A Case for Leveraged Loans

DISCIPLINE DRIVES PERFORMANCE March 22, 2012 Alexander Chan Vice President, Quantitative Strategy and Analytics achan@shenkmancapital.com +1 (203) 363-1785 For more information, please contact: Nicholas G. Keyes, CFA, CAIA Director of Business Development Kim I. Hekking Director of Client Services marketing@shenkmancapital.com +1 (203) 348-3500 Highlights: Leveraged loans have become an institutionally accepted asset class. Leveraged loans are senior secured debt instruments. Leveraged loans benefit from rising rates as their coupons are floating rate. Leveraged loans have similar annualized return and volatility as investment grade rated bonds. A Case for Leveraged Loans Over the past decade, leveraged loans have transitioned from being a bankdominated market to an institutionally accepted asset class with a market value of $1 trillion at the end of 2011. During this transition, there were many positive developments, including better liquidity, greater transparency, broader diversification, total return benchmarks, trade groups, public ratings, and standardized trade documentation. In this piece, we examine the development and characteristics of the loan market and its suitability within an institutional investment portfolio. Introduction The leveraged loan market consists of the floating rate bank debt of below investment grade companies. While leveraged loans have been historically held by banks and other financial institutions, today they are broadly syndicated to a diverse group of institutional investors. To be clear, the term "leveraged" loan refers to the credit quality of the issuers (i.e., leveraged issuers). The instruments themselves do not employ any type of leverage. The terms bank loans, leveraged loans and high yield loans are used interchangeably, though the term bank loan officially includes investment grade loans (which differ greatly from leveraged loans in structure and tenor and are primarily held by banks). Leveraged loans are not securities; they are privately structured debt obligations between a borrower and a lender or a group of lenders. The terms of the loan (including tenor, coupon, maturity date, etc.) are specified in a credit agreement, which is negotiated between all relevant parties and may be amended during the life of the loan. Leveraged loans can be unfunded commitments or fully-funded term loans. An unfunded commitment is typically a revolving line of credit to the company ( revolver ). This is similar to a consumer-level home equity line of credit or a credit card. Money is drawn and repaid at discretion of the borrower. Conversely, a loan in which the debtor receives the entire amount at issuance and is obligated to repay in fixed installments is known as a term loan. A term loan more closely resembles a traditional bond, and is often classified based upon its amortization schedule. Term loans are typically issued in different tranches. 461 Fifth Avenue, 22 nd Floor New York, NY 10017 Phone: +1 (212) 867-9090 SHENKMAN CAPITAL 262 Harbor Drive, Fourth Floor Stamford, CT 06902 Phone: +1 (203) 348-3500 7 Clifford Street London, UK W1S 2FT Phone: +44 (0) 20 3371 8234 2012 SHENKMAN CAPITAL MANAGEMENT, INC. All Rights Reserved

The "A" tranche of a term loan (TLa) is typically short term in nature (5 to 7 years), and has an accelerated amortization schedule. Revolvers and term loan A s are referred to as pro rata loans because they were historically syndicated on a pro rata basis to bank investors. The term loan A tranche is commonly held by banks and has a required amortization of 15-25% per annum. Term loans "B", "C", and "D" (and beyond), more commonly known as institutional term loans, are structured similar to traditional bonds with the intention of meeting the requirements and appetite of institutional investors. Like bonds, institutional term loans tend to have longer-dated maturities (7 to 10 years), and back-ended amortization schedules. The majority of non-bank buyers focus on these institutional tranches for their investments. Therefore, in this report the term leveraged loan generally refers to the institutional loan, unless otherwise specified. Most leveraged loans possess the following five unique characteristics: Leveraged loans are senior secured, floating rate debt instruments. 1. Seniority Leveraged loans usually sit at the top of the corporate capital structure. This typically means borrowers are contractually obligated to make payments on their loans before they make payments to other creditors, including most bondholders. 2. Security Leveraged loans are typically secured by the company s physical assets (property, plant and equipment) and sometimes other assets. Most leveraged loans have a first-lien priority against these assets in the event of a default. In theory, the lender would have the right to take possession of these assets and sell them to the highest bidder. In practice, this liquidation option is rarely used, though it has helped investors maximize their recovery of principal and interest in restructurings. 3. Floating Rate Coupon The coupons for leveraged loans, unlike most other debt instruments in the U.S., are floating rate in nature. They pay a spread over a specified benchmark, generally 3-month USD Libor, but can be any other benchmark as specified in the credit agreement. As a result, loans have a duration close to zero. Loans also have low sensitivity to rate movements because their coupons are typically reset every three months, and therefore can act as a hedge to rising rates. Seniority, security and covenants have all helped mitigate credit risk with average recovery rates near 70%. 4. Covenants Leveraged loan investors are generally protected by maintenance and incurrence covenants. Maintenance covenants require the borrower to maintain its credit quality by adhering to predetermined ratios at regular intervals. Typical maintenance covenants are based on total leverage, interest coverage and maximum capital expenditures, and are usually tested quarterly. Incurrence covenants force the borrower to comply with predetermined criteria when the borrowers issue more debt. A breach of any 2

