Tetragon Financial Group Limited (TFG): Tender
Offer announcement and Supplemental Information to
the Monthly Update For December 2013
Tetragon Financial Group Limited (TFG) is a Guernsey closed-ended investment company
traded on the NYSE Euronext in Amsterdam under the ticker symbol "TFG".
In this update, unless otherwise stated, we report on the consolidated business
incorporating TFG and Tetragon Financial Group Master Fund Limited.(1)
Tender Offer
TFG announces its intention to repurchase TFG non-voting shares up to a maximum value
of $50 million. Deutsche Bank will act as dealer manager in the tender offer, which will
use a modified Dutch auction structure. Details of this planned tender offer will be
announced shortly.
Supplemental Information to the Monthly Update for December 2013
Set forth below, we provide additional information explaining the recalibration of
certain inputs used in the determination of the fair value of TFG's CLO equity
investments.
Fair Value Determination for TFG's CLO Equity Investments:
In accordance with the valuation policies set forth on TFG's website, the values of
its CLO equity investments are determined using a third-party cash flow modeling tool. The
model contains certain assumption inputs that are reviewed and adjusted as appropriate to
factor in how historic, current and potential market developments (examined through, for
example, forward-looking observable data) might potentially impact the performance of
TFG's CLO equity investments. Since this involves modeling, among other things, forward
projections over multiple years, this is not an exercise in recalibrating future
assumptions to the latest quarter's historical data.
Subject to the foregoing, when determining the U.S. GAAP-compliant fair value of TFG's
portfolio, the company seeks to derive a value at which market participants could transact
in an orderly market and also seeks to benchmark the model inputs and resulting outputs to
observable market data when available and appropriate. Please refer to the 2012 Annual
Report for a more detailed description of the cash flow projection and discounting
process.
Forward-looking CLO Equity Cash Flow Modeling Assumptions Recalibrated in Q4 2013:
The Investment Manager reviews and, when appropriate, adjusts in consultation with
TFG's audit committee, the CLO equity investment portfolio's modeling assumptions as
described above. At the end of Q4 2013, certain key assumptions relating to defaults were
recalibrated. Those relating to recoveries, prepayments and reinvestment prices were
unchanged from the previous quarter.
U.S. CLOs - default assumptions recalibrated
For the U.S. deals, near-term default assumptions were unchanged but medium-term
default multiples were reduced to base case to reflect, among other things, the effective
resolution of the so-called "maturity wall" issue as well as the perceived return to a
more normalized credit cycle after the financial crisis. These changes, which are detailed
in the table below, result in base case default assumptions being applied for all future
periods. This had a positive impact on the undiscounted future projected cash flows of the
U.S. deals.
<pre>
Variable Year Current Assumptions Prior Assumptions
CADR
1.0x WARF-implied 1.0x WARF-implied
2013-14 default rate (2.2%) default rate (2.2%)
1.0x WARF-implied 1.25x WARF-implied
2015-17 default rate (2.2%) default rate (2.7%)
1.0x WARF-implied 1.0x WARF-implied
Thereafter default rate (2.2%) default rate (2.2%)
Recovery Rate
Until deal
maturity 73% 73%
Prepayment Rate
Until deal 20.0% p.a. on loans; 20.0% p.a. on loans;
maturity 0.0% on bonds 0.0% on bonds
Reinvestment Price
Until deal
maturity 100% 100%
</pre> European CLOs - default assumptions recalibrated
For the European deals, elevated default multiples were previously maintained in the
near and medium term. In light of some positive developments, such as more optimistic
default projections by rating agencies and the perception of progress towards a more
normalized credit cycle in Europe, the medium term multiple was reduced to base case and
the very near term multiple to 1.25x base case. This had a positive impact on the
undiscounted future projected cash flows of the European deals.
<pre>
Variable Year Current Assumptions Prior Assumptions
CADR
1.25x WARF-implied 1.5x WARF-implied
2013-2014 default rate (2.6%) default rate (3.1%)
1.0x WARF-implied 1.25x WARF-implied
2015-2017 default rate (2.1%) default rate (2.6%)
1.0x WARF-implied 1.0x WARF-implied
Thereafter default rate (2.1%) default rate (2.1%)
Recovery Rate
Until deal
maturity 68% 68%
Prepayment Rate
Until deal 20.0% p.a. on loans; 20.0% p.a. on loans;
maturity 0.0% on bonds 0.0% on bonds
Reinvestment Price
Until deal
maturity 100% 100%
</pre> These key average assumption variables include the modeling assumptions disclosed as a
weighted average (by U.S. dollar amount) of the individual deal assumptions, aggregated by
geography (i.e. U.S. and European). Such weighted averages may change from month to month
due to movements in the amortized costs of the deals, even without changes to the
underlying assumptions. Each individual deal's assumptions may differ from this
geographical average and vary across the portfolio.
