BMO Harris Bank Sponsor Finance Q Leveraged lending guidelines take hold.

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1 BMO Harris Bank 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 first quarter of We collected this data through our deal sourcing and reviewed and synthesized it into what we believe is an accurate view of the middle market (which we define as businesses with EBITDA less than $50 million). In this issue we examine the effects leveraged lending guidelines are beginning to have on middle-market transactions. We also turn the spotlight on cost-containment deals in the healthcare sector, as well as an update on general market conditions. Leveraged lending guidelines take hold. Although the leveraged lending guidelines came out in early 2013, it took until the end of 2014 for them to take hold in the market. The large market (companies with greater than $50 million ) has been affected most as many large market deals had historically been completed with leverage in excess of 6x and most lead arrangers are regulated. In the middle market (companies with less than $50 million ), fewer deals have exceeded 6x leverage historically, and has had less of an impact on guidance. For those middle-market transactions that warrant and attract deep leverage, the pool of potential lenders is greater than in the large market as numerous nonbank lenders are active and sometimes willing to meet the leverage requirements. Evidence of the effect of the guidelines can be seen in average total leverage levels, which have dropped from high 5x in the summer of 2014 to mid 5x today. In the overall market, deals financed above 6x have dropped from more than 50 percent of the deals done in the third quarter of 2014 to less than 25 percent of the deals completed in the first quarter of Bulge bracket banks are feeling the effect of the guidelines even more as the Federal Reserve, Office of the Comptroller of the Currency and FDIC are now reviewing and providing feedback on every loan issued shortly after closing. The commentary includes regulators feedback on leverage, structure and covenant packages. In line with the market, when looking at the third-highest leverage level in LBOs completed by quarter by BMO (we chose the third highest to eliminate outliers in certain quarters), total leverage has peaked at 6x for the last eight quarters. (See chart on page 2.) Over the same time frame, senior leverage has crept up slightly to. Transaction Trends provides private equity sponsors with middle-market transaction information and insights compiled by the BMO Harris Sponsor Finance group information that helps sponsors better understand the current financing climate in the middle market. For past issues, visit: bmoharris.com/transactiontrends Continued

2 Third highest leveraged LBO 5.0x 5.8x 5.5x 5.5x 5.5x 4.9x 4.3x 4.3x 4.3x 4.6x 4.6x 2.0x 1.0x 0.0x All Senior Total Use of proceeds. In addition to the effect of leveraged lending guidelines, the market continues to be affected by a lack of strong and consistent deal flow. The volume of middle-market transactions in the first quarter has dropped to its lowest levels in several years. Estimates are that deal volume in the first quarter of 2015 was more than one-third off from the first quarter of We have also seen this trend in the number of new LBOs closed, which dropped by one-third from the first quarter of 2014 to the first quarter of Only 33 percent of the transactions completed by BMO Sponsor Finance in the first quarter of 2015 were for LBOs, while refinancings and dividend recaps accounted for 59 percent of the closed transactions. Refinancings remained high in the first quarter as sponsors took advantage of a slow market to adjust capital structures by refinancing higher-priced second lien and mezzanine debt or extending maturities. LBOs have failed to account for greater than 50 percent of the deals closed since the third quarter of Use of proceeds closed deals 100% 90% 80% 70% 60% 50% 30% 20% 0% 2% 3% 8% 8% 6% 23% % 21% 53% 25% 42% 2 21% 27% 2 17% 22% 18% 19% 23% 17% 25% 22% 17% 57% 2 42% 27% 28% 22% 25% 18% LBO Dividend Recap Refinance Add-On Acquisition Refinance/ Acquisition Amendment/ Restatement Transaction Trends 2

3 Purchase price multiples. Purchase price multiples dropped to below 9x in the first quarter of Continued choppy deal flow and inconsistent quality were the primary drivers behind the decrease. For the third consecutive quarter, all senior structures represented almost half of the deals that we closed and have often represented more than 50 percent of closed deals over the last three years. We re finding that many sponsors are opting for the senior stretch structure for ease of execution as there are fewer constituencies to work with in either a very active company or a distressed situation. Purchase price multiples Purchase Price Multiple x 9.3x 9.4x 8.7x 8.7x 8.6x 8.4x 8.1x 7.9x 7.7x 7.5x 7.3x 65% 60% 55% 50% 45% 30% 25% 20% Equity as Percentage of Cap Structure Purchase Price Multiple Equity as Percentage of Cap Structure Percent of closed LBOs with junior debt 100% 90% 80% 70% 60% 50% 30% 20% 0% 32% 48% 51% 47% 47% 46% 45% 55% 63% 67% 6 71% 68% 52% 49% 53% 53% 5 55% 45% 38% 36% 29% Senior/Junior All Senior Transaction Trends 3

