SPP s Middle Market Leverage Cash Flow Market At A Glance

Transcription

1 Market Update February 2013 SPP s Middle Market Leverage Cash Flow Market At A Glance Deal Component February 13 January 13 February 12 Cash Flow Senior Debt (x EBITDA) <$8MM EBITDA >$10MM EBITDA >$25MM EBITDA <$10MM EBITDA >$15MM EBITDA >$25MM EBITDA <$10MM EBITDA x >$15MM EBITDA >$25MM EBITDA 2.75x4.0 Total Debt Limit (x EBITDA) <$8MM EBITDA >$10MM EBITDA >$25MM EBITDA <$10MM EBITDA >$15MM EBITDA >$25MM EBITDA <$10MM EBITDA >$15MM EBITDA x >$25MM EBITDA Senior Cash Flow Pricing L+3.50%4.50% (bank) L+4.50%6.50% (nonbank) L+3.50%4.50% (bank) L+4.50%6.50% (nonbank) L+3.50%4.50% (bank) L+4.50%6.00% (nonbank) Second Lien Pricing (Avg) <$10MM EBITDA L+9.00%12.00% floating >$15MM EBITDA L+7.50%9.00% floating <$15MM EBITDA L+9.00%12.00% floating >$20MM EBITDA L+7.50%9.00% floating L+8.00%10.00% (with 1.0% floor) Subordinated Debt Pricing <$10MM EBITDA 117.0% >$15MM EBITDA 13.0%15.0% >$25MM EBITDA 11.0%1 <$10MM EBITDA 117.0% >$15MM EBITDA 13.0%15.0% >$25MM EBITDA 11.0%1 <$10MM EBITDA 117.0% >$15MM EBITDA 13.0%15.0% >$25MM EBITDA 11 OneStop Pricing <$8MM EBITDA 10.0%1 >$10MM EBITDA L+7.50%9.00% 10.0%1 fixed <$10MM EBITDA L+9.00%10.00% floating >$15MM EBITDA L+8.00%9.00% floating 8.5%11.5% fixed L+8.00%9.00% floating Warrants Feature Coupononly deals the norm in the market absent compelling circumstances (>4.5x leverage, sub$7.5 million EBITDA, challenged/distressed credits). Coupononly deals the norm in the market absent compelling circumstances (>4.5x leverage, sub$7.5 million EBITDA, challenged/distressed credits). Coupononly deals the norm in the market absent compelling circumstances (>4.5x leverage, sub $7.5 million EBITDA, challenged/distressed credits). Libor Floors No Libor floor for most bank deals 1.0%1.5% for nonbank deals 0.0%1.0% for most bank deals 1.0%1.5% for nonbank deals 0.0%1.0% for most bank club deals 1.0%1.75% for syndicated or nonbank deals in most cases Mezzanine Opt. Prepayment (first 3 years) Highly negotiated; coupononly deals (no warrants) seeking nocall 12 years, with declining prepayment penalties (3.0%,, 1.0%, par). Significantly more latitude in warrant deals (SBIC maximum limited to 5.0%,, 3.0%,, 1.0%). As coupononly deals dominate, prepayment premiums scrutinized. Highly negotiated; coupononly deals (no warrants) seeking nocall 12 years, with declining prepayment penalties (3.0%,, 1.0%, par). Significantly more latitude in warrant deals (SBIC maximum limited to 5.0%,, 3.0%,, 1.0%). As coupononly deals dominate, prepayment premiums scrutinized. Highly negotiated; most mezzanine lenders seeking increased call protection on coupononly deals (i.e., noncall 12 years, with declining coupon 3.0%,, 1.0%, par). Significantly more latitude in warrant deals (SBIC 5.0%,, 3.0%,, 1.0%). As coupononly deals dominate, prepayment premiums scrutinized. Minimum Equity Contribution 25.0%35.0% total equity (including rollover); minimum 20.0% new cash in. 25.0%35.0% total equity (including rollover); minimum 20.0% new cash in. 25.0%35.0% Recap Liquidity Recap liquidity continues to be abundant. Pronounced dearth of new recap opportunities after crush of. Gone is the pricing discrimination associated with recaps, though lenders do report a continued resistance where money out significantly exceeds initial investment. Most recap activity pushed through at yearend to capture expiring tax benefits. Market participants expect a pronounced drop off in new recapitalization transactions as a function of less generous tax environment and a desire for sponsors to continue to harvest assets held beyond their normal investment horizon. Lenders/investors across the credit spectrum are still interested in funding leveraged recapitalizations. Plentiful; market making little distinction on use of proceeds if underlying asset is performing well. Stricter provisions in nonsponsored deals. Story Receptivity Lack of new deal activity combined with fresh allocations of new capital to be deployed in 2013 has resulted in exceedingly receptive conditions for storied paper in both assetbacked and cash flow structures, especially in the nonbank commercial lending constituency. Likely to be among the best opportunity of the new year to bring challenged credits to market or any financing where existing credit relationships are strained. is historically the most forgiving market of the year. Lack of deal flow in the January / February period after the yearend crush of deals (more poignant in as a result of tax considerations) suggests a very good market for storied paper (including distressed issuers, failed M&A auctions, and smaller issuers often overlooked in a busy market). Financing markets remain exceedingly liquid and open to storied credits and deals with a little hair. Credit opportunity funds awash in cash willing to dig deep but expect more mezzaninelike returns for senior debt. *Changes from last month in red

