G L O B A L C R E D I T D E R I V A T I V E S

DECEMBER 31, 2002

R E S E A R C H

Credit Derivatives
GLOBAL

Sanjay Mithal
(212) 816-0525
sanjay.mithal@citigroup.com

New York Jure Skarabot

212-816-5728
jure.skarabot@citigroup.com

Single-Name Credit Default Swaps

A Users Guide The market for credit derivatives has grown
exponentially over the past five years. Results from recent market surveys are provided.

New York

The single-name credit default swap transaction is

described and the operation of the swap is highlighted. The requirements for executing a credit default swap transaction are outlined.

The use of the default-cash basis as a measure of

relative value between selling protection and owning a cash instrument referencing the same credit is described.

Investors may earn additional yield pickup by selling

This report can be accessed electronically via: SSB Direct Yield Book E-Mail

default protection when the default-cash basis is positive.

A typical credit default swap transaction term sheet

is explained in simple terms.

Please contact your salesperson to receive SSB fixed-income research electronically.

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Single-Name Credit Default Swaps

Contents
The Market for Credit Derivatives The Credit Default Swap Transaction What Is a Credit Default Swap? ........................................................................................................ Prerequisites for Credit Derivative Transactions................................................................................ What Happens in Case of a Credit Event? ......................................................................................... Investment Considerations Pricing Issues and Quoting Conventions ........................................................................................... Relative Value: Buying a Note Versus Selling Default Protection...................................................... 3 6 6 6 7 9 9 9

Unwinding Default Swap Transactions ............................................................................................. 11 Documentation................................................................................................................................. 12

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Single-Name Credit Default Swaps

The Market for Credit Derivatives

The market for default swaps originated with banks looking to hedge credit risk in their loan portfolios. This market has grown rapidly in recent years as more players seeking credit hedges or yield (pickup over conventional cash instruments) have begun to participate. Banks, insurance companies, corporations, and hedge funds actively trade in the default swap market, which is expected to grow substantially in coming years. The intent of this report is to provide a basic understanding of the single-name credit default swap product and its practical implementation in the credit derivatives marketplace. The dramatic increase in the demand for credit protection has been a major force behind the rapid growth of the credit derivatives market. This market has grown exponentially since 1997, exceeding the expectations of market participants, and the pace of this growth shows little sign of abating.
Figure 1. Credit Derivatives Market Growth, 19972004E
5,000 1997/98 Survey 1999/00 Survey 4,000 2001/02 Survey

US $ Bn

3,000

2,000

1,000

0 1997
E:Estimate. Source: BBA Surveys.

1998

1999

2000

2001

2002

2004

As measured by total outstanding notional, the credit derivatives market has grown from approximately $180 million in 1997 to more than $1 trillion at the end of 2001. In its recently published 2001/2002 Credit Derivatives Report, British Bankers Association (BBA) estimated that the global credit derivatives market will nearly double in size from the 2001 level to $2 trillion in 2002 and reach $4.8 trillion by the end of 2004 (see Figure 1). The recent flow of debt restructurings, defaults, and high-profile bankruptcies has increased the awareness for the need to manage credit exposure. Regulatory factors, shareholders demanding higher returns, the ability to customize the maturity of the desired credit exposure (a feature not available in the cash market), and the standardization of default swap contracts have all played an important role in shaping the current state of the market. Credit derivatives have been tested on several occasions through various triggering credit events. Yet, even after major bankruptcies, settlements caused only a minimal

