Defaults up as European mezz market doubles

Highly-leveraged buyouts drove up European mezzanine volume in 2005, but default rates have also increased, according to Fitch Ratings.

The European mezzanine market totalled a record €10.7 billion ($12.75 billion) in 100 deals in 2005, almost double that of 2004’s record €5.8 billion in 68 deals, according to credit ratings agency Fitch Ratings.

However, Fitch also reported a record volume of mezzanine defaults. There was €539 million of mezzanine defaults in 2005, equating to a 3.3 percent annual default rate. Fitch said that while this is smaller than the volume of defaults in the high yield bonds market – which was €713 million – it was nonetheless of concern due to the comparative lower scale and depth of the mezzanine market.

“Strong demand points to a maturing market but high leverage, not always supported by business valuations, increased refinancing risk in back-ended debt structures, less frequent use of warrants and further subordination by second lien, all point towards increasingly equity-type risks for mezzanine investors,” said Pablo Mazzini, director in Fitch’s leveraged finance team, in a statement.

Fitch said that, in the long term, mezzanine was likely to be the subordinated debt instrument of choice for sponsors for tranches as large as €500 million, with high yield bond investors increasingly lending to “larger than ever LBOs and crossover corporates”.

The use of mezzanine facilities rather than high yield bonds in the Gala and Yellow Brick Road LBOs, said Fitch, was evidence of both the increasing popularity and maturity of the asset class