Default Rate by Underwriter: Cibc Performs Best

TM
The Weekly Publication of High Yield Strategy February 6, 2004 Vol. 2, No. 6
Contact us at: BIG PICTURE…

LeverageWorld@FridsonVision.com
Learn more at:

Default Rate by Underwriter
www.FridsonVision.com
CIBC PERFORMS BEST
CIBC takes top honors in the newest Leverage World ranking of high yield
underwriters by long-run default rate. The figures adjust for the quality of issues
that each firm brought to market. Despite underwriting a mix of deals with
above-average default risk, CIBC has achieved a below-average default rate.
Deutsche Bank, which has the lowest unadjusted default rate for the period, is
runner-up this year after taking first-place honors in 2003.
How the Rankings Benefit Investors
Calculating default rates by underwriter provides two potential benefits to

investors:
(1) The findings may enable investors to improve their new issue security
Martin@FridsonVision.com selection beyond what they can achieve by relying on ratings, financial
statements, company disclosures, and road show presentations. Specifically, we
believe it is rational to overweight the offerings of investment banks that
CONTENTS produce lower rates than one would predict, based on the quality mix of their
deals. The implication is that those banks’ deals are systematically less risky
BIG PICTURE than the rating agencies perceive, based on the hard data available to them for
analysis. (Readers can draw their own conclusions about how to respond to a
Default by Underwriter ................. 1
finding that an investment bank’s deals default at a higher rate than one would
Late to the Party ........................... 9 predict from the ratings.)
SECURITY SELECTION
(2) Publishing an objective ranking of underwriters by default rates creates a
Rich/Cheap: basis for competition other than maximizing volume, i.e., the league tables. To
Amkor Technology / Unisys ....... 11 the extent that investment banks begin to forgo the marginal deal in order to
Focus Issues minimize their default risk, fewer secret pigs1 are likely to get foisted on the
Additions: ↑ Dillard's, Rural market. “Objective” is the key word in accomplishing the goal of changing
underwriters’ incentives. The default rate rankings cannot be an exercise in
Cellular, Unisys ↓ Avista, Manor
“proving” the foregone conclusion that a particular underwriter performed well
Care, Plains All American Pipeline, or poorly. Transparent methodology is essential to certifying the objectivity of
Smurfit-Stone Container ............. 15 the rankings.
SECTOR ALLOCATION
Data
Industry Value Tracker ............... 18
Credit Ratings Value Tracker...... 19 From the database of Bloomberg, we create a comprehensive list of high yield
MARKET TIMING new offerings for the period 1997-2002. We define high yield new issues as
bonds rated Ba1 or lower by Moody’s or BB+ or lower by Standard & Poor’s.
High Yield Sector Value
Our sample therefore includes a number of split-rated issues, e.g., Baa3/BB+,
Tracker........................................ 20 Ba1/BBB-. For each issue, we collect the ratings, ranking within capital
ODD LOTS...............................21 structure (seniority), and underwriter.
LEGAL NOTICES ...................22 1
By this we mean deals that obtain Triple-C or even Single-B ratings and can be sold at moderately
above-average spreads, but which have extraordinarily high default probabilities due to hidden risks.
Regrettably, it appears that underwriters sometimes take the view that it is acceptable practice to put
Brought to You in FridsonVision.TM their names on such offerings, as long as no paper trail can show that they knew of the concealed
hazards.
Copyright 2004 by FridsonVision LLC. All Rights Reserved.

See last page for usage restrictions and other legal terms.
BIG PICTURE…
Using the database of Income Securities Advisor, we identify all defaults on

the new issues in our sample. Our analysis does not penalize underwriters for
defaults on “fallen angels” that they brought to market as investment grade
bonds.
Methodology
Cumulative Default Experience
The primary focus of our analysis is three-year, cumulative, default

experience, adjusted for the quality of each underwriter’s deals and expressed in
levelized, annual terms. Empirical analysis shows that the third year after
issuance is generally the point at which the incidence of default peaks or at least
begins to level off. Therefore, experience over three years eliminates distortion
that could result from studying an insufficiently seasoned sample. Converting
the three-year cumulative rate to an annualized rate, by the simple procedure of
dividing by three, puts the results into terms that most readers are likely to find
intuitive, without affecting the resulting rankings. Further statistical noise is
eliminated by averaging the results of four new issue cohorts (1997, 1998, 1999,
and 2000). In averaging the results, we weight each year by its percentage share
of issues over the four-year period.
Our analysis considers defaults through the end of 2003 on the seasoned
issues. We do not, however, ignore the experience on the issues of 2001 and
2002. Defaults on those offerings do not enter into our main findings, but we
display summary statistics on them near the end of this report. We plan to
include the 2001 and 2002 new issue cohorts in future updates of our default rate
rankings as they become fully seasoned.
Aggregate Default Rates
To begin, we generate aggregate default rates by senior-equivalent rating2 on

the seasoned cohorts. The conversion to senior-equivalent ratings is necessary
to classify issues properly by their default probabilities. Nominal ratings on
bonds reflect both probability and default severity, or expected recovery of
principal in the event of default. A subordinated debenture rated B+ is the
obligation of a company rated BB at the senior level. It is therefore less likely to
default than a senior bond, rated B+, of a B+ company. Exhibit 1 details the
Distributed by FridsonVision LLC. equivalencies used in the conversion.
Martin Fridson, CEO.
Greg Braylovskiy, Analyst.
Note that we do not deny the importance of recoveries in overall returns. The
The material contained in this publication is
protected by the copyright laws of the United
present study, however, measures underwriters’ performance by their default
States of America and by international treaty. rates alone, not by their default loss rates, i.e., the combined effects of default
Any unauthorized use, reproduction or
distribution is punishable by civil and criminal probability and default severity. Based on our experience with default statistics,
penalty. See last page for usage restrictions and
other legal terms.
we consider it unlikely that rankings by default loss rates would differ radically
from the rankings we display below.
2
We treat each tranche within a multiple-tranche offering as one issue. The alternative of treating
them as one would reduce comparability with data for issuers that came to market with two or more
single-tranche offerings within short intervals. In addition, our adjustment for ratings requires
separate treatment for differently rated (by virtue of differences in seniority) tranches. Underwriters
of multiple-tranche deals that default are not disadvantaged in our quality-adjusted rankings, as their
expected default accounts are credited appropriately for each issue charged to them.
Leverage World –February 6, 2004 Copyright 2004 by FridsonVision LLC. All Rights Reserved. 2
BIG PICTURE…
Exhibit 2 displays default experience on the 1,983 new issues of 1997-2000.

