Tetragon Financial Group Limited (TFG): Performance Report For Period Ended 30 June 2011

Tetragon Financial Group Limited (TFG) is a Guernsey closed-ended investment company traded on Euronext Amsterdam by NYSE Euronext under the ticker symbol "TFG." ^[1]In this report we provide an update on TFG's results of operations for the period ending June 30, 2011.^[2]

Corporate-Level Results

Figure 1: TFG Consolidated Net Assets ($MM) and NAV per Share^[1]

Investment Portfolio Performance Highlights

Figure 2: Weighted-Average IRR on TFG's CLO Investments^[1]

Asset Management Platform

Performance Fee

A performance fee of $26.2 million was accrued in Q2 2011 in accordance with TFG's investment management agreement and based on a "Reference NAV" with respect to Q1 2011. The hurdle rate for the Q3 2011 incentive fee has been reset at 2.8936% (Q2 2011: 2.9489%) as per the process outlined in TFG's 2010 Audited Financial Statements and in accordance with TFG's investment management agreement.^[4]

Figure 3: Quarterly TFG NAV per Share and Cumulative Dividends per Share (DPS) ($)^[1]

Figure 4: Quarterly TFG Share Repurchases (in '000s)^[1]

The performance of TFG's U.S. CLOs continued to be strong, with 100% of U.S. CLOs by fair value and by number passing their junior-most O/C tests (note that U.S. CLOs represented approximately 87% of the total fair value of TFG's CLO investment portfolio as of June 30, 2011).^[9,10]  In comparison, the market-wide average of U.S. CLOs estimated to be passing their junior O/C tests as of the end of Q2 2011 was approximately 94.0% (when measured on a percentage of deals basis).^[11]  Please refer to Figure 5 below for a historical summary of TFG's investments' junior O/C test performance.

Figure 5: TFG's Gross Investment and Operating Cash Flows ($MM) vs. % of CLOs Passing Junior-Most O/C Tests^[1,2]

Figure 6: TFG and U.S. Market-Wide Trailing 12-Month Default Rates^[i,ii]

(i) Source: TFG as of the outlined quarter-end date. The calculation of TFG's lagging 12-month corporate loan default rate does not include certain underlying investment collateral that was assigned a "Selective Default" rating by one or more of the applicable rating agencies. Such Selected Defaults are included the S&P/LCD lagging 12-month U.S. institutional loan default rate discussed above. Furthermore, TFG's investment portfolio includes approximately 13% CLOs with primary exposure to European senior secured loans and such loans are included in the calculation of TFG's corporate default rate.

(ii) Source: S&P/LCD Quarterly Review as of the outlined quarter-end date.

Asset Management Platform Details:

Based on a preliminary analysis, RBS estimates that Moody's upgrades may permit approximately 42% of outstanding CLOs to continue to reinvest prepayments post their reinvestment periods by turning-off the so called "restricted trading conditions" triggered by prior downgrades.^[46] While "restricted trading condition" provisions vary across CLOs, they typically require that senior tranches maintain their original ratings and mezzanine tranches remain within 1-2 notches of original ratings, by Moody's and/or S&P. CLOs with Moody's-only based rating requirements and those with the greatest permitted rating differentials between original and current ratings will benefit the most from Moody's upgrades. As noted in our Q1 2011 report, we continue to believe that Moody's upgrade actions may have a positive effect on TFG's CLO investments, by allowing certain of our CLO managers to continue to reinvest unscheduled repayments post their reinvestment periods, thus slowing the process of de-leveraging and potentially extending the benefit of historically tight liabilities in the context of wide asset spreads and LIBOR floors.

Forward-looking Cash Flow Modeling Assumptions Unchanged vs. Q1 2011

As of June 30, 2011, the Company had no direct credit hedges in place, but employed certain foreign exchange rate and "tail risk" interest rate hedges to seek to mitigate its exposure to Euro-USD foreign exchange risk and a potential significant increase in U.S. inflation and/or nominal interest rates, respectively. Any potential losses on the above-mentioned interest rate hedges would be limited to the loss of premium paid, totaling approximately $17.8 million as of the end of Q2 2011. We review our hedging strategy on an on-going basis as we seek to address identified risks to the extent practicable and in a cost-effective manner. In the future, our hedging strategy may include the use of single name or index credit hedges, foreign exchange rate hedges, and interest rate hedges, among others.

