SPP s Middle Market Leverage Cash Flow Market At A Glance Deal Component April 15 March 15 April 14

Transcription

1 Check out SPP online: Market Update April 215 SPP s Middle Market Leverage Cash Flow Market At A Glance Deal Component April 15 March 15 April 14 Cash Flow Senior Debt (x EBITDA) Total Debt Limit (x EBITDA) Senior Cash Flow Pricing Second Lien Pricing (Avg) <$7.5MM EBITDA 1.5x2.x >$1.MM EBITDA 2.x3.5x >$25.MM EBITDA x <$7.5MM EBITDA 3.x4.x >$1.MM EBITDA 3.75x4.5x >$25.MM EBITDA 4.x5.x L+2.%3.5% (bank) L+4.%6.% (nonbank) >$1.MM EBITDA L+6.%9.% floating >$25. MM EBITDA L+5.5%7.5% floating Subordinated Debt Pricing <$7.5MM EBITDA 12.%14.% >$1.MM EBITDA 11.%13.% >$2.MM EBITDA 1.%12.% Warrants limited to special situations; Second lien may buy down rate to ~9.%. Unitranche Pricing Libor Floors Mezzanine Opt. Prepayment Minimum Equity Contribution Recap Liquidity Story Receptivity Tone of the Market *Changes from last month in red <$7.5MM EBITDA L+8.%11.% >$1.MM EBITDA L+6.5%8.5% >$25. MM EBITDA L+6.%7.5% Potential for fixed rate with BDC or mezz lender. Most Unitranche lenders allow a small ABL facility outside of the loan. No Libor floor for most bank deals. In fact, some deals now contain Libor Discounts; 1.% for nonbank deals, second lien, and floatingrate unitranche. Though it varies with the lender, there are increasingly no noncall periods with a market norm of 3.% in year one, 2.% in year two, 1.% in year three, and par thereafter (SBICS at 15 in year one and then decline); for second lien unitranche, there are more aggressive prepayment schedules (12, 11, par). 25.%35.% total equity (including rollover); minimum 1.% new cash combined with rollover or seller notes. Focus continues to be more on aggregate credit metrics (Total Debt/EBITDA, etc.) than on the level of equity contribution. Promote to Independent Sponsors will differ but fall in the 5.%15.% range with or without a minimum return to common. The recent shakeup in the commercial banking world is having a materially adverse impact on bank funded recaps in excess of the 3.x by 4.x Fed leverage guidelines. There is no such limitation in the nonbank and unitranche communities. Sponsors looking to quickly recap after a purchase are best served by structuring their initial investment as common shares, combined with a preferred or subordinated tranche, and positioning a subsequent recap as a refinancing. A surplus of liquidity combined with a dearth of new deal flow has created a window to execute more challenging credit stories. A number of distressed funds have been created to take advantage of the drop in valuations in the energy sector with a specific focus on oil and gas service businesses but the anticipated inventory has not materialized to date. The sponsor community is getting accustomed to a less aggressive banking community (at least, with respect to highly leveraged credit scenarios) and the clear beneficiaries of the bank pullback are the nonbank commercial lenders and the unitranche providers. New nonbank lenders are emerging weekly; the most notable recent entrant is TIAACREF backed Churchill Asset Management, which could signal a concerted push into the leveraged markets by the major insurance companies. <$7.5MM EBITDA 1.5x2.x >$1.MM EBITDA 2.x3.5x >$25.MM EBITDA x <$7.5MM EBITDA 3.x4.x >$1.MM EBITDA 3.75x4.5x >$25.MM EBITDA 4.x5.x L+2.%3.5% (bank) L+4.%6.% (nonbank) >$1.MM EBITDA L+6.%9.% floating >$25. MM EBITDA L+5.5%7.5% floating <$7.5MM EBITDA 12.%14.% >$1.MM EBITDA 11.%13.% >$25.MM EBITDA 11.%12.% Warrants limited to special situations; Second lien may buy down rate to ~9.%. <$7.5MM EBITDA L+8.%11.% >$1.MM EBITDA L+6.5%8.5% >$25. MM EBITDA L+6.