Recent trimming in first lien debt appetite resulted in a higher proportion of second lien and junior debt in capital structures. The fuller covenant packages typical of the private market, combined with unabated growth in private investor capital formation, have served to differentiate middle market conditions from those of the broader liquid markets. While the weighted average cost of debt for middle market issuers has increased modestly, credit availability — both in terms of leverage multiples and cost — is robust.
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Capital Markets Insights: Credit Availability for the Middle Market Remains Robust
1. Industry Insights:
Capital Markets
November 2015
Highlights
Credit activity remains robust despite recent volatility in global markets
“Flight to quality” has contributed to a modest increase in non-investment grade
bond and leveraged loan yields over Q3 2015
Moderate increase in yields of middle market credits has been tempered by
fuller covenant packages and continued robust investor demand for private (and
illiquid public) debt exposure
Traditional bank lenders tightened credit parameters citing macroeconomic
volatility and energy sector weakness, leading to a partial reallocation of capital
structures
Market volatility in China triggered a global slowdown in demand for
commodities and finished goods
2. The third quarter began rather benignly for the credit markets and became increasingly
volatile as the months progressed. While domestic macroeconomic fundamentals steadily
improved over the quarter, the ongoing uncertainty concerning the timing and magnitude of
monetary policy adjustments garnered considerable market attention. More significant, the
sharp slowdowns experienced in the Eurozone and Asia—China in particular—soon carried
over into the commodity and equity markets. Increases in credit spreads soon followed.
Non-investment grade bond yields increased by over 150bp over the quarter (Barclays U.S.
Corporate High Yield Index) while leveraged loan spreads experienced a 40bp increase
(S&P/LSTA U.S. Leveraged Loan 100 Index).
The middle market, the focus of our private capital markets practice at Duff & Phelps, moved
in tandem with the public markets, though with a few key differences. First, we observed
a relatively modest (~50bps) increase in private note yields. Second, a trimming in first
lien debt appetite resulted in a higher proportion of second lien and junior debt in capital
structures. We believe the fuller covenant packages typical of the private market, combined
with unabated growth in private investor capital formation, have served to differentiate
middle market conditions from those of the broader liquid markets. Thus, while the weighted
average cost of debt for middle market issuers has increased modestly, credit availability—
both in terms of leverage multiples and cost—is robust.
Capital Markets Industry Insights – November 2015
Executive Summary
Duff & Phelps 2
Indicative Middle-Market Credit Parameters
Leverage Multiples EBITDA of $10MM - $20MM EBITDA of $20MM - $50MM
Senior Debt 2.50x - 3.25x 2.00x - 4.00x
Total Debt 3.75x - 4.50x 4.00x - 5.25x
Pricing EBITDA of $10MM - $20MM EBITDA of $20MM - $50MM
First Lien Libor + 3.00% - 4.00% Libor + 2.75% - 3.50%
Second Lien Libor + 6.50% - 9.50% Libor + 6.00% - 9.00%
Subordinated Debt 11.00% - 13.00% 10.00% - 12.00%
Unitranche Libor + 6.50% - 9.00% Libor + 6.00% - 8.50%
3. New Issuance
New issuance volume of high yield bonds and
leveraged loans was strong for most of the
third quarter, having largely kept pace with
activity levels in the first two quarters of 2015.
Market volatility late in the third quarter led
to a material slowdown in primary issuance,
however. Notably, the slowdown in leveraged
loan issuance was materially greater than that
experienced in the bond market, presumably
reflecting the expectation of increasing short
term interest rates.
0
25
50
75
100
3Q152Q151Q154Q143Q142Q141Q144Q133Q132Q131Q134Q123Q122Q121Q12
Total Bond Volume ($B)
150
200
250
300
100
Number of Deals
50.9
53.7
76.2
57.0 55.6
73.6
53.4
44.2
50.0
70.9
50.1 49.3
51.5
62.0
59.6
190
212
238
191
185
212
153 153
159
232
159 155
169
191
144
Total High-Yield Bond Issuance
Total Loan Issuance
Duff & Phelps 3
0
80
160
240
320
3Q152Q151Q154Q143Q142Q141Q144Q133Q132Q131Q134Q123Q122Q121Q12
Total Bond Volume ($B)
200
250
300
350
150
Number of Deals
129.0
164.4
129.6
159.6
211.4
217.7
201.1
189.0
176.0
232.3
189.1
222.6
175.9
263.1
208.7
204 202
181
239
204
259 260 255
217
266
247
272
208
282
178
Source: SDC Platinum
Source: SDC Platinum
Capital Markets Industry Insights – November 2015
4. New Issuance - Continued
Duff & Phelps 4
Total Loan Issuance EBITDA < $50MMThe energy and power vertical experienced
the sharpest drop in activity, a decline of
54% in the quarter and 25% YTD versus
last year (by dollar volume). As collateral
bases continue to decline in the space, we
anticipate further shrinking in bank debt
exposure (largely through redeterminations).
