prots, UOP = PopCap acq, warrant trans & gcp. EA is a leading video gamer (think Madden NFL). They just announced acq of PopCap (plants vs zombies) for $650m cash +100m stk +w/up to $550 m future payments. But other recent acq have not gone as well as esp. w/$2B cash and no other debt, solid credit. We’ll usse L+325 (see credit color) Jan 13 $30 options are 34 bid. We will use 30v. Theo = 101.125. Decent sized deal, clean structure, balanced (85fl/60d). Model prefers mids but we know this is not model driven. Get in the game. BUY Significant player in electronic s/w Key rev drivers in FY 11 madden NFL II. FIFA II & need for speed hot puisuit. Focused on growing digital presence, saw rev grow from $522m FY10 to $743m FY11 & guiding for >$1B FY12. Pop cap acq will bolster digital. Paying $650m cash plus $100m stock w/up to $550m cont payments. Recent acq have not gone as well as expected. Announced stock buyback prog earlier this yr. $149m done ytd L+325 Novellus (NVLS) new issue 07/11/11 Daiwa new issue color (5/4/11) $525m (+75m) 144a sen cb pricing tonight from JPM/BOA. Terms: 30yr, 2.5-3% up 15-20%, soft call yr 10@150% Happy meal: up to $400m used to buy back stock. Last week NVLS gave disappointing guidance & stk got hit. They’ve now upsized previous shs buyback by $600m. This is a breakeven trade: b/e = 5.5 yrs vs VRSN in 5.25 vs VSH in 5 yrs & BGC in 4.95 yrs. VRSN crosses par as 3.25 up 24%, VSH 2.25 up 15%, & BGC 4.5 up 33%. For model’s sake, we’ll use L+500 and 25v, theo = 104.5. Richer than its b/e peers but is first large deal in a while on a

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
decent credit. O/R wont love the 90 delta unless they have high conviction but there’ll be hedge demand. Nothing novel about this, push for mids. NVLS had a steep fall-off in sales & EBITDA in 08 nad 09 but experienced strong recovery since. Co. is strong consistent FCF generator, even during downturn. Near term guidance has disappointed due to order push outs, but expected to come back in 2H11. Non-convert debt is secured bank debt, matures 6/12. Fully drawn, but some s/t facilities available. Liquidity strong with significant cash. Using FCF to buy back stock w/$273m done FY10 & 200m 1Q11 & $400m of conv deal. Our assigned spread L+500 Insulet Corp (PODD) new issue 06/28/11 $110m (16m) sen sc coming tonight from JPM. Terms: 5yr, 3.5-4% up 30-35%, s/c 4 yr @130% & hc 5 yr, full pctn, cncrrnt 1.15m stock sale (wont receive proceeds). UOP = gcp/buyback 5.375% ’13 old cb issued 2008 (5.375 up 34% w/strike @15.93). Illiquid & fair/straightly rich (120.5 vs 20.49 = L+410 for 2 yr). $940 mkt cap w/1 product (Ominpod). Approveal of version 2 poss/in 2011. N/hood diabetes acq for $68m w/expanded product cuetomers.. Co expects c/f/b/e YE11 & have up’d FY rev guidance to $160m. Will expand 2 supply EUR & Canada this yr. We’ll use L+800 (CCC). Adv = 310k no leaps, so use 32%. Not model trade. Theo = 99.375. Small deal, will be illiquid w/few concentrated holders who believe in growth story. If you don’t then u’ll think it is a piece of D NuVasive (NUVA) new issue 06/22/11 $325m (48.75m) reg senior cb pricing tonight from BAS/GS Terms: 6 yr bullet. 2.5-3% up 27.5-32.5%, protect. UOP =gcp & repurchase olds 2.25% ($230m). NUVA is a medical device company focused on spinal surgery mkt. Mkt cap = $1.3B. Their competition is from much larger MDT/SYK. B/S is decent: PF Cash = $311m, PF Debt = $325m, LTM FCF = +24m. Olds trade tight @200 for 2013. We’ll use L+575 for 6 yr. See credit color 2 yr 90d 50/10 ile= 48/32. Use 30v for 6 yr Stk brw is not normal tho exp to get better. Use 100bps fee = theo = 100. Stk -5% today so you may get a pop, but 2.5m shares to be shorted if 1/2 go to HFs (65d) ORs will note stk perf & 25 ps from floor. Takes backbone to pay anything better than Cheaps Small co focused exclusively on spine. Competes against much larger cos incl Medtronic & Strykeer. Nearly all sales from US though looking to expand to Japan. Spine mkt challeges incl reimbursement issues, lower volumes, & pricing pressures. Has generated modest +FCF in last 2 yrs. Large cash balance to be drained by milestone payment to Cervitech ($33m), purchse of add’ shs of Progentix ($45m), & MDT litigation judgement ($60m). Co could also be looking to do acquisitions Our assigned spread 575 Integra LifeSciences (IART) new issue 6/17/11 $200m (+15m) sen unsec cb coming tonight from JPM. Term: 5.5y, 1.25-1.75% up 22.5-27.5%, full pctn. UOP hedge, $40m stk buyback, Mkt leader in surgical instruments, last in out mkt in ’07 (5 yr came 2.3 75% +25% with stk amazingly at this lvl). Co spent $89m cash but will double spinal mkt rev w/Seaspine acq. Liq good $660m ’16 revolver available. LTM FCF =62m, EBITDA = 137m, PF cash = 104m, debt = 506m. We’d assume L+400. ADV = low 150k, no leaps w/2yr 9 0d 10/50 ile = 20/23 vol Not a lot of vol here, we’ll use 22% to give it benefit of doubt.. Theo= 99.2. We want to like it esp as we all want to see more paper but struggling here. AVOID

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
IART is a mkt leader in surgical instruments & neurosurgery. However, they compete against much larger companies incl J&J and Medtronic. Has historically been acquisitive. Taken a breather since 9/09 but now back w/seaspine acq last month. Spent $89m cash & will couble spinal mkt rev & distribution. More acq likely. Liquidity good w/new $600m sec revolver (due 6/16) all available and history of +ve FCF Our assigned apread L+400 Molycorp (MCP) new issue 06/08/11 $200m (+30m) sen unsec cb coming Thurs night from JPM/MS. Terms: 5yr, 3.25-3.75% up 27.5-32.5%, full pctns. Concurrent 10m stk. UOP = prod xpnsn/gcp. Good David vs Goliath story: China conrols 97% of the mkt w/its protectionism has created px spike. Mines idle since 2002. Will need $781m capex to YE13 to modernize. Sumitomo may prvide add’l capital.

See credit color

We’d assume CCC and L+800. We are always more conservative on vol w/credits like this esp when brw is not gc (~1% fee) Can/will get tricky on way down We’ll use 35%, being fully aware mkt will use higher. Theo = 103.8/102 Mid/Rich using 100bp brw. Lots of stk believers so expect to here interest. Another CB deal for eqty mkt. BUY MCP is start-up having acquired CA mine/fac sitting idle since ’02. Aggressive midernization & expan plan that will require $781m of cap-ex thru YE13. Expect prod ramp from 3k mt/yr to 40k. Conv proceeds plus $200m conv pfd issued in March & 8/10 IPO proceeds will fund large portion. Working on stock/loan deal with Sumitomo & DOE loan to provide add’l Key risks incl constuction, cost over runs & pricing of end products Our assigned spread = L+800 Alaska Communications (ALSK) new issue 05/04/11 $100m 144a unsec sub cb pricing tonight from JPM/Opco. Terms: 7yr bullett, 5.75-6.25% up 15-20%, protections. UOP=gcp incl pay down debt & capex funding. As part of bank deal in OCT, co req to repurchase ~100mm of old cvt by 12/12. This enables them to do that (see credit color). New Term Loan came L+400, so for 7 yrs we’ll use L+650. No leaps, 2yr 90d 10/50 ile = 26/33, ADV ~452k. Small mkt cap, high div yld & illiquid stk, unlikely that you buy your deltas back on way down, so we’ll use 28 vol. Using 75bps brw (not gc), theo = 98.25. Small deal, limited audiance, but deal will get done. If you like stk, then buy it if you can. We’d pass on this deal, for fear of being left out in the cold on the way down AVOID ALSK experiencing comp pressures in wireline & wireless biz. Wireless from iphone & possible entry Verizon w/4g network in future. Wireline driven by line losses from cable and wireless sub. Focused on increasing enterprise biz, but GCI (cable op) has dominant mkt share. Plans to launch 4G which will increase spending. New bank line entered 10/10 w/$440mm term loan & 30mm rev (not drawn), maturity to escalate to 12/12 unless refinance $100mm of older converts – reason for new deal. Our assigned spread L+600

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Apollo Investment Group (AINV) new issue 04/26/11 $200m ($30m) sen unsec cb coming tonight from JPM/BAC. Terms: 6yr, 5.625-6.125% up 15-20%, full pctns. UOP=reduce sec/debt & port/inv. Existing deal came 01/11 5.75% up 17% (came at 98.5) w/stock 14c lower ($11.7). Key 4 these deals is size (big=greater fool will come, small=not obv index inclusion) $575m ARCC came 5.75% up 17.5% now x/par up 27%, $200m ARCC new=5.125% up 17.5% & now x/par up 19%. We assumed L+500 for BBB AINV 5.75% in Jan, sprds have tightened so we’ll use L+450 here. Existing ARCC’s ~22iv, we assumed 22 vol b4, we’ll stock with it. Theo 101. Mkt still needs paper but as a lot of us learned w/ARCC & ORI repeat issues, BBB rating does not guarantee an o/r squeeze plus inflows aren’t what they were. Size w/get done. Push for mids or better First Street Finance (FSC) new issue 04/13/11 $150m (+22.5m) sen unsec cb overnight from JPM/MS/WFC. Terms: 5yr 4.875-5.375% up 10-15%, full pctn (div>0.166). UOP = paydown debt/gcp $800m inv co incorporated in 2008. Credit assumptions btw L+450 to L+500. However, they renegotiated 2013 term loan in 09/10 @ L+350. ARCC bigger co, BBB rated adn bonds back out L+400 using 22v. We hear Fitch BBB- rating soon but we’d use L+600. Again, not model trade b/c mkt will be o/r v/light cos 1) stk down & 2) div & 3) shoprten b/e. However, to humor model we’ll use 22 vol. Theo with stk unch (now below $13) 75bp brw (not GC) = 96. Look we’re realists: small deal w/strong u/w, some may evern use tighter spread but why not own 9% up 0% (no obv switch) no doubt it will get done & poss trade up w/stock. Not for us. 123 (AONE) new issue 04/01/11 $125m (+18.75m) reg sub cb pricing tonight from DB/GS. Terms: 5yr bullet, 3.25%-3.75% up 20-25%. Concurrent 18m common offer, A123 Systems makes advanced batteries & energy storage systems for cars & electronic grid serv. Company went public in 2009. Stock hit a high shortly after ($25.77) & languished since (down 20% since deal announced). Spending heavily on bet of future demand using govt subsidies to fund 50% of cap ex. Project +EBITDA in 2013, but unclear if/when FCF turns +1.5yrs of cash left $700m mkt cap. 1000 over credit but will dispense w/model. Stock brw hi (8%) & may not improve much post placement. Deal getting done depends on equity view. Crunch candidate into stock pop. Need AONE sauce on this to make it edible. AVOID. AONE is a start-up that just went public 9/09. Co spending heavily to expand capacity ahead of anticipated future demand leading to significant cash burn. Received DOE govt grant to fund 50% of cap ex, received $87m in 2010 w/$162m to go. Also working on $233m govt loan, would pay 80% of cap-ex. COmpeting w/jv of much large cos (panasonic, LG, Samsung) Co project +EBITDA 2-13, uncertain if/when FCF turns positive. Our assigned spread L+1000 Ares Capital (ARCC) new issue 03/22/11 $200mn (+30mn) sen unsec cb coming tonight from JPM/BOA/WFC/DB. Terms: 5y, 4.875-5.375% up 15-20%, div ptcn > 35c. UOP= GCP and repay debt. As we know, invests in debt/equity of middle mkt cos (pfolio: 40% 1st lien, 36% sub, balance eqty & other). We’ll use L+500 and 20%iv (high div stk=low vol), Theo 97.74/99.34/100.98. Existing CB (remember Jan) trades 3pts thru’ theo due to IG-rating (BBB), high bondfloor and profile ap peal. A trend isn’t always a friend (think multiple REIT issues)but

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
this works for us. Model (like existing) doesn’t love it, but we think >BUY<, preferring MIDS (11% from SBV, 17.5% premium). Should see some convergence btwn existing/new, price point prob ably doesn’t incentivize o/r switchers. (srce; bbg/co filing) James River Coal (JRCC) new issue 03/22/11 Daiwa $125m (+18.75m) sen unsec cb coming wed from DB/UBS Terms: 7yr 3.25-3.75% up 25-30%, full pctns. Concurrent eq & str8 deals. UOP=Fund part of IRP acq and GCP. JRCC focuses on steam and industrial grade coal & one of largest suppliers of US coal to India. Thru acq enter matallurgical coal mkt. Lev increase, but acq expected to be accretive to earnings and cash flow in yr 1. Converts sub to both straights. 4.5% now x-par 4.5 up 67% back out L+450 for 4 yrs. We’ll use L+700 for 7 yr. Realized vol 40+, we’ll discount vol to 33 for 7 yrs. Theo = 104.25 Credit pos, hungry mkt, paired with cheapest looking coal play in mkt means don’t get stuck in a ” van down by the River” and miss BUY nvertible bonds including credit analysis, indenture analysis and convertible arbitrage trade ideas. Rait Financial (RAS) new issue 03/14/11 $100m (+14m) sen unsec cb coming tonight from ML. Terms: 20 yr, 5.75-6.25% up 17.5-22.5%, call 5y, puts 5,10,15y. Full pctns. UOP = repay debt/gcp. REIT that does not conjur pleasent memories. Hit hard in 2008, it has attempted to reduce debt (incl 6.875% w/$136m outstanding. Most recent trans 1/11 @88). Credit color will touch on highlights but unless you know this co well it is very tough to get comfortable. Model is redundant, brw weak, ve gamma so even w/the gr8 carry & b/even you will have to live w/mark to mkt. For those who w/look at model, using L+1100, 35% & blended 200 bp brw = 105. It is small enough to get a few credit long only buyers but as we said, unless you are in bed with company we would RAIT it avoid RAS hit hard by downtown & have been working to reduce debt. Inv portfolio is comprised of $1.1B comm r/e loans, $841m props (mult-family, office), & $705m sec. Solid residential mort port 7/09. Have been working to take out 6.875% converts for several years, $136m (of $425) remain. SOme exch combo stk/cash/secured cvt )due 2014). Most recent trans 1/11 at 88. Most debt secured & non-recourse, most assets encumbered Our assigned spread L+1100 Illumina (ILMN) new issue 03/14/11 $800m (+120m) sen unsec cb coming tonight from MS/GS. Terms: 5yr 0.25% up 30%, full pctns. re-offer 98.5-100, happy meal (60d). UOP=stk buyback & fund 0.625% conversion. Well, where does one even start? We all want the same thing, issuance but not like this. Going to keep this brief; MCP, ORI, WBMD new, CX all examples of how mkt would have saved $ if it had bought in secondary. We’ll give benefit of d oubt & use L+200 & 27% (vol s generous. 01/12 same delta = 31 iv bid but historic in low 20s & don’t forget this is $800m). Theo = 98.5. Given CX hangover & the change in 2ndary mkt sentiment what are the bankers thinking? Please illuminate us. You don’t n eed the AVOID on this. It’s a bought deal, so at least u/writer is supporting it this time. Tivo (TIVO) new issue 03/08/11 $120 (+18m) sen unsec cb coming tonight from UBS. Terms: 5yr, 4-4.5% up 22.5-27.5% full pctns. UOP=fund i/p litigation & gcp. T+1 cos deal w/get pulled if Echostar wins case b4 settlement date. This is obv med/term driver. Had edge w/jury trial/appeal. Stock spiked to $18 on appeal win but tanked > rare en banc review decision. worst case = back 2 district court = more cost & uncertainty. Next few months key. Partnered w/CHTR, VMED, RCN & Suddenlink.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
No debt & should turn CF +ve w/lower legal costs. Equity story but 4 model’s sake we’ll use L+900 & 35%. Theo = 105.7 Listed volatility bid on back of catalyst, equity mkt interest obvious i n our mind. Good way to get long story, don’t freeze or pause BUY Old Republic (ORI) new issue 03/03/11 $250m (+37.5m) sen unsec cb coming tonight from MS/UBS. Terms: 7yr 3.5-4% up 30-35%, pctns (div > 0.175 qtr), concurrent $250m 10 yr str8 (L+250). UOP=r epay debt/gcp. Existing 8% ’12 mostly held by o/r (6.8% up 13%@117 w/div pctn > 17c using L+100 = 23iv). Use L+200 for 7yr. No leaps, ADV=1.5m, 100w=29, 100d=21 so wont use more than 23 vol. Theo = 100.5. We were generous on inputs & model doesn’t like it. Given rating & mkt, that’s not what h/f’s want to hear. There will be o/r interest but to buy this on swap really would be lesson in greater fool theory. Structured well 4 o/r community & given technicals in IG space, we all know outcome over time. Know that u r buying fair to make rich. Want to say CHEAPs (wont happen) so push for mids. Health Care REIT (HCN) new issue 03/01/11 $625m (93.75m) perp prf coming tonight from UBS/MER/DB/JPM/WFC. Terms: 6.5-7% up 15-20%, s-c@130 yr8, pctns (div> new 0.715). COncurrent stk of 25m (3.75m). UOP=genesis assets. 3 existing issues most notably 1.3 yr 4.75% ’27=17iv (25bp) 4 yr 3%=19iv (90bps) or L+150ics. 5 yr CDS = 90bps. Tough to apply 2.5x CDS formlua in cycle. We’ll use L+350 No leaps ADV = 1.6m, need to dscnt for structure existiing 3% valuation & tight credit/low vol env. We’ll use 15%. Theo 104.2/107.2 rich/mid. Eg’s of preferreds from prev cycle; ARE (7% up 15% 03/08), DLR (5.5% up 17.5%) so priced in line. No obv stk switch h/ever being paid L+500 to own just the credit option (0 vol) on BBB- prf is not bad. Guys will play stk, big deal but will get done in this mkt. Prefer mids obviously Jaguar Mining (JAG) 02/07/11 $90m (+13.5m) 144a senior unsec cb pricing tonight from BOA. Terms: 5yr bullet, 5.5-6% up 32.5-37.5, protections. Jaguar is a $500m mkt cap, emerging gold mining company w/3 producing mines in Brazil. UOP=to develop 4th time (Gurupi). PF Cash = $136m, PF Debt = $284m LTM EBITDA = $22m LTM FCF = neg $110m They have a history of disappointing on guidance. So caution warranted. Their o/s 4.5 of 2014 imply 750 over. We’ll use L+900. See credit color And will cap vol @35v. Stk brw is between neg 2-3% but should improve. We’ll use 200 bps at this juncture. Theo = 102.5 Small deal, strong demend for paper, incl possibly equity demand for this name watch for possible upsize. BUY Daiwa New Issue Credit Color JAG began ops in 2004 and now has 3 prod mines in brazil, last commissioned in May 2010. Co has a history of disappointing on prod and cost guide, which continued into 2010. FY prod 138oz, down from original guid of 200k