Note that the small BBB category does not consist of bonds rated Baa3/BBB- or
higher. Rather, that S&P-based category includes split-rated issues rated Ba1 or
lower by Moody’s and subordinated bonds rated BB+ or BB, for which the
senior-equivalent rating is BBB-. We assign all nonrated issues to the CCC
category, consistent with empirical findings regarding the credit quality of
nonrated high yield bonds.3
Exhibit 1: Ratings Conversion Table

S&P Rating Capital-Structure Priority Senior-Equivalent Rating
BB+ Senior BB+
BB+ Subordinated BBB-
BB Senior BB
BB Subordinated BBB-
BB- Senior BB-
BB- Subordinated BB+
B+ Senior B+
B+ Subordinated BB
B Senior B
B Subordinated BB-
B- Senior B-
B- Subordinated B+
CCC+ Senior CCC+
CCC+ Subordinated B
CCC Senior CCC
CCC Subordinated B-
CCC- Senior CCC-
CCC- Subordinated CCC+
Source: FridsonVision LLC.
Exhibit 2: Aggregate Weighted Cumulative Three-Year Default Rate

1997-2000 Issuance
Senior-Equivalent Rating # of issues # of defaults Default Rate
BBB 19 2 10.53%
BB 653 71 10.87%
B 1027 228 22.20%
CCC 284 81 28.52%
Total 1983 382 19.26%
Sources: Bloomberg, Income Securities Advisor.
As a caution, readers should not attempt to compare this table with similar-
looking mortality tables published by sources such as Moody’s and Edward
Altman of New York University. Devised for somewhat different applications,
those tables appropriately remove issues from the denominator of a given year’s
annual default rate if they have been called without defaulting. That procedure
is by no means incorrect for the applications envisioned, but we calculate the
denominator only once, at issuance. Note that following the alternative
procedure would increase the underwriters’ reported default rates.
3
Martin S. Fridson, "Modeling the Credit Risk of Nonrated High Yield Bonds," Risks and Rewards:
The Newsletter of the Investment Sector of the Society of Actuaries (March 1992), pp. 6-11.
BIG PICTURE…
The three-year, cumulative, default rates shown in Exhibit 2 vindicate

Standard & Poor’s rating process in the sense that each step down the rating
scale is associated with an increase in default risk. By the same token, we note
that the increase from BB to B is 11.33 percentage points (22.20% - 10.87%),
while the increase from B to CCC is only 6.32 percentage points. Over the
longer run, the pattern is just the opposite, i.e., the rise in the default rate
accelerates as the rating declines. By inference, one could argue that many of
the 1997-2000 issues rated B should have been rated CCC instead. If so, the
agency could have achieved a more appropriate curve, with a clearer
differentiation in default rates between the B and CCC categories.
We divide the cumulative, three-year, default rates in Exhibit 2 by three to

generate annual default rate factors (Exhibit 3). These are the factors applied
to each underwriter’s ratings mix to calculate an expected default rate. Observe
that the default rate for the 1,983-bond universe of 1997-2000 is 6.42% a year.
The observation period includes a cyclical peak in default rates that occurred in
2001-2002.
Exhibit 3: Annual Default Rate Factors

Senior-Equivalent Rating Default Rate
BBB 3.51%
BB 3.62%
B 7.40%
CCC 9.51%
Total 6.42%
Quality Distribution by Underwriter
The final preparatory step is to calculate the senior-equivalent ratings

distribution for seasoned issues, i.e., the cohorts of 1997-2000. We credit the
deals solely to the lead underwriter. An underwriter must lead a minimum of 60
issues to qualify for separate listing in our results.4 Mergers that took place
during the observation period are reflected by consolidating the results of the
predecessor firms.
Twelve underwriters, listed in Exhibit 4, meet the requirements. Each firm’s

percentages by senior-equivalent rating category sum to 100% horizontally. As
an indication of the variance in quality mix among underwriters, just 10.61% of
Jefferies’s deals were rated BB at the senior level, but fully 47.14% of Merrill
Lynch’s were in that category. Similarly, concentrations in the CCC category
(which includes nonrated issues) ranged from 5.17% for Banc of America to
23.89% for Morgan Stanley. Overall, the B category accounted for just over
half (51.79%) of the four-year period’s deals.
4
Inclusion of an underwriter with an unacceptably small number of deals could undermine the
fairness of the rankings. At the extreme, if a firm underwrote only one deal and it not default, the
firm would be portrayed as the best underwriter, a clearly absurd result. Our cutoff of 60 issues
derives from an annual average requirement of 15 issues.
BIG PICTURE…
Results
Before adjustment for quality of issuance, the top-ranked underwriter is

Deutsche Bank, with a 4.57% annual default rate. (See Exhibit 5.) CIBC and
JP Morgan are behind by inconsequential margins, at 4.76% and 4.83%,
respectively. Jefferies has the unenviable distinction of producing the highest
annual ratio of defaults – 10.10%. Lehman Brothers (6.13%) and Goldman
Sachs (6.76%) straddle the group average of 6.42%.
Exhibit 4: Quality Distribution by Underwriter

New Issuance of 1997-2000
Senior-Equivalent Rating
Underwriter BBB BB B CCC
Banc of America 2.86% 30.00% 61.43% 5.71%
Bear Stearns 0.88% 28.32% 57.52% 13.27%
CIBC 0.00% 15.87% 73.02% 11.11%
Citigroup 0.90% 36.94% 51.35% 10.81%
CSFB 0.54% 33.06% 53.66% 12.74%
Deutsche Bank 1.61% 29.84% 56.45% 12.10%
Goldman Sachs 0.70% 39.86% 48.95% 10.49%
Jefferies 0.00% 10.61% 75.76% 13.64%
JP Morgan 0.93% 35.05% 56.07% 7.94%
Lehman Brothers 0.00% 26.44% 52.87% 20.69%
Merrill Lynch 2.86% 47.14% 30.71% 19.29%
Morgan Stanley 1.11% 38.33% 36.67% 23.89%
Others 0.52% 27.08% 50.00% 22.40%
Total 0.96% 32.93% 51.79% 14.32%
Source: Bloomberg.
Exhibit 5: Unadjusted Annual Default Rates by Underwriter*

