Download - Capital Markets Industry Insights - Q1 2016

Industry Insights:

Capital Markets

Q1 2016

Highlights

Lender demand for new middle-market offerings remains robust in spite of volatility in the high yield and leveraged loan markets

Offerings with strong covenant and call protection are being greeted enthusiastically, in part due to moderating M&A activity

A slowdown in large cap new issuance, combined with superior covenant protection typical of private offerings, has generated a strong crossover bid from public bond (and leveraged loan) investors

Monetary policy concerns weighed heavily on the market for much of the quarter; the Fed’s recent downward revision of discount rate expectations has settled investors

The end-of-quarter rally in equities, Treasuries, and commodities bodes well for increased credit risk appetite

The Fed’s more dovish posture of recent weeks has triggered an increase in risk appetite across the credit markets. Most of the first quarter was characterized by muted GDP growth, hawkish domestic monetary policy, slowing growth in China and volatility in U.S. equity and commodity markets. Consequently, credit risk appetite became more dear. However, by mid-March—and in particular after a dovish statement by Fed Chair, Janet Yellen, following the March Fed meeting—credit market conditions improved considerably.

As the quarter progressed, we observed a notable increase in demand for well-structured, privately negotiated credit solutions. Anecdotally, we note both an increase in aggregate demand and an increase in breadth of capital sources. Traditional private investors have expressed to us their frustration at the slowdown in new issuance, attributable largely to a moderation of M&A activity in the quarter. In parallel, crossover public bond and large cap loan investors have expressed to us worries about liquidity availability and the continuing prevalence of covenant-lite structures. Consequently, appetite has migrated to well-structured middle-market transactions offering (implicit) illiquidity premiums. Finally, we note that intermediaries are increasingly able to orchestrate substantive, albeit informal, “staple” processes in tandem with sell-side mandates.

In summary, prospective middle-market issuers are being greeted with robust demand from both traditional private credit investors and crossover participants. This window of opportunity is, we believe, a function of moderating middle-market M&A activity, limited high yield and leveraged loan liquidity and the continued availability of traditional private market covenants.

Capital Markets Industry Insights – Q1 2016

Executive Summary

Duff & Phelps 2

Indicative Middle-Market Credit Parameters

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

Senior Debt 2.25x - 3.25x 2.50x - 3.50x

Total Debt 3.75x - 4.25x 4.00x - 5.00x

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

First Lien Libor + 3.00% - 4.00% (bank) Libor + 4.00% - 6.00% (non-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%

New Issuance

Loan issuance continued to decline as the quarter came to a close for both middle-market and large cap transactions. Volatile equity and credit markets deterred investors in the first half of the quarter, but funds began flowing again as the market righted itself in March.

0

50

100

150

1Q164Q153Q152Q151Q154Q143Q142Q141Q144Q133Q132Q131Q134Q123Q122Q12

50

150

250

350

450

Total Bond Volume ($B) Number of Deals

79.9

300

354

133.8

327

111.2108.9

323

116.3

335

105.2

265

90.9

282

88.1

259

123.8

374 103.2

287

90.9

257

115.0

299

105.0

282

82.6

195

52.0

150

57.9

123

Total High-Yield Bond Issuance

Total Loan Issuance

Duff & Phelps 3

0

50

100

150

200

250

300

350

400


200

400

600

800

1000

125.9

315

149.6

417

229.1

486

286.9

619

464

267.1

723230.9

702

289.6

783

284.8

713

287.0

797

230.8688

346.6

796

346.4

675

255.1

728

144.6

479

169.3

530

Total Loan Volume ($B) Number of Deals

147.8

Source: SDC Platinum



New Issuance - Continued

Duff & Phelps 4

Total Loan Issuance (EBITDA < $50MM)As a reflection of the tightening credit supply, CLO issuance and high yield bond fund flow dropped nearly 75% in number and volume quarter-over-quarter.

0

50

100

150

200

250


Number of Deals

88.6

224.0215.9

139.1

185.1194.5 195.1

153.3 155.2

136.0

98.5

59.4406 392

613 543

664

574

655595

659

598

498

381420

356

269

Total Loan Volume ($B) Number of Deals

200

350

500

650

800

602

151.0

79.2

155.1

83.6


High Yield Bond Mutual Fund Flows

($20)

($15)

($10)

$5

0

$5

$10

$15

Mar -12 Sep -12 Mar -13 Sep -13 Mar -14 Sep -14 Mar -15 Mar -16Sep -15

Total Fund Flows ($B)

Source: Investment Company Institute


New Issuance - Continued

Duff & Phelps 5

Leveraged Loan Mutual Fund FlowsHigh-yield bond issuance in the energy sector remained severely depressed despite a significant recovery in oil prices. Energy issuance fell 82% by volume in the first quarter compared to the first quarter of 2015.