98

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
to 217k & below 2009 prod of 155k, with all 3 mines falling short. Op issues likely to cont into 2011. Co raising cash to dev Gurupi (#4 mine). Pre-op cap ex estimate of $278m w/start up in 2013. EBITDA expected to ramp, but w/poor history it is hard to count on that. Our assigned spread L+900 MF Global (MF) new issue 02/07/11 $250m (+37.5m) sen unsec cb coming tonight from GS, Citi, DB. Terms: 5yr bullet, 1.75-2.25% up 25-30%. UOP=pay down revolver, hedge V shape recovery reminder again: 9% in 2008 to 2% cpn in 2011. Co plans to double rev < 5yrs by becoming inv bank. Liq good = $690 of $1.2 revolver ext to 06/14 (balance due 6/12), $200m being paid, leaving $1B. PF Cash = 761, debt 660m, LTM ebitda 182m, fcf (115m). Existing 9% (07/13) ~390 using 33 vol. Use L+500. ADV = 1.75m. 06/11 calls ~35iv bid. Use 30v for 5yr. Theo = 100.625. hearing tighter spreads/higher vol out there bt w/9% its str8 forward to price. If you use 30 vol, u get tght er ics but then u can’t px 5yr vol thru that to get this deal to look cheap. Smallish size helps, but AVOID unless Cheaps. MF has good niche franchise but competes against much larger comps incl Goldman, UBS, Citi, BAC. Jon Corzine joined as CEO early 2010 & just extended contract thru 2014. Profit has been weak since downturn due to reliance on trans volumes & interest rates. Strat plan to transform from broker to inv bank w/goal to double rev w/in 5 yrs, will increase risk. Liquidity ok, extended $690mm of $1.2b rev to 6/14, bal due 6/12. Proceeds to pay down rev, leaving $1B available. Our assigned spread L+500 Savient Pharmaceuticals (SVNT) new issue 01/31/11 $125m (+18.75m) sen unsec cb coming 2night from JPM. Terms: 7yr, 4.5-5% up 20-25%, nc4 pctns. UOP=KRYSTEXXA. > 09/10 FDA approval co failed to sell themselves hence the capital raise. Imminent US launch w/EU filing. Co needs liquidity (w/out cb, cash will be flat by mid yr.) Like DNDN, those that believe will see this as tighter spread/lower vol in time & those like us who are not experts will avoid. Historic financials & model r not relevant. For those who do care, L+900/35 vol & 50bp brw blended = Theo = 103.4 MKT likes these names (DNDN gr8 example). We don’t like call b4 maturity but if u believe then b/e right there. Too much risk for us SAVVY would push 4 cheaps SVNT received FDA approval for Krystexxa in Sep 2010 & planned to sell themselves then. That didn’t work out so they decided to go it alone w/a US launch, expected in few wks. Also pursuing EU filing. Have 1 other tiny product & no pipeline. Co would be out of cash mid year w/o convert deal. Estimaes vary on size of patient pop for Krystexxa, questionable if/when co becomes profitable. Safety issues & reimburse are other risks. Our assigned spread L+900 Dendreon (DNDN) new issue 01/26/11 $500m (+75m) sen secured cb coming tonight from JPM. Terms: 5yr, 2.375-2.875% up 40-50%, pctns. Happy Meal. UOP = m/facturing expansion. All about Provenge. Exp to peak w/$2.2B US & 1.3B EUR rev & exp 2012 rev of $865m & EBITDA of $360m (wont even refer to LTM cos you buy this for the future event) Supply issues = difficult to understand real demand but co exp supply constraints to clear end 2011. Heard assumptions between 400 and 600. We’ll use L+500 ADV = 3.1m, 0/13 50c=47iv bid. We’ll use 35 vol. MID/CHEAP theo off close = 101.3/103.1, off crnt $35.8 = 100.4/102.1 off $35.14=99.6/101.4. Improving credit story w/dampen vol so you need to look at this stock up, credit tighter & vol in. Will take time but think pre-CEPHALONic. Squeeze the lead for cheaps

99

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Ares Capital (ARCC) new issue 01/26/11 $300m ($45m) sen unsec cb coming tonight from JPM/BOA/WFC/DB. Terms: 5yr, 5.75-6.25% up 17.5-22.5%, div pctn > 35c. UOP = repay debt/gcp. invests in debt/equity of middl e mkt co’s (portfolio = 40% 1st lien, 36% sub, balance equity & other). CP & revolver financing done @same time as Allied Capital acq in 2010. BBB/Ba1 rates. One convern is quality of portfolio > Allied acq. PF debt = 1.6B (~50% sec), EBITDA = 448m, lev 36x. CP line = L+275 & revolver L+300. Unsec 5yr CB, use L+500. High div stk = low vol so use 20%v. Theo = 102. Tricky sctr but given high coupon, high bond flr & IG rating, expect o/r interest. Not obv for hedgers but good risk/reward in slightly cheap IG bonds w/shrinking universe & o/r interest. Ask for mids but we’d buy ARCC invests in small private companies, primarily debt Performed well during downturn & did not violate any credit line covenants. Acquired Allied in April 2010 at discount to book (they did not fair as well). Led to improved mkt pos & divers revenue, but concerns over addl write downs. Liquidity good with increased cash from recent trans & $675m avail on funding lines. ~50% of debt secured, paying L+300m on revolver. Our assigned apread L+500 Apollo Investment Group (AINV) new issue 01/16/11 $150m (22.5m) 144a senior cb overnight from MS. Terms: 5yr bullet, 5.75% up 17.5%, dvd prot > 28c per qtr. UOP = repay credit facility & gcp refooered 98-98.5. Shall we just cut & paste ARCC color? A closed end mgmt co. BBB rated. $2.2B mkt cap. Cash = 26m, debt = 1.4B, $880m available on revolver. New L+300 sec bank line in 2010. Appears to be less sub debt, more liquid portfolio than ARCC. But use same inputs (500/20), taking stock down to $11.50 (19.50% premo) = 99.5. Again it feels like the CB mkt is patsy of the cap structure. For the same reasons we thought ARCC would do well over time (high cpn/bond flr/IG trifecta) we feel same here. We think another investment. Dont pay more than 98 China Medical (CMED) new issue 12/01/10 $100m (+25m) sen unsec cb coming tonight from BOA. Terms: 6 yr, 5.75-6.25% up 25-30%, sc 4 yr@130%, pctns. 30d term swap. UOP = 3.5% b/back, hedge. $450m niche playa w/recurring rev streams in mkt with high barriers to entry 4 overseas co’s/ Mgt felt turnaround was not being reflected in $200m str8 pricing so deal was pulled in sept (B+ S&P rated). No quarterly data but co fcf +ve on f/yr basis. 3.5% 11 L+400, 4% L+1000 post announcement. Credit/vol relationship = higher vol/wider credit but ADV=280k & brw is big issue (1-2.5% & v thin). We hear 40-45 vol assumptions but how do you capture that? Name has core following, not a h/f model trade. 4 those who will model we’ll use 1000/30%/150bp. Theo = 102.7 Good credit brw call, small deal will get done but we prefer 4% to play Lennar (LEN) new issue 11/04/10 $350m ($52.5m) sen unsec cb coming tonight from JPM/Citi. Terms: 10yr, 2.5-3% up 37.5-42.5% put/call 5yr, full pctn. UOP=repay debt/gcp. Existing 2% ’20 (12/13 put call) came 2% u p 37.5% now x/par up 45% (static 37d). 3.5y DHI ~31 iv (300 bps CDS) w/leaps 40 iv bid. LEN 3yr CDS ~355=25iv & 3/4.7 pts cheap (35/40 vol). 5yr CDS ~425 so we’ll use that (although there is basis vs str8). ADC 5.5m, no leap liq, 2yr 10/50 ile = 53/42 vol. In short, space trades cheap (tricky sctr w/alot of mkt won’t play CDS). We’ll use 32 for 5 yr. Theo = 105.5. Existing cb has worse strike (27 vs 21), x/par w/more premo but we prefer 3 vs 5. New Issue implied (mids) = 23 iv so slightly cheap to existing. So on that basis, we would LENd $ to co but would ask for mids or better Our assigned spread L+425

100

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Lennar (LEN) new issue 04/26/10 $250m (+37.5m) 144a sen cb pricing tonight from JPM/Citi Terms: 10yr, 1.5-2% up 37.5-42.5, put/call 3.6 yr (12/1/13), t/o & dvd prot. Concurrent $200m straight deal. UOP=debt repayment. Lennar is one of the largest homebuilders in the US. Stk has recouped losses from last 3 yrs. 5 yr CDS 260-270. We’ll be conservative and use the 270 offered side for this shorter duration. Vol in past few yrs has been 50+. We’ll use 35: 101.75/102.5/104. Another issuer taking advantage of tight credit markets. With rich optics, we fear this deal is just another model trap. DHI originally traded poorly for same reasons. But now we’d rather own DH I on swap for the vol skew. Given recent primary cheapness, only play CHEAPs (if you want housing exp and 30 implied vol. Cemex (CX) new issue 03/24/10 $500m (+75m) sub cb coming tonight from CITI. Terms: 5yr, 5.25%-5.75% up 27.5-32.5% ppctns. UOP = CB hedge, repay debt, gcp. #rd biggest cement co in world. Great recovery play. Lost IG rating in 01/09 which led to $15.1B bank refi, asset sales, $1.75N s/debt deal & aggressive cost cutting. Aim= avoid b/debt interest increases (heaviest burden of debt falls late 2012). See credit color. 9.5% 16 sec @finance opco L+525. CB is sub @holdco so we’ll back out to L+850 (assume zero reov in liq/~20 in resturcture). ADV = 980k, same delta leaps ~50iv (small OI), 2yr 50/10ile = 76/42. We’d heavily dscnt to 32 vol. Theo = 106.8. Great Play on macro turnaround although ’12 brings risk BUT mkt compensated for that. Solid as CONCRETE. READY to GET in MIX? BUY Old Republic (ORI) new issue 04/24/09 $250m (37.5m) REG sen unsec tonight from JPM/MER. Terms: 3yr bullet, 7.75%-8.25% up 17.5-22.5% prot. UOP=pay down cp ($200m). $2.6B title, liability & mortgage insurer. Quality inv port but 1Q rev down in all businesses (mortage/titla = 1Q op losses) ’08 inv w/downs in MGIC/PMI but port now looking more stable w/conservative FI focus. Property/liability & mortgage biz will see difficult ’09 (mortgage biz will need more cash) so we’ll dscnt sprd to L+1000. Again, we’ll dscnt vol for inability to capture d/side (no c/hedge). We’ll use 30% THeo=102.75/104.25/105.625 Theo is only part of this story. A small deal with obvious x/o interest. Some using tighter credit so w/see more value but beware of the model trap – BUY China Medical (CMED) new issue 08/14/08 $150m (22.5m) sen unsec cb coming from CS/MS. Terms: 5yr, 3.75%-4.25% up 20-25%, pctn. Brw-fac. UOP=gcp/acq. $1.5B med supply co (now sell higher margin diagnostic reagents rather than non-recurring equipment). Grow thru acq (used $115m cash FY08) w/more to come. LTM EBITDA and FCF = 76/62m resp. lev 3.9x co competes against BEC, Roche, J&Jetc in some mkts. We use L+550 for 3.5% ’11 3.5 yr sr -sub (low CS01), so we’ll use L+700 for 5 yr sen cb. ADV=low 620k w/75% delta listed indic 48 iv bid (low OI). 3yr 90d 5/10ile – 50/35%. We’ll discount 5 yr, low ADV & mkt cap to 40 vol. Thry = 104. 5/106.5/108.5. Brw is 150bp away from facility so will be secondary away from lead. Stk downside & lead support always concern us so get rewarded. BUY on mid/cheaps only. NuVasive (NUVA) new issue 3/3/08 $200m [+30m] sr cb from JPM/GS pricing tonight. Terms: 5yr 2.25-2.75% up 22.5-27.5, nc-life, protections. Partial Happy Meal, UOP = gcp, potential M&A, call spread. NuVasive is a medical device so focusing on spine products [$1.3B mkt cap]. It’s an interesting growth story but not a great credit. EBITDA has turned positively. This will be their only debt. We’ll use L+750. Vol has historically been in the 30s but daily has been 40s. We’ll use 37%. Theo=99/101.125/103.25. KYPH was their best comp until MDT bought them, which leaves MDT and JNJ as NUVA’s biggest comp. Good story with takeout potential. But protect yourself in this market. get paid for credit risk, push for cheaps.

101

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Illumina (ILMN) new issue 02/13/07 325m (+50m) senior cb coming tonight from GS/DB. Terms: 7yr bullet, 1/2-1% up 22 1/2-27 1/2%. dvd/t/o prot. Prcds to buy back $200m stk. Happy Meal. The mkt historically likes human genome cb issues & guys will focus on the patent infringement case, pending March 5th decision as a short term vol catalyst. Co turned EBITDA +ve 4 qtrs ago & FCF +ve 2 qtrs ago, has a strong foot hold in geno typing mkt & has made a significant stk acq in the sequencing mkt w/Solexa. We think rating would be CCC+ & we will use L+400bp, using tighter is a risk given unknown costs associated w/sequence mkt. Listed is in high 40s but illiquid. We think 40 vol is right for 7yrs. Theory=95.1/97.5/100.1. We like high theo delta but don’t ILuMiNate unless on -> CHEAPS <Health Care REIT (HCN) new issue 11/14/06 $300m [+45m] senior cb on HCN from UBS & DB pricing tonight Terms: 20yr, 4 3/8- 7/8% up 20-25%, nc5y, puts 5/10/15, dvd & t/o prot. Proceeds to buy additional properties & repay credit fac. HCN has 477 facilities in 38 states. 5yr CDS @ 55bps. Weekly vol is 17%. Listeds are scant. ADV stinks [285k]. On avg, REIT universe implies 16% vol. We’ll go w/that. Borrow is not normal UNLESS you p.b. through u/w. Much is tied up w/stk arb guys [HCN buying Windrose.] An avg, borrow fee=1 3/8, but MAY turn normal when deal closes [yr end?]. Using 138 fee, theo=97 7/8/99 1/4/100 11/16. REG borrow=98 3/4/100 1/8/101 3/4. Unless reg brw, who wants another REIT, w/uncertain brw, when you have so many other deals to choose from? We’re sick of REITs unless cheap. >AVOID< otherwise Greenbrier (GBX) new issue 05/16/06 $85m [$15m] senior unsec cb on GBX pricing tonight from BS/Boa. Terms 20yr, 2 1/8-5/8% up 27.5-32.5%, nc7, puts 7,10,15 t/o dvd prot. This deal was a real eye opener this am. GBX is a $625M mkt cap that burns cash. We were surprised to see that their pari-passu 8.75% trades at L+195. Pro-forma leverage is modest at 3.5x but we are not comfortable using 200 over. Duration to the call of the 8 3.8% is 5 yrs. THis convert is 6+. SO we;ll use L+225. Historically, vol=40s, but ADV is only 244k. If 70% is hedged on a 75%, 1M shares need to be sold. Only the 1st 500K are reg borrow. So we’ll use 30% vol and 50bps. THeo=97/99.25/101.75. We don’t believe in sustainability of 200 over. However, 85m deal will get done, but is not suited to most. AVOID Mentor Graphics (MENT) new issue 02/27/06 Original research I would use L+400 as the credit spread for the new MENT $175M 6% up 65 convert issue with 7 year put. Proceeds will be used to retire the existing $171M 6.875% convert. After the offer, MENT will have $95M in cash and $$285M in debt ($175m new converts and $110m floating converts w/2010 put). In the last 12 months, the company generated $19m in FCF. Although MENT is not rated, its credit metrics place it in the B- range. EBIT/Interest is 1.1x, EBITDA/interest is 3.0x, Debt/EBITDA is 4.9, Debt to capital is 49%. Companies with these metrics trade in the L+350 range. However, MENT deserves to trade at a discount because it is a small technology company ($1B market cap) with uneven FCF. On the positive side, the company has high gross margins (80%) and whether any downturn with cuts in SG&A and R&D. Omnicare (OCR) new issue 12/13/05 $750 (+15% shoe) deal from LEH/JPM/CIBC pricing tonight con-current w. $750 common +$750M sr sub notes. 3.125%-3.625% up 32.5-37.5%. 30 yrs, NC 10, put in yr 10 only, 130% coco 120%copa. Div prot above $0.0225/qtr. Convert is structually SUB to new sr sub notes which have OCR Holdco guarantee. OCR is the largest

102

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
provider of pharma sesvices primarily to the elderly. Strong sales fueled by aggressive acq strategy. Strong FCF but high leverage. Liquidity is OK with $700M avail on revolver. Using L+275bps (100bps wider than existing HY debt) & 25 vol. bonds are worth 99.67/102.45/10.29. THese are a BUY on mids or better Credit Analysis Reports GY 2.25% converts analysis 03/24/10 March 24, 2010 Near term catalyst On 3/19/10, GY amended their credit agreement to allow the company to refinance their outstanding unsecured bonds. The agreement allows GY to issue up to $438m in debt but the company has to use the proceeds to retire either the term loan or the unsecured bonds. In exchange, GY will pay L+325, 100 bps higher than the old rate for the term loan. We bought some 2.25% bonds at 92.75 (7% yield to put 11/20/11). We feel that the company is likely to take action to refinance either the 2.25% converts or the 9.5% straights, which could lead to a tender offer for the 2.25%. I feel very comfortable about GY credit. The company is a defense contractor with long product cycle including a funded backlog that covers 1 years worth of sales. The company is free cash flow positive, fresh off a Moody’s review for upgrade and a credit agreement amendment GY Analysis Cash = $158m Term loan due 2013 = $51.5m drawn ($75 capacity) Revolver = $65m undrawn Letter of credit = $85m drawn ($125m capacity) 2.25% sub convert due 11/20/11 = $132m 9.5% sub straights due 8/15/13 = $75m 4.0625% sub convert due 12/31/14 = $200m Total debt = $477m Environmental remediation and postretirement liabilities = $520m GY should generate about $140m EBITDA in 2010 for a leverage of 3.4x. EBITDA/Interest expense is 5.3x. These metrics are consistent with a BB rating. Moodys currently rates it B3, on review for an upgrade. Business GY is a manufacturer of aerospace and defense systems with a real estate segment. Aerospace includes AerojetGeneral, which makes propulsion systems (mostly for missiles) for defense and space applications. GY is one of the