Underwriter Default Rate
1.Deutsche Bank 4.57%
2.CIBC 4.76%
3.JP Morgan 4.83%
4.Banc of America 5.24%
5.Citigroup 5.71%
6.Merrill Lynch 5.95%
7.Lehman Brothers 6.13%
8.Goldman Sachs 6.76%
9.CSFB 7.05%
10.Bear Stearns 7.96%
11.Morgan Stanley 8.33%
12.Jefferies 10.10%
Others 6.42%
Total 6.42%
*Based on average three-year cumulative default rate.
BIG PICTURE…
The most important statistics, however, are the rankings adjusted for quality
of issuance (Exhibit 6). Our key findings are as follows:
CIBC has the best long-run underwriting record, measured by actual versus
expected defaults. Based on its deal mix, the firm would have been expected to
produce a 7.03% default rate. That is not only well above the group average of
6.42%, but the second highest (behind Jefferies) among the dozen leading
underwriters. Despite its aggressive underwriting profile, CIBC has the second
lowest actual default rate – 4.76%. The difference between CIBC’s actual and
estimated rates is a first-in-class -2.27 percentage points. That is good enough
to edge out last year’s winner, Deutsche Bank, which combines a nearly average
expected default rate (6.47%) with a lowest-in-group actual rate (4.57%) to
finish with a difference of -1.90 percentage points.
Jefferies brings up the rear, dropping from #10 last year to #12 this time. The
firm’s expected default rate is 7.29% is the group’s highest, but so is its actual
rate – 10.10%. At 2.81 percentage points, its excess of actual over estimated is
not only the biggest in the current rankings, but twice as great as the difference
posted by last year’s worst performer (Morgan Stanley, at 1.37 percentage
points).
Merrill Lynch claims the highest quality mix of the period, reflected by an
expected default rate of only 5.92%. The Thundering Herd also comes closest
to matching actual (5.95%) with estimated.
The period’s underwriting volume leader, Credit Suisse First Boston, can
counter anyone who might claim that it owes that distinction to chasing deals of
dubious quality. CSFB’s expected default rate, at 6.40%, is almost identical to
the group average of 6.42%. The firm’s actual default rate (7.05%), though,
places it only ninth out of 12, while its excess of actual over estimated defaults
(0.67 percentage points) merits only a #8 ranking.
Exhibit 6: Adjusted Annual Default Rates by Underwriter*

Underwriter Actual Expected Difference
1.CIBC 4.76% 7.03% -2.27%
2.Deutsche Bank 4.57% 6.47% -1.90%
3.JP Morgan 4.83% 6.21% -1.38%
4.Banc of America 5.24% 6.28% -1.04%
5.Lehman Brothers 6.13% 6.84% -0.71%
6.Citigroup 5.71% 6.20% -0.49%
7.Merrill Lynch 5.95% 5.92% 0.04%
8.CSFB 7.05% 6.40% 0.65%
9.Goldman Sachs 6.76% 6.09% 0.67%
10.Bear Stearns 7.96% 6.58% 1.39%
11.Morgan Stanley 8.33% 6.41% 1.92%
12.Jefferies 10.10% 7.29% 2.81%
Others 6.42% 6.83% -0.41%
Total 6.42% 6.42% 0.00%
*Based on difference between actual and expected, average, three-year, cumulative, default rates.
BIG PICTURE…
Postscript
The new issue cohorts of 2001 and 2002 have not yet reached their three-year,
peak, default rate periods. Investors should therefore draw no hard conclusions
from the default experience to date of these unseasoned deals. For purposes of
information, however, we display the cumulative default experience for the two
years in Exhibits 7 and 8.
Exhibit 7: Default Experience by Underwriter*

2001 New Issuance
Banc of America 0.00% 2.27% 7.14% 50.00%
Bear Stearns 0.00% 0.00% 0.00% 0.00%
CIBC 0.00% 0.00% 0.00% 0.00%
Citigroup 0.00% 4.76% 7.14% 16.67%
CSFB 0.00% 0.00% 10.71% 7.14%
Deutsche Bank 0.00% 5.56% 4.55% 0.00%
Goldman Sachs 0.00% 4.76% 0.00% 0.00%
Jefferies 0.00% 0.00% 0.00% 0.00%
JP Morgan 0.00% 0.00% 0.00% 0.00%
Lehman Brothers 0.00% 0.00% 0.00% 0.00%
Merrill Lynch 0.00% 5.56% 0.00% 0.00%
Morgan Stanley 0.00% 0.00% 14.29% 0.00%
Others 0.00% 0.00% 0.00% 0.00%
Total 0.00% 2.26% 4.41% 11.76%
*Average, two-year, cumulative, default rates.
Exhibit 8: Default Experience by Underwriter*

2002 New Issuance
Banc of America 0.00% 5.00% 0.00% 0.00%
Bear Stearns 0.00% 0.00% 0.00% 0.00%
CIBC 0.00% 0.00% 0.00% 0.00%
Citigroup 0.00% 0.00% 0.00% 0.00%
CSFB 0.00% 0.00% 0.00% 0.00%
Deutsche Bank 0.00% 0.00% 5.88% 0.00%
Goldman Sachs 0.00% 0.00% 0.00% 0.00%
Jefferies 0.00% 0.00% 0.00% 0.00%
JP Morgan 0.00% 0.00% 0.00% 0.00%
Lehman Brothers 0.00% 0.00% 0.00% 0.00%
Merrill Lynch 0.00% 0.00% 0.00% 0.00%
Morgan Stanley 0.00% 0.00% 0.00% 0.00%
Others 0.00% 0.00% 0.00% 0.00%
Total 0.00% 2.11% 0.98% 0.00%
*One-year default rates.
BIG PICTURE…
Conclusion
Avoiding defaults is a key objective of high yield portfolio managers. Aside

from their direct impact on returns, defaults undercut the efforts of money
management firms that pursue institutional mandates by highlighting their credit
skills. Managers who already take ratings and financial statement data into
account may be able to lower their exposure to defaults by skewing new-issue
purchases to deals underwritten by the following firms:
· CIBC
· Deutsche Bank
· JP Morgan
· Banc of America
· Lehman Brothers
· Citigroup
These underwriters have produced lower default rates than would be expected,
based on the ratings of their deals. Our analysis takes into account bonds that
were floated after 1996 and that became fully seasoned prior to this year.
As with any similarly grounded strategy, the success of our proposed

discrimination by underwriter is subject to the caveat that past performance may
not be indicative of future results.
LW
BIG PICTURE…
Late to the Party?

