Private Debt with Rapid Growth and Better Risk/Return-Profile than Public Debt

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1 Private Debt with Rapid Growth and Better Risk/Return-Profile than Public Debt In the past few years the European direct lending market has steadily gained popularity. The committed capital to private debt funds focusing their investments on Europe has experienced above average growth in recent years. Moreover, with a value of USD 18.8 billion of committed capital in 2015, Europe-focused private debt funds have for the first time overtaken funds focusing on North America. Risk factors associated with privately placed bonds are the absence of an independent rating, limited market liquidity of the bonds as well as the missing information regarding the default risk of issuers. With the S&P implied rating and an attractive illiquidity premium Remaco Direct Lending already tackles the first two issues. In this report we shed light on the default probabilities of issuers of privately placed bonds and compare them to those of public companies. Combined with an analysis of the offered yield to maturity (YTM) of issues between 2006 and 2015 we are able to draw some conclusions on the risk/ return-profile of privately placed bonds: Our sample exhibits a lower average issuer probability of default than the comparable sample of issuers of public placements. The difference is remarkable in non-investment grade issues as well as in bonds with medium- or long-term maturities. The offered YTM in private placements is on average 37% higher than in comparable public placements. The results suggest investments in private debt offer higher returns at a comparable or lower probability of default. Remaco Direct Lending Report June 2016 Facts: For the first time, committed capital raised by private debt funds focusing Europe (committed capital totaling USD 18.8 billion) was higher than that of private debt funds focusing on the US Committed capital increased by 437% from 2012 to Two thirds of private debt investors prefer investments in direct lending. Average probability of default of private placement issuers with non-investment grade rating is lower than that of public issuers, but offers higher offering yields. For investment grade issuers, the probability of default is comparable but still, offering yields for private placements are higher.

2 As a FINMA-regulated securities dealer Remaco provides qualified investors with attractive investment opportunities and facilitates direct lending investments with a volume of CHF 5.0 millions or higher. Registered qualified investors, who can accurately judge the risks involved in private debt investments can grasp the opportunity to invest in selected private bonds and loans. Transactions are settled by the Swiss bank clearing system via Six Securities Services AG. Each bond possesses its own ISIN- and Swiss security number and can be signed on the Remaco-platform at the principal bank or custodian. For further information please contact: Institutional Investors (Banks, insurance companies, pension funds) Pascal Böni, Tel , pascal.boeni@remaco.com Robert Bareder, Tel , robert.bareder@remaco.com External wealth manager Pascal Trösch, Tel , pascal.troesch@remaco.com General Information Pascal Rietmann, Tel , pascal.rietmann@remaco.com The core direct lending team of Remaco consists of adjacent experts. Our internal experts in law, tax and audit can be consulted on a case to case basis for the assessment of individual cases. Members of the direct-lending-team: Pascal Böni MBA, M.B.L-HSG, Chairman of the Board of Directors Remaco Wealth Management AG & CEO Remaco Group Robert Bareder MBA, CEO Remaco Wealth Management AG & Head Remaco Direct Lending Daniel Mischler Dipl. Ing. HTL, Head Business Development Remaco Direct Lending Pascal Rietmann MSc Finance HHS, Consultant Corporate Finance Remaco Advisory Services AG Martin Strobel Dr. rer. pol., member of the advisory board Remaco Direct Lending

3 Development of the Private Debt Market Increased Investor Appetite for the European Direct Lending Market Committed capital to private debt funds focusing on Europe overtook raised capital by funds focused on North America for the first time in As figure 1 shows, in 2015 raised capital by private debt funds focused on Europe amounted to USD 18.8 billion. In the same year funds focusing their investments on North America were able to raise USD 17.1 billion. The shift towards Europe is also reflected in surveys on the geographic preference of private debt investors. According to the December 2015 survey of Preqin 1 amongst private debt investors, 71% of responded that they plan to invest in Europe within the next 12 months (66% in North America). Figure 1: Commited Capital Private Debt Funds Source: Preqin Private Debt Spotlight May 2016, Preqin Private Debt Onlinee European Focus North America Focus 2015 Closing Year USD Billions A comparison of the growth of raised capital by Europe-focused funds to the growth rate of funds focusing on North America reveals the increased investor appetite for the European private debt market. From its 2012 volume, capital raised by funds focused on North America has grown by 144%. However, during the same period committed capital to funds focusing on Europe grew by an impressive 437%. The YoY growth-rate (CAGR) from 2010 to 2015 further underlines the above average growth that Europe-focused private debt funds have experienced. With a committed capital CAGR of 78% they have grown significantly faster than funds focusing on North America with a CAGR of 58% 2. ¹ Preqin Investor Outlook: Alternative Assets, H Remaco calculations based on data from the Preqin Private Debt Spotlight May 2016 Remaco Direct Lending Report 3

