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Leveraged Finance Market Update Recaps 2014 Market-Wide Leveraged Financing Activity and Provides Our Initial Outlook for 2015

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Leveraged Finance Market Update Recaps 2014 Market-Wide Leveraged Financing Activity and Provides Our Initial Outlook for 2015 Winter 2015 Kelly Martin [email protected] +1 312 364 8832 Leveraged Finance Kent Brown [email protected] Market Update +1 312 364 8952 Michael Ward [email protected] +1 312 364 8529 Mark Birkett [email protected] +1 312 364 5483 Matt Thomas [email protected] +1 312 364 5261 William Blair & Company Spotlight on the Leveraged Finance Market This issue of Leveraged Finance Market Update recaps 2014 market-wide leveraged financing activity and provides our initial outlook for 2015. The leveraged loan market recorded its second best year since 2007 with $528 billion in 2014 (behind record issuance in 2013 of $607 billion), while the high yield market turned in another solid year of activity with $314 billion of total issuance (just 9% below its all-time record in 2013). Middle market borrowers (companies with less than $50 mm of EBITDA) raised $15 billion in leveraged loans in 2014, up 11% from $13.5 billion in 2013. Financing conditions, especially for strong borrowers with recurring revenue business models, scale and diversification, are robust. We are seeing leveraged mid-market software and other recurring revenue models routinely breach 6x and even 7x leverage. However we may be nearing peak conditions as less strong credits are seeing still good, but a more measured response from the leveraged lending market. And despite near record volume for 2014, conditions in the leveraged finance market became more volatile as the year progressed with borrowers facing increased financing costs and choppier markets by year end. For example while 75% of leveraged lenders responding to the William Blair Leveraged Finance Survey in Q3 2014 said that they were seeing looser deal terms and higher leverage over the prior six months, only 48% of respondents currently have this view. Lenders reporting tighter terms and leverage increased from 7% in Q3 to 13% most recently. Going forward, 29% of respondents expect terms and leverage to tighten over the next 12 months (up from 22% last quarter). Loan pricing appears more stable. Lenders reporting lower pricing declined slightly to 49% of respondents from 58%. Only 15% report realizing higher pricing in the most recent six month period (up from 9% in Q3). More generally respondents to the survey rated conditions in the leveraged finance market at 3.9 in terms of borrower favorability (on a scale of 1.0 to 5.0, with 5.0 being most borrower-friendly) down from 4.3 at Q3. One possible take-away from these results is that borrowers considering a leveraged financing in 2015 may want to accelerate their financing plans and plan to pursue a broad- based marketing effort to achieve optimum leverage, terms and pricing. These survey results are consistent with the experience of our debt arrangement practice and our view of the LBO financing market from our M&A advisory business. Our mid-market debt arrangement clients benefited from generally strong markets during the year as well as broad market-clearing financing processes, but the variability in lender response and level of aggressiveness widened as the year progressed. William Blair advised on a record level of M&A transaction volume in 2014. We completed or announced 90 transactions in 2014; including 35 financial sponsor LBOs aggregating more than $20 billion in transaction value. On average, sponsors leveraged these acquisitions to approximately 4.9x. We hope you find the Winter Issue of the Leveraged Finance Market Update informative. Regards, Kelly Martin Managing Director Group Head Capital Advisory Group/Leveraged Finance Team 312.364.8832 [email protected] Leveraged Finance Market Update Spotlight on the Leveraged Finance Market 1 William Blair & Company William Blair Leveraged Finance Survey The survey reflects the views of mid-market leveraged finance professionals representing leading commercial banks, credit funds, BDCs, commercial finance companies and other credit providers. The Market Index is a measure of both the current tone and direction of the mid-market leveraged finance market. Highlights of the survey include: 85% of lenders responded that over the past 6 months their pricing has declined (49%) or remained constant (36%) Going forward, 29% of lenders expect pricing to increase vs. 24% who responded this way last quarter On a scale of 1 to 5, with 5 being the most issuer/borrower friendly conceivable, respondents rated conditions in the credit markets as 3.9 Suggesting we may have reached a ceiling to leverage level and loosening of terms; 48% of respondents indicated seeing looser leverage and terms (versus 75% in Q3) while 29% expect leverage to lessen and terms to tighten How has the Comptroller of the Currency and Fed guidance If interest rates rise in 2015, how would you expect on leveraged lending impacted your financing business? leverage multiples to react? 