May 2014 EVALUATION Page 3

who are non-economic sellers. And ultimately, your credit work or credit analysis needs to be a

little bit better than someone else’s (either the

sellers or other buyers). On the distressed side,

there’s a bias against companies that are in trouble. Here’s an example: if someone says they’re buying a bond at par, the foll

ow up

question is, “what’s the coupon?” If som e says they’re buying a bond at 60, the follow up question is, “why not 50?” People tend to have a

natural bias against something that has traded down significantly.

EV: How has the distressed inves ting landscape changed since you first got started in the mid-1980s? Given the influx of capital into the space, it is more difficult to find attractive risk-adjusted returns today?

ML:

Frankly I think it’s always difficult to find

returns

–

it’s always

hard to make money. And everyone believes that the current environment

you’re in is somehow harder than it was in

the past.

I’m not sure that’s always the case. I will

say, however, that the biggest difference between today versus when we first got started is that back then the risk free rate was somewhere between 4% and 8%. Today, the risk free rate is 25 bps. So, for that reason, today is actually a pretty difficult time because people expect you to make 8%-12%, which is about 40x the risk free rate. Compare this to say ten years ago, when if you made just 5x the risk free rate, that was a 20% return.

EV: Could you speak a bit about the investment process at Avenue Capital? What are a few things that you tend to focus on when evaluating opportunities? ML:

Well I think the most important thing we

look at, particularly when we’re looking at a

company from a credit standpoint, is the liquidation value. Should the company exist as a going concern, and can the company turn things around? So, the first question to answer is, are

we protected from losing money? But we can’t

stop there

–

because in addition to being protected on the downside, you also need to believe that you can generate returns.

EV: Could you give an example of that? ML:

In terms of something going on today, look

at TXU. In the case of Oncor (TXU’s regulated

electricity distribution and transmission business), we started buying the bonds in the low 60s, and today those bonds are trading in the high 90s to par. Our goal is to invest in

situations where we’re coming in at a 3 x

- 5x

EBITDA multiple, and believe that we’ll be

covered in the case of a liquidation scenario.

Then we’ll make money as the market re

-adopts

what we’ve invested in, and the value gets back

to a normalized 6x - 10x EBITDA multiple.

EV: Given the low corporate default environment in the U.S. right now, where are you finding interesting investment opportunities? ML:

Well, the fact that you have a low default

environment doesn’t mean that there aren’t a l

ot of corporate restructurings going on. So there is still a fair amount to do in the U.S., though I

would say that there’s definitely more activity in Europe. We’re focused on northern Europe as opposed to southern Europe, but that’s mainly a

If someone says they’re buying a bond at par, the follow up question is, “what’s the coupon?” If some says they’re buying a bond at 60, the follow up question is, “why not 50?” People tend to have a natural bias against something that has