European Leveraged Loan Chart Book 4Q17

Transcription

1 European Leveraged Loan Chart Book 4Q17 Fitch Ratings quarterly European Leveraged Loan Chart Book series illustrates recent trends in leveraged loan issuance, maturities and default rates

2 Contacts Paul-Antoine Conti Senior Director European Leveraged Finance T: E: Edward Eyerman Managing Director European Leveraged Finance T: E: Edouard Porcher Associate Director European Leveraged Finance T: E: 1

3 Contents 1 Primary Market Trends 4 2 Portfolio Quality 36 3 Default and Recovery Outlook 60 4 Appendices 71 2

4 Recent Trends in the European Leveraged Loan Market The data and analysis provided in this chart book are based on Fitch s portfolio of private credit opinions (COs), and private and public ratings on 428 European leveraged credits (as of 31 December 2017), primarily LBOs. Seventy percent of the portfolio is composed of leveraged loan-only borrowers, 24% of issuers with both loans (RCF or term loan) and high-yield bonds in the capital structure, and 6% of private debt/unitranche borrowers. In total, the portfolio represents about EUR332bn of committed senior and junior debt. COs are private point-in-time assessments of credit risk principally based on confidential information supplied by asset managers (mainly CLO investors) on individual borrowers. COs are regularly updated but are not monitored as private monitored or public ratings, and there is no formal relationship between Fitch and the borrower s management or owners. They are identified by lower-case letters and an asterisk. Data and charts fall into three categories: Primary Market Trends, Portfolio Quality, and Default and Recovery Outlook. We also highlight market cohorts by distinguishing sponsor and non-sponsor deals, broadly syndicated and privately placed issues, covenanted and covenant-lite structures as well as borrowers by debt size (below EUR200m, between EUR200m-EUR500m and above EUR500m). Primary Market: European leveraged loan issuance (excluding repricings and US borrowers) reached EUR75 billion in 2017 with EUR25 billion issued in the fourth quarter alone. Enterprise valuations in European leveraged buyouts reached a new post-crisis median high of 12x EV/EBITDA in 2017, and the environment remains favourable for sellers, while sponsors have greater confidence in the European business environment over the next few years. We expect 2018 loan supply will be supported by secondary and tertiary buyout activity as well as by large corporates looking to secure high multiples when selling some divisions ahead of a potential correction in valuations. Corporate carve-outs and take-private buyouts of listed companies represent medium-term complex situational opportunities for financial sponsors where they employ specific sector expertise in addition to high leverage to realise value. However, activity in Fitch s portfolio shows that the number of LBOs (including recycled transactions) in 2017 was less than half its level. This is because senior leverage and total leverage at 5.5x and 6.0x respectively have not kept up with rising EVs. Consequently, shareholder equity contributions (at a median 5 in 2017) from financial sponsors in the post-crisis period are the highest recorded since Equity cushions reflect sponsors focus on asset-light businesses and target acquisitions with secular growth characteristics. Portfolio Quality: Improving top-line revenue growth and sustained operational efficiency have led companies in Fitch s portfolio to perform in line with Fitch s base cases, translating into a stable portfolio of credit opinions. Low coupons have led to comfortable debt-service capacity given long-dated yet highly leveraged debt structures. However, the medium-term performance of issuers in Fitch s portfolio will have to increasingly rely on sustained demand-driven cash-flow performance rather than liability management. Medium-term risks are evident in loose covenants and the use of aggressive definitions of EBITDA, including in mid-market transactions, which translate into medium-term execution challenges. Default and Recovery Outlook: Fitch expects operating performance and funding conditions to remain supportive of an "at-risk" portfolio (one of credit opinions rated 'b-' with Negative Outlook and below) remaining just under 1 of the overall portfolio in This will support low leveraged loan default rates around 2% during In addition, Fitch s expected senior secured recoveries have declined to post-crisis lows (median under 6 as of December 2017 in Fitch s portfolio versus 7 in August 2014) due to higher senior leverage and larger revolving credit facilities, often ranking supersenior to senior secured notes or unitranche instruments, representing rising claims against distressed enterprise value in a default scenario. 3

5 1 Primary Market Trends 4

6 Primary Market European CLO and Leveraged Loan Issuance 2017 European CLO issuance reached EUR19.4bn from 47 deals, a post-crisis record, and Fitch expects CLO issuance for 2018 to exceed EUR20bn. Stated spreads for new issue senior notes reached the lowest level since the crisis and averaged 78bp over Euribor in 4Q17. In addition, CLO managers took advantage of the favourable financing conditions and refinanced liabilities as soon as the transactions exited the non-call period. New CLO issuance has remained constrained by a scarcity of assets as new loan supply relies on financial sponsors ability to compete with global trade buyers for European assets loan issuance increased dramatically yearon-year, as IPO exits remained rare in 2017 and sponsors opted for secondary buyouts, dividend recapitalisations, bolt-on acquisitions and refinancing and repricing activity. Fitch expects 2018 issuance (excluding US borrowers and repricings) will be equally strong, at around EUR75bn. High valuations and shareholder activism support more supply as large corporates and family-owned corporates can realise asking prices. High entry multiples, lower expected recoveries on senior debt and the threat of ECB tapering complicate the outlook for European CLO Issuance (EURbn) EUR notional (LHS) Fitch projection (LHS) Number of CLOs (RHS) Source: Fitch, Bloomberg Western European Leveraged Loan Issuance (excluding US Borrowers and Repricings) (EURbn) Sponsor (LHS) Sponsorless (LHS) Fitch projection (LHS) Number of deals (RHS) (No) (No)

