hybrid bonds in focus. - seb norge · hybrid bonds in focus. ... barclays bank . coventry bs . hsbc...

Assenagon Asset Management S.A. 31. Mai 2016

Hybrid Bonds in Focus. A comparison between Financial and Industrial Subordinated bonds

Assenagon Asset Management S.A. 31. Mai 2016 Seite 2

Overview: CoCos vs. Hybrid Bonds.

Source: Bloomberg, Merrill Lynch As of: May 2016

CoCos Hybrid Bonds

Issuers Financial Institutions Industrials

Seniority Subordinated bonds: Additional Tier 1 or Tier 2-Capital

Subordinated bonds

Maturity Perpetual (AT1) / fixed maturity (Tier 2) Minimum maturity of 30 years (Moody's), perpetual from 60+ years

Early redemption Issuer has right to call, but with permission from the regulator

Issuer has right to call

Coupons Fully optional coupons (AT1), must-pay coupons (Tier 2)

Full optionality to temporarily defer coupons with an obligation for a later payment

Coupon reset At first call date At first call date

Risk of loss of principal 1) Write-down or conversion into equity if bank's equity ratio falls below a predefined threshold

2) Regulator can force a write-down or a conversion into equity earlier if bank is non-viable

Principal loss only in case of default

Average credit spread 6,00 % 3,85 %

Average excess spread over senior bonds 5,37 % 3,01 %


Motivation for the Issuance of Subordinated Bonds and the Rational for their Incorporation in a Bond Portfolio.

Reasons for the issuing: Reasons for investing in:

Hybrid bonds There are no regulatory requirements for the issuance of hybrid bonds in contrast to financials subordinated bonds (Basel III, Solvency II)

50%-100% equity capital classification under IFRS, dependent on their maturity.

The equity capital structure of a company plays an important role for the rating agencies when determining ratings.

The bond's credit rating influences both cost of funding and the potential investor base.

Comparable bonds from the high yield bond market have a lower issuer rating and a higher probability of default.

Market price volatility is more muted due to having a senior bond curve as reference.

Higher payment discipline due to the potential reputation risk which would also impact senior bonds.

Hybrid bonds do not benefit directly from the ECB purchase programme (CSPP), but do benefit indirectly from the performance of the seniors.

However, due to lack of direct influence, the credit risk should match the fundamental risk of the bond more closely than for senior bonds.

CoCos CoCos are issued due to regulatory requirements.

CoCos help banks to enhance their going concern capital levels.

According to CRD IV, banks must issue Tier 1 CoCos equal to 1,5% of their risk weighted assets. This is less expensive for the banks than the alternative of filling this bucket with equity capital.

The Pillar 1 capital requirements also include a requirement for CoCos. Not meeting this requirement increases the risk that dividends will not be paid to shareholders.

CoCos are also classified as core equity capital for the leverage requirements

The increased regulatory requirements have resulted in higher core equity capital and a safer banking system.

CoCos offer attractive coupons and yields.

CoCos are the only instruments which fully compensate for bail-in risk (according to BRRD even senior bonds can absorb losses)

CoCos are usually issued with a volume of one billion or more. and therefore they offer higher liquidity than other high yielding market segments.

Future regulatory changes should be positive for CoCo performance


Market Overview: CoCos.

Source: Bloomberg, internal database. As of: May 2016

COCO-ISSUERS ARE PREDOMINANTLY NATIONAL CHAMPIONS WITH HIGH MARKET SHARE.

8

3 2 1

4 Nordea SEB Svenska Swedbank

Dankse Bank Nykredit

Aareal Bank Deutsche Bank

Intesa UniCredit

Banco Popular BBVA

Santander

Allied Irish Bank Bank of Ireland Permanent TSB

Barclays Bank Coventry BS HSBC Lloyds Nationwide RBS Santander UK Standard Chartered

BNP Crédit Agricole Société Générale

KBC

ABN ING Rabobank

Credit Suisse UBS Züricher Kantonalbank

DNB Nor

-

20

40

60

80

100

120

140

Q42009

Q42010

Q42011

Q42012

Q42013

Q42014

Q42015

CoC

o vo

lum

e (b

illion

EU

R)

EUR USD GBP CHF

DISTRIBUTION PER CURRENCY


CoCos: An Overview.

