How Does Rising Interest Rates Affect Mezzanine Debt Pricing

Posted on: July 15th, 2022

mezzanine-debt

2022 has been far from an ideal year for the economy and with a looming recession, interest rates are spiking at decade highs. So how does the economy and more specifically the record high interest rates affect your company and the future of mezzanine debt?

Unlike the majority of loans, mezzanine debt pricing will not be affected a significant amount. The loans are based on fixed rates that are comprised of 10% current pay interest and 2% deferred interest. Therefore, the interest rates will cap out at 12% total interest and do not move in tandem with the rest of the floating rate debt market. While floating rate bank loans and private debt fund loans are increasing due to their peg to floating rate indices, mezzanine debt loans do not change.

Mezzanine debt can be a great tool in helping your company through a tough economy. With stabilized interest rates and generous loan proceeds, companies are able to weather downturns and keep a strong balance sheet until the proper time period for growth. However, the rising interest rates and economic downturn will cause lenders to be more risk averse and only companies that have proven business models or substantial credibility will be granted a loan.

Lenders will place a premium on lending to only high-quality companies. The one part of a mezzanine debt deal that could potentially change is the warrant percentage. Since lenders include warrants in the deal to achieve their overall rates of return, they may discount future growth causing the need for a higher warrant percentage. When the lending markets turn tight, mezzanine lenders are able to realize higher warrants due to the lack of competition as well.

So, if you’re a company either looking for or have mezzanine debt, the country’s rising interest rates will not affect your loan’s interest rates. Focusing on how your company will survive and even thrive in this economy should be the top priority since the lenders will continue to invest in high potential companies and markets.

During their underwriting processes, acquisition financing providers analyze probable performance projections for their proposed borrowers. The underwriter often toggles between a few scenarios to sensitize the growth variables leading to slower revenue and margin growth over time. The lender’s underwriting view is usually an extension of its credit intelligence and historical experience.

Mezzanine debt loans occupy the risky echelon beneath the bank but ahead of the equity in a capital structure. They are naturally subordinated to the bank loan via an intercreditor agreement wherein the senior lender retains the power to block their interest or force them to standstill.

In the middle market, acquisition financing providers are regarded as super intelligent and hardworking. They have distinguished themselves at elite banks or consulting firms and possess the ability to synthesize voluminous levels of info into a coherent, succinct takeaway or observation. This skill is extremely valuable in attributing causation to business drivers in a financial model used to foretell the future.