Friday letter: Mezz – a private revival

The syndicated mezzanine remains weak, but fans of the product should not despair. It has adopted the direct lending approach to stage a comeback

The death of mezzanine has been declared more than once. In the wake of the credit crisis, the risky end of debt suffered as both borrowers and lenders battened down the hatches and forwent the extra turn or three of leverage on offer from a subordinated tranche. 

And like the year before, the syndicated market for mezzanine shows little sign of revival in 2015. In Europe, the Middle East and Africa (EMEA), issuance hit a 2015 high of $150 million in March. Volumes in May totalled $90 million, according to S&P Capital IQ.

In the US, volumes are higher but the market is still moribund compared to its pre-crisis heyday. Stripping out a bumper January when North American mezzanine issuance totalled more than $4 billion, average monthly issuance between February and May 2015 was around $1.3 billion, says the S&P Capital IQ data.

But in the private market, deeply subordinated debt appears to be having a cautious revival in both the US and EMEA. This week PDI reported on a $500 million mezzanine deal provided by Highbridge and Partners Group in support of the merger of Lightower Fiber Networks and Fibertech Networks. 

Commenting on the trend, Bill Brady, a partner with law firm Proskauer, said that for his firm, mezzanine financings made up just four percent of the debt deals they worked on in 2014. So far this year, however, that four percent figure has been well outstripped, he confirmed. It’s a small sample size, he admitted, but from his perspective, the jump start in mezzanine is real.

Capital raised as well as funds still in the market suggest lenders are confident that they can deploy. KKR is hitting the road with its newest fund. Morgan Stanley Credit Partners raised $1 billion for its mezz strategy in January. In the Nordics, Armada recently closed its €107 million third fund. The $1 billion Audax Mezzanine Fund IV is gaining traction while earlier this week, an affiliate of France’s ACG Capital, ActoMezz, announced that it had broken its €200 million target by raising €210 million for FPCI Acto Mezzanine II.

Meanwhile Babson’s Gateway Mezzanine Fund II raised $177 million for its Asia-Pacific-focused strategy, demonstrating that the interest extends beyond Europe and North America. 

Key to this movement is the retreat from the syndicated market. Mezz providers are adapting to the new environment. The investors and managers who have stuck with the instrument are taking a direct lending approach to origination. 

In ICG’s most recent invested mezz fund, Europe Fund V – which closed at €2.5 billion in early 2013 could be described as the daddy of European mezz vehicles – around 90 percent of the deals were for sponsorless borrowers. The London-based firm’s originators cultivate relationships and apply a flexible approach to structuring that puts their facilities in territory beyond the standard packaging of a syndicated deal. 

Private clubs are the way Brady’s clients are originating and executing their mezzanine transactions, he added. And the senior lenders are a mix of bank and non-bank providers.

There’s a suggestion that this quiet revival is driven by some reluctance on the part of both bank and non-bank lenders to do that extra turn of leverage. Under pressure from the SEC on leverage levels, that’s not surprising in the US. But it doesn’t change the fact that sourcing mezz deals is now much more labour-intensive than pre-crisis. 

And the key to success are the same skills that mark out the best direct lenders – strong relationships and flexibility. Some things really do never change.