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

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

High Yield Spread

Spec-Grade Default Rate

1-Yr Chg in Unemployment

Source: Moody’s Investors Service

Investment-Grade Default Rates Are Low For Non-Financial US Corps Few defaults despite massive unemployment rate shock during global financial crisis

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Default within 1 Year

Default within 3 Years

Default within 5 Years

Source: Moody’s Investors Service

Rapid Migration Rates* for IG Non-Financial US Corps Are Low No major accounting irregularities, litigation, or distress & few leveraging transactions

0%

1%

2%

3%

4%

5%

6%

7%

1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Leveraging Transaction

Industry or Company Distress

Litigation

Accounting Irregularity

* 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

180

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

12

13

14

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

Comparables

Asset Type Rating

(Moody’s / S&P) EV/EBITDA

Net Leverage @ Create

Asset Coverage

Z-spread (bps)

Spread to Sovereign (bps)

Gazprom Quasi-Sov Baa1/BBB 2.4x 0.6x 4.2x 415 134

Petrobras Quasi-Sov Baa1/BBB 5.5x 2.8x 2.0x 272 139

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

Yield 10.4%

Spread T+ 867bps

Asset Coverage 1.7x

Price $23.89

Adjusted Book Value Multiple

0.48x

European CLO: Munda CLO I

CLO Tranche Overview

Issued December 2007

At-Issue Rating (Current Rating) Baa3/BBB- (Ba2/B+)

Price €88.05

Yield to Worst (Discount Margin) 7.3% (E+626bps)

Current Coupon E+375 bps

Average Life to Worst 6.0 Years

Reinvestment Period End Date January 2014

Legal Final July 2024

Underlying CLO Portfolio Characteristics

Underlying Portfolio Price / Ranking 92.5% / 38.4%

% Immediate Defaulted 8.7%

CLO Tranche Metrics

Market Value Coverage 103.0%

Par Value Coverage 111.3%

Base Case X/X/5 Break Point 17.8%

Forward 3/X/X/5 Break Point 24.5%

Forward 3/5/X/X/5 Break Point 29.3%

Bear Case X/X/5 Break Point 15.1%

Managed by Munda Asset Management, Cohen & Company’s corporate credit asset management platform in Europe

Cohen & Company has €1.77 billion of assets in Europe, mainly in CDOs and separately managed accounts

Reinvestment period end just ended in January and CLO will begin to pay down senior debt at par

Upside Return Scenarios

17.6% 15.0%

7.3%

0.0%

5.0%

10.0%

15.0%

20.0%

Base 1 Yr Spread Tightening

(E+338)

Bear 1 Yr Spread Tightening

(E+438)

Yield to Maturity

ABS CDO: Lakeside 2004-1A A-1

Opportunity to buy the 1st pay tranche of a seasoned high grade ABS CDO that is a very well protected, short duration bond.

Attractive Return Profile:

– 18.5% return potential with attractive financing, offering positive convexity & levered exposure to hard-to-source seasoned senior / mezzanine subprime

High Margin of Safety against Defaults:

– 151% Market Value OC (“MVOC”) vs. 135% MVOC typical AAA CLO debt

– Seasoned subprime asset performance has stabilized

Catalyst for Additional Total Return:

– Improving housing fundamentals; home price appreciation with potential for higher prepayments

– Potential ratings upgrade on Class A-1 notes opens market to broader set of investors

– Potential for asset sales resulting in faster pay down

Price $93.5

Risk Adjusted Yield (Base Case)

4.5% (375bps DM)

Weighted Average Life

2.0yrs

Total Return Potential

18 - 22%

Investment Overview Investment Thesis

Class A-2

Class A-1

$141.5

Transaction Overview

Capital Structure $ Millions

46.0% 23.0% 17.0% 14.0%

Seasoned Subprime (2004 or earlier)

Alt A TRUPS ABS CDO

Underlying Assets (% of Market Value) - $243.5 million

Mike Milken

Increase in U.S. Corporate Cash Balances

Source: Bloomberg. Notes: Data are for cash and marketable securities. Some companies are as of Q4 2013.

