Mezzanine financing is making a comeback.
In recent years private credit lenders, which have been gobbling up leveraged loan market share, have focused on other types of financing, like unitranche deals, which combined senior and junior debt into a single loan.
But as interest rates have risen and lending conditions have tightened, mezz financing, which is situated in a company’s capital structure between senior debt and common equity, has found new life. Recent turmoil at regional banks may further open up investment opportunities for mezzanine lenders.
Fundraising in the segment has followed the growing demand. Last year, private credit managers raised billions of dollars of dry powder for mezzanine financing.
A total of $30.1 billion was raised by global mezzanine funds in 2022, almost double that of 2021, and the most since 2016, according to PitchBook data.
Capital raised by mezzanine funds accounted for 16% of the total raised across all private debt strategies last year, surpassing distressed debt as the second most popular private debt sub-strategy, behind only direct lending.
A number of mega-funds have reached final closing in the last year, topped by Goldman Sachs’ $15.2 billion fund, West Street Mezzanine Fund VIII, which focuses on originating second-lien and junior debt to large-cap companies backed by private equity firms in non-cyclical sectors. UK-based credit specialist Intermediate Capital Group also closed a sizable fund targeting mezzanine financing last year.
The growing heap of dry powder comes alongside the rise in demand for mezzanine financing from private equity firms and their portfolio companies as other parts of the credit world — from the syndicated loan market to direct lenders — have become more risk-averse.
Why mezz, why now?
Junior capital, which includes mezzanine financing, can range from second-lien loans to holding-company level PIK (payment in-kind) notes to preferred equity. Mezzanine capital has uses for both performing and stressed companies.
There are several factors currently driving demand.
Shrinking access to senior debt and unitranche loans is one. Many first-lien loans in recent years have been governed by MFN or “most favored nation” clauses that prevent new debt from being issued at more attractive levels than existing lenders receive. An MFN clause could make it impossible for a borrower to bring in new senior debt without repricing an entire first-lien facility, an unattractive prospect at this time, as interest rates are significantly higher today. (The chart below details broadly syndicated leveraged loan yields and spreads.)
