Mezzanine Q&A: Joseph W. Ferrigno III

Q: What new functions and advantages does mezzanine have in today's business and financial environment?

A: Post the GFC, Asian issuers have become more concerned about the relatively short maturities of financing available from lenders; in particular, from commercial and investment banks. Issuers are seeking to develop more stable and longer-term relationships with other sources which can provide longer-term commitments. Closed-end mezzanine funds are a source of longer-term capital.

Bank prop desks, globally and in Asia, are being dismantled, due to risk management concerns and the impact of the Basel accords, and new regulations stemming from the Dodd-Frank legislation in the US. Hedge funds have become more focused on public deals since they have a high need for short-term liquidity. This has improved terms for mezzanine players that operate via traditional fund structures that are not susceptible to short-notice investor withdrawals.

Q: How is mezzanine acting in post-GFC Asia? Does it enable investors to participate in Asia's growth opportunities, and if so, how?

A: Due to the tightening of the credit markets and more strict regulatory requirements affecting banks, mezzanine capital from various sources has become an attractive financing alternative, particularly for mid-sized companies that are at the forefront of the Asian growth story. The terms and investment structures have improved for mezzanine investors/lenders.
Mezzanine capital funds enable global investors to participate in financing later-stage growth companies that have moved beyond the pure ‘venture' stage, but which are still not ready for an IPO, due either to scale or market conditions.

Q: To which kind of market and proposition is mezzanine best suited?

A: Mezzanine fills the financing gap when credit markets are tight, and when enterprises have limited or no access to more senior debt and/or to the public equity markets, due to the conditions in the global and local credit and equity markets. Mezzanine significantly lowers the cost of capital for issuers, because it requires less equity dilution from existing shareholders. It is complementary to PE funds, which provide straight equity.

Mezzanine capital in Asia is currently most appropriate for medium-sized financing requirements of between $10 million and $100 million. For larger amounts, the issuer may have access to the high-yield market under the current market conditions.

Q: What is the level of understanding and acceptance of mezzanine among Asian corporates? Has this improved?

A: Mezzanine is a relatively new type of capital available for companies in certain Asian countries, and the level of understanding on the part of issuers, their advisers and PE firms varies. When stakeholders realize that the use of mezzanine capital enables the minimization of equity dilution relative to a pure private equity round, everyone pays attention. When you walk them through how a mezzanine investment would work – that the mezzanine investor is providing a long-term, flexible investment, with a repayment profile that is keyed to future cash flows of the business – the high value of the relatively small dilution becomes apparent, and the interest level rises.

Q:  What is the value of mezzanine as a separate asset class for investors, especially in Asia Pacific? How does it play into LPs' overall PE commitments?

A: LPs can use commitments to mezzanine funds to generate current income, reduce risk, and increase diversification in their overall PE commitments.

Mezzanine investments can be conservatively selected and structured with lower risk and less volatility than traditional private equity in Asia, while capturing a portion of potentially higher equity returns.

Experienced mezzanine fund investors focus principally on the credit-worthiness of investees, and they therefore tend to select industries and companies which are more stable and resilient. Mezzanine investing tends to result in a strongly positive lower-risk selection bias on the part of the fund manager and investor, as a result of the needs for servicing periodic interest and principal repayments. The requirement of interest and principal servicing also creates inherently lower ‘exit risk' than pure private equity. 

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