7 Primary Market Enterprise Value, Debt Multiples and Credit Opinions Distribution EV multiples over 2017 have increased further to 12x EBITDA (median) as sponsors remain focused on secular growth. The number of new transactions remains muted despite historically accommodative debt market conditions. At a median 6x EBITDA over 2017, total leverage remains at a post-crisis high. Senior leverage level median of 5.5x remained broadly stable throughout 2017 as junior debt reappeared in some aggressive primary market transactions. Equity cushion is around 5, much higher than in (around 3). b-* and below Issuer Default Credit Opinions (IDCOs) accounted for the largest proportion of first-time leveraged buy-outs (LBO), secondary buy-outs (SBO) and tertiary buyouts (TBO) in a post-crisis vintage in The proportion of b-* has fallen since then, as high leverage is partly compensated by stronger business profiles, comfortable interest coverage ratios, supported by declining median margins on TLBs and improving operating profit outlook in many sectors. Financial sponsors and leveraged credit investors exercise risk aversion via business model selection rather than leverage or covenant constraints, with the high-yield bond market accepting more credits from challenged sectors such as retail. Enterprise Value (EV), Leverage and Interest Cover Multiples at Closing (Median) , Primary market LBO/SBO/TBO/QBO (EBITDA x) (56) 2002 (68) 2003 (51) EV/EBITDA Total gross debt/ebitda Senior gross debt/ebitda EBITDA/Interest 2004 (96) 2005 (103) 2006 (124) 2007 (132) 2008 (34) 2009 (9) (Year (no. of deals)) Note: Multiples are based on a Fitch EBITDA which may differ from the reference EBITDA used in information memoranda and marketing materials (34) Distribution of Issuer Default Credit Opinion (IDCO) in New Issuance As % of total number of primary market LBO/SBO/TBO/QBO (35) 2012 (23) 2013 (43) bb+* bb* bb-* b+* b* b-* ccc* cc* 2014 (62) 2015 (54) 2016 (43) 2017 (48) 6

8 Primary Market Buyout and Refinancing Deals Above 6x Total Gross Leverage More aggressive structures accompanying the return of institutional demand in 2014 prompted the ECB to propose US-style leveraged lending guidelines (LLG) for eurozone banks at the end of Following a consultation and implementation period, the ECB s LLG came into effect in November Regulated banks will have to report new transaction exposures of 6x total debt to EBITDA. In 2017, half of the 123 European leveraged finance transactions observed by Fitch, including both buyouts and refinancings, had a total gross loan debt to EBITDA multiple in excess of 6x, on a fully drawn basis at closing (excluding shareholder debt). Fitch anticipates more floating rate note issuance as these borrower-friendly instruments remain eligible CLO collateral, which are unconstrained by LLG. However, the substitution effect may be limited as ECB s LLG will also capture regulated banks exposure to senior secured revolving credit facilities supporting FRN and unitranche financings. German borrowers represent a materially smaller share of highly leveraged deals than in the total loan portfolio as they tend to operate in more cyclical or capital-intensive industries with less tolerance for leverage. Proportion of Transactions with Loan Debt Multiple Above 6x - Entire Portfolio , Primary market LBO/SBO/TBO/QBO and Refinancings (EBITDA x) (124) 2005 (176) % Issuers with loan debt multiple > 6x (RHS) Total fully drawn loan debt/ebitda (median, all portfolio) Total fully drawn debt/ebitda (median, all portfolio) 2006 (186) 2007 (203) 2008 (39) 2009 (20) 2010 (43) 2011 (53) (Year (no. of deals)) Note: Multiples are based on a Fitch EBITDA which may differ from the reference EBITDA used in information memoranda and marketing materials (42) Proportion of Transactions with Loan Debt Multiple Above 6x - By Country , Primary market LBO/SBO/TBO/QBO and Refinancings (EBITDA x) (124) 2005 (176) France Other Germany UK Total fully drawn loan debt/ebitda (LHS) Total fully drawn debt/ebitda (LHS) 2006 (186) 2007 (203) 2008 (39) 2009 (20) 2010 (43) 2011 (53) (Year (no. of deals)) Note: Multiples are based on a Fitch EBITDA which may differ from the reference EBITDA used in information memoranda and marketing materials (42) 2013 (99) 2013 (99) 2014 (142) 2014 (142) 2015 (95) 2015 (95) 2016 (91) 2016 (91) 2017 (123) 2017 (123)

9 Primary Market Buyout and Refinancing Deals Above 6x Total Gross Leverage (Cont.) In 2017, the broad consumer and health-care sector continued to stand out as the most aggressive on leverage, just above TMT. 42% of transactions crossing the 6x threshold were originated in that sector, although most highly leveraged structures came from health-care issuers with strong free cash-flow and deleveraging profiles. However, issuers in the more challenged nonfood retail segment also exhibited debtfunded expansion and dividend recap strategies, despite less robust top-line revenue and like-for-like operating profit performance. Mid-market and larger deals, with total debt committed above EUR200m, are often able to issue in both the leveraged loan and high-yield bond markets and therefore drive median leverage up. Smaller borrowers with less than EUR200m in debt represent a small proportion of deals exceeding 6x as this cohort primarily consists of borrowers in loan-only club style deals or unitranche financings, with notably smaller EV multiples yet higher debt service costs. Proportion of Transactions with Loan Debt Multiple Above 6x - By Industry , Primary market LBO/SBO/TBO/QBO and Refinancings Industrials Utilities TMT (EBITDA x) (124) 2005 (176) Consumer & Healthcare Total fully drawn loan debt/ebitda (LHS) Total fully drawn debt/ebitda (LHS) 2006 (186) 2007 (203) 2008 (39) 2009 (20) 2010 (43) 2011 (53) (Year (no. of deals)) Note: Multiples are based on a Fitch EBITDA which may differ from the reference EBITDA used in information memoranda and marketing materials. Proportion of Transactions with Loan Debt Multiple Above 6x - By Loan Size (EURm) , Primary market LBO/SBO/TBO/QBO and Refinancings (EBITDA x) (124) >500m Between 200m and 500m <200m Total fully drawn loan debt/ebitda (LHS) Total fully drawn debt/ebitda (LHS) 2005 (176) 2006 (186) 2007 (203) 2008 (39) 2009 (20) 2010 (43) 2011 (53) (Year (no. of deals)) 2012 (42) 2012 (42) 2013 (99) 2013 (99) 2014 (142) 2014 (142) 2015 (95) 2015 (95) 2016 (91) 2016 (91) 2017 (123) 2017 (123) Note: Multiples are based on a Fitch EBITDA which may differ from the reference EBITDA used in information memoranda and marketing materials. 8

