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European Direct Lending Presentation on: European Direct Lending May 2014 Macro-Economic Context: Supply of Capital 2 Regulations Encourage Banks to Focus on Balance Sheet Size and Composition Estimated Basel III Compliance Capital Shortfalls1 € 180 165 Banks are under pressure from international € 160 and national regulators to meet higher capital € 140 ratios and reduce balance sheet risk € 120 103 € 100 European Banks are far from having de- leveraged to the extent required by regulators Billions € 80 € 60 36 € 40 Deleveraging in the European Banking sector is expected to take 5-7 years2 € 20 € 0 Core Tier 1 Shortfall Tier 1 Shortfall (8.5% Total Capital Shortfall Based on a conservative estimate banks (7.0% Ratio Target) Ratio Target) (10.5% Ratio Target) have a shortfall of liquid assets of €262 billion1 Retrenchment from lending by Banks creates new opportunities for non-banks lenders Please see important disclosures at the end of this presentation. 1European Banking Authority (EBA) Basel III Monitoring Exercise, March 2014 2The Deloitte Bank Survey, October 2012 3 Banks Lending Cautiously and Reducing Emphasis on Non-Core Activities Loans to Non-Financial Corporations across the EU1 20 15 10 5 0 -5 -10 Jul-06 Apr-03 Oct-09 Jun-05 Jan-13 Feb-14 Aug-07 Sep-08 Nov-10 Dec-11 May-04 Faced with regulations and volatile market conditions, Banks are favouring traditional retail and larger corporate credit Bank preference towards financing larger publicly traded companies stems from the following: – Significant underwriting fees – Ancillary business – Credit risk is more standardised and typically easier to assess for listed companies Direct lenders could fill the financing gap left by Banks Please see important disclosures at the end of this presentation. 1ECB Statistical Data Warehouse, February 2014 4 Lack of Alternative Non-Bank Sources of Financing European Leveraged New Issuance1 750 600 The high-yield sector in Europe has 450 historically been much smaller than 2 300 in the US ($232.5bn versus $1,050bn3) 150 0 2006 2007 2008 2009 2010 2011 2012 2013 1Q14 Institutional leveraged loan new Leveraged Loans HY Bonds issuance volumes in Europe have declined sharply from pre-crisis US Leveraged New Issuance1 levels 750 600 Compounding this, in Europe 450 (unlike in the US) there are no 300 BDCs and only a limited number of private investors 150 0 2006 2007 2008 2009 2010 2011 2012 2013 1Q14 Leveraged Loans HY Bonds The shortage of capital faced by European companies is further exacerbated 1S&P LCD Global Report Q1 2014; 2Europe's Long Road to the Bond Markets, Wall Street Journal, March 2013; 3Bank of America Merrill Lynch, March 2013. Please see important disclosures at the end of this presentation. 5 €64bn of loan portfolios traded in 20131 Loan Portfolios Traded1 90 Est. €80bn 80 €64bn 70 ) 60 bn €46bn € 50 €36bn 40 30 Face value ( value Face 20 10 0 2011 2012 2013 2014 Specialized SME/Corporate Unsecured Retail Secured Retail CRE Estimated In progress CRE and unsecured retail remain the most actively traded asset class Please see important disclosures at the end of this presentation. 1PWC March 2014, European Portfolio Advisory Group Market Update. Note: “Specialised” includes certain structured and asset backed products, shipping, infrastructure, energy and aviation exposures 6 Banks Are Re-Allocating Across Balance Sheets Ahead of Basel III1 Loan Portfolios Traded Average Basel Capital Requirement2 100 5.0% 4.70% 80 4.0% 3.40% 60 3.0% 2.40% 1.80% 40 2.0% 1.50% 1.0% 0.40% 20 0.0% 0 % Share of Total EAD (end 2012) %Share of Total Basel Capital Requirements (End 2012) Corporate Central Bank/Sovereign Residential Mortgage Retail (ex-mortgage) Finanical Insitution Securitization EAD, EUR Bil. Change Since 2010 EAD, % Change Since 2010 800 26.0% 552 30% 600 20% 400 277 12.0% 200 10% 0 0% -200 -10% -172 -167 -169 -9.0% -9.0% -9.0% -400 -20% -600 -441 -30% -26.0% Please see important disclosures at the end of this presentation. 1Fitch Ratings, December 6, 2013. 2As % of EAD, End 2012 7 Macro-Economic Context: Demand for Capital 8 European Corporates Refinancing Needs Set to Increase Institutional Leveraged Loan Maturity Wall1 The recent crisis and economic uncertainty €40B have adversely affected refinancing plans of many corporate borrowers €30B As a result, a number of pre-2009 LBOs, €20B supported by debt maturing in 2016-2018, are now facing a so-called "Maturity Wall” €10B The maturity peak for institutional European leveraged debt is currently expected to fall €0B in 2018 2014 2015 2016 2017 2018 2019 2020 In Europe, corporate borrowers have much 2021 or Later greater refinancing requirements than the public market is currently capable of absorbing Direct lenders can help businesses refinance maturing debt or restructure Please see important disclosures at the end of this presentation. 