Why Bank Realignment is Good for Mezzanine Financing

Posted on: May 15th, 2023

mezzanine-financing

Mezzanine financing is a value-added form of lending available to middle market companies that helps them acquire and grow faster. It is provided by lenders who have evolved outside of the banking industry primarily as private lenders and private credit funds. The growth of the mezzanine financing sector is due both to the inherent attractiveness of the loan structures and the inability of banks to satisfy the middle market’s needs for this type of capital.

Historically, as banks have retrenched, mezzanine financing providers have been able to increase their share of the acquisition financing and growth capital market. This happened in the early 1990’s in the aftermath of the S&L crisis, as well as in the 2008 -2009 period after the Great Recession. As banks were being restructured, consolidated, or liquidated, non-bank lenders such as mezzanine financing providers emerged to address the market need. This current banking crisis will be no different as the banking industry goes through yet another period of realignment.

As depositors flee smaller banks in search of larger, more capitalized banks, less lending will be allocated to the middle market. Small and regional sized community banks tend to allocate more of their asset base to both C&I as well as middle market loans than large banks. As the industry consolidates and the big banks get even bigger, market displacement will fall disproportionately on small and medium sized businesses. While Big Banks say they focus on small business and middle market lending, the reality is that the sheer massiveness of their asset base forces them to do much bigger deals than a conventional sized middle market deal.

For example, a medium sized community bank will make a C&I loan to a company with $3 million in EBITDA. Most big banks such as JP Morgan or Citibank focus on companies with EBITDA of $10 million or more. Going forward, as these Big Banks see torrential deposit growth, they will likely go even bigger in their deal size screen. As this industry realignment unfolds, there will be a large gap available for non-bank providers of mezzanine financing for middle market companies with $3 to $10 million in EBITDA. Mezzanine financing lenders will have a once in a decade opportunity to fill this gap and bring much needed capital to a dynamic sector of the economy.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.