10 Primary Market EV, Debt Multiples and CO Distribution in Healthcare and Pharma The Fitch credit opinions assigned to health-care and pharma transactions over reflect a balanced portfolio of b* and b-*, as opposed to the pre-crisis period of that had a strong bias towards b-*. Despite more conservative valuations and credit metrics post-crisis overall, business models are more niche and tend to lack product and/or geographical diversification. However, high valuation multiples in the sector can sometimes be justified through potential synergies and increasing scale which may lead to margins expansion, stronger cash generation and a higher multiple at exit. The health-care and pharma sector stands out as the most aggressive on leverage in the post-crisis period. About 52% of all transactions (including refinancings) completed since 2013 in the sector have crossed the 6x total loan debt to EBITDA threshold on a fully drawn basis. Distribution of IDCOs in New Issuance Healthcare and Pharma As % of total number of primary market LBO/SBO/TBO/QBO and Refis in the sector bb+* bb* bb-* b+* b* b-* ccc* cc* Total Debt and EV Multiples (Median) Healthcare and Pharma , Primary Market LBO/SBO/TBO/QBO and Refis in the sector (EBITDA x) % Loan debt multiple >6x (RHS) Total fully drawn loan debt/ebitda Total fully drawn debt/ebitda EV multiple* (43) (20) (13) (69) * Applies to LBO, SBO, TBO, QBO only (Year (no. of deals)) 9

11 Primary Market EV, Debt Multiples and CO Distribution in Industrials Borrowers in the broad industrials sector maintain a higher equity cushion than in the period and a lower leverage level. In the pre-crisis period, confidence in profit growth and the ability of companies to generate free cash flow and deleverage supported a majority of b* credit opinions. In the post-crisis period of , the more conservative leverage metrics (only 29% of transactions exceeded 6x total debt to EBITDA on a fully drawn basis) were offset by slower revenue growth and weaker margin expansion prospects that limit deleveraging potential and leave high refinancing risk at maturity in most cases. The share of b-* credit opinions has been growing since High valuations can be justified for companies with niche applications and defendable market positions and stable profitability. Distribution of IDCOs in New Issuance Industrials As % of total number of primary market LBO/SBO/TBO/QBO and Refis in the sector bb+* bb* bb-* b+* b* b-* ccc* cc* Total Debt and EV Multiples (Median) Industrials , Primary Market LBO/SBO/TBO/QBO and Refis in the sector (EBITDA x) (129) % Loan debt multiple >6x (RHS) Total fully drawn loan debt/ebitda Total fully drawn debt/ebitda EV multiple* (65) (32) (115) * Applies to LBO, SBO, TBO, QBO only (Year (no. of deals)) 10

12 Primary Market EV, Debt Multiples and CO Distribution in Retail, Lodging and Rest. Transactions in the retail, lodging and restaurants sector completed since 2013 have lower leverage and higher equity cushion than in Only 35% of transactions exceeded 6x total debt to EBITDA on a fully drawn basis in compared to 75% in This is supported by the fact that non-food retailers are largely confined to their core markets with benefits from greater scale less obvious than in manufacturing activities, thus resulting in less strategic M&A in retail than in other segments. Moreover, differences in culture leading to high integration risk is also a constraint to cross-border non-food retail M&A. The three sub-sectors face significant challenges from weak organic growth, disruptive technology and changing competitive dynamics in certain segments that exert pressure on profitability and cash-flow generation, which is ultimately reflected in lower leverage ratios at closing of LBOs compared to Distribution of IDCOs in New Issuance Retail, Lodging and Restaurants As % of total number of primary market LBO/SBO/TBO/QBO and Refis in the sector bb+* bb* bb-* b+* b* b-* ccc* cc* Total Debt and EV Multiples (Median) Retail, Lodging and Restaurants , Primary Market LBO/SBO/TBO/QBO and Refis in the sector (EBITDA x) (43) % Loan debt multiple >6x (RHS) Total fully drawn loan debt/ebitda Total fully drawn debt/ebitda EV multiple* (28) (32) (77) * Applies to LBO, SBO, TBO and QBO only (Year (no. of deals)) 11

13 Primary Market EV, Debt Multiples and CO Distribution in Business Services Despite similar enterprise valuations (EVs) in the and periods, business services companies exhibit more conservative leverage in the present cycle than in Around 43% of transactions exceeded 6x total loan debt to EBITDA on a fully drawn basis in compared with 81% in Higher equity contributions often reflect sponsor comfort in the high-margin, high barrier-to-entry and growth profiles of multiple service sub-sectors. The better balance between financial risk and business risk in the recent vintages is reflected in a higher proportion of b* and above credit opinions compared with ; their business model is typically supported by long-term customer relationships, low churn rates, stable levels of profitability and low cash-flow volatility, all of which underscore confidence in deleveraging forecasts. Distribution of IDCOs in New Issuance Business Services As % of total number of primary market LBO/SBO/TBO/QBO and Refis in the sector bb+* bb* bb-* b+* b* b-* ccc* cc* Total Debt and EV Multiples (Median) Business Services , Primary Market LBO/SBO/TBO/QBO and Refis in the sector (EBITDA x) % Loan debt multiple >6x (RHS) Total fully drawn loan debt/ebitda Total fully drawn debt/ebitda EV multiple* (36) (31) (21) (88) * Applies to LBO, SBO, TBO, QBO only (Year (no. of deals)) 12