* MDA: Maximum Distributable Amount. If a bank does not meet its core equity capital requirements, the bank is not allowed to pay out more than the MDA in Tier 1 coupons, dividends and bonuses. If the MDA is zero, no payments are allowed to be made. The MDA is made up of realised gains as well as gains and losses carried forward. ** AT1: Additional Tier 1 CoCos represents the part of the capital structure which is senior to core equity capital but junior to all other liabilities. Source: Deutsche Bank, own estimations

KEY CAPITAL THRESHOLDS FOR AT1** COCOS (EXAMPLE: DEUTSCHE BANK)

ILLUSTRATIVE STRUCTURE OF A COCO'S YIELD

Yiel

d

4,50 % Minimum

Core Equity requirement

5,125% Pillar II requirement

1,25 % additional

CET1 buffers

0%

2%

4%

6%

8%

10%

12%

14%

Cap

ital R

atio

Capital Conservation BufferPillar II CET1 requirementMinimum Core Equity Tier 1 Requirement

Buffer for Coupons, Dividends etc.

CoCo Trigger Points (5,125 % or 7 %)

Point of MDA*


4%

5%

6%

7%

8%

9%

10%

11%

12%

13%

14%

Okt 15 Dez 15 Feb 16 Apr 16

Yiel

d in

%

Credit Agricole 6,5 % EUR AT1BBVA 6,75 % EUR AT1Nordea 5,5 % USD AT1

CoCo Market Development: Clarification Concerning Potential Coupon Cancellation is Positive for CoCos.

On 18th December 2015 the EBA* published a recommendation regarding the lowest capital levels at which coupons, dividends and bonuses can still be paid. These requirements reduced the existing buffers. The interpretation was adopted by the ECB, but not by the European Commission (EC) and other central banks.

In January 2016** Deutsche Bank announced record losses and published a statement that the CoCo coupons will be paid.

In February 2016 the ECB distanced itself again from the EBA claim.

In the March 2016 ECB meeting, Draghi referred to an unknown memo from the EC, which would enhance the rights of CoCo investors with the following possible measures: > Make CoCo coupons senior to dividends > Replace automatic coupon cancellation with a soft buffer

(e.g.. as in the UK or Sweden).

* European Banking Authority. ** See. https://www.db.com/newsroom_news/2016/ir/deutsche-bank-publishes-updated-information-about-at1-payment-capacity-en-11391.htm Source: Bloomberg, As of: May 2016

1

2

3 1

2

3

4

4

https://www.db.com/newsroom_news/2016/ir/deutsche-bank-publishes-updated-information-about-at1-payment-capacity-en-11391.htm


Potential Coupon Cancellation.

0%

5%

10%

15%

20%

25%

CE

T1 in

%

Minimum Capital Ratio Actual Capital Ratio

Source: Own estimations, annual reports. As of: May 2016

MDA* IS ASSOCIATED WITH THE COUPON CANCELLATION RISK FOR AT1


Potential for not Exercising the Right to Call.

Source: Bloomberg, own calculations

PROBABILITY TO CALL IS DEPENDENT ON THE MARKET CONDITIONS AND THE BACK-END SPREAD: SPREAD-NARROWING INCREASES THE PROBABILITY TO CALL

EXAMPLE: NEW ISSUE FROM BBVA

Bond BBVASM 7 49 BBVASM 6.75 49 BBVASM 8.875 49 Currency EUR EUR EUR Call date 19.02.2019 18.02.2020 14.04.2021 Reset Index EUSA5 EUSA5 EUSA5 Back-end Spread 615,5 660,4 917,7 Trigger 5,125 % - Conversion to Equity Price 89,99 89,67 100,86 Yield to Call 11,36 10,16 8,70 Yield to Perpetuity 7,12 7,49 8,99 Difference 4,24 2,67 -0,29

0

2

4

6

8

10

12

10. Apr 18 15. Mai 19 18. Jun 20 23. Jul 21

Yiel

d in

%

Year to Call

-50

0

50

100

150

200

250

300

350

400

450

4. Jan 16 4. Mrz 16 3. Mai 16A

sset

Sw

ap S

prea

d ch

ange

(bas

is p

oint

s)

HSBC 6,375 % USD AT1 – back-end 5y US swaps + 437bp HSBC 5,625 % USD AT1 – back-end 5y US swaps + 363bp


Opportunities for CoCos Investors.

