KDP ASSET MANAGEMENT, INC.

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1 ASSET MANAGEMENT, INC. High Yield Bond and Senior Secured Bank Loan Outlook January 2019 Asset Management, Inc. 24 Elm Street Montpelier, Vermont

2 High Yield Observations Fundamentals The Moody s US HY issuer default rate declined to 2.3% in December down from 2.9% a month earlier. Defaults are projected to continue to be modest, remaining well below average historical levels. Near-term maturities are very low given the magnitude of ongoing refinancings. Earnings for HY companies have been improving in most industries. HY credit metrics continue to improve with higher EBDITA, improving coverage, and moderating leverage. analysts continue to see supportive fundamentals. Technicals HY weekly fund flows were a negative -$7.6B in December compared with a negative -1.9B in November and -$6.5B in October. Continued outflows caused HY to report its third consecutive monthly negative return. The HY market posted a -2.2% return in December compared with -0.9% in November. The decline was broad-based with practically all HY sectors in negative territory. The decline again was led by the sizable Energy sector that posted a -4.0% return for the month. Other significant decliners included Food & Drug Retail (-3.1%), Healthcare (-2.6%), Non-Food Retail (-2.6%), Financials (-2.4%) and Consumer Products (-2.3%). Returns by rating again reflected a risk-off environment. For December CCCs returned -4.4%, Bs returned -2.5%, and BBs were -1.4%. Indeed, despite CCCs outperforming for most of 2018, CCCs for the year underperformed other credit tiers with a return of -4.2%. Not a single HY bond was issued in December due to market volatility. In November primary new issuance was a meager $5.4B compared with a larger, but still inactive, $11.3B in October. The last eleven months of issuance have been muted following January which saw the heaviest start to a calendar year since Net HY issuance remains well below historical monthly averages and proceeds have been primarily for refinancings, providing a positive technical tailwind net HY new issuance was down 43% from Valuations Market performance is currently more dependent on economic activity rather than interest-rate risk, reflecting slowing global economic activity and tightening financial conditions. Higher-quality carry remains attractive, reflecting a broadly supportive macro environment and given ongoing spread widening. The risk/reward for CCCs will likely continue to diminish as economic activity wanes. Macro Supportive global economic growth and low credit default expectations augur well for HY relative returns in the foreseeable future. believes that Defensive HY credits will continue to offer attractive risk/return opportunities compared to other fixed income classes given their: Significant spread advantages Relative shorter duration Lower correlation when interest rates rise maintains its up-in-quality preference given the relatively late stage of the credit cycle and potential geopolitical or policy uncertainties/missteps. 2

3 The Case for High Yield Fundamentals: HY Default Rates to Remain Low and Well Below Historical Averages Technicals: 2018 HY Issuance Lowest in 9 Years Provides a Positive Tailwind and More Than Offset Retail Outflows Source: J.P.Morgan, Default Monitor, 1/2/2019 Source: J.P.Morgan, Credit Strategy Weekly Update, 1/4/2019 Macro: HY Spreads Now Exceed Fair Value Valuation: Yields Surge in 2H18 For HY Source: Morgan Stanley, US Corporate Credit Strategy Brief, 1/7/2019 Source: Credit Suisse, CS Credit Strategy Daily Comment, 1/3/2019 3

4 Senior Secured Bank Loan Observations Fundamentals Default activity remained low in December with two loan defaults. The par weighted default rate in December was 1.63% compared with November s 1.56%. The default rate excluding iheart was 1.08% in December. The overall low level of defaults reflects solid economic and credit fundamentals. No near-term maturity concerns reflecting record level of refinancing/repricing. Leverage levels in the primary market continue to increase primarily due to M&A activity and dividend payments. Interest coverage levels remain at historically high levels. Technicals Weekly loan fund flows in December were a record -$10.4B compared to -$2.9B in November. December s record negative flow was only the third negative month after nine consecutive positive inflow months. Reflecting the record surge in retail outflows loans produced a -2.31% return in December compared with -0.83% in November. In December, loans rated B posted a return of -2.20% and BBs returned -2.40%. Loans rated Split-B/CCC, which had led loan performance most of the year, came under the most pressure posting a return of -3.83%. Gross loan issuance in December was at a four year low of $8.3B compared with November s $36.1B and October s $64.8B. Gross CLO issuance in December was $8.4B, the lowest total since August In November Gross CLO issuance was $24.6B. Valuations Loan prices came under severe pressure in December falling to compared with in November as liquidity evaporated. The percent of loans trading above par at the end of December was 3.2% compared with November, 3.8%, but down from 36.2% at the end of October. For comparison, in April of this year, the percent of loans trading above par stood at 75.1%. Notwithstanding, 2018 loan performance at +1.08% was among the world s best preforming asset classes. Despite the recent rise in loan prices there is still an opportunity to purchase higher-quality loans at a discount. The spread to the 3-year takeout in December was 559bp up from November s was 451bp, The yield to the 3-year takeout for the broad-loan market was 8.13% in December up from 7.42% in November and 7.06% in October. Loans again underperformed HY Bonds by a few basis points in December but for the year outperformed HY Bonds which returned -2.19%. Typically, loan volatility tends to be significantly lower when compared to HY bonds as loans are higher in the cap structure, have higher recovery levels, and are floating with LIBOR rates which are expected to continue rising. Macro Loans, due to their negative convexity and short duration, are a carry-asset trade. In the current environment, loans are also an attractive total return vehicle. High quality floating-rate bank loans are compelling given the attractive risk/reward adjusted returns, and portfolio diversification benefits. Elimination of the CLO risk retention rule has been a near-term tailwind for secondary loan prices and potentially wider spreads. Negative flows into leveraged loans projected to subside given higher LIBOR rates, and strong CLO and Institutional demand. Floating-rate nature of bank loans provides a natural hedge to increasing interest rates and lowers duration risk. Negative correlation to Treasuries and low correlation to other asset classes. 4

5 The Case for Senior Secured Bank Loans Fundamentals: Loan Default Rates to Remain Low and Well Below Historical Averages Technicals: December s Loan Outflows Resulted in Indiscriminate Selling With No Differentiation for Quality on Technical Factors This Has Reversed in 2019 Source: J.P.Morgan, Default Monitor, 1/2/2019 Macro: Loan Spreads Now Exceed Fair Value Source: Morgan Stanley, 2018 Performance Recap, 1//2019 Valuation: Despite Recent Rally, Loan Yields Trading Cheap Compared to Rating-Adjusted HY Bonds Source: Morgan Stanley, US Corporate Credit Strategy Brief, 1/7/2019 Source: Credit Suisse, CS Credit Strategy Daily Comment, 1/7/2019 5

6 This is an analytical piece and the asset classes discussed herein, and any other materials provided to you, are intended only for discussion purposes and are not intended as an offer or solicitation of an offer with respect to the purchase or sale of any security and should not be relied upon by you in evaluating the merits of investing in any securities. These materials are not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to local law or regulation. Past performance is not indicative of future results. The asset classes discussed herein should not be perceived as investment recommendations. It should not be assumed that investments in any asset class discussed was or will prove profitable. The views expressed herein represent the opinions of Asset Management, Inc. and its affiliates and are not intended as a forecast or guarantee of future results. This material may not be reproduced or used in any form or medium without express written permission. Additional information on, including fee schedules can be found in Form ADV Part II which is available upon request. 6