covenant can have a variety of outcomes, including higher spreads, upfront payments, or even default. Ultimately, covenants can give lenders crucial bargaining rights when the credit is deteriorating. 5. Callability Leveraged loans are generally callable at par at any time by the issuer. In recent years, a soft call provision, generally at 101, has emerged to protect investors in the event the company wishes to refinance an existing loan with a new loan issuance. This callability puts a relatively low price ceiling on the loan market. While this feature gives leveraged loans a negative convexity, fees are sometimes associated with these repayments, which can help offset the reinvestment risk. Exhibit 1 Comparison of Key Attributes among Credit Asset Classes Attribute Leveraged Loans High Yield Bonds Investment Grade Bonds Rank Senior Generally Subordinate Generally Subordinate Security Generally First Lien Generally none N/A Covenants Generally Restrictive Less Restrictive N/A Term 5-8 years 7-10 years 10-30 years Income Cash pay Floating Cash pay Fixed Cash Pay Fixed Spread* L+600 T+700 T+250 Call Protection Some Soft Calls 3-5 year N/A Agreement Credit Agreement Indenture Indenture *Note: Leveraged loan spreads use 4-year discount margin. Data as of December 31, 2011. Source: Shenkman Capital, Bloomberg History of the Leveraged Loan Market Banks and other financial institutions have been making corporate loans and extending lines of credit for decades. However, the LBO-boom in the 1980s was the first real developmental milestone for the leveraged loan market. A radical shift away from Asset-Backed Loans (ABLs) to loans based on cash-flow for below investment grade companies began to emerge. That was followed quickly by loan-market specific publications and the launch of managed leveraged loan funds. The savings and loan crisis in the early 1990s was also a pivotal moment for the leveraged loan market. The recession forced banks to rethink their lending practices and the amount of capital they had at risk, especially to leveraged corporations. Banks sought to reduce losses in these loans while shifting focus to maintaining the lucrative banking business in order to reduce earnings volatility. As a result, banks began to syndicate 3

Institutional investors entered the leveraged loan market in the 1990s. loans, where an agent bank negotiated the terms with a borrower and then distributed that loan on a pro-rata basis to a group of banks (Revolvers and TLa). By the mid-1990s, term loan investors expanded to include non-bank financial institutions. However, those investors generally did not like the revolving lines of credit or short maturities. This led to the creation of the institutional tranche (TLb). Later in the 1990s, several other milestones were achieved: the development of back-office accounting systems, the creation of total return indices, the formation of an association for market participants, the standardization of documents and market practices, and finally, mark-to-market pricing services. S&P rated its first leveraged loan in 1995 and Credit Suisse launched the first leveraged loan index with data beginning in 1992. Exhibit 2 Growth of the Leveraged Loan Market The turning point of the transition of leveraged loans from a club (with mostly banks participating) to a capital market asset class was the explosion in the volume of secondary trading. Secondary volumes grew to about $100 billion in 2001 and reached over $580 billion in 2007. While the financial crisis slowed secondary activity, roughly $400 billion in leveraged loans still traded in 2011. 1 Size of Institutional Loan Market ($ billions) 900 800 700 600 500 400 300 200 100 0 1993 1996 1999 2002 2005 2008 2011 Leveraged Loan Issuance ($ billions) 600 Pro rata 500 Institutional 400 300 200 100 0 1998 2000 2002 2004 2006 2008 2010 Source: Shenkman Capital, Credit Suisse, S&P LCD The leveraged loan market, with prorata and institutional tranches, is well over $1 trillion dollars. Leveraged loan issuance skyrocketed in the mid-2000s. Supply was fueled by LBOs seeking cheap financing and demand surged as a result of Collateralized Loan Obligations (CLOs), which were gaining in popularity. In fact, CLOs bought over 70% of the institutional loan market in 2006-2007, and while their influence is waning, they are still the largest buyer of new institutional tranches (a third of all loans in 2011 2 ). This demand, coupled with secondary trading in leveraged loans, led to exponential growth in the institutional loan market, which grew from roughly $23 billion in 1995 to over $850 billion in 2008. While the market has contracted in the 1 Secondary leveraged loan volume data from Loan Syndications and Trading Association (LSTA.org). Includes Par and Distressed Sales and Purchases 2 S&P LCD, Leveraged Lending Review 4Q11 4

