Capital Markets Insights - Q2 2016

Industry Insights:

Capital Markets

Q2 2016

Highlights

Credit providers vigorously pursued well-structured offerings by middle-market issuers throughout the second quarter

Demand for new issuance was driven by a strong crossover bid, a build-up of credit fund “dry powder” and modestly growthful macroeconomic conditions

Acquisitive middle-market issuers capitalized on lenders’ increased risk appetite by entering into attractively priced and structured financings, including facilities consisting of both immediately drawn and open ended acquisition tranches

While U.S. monetary policy took center stage briefly in June, weak labor market data kept the Fed largely on hold throughout the quarter

The dramatic rally in Treasury yields (and other safe haven assets) triggered by the “Brexit” referendum at quarter’s end, augurs well for further improvement in domestic credit market conditions

Middle-market issuers enjoyed another quarter of strong demand from credit providers. Competition among lenders for new offerings triggered a rally in pricing, covenant protection, and, in particular, prepayment terms. Further, leverage levels moved up by approximately a half turn of EBITDA over the prior quarter.

Investment demand was strong among most genres of private market participants, in particular credit funds approaching investment period limits. Crossover interest from high-yield and leveraged loan buyers, resulting from a modest pace of large cap deals, added further to competition for middle-market new issuance.

We observed a marked increase in risk appetite this quarter among commercial banks in transactions offered by Duff & Phelps. Conversely, we noted continued tepid demand from the mainstream BDC community.

Opportunistic borrowers have increasingly called on us to provide financing in support of contemplated bolt-on acquisitions. Such financings oftentimes are structured as dual- tranche facilities that include both an immediately drawn portion and an unfunded acquisition line. The combination of attractively priced debt and modest macroeconomic growth suggests continued activity of this type in the coming quarter.

We believe market conditions for middle-market issuers are compelling. Attractive base interest rates, credit spreads, leverage levels and prepayment terms allow issuers to craft contracts tailored to reflect idiosyncratic priorities. While exogenous risks—“Brexit” contagion, energy supply disruptions, terrorist attacks—remain chronic concerns, risk appetite among credit providers continues to be keen.

Capital Markets Industry Insights – Q2 2016

Executive Summary

Duff & Phelps 2

Indicative Middle-Market Credit Parameters

Leverage Multiples EBITDA of $10MM - $20MM EBITDA of $20MM - $50MM

Senior Debt2.50x - 3.50x 2.25x - 3.25x

3.00x - 4.00x2.50x - 3.50x

Total Debt4.00x - 4.50x3.75x - 4.25x

4.50x - 5.50x4.00x - 5.00x

Pricing EBITDA of $10MM - $20MM EBITDA of $20MM - $50MM

First Lien

Libor + 2.75% - 3.50% (bank)Libor + 3.00% - 4.00% (bank)

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

Libor + 2.50% - 3.25% (bank)Libor + 2.75% - 3.50% (bank)

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

Second Lien Libor + 6.50% - 9.50% Libor + 6.00% - 9.00%

Subordinated Debt 11.00% - 13.00% 10.00% - 12.00%

Unitranche Libor + 6.50% - 9.00% Libor + 6.00% - 8.50%

Note: Data in red reflects change vs. Q1, if applicable.

New Issuance

The number of high-yield issuances this quarter reflected a modest decline in activity. (However, dollar volume improved due to a handful of aberrational large offerings). The number, and, to a greater extent, dollar volume of new loan issuance improved this quarter as a result of pent up demand and increasing risk appetite.

Total High-Yield Bond Issuance

Duff & Phelps 3

0

2Q161Q164Q153Q152Q151Q154Q143Q142Q141Q144Q133Q132Q131Q134Q123Q12

Number of Deals

111.2

90.9 88.1

124.8

103.2

90.982.6

113.5104.8

59.1

72.8

116.3

105.2

52.2

Total Bond Volume ($B)

109.2

133.8

$0

$50

$100

$150


100

200

300

400

500

137141158

220

312327

290282283

302

362

344347

370

320

409

Total Loan Issuance

$0

$100

$200

$300

$400

$500

$600

$700


Number of Deals

319.7

506.3

596.1

531.6543.8

467.7

587.1

450.0

592.6

386.7

591.3

532.2 539.6

356.9

592.2

808

1,123

887

1,103

1,014

1,047

959

1,116

994

1,033

864

1,071

985

757

850

Total Loan Volume ($B)

600

800

1,000

1,200

1,400

490.4

784

Source: SDC Platinum



New Issuance - Continued

Duff & Phelps 4

Total Loan Issuance (EBITDA < $50MM)CLO issuance rebounded to levels seen in the third and fourth quarters of last year, in terms of both number and volume.Leveraged loan funds remained largely constant. High-yield bond funds, however, continued to experience net outflows.

