Opportunities in the US Loan Market Today Moderator: Panelists: Bram Smith, LSTA Scott Baskind, Invesco Chris D Auria, LCM Dan McMullen, GSO Steven Oh, Pinebridge John Popp, Credit Suisse Asset Management Tokyo - June 6, 2017
Agenda 1. How to Invest in Loans 2. Compelling Relative Value Returns Yield Spread Price 3. Loans as a Permanent Part of a Fixed Income Portfolio 4. A Look Forward 2
Breakdown of US Fixed Income Asset Class (as of 12/31/16) US Fixed Income Universe ($40.3 Trillion) US Corp. Debt Universe ($9.5 Trillion) Muncipal $3,834B 10% Fed Agencies $1,972B 5% Money Market $885B 2% Asset-Backed $1,330B 3% Inst. Lev. Loans $962B 2% Inst. Lev. Loans $962B Mortgage Related $8,916B 22% HY Bonds $1,565B 4% HG Bonds $6,952B 17% HG Bonds $6,952B HY Bonds $1,565B Treasury $13,908B 35% Source: Credit Suisse 3
Institutions in 59 Countries and Regions Worldwide Invest in the Corporate Loan Market 4
How to Invest in Loans
How to Invest in the Loan Market Separately Managed Accounts Customized Large Investment Liquidity Comingled Current Income Medium Investment Size Liquidity CLO s Structured Vehicle Different Risk Tranches Floating Rate Notes vs. Equity Primary vs. Secondary Loan Mutual Funds Retail Funds/ETF Small Investment Size Small Institutions/Pensions Insurance Companies High Current Income Capital Preservation Daily Liquidity 6
Comparison of Various Ways to Invest in Loans Retail Comingled Separate Managed Accounts CLO Note CLO Equity Return vs. Index Peer Comp Bench Marked Bench Marked Coupon Mark to Model Redemption Features High Medium Portfolio Liquidation Secondary Market Sale Secondary Market Sale Risk Profile Moderate Moderate Moderate Full Range Aggressive Capital Protection No No No Yes 1 st Loss Tenor Daily 3 months to 1 year Investor Option 10-12 years 12 years Customization None Limited High None Limited Investment Features $ $$ $$$ $$ $$ Leverage Limited Up to 3X Investor Option Yes Yes Hedged Available Available Available No No Mark-to-Market Accounting NAV NAV Varies Market Value Market Value Expense Load High Modest Low Modest High Communication with Managers Quarterly Quarterly Active Limited Monthly 7
Compelling Relative Value to Other Fixed Income Assets
Returns for Selected Debt and Equity Assets Over the Last 10 Years* 20% 15% 10% 5% 0% S&P/LSTA Index ML US High Yield ML US Corp ML 10yr US Treasury S&P 500-5% -10% 1 year 3 year 5 year 10 year Source: S&P Capital IQ 9 * As of March 2017
Loans and High Yield Bonds: Distribution of Quarterly Total Returns: 1992 - Q1 2017 40 35 30 # of Quarters Observed 25 20 15 High Yield Returns have been negative for 24% of quarters since 1992. Loan Returns have been positive in 86% of quarters since 1992. 10 5 0 < -5% -5 to -4% -4 to -3% -3 to -2% -2 to -1% -1 to 0% 0 to 1% 1% to 2%2% to 3%3% to 4%4% to 5% >5% Loans High Yield Source: Zephyr, 3/31/17. Data provided is for informational use only. Loan performance is represented by the Credit Suisse Leveraged Loan Index.
Comparison of Loans, High Yield Bonds and Investment Grade Bond Credit Spreads High Yield Corporate Loans Investment Grade Corporate 1000 Current 1-Mo. ago 12-Mo. ago Median HY Corporate 381 392 597 569 Loans 420 438 573 567 IG Corporate 116 118 149 153 Basis Points 500 0 '10 '11 '12 '13 '14 '15 '16 '17 Source: Bloomberg Barclays, BofA/Merrill Lynch, LCD as of 4/30/17. Data provided is for informational use only. Past performance is no guarantee of future results. See end of report for important additional information. Corporate spreads are in basis points and measure optionadjusted yield spread relative to comparable maturity U.S. Treasuries. Loan Index spread represents the three-year discounted spread over LIBOR.
