LPs turn to mezzanine

In an era marked by uncertainty and volatility in the financial markets, limited partners are increasingly looking to the down-side protection offered by mezzanine investment as an attractive component of their alternatives or fixed income portfolios. This is particularly relevant as many investors struggle to maintain acceptable cash yields in the current interest rate environment. 

The opportunity for sponsored mezzanine lenders is further supported by the lack of financing alternatives for buyout groups. The willingness and ability of senior lenders to provide all the financing for acquisitions, as was the case just a few years ago, has significantly diminished. Mezzanine has stepped in to fill the void and so the industry is seeing ample deal flow overall.

Take a generic buyout deal today –senior debt may comprise a total of 3x or 3.5x EBITDA of the total capital structure of an acquisition. In 2006 or 2007, the level provided might have been upward of 5x EBITDA, leaving much less room for mezzanine lenders. The challenges faced by the banks today has resulted in their reluctance to lend at the same leverage levels we witnessed in peak years and resulting in better opportunity for mezzanine investors.

Thomas Haubenstricker

Another driver of growth for this asset class has been LP recognition of key mezzanine characteristics that include a short, mitigated J-curve and constant cash flow.

This is particularly important to investors who went through 2008 and 2009, where realisations dried up and LPs had very little cash flow coming in. LPs with big commitments were concerned about liquidity positions to fund capital calls because they weren’t getting distributions.

During this time, cash flow from interest payments started to gain appeal, along with the strategy’s return profile, which generally falls into the mid-teens. The risk profile for mezzanine investments also attracted LPs, as the investments sit above equity in the capital structure, and with more equity being used in deals than ever – the strategy offers potentially more protection than in the past.

We have been active in this space for more than 20 years and have seen a number of cycles and market trends. While future market dislocations cannot be discounted, the current macroeconomic environment of constrained credit and slow economic growth is expected to produce high quality investments for experienced mezzanine lenders going forward. We believe we are witnessing the true maturation of mezzanine debt as a viable asset class – and one that has offered consistent returns. Our observation of LP interest has only validated this view.

Thomas Haubenstricker is the CEO of New York Life Capital Partners.