103

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
largest providers of such propulsion systems in the US. Customers include the major prime contractors (LMT, RTN, BA) to the US government, the department of defense, and NASA. GY also owns about 12,200 acres of land adjacent to US Highway 50 east of Sacramento. GY is seeking to change zoning rules to optimize its value. The land is estimated to be $200m at the low end. Aerojet has been an industry leader in propulsion systems for 60 years. It is the only domestic supplier of all four propulsion types – solid, liquid, air-breathing, and electric. Competitors include Alliant Techsystems (solid, air), American Pacific (liquid, electric), Astrium (solid, liquid), Northrup (liquid), Pratt & Whitney (liquid, air, electric) and SpaceX (liquid). Aerojet is number 2 in solids behind ATK and liquids behind Pratt. Prime contractors Raytheon and Lockheed Martin account for 31% and 26% of 2009 sales, respectively. About 51% of sales were fixed price contracts, 37% from cost reimbursable contracts, and 12% from other sales. Many products have life cycles of over 10 years. These contracts are initially small during the development phases that can last two to five years, followed by low-rate and then full rate production. GY’s funded backlog is $811m and unfunded backlog is $379m. Funded backlog is the amount of money that has been directly appropriated by the US congress and unfunded backlog is the amount for which funding has not been appropriated. GY’s annual sales are $800m, so funded backlog covers 1 year of sales. Most of GY’s R&D are funded by customers so the company does not have much R&D expense. Steel Partners owns about 7% of the company and in the past have pressured the company to make strategic changes. On January 6, 2010, the company appointed a new president and CEO Scott Seymour from Northrop Grumman. In December 2009, Moody’s placed GY on review for upgrade from its current B3 rating. March 26. 2010 Met with GY management today. The company has $230m in cash (there is $30m restricted that has to be used to buy back debt). The 2.25% converts are the next maturity $132m. The company just amended their credit facility so that any new proceeds from a debt issue have to go directly to repaying debt. The company says they are looking hard at all options and reducing debt remains their top priority. GY hired a new CEO about 6 months ago and I believe he would like to right size the capital structure as soon as possible. This includes terming out maturities to give the company a more stable debt structure. Prior to the credit agreement, the company could only issue a bond that had lower coupon than the debt that they were retiring. This restriction is now gone. Also in the prior agreement, GY was only able to buy back $10m of bonds. Now they can buy use any cash to buy back bonds as long as their net debt leverage ratio is below 3.0x. It is currently below that. GY has a backlog that covers 1 years of revenues and about $20m FCF per quarter. GY is a defense company that makes missiles for government programs. They have long product cycles and 1 year visibility into their order book. Conclusion GY never did tender for the 2.25% converts or do a large buy back. Instead, they will wait until maturity. However, the trade still worked as the bonds traded up to 98 from 92 in just a few short months. Cal Dive (CDIS) Analysis May 16, 2005 CDIS analysis – May 16, 2005 Summary

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
I estimate a 300 over Libor spread for CDIS based on strong credit metrics but offset by their small size and exposure to a capital intensive and cyclical industry. The company is not rated by S&P or Moodys. I would rate CDIS a B+ credit. The recent price for the converts of 94 vs. 42.55 and 300 over Libor spread imply 21% vol. The converts are protected for both dividends and takeover (less than 90% stock). I believe the credit is solid for the following reasons: 1) In practical terms, the credit will be correlated with the oil and gas industry, which continues to do well. TheGulf of Mexico, where CDIS primarily operates, is seeing increasing drilling activity, thus benefiting CDIS operations. 2) The company has a strong cash position and liquidity. CDIS has $362M in cash and $443M in debt ($300M converts and $143M in bank debt). The company expects to generate about $100M in free cash flow in 2005. 3) One support for the credit is the company’s large oil and gas rese rves of 12.5M barrels in oil reserves and 74.7 Bcf of natural gas, which are valued at about $500M after taxes and production costs (based on $40 oil and $5.50 gas prices). Every $1 move in oil prices leads to a 7c move in EPS, which is the reason for the company’s wide range of $2.30 to $2.90 EPS for 2005. 4) CDIS management has enough on its plate for 2005-2006 and will only make small acquisitions with its free cash flow. They are happy with their capital structure and do not want to add any more debt. 5) The major risk for CDIS is if oil prices plunges to below $25 per barrel (FCF breakeven), which is unlikely to happen in the near term. Other risks relate to oil reserve estimate revision or unforeseen shutdowns of its properties. Capital Structure and Credit Analysis CDIS has $362M in cash and $443M in debt ($300M converts and $143M in bank debt). The company expects to generate about $100M in free cash flow in 2005. Capex for 2005 is expected to be $220M consisting of $110M maintenance, $45M for Independence Hub, and $65M for PUD oil field acquisitions) The 3.5% converts are takeover and dividend protected and senior ranked. The converts are contingent interest with 0.25% contingent if trading over 120% of the principal amount. Aa AA 42 10.1x 12.9x 1.2 37.7 A A 59 6.1x 9.1x 1.6 42.5 Baa BBB 189 3.7x 5.8x 2.3 48.2 Ba BB 262 2.1x 3.4x 3.4 62.6 B B 387 0.8x 1.8x 4.9 74.8 Caa CCC 860 0.1x 1.3x 13.0 6.3 2.0 87.7 Debt/Capital 44.2

cdis

Spread over treasuries EBIT/Interest Coverage EBITDA Interest Coverage Debt/EBITDA

7.1

The converts are not rated by S&P or Moodys. I would rate CDIS a B+ credit and estimate the spread at 300 over L. CDIS has strong credit metrics but offset by their small size and exposure to a capital intensive and cyclical industry The most comparable company to CDIS with publicly traded debt is Key Energy (KEGS) which is rated B/B1 and is trading at about 325 over treasuries. CDIS is similar in size to KEGS but KEGS is less profitable with an interest coverage ratio of only 1.5x.

105

Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
One support for their credit is their large oil and gas reserves of 12.5M barrels in oil reserves and 74.7 Bcf of natural gas, which are valued at about $500M after taxes and production costs (based on $40 oil and $5.50 gas prices) The company said they are comfortable with their capital structure and will not look to add any debt in the near future. They are still on the look out for acquisitions, particularly looking for more mature properties and to enter theNorth Sea. LDK Solar analysis – 06/01/10 LDK converts analysis – 35% YTP less than a year to maturity June 1, 2010 LDK has $400m of 4.75% convertible bonds with a put on 4/15/11 trading at 79 for a ytp of about 35%. I think this is an attractive yield. The company’s main problem is that it has too much short term debt ($980m) but my analysis shows that they should be able to take care of these through a combination of extending the loans, issuing new equity, and selling additional interest in their polysilicon plant. The company has $384m cash (plus another $70m restricted), $980m of short term debt, $400m converts, and $450m of long term debt, for a total of $1.7B. This equates to a debt /equity ratio of 170%, which is too high. A better ratio would be to bring it down to 100%. To do this, the company could raise $300m in new equity and sell another 35% of its new poly plant for about $400m and push out $680m of short term debt. Given that the debt overhang is keeping a lid on the stock, the near term business environment is improving, and the financing markets are wide open (ESLR $1.20 stock just did a $175m convert), I think LDK takes steps to fix its capital structure sooner than later. Ownership & structure Xiaofeng Peng (CEO) owns 67% of the stock. LDK was incorporated in the Cayman Islands in May 2006 by Xiaofeng Peng to acquire Jiangxi LDK Solar from Suzhou Liuxin. In 2009, the company sold 15% of its Polysilicon project for $220m to Jiangxi ($1.5B implied value). Analysts said the company is looking to sell another 35% stake to reduce its ownership to 50%. LDK is the holding company with two main divisions 1) LDK Silicon (polysilicon) 2) LDK Solar (Wafer, cell, module). Bankers LDK’s bankers are Agricultural Bank of China, Bank of China, China Development Bank, Export -Import Bank, Huarong Int’l, and several domestic Chinese banks. I could not find any detailed information on the loan terms. Given that in early April 2010, China Development Bank gave Suntech Power STP a $7B credit line and Trina Solar TSL a $4B credit line, it appears that the Chinese Banks are very supportive of the solar industry, which is becoming a very important export market. I see no reason why China Development would not extend the loans to LDK. Xiaofeng Peng is a powerful figure in China and owns 67% of LDK. By comparison, LDK had 2009 sales of $1B, STP had $1.7B, and TSL had $850M, so it would not be a stretch for the Chinese banks to extend maturities of $1B to LDK. Recovery value (rough estimate) In case LDK has to file for bankruptcy, I see the recovery value for the bonds at 25%. LDK’s polysilicon facility has a $1.275B value based on the recent transaction. The rest of LDK’s business is similar to that of ReneSola (SOL), which has a $1B enterprise value (LDK is about twice the size of SOL but I will be conservative). That gives a total value of $2.275B or $1.82B if discounted by 30%. That leaves $100m available to convert holders after paying the

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
banks $1.43B and $290m for trade payables and admin costs. This is also assuming that the company burns through its existing cash. Solar supply chain The solar supply chain has 5 basic steps: 1) Polysilicon, 2)Wafers, 3) Cells, 4) Modules, 5) Systems. Solar begins with the manufacturer of polysilicon which are made into wafers, which are then processed into cells. The cells are grouped into an electric array, and assembled into weatherproof modules that can easily shipped and installed by specialized system integrators on site. LDK began as a manufacturer of Wafers but has now also ramped up production of Polysilicon. LDK has 2.0 GW wafering capacity, the world’s largest (10.8% share), 6,000 MT (18,000 MT by end 2011) of polysilicon manufacturing capacity, and 600MW of module manufacturing capacity. Currently, the bottleneck is in the Wafer part of the supply chain, which is LDK’s main business. This supply constraint is leading to better pricing for wafers, which greatly benefits LDK. Properties In the last two years, LDK has spent about $2B on capex to build out its plants, most of which are the low cost producers, so there is a lot of value in these properties. 15,000 MT polysilicon plant “Ma Hong” 3,000 MT polysilicon plant “Xia Cun” 2.0GW ingot, wafer and cell plant Solar Cells – plans for 3Q10 start (240MW by end 2010) LDK Solar Module – Nanchang plant, Suzhou plant (1.5 GW capacity expected end 2010) 50% JV with Q-cells for 42MW system Pipeline projects : Systems in Italy, France, Germany, Spain Solar industry In 2009, the leaders were Germany 40%, Italy and Czech Republic (combined for 23%), Other Europe 10%, US 10%, Japan 8%, Rest of world (11%). In Germany, there is a feed-in-tariff, which requires utilities to buy electricity from solar power generators at a high fixed price (20 year contracts). There will be a 15% cut to subsidies on July 1, 2010 so there is a fear that we may get a drop off in demand. However, many German projects are being pulled into 1H10 (to lock in better contracts) causing a surge in near term demand and capacity constraints in parts of the supply chain. Due to the constraints, some projects that are not related to German subsidies are being pushed into 2H2010. Combined with potential pullins into 2H2010 from 2011 from other counties whose subsidies get reduced on January 1, 2011, the order book for 2H 2010 is filling up quickly. There are many bears that think demand will fall off a cliff after July 1 but evidence is quickly contradicting that theory as some companies are now sold out through October 2010. As the near term environment improves, LDK will have more opportunities and flexibility to refinance its debts. It is also possible that China could enact some kind of National feed in tariff (2010 or 2011), in which case the solar industry would benefit greatly. Risks 1) A sharp downward move in the Euro. This could have be negative for demand in Europe. 2) A sharp rise in the Renminbi. This would be negative for LDK because it would make them less competitive with non-Chinese rivals. 3) Problems with their polysilicon facility in terms of production. SO far, all signs indicate that the new plant is running smoothly. June 29, 2010 I spoke to Jack Lai, CFO of LDK today. These are the key points.

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1) The company has $384m in cash but $980m in short term debt and $400m in converts due 4/2011. There is another $450m of long term debt. Jack says there is usually about $200m due every quarter. In the past, they have extended the loans every quarter. The loans are all from Chinese Banks who are very accommodating to extensions. 2) Jack is currently working with bankers on a potential IPO of its 85% owned poly silicon plant. Based on LDK’s sale of the initial 15% stake, the remaining 85% is valued at $1.275B. LDK would likely keep 50% and sell off another 35%. 3) Jack is aware that there are $400m converts due 4/2011. He expects the company to generate some free cash from now to the end of the year and he will use that to buy back some converts in 2010 before addressing the rest when it matures. 4) Jack says he is working on a credit line similar to what STP and TSL got. STP got a $7B credit line and TSL got $4B. Jack feels that he can get something similar. 5) Near term business is good. Germany is pulling forward business but 2H order book is filing up. They are sold out through October. Wafer pricing is 80c, firming. August 16, 2010 -converts trade up to 91 following good report LDK ended the quarter with $443m cash and free cash flow of $25m (cash flow from operations of $152m and capital expenditures of $127m). Wafer prices have been moving up given strong demand in solar that will probably continue to be strong at least through year end. The company has $1.1B short term bank borrowings, $400m of converts, and $487m of long term borrowings. LDK’s plan is to continue to convert the short term loans into long term loans, which they have had no problems doing. Given the cash on hand of $443m and now the company is FCF positive, I am more comfortable that LDK can take out the convert due 4/2011 fairly easily. It probably needs to raise about $200m to be in a good position. LDK’s plan to raise cash is the following 1) They are in final staegs of discussions to expand its line of credit with state level institutions 2) The are negotiating with potential investors for a placement of common stock, 3) Look to provide a dividend to the holding company in cayman islands from the chinese operatiing company. On the business side, wafer prices are going up in 3Q and 4Q. The spot market is not $1 per watt, higher than the 85c in the second quarter, Non silicon costs for the wafer busines sis 31c per watt, targeting 25c in six quarters. They also see a big increase in poly prices and continuing to increase in the next few months. Currently, they see $60 but could go up to $80 or even $100 if demand continues to be strong. ABout 40% of LDK’s poly is going to the market and the rest being used in-house September 16, 2010 – Converts trade up to 94.5 I spoke to Jack Lai, CFO of LDK about the converts due 4/1/11. He said the company is in negotiations to sell a stake in the poly plant for between $150m and $200m and that the de al should close within the next 30 days. LDK’s plan is to use this cash to buy back half the issue before the end of the year. The company then plans to retire the other half in early 2011 with the proceeds from a stock sale or other fund raising. LDK currently has $443m in cash and $126m in short term pledged deposits. However, the company would like to keep this money at the company to finance potential future expansion. So to retire the convert, the company wants to raise new money.

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On the business front, Jack says business is very strong for Q3 and visibility into Q4 is good as well. Contract pricing for wafers is about 85c for Q3 and Q4. This would likely drop by 10% in 1H2011. Spot pricing is higher at 90c to $1. (this is very good pricing) The order book for Q1 is building in terms of volumes although pricing is not yet set. While most of the street is bracing for a drop off in 1Q, he says weakness in Germany is being replaces by strength in Japan, China, California, UK and France. I believe that LDK is close to a fund raising deal and the converts, which trade at about 94, will move to the 97-98 range when a deal gets announced. September 27, 2010 – Converts trade up to 97.5 LDK announced that it entered into a strategic financing agreement with China Development Bank for up to 60B RMB ($8.9B US) of credit facilities to LDK Solar over a year period. I spoke to Jack Lai, CFO, today and he confirmed that the company can use this credit line to retire the 4.625% converts and other short term debt. Jack sees the converts trading at 98 today and says he is looking to buy chunks of bonds (10-15m at a time) back in the open market opportunistically. He wants to cut down as much of the issue as possible. I would not rule out an early tender. Jack says he is watching the stock price and may look to sell equity if the price is right. He is also continuing to negotiate a sale of their poly plant and should be in a better bargaining position given the new Chinese credit facility. Event Driven Converts MTG deferred coupon trade – August 2010 MTG deferred coupon trade – August 2010 Trade Summary   September 2010: Long MTG 9% convertible bonds and long October 6 strike put options. MTG began deferring coupons on the MTG 9% convertible bonds beginning with the April 1, 2009 coupon. According to the indenture, MTG had the right to defer the coupons for up to 10 years. However, the coupons are cumulative and compound at 9% annually, thus making this convertible bond the highest cost of capital security in the capital structure. Once the coupon has been deferred, MTG can only use proceeds from the issuance of common stock within the previous six month period to pay the deferred coupons. MTG issued $1B in common equity in April 2010, which meant the company only had until October 2010 to use the capital raised to apply the proceeds to the deferred coupons ($74m). Based on our analysis of the indenture, the company’s cost of capital, and conversations with management and analysts, we determined that there was a 75% chance that MTG would reinstate the coupons beginning with the October 1, 2010 payment. We believed the MTG 9% converts did not price in a high probability of a coupon reinstatement. We initiated a long convert position at 107 versus $8.64 for the stock and long Oct 6 strike options at 20.7c to protect the downside. In first scenario where MTG reinstates the coupon, the converts would pay out 19 points of accrued interest with the position falling to 100 versus 8.64 (supported by a 9% yield) for a 12 point gain. In second scenario where MTG does not reinstate the coupon and the stock drops to $7.30, we believed the converts would lose 4 points in value, offset by a gain of 1.2 points on the options for a net loss of 2.8 points. Given our probability weighted scenarios, we felt the risk/reward of the trade was favorable.

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 In October, MTG reinstated the coupon and the position was up 12 points.

Trade Details Summary MTG has deferred coupons on its 9% convertible sub bonds beginning with the April 1, 2009 coupon. These coupons compound at a 9% annual rate. By October 1, 2010, MTG will owe 19.22 points. I looked at the cost of capital for MTG 9% converts and concluded that it is very expensive capital (15.71%) if the company continues to defer the coupons. Even if they reinstate the coupons, the 9% converts are still expensive capital (12.77%), so a flush is also a possibility. I think the company can pay between 36.67 and 41.72 points in a flush (similar to MF 9%, which offered 48 points). The one thing that can hold the company back from reinstatement is if the business environment deteriorates or potential government regulations cause uncertainty. While this is certainly possible, MTG has until September 15 to decide what to do, so that is a short amount of time for things to change. The company just reported a very good quarter in July. Based on my conversations with MTG IR and sell-side analysts, the earnings conference call, and my calculations of the company’s cost of capital, I believe that is about 75% chance that we see a reinstatement or flush by October 2010. Facts about the converts 9% convertible junior subordinate debentures due 2063 ($389m) 1) The converts pay coupons semi-annually on April 1 and October 1 of each year starting with October 1, 2008. Starting with the April 1, 2009 payment, MTG deferred the coupon. By October 1, 2010, MTG would have missed 4 coupon payments. These coupon payments compound at 9%, which would give a value of 19.22 points as of October 1, 2010. (total of $74m) 2) Once the coupon is deferred, MTG can only use proceeds from the issuance of common stock within the previous 6 month period to pay the deferred coupon. For example, MTG issued common stock in April 2010. It has until October 2010 to apply those proceeds to the deferred coupons ($74m). 3) MTG must give notice of a coupon deferral at least 15 days prior to the interest payment date. This means MTG must decide on the next coupon deferral by September 15, 2010. 4) MTG has the right to defer coupons for a total of 10 years. However, after 5 years, the company must use its best efforts to issue common stock or preferred stock and use the proceeds to pay the missed coupons. During the deferral period, MTG cannot pay common dividends or buy back common stock. (page 91) 5) The converts can be redeemed at par on or after April 6, 2013 if the common stock exceeds $17.55 for 20 out of 30 business days. (page 98) 6) The converts can be redeemed at par plus make-whole prior to April 6, 2013 if there is a “tax event” or a “ratings agency event”. The make-whole is the present value of the present value of the principal payment on April 6, 2063 and coupon payments from redemption date to April 6, 2063 at a discount rate equal to treasury rate + 50 bps. (page 98) 7) The convertible bonds are dividend protected from 0c and take-out protected with a make-whole matrix.

MTG Capital Structure

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Holdco debt: 5.625% senior debt due 9/2011 = $78.4m 5.375% senior debt due 11/2015 = $300m 5% converts due 2017 = $345m 9% converts due 2063 = $389m Market value of equity = 1.816B Cost of Capital

Security amount 5.625% sr debt due 9/2011 78.4 5.375% sr debt due 2015 300 5% converts due 2017 345 9% converts due 2063 389 equity 1816 Total capitalization 2928.4

After tax

cost of capital 3.51% 4.71% 8.15% 14.39%

15.55%

13.09%

Input stock price CDS

assumptions 9.02 485

sub spread 950 beta 2.3 30 year 4.05 The above tables show that the 9% convertible bonds have a very high cost of capital, almost as much as the equity. This cost of capital of the convertibles would be even higher if MTG continues to defer coupons and if the company cannot shield the 9% coupon from taxes (very likely given that MTG is not profitable and has significant Net Operating Loss Carry Forwards).

