BMO Sponsor Finance Q Economic Review and Forward Outlook

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1 BMO Sponsor Finance Q Transaction Trends This issue of Transaction Trends includes data and commentary on relevant and interesting developments affecting middle-market leveraged finance and private equity in the second quarter of Through our extensive deal sourcing, we collected, reviewed and synthesized this data into what we believe is an accurate view of the middle market, which we define as businesses with EBITDA of less than $50 million. Economic Review and Forward Outlook While the U.S. economy slowed to a 1.2 percent annualized rate in the first quarter, there is optimism that it could improve. The Commerce Department s inability to account for shifting seasonal influences may have sliced a percentage point from growth, with the positive payback being spread over several quarters. Also, the first-quarter weakness was concentrated in personal consumption which has rebounded recently as well as in defense spending and inventories, which are likely to spring back. Importantly, business spending accelerated in the first quarter, a major about-face after last year s contraction. Residential construction also remained strong, with housing starts and sales at decade highs. Home prices continue to rise briskly (around 6 percent year over year), helping to drive construction and creating wealth. After stalling for years, new home ownership has finally showed signs of improving. Second-quarter GDP growth increased 2.6 percent, which was only 0.1 percent below expectations, and is expected to hold steady in the second half of the year. Consumer spending rebounded nicely in March and April, supported by rising income, wealth and credit. The best job prospects in 16 years have lifted consumer confidence to similar highs. Businesses will likely continue to unleash pent-up demand ahead of anticipated lighter taxation and looser regulatory burdens assuming the government doesn t wield its protectionist hammer. We believe a good portion of the president s tax-cut proposals will eventually pass Congress before mid-2018, after compromises are made to ease concerns about the budget deficit. The top personal and corporate tax brackets might decline less than currently proposed (to 35 and 15 percent, respectively), and tax reductions could be temporary to avoid increasing the deficit beyond the 10-year window permitted by Senate reconciliation rules. But most Republicans believe the reductions will spur economic growth, partially cushioning the budget, so they are likely to pass a pro-stimulus plan. Transaction Trends provides private equity sponsors with middle-market transaction information and insights compiled by the BMO Sponsor Finance group information that helps sponsors better understand the current financing climate in the middle market. Continued

2 State Economic Performance BMO Capital Markets State Economic Scorecard shows continued relative strength in the West, led by Utah, Oregon and Colorado. Washington also boasts a top quartile ranking, while California continues to handily outperform the national average on a number of metrics. Most importantly, job growth in this part of the country is strong (Utah, for example, saw payrolls growth more than 3 percent year over year in the second quarter). Though most Midwest states continue to lag, they stand poised to benefit from a less-sluggish business investment climate. Indeed, growth in the Midwest states is expected to improve from last year but remain slightly below 2 percent overall. The Southeast is another area of continued strength, led by Florida, where solid job growth is helping to support population growth in this region. Overall state economic performance State rankings are derived from the weighted average number of standard deviations away from the 50-state average, across four indicators in each of four categories: business conditions, labor market, housing market and state finances. Rankings are based on the latest full quarter of available data for each indicator at the time of publication. Publication is quarterly, usually upon the availability of state labor market indicators and the Philadelphia Fed s coincident index. If you have any questions on the economic environment and the topics above, please reach out to your respective BMO Sponsor Finance contact. Deal Flow: Are there still deals out there? M&A activity rebounded in the second quarter as continued economic prosperity, strong equity market conditions and positive selling conditions for both sponsors and business owners led to an increase in new LBO loan volume over the prior year. Enterprise values remain near or at historical highs, which has led sponsors to become more selective in their investment approach, relying on sector experience or operating professionals to gain an edge in competitive auction environments. However, the influx of new private equity funds and the maturation of existing funds have created an imbalance in the supply of new deals relative to market demand. The increasing amount of new lenders entering the middle market has helped create the same effect in the debt capital sector, further contributing to near-record leverage levels. Based on market feedback, sponsors and lending groups have both expressed concerns about both the quantity and quality of new opportunities through the first two quarters of Recent market chatter would suggest that deal flow is expected to increase in the latter half of the year as sponsors have reported that new books have finally met 2016 volumes, which should lead to continued improvement in LBO activity through the rest of BMO Sponsor Finance s deal flow statistics have been relatively consistent with the overall market. Below are some of the highlights: BMO Sponsor Finance has seen a 11 percent increase in overall auction opportunities through June 2017 compared to the prior year. Many of the gains over the prior year were captured in the second quarter as January and February saw the fewest amount of new deals. Our Healthcare team saw a huge rush of deals in 2016 and the trend continued in 2017, seeing a nearly 45 percent increase in new auction transactions compared to The activity was driven mostly by companies in various areas of practice management, such as dental and dermatology providers. New Food and Consumer opportunities increased slightly in 2017 with consistent movement across various subsectors, such as branded consumer products and services, as well as value-add food providers. This group has seen the biggest increase in the bakery and prepared dessert sectors. In line with broader M&A volume in the IT segment, our Technology and Services team saw deal flow increase almost 17 percent. Our Industrials group experienced a slight decline in overall volume but was buoyed by momentum in the industrial outsourced service and testing space. Transaction Trends 2