Investors were reluctantly willing to buy selected dividend deals even before
2004 began, but January’s hot new issue market flung the window wide open.1
Investment bankers dutifully carried the message to financial sponsors: “This is
your chance to take equity out of your leveraged buyout, even if you issued
bonds to finance it as recently as last month. Money is flooding into the high
yield market so fast that high yield portfolio managers will buy anything we
offer.”
Madison Dearborn responded by proposing a dividend deal for its 2002 LBO
of Jefferson Smurfit. The structure struck almost every cold button for high
yield investors – a holding company, payment-in-kind (PIK) that prompted
Moody’s to downgrade the cardboard box producer’s existing bonds.
Some investors cried foul over the downgrade, arguing that Jefferson
Smurfit’s capital structure would not be weakened by the addition of a
structurally subordinated, non-cash-pay issue. Furthermore, they noted,
Standard & Poor’s left its rating unchanged after the dividend deal was
2
proposed. S&P, however, was on the same page as Moody’s in saying that it
had expected the company to reduce its leverage, rather than increase it.
Hmmm, we wonder where the rating agencies got that idea? Perhaps it was
from the company’s management and LBO sponsor. In any case, we repeat our
earlier advice to high yield analysts to add a new question to their road show
checklist for LBO deals: “If you see an opportunity to take out a huge dividend
a short time after we buy these bonds, will you take it?” Regardless of how the
issuer equivocates, the honest answer is probably “Yes.”
Notwithstanding Jefferson Smurfit’s effort to take the dividend deal to a new

level, we are probably already past the worst of the skewing of terms in favor of
issuers. As noted, the increased receptivity to dividend deals (as well as
offerings with highly issuer-friendly covenants and call features) resulted from a
massive influx of cash to the high yield sector. After 13 straight weeks of
inflows, however, AMG Data Services reported an outflow of $1.57 billion from
weekly reporting high yield mutual funds in the period ending February 4, 2004.
That was the biggest cash exodus since $2.56 billion left the funds in the August
6, 2003 reporting period. Moreover, this week’s figure was the first $1 billion
flow since a $1.14 billion inflow in the week ended September 3, 2003, just as
New York Attorney General Eliot Spitzer began his crackdown on market-
timers. Now, the timers are back in action, promising renewed volatility.
1
See “The Art of the Dividend Deal,” Leverage World (January 23, 2004), pp. 13-14.
2
Given the stated conviction of many high yield market participants that the rating agencies do not
know what they are doing, we do not understand how one agency’s stance proves that the other’s is
wrong. The same “logic” could be employed to argue that Moody’s action proved that S&P was
wrong. Parenthetically, we note that the assertions of rating agency ignorance are based largely on
the agencies’ failure to tell market participants what they want to hear. Claiming that a given rating
is wrong, based on financial data, is an intellectually bankrupt exercise because the correct rating is
unobservable. The only scientifically valid criticism or praise of the rating agencies’ records must
proceed from an after-the-fact analysis of default rates by rating category. The bond rating bashers
willfully ignore the inconvenient (to them) fact that Triple-Cs default at a higher rate than Single-Bs,
which default at a higher rate than Double-Bs – the pattern that an effective rating system ought to
achieve.
BIG PICTURE…
High yield investors must also reckon with the possibility of sizable
redeployments out of the sector by hedge funds. That opportunistic group
would have been unwise to bolt before the customary January rally, but with
3
2003’s high yield total return of 28% unlikely to be repeated any time soon, it
is time for them to seek greener pastures. They are not in the position of
conventional high yield managers, who will be heroes to their pension plan
clients if interest rates rise so sharply that government bond returns turn negative
and they post a robust 0% return. The arithmetic works much differently for
hedge fund managers. Their key equation is 20% X 0% = 0%. That is, they get
paid a cut of their absolute returns, not of their relative returns.
The shift in supply/demand dynamics probably had more than a little to do

with the emphasis on Euro buyers in marketing the Jefferson Smurfit deal. For
the moment, the cessation of massive inflows to the high yield sector should
make it easier for dollar-based, U.S. high yield investors to hold the line on
terms and use of proceeds.
LW
3
As measured by the Merrill Lynch High Yield Master II Index.
SECURITY SELECTION…
THE PRESENT 131-BASIS-POINT DIFFERENCE IN SPREADS BETWEEN

THE UNISYS 7-7/8% OF 2008 AND THE AMKOR TECHNOLOGY 9-1/4%
OF 2008 REPRESENTS THE MOST ATTRACTIVE SWAP POSSIBILITY
AMONG NONDISTRESSED, HIGH YIELD, TECHNOLOGY ISSUES,
BASED ON OUR FINANCIAL VALUATION MODEL. UNISYS HAS
DELIVERED STRONG OPERATING PERFORMANCE AND WILL
POSSIBLY BE UPGRADED TO INVESTMENT GRADE. MEANWHILE
AMKOR TECHNOLOGY IS UNDERTAKING AN EXPENSIVE CAPITAL
SPENDING PLAN THAT MIGHT LEAD TO FURTHER LEVERAGING.
Technology: Unisys and Amkor Technology
Our Rich/Cheap methodology identifies on a weekly basis an industry pair

that offers potential as a long-short relative value trade.1 (Note that the analysis
does not preclude executing only one side of the proposed swap.) This week’s
analysis concentrates on the Technology industry. Exhibit 1 presents two
potentially misvalued bonds with their Focus Issues model estimates and actual
spreads. If we were to judge solely by the model-generated numbers, the Unisys
(NYSE: UIS) 7-7/8% senior notes due April 1, 2008 would be 367 basis points
too wide versus the Amkor Technology (NASDAQ: AMKR) 9-1/4% senior
unsecured notes due February 15, 2008.
Exhibit 1: Focus Issues Model Estimates and Actual Spreads*