Q2 2011 witnessed incremental improvements in CLO credit fundamentals and structural strength, realized despite heightened asset price volatility and macroeconomic uncertainty. During this quarter, TFG's CLO and direct loan portfolios continued to generate significant cash flows, benefiting from wide loan spreads, LIBOR floors, and low credit losses and downgrades to Caa1/CCC+ or below. Given the progress achieved to date in shoring up both corporate balance sheets and CLO O/C test cushions, we remain constructive in our near-term outlook for the performance of the company's investments. While we remain concerned about a number of potential negative shocks, including among others, sovereign credit distress, geopolitical unrest, and rising commodity prices, we believe that the headroom achieved by underlying leveraged loan borrowers and the structural cushion built by CLO managers to date, may allow TFG's investments to withstand a greater amount of stress than may have been possible only a few quarters before.

We also believe that ratings upgrades, driven by Moody's methodology changes, improving credit quality, and the structural robustness of CLOs, may create further positive tail-winds for TFG's CLO portfolio by allowing certain of our CLOs to potentially extend the benefits of their historically-tight liabilities beyond their reinvestment periods. Furthermore, Moody's rating upgrades may help broaden the CLO investor base by reducing the regulatory capital holding requirements of these investments for certain investors, thus potentially providing support for CLO debt demand and prices. On the new issue CLO front, we are encouraged by the pick-up in issuance volumes this quarter, as well as the accompanying tightening of AAA-rated liability spreads and the return of structural leverage closer to levels achievable before the credit crisis. We anticipate that these developments bode well for our ability to continue to invest in new issue CLO equity with attractive risk-adjusted returns and structural characteristics, managed by LCM as well as select third-party managers. While uncertainty around the implementation of risk-retention regulations in the U.S. and Europe remains significant, we continue to believe that TFG's strong financial position and permanent capital base, may allow the company to weather any adverse changes more easily than other participants in the CLO market.

As we look toward the remainder of the year, we expect to focus on taking advantage of attractive investment opportunities in varied asset classes, including the CLO and leveraged loan markets, and expanding our burgeoning asset management business. We believe that the successful issuances of LCM VIII and LCM IX demonstrate LCM's ability to attract investment capital. The other component of our asset management platform, GreenOak, also continues to make progress in executing on its business growth strategy. We expect GreenOak to continue to look for attractive real estate investments around the world and we will report on any future developments. Over the long-term, we expect to continue the company's transition to a broadly diversified financial services firm. We believe that doing so will strengthen TFG's income streams and ultimately create value for TFG shareholders.

Directors' Statements:

The Directors of TFG confirm that (i) this Performance Report constitutes the TFG management review for the six month period ended 30 June 2011 and contains a fair review of that period and (ii) the financial statements in the accompanying unaudited interim report for the six month period ended 30 June 2011 for TFG have been prepared in accordance with applicable laws and in conformity with accounting principles generally accepted in the United States of America.

We will host a conference call for investors on August 4, 2011 at 15:00 GMT/16:00 CET/10:00 EDST to discuss Q2 2011 results and to provide a company update.

The conference call may be accessed by dialing +44(0)20-7162-0025 and +1(877)491-0064 (a passcode is not required). Participants may also register for the conference call in advance via the following link:

https://eventreg1.conferencing.com/webportal3/reg.html?Acc=247751&Conf=179214

A replay of the call will be available for 30 days by dialing +44(0)20-7031-4064 and +1-954-334-0342, access code 876111 and as an MP3 recording on the TFG website.

[(1)] Gross cash receipts from CLO portfolio.

[(2)] Excludes CDO-squared and ABS CDO transactions written off in October 2007.  TFG continues to hold the economic rights to 3 of these written-off transactions.

CLO Portfolio Details

As of June 30, 2011

CLO Portfolio Details (continued)

As of June 30, 2011

Notes
[(1)] The USD investment cost fixes the USD-EUR exchange rate of European CLOs at the same rate to avoid the impact of skewed weightings and FX volatility.
[(2)] Par weighted average spread over LIBOR or EURIBOR (as approproate) of the underlying loan assets in each CLO's portfolio.
[(3)] Notional weighted average spread over LIBOR or EURIBOR (as appropriate) of the debt tranches issued by each CLO, as of the closing date of each transaction.
[(4)] The current junior-most O/C cushion is the excess (or deficit) of the junior-most O/C test ratio over the test requirement, as of the latest trustee report available as of the report date.
[(5)] The junior-most O/C cushion at close is the excess (or deficit) of the junior-most O/C test ratio over the test requirement that was expected on each deal's closing date. Please note that two of TFG's investments are so so called "par structures" which don't include a junior O/C test. They have been marked by an "N/A" in the relevant junior-most O/C test columns.
[(6)] Calculated by annualizing the change from the expected closing date junior-most O/C cushion to the current junior-most O/C cushion.
[(7)] Calculated from TFG's investment date. Includes both historical cash flows received to-date and prospective cash flows expected to be received, based on TFG's base case modeling assumptions.
[(8)] Inception to report date cash flow received on each transaction as a percentage of its original cost.