0
10
20
30
40
50
60
3Q152Q151Q154Q143Q142Q141Q144Q133Q132Q131Q134Q123Q122Q121Q12
Total Bond Volume ($B)
75
100
125
150
50
Number of Deals
15.3
22.9
24.8
35.9
52.7
39.0
32.4
41.5
43.2
51.0
32.2 33.0
18.6
56.4
19.5
58
61
65
96
60
96
84
90
79
110
97
110
61
108
57
Source: SDC Platinum
U.S. High Yield Bonds by Industry (YTD through Q3)
Total Bond Volume ($B) YTD 2014
YTD 2015
0.0
10.0
20.0
30.0
40.0
50.0
60.0
Financials
Energy
&
Pow
erH
ealthcareM
edia
&
Enter.
Industrials
M
aterials
Telecom
.RealEstate
Technology
C
onsum
erDiscr.
Retail
C
onsum
erStaples
Source: SDC Platinum
Capital Markets Industry Insights – November 2015
5. Yield (%)
4.5
5.5
6.5
7.5
8.5
Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15
Barclays U.S. Corporate High Yield
S&P/LSDA U.S. Leveraged Loan 100
Yields
Yields on high yield bonds and leveraged
loans rose 153bps and 42bps, respectively,
this quarter. A modest “flight to quality”—
especially as the slowdown in economic
activity in China became apparent—drove
Treasury yields down. The increase in risk
premiums, however, dominated as the quarter
progressed.
Source: SDC Platinum
Duff & Phelps 5
U.S. Corporate High Yield Bonds and Leveraged Loans
Acquisition Financing
Leverage multiples for middle market
change-of-control financings increased by
approximately a half turn of EBITDA in the
quarter, to ~5.5x, attributable in part to a
higher proportion of larger deals. Notably,
the increase was funded almost wholly by
junior capital providers.
Anecdotally, in recent weeks we have
observed a considerable tightening of credit
parameters among regional banks (and,
to a lesser degree, money center banks).
Lenders with whom we transact attribute
the tightening to worries about energy-
oriented exposure at least as much as
macroeconomic conditions. We anticipate,
at this writing, a reordering of capital
structures on de novo financings such that
one half to a full turn of leverage will reside
in a junior position until present challenges
are resolved.
LBO Leverage Multiples (EBITDA < $50 MM)
First Lien
Second Lien
Subordinated
3.9x 4.2x 4.3x 4.5x 5.0x 4.5x 4.8x 4.4x 4.7x 4.9x 4.9x 4.7x 4.9x 4.8x 5.5x
0.0x
1.0x
2.0x
3.0x
4.0x
5.0x
6.0x
1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15
EV / EBITDA Multiple
Source: SDC Platinum
Capital Markets Industry Insights – November 2015
6. 0.0%
1.0%
2.0%
3.0%
4.0%
Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15
Yield (%)
10 year
2 year
5 year
100
150
200
250
300
Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15
Spread (bps)
Macroeconomic Update
In spite of continuing improvement
in domestic economic conditions,
particularly the labor market, the quarter
was characterized by a steady stream of
exogenous cross currents.
Slowdowns in Southern Europe, Brazil,
and China, Japan and South Korea led to
a relative strengthening of the US dollar
as well as a sharp downturn in commodity
demand. The European Central Bank
and central banks in Japan and China
moved aggressively to cut interest rates,
employ quantitative easing and selectively
intervene in public capital markets.
Expectations for most of the quarter
of a tightening in US monetary policy
(accompanied by a flattening of the
yield curve) were dashed in deference
to continuing global weakness and the
associated decline in U.S. export related
activity.
Source: Bloomberg
Source: Bloomberg
2 Year vs. 10 Year Treasury Spread
2, 5 and 10 Year Treasury Yields
Duff & Phelps 6
Capital Markets Industry Insights – November 2015
7. Macroeconomic Update - Continued
Source: Capital IQ
U.S Employment
Global Commodity Indices
Duff & Phelps 7
The availability and cost of leverage for
middle market issuers held up quite well
relative to those of the public markets in
the third quarter. A combination of fuller
covenant protection for private securities
and unabated private investor demand
largely offset the effects of the quarter’s
macroeconomic headwinds. Consequently,
middle market issuers continue to enjoy the
benefits of “full” leverage, albeit at a slightly
higher weighted cost reflecting greater
reliance on junior capital.
0
100
200
300
400
500
6.0%
7.0%
8.0%
9.0%
Jan -12 Jul -12 Jan -13 Jul -13 Jan -14 Jul -14 Jan -15 Jul -15
Unemployment Rate Jobs Added (thousands)
Source: Federal Reserve
(100.0%)
(80.0%)
(60.0%)
(40.0%)
(20.0%)
0.0%
20.0%
Jan-12 Jul -12 Jan-13 Jul -13 Jan-14 Jul -14 Jan-15 Jul -15
Dow Jones U.S. Coal Index
S&P GSCI Crude Oil Index
S&P GSCI Copper Index
Capital Markets Industry Insights – November 2015