capital markets industry insights - q3 2016

I N D U S T R Y I N S I G H T S :

Capital Markets Q 3 2 0 1 6 R e v i e w

Capital Markets Industry Insights | Q3 2016

Middle-market issuers enjoyed a welcoming lending environment

this quarter during which leverage providers took on increased

levels of fundamental risk. This tolerance for increased risk

reflected improving macroeconomic conditions on the one hand

and appetite for yield on the other.

While aggregate issuance of high-yield bonds and leveraged

loans declined modestly this quarter, we observed a migration of

appetite toward those credit and hedge funds with higher

risk/return parameters.

The return of leveraged recapitalizations largely offset a decline in

middle market M&A related financing. Modestly positive fund

inflows facilitated the successful absorbing of recap issuance.

Market analysts continued to closely follow monetary policy, even

as major central banks largely stood pat for the quarter. To our

surprise, geopolitical developments (other than a sharp, though

brief, Brexit scare) and macroeconomic strengthening, had little

lasting impact on market conditions.


Central banks remain

accommodative, though

signals from the Federal

Reserve suggest a December

rate hike.

In light of improving macroeconomic conditions, credit

sources are taking on higher

degrees of fundamental risk.

Lenders are focused on well-

structured transactions; we noted

increased appetite for growth-

oriented financings (typically

including unfunded acquisition lines).

2

Highlights


Executive Summary Middle-market issuers were greeted by strong demand this quarter

from mainstream credit sources as well as those seeking higher

degrees of risk and return. Commercial banks, while largely hewing

to traditional leverage parameters, exhibited unusually high

leverage tolerance for larger deals in noncyclical spaces. Business

development companies returned to the market as their portfolio

challenges began to abate. This mainstream demand was

supplemented by increased activity among credit and hedge funds,

as well as historically passive investors initiating direct credit

programs. We observed increasingly aggressive credit parameters

among these opportunistic participants, wherein borrowers were

offered alternatives with higher leverage and structural

characteristics.

Macroeconomic fundamentals continued to improve, though the

focus remained on monetary policy. With an increasingly stark

dichotomy of views at the Federal Reserve, volatility persisted in

anticipation of clearer guidance on the pace and timing of rate

hikes. Ultimately, central banks largely held pat in the third quarter,

with the European Central Bank electing to continue its stimulus

program, and the Fed left benchmark rates unchanged. The Bank

of Japan, rather than cut into further negative territory, announced

that it would maintain its easing program and focus on managing

long-term yields.

Much of our activity this quarter involved transactions designed to

facilitate organic and acquisition oriented growth, among other

objectives. An improving macroeconomic backdrop, combined with

the broadening of investment strategies among market participants,

has allowed us to deliver increasingly holistic solutions to our

clients. In particular, financings that incorporate unfunded

acquisition lines alongside funded term loans have become

increasingly widely available.

We anticipate that issuers will enjoy the benefits, in coming

quarters, of a diverse universe of market participants offering an

array of credit solutions. The market for ordinary course leverage

should continue to be welcoming; this appetite will increasingly be

complemented by solutions of a higher risk/higher reward, offering

deeper leverage and more aggressive structures. Consequently,

borrowers will enjoy an unusually broad menu of solutions from

which to choose.

3


LEVERAGE MULTIPLES

SENIOR EBITDA OF $10MM - $20MM

2.50x - 3.50x

EBITDA OF $20MM - $50MM

3.00x - 4.00x

TOTAL DEBT EBITDA OF $10MM - $20MM

3.50x - 4.50x

EBITDA OF $20MM - $50MM

4.00x - 5.50x

Indicative Middle-Market Credit Parameters

4


PRICING EBITDA OF $10MM - $20MM EBITDA OF $20MM - $50MM

SECOND LIEN LIBOR + 7.00% - 10.00%

LIBOR + 6.50% - 9.50%

LIBOR + 6.50% - 9.50%

LIBOR + 6.00% - 9.00%

SUBORDINATED

DEBT 11.00% - 13.00% 10.00% - 12.00%

UNITRANCHE LIBOR + 7.00% - 9.50%

LIBOR + 6.50% - 9.00%

LIBOR + 6.50% - 9.00%

LIBOR + 6.00% - 8.50%

Indicative Middle-Market Credit Parameters

FIRST LIEN LIBOR + 3.00% - 4.00% (bank)

LIBOR + 2.75% - 3.50% (bank)

LIBOR + 4.50% - 6.50% (non-bank)

LIBOR + 4.00% - 6.00% (non-bank)

LIBOR + 2.75% - 3.50% (bank)

LIBOR + 2.50% - 3.25% (bank)

LIBOR + 4.00% - 6.00% (non-bank)

FIRST LIEN

INFORMATION IN RED REPRESENTS PRIOR QUARTER VIEW

5

Capital Markets Industry Insights | Q1 2016 Capital Markets Industry Insights | Q3 2016

The number of high-yield issuances this quarter ticked up modestly, though dollar

volume fell from the second quarter and remains below long-term averages. Given the

largely benign near-term monetary policy outlook, relatively little discretionary bond

financing occurred this quarter.