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Calculation of cost of capital for 9%cvt 40% tax rate cost of debt portion 8.13% debt value component 50.00% cost of equity portion 15.55% equity value component 50.00% cost of convert 12.77% cost of convert w/deferred dvd (2010) 14.39% cost of convert w/deferred dvd (2011) 15.71% 18.42% 17.10% 15.48% 50.00% 15.55% 50.00% 13.55% 0% tax rate

Since the deferred coupons compound at a 9% rate, continued deferral increases the cost of the convert to 14.39% from 12.77% in 2010. If MTG were to defer again, the cost of the convert rises to 15.71% in 2011. Given, the cost of capital calculations, I believe it makes sense for MTG to reinstate the coupon because the cost of the convert will be higher than the cost of equity by 2011 without getting the benefit of getting full equity credit. Furthermore, if MTG cannot take advantage of the 9% interest tax shield, the cost of the convert will be even greater at 17.1% for 2010 and 18.42% for 2011. Potential for a flush Since the cost of the convert is very high even if MTG were to reinstate the dividend, it makes sense for the company to flush the converts at the right price. I think it makes economic sense for the company to pay between 36.67 and 41.72 points for a flush. The 36.67 points are based on the 19.22 points of deferred coupons plus the present value of future coupons for the next 2.5 years discounted back at the 15.55% cost of equity. This makes sense if the company were to issue equity to pay for the flush. On the high end, MTG could decided to pay as much as 41.72 points based on the 19.22 points of deferred coupons plus undiscounted future coupons if it makes the argument that it makes sense to pay for the flush with excess cash on the balance sheet that is earning close to 0% interest. Obviously, the potential for a flush increases as MTG stock increases since the company would likely have to pay fewer points to get holders to accept. This situation is very similar to MF 9% converts, where MF offered to tender for the converts at 44.5 points but most holders did not tender even at that offer. MF converts are also 9% coupon with 2.89 years left. Holding company cash In April 2010, MTG issues $700m of equity and $345m converts. Of the capital raised, only $200m was downstreamed to the operating company, leaving the remaining $845m at the holding company. This cash at the holding company gives the company flexibility to use that cash to reinstate the dividend and/or flush the converts.

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Why is October 2010 the right time to reinstate the dividend? MTG just raised $1.045B of new capital in April 2010. Under terms of the indenture they must use new equity capital (issued within 6 months) to pay deferred coupons. October 2010 will be the first opportunity that MTG has to reinstate the coupons since the capital raise. The company is purposefully keeping cash at the holding company to give themselves flexibility to do something with the cash. MTG also reported a good quarter in July, their first profitable quarter in over two years. Their stock is high enough where they can raise new equity. With their 5 year CDS at 485, they could probably issued 5 year bonds at about 8%. It makes sense to either reinstate the coupons or to flush the converts. Conversation with MTG I spoke to Mike Zimmerman, IR of MTG 414-347-6596. He said the company has not made any decision about paying the deferred coupons but they have to decide by September 15, 2010 on the next coupon. The proceeds from the April 2010 common stock offering can only be used to cover deferred coupons for 6 months after issuance. So if they were to defer again in October, the company would have to raise new common equity. The disadvantages for continuing to defer is that the 9% converts are the high cost of capital that MTG has due to the 9% coupon and compounding effect. The advantage of continuing to defer is that the extra conserved cash gives the company more flexibility. The company’s decision will be based on how they see the business going on 9/15, specifically credit trends of their portfolio but also the outlook for the mortgage insurance business. He has received several calls from holders with some of them suggesting that MTG flush the bonds. They will consider all options when the time comes. Conference call comments John Evans - – Analyst You raised about $1.1 billion in capital. Can you talk a little bit about uses of that capital? Do you think you will bring back the interest on the convert? And you were very aggressive in buying back some of your debt early at very favorable prices. Can you talk a little bit about that? Mike Lauer - MGIC Investment Corp. – CFO and EVP We have got — as I mentioned, or Curt mentioned early in the call — we did put $200 million down to MGIC, and use that for supporting the core Company. We don’t a nticipate putting any additional capital down the balance of the year relative to risk to capital levels. There is about $1 billion at the holding Company. Relative to the repurchase of the debt, at that time, it was trading at a significant discount. And now it is trading at par. So there isn’t much opportunity there, and then relative to the reinstatement of the interest on the convert, we have not made a decision on that as of this date. John Evans - – Analyst And can you just tell me what — is that a Board decision? Or what will trigger that because it is in arrears, right?

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Mike Lauer - MGIC Investment Corp. – CFO and EVP That’s correct. The next payment is due, I believe, October something. So if in fact we’re going to do that, we’ll decide between now and that date. Curt Culver - MGIC Investment Corp. – Chairman & CEO With the Board. Mike Lauer - MGIC Investment Corp. – CFO and EVP With the Board, yes. John Evans - – Analyst Okay. Great. Thank you so much. Michael Levine - – Analyst Hello. Thanks. I just have a follow-up to the question on the 9% convert. Is there any penalty to not going current on that? Or is it simply — it’s just in arrears? Mike Lauer - MGIC Investment Corp. – CFO and EVP The interest continues to compound on all the deferrals. I guess that would be the penalty. Nothing additional to that. Conversation with GS credit analyst Donna Halverstadt thinks whether MTG reinstate the convert coupons will depend on management’s outlook on the future business by the time September 15 comes. If business conditions stay as they are or improve, MTG will likely reinstate the coupon. If business conditions turn down, MTG may decide to defer the coupons again. But economically, given the high cost of capital for the converts with the compounding, it makes sense to reinstate the coupons. Rating agency treatment of junior sub debt I have to follow up on this but there has been talk that trust preferred securities may not get as much equity treatment in the future. I’m not sure what this means for junior s ub debt with deferrable coupons. If these securities get less equity credit in the future, they become very expensive capital and would be one more reason to flush the securities. Background on MTG business Mortgage insurance is typically taken by buyers of homes who want to have their mortgages to be GSE eligible. GSEs will only accept mortgages with a greater than 80% Loan to value. Therefore, buyers take out mortgage insurance to cover the other 20% in case of a default. About 75% of MTG’s insurance come s from GSE eligible loans. For example, a house costs $200,000 In order to be GSE eligible, the mortgage can be at most $160,000 (80%)

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However, if the buyer does not want to put down $40,000, he can borrow the additional $40,000 but buy mortgage insurance to cover that amount. For the mortgage insurer, this amounts to insurance in force of $200,000 and risk in force of $40,000. The maximum loss that the mortgage insurer is responsible for is $40,000. Annual premium = 2% ($800) Run off value (MTG) Below we look at the run-off value of MTG’s existing portfolio using GS estimates. This gets us to a discounted stock price of $10.32. Keep in mind that this price is very sensitive to assumptions. Realistically, the stock can worth $0 or $20 in 2 years. Risk in force = 55,700 Premiums = 3,825 Cash = 9,035 Money coming in = $12,860 Losses = 10,013 Debt = 768 Money owed = 10,781 Excess = 2,079 Shares = 125 $/share = 16.62 PV = 10.32 Key issues 1) HAMP modifications that reduce payments for certain homeowners started last year. Depending on who you talk to, this program has been a success or a failure. The program has helped MTG because it has slowed foreclosures but many consider the program a failure because it has not helped as many people as expected. 2) A new HAMP program is expected to start in the Fall of 2010 where principal will be reduced. The government would pay a 21% subsidy to the banks. If the principal gets reduced, the mortgage insurers do not have to make payments. 3) Rescissions – In 20% of defaults, MTG has not paid claims due to misleading information about the loan. Rescissions have gone up and have helped MTG. 4) Future of FRE, FNM – This is a big wild card because the reason for mortgage insurance to exist is to get mortgages to be GSE eligible. The future of the GSEs will have a big impact on mortgage insurance.

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5) Credit improvement – Delinquency trends have improved in the recent months. Some analysts think this is a seasonal improvement that will reverse in the fall. Other think the improvement will continue. It is hard to know what happens. 6) Fin Regulation – It is unclear how the financial regulation reform impacts mortgage insurers because the rules are still unclear. There is a 5% retention rule which forces banks to hold 5% of the residual of securitizations. Does this put mortgage insurers at a disadvantage because the FHA and VA are exempt? Or are mortgage insurers also exempt? Ford deferred dividends on preferreds – Feb 2010 Trade Summary Based on our analysis as detailed below, we believed there was a high likelihood that Ford would take some corporate action that would include a resumption of dividends or a call for redemption, or a tender offer. The trade was initiated with the possible three outcomes: I) The company would initiate the dividend and pay the accrued. Based on the current yield where we expected Ford junior debt to trade we thought we would make 2pts net of the accrued dividend payment. Expected outcome 1.5 pts II) The company would call these for cash + accrued dividends if the stock went up high enough ($15 +). Expected outcome 7+pts III) The company would flush these for added stock + accrued. 8+ pts Due to the risk reward profile of the trade, it was our biggest position in the book by LMV. We also thought that Ford would do something with the preferred within two quarters from when the trade was initiated. The position setup was via stock on a lighter delta (20-40 delta, depending on stock price levels) to ensure the fact that if the stock ran we crossed par at approx 1 – 2pts over parity. The balance of the hedge was done via short dated OTM puts options to ensure we would pick up delta on the way down, thus allowing us to trade some gamma. The position had been coming in primarily due to a weak tape and Ford credit drifting wider. However, through all of this we continued to believe, as was relayed by the company, their intent to reduce debt and as part of this, apply one of the three outcomes to the preferred stock. On June 30th, Ford announced they were reducing $3.8B VEBA trust debt and also re-initiating the preferred dividends and paying back the accrued. We made about 3.6pts that day, for a net of 2pts since the position was initiated. We feel that at some point they will want to take out the preferred stock but are closely monitoring the situation as to when is best to re-initiate the position. Background details In January 2002, Ford issued $5B of 6.5% convertible trust preferred stock, of which only $2.9B remained outstanding today following an earlier tender offer. The indenture states that Ford has the right to defer quarterly dividend payments for up to 20 consecutive quarterly periods. However, the company would have to pay all dividends then accrued and unpaid (at a 6.5% annum compounded quarterly) at the end of the deferral period. After six quarters, the owed dividend totaled $5.08 per preferred share. Ford also would not be able to pay any common dividends until the company was current on the trust preferred stock. Ford’s first deferred coupon occurred on April 15, 2009. The company’s reason for doing so was that it needed to conserve cash due to the unprecedented drop in auto sales that ultimately drove both GM and Chrysler into bankruptcy.

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However, six quarters later, Ford is in much better financial shape. The company generated $1.5B of free cash flow in 1Q 2010 and expected to post a similar amount for 2Q. Although the company never stated its intentions about the preferred dividend, management’s public statements, our conser vations with investor relations and management, and our experience with corporate actions led us to believe that Ford would either reinstate the dividend or tender for the securities within a short time frame. In March 2010, at JP Morgan’s high yield conference, Ford VP Neil Schloss stated, “So as we generate cash …. we will pay back debt and the trust preferred dividend will be part of that.” In April 2010, we met with Robert Shanks, Ford’s controller, at the Merrill Lynch auto conference, who told us that the company has “thoughts and plans around that [trust preferred] but nothing to share [today].” In a follow-up call with investor relations, Shawn Ryan, head of fixed income IR, said management is well aware of the trust preferred dividend issue and it is high on their priority list of things to address. Additionally, in April 2010, Ford paid back $3B of its credit revolver early in a sign that the company was executing their debt reduction plan. Another hint that Ford would address the dividend soon was that July 15, 2010 would have been the sixth quarter of missed dividends. It is customary language in preferred stock indentures that a sixth missed dividend would allow preferred stock holders to elect two directors to the board. This was the case with two earlier series of Ford preferred stock and many other companies including Dana Holdings (an automotive supplier) 4% convertible preferred stock. Although this language was not in the 6.5% Ford trust preferred indenture, we felt that missing more than six preferred dividends would carry a certain stigma within the preferred community. Ford also has a history of tendering for its convertible securities so we thought this was a possibility as well. Almost exactly 3 years ago, Ford tendered for the same 6.5% convertible trust preferred stock and was only partially successful. In July 2007, Ford offered 2.8249 common shares plus a premium of $14.25 in stock for each trust preferred share. Of the $5B issue, only $2.1B preferred shares were tendered, leaving $2.9B outstanding. In a more recent case, Ford launched a tender offer in April 2009 for its 4.25% senior convertible bonds where the company offered to pay a cash premium to induce the holders of $4.9B principal amount outstanding to convert the preferred into common stock early. Feb 12, 2010 The Ford 6.5% preferred bonds have deferred the dividend since the 12/31/08 dividend payout. The company has missed 4 dividends through today. Ford can defer coupon payments for up to 20 consecutive quarters, after which they must pay the cumulative amount of dividend at a 6.5% annual rate compounded quarterly on each missed dividend. Ford must pay all cumulative dividends if they call the preferred. There are $2.9B outstanding ($50 par) and each coupon is 0.81c, so Ford owes about $47m per quarter. I spoke to Brian Jacoby, credit analyst for Goldman, who said that he sees Ford resuming the trust preferred dividend some time in 2010. This is because Ford’s business is doing much better and the company has $25B in cash which is earning close to 0%. The 6.5% compound interest on coupon makes this security very high cost of capital compared to what they are earning with their cash. If Ford lets the dividend continue to accumulate, the company would owe over $1B by the end of the 20 quarters. It makes sense for Ford to resume the dividend soon. Ford will not comment on their plans. I have spoke to IR and heard them on conference calls say that “at this point we aren’t saying anything from a standpoint of what we will do with that security as we go forward.” Brian compared the Ford preferred situation with companies who had switch to paying coupons with pay in kind securities at a 2% higher rate than cash during the crisis. Many of these companies have switched back to paying cash coupons. The next record date for Ford will be 3/31/10 so we think that a resumption of the dividend will be announced soon if Ford decides to go that route Feb 16, 2010 – discussion with IR

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I spoke to Dave Dickenson 1-313-621-0881 of Ford about the preferred dividends. He said the company has not made a decision to resume the dividend. Additionally, there was a rumor that the Ford family owns a significant percentage of the issue. However, Dave said he didn’t think this was the case and the bloomberg holdi ngs page confirms that the Ford family does not own much of it. The institutional holders list owns 86% of the issue. March 2, 2010 – Ford comments at investor conference The takeaway is the as Ford generates operating cash, they will look to reinstate dividends. And then we have just one question for you, you guys have a preferred given you have held out for some quarters accounting dividend I think was cancelled a couple of years ago none lot of money compared to liquidity you have at the auto company, why not reinstate those as you’ve signed a confidence? : I think if you look at our capital strategy today there is a lot different instruments. Its not just simply unsecured debt and common stock which is how was in the grow days, and so when we look at the need to improve our balance sheet clearly the dividends on the trust preferred will be one of those items that we will consider as part of the key there. The key to restate the dividend, the key to paying down our debt is going to be generating operating cash flow in the business right and we are starting to see that at least the last two quarters of 2009 at still a very depressed industry. So as we generate cash we are going to reinstate other things,we will pay back debt and trust preferred dividend will be part of that. : And then could you prioritize you top three uses of liquidity at the Motorco [ph]. : No. : That’s a pay down debt, this is a debt [ph]. : Pay down debt is the fixing the balance sheet and generating positive cash flow — two go very well together. April 7, 2010 – I asked the Ford Controller about the preferred dividends at investor conference. Below is the transcript. I asked Ford about preferred dividends at their presentation. This was the exact question and response: Ray Lam – AM Investment Partners – Analyst Ray Lam, AM Investment Partners. The Company deferred dividends on the trust preferred securities about a year ago. Have you thought about when you might want to reinstate that? And are you also considering other options including calling them or exchanging them for the stock? Robert Shanks – Ford Motor Company – VP & Controller Yes, I mean we don’t have anything to say about that today. We clearly did that for cash conservation. We can’t defer indefinitely. As part of our overall plan on fixing the balance sheet clearly we have thoughts and plans around that, but nothing to share today.

Merger Arb Using Converts Advantest acquires Verigy March 18, 2011

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On March 18, Advantest offered to acquire Verigy for $15 per share. The conversion ratio for the converts were 76.263 but holders get an additional 8.5 shares under the make-whole matrix for a total of 84.763. Following the announcement, the VRGY 5.25% converts were trading at 124.75 vs 14.06 stock price. Upon completion (deal was completed on July 6), holders get cash equal to the new conversion ratio (84.763) times $15 for a total of 127.14. This is a gain of 2.39 points plus 1.75 points of coupon for a total of 4.14 points. This was an annualized rate of return of 10%, which is less than about 20% for the stock but you have better protection to the downside. The converts have downside of 4% while the stock has downside of 8% compared to where the securities were trading the day before. The key to this trade is whether you get to keep that last coupon that the converts is scheduled to pay out on July 15, 2011. This is where convert indenture analysis of the takeout make-whole language and analysis of the merger time line becomes important. Verigy has up to 20 days to send out the Fundamental Change Company Notice, which will specify the Fundamental Change Purchase Date. The Fundamental Change Purchase date will be between 20 and 35 days after the Fundamental Change Company Notice. In total, the last day to convert will be between 20 and 55 days after the merger completion date. Holders can convert in connection with the make whole any day after the effective date of the merger and the Fundamental Change Purchase date specified by the company (p 67, 72, 74). Page 57 says even if the fundamental change date is between the record and pay dates, you still get the coupon. So if the merger closes 6/12/11, the fundamental change purchase date could be 7/2/ ENDP acquires AMMD April 11, 2011 This is an example where a faster than expected close caused convert holders to lose the last coupon. AMMD agreed to be acquired by ENDP for $30 in cash with an expected closing date in late 3Q2011. According to the indenture, AMMD has 0 to 20 days after the merger completion to issue a FC company notice. The FC repurchase date will then be 20 business days to 40 calendar days after the notice. Holders can convert in connection with he make-whole between the merger effective date and the FC purchase date. (20 to 60 days). The next coupon date for AMMD 3.75% converts is 9/15/10 so the dela would have to close after 8/15/10 for holders to get the last coupon. We belive that the FC repurchase date and FC purchase date refer to the same day and it is used differently here only due to typigraphical error. Section 4.01 also says holders will get to keep the interest as long as the FC repurchase date is after the record date if we convert after the record date. Expected close We expected the close to be 10/10 close because of potential anti-trust risk. ENDP owns Revolix 11% mkt share($20-30MM in revs) and AMMD is the leader with a 65% mkt share; believe there’s a 95% prob. deal gets done & 2/3 prob. of a 2nd request; using 10/1 for timing.

