Industry Insights: Capital Markets Q4 2015 Highlights Credit market conditions continue to be compelling for middle market issuers in spite of recent capital markets volatility. While credit standards have tightened for middle market issuers, the effect has been quite modest relative to corrections in the commodity, equity and high yield markets. Investor composition is evolving…commercial banks and BDCs are curtailing activity while non-banks and credit funds are filling the void. Structural protections typical of private financings represent heightened value relative to “covenant light” structures. With the “normalization” of monetary policy having begun in December, the pace and magnitude of subsequent rate hikes have become topics of prime focus among market participants.
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Industry Insights:
Capital Markets
Q4 2015
Highlights
Credit market conditions continue to be compelling for middle market issuers in spite of recent capital markets volatility.
While credit standards have tightened for middle market issuers, the effect has been quite modest relative to corrections in the commodity, equity and high yield markets.
Investor composition is evolving…commercial banks and BDCs are curtailing activity while non-banks and credit funds are filling the void.
Structural protections typical of private financings represent heightened value relative to “covenant light” structures.
With the “normalization” of monetary policy having begun in December, the pace and magnitude of subsequent rate hikes have become topics of prime focus among market participants.
The availability of attractively priced and structured credit for middle market transactions continued largely unabated in the fourth quarter. The market experienced 1) a modest increase in pricing and 2) a tightening of leverage parameters, but far less so than we observed with respect to large cap transactions. Macroeconomic conditions continued to be strong domestically (notably, labor market conditions), though heightened geopolitical concerns and the dramatic downturn in commodity prices tempered risk appetite.
We noted a significant bifurcating of underwriting standards among institutional genres this quarter. Commercial bank appetite moderated, both in terms of bite size and volume, as did BDC appetite. Conversely, non-banks and credit funds stepped up to fill the void and, at this writing, represent the more compelling credit sources in the middle market.
Market participants were, and remain, laser focused on domestic monetary policy and Federal Reserve actions. While the inaugural rate hike that occurred in December was almost universally
anticipated, the pace and magnitude of subsequent hikes is far less certain. Though a base case expectation of cumulative 100 basis point increases in each of the next two years has been communicated by the Fed, the overarching qualifier of “data dependency” introduces a nontrivial element of ambiguity that will keep credit market participants on edge.
In summary, we anticipate a continued strong credit environment for middle market issuers contemplating refinancings, acquisition financings, leveraged recapitalizations and leveraging for growth. We observed 1) the cost of floating rate debt corrected this past quarter by approximately 50 basis points, representing a combination of base rate increase and spread widening, and 2) senior leverage multiples tightened by one quarter to one half a turn. We noted no material correction in fixed rate subordinated debt pricing nor in total leverage appetite. Relative to the far more significant corrections experienced in the large cap market, as well as in the equity and commodity markets, we believe the credit markets represent a compelling financing opportunity for middle market issuers.
Capital Markets Industry Insights – Q4 2015
Executive Summary
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Indicative Middle Market Credit Parameters
Leverage Multiples EBITDA of $10MM - $20MM EBITDA of $20MM - $50MM
Senior Debt 2.25x - 3.25x 2.50x - 3.75x
Total Debt 3.50x - 4.25x 3.75x - 4.50x
Pricing EBITDA of $10MM - $20MM EBITDA of $20MM - $50MM
Primary issuance volume of leveraged loans and, in particular, high yield bonds declined significantly in the fourth quarter. Many investors took a wait-and-see approach due in large part to uncertainty about the timing of Fed policy actions and a perceived decline in secondary market liquidity.