3 Leverage The broader middle market saw average leverage multiples remain near all-time highs in the second quarter. Despite further contractions in pricing, overall total leverage multiples grew, while ancillary terms and covenants proved to be increasingly borrower friendly. These trends mirrored the larger institutional market, which saw covenant-lite issuances reach its highest levels in the last year. More than 30 percent of new issuances in the broader middle market were in excess of 6.0x in the second quarter versus less than 10 percent in the prior year, demonstrating the appetite for quality assets in the market. BMO s Senior/Total Leverage multiple index, which encompasses dozens of proposed and closed transactions, averaged 5.3x EBITDA in the second quarter, which is a slight increase from previous quarters but still well below BMO s maximum leverage for financings, which again topped out at 6.5x EBITDA. The chart below displays the average leverage multiples for closed transactions within BMO s portfolio. The use of senior-only and unitranche facilities increased in the first and second quarters, leading to a slight dip in the average total leverage multiple but a rise in senior leverage. Some sponsors have been willing to forgo the last 0.25x to 0.50x of leverage in exchange for increased flexibility and a discount in the overall cost of capital. Senior/total leverage for all companies 6.0x 5.0x 4.0x 4.9X 5.3X 1.7X 5.2X 5.1X 5.2X 1.4X 5.2X 1.7X 1.4X 4.9X 5.4X 1.2X 4.9X 1.2X 3.0x 2.0x 3.4X 3.7X 3.4X 3.4X 3.6X 3.7X 3.6X 4.2X 3.7X 1.0x 0.0x Q4 13 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1-16 Q2-16 Q3-16 Q4-16 Q1-17 Q2-17 Senior Leverage Junior Leverage Transaction Trends 3

4 Pricing The broadly syndicated market saw a flattening in loan spreads with a slight decline in the middle-market segment in The continued flow of inbound funds from CLO issuances, which doubled in the second quarter, contributed to available dollars in the market and competitive pricing environment. Yields to maturity, however, have been impacted by the reduction in issuer discounts. There have been many instances of reverse flex as some loan premiums have moved above 100 in the more successful offerings. This is a dramatic change from early 2016 when a more volatile capital markets environment required the use of pricing flex in weaker credits. We have seen some of the institutional market s impact on the traditional middle market as yields have declined slightly, but we expect the overall quoted pricing in the market to remain steady. Increased competition from new lenders in the market as well as the numerous financing alternatives such as senior only, unitranche, etc. will likely make it more difficult to determine the market price for any given deal. The almost standard LIBOR floor of 1 percent still prevails in the market despite the underlying rate reaching as high as 1.2 percent in the second quarter. Some new issuers have included a higher LIBOR floor in term sheets to account for the change. We have not witnessed an overall market adjustment to the quoted stream rate to account for this changing dynamic, as the increasing rate is likely impacting the corresponding cost of funds for some of the new issuers in the industry. Senior/mezzanine pricing, spread over LIBOR 5.50% LIBOR + Spread 5.00% 4.50% 4.00% 4.9% 4.5% 4.5% 4.4% 4.4% 4.1% 4.5% 4.4% 4.7% 4.5% 4.6% 4.7% 4.7% 4.8% 5.1% 5.0% 5.1% Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3-15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q % Transaction Trends 4

5 Purchase Price Multiples Prior to the second quarter, the broader institutional market experienced two consecutive quarters of purchase price multiples falling below 9.0x as well as a corresponding decline in contributed equity. Despite the dip in overall enterprise values, purchase price levels remained near the upper end of historical ranges within the sponsor middle market. The increase in second-quarter M&A activity and the previously mentioned imbalance between equity dollars waiting to be invested versus mid-market businesses for sale, purchased multiples increased to the fourth-highest average level over the last five years. BMO has witnessed similar trends within the traditional middle market sector as the average purchase price for closed transactions reached a new five-year high. Equity as a percentage of the capital structure remained above 50 percent on average for the second quarter in a row. Despite the continued increase in available leverage in the market, sponsors are being forced to write larger equity checks to meet asking prices in the current seller s market. Purchase price multiples Purchase Price Multiple x 9.7x 9.8x 9.4x 8.8x 9.0x 8.9x 8.7x 8.2x 7.7x Q1 15 Q2 15 Q3-15 Q4 15 Q1-16 Q2-16 Q3-16 Q4-16 Q1-17 Q % 55% 50% 45% 40% 35% 30% 25% 20% Equity as Percentage of Cap Structure Purchase Price Multiple Equity as Percentage of Cap Structure Transaction Trends 5

6 About us Consistency, speed and surety of close are crucial when it comes to serving the needs of middle-market private equity firms. Whether it s providing capital for mergers and acquisitions, leveraged buyouts, recapitalizations or growth capital, BMO Sponsor Finance group works with you from initial review to ongoing portfolio management for reliable execution and follow-through with no handoffs. Let s connect Timothy Dana timothy.dana@bmo.com Alexander Geier alexander.geier@bmo.com Aleen Hartje aleen.hartje@bmo.com Stephen Isaacs Head of Sponsor Finance stephen.isaacs@bmo.com Jennifer Kloud jennifer.kloud@bmo.com Craig Munro craig.munro@bmo.com To sign up for current industry, economic, and business strategy content, visit our subscription center at bmoharris.com/subscribe The opinions, estimates and projections, if any, contained in Transaction Trends are those of BMO Sponsor Finance as of the date hereof, and are subject to change without notice. BMO Sponsor Finance endeavors to ensure that the contents herein have been compiled or derived from sources that it believes to be reliable and which it believes contain information and opinions which are accurate and complete. However, BMO Sponsor Finance makes no representation or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions which may be contained herein and accepts no liability whatsoever for any loss (whether direct or consequential) arising from any use of or reliance on this report or its contents. Information may be available to BMO Sponsor Finance and its affiliates which is not reflected herein. This report is for informational purposes only, is not investment advice and is not to be used as a basis for any investment decision. This report is not to be construed as an offer or solicitation to buy or sell any security. BMO Sponsor Finance is a brand name used by Bank of Montreal and its subsidiaries BMO Financial Group (8/17) bmosponsorfinance.com