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There’s also a divestiture cap of 50MM in revenues but this should be enough f or potential overlaps; the overlap exist in procedures for treatment of enlarged prostates(specifically lasers where the combined co. would have a 76% mkt share); June 20, 2011 ENDP closes the acquisition of American Medical Systems much earlier than the 10/10 date that we expected. Because of the early close, the convert holders will not receive the last coupon. SAP acquires SY May 17, 2010 In May 2010, SY agreed to be acquired by SAP for $65 cash. The deal was expected to be completed by mid July 2010. The next coupon is 8/15/10. However, the indenture says you can hold the convert for between 20 to 30 days after the closing date before converting. In that case, if you convert after record date (8/1/10), you will get that next coupon 8/15/10 Section 3.7 says that the company has up to 20 days after the deal closes to put out a fundamental change notice. In this notice, they must announce a day for the repurchase of the bonds which is between 20-35 days later (repurchase date). If holders convert up to the business day prior to the fundamental change repurchase date as discussed above, that will be deemed to be “in connection” with the fundamental change and entitles you to the make whole. Section 4.2 (c) says that if the fundamental change repurchase date is in between the record and pay date (Aug 115), then you also get to keep the interest. So if the deal closes on July 15 and the company gives the notice immediately, then the earliest repurchase date would be Aug 4, which is after the record date, so you would keep the accrued. May 26, 2010 The SAP tender offer for SY will expire 7/1/10. The deal needs EU approval which takes 35 calandar days from the date of filing. SAP has not yet filed with the EU. If sap were to file on May 27, it would take at the deal to 7/1/10. Any delay would cause the deal close to get pushed back. In order to make sure we get the next coupon, the deal has to close 7/13 or after. July 19, 2010 SAP extended the tender offer for SY to July 26 July 30, 2010 SAP closes acquisition of SY. Convert holders get the last coupon. The following is the press release: Sybase, Inc. Announces Closing of Merger and Entry into Supplemental Indenture Relating to its 3.50% Convertible Senior Notes Due 2029

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
DUBLIN, CALIF. – JULY 30, 2010 – Sybase, Inc., an industry leader in enterprise and mobile software, today announced that it is delivering notice to the holders of its 3.50% Convertible Senior Notes Due 2029 of the closing on July 29, 2010 of the “second-step” cash merger of Sheffield Acquisition Corp., a wholly owned subsidiary of SAP America, Inc., with and into Sybase at a price of $65.00 per share, with Sybase being the surviving entity. As more fully described in the notice of the merger being delivered to noteholders, pursuant to the indenture under which the notes were issued, the notes are convertible in connection with the merger and continue to be convertible under other sections of the indenture as set forth in the Fundamental Change Notice and Non-Stock Fundamental Change Notice dated July 27, 2010(the “Fundamental Change Notice”). Sybase also today announced that it has entered into a supplemental indenture on July 29, 2010 with U.S. Bank National Association, the trustee under the indenture with respect to the notes, providing that from and after the effective time of the merger, each $1,000 principal amount of notes will be, at the option of the noteholders, convertible into the amount of cash equal to the per share merger consideration multiplied by the conversion rate. The conversion rate for conversions submitted on or prior to the close of business on August 17, 2010 will be 22.9939, and we expect the conversion rate for conversions submitted after the close of business on August 17, 2010 to be 20.8836, each as subject to the terms of the indenture and as more fully described in the Fundamental Change Notice. Noteholders should read carefully the notice they have received or will be receiving regarding their conversion rights resulting from the merger and their conversion rights and rights to require Sybase to repurchase their notes as set forth in the Fundamental Change Notice, as each contains important information as to the procedures and timing for the exercise of such rights, as well as information regarding the interest payable by Sybase on such notes. Astellas acquires OSIP May 17, 2010 Astellas agrees to acquire OSI Pharmaceuticals (OSIP) for $57.5 in a tender offer scheduled to close 6/4/2010. The OSIP 3% converts has an interesting take out matrix because there is an incremental share factor involved. Make whole language Conversion rate = base conversion rate + ((57.7 – base conversion price)/57.5 times incremental share factor) Where base conversion rate = 13.5463 Base conversion price = 73.82 Incremental share factor = 7.4505 Where the second part of the equation is 0 if the calculation is a negative number. At the current price, the conversion ratio equals 13.5463. However, in a fundamental change make whole, the base conversion rate is increased by 5.44 shares (make whole shares) to become 18.9863. The base conversion price is now 52.67 (1000/18.9863) The incremental share factor is now 10.43 (7.4505 *1.40) The new conversion rate is 19.86

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Parity (with takeout at $57.5) is 114.2 Conversion on make whole Fundamental change date = 6/4/10 (estimated). The company has declare a fundamental change purchase date that is at least 30 business days after the takeout date. Holders can convert any day between the fundamental change date and the fundamental change purchase date. As long as we convert after the record date of 7/1/10, we will get the next coupon. We should be able to do that according to this timeline.

July 17, 2010 As previously announced he Company has made an Offer to Purchase its 3% Convertible Senior Subordinated Notes due 2038 (the “3% Notes”) pursuant to an Offer to Purchase dated June 17, 2010 as amended and supplemented (the “Offer to Purchase”). Each holder of a 3% Note has a right (the “Purchase Right”) to require the Company to purchase all or part of the holder’s 3% Notes as a result of a Fundamental Change. As explained in the Offer to Purchase, three Fundamental Changes have occurred. One Fundamental Change occurred on June 3, 2010 as a result of the acquisition by Astellas Pharma Inc. of beneficial ownership of more than 50% of the Company’s common stock (the “Change of Control”). A second Fundamental Change occurred on June 8, 2010 as a result of the merger of the Company with an indirect subsidiary of Astellas Pharma Inc. (the “Merger”). A third Fundamental Cha nge occurred on June 18, 2010 as a result of the delisting of the Company’s common stock from the NASDAQ Global Select Market (the “Delisting”). The Company has amended its Offer to Purchase the 3% Notes so that the Expiration Time of the Purchase Right is July 30, 2010, regardless whether the Purchase Right arises as a result of the Change of Control, the Merger or the Delisting. For each $1,000 principal amount of 3% Notes validly tendered pursuant to the Purchase Right and not validly withdrawn on or prior to July 30, 2010, the Company will pay, in cash, the purchase price of $1,000 plus accrued and unpaid interest to, but excluding, August 2, 2010. Such payment will be made on August 2, 2010. To exercise their Purchase Right as a result of the Change of Control, Merger or the Delisting, holders must surrender their 3% Notes for purchase to the paying agent at any time on or before July 30, 2010 and follow the applicable procedures, as described in the Indenture and in the Second Amended and Restated Fundamental Change Purchase Notice distributed to the holders of the 3% Notes and published on the Company’s web site.

Short Dated Converts

CETV 3.5% converts analysis 11/2010 November 2010 I like the CETV 3.5% converts due 3/15/13 trading at about 89 for a 9% yield to maturity. There is s a good chance that the company will try to pre-fund the maturity of this convert so the overhang on the stock is lifted. I spoke to Romana Wyllie, VP corp communications, about the company. They are looking to refinance the convert issue due 3/15/2013 prior to maturity and possibly in the next few months. The converts are the first maturity but

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
current cash is not enough to take out the issue so CETV would have to raise new money. The company expected to be FCF break-even in 2011. CETV Analysis Cash = $302m Subsidiary Debt CZK 300m facility = $16.6m available; 0 drawn CZK 1.5B 5.25% credit facility ($85.4m) = undrawn, available with another $54m unsecured bond repurchase CET 21 €170m 9% senior secured = $237m Holdco debt (all pari passu) $475m 3.5% converts 3/15/13= $440m €207m floaters 5/15/14 = $207m €440m 11.625% 9/15/16 = $607m Total debt = $1.49B Market cap = $1.5B Net leverage = 11x (estimated 5.3x by end 2011) CETV operates “free to air” TV broadcast stations and owns c ontent in central and eastern Europe including Czech Republic, Romania, Slovak Republic, Slovenia, Croatia, and Bulgaria. In January 2010, CETV sold its Ukraine operations for $400m. In April 2010, CETV bought a Bulgarian channel from News Corp for $400m. CETV owns the leading TV station in all of its markets except Croatia where it is number 2. Sales 39% 24% 13% 9% 8% 7% EBITDA 2009 $128m $38.5m $13.9m $17.8m $0.2m -$44.8m Market share 42% 31% 36% 47% 27% 46% Country CDS 80 280 75 70 220 220

Czech Republic Romania Slovakia Slovenia Croatia Bulgaria

The company’s revenues and EBITDA is cyclical due to its reliance on advertising. Quarterly LTM EBITDA peaked at $349m in 2Q 2008 and troughed at $61m in 1Q 2010. As of 3Q 2010, it was $88m. 2010 was a tough year for the company due to negative GDP growth in half of its markets (Romania, Croatia and Bulgaria), however, all of its markets are expected to grow in 2011 at an average of about 2.5%. Bank of America forecasts EBITDA to be $202m in 2011 and FCF to be $28m.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
CETV has two share classes: 56.9m Class A (one vote per share) and 7.5m Class B (10 votes per share). Time Warner is the largest shareholder with a 30% stake. Ronald Lauder owns a 5% stake; 68% of voting stake. The TV stations have asset value. The Ukrainian unit was sold for over $300m in early 2010 despite having negative EBITDA. In October 2010, CETV sold €170m 9% secured notes due 11/1/17. Proceeds were used to repay $160m credit line and repurchase 34.8m converts at 88.25 and €2m floaters at 81.75, €6m of the 11.625 at 102.5. CETV also entered into a new CZK1.5B ($85.4m) credit facility that requires the company to repurchase an aggregate of $100m unsecured bonds. CETV depends on selling advertising on its channels with about 70% sold forward 1 year. Currently, Czech Republic and Slovenia are seeing positive trends while Romania and Bulgaria are struggling. Bulgaria was -$44.8m ebitda in 2009 but should be positive in Q4 2010, helped by the acquisition. CETV is expected to generate about $185m EBITDA in 2011. Cap ex should be about $50m. The company’s costs are local content which are more variable and acquired studio content under 2-3 year contracts that are not as variable. Covenants The convertible bonds do not have the major financial covenants contained in the non-convertible bonds. However, the convert indenture has a restriction on liens. The non-converts have incurrence covenants but not maintenance covenants. Incurrence covenants prevent a company from taking any action but do not require a company to maintain some minimum ratio to avoid default. Feb 22, 2001 CETV has completed the privately negotiated exchange of a $206,252,000 aggregate principal amount of its 3.50% senior convertible notes due 2013 for a $ 206,252,000 aggregate principal amount of 5.0% senior convertible notes due 2015 and cash consideration as well as accrued interest on the 2013 notes of approximately $ 30.2M. • New notes will bear interest at 5.0% per annum and will mature on 15 -Nov, 2015 • New notes will be convertible into shares of Class A common stock upon the occurrence of certain specified events based on an initial conversion rate of 20 shares of CME’s Class A common stock per $1,000 principal amount of notes (which is equivalent to an initial conversion price of $50 per share of CME’s Class A common stock) • New notes will be jointly and severally guaranteed on a senior basis by two of CME’s wholly-owned subsidiaries • New notes will be secured by a security interest in shares of these two subsidiary guarantors June 24, 2011 Central European Media Enterprises announces exchange of senior convertible notes due 2013 for senior convertible notes due 2015 ($19.76) • Compnay announces an agreement to repurchase, in privately negotiated transactions, $52.3M aggregate principal amount of its 3.50% senior convertible notes due 2013 (the “2013 notes”). In e xchange for their 2013 notes, holders will receive $52.3M aggregate principal amount of 5.0% senior convertible notes due 2015 (the “2015 notes”) and $4.6M in cash, including a net interest payment in respect of accrued interest on the 2013 notes and the 2015 notes. • Company initially issued $206.3 million aggregate principal amount of 2015 notes 18 -Feb. The 2015 notes pay interest semi-annually at 5.0% per annum, mature 15-Nov-2015, and have an initial conversion price of $50/share. Conclusion

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
This trade performed well, as CETV pushed out $260m of the 3.5% converts to 2015. There are now only $130m of the converts remaining which is very manageable for the company. The 3.5% converts traded up to 96 after the announcement of the first exchange for a three month return of about 9%. GY 2.25% converts analysis 03/24/10 March 24, 2010 Near term catalyst On 3/19/10, GY amended their credit agreement to allow the company to refinance their outstanding unsecured bonds. The agreement allows GY to issue up to $438m in debt but the company has to use the proceeds to retire either the term loan or the unsecured bonds. In exchange, GY will pay L+325, 100 bps higher than the old rate for the term loan. We bought some 2.25% bonds at 92.75 (7% yield to put 11/20/11). We feel that the company is likely to take action to refinance either the 2.25% converts or the 9.5% straights, which could lead to a tender offer for the 2.25%. I feel very comfortable about GY credit. The company is a defense contractor with long product cycle including a funded backlog that covers 1 years worth of sales. The company is free cash flow positive, fresh off a Moody’s review for upgrade and a credit agreement amendment GY Analysis Cash = $158m Term loan due 2013 = $51.5m drawn ($75 capacity) Revolver = $65m undrawn Letter of credit = $85m drawn ($125m capacity) 2.25% sub convert due 11/20/11 = $132m 9.5% sub straights due 8/15/13 = $75m 4.0625% sub convert due 12/31/14 = $200m Total debt = $477m Environmental remediation and postretirement liabilities = $520m GY should generate about $140m EBITDA in 2010 for a leverage of 3.4x. EBITDA/Interest expense is 5.3x. These metrics are consistent with a BB rating. Moodys currently rates it B3, on review for an upgrade. Business GY is a manufacturer of aerospace and defense systems with a real estate segment. Aerospace includes AerojetGeneral, which makes propulsion systems (mostly for missiles) for defense and space applications. GY is one of the largest providers of such propulsion systems in the US. Customers include the major prime contractors (LMT, RTN, BA) to the US government, the department of defense, and NASA. GY also owns about 12,200 acres of land

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
adjacent to US Highway 50 east of Sacramento. GY is seeking to change zoning rules to optimize its value. The land is estimated to be $200m at the low end. Aerojet has been an industry leader in propulsion systems for 60 years. It is the only domestic supplier of all four propulsion types – solid, liquid, air-breathing, and electric. Competitors include Alliant Techsystems (solid, air), American Pacific (liquid, electric), Astrium (solid, liquid), Northrup (liquid), Pratt & Whitney (liquid, air, electric) and SpaceX (liquid). Aerojet is number 2 in solids behind ATK and liquids behind Pratt. Prime contractors Raytheon and Lockheed Martin account for 31% and 26% of 2009 sales, respectively. About 51% of sales were fixed price contracts, 37% from cost reimbursable contracts, and 12% from other sales. Many products have life cycles of over 10 years. These contracts are initially small during the development phases that can last two to five years, followed by low-rate and then full rate production. GY’s funded backlog is $811m and unfunded backlog is $379m. Funded backlog is the amount of money that has been directly appropriated by the US congress and unfunded backlog is the amount for which funding has not been appropriated. GY’s annual sales are $800m, so funded backlog covers 1 year of sales. Most of GY’s R&D are funded by customers so the company does not have much R&D expense. Steel Partners owns about 7% of the company and in the past have pressured the company to make strategic changes. On January 6, 2010, the company appointed a new president and CEO Scott Seymour from Northrop Grumman. In December 2009, Moody’s placed GY on review for upgrade from its current B3 rating. March 26. 2010 Met with GY management today. The company has $230m in cash (there is $30m restricted that has to be used to buy back debt). The 2.25% converts are the next maturity $132m. The company just amended their credit facility so that any new proceeds from a debt issue have to go directly to repaying debt. The company says they are looking hard at all options and reducing debt remains their top priority. GY hired a new CEO about 6 months ago and I believe he would like to right size the capital structure as soon as possible. This includes terming out maturities to give the company a more stable debt structure. Prior to the credit agreement, the company could only issue a bond that had lower coupon than the debt that they were retiring. This restriction is now gone. Also in the prior agreement, GY was only able to buy back $10m of bonds. Now they can buy use any cash to buy back bonds as long as their net debt leverage ratio is below 3.0x. It is currently below that. GY has a backlog that covers 1 years of revenues and about $20m FCF per quarter. GY is a defense company that makes missiles for government programs. They have long product cycles and 1 year visibility into their order book. Conclusion GY never did tender for the 2.25% converts or do a large buy back. Instead, they will wait until maturity. However, the trade still worked as the bonds traded up to 98 from 92 in just a few short months. NFP will likely refi converts early March 29, 2010 NPF 0.75% converts due 2/1/12 are trading at 88, which presents a great opportunity for capital appreciation because I believe that management wants to refinance the convertible soon. I spoke with management and they expressed interest in issuing either a high yield bond or a new convert so that they can clear out near term maturities.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Also, NFP has a credit facility due 8/22/11 and I believe that the company may be in negotiations to extend the credit facility maturity, which may require it to refinance the converts to a longer maturity date than the new credit facility. Business Description National Financial Partners is a insurance broker that sells to high net worth individuals on a commission basis. NFP has a network of brokers that sell insurance products for a wide range of insurance firms including Lincoln financial, Hartford and others. NFP collects a commission fee for each product sold. NFP itself is not an insurance company so it does not have a portfolio of assets and has no credit risk. It only takes a fee for each transaction. Capital Structure Cash = $56m Credit Facility = $40m ($160m undrawn) –matures 8/22/11; debt /EBITDA has to be less than 2.5x 0.75% converts due 2/1/12 = $230m The company generated $116m FCF in 2009 ($123m of CFFO and only $7m Capex). The company has been FCF positive every year for the last 10 years. Traditionally, the company has use the FCF to make acquisitions. It is likely that NFP would have to extend its credit facility and refinance the convert in order to give it the most flexibility for future acquisitions. June 9, 2010 NFP announces plans to issue $125m of new convertible bonds. The company will tender for the old 0.75% converts for 95.5 for a quick 7.5 gain in just a few months. UAUA and BZH short dated converts March 3, 2010 There are opportunities in busted converts that mature in 2011 that trade in the mid 90s. Many companies, particularly high yield companies, have been calling or tendering for their debt that is coming due within 2 years. Companies have been especially active retiring debt before they have to be classified as short term maturities on the balance sheet. So as of today, that means any debt due or put in the 1H of 2011 will be prime targets. The two that I like most are the UAUA and BZH converts because they have a significant cash cushion and are strong enough companies to carry out a refinancing right now. United Airlines (UAUA) 4.5% subordinated converts 95.0625 ask $726M put at par 6/30/2011 5% senior converts 96.625 ask $150M put at par 2/1/2011 UAUA will end 1Q10 with $3.2B in unrestricted cash. Furthermore, the company will likely end 2Q with $4.4B in cash because they will settle a $700M debt offering secured by its Japanese routes. UAUA generated $443m of free cash flow in 2009 and is expected to generate $700m of free cash flow in 2010.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
UAUA has $545M in amortizing capital leases due in 2010. These converts are the next debt maturities for the company after that. Both the 4.5% and 5% converts can be repaid using cash or co mmon stock at the company’s option. Equity analysts think UAUA will potentially take out both convertible issues because they are an overhang for the equity. There is a good chance that UAUA will tender for both convert issues in March 2010 because 1) the bond market is wide open 2) the stock is at new 52 week highs. March is also a window of opportunity because the company will report in April. UAUA is scheduled to speak at the JPM transport conference on March 9, which could be a good time for them to tender for the bonds. I think there is a good opportunity to make a quick 3-5 points. I would think the company would take care of both convertibles at the same time due to the close proximity of their put dates. Beazer Homes (BZH) 4.625% converts 95.75 ask $145m put 6/15/2011 On January 11, 2010, BZH called the $127m 8.625% straight bonds due 5/15/2011 with proceeds from a $50m mandatory and $90m equity issue. The company will also get a $101m tax refund in 1Q. Management has made it clear that their number one priority is to deleverage. At the end of 1Q, BZH will have about $560m in cash. The next debt maturity is the $145m converts with a put at par on 6/15/2011. BZH generated $61m FCF in FY 2009 (Sep) and is expected to generate $113m FCF in FY 2010. The FCF by quarter is very seasonal with the most recent Dec Q -65m FCF, March Q expected +69 FCF, June Q -30m, and Dec Q +$140m. Trade Ideas 04-02-13 AIMC trade idea The AIMC 2.75% converts were recently offered at 120 vs. 27.22 at Jefferies. This is a very small issue at $85m so 4m is the most I want to own. I like the profile of this balanced convert, which has a 2.3% current yield and 21% premium and five years until the put date. Using 450 credit spread and 30 vol., the bonds model about fair, which in this environment is about the best you can do for a balanced name in the 120s. The trade-off is that it is a small, illiquid issue. The converts have come in about 0.75 points over the past month. My guess is that outrights are looking to exit after a strong run-up in the stock. Additionally, AIMC’s realized vol. has declined with the stock’s upward move but has been much higher in past years. Theo delta for the convert is 71, which is where I initially want to be but I would look to aggressively buy stock on pull backs to get to as much as 10 deltas light. To the upside, on 71 delta, the converts nuke to 141.7 at the soft call trigger of 35.586 (11.7 points). The converts are soft-callable on 3/1/15 (about 2 years) with a max make-whole of 8.25 points decremented PV of coupons. I would expect the bonds to expand by about 2 points at this price.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
To the downside, the converts cross par at 2.75% up 40.2% at 19.51, which seems reasonable for a 5 yr maturity. Additionally, we actually sold these converts in July 2012 at 92.81 vs. 14.92. If we nuke down on a 71, the converts nuke to 88. Granted, time has passed and the converts were subject to theta decay but it does show that this particular name has held well to the downside even in a less favorable convert/credit environment. AIMC currently pays 8c quarterly dividend (1.21% yield) but the converts are fully dividend protected from zero. Borrow is GC. You make 3.5 points on a $36 cash take-out. Business Description Altra Holdings (AIMC) is a manufacturer of a wide range of mechanical power transmission (MPT) for a diverse group on industries including energy, mining, transportation, and turf and garden. Products include 1) clutches and brakes for elevators and commercial lawn mowers, 2) gearing for conveyors and packaging machinery, 3) engineered couplings for turbines, 4) Power transmission components for machine tools, and many more industrial type products. AIMC is the world’s largest manufacturer of clutches and brakes, which are used to hold a piece of industrial equipment to keep it from moving. You can find these on top of an oil rig to control the cables that goes down into the ground to extract the fuel or in a helicopter to keep the rotors from spinning only in one direction and not letting them back drive. In gearing, AIMC is one of many manufacturers in a highly fragmented market. These are used in conveyor systems, military vehicles, and sewage plants. Industrial couplings connect two pieces of rotating equipment in applications such as oil refineries. All together, AIMC sells into 36 different industrial markets with a mix of early (20%), mid (40%) and late cycle (20%) industries. The company’s products serve many niche markets that are difficult for competitors to enter. 40% of sales were from the aftermarket. 55% of sales North America; 31% Europe; 14% Asia and rest of world AIMC is the number 1 or 2 player in over 50% of the products segments that is serves. 17% of US employees are unionized; 59% of European employees are unionized Industry Description The industrial power transmission products market generated $36B, divided into three areas 1) Mechanical Power Transmission (MPT), 2) Motors and generators, 3) Adjustable speed drives. AIMC only competes in MPT, which is a $19B market but very fragmented with over 1,000 small manufacturers. Equity analysis AIMR stock trades at 14.6x PE to 2013 estimated EPS of $1.81 and 12.3x PE to 2014 estimated EPS of $2.12. Management has been conservative in the guidance in past years and is likely too low for 2013 given the recent pick-up in industrial activity. AIMC participates in a broad range of industrial markets that are seeing significant strength. Revenue growth for 2013 is expected to be 2% and for 2014 to be 5%. These numbers could be too low in a strong cyclical rebound. I think the company could earn as much as $3 in 2014, which using a 12 multiple get to $36 per share. However, the stock is up 21% year to date and could be due for a pull back. We could get lighter delta on weakness.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
AIMC stock has been volatile on earnings with fairly large moves in 6 of the last 8 quarters including one quarter when the stock was down 27%. earnings date stock reaction 2/14/2013 -0.4% 10/25/2013 3.8% 7/27/2012 8.6% 4/27/2012 5.6% 2/16/2012 -4.6% 11/1/2011 1.8% 8/8/2011 -27.4%

