The Leveraged Loan Market 2017 Review and 2018 Preview. Meredith Coffey, LSTA

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1 The Leveraged Loan Market 217 Review and 218 Preview Meredith Coffey, LSTA 1

2 On Deck for Today The 217 technical picture What it meant for T&Cs Where 218 may go Public sector plans, private sector impacts? 2

3 Nominal Lending Volumes Strong But Mostly Refinancing and Repricing Institutional and Pro Rata Gross Lending Volumes 217 Institutional Lending Activity: Dominated by Repricings 6 4 Loan Volume ($Bils.) Institutional Pro rata Lending $(Bils.) Repricing via Amendment Repricing via Syndication Other new-issue M&A Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 Source: Thomson Reuters LPC, S&P/LCD

4 There Was Decent M&A But Even This Created Modest Net Lending 4 M&A Loan Volumes Near Record Highs 4 But Even High Levels of New Lending Brought Refinancings, Modest Net Supply 35 Leveraged M&A loans (excl. LBOs) LBO loans Loan Volume ($Bils.) Loan Volume ($Bils.) 1-1 1Q17 2Q17 3Q17 4Q Other Repmts Associated Repmts Priced Loan Volume Net Loan Supply Net Loan Supply According to LevFinInsights was $16B Net Growth in the S&P/LSTA Loan Index was only $72B Source: Thomson Reuters LPC, LevFinInsights

5 Visible Institutional Demand Greatly Outstripped Supply Visible Demand from CLO Issuance, Loan Mutual Fund Flows CLO Issuance 7 Since 212, Cumulative Institutional Demand Has Outstripped Supply by $162B Axis Title Loan Fund Flows Visible Demand Supply/Demand ($Bils.) Cumulative Visible Demand Cumulative Supply Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17-1 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17-4 Source: Thomson Reuters LPC, S&P/LSTA Leveraged Loan Index

6 Impact: Reduced Opportunities in Secondary Market Bid Appreciation Opportunity in 216; Prices High and Flat in 217 By 217, Many Loans Bid Above Par 11 1% 1 9% Bid (% of par) % Priced > 1 8% 7% 6% 5% 4% Median Bid Avg. Bid 3% 2% 1% Market Overall > 1 Large Liquid Market > 1 92 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 % Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Source: Thomson Reuters LPC, SMI

7 Impact: Declining New Issue (and Portfolio) Spreads 8 New Issue Loan Spreads vs. Average Outstanding Loan Spreads Loan Spread (bps) New Issue BB/BB- Spread New Issue B+/B Spread LLLI Nominal Spread 2 1 Jan-99 Jun-99 Nov-99 Apr- Sep- Feb-1 Jul-1 Dec-1 May-2 Oct-2 Mar-3 Aug-3 Jan-4 Jun-4 Nov-4 Apr-5 Sep-5 Feb-6 Jul-6 Dec-6 May-7 Oct-7 Mar-8 Aug-8 Jan-9 Jun-9 Nov-9 Apr-1 Sep-1 Feb-11 Jul-11 Dec-11 May-12 Oct-12 Mar-13 Aug-13 Jan-14 Jun-14 Nov-14 Apr-15 Sep-15 Feb-16 Jul-16 Dec-16 May-17 Oct-17 Source: S&P/LCD, S&P/LSTA Leveraged Loan Index

8 M&A Docs Looser: Adjustments Increasing, Accordions Growing EBITDA Adjustments on M&A Deals Increase Free & Clear Accordion Sizes Trend Up 35% 1 3%.9.8 Adjustments (%) 25% 2% 15% 1% 5% % EBITDA Adjustments (% of Reported EBITDA) EBITDA Adjustments (% of PF Adjusted EBITDA) 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 Turnof Adjusted EBITDA Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 Source: Covenant Review

9 M&A Deals: Tracking Movement From Basic Leverage to All-In Leverage Leverage Trends Based on ADJUSTED EBITDA Leverage Trends Based on REPORTED EBITDA 9 9 Leverage (x:1) First Lien Leverage First Lien Leverage + Accordion F&C Total Leverage Total Leverage + Accordion F&C Leverage (x:1) First Lien Leverage 3 3 First Lien Leverage + Accordion F&C Total Leverage 2 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 2 Total Leverage + Accordion F&C 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 *Note, 4Q17 moderation in leverage due to increase in corporate cohort Source: Covenant Review

