Q3 2016 Leveraged Finance Market Resurgence Continues In This Report Issuer-friendly conditions continue Institutional market surges Leveraged Finance Rise of the unitranche Active high-yield market amid strong investor demand
w EXECUTIVE SUMMARY Leveraged Finance Market Resurgence Continues The third quarter built on the second quarter s improved tone, resulting in the strongest quarterly volume since second quarter 2014 and improved pricing and terms for issuers. The midmarket leveraged lending environment continued to favor issuers in the third quarter. In the latest William Blair Quarterly Leveraged Lender Survey, 94% of respondents indicated lower or stable pricing and 89% indicated looser or similar terms for borrowers during the quarter. Lenders continue to support recapitalizations, with appetite bolstered by implied equity cushions supported by recent transactions and a strong business case. Recent William Blair transaction experience resulted in significant returns of capital relative to sponsors cash equity. While these opportunistic financings can be achieved for more cyclical and higherrisk credits, they often come with higher yields and/or lower leverage as lenders predominantly have taken the view that we are closer to the next cycle than we are from the last one. The market for midmarket sponsor LBO financing remains active as well. The William Blair Proprietary Mid- Market LBO Financing Database shows that average total leverage levels have held steady around 5.3x for the past several quarters. 1 The second-lien market has become a more attractive instrument in midmarket sponsor LBO transactions over the past six months, as the median cost of capital (spread plus LIBOR floor) for second-lien tranches decreased by approximately 25 basis points to 9.75% in the third quarter after falling 88 basis points in the second quarter, according to the William Blair database. Institutional Market Surges New-issuance volume increased 63% year-over-year to $107 billion in the third quarter, representing the highest levels since the second quarter of 2014. When the quarter closed, September 2016 was the busiest month from a volume perspective in the institutional leveraged loan market s history, and August 2016 was the busiest August ever. Opportunistic loan activity (refinancings and dividend recapitalizations) a key indicator of an issuer-friendly environment accounted for 55% of market volume in the third quarter, the highest level in over three years. This comes on the heels of a strong second quarter in which 45% of the volume was allocated to opportunistic transactions. After a sluggish start to the year, 2016 is on pace to exceed the 38% and 29% levels recorded in 2014 and 2015, respectively. Pricing continued to improve in the third quarter. New-issuance yields for single-b-rated loans fell 31 basis points, furthering the 74 basis points Issuer-Friendly Dynamic Continues Each quarter, William Blair s Leveraged Finance Survey asks respondents to rate the overall conditions in the leveraged finance market on a scale of 1 to 5, with 5 being the most borrower-friendly conceivable. Building on the improving conditions seen in the second quarter, the third quarter marked the secondhighest level since the metric was instituted in third quarter 2014. In our latest survey, 82% of respondents indicated that the market was borrower-friendly and only 4% indicated that the market was slanted toward lenders. (1 = most lender-friendly; 5 = most borrower-friendly) 4.3 3.9 4.1 4.0 4.0 Source: William Blair Quarterly Leveraged Finance Survey 3.4 3.4 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 3.8 4.1
of pricing relief experienced in the second quarter, according to LCD. The market improvement continues to be driven by technical support stemming from a demand imbalance; demand for assets has outpaced supply for seven consecutive months. Investor liquidity has also positively affected secondary trading levels, with the LSTA Leveraged Loan Index returning 3.1% for the quarter and 7.7% year-to-date. Rise of the Unitranche Unitranche loans burst into the mainstream in the third quarter following several significant M&A transactions that were financed via a unitranche loan rather than in the institutional market. The highestprofile of these transactions was the $1 billion unitranche backing Thoma Bravo s acquisition of Qlik Technologies. In addition to being the largest unitranche ever, this transaction also disproved the old adage that unitranche loans top out around $250 million. One of the primary benefits of this type of financing is the speed and ease of execution, as transactions often close with a single or small group of lenders, eliminating the market risk that comes with broad market syndication. Unitranche lenders make up a large portion of the alternative lender universe that has long been a staple of a William Blair leveraged loan arrangement process. The market is very deep, with lenders having varying degrees of capital costs and appetites for specific industries and business models. This was illustrated by two arrangement processes that William Blair recently conducted in support of dividend recapitalizations for companies in very distinct industries. In the first transaction, the cost of capital range was 225 basis points, and