three years since then, it still remains a large, diversified pool of over $600 billion in loans (Exhibit 2). Issuance trends shifted towards institutional tranches in 2003 as a result of the changing buyer base. Starting that year, the majority of new issue leveraged loans were institutional tranches, rather than pro-rata tranches for the banks. In 2011, roughly two-thirds of the $373 billion of new issues were for institutional buyers. After two years of record low issuance in 2008 and 2009, the leveraged loan primary market has recovered. The volume of new issuance in 2011 was the third highest level. Only 2006 and 2007 had more issues come to market. Most market participants expect the new issue market to continue to grow, though likely not to levels seen during the LBO boom in 2006-2007. Syndication Process Exhibit 3 Shift in Leveraged Loan Investor Base The syndication process for leveraged loans has evolved over time. Historically, these debt instruments did not need to be syndicated because banks simply originated loans to companies and held the investments on their own balance sheets. However, with the majority of loans being sold to institutional investors (Exhibit 3), the syndication process has become crucially important to the success of any origination. Primary Market for All Leveraged Loans by Investor Market Flex (% of Institutional Tranches) 90% 80% 70% 60% 50% Flex Down Flex Up 60% 40% 50% 40% 30% 30% 20% 20% 10% 0% Banks Non-Banks 1994 1997 2000 2003 2006 2009 10% 0% 1999 2001 2003 2005 2007 2009 2011 Source: Shenkman Capital, S&P LCD The role of banks in leveraged loan syndications today has shifted from being a provider of capital to a distributor of risk. In today s leveraged loan syndications, the investment banks play a similar role to any other debt offering, where an arranger (underwriter) or group of arrangers commits to syndicate a loan on behalf of a borrower. Generally, most underwritten deals come with a guarantee from the syndicate for the entire commitment amount. If the arrangers cannot distribute the entire commitment, then they will be forced to keep the loan on their own balance sheets and sell the remainder at a later time, possibly at a loss. While this agreement is obviously beneficial to the borrower, most investment banks do it to be competitive and to win or retain future underwriting or 5

investment banking business. Leveraged loans can also be syndicated on a best efforts basis, which is similar to an underwritten deal but the arranger has not commited to a specific amount. A crucial part of the syndication process today is the market-flex language. Prior to the late 1990s, loans were syndicated at a price and spread that the arranger thought could clear the market. Arrangers faced the possibility of significant losses if the loan was undersubscribed or borrowers could not benefit from lower coupons if the loan was oversubscribed. In 2007, nearly every institutional tranche that was brought to market was flexed up or down. In other words, the coupon on the loan was increased or decreased based upon how well the new loan was being received by investors. In 2011, about half of all new-issue loans saw pricing change (Exhibit 3). Despite not being a security, leveraged loans are syndicated much like bonds. The accepted use of market-flex along with the growing number of investors make leveraged loan syndications even more like bond underwritings, with loans being launched with price talk (a range of potential spreads) to gather indicative interest from lenders. Lenders today can make commitments for a new issue loan to the arranger subject to specific spread levels and/or original-issue discounts ( OIDs ) from par. Lastly, an important distinction in leveraged loan syndications and secondary trading is public side versus private side information. Early on, as part of the due diligence and ongoing monitoring processes of commercial banks, material non-public information about the borrower was disclosed. Even when loans began to be syndicated to a group of agent banks, the disclosure of private information was still not an issue. However, as non-bank investors grew in number and, more importantly, secondary trading volume increased, the need to distinguish between private and public information became apparent. Today, non-bank institutional investors can participate in bank loans either on the public or private side (i.e., investors can choose whether or not to receive private information). Many investors choose to remain on the public side so that they can also invest in the public securities (e.g., high yield bonds, convertibles, equities) of the borrower. The underwriting process has therefore adapted to this separation as well. Arrangers now prepare public versions of investment documents or bank books and hold public investor meetings for nearly every large new issue that occurs. If a public side institutional investor believes that private information is a necessity, the investor can generally choose to receive private information on a specific borrower, while remaining public on the rest of their leveraged loan portfolio. Return and Risk Profile The risk/return profile of leveraged loans is driven mostly by the key characteristics of the asset class mentioned above. In short, loans are generally floating rate, senior secured instruments with a first-lien on the assets of the issuer. As a floating rate product, leveraged loans are insulated from rising rates, unlike most other fixed income asset classes. As a credit instrument, leveraged loans are subject to credit specific and industry specific trends, but generally perform well during economic 6