4 25 Figure 2: Growth of Committed Capital to Private Debt Funds Source: Remaco, Preqin Private Debt Spotlight May 2016, Preqin Private Debt Online 20 CAGR + 58% European Focus USD Billions CAGR + 78% Growth : 437% North America Focus Growth :144% Closing Year Direct Lending Preferred Strategy within Private Debt and increasing Competition Within the private debt segment, direct lending is the clearly favored investment strategy. Around two thirds of investors state direct lending as their preferred investment type. The rise in popularity of direct lending has also increased the competition amongst direct lending funds for capital from institutional investors as well as in the search for attractive investment opportunities. However, the Swiss direct lending market still offers a large unused potential. Switzerland is characterized by a stable economic and political environment and a large number of successful companies that are ideal candidates for direct lending transactions. Yet only few private debt transactions were realized by Swiss companies in the last few years. The most probable reason for the lack of Swiss issuers of private debt is the strong banking tradition in Switzerland. On the other hand increasing regulatory requirements (Basel III and IV) have also led to a decrease in bank lending. Since a lot of the regulatory requirements are not yet in effect, this trend is most likely to continue and increase the demand by Swiss companies for alternative funding sources such as direct lending. 36% Figure 3: Preferred Investment Strategy next 12 months Source: Preqin Private Debt Spotlight May % Direct Lending Not Direct Lending 4 Remaco Direct Lending Report

5 Risk/Return-Profile of Private Debt Issues with higher Return but similar or lower Probability of Default Little is known so far about the risk profile of private debt issues. In this report we analyze the risk/return-profiles of private debt issuers and compare them to issuers of publicly placed bonds. Separating the samples of private and public placements according to the rating (credit score) of the issuers into an investment grade (BBB- and higher) and a non-investment grade category (BB+ and lower) yields interesting results: Table 1 shows that there is no apparent difference between investment grade issuers of private and public placements in the average probability of default. Moreover, issuers in the non-investment grade category display a pronounced difference: The average one year probability of default for issuers of private debt with a value of 3.5% is significantly lower than the probability of default of public placement issuers with 4.24%. Offering yield to maturities of private placements are systematically higher. The difference in average offering yields amounts to 2.3% in the non-investment grade segment and 1.45% in the investment grade segment. The difference in returns can be explained by the limited liquidity of privately placed bonds and, given our analysis, not with higher risk measured by the probability of default. These results suggest that investors seeking for medium to long-term investments can achieve a higher return with similar or even lower probability of default in the private debt segment than in the public debt segment. Figure 4: Private vs., Risk/Return-Profiles Source: Remaco, S&P Capital IQ, Corporate Debentures, , European Market, excluding financial companies Investment Grade 4.5% Average 1y Standalone PD 0.01% 1.45% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% Average 1y Standalone PD -0.75% 2.31% Non-Investment Grade % 1% 2% 3% 4% 5% 6% 7% 0.0% 0% 2% 4% 6% 8% Table 1: Private vs. Public Placements, Investment Grade vs. Non-Investment Grade Investment Grade Non-Investment Grade Average Offering Yield Average 1y Standalone PD 5.86% 0.19% 4.41% 0.18% 7.24% 3.50% 4.93% 4.24% Remaco Direct Lending Report 5

