Opportunities through the market cycle

Transcription

1 Summit Series Forums 2017 Opportunities through the market cycle Darrin Smith, CFA High Yield Portfolio Manager Randy Woodbury, CFA Investment Grade Portfolio Manager

2 Key takeaways We are not as late in the credit cycle as many people fear Investors may be well compensated for constructing portfolios with structural carry advantages. Down-capital-structure securities are one of those options 2

3 Are we really in the late stages of the credit cycle?

4 What does late cycle actually mean and look like? Strong credit metrics, trending better cycle top Strong but weakening credit metric trends Weak credit metrics but on an improving trend Source: JP Morgan CREDIT CYCLE cycle bottom Weak credit metrics which continue to trend down 4

5 Is a recession imminent? 70% Probability of a Recession 60% 50% 40% 30% 20% 10% 0% US Recessions Average Recession Probability Signal Level 1 5 As of 24 August 2017 Source: Principal Global Investors 1 We define a recession signal as a reading above this line. The line is the long term average.

6 Have default rates picked up yet? LTM default rate Based on number of issues LTM upgrade-to-downgrade ratio Based on par amount 6 As of September 2017 Source: Citi Research

7 Are financial covenants worsening? U.S. cov-lite loan issuance ($billion) European cov-lite loan issuance ( billion, cov-lite as share of institutional debt %) 7 As of September 2017 Source: Citi Research

8 Have corporate profit margins turned? 33 High Yield Margins Investment Grade Margins Mar 98 Mar 00 Mar 02 Mar 04 Mar 06 Mar 08 Mar 10 Mar 12 Mar 14 Mar 16 8 As of 30 June 2017 Source: BofA Merrill Lynch, JP Morgan

9 Are leverage and interest coverage cracking? Investment grade net leverage Investment grade interest coverage 9 As of 12 July 2017 Source: JP Morgan

10 Are leverage and interest coverage cracking? U.S. high yield net leverage U.S. high yield interest coverage 10 As of September 2017 Source: Citi Research

11 Is access to capital more difficult? CCC price vs trailing 12-month default rate Federal Reserve senior loan officer survey 11 As of September 2017 Source: Citi Research, Moody s

12 What opportunities are available in such a split environment?

13 The case for banks: Liquidity and capital Cash on balance sheets Bank capital ratios have increased 13 As of 3 October 2017 Source: Barclays Research

14 The case for banks: Liquidity and capital 14 As of October 2017 Note: Reflects banks supervised by ECB Source: Imperial Capital, LLC

15 The case for banks: Nonperforming loans 15 As of October 2017 Note: Reflects banks supervised by ECB Source: Imperial Capital, LLC

16 16 Bank capital structure US$ Billions Outstanding 3,000 2,500 2,000 1,500 1, , Bank Capital Stack 19 Less risky More risky Covered Bonds Senior Unsecured Lower Tier 2 Legacy Tier 1 Preferred Contingent Capital Yield to-worst Description 0.35% Secured claim on a pool of assets plus a senior unsecured claim. To date, no covered bond in the market has ever suffered a loss. 2.66% Highest level unsecured claim. Non-deferrable. 2.96% Unsecured claim that is subordinated to senior debt. Non-deferrable form of regulatory required capital. 3.64% Legacy instruments that are deferrable and generally non-cumulative. Being phased out of regulatory capital due to low ability to absorb losses. 1.86% Perpetual instruments that count toward regulatory capital in the U.S. Deferrable and non-cumulative. 5.15% Instruments issued in different host securities with differing rank. All are written down or converted to equity at varying capital trigger levels. Additional Tier 1 securities have discretionary and mandatory coupon suspension language. As of 30 June 2017 Source: Principal Global Investors 1 Barclays Global Covered Bond Index; 2 Barclays Investment Grade Banking Senior Index; 3 Barclays Global Capital Securities Lower Tier 2 Index; 4 Barclays Global Capital Securities Tier 1 Index; 5 Bank of America Merrill Lynch Fixed Rate Preferred Securities Index; 6 Barclays Global Contingent Capital Index The potential yield increases associated with investing further down the capital structure may result in an increased level of risk

17 How high yield and investment grade utilize bank debt in this environment Yield difference between USD CoCos and U.S. single B s 17 As of February 2017 Source: Barclays Research

18 How high yield and investment grade utilize bank debt in this environment YTD total return AT1/LT2 spread ratio 18 As of 28 September 2017 Source: Barclays Research

19 Thank you

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