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Mezzanine Financing: Tools, Applications and Total Performance


Mezzanine finance is an increasingly important part of the financing spectrum for lenders, corporations and project finance. It has many unique characteristics and categories and includes products and features which are meaningful in a diverse set of situations. Most mezzanine products are designed legally as debt instruments, but they are often exposed to equity-like risk. Proper pricing is therefore required. However, since most of the products are considered debt products, term sheets and covenants are essential to model the risk in an appropriate way.

The flexibility afforded by mezzanine products is appreciated as it allows firms to structure their balance sheet in a way that acknowledges the financial sensitivities in the firm’s, or project’s, business model. That flexibility has triggered countless innovations during the last 15 years, taking into account different and evolving risk appreciation and industry specifics. Most of that innovation has occurred through contractual arrangements and adjustments. Mezzanine finance has become an area where finance, legal, accounting and credit assessment come together and are blended with industry specifics.

Mezzanine Financing: Tools, Applications and Total Performance therefore takes a multidisciplinary approach, combining those factors to provide an holistic overview of the mezzanine product group and its applications.

The book is divided into four sections covering: 

  • The mezzanine market and the demarcation of the product group.
  • A detailed examination of the individual products, with do’s and don’ts, analysis of technical features and their impact on the risk--return trade-off, valuation dynamics, pricing grid of the instruments and structuring considerations.
  • The implications of regulation and the peculiarities of the product group when applied within specific industries, including banking, insurance, project finance, real estate and private equity.
  • Structuring the products, legal, accounting and credit rating intricacies.

Concluding with an analysis of innovations in the field in recent years, and an examination of the outlook for mezzanine products, this book is completed with appendices containing case studies and sample legal and contractual support documents to illustrate the more complex positions. References and footnotes throughout provide ideas for extensive further reading, making Mezzanine Financing: Tools, Applications and Total Performance the complete guide to mezzanine financing, and a valuable resource book for academics and professionals alike.

Luc Nijs is the founder, chairman and group CEO of The Talitha Group, a global merchant banking group and global investment holding. Before that he was with Arthur Andersen and Deloitte. In addition, Luc provides extensive advisory, executive coaching and financial training for corporations, investment funds and financial institutions, and is active in over 160 countries worldwide on a wide array of strategy, investment and capital allocation issues. 

He has held academic positions in international taxation, finance and capital markets at UAMS/IPO (Belgium), Instituto de Empresa (Spain) and most recently the Aizkraukles Banka Chair in investment banking, private equity and entrepreneurial finance at the Riga Graduate School of Law (Latvia).

Luc is fluent in Dutch, English, French, German, Portuguese and Spanish and is competent in Russian and Chinese.

He authored Shaping Tomorrow’s Marketplace: Investment Philosophies for Emerging Markets and a Semi-Globalized World which was published by Euromoney in 2011, as well as the upcoming Global Agricultural Markets: Financial Dynamics and Industry Challenges, Palgrave Macmillan, (2014).