(Basis Points)
Potential Relative
Ratings Price Estimated Actual Value Pickup
BUY
Unisys 7.875% 4/1/2008 Ba1/BB+ 101.75 260 456
Amkor Technology 9.25% 2/15/2008 B1/B 113.5 496 325
SELL Difference -236 131 367
* Spreads as of February 4, 2004.
Sources: Advantage Data, FridsonVision LLC.
As of February 4, 2004, the spread of the UIS notes was 131 basis points
wider than the AMKR issue’s. Based on differences in coupon, coverage ratio,
and EBIT (neither issue is rated below B-), a yield giveup of 236 would be
predicted. Exhibit 2 graphs the relationship between the spreads of this industry
pair since February 2002. Note that from February 2002 to July 2003, UIS’s
issue traded at a tighter spread than AMKR’s. Moreover, the two issues traded
at nearly identical spreads as recently as October 2003.
1
See “Rich/Cheap,” Leverage World (August 1, 2003), pp. 1-5.
Exhibit 2: Option-adjusted Spread for UIS and AMKR notes
Source: Advantage Data.
Fundamental Factors
AMKR’s bond has experienced dramatic spread-tightening and price

appreciation since October 2002, outpacing the overall high yield market.
Initially, recovery in semiconductor industry revenues gave impetus to the rally.
Subsequently, the company returned to profitability in the third quarter of 2003
as its capacity utilization jumped to nearly 90% from 60%, providing more
reason for optimism. Furthermore, Amkor managed to reduce its high debt
levels somewhat in 2003. Meanwhile, the UIS bond’s spread has stayed
essentially unchanged throughout 2003, despite the company’s ability to resume
revenue growth by concentrating on its core Services business. Furthermore,
Unisys closed several large-ticket, long-term outsourcing contracts during the
year. That accomplishment went unnoticed by the high yield market, which was
more attracted by lower-quality issuers.
We can identify two major fundamental factors that suggest that the
divergence in spreads will disappear or decrease significantly:
· Last week, Amkor projected that its capital spending in 2004 will be in the
$300 million to $500 million range, far ahead of the Wall Street
expectations and the company’s own earlier guidance. This high level of
capex renders unlikely the continuation of the company's debt reduction
program, undertaken in 2003, which was modest to begin with.
Furthermore, any downtick in revenues or in margins, would probably force
the company to try to raise more capital. Time will tell, but it is not
probable that high yield investors will be as friendly toward a B-rated,
highly leveraged issuer in December 2004, as they were in December 2003.
· Unisys surprised Wall Street by exceeding revenue and earnings projections

in the fourth quarter of 2004. With a large portion of the company’s
Services sales secured through long-term contracts combined with a healthy
backlog of orders, UIS should be able to continue its revenue growth.
Furthermore, any positive surprise in the Technology business, which is
projected to continue shrinking for the next couple of quarters, will provide
another boost. Finally, with Standard & Poor’s Ratings Services revising its
outlook on the company to positive, an upgrade to investment grade is
possible in the intermediate term.
Unisys
Description
UIS, headquartered in Blue Bell, Pennsylvania, is one of the largest global

providers of information technology consulting services. The company traces
its roots back to 1873, when E. Remington & Sons was formed to produce the
first commercially viable typewriter. For the full year 2003, UIS recorded sales
of $5.9 billion, while posting net income of $259 million. Currently, the
company has about $1 billion of high yield debt outstanding, with half of it
maturing before 2006. Unisys last tapped the high yield debt market in March
2003 with a $300 million issue.
Overview
In 1992, Unisys, a pure play hardware company at that time, formed a unit to
deliver information technology services such as outsourcing to its corporate
clients. By 1994, the Services unit became the company’s single largest
business and it currently represents 80% of UIS’s annual revenues. Unisys’
focus on expanding its array of business services and building stronger
relationships with customers generated a number of long-term contracts in 2001
that provide a safety net in the volatile technology industry. Now, the company
is well positioned to take advantage of its strong financial position and recent
improvements in the operating performance with a $9 billion backlog of
Services orders and a projected recovery of the Technology business by the end
of 2004.
Recent Developments
On January 20, 2004, Unisys reported strong financial results for the fourth
quarter and full year 2004 with stronger-than-expected revenues and free cash
flow. For the fourth quarter, revenues rose by 5% from the preceding-year
period to $1.64 billion, driven by Services growth and the favorable impact of a
weak dollar. For the full year, the company generated $134 million in free cash
flow and delivered earnings per share in line with expectations. Also, the
company provided higher-than-expected earnings guidance for the full year
2004. On January 29, 2004, Standard & Poor’s Ratings Service affirmed its
BB+ corporate credit rating on the company and revised the outlook to positive
from stable. In the statement, S&P noted that “the prospects for sustained
internal revenue growth and earnings improvement could lead to an investment-
grade rating over the intermediate term.”2
2
http://biz.yahoo.com/rf/040129/services_s_p_unisys_1.html
Amkor Technology
Description
AMKR, headquartered in West Chester, Pennsylvania, is the largest provider

of semiconductor packaging and test services. The company’s founder and chief
executive officer, James Kim, controls more than 40% of Amkor. For the full
year 2003, AMKR recorded sales of $1.6 billion, while posting net income of
$2.2 million. Currently, the company has about $1.1 billion of high yield debt
outstanding, with none of it maturing before 2008. Amkor Technology last
accessed the high yield debt market in October 2003 with a $425 million issue.
Overview
Amkor Technology was launched in 1968 to pioneer the outsourcing of