15

61

23 15

22

7

25

8 8

147

133

77

62 51

37 34

18 17

0

20

40

60

80

100

120

140

Apple +854%

GE +118%

Microsoft +229%

Google +303%

Cisco +127%

Oracle +430%

Pfizer +32%

Merck +121%

Chevron +113%

Q4 2007 Q1 2014 US$ billions

Increase in Corporate Cash Balances 2005 to 2014 Cash holdings of publicly listed companies, percent of GDP

6% 7%

17%

8%

4% 6%

9% 6% 7%

3% 1%

3% 4%

38% 36% 35%

25%

19%

15% 14%

10% 8% 8% 8% 7%

4%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

China U.K. Japan France Spain Korea U.S. Brazil Germany Italy Russia India Mexico

Q4 2005 Q1 2014 Percent of GDP

Source: Bloomberg and International Monetary Fund. Note: Includes cash and near cash items.

Japanese Companies’ Cash Stockpiles

Source: Bloomberg.

20

3 2

11 8 7 8

37

21

15 15 15 14 11

0

5

10

15

20

25

30

35

40

Toyota Softbank Rakuten Sony Mitsubishi Mitsui Honda Motor

2007 2013 US$ billions

0%

20%

40%

60%

80%

100%

Banks CLOs Hedge, distressed and high-yield funds

Prime rates funds, financial and insurance companies

Sources: S&P LCD / JPMorgan.

Institutional investor base for non-investment grade loans

Wealth Generation January 2013-2014YTD

0%

10%

20%

30%

40%

Japan United States

Spain Switzerland France Germany Australia

Source: Bloomberg 4/15/14.

Stock market performance by nation

World stock market performance

Source: Bloomberg, April 22, 2014.

World stock market performance

Source: Bloomberg, April 22, 2014.

World stock market performance

Source: Bloomberg, April 22, 2014.

1981 2014 • 3-year loan • $10,000 car • 18% interest

$796* monthly payment

• 5-year loan • $25,000 car • 2.91% interest

$728 monthly payment

Terms of Buying a Car

Source: Bankrate.

Note: 2014 data represents national overnight averages for 60 month new car loan. * = 2012 dollars

1981 2014 • 3-year loan • $25,000 car • 18% interest

• 5-year loan • $25,000 car • 2.91% interest

Interest Rates and Buying a Car

$728 monthly payment

$2,006* monthly payment

Source: Bankrate.

Note: 2014 data represents national overnight averages for 60 month new car loan. * = 2012 dollars

Dow Industrials: 1973-77 and 2008-14

3/28/2014

5000

7000

9000

11000

13000

15000

17000

500

600

700

800

900

1000

1100

578 on Dec. 6, 1974

6,547 on March 9, 2009

DJIA, 1973-1979 DJIA, 2008-2014

Equity market capitalization: 2009 to present

Source: Bloomberg.

Country 3/1/2009 4/15/2014 Increase

U.S. (S&P 500) $6.6 T $16.9 T 155%

U.K. (FTSE 100) $1.4 T $3.0 T 116%

Japan (Nikkei 225) $1.6 T $2.6 T 58%

Germany (DAX) $583 B $1.3 T 116%

Mexico (Bolsa IPC) $115 B $337 B 193%

Many advanced economies are struggling with high debt and

excessive leverage

Source: Federal Reserve Bank of St. Louis (2013). .

58% 59%

81% 90% 95% 95%

204%

Germany Italy U.S. South Korea Canada Australia U.K.

Household Debt (% of GDP)

European Credit is a Bank Market

Sources: ECB

Bonds and loans as a share of total corporate debt

0%

20%

40%

60%

80%

100%

Spain Germany Ireland Portugal Italy France UK

Bonds Loans

EU vs U.S. Total Banking System Assets

(% of GDP))

Data as of 2011. Sources: World Bank’s Financial Development and Structure.

724% 723%

396% 338% 335% 309%

270% 220%

85%

Assets of the 4 Biggest Banks (% of GDP, 2013)

Sources: Bankscope, IMF WEO, Milken Institute. U.S. ratio reflects IFRS accounting treatment for derivatives; under GAAP, the ratio is 47%.