2 We gotta install ovens Custom kitchen deliveries We gotta move these refrigerators We gotta move these color TVs, Lord Now that ain't workin' that's the way you do it You play the guitar on the MTV That ain't workin' that's the way you do it Money for nothin' 6.0% 0.0% Quarterly Growth in Real GDP 4.1% 3.1% 2.6% 2.3% 2.4% 2.5% 2.2% 1.4% 1.3% 1.3% 0.1% 0.1% 0.3% Money for Nothing, Dire Straits Money for Nothing? SPP s February Market Update is aptly themed Money for Nothing. Banks and institutional investors in the private capital markets have more capital available for deployment than they have had in years while deal flow continues to contract, creating liquidity conditions that exceed even the best of the prerecession boom years of 2005 and In, the annual deal count fell to the lowest it has been in three years (2,041 deals, vs. 2,225 and 2,060 in and, respectively). In the middle market, the reduction in deal flow is even more stark: for transactions less than $250 million, the deal count shrunk to 399 in, down from 487 and 519 in and, respectively (a 23.1% contraction from ). During this same time period, capital has steadily poured into all of the private middle market lender constituencies: Middle market CLO issuance hit $2.6 billion in (vs. $0.4 billion in and $1.3 billion in ); Business development companies ( BDCs ) raised a total of $5.8 billion of new capital in (vs. $3.1 billion in each of and ), and this doesn t even take into account an equal amount of leverage available to BDCs on top of the equity; Mezzanine funds raised $10.6 billion in (vs. $9.4 billion in and $7.4 billion in ); and Small Business Investment Companies ( SBICs ) raised a total of approximately $2.9 billion in, including both initial equity and SBA debt commitments (vs. $2.7 billion in and $1.8 billion in ). Add to these secular trends the historical seasonal scarcity of deal flow, and an exceedingly compelling value proposition can be made, to wit, issuers planning to raise capital in 2013 have a significant incentive to get in front of investors sooner rather than later. Who are the greatest beneficiaries of issuance? To borrow from Emma Lazarus, Give me your tired, your poor, your huddled masses yearning to breathe free. The wretched refuse of your teeming shore. Send these, the homeless, tempesttossed to me, I lift my lamp beside the golden door!" In other words, those issuers with the most to gain from current market dynamics are the more marginal, storied credits typically neglected in an active market or otherwise relegated to the most expensive universe of alternative lenders. February is the perfect time to examine portfolio assets with a view to optimize lending relationships. This could take the form of a simple refinancing where legacy relationships have soured or where operating companies 6.0% Source: BEA Source: Institute for Supply Management % 8.0% 6.0% 0.0% Source: BLS 67.0% 66.0% 65.0% % 6 Source: BLS 5.3% 5.8% ISM Manufacturing Index Unemployment Rate % 9.8% Labor Force Participation Rate 01/03 01/04 01/05 01/06 01/07 01/08 01/09 01/10 01/11 01/12 01/ % 65.8% 66.4% 7.9% 63.6% 01/03 01/04 01/05 01/06 01/07 01/08 01/09 01/10 01/11 01/12 01/13

3 require additional covenant latitude or relief from amortization requirements. Alternatively, the excess liquidity evident in the market could be used to raise capital for growth or fund a partial recapitalization. If an existing debt facility is coming due in 2013 (or 2014 for that matter), it is hard to contemplate a better time for issuance. A Deeper Dive into OneStops As their presence in the private capital markets has morphed from the occasional oneoff deal under unique circumstances to a permanent fixture in the leveraged finance lending strata, onestops (a.k.a. unitranches ), have increasingly become a natural funding alternative to traditional bifurcated senior/sub