Credit Markets: What’s Next? Mark Attanasio Co-Founder and Managing Partner, Crescent Capital Group Richard Cantor Chief Risk Officer Moody's Corporation Joshua Friedman Co-Founder, Co-Chairman and Co-CEO, Canyon Partners, LLC Mark Rowan Co-Founder and Senior Managing Director, Apollo Global Management Steve Tananbaum Managing Partner and CIO, GoldenTree Asset Management David Warren Chief Investment Officer, Brevan Howard Credit Catalysts Fund Michael Milken Chairman, Milken Institute
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Credit Markets: What’s Next?
Mark Attanasio Co-Founder and Managing Partner, Crescent Capital
Group
Richard Cantor Chief Risk Officer
Moody's Corporation
Joshua Friedman Co-Founder, Co-Chairman
and Co-CEO, Canyon Partners, LLC
Mark Rowan Co-Founder and Senior Managing Director, Apollo
Global Management
Steve Tananbaum Managing Partner and CIO,
GoldenTree Asset Management
David Warren Chief Investment Officer,
Brevan Howard Credit Catalysts Fund
Michael Milken Chairman, Milken
Institute
Richard Cantor
SG Default Rate Follows HY Spread + Changes in Unemployment Unemployment outlook, liquidity, and covenant cushions imply default rate spike unlikely
* Rapid Migration Rates are defined as the share of investment-grade issuers downgraded by at least 5 rating notches in 12 months. Source: Moody’s Investors Service
China’s GDP Growth Rate Has Been Falling
Source: Haver, BIS, IMF
120
130
140
150
160
170
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190
200
40
41
42
43
44
45
46
47
48
49
2006 2008 2010 2012
Investment/GDP (left scale, pp)
Credit-To-GDP (right scale, pp)
Despite a High and Rising Investment Rate Funded by a Rising Debt Ratio
40
41
42
43
44
45
46
47
48
49
7
8
9
10
11
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15
2006 2008 2010 2012
GDP Growth (left scale, pp)
Investment/GDP (right scale,pp)
Managing the Deleveraging Process Will Be Challenging Losses will likely hit private investors, bank profits, and the public sector
Source: BIS, IMF, WIND, Moody’s Investors Service
0
10
20
30
40
50
60
China (2012)
US (2009) Japan (1990)
Korea (1998)
5-Year Change in Credit/GDP, pp
0
1
2
3
4
5
6
Cumulative Growth in Trust Liabilities since 2007, in trillions of RMB
Steve Tananbaum
5.2% 7.4% 5.9%
Historical Default Rates for HY Bonds
After 3 Years of Low Defaults
Source: Moody’s Global Speculative Grade Default Rates
0%
2%
4%
6%
8%
10%
12%
14%
16%
Global Speculative Grade Default Rates
Historical
Average
4.4%
Average Default Rate 5 years after period of defaults lower than Historical Average
Loans Attractive Vs. Bonds
Source: JP Morgan as of April 17, 2014. JPM Leveraged Loan Index vs. JPM HY Domestic Bond Index. Yields are defined as yield to worst for bonds and yield to maturity for loans
High Yield Bond YTW vs. Leveraged Loan YTM
The yield differential between high yield bonds and loans has narrowed materially
-100 bps
0 bps
100 bps
200 bps
300 bps
400 bps
500 bps
600 bps
700 bps
Yield Implied Zero Spread
Default Rate
HY Domestic Bonds 5.33% 5.32%
Leveraged Loans 5.81% 13.83%
Historical
Average
150 bps
April 17th
-48bps
Difference in Yields1
Emerging Market vs. Developing Economies
Source: Merrill Lynch HY Bond Index; JPM Leveraged Loan Index; GoldenTree estimates
Returns Vs. Defaults
Current Spread
Default Rate
Loss Severity
Loss Adjusted Spread
HY Bonds Leveraged Loans Student Loans
Senior Debt AAA CLOs
373 bps 415 bps 175 bps 155 bps
5.0% 5.0% 0% 0%
70% 30% n/a n/a
23 bps 265 bps 175 bps 155 bps
Expected Losses
350 bps 150 bps NM NM
European Sourcing Opportunity
1. Source: RBS Macro Credit Research, September 2013 2. Source: RBS Macro Credit Research, The Revolver January 23, 2014 – European Banks: Still Too Big To Fail 3. Source: Morgan Stanley Research, Earnings reports as of April 1, 2013
646% 556% 513%
411% 312% 292% 265% 217% 200% 189%
84%
Europe’s Banks
Are Still Too Large
Banking System Assets Relative to GDP1 European Banks Remain Overleveraged and we expect continued
deleveraging driven by Higher Capital Needs, EU State Aid Requirement, Funding Cost, Capital Markets Pressure
– Basel III in full effect over the next 5 years
– Asset Quality Review (AQR) & stress tests in 2014
– Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) phasing in over next few years
€2.9 trillion further deleveraging (3–5 years)1 through equity raise (if able), liability management, retained earnings, run-off, divestures
-200
-150
-100
-50
0
European Bank Assets to Be Cut2
Reduction in Assets Needed for Banks to
meet Capital and Leverage shortfalls
345.8
222.4
3Q 2011 4Q 2012
European Bank Structured Product Exposure3
Structured Products’
Holding Still Significant
January 2013: Spanish Regional Debt
Source: S&P, Morgan Stanley, Bank of Spain, Barclays. Spain Ministry of Finance and Public Administration 1. North Rhone Westphalia, the largest state within Germany. 2. Data for New York is USD for GDP, Debt and Revenue statistics. 3. Spread over respective 10 year sovereign bond. 4. GDP data as of 3Q 2012.
