Market At A Glance October 2018 http://sppcapital.com Cash Flow Senior Debt/EBITDA October 2018 1.75x 2.50x 2.75x 3.75x 3.25x - 4.75x September 2018 1.75x - 3.00x 2.75x - 4.00x 3.25x - 4.75x October 2017 1.75x - 3.00x 2.75x - 4.00x 3.25x - 4.75x Total Debt/EBITDA October 2018 3.50x 4.00x 4.00x - 5.25x 4.50x - 6.00x September 2018 3.50x - 4.50x 4.00x - 5.50x 4.50x - 6.00x October 2017 3.25x - 4.50x 3.50x - 5.00x 4.50x - 6.00x Senior Cash Flow Pricing Bank Non-Bank < $7.5MM EBITDA Non-Bank > $15MM EBITDA October 2018 L+ 2.50% - 5.00% L+ 4.50% - 6.50% L+ 4.50% - 6.00% September 2018 L+ 2.50% - 5.00% L+ 4.50% - 7.00% L+ 4.50% - 6.00% October 2017 L+ 3.00% - 5.00% L+ 5.50% - 8.00% L+ 4.50% - 6.00% Second Lien Pricing October 2018 L+ 7.00% - 10.00% L+ 6.50% - 8.50% L+ 5.50% - 7.00% September 2018 L+ 7.50% - 10.00% L+ 6.50% - 8.50% L+ 5.50% - 7.00% October 2017 L+ 7.00% - 12.00% L+ 6.50% - 8.50% L+ 6.00% - 7.50% Sub Debt Pricing October 2018 11.00% - 14.00% 10.00% - 12.00% 9.00% - 11.00% September 2018 12.00% - 14.00% 10.00% - 12.00% 9.00% - 11.00% October 2017 12.00% - 14.00% 10.00% - 13.00% 10.00% - 12.00% Unitranche Pricing < $5MM EBITDA > $10MM EBITDA > $20MM EBITDA October 2018 L+ 7.00% - 10.00% L+ 6.50% - 8.50% L+ 5.50% - 7.00% September 2018 L+ 7.50% - 10.00% L+ 6.50% - 8.50% L+ 5.50% - 7.00% October 2017 L+ 7.00% - 12.00% L+ 6.50% - 8.50% L+ 6.00% - 7.50% Libor Floors Libor floors remain in second lien, subordinated, and unitranche deals, but are becoming less and less of an issue for senior loans considering rising rates. Approximately 72% of loans in Q1 2018 had no Libor floor. When a floor is required however, lenders are looking for a minimum 1.75%.
Minimum Equity Contribution As a general proposition, lenders require minimum cash equity contributions of at least 25.0% and are steering away from thinly capitalized deals, especially for sub $10.0 million EBITDA borrowers. Aggregate minimum of 40.0% base level equity (inclusive of any rollover) is required for most deals. As leverage levels creep up in excess of 5.0x, 40.0%-50.0% cash equity (exclusive of rollover) is required. Most lenders discount rollover equity in excess of 20.0%. Equity Investment and Co-Investment Liquidity for direct equity investment (and co-investment) is still quite robust among insurance companies, family offices, credit opportunity funds, and select SBICs. Most traditional mezzanine funds will also provide up to 20% of their aggregate debt commitment as an additional strip of equity. Capital to support independent sponsors is at an all-time high, with new funds created exclusively to support independent sponsors. Promotes and carry will vary depending on the role the sponsor plays post-closing and how much, if any, of their own equity is deployed. Most carry provisions will contain performance contingencies to enhance the initial promote. While structures differ based on the circumstances of each deal, most investors are willing to sacrifice some yield for the liquidity preference. Recap Liquidity Recap liquidity is as strong as it has been all year, with lenders making little distinction, if any, between accretive versus non-accretive use of proceeds; however, sponsored transactions will achieve higher leverage and better pricing for leveraged recapitalizations. Story Receptivity While story receptivity remains high, it is increasingly becoming more sector selective. Challenged issuers in more cyclical sectors deemed most vulnerable to macroeconomic volatility are more likely to receive higher pricing, less leverage (i.e. one turn less of EBITDA) and potentially, some equity upside incentive features. The general feeling in the market is that we are near the end of the current credit cycle, and lenders will stress test more marginal credits against less generous macroeconomic conditions. Tone of Market Q4 is historically the most frenetic part of the year with issuers and lenders eager to close deals by year end. Generally, October marks the last month where issuers can remain relatively comfortable with a year-end closing, though there will be limited opportunities to complete deals approaching the market in November, and to a lesser extent, December. Many strategies to accelerate transaction consummation remain available. On a more generic note, while pricing in Q4 is at its most competitive level for the year, lenders are pulling back somewhat on maximum leverage tolerances and covenant flexibility reflecting increased concern with a potential slowdown in EBITDA growth resulting from increased interest rates and a potential deterioration in macroeconomic conditions. Start by saying I'm a couple years too late Not the reunion I was planning on Now I just came to give my regards and keep my faith Let go of your words that I've been hanging on Oh, I've been setting fire to my bed sheets Oh, don't you twist your tongue just to protect me Just scream, Mayday, we're going down" Now I must say you've had my mind in quite the wreck And I deceived you with false virtue Now I am sitting like a gambler in his debt Counting all the ways that I would hurt you Oh, I've been setting fire to my bed sheets Oh, don't you twist your tongue just to protect me Just scream, Mayday, we're going down Mayday, Wild Rivers