0
50
100
150
4Q15
3Q15
2Q15
1Q15
4Q14
3Q14
2Q14
1Q14
4Q13
3Q13
2Q13
1Q13
4Q12
3Q12
2Q12
1Q12
50
150
250
350
450
Total Bond Volume ($B) Number of Deals
121.0
314
79.6
296
133.0
349107.7
321
111.2
322
116.3
333
105.2
263
90.3
279
88.1
259
122.1
370 102.6
286
90.9
257
114.0
295
104.8
27882.6
195
48.1
131
Total High-Yield Bond Issuance
Total Loan Issuance
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0
50
100
150
200
250
300
350
400
4Q15
3Q15
2Q15
1Q15
4Q14
3Q14
2Q14
1Q14
4Q13
3Q13
2Q13
1Q13
4Q12
3Q12
2Q12
1Q12
200
400
600
800
1000
149.7
414
229.2
485
295.5
623
147.3
462
268.7
727233.5
703
291.2
786
284.8
713
287.4
794
231.1
689
346.9
797
346.4
675
255.1
728
147.0
484
169.3
530161.1
516
Total Loan Volume ($B) Number of Deals
Source: SDC Platinum
Source: SDC Platinum
Capital Markets Industry Insights – Q4 2015
New Issuance - Continued
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Total Loan Issuance (EBITDA < $50MM)Issuance in the energy and power sector essentially ground to a halt this quarter—a decline of 81% on the quarter and 43% for the year—as commodity market conditions became increasingly problematic for producers and service providers. Further, collateral base redeterminations triggered credit line downsizings throughout the sector.
Barclays U.S. Corporate High YieldS&P/LSDA U.S. Leveraged Loan 100
Yields
Yields on high yield bonds and leveraged loans rose 80bp and 50bp, respectively, this quarter. Yields rose steadily as the quarter progressed, as uncertainty with regard to U.S. monetary policy weighed increasingly heavily. In addition, liquidity concerns surfaced, and were further elevated in December by the imposing of a redemption prohibition on a large high yield mutual fund.
Source: SDC Platinum
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U.S. Corporate High Yield Bonds and Leveraged Loans
Acquisition Financing
Leverage multiples for middle market change-of-control financings, approximately 5.7x trailing EBITDA, were essentially unchanged from the third quarter. Notably, the increased reliance on junior capital that began in the third quarter continued in the fourth quarter.
The composition of market participants evolved over the quarter. We observed a considerable tightening of underwriting criteria by commercial banks and BDCs, with non-banks and credit funds having filled the resulting void.
The US economy continued to demonstrate consistent, though modest, growth fostered most notably by accommodative monetary policy. Labor market conditions were particularly affirming. Equity markets recovered from a downturn in the third quarter, with the S&P 500 rising 8.5% in the fourth quarter.
Evolving monetary policy, commodity price volatility and geopolitical events all garnered keen attention from market players this quarter.
The Federal Reserve’s decision to begin the process of monetary policy “normalization” was a seminal event this quarter. The increase in the Fed Funds Rate target that occurred on December 16th, and the anticipation of subsequent rate hikes over the next two years, triggered a flattening of the yield curve and a modest rise in all-in yields on floating rate debt.
Source: Bloomberg
Source: Bloomberg
2 Year vs. 10 Year Treasury Spread
2, 5 and 10 Year Treasury Yields
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Capital Markets Industry Insights – Q4 2015
Macroeconomic Update - Continued
Source: Capital IQ
U.S. Employment
Global Commodity Indices
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Commodities continued to suffer dramatic price declines, reflecting worries about global growth prospects. In 2015, copper prices declined by 39.5%, crude by 64.0%, and coal by 92.3%. The accelerated decline in crude prices in recent weeks also reflects anticipated supply growth, triggered in no small part by OPEC’s December 4th decision to increase production.
In addition, concerns about a slowdown of growth in China, foreign policy tensions with Iran and Russia, and acts of terrorism all warranted concern by market participants.
Dow Jones U.S. Coal IndexS&P GSCI Crude Oil IndexS&P GSCI Copper Index
Capital Markets Industry Insights – Q4 2015
Conclusion
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The availability of attractively priced and structured credit for middle market transactions continued largely unabated in the fourth quarter. While credit standards tightened modestly, agregate demand for new issuance was robust. Demand was particularly strong among non-banks and credit funds, while commercial bank and BDC appetite waned. We are mindful, however, of potential headwinds, most notably regarding volatility in the equity and commodity markets and the pace at which accommodative monetary policy is unwound.
Capital Markets Industry Insights – Q4 2015
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