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level of dispute underscoring the robustness of the product and the enforceability of the contract. A range of products have accompanied the growth in the market. According to the BBAs 2001/2002 Credit Derivatives Report, single-name credit default swaps and synthetic portfolio/CLO products are still the major product types in the market. Credit default swaps constitute nearly half of the credit derivatives market with a 45% share in 2001 and a 43% market share projected for 2004. The percentage of synthetic portfolio/CLO products has substantially increased over the past few years. In 2001, it was the second-largest class with 22% market share, and the share of this product type is projected to increase to 26% in 2004. The rest of the market consists of other products; primarily credit-linked notes, total return swaps, basket products, and credit spread options (see Figure 2). Innovations in synthetic structures will continue to develop, and industry participants expect portfolio/CLO products to increase in market share over next few years.
Figure 2. Breakdown of Credit Derivative Products by Current Outstanding Notional (Year 2001)

Single-Name CDS 45%

Basket Product 6% Credit Spread Options 5% Asset Swaps 7% Total Return Swaps 7%
Source: BBA Survey 2002.

Portfolio/CLOs 22% CLNs 8%

The composition of market participants has also changed over the past few years. According to its 2001/2002 Credit Derivatives Report, BBA found that banks and securities houses are still the main buyers of credit protection. Banks constituted 52% of the buyers market share in 2001. This share is expected to decrease to 47% in 2004 as more players enter the credit derivatives market. Securities houses constituted 21% of the market share in 2001, and their share is expected to drop to 17% in 2004 with the advent of new entrants. The survey found an unexpected emergence of hedge funds as buyers of credit protection. In 2001, their market share was at 12%, up from 4% according to the BBA, substantially higher than was projected a few years ago. The increase in their market share follows from the fact that hedge funds are active buyers of defaults swaps as well as the first-loss tranche in synthetic securitization deals. It is projected that the hedge funds will maintain their market share in the future and potentially even replace securities houses as the second-biggest market participant on the buy side. The rest of the market is distributed among insurance companies, corporations, mutual and pension funds, and government export agencies (see Figure 3).

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Figure 3. Credit Derivatives Market Buyers and Sellers Breakdown (Year 2001)
Buyers Sellers

Banks 52% Government/Export Agencies 2% Pension Funds 1% Mutual Funds 2% Insurance Companies 3% Monoline/Reinsurers 3% Corporates 4%
Source: BBA Survey 2002.

Corporates 2% Pension Funds 2% Mutual Funds 3%

Securities Houses 21%

Banks 39%

Hedge Funds 5% Insurance Companies 12%

Monoline/ Reinsurers 21% Securities Houses 16%

Hedge Fund 12%

On the sell side of the credit protection market, banks still hold the largest market share of 39% in 2001, but their share is expected to drop to 32% in 2004 as the market develops. Monoline insurance companies and reinsurers are second with a 21% according to BBA share in 2001, and they are expected to retain their market share through 2004. The sell side market share of securities houses has remained steady in the recent years and will probably stay at the same levels. In contrast to the buy side of the market, hedge funds do not appear to be as a prominent player in the sell market, although their share is expected to increase from 5% in 2001 to 7% by 2004. The rest of the market participants are not expected to capture a substantial portion of the sell side market for default protection (see Figure 3). In the next section we describe the product and outline the operation of the basic default swap transaction.

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Single-Name Credit Default Swaps

The Credit Default Swap Transaction

What Is a Credit Default Swap?
Credit default swaps are contracts that transfer credit risk and allow investors to manage credit exposures by separating their credit views from other market variables. A simple credit default swap is described in Figure 4. The buyer is the party that seeks credit protection and is willing to pay a credit spread. This creates a short credit risk position for the buyer. The seller is the party that sells credit protection and receives a credit spread from the protection buyer. This creates a long credit risk position for the seller.
Figure 4. A Credit Default Swap
Notional: US$20MM Term: 5 Years Notional: x 225bp p.a. Buyer Credit Risk of ABC Corp Seller

Occurrence of a Credit Event (Physical Settlement)

Delivery of US$20MM Principal ABC Corp. Senior Unsecured Obligation Buyer US$20MM cash Seller

Source: Salomon Smith Barney.

