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The wilting of mezzanine

Wilting flower

The stars are not aligning for mezzanine loans in leveraged finance this year. While investors would still love to play, they are being pushed out as borrowers have too many cheaper options.

Mezzanine loans have been on a slow but steady decline since first re-emerging strongly in the post-crisis world. European issuance has never come close to its 2007 level of $21.9bn but post-crisis issuance was ahead of other junior debt products by 2011. Then, $2.46bn of issuance put mezzanine well above second lien and PIK loans, according to Dealogic data.

Second lien issuance was $2.28bn in 2011 while PIK issuance languished at $381m. But in 2015, mezz is no longer king of the junior debt world.

It became clear last week that Mezzvest, which won GlobalCapital's award for best mezzanine investor for the sixth consecutive year in February, was targeting a €100m capital raise for direct lending in secured loans and unitranche.

The investment house is latest of many to have diversified its loan investments to a broader range of opportunities. In the same week, Intesa Sanpaolo and GSO Capital Partners announced a joint direct lending initiative.  The two lenders are planning to lend to Italian midmarket companies.

Of course, direct lending has become an established part of the landscape in leveraged finance. The Ares and GE Capital war chests for unitranche and secured loans to midmarket borrowers have been swelling for some time now. 

But seeing a player such as Mezzvest follow contemporaries such as ICG into the space suggests mezzanine will be taking an extended sabbatical from levfin markets.

Following 2011’s post-crisis peak there were three consecutive years of decreasing issuance. Mezz enjoyed a small rebound last year, but $589m of issuance will still starve investors of supply. 

In DLA Piper’s 2015 survey of debt providers, advisors, sponsors and corporates that use the European debt markets for acquisition finance, mezzanine was expected to be the leading non-bank lending structure by 28% of respondents, 3% up from last year, but still behind unitranche loans, which got 33% of the vote.

When it comes to choosing a a junior debt product, borrowers are favouring unitranche, which offers a simplified structure and flexible covenants to the midmarket.

But of the products left fighting for the scraps, mezzanine looks set to lose. Even PIK debt has had a better time of it of late, almost hitting double the amount of mezzanine issuance over the last two years. European PIK issuance was $572m and $1bn in 2013 and 2014, while mezzanine managed $277m and $589m in the same years.

As central banks continue to chip away at the short end of the yield curve there is little sign of a renaissance in mezzanine. Borrowers are in pole position to drive down their costs across senior and subordinated debt, and in that climate, mezzanine looks set to hibernate.

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