Asset Class
Mezzanine Debt
Mezzanine Debt is subordinated capital that sits below senior loans and above equity, often with equity kickers. Allocators evaluate it through loss severity controls, documentation, sponsor alignment, and realistic recovery assumptions.
Mezzanine is junior debt used in leveraged transactions to increase flexibility and returns, typically priced with higher coupons and equity participation.
For allocators, mezzanine is defined by loss severity risk. The underwriting focus is not yield—it is capital structure positioning, control rights, and recovery realism.
How allocators define Mezzanine exposure
They segment by:
- Subordination level: second lien vs unsecured vs preferred-like
- Equity participation: warrants/PIK; how upside offsets downside
- Documentation: intercreditor terms, remedies, protections
- Sponsor behavior: willingness to support vs walk-away
- Sector cyclicality: downside sensitivity
- Portfolio concentration: correlated default clustering risk
Allocator framing:
“If performance deteriorates, how much of principal is realistically recoverable?”
Core strategies within Mezzanine
- Sponsor-backed mezzanine: priced junior capital in LBO stacks
- Unitranche-like junior sleeves: structured junior return layers
- Structured mezzanine: preferred/PIK features shaping outcomes
How Mezzanine fits into allocator portfolios
Used to:
- Increase portfolio yield with defined downside assumptions
- Add equity-linked upside while staying in a credit mandate
- Complement senior secured lending with a higher-return sleeve
How allocators evaluate managers
Conviction increases when managers show:
- Conservative loss and recovery modeling
- Strong intercreditor and remedy execution experience
- Disciplined sizing and portfolio construction (avoid correlation traps)
- Transparent history through stressed vintages
- Clear rules for restructurings and amendments
What slows allocator decision-making
Blockers include:
- Over-optimistic recovery assumptions
- Weak visibility into intercreditor protections
- Underwriting that depends on perpetual refinancing
- Concentrated exposure to cyclical sectors
Common misconceptions
- “Higher coupon equals better returns” → junior debt can lose principal quickly.
- “Warrants solve risk” → warrants help upside, not principal recovery.
- “Sponsors always protect junior capital” → sponsors optimize equity, not mezz.
Key allocator questions
- What is the intercreditor reality in workouts?
- How do you size mezzanine risk to avoid loss clustering?
- What’s the realized loss rate across downturns?
- What drives recoveries: collateral, control, or sponsor support?
- How do you avoid “hidden equity” risk?
Key Takeaways
- Mezzanine is about loss severity discipline
- Docs and intercreditor positioning determine outcomes
- Portfolio construction is as important as underwriting