Because the default swap is an instrument for the purchase and sale of protection (the opposite of risk), it is quoted backwards from bond market convention. That is, the bid is the price that the bidder would pay to buy protection (sell the risk), and the offer is the fixed rate that the protection seller would require to provide protection (take the risk); thus, the bid is a lower number than the offer.

Prerequisites for Credit Derivative Transactions

Before entering into a transaction, both parties in the default swap usually have a signed ISDA in place. This is an agreement that sets forth the rights and duties of the two parties under all swap contracts. Early credit derivative contracts suffered from the ambiguity surrounding the documentation of the agreements. Since 1999, ISDA has provided a standard template to document a default swap transaction between the two parties. These contracts are governed by a set of common rules and definitions published by ISDA. Before a credit default swap is executed, credit lines

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between the counterparties must be in place because each party is taking on credit exposure to the other. The terms of a credit default swap contract are flexible and are negotiated between the buyer and seller of protection. Some key terms are described below:

The reference entity is the obligor on which protection is either being bought
or sold, e.g., ABC Corporation.

Reference obligation is an obligation of the reference entity that is referred to

in the default swap contract. The characteristics of the reference obligation often provide a basis on which to compare any obligation that may be delivered to the protection seller (a deliverable obligation) if a credit event occurs. These characteristics typically require that any deliverable obligation be pari passu with the reference obligation in the priority of payments of the debt of the reference entity.

Floating-rate payer calculation amount or the notional amount of the default

swap is the amount of exposure to a particular credit (the reference entity) for which protection is either being bought or sold for a particular period of time.

Tenor for which risk is being transferred is the period for which the protection
under the default swap will remain effective (typically five years)

Credit events are the circumstances that must occur for the protection buyer
(or seller) to require the buyer to exercise its right to exchange a deliverable obligation with the seller for a payment of par. These events typically include failure to pay, bankruptcy, obligation acceleration, restructuring, and moratorium/repudiation and are described later in more detail.

Default swap premium is the premium (fixed rate) that the buyer agrees to pay
the seller in exchange for the transfer of credit risk. The market convention is to pay quarterly on an A/360 basis. If a credit event on the underlying reference entity should occur, the credit default swap is designed to unwind in an orderly manner. We next describe the series of events that unfold upon a credit event.

What Happens in Case of a Credit Event?

The following sequence of events is generally executed upon a credit event.
The Occurrence of a Credit Event Is Established

A credit event is often documented in local newspapers, business magazines, or other publications that are publicly available. The recording of such an event allows the buyer to exercise the right to put the deliverable obligation to the seller at par.
A Credit Event Notice Is Delivered by Either the Buyer or the Seller

The notice informs the seller (or buyer) as to which credit event has occurred within a specified interval of time called the notice delivery period. In most cases a notice of publicly available information concerning the credit event must also be delivered (either as part of the credit event notice, or delivered separately). This notice cites the sources of information confirming the occurrence of the credit event.

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The Buyer Delivers a Notice of Intended Physical Settlement to the Seller (When the Buyer Delivers the Credit Event Notice)

This notice is an expression of the buyers intent to physically settle the credit default swap contract. The notice also contains a detailed description of the type of deliverable obligations that the buyer reasonably expects to deliver to the seller.
The Buyer Delivers a Deliverable Obligation to the Seller

These obligations are obligations of the reference entity that may be delivered in connection with physical settlement. A deliverable obligation must typically be either a bond or a loan and must meet certain characteristics. Investors should see the International Swaps and Derivatives Association (ISDA) credit derivatives definition documents for details, but in general, the deliverable obligation must be pari passu with senior unsecured obligations of the reference entity.
Seller Pays Par to the Buyer

If the contract is physically settled, the seller pays par to the buyer in exchange for the deliverable obligation. In some special cases delivery cannot be completed. In such cases, a market value is determined for the reference obligation and a cash payment is made to the protection buyer for the implied loss on that obligation (the difference between par and the market value). If market conditions prohibit the successful delivery of the obligations to the seller, the transaction terminates unexercised. If no credit events occur during the term of the default swap the swap expires unexercised.

