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.