1
Credit Strategies
in an Uncertain World
PA
RT
ON
E:
Part one :
The credit market landscape
Part two :
Alternative credit strategies
Part three :
What strategy in which
environment
2
Part one:
The credit market landscape
3
Fixed Income Solar System
US
CMBS
US
RMBS
US
ABS
US
Municipal
US
Agency
US IG
US Lev.
Loans
EM
US
HY
G7 Government
Bonds
Peripherals
European
HY
Asia
European
Covered
Bonds
Source. Claren Road, Credit Suisse, JP Morgan, Metacapital.
European
ABS
European
IG
European
Leveraged
Loans
European
CMBS
EU
RMBS
4
Government Bonds
Annual Performance of US 10 year Treasuries: coupon & price returns
16%
35%
Price Return
30%
Coupon Return
25%
US 10Yr Yield
12%
15%
10%
10%
8%
5%
6%
0%
US 10 Year Yield
20%
14%
4%
-5%
2%
-15%
0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
-10%
Source: Bloomberg
5
High Yield Debt
High Yield Spread vs Next Quarter S&P 500 EBITDA growth
Source: Credit Suisse, Bloomberg
6
High Yield Debt
Annual Performance of CS US High Yield Index: coupon & price returns
60%
Coupon return
50%
Price return
40%
30%
20%
10%
0%
-10%
-20%
-30%
Source: Credit Suisse
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
-40%
7
Leveraged Loans
Leveraged Bank Loans (USD bn)
Source: Lipper
8
Leveraged Loans
Annual Performance of CS US Leveraged Loan Index: coupon & price returns
50%
Coupon return
40%
Price return
30%
20%
10%
0%
-10%
-20%
-30%
Source: Credit Suisse
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
-40%
9
Emerging Markets Debt
EM Debt Funds (USD bn)
Source: Lipper
10
Part two:
Alternative credit strategies
11
Event Driven (Refinancing) Strategies
New Issues by Use of Proceeds 2013
Loan
Refinance
24%
General
Corporate
15%
Acquisition
Finance
21%
Bond
Refinance
30%
Dividends
7%
Bond & Loan
Refinance
3%
Conceptually the strategy is amplifying default risk in exchange
of a better yield.
Source: Credit Suisse
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Event Driven (Refinancing) Strategies
Yield-to-Worst versus Coupon of CS HY Index
Conceptually the strategy is amplifying default risk in exchange of a
better yield.
Source: Credit Suisse
13
Distressed strategies
Source: Thomson Reuters
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Distressed strategies
Large % of lower rated debt defaults within four years
MORTALITY RATE
Years after issuance
Original Rating
B Yearly
B Cumulative
CCC Yearly
CCC Cumulative
Source: Edward, Altman-NYU Salomon Center
1 year
2.96%
2.96
8.30
8.30
2 years
7.86%
10.59
12.65
19.9
3 years
7.95%
17.70
18.28
34.54
4 years
7.93%
24.22
16.35
45.24
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Distressed strategies
OTHER INDICATORS OF DECLINING QUALITY
2006
2007
2008
2009
2010
2011
2012
2013
HY Proceeds
Used for Dividends
3.6% 2.0% 0.0% 1.9% 4.8% 4.8% 4.6% 3.9%
Covenantlite as %
of Annual Loan Volume
7.0% 25.0% 4.0% 9.0% 5.0% 24.3% 33.4% 51.0%
Source: Credit Suisse
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Lending
Source: European Central Bank
17
Structured Credit
Issuance history (USDbn)
Source: Thomson Reuters, S&P LCD, Deutsche Bank
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Short Strategies
Shorting is unusual in credit but it offers a tremendous asymetry.
Here a 0.50% annual cost lead to a 7.5% gain, as Heinz was LBO’d.
Source: Bloomberg
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Part three:
What strategy in which
environment
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Credit Strategies are highly dependent of Macro
Annual U.S. Money Supply Growth – ShadowStats Continuation
Source: Shadow Government Statistics, American Business Analytics & Research LLC.
21
Scenario 1 : Status Quo
Refinancing: Ample liquidity means no default and therefore good
performance;
Structured Credit: Search for yield intensifies and therefore structured
credit markets enjoy growth which leads to good performance;
Lending: Banking systems remains broken letting private players tap
traditional banking opportunities;
Distressed: There is little to do for such players who should deploy
minimal capital;
Shorting: Impossible to make money, losses should be no larger than
underlying market yield.
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Scenario 2 : Fixed Income Exodus
Refinancing: Credit markets are not operating and surge in defaults
leads to heavy losses (mostly realized);
Structured Credit: Credit markets are ceasing and increasing risk
premium linked to complexity and liquidity leads to heavy losses
(not necessarily realized);
Lending: Absence of mark to market soften the blow but poor
underwriting will lead to realized losses. Opportunity set becomes
outstanding;
Distressed: Initial mark to market losses is amplified by active
purchases but it does creates a great investment opportunity;
Shorting: Perfect scenario, large gains.
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Scenario 3 : Controlled Tapering
Refinancing: Activity slows down and natural increase in default leads
to mediocre performance;
Structured Credit: Benign environment, mediocre returns should lead
to increasing leverage;
Lending: Banks are back in business and should crowd out private
players;
Distressed: Higher rates leads to higher default rates through time,
which generates an attractive investment environment for several
years;
Shorting: Negative carry should offset gains generated by the few
captured defaults.
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Mixing things up to cope with an uncertain future
All strategies have strong and weak behaviour in each scenarios;
No Panacea;
Additional value can be created by combining them:

LENDING
+
STRUCTURED

DISTRESSED
+
SHORTING
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Important Information
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all investments, contains risks, including total loss for the investor.
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Contacts
Nicolas Rousselet – Unigestion SA
Head of Hedge Funds
Tel. +41 (0) 22 704 43 43
E-mail: [email protected]
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