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Single-Name Credit Default Swaps

Investment Considerations
Investors in credit default swap transactions should be aware of pricing conventions, relative value considerations and the details of the accompanying documentation. In this section we highlight key issues related to all three considerations.

Pricing Issues and Quoting Conventions

Note that default swap premiums are quoted as an annualized spread, while corporate bonds are typically quoted as a spread to Treasuries. Because most cash bonds are issued as fixed-rate instruments and because most investors fund on a LIBOR basis, it is necessary to convert the Treasury spread to a spread to LIBOR so that a comparison between default swap spreads and the spreads on the corresponding-maturity cash instruments is possible. In practical terms, we compare the (par) bond asset swap level for the cash bond and the default swap premium so as to determine relative value between the cash and default swap market. The asset swap is used to convert a fixed-rate instrument to an equivalent floating-rate instrument. Many calculators are available to do this:
Yield Book

Yield Book has an asset swap calculator that transforms fixed-rate corporate bond spreads into an equivalent asset swap level.
Bloomberg

Bloomberg has two simple calculators for converting a corporate bond price or spread to Treasuries to an equivalent asset swap level.

Simply pull up the corporate bond and type ASW <GO>. In the lower half of the
page, you can enter the bond price or yield, hit <GO> and the calculator will return the equivalent asset swap spread in the red box on the right side of the page. You can adjust the underlying curves (bid/mid/offer, country, basis) in the upper right hand corner of the page. Most dealers will use the midpoint of curve 23 (US semi bond).

Alternatively, you can use YAS <GO> and enter the bond price, yield, or spread
to a particular benchmark. This screen will also return an asset swap level. The difference between the default swap spread and the corresponding asset swap spread is called the default-cash basis.

Relative Value: Buying a Note Versus Selling Default Protection

The cash flows of a (funded) cash instrument can be replicated using a credit default swap. In this sense a default swap is a synthetic bond and provide investors alternatives to investing in cash instruments at a potentially higher return for essentially the same risk. As an example, consider a trade in which an investor is faced with the choice of buying the cash instrument or selling protection as described in Figure 5. Suppose a

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customer can choose the form of exposure, to say Acme Corporation, i.e., either the customer buys Acme notes or sells Acme protection (in lieu of buying the notes).
Figure 5. Acme Corporation Cash or Derivative Exposure?
Buy 8% Acme Notes 5/15/07 (Mid) Sell Five-Year Acme Protection (Mid)

Indicative spread of 240bp to five-year Treasury At +240bp, with mid-market swap spreads of 58bp, the notes asset swap to LIBOR+182bp.

Indicative spread of 215bp in default swaps. Unfunded position, so seller receives 215bp per annum.

If financing cost is LIBOR flat, net spread on the 4.5-year trade is Market price assumes that counterparty funds at LIBOR flat. 182bp per annum.
Source: Salomon Smith Barney.

In this example an investor can pick up a spread of 33bp (i.e., 215bp182bp) per annum by selling Acme protection over buying the corresponding Acme notes. Some considerations in making an investment in the credit risk of Acme Corporation are highlighted in Figure 6.
Figure 6. Investor Considerations in the Cash Versus Default Trade
Buy Acme Corporation Cash Bond Sell Protection on Acme Corporation

Investor holds a specific bond

If a credit event occurs, the protection seller will purchase the cheapest Acme bond or loan (within certain parameters) at par. Larger benefit for investors who fund at LIBOR +

LIBOR + funding costs results in lower spread pickup

Source: Salomon Smith Barney.

