New Lending Trends, Middle Market Lending and Other Developments September 18, 2014 2014 Morrison & Foerster LLP All Rights Reserved mofo.com
Size of the company Annual revenues less than $500 million Annual EBITDA less than $100 million Three Segments What Is the Middle Market? Upper: Annual EBITDA in excess of $75 million Traditional: Annual EBITDA between the upper and lower segments Lower: Annual EBITDA below $10 million Size of the loan Upper: $100 million to $500 million Traditional: Less than $100 million Lower: Less than $30 million 2
Middle Market Loan Issuance Source: Thomson Reuters LPC 1 Deals less than $350MM 3
Middle Market M&A Activity Source: Thomson Reuters 4
Middle Market M&A by Industry Source: Thomson Reuters 5
Loan Pricing in the Middle Market Large Corp. Middle Market Market Premium Mean 6.04% 7.07% 1.03% Medium 5.70% 6.99% 1.30% High 10.32% 12.47% 2.15% Low 3.95% 4.56% 0.61% Current 5.26% 6.37% 1.11% Source: Thomson Reuters LPC 6
Rise of Non-Bank Lenders U.S. banks share of middle-market leveraged loans dropped to 9% in 2013 (Source: S&P Capital IQ LCD) The trend continues in 2014 7
Who Are Non-Bank Lenders? Companies that provide lending services, but do not accept deposits Not registered under The Bank Holding Company Act Examples Asset Managers Private equity funds Small business investment companies Peer-to-peer lenders Factors Venture capital providers CLOs Business development companies Hedge funds Finance companies Microfinance lenders Credit unions Community development financial institutions Mortgage lenders 8
Leveraged Lending Guidelines Interagency guidelines issued by the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Federal Reserve Board of Governors Areas covered by the Guidelines include: Definition of leveraged lending Underwriting standards Valuation standards Pipeline management Reporting Risk rating Application to loan transfers Stress testing 9
Leveraged Guidance (cont.) Suggested definitions of leveraged lending include characteristics of many middle market loans Total leverage of 4x Senior leverage greater than 3x Loans for acquisitions, buyouts and dividend recaps Underwriting guidelines suggest closer monitoring of loan portfolios with terms common in many middle market loans Loans to companies with debt that doesn t amortize in the medium term Loans without financial performance covenants Loans with PIK interest Loans with total debt to EBITDA in excess of 6x 10
Leveraged Guidance (cont.) Bank Leverage Tolerance Sentiment Non-Bank Leverage Tolerance Sentiment 11
Sponsors in the Middle Market Source: Thomson Reuters LPC 12
Covenant Lite Term loans with no financial maintenance covenants Revolving loan commitments with springing financial maintenance covenants Incurrence based negative covenant tests instead of fixed dollar baskets 13
Covenant Lite Issuances $300B 100% $250B 80% $200B 60% $150B 40% $100B $50B 20% $0B 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1/1-9/11/13 1/1-9/11/14 0% Volume Percent Source: S&P Capital IQ LCD 14
Flexibility & More Control for Borrowers Lenders are agreeing to bespoke structures and terms that give borrowers more flexibility and control Capital structure flexibility Builder baskets Excluded collateral More carve outs to mandatory prepayments Borrower control over assignments 15
Flexibility and More Control (cont.) What is the cause? Availability of capital Growth of non-bank lenders Mezzanine lending experience of many non-bank lenders Sponsor pressure 16
Unitranche Senior secured debt on the borrower s capital structure Lenders separately agree among themselves to create first and last out tranches Outside of the loan documents with the borrower Lenders synthetically create the benefits and risks to the lenders of a senior and mezzanine financing 17
Unitranche Data Source: Thomson Reuters LPC 18
Globalization U.S. middle market companies are increasingly global U.S. middle market structures spread globally Covenant lite Unitranche Asset-backed lending 19
Michael Girondo Michael Girondo Head of Capital Markets Varagon Capital Partners 488 Madison Avenue New York, NY 10022 212-235-2607 mgirondo@varagon.com Michael Girondo is an Executive Director of Varagon and Head of Capital Markets. Michael has an extensive background in leveraged finance with experience in a range of industries and in products across the debt capital structure. He manages the firm's external capital markets relationships. Michael joined Varagon from Citi Credit Opportunities, a principal investing group within Citigroup, where he focused on first-lien, unitranche, second-lien, and mezzanine credits. He also has significant industry expertise in Technology, Media & Telecommunications, as well as in the Chemicals, Healthcare, and Retail sectors. He earned a B.A. in Business Administration from George Washington University. 20