Position in the Capital Structure Generates Better Credit Outcomes for Leveraged Loans Seniority and security offer meaningful downside protection. Average annual default rates 1 1998 2016 Average recovery rates 2 1998 2016 Average annual principal loss rates 3 1998 2016 4% 80% 3% 3.34% 3.29% 65.70% 3% 60% 2.12% 98 bps 2% 2% 40% 39.65% 1.14% 1% 1% 20% 0% Leveraged Loans High Yield Bonds 0% Leveraged Loans High Yield Bonds 0% Leveraged Loans High Yield Bonds 1.JP Morgan par-weighted high yield bond default rates and S&P/LCD par-weighted loan default rates. 2.JP Morgan Default Monitor, 4Q 2014. Average issue-weighted recovery rates based on price 30 days after default date. 2009 Adjusted recoveries are based on year-end prices. 3.Calculated by multiplying Average Annual Default Rate by 1 minus Average Recovery Rate. Source: JPMorgan 12
Relative Attractiveness of Senior Secured Loans 10 9 8 7 6 5 4 3 2 1 0 Market yields (%) and duration (years) 1 8.69 7.13 5.76 4.75 3.14 1.82 2.28 0.25 5Y Treasury 10Y Treasury Barclays IG S&P/LSTA Leveraged Yield Duration Loan Index Relative yield 2 6.05 3.54 JPM US HY $ Price Yield to Worst Spread to Worst At Forward Libor Duration (Years) 5 Year Treasuries 100-09 1.82% 4.75 10 Year Treasuries 99-23 2.28% 8.69 Bloomberg Barclays US Agg 103.20 2.53% T + 0.61 5.96 Bloomberg Barclays IG 104.87 3.14% T + 1.13 7.13 JPM US HY Index 102.47 6.05% T + 4.45 3.54 S&P LSTA Lev Loan Index 98.34 L+4.20% T+ 4.32 5.76% 90 Days Source: 1 Bloomberg LP, as of 4/30/17. 2 S&P s LCD, Bloomberg LP and Bloomberg Barclays 4/30/17. 13
Comparison of the 10 Year Treasury Yields and 3-Month LIBOR for the Past 20 Years 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 10-Year Treas. 3-Mo.LIBOR Source: Federal Reserve 14
Loans are a Permanent Part of a Fixed Income Portfolio
Loans vs. Common Fixed Income Investments 8% Short Duration Long Duration Yield to Maturity 7% 6% 5% 4% 3% 2% Floating Rate Loans 3-month US Treasury Bill Bellwether Barclays High Yield Bonds Index Barclays US Aggregated Index Barclays Investment Grade Bonds Index Barclays Government Bonds Barclays Muni Bond Index 1% 0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 Duration in Years Source: Barclays 16
Asset Class Correlations January 1997 March 2017 Leveraged Loans High Yield Bonds 10-Year Treasury S&P 500 High Grade Corporate Leveraged Loans 1.00 High Yield Bonds 0.77 1.00 10-Year Treasury -0.35-0.51 1.00 S&P 500 0.43 0.62-0.26 1.00 High Grade Corporate 0.35 0.55 0.62 0.22 1.00 Source: S&P LCD, Bloomberg, Bank of America Merrill Lynch, Credit Suisse Data from Jan. 1997 to April 2017 17
Loans Have Exhibited Higher Risk Adjusted Returns Volatility of monthly returns for loans has been more muted than other fixed rate asset classes over the previous 5 years. Loans have outperformed high yield bonds on a risk adjusted basis over that time but absolute returns have trailed. The average annual volatility for the JPM Leveraged Loan Index over the last 5 years (2.5%) has been significantly less than the JPM High Yield Bond index (5.6%) and the JPM US Aggregate Bond Index (3.4%). Annualized 5Yr Returns, Volatility, and Sharpe Ratio Annualized Data 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 7.6% 2.2 5.5% 5.6% 1.4 3.4% 2.5% 2.8% 0.8 JPM Leveraged Loans JPM US HY Bonds JPM US Aggregate Bonds 2.50 2.00 1.50 1.00 0.50 0.00 Sharpe Ratio 5yr Annualized Return 5yr Annualized Volatility 5yr Sharpe Ratio Source: JPM Leveraged loan Index, JPM US HY Bond Index & JPM US Aggregate Bond Index as of 03/31/17. Past performance is not a guarantee of future results. An investment cannot be made in an index. Updated quarterly. 18
A Look Forward
The Implied Forward Markets Are Predicting Several More Rate Hikes in the Immediate Future Historical Rates & Implied Forward Rates 800% 700% 600% 500% 400% 300% 200% 100% 3-Mo.LIBOR 3-MO LIBOR Forward Rates 10-Year Treas. 10YR Treas. Forward Rates 0% May-97 May-99 May-01 May-03 May-05 May-07 May-09 May-11 May-13 May-15 May-17 May-19 May-21 Source: Federal Reserve 20
Senior Loans Have Outperformed Bonds in Flat and Rising Rate Periods 98 Rising Rate Periods 99 Falling Rate Periods Bonds Outperformed Senior Loans Outperformed Average 1-Yr Returns: Loans: 6.7% Bonds: 4.0% Average 1-Yr Returns: Loans: 2.8% Bonds: 7.7% 91 Flat Rate Periods Average 1-Yr Returns: Loans: 8.4% Bonds: 5.4% Source: Credit Suisse. Barclays. Data as of 12/31/16. Analysis includes all rolling one-year periods since inception of the Credit Suisse Leveraged Loan Index in Feb. 1992. Historical performance indications and financial market scenarios are no reliable indicators of future performance.
Impact of Duration on Fixed Income Asset Returns During a Rapid Rate Increase CS Lev. Loan Index Barclays Intermediate Term Treasury Barclays High Yield Barclays US Agg Barclays Global Agg Barclays Corp Barclays EM Debt USD Barclays Long Term Treasury Return -0.25% Duration 0.25 Return -2.46% Duration 3.65 Return -3.23% Duration 4.28 Return -4.30% Duration 5.63 Return -5.26% Duration 6.25 Return -5.90% Duration 6.74 Return -7.10% Duration 5.69 Return - 11.78% Duration 16.19 3.0% 2.8% 2.5% 2.3% 2.0% 1.8% 1.5% 1.3% 1.0% 10-Year Treasury May 1, 2013 May 6, 2013 May 11, 2013 May 16, 2013 May 21, 2013 May 26, 2013 May 31, 2013 June 5, 2013 June 10, 2013 June 15, 2013 June 20, 2013 June 25, 2013 June 30, 2013 July 5, 2013 July 10, 2013 July 15, 2013 July 20, 2013 July 25, 2013 July 30, 2013 Source: Federal Reserve/Credit Suisse 22
Summary Why Loans and Why Now? Good Economy Mediocre Economy Recessionary Economy 23