CLOs Today and Tomorrow Moderator: Meredith Coffey, LSTA Speakers: Wynne Comer, Bank of America Merrill Lynch Loris Nazarian, Morgan Stanley Kei Okuyama, MUFG Clayton Perry, KKR Adnan Zuberi, BNP Paribas
Topics Volume, Spread & Relative Value Trends Pricing and Volatility Trends Comparing US and Europe Regulatory Update 2
US CLO Volume, Pricing and Investor Trends 3
US CLO Formation Slows, Spreads Widen Annual US CLO Formation US CLO AAA Spreads Remain Wide 140 190 120 180 US CLO AAA Spread Volume ($Bils.) 100 80 60 40 Spread (bps) 170 160 150 140 Min (Static Pool) Max (Debut CLO) 20 130 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 YTD May-15 YTD May-16 120 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2QTD US CLO formation slows in 2015 and year-to-date 2016 CLO AAA spreads widen and are dispersed by manager and strategy Source: LCD, an offering of S&P Global Market Intelligence; LSTA 4
Relative Value: US, European CLOs, Other Asset Classes US CLO Primary Euro CLO Primary spread in bps US New Issue AAA 143 158 160 spread in bps EUR New Issue AAA 126 145 150 US New Issue AA 195 225 250 EUR New Issue AA 198 210 225 US New Issue A 270 320 380 EUR New Issue A 275 320 375 US New Issue BBB 380 500 625 EUR New Issue BBB 348 480 525 US New Issue BB 610 810 990 EUR New Issue BB 515 760 840 Other Asset Classes spread in bps BB Loans Index B Loans Index Primary CMBS AAA Spread (LCF) HY Cash Index STW BB HY Cash Index STW Single-B IG Cash Index OAS BBB 381 523 82 325 495 173 381 591 125 420 659 196 473 765 165 656 938 290 US CLO AAA spreads near their 12-month high European CLO AAA spreads lower Collateral spreads closer to 12-month lows Source: Morgan Stanley 5
US CLO Investor Base is Evolving 6
Secondary Pricing, Volatility and Quality Trends 7
CLO Tranche Prices Fall, Spreads Rise Then Reverse CLO Debt Tranche Prices Fall Through Feb 2016, Partially Recover CLO Tranche Spreads Widen Materially, Partially Contract 105 1,600 AAA (155) AA (215) 100 1,400 A (315) BBB (525) CLO Debt Tranche Prices (%) 95 90 85 80 75 70 AAA (99.5) AA (98.2) A (97.4) BBB (91.1) CLO Note Spreads (bps) 1,200 1,000 800 600 400 BB (925) B (1400) 65 BB (80.9) 200 60 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 0 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 Secondary CLO debt tranche prices declined and spreads widened substantially through mid-february Prices and spreads recovered through mid-may 2016 Source: BAML 8
Collateral Quality Trends: US CLO WARF and Assets Rated CCC/Caa and Below Increase 3,000 Average US CLO WARF 8.0% US CLO Portfolio Exposure to Loans <= CCC+/Caa1 2,900 7.0% 6.0% WARF 2,800 2,700 2,600 Share of Portfolio (%) 5.0% 4.0% 3.0% S&P CCC+ or below Moody's Caa1 or below 2.0% 2,500 1.0% 2,400 0.0% Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 US CLO WARF has increased since January 2013 Likewise, the share of assets rated <= CCC+/Caa1 has grown Source: BAML 9
Loan Prices Fall, Recover; CLO Equity NAVs Follow Trend US Secondary Loan Prices Decline, Recover Median US CLO 2.0 Equity NAV Falls, Recovers 100 70 98 60 Secondary Loan Prices (% of par) 96 94 92 90 88 86 Equtiy NAV 50 40 30 20 10 84 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 0-10 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 Loan prices dropped through February 2016 due to technical factors and credit/commodities concerns However, fundamental concerns may have been overblown and technicals rebalanced Loan prices recovered sharply through mid-may 2016 Because of position in capital stack, trend in CLO equity was more extreme However, CLOs are not market value vehicles and are structured to withstand market volatility Source: S&P/LSTA Leveraged Loan Index, Morgan Stanley 10
Market Value OC (MVOC) Dips with Loan Prices in February, Recovers in March, April 169% 159% Sharp Drop in Loan Prices Hits CLO Notes MVOC AAA (153%) AA (128%) A (117%) BBB (110%) BB (104%) B (102%) Loan Prices (RHS, 93.0) 100 98 149% 139% 129% 119% 96 94 92 109% 90 99% 88 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 MVOC Sep-15 Nov-15 Jan-16 Mar-16 Loan Price (% of Par) Source: BAML Loan prices declined sharply in 2H15, early 2016 Based on loan prices, the MVOC of CLO debt tranches dropped Note: A loan whose price has dropped from 100 to 90 is still highly likely to repay at par Note: CLOs are not mark-to-market vehicles and are very unlikely to liquidate portfolios In turn, while MVOC may be a useful metric, it may not reflect likely outcomes 11
