1 ACG St. Louis The State of the Credit Markets June 19, 2009 Ronald Kahn Managing Director Lincoln International LLC (312) 580-6280 [email protected]

1

ACG St. Louis

The State of the Credit Markets

June 19, 2009

Ronald KahnManaging DirectorLincoln International LLC(312) [email protected]

2

Experience with High Profile Financial SponsorsLincoln International’s investment bankers have worked with a number of high profile sponsors to

execute financings across a range of transaction types and capital structures

Transaction Types

Acquisition Financing

Closes concurrently with acquisition

Coordination and commitments are paramount

Critical to have options available to the end

Post - Acquisition Financing

Initial deal is bridged / over-equitized to guarantee quick closing

Effected post-acquisition to optimize solicitation process and/or take advantage of credit market conditions

Refinancing

Improve pricing and other terms

Take out fatigued lender(s)

Rebalance senior and junior tranches

Expansion Financing Creates additional availability to fund growth

Possibly includes a delayed draw capex or acquisition line

Dividend Recap

Proceeds to shareholders in the near-term

ABL and mezz less sensitive to dividends

Interim realization when a sale is not optimal or timely

ABLsCash Flow

LoansSale-

LeasebacksSecond

LienMezzanine/ Sub Debt

Minority Equity

Types of CapitalPlaced by Lincoln

3

The Market at a CrossroadsTechnical aspects of the market have been improving . . .

Average First- and Second-Lien Secondary Spread (Index of 15 Largest Issuers with Both Tranches) Market Dynamics

Source: Standard & Poor’s Leveraged Commentary and Data (as of 4/23/2009)

Average Bid and Ask of Leveraged Loans

Source: Standard & Poor’s Leveraged Commentary and Data

Bloomberg US Industrial BB Yield Curve

Source: Bloomberg

• Greater demand for higher-yielding debt securities has driven yields

downward

• The re-pricing of credits, in conjunction with amendments and

extensions, has resulted in higher yields and, therefore, higher loan

values

• A resurgence in the high-yield market has resulted in the repayment

of leveraged loans, creating additional liquidity

60

70

80

90

100

110

All Loans First-Lien Loans

4.000

6.000

8.000

10.000

12.000

0.25

1.75

3.25

4.75

6.25

7.75

9.25

Maturity (in years)

Yie

ld

(in

%)

March 31, 2009 Curve June 11, 2009 Curve

L+ 000

L+ 800

L+ 1600

L+ 2400

L+ 3200

L+ 4000

L+ 4800

Jul-0

7

Sep-0

7

Nov-0

7

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-0

8

Nov-0

8

Jan-

09

Mar

-09

May

-09

Jul-0

9

First-Lien Second-Lien

4

And the price per share of most BDCs is on the rise, as BV/share begins to stabilize . . .

BDC Performance

Last 18 Months of BDC Price per Share and BV/Share

Market Dynamics Last 18 Months of BDC Price per Share and BV/Share

Source: Capital IQ

Source: Capital IQ

• Lincoln created an index to monitor the price per share and book

value per share of the eleven largest business development

corporations (“BDCs”) (market cap over $180 million)

• Since December 2007, while the BV/share of each BDC has

deteriorated 34.4%, the average price per share of Lincoln’s BDC

index has decreased by 63.7%

• Recently, the price per share index has begun to improve, and the

gap between price per share and BV/share has narrowed

• Signs of returned strength to BDCs indicate potential for additional

liquidity and improved conditions throughout the broader financing

markets

$2.00

$5.00

$8.00

$11.00

$14.00

$17.00

Price per Share BV/Share

12/31/2007 x 12/31/2008 x 3/31/2009 x 6/15/2009 x

Business Development Corporation Price per Share BV/Share Price per Share BV/Share Price per Share BV/Share Price per Share BV/Share