Potential volatility events include: AIMC is in the middle of a 3 year transition to a SAP implementation. These large scale changes could often lead to disruptions from quarter to quarter. We have seen SAP cause short term problems for many companies. The company has a large exposure to Europe (31%), which could have unexpected results. AIMC is hosting an analyst day for the first time in the company’s history on May 16, 2013. Credit analysis AIMC has low leverage with net debt/ebitda of 1.67x. Management has a strong history of maintaining a strong balance sheet and one of its goals is to pay down $27m of debt in 2013 using free cash flow. The company has generated positive free ash flow in each of its 9 calendar years since it began in 2004, including 2008 and 2009. The negatives are that AIMC is a small cap company at only $713m. It also has a history of making acquisitions which could potentially increase leverage. 03-24-13 EXXI trade idea EXXI trade analysis I like the EXXI position for the arb book. EXXI convertible preferred was offered at 303.24 vs. 28.32 on March 22. We currently own 6,700 pref shares (1.67m in bond terms) on a 64 stock only delta and short 152 June 29 strike calls for an effective delta of 74. Using assumptions of 750 credit and 30 vol., I get theo delta of 72. I would like to increase the position to 20,000 pref shares (5m in bond terms) and move to a 62 stock delta and 72 effective delta. Below I adjusted numbers into bonds points to make it easier to analyze.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas

using 750 credit and 30 vol Convert price stock price current yield conversion premium points premium delta Coupon (points per year) CF to soft call (12/15/13) nuke on 62 to call trigger ($32.969) points at call trigger

pref terms 303.24 28.32 4.64% 8.62% 24.07 72 14.063 10.547 331.654 6.65

100% par 121.3 28.32 4.64% 8.62% 9.63 72 5.625 4.2 132.66 2.66

Cash flows from the coupon (3 more quarterly payouts) to the soft call date is 4.2 points. If EXXI stock moves up to the call trigger ($32.969), on a 62 delta, the converts would nuke to 2.66 points for a positive 1.5 points gain. (My reading of the prospectus is that holders will get the last coupon on a soft call) Shorting the June 29 strike calls at 1.3 would give us additional income if they expire worthless. If they get into the money, then the EXXI prefs should move up as there would still be 6 months to the soft call date. To the downside, the converts should hold up due to the high yield. At $19.6 on 62 delta, the converts cross par at 5.6% current yield up 30% premium. These converts should hold well to the downside. This is a position where we should let the stock run before re-hedging delta. The converts are dividend protected from zero. The common stock pays a 7c quarterly dividend. Credit Analysis The key to this trade is being positive on the credit of EXXI. EXXI is a Houston based independent oil and natural gas exploration and production company with operations focused in the US Gulf and Gulf of Mexico. The company is the third largest oil producer in the Gulf of Mexico Shelf with interests in six of the eleven largest oil fields in the GOM shelf. About 70% of revenues is from oil. In recent quarters, EXXI has guided production down several times, which has caused weakness in the stock. The latest guide down came on 3/20/13, when the company lowered March Q volumes to 44 mboed from 47 mboed due to continued infrastructure downtime and lower than expected production from recent wells. However, analysts value EXXI’s proved reserves at about $30 per share (using $95 oil and $4 gas) and an additional $5 for exploration upside. The company has low leverage at 1.2x debt/ltm ebitda. I think the stock is close to a bottom and the credit will hold up sell barring an oil price collapse. Cash = $41m Revolver ($925m undrawn)

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Debt = 1B (9.25% bonds due 2017 $750m, 7.75% bonds due 2019 $250m, rated B+) LTM EBITDA = $820m Debt/EBITDA = 1.2x Expected 2013 capex = $800m Market cap = $2.2B The 2017 bonds trade at 350 credit spread and the 2019 bonds trade at 500 credit spread. 03-07-13 ZINC trade idea Trade idea Arbitrage: ZINC Horsehead Holding (ZINC) is the largest producer of zinc products in the US and the largest recycler of EAF dust in North America. It is an integrated producer using recycled zinc feedstock and low-cost recycled electric arc furnace (EAF) dust to produce its zinc products. The company diversified into nickel recycling when it acquired International Metals Reclamations Company (INMETCO) in December 2009 for $39m. In November 2011, Zinc acquired Zochem, a Canadian zinc oxide producer for $15m. Current operations include seven facilities across four states and Canada. No customer accounts for more than 10% of revenues. Convert Analysis ZINC 3.8% converts are offered at 100.25 vs. 10.93. Using 850 credit, implied vol. is 33.6 compared to options vol. in the high 30s/low 40s. 100day realized vol. is 32 and has been steadily declining to reflect the improving credit and lower risk of the new facility that is scheduled to come on-line in July 2013. I am positive on the stock and credit with targets of $14 for the stock and 700 for the credit, driven by production in the new facility expected to begin in July 2013 that should contribute $100m EBITDA on an annual basis. I would like to own 4m on a 57 delta (5 deltas light). At $14, the converts nuke to 111.9, compared to fair value of 115.9 using 700 credit and 32 vol. Borrow is full. Cash takeout is flat at $14 and 57 delta. Stock analysis My price target is $14 based on 5.5x 2014 EBITDA of $150m (post new plant completion), which would bring it closer to its peer group average of 6.1x. The new plant is 70% done so management should have a good grasp of the progress of completion. Given the impending zinc mine closures, zinc fundamentals are improving and prices are trending upwards. About 50% of zinc demand is related to steel demand. Even without price increases, ZINC should be able to grow earnings with the new plant, cost improvements and byproduct credits. The company also has put options (0.85c/lb) through 1Q14 as downside protection. New zinc plant ZINC is constructing a new zinc plant (slated for operational start-up in 3Q13) that should drive down the company’s cost structure dramatically. Once operational and fully ramped, the new plant should permanently reduce the cash breakeven point from 0.65/lb to 0.4-0.45/lb vs. low-cost mined zinc that carries breakeven costs at 0.80/lb. This would make ZINC one of the lowest cost producers of zinc products in the world.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
The new plant focuses on higher grade, higher margin zinc that offers a large market opportunity. Currently, most of Zinc’s metal is the lowest grade called Prime Western (PW) zinc that sells at a lower premium because it is not suitable for continuously galvanized products such as steel used in automobiles and appliances. The new plant will focus on special high grade (DHG) and continuous galvanized grade (CGG) zinc, which has lower lead content and sells at a higher premium ($50-$60/ton over PW metal). The CGG market is 10x the PW market. The new facility is expected to generate $100m EBITDA per year. ZINC has 65-70% market share of available EAF dust (byproduct of carbon steel galvanizing process), which acts as an effective barrier to entry against other metals recyclers gaining a market foothold. Most of ZINC’s EAF dust supply is from long term contracts (10+ years) with leading mini-mills such as Nucor and Steel Dynamics. Zinc market Zinc is produced via conventional mining and Electric Arc Furnace (EAF) dust recycling. EAF dust is classified as hazardous waste and is produced from steel and mini mills such as Nucor and Steel Dynamics. This dust, which contains 20% zinc, is collected by Horsehead and other competing EAF dust removal services from steel mills. About 50% of all zinc slabs in the US are produced by recycling EAF dust. Zinc is levered to steel demand as roughly 50% of all domestic zinc consumption is as an anti-corrosion coating in the production of galvanized steel. Zinc is also alloyed with copper to make brass or bronze. Other uses include alkaline batteries, rubber, paint and pharmaceuticals. The US market currently consumes about 1m tons of refined zinc. About 70% of supply comes from imports (Canada, Mexico, Peru).

Credit analysis ZINC has secured debt that is rated B2/B-and trading at about 700bps credit spread. The converts are not rated. As of 12/31/12, the company had $244m in cash, $75m in access to the revolver, and $30m of operating cash flow through 2013 to cover the remaining $200m needed to complete the new plant. The company is highly levered at 7.1x so the bet here is on the credit and the completion of the new plant. Cash = $244m Revolver ($75m, 09/2016) = undrawn 10.5% senior secured notes due 6/2017 = $175m (rated B2/B-) 3.8% convertible notes (7/2017) = $100m Total debt = $285m Market cap – $481m EBITDA 2012 = 40m EBITDA 2013 = $52m EBITDA 2014 = $132m Debt/EBITDA (2012) = 7.1x Debt/EBITDA (2013) = 5.5x Debt/EBITDA (2014) = 2.2x The secured notes trade at 108 (spread of about 700). I would use 850 spread assumption for the converts.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Remaining capex to complete the new zinc plant is $210m

02-07-13 WNC trade idea Trade idea Arbitrage: WNC Wabash (WNC) is a manufacturer of truck trailers for the North American market. The company reports in three segments: 1) Commercial trailer products (71% of sales), 2) Diversified products (26%) and 3) Retail (7%). Convert Analysis WNC 3.375% converts are offered at 116.25 vs. 9.66. Using 500 credit, implied vol. is 38.6, compared to 50 day vol. of 45 and 100 day vol. of 42. Options are not very liquid but imply mid-40s vol. Delta is 66 using 500 and 40. I would like to own these bonds at 56 delta (10 deltas light) due to my thesis that the stock will go up with a price target of $14. We currently own 1.2% position in the outright book. At $14, the converts nuke to 137, compared to fair value of 143 using 400 credit 35 vol. Borrow is full. Cash takeout is flat at $14 and 56 delta. Stock analysis My price target is $14 based on 8x 2013 estimated EBITDA of $175m. At similar points of prior cycles, WNC has traded between 8x- 10x forward EBITDA. I believe that we will see a strong trailer replacement cycle over the next two to three years and WNC’s recent acquisitions in the tank trailer space should significantly improve margins and reduce earnings volatility. WNC reported solid earnings on 2/6/13. However, the report fell short of heightened expectations going into earnings. In the following two days, the stock sold off 11%. I believe the sell-off is an opportunity to buy the converts on a light delta. The truck trailer cycle should be good this year but there will be hiccups along the way. This provides good trading opportunities and volatility. WNC is the leader in trailer manufacturing with about 22% market share. Going forward, the company is focusing on profitability even at the expense of losing some share. Early indications are that pricing has held up well, especially in the more technologically sophisticated product offerings such as liquid tank trailers, added through the Walker acquisition, which are less commoditized, higher margin businesses. Credit analysis WNC is rated B1. The company does not have any debt maturing until the converts in 2018 and has ample liquidity with $39m cash and $150 undrawn revolver. WNC also generates significant free cash flow of over $100m per year. I think a fair spread assumption is 500. Cash = 39m Revolver 5/8/17 = 0 drawn; $150m available Term Loan 5/8/19 = $300m

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
3.375% converts 2018 Total debt = $450m Market cap = $668m Enterprise Value = $1.079b 2012 EBITDA = $120m; capex $15m Secured debt/EBITDA = 2.5x (term loan covenant <4.5x) Total debt/EBITDA = 3.75x Interest coverage = 5.7x (term loan covenant > 2.0x) 01-15-13 SGY trade idea Stone Energy (SGY) trade idea The SGY 1.75% convertible bonds due 3/1/17 trade at 89.75 vs. $20.81. Using 500 credit, the converts imply 31 vol., which is cheap to 100 day realized vol. of 41 and options implied vol. in the mid 40s. The 500 credit spread assumption is based on the trading levels of SGY’s 8.625% bonds due 2/1/17 and 7.5% bonds due 11/15/22 (both pari passu with same subsidiary guarantees as converts). The yield/premium relationship does not look good optically but if we set the converts up on a 40 delta, the converts cross par (at 31.95) at a reasonable 33% premium, which is also where the converts were issued about 10 months ago. The converts traded +3 on the first day. Using 500 credit and 35 vol. at that stock price values the converts at 103, using 500 and 40, the converts are valued at 105. We can also sell 21 strike Jun call options for 2.4 to generate income. Per 1m converts, we can sell 50 call options on a 55 delta. This would generate up to 1.2 points in income with breakevens at $17 and $26 with an effective delta of 40 and stock delta of 29. The key to this trade is to be comfortable with the credit so that the converts can be set up on a 40 and still be able to make money (or at least hold value) to the downside. I am comfortable with the credit due to SGY’s strong liquidity ($250m cash and $400m undrawn revolver), its large reserves ($21/share of proven reserves), and its oil hedges on 61% of oil production at $98.87. There is no secured debt ahead of the converts and senior notes. I also feel that the stock is trading near the low end of its valuation range of $20 to $30. SGY has no maturities until 2017 when the converts and 8.625% bonds mature and although the company is not expected to be free cash flow positive in 2013, it has more than enough cash on hand and undrawn revolver to fund its cash needs in even the most dire scenarios. SGY should be free cash flow positive in 2014. The converts are pari passu with the bond with identical subsidiary guarantees, rated B- by S&P, and there is no debt ahead of it in the capital structure. Business description SGY is an independent oil and gas company with properties in the Gulf of Mexico Deepwater (21% of proved reserves), GOM shallow water shelf (50% reserves), Marcellus shale (28% of reserves) and Eagle Ford shale (1% reserves). About 50% of 2013 production will come from oil and 50% from natural gas. The company has hedged out 47% of total 2013 production (61% of 2013 oil production at $98.87 and 24% of gas production at $4.86) and 31% of total 2014 production. All the oil comes from GOM which is priced at a $20 premium to WTI. Capital structure Cash = $250m (pro-forma 7.5% senior note issued on 10/23/12) Undrawn credit facility = $400m

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
Debt = $975m $300m = 1.75% converts due 3/1/17 $375m = 8.625% bonds due 2/1/17 $300m = 7.5% bonds due 11/15/22 Market cap = $1.03B Expected capex 2013 = $650m Expected cash flow from operations 2013 = $550m Expected cash needs 2013 = $100m Equity valuation SGY currently trades at 9.8x 2013 estimated EPS of $2.12, down from $3.40 as recently as July mostly due to tightness in the deepwater rig market. The company had expected a platform rig to be on location at Pompano in 2013 but that has now been pushed back to mid-2014. SGY’s shallow water drilling will also be delayed by several months due to tightness in jack-up rigs. Although, 2013 EPS estimates were lowered, the company is set up well for a ramp up in EPS to over $3 in 2014. A good way to value E&P companies is to look at the sum of the parts broken down by proven reserves, unproven reserves, and net debt. E&P stocks typically trade between the value of proved reserves and unproven reserves (net of debt). For SGY, the stock should trade between $21 (value of proven reserves) and $31 (value of proved and unproved reserves) at current oil and gas prices. This leaves significant upside potential for the stock. Additionally, SGY has the potential to add to its proved and unproved reserves through new exploration and development. (After the close on 1/15/13, SGY announced that it had grown its proved reserves by 28% from last year.)

