Insight 2013: Mezzanine in the small market

Activity could start out slow but should pick up through the year to make for a robust environment for mezzanine, according to Mike Klofas, managing director with Babson Capital.

2013 should prove to be a good year for providers of mezzanine capital – at least for those in the smaller end of the market – though the year could start out slow.

“I see no reason why mezzanine won’t continue to be very active, all the elements are there for it: deal flow will be very good, private equity has a lot of money to invest, a lot of companies to sell, there’s plenty of senior lending capacity out there in the market – all those ingredients come together for good environment for mezzanine,” said Mike Klofas, managing director with Babson Capital in the mezzanine and private equity group.

Babson operates in the smaller end of the market, lending into change of control deals brought to the firm by a network of private equity firms. The firm is coming off one of the busiest years in its history, Klofas said.

Many sellers have been trying to get their deals closed before the end of year over concerns about impending tax changes, so the fourth quarter has been especially busy, he said. However, that could mean s slowdown in the early months of 2013.

“New deal flow activity has been pretty quiet over the past few weeks, people are focused on closing deals by year end, or early to mid-January,” Klofas said. “Our expectation is there will be some level of slow down in activity in the first part of 2013 as people really take a breather from the hectic pace from the fourth quarter.”

Still, the environment looks to be ripe for robust M&A activity. “There’s still pent up need for private equity firms to be selling companies,” he said. And the market has capacity for sales – there appears to be “no shortage of capital across all layers of the capital structure,” Klofas said.

One thing Babson will be watching for is leverage levels, which has been on a steady climb. “It worries me as sponsors will expect mezzanine providers to add additional leverage on top of where senior financing is at and senior is somewhere between 3x and 4x, and 4x is a bit worrisome to us, especially if you’re looking to put mezzanine on top of it. 5x to 5.5x leverage is worrisome to us,” Klofas said.