managing across the credit spectrum - iqam · risk is low and global regulation has forced stronger...
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Managing Across the Credit Spectrum
Investment Counsel Since 1933
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1
Recovery Deleverage
Consolidation Leverage Throughs
Deterioration Releverage
The Credit Cycle
IG Credit CycleIG Credit Cycle
Corporate Credit Cycle
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2
Historical Spread Levels
► We believe spreads are sending false recessionary signals, but these type of moves are common late in the credit cycle.
Global Corporate Spreads 2006 - 2016 (10 yrs)
0
100
200
300
400
500
600
basi
s poi
nts
OAS = 188Bps Average = 175Bps +1 Std Dev = 269Bps -1 Std Dev = 81Bps
"Great Moderation"
Lehman Failure
European Sovereign Debt Crisis
Source: Barclays as of February 29, 2016.
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3
Historical Spread Levels
Source: Barclays as of December 31, 2015
► We are constructive on valuations as spreads are historically wide for any non-recessionary period.
0
100
200
300
400
500
600
700
Bps
Recession Investment Grade OAS
0
500
1000
1500
2000
2500
Bps
Recession High Yield OAS
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4
U.S. Credit Fundamentals Have Likely Peaked
Source: JPMorgan as of December 31, 2015
► Much of the increase in debt has been driven by companies with low starting leverage (ex. Apple). Low rates have benefited companies, but lower interest expense is being offset by an increase in debt.
U.S. Net Leverage
0.80x
1.00x
1.20x
1.40x
1.60x
1.80x
2.00x
2.20x
2.40x
U.S. EBITDA Margin %
15%
17%
19%
21%
23%
25%
27%
29%
31%
U.S. Earnings Payout Ratio
0%5%
10%15%20%25%30%35%40%45%
U.S. EBITDA/Interest
8.0x
9.0x
10.0x
11.0x
12.0x
13.0x
14.0x
15.0x
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5
Euro vs. U.S. Credit Fundamentals
Source: JPMorgan as of December 31, 2015
► Activist investors have pushed companies to return more cash to shareholders in the form of dividends and share repurchases. European companies as a whole have not taken on incremental debt for shareholder returns like U.S. companies.
► Margins may have peaked. There has not been a post war cycle where profit margins didn’t start to decline prior to a recession.
Earnings Payout Ratio
0%
10%
20%
30%
40%
50% US Europe
Net Leverage
0.80x
1.30x
1.80x
2.30x
2.80x
3.30x
3.80x US Europe
EBITDA Margin %
10%
15%
20%
25%
30%US Europe
EBITDA/Interest
8.0x9.0x
10.0x11.0x12.0x13.0x14.0x15.0x16.0x US Europe
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6
Moody’s Upgrade/Downgrade Ratio
Source: Moody’s as of January 31, 2016
► Usually lag the cycle so limited in terms of how informative they can be, but still useful indicator to keep track of as we expect further downgrades in the energy and commodity sectors.
United States
-180
-135
-90
-45
0
45
90
# of
upg
rade
s/do
wng
rade
s
Downgrades Upgrades
Western Europe
-200
-150
-100
-50
0
50
# of
upg
rade
s/do
wng
rade
s
Downgrades Upgrades
United States
0.000.501.001.502.002.503.003.504.004.50
Ratio
US Ratio
Western Europe
0.00
0.50
1.00
1.50
2.00
2.50
3.00
Ratio
Western Europe Ratio
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7
M&A Activity Increasing
► M&A activity has now returned to levels last seen prior to the financial crisis in terms of both deal count and volumes as sluggish growth prospects and cheap borrowing costs are causing many companies to explore the possibilities of expansion through acquisitions instead of through organic growth.
► Important differences between current and pre-crisis: More strategic M&A for industry consolidation, fewer LBOs by private equity and larger equity/cash funding as companies still value being investment grade rated for access to capital markets and low funding costs.
Source: Bloomberg as of December 31, 2015.
0
2,000
4,000
6,000
8,000
10,000
12,000
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
Volume (millions) Deal Count
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8
Technicals– Corporate Debt Supply
Source: Barclays as of December 31, 2015.
