Mezzanine lender expects defaults

Tom Attwood photo

Mezzanine lender Intermediate Capital Group (ICG), which has taken advantage of the changed credit conditions over the past year, has warned that backers of highly leveraged buyouts concluded before last August could suffer.

“Buyouts structured in the benign credit climate prior to August 2007 were often over-geared with no margin for safety. This is likely to lead to an increase in default rates over the next year or two,” said managing director Tom Attwood.

He added: “What was a liquidity crisis is likely to lead to a credit crisis.” He was speaking last week as the lender reported a 22% rise in core income, from interest and dividend payments plus fees less costs, to £136m for the year to the end of March.

As a mezzanine lender, ICG is positioned differently to others involved in financing leveraged transactions. With syndication dead, banks are less willing to lend large amounts of senior debt in order to finance virtually all of a buyout. Financial sponsors are therefore forced to stick to smaller deals or put in more of their own cash through equity.

The other alternative is to tap more expensive sources of capital. Mezzanine lenders, after the famine they suffered for the previous two years when cheap cash on easy credit was bountiful, are more than willing to step in. ICG said 73% of LBOs had mezzanine and senior debt in the first quarter of this year against 19% in the same period of 2007.

Over the past year ICG’s funds under management rose 25% to £7.3bn. Managing director Tom Attwood said this was because borrowers are taking longer to repay loans in the current leveraged acquisition market. This meant the group’s investment gains on its portfolio, which are realised as the loans are repaid, fell 31.5% to £135m as refinancing the mezz debt is harder.

Having raised £175m through a rights issue and arranged a fresh £550m debt facility earlier this year, ICG, together with its existing facilities, also has up to £1bn to lend. Attwood said it might take advantage of the current turmoil and use some of this cash to invest in sub par senior debt too.

ICG has already started doing this and has also bought “hung deals from banks at a discount”, investing £130m over the last six months in LBO debt that has failed to be syndicated. Attwood said: “Investment opportunities are increasing daily as banks recognise their losses and begin to accept discounted prices for their hung assets”.

However, the lender wants primarily to stick to its knitting and finance mid-market deals. Here, Attwood said, the “the market is still active. Gearing is lower and structures are stronger in these deals, and mezzanine has rapidly regained its place in the capital structure”.

Attwood criticised the banks and their remuneration systems for the current credit crisis, saying: “The problem was the way people were paid. People were paid to lend more and more money, so they did.” As a mezzanine lender “we reward our investment executives for successful cash realisations and not for simply lending money”.