Mayday? Debt levels continue to rise precipitously through Q4 of 2018; in fact, year to date, US leveraged loan issuance has already reached record levels of almost $400 billion (that is more than the full year 2017). Leveraged loan issuance specifically targeted to support LBOs is also at record levels, currently hovering at approximately $90 billion, whereas last year LBO leverage loan issuance at this time in the US was not even $80 billion. There are two takeaways from this data. The first and most obvious takeaway is that leverage loan issuance is on a tear this year, and all the new capital that has been raised in the last couple of years (and that we have been writing about all this year) is not only finding its way into the market but is redefining the leveraged loan market itself. The second takeaway is that the use of leveraged capital far exceeds simply supporting LBO activity. LBO activity has declined during 2018. At the same time leveraged loan activity has accelerated. Through September of 2018, leveraged loans supporting LBOs only account for approximately 23% of all leveraged loan activity. Given the concern by many that we are heading toward the end of the current economic cycle (now in our 121 st month of expansion), the heightened use of leverage would suggest that the potential for large scale defaults is also reaching an inflexion point, yet the default rate is heading lower, not higher. While net corporate debt as a percentage of GDP currently sits at approximately 34.5% (up from 29% in 2010), the high yield default rate is now at 29.5% (down from 37% in 2010). In short, it might be a little premature to issue a mayday even with higher leverage and a widespread belief that we are in the twilight of the current recovery. SPP is making some minor tweaks to its metrics and guidance for the month of October. Given the continued excess liquidity conditions, especially in the direct lending, non-bank market, we are lowering spreads for non-bank senior (<$7.5MM LTM EBITDA) by 50bps; for second lien, unitranche deals and subordinated debt borrowers by 50 bps to 1% (see the Market- At -A Glance above). In an effort to get deals, lenders are continuing to go down market and with the increased competition, smaller issuers are getting the benefit of lower spreads. However, what the market giveth with one hand, it taketh with the other i.e. while spreads for these smaller issuers are coming in, aggregate leverage tolerances are getting more restrictive. SPP has accordingly tightened leveraged metrics for smaller middle market issuers in October. In short, lenders will happily cut spread to get increased deal flow for lower middle market deals, but they will not do so unless they have greater downside protection (i.e. less leverage). The lower middle market is really a perfect microcosm of the larger economic picture excess liquidity is giving way to tighter spreads, while fears of a larger macroeconomic slowdown influence leverage tolerances and credit risk exposure. U.S. Leveraged Loan Issuance for YTD Periods ($Bn) Source: Bloomberg LP US Leveraged Loan Issuance Backing LBOs Source: S&P Global Market Intelligence Debt Fuels M&A, Buybacks Source: Bloomberg, Federal Reserve, S&P Private Capital Funds in Market over Time The Macroeconomic Picture Uncertainty around trade has been a constant discussion among citizens, politicians, and businesses throughout the summer and into early fall. This week the U.S. took a significant diplomatic step with its continental neighbors, updating the decades old North American Free Trade Agreement (NAFTA) as the United States Mexico Canada Agreement (USMCA). In this latter agreement Canada will join Mexico and the U.S. in an accord reached in August that outlines a new rule book for commerce in North America. The USMCA makes changes to the pact between the North American superpowers impacting regulations in American auto production, access to the Canadian dairy market, labor standards, exchange rates, financial services, and digital businesses. Congress must approve this treaty in November, and the agreement faces a sunset after Source: Preqin
16 years when it will have to be renegotiated or renewed. In a U.S. effort to reduce the $19.35 billion trade deficit with Mexico, the USMCA states that 45% of North America built cars must be built by workers earning at least $16 per hour by 2023. Additionally, 75% of parts for cars they build for export within North America must be made in North America to qualify for duty free shipping, up from 62.5% in NAFTA. Trump s America centric and isolationist rhetoric continues, but global policymaking has begun to open, and discussions with China and other European superpowers are forthcoming. The Federal Reserve, in its September 26 th meeting, raised the target range for the federal funds rate to 2.00%-2.25%, in line with market expectations. Powell described his policy as a long way from neutral, indicating there is more room before the inflection point to contractionary fiscal policy. There is now a 73.8% probability of a fourth rate-hike in December. Chairman Powell continued discussion of a gradual raising of rates and used purposely cautious language to guide the discussion. Treasury yields rose to record highs as the yield curve flattened, and fixed income investors became more attracted to floating rate bonds. There are no signs of job growth slowing down with unemployment coming in at 3.7%, wage growth continuing to rise, and inflation hovering around the 2% target