Investment Grade Gross Issuance
$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
$1,600
billi
ons
US Europe
Investment Grade Net Issuance
-$400
-$200
$0
$200
$400
$600
$800
billi
ons
US Europe
► Record levels of corporate bond supply, in the U.S., were met with strong demand for several years until the start of 2015, when supply began to overwhelm demand. As supply is typically a function of investor demand, and not the reverse, we expect primary market volumes to recede in environments where investor demand weakens, or as government yields begin to rise.
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9
Cash to shareholders
Source: Bloomberg as of December 31, 2015.
U.S. Earnings Payout Ratio
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
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10
Lending Standards
► Lending standards have lagged for the past 4 quarters. Tighter lending equates to higher default rates.
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
-40.00
-20.00
0.00
20.00
40.00
60.00
80.00
100.00
1990 1992 1994 1996 1998 2000 2002 2005 2007 2009 2011 2013 2015
C&I Loan Standards (%) US HY Default Rate (RHS)
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11
Credit Cycle & Defaults
SBGCCQ4012616JB
Bank of America Merrill Lynch High Yield Global Distressed Ratio1
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
0
10
20
30
40
50
60
70
80
90
Def
ault
Rate
Dis
tres
sed
Ratio
(%)
Distressed Ratio (%) Moody's Default Rate
Distressed Median = 9.3%
Source: Bank of America Merrill Lynch as of December 31, 20151 = Percentage of issues out-yielding Treasuries by 1,000 bps or more
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12
Spread Dispersion
► More idiosyncratic risk creating more negative outliners. According to Citi, only 20% of all index-eligible CUSIP’s fell within the +/-25bp range around the average spread level.
Source: Barclays Point
High Yield Spread Change
0
50
100
150
200
250
Spread Change (bps)
Investment Grade Spread Change
0
50
100
150
200
250
Spread Change (bps)
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13
Outlook & Strategy – Investment Grade Credit
Risks1
Central bank policy decisions have a negative impact on global growth.
Emerging market defaults and contagion due to collapse in oil prices.
An unexpected deterioration in global growth, particularly in China and Europe.
1 This is not an exhaustive list. For a more comprehensive list of the risks associated with investing in foreign markets, please refer to the disclosures in the back of the presentation.Note: As of December 31, 2015. Portfolio holdings are subject to change at any time.
Maintain overweight to the Financial sector as we believe eventrisk is low and global regulation has forced stronger balancesheets. Favor Industrial issuers with low event risk. Similarly,selectively add to BBB rated issuers where extreme event risk ismore than priced in.
Rising overall debt levels in the non-financial universe hasresulted in increased leverage. However, profitability andcorporate liquidity remain strong, at decade high levels. Eventrisk in the industrial sector remains elevated given thehistorically low ‘all-in’ cost of debt. The financial sectorcontinues to de-risk, with equity capital now double ‘pre-crisis’ levels, at the request of regulators.
Remain highly selective in the primary market, focusing on lessefficient areas of the secondary market which often offeradditional spread for liquidity. Look to participate in post eventrisk deleveraging stories where we think the proposed synergiesare achievable.
Issuance in the US remains elevated, largely due to M&Aactivities. Going forward, bank issuance should increase driven byregulatory requirements. In Europe, issuance increased given therelatively low funding costs. However, demand will likely continueto outstrip net supply given the ECB’s involvement through its QEprogram.
Position dedicated credit portfolios with more carry relative tobenchmarks. Continue to overweight Financials and Cyclicals thatwould benefit from an improving U.S. economy. Avoidcompanies/industries with significant releveraging risk. Look toadd to those names and sectors that have widened in the recentsell off without a material change in our investment thesis.
Corporate spreads were significantly wider in 2015 (+35 bpsU.S., +46 bps Europe). While spread volatility may persist inthe short-term, longer term, we believe certain sectors of themarket offer attractive relative value as underlying economicgrowth should lead to stable to improving credit metrics.
Portfolio StrategyInvestment Environment
SBGCCQ4012616JB
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14
Recovery Deleverage
Consolidation Leverage Throughs
Deterioration Releverage
Asset Allocation is Important
Corporate Credit Cycle
Source: Barclays as of January 31, 2016. Excess Returns are shown gross of fees.
Energy
Food & Beverage
Health Care
Industrials
Technology
Media
Retail
Transportation
Chemicals
Consumer
Insurance
Utilities
IG Credit CycleIG Credit Cycle
REITs Autos
Banks
Media
Retail
Chemicals
Metals & Mining
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15
Global Corporate Scorecard
Source: Barclays as of March 31, 2016. Excess Returns are shown gross of fees.
