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Dual Tranche Deals Come Out Of The CLOset

To combat a CLO market frozen stiff by a lack of new capi- tal, price declines, and waning confidence, some firms are working on new CLO portfolio strategies to bring in business and keep current clients interested in the loan market. Citigroup, Morgan Stanley, Natixis, JPMorgan, Pruden- tial, Barclays and Deutsche Bank are some of the firms creat- ing new CLO structures that have just two tranches, sources said. In this structure, one tranche is all triple-A debt and the other is equity—a nomenclature for unrated debt. These struc- tures differ from the multi-tranche CLOs that helped balloon the securities market to more than half a trillion. Those CLOs had everything from mezzanine to tripIe-C tranches.

So far, these firms have not finalized a CLO using the two- tranche structure, because the loan market is still frozen. However, once the market thaws, demand for new products will come from a new crop of investors, such as pension funds, sources said. Spokespeople for Prudential and Barclays declined to com- ment, and calls to the other aforementioned firms were not returned by press time. "Many bankers we have spoken to tell us they want to struc- ture deals with one triple-A tranche and one equity tranche, so

(See CLOs on page 4)

INSIDE THIS ISSUE

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Market Sezz: Where's the

Mezz?

Last year, more than $25 billion was raised by roughly 30 mezzanine provid- ers, according to data from Thomson Reuters. While other lending sources have effectively dried up amid the cred- it crisis, one would think the mezzanine market would be enjoying a renaissance as one of the few financing options still available. Such a scenario, however, has yet to materialize.

"Very few private equity firms will do a mezz and equity deal; they want senior lending," said Andy Steuer- man, a senior managing director with

Golub Capital. "If you can't get the senior lenders interested, then you have no transaction. That is the situ- ation today." Another factor is, quite simply, that the deal market has effectively stalled. Economic uncertainty, on top of the credit woes, has both buyers and sellers retreating to the sidelines until more clarity emerges. For the most part, the only deals being pursued are transac- tions that are absolutely necessary for

(See MEZZ on page 5)

LyondellBasetl Files For Chapter 11 ....4

DATA

Europe's Distress: Deals Find No Shoppers

Most Recent Ratings Actions

Term Sheets

Secondary Market Data

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Closed End Fund Performers

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P^«"^' ^^'^^''^ opportunities abound for distressed debt investors. Yet no one has really risen to the occasion, it seems, and although there are stories of distressed and special opportunities funds gearing

up for action, sources don't think they'll make a serious move into leveraged loans for some time to come. "For various reasons, the distressed market has been quiet over the past six months and continues that way," said Dan Hamilton, head of law firm White & Case's financial restructuring prac- tice. "Earlier in 2008, funds put their

(See DISTRESS on page 6)

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BANK

LOAN

REPORT

vey any worry about the future of the mezz market. "Everyone came back to mezz then, and the same thing will occur again."

Like Steuerman, Hermsen alluded to the role the rest ofthe market will play. "The senior lenders aren't being very aggressive at all; we will be here to fill the gap," he said. "The purchase price multiples are

becoming more at- tractive and pricing is getting better."

Babson is among those prepared for themarketrebound, having closed

its

Tower

Square

weakness, the mezz market held strong.

And during the first two quarters of 2008, the percentage of mezzanine fi- nancing going into deals grew substan- tially compared with the same period in 2007, roughly doubling its average allo- cation within the capital structure. "Prior to the chaos that started in September 2008, the mezz mar- ket was getting

stronger, and it was starting to shine. We were busy," said Mi- chael Klofas, a managing direc- tor with Babson.

"But since Octo-

ber,

we are

not

MEZZ

continued from page 1

a company's survival. "We are telling our clients to hang on, now is not the time to sell," one banker said. That in turn keeps the private equity market stagnant, which effectively idles the mezzanine providers, even if they're armed with billions of dollars worth of dry powder. For the few deals that are out there, another factor is limiting the appeal of mezz financing—namely its price. Mezzanine financing has become cost- ly, almost to the point that it rivals the equity portion ofthe deal. Last year, for instance, mezzanine shops were pricing deals with IRRs of between 15% and 18%, including a pay-in-kind component—rates that were already considered high. Today, mezzanine tranches are being priced between 16% and 20%, according to Ronald Kahn, a managing director at Lincoln internationaL He adds that mezzanine co-investments are now almost always being replaced with warrants, and most deals also require higher pre-payment penalties, often starting out with two-year no-call provisions. Accordingly, sponsors are over-equi- tizing their deals. "Private equity firms are willing to put more equity in trans- actions," Steuerman said, noting that the "return profiles

[between equity and mezzanine] are converging. There is also the benefit of [reducing risk] with less debt." To some lenders,

'Regular people can't even get mortgages; how is a leveraged buyout supposed to be oompleted?"

Capital Partners 111 fund in Decem- ber with $1.58 billion of capital under commitment. Mezz is undoubtedly a necessary part of the structure of current deals. In fact, it is so important that many equity sponsors have raised their own mezzanine funds. Endeavour Capital, a lower middle market firm, is trying to raise between $200 million and $300 million for Endeavour Structured Eq- uity and Mezzanine Fund I LP, which would finance deals sponsored by En- deavour and other firms. KRG Capital Partners, meanwhile, is in the market with a $200 mil-

lion mezz fund, which would be

used to finance its own deals. Other firms such as The Audax Group, Summit Partners and TA Associates have

always

raised

mezz funds, al-

though

some,

seeing a lot of deal activity in general, and mezz deals in particular have been few and far be- tween."

Indeed, prior to September 2008, Tower Square III had already com- pleted 13 transactions and deployed 11% of its capital under management. Since then the fund has only com- pleted one transaction, with three in the pipeline. The bottom line is that senior lenders need to start lending again before mezz players can make any kind of headway. "Regular people can't even get mortgages; how is a leveraged buyout supposed to be completed?" one lend- er asked. "We need the entire lending market to start running well again, but who knows exactly when that will happen." While tew will guess as to when the credit markets will loosen up, commercial banks weren't created for long term CDs. Eventually, when the remaining banks regain their appetite for risk, the mezzanine market will be positioned to benefit. "There's a lot of private equity money on the sidelines. Senior lend- ing will come back, purchase price multiples will come down, and mezz will do better," Steuerman said. For now, however, it's a renaissance delayed. —Danielle Fugazy, M&A

'The senior lenders aren't being very aggressive at all; we will be here to fill the gap. "

the current envi- ronment bears a re- semblance to other periods in the market's history. "This is the same thing we experienced in 1999 through 2001, when firms want-

ed to patch a deal together to avoid the cost of mezz," said Michael Hermsen, a managing director with Babson Capital Management.

Hermsen, however, does not con-

such as Audax, won't invest alongside their equity vehicles. While the mezz market remains stagnant going into 2009, it has shown signs of life at times during the credit crisis. In the early part of last year, for instance, when the second-lien market crumbled and BDCs began showing

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January 12, 2009