DEBT CAPITAL MARKETS EXECUTIVE SUMMARY MIDDLE MARKET

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1 MARKET INSIGHTS 1Q 2018 DEBT CAPITAL MARKETS EXECUTIVE SUMMARY Borrowers are seeing increased liquidity and strong competition among lenders in the middle market and in asset-based lending, making it an opportune time to access debt markets. The leveraged loan market saw a record-breaking year in new-issue volume, and BB borrowers cut pricing as low as L+200, with some even as low as L+175. The high yield bond market also saw a strong year, with spreads staying at low levels. The market outlook for investment grade borrowers is strong. The loan market remains open and corporate bond credit spreads continue to tighten as demand outstrips supply. MIDDLE MARKET In middle market lending, syndicated bank loans to nonprivate equity owned, or non-sponsored, companies edged up slightly while volume backing PE-owned companies lifted the market to a three-year high. Lenders are showing strong appetite for new loans, and the lack of significant volume growth for non-sponsored companies perpetuated an environment in which more lenders are competing for fewer high-quality deals. As a result of demand for loans in excess of new supply, 2018 is setting up to be a favorable time for companies to borrow. Lenders are competing on price, looser structures, leverage tolerance and terms like EBITDA add-backs to win deals. Debt Capital Markets There s a growing trend of banks overcommitting to earn a better allocation. We re also seeing increasing appetite from small regional and community banks for C&I loans in an effort to offset a concentration of real estate loans. At the same time, some of the larger banks are maintaining discipline. While lenders to large corporates are willing to commit large amounts to uptier and to earn higher transaction fees, some banks are also exiting or reducing commitments in the middle market when there is little ancillary business, or for deals with low returns. Leveraged middle market borrowers with limited ancillary business opportunities have been particularly affected in this regard. That said, we expect to see leverage, tight pricing and looser structures carry into One reason is the influx of new capital into private debt funds. Direct lenders, also called non-bank lenders, are raising capital at record levels, and as new capital comes online to be invested, the market will see even more demand relative to supply. For sponsored deals, we re seeing significantly higher leverage. In fact, for institutional tranches, 2017 first lien leverage levels were in line with 2016 s total leverage levels, and nearly two-thirds of sponsored deals were leveraged at 6x or higher. Further illustrating the point that banks are looking for loan growth, the majority of lenders missed their lending goals every quarter throughout

2 Debt Capital Markets 2 MIDDLE MARKET VOLUME: SPONSORED V. NON-SPONSORED % OF LENDERS THAT MISSED THEIR LENDING GOAL $ % 90% $200 $150 $100 $50 $ Sponsored Non-sponsored 80% 70% 60% 50% 40% 30% 20% 10% 0% 1Q17 Bank 2Q17 3Q17 4Q17 In conclusion, to underscore current market trends, buyside accounts indicated to us that for deals where they passed mid-year, they would commit to the same deals today. INSTITUTIONAL MIDDLE MARKET LEVERAGE LEVELS RISING MIDDLE MARKET DIRECT LENDING CAPITAL RISING 6.00x 5.00x 4.00x 3.00x 2.00x 1.00x 0.00x Junior Debt to EBITDA 1st Lien Debt to EBITDA $80 $70 $60 $50 $40 $30 $20 $10 $ BDC Public Equity MM CLO Mezzanine Direct Lending Funds ASSET-BASED LENDING In asset-based lending (ABL), 2017 volume is marked the fourth highest total on record at $83 billion. The market remains issuer-friendly, as arrangers continue to take larger hold positions alongside more club-type syndications. The continuation of the supply/demand imbalance has driven flexibility and more borrowerfriendly structures. For example, in syndicated ABL deals, we are frequently seeing the inclusion of First-In, Last-Out (FILO) tranches, which provide incremental liquidity at the cost of premium pricing over the traditional revolver. The FILO was most typically utilized in the retail industry, but has recently been accepted in the broader ABL market. In addition, the excess demand in the market has created borrower-friendly enhancements in financial covenants, advance rates, voting rights and liquidity triggers. On some deals we re seeing in the market, companies are able to raise more capital than they need. As a result of oversubscription, some borrowers are increasing the tranche size and taking down the extra capital. Source: Thomson Reuters LPC