Actual OC Cushions Have Weakened, But Far Less Dramatically than MVOC 12% Median US CLO Sr OC Cushions by Vintage 6% Median US CLO JrOC Cushions by Vintage 11% 5% 10% 4% OC Cushion (%) 9% 8% 2012 Vintage US CLO Median Sr OC Cushion 2013 Vintage US CLO Median Sr OC Cushion OC Cushion (%) 3% 2% 2012 Vintage US CLO Median Jr OC Cushion 2013 Vintage US CLO Median Jr OC Cushion 2014 Vintage US CLO Median Sr OC Cushion 2014 Vintage US CLO Median Jr OC Cushion 7% 2015 Vintage US CLO Median Sr OC Cushion 1% 2015 Vintage US CLO Median Jr OC Cushion 6% 0% 2012-04 2012-07 2012-10 2013-01 2013-04 2013-07 2013-10 2014-01 2014-04 2014-07 2014-10 2012-04 2012-07 2012-10 2013-01 2013-04 2013-07 2013-10 2014-01 2014-04 2014-07 2014-10 2015-01 2015-04 2015-07 2015-10 2016-01 2016-04 2015-01 2015-04 2015-07 2015-10 2016-01 2016-04 Actual OC cushions, which are what trigger amortization, have deteriorated However, they have deteriorated far less than MVOC Source: Morgan Stanley 12
Stress Tests: What Creates Actual Losses? Applying the 2001 and 2007-2009 Default Scenarios Forward 12 Applying 2001 and 2007-9 Defaults Forward Breakeven 2001 scenario multiplier Severities (%) 20 30 40 50 Default rate (%) 10 8 6 4 2 - May-16 Oct-16 Mar-17 2007-9 had a short period of record high default rates 2001 s peak default rate was lower, but defaults extended over a longer period of time Chart illustrates how these default scenarios would look going forward Source: BAML Aug-17 Jan-18 Jun-18 Nov-18 Apr-19 Sep-19 Feb-20 Jul-20 Dec-20 2001 Scenario 2007-2009 Scenario May-21 Oct-21 Mar-22 Aug-22 Jan-23 Jun-23 Nov-23 13 AAA NA NA N/A 9.03 AA NA NA 7.23 5.24 A NA 6.25 4.08 3.13 BBB 6.29 3.68 2.71 2.03 BB 3.19 2.06 1.52 1.18 B 2.08 1.43 1.06 0.79 Breakeven 2007-2009 scenario multiplier Severities (%) 20 30 40 50 AAA NA NA NA 8.67 AA NA NA 7.48 5.36 A NA 6.22 4.55 3.43 BBB 6.26 3.98 2.98 2.41 BB 3.45 2.44 1.82 1.47 B 2.49 1.64 1.22 0.96 Tables illustrate the level of loss given default severities necessary to create principal losses in CLO notes in a 2001 or 2007-9 default environment For instance, if loss severity were 30%, then for BB notes to suffer principal losses, defaults would have to be 2x 2001 levels of 2.4x 2007-9 levels It is hard to force AAA or AA losses
Comparing US and European CLOs 14
US and European CLO Formation Annual US CLO Formation Annual European CLO Formation 140 50 120 40 100 Volume ($Bils.) 80 60 40 30 20 20 10 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 YTD May-15 YTD May-16 2005 2006 2007 2008 2009 2010 2011 2012 Volume ($Bils.) 2013 2014 2015 YTD May-15 YTD May-16 US CLO formation materially higher than European CLO formation 2015 US CLO formation: $98 billion 2015 Euro CLO formation: 14 billion However, US CLO formation has been slowing since 2014, while European CLO formation has been stable Source: LCD, an offering of S&P Global Market Intelligence; LSTA 15
US and European CLO Outstandings 500 450 400 U.S. US and European CLO Outstandings Europe 350 300 250 200 150 100 50 0 Jan-13 Mar-13 May-13 Outstandings ($/ BIls.) Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 US CLO outstandings higher and growing Outstandings of more than $430 billion, up more than $100 billion since early 2014 Euro CLO outstandings lower and flat (until recently) Outstandings of 62 billion, up from 60 billion in January 2016, but down from 67 billion in early 2014 Source: ThomsonReuters LPC 16
US and European CLO AAA Spreads US CLO AAA Spreads Wider and Diverging 165 160 155 150 Spread (bps) 145 140 135 130 125 120 US CLO AAA Spread Euro CLO AAA Spread 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2QTD US CLO spreads are wider than European spreads However, exchange rate may be less favorable Source: LCD, an offering of S&P Global Market Intelligence; LSTA 17
Relative Value: US vs European CLOs US CLO Primary Euro CLO Primary spread in bps spread in bps US New Issue AAA 143 158 160 EUR New Issue AAA 126 145 150 US New Issue AA 195 225 250 EUR New Issue AA 198 210 225 US New Issue A 270 320 380 EUR New Issue A 275 320 375 US New Issue BBB 380 500 625 EUR New Issue BBB 348 480 525 US New Issue BB 610 810 990 EUR New Issue BB 515 760 840 US CLO note spreads are generally wider than Euro CLO note spreads across the capital stack In addition, there are differences in US/Euro note structure (subordination, etc) and collateral (ratings, prices, diversity, etc) Source: Morgan Stanley 18