60% 40% 42% 60% 46% 53% 40% 18% 40% 20% 20% 1% 0% 0% Not at all Negatively Positively Increase Decrease No material change Does your organization prefer to finance For transactions involving a private equity sponsor, what is transactions that: the minimum equity contribution you require? 60% 49% 40% 40% 36% 40% 28% 26% 20% 11% 20% 10% 0% Involve a private Do not involve Equally focused 0% equity sponsor a private on sponsored and non- Less than 25% 25-30% 30-35% Greater than equity sponsor sponsored transactions 35% Leveraged Finance Market Update 2 William Blair Leveraged Finance Survey William Blair & Company Leveraged Loan Deal Volume Leveraged loan volume in 2014 was $528 billion marking the second best year since 2007. However, volume did decline 13% when compared to 2013’s all-time high issuance of $607 billion. - Despite the YoY decline, 2014 was a robust year led by increased M&A activity. The volume of LBO and other acquisition related financings was the highest since the financial crisis, which partially offset the significant decline in repricing volume. A strong first half of the year supported nearly two thirds of 2014 issuance, while fourth quarter volume came in at $69 billion, a three-year low and down from $127 billion during the prior year period due to market volatility. The weakness experienced during the fourth quarter is perhaps best illustrated through repricing activity, which was virtually non-existent in 4Q14. CY 2014 reported $114 billion of repricing volume, of which nearly 80% occurred during the first quarter. Only $1.5 billion of repricing volume was recorded in the 4th quarter, representing a 98% decline YoY. Increased market volatility in 4Q14 also impacted the volume of covenant-lite activity during the quarter. Issuance of cov-lite loans in 4Q14 dropped to a 1.5-year low at 57% of total institutional volume, a decline from 70% in the 1H2014 and 62% during 2013. Demonstrating lenders continued receptivity to dividend recapitalization transactions, dividend volume during 2014 was $53 billion, which nearly matches the four-year average of $54 billion. The 2014 volume is down slightly all-time high issuance levels seen in 2012 and 2013. 2014 was a record year for second lien issuance at almost $36 billion, an increase of 23% over 2013 volume. However, this was largely supporting by record issuance in 1H14. Second lien volume declined to just $4.2 billion in 4Q14, the lowest quarterly total since 3Q12. Middle Market Leveraged Loan Volume Large Corporate Leveraged Loan Volume ($ in billions) ($ in billions) $29 $592 $506 $455 $512 $362 $14 $15 $12 $13 $222 $8 $10 $149 $5 $71 2007 2008 2009 2010 2011 2012 2013 2014 2007 2008 2009 2010 2011 2012 2013 2014 Institutional Pro Rata Institutional Pro Rata Source: S&P LCD. Loan Repricing Volume Recapitalization Loan Volume ($ in billions) ($ in billions) $282 $70 $56 $49 $53 $140 $114 $38 $36 $74 $72 $0 $0 $4 $3 $1 2007 2008 2009 2010 2011 2012 2013 2014 2007 2008 2009 2010 2011 2012 2013 2014 Institutional Pro Rata Source: S&P LCD. Leveraged Finance Market Update Leveraged Loan Deal Volume 3 William Blair & Company Leverage Multiples and Equity Contribution The average large corporate LBO leverage for 2014 was 5.8x, the highest level since 2007 when LBOs averaged 6.2x. 2014 LBO leverage was supported by a strong second and third quarter as average leverage reached 5.9x and 6.3x, respectively. Weaker market conditions in the fourth quarter pulled down the full-year average as 4Q14 leverage came in at just over 5.6x. Debt multiples for middle market LBOs have followed a similar trend, averaging 5.3x in 2014 compared to 4.8x in 2013 and a recession low of 3.3x in 2009. Lenders remain receptive to more highly leveraged transactions with 74% and 52% of the transactions being completed above 4x and 5x leverage, respectively. For transactions with at least 5x leverage, this represents a 13% increase over 2013 and is indicative of lenders continued willingness to push total debt multiples, though this somewhat slowed during 4Q14. Equity contribution levels have increased slightly to 39% during 2014 from 37% in 2013. However, when looking at the largest 10 LBOs completed in 2014, equity contribution accounted for just 34% of the purchase price. In Blair’s experience, the contribution level across the entire market should not be viewed as a minimum as it is likely inflated by high purchase multiples coupled with absolute caps on leverage levels. Lender’s appetite for dividend recap transactions remained robust in 2014 as pre- and post-dividend leverage were near all- time highs at 3.5x and 4.9x, respectively. This is nearly on par with 2007 which saw the all-time high for post-dividend leverage at 5.0x. Strong enterprise valuations have resulted in higher implied equity values and in turn supported the increased leverage for dividend transactions.
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