375%

313%

243% 241%

182% 181% 157%

122% 112% 65%

Sovereign Debt Defaults

Sources: This Time is Different Chartbook: Country Histories on Debt, Default, and Financial Crises, Carmen M. Reinhart / Milken Institute

• 1828

• 1898

• 1902

• 1914

• 1931

• 1937

• 1961

• 1964

• 1983

• 1986

• 1990

• 1832

• 1868

• 1911

• 1914

• 1931

• 1982

• 1999

• 2008

•1876

•1915

•1931

•1940

•1959

•1965

•1978

•1982

•2000

• 1826

• 1848

• 1860

• 1865

• 1892

• 1898

• 1983

• 1990

• 1995

• 1998

• 2004

Brazil Ecuador

• 1839

• 1885

• 1917

• 1918

• 1947

• 1957

• 1991

• 1998

Russia

•1826

•1843

•1852

•1893

•1932

•2011

Greece Turkey Venezuela

• 1982

• 1986

• 1992

• 2001

• 2004

Nigeria

U.S. vs. Europe high yield debt markets

56 39

7 41

61 66 89

128 147 136

43

148

264 224

329 336

0

50

100

150

200

250

300

350

400

2006 2007 2008 2009 2010 2011 2012 2013

Europe U.S.

Issuance, US$ billions

Source: SIFMA. Note: Data as of Q3 2013. Europe includes Western and Eastern Europe.

Historical Growth of U.S. High-Yield Market

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1972 1976 1980 1984 1988 1992 1997 2001 2005 2009 2013

Sources: Edward Altman; FitchRatings

US$ trillions

0

500

1,000

1,500

2,000

2,500

1979 1984 1988 1992 1996 2000 2004 2009 2013

Index, December 1979 = 100

High Yield

Treasuries

Inflation

High-Yield Bonds vs. Inflation and Treasuries

March 31, 2014.

Sources: Bank of America; Merrill Lynch, March 23, 2012

Percent

-40

-20

0

20

40

60

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 YTD

High-Yield Annual Returns 2004 - 2014

Milken Institute

Global corporate bond issuance

0.0

1.0

2.0

3.0

4.0

5.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

US$ trillions

Source: Bloomberg.

Global high-yield corporate bond issuance

0

100

200

300

400

500

600

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

US$ billions

Source: Bloomberg.

Global high-yield bond market has surpassed $2 trillion

0

0.4

0.8

1.2

1.6

2

Source: BofA Merrill Lynch Global High-Yield.

Market value, US$ trillions

U.S. high-yield bond market Market value

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1971 1975 1979 1983 1987 1991 1996 2000 2004 2008 2012

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.

-3

-2

-1

0

1

2

3

4

5

1996 1998 2000 2002 2004 2006 2008 2010 2012 2013 Q4

3-month real interest rate, percent

Real short-term interest rates

Sources: Datastream, OECD Statistics, Oxford Economics.

Percent

-6

-4

-2

0

2

4

6

8

10

12

1998 2002 2006 2010

China Japan U.S. Eurozone UK Percent

Central bank assets

0

2

4

6

8

10

2006 2007 2008 2009 2010 2011 2012 2013

BoE BoJ Fed ECB US$ trillions

Source: Datastream.

Central bank target interest rates in advanced countries

remain low

Source: Bloomberg.

0

1

2

3

4

5

6

2007 2008 2009 2010 2011 2012 2013 2014

Policy rate, percent

United Kingdom

Eurozone

Japan

United States

Seven-year asset class real return forecasts As of April 2013

5.4 4.3

2.5 2.1 1 0.7 0.5 0.3

-0.4 -1.3

-2.3

-5 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6

Timber Emerging equity

Emerging debt

U.S. high quality equity

Int'l large cap

equity

Inflation linked bonds

U.S. bonds

Int'l small cap

equity

Cash U.S. large cap

equity

Int'l hedged bonds

U.S. small cap

equity

Percent

Source: GMO.

10-year U.S. Treasury yield

Source: Bloomberg.

0

2

4

6

8

10

12

14

16

18

1964 1971 1978 1985 1992 1999 2006 2013

Percent

Average: 6.6 percent

Long-term U.S. Treasury yields have dropped Treasury yield curves

0

1

2

3

4

5

1M 3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 30Y

Percent

1/1/14

3/28/14

Source: Bloomberg.