financings, and in many cases, the only viable source of cash flowbased leverage for lower middle market issuers (sub$7.5 million EBITDA). Onestops constitute one of the most liquid and active providers of private leveraged finance and can address a broad spectrum of capital needs from lower middle market issuers to large private high yield issuers. Commentary on onestops tends to note the obvious benefits over a traditional senor/sub bifurcated financing; specifically, the absence of intercreditor agreements, lower legal fees, faster execution, and greater senior debt capacity. The negatives of onestop financing are also the subject of frequent market discussions, notably the higher cost of capital than traditional senior debt, the risk of one borrower controlling all of the debt, and the lack of blockage/standstill provisions to cushion a defaulting obligor. However, much less market information is available respecting the relative economics of onestop facilities visàvis traditional bifurcated financings. Starting this month, SPP will begin monitoring onestop metrics in the Update s Market Source Overview (below) where we currently benchmark assetbased, cash flow senior, and mezzanine lenders. The data pool for this month s onestop review was based on data from approximately 22 transactions and 189 total bids. Of the applicable recent transactions that constituted the source of our data, the breakdown of the bids was 72 senior tranche only, 91 mezzanine tranche only, and 26 combined unitranche. The sampling was filtered to include only generalist leveraged finance transactions (i.e., no insurance, specialty finance, or other unique lending sectors). For companies with less than $10 million of LTM EBITDA, there were 35 bids, of which 10 were senior tranche only, 15 were mezzanine tranche only, and 10 were combined unitranche. While there will naturally be deviations given a variety of quantitative and qualitative factors, certain general trends appear. Among them: For most sub$10 million EBITDA issuers, there is a dramatic decline in the number of commercial bank lenders willing to provide pure cash flow term loans, relegating the overwhelming majority of issuers to use a onestop or execute a bifurcated deal with an assetbased revolving credit facility and a mezzanine tranche; Most onestop providers are apprehensive to provide aggregate leverage (total debt/ebitda) in excess of 4. with the majority averaging between 3.5x and 3.75x; o We have seen bids as high as 5.5x, but that would be for larger issuers (>$25 million EBITDA) and includes an equity coinvestment. Most onestop providers are comfortable with more modest amortization than commercial bank lenders and range from 0.0%5.0% per annum, often with an excess cash flow sweep; Average Debt Multiples of Large Corporate Loans Average Debt Multiples of Middle Market Loans Average Debt Multiples of Large Corporate LBO Loans Average Debt Multiples of Middle Market LBO Loans

4 Onestops tend to be more expensive on fees than other senior lenders with an average expectation of about ; and There seems to be a growing distinction within the onestop community between those lenders that are more seniororiented and those that are more mezzanineoriented in their focus. The seniorfocused lenders are characterized by more competitive pricing, but usually provide for tighter covenants and more aggressive fixed amortization structures (combined with sweeps). Middle Market Source Overview 2,500 2,000 1,500 1, YTD 2013 Deal Counts 2,225 2,060 2, FY FY FY AssetBased Loans There was a pickup in activity at yearend, but annual issuance was down in about 25.0% from. Lenders require a positive fixed charge coverage (>1.) for funding, regardless of collateral coverage or quality of collateral. Lenders are comfortable with a modest (approx. 