6 Lower Probability of Default with medium- and long-term Private Debt Issues Splitting the sample into three different tenor-categories allows more interesting conclusions: Bond placements are grouped into long-, medium and short-term bond issues with a tenor of less than five years being shortterm, a tenor of 5-10 years being medium-term and a tenor of more than 10 years being classified as long-term. Table 2 shows that short-term private placements have a higher average issuer probability of default than public placements with a value of 3.19% compared to 1.96% respectively. However, this seems to be the exception. For both, medium- and long-term placements, the average probability of default is higher for issuers of publicly placed bonds. The results again underline the suitability of private debt investments for institutional investors without short-term liquidity needs. For long-term investors such as pension funds and insurances the conclusion that private debt investments offer higher returns with a similar or lower probability of default may be of significant importance in their search for suitable investments. Moreover, the majority of private placements are issues with a medium- to long-term tenor. While around 80% of publicly placed bonds are issued with a maturity of more than five years, the percentage of privately placed bonds with a maturity of more than five years is 92%. This emphasizes that private placements are especially popular with long-term investors. long-term (> 10 Jahre) medium term (5-10 Jahre) short term (< 5 Jahre) Average Offering Yield Average 1y Standalone PD 5.67% 0.42% 5.61% 1.20% 6.76% 1.46% 4.68% 1.78% 5.57% 3.19% 2.94% 1.96% Table 2: Risk/Return-Profiles for different Tenor Categories 8% 6% Figure 5: Offering Yield and Probability of Default grouped by Tenor Source: Remaco, S&P Capital IQ, Corporate Debentures, , European Market, excluding financial companies 4% 2% Average 1y Standalone PD 0% long-term (> 10 years) medium term (5-10 years) short term (< 5 years) The average offering yield was calculated using data from S&P Capital IQ and a yield to maturity approximation formula frequently used in the academic literature. Data from S&P Capital IQ regarding offering coupon, number of coupon payments per year, offering price as well as the tenor of the bonds constituted the base for our analysis. Coupon data was manually crosschecked using Bloomberg in order to complement our sample. The average values displayed in the evaluation of different rating categories, industries and tenors correspond to equally weighted averages. Average Standalone 1y PD In order to assess the probability of default the one year fundamental standalone probabilities of default for the issuers were collected from S&P Capital IQ. For issuers lacking data on the probability of default, the one year fundamental standalone probability of default for the direct parent company was used to supplement the sample. The average values displayed in the evaluation of different rating categories, industries and tenors correspond to equally weighted averages. 6 Remaco Direct Lending Report

7 A Comparison across Industries confirms the Attractiveness: Average surplus Offering Yield of 37 % Finally we analyzed the probability of default and the offering yield to maturity of placements grouped by primary industry of the issuer. The analysis shows that in eight of nine primary industries issuers of privately placed bonds exhibit a lower average probability of default. The return, measured by the average offered YTM, is higher for private placements in all of the evaluated industries. The surplus offering yield of private placements versus public placements varies between industries and ranges from 11% in the industrials sector to almost 50% in the materials, consumer discretionary and telecommunication services industry. On average private placements present a surplus offering yield of 37%. The results of our analysis suggest that issuer probability of default of private placements is, on average, lower than that of public placements. These findings in combination with diversification effects of private debt investments, emphasize the attractiveness of private debt and direct lending investments. 8% 6% 4% Figure 6: Offering Yield and Probability of Default of Issuers grouped by Primary Industry Source: Remaco, S&P Capital IQ, Corporate Debentures, , European Market, excluding financial companies 2% 0% 3% 2% Energy Materials Industrials Consumer Discretionary Consumer Staples Healthcare Infor. Technology Telecomm. Services Utilities Average 1y Standalone PD 1% 0% Energy Materials Industrials Consumer Discretionary Consumer Staples Healthcare Information Technology Telecomm. Services Number of Number of Utilities The present report has been published by the Remaco Wealth Management AG. It is not meant for distribution and use by natural or legal persons, who are citizens or residents of a state, country or territory in which the current laws prohibit the distribution, publication, issue and use of it. The user itself is responsible to prove, that the acquisition of the information within this report is legal. This material is for informational purposes only and should not be considered as an offer or a request to buy or sell a financial instrument or as a contractual document. The market valuations, conditions and calculations contained in this report are only estimates and can be changed without announcement. The information presented are considered reliable, though the Remaco Wealth Management AG does not guarantee their accuracy and completeness. Past performance is not a guide to future performance. Remaco Wealth Management AG excludes without restriction any liability for losses and/or damages of any kind including any direct, indirect or consequential damages that arise from the use of the present document. Remaco Direct Lending Report 7

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