capital markets insights - q4 2016

Capital Markets Insights Q 4 2 0 1 6 R e v i e w

Capital Markets Insights | Q4 2016

Highlights

Following the quarter-point

December rate hike and

hawkish Fed statement, U.S.

monetary policy lessened as a

source of market volatility.

A surge in demand for new credit

issuance contributed to increasingly

competitive pricing and, in

particular, structural terms for

middle-market issuers.

Energy-related issuance surged in

recent months as commodity markets

reacted to increased demand and

OPEC-led supply discipline.

2

Investors enjoyed a strong rally in equities, energy and the dollar in the

final quarter of 2016, while Treasurys and precious metals largely traded

downward. A newly hawkish Federal Reserve policy, combined with an

incoming administration biased to fiscal stimulus and tax reduction,

accounted for much of the reaction of the capital markets.

Corporate credit costs for middle-market (non-investment grade) issuers

held roughly constant. The sharp Treasury sell-off was largely offset by a

tightening of corporate spreads. And while we attribute most of the

spread tightening to improving fundamental conditions, increasingly

issuer friendly technical conditions contributed as well. We observed

robust fundraising, especially among capital pools oriented toward

floating rate loan strategies.

Energy bond issuance, having been moribund for much of the year,

increased dramatically - a 17% increase in volume over the third quarter

of 2016 and over 450% increase over the fourth quarter of 2015 - as oil

reached its highest price since July 2015.

Dividend recap issuance surged prior to the election due to concerns

about a potential slowdown in growth under the broadly anticipated new

Democratic administration. Upon the election’s outcome, recap activity

significantly diminished.

Finally, we note that the 90-day LIBOR rate pierced 1%, the floor

oftentimes incorporated into corporate loans, for the first time since the

Great Recession. Consequently, floating rate loan costs have become

directly linked to monetary policy changes for the first time in more than

seven years.


Executive Summary Market conditions at the fourth quarter’s outset largely reflected expectations of

continued (albeit modest) economic growth and accommodative monetary policy.

At mid quarter, the presidential election results portended a period of fiscal

stimulus and tightening monetary policy. Further, the first significant OPEC-led oil

supply contraction in eight years triggered a firming of energy prices. Overall, the

quarter witnessed a sharp rally in equities, tightening credit spreads, a downturn in

Treasury prices and a strengthening of the U.S. dollar.

The broad S&P 500 index rallied 3.0% in the quarter (4.8% since the election),

while the Nasdaq rallied 1.3% (4.0% since the election). Much of the post-election

rally was attributable to the market’s anticipating a period of regulatory relief, fiscal

stimulus and tax cuts under the new administration. In parallel, the Treasury

market sold off, as the combination of more restrictive monetary policy and inflation

concerns surfaced. The 10 year yield, having reached a trough of 1.37% in July,

rose from 1.60% to 2.45% over the quarter.

As interest rates began to correct, spurred upward in no small part by the Fed’s

announcing plans to raise the Fed funds rate by 75 basis points in 2017, asset

managers are revisiting their asset allocation strategies. In recent weeks, we have

observed numerous middle-market credit managers announcing the launch and/or

closure of new funds, as well as the reallocating of assets among pension funds,

multi-strategy managers and life insurance companies.

Anecdotally, Duff & Phelps has observed a significant broadening of the universe

of bidders for our recent middle-market credit offerings as a result of new entrant

participation. The competition for new issues has empowered agents to negotiate

aggressively with respect to cost of capital and, at least as important, unusually

favorable structural terms.

Dividend recapitalizations accelerated into the election on anticipated changes to

tax policy and slow growth assumptions, with October volume alone exceeding

that of the third quarter. Post-election recaps subsided as macroeconomic

concerns abated.

The relevance of interest rate floors in floating rate loans has begun to wane in

recent weeks. The 90-day LIBOR rate rose above the 1% floor typical of non-bank

loans during the quarter. Consequently, lenders are enjoying direct linkage to base

rate increases for the first time since the financial crisis in 2009.

We believe prevailing credit market conditions are compelling for prospective

middle-market issuers. Technical conditions are unusually favorable, with a flurry of

new vehicles coming to market and asset managers increasing allocations to fixed

income. And, while base interest rates and, to a lesser degree, credit spreads are

expected to correct, currently prevailing all-in rates are largely unchanged from the

beginning of the quarter. Finally, favorable market conditions have garnered

issuers exceptionally flexible structural terms.