15.0%) air ball for traditional assetbased structures. Middle market pricing remains competitive: o L+1.50%2.25% for most clean deals (larger $150 million deals toward outer band); o L+2.50%3.00% for more storied credits; and o No Libor floors. The market remains competitive and is characterized by increasing flexibility, including the usage of M&E (75.0%85.0% of appraised OLV) and real estate (70.0%80.0% of appraised FMV) in the borrowing base. Capex lines are readily available (80.0% of cost; amortization highly negotiable once drawn). Undrawn pricing ranges from 0.25%0.50% and is inversely related to usage of facility. We typically see four to fiveyear maturities. Closing fees are in the 0.25%0.50% range. Senior Cash Flow Market Pricing remains competitive: o Best pricing at L+2.50%; o Most deals range from L3.50%4.50%; o Banks generally seek funded assets; o No floor in most commercial bank deals; o 1.00%1.50% floor for most nonbank commercial lenders; and o Fiveyear tenors are most common. Lower middle market pricing and leverage metrics: o Commercial banks are bidding sub$10 million EBITDA only in limited circumstances, pushing most borrowers to nonbank senior and onestop alternatives; o Lenders are wary to go above 1.5x2. LTM EBITDA for credits with less than $10 million in EBITDA; o Less than $5 million EBITDA deals are generally limited to unitranche structures; and o Recap liquidity is still available for both sponsored and nonsponsored deals. Term facilities are being priced at a 0.25%0.50% premium to revolving credit facilities. Amortization structures: o Commercial banks: The most common amortization is a seven to tenyear straight line with a balloon in year five; and 1, YTD 2013 Exits January January 2013 Deal Counts January January 2013 Exits 275 FY FY FY Jan Jan Jan Jan Jan Jan

5 o Pricing grids: o o They generally want to see a minimum of 25.0% 30.0% amortized in the first three years, but will consider slightly backloaded structures. Nonbank commercial lenders: 1.0%5.0% amortization per annum with a 50.0% excess cash flow sweep. Commercial bank lenders: L+3.50%4.50% for leveraged middle market deals; Higher quality, less leveraged deals as low as 2.50%; L+4.50%5.50% for more cyclical issuers; Upfront fees: 0.375%0.563%; 0.25%0.375% unused generally higher where there are more unused proceeds; and Par call. Nonbank commercial lenders: L+4.50%6.00% for <2.5x SD/EBITDA; L+5.00%6.00% for >2.5x SD/EBITDA; L+5.50%6.50% for <$10 million EBITDA; Upfront fees: 0.75%2.00%, 0.75% unused; and Prepayment penalties: noncall year one, 1.0% in year two, par call in year three. $1000B $750B $500B $250B $0B $125B $100B $75B $50B $25B Bank Debt and Bonds By Year Pro Rata Institutional HighYield Total Bank Debt and Bonds By Month OneStops $0B 4.8 Onestop lenders are among the most liquid constituencies in the private capital markets. o Focused primarily on $5 million to $15 million in LTM EBITDA; and o Largely industry agnostic. Cash flowbased. Lenders generally can provide revolving credit facilities. o Will size the revolver in accordance with current assets; and o In cases where lender cannot provide a revolving credit facility, they will contract out the revolver to a local commercial bank. Amortization ranges from 0.0%10.0% per annum with an excess cash flow sweep. o Most lenders focus on 5.0% amortization per annum. Closing fees range from 2.00%3.00% with best pricing at 1.00%. Prepayment provisions range among investors, but the norm is a 3.0%,, 1.0% declining premium. Investors include commercial finance companies, BDCs, traditional mezzanine funds, and credit opportunity funds. Lenders fall into two groups: o Senior debt focus generally require greater stated amortization, but provide lower interest cost; or o Mezzanine focus generally require less (or no) stated amortization, but on the higher end of the pricing grid. Total debt limitations range from x with an average of approximately 3.25x. o The most aggressive seen is 5.5 with an equity coinvestment. Fixed charge coverage is routinely set at a 20.0% discount to projections with a floor of 1.2. Pricing is surprisingly consistent across the credit spectrum: o 10.0%11.0% the norm for most credits; o Most competitive pricing at 9.0%; o Least competitive at 1; and o Maturity commonly 5 years. NewIssue FirstLien Spreads Percent Outstanding Loans in Default or Bankruptcy Pro Rata Institutional HighYield Total L+700 L+600 L+500 L+400 L+300 L+200 L+100 Pro Rata Institutional % 8.0% 6.0% 0.0%