semiconductor assembly and test services (SATS). The company relies heavily
on large semiconductor manufacturing customers, with Toshiba and Agilent
accounting for nearly 25% of its revenues. In recent years, Amkor has struggled
in growing its market share amid a consolidating industry. Unlike AMKR, some
of its biggest competitors have been able to steal revenues from the smaller
companies as customers have sought to reduce the number of subcontractors that
they use. While Amkor had an impressive year in 2003, especially when
compared to a dismal 2001 and 2002, it is still not solidly back on its feet.
Amkor remains highly leveraged following the acquisition of four factories in
South Korea in 1998 and high capital expenditures between 1998 and 2001.
Now, the company’s plan to resume spending at a breathtaking pace might have
adverse effects, especially if projections of semiconductor industry growth prove
overly optimistic
Recent Developments
On January 28, 2004, Amkor Technology reported solid financial results for
the fourth quarter and full year 2004. For the fourth quarter, earnings per share
were $0.13, $0.03 higher than the First Call average estimate. That also
represented a healthy change from the fourth quarter of 2002 when the company
lost $1.19 per share. Revenues rose by 23% to $459 million from the preceding-
year period when capacity utilization was much lower than currently. The
company also announced plans to increase its production capacity by investing
between $300 million and $500 million in Taiwan and China during 2004.
Technology Industry Trends
According to index data provided by Lehman Brothers, the high yield

Technology sector returned 43.21% in 2003. This is significantly more than the
overall U.S. Corporate High Yield Index’s 28.97% 2003 return. This relative
outperformance partially reflects the Technology industry’s concentration in
lower-priced issues, which underperformed the index in 2003. The Technology
index started 2003 priced at 70.24, nearly 13 points below the overall index.
Furthermore, the industry’s strong return was helped by the economic recovery
and an uptick in the corporate information technology spending.
LW
Focus Issues
Spread Wider than Estimated
by Financial Statement Data Spread February 4, 2004
Issuer Coupon Maturity Estimated Actual Difference
Boyds Collection 9.000% 05/15/2008 397 593 196
Calpine 8.750% 07/15/2013 304 561 257
Dillard's* 6.875% 06/01/2005 288 575 287
Dillard's* 7.150% 02/01/2007 296 511 215
Dillard's* 7.375% 06/01/2006 303 559 256
Friendly Ice Cream 10.500% 12/01/2007 465 732 267
General Binding 9.375% 06/01/2008 422 645 223
KCS Energy 8.875% 01/15/2006 382 567 185
Nash Finch 8.500% 05/01/2008 366 642 276
Pantry 10.250% 10/15/2007 428 655 227
Philippine Long Distance 7.850% 03/06/2007 315 502 187
Pogo Producing 10.375% 02/15/2009 281 569 288
Rogers Wireless 8.800% 10/01/2007 299 535 236
Rural Cellular* 9.750% 01/15/2010 490 750 260
Shopko Stores 9.000% 11/15/2004 368 646 278
Standard Commercial 8.875% 08/01/2005 369 650 281
Unisys* 7.875% 04/01/2008 260 456 196
Spread Narrower than Estimated

by Financial Statement Data Spread February 4, 2004
Issuer Coupon Maturity Estimated Actual Difference
Amkor Technology 10.500% 05/01/2009 623 420 -203
Avista* 9.750% 06/01/2008 381 187 -194
Manor Care* 7.500% 06/15/2006 282 99 -183
Plains All American Pipeline* 7.750% 10/15/2012 327 147 -180
Pride International 10.000% 06/01/2009 389 160 -229
Smurfit-Stone Container* 11.500% 08/15/2006 445 119 -326
* Addition since last update.
Model Update
The current version of the multiple regression formula is presented here:
Spread = 255.55 + 87.46a + 31.702b – 3.980c – 76.021d
Where:
255.55 is a constant
a = Dummy variable for CCC+ or lower rating (Yes = 1, No = 0)
b = Coupon, expressed without considering percentage sign, i.e., 7.5% = 7.5, not
0.075
c = Coverage, defined as EBITDA divided by interest expense
d = Earnings, defined as log of trailing-twelve-months EBIT in millions of
dollars
Regression Statistics:
Standard Error = 89.88 basis points

R2 = 54.8%
Adjusted R2 = 54.5%
Predictor t-statistic P-Value VIF

Constant 7.87 0.000
a 4.49 0.000 1.1
b 11.42 0.000 1.2
c -3.54 0.000 1.1
d -10.86 0.000 1.2
The analysis indicates that each explanatory variable is significant at the 99% confidence level or
greater. In no case is there greater than a 0.1% probability that variable’s coefficient is equal to 0,
which would signify that the variable has no explanatory power. Low values of variance inflation
factors (VIF) suggest that multicollinearity is not present in this model.
Focus Issues: Why Are They on the List?
The key to exploiting the Focus Issues list is fundamental analysis of factors
outside the historical financial statements. If, in the investor’s judgment, the
factors do not fully justify the disparity between the bond’s estimated and actual
yields, the investor should regard the bond as an opportunity to enhance relative
performance. The following comments provide the basic reason for each of this
week’s additions to and departures from the list.
Issuers with Issues That Entered the:

Yielding-More-than-Estimated List
Dillard’s issues joined the Focus Issues without any apparent fundamental
cause, even though the High Yield Retailers index outperformed the general
index during the last week.
Rural Cellular’s 9-3/4s widened in conjunction with the High Yield Wireless
group underperforming the high yield index during the past week.
Unisys’ 7-7/8s widened despite Standard & Poor’s Ratings Services affirming
its BB+ corporate credit rating on the company and revising its outlook to
positive from stable.
Yielding-Less-than-Estimated List
Avista’s 9-3/4s tightened despite the company missing the First Call average
earnings per share estimate by $0.02 in the fourth quarter of 2003.
Manor Care’s 7-1/2s tightened on news that the company reported a strong
increase in revenues in the fourth quarter of 2003.
Plains All American Pipeline’s 7-3/4s joined the Focus Issues list as the
spread estimated by the model widened by more than the actual spread.
Smurfit-Stone Container’s 11-1/2s joined the yielding-less-than-estimated

list even though the company warned that its results for 2004 will be influenced
by higher energy costs and employee benefit expenses.
Issuers with Issues That Exited the:

Yielding-More-than-Estimated List
Spread on Spread on
Issuer Coupon Maturity 1/28 2/4 Change
Rogers Wireless 9.375% 06/01/2008 481 490 9
Sea Containers 7.875% 02/15/2008 462 473 11
St. John Knits 12.500% 07/01/2009 740 688 -52
Winn-Dixie Stores 8.875% 04/01/2008 536 1234 698
Rogers Wireless and Sea Containers’s issues experienced no change in price

despite the declining high yield market. This caused both issues to exit the
yielding-more-than-estimated list as the estimated spreads widened.
St. John Knits’s 12-1/2s gained one point as the High Yield Textile index
handily outperformed the general index during the last week.
Winn-Dixie Stores’ 8-7/8% issue was removed as a statistical outlier

following an extreme widening of its spread. (The issue will not be excluded
from the sample in future calculations of the success of the Focus Issues
methodology.)
Yielding-Less-than-Estimated List
Spread on Spread on
Issuer Coupon Maturity 1/28 2/4 Change
Amkor Technology 7.750% 05/15/2013 237 297 60
Amkor Technology 9.250% 02/15/2008 244 325 81
Cummins 9.500% 12/01/2010 182 215 33
Gaylord Entertainment 8.000% 11/15/2013 277 312 35
Amkor Technology’s issues both lost 2-3/4 points in dollar price on concerns
that the company’s proposed capital spending plan for 2004 will result in lower
gross margins and cash balances.
Cummins’s 9-1/2s exited the list as the High Yield Automotive index
declined along with the overall index.
Gaylord Entertainment’s 8s lost 1-1/2 points in dollar price in conjunction

with the High Yield Entertainment index underperforming the general index
during the last week.
LW
SECTOR ALLOCATION…
Industry Value Tracker

The Industry Value Tracker ranks industries within the Lehman Brothers U.S.
Corporate High Yield Index according to the percentage of issues trading wider
(by even one basis point) than the spreads estimated for them by the Focus
Issues model. (For an explanation of this model, see “Focus Issues
Methodology” and “Performance of Focus Issues” in the Sample Research
section of www.LeverageWorld.com.) The underlying premise is that if an
industry has a pronounced concentration of undervalued (overvalued) issues, it
probably reflects a group effect whereby investors are shunning (flocking to) an
industry more energetically than the fundamentals warrant.
Portfolio managers should not attempt to fine-tune their portfolios to minor

differences in rankings. Instead, we recommend that they concentrate on
overweighting or underweighting major industries (those with large numbers of
outstanding issues) that appear near the top or bottom of the table.
Exhibit 1: Industry Value Tracker*
Total # of
Industry % Trading Wider than Estimated Issues
Packaging 72.22% 18
Cheap Consumer Cyclical Services 71.43% 21
Environmental 64.29% 14
Home Construction 61.54% 13
Paper 60.47% 43
Retailers 59.02% 61
Technology 58.82% 17
Media Cable 57.14% 21
Consumer Products 56.25% 16
Independent Energy 53.57% 28
Automotive 50.00% 22
Industrial Other 43.75% 16
Food/Beverage 43.75% 16
Aerospace/Defense 40.00% 10
Oil Field Services 36.36% 11
Wireless 35.00% 20
Health Care 33.96% 53
Electric 26.67% 15
Chemicals 23.08% 26
Gaming 22.50% 40
Rich Media Non-Cable 21.43% 28
Lodging 20.00% 20
Construction Machinery 18.18% 11
Diversified Manufacturing 7.14% 14
* Based on Spreads as of February 4, 2004.
Sources: Advantage Data, FridsonVision LLC, Lehman Brothers.
Update
Valuation differentials among industries widened out over the past week,
although the ordering from best to worst value changed little. Chemicals,
Construction Machinery, Diversified Manufacturing, Gaming, Lodging, and
Media Non-Cable all represent industries crying out for deemphasis, with
Consumer Cyclical Services and Packaging representing the most attractive
areas into which to redeploy assets. Last week’s second-cheapest industry,
Retailers, handily outperformed the Lehman Brothers U.S. Corporate High
Yield Index by a margin of -0.57% to -1.10% in the intervening sessions. The
percentage of Retailers issues trading wider than their estimated spreads
declined from 63.93% to 59.02%.
LW
SECTOR ALLOCATION…
Credit Ratings Value Tracker

These rankings are not based on historical yield spreads, but instead on each
rating category’s degree of concentration in issues trading wider than the
spreads estimated by our Focus Issues model.1 (See accompanying conversion
table to determine a bond’s senior-equivalent rating, based on its nominal
rating.)
Exhibit 1: Credit Ratings Value Tracker*

Senior-Equivalent Rating % Trading Wider than Estimated Total # of Issues
BBB 28.41% 88
BB 42.06% 378
B 54.19% 155
CCC 43.75% 16
* Based on Spreads as of February 4, 2004.
Sources: Advantage Data, FridsonVision LLC.
Exhibit 2: Conversion Table

Senior-Equivalent Rating S&P Rating Seniority
BBB Senior
BBB- Senior
BBB
BB+ Subordinated
BB Subordinated
BB+ Senior
BB Senior
BB- Senior
BB
BB- Subordinated
B+ Subordinated
B Subordinated
B+ Senior
B Senior
B- Senior
B
B- Subordinated
CCC+ Subordinated
CCC Subordinated
CCC+ Senior
CCC Senior
CCC- Senior
CCC NR Senior
CCC- Subordinated
CC Subordinated
NR Subordinated
Source: FridsonVision LLC.
Update
There is substantially less value than a week ago in crossover bonds (“5Bs”
rated Ba by Moody’s and BB+ or BB- subordinated issues of BBB- companies).
In the intervening period, that group’s ratio of issues trading wider than their
model-estimated levels has shrunk from 42.05% to a piddling 28.41%. This
may reflect a misguided flight to relative safety among high yield investors. The
highest-rated issues are the most exposed to a rise in interest rate risk, which we
consider a bigger threat at present than a general increase in credit risk. Bonds
of Single-B companies continue to offer the best near-term relative value within
the high yield sector.
LW
1
See “Focus Issues Methodology” in the Sample Research section of www.LeverageWorld.com.
MARKET TIMING…
High Yield Sector Value Tracker

The High Yield Value Tracker is based on the Leverage World Model.1 This
econometric model explains 91% of the historical variance in the spread
between the Merrill Lynch High Yield Master II Index and ten-year Treasuries.
From indicators of default risk, market liquidity, and monetary conditions, the
model estimates the currently appropriate spread. The accompanying diagram
depicts the difference between the model's current estimate and the actual spread
observed in the market, expressed in standard deviations. (One standard
deviation equals 55 basis points.) Divergences of less than one standard
deviation are deemed immaterial
The High Yield Value Tracker's usefulness as a market-timing tool is

indicated by the following average annualized monthly returns, calculated over
the period 1986-2002:
Period Mean Return # of Observations

Undervaluation 19.63% 30
Overvaluation 4.26% 33
ALL PERIODS 8.45% 196
Actual minus Estimated Spread-versus-Treasuries*

Units: Standard Deviations
* Based on February 5, 2004 data.