14 Primary Market EV, Debt Multiples and CO Distribution (Debt Below EUR200m) A majority of new deals with total debt committed below EUR200m carry a b-* IDCO due to their small operating scale, lack of diversification and keyman risk. Private equity sponsors face less competition for smaller targets, although their efforts to combine portfolio companies and emphasise synergies from size and scale has contributed to an increase in valuations since While leverage for this category of borrowers remains lower than new issuance across the portfolio as a whole (around 28% of transactions exceeded 6x total debt to EBITDA on a fully drawn basis in ), the high proportion of b-* IDCOs reflects the idiosyncratic business risks facing smaller borrowers. Distribution of IDCO in New Issuance with Debt Below EUR200m As % of total number of primary market LBO/SBO/TBO/QBO and Refis in this segment 10 bb+* bb* bb-* b+* b* b-* ccc* cc* Total Debt and EV Multiples (Median) in New Issuance Below EUR200m Debt , Primary Market LBO/SBO/TBO/QBO and Refis in this segment (EBITDA x) 12 % Loan debt multiple >6x (RHS) Total fully drawn loan debt/ebitda Total fully drawn debt/ebitda EV multiple* (105) (34) (44) (85) * Applies to LBO, SBO, TBO, QBO only (Year (no. of deals)) 13

15 Primary Market EV, Debt Multiples and CO Distribution (Debt Betw. EUR200m-500m) New transactions with committed debt between EUR200m and EUR500m carry higher leverage than those with less than EUR200m, but a higher proportion is rated b*. The larger debt amount often implies that the underlying businesses enjoy the benefits of scale and incumbent status in their sectors. Geographic and product diversification typically helps mid-sized credits absorb adverse market or operating conditions better than a smaller issuer, hence supporting a higher IDCO for a given leverage profile. Distribution of IDCO in New Issuance with Debt Between EUR200m-500m As % of total number of primary market LBO/SBO/TBO/QBO and Refis in this segment bb+* bb* bb-* b+* b* b-* ccc* cc* Total Debt and EV Multiples (Median) in New Issuance Between EUR m Debt , Primary Market LBO/SBO/TBO/QBO and Refis in this segment (EBITDA x) (158) % Loan debt multiple >6x (RHS) Total fully drawn loan debt/ebitda Total fully drawn debt/ebitda EV multiple* (75) (51) (199) * Applies to LBO, SBO, TBO, QBO only (Year (no. of deals)) 14

16 Primary Market EV, Debt Multiples and CO Distribution (Debt Above EUR500m) IDCOs of larger transactions with committed debt above EUR500m can often reach the b+* and above levels. Larger transactions are often international or domestic champions with proven market positions, pricing power and cash generation profiles that imply the ability to service debt and reduce leverage. However, since 2013, around of new issues above EUR500m have received an IDCO of b-*, primarily due to limited deleveraging visibility from topline revenue growth, limited pricing power, and aggressive debt-funded acquisition and financial policies. Forty-two percent of transactions have also exceeded the 6x threshold over that period. Distribution of IDCO in New Issuance with Debt Above EUR500m As % of total number of Primary Market LBO/SBO/TBO/QBO and Refis in this segment bb+* bb* bb-* b+* b* b-* ccc* cc* Total Debt and EV Multiples (Median) in New Issuance Above EUR500m Debt , Primary Market LBO/SBO/TBO/QBO and Refis in this segment (EBITDA x) % Loan debt multiple >6x (RHS) Total fully drawn loan debt/ebitda Total fully drawn debt/ebitda EV multiple* (209) (131) (59) (256) * Applies to LBO, SBO, TBO, QBO only (Year (no. of deals)) 15

17 Primary Market EV and Debt Multiples By Size and Ownership Financial sponsor-led deals contributed to historically high leveraged loan volumes, but competition from strategic buyers and IPO markets have driven up EVs for larger, established European market leaders since Large equity cushions in recent sponsor transactions reflect demand for companies in growth-related technology and services sectors. Larger sponsor deals have seen modest equity cushion contraction since 2013 as leverage increased. Total Debt and EV Multiples (Median) by Ownership and Debt Size at Issuance in EUR LBO/SBO/TBO/QBO Leverage x EV x (x) Sponsor Sponsor less Sponsor Sponsor less Sponsor Sponsor less Sponsor Sponsor less Sponsor Sponsor less Sponsor Sponsor less Sponsor Sponsor less Sponsor Sponsor less Sponsor Sponsor less <200m Between 200m and 500m >500m <200m Between 200m and 500m >500m <200m Between 200m and 500m >500m Transactions (31) (33) (26) (34) (63) (60) (9) (37) (42) 16

18 Primary Market Use of Proceeds and Size of Transactions 2017 confirmed the scarcity of first-time LBOs as the majority of transactions are refinancings (repricings are excluded). The trend towards smaller sponsor deals began in 2015 as private equity firms struggled to compete with strategic trade buyers in large primary transactions (e.g. Holcim and Lafarge assets bought by CRH, Portugal Telecom bought by Altice). In 2016 and 2017, the median debt volume for first-time LBOs increased due to a few relatively large transactions (Kuoni, Hotelbeds, Keter) but the number of first time LBO opportunities declined to around 20, the lowest level since Given the difficulties of competing on valuations for primary assets, sponsors have increasingly relied on recycling credits via SBO, TBO, dividend recaps and bolt-on acquisitions. Refinancing deals remain the main driver of loan issuance in Europe, supported by a strong bond-to-loan trend in early 2017 as cov-lite loans became the norm, with no prepayment penalty and lower senior loan pricing. The number of dividend recaps dramatically fell in 2015 and 2016 compared with 2014 but has picked up in 2017 driven primarily by favourable market conditions and sustained loan investor appetite. Median Committed Debt at Issuance for First-time LBOs (EURm) (51) 2002 (65) 2003 (45) 2004 (73) 2005 (60) 2006 (79) Use of Proceeds in Fitch Rated Transactions (No. of deals) (65) 2008 (22) 2009 (5) 2010 (11) (Year (no. of deals)) (16) 2012 (10) 2013 (25) LBO SBO/TBO/QBO Div-Recap Other Refi 2014 (48) 2015 (31) 2016 (21) 2017 (20) 17