* EBA: "2015 EU-Wide transparency exercise" average Core Equity Capital ratio for 59 EU-Banks Source: Bloomberg, EBA

AVERAGE EFFECTIVE YIELD FOR COCOS AMOUNTS TO ~ 6,5 %

HIGHER CAPITAL REQUIREMENTS HAS LED TO SAFER BANKS*

8,0 %

8,5 %

9,0 %

9,5 %

10,0 %

10,5 %

11,0 %

11,5 %

12,0 %

12,5 %

13,0 %

2011 2012 2013 2014 2015

Cor

e C

apita

l Rat

io

0%

2%

4%

6%

8%

10%

12%

14%

0 5 10 15Yi

eld

to C

all

Years to Call


Modelling CoCos: Equity Derivatives Approach.

In co-ordination with Prof. Dr. Wim Schoutens, professor in financial engineering at the Catholic University of Leuven, Belgium, and holder of the John von Neumann guest professorship at the Technical University of Munich, Assenagon has developed a proprietary model to analyse CoCos, which also extends to other bank capital securities.

We analyze CoCo bonds by comparing them with an equity product with exactly the same cash flows and anatomy, except that conversion or write-down is triggered by hitting a stock barrier. The conversion or write-down at trigger is modelled using a long down-and-in forward, and the cancellation of coupons at trigger using short binary down-and-in barriers.

Under customised Black-Scholes' dynamics, which uses market implied volatility 'smile' dynamics and available credit default swap data, we see the probability of hitting barrier S* (the CoCo trigger) before time T:

Hence, we can easily relatively compare > Trigger probabilities versus default probabilities > Implied trigger level and expected recovery rates > Tail events and tail volatilities


Model Based Valuation Model for CoCos through Equity Derivative Approach.

In co-ordination with Prof. Dr. Wim Schoutens, Assenagon has developed a proprietary model to analyse CoCos.

The model compares the CoCo with a synthetic equity product with exactly the same cash flows and anatomy.

The calculated trigger probability allows for performance optimisation and for a suitable hedge against default risk.

* Professor in financial engineering at the Catholic University of Leuven, Belgium, and holder of the John von Neumann guest professorship at the Technical University of Munich.

HEDGING

MARKET DATA

ASSENAGON COCO VALUATION MODEL PERFORMANCE OPTIMISATION

Implied volatility

CDS Spreads, Interest Rates

Dividend yield

Maturity/Call Structure

An extension of the Black-Scholes Model

The probability of trigger is calculated

The trigger probability can be compared across different CoCos from the same issuer

Trigger probability can also be compared with default probability

Determination of fair price

Calculation of new issue premium

Basis for an active trading strategy

Determination of the equity price corresponding to trigger

Basis for calculation of appropriate put strike for hedge


Model Initiated Trading, example Lloyds.

Source: Bloomberg, internal Database

LLOYDS 6.375% EUR LLOYDS 7% GBP LLOYDS 7.625% GBP LLOYDS 7.875% GBP Buy 1: 25.03.2014 101.875 100.812 102.996 104.929

Buy Lloyds 6.375% 30.07.2014 107.3 102.209 105.13 107.855

% Change 5.33% 1.39% 2.07% 2.79%

Buy 2: 30.07.2014 107.373 102.25 105.13 107.855

Switch into Lloyds 7% 10.09.2014 103.533 99 101.209 103.298

% Change -3.58% -3.18% -3.73% -4.23%

Buy 3: 10.09.2014 103.533 99.903 100.625 103.298

Switch into Lloyds 7.625% 08.12.2014 103.656 100.968 101.75 103.051

% Change 0.12% 1.07% 1.12% -0.24%

Buy 4: 08.12.2014 103.656 100.968 102.02 103.375


% Change 1.39% 0.81% 2.17% 2.06%

Buy 5: 12.08.2015 105.25 101.782 104.237 106.22


% Change -0.11% -0.14% -0.85% -1.27%


Market overview: Hybrid bonds.

Source: Credit Suisse, Assenagon

TOP 10 ISSUERS MARKET VOLUME IN EUR MIO.