Implicit in the investors choice in the Acme example was the difference between the differential swap spread and the comparable bond spread. This difference is called the default-cash basis, a measure of relative value between the two markets. In the next section we describe the basis with an example.
The Default-Cash Basis is a Measure of Relative Value

Default swap spreads will typically be wider than corresponding levels for asset swaps, i.e., the default-cash basis is generally positive. The historical default-cash basis for Ford Motor Credit (FMCR) is illustrated in Figure 7. To match the tenor of the bond, we use the most liquid FMCR issue that matches the tenor of the default swap contract for which default levels are quoted (five years in the case of Figure 7). Notice that the three-month average of the Ford default-cash basis is approximately 29bp. Many technical and fundamental factors affect the value of the default-cash basis. Default swap spreads are generally considered to be leading indicators of deteriorating credit quality in addition to being more volatile than cash spreads. In the case of Ford for example, there has been a steady widening in credit spreads (both default and cash) since July 2002, incorporating the markets concern about Fords long-term credit quality.

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Single-Name Credit Default Swaps

Figure 7. Ford Motor Credit Historical Default-Cash Basis

Default Cash Levels Ford Motor Credit 6.5% Jan 07 Default Cash Basis Ford Motor Credit 6.5% Jan 07

759 699 639 (bps) 579 519 459 399 339 18 Sep 02
Source: Salomon Smith Barney.

70 60 Default Cash (bps) 50 40 30 20 10 0 -10 -20 28 Oct 02 07 Dec 02 18 Sep 02 28 Oct 02 07 Dec 02

Among the technical factors that contribute to a positive basis is the fact that default swaps have slightly greater risk than bonds or loans for a particular reference entity. An investor who buys a bond or loan knows exactly what obligation they hold in the event of a credit downturn. The protection seller on the other hand knows broadly that he will hold a senior unsecured bond or loan that meets the criteria of a deliverable obligation. He will not know the specific bond or loan he will receive until there is a credit event, although he will know that it will be the cheapest bond or loan that meets the criteria. (If the buyer were long a different obligation other than the cheapest), he will sell that obligation, buy the cheapest one, and deliver it). It is also important for investors to understand how to unwind a position in default swaps. We describe this operation next.

Unwinding Default Swap Transactions

When market conditions dictate, an investor may wish to terminate the swap prior to the final maturity of the default swap, for example, when the investor wants to book a profit. In such a situation, the investor will, in most situations, unwind the default swap contract with the dealer with whom he entered into the transaction at the current market value of the swap. Suppose the investor buys protection today on Acme Corporation credit (i.e., shorted Acme Corporation credit risk) at a spread of say 100bp (for five years). Now suppose Acme Corporation credit deteriorates and default spreads steadily widen out. Assume that after one-year from having entered into the transaction the investor finds that protection on Acme Corporation credit is worth 400bp, then the investor can book a profit by unwinding the transaction with the dealer from whom he bought protection (typically). Unwinding the transaction reduces to selling protection on Acme Corporation for the remaining life of the original default swap transaction, i.e., four years. In practice however, a transaction is unwound by way of a tear-up, where the dealer effectively tears up the original contract after agreeing to pay (in this case) an amount that represents an investors profit on the trade. In this example the investor receives the difference between the two positions (i.e., premium received from selling protection, i.e. 400bp per annum, minus the premium paid for buying protection, or 100bp per annum), or 300bp per

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annum, running, for four years adjusted for the likelihood of Acme Corporation defaulting during the next four years. In the next section we explain in simple terms, a typical term sheet used in credit default swap transactions.