3 Debt Capital Markets 3 Capitalizing on excess demand over supply, sponsors continue to assert more control over the documentation process leading to more favorable borrower-friendly provisions. LIBOR NEW BENCHMARK FOR QUALITY ABL CREDITS To further illustrate the point, approximately 80% of ABL lender respondents to a Thomson Reuters survey expect structures to weaken into 2018, as the application of large corporate ABL deal terms continue to infiltrate into middle market deals. In addition, 60% of ABL lender respondents stated they could not lend as much as they wanted in Too many lenders are chasing too few deals. Pricing on ABL deals is near record low levels L+125 bps is now the market benchmark for high-quality ABL credits. Robust capital raising by direct lenders creates the opportunity for these lenders to play a bigger role across unitranche, Term Loan B, second lien and mezzanine tranches. While we expect to see more ABL lenders partnering with direct lenders to provide one-stop shop financing solutions, we re also seeing lead arrangers/bookrunners pursue larger deals to help offset the direct lender origination model. LEVERAGED / HIGH YIELD The leveraged loan market experienced record-breaking volume in Total pro rata and institutional new-issue loan volume tallied $645 billion, easily eclipsing 2013 s previous record of $607 billion. A frenzy of repricings led the charge and new money was strong, as borrowers seized the opportunity to tighten spreads to levels untouched for years. NEW-ISSUE LEVERAGED LOAN VOLUME INSTITUTIONAL NEW-ISSUE AND REPRICING VOLUME New-Issue Repricing Sources: S&P Capital IQ LCD, Thomson Reuters

4 Debt Capital Markets 4 For institutional BB issuers, 64 tranches were repriced to L+200 in For context, no issuers repriced to L+200 in One client was even able to issue a seven-year Term Loan B at L+175, a trend we expect to continue into the first quarter of Another market trend we expect to continue into 2018 is the ability to reduce TLB spread by incorporating a pricing grid with a leverage-based step-down. In the high yield bond market, spreads over treasuries, as measured by the Option Adjusted Spread, are among their lowest levels post financial crisis, and we re seeing covenant packages for high yield bonds continue to weaken, especially for sponsor-driven transactions. Investors continue to hunt for opportunities and are hopeful that the new tax reform legislation will lead to M&A activity in the early part of VOLUME OF SPREADS BELOW L+300 RELATIVELY LOW HISTORICALLY While we have seen an outflow from loan mutual funds and EFTs in recent months, we do not expect loan demand to dry up anytime soon. In fact, institutional investors indicated to us that they are sitting on much higher cash levels than desired given the limited supply of new-issue paper. In all, collateralized loan obligations, which raise money to invest in leveraged loans, raised approximately $118 billion in 2017, shattering 2016 s mark. Wall Street analysts believe that 2018 will meet or exceed 2017 levels, which is even more likely if CLOs are able to raise financing at lower levels. We continue to keep an eye on the loan maturity wall, which pushed out to , when 53% of all leveraged loans now come due. HIGH YIELD SPREADS REMAIN AT HISTORICALLY TIGHT LEVELS A significant chunk of single B rated loans comes due before 2023 and, given the fact that the majority of repricings occurred in the mid-bb space, this leaves ample runway for single B issuers to take advantage of loan demand and borrower friendly price flex. While the percentage of BB borrowers with spreads below L+300 is on par with pre-recession levels, the overall institutional market below L+300 is still below pre-recession levels, indicating that the next big wave of repricing activity will likely occur for single B credits. Sources: S&P Capital IQ LCD, Bloomberg