10 Where Do We Go in 218? Default Rates Flat 12 Institutional Leveraged Loan Default Rate 1 8 (Default rate %) F Source: Fitch

11 Where Do We Go in 218? Pro Rata Lending Up, Institutional Flat to Down Pro Rata Lending Expected to Climb Institutional Refis Down by 4%, New Lending Expected Flat 8% 7 % of Respondents 7% 6% 5% 4% 3% 217 Lending ($483B) 217 Estimates 218 Estimates Volume Forecasts ($Bils.) Refinancings New Lending 2% 1% % < > Est Est Source: Thomson Reuters LPC

12 So Where Do We Go in 218? Institutional Spreads Flat to Down 6% BB Institutional Loan Spreads Flat(ish), B Spreads Down(ish) 5% Respondents (%) 4% 3% 2% BB credits Single B credits 1% % (> 3%) (1-2%) ( -1%) No change -1% 1-2% > 3% Source: Thomson Reuters LPC

13 So Where Do We Go in 218? Returns Looking at Sub-Coupon Year (bp) 6 Forecast Components of Institutional Loan Return in Nov-17 Levels 15 4 (5) Coupon Libor Libor Change Default Loss Repricings Price Chg Total Return Source: Barclays

14 Regulatory Watch List LIBOR Leveraged Lending Guidance Tax Reform Risk Retention Flood Insurance Custody Volcker Rule 14

15 Why LIBOR Might Go Away Allegations of manipulation by LIBOR submitters during the financial crisis Submitters in tough spot Decline in liquidity of LIBOR More than 7% of three-month LIBOR submissions are based on expert judgement by submitters, not actual transactions or interpolation of transactions Liability for LIBOR submitters Speech by Andrew Bailey, Chief Executive of U.K. s Financial Conduct Authority indicated they were not going to force banks to submit LIBOR after the end of 221 It s not clear whether banks will choose to continue submitting thereafter 15

16 Proposed US$ LIBOR Replacement: Introducing SOFR Bps Mo LIBOR vs 3-Mo Compounded SOFR (Secured Overnight Funding Rate) SOFR 3-Mo LIBOR Nov-14 Mar-15 Aug-15 Dec-15 Apr-16 Aug-16 Jan-17 SOFR Cost of overnight loans that use US government debt as collateral It is liquid and deep, with average daily trading volume of more than $7 billion It will likely remain robust over time Issues for cash markets? It s an overnight rate, not a term rate It s a secured repo rate It s lower than LIBOR Some milestones FRBNY will publish SOFR starting mid-218 Term curves should develop once trading begins; term reference rate scheduled by end of 221 Credit spread calculated for legacy contracts? Source: FRBNY, St Louis Fed 16

17 LIBOR: What Do Loans and the Loan Market Need? Credit spread between LIBOR and SOFR? Economic equivalency on date of transfer? Term reference rates (1-month, 3-month) vs. overnights? Multicurrency facilities? Infrastructure/technology? Hedging capability? 17

18 LIBOR: What Can Market Participants Do? Check your existing documentation for fallback language Review new loans/amendments for LIBOR transition language Agent/borrower determination? Agent/borrower determination with negative consent? Agent/borrower determination with majority amendment? Engage with the LSTA on our LIBOR work streams! 18

19 Leveraged Lending Guidance 19

20 Leveraged Lending Guidance: The Players and Actions In February 217, President Trump signed order to refine and streamline financial regulation In March 217, Senator Patrick Toomey (R-PA) sent a letter to GAO alleging that Leveraged Lending Guidance was a rule under the Congressional Review Act, and asking GAO to opine In June 217, the Treasury said that the Leveraged Lending Guidance should be refined In October 217, the GAO said Leveraged Lending Guidance was a rule In November 217, Representative Luetkemeyer (R-MO) sent a letter asking the Fed, OCC, FDIC to respond to the GAO report In November and December 217, the Fed, OCC and FDIC suggested they would considering reopening the Guidance for comment and refinement 2

21 Leveraged Lending Guidance: 218 To move forward on any refinement of Leveraged Lending Guidance, may need all new Agency heads confirmed OCC in place Jerome Powell confirmed as Fed Chair by Senate on January 23, 218 Hearing for FDIC Chair on January 23, 218 Potential process Determine what the market needs: Definition of Leveraged Loan vs. Non-Pass Origination Request for Comment? Notice of Rulemaking? Comment Letter New/Refined Rule? 21