Mezzanine: Waiting for the rain

The current mezz market "stinks", as Robin Doumar of Park Square Capital put it in his presentation. He was speaking at the Pan European Mezzanine Finance conference in Paris this week, where conference attendees have become accustomed to putting on a brave face about difficult market conditions over the past few years.

Although primary deal-doing is back, thanks to a substantial recovery in the secondary market to pre-crisis levels - the SMi-40 now trades at 98bps compared to the market low of 59bps in February 2009 - mezzanine has been kept out of structures by high yield, stretched senior tranches and unusually high equity cushions driven by the remaining capital overhang in many private equity funds. Thankfully for the product though, and as common sense would suggest, current market events are not sustainable in the long term. Indeed, the general consensus on several panels was that the fundamentals for mezzanine will look strong in 18-24 months. Even cynics agree the future is bright(er).

For a start, mezzanine pricing, which some regard as being indirectly dictated by high-yield pricing, is set to improve. The CLO capacity that is fuelling current liquidity and is responsible for the significant downward pressure on high-yield pricing is set to expire in the next two years as credit fund investment lifetimes come to an end. Further driving this are the expiring investment periods of most private equity funds currently rushing to do deals and deploy as much capital as possible - anecdotes were being exchanged on panels of private equity houses structuring recent deals with more than 55% equity or even all-equity, despite there being a plethora of leverage providers and product options to chose from.

Last but not least, mezzanine has an unlikely ally in the form of regulation. Banks will have to be more conservatively structured with smaller balance sheets, which also implies shrinking senior debt liquidity to put into deals. All this should re-introduce the gap in the capital structure that was traditionally filled by mezzanine.

Although this last scenario is still some time away, for now there is at least a primary LBO market again for mezzanine to be involved in. True, current conditions are far from being ideal for the product, but those traditional players have the opportunity to apply their tailor made solutions.

With plenty of businesses throughout Europe that have managed through the recession now in need of growth financing, mezzanine surely should find a home. As Matthias Unser from DB Private Equity highlighted, there is still a large potential for sponsorless transactions to be done in Europe as private owners look to grow their businesses without having to give up ownership of their company. After all, isn't this what mezzanine is supposed to do? To be a bespoke product, providing solutions that other products can't.

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