Ares Capital Corporation 14.63$ 15.47$ 6.33$ 11.27$ 4.84$ 11.20$ 7.79$ 11.20$ Allied Capital Corporation 21.50 17.54 2.69 9.62 1.59 7.67 3.31 7.67 American Capital, Ltd. 32.96 32.88 3.24 15.41 1.87 12.32 4.28 12.32 Apollo Investment Corporation 17.05 17.71 9.31 9.87 3.48 9.82 6.90 9.82 BlackRock Kelso Capital 15.28 13.78 9.86 9.23 4.19 9.04 6.81 9.04 Compass Diversified Holdings 14.90 13.73 11.25 14.73 8.92 13.61 8.18 13.61 Hercules Technology Growth Capital, Inc. 12.42 12.31 7.92 11.56 5.00 10.94 8.04 10.94 KKR Financial Holdings 14.05 14.35 1.58 4.43 0.88 4.59 1.09 4.59 MCG Capital Corporation 11.59 12.73 0.71 8.66 1.28 8.02 2.50 8.02 MVC Capital 16.14 15.21 10.97 17.36 8.41 17.28 8.39 16.84 Prospect Capital 13.05 14.58 11.97 14.43 8.52 14.19 9.34 14.19

Average 16.69$ 16.39$ 6.89$ 11.51$ 4.45$ 10.79$ 6.06$ 10.75$

5

Loan Volumes and M&A Activity – Waiting to RecoverHowever, loan volumes and M&A activity remain anemic . . .


Source: Factset Mergerstat

Note: Transaction Values between $10 million and $250 million

Total Middle Market Loan Volume ($ in billions) (Issuers with EBITDA of Less Than $50 million)

Middle Market M&A Transaction Volume (Rolling TTM)Market Dynamics


Global New-Issue Leveraged Loan Volume ($ in billions)

$256.0 $264.0$238.3

$201.1$177.2

$218.8

$340.2

$448.1

$650.5

$762.0

$233.9

$58.0$12.5

$0

$150

$300

$450

$600

$750

$900

$26.7

$38.7$41.3

$34.5

$11.9

$17.2

$12.5

$26.0

$34.8 $34.2

$28.7

$8.0

$0.3

$0.0

$10.0

$20.0

$30.0

$40.0

$50.0

1,5611,602

1,666

1,7521,799

1,7581,806

1,900

2,047

2,1392,108

1,997

2,1072,168

2,001

1,9101,845

1,8111,761

1,508

1,279

1,039

1,797

1,625

1,000

1,250

1,500

1,750

2,000

2,250

2,500

Num

ber o

f Tra

nsac

tions

$60

$70

$80

$90

$100

$110

$120

$130

$140

$150

$160

$170

$180

Transaction Value in Billions

Number of Deals Transaction Value

• The recent stagnation in loan volume and M&A activity is due to a

combination of:

– Continued poor economic conditions

– Lack of visibility into many borrowers’ future performance

– The underwriting standards of lenders still providing capital have

remained very tight

– Mismatch of buyer and seller expectations

6

Despite the improvement in the technical aspects of the market, the fundamentals remain weak . . .

Credit Quality – The Great Indicator

Percentage of Issuers with Outstandings in Payment Default or Bankruptcy


Market Dynamics

Source: Standard & Poor’s Ratings Direct

U.S. Speculative-Grade Default Rate and 12-Month Forward Forecast

0.0%

3.0%

6.0%

9.0%

12.0%

15.0%

De

fau

lt R

ate

s

U.S. Speculative-Grade Default Rate Default Rate Forecast Recession Bars

• Defaults have been rising and are expected to continue to increase

throughout 2009

• Increase in defaults delayed by:

– Covenant-light transactions

– Use of equity cures

– PIK toggle provisions

• According to LCD, EBITDA is down by an average of 15% vs. last

year; the reduction in EBITDA has resulted in an increase to total

leverage ratios

• Significant increase in restructuring activity is anticipated

7

Increase in Amendment ActivityThe deepening economic slump has sparked increased amendment activity

Leveraged Loan Market Monthly Amendments Dynamics of Amendment Activity


1

5

9

4

6

34

2

5

32

1

4

2 2

5

8

5

27

21

6

1514

12

17

29

19

10

33

44

66

49

62

20

1

0

5

10

15

20

25

30

35

40

45

50

55

60

65

70

Aug-0

6

Oct

-06

Dec-0

6

Feb-0

7

Apr-0

7

Jun-

07

Aug-0

7

Oct

-07

Dec-0

7

Feb-0

8

Apr-0

8

Jun-

08

Aug-0

8

Oct

-08

Dec-0

8

Feb-0

9

Apr-0

9

Throu

gh 6

/15/

2009

• As of June 16, 2009, there have been 192 amendments that have

been approved vs. 54 during the same period last year

• The economic recession has resulted in a steady increase in the

number of defaults. Lenders have been able to improve their

position by providing amendments and forbearance agreements for

existing credits

• Recent amendment activity has shown the following dynamics:

– Amendment Fees: On average, issuers paid 48 basis points

of amendment fees in May, down from 60 basis points in

1Q09

– Rate Increases: Raising rates are typically the highest

priority for lenders who provide amendments; the average

spread increase in May was 191 basis points, down from 204

basis points in 1Q09 and 202 basis points in 4Q08

– Reduction in line: 1Q08 through 2Q09 have shown more

amendments requiring a reduction in line commitments

– Paydowns: Approximately 10% of amendments over the first

five months of 2009 have required borrowers make a

paydown to the amount outstanding

2008 2009 % Change

YTD Approved Amendments 54 192 256%

8

Between 2004 and early 2007, the capital markets introduced new forms of debt financing and competition resulted in higher multiples, lower pricing and more flexible terms

Transition of Debt Capital Availability – “The Credit Bubble”

Limited Sources of Debt Financing Available Prior to 2004

RevolverTermLoan

Libor +275

Libor +325

SubordinatedNotes

22%

PreferredStock

27% 30%

CommonEquity

Revolver Term Loans

Libor +250

Libor +400 - 900

Libor +350

Last OutSenior

TrancheB

SecondLien Loans

Enterprise ValueSecond Lien Loans

Rate OnlySub Debt

15 - 17%

Sub DebtW/ Warrants

17 - 19%

PreferredStock

21 - 25% 25%+

CommonEquity

Traditional BanksFinance

Companies BDCs Hedge FundsInsurance

CompaniesMezzanine

FundsPrivate Equity

Funds

Increased Sources of Debt Financing and Competition by 2007

9

For about the past year and one half, there has been a continual reduction in both the number of lenders and the types of securities available

Current Market Liquidity

Current Landscape of Debt Financing

Revolver1 Term Loans1

Libor +

550 - 650 (Cash Flow)

300 - 400 (ABL)

Libor +

600 - 700 (Cash Flow)

350 - 450 (ABL)

Last OutSenior

TrancheB

SecondLien Loans

Rate OnlySub Debt

Traditional

16 - 20%

PreferredStock

18 - 23% 20 - 25%+

CommonEquity

Traditional BanksFinance

Companies BDCs Hedge FundsInsuranceCompanies

MezzanineFunds

Private EquityFunds

Sub Debt2

1.) LIBOR floor typically established for revolver and term loans; 300 – 350 basis point floor for cash flow loans and 200 – 250 basis point floor for asset-based loans

2.) Traditional sub-debt must include warrants or co-investment

• Continued decline in the number of active senior and second lien lenders

• Capital providers that remain are gravitating towards larger companies

• Senior debt with minimal amortization (Tranche B loans), as well as second lien loans and rate only subordinated debt, are rarely available

• Landscape gravitating back to conditions similar to those pre-“Credit Bubble”

10

Financing Sources – Current Landscape

Active lenders are seeing significant deal flow and have increased underwriting standards

• Primarily focused on large credits of higher quality (BB and above)

• New issue activity remains sparse

• Any lending to the middle market is primarily asset-based

Money Center Banks

• Primarily focused on large credits of higher quality (BB and above)

• New issue activity remains sparse

• Any lending to the middle market is primarily asset-based

Money Center Banks

• Recently retrenched from middle market lending

• Raising capital to shore up their own balance sheet issues

• Any lending done by regional banks is primarily asset-based

Regional Banks

• Recently retrenched from middle market lending

• Raising capital to shore up their own balance sheet issues

• Any lending done by regional banks is primarily asset-based

Regional Banks

• Trading under book value, restricting ability to raise new capital

BDCs

• Trading under book value, restricting ability to raise new capital

BDCs

• CLO vehicles continue to be capital constrained

• While some equity may be available, obtaining leverage is problematic

• Primarily recycling existing capital

CLO Vehicles

• CLO vehicles continue to be capital constrained

• While some equity may be available, obtaining leverage is problematic

• Primarily recycling existing capital

CLO Vehicles

• Many have exited or retrenched from the market

• The few that remain are seeing heavy deal flow

• Many are focused on larger companies and top tier sponsors

Commercial Finance

Companies

• Many have exited or retrenched from the market

• The few that remain are seeing heavy deal flow

• Many are focused on larger companies and top tier sponsors

Commercial Finance

Companies

• Facing issues related to broader capital markets, forcing some to exit the financing market