Oil (MBbls) Proved Developed Undeveloped Total Proved Total Unproved Total Proved and Unproved Net Debt Shares outstanding Per share proved reserves Per share unproved reserves 31,026 14,728 45,754

Gas MMCF 174,067 153,285 327,352

Oil and Gas Mmcfe 360,224 241,656 601,880

Value ($mil) 1,066 715 1,782 500 2,282 725 50 $21.13 $31.13

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas

Cash flow scenario analysis Based on Barclay’s research, the following table details SGY’s cash flows based on different realized oil and natural gas prices. Even in a stressed scenario of $60 oil and $2 gas, SGY would be able to generate $479m in operating cash flow (due largely to hedges detailed in the next table). With $650m of liquidity and no maturities, the company could easily cover $650m of capex, which in reality would likely be less due to the lower energy prices. Capex budget The company’s expected 2013 budget of $650 will go towards the following: 1) 29% on deep water projects covering Pompano infrastructure and exploration activities 2) 27% on development wells and facilities on continental shelf 3) 8% on a third La Cantera deep gas well and related exploration 4) 36% onshore, liquids rich areas of Marcellus, and exploration in Eagle Ford Convert specifics Pay dates March 1 and Sept 1 Record date Get last coupon before maturity if converting Convertible only if stock is 130% of conversion price for 20 of 30 days ending the previous quarter. SGY can choose settlement in cash, stock or a combination of cash and stock Flat PNL on cash takeout at $32 Fully adjusted for cash dividends 11-19-12 CSGS trade idea We are looking to re-initiate a position in CSG Systems (CSGS) 3% convertible bonds offered at 104.5 vs. $17.84. The issue is $150m with 4.6 years to maturity. Using a 400 credit spread, I get implied vol. of 27 and delta of 49. The stock has historically realized about 30 vol. over the past few years if you take the outlier periods out. In the past two years, the stock has been as high as $23.04 (Sept 2012) and as low as $12.34 (October 2011). We will likely see more volatility in the next 6 months as CSGS has two large contracts that are coming up for renewals in December 2012 (Comcast 19% of sales) and March 2013 (Time Warner 10% of sales). These contracts typically last for 5 years. Last time when these contracts were up to renewal in late 2007/early 2008, the stock went from $28 in June 2007 to $11 in March 2008 due to speculation about a contract loss. This time, the stock went from $23.04 in Sep. 2012 to $17.84 currently due to fears that contract renewals will result in significant discounts on price and would thus pressure margins and EPS in 2013. I believe that the stock price decline is overdone and the stock will rise when the contacts are settled. I see the stock trading back to $24 (12x PE) in a bull case scenario or down to $13 (2011 lows) in a bear case scenario. I would put the trade on a slightly light delta of 45 delta because this will make the trade more balanced since the convert has a lot of points (31) to the upside. I also think that the most likely scenario is that CSGS will be able to renew the contracts at favorable rates in addition to winning other new contracts in 2013 year. CSGS is rated BB by S&P. However, the convertible bonds are senior subordinated bonds and are not rated. The company has no other bonds other than the converts and only $178m of term loans due 2017. The company reports earnings in Feb 2013. Company profile

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
CSGS provides outsourced customer care and billing solutions primarily to the cable and direct broadcast satellite industry in North America. In 12/10, CSGS acquired Intec Telecom Systems, which is focused on telecom carrier billing. The top 4 customers account for 51% of sales. These are: 1) Comcast (19% of sales) – uses dual vendors with the contract split between CSGS (16m subs) and Amdocs (8m subs). Both contracts are up for renewal on 12/31/12 2) Time Warner (10% of sales) – uses dual vendors with the contract split between CSGS (5.6m subs) and Convergys (7.2 subs). Both contracts are up for renewal on 3/31/13 3) 4) DISH – (13% of sales) Uses CSGS exclusively (13.7m subs). The contract runs through 12/31/17 Charter (9% of sales) Uses CSGS exclusively (6m subs). The contract runs through 12/31/14

Cable and Satellite customers account for 60% sales with the remainder coming from Telecom Providers (30%) and Utilities (10%). CSGS gets paid on average about $10 per customer per year although this varies depending on the level of services. Competitors – in-house systems, Amdocs, Convergys (satellite and cable), Accenture, Comverse (wireless and wireline) Credit Analysis CSGS is a solid credit with low leverage and a high percentage of recurring revenues. Even if CSGS loses one or two customers, I believe that the company has a large enough base of other customers with long term contracts and recurring revenues to allow it to right size itself into the current capital structure. The negative is the company’s small market cap. CSGS is rated BB by S&P but the convertibles are senior subordinate bonds. I believe 400 credit spread for the convertible bonds is appropriate. Cash $185m (plus $100m undrawn revolver) Total debt $300m ($150m converts 3/1/17 and $150m term loan due 12/31/17) Debt/EBITDA = 1.71x, Net Debt/EBITDA = 0.66x EBTIDA/interest = 10x LTM FCF = $117m LTM Capex = $23m Market cap = $601m Equity analysis At $17.83, CSGS stock trades 8.4x PE to 2012 estimated EPS of $2.13. This is below DOX at 11.2x and CVG at 19x. Part of the reason for the discount is uncertainty about the upcoming contract renewals, which includes not only getting the contract but the pricing of the contracts and the split between vendors. I believe that the contract negotiations could create some large moves in the stock with the bull case being that CSGS stock trades up to $24 (12x PE) and the bear case going down to $13 (2011 lows). The stock has also had decent sized moves on earnings as shown in the table below. earnings date stock reaction 10/30/12 -2.7% 08/07/12 10.4% 5/1/2012 9.4%

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
2/7/2012 11/1/2011 8/2/2011 5/3/2011 2/8/2011 10/26/2010 -6.1% 4.1% -6.4% -2.6% -2.4% 8.9%

Convert specific Due to CSGS’s small size and leading position in the industry, the company could be a takeout target. On 45 delta, the breakeven takeout price is $22.75 (28% premium). I believe a takeout would be higher than $23 given the stock’s low valuation and market position. Get the last coupon if converting before maturity. Full dividend protection Net share settle; 20 day averaging period 10-03-12 EXH trade idea Trade Idea: Exterran Holdings (EXH) $355m 4.25% converts due 6/15/14 trade at 107.75 vs. 18 for 3.9% current yield and 38.6% premium. Using 500 credit spread, the implied vol. is 38 and delta is 55. This seems cheap given the historical realized vol. of over 50. The credit also has potential for tightening as we get closer to maturity. On 8/7/12, EXH announced that its Venezuela subsidiary completed the sale of assets nationalized in 2009 to PDVSA Gas for a total consideration of $442m ($177m initial payment and $265m in periodic payments through 3Q 2016). Proceeds will be used to repay $50m of previously collected insurance money with the remainder to reduce debt and for general corporate purposes. This development significantly improves EXH’s credit profile, particularly for the two convertible bond issues due in 2014, the next maturing debts ($144m 4.75% converts due 01/2014 and $355m 4.25% converts due 06/2014). Following the news, EXH stock was up 17% to $18.21. The converts were up about 1 point on a 48 delta. The 7.5% straight bonds of 2018 traded up 2 points with the spread tightening from 570 to 512. Even prior to this news, EXH was in the process of delivering, with Debt/EBITDA declining from 4.3x to 3.7x in the last 6 months. EXH is highly leveraged to the natural gas market, particularly production volumes. While the natural gas market in North America remains challenged, the international natural markets remain robust (about 30% of profits). The company generated about $400m of EBITDA in the last 12 months with expectations of $530m in 2013. In the bull case scenario, EXH can trade at 5x 203 EBTIDA of $580m for an implied stock price of $25. In the bear case, EXH can trade at 4x 2013 EBTIDA of $320m for an implied stock price of $8. Company profile EXH is the largest compression services company in the US with about 50% market share. The company packages compression equipment from suppliers, which is then leased or sold to the natural gas E&P operators. The company assembles a compressor (Ariel or Dresser-Rand), engine (Waukesha or Caterpillar), and a cooling system onto a truck mountable skid for easy transportation. Roughly 30-35% of onshore US operators outsource compression services. Larger E&Ps (such as CHK) are more likely to use their own compressor equipment.

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
EXH does not manufacture compressors but instead assembles these components into a compressor package. The company adds little value in the assembly process but does add value (which E&P’s are willing to pay for) through services to reduce downtime and logistics. Services provided include designing, sourcing, owning, installing, operating, servicing, repairing and maintaining compressor equipment. Advantages to using EXH services: 1) Upgrade/downgrade equipment with other EXH customers, 2) Better equipment service, 3) less capital required. Contracts are fee based over several years, which EXH then either keeps them on its books (about 50% of horsepower) or sells to its majority owned MLP (Exterran Partners). Compression equipment is used in several natural gas production applications including: 1) at the well head (field compression), 2) through gathering systems (field compression), and 3) along long-haul pipelines. As natural gas wells mature, production levels naturally decline as reservoir pressures fall. Once pressures fall below a certain level, field compression is needed for boosting onto the gathering system. But even with compression, production will continue to decline and will require steadily increasing compression levels to maintain production. Compressor leasing revenue roughly tracks total gas production. However, in 2008, natural gas producers ordered extra compression equipment at the top of the market, thus creating an overhang for the entire market. Unconventional shale plays need compression equipment later in its life cycle than conventional sources thus pushing out demand even further. EXH gets revenues from 3 segments: Contract compression (41% revenues, 70% gross profit) – 42% of the gross profit is from North America and 28% is from international (Latin America, Middle East, Indonesia) Fabrication (48% revenues, 23% gross profit) – equipment sales that are not part of the contract compression leasing business. This includes assembling compressor systems as well as more complicated equipment for refineries and petrochemical plants. Aftermarket (11% revenue, 7% gross profit) – after market services provide support services for compression systems.

MLP model In this structure, the MLP (Exterran Partners) purchases assets from Exterran holdings and distributes all available cash earnings from those assets to investors in the MLP quarterly. Currently, the dividend yield on Exterran Partners (EXLP) is 8.9% assuming a constant .5025 quarterly distribution. Exterran plans to use the MLP as a vehicle to sell the slower growing North American contract compression business and invest the proceeds in the faster growing International business. Selling the assets to the MLP is ideal because of the arbitrage created through the sale as EXLP typically trades at a higher multiple than EXH, mostly due to the favorable tax treatment of the partnership structure and a lower cost of capital. The partnership will most likely have the opportunity to purchase the remaining portion of the US contract operations in the coming future. Exterran Holdings (EXH) has historically transferred about 250,000 horsepower to Exterran Partners (EXLP) a year

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
so at that rate the entire North American contract compressor business would be transferred to EXLP in about 10 years. The public owns 70% and EXH owns 30% of EXLP. The partnership buys customer relationships and all equipment and service deals with that customer. The recent 8/12/2010 transaction included the drop-down of 43 customers and 580 compressor units, representing about 255k HP. The partnership buys assets from Exterran (EXH) by issuing shareholder units to the company, assuming EXH debt, or paying cash. Typically units are issued, which the company can sell in the open market at a later date to raise capital. The sale price of the assets is treated as an arm’s length transaction and monitored by the conflict of interests committee (three independent board members). This becomes more important as more of the partnership shares are owned by the public. Credit I feel that using 500 credit spread for the 4.25% convertible bonds is appropriate given that the convert has less than 2 years remaining. The 7.5% straight bond (higher rank due to sub guarantees) due 2018 trades at 550 spread. The company is rated B+/Ba2. Although EXLP is only 30% owned, its financials are consolidated into EXP when presented. Cash = $21m (6/30/12), 30% Ownership of EXLP = $319m Total debt = $1.68B (EXH stand-alone = $1.079B) PF 06/30/12 for Venezuela asset sale 4.75% convertible bonds due 1/2014 = $144m (no sub guarantee) 4.25% convertible bonds due 6/2014 = $355m (no sub guarantee) EXLP Revolver due 2015 = $493m drawn ($57m available) EXLP Term loan due 2015 = $150m Revolver due 2016 = $250m drawn ($670m available) 7.25% senior notes due 2018 = $350m (guaranteed by subs) LTM EBITDA = $402m (stand-alone = $320m) Debt /EBITDA = 4.6x (stand alone and covenant purposes = 3.3x) EBITDA/Interest expense = 2.6x (stand alone and covenant purposes = 4.0x) Secured debt/EBITDA = 1.2x Market cap = $1.2B Covenants: Debt/EBTIDA < 5.0x EBITDA/Interest expense > 2.25x Secured debt/EBITDA < 4.0x The 4.75% converts were originally issued by Hanover Compressor and were considered structurally senior to the 4.25% converts which were issued by the holding company. However in 2Q12, the 4.75% converts were assigned to the holding company in a corporate restructuring that eliminated Hanover Compressor. Currently, the two converts are considered pari passu. Cash flow EXH is a consistent cash flow generator. Capex can fluctuate and should be offset by equipment sales and sales to EXLP since much of the capex is used for contracts sold to EXLP. LTM 179 -403 40 184 2011 120 -282 46 223 2010 364 -235 31 214 2009 477 -368 69 2008 486 -466 56 2007 239 -352 36

CFFO Capex Equipment sales Sales to EXLP

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Convertible Bons, Credit Analysis, Indenture Analysis & Convertible Arbitrage Trade Ideas
FCF 0 107 374 178 76 -77

Stock reaction on earnings earnings date stock reaction 8/2/2012 2.5% 5/3/2012 -0.2% 2/23/2012 19.2% 11/3/2011 20.7% 8/4/2011 -20.0% 5/5/2011 -1.4% 2/24/2011 -4.0%

4.25% Converts specifics: Lose 4 points on a $25 takeout using 55 delta. I don’t think a takeout is likely since EXH is the market leader and there isn’t a larger natural buyer. Dividend protected from zero. Get last coupon before maturity if converting. 07-25-12 CSGS trade idea CSG Systems (CSGS) CSGS 3% convertible bonds are offered at 101 vs. 17.15 (JP Morgan). The issue is $150m with 4.6 years to maturity. Using a 500 credit spread, I get implied vol. of 27 and delta of 49. The stock has historically realized about 30 vol over the past few years if you take the outlier periods out. In the past two years, the stock has been as high as $21.34 (May 2011) and as low as $12.34 (October 2011). We will likely see more volatility in the next 12 months as CSGS has two large contracts that are coming up for renewals in December 2012 (Comcast 19% of sales) and March 2013 (Time Warner 10% of sales). These contracts typically last for 5 years. Last time when these contracts were up to renewal in late 2007/early 2008, the stock went from $28 in June 2007 to $11 in March 2008 due to speculation about a contract loss. This time, either the overhang of the contracts uncertainty lifts and the stock trades much higher or the loss of the contracts will cause the stock to decline. I see the stock trading to $24 (12x PE) in a bull case scenario or down to $13 (2011 lows) in a bear case scenario. I would put the trade on a slightly light delta of 45 delta because this will make the trade more balanced since the convert has a lot of points (31) to the upside. I also think that the most likely scenario is that CSGS will be able to renew the contracts at favorable rates in addition to winning other new contracts this year. CSGS is rated BB by S&P. However, the convertible bonds are senior subordinated bonds and are not rated. The company has no other bonds other than the converts and only $178m of term loans due 2015. The company reports earnings on 8/7/12.

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Company profile CSGS provides outsourced customer care and billing solutions primarily to the cable and direct broadcast satellite industry in North America. In 12/10, CSGS acquired Intec Telecom Systems, which is focused on telecom carrier billing. The top 4 customers account for 51% of sales. These are: 1) Comcast (19% of sales) – uses dual vendors with the contract split between CSGS (16m subs) and Amdocs (8m subs). Both contracts are up for renewal on 12/31/12 2) Time Warner (10% of sales) – uses dual vendors with the contract split between CSGS (5.6m subs) and Convergys (7.2 subs). Both contracts are up for renewal on 3/31/13 3) 4) DISH – (13% of sales) Uses CSGS exclusively (13.7m subs). The contract runs through 12/31/17 Charter (9% of sales) Uses CSGS exclusively (6m subs). The contract runs through 12/31/14

Cable and Satellite customers account for 60% sales with the remainder coming from Telecom Providers (30%) and Utilities (10%). CSGS gets paid on average about $10 per customer per year although this varies depending on the level of services. Competitors – in-house systems, Amdocs, Convergys (satellite and cable), Accenture, Comverse (wireless and wireline) Credit Analysis CSGS is a solid credit with low leverage and a high percentage of recurring revenues. Even if CSGS loses one or two customers, I believe that the company has a large enough base of other customers with long term contracts and recurring revenues to allow it to right size itself into the current capital structure. The negative is the company’s small market cap. CSGS is rated BB by S&P but the convertibles are senior subordinate bonds. I believe 500 credit spread for the convertible bonds is appropriate. Cash $189m (plus $100m undrawn revolver) Total debt $328m ($150m converts 3/1/17 and $178m term loan due 12/31/15) Debt/EBITDA = 1.72x, Net Debt/EBITDA = 0.65x EBTIDA/interest = 11x LTM FCF = $111m LTM Capex = $20m Market cap = $607m CSGS is a consistent FCF generator (see below) due to the company’s recurring revenues and low cap ex requirements. $mil CFFO Capex FCF 2011 61 22 39 2010 131 14 117 2009 153 40 113 2008 114 22 92 2007 115 20 95 2006 118 13 105 2005 102 13 89 2004 119 10 109 2003 60 9 51 2002 88 13 75

Covenants:

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Debt/Ebitda < 4x (current 1.72x) Ebitda/Interest > 2x (current 11x)

Equity analysis At $17.40, CSGS stock trades 9x PE to 2012 estimated EPS of $2. This is below DOX at 11.2x and CVG at 19x. Part of the reason for the discount is uncertainty about the upcoming contract renewals, which includes not only getting the contract but the pricing of the contracts and the split between vendors. I believe that the contract negotiations could create some large moves in the stock with the bull case being that CSGS stock trades up to $24 (12x PE) and the bear case going down to $13 (2011 lows). The stock has also had decent sized moves on earnings as shown in the table below. earnings date stock reaction 5/1/2012 9.4% 2/7/2012 -6.1% 11/1/2011 4.1% 8/2/2011 -6.4% 5/3/2011 -2.6% 2/8/2011 -2.4% 10/26/2010 8.9%

Convert specific Due to CSGS’s small size and leading position in the industry, the company could be a takeout target. On 45 delta, the breakeven takeout price is $22 (23% premium). I believe a takeout would be higher than $22 given the stock’s low valuation and market position. Get the last coupon if converting before maturity. Full dividend protection Net share settle; 20 day averaging period 07-09-12 CNQR trade idea Trade idea CNQR 07-09-12 CNQR has 2.5% convertible bonds due 4/15/15 ($288m) trading at 140.375 vs. 66.28. Using 300 credit spread, the model implies 34 vol and 77 delta. The convert trades at 10.9% premium pct and 13.8 points. With a 2.5% coupon and 2.77 years remaining (7 points), this seems attractive and cheap vol for a tech growth stock that trades at 41x PE to $1.66 2013 EPS. The stock is near new all time highs and has developed a cult like following among tech investors and momentum players. Short interest is high at 16% but the borrow is full and rebate is GC. Historical 90 day vol is 37, 250 day vol is 47, and options are not active. I would put the trade on a slightly higher delta of 79, as I believe the current technology spending environment is likely to have a negative effect on the company’s near term earnings. We have seen several software companies guide down such as INFA (down 27% on the day) on 7/6/12. There aren’t any identifiable catalysts for CNQR other than earnings reports. However, I expected vol. to be elevated as the stock price now factors in very optimistic assumptions for growth. The stock also moves with contact announcements and news about competitors. For example, on 6/4/12, CNQR stock was up 7% on news that it won

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an e-travel contract with the General Services Administration (GSA). This contract is now being protested by other software companies on the grounds that the contract gives CNQR a monopoly on providing travel management to a government agency. Palisade’s equity group owned this stock earlier this year but sold in the low-mid 50s earlier in 1Q 2012. I exchanged emails with Lisa Chai who follows the stock and her thoughts are that the company is well positioned but she is not comfortable with the valuation. There has also been a series of insider selling in recent months in the midhigh $60s. This trade would work well to the downside. If the stock trades down to $50, convert nukes to 115.8 with fair value at 118.6 and crosses par at $39.6 at 32% premium. To the upside, stock trades up to $85, convert nukes to 168.6, or 6.2 points of premium. Given that the convert is 2.5% with 2.78 yrs remaining, bonds should expand by at least 1 point. The risk of the trade is that the stock doesn’t move or trades in a tight range. CNQR stock moves for previous 5 earnings reports: 5/2/2012 10.20% 2/1/2012 8.70% 11/15/2011 -2.70% 7/27/2011 -5.50% 5/3/2011 -9.30%