Foreign holdings of U.S. Treasuries Three largest holders

0

200

400

600

800

1,000

1,200

1,400

2007 2008 2009 2010 2011 2012 2013

Japan

Belgium

US$ billions

China

Source: Datastream.

Markets are pricing in lower sovereign yields in a year 10-year sovereign bonds

1

1.5

2

2.5

3

3.5

2012 2013 2014

U.K.

1 year forward rates, percent

Eurozone

U.S.

Source: Bloomberg.

Total U.S. credit market debt

0

10

20

30

40

50

60

70

'45 '49 '53 '57 '61 '65 '69 '73 '77 '81 '85 '89 '93 '97 '01 '05 '09 '13

US$ trillions

Total credit market debt outstanding

GDP

Debt/GDP (1950-1980): 1.5

Debt/GDP (2013): 3.5+

Source: Federal Reserve, BEA. Note: Total credit market debt includes that owed by domestic nonfinancial, the financial sectors, and the rest of the world.

U.S. corporate bond issuance

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 YTD

Investment Grade High Yield Issuances, US$ trillions

Source: SIFMA.

U.S. corporate bond average maturity extended

6

7

8

9

10

11

12

13

14

1996 1999 2002 2005 2008 2011 2014

Years

Source: Bloomberg.

U.S. high-yield corporate bond yield

0

5

10

15

20

25

1986 1989 1992 1995 1998 2001 2004 2007 2010 2013

Percent

Source: Bloomberg. Note: Bank of America Merrill Lynch U.S. HY Master II.

0

100

200

300

400

500

600

700

2006 2007 2008 2009 2010 2011 2012 2013 2014

Basis points

A rated

Source: Bloomberg.

Corporate bond spreads near lows Corporate bond spreads over U.S. Treasuries

BBB rated

IG corporate bond spreads: U.S. vs Eurozone

75

125

175

225

275

325

2010 2011 2012 2013 2014

Option-adjusted spreads, bps

U.S. IG

EUR IG

Source: Bloomberg.

The premium paid for high-yield corporate bonds in U.S. and

Eurozone

150

250

350

450

550

650

750

2010 2011 2012 2013 2014

Option-adjusted spreads, bps

U.S. IG-HY spread

EUR IG-HY spread

Source: Bloomberg.

Default levels remain low

0

2

4

6

8

10

12

14

16

18

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Historic global single B default rates, percent

Sources: Bloomberg, Bond Vigilantes.

LT avg: 5.2%

10-yr avg: 1.9%

High-yield credit rating upgrades have outnumbered downgrades

0

1

2

3

4

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Ratio of credit rating upgrades to downgrades

LT average: 0.7

Q4 2013: 1.2

Sources: Bloomberg, Datastream, JPMorgan, IIF.

Negative bias fell to a new low in Q4 2013

0

5

10

15

20

25

30

35

40

45

50

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Proportion of high-yield companies with negative credit outlooks

Q4 2013: 12%

Source: S&P.

Markets are pricing in further ECB easing 3-month Euribor futures

0

1

2

3

4

2013 2014 2015 2016 2017 2018 2019

Euribor 3M, 3/28/14

Percent

Euribor 3M, 12/31/13

Source: Bloomberg.

German sovereign bond spreads have tightened Spread of 10-year Bunds over 2-year Bunds

-50

0

50

100

150

200

250

2008 2010 2012 2014

Bps

Source: Bloomberg.

European peripheral sovereign default risks have fallen Sovereign 5-year credit default swap rates

40

140

240

340

440

540

640

Apr-13 Jul-13 Oct-13 Jan-14 Apr-14

Index, 100=4/18/13

Portugal

Italy

Ireland Spain

Source: Bloomberg.

Corporate default risks across the EU have fallen 5-year credit default swap rates

50

60

70

80

90

100

110

120

Apr-13 Jul-13 Oct-13 Jan-14 Apr-14

Index, 100=1/18/13

Euro HY

Euro IG

Source: Bloomberg. Note: The Markit iTraxx Europe index is composed of entities incorporated in the EU and EFTA member countries.

Nonbank direct loans to European companies increase

0

10

20

30

40

50

60

Q1 2013 Q2 2013 Q3 2013 Q4 2013

Deal count

Source: Deloitte.

