June 11, 2015

ACIC CLE Presentation

Middle Market Lending: A Primer and

Market Update
Sutherland Asbill & Brennan LLP:
Peter A. Fozzard | 404.853.8330 | Peter.Fozzard@sutherland.com
Brennan A. Posner | 404.853.8183 | Brennan.Posner@sutherland.com

Allstate Insurance Company:

Alfredo M. Cantoral | 847.402.6187 | Alfredo.Cantoral@allstate.com

©2015 Sutherland Asbill & Brennan LLP www.sutherland.com

Table of Contents

• Presenters
 Peter A. Fozzard (Sutherland)
 Brennan A. Posner (Sutherland)
 Alfredo M. Cantoral (Allstate)
• General Overview
• Middle Market Statistics
• Typical Middle Market Loan Products
• Notable Loan Provisions
• Market Trends in Loan Terms

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Presenters
Peter A. Fozzard, Partner,
Sutherland Asbill & Brennan LLP
Working with lenders and borrowers, Peter Fozzard helps
these clients finance energy, telecommunications,
agricultural and other corporate operations and project
development. His finance background includes senior,
second lien and subordinated commercial financings;
private placements and other taxable long-term debt
issuances; government-guaranteed financings; project
financing; public, pollution control and industrial revenue
bond issuances; commercial paper offerings; lines of
credit; and letter of credit transactions.
3 ©2015 Sutherland Asbill & Brennan LLP
Brennan A. Posner, Counsel,
Sutherland Asbill & Brennan LLP
Brennan Posner represents clients in a wide variety of
commercial lending, structured finance and project
finance transactions. His finance background includes
senior, second lien and subordinated financings; working
capital and leveraged acquisition financings; accounts
receivable financings; loan portfolio financings, including
collateralized loan obligation (CLO) transactions and
warehouse facilities; timber installment note transactions;
total return swaps; and receivables securitizations. He
also helps both borrowers and lenders finance oil, gas
and electric projects.
Presenters (cont.)

Alfredo M. Cantoral, Attorney,

Allstate Insurance Company
Alfredo Cantoral is an attorney for the Allstate Insurance
Company’s investment division. Alfredo counsels
clients on private equity fund, direct, and co-
investments, middle market lending, structured
securities (including management of and investment in
CLOs), and distressed investments. Prior to joining the
investments legal team, Alfredo served as a public
policy attorney, responsible for developing regulatory
strategy at the state and federal level on issues
important to Allstate, including implementation of the
Dodd-Frank Act, regulation of credit rating agencies,
regulation of the connected car, and e-commerce
developments. Prior to joining Allstate, Alfredo was a
corporate associate at Whyte Hirschboeck Dudek S.C.,
a major Milwaukee law firm. He received his J.D. from
Marquette University Law School and his B.S. in
Economics from Marquette University’s College of
Business Administration.

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General Overview

• What is the “middle market”?

 Size of the borrower
 Annual revenues less than $500MM or annual EBITDA
less than $100MM
 Size of the loan
 Loan size less than $500MM, with “lower” middle market
less than $30MM, “traditional” middle market $30MM to
$100MM and “upper” middle market $100MM to
$500MM
 Above the middle market is the “large cap” loan market

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General Overview (cont.)

 Other typical characteristics

 Private deals; more relationship driven; more club deals
 Some variation among middle market segments
 Less liquidity due to lenders holding for the term of the
deal (liquidity is a matter of the market, not a provision of
the credit agreement)
 Often secured; certain loan products more typical
 More robust covenant packages
 Less robust/developed reporting than for large cap
borrowers

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General Overview (cont.)

• Recent Developments/Shifts in the Middle Market

 Competition for middle market loans has increased
significantly
 The “middle market” classification has widened
 Portion of middle-market loans held by U.S. banks has
declined while participation by non-bank/alternative lenders
(e.g., insurance companies, asset managers, business
developments companies) has increased
 “Leveraged lending guidance” and other regulation
effecting commercial banks’ liquidity, capitalization and
lending practices impacting cost / appetite
 New products have emerged (e.g., unitranche)

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General Overview (cont.)

 Continued “convergence” of certain large cap borrower

flexibility among segments of middle market
 With increased competition, borrowers (particularly, but
not limited to, sponsor owned borrowers) are again
pushing the envelope on leverage multiples and
covenant flexibility (“market” is their last deal or most
favorable deal they can find on their list)
 Insurers are becoming increasingly interested in middle
market loans as they continue to increase risk tolerance in
search of higher yields

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Middle Market Statistics

• Volume on the Rise

 Source: Thomson Reuters LPC; Large Middle Market Deal Size $100MM to $500MM; Traditional
Middle Market Deal Size Less Than $100MM

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Middle Market Statistics
(cont.)