rate. With unemployment continuing to fall there is continued questioning whether the economic theory of the Phillips curve is still an accurate predictor of the short-term relationship between the increase in wages and unemployment. Since 2008 there has been very little correlation between these variables and the slope of the Phillips curve has been variable and unpredictable. Unemployment is at historic lows, but wages are not rising at a rate inversely correlated. Amazon which employs 541,000 people globally, is raising its minimum wage to $15, leading the charge in increasing wages for low skilled workers in the shipping, e-commerce, and retail economy. The macroeconomic outlook is still optimistic, but some economists predict the credit cycle nearing its end with interest rates gradually rising and unemployment at its lowest level since 1969. Quarterly Change in Real GDP (%) Unemployment Rates (U-3 and U-6) Source: Bureau of Labor Statistics University of Michigan Consumer Sentiment Below is a recap of this month s key economic releases: Unemployment edges lower to 3.7% and job creation misses expectations Nonfarm payrolls came in at a yearly low of 134,000, missing expectations of 185,000. Hurricane Florence likely had an impact on results in the Southeast United States during September, decreasing payrolls. Unemployment hit a record low of 3.7% as the labor supply becomes even tighter for healthcare, business services, transportation, and warehousing sectors. Average hourly nonfarm wages increased by $0.08, to $27.24, 2.8% annual growth (down from 2.9% a month earlier). Consumer Sentiment soars to a 14 year high in September The University of Michigan index of consumer sentiment soared to 100.1 (up 5.3% yearover-year), to the highest level in 14 years. Inflation concerns fell and household earnings expectations remained optimistic. Tariff unease is still present in nearly a third of responses as consumers wait for confirmation of the USMCA and continued discussion with China and Europe over trade. The current economic conditions component was up 3.1% year-over-year and the index of consumer component was up 7.2% year-over-year. Third Estimate of Real GDP Growth Rate remains unchanged The bureau of economic analysis released its third estimate of GDP growth which incorporated a downward revision to imports and a downward revision to private inventory investment, offsetting each other and keeping GDP growth at a solid 4.2%. The Atlanta Fed in its most recent release on October 5 st, tracked quarterly change in real GDP at 4.1%, driven by positive trade data released by the BEA and increased Non- Farm Payroll (Seasonally Adjusted) 134,000
optimism around global commerce. There are few signs of GDP growth slowing down in the 3 rd quarter. GDP Now Data Real GDP Forecast for Q3 2018 Personal consumption expenditure edges up while core component remains unchanged According to the Bureau of Economic Analysis, in August, personal income increased a robust $60.3 billion (0.3%), disposable personal income increased $51.4 billion (0.3%), and personal consumption expenditures increased $46.4 (0.3%). Core PCE, which excludes food and energy, stayed mostly unchanged at the target Fed inflation rate of 2.0%. The ISM manufacturing index falls amid tariff concerns, while the nonmanufacturing index hits a record high The ISM reports a nonmanufacturing index at a 10 year high of 61.6%, the 104 th month of consecutive growth. The non-manufacturing index grew due to the business activity index increasing to 65.2% (4.5% increase month-overmonth), the new orders index increasing to 61.6% (1.2% increase month-over-month), and the employment index increasing to 62.4% (5.7% increase month-over-month). NMI respondents remain concerned over capacity, tight labor supply, and trade agreements with China, Europe, and Canada. The manufacturing index edged down to 59.9% (1.5% decrease month-over-month). MI respondents discussed robust demand for new orders, supply chain inefficiencies, reciprocal tariffs, employment constraints, and expansion of imports. Housing starts rose to 1.28 million, bolstered by strong economic outlook Privately owned housing starts up are up to a seasonally adjusted rate of 1.28 million, up 9.2% month-over-month. The single-family homes component had marginal change with a 1.9% increase month-overmonth to 0.876 million, while multi-unit starts increased 27.3% monthover-month to a rate of 0.392 million. Building permits were down by 5.7% month-over-month, while housing completions came in above expectations at 2.5% up month-over-month. Source: Federal Reserve Bank of Atlanta PCE and Core PCE ISM Manufacturing & Non-Manufacturing Indices (%) Stefan Shaffer Managing Partner 212.455.4502 DISCLAIMER: The "SPP Leveraged Cash Flow Market At-A-Glance" 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 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. New Privately-Owned Housing Starts To unsubscribe to this email, please click here. To request to be added to our distribution list, please click here
Supporting Data Historical Senior Debt Cash Flow Limit (x EBITDA) Historical Total Debt Limit (x EBITDA) Historical Senior Cash Flow Pricing (Bank) Historical Senior Cash Flow Pricing (Non-Bank) Historical Second Lien Pricing Historical Subordinated Debt Pricing Historical Unitranche Pricing Historical Minimum Equity Contribution