Issuer Sector Issuer Rating

Issue-Rating

Nominal Mi. EUR

Électricité de France SA Utilities A BBB 10,97

Volkswagen AG Consumer, Cyclical BBB- BBB- 7,50

Total SA Energy A+ A- 6,75

Orange SA Communications BBB+ BBB- 5,82

BHP Billiton Basic Materials A- BBB 5,61

Telefónica SA Communications BBB BB+ 5,10

Bayer AG Consumer, Non-cyclical A- BBB 4,55

Enel SPA Utilities BBB BB+ 4,48

ENGIE SA Utilities A- BBB+ 3,73

RWE AG Utilities BBB- BB+ 3,51 0

20 000

40 000

60 000

80 000

100 000

120 000

0

1 000

2 000

3 000

4 000

5 000

6 000

7 000

8 000

9 000

10 000

Jan 13 Sep 13 Mai 14 Jan 15 Sep 15 Mai 16

Issue Nom./Month Total Volume


Market overview: Hybrid bonds.

Source: Credit Suisse, Assenagon

ISSUER/ISSUE RATING SECTOR ALLOCATION

0%

5%

10%

15%

20%

25%

30%

Issuer % Issue %

9%

16%

10%

8% 2% 13% 1%

3%

39%

Basic Materials

Communications

Consumer, Cyclical

Consumer, Non-cyclical

Diversified

Energy

Real Estate

Industrial

Utilities


ILLUSTRATION OF A CORPORATE BALANCE SHEET

Hybrid bonds: Issuer and Investor Perspective.

Hybrid bonds look attractive from the issuer perspective, because they: > have equity features and are usually more cost effective > in comparison to equity they provide tax deductibility.

For investors they offer: > a trade-off between profit sharing potential from the equity and

regular coupon payments and > a higher compensation for the higher losses in case of default,

with an identical default probability to the senior bonds.

The hybrid bonds can be classified as core equity capital only if they are perpetual and non-callable.

Current Assets

Non- Current Assets

Equity Capital • Subscribed Capital • Capital Reserves

Debt Capital

Unsecured Bonds

Secured Bank Credit

Subordinated bonds

ASSETS LIABILITIES

Hie

rarc

hy in

Inso

lven

cy


Components of Credit Risk Premia.

Credit risk priced by financial markets comprises of the Expected Loss plus an Additional Spread: Credit Spread = Expected Loss (EL) + Excess Spread, where EL = Probability of Default (PD) * Loss Given Default (LGD)

While for industrial borrowers all liabilities are subject to the same probability of default, the ranking of the claims will make a material difference in terms of losses in case of default.

Approximation:

Type of Risk

Risk Compen-

sation EL = PD * LGD

Issuer specific default risk or risk of material credit quality

deterioration

IDIOSYNCRATIC RISK

Excess Spread

Market, segment or credit specific risks (i.e. market uncertainty, transparency, regional or sector issues)

ADDITIONAL RISK

Excess Spread

Risk of highly correlated value changes due to systematic

factors (i.e. recession, illiquidity etc.)

SYSTEMIC RISK

𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 − 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛 𝐼𝐼𝐼𝐼𝐼𝐼𝑛𝑛𝑅𝑅𝑛𝑛𝐼𝐼 𝑃𝑃𝑛𝑛𝑃𝑃𝑃𝑃𝑛𝑛𝑃𝑃𝑅𝑅𝑛𝑛𝑅𝑅𝑛𝑛𝑃𝑃 𝑃𝑃𝑜𝑜 𝐷𝐷𝑛𝑛𝑜𝑜𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛 =1 − 𝑛𝑛−𝐶𝐶𝐷𝐷𝐶𝐶 𝑅𝑅𝐼𝐼𝑛𝑛𝑛𝑛𝑛𝑛𝐼𝐼 × 𝑇𝑇

1 − 𝑅𝑅𝑛𝑛𝑅𝑅𝑃𝑃𝑅𝑅𝑛𝑛𝑛𝑛𝑃𝑃 𝑅𝑅𝑛𝑛𝑛𝑛𝑛𝑛


The three pillars of fundamental credit analysis.

Quantitative credit analysis focused on the key accounting and financial ratios via an internally developed tool.

Supplementing the quantitative results with a systematic, qualitative factor analysis and event risks consideration, enabling an efficient assessment of the creditworthiness of an issuer, and thus a "fair premium" can be calculated.

External ratings and peer analysis are also considered.