%7.5% Potential for fixed rate with BDC or mezz lender. Most Unitranche lenders allow a small ABL facility outside of the loan. No Libor floor for most bank deals. In fact, some deals now contain Libor Discounts; 1.% for nonbank deals, second lien, and floatingrate unitranche. Though it varies with the lender, there are increasingly no noncall periods with a market norm of 3.% in year one, 2.% in year two, 1.% in year three, and par thereafter (SBICS at 15 in year one and then decline); for second lien unitranche, there are more aggressive prepayment schedules (12, 11, par). 25.%35.% total equity (including rollover); minimum 1.% new cash combined with rollover or seller notes. Focus continues to be more on aggregate credit metrics (Total Debt/EBITDA, etc.) than on the level of equity contribution. Promote to Independent Sponsors will differ but fall in the 5.%15.% range with or without a minimum return to common. While recap liquidity is still favorable, it is not as good as it was at the beginning of the year, especially for issuers with no sponsor. The banks are clearly backing off recaps outside the 3/4 box. Some, but certainly not all, SBICs now are interpreting SBA regs to prohibit recap deals as well. Lenders are becoming increasingly sensitive to trends. Typically, lenders are open to EBITDA adjustments if profitability is improving. If there is credit deterioration, those same adjustments are nonstarters. Unitranche lenders are generally the most competitive constituency of storied deals. The market seems to be in transition as we end Q1, and increasingly becoming barbelllike (i.e. the low leverage deals inside the 3/4 box are being priced at all time lows see Senior Cash Flow Pricing above). In some competitive deals, banks are offering Libor discounts to entice issuers. However, as leverage creeps outside that 3/4 range, pricing and terms become increasingly less competitive. Highly leveraged deals are still getting done, even in excess of 5.x leverage, but at a hefty premium. <$7.5MM EBITDA 1.5x2.5x >$1.MM EBITDA 2.x3.5x >$25.MM EBITDA 3.4.x <$7.5MM EBITDA 3.x4.25x >$1.MM EBITDA 3.75x5.x >$25.MM EBITDA 4.x5.75x L+3.%4.5% (bank) L+4.5%6.5% (nonbank) >$1.MM EBITDA L+6.%9.% floating <$7.5MM EBITDA 12.%14.% >$1.MM EBITDA 11.%13.% >$25.MM EBITDA 11.%12.% Warrants limited to special situations; Second lien may buy down rate to ~9.%. (1.% floor) >$1.MM EBITDA L+6.%8.% floating (1.% floor) Definite signs of rate compression evident; Potential for fixed rate with BDC or mezz lender. No Libor floor for most bank deals; 1.% for nonbank deals, second lien, and floating rate unitranche. Though still subject to negotiation, there are increasingly no noncall periods with a market norm of 3.% in year one, 2.% in year two, and 1.% in year three par thereafter; more aggressive prepayment for second lien and unitranche (12, 11, par). 25.%35.% total equity (including rollover); minimum 1.% new cash combined with rollover or seller notes. Greater focus recently if on general deal metrics than on level of new equity going in. Nonbank commercial lenders, finance companies, and BDCs are providing the greatest liquidity on recaps as the commercial banks continue to take a harder credit perspective. Story receptivity remains strong, though primarily among nonbank commercial lenders and onestops in cash flow deals. Banks are still quite aggressive on the more challenging credits for ABL deals with good asset coverage and at least a 1.15X fixed charge coverage (really frowning in term facilities with air ball exposure). Deal flow continues to outpace 213 as M&A activity steps up combined with corporate issuers seeking expansion (capex, acquisitions, and general growth initiatives). Many commercial banks remain in a state of flux as enhanced capital adequacy guidelines are working their way through credit committees to actual underwriting policies.

