The mezzanine debt market in the United States is flush with capital in search of quality deals. Many middle market funds are expanding with new funds in new locations. Some funds have discovered untapped market potential in international markets such as the United Kingdom and Germany. This is welcome sign for the European middle market as the Eurozone struggles with weak economic growth and a retrenching bank sector.
The large number of funds raised in the 2011 through 2013 timeframe are in prime investment mode in the U.S. Traditional mezzanine lenders are finding that while middle market M&A is booming, there is less a role for them to fill the funding gap with aggressive banks and large equity contributions from private equity investors. The emergence of business development public debt vehicles is also making life difficult for middle market mezzanine lenders. Many are adopting direct lending approach to deal origination. While capital raising for large funds appear to be tapering off according to Preqin, with only 16 mezzanine funds have held a final close so far in 2014. Large asset management companies seem to have discovered the asymmetry in pricing in the middle market for mezzanine loans. Some firms have added captive funds and others have increased their total asset allocation to the class due to the high risk adjusted returns.
Notwithstanding this, mezzanine debt rates throughout the remainder of 2014 are likely to continue to be favorable for borrowers. Pricing is very deal specific with the same transaction receiving a wide spread of pricing terms from straight interest deals to fully priced deals with interest, PIK interest and equity warrants.
As for the mezzanine market’s appetite for credit risk, the mezzanine market appears to taking its cue from the diminishing risk premia in financial assets, brought upon by many years of low interest rates. This backdrop creates more active liquidity in the lending markets and emboldens lenders to do more deals and take more risk. Multiples have crept up to over 4 times, yet sector selectivity is disciplined.
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