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Strategic Asset Alliance Insurer Investment Forum XIII Cliff Noreen, President – Babson Capital March 21, 2013 Table of Contents Babson Capital Section 1: MassMutual and Babson Capital Management Overview 2 Section 2: Global Economy 5 Section 3: Credit Markets 31 Section 4: Insurance Industry Challenges 40 Section 5: Insurance Solutions/Asset Allocation 47 Appendix: Important Information 71 13/358 1 MassMutual and Babson Capital Management Overview MassMutual Investment Platform Over $508 billion in assets under management1 MML company assets in excess of $167 billion1 MML is a highly rated, 160 year old financial institution (A++, AA+, Aa2, AA+)2 $52 billion1 in assets under management $160billion1 in assets under management $195 billion1 in assets under management 1. As of December 31, 2012 2. Ratings: A++ (Superior) A.M. Best Company; AA+ (Very Strong) Fitch Ratings; Aa2 (Excellent) Moody’s Investor Service; AA+ (Very Strong) Standard & Poor’s. Ratings as of January 1, 2013. Ratings are subject to change. Babson Capital 13/358 3 Babson Overview $160 Billion in AUM Babson Capital1 Global High Yield $39B Sr. Secured Loans: (par & distressed) – U.S. & European High Yield Bonds Global Fixed Income $63B $22.2B $6.5B Structured Credit: $10.0B – CLO Debt and Equity portfolio management – Investment Grade CDOs Cornerstone $36B $123B Primary Strategies: $58B – Short Duration – Long Duration – Core / Core Plus – Corporate Bonds – Inflation-Protected Bonds Securitized: – RMBS – ABS Alternatives: – Event Driven – Multi-Strategy $1.5B Private Placements Mezzanine & Private Equity: – U.S., Europe & Australia $15.5B $5.1B Real Estate $36B $0.3B $1B Real Assets $1B CMBS Agricultural Real Estate Comm Mtg Loans Infrastructure Res Whole Loans Transportation Core Equity Entertainment Intellectual Property – Film & music copyrights Core Mortgage Equity: $1.4B – Disciplined Growth – Disciplined Value Investment Professionals 202 Global Private Finance $21B Wood Creek Mezzanine Debt RE Securities Value-Added Equity Other Investment Professionals 120 Investment Professionals 12 As of December 31, 2012 1. Includes subsidiaries Babson Capital 13/358 4 Global Economy U.S. GDP Accounts For 22% Of $71 Trillion Global Economy Top 10 World Economies Fiscal Year 2012 ($Trillions) China, $8.3T U.S. $15.7T Japan $6.0T Germany $3.4T France $2.6T Brazil $2.4T U.K. $2.4T Rest of World $24.7T Italy $2.0T Russia $2.0T India $1.9T Source: IMF 10/9/2012 WEO Database Babson Capital 13/358 6 U.S. Public Companies Comprise 33% Of Global Equity Value U.S.& EuropeMarket Market Capitalization CapitalizationVs. vs. Rest U.S. & Europe Rest of of World World January2005 2005– -March March2013 2013 January 70 Current World Market Cap $55.2T World Market Capitalization $ Trillion 60 50 $18.3T 40 $5.6T 30 $31.3T 20 10 0 Rest of World *Europe = Eurozone 17 As of 3/7/2013 Babson Capital 13/358 Europe* US Source: Bl oomberg 7 U.S. Corporations Are Very Healthy • Corporations have strong earnings and balance sheets • Cash balances are historically high • Strong free cash flow generation • M&A activity increasing in 2013 • Access to capital flowing • Investment grade market • High yield bond market • High yield loan market • Corporate default rates are low Valuable Leading Companies Company Market Cap • Apple $400B • Exxon $400B • Google $276B • Berkshire Hathaway $254B • General Electric $247B Source: U.S Census Bureau, CIA Fact Book, Bloomberg 3/7/2013 Babson Capital 13/358 8 2013 M&A Off To A Quick Start Mergers will top $1T in 2013 at current pace Target Acquirer Deal Size Heinz Virgin Media Dell NBC Universal Clearwire Copano Energy Cole Credit Albertsons Tysabri US Airways Berkshire Hathaway Liberty Global LBO/PE ( CEO Michael Dell) Comcast Dish Kinder Morgan Spirit Realty Capital LBO/PE (Cerberus) Biogen American Airlines $27B $21B $18B $17B $8B $4B $4B $3B $3B $3B Total U.S. M&A activity YTD = $152B Source: Bloomberg 2/20/13 Babson Capital 13/358 9 U.S. Corporate Profits Have Rebounded To Near All-Time Highs Inflation Adjusted Net Profits of U.S. Corporations January 1953 to September 2012 2,000 1,800 $1.74T Adjusted Net Profits $ Billion 1,600 1,400 1,200 1,000 800 600 400 200 0 Recessions U.S. Real After Tax Corporate Profits Source: Federal Reserve Economic Database Babson Capital 13/358 10 Wages Are At Historical Lows as Earnings Hit