Magazine article American Banker

Wall Street Embracing Mezzanine Lending

Magazine article American Banker

Wall Street Embracing Mezzanine Lending

Article excerpt

Faced with subpar returns from private equity funds over the past several years, investors with an appetite for risk have been pouring money into mezzanine finance funds, a little-known sector of the venture capital market.

Fund-raising in the private mezzanine securities market has more than doubled, from $15.2 billion in 1998 to $37.3 billion last year, Derek McGirt, an analyst with the New York debt rating agency Fitch Inc., wrote in a June 5 report entitled "Mezzanine Debt: Another Level to Consider."

Increasingly, investment banking firms have started their own mezzanine funds, once the exclusive domain of money managers. The funds provide capital to middle-market companies that are too small to access the high-yield corporate debt markets (where the minimum offering is about $125 million) but need money for anything from expansion to leveraged buyouts.

Fund managers have been able to attract investors -- and borrowers -- because the typical yield is in the mid-teens, and mezzanine borrowers pay their loans directly from cash flow, which means less volatility for investors.

But there is a hitch: Unlike asset-based loans, for which the borrower has to pledge machinery or inventory as collateral, mezzanine loans are typically unsecured. They are also subordinated, so if a borrower goes belly up, investors in the mezzanine funds can lose a lot of money.

"No one in the mezzanine industry has an unblemished track record," said John C. Rocchio, a managing director at TCW Group Inc., a Los Angeles subsidiary of Societe Generale SA, who runs two funds with $2 billion of combined assets. "We have investments that have worked out less satisfactorily than we had anticipated."

According to Mr. Rocchio, who has been in the business for more than a decade and has provided financing for Del Monte Foods Co., Beringer Wine Estates Holdings Inc. …

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