Investment Thesis
Macro uncertainty at the sovereign level often leads to volatility in asset prices of any debt with quasi-sovereign risk
Pockets of opportunity exist in risk that is better protected than the underlying sovereign credit, often rated higher and trading at a discount
One such opportunity is the relative value in certain Spanish Regional Debt where investors are still worried about the creditworthiness of Spain
Some regions have credit ratings 2 notches better than the sovereign
Regional debt is available with less than half debt/revenue ratios of Germany and US peers and better debt/revenue ratios than Italian peers
Spanish regions have a constitutional priority to service debt over all other expenditures
Range of Regional Debt Statistics
Spain: Madrid
Spain: Castilla y
Leon
Germany: NRW1
Italy: Lazio
US: New York2
GDP (€bn) 185 58 568 177 1,159.5
Debt (€bn) 15.4 5.5 141.9 12.4 188.4
Revenues (€bn) 24.2 7.6 49.8 15.2 47.1
Debt/Revenue (%) 64 72 284 81 400
Spread (bps)3 400 610 40 160 58
Range of Regional Debt Statistics4
Germany US Italy France Spain
Household Debt/GDP 59% 81% 51% 67% 86%
Financial Debt/GDP 99% 87% 107% 174% 115%
Non-financial Debt/GDP 95% 77% 115% 158% 181%
Sovereign Debt/GDP 82% 90% 127% 90% 77%
Total Debt/GDP 335% 336% 400% 487% 460%
Gazprom
Gazprom is the world’s largest natural gas producer. It owns and controls the gas pipeline
infrastructure in Russia, is 50.01% state-owned and has a monopoly on Russian gas exports.
Characteristics
Security Senior Unsecured Bond
4.95% 2022
Asset Type Quasi Sovereign Bond
Rating(1) Baa1*(-)/BBB-
Current Price $89.6
1yr Target Return
11.5%
Investment Details
Strong fundamentals with $78 billion in market capitalization, 2.4x EV/EBITDA, 2.4x P/E and 0.7x net leverage
Gazprom is ranked globally as: – #1 oil & gas company in terms of profitability: $38bn vs. $33bn Exxon, $22bn Chevron, and
$21bn Petrochina – #2 in total barrels of oil equiv. (boe) production: 8.8 million boe/day – #3 based on reserves: 123 billion boe proven reserves valued at $229 billion
Supplies 30% of Europe’s gas consumption (51% of sales) At a 2.4x multiple, the bonds offer asset coverage at 4.2x Bonds trade wide to Russia and global energy companies
Repsol Int Corporate Baa1/BBB- 6.1x 1.7x 3.6x 94 (5)
ENI SpA Corporate A3/A 3.9x 0.9x 4.5x 59 (158)
(1) Russian sovereign was downgraded by S&P from BBB to BBB- so we adjusted Gazprom to reflect sovereign ceiling.
Systemic Risk – Monolines
Monolines are being too harshly penalized because they are viewed as systemic trades. Applying relatively severe stress scenarios, Monolines still look attractive on a risk-adjusted basis
MBIA AAA
5 Year CDS
AGO Stock
Future contracted revenue streams
Defaults by Illinois, Chicago, Puerto Rico and other below IG Muni
exposure over next 5 years (assuming 65-70% recoveries)
After 5 years, a normalized default rate of 15bps per annum 10x
historical average
Current average muni default rate is 3bps
Assumptions Key Statistics
Asset coverage that can withstand losses up to:
3X reserve levels – MBIA has historically been accurate with reserve
levels
2X GoldenTree estimates based on structured product book
evaluation; representing a significant margin of safety
Source: Edward Altman; BofA Merrill Lynch U.S. High-Yield Master II Index (market value); data as of April 2014.
US$ trillions
Global real short-term interest rates
Source: Datastream, IMF, Milken Institute. Note: 3-month interest rates: Canada, China, France, Germany, Italy, Japan, United Kingdom, United States; Weighted by GDP.
Source: Federal Reserve, BEA. Note: Total credit market debt includes that owed by domestic nonfinancial, the financial sectors, and the rest of the world.
A bulk of total lending goes to support Chinese real estate Top 10 industries
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10
15
20
25
0
10
20
30
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50
60
70
US$ billion Percent
Source: Bloomberg. Note: “M&M” refers to metals and mining, and “Govt” refers to local and regional government. Only loans from ICBC, Bank of China, BoAg, BoCom, China Construction Bank, China Merchants, Minsheng, Everbright, and Citic are included.
Total loan tranche size (left)
Market share (right)
China’s biggest maturing loans concentrated in real estate
Source: ICI. Note: Most ETFs are 1940 Act ETFs, which are regulated by the SEC under the Investment Company Act of 1940. “Net issuance” refers to the total dollar amount of shares issued/created by an ETF sponsor, less the total dollar amount of shares redeemed by the ETF sponsor.
Issuance of ETF shares By investment classification
28
10
42
30
8
35
10
24
46
3
58
14
52 53
9
0
10
20
30
40
50
60
70
Broad-based domestic equity
Domestic sector equity
Global/International equity
Bond and hybrid Commodities
2010 2011 2012 US$ billions
Source: ICI. Note: Most ETFs are 1940 Act ETFs, which are regulated by the SEC under the Investment Company Act of 1940. “Net issuance” refers to the total dollar amount of shares issued/created by an ETF sponsor, less the total dollar amount of shares redeemed by the ETF sponsor.
Bond funds are the majority of the closed-end fund market Percent of closed-end fund total net assets
Domestic equity 26%
International equity 12%
Domestic taxable bond 21%
Domestic municipal bond
34%
International bond 7%
Total closed-end fund net assets: $265 billion, as of 2012
Source: ICI. Note: Net assets are total assets minus total liabilities.