where 's the mezz

8/6/2019 Where 's the Mezz

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Dual Tranche Deals Come Out Of The CLOsetTo combat a CLO market frozen stiff bya lack of new capi-

tal, price declines, and waning confidence, some firms areworking on new CLO portfolio strategies to bring in businessand keep current clients interested in the loan market.

Citigroup, Morgan Stanley, Natixis,JPMorgan, Pruden-tial, Barclays and D eutsche Bank are some of the firms creat-ing new CLO structures that have just two tranches, sources

said. In this structure , one tranche is all triple-A debt and theother is equitya nom enclature for unrated debt. These struc-tures differ from the m ulti-tranche CLOs that helped balloonthe securities market to more than halfa trillion. Those CLOshad everything from mezzanine to tripIe-C tranches.

So far, these firms have not finalized a CLO using the ttranche structure, becausethe loan market is still frozenHowever, once the market thaws, demand for new prodwill come froma new crop of investors, suchas pension fundssources said.

Spokespeople for Prudential and Barclays declined to cment, and calls to the other aforementioned firms were

returned by press time."Many bankerswe have spokento tell us they wantto struc-ture deals withone triple-A tranche andone equity tranche, s

(See CLOs on page 4)

INSIDE THIS ISSUE M arket Sezz: W here's the M ezz?Last year, more than $25 billion was

raised by roughly30 mezzanine provid-ers, according to data from ThomsonReuters. While other lending sources

have effectively dried up amid the cred-it crisis, one would think the mezzaninemarket would be enjoyinga renaissanceas one of the few financing options stillavailable. Such a scenario , however, hasyet to materialize.

"Very few private equity firms willdo a mezz and equity deal; they wantsenior lending," saidAndy Steuer-man, a senior managing director w ith

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DATA

With most credits tradingat bar-Most Recent Ratings Actions 7 g^j^ p^j^^^^ jj^^ ^^ y^^^ t>rings withTerm Sheets 8-15 it a great time to shop for dealsin the _ , . . , . , European leveraged loan market. ThisSecondary Market Data 16 . . , r ihas been the case for some months, ac-Closed End Fund Performers 16 tually, and looking ahead into 2009, ex-Loanbase Statistics 16 P^"^' ^^'^^''^ opportunities aboundfor

distressed debt investors. Yet no one hasreally risento the occasion, it seems, andalthough there are stories of distressed

and special opportunities funds gearing

Golub Capital. "If you can't get thesenior lenders interested, thenyouhave no transaction. Thatis the situ-ation today."

Another factor is, quite simply, ththe deal market has effectively stallEconomic uncertainty,on top of thecredit woes, has both buyers and sellretreating to the sidelines until morclarity emerges. For the most part, tonly deals being pursued are transations that are absolutely necessaryfor

(See MEZZ on page 5)

Europe's Distress: Deals Find No Shoppersup for action, sources don't think theymake a serious move into leverageloans for some time to come.

"For various reasons, the distressmarket has been quiet over the past months and continues that way," saDan Hamilton, head of law firmWhite& Case's financial restructuring pratice. "Earlierin 2008, fundsput their

(See DISTRESSon page 6)

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BANK LOAN REPORT

MEZZ

continued from page 1

a company's survival. "Weare tellingour clientsto hang on, nowis not thetime to sell," one banker said. Thatin

turn keeps the private equity marketstagnant, which effectively idlesthemezzanine providers, evenif they'rearmed with billions of dollars worth ofdry powder.

For the few deals that areout there,another factor is limiting the appealof mezz financingnamelyits price.Mezzanine financing has become cost-ly, almost to the point thatit rivals theequity portion ofthe deal.

Last year, for instance, mezzanine

shops were pricing deals with IRRsof between 15%and 18%, includinga pay-in-kind componentrates thatwere already considered high. Today,mezzanine tranchesare being pricedbetween 16%and 20%, accordingtoRonald Kahn, a managing directoratLincoln internationaL He adds thatmezzanine co-investmentsare nowalmost always being replaced withwarrants,and most deals also requirehigher pre-payment penalties, oftenstarting out with two-year no-callprovisions.

Accordingly, sponsors are over-equi-tizing their deals. "Private equity firmsare willing to put more equity in trans-actions," Steuermansaid, noting thatthe "return profiles[between equityand mezzanine]areconverging. Thereis also the benefit of[reducing risk] withless debt."

To some lenders,the current envi-ronment bears a re-semblance to otherperiods in the market's history. "T hisis the same thing we experiencedin1999 throug h2001,when firms want-ed to patch a deal together to avoid thecost of mezz," saidMichael Hermsen,a managing director withBabsonCapital M anagement.

Hermsen, however, doesnot con-

vey any worry about the futureof themezz market. "Everyone came backto mezz then,and the same thing willoccur again."

Like Steuerman, Hermsen alludedto the role the rest ofthe market will

play. "The senior lenders aren't beingvery aggressiveat all; we will be hereto fill the gap,"hesaid. "The purchaseprice multiplesarebecoming moreat-tractive and pricingis getting better."

Babson is amongthose preparedforthemarketrebound,having closed

its Tower SquareCapital Partners111 fund in Decem-ber with $1.58 billionof capital undercommitment.

Mezz is undoubtedly a necessarypart of the structureof current deals.In fact, it is so important that manyequity sponsors have raised their ownmezzanine funds.Endeavour Capital,a lower middle market firm,is tryingto raise between $200 million and $300million for Endeavour StructuredEq-uity and Mezzanine FundI LP, whichwould finance deals sponsoredby En-deavour and other firms.KRG CapitalPartners, meanwhile,is in the market

with a $200 mil-lion mezz fund,which would beused to financeits own deals.Other firms suchas The AudaxGroup, SummitPartners and TAAssociates havealways raisedmezz funds, al-though some,

such as Audax, won't invest alongsidetheir equity vehicles.

While the mezz market remainsstagnant going into 2009,it has shownsigns of life at times during the creditcrisis. In the early part of last year, forinstance, whenthe second-lien marketcrumbled and BDCs began showing

'Regular people can'teven get mortgages;how is a leveragedbuyout supposed to

be oompleted?"

'The senior lendersaren't being veryaggressive at all;

we will be here tofill the g a p . "

weakness, the mezz market held stronAnd during the first two quartersof2008, the percentageof mezzaninefi-nancing going into deals grew substatially compared w ith the same period2007,roughly doubling its average all

cation within the capital structure."Prior to the chaos that startedinSeptember 2008the mezz mar-ket was gettingstronger, and itwas starting toshine. We werebusy," said Mi-chael Klofas, amanaging director with Babson

"But since October, we are notseeing a lot of

deal activity in general, and mezz dein particular have been few andfar be-tween."

Indeed, prior to September 2008Tower Square III had alreadycom-pleted 13 transactionsand deployed11% of its capital under manag emenSince then the fund has only com-pleted one transaction, with threein

the pipeline.The bottom line is that seniolenders need to start lending agaibefore mezz playerscan make anykind of headway.

"Regular people can't evengetmortgages; howis a leveraged buyousupposed to be completed?" one lener asked. "We needthe entire lendingmarket to start running well againbut who knows exactly when thwill happen."

Whiletew

will guessas to

whenthe credit markets will loosenup,commercial banks weren't createdforlong term CDs. Eventually, whentheremaining ban ks regain their appetfor risk, the mezzanine market willbepositioned to benefit.

"There's a lot of private equitymoney on the sidelines. Senior lending will come back, purchase primultiples will come down,and mezzwill do better," Steuerman said.

For now, however, it's a renaissandelayed.Danielle Fugazy, M&A


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