An evaluation of key financial ratios in the context of the overall market gives a clear indication of an issuer's competitiveness, and the development of such ratios serves as an early indication for market trends.

Management quality

Business strategy

Product diversification and cyclicality

Customer and supplier dependence

Ability to innovate

Sustainability

M&A risks

Legal risks

Accounting risks

Earnings volatility and potential for earnings surprises

Shareholder orientation

Event Risks Qualitative Analysis Quantitative Analysis

Coverage Ratios (EBIT, EBITDA Interest Coverage)

Gearing Ratios (Total Debt to EBITDA, Debt Capital Ratio)

Profitability (RoC, RoR, RoS)

Cash Flow (Free Operating CF to Total Debt, FFO to Total Debt)

Credit Analysis


Version 1.10 Rating BBB1 as of Dec '14 PD 0,67%

ISIN Bond FR0012005924 Credit RatingsUltimate Parent AC FP Rating Outlook DateISIN Equity FR0012005924 S&P BBB- STABLE 05.04.2011SEDOL Equity 5852842 Moody's - - -Currency (pls select) LOC Equity Fitch BBB- STABLE 24.02.2010Website http://www.accor.comNumber of Employees 141243Period Type ANN

Equity Data (Currency: LOC, in mn) Bond Data (Currency: LOC, in mn) AnnouncementsMarket Cap (MM) 10.249,4 Name ACCOR SA Date DescriptionShares Out. (MM) 233,4 Ticker 4,125 14.10.2015 Q3 2015 Sales and Revenue ReleaseFloat % 85,98% Coupon 4,125 17.02.2016 Q4 2015 Earnings Release (Projected)Shares sold short (MM) -4,7 Maturity 01/31/2049 Last EventsDividend Yield % 2,2 Curncy EUR 30.07.2015 Q2 2015 Earnings CallDiluted EPS Excl. XO 0,0 Market EURO-ZONE 30.07.2015 Q2 2015 Earnings ReleaseP / Diluted EPS Before XO 31,4 Country FR ModifiersBeta 0,99 Rank Jr Subordinated +Currency EUR Type VARIABLE Country Risk NeutralExchange Euronext Paris Cpn Freq Annual Demand positiveSector Consumer Services Date Issue 30.06.2014 Economic Growth cyclicalIndustry Hotels/Resorts/Cruiselines Amount 900 Competitive Environment Neutral

Exchange STUTTGART Management and Company +Financial Information (Currency: LOC, in mn) Financial Policy NeutralRevenue - LTM - Cash & ST Invst. 2.677 Management positiveEBIT - LTM - Total Assets 8.755 Corporate Governance NeutralEBITDA - LTM - Total Debt 2.866 Entity Structure NeutralNet Income - LTM - Total Liabilities 4.888 Business and Earnings Characteristics +Total Enterprise Value 11.479,4 Total Equity 3.867 Diversification positiveTEV/ Total Revenue 1,7 x CFO - LTM - Technology / Innovation NeutralTEV/ EBITDA 9,8 x CFI - LTM - Cost Structure Neutral

CFF -LTM 0 Event Risk n

Key Financial Ratios RatingDec '14 Dec '13 Dec '12 Dec '11 Dec '10 Dec '09 Dec '08 Dec '07 Dec '06

Full Rating BBB1 BBB2 BB1 A3 BBB1 BB1 A3 A1 A2Probability of Default 0,13% 0,16% 0,67% 0,09% 0,13% 0,67% 0,09% 0,05% 0,06%Int Cov I: EBIT/Int Expense 10,20x 6,31x 6,26x 5,35x 3,19x 3,79x 7,96x 10,17x 7,53xInt Cov II: EBITDA/ Int Expense 15,59x

10,16x

10,70x

9,37x

6,61x

7,52x

12,29x

14,91x

11,88x

Gearing I: Total Debt/ EBITDA 3,12x 2,58x 2,65x 1,85x 2,15x 2,87x 1,82x 1,10x 1,56xGearing II: Total Debt/ Capital 0,44x 0,47x 0,46x 0,33x 0,35x 0,49x 0,41x 0,28x 0,31xFree Operating CF/ Total Debt 0,15x 0,12x -0,07x 0,20x 0,19x 0,02x 0,25x 0,67x 0,41xReturn on Capital 10,7% 10,8% 10,1% 9,7% 7,8% 8,7% 15,2% 15,9% 10,5%FFO/ Total Debt 0,24x 0,23x 0,05x 0,37x 0,33x 0,13x 0,46x 1,00x 0,66xOperating Income/ Revenues 11,0% 9,7% 9,3% 8,7% 7,5% 7,2% 10,7% 10,9% 9,8%Curr. Ratio: Curr.Assets/Curr.Liab.