• Those who remain have gravitated towards larger deals, providing better returns

• Continue to be opportunistic and very yield-focused

Hedge Funds

• Facing issues related to broader capital markets, forcing some to exit the financing market

• Those who remain have gravitated towards larger deals, providing better returns

• Continue to be opportunistic and very yield-focused

Hedge Funds

• Funding source remains constant• Pricing has moved upwards• Usually now require warrants or co-

invest opportunities• Proliferation of deal flow resulting in

more selectivity

Mezzanine Funds

• Funding source remains constant• Pricing has moved upwards• Usually now require warrants or co-

invest opportunities• Proliferation of deal flow resulting in

more selectivity

Mezzanine Funds

11

33

72

81

6058

52

3634

28

66

80

98

110

49

-

20

40

60

80

100

120

Sources of Capital – A Changing EnvironmentWhile many traditional cash flow senior lenders have exited the market, senior asset-based

lending has increased in popularity

Source: Standard & Poor’s Leveraged Commentary and Data Source: Standard & Poor’s Leveraged Commentary and Data

Asset-based Lending as a Percentage of All Leveraged Loans

Most Active Pro Rata Investors (Lenders that Made Ten or More Primary Commitments)

53.5%

42.7%

5.3%

9.4%

5.4%7.1%

20.4% 20.9%

0.0%

20.0%

40.0%

60.0%

~54%

decline

12

Senior Lenders – A Changing Landscape

3.5x 3.4x 3.4x

3.1x

2.8x

3.1x3.0x 3.0x

3.4x3.7x 3.6x

4.7x

4.0x

3.7x

3.3x

2.9x

3.5x

2.1x

0.0x0x

1x

2x

3x

4x

5x

Decreasing availability of senior debt has driven senior leverage downwards and pricing upwards

Average Senior Debt Multiples of LBO Middle Market Loans


Note: Data on Average Senior Debt Multiples is not available for 1Q09 due to lack of market activity


Average Institutional Spreads of Middle Market Loans(Issuers with EBITDA of Less Than $50 million)

Market Dynamics

L+360 L+371L+396

L+438

L+367L+330

L+303L+281

L+344

L+400 L+415 L+428

L+600

L+499

L+000

L+100

L+200

L+300

L+400

L+500

L+600

L+700

1999

2000

2001

2002

2003

2004

2005

2006

2007

1Q08

2Q08

3Q08

4Q08

LI E

stim

ate

2009

• Senior cash flow lending for companies with under $10 million of EBITDA is extremely limited

• Cash flow loans are limited to companies with strong fundamentals that are perceived to be recession resistant

• Currently there are no underwritten deals in the market

• “Club” deals are more the norm, with hold sizes rarely exceeding $20-$25 million and often in the $10-$15 million range

• Due to the decline in financial performance in 4Q08, lenders are now less focused on TTM performance and more focused on the last six months

or 2009 run rate

• Senior lenders are increasingly focused on the “agency” role when deciding whether to participate in a transaction

• Increased amortization now required – focus on fixed charge coverage

• Any changes to the existing agreements (i.e., forbearance agreements, amendments, waivers) are resulting in a re-pricing of the outstanding loans

13

0

100

200

300

400

500

600

Asset Based All-in Institutional

Asset-based Lending – A Market Re-emergingAsset-based lending has been established as an attractive funding alternative

for companies with appropriate collateralAsset-based Spreads vs. BB/BB- All-in Institutional Spreads

Typical Asset-based Formulas

Asset-based Lending Market Dynamics


Note: Data on Asset-based Spreads is not available for 1Q09 and 2Q09 due to lack of market activity