Tetragon Financial Group Limited (TFG)

Portfolio Composition

Portfolio Held by Tetragon Financial Group Master Fund Limited

(unless otherwise stated)

As of June 30, 2011

EUR-USD FX:    1.450149655
[(1)] Calculated using TFG shares outstanding and month end exchange price.
[(2)] Excludes CDO-squared and ABS CDO transactions which were written off in October 2007.  TFG continues to hold the economic rights to 3 of these written-off transactions.
[(3)] Excludes TFG's investments in LCM Asset Management LLC and GreenOak Real Estate LP.    
[(4)] Equivalent to Investment in Securities at Fair Value in the US GAAP Financial Statements.
[(5)] Includes par amount of loans held directly by TFG and also loan exposures via TFG's investments in CLOs.  With respect to CLO investments, calculated as a percentage of total corporate loan assets that TFG has exposure to based on its equity-based pro-rata share of each CLO's total portfolio.  All calculations are net of any single name CDS hedges held against that credit.

An investment in TFG involves substantial risks. Please refer to the Company's website athttp://www.tetragoninv.comfor a description of the risks and uncertainties pertaining to an investment in TFG.

This release does not contain or constitute an offer to sell or a solicitation of an offer to purchase securities in the United States or any other jurisdiction. The securities of TFG have not been and will not be registered under the US Securities Act of 1933 (the "Securities Act"), as amended, and may not be offered or sold in the United States or to US persons unless they are registered under applicable law or exempt from registration. TFG does not intend to register any portion of its securities in the United States or to conduct a public offer of securities in the United States. In addition, TFG has not been and will not be registered under the US Investment Company Act of 1940, and investors will not be entitled to the benefits of such Act. TFG is registered in the public register of the Netherlands Authority for the Financial Markets under Section 1:107 of the Financial Markets Supervision Act ("FMSA") as a collective investment scheme from a designated country. This release constitutes regulated information ("gereglementeerde informatie") within the meaning of Section 1:1 of the FMSA.