Historical Highs Wages and Corporate Profits 54% 12% 52% 10% 50% 8% 48% 6% 46% 4% 44% 2% 42% 0% Recessions Average (Wages) Average (Corp Profits) Corporate Profits as % of GDP Wages as % of GDP January 1952 – September 2012 Wages as a % of GDP Corporate Profits as % of GDP Source: Federal Reserve Economic Database 1/9/13 Babson Capital 13/358 11 Quality of GDP Growth GDP Growth Rate in U.S. is Artificially Supported by: • Negative real short term interest rates (ZIRP-0% interest rate policy) • QE1, QE2, Operation Twist, QE3 (now) • Deficit ($1.3T in 2011, $1.1T 2012, and $.88T 2013 Proj) • $3.54T of spending vs. $2.45T of revenue • Support for housing (Mortgages, FHA, Fannie, Freddie) Source: CBO Babson Capital 13/358 12 Federal Debt Has Grown Over $10 Trillion Since 2002 Gross Federal Debt December 2002 to February 2013 18 1 $16.7T 16 1 Total Federal Debt $ Trillions 14 12 1 10 8 0 6 4 0 2 0 0 Recession Gross Federal Debt Source Federal Reserve Economic Data, Treasury Direct as of 3/6/2013 Babson Capital 13/358 13 U.S. Government Revenues by Source U.S. Government Revenues by Source 2001 to 2012 3.0 2012 Federal Revenue $2.45T Receipts as a % of GDP Federal Receipts in $ Trillions 2.5 1.6% 2.0 1.5% 1.5 1.0 Corporations Other 5.5% Social Insurance 7.3% 0.5 Individuals Total 15.8% 0.0 Source: Budget of the United States Government 2013 Babson Capital 13/358 14 U.S. Government Outlays By Use U.S. Government Outlays 2001 to 2012 Outlays as a % of GDP 4.0 2012 Federal Spending $3.54T 3.5 1.3% 1.7% 1.5% Federal Outlays in $ Trillions 3.0 4.2% 2.5 General Government Spending 2.0 Energy - Transportation Net Interest 1.5 Defense Spending 14.7% 1.0 Social Spending (Education, Medicare/Medicaid, Social Security, Veterans) 0.5 Total 23.1% 0.0 Social Spending National Defense Net interest Energy - Transportation General Government -Other Source: Budget of the United States Government 2013 Babson Capital 13/358 15 Social Programs Dominate the Budget Federal Spending on Social Programs Federal Spending on Social Programs January 2001 – December 2012 2001-2012 1.8 Federal Social Spending in $ Trillions 1.6 Social Security Medicare Food Stamps and Other Unemployment Insurance Veterans' benefits, workers comp, Other % of Federal Outlays Social Programs $1.8T 50% of Federal Spending 75% of Federal Revenues 60% 50% 1.4 40% 1.2 1.0 30% 0.8 20% 0.6 0.4 10% Federal Social Spending as % of Federal Outlays 2.0 0.2 0.0 0% Source: Bureau of Economic Analysis and Babson Capital. Babson Capital 13/358 16 U.S. Budget Receipts, Outlays, Deficits 2001-2012 U.S. Deficit 4.0 2001 to 2012 U.S. Budget Recipts/Outlays/Deficits in $ Trillion U.S. Budget Recipts/Outlays/Deficits $ Trillion 1.0 Outlays $3.54T 3.5 Deficit $1.09T 0.8 3.0 2.50.6 Receipts $2.45T 2.0 0.4 1.5 0.2 1.0 2001 0.0 Receipts 2.00 Outlays 1.86 Deficit - 2002 2003 2004 1 1.852 1.78 3 1.88 4 2006 2007 5 2.156 2.41 7 2.57 8 2008 2009 9 2.5210 2.10 11 2010 2011 2012 Average 2.16 132.30 12 2.45 2.18 2.01 2.16 2.29 2.47 2.66 2.73 2.98 3.52 3.46 3.60 3.54 2.77 -0.16 -0.38 -0.41 -0.32 -0.25 -0.16 -0.46 -1.41 -1.29 -1.30 -1.09 -0.66 Source: Budget of the United States Government 2013 Babson Capital 2005 13/358 Recessions 17 Fiscal Cliff Largely Avoided But Governing By Fire Drill Continues Approximately $300B in Tax increases 2% of GDP Approximately $87 Billion in Tax Increases on High Earners 124B 120B 100B 89B $ Billions New 2013 Revenue $ Billions 140B 80B 60B 40B 40B 24B 15B 20B 8B B Payroll Tax on All Employees Obama Care Personal Higher Rates Capital Gains Exemptions, on High and Estate Deductions Earners Tax Good News 80%+ of Bush Tax Cuts Made Permanent Capital Gains Unchanged For Most Worst Of The Tax Increases Avoided Other Tax Provisions 90 80 70 60 50 40 30 20 10 0 Hit March 1st $85B In spending cuts in 2013 Sequester Cuts (50% Defense 50% Social Programs) Hit March 1st Bad News Gov’t shut down possible March 27th Debt Ceiling hits in May Top Income Taxpayers Hit Hard Did Not Help Reduce The Deficit Source: Congressional Budget Office 5/12 Babson Capital 13/358 18 Entitlement Cliff Average 401K balance for people 55-64 is • • • • State Pensions are underfunded by U.S. Corporate Pensions are underfunded by Medical care in the U.S. is 19% of the economy • • $1.4T $360B $2.8T Larger than all but the largest 3 countries GDP U.S. Spends $8,900 per person on health care. More than double the developed world average of $3,200(OECD) Workers per Beneficiary Number of Beneficiaries • Simple Math… • People are living longer now than when Social Security (1935) and Medicare (1965) were created • $120,000 Enough to purchase an annuity for less than $600 a month Baby Boomers are retiring at a rate of nearly 4 million a year, the number of workers available to support them is falling. 