Loans perform well in bull markets, but generally have a floor in bear markets given their seniority and security. recoveries. As senior-secured debt, leveraged loans typically fare better than other corporate debt instruments in the event of default. Therefore, in a bull market, leveraged loans can perform well as underlying corporate fundamentals improve. In a bear market, the first-lien on assets should provide a natural floor to loan prices. The seniority and security of leveraged loans has helped investors capture high recovery values in default situations. As mentioned above, most leveraged loan investors have a lien against the assets of the borrower and could, in theory, seize these assets and sell them to raise cash. In practice, however, this liquidation option is rarely used; though it does put leveraged loan investors in an excellent position to negotiate with the issuer to minimize losses and help provide some principal protection. In fact, some holders of defaulted leveraged loans have even been able to recover par. Exhibit 4 Trailing 12-month Default and Recovery Rates of Leveraged Loans and High Yield Bonds Default Rates Recovery Rates 18% 16% 14% 12% 10% 8% 6% 4% 2% High Yield Bonds Leveraged Loans 100% 90% 80% 70% 60% 50% 40% 30% High Yield Bonds Leveraged Loans 0% 1995 1997 1999 2001 2003 2005 2007 2009 2011 20% 1995 1997 1999 2001 2003 2005 2007 2009 2011 Source: Shenkman Capital, Credit Suisse Historically, loan investors have recovered substantially more than bond investors in general. According to Credit Suisse, the average recovery rate for all leveraged loans from 2000 2011 (which included two default cycles) was 66% compared to 44% for all senior unsecured bonds. Recent years have seen a convergence of recovery rates as default rates plummeted and only the weakest credits with little collateral defaulted. Over the long term, the return and volatility of leveraged loans compare quite favorably to other asset classes, as shown in Exhibit 5. While leveraged loans are rated below investment grade, the importance of both the security and floating rate nature of leveraged loans helps the asset class compete with much higher rated instruments. Leveraged loans have a similar annualized return and risk as investment grade bonds. More importantly, over the last 18 years, leveraged loans exhibited lower volatility than 10-year U.S. Treasury bonds. As of December 31, 2011, leveraged loans had similar coupons to investment grade bonds with significantly lower interest rate sensitivity. We believe this has led to shifts in asset allocation 7