• Leverage on the Rise

4.8x 4.8x 5.0x

4.3x 4.2x 4.3x
3.4x 3.7x

2007 2008 2009 2010 2011 2012 2013 2014

 Source: S&P LCD

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Typical Middle Market Loan
Products

• Cash Flow Loans

 Loan against expected cash flows of borrower
 Financial maintenance covenants to monitor/ensure healthy
cash flows (e.g., leverage test, interest coverage, fixed
charge coverage)
 All assets security interest
• Asset Based Loans (ABL)
 Loan against a certain category of “eligible” assets (e.g.,
receivables, inventory; to a lesser extent, PP&E, IP,
investments, etc…)
 Fewer and/or less onerous maintenance covenants
 Frequent and detailed collateral reporting
 Security interest in assets lent against, sometimes more
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Typical Middle Market Loan
Products (cont.)

• Senior Stretch Loans

 Hybrid loan with cash flow and ABL characteristics
 Typical where there is an issue with cash flows but not the
asset base, or vice versa
• Second Lien Loans
 Second lien lender’s security interest in collateral ranks
behind another lender with first priority (but, typically no
payment subordination)
 Amortization heavily backloaded
 Usually cheaper than mezz and benefit of no equity dilution

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Typical Middle Market Loan
Products (cont.)

• Mezzanine Loans and Subordinated Loans

 “Mezz” describes a tier in the capital structure between debt
and equity
 Unsecured or “silent” second lien, typically with significant
payment subordination
 Low amortization (e.g., less than 1% per annum) or none at
all
 Interest part cash pay and part “payment-in-kind” (PIK)
 Maturity usually at least 90 days after the senior
 Covenants and default thresholds set at 5% to 15% cushion
to senior level
 Often equity participation in the form of a warrant, option,
convertible or co-commitment feature
 Call protection in the form of prepayment premiums
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Typical Middle Market Loan
Products (cont.)

• Unitranche
 Combination of senior and sub debt into a single facility with
a blended rate of interest
 Usually “closed club deals”, with same group of lenders
participating in a number of deals together
 Lien and payment priorities dealt with in an “Agreement
Among Lenders” or “AAL” that borrowers are not party to
and may not even see
 Single facility simplifies financing process and may reduce
transaction costs for borrowers
 Bankruptcy Concern: Jurisdiction of bankruptcy court to
enforce AAL

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 Typical Middle Market
Loan Products (cont.)

• High-Yield Offerings (and Term Loan B Loans)

 Longer maturities
 Limited amortization
 More flexible covenants
 More market driven
• Debt Stack Examples
 Senior secured cash flow or ABL loan
 Second lien loan
 Junior, unsecured mezz loan
 Split lien structure (e.g., ABL revolver with a first lien on
current assets and term loan with a first lien on fixed assets)
 High yield bond offering pari passu with ABL or term loan B

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Notable Loan Provisions

• Maintenance/Financial Covenants
 Maximum leverage tests (total or senior)
 “Net debt” concept becoming fairly common
 Minimum interest or fixed charge coverage tests
 “Cov-Lite” = No or “springing” financial maintenance
covenants
 Cushion to projections may make deal effectively cov-lite
 Equity Cure Rights

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Notable Loan Provisions
(cont.)

• Mandatory Prepayments
 Excess cash flow, asset dispositions, casualty and
condemnation events, debt incurrence (other than permitted
debt) and equity issuance (though less common)
 Reinvestment rights for asset sales and
casualty/condemnation events
 Varying prepayment thresholds, exceptions, etc…
• Limitations on Other Debt / Liens
• Limitations on Acquisitions / Investments
• Restricted Junior Payments
 Limits distributions to equity holders, equity redemptions,
often payments on junior debt, and sometimes sponsor
payments (though often dealt with in limitations on affiliate
transactions)
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Notable Loan Provisions
(cont.)

• Call Protection
 Only with certain products, and now often only “soft call”
protection – Repricing event within 6 to 12 months of closing
 Different than a true prepayment penalty / make whole
• Incremental Facilities
 Permits the incurrence of addition debt that is parri passu in
right of payment and lien priority
 Limiters vary
 “Most Favored Nation” pricing provisions
• Amend & Extends; Refinancing Facilities

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Market Trends in Loan
Terms

• Overall Themes:
 Strong competition for deal flow is allowing borrowers and
PE sponsors to push for more borrower-friendly loan terms
 Convergence of the high yield bond / large cap markets and
the middle market
 Novel sources of competition, such as unitranche
 Traditional lenders are losing market share to BDCs and
other unitranche providers
 Unitranche typically cheaper on a blended basis than a
traditional first lien / second lien structure

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Market Trends in Loan
Terms (cont.)

• Examples:
 Ratio debt baskets
 “Free and clear” basket
 Grower baskets
 Builder baskets
 Reclassification rights
 Uncapped permitted acquisitions
 Financial covenants
 EBTIDA add-backs
 Indebtedness net of cash and cash equivalents
 Equity cure rights
 Sunguard conditionality

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Market Trends in Loan
Terms (cont.)

 Disqualified lender concepts; sponsor or borrower loan

assignments/purchases
 Sponsor counsel control of loan documentation
 Excluded collateral
 Slippage in mandatory prepayment scope
 Less call protection
 Increased inclusion of LIBOR floors

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