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


SECOND LIEN LIBOR + 6.50% — 9.50% LIBOR + 6.00% — 9.00%

SUBORDINATED

DEBT

11.50% — 13.50%

11.00% — 13.00%

10.50% — 12.50%

10.00% — 12.00%

UNITRANCHE LIBOR + 6.50% — 9.00% LIBOR + 6.00% — 8.50%

Indicative Middle-Market Credit Parameters

FIRST LIEN LIBOR + 2.75% — 3.50% (bank)

LIBOR + 4.00% — 6.00% (non-bank)

LIBOR + 2.50% — 3.25% (bank)

LIBOR + 4.00% — 6.00% (non-bank) FIRST LIEN

5

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

INFORMATION IN RED REPRESENTS PRIOR QUARTER VIEW


High-yield volume declined for the third consecutive quarter, with dollar volume falling

by 25% and deal volume declining by 17% versus the third quarter. Uncertainty around

the election outcome and monetary policy muted issuance in October and November; a

meaningful uptick followed in December (highest December since 2013) as issuers

changed course and sought to lock in rates. A significant increase in new energy

issuance, largely due to OPEC’s decision to reduce production, accounted for the

highest issuance by any sector in the quarter and totaled 35% of 2016 issuance. Total High-Yield Bond Issuance

Source: LCD Comps

83.9 82.5 82.1

68.6 74.9

105.1

68.9 64.5

91.3 94.1

39.8 36.3 36.1

83.4

62.7

47.1

166 176 155

146 146

178

123 112

129

163

61 53 55

112 107

89

0

50

100

150

200

250

300

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

$0

$25

$50

$75

$100

$125

TH

OU

SA

ND

S

Total Bond Volume ($B) Number of Tranches

New Issuance

6


506.4

596.4

547.8

606.9

480.5

621.7

507.5

672.1

436.9

662.5

605.0 604.5

398.0

692.6

499.4

706.9

888

1,104

1,054

1,210

1,026

1,216

1,142

1,192

897

1,248

1,029

1,148

879

1,149

1,006

1,106

500

1,000

1,500

2,000


$0

$200

$400

$600

$800

TH

OU

SA

ND

S

Total Loan Volume ($B) Number of Deals

Dollar volume of new loan issuance reached the highest mark we have seen in recent

quarters, while number of transactions reverted toward the mean. Refinancings

constituted the largest share of uses of proceeds, followed by M&A activity and

leveraged recaps.

Total Loan Issuance

New Issuance

7

Source: SDC Platinum

Volume data includes deals reported as of 1/15/2017


Total middle-market loan issuance rebounded strongly in the fourth quarter.

Total Loan Issuance (EBITDA < $50MM)

254.8

294.6

217.0

277.1 265.8

307.2

231.1

256.6

174.3

304.3

244.9

269.8

170.6

323.5

262.9

335.2

664

856

796

916

799

954

896

897

675

939

806

885

686

903

815

891

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

Collateralized loan obligation (CLO) issuance increased for the fourth consecutive

quarter, as managers and investors prepared for stricter risk retention rules under

Dodd-Frank.

Total CLO Issuance

Source: LCD Comps

26.3

16.0 17.0

24.6 22.6

38.3

32.4 30.7 30.8

28.6

18.9 19.6

8.2

18.0 19.9

25.6

52

34 36

53

45

69

58

63

57 55

36 40

20

42 41

52

0

20

40

60

80


$0

$10

$20

$30

$40

$50

$60

Total Fund Flows ($B) Number of Deals

9


Leveraged loan funds in the fourth quarter enjoyed inflows at the highest rate since the

first quarter of 2014 as mutual fund investors positioned themselves for a rising yield

environment. Given relative uncertainty around interest rates prior to the December Fed

meeting, high-yield bond fund flows fluctuated before sharply increasing at quarter’s

end.

Mutual Fund Flows

Source: Investment Company Institute; Lipper FMI

Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

($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

10


Leverage Mean total leverage multiples for middle-market financings tightened slightly this quarter.

Second lien debt represented a significantly larger portion of capital structures than in the

third quarter. While commercial banks continued to demonstrate modest risk appetite,

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

Leverage Multiple (EBITDA < $50MM)

Source: LCD Comps

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 4.8x


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 activity continued at the robust pace of the prior two quarters.

