Navigating the Credit Cycle Dan Henken, CFA - Portfolio Manager - Technology Media & Telecom Analyst John Leiviska, CFA - Minnesota Life Portfolio Manager Tom Houghton, CFA - Total Return Portfolio Manager June 15, 2017 www.advantuscapital.com
The only person who sticks closer to you in adversity than a friend is a creditor. - Anonymous
Overview DEFINE OUR PERSPECTIVE CURRENT STATE APPROACH 3
What is a Credit Cycle? A credit cycle is a cycle involving the access to credit by borrowers. Credit cycles first go through periods in which funds are easy to borrow; these periods are characterized by lower interest rates, lowered lending requirements and an increase in the amount of available credit. These periods are followed by a contraction in the availability of funds. During the contraction period, interest rates climb and lending rules become more strict, meaning that less people can borrow. The contraction period continues until risks are reduced for the lending institutions, at which point the cycle starts again. Source: Investopedia. 4
The Four Phase Credit Cycle GROWTH Recovery Repair Expansion Downturn RISK APPETITE Source: Advantus Capital Management. 5
Advantus Perspective Percent of GDP 26 25 24 23 22 Latin American Debt Crisis ('81) Japanese Banking Crisis ('91) Global Savings Asian Contagion ('97) Russia Default ('98) Technology Bubble ('00) Global Housing Bubble ('08) Financial Crisis ('09) 21 20 1980 1985 1990 1995 2000 2005 2010 2015 2020 Source: International Monetary Fund and Advantus Capital Management. 6
Economic Growth Credit Growth Monetary Policy Inflation Volatility Risk Appetite Liquidity Yield Curve Fundamentals Asset Valuations Credit vs. Equity DOWNTURN REPAIR RECOVERY EXPANSION CURRENT Steepening Steep Flattening Flat/Invert Flattening Both Down Credit Biased Both Up Equity Preferred Both Up Source: Advantus Capital Management. 7
Economic Growth U.S. Real GDP Percent of GDP 10 8 6 4 2 0-2 -4-6 -8-10 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 Source: Bloomberg. 8
Credit Growth Investment Grade and High Yield $1,600 US Corporate Bond Issuance* $1,400 USD, Billions $1,200 $1,000 $800 $600 $400 $200 $0 Source: Thomson Reuters. * Includes all non-convertible corporate debt, MTNs and Yankee bonds. Excludes all issues with maturities of one year or less and CDs. 9
Monetary Policy Federal Funds Target Rate 22 18 14 Percent 10 6 2-2 Source: Bloomberg. 10
Risk Appetite US Aggregate Corporate Average OAS 600 500 Basis Points 400 300 200 100 0 Source: Bloomberg. 11
Inflation Consumer Price Index 0.7 0.6 0.5 0.4 Percent 0.3 0.2 0.1 0-0.1-0.2 Source: FactSet. Excludes Food and Energy. 12
Volatility VIX Index 45 40 35 30 25 20 15 10 5 Source: Bloomberg. 13
Yield Curve 3.5 0.90 3.0 0.85 2.5 0.80 Yield 2.0 1.5 0.75 0.70 30-10 Year 1.0 0.65 0.5 0.60 0.0 0.55 May-16 Aug-16 Nov-16 Feb-17 May-17 30 Year Yield 10 Year Yield 30 Year - 10 Year Source: Bloomberg. 14
Fundamentals 6.0x Leverage Trends by Rating Class 30% EBITDA Margin Trends by Rating Class 4.0x 25% 20% 2.0x 15% 10% 0.0x A BBB BB B 5% A BBB BB B Aug-14 Jan-15 Jun-15 No-15 Jun-16 Nov-16 Aug-14 Jan-15 Jun-15 No-15 Jun-16 Nov-16 10% Default Rates $120 Trailing 12M Earnings per Share 8% 6% 4% 2% 0% $100 $80 $60 $40 $20 $- Source: Bloomberg. 15
Insurance Approach
Cumulative Issuer-Weighted Global Default Rates 1920-2016* 40 5-Year Holding Period by Rating 35 30 Percent 25 20 15 10 5 0 Aaa Aa A Baa Ba B Caa-C Source: Moody s. 17