France 25%

U.K. 50%

Germany 11%

Rest of Europe

14%

Deal location

Most European alternative lending deals are LBO-related

0

5

10

15

20

25

30

35

40

45

50

LBO Dividend recap Refinancing Bolt-on M&A Growth capital

U.K.

Euro

Deal purpose, percent

Source: Deloitte.

Unitranche is a popular structure for European direct lending

0 5

10 15 20 25 30 35 40 45 50

Senior Unitranche Second lien Mezzanine PIK/other

U.K.

Euro

First lien

Deal structure, percent

Source: Deloitte. Note: “PIK” refers to payment in kind lending.

EM corporates are raising more international debt

0

100

200

300

400

500

600

'93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13

Latin America & Caribbean Asia & Pacific Europe Africa & Middle East

Outstanding, US$ billions

Source: BIS. Note: Non-financial corporate international debt securities outstanding.

China’s debt is on the rise

-10

0

10

20

30

40

50

60

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

RMB trillions

Non-bank debt

Bank loans

Source: Datastream. Note: “Non-bank debt” refers to entrusted loans, trust loans, bank acceptance, and corporate bond financing.

Decline in China’s NPL to total loans ratio

0

5

10

15

20

25

30

35

40

0

10

20

30

40

50

60

70

80

Total loans

RMB trillions

Non-performing loans, percent of total

Sources: Economist, Bloomberg.

China relies on increasing domestic credit to support growth

0

2

4

6

8

10

12

100

110

120

130

140

1997 2000 2003 2006 2009 2012

Percent of GDP

Current account balance

Domestic credit to private sector

Percent of GDP

Source: World Bank.

China dim sum bond issuance By country

0

5

10

15

20

25

30

35

40

45

2011 2012 2013 2014

US$ trillions

China

Hong Kong

Other

Source: Bloomberg.

CNYs onshore-offshore funding costs converge

6.1

6.2

6.3

6.4

6.5

6.6

6.7

6.8

6.9

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14

Percent

Onshore CNY

Offshore CYN

Source: Bloomberg.

Financial issuers have dominated the dim sum bond market

0

5

10

15

20

25

30

35

40

Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014

Issuance, US$ billions

Other sectors

Financials

Source: Bloomberg.

A bulk of total lending goes to support Chinese real estate Top 10 industries

0

5

10

15

20

25

0

10

20

30

40

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

64

14

42 41

17

5

19

0

10

20

30

40

50

60

70

Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015

Percent of total expiring loans

Source:

Importance of China’s property market to wider economy

16

33

20

26

39

0

5

10

15

20

25

30

35

40

45

GDP Fixed asset investment

Outstanding loans New loans Government revenues

Property market, percent of each category

Source: Nomura.

Non-loan credit extension has accelerated substantially China, moving 12-month average

0

2

4

6

8

10

12

14

16

18

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

RMB billions

RMB loans

Alternative financing

Social financing

Sources: PBOC, Datastream.

Chinese banks’ wealth management products continue to rise Assets under management

0

20

40

60

80

100

120

Q3 2010 Q1 2011 Q3 2011 Q1 2012 Q3 2012 Q1 2013 Q3 2013

CNY billions

Sources: CEIC, Standard Chartered.

WMP

Deposits

Lack of access to bank loans for small and medium-sized

enterprises in China

99

60 80

10

1

40 20

90

0

20

40

60

80

100

Proportion of enterprises

GDP Proportion of employees

Access to bank loans

Small and medium-sized enterprises Large enterprises Percent

Sources: China Association of Small and Medium Enterprises, Milken Institute.

Puerto Rico bond yields 10-year municipal bond yields

0

2

4

6

8

10

12

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14

Percent Puerto Rico

B

AA

A

Source: Bloomberg.

U.S. municipal bonds issuance

0

50

100

150

200

250

300

350

400

450

500

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 YTD

Issuance, US$ billions

Source: SIFMA.

U.S. municipal bond holdings Outstanding

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

'96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13

Individuals Mutual Funds Banking Institutions Insurance Companies Other

US$ trillions

Source: SIFMA.