6 May10 Nov10 May11 Nov11 May12 Nov12 May10 Nov10 May11 Nov11 May12 Nov12 Mezzanine Market Lack of deal flow in 2013 is making investors increasingly anxious and accordingly very competitive. 144A and public high yield market prices remain high, enhancing participation by hedge funds and credit opportunity funds. Creative mezzanine alternatives are abundant lastout notes, senior unsecured notes, secondlien notes, splitlien notes, preferred shares. A cash coupon of 11.0%1 is required. Allin (cash, PIK, and/or warrant) pricing schemes: o <$10 million EBITDA: 117.0%; o >$15 million EBITDA: 13.0%15.0%; and o >$20 million EBITDA: 11.0%1. Coupononly: warrants rarely required, and limited to leveraged recaps with more than initial equity investment returned, lack of equity sponsor, smaller issuers, storied credits, or nosebleed leverage (in excess of 4.5x). o Investors routinely seeking silent secondlien positions; and o Current leverage metrics: <$10 million EBITDA: ; <$15 million EBITDA: 3.75x4.75x; >$25 million EBITDA: ; and Leveraged recaps or storied credits: 3.75x4.25x. Maturities are equal to the greater of five years or six months after maturity of the senior debt facility. Full participation by all investor constituencies: o Traditional LP funds, credit opportunity funds, captive bank funds, hedge funds, commercial finance companies, BDCs, credit opportunity funds, and insurance companies creating pricing pressure; and o Regional bank mezz funds often provide below market pricing dynamics: 13.0%15.0% subordinated and L+6.00%9.00% second lien pricing for less than $15 million EBITDA issuers, but will only lend where the bank provides the senior debt; and Transactions are generally less than $15 million in aggregate principal amount. Minority equity and coinvest equity strips are readily available. Prepayment provisions are highly negotiable and very investorspecific. Upfront fees average 1.0%. SPP Tracked Market Activity Loan Availability, Deal Count, Exit Activity, and Leverage Multiples The National Federation of Independent Business (NFIB) reports December loan availability to be even with November s figure (a 9% reading suggests that the number of small business owners who believe loans are harder to get now than three months ago is 9% greater than the number who believe otherwise), and consistent with s overall improvement from numbers. Leveraged loan volume for shows a full recovery back to prerecession levels, and S&P loan statistics show 57 deals completed in January this year, which more than double last January s 26 deals Historical Cash Flow Senior Debt (x EBITDA) Historical Total Debt Limit (x EBITDA) 900 bps 800 bps 700 bps 600 bps 500 bps 400 bps 300 bps 200 bps 100 bps 0 bps Historical Senior Cash Flow Pricing (Bank) Bank Bank Historical Senior Cash Flow Pricing (NonBank) 900 bps 800 bps 700 bps 600 bps 500 bps 400 bps 300 bps 200 bps 100 bps 0 bps NonBank NonBank The recent S&P data on monthly loan leverage multiples shows a pronounced decrease in average debt multiples going from December to January, which is largely explained by an exceptional willingness to close

7 by yearend and a current shortage of activity. When compared to January, January 2013 shows a notable increase in the average debt multiples of loans and highlights the substantial amount of capital available in today's market. However, January's leverage multiples continue to show a significant discrepancy between middle market issuers and their larger corporate peers, providing further evidence of smaller issuers inability to access capital from all lender constituencies. 60% 50% 40% 30% 20% Historical Minimum Equity Contribution Finally, there is certainly plenty of liquidity in the private capital market. Banks and institutional investors have more capital available for deployment than they have had in years, and hedge funds and credit opportunities funds continue to be active players in the market due to the current secondary high yield pricing environment. Please feel free to call any of the professionals at SPP Capital to discuss a particular financing need, amendment or restructuring advisory, or just to get a little more color on the market; you don t need a deal ready to go to the market to call us. Our hope is that you use SPP as your go to resource for any information, analysis, and review of potential transactions. Stefan Shaffer Managing Partner (212) sshaffer@sppcapital.com 10% 0% 16% 14% 12% 10% 8% 6% 4% 2% 0% Historical SecondLien Pricing LIBOR Floor LIBOR Floor 25% 20% 15% 10% 5% 0% Historical Subordinated Debt Pricing Secondary High Yield Pricing 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. To unsubscribe to this , please click here. To request to be added to our distribution list, please click here Secondary High Yield Pricing Source: Piper Jaffray Debt Capital Markets Update SPP Value Inflection Point