the second transaction had an even wider range of 450 basis points. The wide dispersion of possible outcomes for unitranche financing illustrates the value of working with an advisor that has deep experience in this market. Active High-Yield Market Amid Strong Investor Demand Spreads tightened and yields declined during the third quarter. This was driven largely by continued fund inflows, favorable decisions from U.S. Federal Reserve and Bank of Japan policy meetings in September, and a rally in oil prices following OPEC s unexpected agreement to reduce production for the first time in eight years. Investor demand was strong, with cumulative fund inflows during the quarter of more than $6 billion a stark contrast to the $6 billion outflow during the third quarter of 2015. The primary market remained active with approximately $62 billion of new issuance in the third quarter. Nearly $30 billion of this issuance was completed in September, a sharp increase to the year-to-date monthly average of $20 billion. New-issue volume trailed second-quarter levels, largely because of the usual summer slowdown, culminating with a hiatus the last two weeks of August, during which no new deals were completed. Refinancing activity was the driving force behind much of the quarter s new business. Refinancing represented approximately 70% of all new issuance during the quarter, while M&A activity accounted for just 13% of new deals, compared with approximately 30% and 57%, respectively, for the third quarter of 2015. Dividend recapitalizations remained robust, with nearly $4 billion of new volume during the period. Jeff Zolkin, William Blair s head of high-yield finance, said that due to strong demand from the buy side, the high-yield market is becoming increasingly accessible to middle-market companies, and it represents an attractive opportunity for these companies to access the covenant-lite market through highyield issuance. The industrial sector remained the largest issuer of high-yield bonds, representing approximately 28% of all new business during the period. New issuance is expected to remain strong as companies seek to take advantage of continued strong buyer demand and complete financings in advance of the U.S. presidential election and November U.S. Federal Reserve policy meeting. To learn more about these and other trends shaping leveraged finance markets, please do not hesitate to contact us. William Blair 2
MARKET UPDATE AND ANALYSIS Middle Market LBO Leverage Multiples Average senior and total leverage multiples for middle-market LBOs remained healthy in the third quarter. Lenders continue to seek quality assets in changeof-control transactions, which provide a fresh equity mark / EV support. 6.0x 5.0x 5.1x 5.3x 5.2x 5.3x 4.7x 4.0x 4.0x 4.0x 4.3x 4.3x 4.4x 4.1x 1Q15 2Q15 3Q5 4Q15 1Q16 2Q16 3Q16 Senior Leverage Total Leverage Source: William Blair Proprietary Midmarket LBO Financing Database Leveraged Finance Market Analysis Each quarter we look behind the numbers to examine the market dynamics that are driving trends in pricing and volume in leveraged finance transactions. Institutional Dividend Recap Volume The second quarter s resurgence in dividend recap activity continued in the third quarter. Dividends are an increasingly common use of proceeds in today s environment. ($ in billions) $16 $15 Sources: S&P LCD $10 $4 $2 $13 $8 $2 $0 $12 $11 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 High-Yield Bond Volume New-issuance volume remained strong in the third quarter, despite a slow start to July following the June 23 Brexit referendum and the usual summer slowdown. Activity rebounded in September, which recorded the secondhighest monthly volume of 2016, trailing April by only $4 billion. ($ in billions) $105 $75 $69 $65 $92 $94 $40 $36 $36 $83 $63 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 Sources: S&P LCD 3
Highlights From William Blair s Second Quarter 2016 Leveraged Finance Survey Each quarter William Blair surveys midmarket leveraged finance professionals representing leading commercial banks, credit funds, BDCs, commercial finance companies, and other credit providers. To receive the results of the full third quarter 2016 survey, please contact Olivier Lopez at olopez@williamblair.com. Issuer-Friendly Environment Remains Pricing and terms continued to display an issuer-friendly slant in the third quarter; 42% of respondents saw decreased pricing and 39% saw higher leverage and looser terms. These improvements come on the heels of the notably issuer-friendly second quarter. Pricing Leverage and Terms 18% 10% 37% 36% 40% 42% 17% 20% 41% 34% 35% 39% 45% 53% 42% 18% 52% 6% 4Q15 1Q16 2Q16 3Q16 Increase Remain the Same Decrease 42% 47% 51% 50% 14% 11% 4Q15 1Q16 2Q16 3Q16 Tighten Remain the Same Loosen Lending Expectations for Remainder of 2016 Roughly 90% of survey respondents expect pricing, leverage, and terms to either decrease/loosen or remain consistent with third-quarter levels over the remainder of the year. This continues the issuer-friendly outlook that materialized at the end of the first quarter. Pricing 9% 35% 56% 21% 14% 52% 68% 27% 18% 24% 68% 8% 4Q15 1Q16 2Q16 3Q16 Increase Remain the Same Decrease Leverage and Terms 13% 21% 18% 24% 26% 61% 47% 33% 62% 63% 20% 13% 4Q15 1Q16 2Q16 3Q16 Tighten Remain the Same Loosen Is the Unitranche a Viable Threat to the Institutional Bank Market? 74% Yes 26% No Given the completion of several sizable unitranche facilities in the third quarter, we asked lenders if they viewed these facilities as a threat to the institutional bank market for LBO financings. The response was resoundingly yes, with lenders citing the bank regulatory environment, along with certainty and speed of a unitranche execution, as an influencing factor. William Blair 4