19 Primary Market EV, Debt Multiples Comparison Between LBOs and SBO/TBOs First-time LBO EV multiples in 2017 exceeded their 2007 levels. EV and leverage multiples in SBO/TBOs has exceeded those of first-time LBOs as sponsors and trade buyers frequently chase the same assets given the scarcity of deals. Comparison of EV Multiples in LBOs and SBO/TBOs (Median) (EBITDA x) LBO SBO/TBO (56) 2002 (68) 2003 (51) 2004 (96) 2005 (102) 2006 (124) 2007 (132) 2008 (34) 2009 (9) 2010 (34) 2011 (35) 2012 (22) 2013 (42) 2014 (61) 2015 (52) 2016 (40) 2017 (42) (Year (no. of deals)) Comparison of Total Debt Multiples in LBOs and SBO/TBOs (Median) (EBITDA x) (56) 2002 (68) 2003 (51) 2004 (96) 2005 (102) 2006 (124) 2007 (132) LBO 2008 (34) 2009 (9) 2010 (34) SBO/TBO 2011 (35) 2012 (22) 2013 (42) 2014 (61) 2015 (52) 2016 (40) 2017 (42) (Year (no. of deals)) 18

20 Primary Market Profile of Loan-Only LBOs, SBOs, TBOs, etc. Comparing separate market phases, transactions since 2015 show higher median leverage in both primary and secondary LBOs than in Rising leverage did not translate into a materially higher margin compensation as asset scarcity and funding conditions contributed to borrower-friendly repricing trends until While senior secured margins peaked at 500bp for first-time LBOs in 2016, pricing has declined since then, despite no improvement in median leverage. Likewise, secondary buyouts observed in 2017 managed to increase leverage further (by around 1x EBITDA) while interest margins decreased. Debt Amounts, Margin, Tenor and Leverage by Period Median statistics No. Drawn amount (EURm) First-time LBOs Margin (bp) Tenor (years) Drawn debt at closing/ EBITDA Fully drawn debt/ EBITDA No. Drawn amount (EURm) SBO/TBO/QBO Margin (bp) Tenor (years) Drawn debt at closing/ EBITDA Fully drawn debt/ EBITDA Note: In the above statistics, fully drawn debt takes committed facilities such as revolver and capex facilities as fully drawn at closing of the transaction. Leverage ratios are based on a Fitch EBITDA which may differ from the reference EBITDA used in information memoranda and marketing materials. 19

21 Primary Market Profile of Loan-Only Dividend Recaps and Other Refinancings Loan-only dividend-recaps and other refinancings replicate the same pattern of deterioration in risk/reward given consistently high leverage and declining compensation overall. However, leverage became more conservative in div-recaps in 2015 as the number of such transactions fell dramatically. In 2016, div-recaps saw a slight increase in median pricing, in line with more leveraged transactions, while other refinancings saw a decrease in median pricing, on the back of more conservative leverage levels. However, 2017 has been characterised by a surge in the number of recap/refinancing transactions. These transactions offered less compensation for around half a turn of incremental leverage. Debt Amounts, Margin, Tenor and Leverage by Period Median statistics No. Drawn amount (EURm) Div-Recaps Margin (bp) Tenor (years) Drawn debt at closing/ EBITDA Fully drawn debt/ EBITDA No. Drawn amount (EURm) Other Refinancings Margin (bp) Tenor (years) Drawn debt at closing/ EBITDA Fully drawn debt/ EBITDA Note: In the above statistics, fully drawn debt takes committed facilities such as revolver and capex facilities as fully drawn at closing of the transaction. Leverage ratios are based on a Fitch EBITDA which may differ from the reference EBITDA used in information memoranda and marketing materials. 20

22 Primary Market Profile of LBOs, SBOs, TBOs and Refis with Secured HY Structures with senior secured notes sitting alongside senior loans saw leverage peak in for leveraged buyouts. Since 2015, few leveraged buyouts have included senior secured notes together with senior loans. Leverage declined whilst pricing increased, as risk appetite for new HY-funded LBOs fell amid volatility prior to the ECB s Corporate Securities Purchase Programme. Refinancings in 2015 saw further increases in leverage and pricing pressure as borrowers took advantage of existing and price-taking investor bases. The supportive credit market conditions and corporate bond yields touching fresh, all-time lows contributed to new refinancing-driven HY issuance in Debt Amounts, Margin, Tenor and Leverage by Period Median statistics No. Drawn amount (EURm) LBO/SBO/TBO/QBO Margin (bp) Tenor (years) Drawn debt at closing/ EBITDA Fully drawn debt/ EBITDA No. Drawn amount (EURm) Margin (bp) Refinancings Tenor (years) Drawn debt at closing/ EBITDA Fully drawn debt/ EBITDA < < <5 n.m. n.m. n.m. n.m. n.m Note: In the above statistics, fully drawn debt takes committed facilities such as revolver and capex facilities as fully drawn at closing of the transaction. Leverage ratios are based on a Fitch EBITDA which may differ from the reference EBITDA used in information memoranda and marketing materials. 21

23 Primary Market Profile of LBOs, SBOs, TBOs and Refis with Secured + Unsecured HY Since , high-yield notes increasingly became an unsecured/subordinated instrument, helping borrowers increase financial leverage. The rise in senior leverage appetite from the term loan B market in 2016 contributed to active refinancing of legacy unsecured note issues into all senior loan structures. Senior secured note issuance since 2016 has remained concentrated in out of favour loan market sectors, such as retail and UK care homes. Debt Amounts, Margin, Tenor and Leverage by Period Median statistics No. Drawn amount (EURm) Margin (bp) Tenor (years) LBO/SBO/TBO/QBO Drawn debt at closing/ EBITDA Fully drawn debt/ EBITDA No. Drawn amount (EURm) Margin (bp) Tenor (years) Drawn debt at closing/ EBITDA Refinancings Fully drawn debt/ EBITDA Senior Sec Unsecured Total Debt Senior Sec. 8 1, n.m. n.m. n.m. n.m. n.m. n.m. Unsecured n.m. n.m. n.m. n.m. n.m. n.m. Total Debt n.m. n.m Senior Sec. <5 1, Unsecured < Total Debt Note: n.m. = not meaningful Adding up the senior secured leverage and unsecured leverage ratios does not match the total debt to EBITDA ratio. This is due to median calculations. In the above statistics, fully drawn debt takes committed facilities such as revolver and capex facilities as fully drawn at closing of the transaction. Leverage ratios are based on a Fitch EBITDA which may differ from the reference EBITDA used in information memoranda and marketing materials. 22