1,89x 1,24x 1,07x 1,12x 0,99x 0,76x 0,73x 0,72x 0,75x

Assénagon Issuer Fact Sheet

Accor SA owns, operates, invests, and leases hotels. Its operations are carried out through the Holes and Other Businesses segments. The Hotels segment manages economy, midscale, and luxury upscale hotels. The Other Businesses segment includes the firm's corporate departments and the casinos business. The company was founded by Paul Dubrule and Gérard Pélisson on April 22, 1960 and is headquartered in Paris, France.

Accor SA

Economic / Industry Outlook

40

50

60

70

80

90

100

110

120

130

25,00

30,00

35,00

40,00

45,00

50,00

55,00

Okt-14 Dez-14 Feb-15 Apr-15 Jun-15 Aug-15

CDS 5

Y [bp

s]

Stoc

k pric

e [C

rncy

]Equity CDS 5Y

Case study for a quantitative credit risk analysis (industrials).

Monitoring-market signals

Financial Ratio Analysis Qualitative Analysis

Monitoring-Release-Information

Rating and Probability of Default


A proven track-record in identifying credits with higher potential for rating upgrades than the overall market

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Nov 14 Feb 15 Mai 15 Aug 15 Nov 15 Feb 16

USA Total Market Europa Total Market Assenagon Credit Selection

* Rating Drift = (Issuer Upgrades – Issuer Downgrades)/Rated Issuers ** Data collection as of 01.10.2013, Excluding multiple counts by credit rating agencies. Source: Moody's, Assenagon

TRAILING 12 MONTH US VS. EUROPE RATING DRIFT* (MOODY'S): CONTINUOUS ANTICIPATION OF RATING CHANGES

Positive Rating Drift in fund since inception

RATING-CHANGES FOR ASSENAGON CREDIT SELECTION INVESTMENTS**:

Rating Outlook

Upgrade Downgrade Positive Negative

50 19 18 11


Inferring Implied Default Probabilities from Bond Swap Spreads.

Source: Bloomberg, Assenagon

CREDIT SPREADS SEN. UNSECURED VS. HYBRID CREDIT SPREAD CURVE FOR ACCOR

25

75

125

175

225

275

325

375

425

475

525

575

625

0 2 4 6 8 10

Cre

dit S

prea

d (b

ps)

Life to Maturity (Years) CDS EUR

50

100

150

200

250

300

350

400

450

500

550

600

650

Jan 15 Apr 15 Jul 15 Okt 15 Jan 16 Apr 16C

redi

t Spr

ead

(bps

)

ACFP 4 1/8 06/30/49 ACFP 2 5/8 02/05/21


Fair Credit Spread derived from John Hull Model.

Source: Assenagon

EQUITY TICKER AC FP Accor SA MATURITY [YEARS] 1 2 3 4 5 6 7 8 9 10 INPUT CDS Spread in % 0,21 % 0,38 % 0,54 % 0,73 % 0,92 % 1,02 % 1,12 % 1,17 % 1,22 % 1,27 %

Discount Rate in % [Swap Rates] -0,16 % -0,16 % -0,13 % -0,07 % 0,01 % 0,11 % 0,23 % 0,35 % 0,46 % 0,57 %

Recovery Rate 37,50 %

Rating Class (PD driver) Baa S&P LT LC: BBB-

Market (PD and Recovery driver) EU MOODY'S SEN UNSEC:

#N/A N/A

Industry (Recovery driver) Services FITCH LT ISSUER: BBB-

Rank of Debt (Recovery driver) Sen. Unsec. Bond BLOOMBERG INDUSTRY SECTOR:

Consumer, Cyclical

OUTPUT

Cumulative Probability of Default 0,34 % 1,20 % 2,57 % 4,58 % 7,12 % 9,37 % 11,86 % 14,01 % 16,26 % 18,59 %

Yearly Forward Probability of Default (implied) 0,34 % 0,86 % 1,38 % 2,01 % 2,54 % 2,25 % 2,49 % 2,15 % 2,24 % 2,34 %