WILLIAM BLAIR LEVERAGED FINANCE INVESTMENT BANKING William Blair By the Numbers Drawing on our deep product expertise and the strength of our relationships, William Blair has built a leading leveraged finance franchise. Business owners turn to us for outstanding execution in support of their capital-raising objectives. Recent transactions include: 60+ completed leveraged finance transactions since 2012 $11.0bn+ arranged financing since 2012 400+ lender and alternative credit provider relationships 5
William Blair s Leveraged Finance team structures and arranges debt capital in support of acquisitions, recapitalizations, and growth through its well established relationships with debt capital providers globally. $6.8 billion of financing arranged since 2014 Specialists who are experts in complex engagements, including those requiring insightful credit positioning and the arrangement of multiple layers of capital Robust distribution capabilities providing a 360 view of the market; relationships with over 400 lenders and significant transaction experience with alternative credit providers Real-time, proprietary view of the leveraged finance market from William Blair s global M&A and debt advisory practices Senior banker attention and unbiased, objective advice; senior bankers average more than 20 years of experience Thoughtful, customized financing processes that produce outstanding outcomes Our recently expanded high-yield team complements established leveraged loan arrangement capabilities with a team of bankers who have deep experience executing high-yield transactions for middle-market issuers. $5 billion+ of lead-managed high-yield financings across 30+ transaction since 2011 Unique expertise in crafting middle-market structures and indentures Significant expertise relating storied credits to the market Extensive experience completing transactions for first-time issuers With more than 150 senior bankers around the world, William Blair has completed more than 2,000 advisory and financing transactions totaling more than $200 billion in value for our clients* Leveraged Finance Kelly Martin Managing Director +1 312 364 8832 kmartin@williamblair.com Michael Ward Managing Director +1 312 364 8529 mward@williamblair.com Jeff Zolkin Managing Director +1 310 734 5809 jzolkin@williamblair.com Jonathan Lee Director +1 310 734 5810 jlee@williamblair.com Heather Mosbacher Reiner Director +1 212 237 2781 hreiner@williamblair.com Matt Thomas Director +1 312 364 5261 mthomas@williamblair.com *In the past five years as of December 31, 2015 William Blair 6
Disclosure William Blair is a trade name for William Blair & Company, L.L.C., William Blair Investment Management, LLC and William Blair International, Ltd. William Blair & Company, L.L.C. and William Blair Investment Management, LLC are each a Delaware company and regulated by the Securities and Exchange Commission. William Blair & Company, L.L.C. is also regulated by The Financial Industry Regulatory Authority and other principal exchanges. William Blair International, Ltd is authorized and regulated by the Financial Conduct Authority ( FCA ) in the United Kingdom. William Blair only offers products and services where it is permitted to do so. Some of these products and services are only offered to persons or institutions situated in the United States and are not offered to persons or institutions outside the United States. This material has been approved for distribution in the United Kingdom by William Blair International, Ltd. Regulated by the Financial Conduct Authority (FCA), and is directed only at, and is only made available to, persons falling within COB 3.5 and 3.6 of the FCA Handbook (being Eligible Counterparties and Professional Clients). This Document is not to be distributed or passed on at any Retail Clients. No persons other than persons to whom this document is directed should rely on it or its contents or use it as the basis to make an investment decision. About William Blair Investment Banking William Blair s investment banking group combines significant transaction experience, rich industry knowledge, and deep relationships to deliver successful advisory and financing solutions to our global base of corporate clients. We serve both publicly traded and privately held companies, executing mergers and acquisitions, growth financing, financial restructuring, and general advisory projects. This comprehensive suite of services allows us to be a long-term partner to our clients as they grow and evolve. From 2011 to 2015, the investment banking group completed more than 350 merger-andacquisition transactions worth $95 billion in value, involving parties in 26 countries and four continents, was an underwriter on more than 20% of all U.S. initial public offerings, and raised more than $120 billion in public and private financing.