$0

$50

$100

$150

$200

$250

$300

$350


Number of Deals

140.1

259.6

295.1

213.4

244.2263.5

282.1

198.9

227.0

148.0

263.3

207.2226.5

160.0

254.9

618

868 856

771

664

796

754774

869

659

767

668

798

744

589

645


500

750

1,000

1,250

220.1

591

669


High-Yield Bond Mutual Fund Flows

($20)

($15)

($10)

($5)

0

$5

$10

$15

Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16

Total Fund Flows ($B)

Source: Investment Company Institute


New Issuance - Continued

Duff & Phelps 5

Leveraged Loan Mutual Fund Flows

($8)

($4)

$0

$4

$8

$12


Total Fund Flows ($B)

Source: Lipper FMI

Total CLO Issuance


Number of Issuances

26.324.6

22.6

38.3

32.430.7 30.8

28.6

18.9 19.6

8.2

18.016.0 17.0

Total Volume ($B)

23.6

10.7

26

46

52

3436

45

53

69

63

58 5755

36

40 42

20

$0 0

20

40

60

80

$10

$20

$30

$40

$50

$60



Yields

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

2 Year vs. 10 Year Treasury Spread


Yields on high-yield bonds and leveraged loans rallied 90 bps and 80 bps, respectively, during the quarter. Modestly positive economic growth, benign monetary policy and tepid labor market conditions all contributed to the rally. The rally accelerated sharply in the last two weeks of the quarter on the heels of the “Brexit” vote and subsequent flight to quality.

Spreads between high-yield bonds and leveraged loans tightened significantly since the yield spike at the beginning of 2016. Spreads narrowed approximately 145 bps since January, as the risk of fixed rate versus floating rate debt diminished.

The spread between the two year and the ten year Treasury yields narrowed further, reflecting the expectation of a continued low interest rate environment.

Yield

4.5%

5.5%

6.5%

7.5%

10.5%

9.5%

8.5%

Jun-12

Barclays U.S. Corporate High-YieldS&P/LSDA U.S. Leveraged Loan 100 All Loans

Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16

0

50

100

150

200

250

300


Spread (bps)

Duff & Phelps 6




0.0%

1.0%

2.0%

3.0%

4.0%

Yield 2 year5 year10 year

Yields - Continued

Duff & Phelps 7

2, 5, and 10 Year Treasury Yields

Acquisition Financing/Dividend Recapitalization

Leverage multiples for middle-market change-of-control financings regained the recent highs seen in the second half of 2015. While traditional senior lenders generally held to leverage levels of the prior quarter, second lien and subordinated lenders increased total leverage appetite by approximately half a turn of EBITDA.

Leverage Multiples (EBITDA < $50MM)

First LienSecond LienSubordinated

4.3x 4.4x

4.9x 4.7x

5.3x

4.5x4.7x

5.1x 5.2x4.8x 4.8x

4.4x

5.6x

4.9x

5.7x5.5x

0.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 1Q164Q15

Debt/EBITDA Multiple

2Q16




2Q164Q153Q152Q151Q154Q143Q142Q141Q144Q133Q132Q131Q134Q123Q12


$0.0

$15.0

$20.0

$25.0

$10.0

$5.0

1Q16

$14.7

$9.5

$16.2 $16.7

$13.0

$3.9

$8.8

$6.3

$14.0

$0.2

$13.7

$21.3

$10.5

$2.2

$14.6$15.3

2.72.62.7

2.72.8

409

2Q164Q153Q152Q151Q154Q143Q142Q141Q144Q133Q132Q131Q134Q123Q12

Total M&A Volume ($B)

$0.0

$6.0

$8.0

$10.0

$4.0

$2.0

1.0

2.6

1.8

3.4

4.2

5.0

1Q16

Number of Deals (Thousands)

$5.9

$6.5$6.8

$7.3 $7.1

$5.9

$8.8

$6.7

$5.5

$4.1

$7.1

$4.5

$9.5

$5.6

$6.3

$5.1

2.62.7

2.32.5

2.4

2.62.72.42.5 2.6

2.7

2.1

2.8

2.1

2.62.6

409

Acquisition Financing/Dividend Recapitalization - Continued

Leveraged recapitalizations resurfaced this quarter, after two quarters of de minimis activity. Exit constraints (most notably, a tepid IPO environment) combined with strong credit conditions suggest a strong environment for recaps in the coming quarter.