4.5 90 80 80 Millions of Beneficiaries • 70 3.4 3.5 64 2.8 3 60 50 4 4 47 2.3 2.5 40 40 2 30 1.5 20 1 10 0.5 0 0 2000 2010 2020p 2030p 2000 2010 2020p 2030p Source: Budget of the United States Government 2013, PEW , Boston College, Bloomberg, Bureau of Economic Analysis, Kaiser Foundation Babson Capital 13/358 19 Federal Medicare & Medicaid Spending Medicare and Medicaid Spending January 2001 – December 2012 600 Medicare Federal Spending in $ Billions 500 Medicaid $566B 400 300 $282B 200 100 2011/12 Medicaid Expense Babson Estimate Source: St. Louis Federal Reserve, Centers for Medicare and Medicaid Services Babson Capital 13/358 20 Food Stamps Use At All Time High Food Stamps vs. Millionaires 2001 - 2012Food Stamps U.S. Households Using 25 Hous eholds i n Millions 20 47.5 Million (15%) of U.S. Population are on Food Stamps as of November 2012 15 10 5 0 Number of Millionaire Households Number of Households Receiving Food Stamps Source: USDA /Spectrem Group Babson Capital 13/358 21 Dramatic Fall Off in Housing Related Purchases Hurt Overall GDP Household Durable Goods Spending and Residential Household Durable Goods Spending and Residential Investment March Investment 1991 – December 2012 January 1991 - September 2012 9% % of GDP 1.0 8.3% 0.8 -$673 Billion 7% 0.6 0.4 5% 4.2% 3% 0.2 0.0 Recessions % of GDP Source: NBER. BEA, Babson Capital Babson Capital 13/358 22 Housing Starts Have Improved Significantly from Lows U.S. Housing Starts U.S. Housing Starts April 2009 2013 May 2009- –January January 2013 1,000 950 Housing Starts SAAR Thousands 900 890,000 850 800 750 700 650 600 550 500 450 Source U.S. Department of Commerce Babson Capital 13/358 23 But are Less than Half of The Long Term Average U.S. Starts U.S.Housing Housing Starts January 1959–-January January 2013 January 1963 2013 2,800 Housing Starts SAAR Thousands 2,500 2,200 1,900 1,600 Avera ge 1,472,000 1,300 1,000 890,000 700 400 Source U.S. Department of Commerce Babson Capital 13/358 24 Financial Assets Fully Recovered, Real Estate Assets Improving Household Financial & Real Estate Assets 600 30 550 28 0 50 0 45 0 26 400 20 350 18 0 30 0 16 24 22 14 25 0 12 200 10 Recessions Financial Assets Houosehold Real Estate Assets $ Trillions Household Financial Assets $ Trillions September 2002 to December 2012 Household Real Estate Assets Source: Federal Reserve Flow of Funds Babson Capital 13/358 25 Booming Oil Production Reducing Foreign Dependence Domestic vs. Imported Oil January 2008– December 2012 12 Millions of Barrels per day 11 10 9 8 7 6 5 Oil Production Oil Imports Source: EIA.gov Babson Capital 13/358 26 The U.S. Energy Boom is Real and Should Drive U.S. Growth • By 2015 the U.S. will be the largest natural gas producer in the world • By 2020 the U.S. could be the worlds largest oil producer in the world • Natural gas is dramatically cheaper in the U.S. Benefits to U.S. Since 2010 • Lower U.S. dependence on foreign oil • Gas production is at all time high, up 35% • Will reduce trace deficit • Oil production is at 20 year high, up 26% • Creates jobs (both in energy and indirectly) • Extraction jobs are plentiful, up 24% • Improves international competitiveness (Due to cheap gas) • Improving state revenue (TX, ND, VA, PA) Source: ISI Group Babson Capital 13/358 27 Peripheral Europe Country Data Peripheral Population (Millions) Unemployment (%) Unem 16-25 yrs (%) Debt (Gross $B) GDP ($B) GDP Growth (%) Debt/GDP (%) Revenue ($B) Deficit ($B) Deficit (% GDP) Maturing (Thru 2015) Rating (Moody's/S&P) Core Greece Portugal Ireland Spain Italy Total 10.8 10.8 4.8 47.7 27 17.6 14.7 26.2 59.4 38.6 30.9 55.5 442 273 237 1,485 289 237 217 1,470 -4.3% -2.2% 1.0% -1.5% 153% 115% 109% 101% 116 100 75 541 -27 -10 -29 -138 -9.4% -4.4% -13.4% -9.4% 61 64 23 425 61 11.7 38.7 2,654 2,193 -0.1% 121% 1,007 -86 -3.9% 865 135.1 18.0 45.3 5,089 4,406 C/B- Ba3/BB 115% 1,839 -290 -6.5% 1,438 Ba1/BBB+ Baa3/BBB- Baa2/BBB+ Germany France Netherlands Eurozone 80.1 66 16.8 403 5.3 10.6 5.5 11.9 7.9 26.9 10.3 24.2 2,988 2,496 570 11,164 3,600 2,773 836 