4 Leverage trends. In a change from the trend last quarter, leverage for senior stretch transactions increased as the deal size increased during the first quarter of The story was slightly different, however, when looking at transactions with both senior and second lien or mezzanine debt. Total leverage increased from 4.9x for companies less than $15 million to 5.3x for companies with EBITDA between $15 million and $30 million. Surprisingly, total leverage for deals over $30 million was 5x. The lack of a clear trend is likely due to lighter deal volume coupled with the impact of regulatory scrutiny, offset by growing presence of nonbank lenders. One clear trend, however, is the pressure on total leverage versus senior leverage. Lenders are willing to go deeper on a senior basis while being more sensitive to the total leverage carried by borrowers. All-senior leverage 5.0x 2.0x 2.9x 3.3x 4.2x 4.1x 4.1x 1.0x 1.7x 0.0x Q2 12 Q3 12 Q4 12 Q3 13 Q4 13 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 <$15MM in EBITDA $15MM $30MM >$30MM in EBITDA All EBITDA Ranges Senior/total leverage 5.0x 2.0x 3.2x 1.4x 3.1x 1.6x 1.2x 3.2x 1.4x 1.3x 1.4x 1.3x 1.3x 1.4x 3.3x 1.4x 1.5x 1.4x 1.3x 1.5x 1.3x 3.5 x 1.4x 3.3x 1.4x 1.4x 1.6x 1.4x 1.7x 3.1x 1.5x 1.4x 1.5x 1.4x 1.5x 1.6x 3.3x 1.5x 3.3x 1.4x 1.5x 1.6x 1.5x 1.5x 1.7x 1.8x 1.7x 3.1x 1.5x 3.3x 1.5x 1.6x 1.6x 1.8x 3.1x 1.6x 1.4x 1.6x 1.0x 0.0x <$15MM <$15MM $15MM $30MM $15MM $30MM >$30MM >$30MM all EBITDA Ranges all EBITDA Ranges Transaction Trends 4

5 Pricing. The middle market took one quarter to catch up with the large market pricing trends. While pricing in the large market climbed in the fourth quarter of 2014, it remained flat in the middle market. The increase in the middle market came in the first quarter of 2015, where pricing rose by 25 to 50 basis points on new transactions. Interestingly, pricing for senior stretch deals was equal to senior/ mezzanine transactions in the first quarter, when there is typically a slight premium in pricing for senior stretch deals. Pricing is now at its highest level over the last two years, and the L+100 floor in the middle market continues to be proven out given the presence of nonbanks with a higher cost of capital. Pricing has not dipped below L+400 since Senior debt pricing all deals, spread over LIBOR 5.50% LIBOR + Spread 5.00% 4.50% 4.00% % 5.08% 5.20% 4.93% 4.92% 4.46% 4.49% 4.42% 4.52% 4.38% 4.47% % 4.57% % % 4.0 Q3 12 Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Senior/Mezzanine Pricing Senior Stretch Pricing Focus on cost-containment deals in healthcare. We ve reviewed a number of transactions related to cost containment within the healthcare industry 12 companies over the last two years. Cost containment remains a key area of interest for many sponsors pursuing strategies focused on improved care coordination, utilization management and provider contracting, as well as reducing overpayments and other waste. Businesses with the potential to contract with providers that can assume risk and manage outcomes across a population are especially in high demand. Our experience includes traditional managed care as well as specialty areas such as dual eligibles; workers compensation; behavioral, dental, wellness and disease management; pharmacy benefit managers; network/ppo management and third-party administration. Below are statistics on cost-containment transactions: Average revenue of $177.1 million and EBITDA of $22.6 million. EBITDA ranged from $10.5 million to $40.1 million. Average EBITDA margin of 19 percent with a wide range from 6 to 34 percent. Most cost containment businesses have EBITDA margins that are 20 to 35 percent. The 6 percent margin in the range is an outlier as this company is a risk-bearing entity. Only two of the transactions were change of control with the seller being a sponsor in each. The remaining transactions were for add-on acquisitions, refinances or dividend recaps. Cost containment businesses are often acquired by strategics, explaining only two change-of-control transactions in our sample. Notably eight of the 12 transactions proposed senior stretch structures vs. senior/mezzanine structures. Leverage over the two years averaged 4.8x for senior/mezzanine transactions and 3.3x for senior-only transactions. Leverage was lower on these transactions because only two of the 12 were change-of-control transactions. Cost containment deals tend to get higher leverage than other deals in the healthcare sector due to the stickiness/recurring nature of the contracts; strong industry tailwinds as health expenditures have grown at a 7.5 percent CAGR in the past 15 years vs. a CPI of 2.2 percent; the fact that there is no reimbursement risk and low capex; and minimal working capital needs. 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 Harris Bank s 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 stephen.isaacs@bmo.com Jennifer Kloud jennifer.kloud@bmo.com Craig Munro craig.munro@bmo.com The opinions, estimates and projections, if any, contained in Transaction Trends are those of BMO Harris Bank N.A. as of the date hereof, and are subject to change without notice. BMO Harris Bank 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 Harris Bank 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 Harris Bank 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. Banking products and services are subject to bank and credit approval. BMO Harris Bank N.A. Member FDIC BMO Financial Group (04/15) bmoharris.com/transactiontrends