What Happens when a Mezzanine Loan is Called?

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 most underperforming loan scenarios, the mezzanine debt lender is borrower supportive if they have a decent relationship with the company and feel management is trying their hardest to turn things around.

The reality of making a risky loan is that you are lending beyond the hard collateral value and are vulnerable to the vicissitudes of the Company’s market forces. The acceptance that the loan’s eventual repayment is subject to risk factors more akin to an equity investment is a defining characteristic of mezzanine debt lenders and usually results in level-headed, patient forbearance. Mezzanine debt lenders usually understand that there is only one way out of a work-out and that is through the cash flow. Because their loan is well beyond the asset value, any acceleration or calling of the loan is likely to be self-defeating. In the case of a loan calling, the senior lender could block them. In the event the loan can be called, the old saying goes “You can call a loan, but it doesn’t have to come.”

The Company does not have the cash to repay it and there is no personal guaranty to backstop it. Because the mezzanine loan is a loan against the fully loaded cash flow value of the company, the liquidation math as to recoverable proceeds is quite grim and the lender knows it. If a loan was made a 4 times EBITDA and EBITDA is now 50% lower, the loan multiple is suddenly a vertiginous 8 times.  Rather than self-destroy their position, mezzanine debt lenders are more likely to hang in for the long term. The key to them going the distance is having belief in the business plan and the management team.   The exception to this is in the case of a mezzanine debt lender calling the loan to blow out the equity and take total control of the company to fund it back to health.