Mezzanine lenders struggling to generate yield in today's competitive middle-market lending environment may want to consider putting their money to work overseas. Mezzanine debt in the Asia-Pacific region provides an opportunity to bring in returns. Mezzanine activity there slowed after the financial crisis, which has created an opening for lenders today.
Mezzanine lenders with established global operations should consider countries in the Asia-Pacific region for lending opportunities, such as Australia, Hong Kong, Japan, New Zealand, Singapore, South Korea and Taiwan, according to Charlotte, North Carolina-based lender Babson Capital Management. (For more on M&A in emerging markets, see 10 Emerging Markets to Watch.)
Mezzanine funds have faced stiff competition in the middle market.
"Today there are about 50 business development companies, and they have infiltrated the middle market and they've essentially disintermediated the mezz funds, so you don't see a lot of mezz funds today," says Ted Koenig, CEO of Chicago lender Monroe Capital.
Babson expects demand for mezzanine financing to remain strong in the Asia-Pacific region for several reasons. First, there is a funding gap created by conservative lending practices from senior debt lenders. Second, there's a lot of undeployed private equity capital; and third, there is a trend toward more refinancings and bolt-on acquisitions as private equity firms increase their holding periods.
The amount of dry powder in the region has increased. In 2006, it was $35 billion, and in September, it was $129 billion, according to data from Prequin. The hold period in Asia has also increased from 2.6 years in 2007 to 4.8 years in 2014.
Because the supply of mezzanine funding in the area is so low, lenders who provide it are able to bring in high up-front fees. The idea isn't without risks. Generally, mezzanine securities have ratings below investment grade, which means investors are subject to credit and default risk.
The supply/demand imbalance results in opportunities for mid-to-high-teen annual returns, including high single-digit cash coupons, according to Babson, which runs a global private credit operation that targets middle-market companies in the Asia-Pacific region and has more than 40 investment professionals.
While things in the U.S. may be tough for mezzanine lenders, they aren't impossible.
"While there's some pressure on pricing, that doesn't mean there isn't an opportunity here," says Nadim Malik (pictured). According to data from Sutton Place Strategies, which tracks middle-market mezzanine loans, in the first three quarters of 2014 there were 364 mezzanine transactions in the U.S. and Canada - that's up from the same period last year, when Sutton Place tracked 323 mezzanine loans in the first three quarters of the year.