Documentation
A typical credit default swap term sheet that explains the nature of the agreement between a protection buyer and protection seller is described in Figure 8. The left column contains the actual terms from a standard term sheet, followed by typical values. The right hand column contains a description/definition of these terms. Please note that actual term sheets are legal documents and the descriptions of the terms in Figure 8 are indicative meanings for explanatory purposes only. These descriptions should not be construed as their true legal meaning.
Figure 8. A Sample Credit Default Swap Term Sheet with Explanations
Item Typical Value Description/Definition

Trade Date Effective Date Scheduled Termination Date

November 5, 2001 November 8, 2001 November 8, 2006

The date upon which the parties agree to the terms of the Credit Derivative transaction. The date upon which the credit protection commences and the date upon which the Fixed Amount begins to accrue. The date upon which the transaction will terminate if any of the specified Credit Events do not occur on or prior to the termination date. If a Credit Event does occur, the transaction may terminate prior to the Scheduled Termination Date or, in certain limited circumstances, after the scheduled termination date. The party from whom credit protection is being purchased; equivalently, the party taking the credit risk. The party purchasing credit protection. The Buyer or Fixed Rate Payer pays the spread for the life of the contract in exchange for being taken out of the credit exposure. The party specified as such, typically the seller/dealer. If no party is specified then the Seller will be assumed to be the Calculation Agent. The Calculation Agent is responsible for making certain calculations and determinations with respect to the terms of the credit default swap contract. These are set forth in the Credit Derivatives Definitions. A day on which commercial banks and foreign exchange markets are generally open to settle payments in the place or places and on the days specified for the purpose in the relevant confirmation and if a place or places are not so specified, in the jurisdiction of the currency of the Floating Rate Payer Calculation Amount. The convention for adjusting a relevant date if it otherwise falls on a date that is not a Business Day. The city in which the Calculation Agent is operating. The notional amount of the trade. The amount of credit exposure being transferred. The entity upon which the credit protection is being bought or sold. CUSIP: 460146AM5 A Reference Obligation is selected based on its relationship to the Reference Entity. Most trades specify a senior unsecured obligation issued by the Reference Entity. If no Reference Obligation is specified, it is assumed to be a senior unsecured obligation of the Reference Entity. A Reference Obligation is automatically a Deliverable Obligation

Seller/Floating Rate Payer Buyer/Fixed Rate Payer

Protection Seller (e.g., Citibank N.A.) Protection Buyer [Customer]

Calculation Agent:

Seller

Business Days

New York

Business Day Convention Calculation Agent City Calculation Amount Reference Entity Reference Obligation

Modified Following New York 10 million US dollars International Paper Co. IP 7 5/8% of 1/15/07

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Figure 8. A Sample Credit Default Swap Term Sheet with Explanations (Continued)
Item Typical Value Description/Definition

Reference Price

100%

The value assigned by the parties to the Reference Obligation on the Trade Date, typically 100%. In cash-settled transactions, the Cash Settlement Amount will be the difference between the Reference Price and the Final Price multiplied by the Floating Rate Payer Calculation Amount. In physically settled transactions, the Reference Price is multiplied by the Floating Rate Payer Calculation Amount to determine the Physical Settlement Amount.