Total High-Yield Bond Issuance

Source: SDC Platinum

109.2 111.2 116.3

105.2

90.9 88.1

124.8

103.2

90.9

114.9

105.7

84.1

52.6 59.1

72.6 64.9

347 344 362

283 302

282

409

320

290

326 316

220 159 142 140 146

100

200

300

400

500

4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16

$0

$50

$100

$150

TH

OU

SA

ND

S

Total Bond Volume ($B) Number of Deals

New Issuance

6



490.4 506.4

596.5

547.8

607.9

485.2

621.9

509.1

671.9

436.5

664.0

599.4 599.2

397.6

694.5

470.2

1,123

888

1,104

1,054

1,212

1,030

1,218

1,140

1,187

893

1,246

1,024

1,134

862

1,111

862

700

900

1,100

1,300

1,500


$0

$200

$400

$600

$800

TH

OU

SA

ND

S

Total Loan Volume ($B) Number of Deals

The total dollar volume of new loan issuance declined, as did the number of

transactions, in the third quarter. On a trailing two-month basis, aggregate dollar volume

and, to a lesser extent, the number of transactions completed, moved toward historical

means(1).

Total Loan Issuance

New Issuance

(1) We attribute the spike in Q2 activity to the deferring of planned Q1 issuance, in light of volatile market conditions early in the year.

7


Consistent with our observations on total loan issuance, third quarter dollar volume and

the number of transactions declined, though less so in the middle-market. We note that

middle-market issuance on a trailing two-quarter basis continued to be strong, as we

observed a migration of appetite toward those credit and hedge funds with higher

risk/return parameters.

Total Loan Issuance (EBITDA < $50MM)


220.1

256.2

294.3

219.4

285.5 271.1

307.5

231.7

256.7

174.4

306.8

242.6

267.6

171.1

322.0

259.5

868

666

855

797

922

804

959

890 895

671

942

805

869

670

868

689

500

750

1,000

1,250


$0

$70

$140

$210

$280

$350

TH

OU

SA

ND

S

Total Loan Volume ($B) Number of Deals

New Issuance

8


Fund Flows

Issuance of collateralized loan obligations (CLOs) increased modestly this quarter. The

relative importance of CLOs in the middle-market diminished somewhat as credit funds,

hedge funds and BDCs exhibited increased risk appetite.

Total CLO Issuance


23.6 26.3

16.0 17.0

24.6 22.6

38.3

32.4 30.7 30.8

28.6

1.9

19.6

8.2

18.0 19.9

46

52

34 36

53

45

69

58

63

57 55

36 40

20

42 41

0

20

40

60

80


$0

$10

$20

$30

$40

$50

$60

Total Fund Flows ($B) Number of Deals

9


Leveraged loan fund inflows grew in each month of the third quarter. It appears that

mutual fund investors are positioning themselves for a rising yield environment.

Source: Investment Company Institute; Lipper FMI

Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16

($20)

($15)

($10)

($5)

$0

$5

$10

$15

MIL

LIO

NS

High-Yield Bond Fund Flows Leveraged Loan Fund FlowsTotal Fund Flows ($B)

Fund Flows

Mutual Fund Flows

10


Leverage Mean total leverage multiples for middle-market financings remained at ~5.0x this quarter.

The amount of first lien debt, however, increased by approximately 0.3x, reflecting a

rotation of lender appetite to single source unitranche structures and away from bifurcated

senior/junior structures. While commercial banks continue to demonstrate modest risk

appetite, credit funds and BDCs, among others, filled the void with unitranche solutions.

Leverage Multiple (EBITDA < $50MM)


4.4x

4.9x 4.7x

5.3x

4.5x 4.7x

5.1x 5.2x

4.8x 4.8x

4.4x

5.6x 5.7x

4.9x 5.0x 5.0x


0.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

First Lien Second Lien SubordinatedDebt / EBITDA Multiple

11


Middle-market M&A transaction volume declined modestly versus last quarter, though

aggregate transaction value held nearly constant. The recent increase in leveraged recap

activity contributed to what we believe was an aberrant M&A slowdown.

