Mezzanine investors could be forgiven for feeling nervous going into 2017. The boost they have received in recent years from regulations that have forced traditional lenders to live within tighter boundaries and pushed borrowers into the private debt space looks as if it may be ending.
President Donald Trump has pledged to reverse Dodd-Frank banking laws, but, even if this happens, will banks stampede back into private credit? Will it make mezzanine debt less attractive to non-bank lenders?
Peter Antoszyk, a partner at law firm Proskauer Rose, which represents junior debt deals for several credit funds and BDCs, says that whatever transpires in Washington DC, mezzanine and alternative lenders in general will continue to be a very attractive source of capital for borrowers and sponsors.
“The banks are not necessarily going to rush back into the mid-market, though we might see some volatility this year,” he says.
Antoszyk notes that the new president and Republican majorities in the US Senate and House have several policy priorities ahead of rolling back financial regulations, which means the banks and alternative lenders have no way of knowing what the new government will choose to tackle in the period ahead.
David Golub, president of Golub Capital and CEO at Golub Capital BDC, told PDI late last year that he believes private debt markets will continue to see “banks losing [market] share to non-banks” in 2017. The private debt space could continue to see “buy-and-hold solutions gaining in popularity versus syndicated solutions, and one-stops [continue] gaining popularity versus complex capital structures”.
Golub said the overall increase of players in the private debt sector could potentially tighten spreads and increase leverage this year, in mezzanine debt particularly.
“The big story in junior debt is the proliferation of players in the space,” he notes. “I put together a list of players in the middle-market junior debt space, and I was surprised at how easy it was to make a list of 75 active players. That degree of fragmentation makes for a very competitive market.”
An increasing number of funds have achieved closings in the private debt sector since the financial crisis. Around 150 (including junior and senior debt) closed last year, compared with only 109 in 2008, according to PDI data.
Golub adds that his firm decided to reduce its investments in junior debt because the “pricing had come down post-crisis and attachment points had become high” and that “we continue to think the middle-market junior debt environment is generally unattractive”.
Antoszyk agrees that the mezzanine space “is highly competive out there” and will remain so this year, but he does not believe this means that mezzanine debt is a faltering product.
The banks are looking for a financial product with a simpler capital structure than mezzanine, which means the flexibility of private credit firms will continue to provide a competitive advantage in the mid-market space, regardless of any regulatory overhaul.
Another positive trend for mezzanine is that pricing and returns have remained steady, leverage ratios haven’t moved significantly over the last couple years, and covenant protections are fairly constant, adds Antoszyk.
Mezzanine “is a tried and true product”, he says. “And I can’t see anything qualitatively making a difference in these trends next year.” Antoszyk says his firm’s mezzanine dealflow doubled last year compared with 2015.
“There was a time in late 2015 when folks were declaring mezzanine dead. But it’s clearly not.”