November 2016 By the Chartwell Capital Markets Team MINNEAPOLIS – November 8, 2016 – As a follow-up to our last commentary, equity capital markets have experienced a weak stretch as both the Dow Jones Industrial Average and the S&P 500 declined for a third straight month in October. Investors continue to exhibit cautiousness in light of unease surrounding interest rates, the ongoing drag from the energy sector, and political uncertainty regarding today's U.S. presidential election. These factors have weighed on equity markets despite recent acceleration in the U.S. economy. However, although gross domestic product advanced at a 2.9% inflation-adjusted annual rate in the third quarter (its strongest pace in two years), underlying data displayed slower growth in consumer spending, sluggish business investment, and contraction in the housing sector. While the end of the election cycle could ease some uncertainty about the path ahead, investors remain cautious for the time being. Despite a 14% decline in middle market loan issuance during the third quarter, debt investors remain determined to deploy capital as evidenced by strong leverage multiples. Notwithstanding prolonged concerns related to market volatility, debt investors continue to move quickly and aggressively to win roles in financing opportunities. On the heels of record deal value and volume in 2014 and 2015, high quality targets in the current market continue to command considerable attention and interest. Fundamentally sound companies with leading market share positions, true competitive advantages, and significant differentiating characteristics in their operations are successfully accessing capital. In the analysis below, we have laid out our view on the current state of the debt capital markets. INTEREST RATES REMAIN NEAR HISTORICAL LOWS, BUT ARE EXPECTED TO TREND UPWARDS Interest rates, as measured by 10-year Treasuries and 3-month LIBOR, remain at historic lows when compared to their 20-year averages of 397 bps and 264 bps, respectively (as of October 27, 2016). Source: Capital IQ From a forward-looking perspective, there is a high likelihood of a rising interest rate environment. Although the Federal Reserve left rates unchanged at its November meeting, a December rate hike is widely expected. MIDDLE MARKET LOAN VOLUME PICKS UP FROM TEPID START IN Q1, BUT DOES NOT MAINTAIN LEVERAGE LEVELS SEEN IN 2015 Source: Thomson Reuters*Note: Traditional MM: Deal Size <=$100M, Large MM: Deal Size >$100M to $500M, For all: Borrower Sales <$500M Middle market lending totaled $88 billion from Q1 to 3Q 2016, down from $103 billion in the same period a year ago. Year-to-date middle market volume is comprised of $66 billion of large middle market issuance (down 12% YoY) and $22 billion in traditional MM volume (down 20% YoY). Middle market loan issuance declined by 14% in the third quarter to $28 billion. DESPITE LOWER LOAN VOLUMES, LEVERAGE MULTIPLES REMAIN STRONG Leverage in the third quarter continued to reflect underlying strength in the middle market, with total leverage multiples exceeding 6.0x all-in for non-cyclical and market leading issuers. Source: Thomson Reuters At 6.0x year to date, average debt to EBITDA levels for broadly syndicated LBO transactions are similar to 2015 levels. Leverage fell to 5.2x for institutional middle market LBOs as fewer deals went the syndicated route and there has been a greater share of lower quality deals this year. SENIOR LOAN PRICING CONTINUES TO INCREASE All-in pricing has trended upward during the past four quarters, driven by increasing LIBOR and aforementioned high senior leverage multiples. Source: BMO Sponsor Finance The current interest rate environment is highly attractive as looming Fed rate hikes continue to drive PE activity ahead of the expected increases. Anticipation of new money market regulations continue to push up bank funding costs – a strong jobs report in July nearly sent the 3-month LIBOR above 0.8% for the first time since May 2009.