($8)

($4)

0

$4

$8

$12

Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Mar-16Sep-15

Total Fund Flows ($B)

Source: Lipper FMI

Total CLO Issuance

0

10

20

30

40

50

60


20

40

60

80

Total Bond Volume ($B) Number of Deals

27

12.1 10.7

26

26.3

52

23.6

46

16.0

34

17.0

36

53

24.6

45

22.6

69

58

32.4

38.3

63

30.7

57

30.8

55

28.6

36

18.9 19.6

40

7.1

17



Yield (%)

4.5

5.5

6.5

7.5

10.5

9.5

8.5

Mar-12

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

Sep12 Mar-13 Sep-13 Mar-14 Mar-15Sep-14 Sep-15 Mar-16

Yields

Yields on high yield bonds and leveraged loans fell 40bps and 10bps, respectively, this quarter. Yields finished the quarter lower despite increasing by as much as 150bps and 55bps, respectively, in the first half of the quarter. Yields on high yield debt increased largely due to continued concerns in the energy space, as well as macro-economic uncertainty. Yields moderated following Fed commentary in mid-March.


Duff & Phelps 6

U.S. Corporate High Yield Bonds & Leveraged Loans

Acquisition Financing

Leverage multiples for middle-market change-of-control financings fell from the highs in the second half of 2015. We observed a reemergence of subordinated lending as traditional senior lenders have reduced leverage appetite. We continue to observe a considerable tightening of underwriting criteria by commercial banks and BDCs, while non-banks and credit funds are filling the resulting void.

Leverage Multiples (EBITDA < $50MM)


EV / EBITDA Multiple

First LienSecond LienSubordinated

0.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

4.2x 4.3x 4.4x

4.9x4.7x

5.3x

4.5x4.7x

5.1x 5.2x

4.8x 4.8x

4.4x

5.6x 5.7x

4.9x



Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16

0.0

1.0

2.0

3.0

4.0

Yield (%) 2 year5 year10 year

50

100

150

200

250

300

Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Mar-16Sep-15

Spread (bps)

Macroeconomic Update

Evolving monetary policy, commodity price volatility and geopolitical events all garnered keen attention from markets. Concerns around slowing growth in China, foreign policy tensions with Iran, Russia and North Korea, and acts of terrorism, also weighed on market participants. The Federal Reserve’s March meeting, and subsequent commentary, reduced expectations for quarter-point rate hikes from four to two for the coming year. The Fed cited relatively weak GDP growth and below-target inflation, as well as the effect of negative rates in Europe and Asia on the strength of the dollar, as reasoning for the delayed tightening schedule.

Source: Bloomberg

Source: Bloomberg

2 Year vs. 10 Year Treasury Spread

2, 5, and 10 Year Treasury Yields

Duff & Phelps 7


Macroeconomic Update - Continued

Source: Capital IQ

U.S. GDP Growth

Global Commodity Indices

Duff & Phelps 8

Domestic labor conditions were particularly affirming, as the job market continued unabated. Equity markets suffered large losses in January and February, though the S&P 500 ended slightly positive for the quarter. The energy sector, despite rising oil prices, remains troubled as reserves continue to be high, and the specter of widespread restructuring continues.

0.0%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

Mar-16Sep-15Mar-15Sep-14Mar-14Sep-13Mar-13Sep-12Mar-12

U.S. GDP Growth Rate

Source: Federal Reserve Bank of St. Louis

Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16

(100.0%)

(80.0%)

(60.0%)

(40.0%)

(20.0%)

0.0%

20.0%

Index Return Dow Jones U.S. Coal IndexS&P GSCI Crude Oil IndexS&P GSCI Copper Index


Conclusion

Duff & Phelps 9

Middle-market issuers of well-structured credit instruments are enjoying broad interest among market participants. While much of the first quarter of 2016 was hampered by a hawkish Fed and modest global growth, the end of quarter rally in financial assets and commodities carried over into a much improved environment for middle market corporate borrowers.

Appetite from traditional private credit sources continues unabated. In addition, a marked slowdown in large cap issuance, as well as reduced bond and loan liquidity, has triggered a strong crossover bid. The resulting window of opportunity is, we believe, inordinately compelling for opportunistic borrowers.


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 and capital raising 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 Germany are provided by Duff & Phelps Securities Ltd., which is authorized and regulated by the Financial Conduct Authority.

Contact Us

Duff & Phelps Copyright © 2016 Duff & Phelps LLC. All rights reserved.

Michael 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]

Ross FletcherHead of Canada M&A +1 416 361 [email protected]

Brian PawluckManaging Director, Canada Restructuring+1 416 364 [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]

Download - Capital Markets Industry Insights - Q1 2016

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