The Current State of the

Capital Markets

Today and Tomorrow

September 2016

September 26th, 2016

S&P 500 Index at Infliction Points

Copyright 2016 Kanaly Trust All rights reserved.

Source: Compustat, FactSet, Standard & Poor’s, J.P. Morgan Asset Mgmt.

International Equity Earnings and Valuations

Copyright 2016 Kanaly Trust All rights reserved.

Source: Compustat, FactSet, MSCI, Standard & Poor’s , J.P. Morgan

Cumulative Net Flows into Equity vs. Bond Mutual Funds

Copyright 2016 Kanaly Trust All rights reserved.

Source: Strategas Research

01/01/08 through 07/31/16

Cumulative Net Flows into Equity vs. Bond Mutual Funds & ETFs

Copyright 2016 Kanaly Trust All rights reserved.

Source: Strategas Research

$BN, 01/01/08 through 07/31/16

Nonfinancial Corporate Business:

Copyright 2016 Kanaly Trust All rights reserved.

Source: Strategas Research

Corporate Equities Net Issuance ($Bil)

Year 2004-2016

Copyright 2016 Kanaly Trust All rights reserved.

Source: FactSet | WSJ.com

Copyright 2016 Kanaly Trust All rights reserved.

Rolling the Dice Investors grappling with lower interest rates have to take bigger risks if they want to equal returns of two decades ago.

Estimates of what investors needed to earn 7.5%

Bonds

U.S. Large Cap

U.S. Small Cap

Non-U.S. Equity

Real Estate

Private Equity

*Likely amount by which returns could vary

Source: Callan Associates The Wall Street Journal.

10

THE CURRENT STATE OF THE CAPITAL MARKETS

MIDDLE MARKET M&A + PRIVATE EQUITY UPDATE

CLIFF ATHERTON | MANAGING DIRECTOR | SEPTEMBER 2016

11

Source: Thompson Reuters

“The Worst Quarter Since 2009” - Mergers and Acquisitions, June 2016

MIDDLE MARKET M&A DEAL FLOW – JANUARY THROUGH JUNE

266 212

93 144 161 124 156 175 191 129

199 176

68

108 110 99

108 121 156

119

206

138

75

113 126 113

113 134

148

116

220

181

76

123 155

138 140

163

168

119

189

133

66

107

151

137 112

127 111

103

223

164

84

146

153

154 94

174 171

70

0

200

400

600

800

1,000

1,200

1,400

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Jun

May

Apr

Mar

Feb

Jan

1,303

1,004

462

741

856

765 723

894 945

656

Q2 2009: 226 Deals

Q2 2016: 292 Deals

12

Middle Market Deal Parameters Have Been Relatively Stable

TEV/EBITDA

Source: GF Data M&A Report; Transactions from $10 Million to $250 Million

5.6x 5.8x

6.0x

5.6x

5.9x 6.0x

7.3x 7.4x 7.5x

7.8x

9.0x

8.3x

6.5x 6.6x

6.8x 6.7x

7.5x

7.2x

4.5x

5.0x

5.5x

6.0x

6.5x

7.0x

7.5x

8.0x

8.5x

9.0x

9.5x

2003-2011 2012 2013 2014 2015 YTD 2016

$10-25 MM $100-250 MM Avg $10-250 MM

SIZE PREMIUM PERSISTS – SOME COMPRESSION IN 2016 UP A FULL TURN – SENIOR LENDERS HAVE LED THE WAY

DEBT/EBITDA MULTIPLES

2.1x 2.4x 2.4x 2.6x 2.7x

3.0x 3.0x

0.9x

1.0x 1.1x 0.8x 1.0x

0.9x 0.9x

0.0x

0.5x

1.0x

1.5x

2.0x

2.5x

3.0x

3.5x

4.0x

4.5x

2010 2011 2012 2013 2014 2015 2016 YTD

Senior Debt / EBITDA Sub Debt / EBITDA

Multiple Multiple

3.0x

3.4x 3.5x 3.4x

3.7x 3.9x 3.9x

13

$139

$226

$178

$0

$100

$200

$300

$400

$500

$600

2007 2008 2009 2010 2011 2012 2013 2014 2015

Cu

mu

lati

ve D

ry P

ow

de

r

Cumulative Dry Powder Under $1B $1B-$5B $5B+

Fund Size

Private Equity Buyers Have Significant Capital to Deploy

Source: PitchBook

DRY POWDER BY FUND SIZE DRY POWDER BY YEAR FUNDS WERE RAISED

Total Dry Powder

$543MM

$33

$73

$34

$0

$20

$40

$60

$80

$100

$120

$140

$160

2008 2009 2010 2011 2012 2013 2014 2015

Dry

Po

wd

er

by

Vin

tage

Ye

ar

Under $1B $1B-$5B $5B+

Fund Size

24.3%

51.9%

23.8%

32.6%

41.7%

25.7%

($ in millions)