• Accounts Receivable: 80% - 85%

• Inventory: 50% - 60%

• Real Estate: 60% - 70% of FMV

• Machinery and Equipment: 80% - 90% of OLV

Funding Availability

• Liquidity exists in this traditional structure provided an issuer has a

significant base of assets

• However, asset-based lenders are becoming more conservative and

focused on company fundamentals

Relative Cost Advantages

• Pricing has increased in tandem with the broader credit markets;

however, it remains lower than cash flow loans by approximately 200

- 250 bps

• Closing fees are increasing as negotiating leverage has returned to

the lending community

Not a Universal Remedy

• Not available for service businesses or companies with little base of

hard assets

• Increased reporting requirements

Reliability of Appraisals

• In light of the recent economic downturn, asset-based lenders have

begun questioning the reliability of asset appraisals and, as a result,

are reducing the amount of term loans they are prepared to provide

borrowers

14

Second Lien Loans – Middle MarketSecond lien loans relying on collateral may be a junior capital alternative when paired with

ABL first lien loans



Second Lien Loans as a Percentage of Mid-Market Volume

Second Lien PricingMarket Dynamics


Second Lien Quarterly Volume in the Total Market ($ in billions)

L+1033

L+893

L+654

L+720

L+661L+572L+559L+640

L+667L+664

L+729

L+513

L+583L+603

L+1069

L+300

L+450

L+600

L+750

L+900

L+1050

L+1200

0.0%0.6%0.6%1.6%1.7%0.9%

5.3%

11.5%

17.7%

9.2%

12.8%

8.7%

0%

5%

10%

15%

20%

25%

$4.4

$3.1$2.7

$1.8

$5.8

$3.9

$2.5

$4.1

$6.8

$5.7 $5.6

$10.2

$14.0

$2.4 $2.2$1.3 $0.9 $0.8

$0.0 $0.3

$11.2

$0

$2

$4

$6

$8

$10

$12

$14

$16

• Due to inter-creditor issues, second lien loans are no longer paired

with senior cash flow loans; however, opportunities are still

available when matched with asset-based loans

• Market conditions have once again begun to resemble the

environment in which second lien loans originated

– Asset-based lenders are becoming more conservative,

leaving more collateral value for second lien lenders

– Higher priced sub-debt leaves the door open for an additional

security

15

Mezzanine Debt – Growing in PopularityMezzanine debt has become all but essential in completing any kind of financing

Market Dynamics


Note: Data on Average Total Debt Multiples is not available for 1Q09 due to lack of market activity

Average Total Debt Multiples of Middle Market LBOs

4.7x4.8x

4.1x4.0x

3.4x

3.9x3.8x

4.2x4.7x 4.7x

5.1x

6.2x6.0x

5.6x

4.5x4.1x

Sub Debt as a Percentage of Total Leverage (Issuers with EBITDA of Less than $50 million)

4.7x

2.6x

Mezzanine Pricing

All Other Debt

87.8%

Sub Debt12.2%

2007

All Other Debt

95.7%

Sub Debt4.3%

2008


• Cash coupons of 12% - 14%

• PIK rates of 2% - 4%

• Closing fees of 2% - 4%

• All-in yields of 16% - 20%

• Warrants are increasingly required; co-investments are becoming

less of an alternative to warrants

• Pre-payment penalties are increasingly stringent and make-whole

provisions are becoming more prevalent

• Mezzanine debt is now being used more frequently to:

– Support LBO transactions due to reduced levels of senior

debt

– De-leverage companies that have excess senior debt

– Perform dividend recapitalizations to replace failed M&A sale

processes

16

Leverage and pricing have tightened over the past three years

Mezzanine Financing – A Changing Landscape

Overview of Transaction Terms (2007 – 2009)

Source: PNC Mezzanine Capital 2009 Mezzanine Market Survey

84.6%86.2%77.3%% of Transactions with Warrants or Equity Buy-In

19.6%18.9%18.0%Average IRR

1.9%2.5%4.5%Five-Year Treasury

17.7%16.4%13.5%Average Spread

3.0%2.4%2.5%Average PIK

% of Transactions with Warrants

Average Equity Ownership

Average Leverage (through Mezzanine)

Average Maturity

Average Fee

Average Cash Coupon

Category 200920082007

55.2%43.6%37.5%

10.1%9.0%7.2%

3.6x3.5x4.0x

5.8 years6.1 years6.2 years

2.3%2.3%1.9%

12.3%12.1%11.8%

84.6%86.2%77.3%% of Transactions with Warrants or Equity Buy-In

19.6%18.9%18.0%Average IRR

1.9%2.5%4.5%Five-Year Treasury

17.7%16.4%13.5%Average Spread

3.0%2.4%2.5%Average PIK

% of Transactions with Warrants

Average Equity Ownership

Average Leverage (through Mezzanine)