Annualized Return SHENKMAN CAPITAL Exhibit 5 Leveraged Loan Return Characteristics towards leveraged loans given expectations for higher rates. Traditional fixed income corporate debt has two main elements of risk: interest rate risk and credit risk. Loans on the other hand are closer to pure credit investments, as changes in Libor rates adjust the future income stream (coupon) rather than leading to a change in price. In other words, coupon income or yield for term loans is only required to compensate for the assumption of credit risk, as there is little to no duration risk. Risk/Return of Various Asset Classes: 1992 2011 10% 8% 6% 4% 2% Lev Loans US T-Bills IG High Yield 10yr UST DJIA Converts S&P 500 0% 0% 5% 10% 15% 20% Annualized Volatility Annual Returns of Leveraged Loans -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% 1992 1997 2002 2007 Leveraged Loan returns based on Credit Suisse Leveraged Loan Index from 1992 1996 and S&P LCD/LSTA Leveraged Loan Index from its inception in 1997 Present. High yield, investment grade and convertible bond performance based on BofA/ML index data (H0A0, C0A0, and V0A0, respectively). Please see endnotes for a description of these indices. Source: Shenkman Capital, Bloomberg, CS, S&P LCD Exhibit 6 Period In addition to superior risk-adjusted returns, leveraged loans can be a useful diversification tool in traditional fixed income portfolios. Over the past 20 years, there have been five periods of significant rate increases, as defined by a move of 100bp or more in the 10-year U.S. Treasury yield. Exhibit 6 compares the total returns between leveraged loans and investment grade bonds during those five periods. Because of their floating rate coupon, leveraged loans outperformed investment grade bonds in every period. Leveraged Loans vs. Investment Grade Bonds in Rising Rate Environments 10-year Treasury Yield Move Leveraged Loans 8 Investment Grade Bonds Leveraged Loan Outperformance Sep-93 to Nov-94 +253bp 13.38% -3.78% 1,716bp Dec-95 to Aug-96 +137bp 6.11% -0.52% 663bp Sep-98 to Jan-00 +225bp 6.08% 1.80% 428bp May-03 to Jun-06 +177bp 21.22% 9.79% 1,143bp Dec-08 to Dec-09 +163bp 47.14% 26.41% 2,073bp Leveraged Loan returns based on Credit Suisse Leveraged Loan Index from 1992 1996 and S&P LCD/LSTA Leveraged Loan Index from its inception in 1997 Present. Investment grade performance based on BofA/ML index data (C0A0). Please see endnotes for a description of these indices. Source: Shenkman Capital, Bloomberg, S&P LCD Leveraged loans can also be a diversification tool for other portfolios as well. Exhibit 7 shows the long-term correlation of leveraged loans to other asset classes. Not

Annualized Return Annualized Return SHENKMAN CAPITAL surprisingly, leveraged loans are highly correlated with high yield bonds as there is a large overlap of issuers in both markets. Loans have historically had negative correlations with U.S. Treasury bills and bonds given the floating rate coupons and positive correlation to economic growth. What may be surprising is that leveraged loans have proven to be more correlated to equities than investment-grade bonds (0.42 vs. 0.32) over this period. Exhibit 7 Correlation of Leveraged Loans to Various Asset Classes: 1992 2011 10-yr Inv Grade High Yield Convertible US T-Bills Treasury Bonds Bonds Bonds S&P 500 Leveraged Loans -0.06-0.33 0.32 0.74 0.52 0.42 Leveraged Loan returns based on Credit Suisse Leveraged Loan Index from 1992 1996 and S&P LCD/LSTA Leveraged Loan Index from its inception in 1997 Present. High yield, investment grade and convertible bond performance based on BofA/ML index data (H0A0, C0A0, and V0A0, respectively). Please see endnotes for a description of these indices. Source: Shenkman Capital, Bloomberg, CS, S&P LCD The relatively low, positive correlations mean that leveraged loans can reduce overall risk when added to portfolios of investment grade bonds and equities. That is, investors can lower overall volatility by allocating a percentage of their portfolios to leveraged loans without significantly lowering expected returns. Exhibit 8 shows two trade-off scenarios between leveraged loans and other asset classes. The highlighted points show the annualized return and annualized volatility when a 25% allocation to leveraged loans is made. On the left, the allocation of leveraged loans to an investment grade portfolio reduces volatility by 75 basis points, while only reducing expected returns by 22 basis points. In fact, the optimal allocation over this period for leveraged loans in an investment grade portfolio is 40%. Exhibit 8 Efficient Frontiers for Leveraged Loans vs. Other Asset Classes: 1992 2011 Vs. Investment Grade Bonds 7.20% 7.00% 6.80% 6.60% 6.40% 6.20% 6.00% 75% IG / 25% LL 50% IG / 50% LL 25% IG / 75% LL 100% IG 100% LL 5.80% 4.70% 5.20% 5.70% 6.20% Annualized Volatility Vs. Equities 7.80% 7.30% 6.80% 6.30% 50% LL / 50% S&P 75% LL / 25% S&P 25% LL / 75% S&P 100% S&P 100% LL 5.80% 6.10% 11.10% 16.10% Annualized Volatility Leveraged Loan returns based on Credit Suisse Leveraged Loan Index from 1992 1996 and S&P LCD/LSTA Leveraged Loan Index from its inception in 1997 Present. Investment grade performance based on BofA/ML index data (C0A0). Please see endnotes for a description of these indices. Source: Shenkman Capital, Bloomberg, S&P LCD 9