The reinvestment price, assumptions about reinvestment spread and reinvestment life
are also input into the model to generate an effective spread over LIBOR. Newer vintage
CLOs may have a higher weighted-average reinvestment spread over LIBOR or shorter
reinvestment life assumptions than older deals. Across the entire CLO portfolio, the
reinvestment price assumption of 100% for U.S. deals and European deals with their
respective assumed weighted-average reinvestment spreads, generates an effective spread
over LIBOR of approximately 289 bps on broadly syndicated U.S. loans, 272 bps on European
loans, and 328 bps on middle market loans.
Application of Discount Rates to Projected CLO Equity Cash Flows:
Pre-crisis U.S. CLO Equity - discount rates reduced from 15% to 13%
In determining the applicable rates to use to discount projected cash flows, an
analysis of observable risk premium data is undertaken. As had been noted over a number of
prior quarters, observable risk premia such as BB and BBB CLO tranche spreads have been
reducing with BB spreads on U.S. deals, for example, edging down to 5.3% in December
2013.(2)
Since the end of Q1 2013, BB and BBB spreads on U.S. deals have both reduced by
approximately 1.0% (3) and have exhibited a relatively low level of volatility at these
reduced levels. Accordingly, TFG's U.S. discount rates on pre-crisis transactions have
been reduced to 13% from 15%, also reflecting compression of equity discount rates over
mezzanine tranches as well as other observable factors. The future movement of mezzanine
tranche spreads as well as the likely range of spreads of equity discount rates over such
spreads, among other factors, will continue to be monitored in coming quarters.
European CLO Equity - discount rates reduced from 20% to 17%
European BB-rated tranche yields have also continued to follow a downward trajectory,
reaching approximately 7.5% in December 2013.(4) This is now just over 2% higher than the
U.S. equivalent (see above), and notwithstanding the potential higher risks connected with
the ongoing Eurozone issues, is reflective of certain other observable data (such as
improving deal performance) and anecdotal evidence pointing to a reduction in the
differential between discount rates in the two geographies. Consequently, the discount
rate applied to European deal projected cash flows has been reduced to 17% from 20%. As a
result, the differential between the discount rates used on U.S. pre-crisis deals and
European deals has fallen from 4% to 3%. The observable range of European risk premia over
the U.S. equivalent, among other factors, will continue to be monitored in coming
quarters.
Historically, we have characterized the difference arising where fair value is lower
than the amortized cost for the portfolio, which can occur when the discount rates used to
discount future cash flows when determining fair value are higher than the modeled IRRs,
as the "ALR Fair Value Adjustment" or "ALR". For European deals at the end of Q4 2013, the
ALR stood at $38.9 million, compared to $51.0 million at the end of Q3 2013. As explained
in prior releases, the ALR is now zero for U.S. deals.
2010 - 2013 CLO Equity - discounted using deal IRR
The applicable discount rate for newer vintage deals is determined with reference to
each deal's specific IRR, which, in the absence of other observable data points, is deemed
to be the most appropriate indication of the current risk premium on these structures. At
the end of Q4 2013, the weighted-average discount rate (and IRR) on these deals was 11.6%.
Such deals represented approximately 17.7% of the CLO equity portfolio by fair value (up
from 16.9% at the end of Q3 2013). We will continue to monitor observable data on these
newer vintage transactions to determine whether the IRR remains the appropriate discount
rate.
Effect on fair value and net income of recalibration of certain inputs into the CLO
model:
--------------------------------------------------
1. TFG invests substantially all its capital through a master fund, Tetragon Financial
Group Master Fund Limited ("TFGMF") in which it holds a 100% share.
2. Citi Global Structured Credit Strategy - 13 December 2013
3. Citi Global Structured Credit Strategy - 9 April 2013
4. Citi Global Structured Credit Strategy - 13 December 2013
Overall, the net impact of the recalibration of certain forward-looking default
assumptions and discount rates described above led to an overall increase in fair value of
the total CLO equity portfolio of approximately $68.2 million, or $51.1 million in bottom
line net income.
<pre>
For further information, please contact:
TFG:
David Wishnow/Greg Wadsworth
Investor Relations
[email protected]
Press Inquiries:
Brunswick Group
Andrew Garfield
+44(0)20-7404-5959
[email protected]
</pre>
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