24 Primary Market Impact of 18 Months Refinancing Activity (2Q16-4Q17) Fitch recorded 63 transactions undertaking refinancings (of which 16 dividend recaps) over the past 18 months. Median total gross leverage has remained stable for refinancings overall, however it has increased by around half a turn of EBITDA for dividend recaps specifically. Dividend recaps senior leverage also increased as senior secured debt extensions replaced junior debt such as second lien. Median pricing decreased by around 75bp. This led to an improvement in EBITDA/cash interest metrics, even for dividend recaps. The higher senior leverage translates into lower recovery expectations for senior secured lenders. Dividend recaps in particular generate no accretive value from the additional debt. The median credit opinion for refinancings remains b* due to improving business performance, stable leverage and a slight improvement in coverage metrics. However, for dividend recaps, the median credit opinion has fallen to b-* from b*, primarily due to higher leverage and extended de-leveraging paths. Impact of Refinancing Activity On Credit Metrics of 63 Transactions in Fitch s Portfolio Median metrics Pre- Refinancing Post- Refinancing Of which Dividend Recaps Pre-Dividend Recap Post-Dividend Recap Number of transactions Drawn amount at issuance (EURm) Margin at issuance (bp) Tenor at issuance (years) Drawn debt at closing/ebitda (x) Senior gross debt/ebitda (x) Total gross debt/ebitda (x) EBITDA/cash interest (x) Free cash flow margin in year 1* 1.3% 1.6% % Fitch-expected senior secured recovery rate Average credit opinion at issuance b* b* b* b-* * Fitch s forecasts 23

25 Primary Market Covenant-Lite and Loose Structures Covenant-lite/loose structures have been prevalent in new issuance since Covenant protection is usually reserved for the revolving credit facility in the form of a springing covenant once drawn above a certain level. Less than 1 of the 2016 transactions in our portfolio had a full set of covenants and in 2017, only 4% offered a full set of covenants. Such structures applied primarily in transactions where debt exceeds EUR500m and predominantly among credits in untested or challenged sectors and generally at the lower end of the b IDCO category. TBOs/QBOs borrowers took advantage of increased risk appetite over time, primary market benchmarks and investor familiarity with the issuer to remove financial covenants. Covenant Lite-Loose Issuers ( ) Debt committed at Issuance (EUR) >500m 51% <200m 12% Evolution of Cov-Lite Issuance ( ) As % of total number of deals (60) 2014 (136) Full set Lite Loose 2015 (90) Between 200m and 500m 37% 2016 (81) 2017 (112) Covenant Lite-Loose Issuers ( ) Credit Quality b-* 48% ccc* 1% bb+* bb* 1% bb-* 3% b+* 4% b* 43% Cov-Lite Issuance by Type of Transaction ( ) As % of total number of deals LBO (120) SBO (53) Full set Lite Loose TBO/QBO (31) Div-recap (74) Other recaps (172) 24

26 Primary Market Covenant-Lite and Loose Structures in Healthcare and Pharma Health-care and pharma credits have been large issuers of covenant-lite and loose structures since Relative to the broader portfolio, cov-lite and loose structures have proven more popular with borrowers with debt below EUR500m in this sector. The structure allows sponsors to maintain high leverage with excess cash to be reinvested for future growth or acquisitions. Health-care and pharma is a good example of a sector where first-time LBOs with untested or niche business models offer covenant protection that subsequently disappears in recycled transactions. Covenant Lite-Loose Issuers ( ) Debt Committed at Issuance (EUR) Healthcare & Pharma >500m 45% <200m 16% Between 200m and 500m 39% Covenant Lite-Loose Issuers ( ) Credit Quality Healthcare & Pharma b-* 46% b+* 2% b* 52% Evolution of Cov-Lite Issuance ( ) As % of total number of deals Healthcare & Pharma Cov-Lite Issuance by Type of Transaction ( ) As % of total number of deals Healthcare & Pharma Full set Lite Loose Full set Lite Loose (8) 2014 (26) 2015 (6) 2016 (12) 2017 (12) LBO (14) SBO (7) TBO/QBO (10) Div-recap (11) Other recaps (20) 25

27 Primary Market Covenant-Lite and Loose Structures in Industrials While Industrials borrowers have historically offered more covenant protection than their peers in other sectors due to business cyclicality and capex requirements, a majority of them have still benefited from high sponsor demand to remove covenants in documentation and the trend remained clear in 2016 and Covenant Lite-Loose Issuers ( ) Debt Committed at Issuance (EUR) Industrials >500m 53% <200m 7% Between 200m and 500m Covenant Lite-Loose Issuers ( ) Credit Quality Industrials) b-* 5 ccc* 1% bb-* 4% b+* 6% b* 39% Evolution of Cov-Lite Issuance ( ) As % of total number of deals Industrials Cov-Lite Issuance by Type of Transaction ( ) As % of total number of deals Industrials Full set Lite Loose Full set Lite Loose (9) 2014 (30) 2015 (22) 2016 (15) 2017 (22) LBO (20) SBO (13) TBO/QBO (8) Div-recap (15) Other recaps (32) 26