12,600 0.9% 0.1% -0.5% -0.4% 83% 90% 68.2% 89% 1,588 1,404 371 5,594 -29 -125 -38 -0.8% -4.5% -4.5% 580 726 2 Aaa/AAA Aa1/AA+ Aaa/AAA U.K. 64 7.7 20.4 2,183 2,453 -0.1% 89% 908 -130 -4.5% 405 Aaa/AAA Red=Deteriorating Green =Improving Source: Bloomberg, Eurostat, IMF World Economic Database 9/1/12, and Babson Capital As of 2/13/2013 Babson Capital 13/358 28 Yield on European Debt Has Fallen Dramatically 40 35 30 Greece Portugal Ireland Spain Italy France UK Germany LTRO: €2T ESM: €80B OMT: Open Ended 10Y Yield in % 25 20 15 10.8% 10 5 4.6% 1.5% 0 Source: FactSet/Bloomberg 3/7/2013 Babson Capital 13/358 29 Economic Recap • Global growth below trend – U.S., Euro zone, China and Japan expected to grow below long term average rate • Central bank intervention in markets – Fed, ECB, BOE and BOJ balance sheets total nearly $9 trillion • Extended low rate environment – major developed economy policy rates at all-time lows • Financial repression creates the search for yield – real yields on high quality assets hover around 0% Babson Capital 13/358 30 Credit Markets Investment Grade Bond Spreads - One Year U.S. Investment Grade Index February 2012 – March 2013 220 200 Basis Points 180 160 160 136 140 120 100 U.S. Investment Grade Average Source: Barclays Capital as of March 6, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 32 Investment Grade Bond Spreads – Long Term U.S. U.S. Investment Grade Credit Index Investment Grade Index January 1990 - March 2013 February 1990 – March 2013 700 0.9 600 0.8 0.7 Basis Points 500 0.6 400 0.5 300 0.4 0.3 141 0.2 136 200 100 125 0.1 0 0 Recessions U.S. Investment Grade Average *Average Omittin g Peak Source: Barclays Capital as of March 6, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 33 High Yield Bond Spreads - One Year U.S. High Index U.S. High YieldYield Credit Index February 2012 – March 2013 February 2012 - February 2013 700 650 Basis Points 600 592 550 488 500 450 400 U.S. High Yield Average Source: Barclays Capital as of March 6, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 34 High Yield Bond Spreads – Long Term U.S.U.S. HighHigh YieldYield CreditIndex Index January 2013 February1994-March 1994 – March 2013 2,500 0.9 0.8 2,000 0.7 0.6 Basis Points 1,500 0.5 0.4 1,000 0.3 555 0.2 507 500 459 0.1 0 0 Recessions U.S. High Yield Average *Average Omitting Peak Source: Barclays Capital as of March 6, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 35 Bank Loan Spreads - One Year CreditSuisse Suisse Leveraged Loan Index Credit Leveraged Loan Index February 2012 – March 2013 February 2012 - March 2013 620 600 Basis Points 580 560 564 522 540 520 500 CSFB Levered Loan Index Average Source: Credit Suisse as of March 8, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 36 Bank Loan Spreads – Long Term Leveraged Loan Index CreditCSFB Suisse Leveraged Loan Index January 20022013 February 2002 March – March 2013 2,000 1 1,800 1 Basis Points 1,600 1,400 1 1,200 1 1,000 1 800 0 600 0 536 400 522 0 200 466 0 0 0 Recessions CSFB Leveraged Loan Average *Average Omitting Peak Source: Credit Suisse as of March 8, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 37 CLO Spreads - One Year U.S. CLO Spread History February 2012 – March 2013 300 250 Basis Points 200 167 150 120 100 50 0 AAA Average Source: Citigroup as of March 8, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. CLO – Collateralized Loan Obligation. Babson Capital 13/358 38 CLO Spreads – Long Term U.S. CLO Spread History February 2004 – March 2013 700 1.0 600 0.8 Basis Points 500 0.6 400 300 0.4 200 183 138 0.2 120 100 0 0.0 Recessions AAA Average Average omitting peak Source: Citigroup as of March 8, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 39 Insurance Industry Challenges “Low Rates For Longer” – Investment Implications • Declining book yields, lower investment earnings • Traditional business lines/products are more likely to experience a loss • Conventionally safe assets, such as government bonds and bank debt, have become less stable • Need to proactively evaluate investment programs to gauge the impact of an extended low interest rate environment and potential solutions Think Outside The Box Babson Capital 13/358 41 Investment Considerations/Constraints • Liquidity – need to assess the % of portfolio in illiquid instruments • Risk-based capital, capital requirements, credit quality • Liability matching • Access to