Structurally sound?

Throughout the credit boom the mid-market remained largely dependent on bank liquidity to fund deals, meaning that debt structures tended to retain the traditional A, B, C formats even into the first half of 2007.

The persistence of this format meant that as the credit crunch began to bite and reverse the excesses of the boom years it was assumed that the mid-market could continue relatively unscathed. However, arrangers now say, even here, the market is undergoing real change.

While mid-market deal flow is down there is still an appetite for debt, and unlike deals dependent on the CLO bid the market remains fairly liquid, at least on the surface. “Bank liquidity is still there in theory,” according to one arranger, “but even bank-only deals are difficult where banks are hoarding cash”.

Where deals are being done, they are fewer in number, often smaller, and less able to rely on syndication to support debt.

With syndication risk a real worry Chris Jackson, senior director at CIT Capital Finance, says that “sponsors are spending more time getting banks in place early in a deal process, to disprove trade suggestions that sponsors are at a disadvantage on deliverability,” adding that “the club deal has re-emerged as a key way for banks to manage risk by bringing forward the syndication effort”.

CIT Capital Finance is providing both senior and mezzanine debt backing Balmoral Capital’s agreed buyout of Oyster Marine, a UK-based yacht maker. Oyster Marine builds boats worth up to £4m and last year generated sales of £50m. Sponsor Balmoral bought Italian motorboat maker Canados in 2007.

“A lot of work is being done to build syndicates early to mitigate risk ahead of deals funding,” said Adam Hewson, senior managing director at GE Commercial Finance. “Partnership deals are very useful for mid-market deals in particular, and can be achieved successfully on sub-€500m deals.”

That club strategy was used on 3i‘s recent US$395m buyout of Active Pharmaceutical Ingredients (API) a Norway-based unit of Alpharma. Alongside global co-ordinator and bookrunner GE is a bookrunner group of Calyon, Danske Bank, European Capital Financial Services and HSH Nordbank.


Club deals not only mitigate syndication risk, but may also act as a balm on what could otherwise be mutually destructive competition between would-be arrangers. With even sub-€500m transactions facing challenging conditions arrangers may be unwilling or unable to compete on margin or structure, preferring to share mandates than undercut rivals.

Even so, the light pipeline of deals ensures this remains a tough market to win mandates.

“The mid-market is competitive for arrangers both as a result of the lower number of deals overall and because banks that had focused on bigger deals are active further down the market,” said GE’s Hewson.

While the mid-market saw far less institutional investor activity than the upper end of the market the lack of any alternative bid in the current market means structures are being tailored to maximise the appeal to banks prepared to hold the debt. Almost all mid-market deals underwritten since June 2007 have come with a classic A, B, C structure, overwhelmingly sitting over a mezzanine tranche.

Adam Hewson plays down suggestions that this in itself represents a major change. “The mid-market escaped the excesses of pre-crunch revisions to structures and terms, but the last nine months has still seen a turnround. Leverage is down by up to two turns, high-yield has evaporated completely, though it was never big in the mid-market, amortisation has increased and mezzanine has become more important.”

But changes are being seen, in particular within structures, and mid-market arrangers are not innovation averse.

“It may be only a matter of time before the C tranche disappears. Arguments about extra yield are spurious if the B tranche comes at the equivalent blended yield, and given most deals have a five-year life span it is irrelevant whether a bullet matures in eight years or in nine,” according to Hewson.

Yield has traditionally been less important to bank investors than credit and therefore less subject to fluctuation. Margins have increased though and deals now start with a 250bp over margin on the A tranche, rising through the structure. And within those structures the constituent tranches have seen significant flux.

“We are only looking at deals with a minimum 35% equity ticket, and seeing up to 50% equity,” said CIT’s Jackson. “The typical structure remains A, B and C tranches above mezzanine, now with a significantly higher weighting to the A.”

Amortisation has always been popular with risk averse bank lenders, with leverage decreasing sponsors are better able to accommodate it, and may well be happy to see ongoing de–risking of portfolio companies given the shaky macro economic climate. As well as hefty equity tickets and amortising tranches the increased focus on credit means lenders also expect to see a cushion of mezzanine between themselves and sponsors.

Chris Jackson says that has given mezzanine investors a significant input into deals. “Mezzanine providers have been keen to start conversations early, and having a greater influence in the final structure of deals. Mezzanine continues to be a feature of most deals, and people now expect a minimum £10m tranche in order to be attractive enough for investors to do the work.”

According to one mezzanine professional that influence is likely to see the role of mezzanine extended to traditionally all senior bolt–on acquisitions as well as new primary financings.

Typical of a deal at the lower end of the market is the recent take private of Premier Research. ECI mandated Lloyds TSB, Barclays and WestLB to arrange £40m of debt backing its £60.1m buyout of the AIM-listed provider of clinical outsourcing services.

The deal is made up of £45m of senior debt and a £10m revolver. A further £16m of mezzanine financing is being provided by Indigo, which will also hold an equity stake in the deal. Leverage is 3.9x senior, 5.3x through total.