Comparing US and European CLO Collateral 19
US and European CLO Collateral: Asset Prices 45% 40% US CLO Asset Prices are Lower Than Euro CLO Asset Prices 35% U.S. Europe Share of Loans (%) 30% 25% 20% 15% 10% 5% 0% <70 70 to <80 80 to <85 85 to <90 90 to <95 95 to <98 98 to <99 99 to <100 >=100 Loans in US CLOs tend to be priced lower than those in European CLOs In addition, there are more loans priced below 70 in US CLOs Source: ThomsonReuters LPC 20
US CLO Collateral: Asset Ratings US CLO Collateral Ratings European CLO Collateral Ratings B 49% CCC 1% CC & Below 3% NR 3% BBB 9% B 65% CCC 2% NR 5% BBB 5% CC & Below 1% BB 22% BB 35% Over 40% of loans in US CLOs are rated BBB-BB, while less than 50% are rated single B In European CLOs, less than 30% are rated BBB-BB, while 65% are rated single B However, US CLOs have more loans rated CCC and below Source: Morgan Stanley 21
US CLO Collateral: More Diverse, But More Oil & Gas, Metals & Mining Exposure Share of U.S. CLO loan assets 16.0% 12.0% 8.0% 4.0% 0.0% Technology Healthcare Retail & Gen. Manufacturing Business Services Chem & Plastics Financial Services Broadcasting US CLO Collateral by Industry Services Telecommunicati Leisure & Entertain Utilities Automotive Oil and Gas Media Wholesale Transportation Aerospace & Bev, Food & Hotel & Gaming Mining Construction Shipping Paper & Packaging Restaurants REITS Textiles and Agriculture Real Estate Government Share of European CLO loan assets 16.0% 12.0% 8.0% 4.0% 0.0% Gen. Manufacturing Healthcare Technology Chem & Plastics Telecom Broadcasting Leisure & Services Retail & European CLO Collateral by Industry Wholesale Media Business Services Bev, Food & Financial Services Paper & Packaging Transportation Automotive Utilities Real Estate Construction Textiles & Apparel Shipping Mining Restaurants Agriculture Government Oil and Gas Hotel & Gaming REITS Aerospace & Source: ThomsonReuters LPC 22
US CLO Collateral: Loan Market Liquidity European Loan Index & Turnover Ratio US Loan Index & Turnover Ratio Trading/Index Size ( Bils.) 900 800 700 600 500 400 300 200 European Leveraged Trading Volume Avg. Size of The ELLI Turn-Over Ratio (%) 100% 75% 50% 25% Turnover Trading/Index Size ($Bils.) $1,000 $750 $500 $250 U.S. Leveraged Trading Volume Avg. Size of the LLI Turn-over Ratio (%) 100% 75% 50% 25% Turnover 100-2012 2013 2014 2015 1Q16* 0% $- 2012 2013 2014 2015 1Q16* 0% US loan outstandings and trading activity much higher than European loans US loans are more liquid, arguably allowing managers to more actively manage portfolios Source: LSTA Trade Data Study 23
Regulatory Update 24
Regulation Update Risk Retention US Goes effective for CLOs on December 24, 2016 Market working on solutions like CMV, MOA, C-MOA, Financing Trade Groups working on legislative and legal fixes Europe Been effective for years, though requirements have changed several times Some third party retainers, but primarily manager capital via sponsor or originator route Responsibility for compliance falls on investors as well as managers 25
In Conclusion 26
Appendix: CLO Returns and Primary vs. Secondary Relative Value 27
JPM Secondary Market: CLO Index (CLOIE) Average Monthly & Quarterly Total Return by Tranche 14.0% Quarterly Monthly 10.0% 6.0% 2.0% -2.0% -6.0% -10.0% -14.0% 1Q15 2Q15 3Q15 4Q15 2015 1Q16 1/31/16 2/29/16 3/31/16 AAA AA A BBB BB B 28
CLO Primary Market Average New Issue CLO 2.0 & JP Morgan CLO Index (CLOIE) Spreads by Tranche Average Bid Price of Loans by Rating bps 1,800 June 1, 2015 March 1, 2016 April 15, 2016 105.0 1,600 1,400 1,200 1,000 800 600 400 L+828 bps L+777 bps L+633 bps L+616 bps L+1652 bps L+[VALUE] bps L+1197 bps L+1422 bps L+1125 L+929 L+[VALUE] bps bps L+838 bps 100.0 95.0 90.0 85.0 80.0 75.0 96.10 89.58 98.65 Avg Bid Price 3Y DM = L+405 bps 93.63 Avg Bid Price 3Y DM = L+700 bps 74.00 Avg Bid Price 3Y DM = L+2099 bps 200 70.0 69.34 0 65.0 Jan 2015 Mar 2015May 2015 Jul 2015 Sep 2015 Nov 2015Feb 2016 Apr 2016 Primary BB CLOIE Secondary BB Primary B CLOIE Secondary B BB Avg Bid Price B Avg Bid Price CCC Avg Bid Price 29