5 Debt Capital Markets 5 INVESTMENT GRADE M&A activity drove investment grade lending last year with $203 billion of volume, 11% higher than 2016, and we saw banks overcommitting to transactions in hopes of receiving higher allocations. Lifting the market to a record was CVS s massive $49 billion of loans put in place to support its $69 billion acquisition of Aetna. Refinances were down 5%, at the lowest level since 2012, as borrowers elected to wait to push out maturity for their revolvers. The market outlook for borrowers in 2018 is strong. Expectations of repatriated cash and increased cash flow from tax reform could hamper new debt issuance, possibly lightening new supply across loans and bonds. However, a boost to M&A from repatriated cash would likely aid new supply in In 2004, the last such tax holiday, data from the Congressional Research Service show that 843 firms repatriated cash at the then 5.25% rate, bringing back $312 billion, about one-third of cash held overseas. An estimated 80% of repatriated proceeds went toward share repurchases. This time around, the market expects borrowers to use cash in more diversified ways, including repaying debt, engaging in CapEx and M&A, and paying dividends in addition to buying back shares. I-GRADE DRAWN SPREADS OFFSHORE CORPORATE CASH CONTINUES TO RISE Remainder of corporates, excludes financials Apple, Microsoft, Alphabet, Cisco, Oracle Analyses of overseas cash hoards show a few hundred billion that could be repatriated thanks to the one-time 15.5% rate on cash versus the normal 35%. Heading into 2018, clients are also focused on changes to Libor, the current benchmark rate for most floating rate loans. Libor is moving toward being phased out in 2021, potentially being fully replaced in the syndicated loan market by a Secured Overnight Funding Rate ( SOFR ). In short, SOFR is a secured Treasuries repurchase rate, which would capture the short-term interest rate for repurchase agreements, repos, backed by Treasuries. The Federal Reserve Bank of New York is planning to begin publishing SOFR beginning in mid Regarding loan spreads over the current Libor benchmark, the market stayed relatively unchanged for another quarter as banks largely did not cut pricing. In 2018, banks are keeping an eye on potential changes to Basel III rules, which influence capital requirements. In particular, a bill in the Senate would ease capital constraints and enable smaller regional banks to cut costs, while a bill working its way through the House would give more discretion to regulators in enacting capital requirements for the regionals. Impacts from both bills would influence banks ability to cut investment grade loan spreads. Sources: Moody s, Thomson Reuters LPC

6 Debt Capital Markets 6 Corporate bond spreads tightened to levels not seen since 2007, as strong demand and even stronger supply pushed the market to a record $1.335 trillion. A culmination of a strong U.S. economy, an expected three rate hikes in 2018, strong corporate earnings, and potentially fewer bond issuances as a result of repatriated cash could possibly lead to even tighter spreads in From the investor s perspective, bond duration is at an all-time high, meaning investors face increasing interest rate risk at the same time spreads are trending downward. That echoes what borrowers are telling us they want to lock in the lowest rate for as long as possible. Clients are also more interested in international capabilities, with interest in tapping the markets in Europe and Asia. Indeed, U.S. corporate bond yields versus eurodenominated yields gapped out to approximately 2.5% difference, as companies sought to lock in lower rates, with the added benefit of being able to capitalize on the tax arbitrage opportunity. Approximately $118 billion in M&A volume from just eight transactions is already lined up for the 2018 calendar, giving a good starting point for what could possibly shape up to be a demand-driven market in Data from PNC s syndicate desk show investment grade bond oversubscription at approximately 3.3x for the first two weeks of 2018, a trend we expect to continue deeper into the quarter SPREAD MOVEMENTS 2018 FORECAST & IMPLIED TREASURY YIELDS DIVERGE FOR MORE INFORMATION Visit pnc.com/dcm. Sources: Bloomberg, WSJ Services such as public finance investment banking, securities underwriting, loan syndication, and securities sales and trading are provided by PNC Capital Markets LLC ( PNCCM ). PNCCM, member FINRA and SIPC, is a wholly-owned subsidiary of The PNC Financial Services Group, Inc. ( PNC ) and affiliate of PNC Bank, National Association ( PNC Bank ) The PNC Financial Services Group, Inc. All rights reserved. CIB ENT PDF