State of the Capital Markets:
Presentation to:
Third Quarter 2017 Review and Fourth Quarter 2017 Outlook
Your Tour Guide to the Middle Market
Capital Markets Review – Third Quarter 2017
2
Public markets remain buoyed; economic growth up 3%
Fed rate hike expectations soften; loan funds saw in-‐‑flows reverse
Overall leveraged loan volume up YTD over 2016; repricings slow
Covenant-‐‑lite structures expand into larger middle market
Overall middle market loan volume remains strong; sponsored activityup from 2Q
Conditions remain constructive for credit across the board
Capital Markets Review – Third Quarter 2017
3
Default rates remain low; moderate economic growth maintainsconstructive backdrop for all varieties of credit issuance
Short-‐‑term rate pressure slowed, causing reversal of fund flows – nowinto high-‐‑yield accounts and out of loan funds
Market volatility at relative lows; low yields in liquid instrumentscontinues to generate investor interest in private credit
Bank arrangers using market conditions to push larger middle marketdeals into institutional market, eroding structures and yields
What’s the setting for debt and equity INVESTORS?
Capital Markets Review – Third Quarter 2017
4
Strong liquidity in broadly syndicated loans pushes volume to recordlevels; emphasis on repricings slow as large cap spreads contract
Larger middle market issuers benefit from arrangers and sponsorspushing large cap terms down-‐‑market
Sponsors toggle between club execution and syndicated market,depending on whether relationships or tightest terms are favored
Leverage has risen slowly, spreads are range-‐‑bound, and covenantsbeing eroded for better credits; arranger competition is keen
How about debt and equity ISSUERS?
Institutional investor market share Source: S&P LCD, Capital IQ
Capital Markets – Behind the Scenes
CLOs remain a significant share of the institutional market
5
CLO59.8%
Finance Co.1.3%
Hedge, Distressed & High-Yield Funds
10.3%
Insurance Co.7.2%
Loan Mutual Funds21.4%
Institutional investor market share
Institutional investor market share Source: Wells Fargo, S&P LCD Capital IQ
Capital Markets – Behind the Scenes
Banks’ share of loans is only 10% of the overall market
6
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Banks & Sec. Firms Non-Banks (institutional investors and finance companies)
Primary Investor Market: Banks vs Non-Banks
Fundraising still hot: 3Q 2017 saw most capital raised since 2Q 2014
Capital Markets – Behind the Scenes
7
Source: PitchBook; data for United States
$17
$14
$23
$18
$31
$22
$18
$18
$28
$32
$23 $2
8
$37
$68
$28
$65
$52
$63
$28
$56
$55
$39
$41
$60
$57
$59
$43
$55
$57
$59
$62
-‐
10
20
30
40
50
60
70
80
90
100
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q
2010 2011 2012 2013 2014 2015 2016 2017*
$0
$10
$20
$30
$40
$50
$60
$70
$80
Capital Raised ($B) # of Funds Closed
Final 3Q value expected to reflect big jump, in-‐‑line with prior 3Qs
Capital Markets – Behind the Scenes
8
Source: PitchBook; data for United States
$85
$83
$75
$93
$79
$78
$77
$138
$80
$103
$101
$157
$128
$121
$144
$138
$129
$119
$170
$132
$131
$134
$185
$127
$123
$116
$135
859
959
0
200
400
600
800
1,000
1,200
$0
$20
$40
$60
$80
$100
$120
$140
$160
$180
$200
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q
2011 2012 2013 2014 2015 2016 2017
Deal Value ($B) Estimated Deal Value ($B) # of Deals Closed
Source: S&P/LCD, Lipper
The year-‐‑long trend of cash flowing into loan funds has reversed
Capital Markets – Behind the Scenes
9
Prime-fund flows (weekly reports only)
-‐1.19
0.51 0.39
-‐1.17
0.25
-‐2.89
-‐2.11
-‐0.75
-‐2.12
-‐4.66
-‐2.49 -‐2.54
0.17
-‐0.50
0.38
-‐0.52
0.170.64
1.49 1.652.23
6.04
3.77 3.584.04
1.71
0.840.22
0.55
-‐0.76 -‐0.51
-‐$5B
-‐$3B
-‐$1B
$1B
$3B
$5B
$7B
Mar 15
Apr 15
May 15
Jun 15
Jul 15
Aug 15
Sep 15
Oct 15
Nov 15
Dec 15
Jan 16
Feb 16
Mar 16
Apr 16
May 16
Jun 16
Jul 16
Aug 16
Sep 16
Oct 16
Nov 16
Dec 16
Jan 17
Feb 17
Mar 17
Apr 17
May 17
Jun 17
Jul 17
Aug 17
Sep 17
New CLO formation already ahead of full year 2016 volume
Capital Markets – Behind the Scenes
Source: S&P/LCD
10
9.38
16.24
10.18
5.66
12.74
7.35
6.025.57
7.33
4.81
7.46
0.83
2.55
4.86
5.915.44
6.645.76 5.86
8.24 8.41
10.64
7.16
0.98
8.537.87
10.249.84
15.02
8.35
12.42
8.51
$0B
$2B
$4B
$6B
$8B
$10B
$12B
$14B
$16B
CLO Volume
Capital Markets Metrics – Loan Volume
Source: Thomson Reuters LPC
11
Sponsored Middle Market Volume
Middle market sponsored activity softened from last quarter
0
5
10
15
20
25
30
1Q00
2Q00
3Q00
4Q00
1Q01
2Q01
3Q01
4Q01
1Q02
2Q02
3Q02
4Q02
1Q03
2Q03
3Q03
4Q03
1Q04
2Q04
3Q04
4Q04
1Q05
2Q05
3Q05
4Q05
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
1Q13
2Q13
3Q13
4Q13
1Q14
2Q14
3Q14
4Q14
1Q15
2Q15
3Q15
4Q15
1Q16
2Q16
3Q16
4Q16
1Q17
2Q17
3Q17
Issu
ance
($B
.)
