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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
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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.
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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.
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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%
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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
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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
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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
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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.
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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
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Investment Considerations – Access to Opportunities
• Size of investment market
• Minimum investment levels
• Investment policy limitations
• Availability of competent investment management
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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.
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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)
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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.
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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
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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.
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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
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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.
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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
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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
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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.
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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
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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.
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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
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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.
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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.
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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
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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.
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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.
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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
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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.
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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
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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
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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
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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.
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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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