Average Maturity

Average Fee

Average Cash Coupon

Category 200920082007

55.2%43.6%37.5%

10.1%9.0%7.2%

3.6x3.5x4.0x

5.8 years6.1 years6.2 years

2.3%2.3%1.9%

12.3%12.1%11.8%

17

The global credit crunch has even impacted private equity groups

Private Equity Funds – Tightened Liquidity

Market Dynamics

Source: Dow Jones Private Equity Analyst

Fund Sizes through April, 2008 and 2009U.S.-Based Fundraising by Quarter

Source: Reuters’ Buyouts

$16.4

$2.6 $2.6$2.6 $1.1

$22.3

$0.8$1.4

$6.2

$56.2

$0

$10

$20

$30

$40

$50

$60

(Dolla

rs in

Billio

ns)

Buyouts/Corporate Finance Venture CapitalFund of Funds MezzanineOther Private Equity

$0

$30

$60

$90

$120

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(Dol

lars

in B

illion

s)

Q1 Q2 Q3 Q4

• After years of robust fund raising, private equity groups are finding LPs reluctant to commit additional capital to the sector; as a result, private

equity groups are having trouble raising new funds

• Private equity groups are also encountering issues in deploying capital:

– The “denominator” effect is causing some limited partners to back away from funding their original commitments – an unprecedented event

– Many groups have found that difficulty in finding leverage makes traditional investing problematic

– A trend has developed towards more creative investing that offsets leverage issues; an example of this is minority investments

18

7.5x7.1x 6.9x

5.9x6.7x 7.0x

8.5x 8.3x

9.3x

8.1x

7.2x

.0x

3.0x

6.0x

9.0x

12.0x

Senior Debt/EBITDA Mezzanine/EBITDA Equity/EBITDA Others

• Overall M&A activity has slowed significantly

• Equity as a percentage of total capitalization is at an all time high

• Financial buyers are having to commit higher levels of equity with a

view of refinancing when credit markets recover

• The following have become useful methods of bridging the financing

gap:

– Seller notes

– Earn outs

– Purchasing less than 100% of the company

– Minority equity investments

LBO Middle Market ActivityCurrent conditions in the leveraged loan market are influencing M&A activity

Source: Factset Mergerstat; Note: Transaction Values between $10 million and $250 million

Note: Data on Purchase Price and Equity Contribution is not available for 1Q09 due to lack of market activity

Average Equity Contribution by Sponsors of LBO Loans

Market Dynamics

Source: Standard & Poor’s Leveraged Commentary and DataNote: Data on Purchase Price and Equity Contribution is not available for 1Q09 due to lack of market activity

Average Purchase Price and Equity Contribution (Issuers with EBITDA of Less Than $50 million)

20%

25%

30%

35%

40%

45%

19

Leveraged Loan Markets - ConclusionCurrent and forthcoming market conditions call for specific keys to complete a financing

Predictions and Key Take Aways

• Overview of financing sources for 2Q – 4Q 2009

– An increased dependence on asset-based

loans

– Minimal near-term return of cash flow

lending

– The potential return of second lien loans

(resembling more classic Second Liens)

– A continued dependence upon mezzanine

financing

• A surge in amendment activity as covenants

begin to tighten in later years

• A decrease in recoveries

• Private equity groups may start getting impatient

sitting on the sidelines

• Sellers may have to adjust to a new reality

Predictions for Market Dynamics in 2Q – 4Q of 2009

• Need to conduct broad process of contacting

financing sources

• Must have relationship with an experienced deal

champion within the lending organization to

ensure reliable and timely feedback on the

transaction

• Propose an appropriate capital structure that

meets market expectations

– In today’s market this means maximizing

ABL and subordinated debt financing

sources

• Expect longer, more time-consuming process

with increased due diligence

Keys to a Successful Financing

Documents

1 ACG St. Louis The State of the Credit Markets June 19, 2009 Ronald Kahn Managing Director Lincoln International LLC (312) 580-6280 [email protected]