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

130.7

113.3

264.0

181.5

150.6

206.8 199.4

165.5

192.1

158.2

258.0

171.2

126.5

208.1 208.1 217.1

2.2 2.1

2.5 2.6 2.5 2.6 2.6 2.7 2.6 2.7

2.6 2.4

2.6

2.8

2.7 2.9

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 recapitalization activity increased to a three-year high this quarter. Prior to the

election, recap volume was largely driven by concerns around unfavorable tax and growth

policy. Upon President Trump’s election, recap volume subsided as macroeconomic

concerns abated.

Loan Issuance for Dividend Recapitalizations

Source: LCD Comps

$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

$11.9

$21.6


$0

$5

$10

$15

$20

$25

$30

Total Loan Volume ($B)

Transaction Volume

13


Yields Yields on widely traded leveraged loans fell approximately 35bps this quarter while

yields on high-yield bonds ended the quarter essentially flat. Despite the announcement

of a Fed rate hike in December, the continued improvement in energy market conditions

kept yields in check.

U.S. Corporate High-Yield Bonds and 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


Spreads between U.S. corporate high-yield bonds and the 10-year Treasury decreased

by approximately 90bps during the quarter, reflecting an overall increase in perceived

fundamental credit quality across sectors. This rally in credit spreads largely offset rising

base rates to keep bond yields essentially flat for the quarter.

Source: Bloomberg; LCD Comps


0

200

400

600

800

1,000

U.S. Corporate High-Yield Bond vs. 10-Year Treasury Spread

Spread (bps)

Yields

15


Treasury yields increased significantly in the fourth quarter, driven almost entirely by

monetary policy, with 10-year yields increasing approximately 85bps. The combination

of the announcement of the Fed rate hike and the associated guidance to three more

25bps rate hikes in 2017 pushed yields higher.

Source: Bloomberg

2-, 5- and 10-Year Treasury Yields


0.0%

1.0%

2.0%

3.0%

4.0%

2-Year 5-Year 10-YearYield (%)

Yields

16


Spreads between long-term and short-term Treasury yields increased by approximately

40bps during the quarter.

Source: Bloomberg


0

50

100

150

200

250

300

2-Year vs. 10-Year Treasury Spread

Spread (bps)

Yields

17


Macroeconomic Update

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

quarter. Positive employment reports, the U.S. election outcome and

strong GDP growth projections contributed to the market rally in equities.

The unemployment fell to 4.7% as the labor force participation rate rose to

62.7% in December.

U.S. Real GDP Growth

GDP Chart Source: Federal Reserve

Labor Statistics Source: U.S. Bureau of Labor Statistics

Fourth quarter data represents Atlanta Fed GDPNow Projection as of 1/15/2017


0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

GDP Growth Rate

18


Macroeconomic Update

In recent months, we have seen a significant strengthening of the U.S.

dollar compared to other major benchmark currencies. The primary drivers

of the rally are a strengthening U.S. economy and a tightening of U.S.

monetary policy.

U.S. Dollar Foreign

Exchange Rates

Source: Federal Reserve


-35.0%

-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

EURUSD GBPUSD USDJPYForeign Currencies vs. USD

19


Contact Us

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]

Ken Goldsbrough Managing Director, European Debt Advisory

+44 (0)20 7089 4890

[email protected]

Ross Fletcher Managing Director, Canada M&A

+1 416 361 2588

[email protected]

Howard Johnson Managing Director, Canada M&A

+1 416 597 4500

[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]

Brian Pawluck Managing Director, Canada Restructuring

+1 416 364 9756

[email protected]

Jim Rebello Global Head of Energy M&A

+1 713 986 9318

[email protected]

20


For more information please visit:

www.duffandphelps.com

Duff & 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 services in the United Kingdom and across Europe are provided by Duff & Phelps

Securities Ltd.(DPSL), which is authorized and regulated by the Financial Conduct Authority. In Germany M&A advisory and capital raising services are also provided by Duff &

Phelps GmbH which is a Tied Agent of DPSL. Valuation Advisory Services in India are provided by Duff & Phelps India Private Limited under a category 1 merchant banker

license issued by the Securities and Exchange Board of India.

About Duff & Phelps

Copyright © 2017 Duff & Phelps LLC. All rights reserved.

21

capital markets insights - q4 2016

Economy & Finance