Frightful Mezzanine Debt Portfolio Management

Like all businesses, mezzanine debt lenders have two distinct components to their business models, consisting of a front end and a back end. On the front end, they market and sell their loans to companies in need of capital. This involves conventional sales processes where the mezzanine debt lenders are nice to the prospective borrower. They then ask a lot of questions and underwrite the loan.

If they like it, they fund the loan. The front end of the process is usually handled by smart, friendly people who try to build a relationship with the borrower. The back end of the process is a very different story. The back end is populated by portfolio managers who are more impersonal and are walled off from the front end. They tend not to have a firm grasp of the operating fundamentals of the business and resort to financial over-analysis to develop their view.

Beware of Mezzanine Debt Lenders with Poor Portfolio Management

In some instances, they are devoid of the reason their company even made the mezzanine debt loan in the first place. Their job is to focus on managing the loan and ensure recovery of principal and interest by making sure the company is operating within covenant compliance. These portfolio manager positions are not where the talented people of the firm are. They are at best a mixed lot consisting of inexperienced newbies and average senior people. They tend to lack higher level business judgement, which causes them to lurch to extreme views in their assessment of company performance.

If the company breaches a covenant, which every company does from time to time, they are prone to overreact and not give the company the benefit of the doubt, which leads to raising red flags where none are warranted. Older portfolio managers, especially those at second and third tier SBIC funds can inflict damaging measures on companies for no good reason, resulting in a frightful portfolio management experience for the company. Despite how much you like the people on the front end and how good their loan offer sounds, it is best to avoid mezzanine debt lenders with frightful portfolio management. The best way to do this is to ask to speak to companies that have recently refinanced them for another lender. You may have to dig to find these recently refinanced portfolio companies, but your effort will be well worth it.