Sources: Economagic.com, Investment Company Institute, Merrill Lynch & Co., Moody’s Investors
Service.
Update
The high yield spread-versus-Treasuries widened by 27 basis points last week,

while the value estimated by the Leverage World Model increased by only 12
basis points. Nonetheless, the high yield sector remains rich relative to its
prevailing risk. The latest week's increase in the required risk premium reflected
a shift to negative flows at high yield mutual funds, partially offset by a drop in
the unemployment rate.
LW
1
For a description of the Leverage World model of the spread-versus-Treasuries, see “Record Short-
Run Overvaluation for High Yield” in the Sample Research section of www.LeverageWorld.com.
ODD LOTS…
Department of Corrections
Putting Words in Dirksen’s Mouth
In today’s www.miamiherald.com, Harold Oppenheim recounts that “the late

Senator Everett Dirksen of Illinois chided the spendthrift Democratic-controlled
Congress that a billion here, a billion there, and pretty soon you’re talking about
real money.”
It’s an amusing quip. The only problem is that there is no evidence that
Dirksen ever said any such thing. Archivists at the Dirksen Congressional
Center undertook an investigation after discovering that 25% of the inquiries
coming into the center concerned this alleged quotation. They turned up no
record of the famous remark in an exhaustive study of Dirksen’s statements on
the Senate floor, as well as 12,500 pages of his own speech notes and the
transcripts of all existing audio tapes of the broadcasts he regularly participated
in as Minority leader.
Leverage World goes beyond the ordinary duty of correcting its own errors by
correcting mistakes that appear in other publications. We hope through our
diligence to set the record straight on such matters as the spurious “billion here,
billion there” quotation. Dirksen was famously loquacious, so it hardly seems
necessary to put words in his mouth.
LW
LEGAL NOTICES…
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America and by international treaty. Any unauthorized use, reproduction or distribution is
punishable by civil and criminal penalty.
The material contained in this publication is proprietary and confidential information of

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above or otherwise as expressly authorized by FridsonVision LLC pursuant to the terms of a written
license agreement, no part of the material contained in this publication may be reproduced,
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THE MATERIAL CONTAINED IN THIS PUBLICATION IS FURNISHED “AS IS” WITHOUT

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How the Rankings Benefit Investors

Calculating default rates by underwriter provides two potential benefits to

Copyright 2004 by FridsonVision LLC. All Rights Reserved.

Using the database of Income Securities Advisor, we identify all defaults on

Cumulative Default Experience

The primary focus of our analysis is three-year, cumulative, default

Aggregate Default Rates

To begin, we generate aggregate default rates by senior-equivalent rating2 on

Exhibit 2 displays default experience on the 1,983 new issues of 1997-2000.

Exhibit 1: Ratings Conversion Table

Exhibit 2: Aggregate Weighted Cumulative Three-Year Default Rate

The three-year, cumulative, default rates shown in Exhibit 2 vindicate

We divide the cumulative, three-year, default rates in Exhibit 2 by three to

Exhibit 3: Annual Default Rate Factors

Quality Distribution by Underwriter

The final preparatory step is to calculate the senior-equivalent ratings

Twelve underwriters, listed in Exhibit 4, meet the requirements. Each firm’s

Before adjustment for quality of issuance, the top-ranked underwriter is

Exhibit 4: Quality Distribution by Underwriter

Exhibit 5: Unadjusted Annual Default Rates by Underwriter*

Exhibit 6: Adjusted Annual Default Rates by Underwriter*

Exhibit 7: Default Experience by Underwriter*

Exhibit 8: Default Experience by Underwriter*

Avoiding defaults is a key objective of high yield portfolio managers. Aside

As with any similarly grounded strategy, the success of our proposed

Late to the Party?

Notwithstanding Jefferson Smurfit’s effort to take the dividend deal to a new

The shift in supply/demand dynamics probably had more than a little to do

THE PRESENT 131-BASIS-POINT DIFFERENCE IN SPREADS BETWEEN

Technology: Unisys and Amkor Technology

Our Rich/Cheap methodology identifies on a weekly basis an industry pair

Exhibit 1: Focus Issues Model Estimates and Actual Spreads*

Source: Advantage Data.

AMKR’s bond has experienced dramatic spread-tightening and price

· Unisys surprised Wall Street by exceeding revenue and earnings projections

UIS, headquartered in Blue Bell, Pennsylvania, is one of the largest global

AMKR, headquartered in West Chester, Pennsylvania, is the largest provider

Amkor Technology was launched in 1968 to pioneer the outsourcing of

Technology Industry Trends

According to index data provided by Lehman Brothers, the high yield

Spread Narrower than Estimated

The current version of the multiple regression formula is presented here:

Spread = 255.55 + 87.46a + 31.702b – 3.980c – 76.021d

Standard Error = 89.88 basis points

Predictor t-statistic P-Value VIF

Focus Issues: Why Are They on the List?

Issuers with Issues That Entered the:

Smurfit-Stone Container’s 11-1/2s joined the yielding-less-than-estimated

Issuers with Issues That Exited the:

Rogers Wireless and Sea Containers’s issues experienced no change in price

Winn-Dixie Stores’ 8-7/8% issue was removed as a statistical outlier

Gaylord Entertainment’s 8s lost 1-1/2 points in dollar price in conjunction

Industry Value Tracker

Portfolio managers should not attempt to fine-tune their portfolios to minor

Credit Ratings Value Tracker