The right hand chart shows a similar result for adding leveraged loans to an equity portfolio, using the S&P 500. A 25% allocation to leveraged loans would reduce volatility by 347 basis points, while giving up only 27 basis points of return. Evolution and Future of the Leveraged Loan Market The leveraged loan market has seen many changes over the past few years. In the mid-2000s, risk tolerance grew rapidly due to increased demand from institutional investors, namely CLOs. Investors were willing to give up some key components of leveraged loans (e.g., maintenance covenants) for additional spread. This trade-off may have been understandable as new issue spreads on leveraged loans were tighter than they had ever been; the average new issue spread for BB-rated loans during 1Q07 was 165bp. The financial crisis managed to reprice risk in all markets, including the leveraged loan market, and reset some of the recent changes that took hold in the market. The increased demand for risk led to the rapid adoption of covenant-lite and secondlien leveraged loans. As their names imply, these loans had no or few covenants, particularly more restrictive maintenance covenants, or had a second lien on the assets of the borrower and thereby were subordinate to first-lien leveraged loans within the capital structure. Volumes of these types of loans grew rapidly until 2007, and dropped dramatically after the financial crisis. Today, volumes of second-lien issuance remain low with $7 billion in 2011 versus nearly $231 billion of total institutional volume. However, after a few years of nearly no covenant-lite issuance, the market saw an increase in covenant-lite loans as investors sought higher yields. In 2011, $57 billion of new issue covenant-lite loan volume came to market, which is roughly half of the peak in 2007 when $97 billion was issued. Exhibit 9 The Changing Leveraged Loan Market Primary Loan Market by Investor Type in 2011 New Issue Leveraged Loans with Libor Floors Hedge and High- Yield Funds 24% Prime Rate Fund 15% Insurance Company 5% Finance Company 6% CDO/CLO 33% Bank 18% 300 Average Libor Floor Percent (right) 105% 250 100% 200 95% 150 90% 85% 100 80% 50 75% 0 70% Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Source: Shenkman Capital, S&P LCD 10

Since the mid-2000s, the investor base for leveraged loans continued to diversify away from long-only credit players like banks and CLOs to relative value investors like hedge funds. Consequently, loans followed other credit markets in the creation of synthetic products. Single-name Loan Credit Default Swaps ( LCDS ) began to trade and the LCDX index was launched in 2007. Like the other CDX indices, the LCDX is a diversified pool of credit that investors could either hold long or short. All of these products became relatively illiquid during the recession and are only starting to return to more normal trading. For primary new issues, leveraged loan funds have filled much of the void left by the decline in CLOs over the past few years. CLOs remained the largest buyer of new leveraged loans in 2011. While there were a number of CLOs issued in 2011, we do not expect new issue volumes for CLOs to reach their prior peaks as the current coupon rate for senior CLO liabilities is still 5-6x higher now than in 2007. Those levels make it unlikely that CLOs will dominate the investor base like they did in 2007. Therefore, we believe the loan market will become broader and more diversified as other types of investors become increasingly important. Retail and institutional mutual funds, for example, saw record inflows in the first half of 2011. Hedge and high yield funds, which were very large players during the credit crisis, continued to see value in the market and were the second largest buyers in 2011 (Exhibit 9). We expect leveraged loan funds, both retail and institutional, to gain in popularity as primary CLO issuance remains subdued and investors continue to seek incremental return as well as consider hedging against inevitable rate increases. Libor floors have helped loans compete at a time when Libor is exceptionally low. Another welcomed development for investors has been new issue bank loans coming Libor floors. In 2010, 95% of all first-lien new issue leveraged loans had Libor floors, though the average floor level declined throughout the year from nearly 200bp to 165bp. By 2011, some loans managed to come to market without Libor floors, however, the vast majority of loans still had them, as 85% of all new issues had a Libor floor. Nearly 50% of the outstanding loan market now has a Libor floor, which has helped leveraged loans remain competitive despite the 3-month U.S. Libor at 58 basis points. 3 Due to a lack of primary activity, the loan market has had a dramatic increase of amend-to-extend volume. As mentioned earlier, leveraged loans are an agreement between a borrower and a group of lenders. The terms of the transaction can only be amended by the borrower with the consent of the lenders. Issuers sought to extend maturities in lieu of issuing new loans as primary market conditions were difficult. The investor has the option to extend or not, but generally the issuer offers compensation for accepting the extension. Finally, leveraged loans have historically exhibited exceptionally low volatility with competitive annual returns. During the financial crisis, however, they were hit particularly hard relative to their historical returns due to systemic deleveraging. Even though loans bounced back very quickly (Exhibit 5), low volatility has clearly not been the case in the recent past. Leading up to the financial crisis, leveraged loans 3 US 3-month Libor as reported by Bloomberg on 31 December 2011 11