Fixed-Rate Payer Payment Dates

February 8, May 8, August 8, and November 8 The dates upon which the Fixed Rate Payer delivers the Fixed Rate in each year with the first payment commencing Payments. The Fixed Rate Payments are generally paid quarterly in arrears. on February 8, 2001. The final payment occurs on the Termination Date; however, Fixed Rate Payments cease accruing on the earlier of the scheduled Termination Date or the date on which the Credit Event notice or notice of publicly available information is delivered. 1.35% p.a. (Actual/360 basis on the Calculation The premium to be paid per annum for the protection. Amount) Credit Event Notice (Notifying Party: Buyer or Seller) Notice of Intended Physical Settlement Notice of Publicly Available Information Applicable Bankruptcy Failure to Pay Obligation Acceleration Restructuring/Modified Restructuring (US) Restructuring (Europe) Repudiation/Moratorium (Europe) Limitation Applicable Upon the occurrence of a Credit Event, the Conditions To Payment must be met before the parties settle the swap (exchange the deliverable obligation for par). First, the Notifying Party must deliver a Credit Event notice once the Credit Event has occurred. The Notice of Intended Physical Settlement lets the Seller know which obligation the Buyer intends to use to settle the swap. Credit Events are events that must occur before the Conditions To Payment may be met and the swap may be settled. Bankruptcy. The Reference Entity files for bankruptcy protection (or its creditors do). Failure to Pay. Failure of the Reference Entity to make a payment when due, after the Grace Period, in an amount not less than the Payment Requirement (generally US$1 million). Obligation Acceleration. An obligation of the Reference Entity has become due and payable before it otherwise should. Restructuring. A change in an Obligation with respect to the interest rate, principal amount, payment date of the interest or principal, priority of ranking, or currency of interest or principal. A Restructuring Event must occur for obligations greater than the default requirement (generally US$10 million). If restructuring is included as a Credit Event, you may choose either Restructuring or Modified Restructuring (restructuring maturity limitation applicable). Most new deals in the US use Modified Restructuring. Modified Restructuring means that in a Restructuring Event, the maturity date of the deliverable obligation is limited to the earlier of no more than 30 months from the date of the Restructuring Event and the final maturity date of the restructured bond or loan unless the swap termination date is longer than both of these. In this case deliverable obligations must mature before the termination date of the swap. Repudiation/Moratorium. When a Reference Entity or government authority disclaims or rejects or challenges the validity of one or more obligations in an aggregate amount that totals at least the Payment Requirement. For a Credit Event to trigger a default swap, it must have occurred on one of these types of obligations with these characteristics. Most deals accept either a Bond or a Loan. Convertible, zeros, and accreting bonds are now considered deliverable. The Deliverable Obligation must fit all the criteria specified in the Deliverable Obligation Characteristics. Pari Passu Ranking. Deliverable must rank Pari Passu to the Reference Obligation listed in the confirmation or senior unsecured debt unless otherwise specified. Standard Specified Currencies. Deliverable Obligation must be denominated in a G7 currency or the Euro. Assignable Loan. A loan that is capable of being assigned to a third party. Consent Required Loan. A loan that is capable of being assigned with the consent of the Reference Entity. Transferable. An obligation that is transferable to institutional investors without any restrictions. Not Contingent. A bond whose repayment of principal does not reference a formula or index, and whose interest payment is computed off a benchmark rate, either fixed or floating. Max Maturity. An obligation, which has a remaining maturity of not greater than the term specified. Not Bearer. An obligation that is not a bearer instrument.

Fixed Rate Conditions to Payment

Credit Events

Obligations (with Respect to Credit Events) Deliverable Obligations

Obligations: Obligation Characteristics: Borrowed Money None Deliverable Obligation/Deliverable Obligation Category: Characteristics: Bond or Loan Pari Passu Ranking Standard Specified Currencies Assignable Loan Consent Required Loan Transferable Not Contingent Max. Maturity: 30 years Not Bearer

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Figure 8. A Sample Credit Default Swap Term Sheet with Explanations (Continued)
Item Typical Value Description/Definition

Partial Cash Settlement of Loan

Not Applicable

If Loans are Deliverable Obligations but the Buyer of protection is not able to obtain enough of a loan to deliver, this provision provides for the ability to Cash Settle the portion that is unattainable. Not Applicable means that Partial Cash Settlement is not allowed and the Buyer must deliver a different obligation for that portion of his protection or forfeit the protection. If Assignable Loans are a Deliverable Obligation but the Buyer of protection is not able to obtain enough of a loan to deliver, this provision provides for the ability to Cash Settle the portion that is unattainable. Not Applicable means that Partial Cash Settlement of Assignable Loans is not allowed. Either party may request that Physical Settlement take place through an independent third party. Any costs will be borne by the party requesting this arrangement.

Partial Cash Settlement of Assignable Loans

Not Applicable

Escrow

Applicable

Documentation

Confirmation to be prepared by the Seller and The seller generally prepares the confirmation. This section makes reference agreed to by the Buyer. The 1999 ISDA Credit to the standard ISDA definitions and any applicable supplements. Derivatives Definitions as supplemented by the Restructuring Supplement, the Successor Supplement, and the ISDA Convertibles Restructuring Supplement (2001) shall apply and shall be incorporated by reference.

