Partners Group predicts stronger mezz market

A study by Switzerland’s Partners Group finds that market conditions for mezzanine financing remain favourable at the outset of 2011 for private equity investors.

Investment opportunities in mezzanine financing are set to be exceptionally strong in 2011, according to a recent research report from Switzerland’s Partners Group.

The research study by the $26.7 billion asset management firm projected the default risk for mezzanine debt would settle in the 1 to 2 percent range in 2011.  Analysts attribute this decline in risk to lower use of leverage combined with higher levels of equity utilised in recent buyouts.

Return potential for mezzanine ranks highly on a risk-adjusted basis, according to the report. Helping is the fact that interest rates on coupons have edged to their highest levels in a decade. Looking at North American and European data from October 2010, Partners Group found that average coupons on new high yield issuance were 8.3 percent, significantly lower than the average coupon return of roughly 13.5 percent for mezzanine investments. And portfolios of mezzanine loans managed stronger performance using only modestly higher leverage of 4.9x, versus 3.9x for high yield.

European mezzanine debt showed particular strength. In Europe, higher yield paid on debt coupons resulted in stronger cash flows for private equity firms financing buyouts. Partners Group analysed portfolios of loans from 50 European companies, finding that asset prices for the sector first began to rebound in December 2008, outperforming stocks and commodities through September 2009. For the first nine months of 2010, European mezzanine coupons experienced an average performance of 11.1 percent, representing cash over PIK.

The study also showed the mezzanine sector had remained resilient during the worst of the market downturn. Between 2007 and 2009, mezzanine debt’s peak drawdown was 11 percent as compared with other asset classes like common stock and commodities, where losses generally exceeded 50 percent, according to the study.