Preface xiii

1 Introduction 1

1.1 The Bi-polar World of Finance 1

1.2 Demarcation of the Product Group 5

1.3 Positioning and Use of Mezzanine Finance 7

1.4 The Risk-Return Conundrum 10

1.5 Providers of Mezzanine Finance 18

1.6 The Market for Mezzanine Products 18

2 The Mezzanine Product Group 25

2.1 Categorization of the Mezzanine Product Group 25

2.2 Case Study: The Kratos Company - Merger Finance 67

3 The Implicit Cost of Mezzanine Products 77

3.1 Measuring Risk 77

3.2 Types of Risk 80

3.3 Equity Risk Versus the Risk of Borrowing: Default Risk and the Cost of Debt 87

3.4 Putting It All Together 90

3.5 How Much Risk is There in a Mezzanine Product? 92

3.6 Cost Versus Return Dynamics for Mezzanine Products 94

4 The ‘Pricing’ Question and Further Financial Dynamics of Convertible Loans and Preferred Convertible Shares 97

4.1 Pricing Grid for Mezzanine Products 97

4.2 Financial Dynamics of Convertibility in Convertible Loans and Preferred Convertible Shares 99

4.3 Case Study: JJ Bars & Restaurants - Mezzanine for Expansion 121

5 The Mezzanine Product Group and the Financial Industry 139

5.1 The Basel Committee and Framework 140

5.2 The Evolution of the Basel Rules (Basel I and II) 140

5.3 Objectives of Basel III and the Central Themes 144

5.4 Impact on the Use of Mezzanine Products in the Financial Sector 163

5.5 Regulation in the Insurance Sector Impacting the Use of Mezzanine Products 163

5.6 CoCo Bonds - Contingent Convertible Bonds 171

5.7 Annex I - Summary Basel III 177

5.8 Annex II - Basel III - Specifi c Features 178

5.9 Case Study Positions: Mezzanine Financing for Financial Institutions 182

5.10 Case Study 1: Financing the Future of Bank Alhanbra 182

5.11 Case Study 2: Growing the Brazilian Market 184

5.12 Case Study 3: Financing a South African FI which is Part of a Larger Conglomerate Prior to an IPO 186

6 Mezzanine and Project Finance 189

6.1 Types of Projects 192

6.2 Financing Aspects 193

6.3 Securitizing Project Loans 195

6.4 Case Study 1: Developing a Toll Road in Poland (A2) 196

6.5 Case Study 2: Building and Operating a Wind Park 203

7 Real Estate Projects and Mezzanine Finance 211

7.1 Wider Application 212

7.2 Other Applications and Return Issues 214

7.3 Case Study: Financing a Real Estate Company in the CEE Region 220

8 Mezzanine and the Private Equity Space 225

8.1 Drivers of Return 228

8.2 LBO Structure 232

8.3 Tax Implications 247

8.4 Alternative Transactions Using Similar Financing Structures 247

8.5 Summary of Different Compartments in the LBO Structure 249

8.6 Summary of Types of Securities in the Leverage Structure of an LBO 251

8.7 Case Study: Buying Orangina - a Typical LBO with Some Interesting Questions Ahead! 251

9 Mezzanine Products and the World of the Rating Agencies and Accountancy Boards 261

9.1 Rating Agencies and the Debt-Equity Continuum 261

9.2 Case Study: Fitch’s Approach to Rating Hybrid for Corporates 272

9.3 Mezzanine Debt, Rating Agencies, the Regulator and Financial Institutions After 2008 284

9.4 Appendix 1: Equity-Content Maximization and Structuring Criteria at Moody’s 293

9.5 Appendix 2: S&P’s and Moody’s Key Structuring Considerations 294

9.6 The Intricacies of the Accounting World 295

9.7 Demarcation Lines and Product Modeling 309

10 Term Sheets, Inter-creditor Agreements and Debt Restructuring 313

10.1 Groups of Covenants 313

10.2 Review of Key Covenants for Mezzanine Products 316

10.3 Other Covenants 318

10.4 Case Studies: The Good, the Bad and the Ugly 319

10.5 A Comparison of Debt Asset Classes 321

10.6 Case Study: LyondellBasell and Lyondell Chemical Company 339

11 Outlook 353

11.1 Introduction 353

11.2 The Not-Too-Distant Past 354

11.3 New Kids on the Block 355

11.4 The Unitranche Product 356

11.5 Reorganization of Insolvency Laws in Europe 359

11.6 Islamic Finance: Sukuks and Non-Risk-Free Bond Look-Alikes 360

11.7 Origination Sources for Mezzanine 361

11.8 The Role of Governmental Organizations 362

11.9 The Refi nancing Wall: Opportunities and Challenges 363

11.10 Performance of Mezzanine Products 363

Appendix 1 Overview of Term Sheets and/or Model Contracts for the Mezzanine Product Group 367

Appendix 2 First Lien/Second Lien Inter-creditor Agreement 415

Glossary 479

Case Guidance/Solutions 489

Index 505