Current OASMarch OAS
ChangeYTD OAS Change
March Excess Return
YTD Excess Return
US Corporates 163 (34) (2) 2.62% 0.16% US Financials 155 (23) 21 1.55% -0.92% Banking 145 (23) 22 1.44% -0.83% Seniors 127 (23) 19 1.16% -0.46% Subordinate 224 (24) 38 2.67% -2.33% US Industrials 168 (42) (15) 3.33% 0.70% Basic 242 (49) (70) 4.19% 3.24% Capital Goods 114 (20) (6) 1.79% 0.44% Communications 185 (43) (8) 4.16% 1.33% Consumer Cyclical 141 (30) (0) 2.44% 0.57% Consumer Noncyclical 123 (24) (6) 2.15% 0.91% Energy 283 (124) (27) 7.22% -0.22% Technology 134 (25) (4) 2.12% 0.33% Transportation 152 (23) 2 2.41% 0.35% Other Industrial 136 6 12 0.38% -0.60% US Utes 151 (11) 1 1.14% 0.13%
EUR Corporates 131 (25) (3) 1.73% 0.48% EUR Financials 147 (18) 17 1.44% -0.20% Banking 128 (16) 18 1.10% -0.17% Covereds 54 (7) 3 0.45% 0.04% Seniors 104 (16) 11 0.99% 0.02% Subordinate 230 (21) 43 1.59% -1.01% EUR Industrials 118 (29) (19) 1.90% 1.02% Basic Industry 169 (43) (124) 2.53% 3.52% Capital Goods 100 (20) (13) 1.26% 0.57% Communications 131 (23) (2) 1.86% 0.85% Consumer Cyclical 121 (30) (11) 1.65% 0.52% Consumer Non-Cyclical 97 (28) (12) 1.71% 0.93% Energy 129 (48) (24) 3.33% 1.36% Technology 90 (17) 1 1.28% 0.22% Transportation 106 (26) (7) 1.70% 0.91% Other Industrial 164 (26) 9 1.76% 0.14% EUR Utes 121 (35) (8) 2.19% 0.99%
A's 125 (24) 3 1.92% 0.08%BBB's 215 (45) (5) 3.47% 0.26%
Intermediate 136 (33) (3) 1.56% 0.17%Long 225 (36) (2) 5.10% 0.11%
US HY 656 (71) (5) 4.26% 0.77%EUR HY 461 (87) 4 3.91% 0.42%
10yr Bund10yr US Treas
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16
U.S. Banks Are A Step Ahead In Recovery vs. European Banks
► European banks are larger and more levered resulting in more systemic risk to their respective countries. The asset deleveraging process is ongoing in Europe while U.S. banks have been forced to delever and derisktheir balance sheets beginning in 2008.
► European banks remain dependent on market sensitive wholesale funding but have benefited from unprecedented liquidity support by the ECB.
Source: Bloomberg US and European bank indices data as of December 31, 2015
Loans/Deposits
75.0
100.0
125.0
150.0
175.0
%
US banks Euro Banks
Assets/Equity Ratio
0.0
5.0
10.0
15.0
20.0
25.0
30.0US banks European banks
Net Interest Margin
0.0
1.0
2.0
3.0
4.0
%
US banks European banks
Non-Performing Loans Ratio
0.0
1.0
2.0
3.0
4.0
5.0
6.0
%
US banks European banks
SBGCCQ4012616JB
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17
U.S. Banks Are De-leveraging
Source: Bloomberg as of December 31, 2015
Net Interest Margin - Profitability
3.72 3.56 3.40 3.42 3.42 3.59 3.42 3.253.06 2.90
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
US banks median
Assets/Equity Leverage
10.4210.81
9.81
8.959.26 9.27
8.86 8.88 8.85 8.84
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
US banks median
Non-Performing Loans Ratio - Asset Quality
0.330.67
1.49
2.99
2.58
1.821.52
1.030.76 0.77
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
US banks median
Tier 1 Capital Ratio
8.757.86
10.8311.54 12.10 12.40 12.01 11.98 12.43 12.00
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Tier 1 Capital Ratio
SBGCCQ4012616JB