28 Primary Market Covenant-Lite and Loose Structures in Business Services In line with the broader portfolio, the covenant-lite trend in the business services sector is equally split between above EUR500m and below EUR500m deals. Not a single business services transaction had a full set of covenants in In 2017, only one issuer had, in the UK. Covenant Lite-Loose Issuers ( ) Debt Committed at Issuance (EUR) Business Serv. >500m 49% <200m 17% Covenant Lite-Loose Issuers ( ) Credit Quality Business Services b-* 41% bb-* 5% b+* 8% Between 200m and 500m 34% b* 46% Evolution of Cov-Lite Issuance ( ) As % of total number of deals Business Services Cov-Lite Issuance by Type of Transaction ( ) As % of total number of deals Business Services Full set Lite Loose Full set Lite Loose (10) 2014 (13) 2015 (14) 2016 (12) 2017 (25) LBO (18) SBO (12) TBO/QBO (2) Div-Recap (15) Other recaps (25) 27

29 Primary Market Covenant-Lite and Loose Structures in Retail, Lodging & Restaurants After benefiting from looser covenants in 2014, retail, lodging and restaurant issuers faced tighter terms in 2015 as more full sets of covenants returned given higher perceived risk in the sector and some credit underperformance, also evidenced by a higher representation of b-* IDCOs than other sectors in the broader portfolio. However, lack of covenant protection has become a standard feature of the market. In 2017 there was only one issuance with a full set of covenants, in France. Covenant Lite-Loose Issuers ( ) Debt Committed at Issuance (EUR) Retail, Lodging & Restaurants <200m 12% >500m 62% Between 200m and 500m 26% Covenant Lite-Loose Issuers ( ) Credit Quality Retail, Lodging & Restaurants b-* 66% ccc* 3% b+* 3% b* 28% Evolution of Cov-Lite Issuance ( ) As % of total number of deals Retail, Lodging & Restaurants Full set Lite Loose Cov-Lite Issuance by Type of Transaction ( ) As % of total number of deals Retail, Lodging & Restaurants Full set Lite Loose (8) 2014 (20) 2015 (12) 2016 (12) 2017 (23) LBO (13) SBO (8) TBO/QBO (1) Div-Recap (12) Other recaps (34) 28

30 Primary Market Covenant-Lite and Loose Structures in the UK Covenant-lite/loose structures for UK issuers broadly replicate the trend observed in the portfolio as a whole. Covenant Lite-Loose Issuers ( ) Debt Committed at Issuance (EUR) United Kingdom <200m 16% Covenant Lite-Loose Issuers ( ) Credit Quality United Kingdom cc* 1% bb+* bb* 1% 1% bb-* 5% b+* 4% >500m 53% Between 200m and 500m 31% b-* 49% b* 39% Evolution of Cov-Lite Issuance ( ) As % of total number of deals United Kingdom Cov-Lite Issuance by Type of Transaction ( ) As % of total number of deals United Kingdom Full set Lite Loose Full set Lite Loose (16) 2014 (33) 2015 (24) 2016 (14) 2017 (28) LBO (32) SBO (13) TBO/QBO (6) Div-recap (15) Other recaps (43) 29

31 Primary Market Covenant-Lite and Loose Structures in France In contrast to the broader portfolio, covenantlite/loose structures in France apply mainly to issuers with debt below EUR500m. Covenant Lite-Loose Issuers ( ) Debt Committed at Issuance (EUR) France <200m 19% Covenant Lite-Loose Issuers ( ) Credit Quality France bb* 1% bb-* 4% b+* 4% >500m 43% b-* 49% b* 42% Between 200m and 500m 38% Evolution of Cov-Lite Issuance ( ) As % of total number of deals France Cov-Lite Issuance by Type of Transaction ( ) As % of total number of deals France Full set Lite Loose Full set Lite Loose (6) 2014 (36) 2015 (17) 2016 (22) 2017 (27) LBO (17) SBO (14) TBO/QBO (12) Div-Recap (21) Other recaps (36) 30

32 Primary Market Covenant-Lite and Loose Structures in Germany Covenant-lite/loose structures in Germany apply to a greater extent to large transactions than in France or the UK. A higher proportion has a b-* or b* CO. Covenant Lite-Loose Issuers ( ) Debt Committed at Issuance (EUR) Germany <200m 5% Covenant Lite-Loose Issuers ( ) Credit Quality Germany ccc* 2% bb-* 3% b+* 1% >500m 63% Between 200m and 500m 32% b-* 52% b* 42% Evolution of Cov-Lite Issuance ( ) As % of total number of deals Germany Cov-Lite Issuance by Type of Transaction ( ) As % of total number of deals Germany Full set Lite Loose Full set Lite Loose (15) 2014 (26) 2015 (19) 2016 (11) 2017 (18) LBO (24) SBO (9) TBO/QBO (8) Div-Recap (13) Other recaps (31) 31

33 Primary Market Covenant-Lite and Loose Structures with Debt Below EUR500m Around 52% of small deals (below EUR200m debt) completed between 2013 and 2017 featured a full set of covenants. Borrowers with debt below EUR200m tend to be more vulnerable to deteriorating market or operating conditions. They are also often financed by a club of banks where documentation tends to include a customary covenant package. However, such deals have increasingly carried covenant-lite or loose structures replicating the broader trend of the market. In 2017, Fitch rated three unitranche/direct lending transactions below EUR200m in debt with a full set of covenants. Medium-sized borrowers with debt between EUR200m and EUR500m have increasingly adopted covenant-lite structures as well, across a variety of transaction types as covenant-lite documentation spread to become the norm in Europe from 2014 onwards. Evolution of Cov-Lite Issuance ( ) As % of total number of deals Debt Committed Below EUR200m (22) 2014 (24) Full set Lite Loose 2015 (20) 2016 (10) 2017 (16) Evolution of Cov-Lite Issuance ( ) As % of total number of deals Debt committed at Issuance between EUR200m and 500m Full set Lite Loose Cov-Lite Issuance by Type of Transaction ( ) As % of total number of deals Debt Committed Below EUR200m LBO (31) SBO (10) Full set Lite Loose TBO/QBO (2) Div-recap (16) Other recaps (26) Cov-Lite Issuance by Type of Transaction ( ) As % of total number of deals - Debt committed at Issuance between EUR200m and 500m Full set Lite Loose (23) 2014 (55) 2015 (31) 2016 (29) 2017 (41) LBO (44) SBO (22) TBO/QBO (16) Div-recap (28) Other recaps (59) 32