The information contained herein is summary in nature and is not intended to constitute legal advice. Before entering into any credit derivative transaction, investors should consult legal counsel and thoroughly understand the economic and legal aspects of these transactions.

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ANALYST CERTIFICATION I, Sanjay Mithal, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject issuer(s) and its (their) securities. I also certify that I have not been, am not, and will not be receiving direct or indirect compensation in exchange for expressing any specific recommendation(s) regarding issuer(s), industries or sector selections contained in this report." ADDITIONAL INFORMATION AVAILABLE UPON REQUEST Salomon Smith Barney ("SSB"), including its parent, subsidiaries and/or affiliates (the Firm), may make a market in the securities discussed in this report and may sell to or buy from customers, as principal, securities recommended in this report. The Firm may have a position in securities or options of any issuer recommended in this report. An employee of the Firm may be a director of an issuer recommended in this report. The Firm may perform or solicit investment banking or other services from any issuer recommended in this report. Within the past three years, the Firm may have acted as manager or co-manager of a public offering of the securities of any issuer recommended in this report. Securities recommended, offered, or sold by the Firm: (i) are not insured by the Federal Deposit Insurance Corporation; (ii) are not deposits or other obligations of any insured depository institution (including Citibank); and (iii) are subject to investment risks, including the possible loss of the principal amount invested. Although information has been obtained from and is based upon sources the Firm believes to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute the Firm's judgement as of the date of the report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a security. Investing in non-US securities by US persons may entail certain risks. Investors who have received this report from the Firm may be prohibited in certain US States from purchasing securities mentioned in this report from the Firm; please ask your Financial Consultant for additional details. This report is distributed in the United Kingdom by Salomon Brothers International Limited, Citigroup Centre, 33 Canada Square, Canary Wharf, London E14 5LB, UK. This material is directed exclusively at market professional and institutional investor customers and is not for distribution to private customers, as defined by the rules of the Financial Services Authority, who should not rely on this material. Moreover, any investment or service to which the material may relate will not be made available to such private customers. This material may relate to investments or services of a person outside of the United Kingdom or to other matters which are not regulated by the Financial Services Authority and further details as to where this may be the case are available upon request in respect of this material. If this publication is being made available in certain provinces of Canada by Salomon Smith Barney Canada Inc. ("SSB Canada"), SSB Canada has approved this publication. This report was prepared by the Firm and, if distributed in Japan by Nikko Salomon Smith Barney Limited, is being so distributed under license. This report is made available in Australia through Salomon Smith Barney Australia Securities Pty Ltd (ABN 64 003 114 832), a Licensed Securities Dealer, and in New Zealand through Salomon Smith Barney New Zealand Limited, a member firm of the New Zealand Stock Exchange. This report does not take into account the investment objectives, financial situation or particular needs of any particular person. Investors should obtain advice based on their own individual circumstances before making an investment decision. Salomon Smith Barney Securities (Proprietary) Limited is incorporated in the Republic of South Africa (company registration number 2000/025866/07) and its registered office is at Citibank Plaza, 145 West Street (corner Maude Street), Sandown, Sandton, 2196, Republic of South Africa. The investments and services contained herein are not available to private customers in South Africa. This publication is made available in Singapore through Salomon Smith Barney Singapore Pte Ltd, a licensed Dealer and Investment Advisor. Salomon Smith Barney is a registered service mark of Salomon Smith Barney Inc. Schroders is a trademark of Schroders Holdings plc and is used under license. Nikko is a service mark of Nikko Cordial Corporation. Salomon Smith Barney Inc., 2002. All rights reserved. Any unauthorized use, duplication or disclosure is prohibited by law and may result in prosecution.

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