Varagon Capital Partners Varagon Capital Partners is an asset manager focused on direct lending to middle market companies. Varagon creates lasting partnerships with middle market companies and financial sponsors by delivering innovative, flexible financing solutions across the capital structure. Varagon offers investors a superior means to invest in middle market credit, providing tailored investment services that meet the needs of sophisticated institutions. Varagon is an independent firm, backed by AIG and by certain partners and affiliates of Oak Hill Capital Management, and launched with a $1.5 billion investment commitment from AIG. For Borrowers and Financial Sponsors Competitive product offering across the debt capital structure Innovative, flexible financing solutions delivered on a relationship basis Industry specialization in the Commercial & Industrial, Healthcare and Energy sectors Serves middle market companies with $10 million to $75 million of EBITDA For Investors Direct access to high quality middle market credits Tailored investment solutions with information transparency Best-in-class management, analytics and reporting Flexible investment mandates that meet the needs of sophisticated institutional investors 21
Geoffrey Peck Partner Morrison & Foerster LLP 250 West 55th Street New York, New York 10019 212-336-4183 gpeck@mofo.com Geoffrey Peck Geoffrey Peck specializes in banking, finance and restructuring. He represents banks, funds, asset managers, business development companies, issuers, secondary markets trading desks, special situations investors and borrowers in a broad spectrum of domestic and international financings, including syndicated and asset-backed financings, mezzanine financings, acquisition financings, bankruptcy financings and restructurings, and energy and project financings. Geoff s work on the market s most complex financing has won national recognition. For example, his leading roles in MoFo s representation of Residential Capital in its $4.5-billion debtor-in-possession financing was recognized as the 2012 Americas Restructuring of the Year by International Financing Review, of IC Power in its $595-million financing of a 525 MW hydroelectric power plant in Peru was recognized as the 2012 Latin American Power Deal of the Year by Project Finance magazine, and of the lead arranger and commercial lenders in $847 million of financings extended to Ecopetrol, the Colombian petroleum company was recognized by Trade Finance as a 2013 deal of the year. 22
Morrison & Foerster Morrison & Foerster is a global firm of exceptional credentials. With more than 1,000 lawyers in 17 offices in key financial, corporate and technology centers in the United States, Europe, and Asia, our clients include some of the largest financial institutions, investment banks, and Fortune 100 companies. We ve been included on The American Lawyer s A-List for ten straight years, and in 2013 Chambers Global named MoFo its USA Law Firm of the Year. Our success comes from the commitment of our lawyers to achieve innovative and business-minded results for our clients, while preserving the differences that make us stronger. Financial Transactions: Lending and other financial transactions have long been a cornerstone of MoFo s practice. More than 100 attorneys firmwide represent banks, institutional lenders, private equity and other investment funds, finance companies, and other non-traditional lenders, as well as emerging growth, mid-cap, and large public and privately-held companies on syndicated loans, structured financings, acquisition financings, real estate financings, project financings, mezzanine financings, loan trading and other financial transactions. Bankruptcy and Restructuring: MoFo s Business Restructuring & Insolvency Group represents debtors, creditors committees, ad hoc committees, secured lenders and other participants in the distressed markets and handles financial institution restructurings, cross-border insolvencies, distressed real estate, insolvencies involving key intellectual property and hedge fund failures, among other things. Our lawyers are experienced across a range of industries and geographical and cultural environments and regularly work with lawyers in our Finance, Corporate, Litigation and Tax Departments to handle various issues that arise in connection with distressed situations. In 2013 MoFo was named Bankruptcy Firm of the Year by Chambers USA. 23