34 Primary Market Covenant-Lite and Loose Structures with Debt Above EUR500m The covenant-lite and loose trend has been driven by larger transactions. Almost all large transactions observed by Fitch in 2016 and 2017 were covenant-lite or loose. Certain large borrowers are well known by credit investors and perceived as less risky than smaller issuers, thereby offering less protection to lenders. Large borrowers have also been active in cross-border transactions that attract US institutional investors accustomed to covenant-lite documentation. Evolution of Cov-Lite Issuance ( ) As % of total number of deals Debt committed at issuance above 500m Full set Lite Loose (15) 2014 (56) 2015 (39) 2016 (41) 2017 (54) Cov-Lite Issuance by Type of Transaction ( ) As % of total number of deals Debt committed at issuance above 500m Full set Lite Loose LBO (44) SBO (21) TBO/QBO (13) Div-recap (30) Other recaps (86) 33

35 Primary Market Loan Documentation English law is considered the most robust and reliable among cross-border bank and non-bank leveraged loan investors. Therefore, the proportion of European leveraged loans agreements governed by English law has been rising since the global financial crisis. However, a number of European loans have actually been governed by New York law as US-style features entered loan documentation in larger European deals from In the UK, the Scheme of Arrangement has developed as the pre-insolvency forum of choice for creditor-driven restructurings. Non-UK credits generally need English law loan contracts and inter-creditor agreements to shift jurisdiction under EU COMI (Centre Of Main Interest) directives. Governing Law in European Loan Documentation As % of total number of deals COMI of Borrowers Using English Law Documentation As % of total number of issuers using English law loan documentation English Local New York UK Non-UK (28) 2011 (44) 2012 (37) 2013 (89) 2014 (135) 2015 (89) 2016 (79) 2017 (118) 2010 (12) 2011 (30) 2012 (26) 2013 (56) 2014 (100) 2015 (67) 2016 (67) 2017 (98) 34

36 Primary Market Unitranche Unitranche financings group a senior loan and a second lien loan into one single tranche with a blended interest rate. This enables borrowers at the smaller end of the market (debt committed below EUR200m) to raise higher leverage than would otherwise be available through an all-senior loan financing traditionally provided by bank investors. Unitranche borrowers in Fitch s portfolio have a median EBITDA of EUR12m compared to around EUR30m for the broadly syndicated deals with debt below EUR200m. Total Debt Multiple and EBITDA at Closing (Median) (EURm) Leverage (RHS) EBITDA (LHS) (x) EUR12m EBITDA Broadly Syndicated < EUR200m Unitrancheᵃ < EUR200m Broadly Syndicated Between EUR200m and 500m 0 (a) 29 unitranche deals 35

37 2 Portfolio Quality 36

38 Portfolio Quality Credit Opinion (CO) Universe At a Glance Healthy refinancing and primary market issuance has skewed the vintage distribution in our portfolio towards As of December 2017, more than a half of the portfolio was related to refinancing and divrecap transactions. Portfolio Split By Vintage Primary market transactions and refinancings of legacy transactions Number of Transactions Portfolio Split by Geography Portfolio Split by Sector Portfolio Split by Type of Transaction Sweden 2% Belgium 2% Switzerland 3% Italy 6% Spain 7% Netherlands 11% Lux. 2% Other 6% Germany 16% United Kingdom 25% France & Media Telecoms 5% and Cable Energy, 5% Util.& Transp. 6% Gaming & Leisure 8% Food, Bev and Consumer Products 1 Broadcasting Healthcare & Pharma 11% Chemicals 5% Industrials 21% Business Services 14% Retail, Lodging & Restaurants 15% Other Refinancing Div-Recap 13% LBO 26% TBO/QBO 7% SBO 14% 37

39 Jun 07 Sep 07 Dec 07 Mar 08 Jun 08 Sep 08 Dec 08 Mar 09 Jun 09 Sep 09 Dec 09 Mar 10 Jun 10 Sep 10 Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13 Mar 14 Jun 14 Sep 14 Dec 14 Mar 15 Jun 15 Sep 15 Dec 15 Mar 16 Jun 16 Sep 16 Dec 16 Mar 17 Jun 17 Sep 17 Dec 17 Portfolio Quality Evolution of COs The proportion of b-* and below rated issuers increased above 5 in 2014 from in 2013 after a marked deterioration in underwriting standards and rising leverage in the first half of In 2017, b-* IDCOs have been more often upgraded than downgraded, which has led the proportion of b-* and below issuers to decline slightly to 45% as of December More than 85% of b* and b-* credits in our portfolio have been affirmed in 2017 supported by adequate balance sheet liquidity situations, satisfactory interest coverage and generally long-dated maturities offsetting high financial leverage. In our performing portfolio, b+* credits have seen the most rating transitions with nearly double the proportion of downgrades to upgrades. b+* credits are typically driven by sponsors re-leveraging the balance sheet or exiting via the equity market. Portfolio Credit Quality Entire Portfolio Evolution of Fitch Ratings' leveraged credit IDCOs LTM December 2017 Credit Opinion Transition Matrix (% in category) d* / rd* (LHS) ccc* & below (LHS) b-* (LHS) b* (LHS) b+* (LHS) bb-* & above (LHS) b-* /below (RHS) Frequency stable Frequency up Frequency down By number By debt amount By number By debt amount By number By debt amount Out of which frequency default By number By debt amount b+* 61% 52% 11% 34% 29% 14% b* 87% 89% 3% 6% 1 5% 1% b-* 87% 88% 11% 9% 2% 2% ccc* to c* 59% 41% 31% 36% 9% 23% 38