When the recession struck, it changed many things. The real estate industry hit rock bottom. Banks took enormous hits as subprime loan scandals came to light. Home foreclosures reached all-time highs. Companies stopped expanding and started downsizing. Massive layoffs occurred as workers found themselves standing in the unemployment line. Bankruptcy courts found more business owners filling their arbitration rooms. And mezzanine lending nearly disappeared.
Mezzanine financing was very popular as a secondary financing option for companies and commercial property owners back in 2007. It wasn’t for young startups looking for an investor to back their corporate dreams. Mezzanine loans were suited for middle market companies and businesses that showed they have future positive growth and sales. This financing option was subordinate to senior debt but above equity when it came time to paying back the loan. Often set at a fixed rate, the subordinated debt was the perfect option for companies that wanted to expand or fund projects yet didn’t have the available capital and couldn’t take out any more senior debt.
Banks liked companies that had the backing of mezzanine lenders. These institutional investors reduced the risks the banks would have to take on by the spreading the company’s debts through other financial players. Borrowers and lenders jumped at the chance to work out mezzanine financing details. They came up with an equitable agreement for the borrower’s interest rates and the lender’s rate of return from the sale of the borrower’s equity. Mezzanine financing was also available through a number of financial investors including private mezzanine loan firms, private equity firms, investment banks, finance companies, hedge funds and mortgage REITs.
Then the recession struck. Companies, especially those involved in real estate, struggled to pay their senior debt obligations to banks. Borrowers of mezzanine financing found themselves stuck in a corner as investors began to own more equity in the company through stock until the lender controlled the business as well as the equity.
Origination of mezzanine loans dipped substantially in 2009. Investors hedged away from mezzanine financing as too risky for their portfolios. Companies didn’t want to get involved with mezzanine loans and find themselves handing over the keys to their business because their sales profits were lower than projected profit growth.
Yet there is light at the end of the metaphorical mezzanine financing tunnel. With investors trusting in the stability of the market again and the lending potential of companies, the lending industry is starting to see a demand for mezzanine loans. The New York Times reports that, in 2010, there were $374 million mezzanine loans and secondary loan options originated for companies in the real estate industry. This number is up from 2009 when only $210 million mezzanine loans were issued.
While rates are still high for mezzanine financing, deals are becoming progressively competitive. Due to this competitiveness, rates are being reduced to entice companies to mezzanine financing as they have dropped down to a range of 7 to 10 percent in 2013, according to The Commercial Observer. As more liquidity enters the market, mezzanine lending is bound to rise and make a comeback in corporate debt portfolios.
We are passionate about the work we do here at Broker Dealer. Sign up with us today to gain access to our incredible network of broker dealers, venture capitalists, angel investors, and more!