Yearly Forward Probability of Default (historical) 0,19 % 0,45 % 0,45 % 0,38 % 0,34 % 0,39 % 0,57 % 0,71 % 0,67 % 0,84 % Excess Spread (w.r.t. historical Default Probabilities and the Input Recovery) 0,09 % 0,18 % 0,32 % 0,50 % 0,69 % 0,79 % 0,87 % 0,89 % 0,93 % 0,95 %

Suggested historical Recovery for specific Market, Industry and Rank 37,50 %

CDS Pricing Errors (Due to Excel's rounding behaviour) 0,00 %

0,03 %


Spread Implied PD's using different LGD's.

Source: Assenagon, Bloomberg

CDS SPREADS REFLECT THE VALUE OF THE FIRM BASED ON STOCK PRICES

PD CURVES FOR DIFFERENT LGD'S.

25

30

35

40

45

50

55

50

75

100

125

150

175

Jan 15 Mai 15 Sep 15 Jan 16 Mai 16

Sto

ck P

rice

in E

UR

CD

S S

prea

d in

bps

ACCOR CDS 5Y (lhs) ACCOR SA (rhs)

0%

10%

20%

30%

40%

50%

60%

1 2 3 4 5 6 7 8 9 10

Cum

ulat

ive

Def

ault

Pro

babi

lity

Years 80% 40% 5%


The market value of the equity can be shown as a European Call-Option CT based on the firm market value with the Basis price(R). At maturity t=T and t=0 hold:

The value of the European call option is dependent on the firm value. The call-option value can be estimated by the Black/Scholes-Options pricing model :

σ2 shows the volatility of the underlying product, T the time to maturity for the option and r the risk-free interest rate. N() denotes the cumulative distribution function for the standard normal distribution.

Asset Value V0

Equity capital S0

Debt capital (Zero-coupon bond) B0

Active Passive

with

Source: Daldrup, Arne: Credit risk models - State of the Art

Price implied Probability of Default (Merton Model): Options Pricing Theory according to Robert C. Merton


30

35

40

45

50

55

60

65

70

75

80

85

90

95

Value of Liabilities (Default Point)

Distance to Default (DD)

Ass

et V

alue

V0

t = 0 t = 1 Zeit

Expected default rate(EDF)

The Merton Model (Structural Model) became well known as KMV (today Moody's KMV) and is broadly used in Credit Risk Management

The model relies on strict assumptions and therefore also has a few weaknesses, e.g. limited applicability – for highly-leveraged acquisitions (Leveraged Buy Out) – a dividend cut, which is positive for the creditor and negative for the equity holder

"Distance to Default" as a measure of the Probability of Default


Hybrid bonds generally exhibit a higher Volatility.

• At the end of 2015 rating agencies lowered their oil price forecasts and in this context they announced a credit review for companies that are active in the energy sector.

• In particular S&P referred explicitly to the BBB- rated crude oil firm Repsol.

• In case of a Repsol downgrade, the implied default probability would have been increased equally for senior and subordinated bonds.

• Nevertheless, the Repsol hybrid bonds fell significantly more in price due to their higher potential loss given default (LGD).

• The publication of the annual results on 25th February lead to the confirmation of the IG Ratings by S&P in March.

Source: Bloomberg, Assenagon

75

80

85

90

95

100

105

Sep 15 Nov 15 Jan 16 Mrz 16 Mai 16B

ond

pric

e (n

orm

alis

ed)

Repsol Senior bond Repsol Hybrid bond

The changes in idiosyncratic risk will be reflected more acutely in the price movements of the hybrid bonds in comparison to the senior bonds, as the following example from Repsol shows:


Contacts.

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All information contained in this document is based on carefully selected sources which are considered to be reliable. However, Assenagon S.A., Luxembourg, Assenagon Asset Management S.A., Luxembourg and its branch office as well as Assenagon Schweiz GmbH and Assenagon GmbH, Munich (hereinafter collectively referred to as "Assenagon Group") cannot guarantee the correctness, completeness or accuracy of the information. Any liability or warranty arising from this document is therefore completely excluded, and the Assenagon Group assumes no responsibility for, among other things, the completeness, correctness, timeliness and availability of the information, despite having compiled it with due care.

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31. Mai 2016

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