High Yield Hans Stoter Head of Credit Investments ING Investment Management LarrainVial Seminario Mercados Globales - Ideas 2010 Santiago, Lima May 11 13, 2010
What is High Yield Corporate debt with rating below investment grade Investment Grade High Yield Moody's S&P Aaa AAA Aa1 AA+ Aa2 AA Aa3 AA- A1 A+ A2 A A3 A- Baa1 BBB+ Baa2 BBB Baa3 BBB- Ba1 BB+ Ba2 BB Ba3 BB- B1 B+ B2 B B3 B- Caa1 CCC+ Caa2 CCC Caa3 CCC- Ca CC C C WR D More risky Higher default probability weak business model, OR high debt level relative to cash flow Lower recovery rate higher debt level vs. value of assets subordination But also High spread relative to government bonds and investment grade credits Upside potential due to credit profile improvement Stronger protection from documentation ING Investment Management 2
High Yield returns 2009 and 2010 ytd Strong rebound of credit bond markets recouping losses of 2008 2009 (Jan-Dec) Total Returns (% in local currency) 2010 (Jan-April) Total Returns (% in local currency) 70% 9% 60% 8% 50% 7% 40% 30% 6% 5% 4% 20% 3% 10% 2% 0% 1% -10% Eur HY (ex subfin) US HY (ex subfin) MSCI Europe EMD HC S&P500 US High Grade Euro High Grade Euro Gov. Bonds (AAA) US Treasury 0% Eur HY (ex subfin) S&P500 US HY (ex subfin) EMD HC US High Grade Euro High Grade Euro Gov. Bonds (AAA) MSCI Europe US Treasury 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% 1983 1984 1985 1986 1987 1988 1989 1990 1991 Annual Total Return (lhs) US HY Index returns 1992 1993 1994 1995 1996 1997 1998 1999 ING Investment Management 3 Cumulative returns (rhs) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1,200 1,100 1,000 900 800 700 600 500 400 300 200 100
High Yield Drivers of HY returns DRIVER IMPACT HY MARKET HY OUTLOOK Macro Outlook Fundamental Outlook Technical Outlook Valuation Macro environment supportive for HY issuers? How is the financial health of HY issuers expected to develop? Supply/Demand, Investor Sentiment? Are investors compensated for risk and which segments offer most value? Allocation to HY and HY portfolio positioning by HY managers 3 key questions: What is going on in the world What does that mean for me (my asset class, my sectors, etc) Given this, how can I make money ING Investment Management 4
Macro Outlook Base case economic forecast is supportive for credits. ING IM Global Economic Outlook Moderate economic growth (1-3%) historically has been positive for credit returns. Increase in spend by corporates, and consumer demand surprising on the positive. Real GDP Inflation Policy Rates (%, YE) 2009 2010 2011 2009 2010 2011 2009 2010 2011 World -0,7 4,6 = 3,9 = 1,6 3,2 = 2,7 = Developed -3,4 2,3 = 2,0 = -0,2 1,1 = 0,9 = 0,45 0,54 = 1,54 = US -2,4 3,2 = 2,5 = -0,5 1,6 = 1,1 = 0,13 0,25 = 1,50 = Euro -3,7 1,3 = 1,5 = 0,3 1,1 = 1,2 = 1,00 1,00 = 2,00 = Japan -5,2 2,2 = 1,3 = -1,4-1,1 = -0,6 = 0,10 0,10 = 0,10 = UK -4,4 1,5 = 2,1 = 2,0 1,8 = 1,5 = 0,50 1,00 = 2,50 = Emerging 2,8 7,5 = 6,3 = 4,0 6,0 = 4,9 = China 8,5 10,4 = 8,5 = -0,7 4,7 = 3,9 = Unemployment rate Budget balance Current account 2009 2010 2011 2009 2010 2011 2009 2010 2011 Monetary policy likely to remain accommodative. Fiscal stimulus is important to keep GDP above zero, although increased focus on budget deficits poses a risk. Developed 8,9 8,7 = 7,9 = -8,7-9,1 = -8,2 = -1,3-1,4 - -1,3 - US 10,0 9,2 = 8,5 = -10,0-10,3 = -9,3 = -2,9-3,3 = -3,3 = Euro 9,4 10,0 = 9,0 = -6,3-7,1 = -6,3 = -0,6-0,4 = -0,2 = Japan 5,2 4,8 = 4,5 = -8,3-8,2 = -8,2 = 2,6 2,8 = 2,8 = UK 6,4 6,5 = 6,0 = -12,1-12,4 + -10,3 = -2,0-1,8 = -1,3 = Emerging China 9,6 9,4 = 9,3 = -2,9-2,8 = -2,2 = 5,8 5,0 = 4,5 = Source: Forecasts from ING IM, historical data from IMF (GDP, inflation) and Economist Inteligence Unit (rest data) ING Investment Management 5
Fundamental Outlook Companies now in Recovery phase. They continue to work on margin improvement through cost reduction, while refinancing debt to longer maturities and reducing the dependency on banks. Limited new debt is being raised to fund capex or M&A. 2010 default rate expected to be 2-4% (from 12% in 2009). Repair Credit better than Equity Low Growth Both Equity and Credit DOWN Downturn Leverage falling Debt-Equity Clock Leverage rising Recovery Both Equity and Credit UP High Growth Equity better than Credit Expansion ING Investment Management 6
Fundamental improvements acknowledged by Rating Agencies Upgrades have exceeded downgrades for the past eight months as a result of improved operating results and debt reduction. Also the downgrades of Investment Grade companies to High Yield has stopped, and is expected to reverse going into 2011. ING Investment Management 7
Technical Outlook Demand for High Yield remains high Global Risk Appetite Index After a brief period of outflows in mid-february, HY mutual funds are again seeing inflows. The flow of institutional money into the asset class remains robust as low interest rates and fear of equity market volatility have pushed investors out of money markets into higher yielding credit classes. This steady inflow of funds has kept asset managers looking for attractive secondary offers and new issues. ING Investment Management 8