14

Historical Overview – Oil Prices and Treasury Yields

CRUDE OIL WTI ($/BBL) AND 10-YEAR TREASURY YIELDS – SEPTEMBER 1980 TO TODAY

0%

2%

4%

6%

8%

10%

12%

14%

16%

$0

$20

$40

$60

$80

$100

$120

$140

Crude Oil Price 10-Yr. Treasury Yield

Source: FactSet

Oil Price Treasury Yield

15

Federal Reserve Notes

$1,424,422 32%

Deposits $2,382,028

54%

Other Liabilities $327,370

7%

Capital $325,574

7%

The Fed: We’re Not in Kansas Anymore…

Source: Federal Reserve Banks and the U.S. Department of the Treasury

$-

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

Trill

ion

s

Federal Reserve Notes

$795,563 87%

Deposits $33,417

4%

Other Liabilities $49,183

5%

Total Capital $40,383

4%

EXCESS RESERVES OF DEPOSITORY INSTITUTIONS JULY 2008 – “KANSAS”

SEPTEMBER 2016 – “OZ”

$0.0 $1.0 $2.0 $3.0 $4.0 $5.0

Jul-08

Total Assets

($ in millions)

$918,546

$0.0 $1.0 $2.0 $3.0 $4.0 $5.0

Sep-16

Total Assets

$4,459,394

16

What will stop the music?

Credit Markets

What could spook them?

Inflation?

Drop in oil price (deflation)?

Macroprudential Policy?

Presented to the September 2014

Boyar Miller Breakfast Panel

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$85

$90

$95

$100

$105

$110Prices During 2014

Crude Oil Price Natural Gas Price

17

$ in billions $ in billions

Destruction of Value in the Energy Sector

INDEPENDENT E&P1

Source: FactSet

OILFIELD SERVICES2

1 Includes Anadarko, Antero, Apache, Cabot, Canadian Natural Resources, Chesapeake, ConocoPhillips, Consol, Continental Resources, Devon, EnCana, EOG, Hess, Linn Energy, Marathon, Noble, Occidental Petroleum, Range Resources and Southwestern Energy

2 Includes Baker Hughes, Basic Energy, Cameron, DXP, Emerge, Exterran, FMC, Forum Energy, Halliburton, Key Energy, National Oilwell Varco, Newpark Resources, Oceaneering, Oil States, RPC, Schlumberger, Seventy Seven, Superior, Tidewater and Weatherford

11%

29% 31%

34%

51% 53%

51%

43% 41%

0%

10%

20%

30%

40%

50%

60%

70%

80%

$–

$100

$200

$300

$400

$500

$600

$700

$800

11%

32% 35% 34%

47% 48%

47%

43% 45%

0%

10%

20%

30%

40%

50%

60%

70%

80%

$–

$50

$100

$150

$200

$250

$300

$350

$400

John Sarvadi – Houston Market President

Middle Market Senior Debt Themes

September 29th, 2016

$21 billion Texas-based commercial and private client bank … but 50% of loans originated outside of Texas

One of the fastest organically grown financial institutions in U.S. history

Middle market focused lender with core competency in leveraged finance

Approximate market capitalization of $2.5 billion

19

Texas Capital Bank Overview

Dallas Fort Worth

San Antonio

Austin

Houston

“I remember when my mortgage was 10%...”

20

Interest rates remain low, debt is cheap, and investors are chasing yield …

The Fed last raised funds rate in December ‘15 for the first time in nearly a decade .

- Fed seems divided among

hawks/doves, but signaling for a post-election increase.

But absent dramatic change in the global economy, are we in a “low for long” environment?

4.8% 10yr UST AVG

Takeaway

Macro Environment US Rate Comparison

Borrowers … take advantage of market conditions

New debt capital from BDCs & private credit funds flooding credit markets

Bank margins depressed … pushing for ancillary business to improve bottom line

Impact On the Middle Market

21

Leverage multiples at near historic highs Abundant non-bank capital available for financing replacing bank debt … How long will it last?

‒ Unitranche structures becoming

more common

‒ BDC market capitalization at all time high of +$30 billion

Middle Market LBO multiples up from ‘12-’14 but have fallen through 2Q’16 …

- Decrease driven by economic

uncertainty? the election? Or…..

Effects Transaction Trends

“It may not feel like it, but the “recovery” is long in the tooth.”

22

+7yrs…

Source: WSJ Data as of July 29, 2016

5.2yr AVG

Takeaway What are the chances of continued expansion vs. possible contraction or recession?

Credit cycle peaking?

Despite lower growth than past recoveries (2.1%), the current expansion is much longer than previous business cycles Globally, monetary options seemingly exhausted

Lingering concern over China and Europe However, US unemployment lower and inflation stable … rate hike imminent?

US Economy Length of Expansions Since 1949

“I’m from Washington and I’m here to help.”

23

Takeaway

Bank regulatory oversight has dampened risk appetite for levered transactions

‒ OCC guidance of 3x senior

and 4x total leverage

Likely eventual significant regulatory infiltration into non-bank sources of capital

Regulatory Environment

Ultimately, greater regulation and cost in the system could lesson availability of credit during future cycles.

Advice to Debt Market Participants

24

1) Raise capital opportunistically, when you can, not when you need it.

- Extend maturities , reprice, amend covenants, even when you don’t need to.

2) Watch capital flows.

- Pay attention to what happens in public debt and equity markets … influences the middle market.

3) Keep relevant financing information updated/fresh.

- Bankers who know you/your story are your friend when the credit pendulum starts to swing.

4) Take capital providers up on their offers for lunch.

- Maintain your relationships, even when no transaction is imminent.