U.S. average municipal bond maturity

15

16

17

18

19

20

21

22

1996 1999 2002 2005 2008 2011 2014

Years

Source: SIFMA.

Banks vs. non-bank banks G-20 countries

0

400

800

1,200

Total assets, percent of GDP Non-bank banks Banks

Source: Financial Stability Board.

Assets of non-bank financial intermediaries G-20 member countries

0

10

20

30

40

50

60

70

80

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

US$ trillions

Source: Global Shadow Banking Monitoring Report 2013, Financial Stability Board.

U.S. commercial bank lending and leasing grow

-100

-80

-60

-40

-20

0

20

40

60

80

100

120

2007 2008 2009 2010 2011 2012 2013

Quarterly change, percent

Source: FDIC.

Stronger U.S. demand for commercial and industrial loans

-80

-60

-40

-20

0

20

40

60

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Percent of banks reporting stronger C&I demand

Small firms

Medium and large firms

Source: FDIC.

Fewer U.S. banks increased lending rates

-80

-60

-40

-20

0

20

40

60

80

100

120

'90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13

Percent of banks increasing loan rates over cost of funds

To medium and large firms

To small firms

Source: FDIC.

U.S. commercial and industrial loan standards

-40

-20

0

20

40

60

80

100

'90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13

Percent of banks tightening C&I lending standards

To medium and large firms

To small firms

Source: FDIC.

European companies have borrowed more from U.S. loan market By currency of loan deal

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

USD EUR GBP Other Percent

Source: Bloomberg. Note: Loans include first lien leveraged loan tranches, excluding revolvers and term loan A.

U.S. vs. European leveraged loan performance

55

60

65

70

75

80

85

90

95

100

105

2007 2008 2009 2010 2011 2012 2013 2014

Index, 100=1/1/07

Europe

U.S.

Source: S&P, Bloomberg. Notes: S&P/LSTA U.S. Leveraged Loan Index, S&P European Leveraged Loan Index.

U.S. vs. European leveraged loan issuance

0

50

100

150

200

250

300

350

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

US Euro US$ billions

Source: Bloomberg.

European leveraged loan issuance By currency of issuance

0

20

40

60

80

100

120

140

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

EUR GBP USD Other US$ billions

Source: Bloomberg.

More subordinated debt issuance in Europe By largest issuers

0

10

20

30

40

50

60

70

80

90

100

2007 2008 2009 2010 2011 2012 2013 2014 YTD

Other U.K. France Italy Spain Germany US$ billions

Source: Bloomberg.

Covenant-lite loans increase in the U.S.

0

100

200

300

400

500

600

2010 2011 2012 2013 2014

Covenant-lite Other leveraged loans Number of loans

Source: Bloomberg.

Global CDOs outstanding

0

200

400

600

800

1,000

1,200

1,400

1,600

2006 2007 2008 2009 2010 2011 2012 2013

CDO CLO SF Other US$ billions

Source: SIFMA.

Re-emergence of CMBS Commercial mortgage-backed securities issuance, U.S. and non-U.S.

0

50

100

150

200

250

300

350

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

US$ billions

U.S.

Source: Bloomberg.

Non-U.S.

Fannie, Freddie, and Ginnie

Mortgage debt outstanding

0

1

2

3

4

5

6

7

1990 1995 2000 2005 2010

US$ trillions

Ginnie Mae

Freddie Mac

Fannie Mae

Source: SIFMA.

Investors are buying corporate bonds while dealers retreat

0

100

200

300

400

500

600

700

800

900

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

IG and HY bonds, US$ billions

Dealer inventory

Including ETFs

Mutual fund assets

Sources: Citi, ICI, NY Fed, Bloomberg, Haver Analytics, U.S. Department of the Treasury.

Fixed income capital costs increase under Basel III

1 x 1 x 1 x 1 x

3.4 x

5.0 x

0.0 x

1.0 x

2.0 x

3.0 x

4.0 x

5.0 x

6.0 x

Investment grade High yield

Basel I Basel II Basel III

Risk-weighted asset charges

Sources: Citi, U.S. Department of the Treasury.