As fundamentals begin to drive the market again, credit analysis and selection should drive outperformance. were put into levered vehicles, some of which had mark-to-market triggers. As the market repriced risk in 2008, these vehicles were forced to liquidate and created a technical downward spiral in loan prices. Eventually, loans repriced to fundamentals and returned 52% in 2009 4. Currently, the loan market is less levered than it was in 2007, especially since most of the mark-to-market vehicles were liquidated in 2008. Therefore, loan pricing should be driven more by fundamentals than technicals going forward and volatility should revert closer to its historical averages. We believe the importance of credit analysis and selection will drive outperformance in the nearterm. Conclusion Leveraged loans have developed into an institutionally accepted asset class because of their competitive absolute returns and superior risk-adjusted returns. Given the maturity and depth as well as the unique investment attributes of this asset class, we believe investors should look at this asset class as a core allocation. The floating rate nature provides a natural hedge against rising interest rates, while the seniority, security, and protective covenants help mitigate credit risk. Moreover, these investment characteristics can improve efficiency and mitigate risks within traditional fixed income and equity portfolios. Investing in leveraged loans should be considered as part of a duration-hedging strategy, especially in light of the meaningful, stable income that the asset class provides. Given the uncertain timing about rate movements, the relatively high coupon on loans helps this asset remain competitive while rates remain low. For more information, please contact: Nicholas G. Keyes, CFA, CAIA Director of Business Development nicholas.keyes@shenkmancapital.com Kim I. Hekking Director of Client Services kim.hekking@shenkmancapital.com marketing@shenkmancapital.com +1 (203) 348-3500 4 Returns based on the S&P/LSTA Leveraged Loan Index 12

Disclaimers and Notes 1. The information and opinions expressed in this paper are for educational purposes only. The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services or an offer to sell or a solicitation to buy any securities. This paper, including the information contained herein, may not be copied, republished or posted in whole or in part, without the prior written consent of Shenkman Capital. 2. Shenkman Capital is the marketing name for Shenkman Capital Management, Inc. and Shenkman Capital Management Ltd. Shenkman Capital Management, Inc. is registered as an investment adviser with the U.S. Securities and Exchange Commission. Shenkman Capital Management Ltd, a wholly-owned subsidiary of Shenkman Capital Management, Inc., is an appointed representative of International Asset Management Ltd which is authorized and regulated by the U.K. Financial Services Authority. This material is provided to you because you have been classified as a professional client or eligible counterparty by Shenkman Capital Management Ltd as defined under the U.K. Financial Services Authority s rules. If you are unsure about your classification, or believe that you may be a retail client under these rules, please contact Shenkman Capital Management Ltd and disregard this information. 3. The Credit Suisse Leveraged Loan Index is designed to mirror the investable universe of the U.S. dollar-denominated leveraged loan market. The S&P/LSTA Leveraged Loan Index is a daily total return index that tracks the current outstanding balance and spread over LIBOR for fully funded term loans. The facilities included in the S&P/LSTA Leveraged Loan Index represent a broad cross section of leveraged loans syndicated in the United States, including dollar-denominated loans to overseas issuers. The BofA Merrill Lynch High Yield Master II Index (H0A0) tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. The BofA Merrill Lynch US Corporate Index (C0A0) tracks the performance of U.S. dollar denominated investment grade corporate debt publicly issued in the U.S. domestic market. The BofA Merrill Lynch All U.S. Convertibles ex. Mandatory Index (V0A0) is representative of a broad convertible market. These indices are unmanaged, not available for direct investment and do not reflect deductions for fees or expenses. 4. Third-party information contained this presentation was obtained from sources that Shenkman Capital Management, Inc. considers to be reliable; however, no representation is made as to, and no responsibility, warranty or liability is accepted for, the accuracy or completeness of such information. SHENKMAN CAPITAL YIELDING RESULTS SINCE 1985 TM 13