Risk-Adjusted Return 0.90 0.80 Return / Standard Deviation 0.70 0.60 0.50 0.40 0.30 0.20 0.10 0.00 Barclays Baa Corporate Index Barclays Ba U.S. High Yield Index Barclays B U.S. High Yield Index Barclays Caa U.S. High Yield Index Barclays High Yield Time period: 1/31/05 through 12/31/16. Source: Barclays. 18
Efficient Frontier Framework 8.00% Barclays Ba U.S. High Yield Index Annual Return 7.50% 7.00% 6.50% 6.00% 5.50% 5.00% Barclays Baa Corporate Index Barclays U.S. High Yield Barclays B U.S. High Yield Index Barclays Caa U.S. High Yield Index 4.50% 4.00% Barclays A Corporate Index Barclays Aa Corporate Index 3.50% 3.00% 3.00% 5.00% 7.00% 9.00% 11.00% 13.00% 15.00% 17.00% Standard Deviation Time period: 1/31/05 through 12/31/16. Source: Barclays. 19
Total Return Approach
Total Return Approach Strategic Credit Income Strategy Multiple sector strategy Corporates investment grade and high yield, domestic and international (including emerging markets) Structured securities ABS, MBS (including credit risk transfer) Bank loans Preferred Municipals Relatively more defensive interest rate positioning Exploits Advantus bottom-up, actively managed total return approach 21
10-Year Treasury Rates Hovering Near All-time Lows 16 14 12 10 Yield 8 6 4 2 0 Source: Bloomberg. 22
International Opportunities Finding Different Stages of the Credit Cycle Multinational Companies Geographic revenue diversification More representative of the global supply chain Emerging Market Debt Potential for improving economic fundamentals Alternative to domestic high-yield European Corporate Debt Earlier stage of the credit cycle Supportive policy backdrop from the European Central Bank 23
Capital Structure Matters Average Corporate Debt Recovery Rates Measured by Trading Prices Issuer-weighted Recoveries Volume-weighted Recoveries Lien Position 2016 2015 1983-2016 2016 2015 1983-2016 1 st Lien Bank Loan 75.0% 64.1% 66.9% 78.0% 53.6% 62.9% 2 nd Lien Bank Loan 22.5% 25.1% 31.3% 22.5% 20.4% 27.3% Sr. Unsecured Bank Loan N/A N/A 46.4% N/A N/A 40.2% 1 st Lien Bond 43.4% 54.8% 52.8% 36.4% 58.7% 52.7% 2 nd Lien Bond 34.1% 25.3% 44.6% 35.8% 20.6% 44.1% Sr. Unsecured Bond 31.3% 37.6% 37.2% 26.3% 33.1% 33.1% Sr. Subordinated Bond 36.7% 36.6% 31.1% 56.1% 20.3% 26.2% Subordinated Bond 24.5% 58.5% 31.9% 24.5% 56.8% 27.1% Jr. Subordinated Bond 0.6% 14.0% 23.2% 0.6% 14.0% 14.2% Source: Moody s. 24
Credit Risk Transfer Securities Securitized Assets 8 7 6 5 Yield 4 3 2 1 0 Credit Risk Transfer 2015 - Non-rated U.S. Corporate High Yield - Yield to Worst Source: Bloomberg. As of 5/23/17. 25
Questions?
Disclosures The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. The information presented in this article has been developed internally and/or obtained from sources believed to be reliable; however, Advantus does not guarantee the accuracy, adequacy or completeness of such information. Predictions, opinions, and other information contained in this article are subject to change continually and without notice of any kind and may no longer be true after the date indicated. Any forward-looking statements speak only as of the date they are made, and Advantus assumes no duty to and does not undertake to update forward-looking statements. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Actual results could differ materially from those anticipated. Advantus Capital Management, Inc. is a subsidiary of Securian Financial Group, Inc. For Institutional Investment Use Only. www.advantuscapital.com 2017 Advantus Capital Management, Inc. All rights reserved. DOFU 6-2017 190195 27