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

Loan Issuance for Dividend Recapitalizations

Duff & Phelps 8



Macroeconomic Update

U.S. Real GDP Growth

Duff & Phelps 9

Muted hiring, in conjunction with low inflation readings, hampered the Fed’s plans for a June rate hike. The Fed remains data driven, with markets now expecting just one rate hike this year.

The U.S. economy grew at a 2.1% rate in the quarter, representing a modest improvement over the prior quarter. Equity markets were volatile, particularly in June, but indexes ultimately increased approximately 1.5%, on average. Meanwhile, commodities continued the rally begun in the first quarter, with gold and oil prices up 18% and 7%, respectively. In spite of significant volatility, most notably in June, the quarter ended positively.

The recent referendum in Great Britain to exit the European Union, surprised investors (and policy makers). The “Brexit” vote triggered a dramatic flight to traditional safe haven assets, resulting in sharp rallies in U.S. Treasury and precious metal markets, in particular. M&A activity, as well as bank lending, in the UK has already slowed, pending further policy clarity. (At this writing, the contemplated pace of UK decoupling from the EU is slowing, with market conditions having already largely reverted to pre-“Brexit” circumstances).


0.5%

0.0%

1.0%

1.5%

4.0%

2.0%

2.5%

3.0%

3.5%

GDP Growth Rate

Source: Federal Reserve Bank of St. Louis


For more information please visit: www.duffandphelps.com

About Duff & PhelpsDuff & Phelps is the premier global valuation and corporate finance advisor with expertise in complex valuation, dispute and legal management consulting, M&A, restructuring, and compliance and regulatory consulting. The firm’s more than 2,000 employees serve a diverse range of clients from offices around the world.

M&A advisory, capital raising and secondary market advisory services in the United States are provided by Duff & Phelps Securities, LLC. Member FINRA/SIPC. Pagemill Partners is a Division of Duff & Phelps Securities, LLC. M&A advisory and capital raising advisory services are provided in a number of European countries through Duff & Phelps Securities Ltd, UK, which includes branches in Ireland and Germany. Duff & Phelps Securities Ltd, UK, is regulated by the Financial Conduct Authority.

Contact Us

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U.S. ContactsMichael BrillHead of U.S. Private Capital Markets+1 212 871 [email protected]

Bob Bartell, CFAGlobal Head of Corporate Finance +1 312 697 [email protected]

Steve BurtGlobal Head of M&A+1 312 697 [email protected]

Dave AlthoffGlobal Co-head of Industrials M&A+1 312 697 [email protected] Josh Benn Global Head of Consumer, Retail, Food, and Restaurants+1 212 450 [email protected]

Brian CullenHead of U.S. Restructuring+1 424 249 [email protected]

Brooks DexterGlobal Head of Healthcare M&A+1 424 249 [email protected]

Kevin IudicelloManaging Director, Technology M&A+1 650 354 [email protected]

Jon MelzerGlobal Co-head of Industrials M&A+1 212 450 [email protected]

Jim RebelloGlobal Head of Energy M&A+1 713 986 [email protected]

Canadian Contacts Ross FletcherHead of Canada M&A +1 416 361 [email protected] Brian PawluckManaging Director, Canada Restructuring+1 416 364 [email protected]

UK Contact Ken GoldsbroughManaging Director, European Debt Advisory+44 (0) 20 7089 [email protected]

Global Capital Markets Commitment

Duff & Phelps provides our clients worldwide institutional investor coverage, with dedicated Capital Markets teams resident in New York, London and Hong Kong. Our comprehensive footprint allows us to access capital in all geographies and across the panoply of investment strategies.

Capital Markets Insights - Q2 2016

Economy & Finance

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