Middle-Market M&A Volume (Target EBITDA < $50M)


172.3

130.4

112.8

263.4

181.4

150.6

206.8 199.4

165.1

189.0

154.2

245.7

157.2

119.4

201.4 188.2

2.8

2.2 2.1

2.5 2.6 2.5 2.6 2.6 2.7 2.6

2.7 2.6

2.4 2.4

2.7

2.0

1.0

1.8

2.6

3.4

4.2

5.0


$0

$50

$100

$150

$200

$250

$300

TH

OU

SA

ND

S

TH

OU

SA

ND

S

Total M&A Volume ($B) Number of Deals

(thousands)

Transaction Volume

12


Dividend recapitalizations for both sponsor- and management-owned businesses

represented an atypically large proportion of loan and private note activity this quarter.

The return of lender appetite for recaps, combined with attractive risk-adjusted leverage

costs and friendly call terms, triggered broad consideration of recaps in lieu of asset

sales.

Loan Issuance for Dividend Recapitalizations


$15.7

$17.8

$27.3

$14.0

$10.7

$17.0 $18.3

$13.4

$4.1

$6.5

$15.2

$12.8

$3.1

$0.2

$14.2 $13.8


$0

$5

$10

$15

$20

$25

$30

Total Loan Volume ($B)

Transaction Volume

13


Yields Yields on high-yield bonds and leveraged loans fell approximately 100bps and 60bps

respectively this quarter. Two notable drivers of the corporate rally are the rally in oil

prices providing some breathing room for highly leveraged energy companies and

continued monetary stimulus in Europe and Japan.

U.S. Corporate High-Yield Bonds & Leveraged Loans



4.5%

5.5%

6.5%

7.5%

8.5%

9.5%

10.5%

HU

ND

RE

DS

Barclays U.S. Corporate High Yield S&P/LSDA U.S. Leveraged Loan 100 All LoansYields (%)

14


Treasury yields were volatile during the third quarter, fluctuating in a ~35bps band for

10-year Treasury bonds, but ultimately ending nearly unchanged as the major central

banks largely stood pat for the quarter. Geopolitical developments and macroeconomic

strengthening had little lasting impact on market conditions.


2, 5 and 10 Year Treasury Yields


0.0%

1.0%

2.0%

3.0%

4.0%

2 Year 5 Year 10 YearYield (%)

Yields

15


Spreads between long-term and short-term Treasury yields decreased only 5bps during

the quarter, after several quarters of yield curve flattening.



0

50

100

150

200

250

300

2 Year vs. 10 Year Treasury Spread

Spread (bps)

Yields

16


Macroeconomics Update

Macroeconomic conditions in the U.S. continued to strengthen in the

quarter. Positive jobs reports and strong GDP growth projections buoyed

markets. According to the Federal Reserve the unemployment rate stayed

essentially flat at 5.0%, as the labor force participation rate rose to 62.9%

in September. Given this backdrop, and the absence of near-term fiscal

stimulus, monetary policy continued to warrant analysts’ focus. U.S. Real GDP Growth

Source: Federal Reserve


0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

GDP Growth Rate

17


Michael Brill Head of U.S. Private Capital Markets

+1 212 871 5179

[email protected]

Bob Bartell, CFA Global Head of Corporate Finance

+1 312 697 4654

[email protected]

Steve Burt Global Head of M&A

+1 312 697 4620

[email protected]

Dave Althoff Global Co-head of Industrials M&A

+1 312 697 4625

[email protected]

Josh Benn Global Head of Consumer, Retail,

Food & Restaurants

+1 212 450 2840

[email protected]

Brian Cullen Head of U.S. Restructuring

+1 424 249 1645

[email protected]

Brooks Dexter Global Head of Healthcare M&A

+1 424 249 1646

[email protected]

Ross Fletcher Managing Director, Canada M&A

+1 416 361 2588

[email protected]

Brian Pawluck Managing Director, Canada Restructuring

+1 416 364 9756

[email protected]

Kevin Iudicello Managing Director, Technology M&A

+1 650 354 4065

[email protected]

Jon Melzer Global Co-head of Industrials M&A

+1 212 450 2866

[email protected]

Jim Rebello Global Head of Energy M&A

+1 713 986 9318

[email protected]

Contact Us

18


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capital markets industry insights - q3 2016

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