Australia: Ripe for mezz

Gary Stead, Managing Director and Co-Founder, Shearwater Capital, explains that mezzanine suffers reputationally in Australia, which has put many off. “From an investor perspective, people tend to think of it as risky because they think, if the bank won’t [lend to the company], then the borrower must be borrowing too much, or there’s a problem. For borrowers, the view is that it’s expensive and they would rather do something else.”

But with bank lending considerably tighter – and anecdotally, lending only to those with whom they have long-standing relationships – and a dire need for restructuring on the horizon, Australian corporates may be well-advised to reconsider their relationship with mezzanine debt.
 
Limited familiarity with mezzanine

For a developed country, Australia’s history with mezzanine is in fact quite limited. Cameron Hillyer, Chief Financial Officer at Clearwater Capital, explains: “It’s a different market in Australia versus Europe. In Australia, you haven’t historically seen a lot of mezzanine financing. Except for some of the larger LBOs, where mezzanine financing was used to fill out the capital structure, most structures have been fairly straightforward, with senior bank debt and equity.”

His colleague, Edward Cairns, Head of Restructuring at Clearwater, explains. “The Australian market didn’t take to mezzanine financing with anything like the gusto of the US and Europe; something which looks like sound banking practice in hindsight. With different financial dynamics, driven by their well-capitalized – and prudentially regulated – big four ‘pillar’ banks, they simply didn’t need to.”

Unlike in Europe, which has recently witnessed a setback with the ruling on IMO Car Wash, Cairns says there are no real red flags when it comes to an Australian view on mezzanine, “but there is a lack of familiarity with the technique.”

Of those mezzanine deals that did get done over the past few years, many were of the variety termed ‘covenant-lite’. “This gives you limited ability to enforce in a downturn,” explains Hillyer. “In the leveraged loan market as a whole, covenant-lite deals grew to almost 19% of all bank debt outstanding, from about 1% at the beginning of 2006, so it’s not surprising to have seen an aversion to this type of financing from some investors. But, it does highlight that there is a sophisticated market there, that maybe just got too hot.”
 
The effects of the global financial crisis

Although Australia only saw one quarter of negative growth and never slid into a recession – unlike most of its developed counterparts – by-products of the economic crisis have shown their faces in other ways. “A number of foreign banks are exiting or scaling back in Australia,” explains Hillyer, “so the capacity to lend has been reduced, not insubstantially.”

Historically Australia has been the “land of the equity cure” he says, noting that in a difficult environment, corporate Australia raised over A$80 billion ($72 billion) in equity in 2009, and A$51 billion ($46 billion) in 2008. “That said, there is considerable refinancing risk ahead, with A$44 billion ($40 billion) due to be refinanced in 2010 and 2011, and this may result in companies looking at non-traditional forms of financing to solve their balance sheet problems.”
 
Stead explains that in the past, borrowers could push the banks for larger loans, but post-crisis this is not the case. “If you can get senior debt, you probably would do [right now], but if you can’t and the alternative is equity, right now that’s an expensive option. This means there is a pool of people who have no real issues, but just can’t get access to bank debt and/or are being forced to put in more equity.”
 
While problems with mezzanine – and realistically, all types of loans – occurred when structures got too loose, “Now we’ve gone to a world where credit is so restrictive, many of the deals restructured need a layer of capital like mezzanine,” says Stead.

Inevitable growth for mezzanine

With opportunities for mezzanine to play an important role in the restructuring of Australian companies, Stead says that the list of companies who stand to benefit is potentially quite long.

“There are different classes of companies facing refinancing,” over the next few years, he says. “Real estate and infrastructure are overleveraged sectors, but private equity is another, and companies with stretched balance sheets are another. That’s quite a large group.”

Cairns believes, “We’re starting at such a relatively low base, there has to be some room there [for mezzanine to grow]. It is a strong creditors’ rights jurisdiction with the rule of law, an independent and competent judiciary; and real bench strength in professional advisors. Legally, Australia is a sophisticated jurisdiction. It would be the first place [in the region] to see an increase in activity.”

While nobody in the industry is arguing that mezzanine will become the next big thing overnight, Clearwater is seeing new proposals in a few particular areas, including natural resources and property development.

Stead is of the opinion that some of the tainted views of mezzanine on the part of investors have subsided as banks have become more restrictive with their lending policies. “Mezzanine no doubt was part of the problem historically,” he says, “but now is part of the solution going forward.”

“The whole market is changing in Australia,” concludes Cairns. “Historically it has been an insolvency-driven market; now it’s looking more restructuring-driven than it was before. These things take time to change, but we see an important new trend developing here – one which we at Clearwater and others like us are keen to support.”

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• Topics
• Australasia
• Funds
• Financing
• Mezzanine
• Cameron Hillyer
• Clearwater Capital Partners