Technical Outlook - New issue activity remains robust Companies are taking advantage of the appetite for new bonds in the credit markets by actively refinancing near-term maturity debt with new, 7-10 year maturity bonds. Especially High Yield issuers continue to raise capital at a rapid pace, using debt proceeds to refinance existing debt, and equity proceeds to de-leverage their balance sheets. ING Investment Management 9
Valuation - High Yield still attractive given lack of options Next 12 months HY Return Forecast # Carry yield 8.0% Losses from Defaults Defaults 3% Recovery rate 30% Loss -2.1% Spread tightening 3% Exp. Change -0.5% Duration 4 Performance 2.0% Forecasted total return to May 2011 7-8% # assuming no large back-up in government bond yields Based on 70% US HY & 30% Pan-Eur HY excl. sub fin, 2% cap Further spread tightening is expected, based on strongly improving fundamentals and low default rates, supportive macro-economics and solid demand for HY bonds, leading to an attractive next 12 month return forecast of 7-8% (assuming no large back up in Government bond yields) ING Investment Management 10
Valuation - Longer term valuation HY appealing Global High Yield (ex sub financials): Buy-and-Hold excess return calculation MARKET DATA* (30 Apr 2010) ASSUMPTIONS purchase price 99.7% cpn loss on defaulted 100% coupon 8.1% recovery rate 30% 5yr gov. bond rate 2.3% default defaulted pri recovery pool cf cf cf cum def promised year % amount amount surviver principal coupon expected rate yield 0 100.0 (99.7) (99.7) (99.7) 1 3.0% 3.0 0.9 97.0 7.9 8.8 3.0% 8.1 2 3.0% 2.9 0.9 94.1 7.6 8.5 5.9% 8.1 3 3.0% 2.8 0.8 91.3 7.4 8.2 8.7% 8.1 4 3.0% 2.7 0.8 88.5 7.2 8.0 11.5% 8.1 5 3.0% 2.7 0.8 85.9 85.9 7.0 93.6 14.1% 108.1 5.8% IRR 8.2% IRR 2.3% Govt Bond Return 3.5% Excess Return *) 70% US HY & 30% Pan-Eur HY excl. subordinated financials, 2% capped Despite the strong rally in High Yield bonds, the asset class still offers value compared to other fixed income asset classes. At a 3% annual default rate, High Yield bonds stand to outperform government bonds by 3.5% a year, making longer term valuations still appealing. Break-even default rate is at 7.5% per annum (=5-yr cumulative default rate of 32%). ING Investment Management 11
Main Risks Double dip Depends on pressure to reduce deficits by cutting spending before earning revenues from economic growth Countries with likely political regime shift at risk, e.g. UK Greece (and the like) Companies that do operate in these countries face increased scrutiny and are expected to pay up over the elevated sovereign spread level There may be spillover effects for countries and, inevitably, the companies operating in these countries Especially companies that have their business tied to local GDP will be affected (banks, utility, telco) Limited exposure of HY issuers to 2 weakest economies, Greece and Portugal. Rate hikes HY bonds are relatively rate insensitive as spread is largest contributor to yield However IG and XO names more sensitive to rate changes, also equity markets can react negatively Impact on asset allocation likely for IGC but limited on HY: technical environment to remain positive for HY market as benign corporate fundamentals underpin a continued search for yield Primary market issuance The markets have not gone mad, not every new issue is readily absorbed Equity stories priced at bond levels are filtered out. Structure deficiencies are recognized and need to come at a premium. The markets still expect to see a new issue premium. New theme of HY senior secured new issuance with security package identical to that of senior bank financiers ING Investment Management 12
Conclusions The Global Market Environment is still positive on improving parameters like liquidity and supportive low interest rates Euro sovereign defaults unlikely in the next few years. Spreads offer good value, but risk of another Greece calls for caution. We remain overweight spread assets: For the remainder of 2010, we expect attractive returns for the various Credit asset classes Base case economic forecast is supportive Credit fundamentals continue to improve Demand for High Yield likely to remain high given low yields on other fixed income asset classes There are risks: Double dip possible in specific countries Greek disease could be contagious Rising interest rates risk ING Investment Management 13
Certain of the statements contained herein are statements of future expectations and other forward-looking statements. These expectations are based on management's current views and assumptions and involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those in such statements due to, among other things, (i) general economic conditions, in particular economic conditions in ING s core markets, (ii) performance of financial markets, including emerging markets, (iii) the frequency and severity of insured loss events, (iv) mortality and morbidity levels and trends, (v) persistency levels, (vi) interest rate levels, (vii) currency exchange rates (viii) general competitive factors, (ix) changes in laws and regulations, (x) changes in the policies of governments and/or regulatory authorities. ING assumes no obligation to update any forward-looking information contained in this document. www.ing.com ING Investment Management 14