Company profile CNQR is a software-as-a-service (Saas) provider focused on corporate travel and expense management. The company’s software allows travelers to book trips from the web on a PC or mobile device, keep track of their plans during the trip, and then submit an expense report after the trip. Currently, CNQR has the best software out there with little competition although big players including Oracle and SAP and looking to enter the market. Most revenues are from the US (85%) and Europe (10%). The company has about 10,000 customers. CNQR sells software though a direct sales force and partnerships with ADP and American Express. Bull case CNQR has a first mover advantage, has built a comprehensive software solution, and gained content management expertise that would be difficult for another vendor to quickly replicate. The corporate travel market is large with most expense management still done on excel spreadsheets. The market for automated travel software solution has only penetrated about 10% of the total travel management market. Customers using CNQR software can reduce administrative and processing cost while cutting down reimbursement time. The company is expected to grow sales by 25% and EPS by 30% annually for the next few years. Bear case For the past few years, CNQR has had little competition as the market for corporate travel management is relatively new. However, in recent months, SAP and ORCL have focused on improving their software offerings and will focus on selling the new modules to its existing customer base. A global economic slowdown would hurt sales because corporate travel and spending generally slows in this scenario. CNQR stock is highly valued at 41x 2013 EPS so any hiccup will lead to a large fall in the stock. Credit CNQR is a strong credit which I estimate to be BB and 300 spread for 2.8 year convert credit. The company ended 3/31/12 with $476m in cash and its only debt being the $288m convertible bonds. The market cap is $3.8B. The company has been a very consistent FCF generator of about $50m per year. Most of its sales are on 1 year subscription contracts that have high rates of renewals (over 90%) so the company can plan its future expenses

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around sales expectations. Typically, once a customer is set-up on the system, it is already invested and highly unlikely to switch vendors. Convert characteristics Lose 2 points on $90 cash takeout on 80 delta Get last coupon before conversion Full dividend adjustment 07-06-12 RHP trade idea Trade idea: Gaylord Entertainment (GET) I like the GET 3.75% convertible bond that is trading at 150.375 vs. 38.87. Using 600 spread, the converts imply 29.5 vol., 88 delta and trade at 7.73 points of premium. This is a very low premium for a convert with 3.75% coupon with 2.24 yrs remaining. I calculate the converts to have 5.6 points of cash flow to maturity after financing. I would run them on theo 88 delta as I feel that the stock risk is balanced to the upside and downside. As the stock moves up, the points premium would likely hold given the cash flows. To the downside, I believe vol. would pick up on any large drop in the stock which would also benefit the converts. The converts trade at such a low premium because investors fear that volatility in GET will contract substantially after expected REIT conversion in 1/1/13. However, I see several reasons why this may not be the case. 1) Unlike other REITS, Lodging REITS have realized decent vol. in the range of 30-35. This could be due to the nature of Lodging REITs, which essentially leases space on a daily or weekly basis, compared to Office REITs or Shopping center REITS that have leases of 10+ years and much higher visibility. The table below shows a list of Lodging REITS and their realized vol. over the past quarter, half year, and year. This leads me to think that GET may not see a de-rating of its implied volatility even after REIT conversion. If we compare to HST, there’s no reason to think that GET should trade at a lower volatility, especially given that we are using 600 for the 2 yr credit spread assumption for GET while HST has a credit assumption of about 250. A stock with a higher credit assumption should usually trade at a higher vol., all else being equal. 2) GET has only 4 properties (Nashville, Dallas, Orlando, Washington DC). This should make the stock more volatile since the concentration of assets exposes GET to more company specific risk. For example, in 2010, an historic flood occurred in Nashville and GET’s Opryland was significantly damaged. After insurance pa youts, the net cash impact of the flood was ~$150 million, or ~$3 per share. Aside from freak occurrences such as floods or other unpredictable events, limited diversity also puts GET at risk of; 1) market specific slowdowns, 2) union labor strikes (16% of GET’s employees are unionized), or 3) the negative impact of new supply in a specific market. 3) Although GET has agreed to the brand name sale/REIT conversion, there is some risk that the deal falls through. In this case, we could see a large drop in the stock followed by a volatility spike. What if vol. does go down to 25 In the case where I am wrong and vol. does collapse, I would expect to see a corresponding tightening of credit spread. If implied vol. were to drop to 25 and credit spreads tighten to 250, it would be neutral to the valuation. I do not see much risk to the downside even if vol. were to decline. Convertible characteristics

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Full cash dividend protection Get last coupon if converting prior to maturity Lose 2.7 points on a takeout at $50 on 88 delta (I feel a takeout is unlikely because GET explored all options including takeouts prior to the REIT conversion announcement) 06-25-12 LPNT trade idea Trade idea I believe that there is an opportunity to buy LPNT 3.5% converts due 5/15/14 ahead of the Supreme Court ruling on the proposed healthcare reform. The converts trade at 103.25 versus 37.6. Using 350 credit, the converts imply 27 vol, theo delta of 30 and premium of 42%. A trade set-up on 27 delta would allow us to benefit from a significant move in the stock, especially in tail event scenarios. LPNT is a solid credit that should hold up, particularly for short dated maturities such as the 3.5% converts. The company is rated BB, converts are sub debt rated BB-. LPNT is usually not a high vol. stock because the company has steady cash flows, low leverage relative to peers, and is generally a well-run company. LPNT also predominately operates hospitals in rural areas, which tend to be monopolistic in nature. The stock has realized about 25 vol over the past few months. However, last summer, realized vol popped from the low 20s to 40-50 after a divided Congress debated budget cuts. We may be on the verge of experiencing a similar scenario. 06-15-12 ONXX trade idea Trade idea I like the ONXX 4% converts and would set it up on a 70 delta and sell 30 of the 7/21/12 44 strike call options at $4.3 to get to a 78 total delta. Using 450 credit spread I get 38 implied vol compared with Jan 2014 options implied vol in the low 40s and implied delta is 79, although Citi says they trade it on a 69 delta. The converts also seem attractive given the wide equity valuation range for the stock based on upcoming catalysts and the wide range of estimates for the company’s Carfilzomb drug. There is a significant event coming up that could accelerate approval for Carfilzomb to 2012 from 2014, which could move the stock -4 or +6. On June 18, documents that will guide FDA panel discussions will come out. These documents usually paint a negative picture for the drug because of the tough questions that it raises but are typically harsh for any FDA panel review. The FDA panel will vote on recommending approval on June 20. The actual FDA approval would take place on July 27. Although the FDA will usually go along with the panel, I think there will be some uncertainty in the case where it is a close vote in favor of approval. This is because the FDA has maintained a stance that it does not like to approve drugs based on phase 2 trials unless it fills an unmet need. It is debatable whether Carfilzomb fill an unmet need because there are other options for multiple myeloma patients. In the last 5 years, there have been 5 drugs applying for accelerated approval with 3 getting approved (SGEN’s Advertris for Hodgkin’s lymphoma in 8/2011, ALTH’s Folotyn for lymphoma in 9/2009, CELG’s Istodax for lymphoma in 11/2009) and 2 being rejected (Roche’s T -DM1 for breast cancer and Genzyme’s Clolar for AML). ISI’s survey reveals that 72% of buy-side analysts believed that the drug would not be approved. Sell-side analysts think the probabilities are about 60% non-approval.

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I exchanged emails with Sammy Oh, who said he saw a -6/+8 scenario but that if the drug does not get approved, he sees the stock moving back up because in the end, the drug is effective and even though it will be approved 2 years later, it is still a valuable drug. It will also remove an overhang for the stock. If ONXX does not get approval, the options will likely expire worthless, providing 1.5 points of 1.3 points of profit. My thesis is that the stock trades down to $41 and then gradually trades back up so being on a 70 delta would not hurt much if at all. To the upside, we are effectively selling stock at 48.30 to get to a theo delta 06-10-12 TIVO trade idea Trade idea: Long 1m Tivo 4% converts due 3/15/16 on 53 delta, short 200 Jan 2014 12 strike call options at 90c. The converts trade at 108 vs 8.17. Using 500 credit spread, the converts imply 35 vol compared to 46 vol for the call options. Using 500 credit spread and 40 vol, the implied delta is 64. Combined with the short calls, the position delta would be 61. I have a positive view on Tivo stock (closed at $8.20 on 6/8/12) because the company’s core business is turning around with a new focus on European cable companies and small-mid size US cable operators where Tivo is the exclusive DVR provider. There are also potential upside catalysts including lawsuit settlements with Verizon, Motorola, Time Warner and Cisco. To the downside, the credit is solid due to its large cash position ($567m cash) and the converts ($173m) being its only debt. The reason for shorting Jan 14 calls as part of the trade is because Tivo converts would lose 4 points on a $12 cash takeout on a 53 delta. The call options would make back 1.8 points in that scenario to mitigate the cash takeout risk. Given that Tivo has a few lawsuits pending which could potentially bring in several hundred of millions, I do not see Tivo selling themselves unless for a large premium (greater than the $12 March 2012 high). A cash takeout at $13 would lose 0.7 points on the converts and 0.2 points on the short calls. According to analysts, the stock was down over 30% in recent months due to 1) Worries about Europe which accounts for a significant amount of net adds (VMED in particular), 2) Fears that Apple TV would change the way set top boxes and DVRs are used and 3) the increased R&D spending. All three issues have the potential to be overreactions that can be fixed by delivering a couple of quarters of good results. To the upside, the converts traded as high as 132 vs 12 in March 2012. On a 53 delta, the converts nuke to 126 for a 6 point gain before factoring in the call option loss of about 3 points. To the downside, the converts would nuke to 97.7 at $6 compared to fair value of 97.3 using 700 spread and 45 vol. Plus, the short call options should make 1 point. 06-04-12 CRM Salesforce.com (CRM) 0.75% converts due 01/15/15 trade at 164.25 vs. 131.5, which using 150 credit spread implies volatility of 43. Options implied vol 2014 is much higher at about 50. The converts have a theo delta of 87. We can put this trade on a slightly higher delta of 90 to better capture the downside move. I chose 150 credit spread based on big cap tech comps including 5 yr cds for Dell at 220, HPQ at 210, ORCL at 65, and CA at 156. I believe that the stock is likely to have a big downside move for several reasons: 1) In recent months, many tech bellweather companies have warned about a slowdown in tech spending, particularly in Europe and US government but also enterprise spending in general. Companies that guided down

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significantly include Cisco, Dell, and Network Appliance, all of which have off quarters (April ended) and thus reported after CRM and most tech companies. Since CRM software is often bought in conjunction with servers, routers, and storage, it is difficult to see how CRM can escape unscathed. CRM relies on closing large million dollar deals to make its quarters. Europe accounts for 18% of CRM sales. 2) Tech spending is famous for the year end budget flush. The seasonal trend for corporate spending on technology tends to be companies spending some of the budget early in the year to meet strategic initiatives, followed by a slowdown in the spring and summer months, and then close the year with a “spend it or lose it” directive before year end. CRM apparently benefited from the budget flush in 2011 as many corporations decided that CRM software was the product that it needed. 3) CRM trades at 80x 2013 EPS. The stock is pricing in a sustained period of high growth. For example, from 2012 to 2023, Nomura has CRM growing sales from $2.26B to $14.7B (18.5% annual growth for 11 years) and EBIT margins growing from 12% to 39%. Even with these aggressive assumptions, their DCF value works out to only $156 (about 18% upside). Is this unreasonable? A good comparison is to look at ORCL at a similar stage of growth from 1994 to 2005 (11 years), the company grew sales from $2.0B to $11.8B (17.5% annual growth for 11 years) and EBIT margins growing from 21.9% to 37.1%. Investors are already expecting CRM to accomplish in the next 11 years what ORCL did. One slip-up and the stock will come crashing down. 4) This does not get talked about much but CRM reports non-GAAP numbers, which analysts are happy to use as well. However, when factoring stock compensation expenses, CRM’s 2013 EPS would be -0.76c rather than $2.10. There are arguments for and against this practice but it nonetheless creates skepticism about the q uality of CRM’s earnings, although no one seems to care right now. Credit analysis CRM has $1.6B of cash and its only debt is the $575m in converts. The company generates about $400m per year in FCF. As a software company, its cap ex requirement is low at about $200m per year. This is a strong credit and I feel comfortable using 150 spread for the converts.

Capital Structure Arbitrage Distressed Debt Investing Capital structure arbitrage is a strategy used by many directional, quantitative, and market neutral credit hedge funds. In essence, it is going long one security in a company’s capital structure while at the same time going shor t another security in that same company’s capital structure. For instance, “long sub bonds, short senior bonds”, or “long equity, short CDS”, or maybe “long 1st lien bank debt, short 1st lien bonds.” A portfolio manager can express many different view po ints inside a single company’s capital structure that exploits things like variations from mean differences, covenant irregularities, market supply/demand technical, etc. This is the first part in a number of posts I plan to do on this topic over the next few months (with others focused on secured vs unsecured, covenant differences, basis trading, etc) The capital structure arbitrage trade is, in theory, less risky than going outright long one security or the next. With that said, because a number of cap structure arbitrage strategies require leverage (via repo, TRS, etc) to hit firm’s target IRRs, a trade going against you can be devastating. One of the more common capital structure trades seen in the market is long senior paper versus short subordinated paper. All else being equal, in very bullish times the difference between the spreads of the two bonds will be tighter

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than in very bearish times. This is because in bull markets, investors search and reach for yield thereby increasing demand for the more yieldy paper. One of the most common functions I use in Bloomberg is HS < go >. This function is dubbed the “Historical Spread Graph/Table” You can pull in two bonds and look at the difference in spread between the two (these can be any bonds…in fact you can pull in all sorts of statistics, but for this exercise we will focus on a select few). Below is a chart of the FDC’s 9 7/8% of 2015 (Seniors) vs FDC 11.25% of 2016 (sub) over the past year. The top part of the chart lays out the spread to treasury of each of the bonds with the bottom chart showing the difference between the two.

What is not shown are the relative statistics. Over this period (since 2/8/2011) the mean spread difference between these bonds was ~350 bps. Today it stands at 268 bps. The low occurred on 5/10/2011 with a spread differential of 92. The high occurred at 843 pm 9/29/2011. Here is another chart of those two dates highlighted:

The above chart is a chart of the VIX over the same time period. As you can see when markets are bulled up (i.e. VIX is low), the spread differential between the senior and sub bonds are tight. When markets are bearish (i.e. VIX is high), the spread differential between the senior and sub bonds are wide. The question then becomes: What is the right spread differential? Or better, what should be the intrinsic compensation and investor receives for taking on additional leverage and further subordination? There is a term in credit analysis: Spread per turn of leverage (or in some cases, yield per

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turn of leverage). If XYZ issuer has $100M of EBITDA, $200M of Senior Debt and $300M of Sub Debt (so $500M of total debt, with both notes maturing on the same day and trading at par), senior leverage would be 2.0x and sub or total leverage would be 5.0x. If the Senior Bonds were yielding 6% and the Sub Bonds yielding 10%, you would be receiving 300bps of yield per turn (6%/2.0x) and for the sub bonds you’d be receiving 200bps of yield per turn (10%/5.0x). All else being equal, the seniors would be a better value.

But let’s add a little bit of complexity to the issue. Let’s say the business of XYZ is worth 10x EBITDA. In that case, in a simple world, the recovery on both bonds would be par+. Then wouldn’t the subs be better value? You are picking 400 bps for the same recovery. With that said, determining the recovery rate of each security becomes fundamental to determining if yield / spread differentials are appropriate. The situation dramatically changes when one layer of the capital structure is levered 23x and another is levered 8-9x. More leverage = more swings in recovery. If one bond is pricing in a recovery rate significantly different than you are calculating, this could create opportunities on either the long or the short side.

And just to add a little more complexity (because this is getting fun): Depending on if the bond is trading above or below par changes the equation as well. This is more relevant for higher quality issuers, but if you have two pari bonds of the same issuer trading at 120 and 100 respectively, the bond trading at 120 will have a higher spread than the bond trading at par. Assume this issuer’s recovery rate in a restructuring is 30 cents. If you buy the 120 bonds today, you stand to lose 90 points whereas if you buy the par bond, you stand to lose 70 points. You thus have $20 extra dollars at risk (Price bond 1-Price bond 2). If the average spread on the bond is 300 bps, and our recovery rate is 30, the implied default rate = 9%. 9% * those 20 extra points at risk = 180bp of extra compensation needed. Lets say the 120 bond is trading 250 bps wide of the 100 bond. Well that would be an interesting opportunity that could be arbitraged by going long the 120 bond, and short the par bond.

As a quick side / corollary point to the above analysis: In his most recent letter, Howard Marks notes that:

“…we don’t undertake the tactical actions described above in response to what we or some economists think the future holds, but rather on the basis of what we see going on in the marketplace at the time. What things do we react to?

The simplest signs surround valuation. What’s the yield spread between high yield bonds and Treasurys? And between single-B and triple-C? What are the yields and premiums on convertibles? Are distressed senior loans trading at 60 cents on the dollar or 90? …” Here is a chart from JP Morgan’s Peter Acciavatti depicting the difference in yields between bonds rated B and CCC:

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As you can see, in very bearish times (late 2008-mid 2009, as well as 2001-2003), this spread blows out. In bullish times the spread is smaller. Currently at 465 bps versus a median of 508 bps, it stands the market is probably slightly overvalued (we have silently moved into the low 4s on my “risk pendulum scale“), which is not to say the market will not continue grinding higher – I just don’t think you are getting compensated for taking that risk. Some strategists are starting to throw in the flag (Goldman Sachs just got marginally constructive on credit). Full capitulation which equates to bubble territory has not happened yet with still many parties on the sell side calling for a pull back which would have been blasphemy in 1Q 2011 Credit spread of convertible bond My previous employer launched a CDO based on credit spreads of FCCBs. The problem as a research team we faced was that of tracking daily movements of the credit spreads as the spreads of these FCCBs weren’t easily available and it used to take more than 3 days to get the spreads from the market makers. But the problem even then was that the market makers didn’t encourage requisitions for runs unless and until they saw some trade happening. Hence the onus was to get the spreads (implied) from other available data in the market rather than depending on the market makers. The data available on any convertible bond were the price of the underlying that is the stock price and price of the convertible bond. Based on the available data using Put Call Parity the implied spread was arrived at. Put Call Parity: Stock Price + Put Price = Call Price + Present Value of the Strike Now, the sum on the RHS has payoffs similar to a convertible bond and hence it is equated to convertible price and the stock price on LHS is parity (here parity is the product of conversion ratio and stock price) of the convertible bond. So the parity relationship becomes, Parity + Put = Convertible Bond Price In the above relationship data on parity and convertible bond price are available and the unknown put price is calculated. From the put price implied volatility is estimated using MS Excel’s goal seek function. The implied volatility is then used to calculate the Call price. Convertible Bond Price – Call Price = Optionstripped Convertible Bond Price

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Based on the above relationship, price of optionless convertible is calculated. And, finally using goal seek again the implied spread is estimated.

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