2019 M&A Forecast - The return of mezzanine financing

There has been an uptick in the number of
mezzanine debt instruments utilised in New
Zealand’s banking and finance sector throughout
2018. Sponsors are increasingly looking to
alternative debt providers to grow the leverage on
their investments and fill funding gaps.

The institutions that provide this mezzanine funding
are often more adaptable with their financing
approaches when compared to the traditional
banks. They generally seek to generate returns
through debt coupons – whether that be paid in
cash, payment in kind, pay-if-you-can or pay-if-youwant.
Sometimes they also take a slice of equity.
Some of the solutions we’ve seen in the market
recently have included unirates (i.e. no base rate
interest components) and interest toggles (where
the borrower has the ability to pay cash interest at a
lower rate than if capitalised).

We have observed that senior banks are generally
more comfortable with mezzanine financing being
provided if the debt is structurally subordinated and
provided to a holding company which sits above
and outside the banks’ security pool – referred to as
“Holdco Mezz”. The alternative is for the mezzanine
financier to provide debt into the operational
companies and share security with the senior banks
– referred to as “Opco Mezz”.

The key downside to Opco Mezz is that it requires
complicated intercreditor arrangements between
the senior banks, the mezzanine financier and the
obligors to regulate all aspects of the mezzanine
financing, including:

  • how the security will be shared;
  • when the mezzanine financier will be permitted
    to receive payments;
  • when the senior banks can turn-off payments
    to the mezzanine financier (i.e. issue a “stop
    notice”);
  • • when the mezzanine financier will be permitted
    to take enforcement action (subject to a
    “standstill period”);
  • when the mezzanine financier will be dragged
    on amendments and waivers; and
  • how any proceeds from enforcement will be
    distributed.

With a surge in offshore institutions providing
mezzanine finance into New Zealand, we predict
it is only a matter of time before the country’s
institutions look to provide similar instruments

"The institutions that provide this mezzanine funding are often more adaptable with their financing approaches when compared to the traditional banks... Some of the solutions we’ve seen in the market have included unirates and interest toggles."

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