1LCD European High-Yield Weekly Review, April 18, 2014 9 Private Equity Dry Powder in Europe Remains High1 European Private Equity dry powder1 700 600 500 400 300 200 100 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 North America Europe Asia Rest of World The amount of capital committed to Private Equity Funds available for investment remains high (just over $200bn)1 As funds move closer towards the end of their investment periods, Fund Managers are keen to find viable investments and deploy remaining capital in the next few years The willingness of Private Equity Managers to invest creates opportunities for direct lenders to be brought in as lead debt arrangers Fund managers keen to invest on the equity side are driving demand for debt Please see important disclosures at the end of this presentation. 1Preqin Global Private Equity Report, 2013 10 Shortage of Capital Compounded for Middle Market Companies Financial Obstacles1 60-80% of SMEs in Europe are financed via the banking sector (versus 40-55% in US) High yield bond market in Europe is often difficult Lack of affordable finance Building cash reserves or impossible to access for middle market 40% Financial health challenges companies given an average issue size of €180mm Middle market companies typically require flexible 30% lending solutions that are unavailable through public markets Euro area SMEs report in net terms an increase in 20% their need for bank loans and a deterioration in the availability of bank loans2 10% ECB survey results point to increased rejection rates for euro area SMEs when applying for a loan (12%) 2 0% The percentage of SMEs reporting access to France Germany Italy UK finance as their main problem remains broadly stable (at 16%) 2 Scarcity of alternative sources of capital allow private investors to negotiate better loan terms Please see important disclosures at the end of this presentation. 1European SME CAPEX Barometer”, GE Capital, June 2012. Research carried out in January 2012, and completed 1st week of February 2012. 2ECB Report on the results of the survey on the access to finance of SMEs in the euro area – April to September 2013, 14th November 2013 11 Opportunity: Attractive Risk-Adjusted Returns 12 Private Lenders Able to Access Senior Debt & Capture Illiquidity Premium Expected Annual Returns of Various Debt Asset Classes1 Yields on Government and Investment Grade 7% credit remain low due to high demand fuelled 6.0% by market uncertainty and quantitative easing 6% 5.5% 2 5% HY bonds produced a 9.1% in 2013 , however 2014 results are expected to be more modest 4% with total return predominantly income as 3% 2.3% apposed to price appreciation (vs. 2013) with increased volatility 2% 1.4% 1% Scarcity of capital is forcing some middle 0% market companies to pay a premium to their Developed Govt. Investment Grade W. European W. European lenders Bonds (Global) Bonds Leveraged Loans High Yield (WELLI) In European Direct Lending Spreads of Mid to High Single Digits are available for Senior and Unitranche loans Higher returns versus fixed income alternatives Please see important disclosures at the end of this presentation. 1Developed Government and Investment Grade Bonds expected annual returns data sourced from Barclays Compass (February 2014), annual returns are based on a 5-year forecast and are expected to be compounded over this period. Western European Leveraged Loans (WELLI) and High Yield expected annual returns sourced from Credit Suisse Leveraged Finance Outlook (5 December 2013) and are a forecast for 2014. 2Credit Suisse Western European High Yield Bond Index. 13 Historically, Loan Default Rates are Lower & Recovery Rates Higher Than High-Yield1 Default Rates Recovery Rates 4.0% 3.5% 70.0% 3.5% 62.2% 60.0% 3.0% 2.7% 50.0% 2.5% 43.2% 40.0% 2.0% 30.0% 1.5% 20.0% 1.0% 10.0% 0.5% 0.0% 0.0% High Yield Bonds Leveraged Loans (1st Lien) High Yield Bonds Leveraged Loans (1st Lien) First lien loans have experienced lower default rates compared to peer asset classes due to a lower risk profile of senior secured loans In the event of default, first lien loan investors are the first to be repaid and can request asset liquidation to generate the cash required The retraction of banks from middle market financing created an opportunity for private investors to tap into the safer senior loan market traditionally dominated by Banks Greater protection in the event of default 1Credit Suisse (8 April 2014) 1995- March 2014 Please see important disclosures at the end of this presentation. 14 Floating Rate Nature of Loans Mitigates Impact of Rising Rates1 Duration and YTM across Fixed Income Investments Empirical evidence suggests that (March 2013) senior loans act as a natural hedge in a rising interest rate environment 7% 6% High Yield Bonds The interest rate on senior loans Bank Loans 5% typically resets regularly resulting in Emerging Market Bonds minimal duration risk 4% Investment-Grade 3% Corporates Senior secured loans offer a 2% Municipal Bonds Yield to Maturity toYield compelling investment opportunity US Fixed Income 1% during flat and rising interest rate Treasury Bills US Government Bonds markets relative to other fixed 0% income investments 0 1 2 3 4 5 6 7 8 Duration (Years) The floating rate nature of loans mitigates interest rate risk Please see important disclosures at the end of this presentation.
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