2 My Grandma still tells me Enough is enough Life ain't a game, son, it s time to grow up Maybe next year I won't be singing the blues Maybe next year I'll start telling the truth Maybe next year I won't stay drunk all the time Maybe next year I'll have a little more peace of mind Maybe next year I won't be so sad when I'm alone 12Month Percent Change Maybe next year, I'll start acting my age Turn a new leaf over my wicked ways Get a real job and start pulling my weight Only 365 days 'til I change my ways Maybe next year CPI and Core CPI Shortly thereafter, Stanley Fischer, Vice Chair of the Fed, went on record to the Economic Club of New York to suggest that a liftoff was more likely in December, noting that An increase in the target federal funds range likely will be warranted before the end of the year. Liftoff should occur when the expected return from raising the interest rate outweighs the expected costs of doing so. To most, that seemed consistent with the most recent spate of increasingly contradictory economic releases. On the one hand, there is a 5.5% unemployment rate and 3.3 million jobs created in the last 12 months; and on the other hand, there are continued declines in manufacturing, retail sales, and GDP growth with concerns that Q1 GDP could be less than 1.%. Then, on April 7th, Minneapolis Fed President Narayana Kocherlakota stated, The central bank should consider waiting until the second half of 216 to raise rates, and only increase them gradually towards 2.% as we near the end of 217. He went on to say that the Fed should be extraordinarily patient and that raising the fed funds rate in 215 would be a mistake. What happened? The headline release that prompted the walkback in liftoff expectations was the March unemployment report, which showed that nonfarm payrolls increased only 126, (additionally, the January and February reports were revised downward by 69, jobs). While the unemployment rate remained at 5.5%, the Participation Rate dropped to 62.7% (from 62.8%, which marks the lowest rate since the 197 s). The recent employment data can t be too much of a surprise to the Fed; the handwriting has been on the wall since late last year. After a robust GDP growth of 5.% in Q3 214 (following a healthy 4.6% in Q2), Q4 GDP was finally revised to 2.2%, with even worse Q1 215 expectations. Durable goods sales and manufacturing reports have all been more anemic in 215. Even retail sales have been weak, notwithstanding the fact that consumers disposable incomes have been enhanced by lower fuel prices. Higher interest rates, while inevitable in a growing economy would only fuel an already supercharged U.S. dollar and make Americanmade goods more expensive to European consumers. Millions of Dollars With the anticipated removal of the word patient from last month s forward guidance on interest rates, conventional wisdom was that a liftoff from the current near zero interest rate policy was inevitable in 215 (conceivably as early as June). However, in her post FOMC meeting press conference, Chairwoman Yellen clarified that Just because we removed the word patient from the statement doesn t mean we are going to be impatient. Core CPI Retail Sales 195, 19, 185, 18, 175, 17, 165, 16, 155, 15, 145, 185,813 Nonfarm Payroll Employment (Seasonally Adjusted) Thousands of Employees Maybe Next Year? CPI Maybe next year Maybe Next Year Corey Smith 4.5% 4.% 3.5% 3.% 2.5% 2.% 1.5% 1.%.5%.%.5% 144, 142, 14, 138, 136, 134, 132, 13, 128, 126, 124, 122, 141,183 Labor Force Participation Rate 65.5% 65.% 64.5% 64.% 63.5% 63.% 62.5% 62.% 61.5% 62.7%

3 Index (29 = ) Below is a summary of the last month s economic highlights: Consumer Confidence/Retail Sales: Consumer spending accounts for approximately 68.% of GDP and accordingly, trends in retail sales will likely provide guidance to future GDP forecasts. According to the February Personal Income and Outlays Report (which tracks personal consumption expenditures, PCE ), consumer spending rose a negligible.1% in February (not adjusted for inflation). While the lackluster spending can be somewhat attributed to the severe weather conditions that gripped much of the country, the report is particularly disturbing because the expectation was that lower gasoline prices would generate increased spending. Adjusted for inflation, consumer spending actually decreased.1% in February, which provided for the weakest report since April 214. The softness of the February report prompted many economists to lower GDP expectations for Q Personal consumption bad news has been tempered, however, by two recent releases that indicate that the American consumer is feeling better about the economy. The latest Bloomberg Consumer Comfort Index almost increased last week to an eight year high as Americans viewed the U.S. economy in a more favorable light. The index climbed to 47.9 by April 5 th (the highest level since May 27). Giving further credence to a slight strengthening in consumer spending, the most recent Retail Sales release showed that sales rebounded.9% in March after dropping.5% in February. Although it is weaker than the market consensus (which was a 1.1% gain), it is still heading in the right direction. Excluding auto, sales gained.4% following no change in February. The release suggests that the earlier data may have been more influenced by weather than a systemic weakening in aggregate economic activity. Inflation: Inflation continues to trend well below the Fed s 2.