ENDNOTES

(1) TFG invests substantially all of its capital through a master fund, Tetragon Financial Group Master Fund Limited ("TFGMF"), in which it holds 100% of the issued shares. In this report, unless otherwise stated, we report on the consolidated business incorporating TFG and TFGMF.  References to "we" are to Tetragon Financial Management LP, TFG's investment manager.
(2) This Performance Report constitutes TFG's half-yearly financial report as required pursuant to Section 5:25d of the FMSA.  Pursuant to Section 5:25d and 5:25m of the FMSA, this report is made public by means of a press release and has been filed with the Netherlands Authority for the Financial Markets (Autoriteit Financiële Markten) and also made available to the public by way of publication on the TFG website (www.tetragoninv.com).
(3) The LCM I, LCM II, LCM III, LCM IV, LCM V, LCM VI, LCM VIII, and LCM IX CLOs are referred to as the "LCM Cash Flow CLOs."  The LCM VII CLO was a market value CLO previously managed by LCM, which was liquidated commencing in 2008, and is not included in the mentioned statistics.  In addition, these statistics do not include the performance of certain transactions that were developed and previously managed by a third-party prior to being assigned to LCM, some of which continue to be managed by LCM.
(4) The hurdle rate is reset each quarter using 3M USD LIBOR plus a spread of 2.647858% in accordance with TFG's investment management agreement.  Please visit http://www.tetragoninv.com/tfg/about/investmentmanagerima/ for more details of the calculation of the hurdle rate and the performance fee.
(5) This figure includes the dividend of $0.10 per share announced on July 29, 2011 with respect to Q2 2011.
(6) Includes only look-through loan exposures through TFG's CLO investments.
(7) Excludes CDO-squared and ABS CDO transactions which were written off in October 2007. TFG continues to hold the economic rights to three of these written-off transactions.
(8) Based on the most recent trustee reports available for both our U.S. and European CLO investments as of June 30, 2011.  
(9) As of June 30, 2011, European CLOs represented approximately 13% of TFG's investment portfolio; approximately 88% of the fair value of TFG's European CLOs and 70%, when measured as a percentage of the total number of European deals, were passing their junior-most O/C tests.
(10) As O/C tests are breached, CLO structures may divert excess interest cash flows away from the equity tranche holders, such as TFG, to pay down the CLO's debt thereby curing the O/C breach via deleveraging.  Accordingly, the affected investments ceased to generate cash flows to TFG or are expected to cease generating cash flows on the next applicable payment date. Once enough debt has been repaid to cure the O/C test breach, distributions of excess interest cash to equity holders may resume to the extent not precluded by the investments' realized or unrealized losses.  
(11) Morgan Stanley CDO Market Tracker, July 5, 2011; based on a sample of 475 U.S. CLO transactions.
(12) Excess Caa/CCC+ or below rated assets above transaction-specific permitted maximum holding levels are generally haircut in our transactions at market value in U.S. CLOs and recovery rate in European CLOs for purposes of the O/C  or interest reinvestment test ratios.
(13) Morgan Stanley CDO Market Tracker, July 5, 2011; based on the lower of Moody's and S&P rating. Furthermore, TFG's investment portfolio includes approximately 13% CLOs with primary exposure to European senior secured loans and such loans are included in the calculation of TFG's average CCC asset holdings.
(14) Weighted by the original USD cost of each transaction.
(15) The calculation of TFG's lagging 12-month corporate loan default rate does not include certain underlying investment collateral that was assigned a  "Selective Default" rating by one or more of the applicable rating agencies. Such Selected Defaults are included the S&P/LCD lagging 12-month U.S. institutional loan default rate discussed above. Furthermore, TFG's investment portfolio includes approximately 13% CLOs with primary exposure to European senior secured loans and such loans are included in the calculation of TFG's corporate default rate.
(16) S&P/LCD News, "With no Defaults in June, Rate Holds at Historical Low," July 5, 2011.
(17) The LCM I, LCM II, LCM III, LCM IV, LCM V, LCM VI, LCM VIII, and LCM IX CLOs are referred to as the "LCM Cash Flow CLOs."  The LCM VII CLO was a market value CLO previously managed by LCM, which was liquidated commencing in 2008, and is not included in the mentioned statistics.  In addition, these statistics do not include the performance of certain transactions that were developed and previously managed by a third-party prior to being assigned to LCM, some of which continue to be managed by LCM.
(18) S&P/LCD News, "With no Defaults in June, Rate Holds at Historical Low," July 5, 2011.
(19) S&P/LSTA Leveraged Lending Review 2Q 2011.
(20) S&P/LCD News, "Loan prices rise with stocks & HY, but end month & quarter in red," June 30, 2011.
(21) S&P/LCD News, "LCD Loan Index: Loans gain 0.04%; YTD return is 2.66%," July 1, 2011.
(22) S&P/LCD News, "S&P ELLI: Loans lose 0.39%; YTD return is 2.83%," July 7, 2011.
(23) S&P/LSTA Leveraged Lending Review 2Q 2011, as of June 24, 2011.
(24) S&P/LSTA Leveraged Lending Review 2Q 2011.
(25) S&P/LSTA Leveraged Lending Review 2Q 2011.
(26) S&P/LSTA Leveraged Lending Review 2Q 2011.
(27) S&P/LSTA Leveraged Lending Review 2Q 2011.
(28) S&P/LSTA Leveraged Lending Review 2Q 2011.
(29) S&P/LSTA Leveraged Lending Review 2Q 2011.
(30) S&P/LSTA Leveraged Lending Review 2Q 2011.
(31) S&P/LSTA Leveraged Lending Review 2Q 2011.
(32) S&P/LSTA Leveraged Lending Review 2Q 2011.
(33) Morgan Stanley CDO Market Tracker, July 5, 2011; based on a sample of 475 U.S. CLO transactions.
(34) Morgan Stanley CDO Market Tracker, April 6, 2011; based on a sample of 477 U.S. CLO transactions.
(35) Morgan Stanley CDO Market Tracker, July 5, 2011; based on a sample of 195 Euro CLO transactions.
(36) Morgan Stanley CDO Market Tracker, April 6, 2011; based on a sample of 196 Euro CLO transactions.
(37) RBS CLO Market Review - July 2011, July 8, 2011.
(38) RBS CLO Market Review - July 2011, July 8, 2011.
(39) S&P/LSTA Leveraged Lending Review 2Q 2011.
(40) Morgan Stanley CDO Market Tracker, July 5, 2011.
(41) Morgan Stanley CDO Market Tracker, July 5, 2011.
(42) "Moody's Approach to Rating Collateralized Loan Obligations," June 2011.
(43)  Moody's CLO Interest, June 30, 2011.
(44)  Moody's CLO Interest, June 30, 2011.
(45)  Moody's CLO Interest, June 30, 2011.
(46)  RBS CLO Market Review - July 2011, July 8, 2011.
(47) J.P. Morgan US Fixed Income Markets Weekly, "Collateralized Debt Obligations," July 8, 2011.
(48)  S&P/LCD News, "With no Defaults in June, Rate Holds at Historical Low," July 5, 2011

For further information, please contact:

TFG:
David Wishnow/ Yuko Thomas
Investor Relations
[email protected]

Press Inquiries:

Brunswick Group
Andrew Garfield/ Gill Ackers/Pip Green
[email protected]

PRN NLD