Mezzanine to soldier on

A bank's leverage portfolio currently has many similarities with the graphic opening scene from Saving Private Ryan, according to Howard Sharp from Royal Bank of Scotland, who was refreshingly frank on the opening panel of the Pan European Mezzanine Finance conference in Paris. Sharp contextualised his analogy by elaborating that a third of his portfolio is not keeping up with payments and up to 50% have defaulted on at least one covenant. "The sheer volume of assets that need some sort of help defies any system," he noted.

The mood at the conference was therefore pragmatic but also cautiously optimistic, especially among the traditional mezzanine representatives. Although the product was said to be getting "washed away" in restructurings and was described as "being toast" from a legal perspective in workouts, specialist investors were upbeat about the fact that current events will separate the wheat from the chaff. Indeed, many remained confident the market could return to pre-2005 pricing and structuring levels; a time when relationships mattered and the product was tailored to fit the requirements of individual deals.

The audience was treated to anecdotes about follies from the market's heyday, when leverage packages were underwritten and syndicated at record speed to willing and badly informed institutional investors - which had populated the space in search for yield - a process described by Robin Doumar of Park Square Capital as "feeding the ducks". Juri Jenker from Partners Group recalled looking into due diligence processes of investors in leverage syndicates, only to find that a staggering 60% of them had failed to even download the intercreditor agreements before committing.

In this light, one was less surprised about Fitch Ratings' latest statistics on defaults and recoveries, with one figure standing out: in case of default, 93% of mezzanine investments are expected to have a likely recovery of 0-10% of the principle. That said, dedicated mezzanine houses were once again quick to point out that such statistics are not representative of the lower mid-market, where credit analysis and due diligence had not been forgotten in recent years.

Furthermore, in spite of the rather depressing economic backdrop and bleak statistics - latest figures to be published in the upcoming unquote" European Mezzanine Review 2009 show a year-on-year drop in mezzanine volume by 43% while value contracted by more than 60% - some speakers and panellists were bullish about the opportunities opening up for the product in the current environment. Doumar, for example, lifted spirits by highlighting the exceptional returns to be achieved in the current market, demonstrating that investors could currently achieve a 2x cash return and 20% IRR on a four-year holding period by investing in the secondary market.

All in all the general consensus at the conference was that mezzanine could potentially see great 2009 and 2010 vintages. That said, there is obviously the issue with fundraising in the current market and a few panels looked to shed some light on LP appetite. With current available capital said to be at around one third compared to 12 months ago, and insurance companies and banks not expected to make any commitments in the near future, there is nonetheless a heartening development showing that some LPs believe there will be attractive opportunities for mezzanine in the medium-term. The European Investment Fund has decided to move into the space, with a new EUR1bn mandate to be invested in European Mezzanine. "We see potential dealflow for mezzanine outside the sponsored buyout market, especially among small corporations in need of financing," stated Jean-Philippe Burcklen from EIF.

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