% annual benchmark. The PCE price index (a Fed watch number and key metric in determining monetary policy) increased.2% in February as gasoline increased from its prior lows (.3% up from this time last year). Excluding the volatile food and energy components, the price index inched up a scant.1% for the month and is up 1.4% for the latest 12 months. The latest consumer price index ( CPI ) release confirmed the PCE data, as consumer prices rose.2% for the month (both with and without food and energy), and 1.7% annually. If there is a liftoff in 215, it won t be a function of inflationary pressure in the economy. To the contrary, the most recent data would suggest a delay in any forward guidance amendment to a 216 time frame. GDP: Expectations for GDP growth in Q1 215 range from weak to practically nonexistent. For Q4 214, the expectation had been for a revision up to 2.4% annualized growth, but it instead settled at 2.2%. The deceleration of GDP from Q3 214 (which peaked at 5.%) is expected to continue into 215 (current estimates range from.1% to about 1.%, as previously mentioned). As of April 8 th, The Atlanta Fed GDP Tracker is currently forecasting U.S. Q1 GDP growth near zero. If recent history is any guide, Q1 215 shares many of the severe weather conditions that characterized Q1 214, and resulted in a 2.4% contraction of the economy. Consumer Confidence Index Source: Conference Board % 4.% 2.%.% 2.% 4.% 6.% 8.% 1.% Personal Consumption Expenditures Quarterly Change in Real GDP ISM Manufacturing and NonManufacturing Indices 2.2% Manufacturing NonManufacturing 2 1 Manufacturing: The ISM manufacturing index for March came in at 51.5, the sixth consecutive month of decline from a high of 59.7 in May 214. Interestingly, the employment component of the index came in at 5. This confirms the weakness of the March nonfarm payroll report, but also illustrates a troubling trend: as many firms are reducing payrolls as increasing them; or, stated a different way, there is zero net hiring. Another particularly worrying metric in the

4 Index (Jan. 2 = ) Thousands of Units Thousands of Units March ISM is the new orders component, which fell seventenths to 51.8, its lowest rating since April 213. The near term prognosis is not much better. The dollar continues to strengthen (it has risen more than 2.% against other major currencies in the last year), which positively correlates to weakening foreign demand and greater headwinds for both GDP and continued economic recovery. Employment: The headline employment numbers for March were uniformly pretty ugly. The expectation for an approximately 25, increase in nonfarm payrolls only came in at 126, new jobs (of which, only 51, were fulltime positions), which is the weakest report since December of 213. To add insult to injury, the original tallies for January and February were revised downward by 69,. Accordingly, that drove the monthly job creation average for Q1 215 to 197, a month, down quite precipitously from the 324, Q4 214 average new jobs. Though the unemployment rate remained at 5.5%, the labor participation rate fell to 62.7%. One small bright spot has been average hourly earnings, which increased by.3% in March (up from.1% in February) and resulted in an average yearonyear gain of 2.1% (about.5% ahead of inflation, but essentially flat to the average 2.% annual wage gains over the last few years). The report certainly muted the chorus calling for rate increases as early as June and suggested that any increases in forward guidance would be a 216 event. One decidedly positive development was that U.S. job openings increased in February by 168, to 5.13 million, the highest total in 14 years (but job openings are not hirings ). The increase provides further support for the growing skills gap in the economy where the demand for jobs exists, but the skills in the workforce simply can t supply them. 12.% 1.% 8.% 6.% 4.% 2.%.% 6, 5, 4, 3, 2, 1, Unemployment Rate Existing Home Sales 5.5% 4,88 Housing: Existing home sales jumped 1.2% in February to a 4.88 million annual pace (up from January s 4.82 million), but it is still a relatively lackluster metric. 215 has put up two of the weakest months of existing home sales since April 214. Continued sluggishness in the housing sector will likely contribute to a bearish approach by the Fed to raise rates and further inhibit home sales. However, low housing inventory has resulted in a firming trend in home prices. The latest reports show a jump of 2.5% in the median home price (up to $22,6), a 7.5% gain from last year New One Family Homes Sold 539 Private Market Update Notes Market metrics for April are almost uniformly consistent with March, albeit there seems to be further tightening in the mezzanine market, especially for larger ($2.+ million in LTM EBITDA) issuers. Accordingly, we are bringing down our subordinated note pricing to 1.%12.% for larger middle market issuers. Although conditions remain exceedingly liquid and are characterized by intense competition across all levels of the capital structure, the mezzanine asset class, in particular, is under tremendous pressure. First, the traditional subordinated debt market is facing competition from a variety of competing mezzaninelike capital instruments (mainly second lien notes and unitranche structures) that offer express or structural subordination, complement a traditional asset based, low cost (L+2.5%) revolving credit facility, and generally are priced at a discount to typical subordinated notes by a magnitude of 3.