Fewer large trades in bond markets

0

20

40

60

80

100

2005 2006 2007 2008 2009 2010 2011 2012 2013

Block trades (>$5m) Block trades ($1-$5m)

Percent of total traded volume

Sources: FINRA TRACE, Milken Institute.

Block trades of bonds are becoming smaller

0

5

10

15

20

25

30

35

2005 2006 2007 2008 2009 2010 2011 2012 2013

Average block trade size, U.S. IG, US$ millions

Sources: Citi, FINRA TRACE, Bloomberg, U.S. Department of the Treasury.

Liquidity is moving toward Treasuries

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

'96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14

Treasury Federal Agency Securities Agency MBS Other

Distribution of daily market turnover, percent

Sources: Citi, SIFMA, U.S. Department of the Treasury.

Investors moving away from Treasuries

-40

-20

0

20

40

60

80

100

120

2008 2009 2010 2011 2012

Govt IG HY Net mutual fund sales, US$ billion

Sources: Citi, ICI, Haver Analytics, U.S. Department of the Treasury.

Total net assets and number of ETFs

0

200

400

600

800

1,000

1,200

1,400

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Total net assets, US$ trillions Count

1940 Act ETFs (left)

Non-1940 Act ETFs (left)

Number of ETFs (right)

Source: ICI. Note: The majority of ETFs are 1940 Act ETFs, which are regulated by the SEC under the Investment Company Act of 1940.

Demand for ETFs has increased Net issuance of ETF shares

0

20

40

60

80

100

120

140

160

180

200

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

US$ billions

Non-1940 Act ETFs

1940 Act ETFs

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.

Closed-end fund total net assets have increased

0

50

100

150

200

250

300

350

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

US$ billions

Bond closed-end funds

Equity closed-end funds

Source: ICI. Note: Net assets are total assets minus total liabilities.

Household net investments in funds, bonds, and equities

-1100

-900

-700

-500

-300

-100

100

300

500

700

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Funds Directly held bonds Directly held equities

US$ billions

Source: ICI. Note: Net new cash flow and reinvested interest and dividends are included.

Funds channel investment to stock, bond, and money markets

0

5

10

15

20

25

30

35

40

45

U.S. corporate equity U.S. and international corporate bonds

U.S. Treasury and government agency

securities

U.S. municipal securities

Commercial paper

Percentage of total fund holdings

Mutual funds

Other funds

Source: ICI. Note: As of 2012.

Cash flow into bond funds is highly related to bond returns

-10

-5

0

5

10

15

20

-2

-1

0

1

2

3

1998 2000 2002 2004 2006 2008 2010 2012

Percent of total net assets Percent

Total return on bonds (right)

Net new cash flow (left)

Source: ICI.

Source: Bloomberg.

0

1

2

3

4

5

6

2000 2002 2004 2006 2008 2010 2012 2014

Net debt-to-EBITDA

S&P 500 leverage has fallen

US households reduce financial obligations Debt service ratio as a percent of disposable income

Sources: Federal Reserve Board, IHS Global Insight.

4

5

6

7

8

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Percent

Consumer debt

Mortgage debt

Household debt falls Percent of disposable personal income

9

10

11

12

13

14

1997 1999 2001 2003 2005 2007 2009 2011 2013

Percent

Sources: Federal Reserve, IHS Global Insight.

US consumer outstanding credit Extended to household and personal expenditures, annual change

Sources: Federal Reserve, IHS Global Insight.

-6

-4

-2

0

2

4

6

8

10

12

14

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Percent, annual change

The composition of the U.S. household debt balance

0

2

4

6

8

10

12

14

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Mortgage Auto loan HE revolving Credit card Student loan Other

US$ trillions

Source: IHS Global Insight.

Historical trend of U.S. household financial obligation ratio US household financial obligation ratio

13

14

15

16

17

18

19

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013

Percent of disposable income

Source: IHS Global Insight.

U.S. debt outstanding by sector (% of GDP)

0

20

40

60

80

100

120

1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013

Percent

Households

Government

Financial sector

Non-financial business

Source: Federal Reserve.

U.S. corporate profits hit record high

0.0

0.5

1.0

1.5

2.0

2.5

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

US$ trillions

Source: BEA, Bloomberg. Note: U.S. corporate profits without IVA and CCA profits before tax, seasonally.