opportunity Babson Capital 13/358 42 Investment Considerations - Liquidity Return Potential More Mezzanine Debt Junior CLO Liabilities Commercial Mortgage Loans Private Placement Debt High Yield Bonds Bank Loans Senior CLO Liabilities Investment Grade Corporate Bonds Treasuries Liquidity Less Babson Capital More 13/358 43 Investment Considerations – Risk-Based Capital Requirements NAIC Rating S&P Rating P&C Risk-Based Capital Life Risk-Based Capital 1 A- to AAA .3% .4% 2 BBB- to BBB+ 1.0% 1.3% 3 BB- to BB+ 2.0% 4.6% 4 B- to B+ 4.5% 10.0% 10.0% 23.0% 30.0% 30.0% CCC- to CCC+ 5 6 D to CC Source: National Association of Insurance Commissioners and Standard and Poor’s. See appendix for S&P rating definitions. Babson Capital 13/358 44 Investment Considerations – Liability Matching • Re-price insurance products • Change insurance product mix • Increase asset duration as liability durations extend • Increase investment allocation to risky assets Babson Capital 13/358 45 Investment Considerations – Access to Opportunities • Size of investment market • Minimum investment levels • Investment policy limitations • Availability of competent investment management Babson Capital 13/358 46 Insurance Solutions/Asset Allocation Solutions For Addressing Declining Book Yields Higher Yielding, High Quality Assets EST. GLOBAL MARKET SIZE • Private Placement Debt • Commercial Mortgage Loans $1,400 • Senior CLO Liabilities $1,200 1,329 Higher Yielding, Lower Quality Assets • High Yield Bonds Billions $1,000 $600 • Leveraged Loans $400 • Junior CLO Liabilities (Mezzanine and Equity Tranches) 796 $800 500 384 $200 73 $0 Higher Yielding Private Market Assets • Mezzanine Debt and Private Equity $2.2T commercial mortgages outstanding, $272B held by life cos. Source: Credit Suisse, SIFMA, Preqin, Federal Reserve and Babson Capital as of February 28, 2013. Babson Capital 13/358 48 Solutions Objective • Capture incremental yield • Seek to improve diversification, • Adequate compensation for additional risk • Understand role and fit of new investments within existing program • Interest rate hedge (floating rate) Babson Capital 13/358 49 Investment Options Investment Strategy Current Yield Estimate Investment Rationale Senior CLO Debt 1.5-4.0% Attractive yield in A or higher, relative value, decent liquidity Private Placement Debt 3.5-4.5% Yield premium, meaningful covenants, diversification Commercial Mortgage Loans 4.0-5.0% Yield premium, customized duration targets, low losses Bank Loans 5.0-7.0% Interest rate hedge, attractive yields, senior secured High Yield Bonds 6.0-8.0% Attractive yield, good liquidity, diversification 4.0-9.0%/10+% Attractive yield, relative value, higher return potential CLO Mezzanine Debt/Equity Mezzanine Debt 13.0-16.0% Attractive yield, current income, low correlation Source: Babson Capital, based on market data as of March 6, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. Babson Capital 13/358 50 Private Placement Bonds - Attributes • Primarily investment grade (NAIC rated 1 or 2) • Meaningful covenants • Fixed rate coupon • Offers yield premium over comparable public market corporate debt • Added diversification by issuer, industry, geography and maturity • Developing secondary market Babson Capital 13/358 51 Private Placement vs. Public Investment Grade Bond Spreads 4Q12 1Q12 2Q11 3Q10 4Q09 1Q09 2Q08 3Q07 BBB Avg 1Q06 2Q05 0 bps 3Q04 0 bps 4Q03 50 bps 1Q03 50 bps 2Q02 100 bps 3Q01 100 bps NAIC-2 4Q00 150 bps 4Q12 150 bps 1Q12 200 bps 2Q11 200 bps 3Q10 250 bps 4Q09 250 bps 1Q09 300 bps 2Q08 300 bps 3Q07 350 bps 4Q06 350 bps 1Q06 400 bps 2Q05 400 bps 3Q04 450 bps 4Q03 450 bps 1Q03 500 bps 2Q02 500 bps 3Q01 550 bps 4Q00 550 bps 1Q00 600 bps 4Q06 AAA Avg 1Q00 NAIC-1 600 bps Source: Bank of America/Merrill Lynch and Bloomberg as of December 31, 2012. Babson Capital 13/358 52 Commercial Mortgage Loans - Attributes • Secured by best in class assets with institutional sponsors • 100% current income • Very attractive spreads on a risk-adjusted basis • Simplicity in capital stack with only core mortgage and equity holder (as compared to CMBS) • Defensive play in light of aggressive equity values • Call-protected fixed income alternative • Very low loss given default Babson Capital 13/358 53 Commercial Mortgage Loans 9% 600 8% 500 6% 400 5% 300 4% 3% 200 Spread to Treasury (bps) Mortgage Rate & Treasury Yield 7% 2% 100 1% 0% 0 2000 2002 2004 Spread 2006 2008 ACLI Contract Mortgage Rate 2010 2012 10 Year Treasury Source: American Council of Life Insurance Companies, Federal Reserve Board as December 31, 2012. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 54 Structured Credit - CLOs • U.S. market size $285B ($65B in BBB,BB and equity), Europe ~$100B • Securitized credit structure backed by senior secured loans • Capital structure comprised of tranches with varying return and risk profiles • Offers flexibility to customize various investment mandates • Structural integrity – effectively weathered the credit crisis • Dynamically managed collateral pool of bank loans Babson Capital 13/358 55 Senior CLO Notes - Attributes • Securitized credit structure backed by senior secured loans • Senior tranches rated AAA through A (NAIC-1) • Floating rate coupon • Attractive risk attributes: structural features, subordination (25-35%), resilient collateral, transparency • Compelling relative value vs. similar rated credit Babson Capital 13/358 56 Senior CLO Notes - Spreads SENIOR CLO TRANCHE RELATIVE VALUE 250 bps 200 bps Spread 150 bps 100 bps 50 bps 0 bps AAA AA A Current Credit Rating CLO Investment Grade Corporate Source: Barclays Capital and JP Morgan as of February 28, 2013. Babson Capital 13/358 57 Junior CLO Liabilities – Mezzanine and Equity Tranches • Mezzanine tranches rated A through BB (NAIC 1-3); still benefit from structural subordination (10-25%) • Equity tranche unrated • Moderate-to-high return investment opportunity • Attractive relative value vs. similar rated credit Babson Capital 13/358 58 Junior CLO Liabilities – Mezzanine and Equity Tranches CLO MEZZANINE TRANCHE RELATIVE VALUE 600 bps 500 bps Spread 400 bps 300 bps 200 bps 100 bps 0 bps BBB BB B Current Credit Rating CLO Bank Loans Corporate Bonds • Equity tranches provide a return profile comparable to other high return alternative assets. Source: Barclays Capital and JP Morgan as of February 28, 2013. Babson Capital 13/358 59 Bank Loans - Attributes • Senior secured debt (top of the capital structure) • Strong covenant protection • Floating rate coupon offers interest rate hedge with LIBOR floors • Attractive risk attributes: relatively low volatility and downside risk Babson Capital 13/358 60 Bank Loan Returns and Yields Bank Loan Total Return and Yield January 1992– February 2013 50% 11% 44.9 40% 10% 30% 9% 20% 8% 11.2 10.3 10% 6.8 8.9 7.5 11.0 8.3 5.3 4.7 4.9 5.6 2.6 5.7 10.0 7.3 1.9 1.1 9.4 7% 1.8 0% 6% -10% 5% -20% 4% -30% -28.8 3% -40% 2% -50% 1% Total Return (Left) 1/31/1992 6.76% Current Yield (Right) Source: Credit Suisse as of February 28, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 61 Bank Loan Spreads and Default Rates BANK LOAN SPREADS VS. DEFAULT RATES 2,000 1,800 1,600 basis points 1,400 1,200 1,000 800 600 400 200 0 DM3 Spread LTM Default Rate Source: Credit Suisse and JP Morgan as of December 31, 2012. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 62 High Yield Bonds - Attributes • Company fundamentals are strong, corporate profits at record high • High cash coupons (compensation for added credit risk) • Institutional, relatively liquid markets • Shorter duration than investment grade corporate market with lower interest rate sensitivity • Diversification benefits – low correlation with other fixed income assets Babson Capital 13/358 63 High Yield Bond Returns and Yields High Yield Bond Total Return and Yield January 1992– February 2013 20% 70% 58.2 60% 18% 50% 16% 40% 14% 29.0 30% 20% 15.8 12% 19.2 17.1 11.4 15.8 15.1 12.8 11.8 11.1 10% 5.3 1.9 2.7 2.4 10% 5.0 8% 1.9 0% 6% -1.0 -1.4 -5.9 -10% 4% -20% 2% -26.2 -30% Total Return (Left) 1/31/1992 6.76% 0% YTW (Right) Source: Barclay’s Capital High Yield Bond Index as of February 28, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 64 High Yield Bond Spreads and Default Rates HIGH YIELD BOND SPREADS VS. DEFAULT RATES 2,000 1,800 1,600 basis points 1,400 1,200 1,000 800 600 400 200 0 Default Rate OAS Source: Barclay’s Capital High Yield Bond Index and JP Morgan as of December 31, 2012. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 65 Mezzanine Debt - Attributes • Private high yield debt (typically financing for lower middle market companies) • Subordinated, unsecured notes with high cash coupons • Attractive return and yield premium above public high yield debt (HY + 500-700 bps) • Low correlation to liquid high yield debt and public equity markets; limited mark-to-market volatility • Fees are higher; more labor intensive investment process Babson Capital 13/358 66 Mezzanine Debt PUBLIC HIGH YIELD BONDS VS. MEZZANINE DEBT YIELDS 24% 22% - Very stable pricing 20% 18% 16% Mezzanine Debt 14% 12% 10% 8% 6% 4% '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 Barclays Corporate High Yield Mezzanine Debt '08 '09 '10 '11 '12 Source: FactSet, Barclay’s Capital High Yield Bond Index and Babson Capital as of February 28, 2013. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an index. Babson Capital 13/358 67 Multi-Asset Strategies • Markets are dynamic; constantly changing relative value, fundamentals and technicals Illustration of Multi-Asset Strategy • Flexible mandates provide opportunity to optimize exposure within a specific credit mandate (e.g. below investment grade) • Multi-asset strategies continue to provide benefits of a specific credit mandate: - incremental yield/return - diversification - interest rate/inflation hedge Babson Capital 13/358 68 Implementing Solutions/Impact on Asset Allocation • Gain incremental yield/return • Improve diversification • Ability to capture interest rate/inflation hedge • Adequate compensation for additional risk; paid for liquidity give up • Fit with investment policy objectives/constraints Babson Capital 13/358 69 Recap - Think Outside The Box • Global growth stays below trend • Lack of economic growth drivers and labor market slack keeps rates low • Central banks continue easy monetary policy • Low book yields impact investment and product decisions • Attractive risk-adjusted returns offer solutions for insurers • Capture benefits of higher yielding assets consistent with investment policy objectives and constraints Babson Capital 13/358 70 Appendix Standard and Poor’s Rating Definitions: ‘AAA’—Extremely strong capacity to meet financial commitments. Highest Rating. ‘AA’—Very strong capacity to meet financial commitments. ‘A’—Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances. ‘BBB’—Adequate capacity to meet financial commitments, but more subject to adverse economic conditions. ‘BBB-‘—Considered lowest investment grade by market participants. ‘BB+’—Considered highest speculative grade by market participants. ‘BB’—Less vulnerable in the near-term but faces major ongoing uncertainties to adverse business, financial and economic conditions. ‘B’—More vulnerable to adverse business, financial and economic conditions but currently has the capacity to meet financial commitments. ‘CCC’—Currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments. ‘CC’—Currently highly vulnerable. ‘C’—Currently highly vulnerable obligations and other defined circumstances. ‘D’—Payment default on financial commitments. Note: Ratings from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. Index Definitions: Barclay’s Capital U.S. Investment Grade Corporate Bond Index is a broad-based benchmark that measures the investment grade, fixed-rate, taxable, corporate bond market. Barclay’s Capital U.S. High Yield Corporate Bond Index is a broad-based benchmark that measures the below-investment grade, fixed-rate, taxable, corporate bond market. Credit Suisse Leveraged Loan Index is designed to mirror the investible universe of the $US-denominated leveraged loan market. Babson Capital 13/358 71 Important Information Babson Capital Management LLC, Babson Capital Securities LLC, Babson Capital Europe Ltd, Babson Capital Australia Pty Ltd, Wood Creek Capital Management, LLC, Babson Capital Cornerstone Asia Ltd. and Cornerstone Real Estate Advisers LLC, each are affiliated financial service companies (each, individually, an “Affiliate”), together known as “Babson Capital” and members of the MassMutual Financial Group*. Each Affiliate may act as introducer or distributor of the products and services of the others and may be paid a fee for doing so. ADDRESSEE ONLY: This document is issued to investment professionals and institutional investors only. It is intended for the addressee’s confidential use only and should not be passed to or relied upon by any other person, including private or retail investors. This document may not be reproduced or circulated without prior permission. NO OFFER: The document is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument in any jurisdiction. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This document is not, and must not be treated as, investment advice, investment recommendations, or investment research. Unless otherwise mentioned, the views contained in this document are those of the Affiliate producing it. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Parts of this presentation may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this document is accurate, Babson Capital makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information. Any forecasts in this publication are based upon the Affiliate’s opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Past performance is not a guarantee of future results or a reliable indication of future performance. The investment results, portfolio compositions and examples set forth in this document are provided for illustrative purposes only and may not be indicative of the future investment results, future portfolio composition or investments. The composition, size of, and risks associated with an investment may differ substantially from the examples set forth in this document. No representation is made that an investment will be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value of your investment. In making an investment decision, prospective investors must rely on their own examination of the merits and risks involved and before making any investment decision, it is recommended that prospective investors seek independent investment, legal, tax, accounting or other professional advice as appropriate. OTHER RESTRICTIONS: The distribution of this document is restricted by law. No action has been or will be taken by Babson Capital to permit the possession or distribution of the document in any jurisdiction, where action for that purpose may be required. Accordingly, the document may not be used in any jurisdiction except under circumstances that will result in compliance with all applicable laws and regulations. Any service, security, investment, fund or product outlined in this document may not be generally available or be suitable for a prospective investor or available in their jurisdiction. It is the responsibility of the prospective investor to ensure that any service, security, investment, fund or product outlined in this document is accordant with any jurisdiction specific guidelines/regulations before any approach is made regarding that service, security, investment, fund or product. INFORMATION: Babson Capital Management LLC is a registered investment adviser with the Securities and Exchange Commission under the Investment Advisers Act 1940, as amended. Babson Capital Management LLC is registered as a Commodity Trading Advisor (CTA) and Commodity Pool Operator (CPO) with the Commodity Futures Trading Commission under the Commodity Exchange Act, as amended. Babson Capital Securities LLC is a registered limited purpose broker-dealer with the Financial Industry Regulatory Authority, Inc. Babson Capital Europe Limited is authorized and regulated by the Financial Services Authority in the United Kingdom (Ref No. 194662) and is a Company registered in England and Wales (No. 03005774) whose registered address is 61 Aldwych, London, WC2B 4AE. Babson Capital Australia Pty Ltd (ACN 140 045 656), is authorized to offer financial services in Australia under its Australian Financial Services License (No: 342787) issued by the Australian Securities and Investments Commission. Babson Capital Cornerstone Asia Limited is licensed with the Securities and Futures Commission of Hong Kong to carry on regulated activities Type 1 (dealing in securities), Type 4 (advising on securities) and Type 9 (asset management) in Hong Kong in accordance with the requirements set out in the Securities and Futures Ordinance (Cap 571). Wood Creek Capital Management, LLC is a registered investment adviser with the SEC specializing in investments in real assets. Cornerstone Real Estate Advisers LLC is a registered investment adviser with the SEC specializing in real estate related investments. COPYRIGHT: Copyright in this document is owned by Babson Capital. Information in this document may be used for your own personal use, but may not be altered, reproduced or distributed without Babson Capital’s consent *MassMutual Financial Group is a marketing name for Massachusetts Mutual Life Insurance Company (MassMutual) and its affiliated companies and sales representatives. 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