%5.%. Additionally, these instruments often require little or no amortization with generous prepayment options, and they generally contain covenant packages that are consistent with subordinated notes. The number of different lending constituencies offering mezzanine structures is growing every week and includes BDCs, SBICs, Credit Opportunity Funds, Traditional mezzanine LPs, and even a number of nonbank senior commercial lenders. In short, the list contains just about everyone but the senior commercial banks CaseShiller 2City Home Price Index 175.8

5 Of course, what is painful for one side of the market translates into opportunity for the other. Low pricing benefits issuers in need of mezzanine capital, and all terms and conditions are subject to increased competition (including covenant structure, prepayment provisions, and importantly, intercreditor provisions). Additionally, as competition for mezzanine assets continues to intensify, more marginal, storied, or challenged credits, and smaller issuers (sub $1. million EBITDA) are receiving greater attention and competitive terms. Lower middle market recapitalizations (with or without institutional sponsorship) are being priced on par with large, wellcapitalized issuers. SPP Tracked Market Activity March was a slow month, in terms of total deal counts and exit activity, which tallied up to 138 and 32, respectively. The deal count total was the second lowest and the total exit activity was the lowest during the last twelve months (however, deal and exit March LTM totals are considerably higher in 215 than previous years due to a plethora of activity that continued from the middle to end of last year). Despite a drop in exits under $5 million, the total deals under $5 million remaining at comparable levels to previous months. This can be attributed, in part, to sellers dissatisfaction with current valuations, unattractive exit opportunities, and potentially, a less aggressive banking community. Apparently, these declining trends are not exclusively limited to the middle market. According to a recent Financial Times article, the volume of private equity takeovers was half the level of a year ago and the lowest since 29. Additionally, Bloomberg recently blamed a lack of PEbacked acquisitions on high prices and increased regulatory scrutiny on what is deemed excessive risk taking. Please feel free to call any of the professionals at SPP Capital to discuss a particular financing need, amendment or restructuring situation, or just to get a little more color on the market. You don t need an imminent or marketready deal to call us. Our hope is that you use SPP as your goto resource for any information, analysis, and review of potential transactions. Stefan Shaffer Managing Partner (212) March Deal Count March 213 March 214 March 215 March Exit Activity March 213 March 214 March 215 March LTM Deal Count 3, 2,5 2, 1,5 1, 5 Mar LTM 213 Mar LTM 214 Mar LTM 215 Total Deals <5M <25M Total Exits <5M <25M Total Deals <5M <25M 1,4 March LTM Exit Activity 1,2 1, Total Exits <5M <25M 2 DISCLAIMER: The "SPP Leveraged Cash Flow Market AtAGlance" and supporting commentary is derived by the anecdotal experience of SPP Capital Partners, LLC, its specific transactions, discussion with issuers, lenders and investors consistent with its standard operating practices. Any empirical data specifically derived by third parties, or intellectual property or opinions of third parties are expressly attributed when utilized. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. All data, facts, tables or analyses provided by Governmental or other regulatory bodies are deemed to be in the public domain and not otherwise expressly attributed herein. SPP Capital Partners, LLC is a member of FINRA and SIPC. This information represents the opinion of SPP Capital and is not intended to be a forecast of future events, a guarantee of future results or investment advice. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Mar LTM 213 Mar LTM 214 Mar LTM 215 To unsubscribe to this , please click here. To request to be added to our distribution list, please click here

6 7.x 6.x 5.x 4.x 3.x 2.x 1.x.x SUPPORTING DATA Historical Senior Debt Cash Flow (x EBITDA) 7.x 6.x 5.x 4.x 3.x 2.x 1.x.x Historical Total Debt Limit (x EBITDA) < $7.5MM EBITDA > $1MM EBITDA > $25MM EBITDA Historical Senior Cash Flow Pricing (Bank) 7 bps 6 bps 5 bps 4 bps 3 bps 2 bps bps bps < $7.5MM EBITDA > $1MM EBITDA > $25MM EBITDA Historical Senior Cash Flow Pricing (NonBank) 7 bps 6 bps 5 bps 4 bps 3 bps 2 bps bps bps Bank Lower Bound Bank Upper Bound NonBank Lower Bound NonBank Upper Bound Historical Second Lien Pricing 18% 15% 12% 9% 6% 3% % Historical Subordinated Debt Pricing 15% 12% 9% 6% 3% % Lower Bound LIBOR Floor Lower Bound Upper Bound LIBOR Floor Upper Bound <$7.5MM EBITDA >$1MM EBITDA > $2MM EBITDA Historical Minimum Equity Contribution 6% 5% 4% 3% 2% 1% % Secondary High Yield Pricing Secondary High Yield Pricing SPP Value Inflection Point Lower Bound Upper Bound Source: Piper Jaffray Debt Capital Markets Update