Source: Thomson Reuters LPC
MM LBO leverage remains below that for large cap deals
Capital Markets Metrics – Leverage
12
3.0x
3.5x
4.0x
4.5x
5.0x
5.5x
6.0x
6.5x
7.0x
7.5x
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
1-3Q
17
LBO
Deb
t to
EB
ITD
A (x
)
Institutional MM Large Corp.
20%
25%
30%
35%
40%
45%
50%
55%
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
1-3Q
17
Equi
ty C
ontr
ibut
ions
Institutional MM Large Corp.
Source: Thomson Reuters LPC
Large cap yields off despite cash coming out of mutual funds
Capital Markets Metrics – Pricing
13
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
Nov
-11
Jan-
12M
ar-1
2M
ay-1
2Ju
l-12
Sep-
12N
ov-1
2Ja
n-13
Mar
-13
May
-13
Jul-1
3Se
p-13
Nov
-13
Jan-
14M
ar-1
4M
ay-1
4Ju
l-14
Sep-
14N
ov-1
4Ja
n-15
Mar
-15
May
-15
Jul-1
5Se
p-15
Nov
-15
Jan-
16M
ar-1
6M
ay-1
6Ju
l-16
Sep-
16N
ov-1
6Ja
n-17
Mar
-17
May
-17
Jul-1
7Se
p-17
Sing
le B
-yie
lds
(3 y
ears
)
Loan
fund
flow
s ($
B)
Loan fund flows Single- B loan yields
Capital Markets Metrics – Pricing
Source: Thomson Reuters LPC
Middle market illiquidity premium narrowed to about 100 bps
14
3%
4%
5%
6%
7%
8%
9%
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
1Q13
2Q13
3Q13
4Q13
1Q14
2Q14
3Q14
4Q14
1Q15
2Q15
3Q15
4Q15
1Q16
2Q16
3Q16
4Q16
1Q17
2Q17
3Q17
All-
in-y
ield
(3-y
ear)
Middle market and large corporate quarterly average yields
Large Corp
MM
LIBOR+ Spread+OID (3-year)
Source: Thomson Reuters LPC; all-‐‑in middle market institutional yields (3 year)
Middle market leveraged loan yields remain in historic range
Capital Markets Metrics – Pricing
15
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
1Q02
2Q02
3Q02
4Q02
1Q03
2Q03
3Q03
4Q03
1Q04
2Q04
3Q04
4Q04
1Q05
2Q05
3Q05
4Q05
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
2008
1Q-3
Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
1Q13
2Q13
3Q13
4Q13
1Q14
2Q14
3Q14
4Q14
1Q15
2Q15
3Q15
4Q15
1Q16
2Q16
3Q16
4Q16
1Q17
2Q17
3Q17
All-
in-y
ield
(3-y
ear)
LIB/LIB Floor LIB Spread Spread due to OID
Source: Thomson Reuters LPC
Covenant-‐‑lite loans persist for larger middle market borrowers
Capital Markets Metrics – Covenants
16
Middle market covenant-lite volume
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
1Q06
3Q06
1Q07
3Q07
1Q08
3Q08
1Q09
3Q09
1Q10
3Q10
1Q11
3Q11
1Q12
3Q12
1Q13
3Q13
1Q14
3Q14
1Q15
3Q15
1Q16
3Q16
1Q17
3Q17
Cov
. Lite
% o
f iss
uanc
e
Cov
-lite
issu
ance
($B
ils.)
MM Cov Lite Volume
% of MM Volume
% of MM Institutional Vol.
US middle market covenant counts
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
LTM
3Q
17
Mar
ket
shar
e
1 cov 2 cov's 3 cov's 4+ cov's
Source: S&P LCD
Capital Markets Review – Credit Quality
Default rates stable with sector-‐‑specific problems well-‐‑defined
17
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
Jan 04
May 04
Sep 04
Jan 05
May 05
Sep 05
Jan 06
May 06
Sep 06
Jan 07
May 07
Sep 07
Jan 08
May 08
Sep 08
Jan 09
May 09
Sep 09
Jan 10
May 10
Sep 10
Jan 11
May 11
Sep 11
Jan 12
May 12
Sep 12
Jan 13
May 13
Sep 13
Jan 14
May 14
Sep 14
Jan 15
May 15
Sep 15
Jan 16
May 16
Sep 16
Jan 17
May 17
Sep 17
Lagging 12-month leveraged loan default rate by number
43.48%
30.43%
13.04%
4.35%
4.35%
4.35%
Services/Retail
Oil & Gas
Telecom
Entertainment & Leisure
Computers & Electronics
Healthcare
Composition of defaults
Capital Markets – Fourth Quarter 2017 Outlook
18
Little change expected in credit conditions or market liquidity
Expectations are that borrower-‐‑friendly market will persist through year-‐‑end
Direct lenders hoping for improved M&A activity, but also some credit discipline
Sponsored middle market volume should improve from 3Q; spreads steady
Competition for lead-‐‑arranged deals will continue to erode structures
Senior leverage of 3.5-‐‑4x; total of 5-‐‑5.5x for traditional middle market; 4.0-‐‑4.5xsenior/5.5-‐‑6.0x total for larger mid caps; >4.5x senior/6.0x total for BSL
Our Partners
19
Your Tour Guide to the Middle Market
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20
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