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What is mezzanine debt?

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Mezzanine debt is a private term loan with a bullet maturity whose claim to interest and principal payments ranks after senior secured debt but ahead of equity, commonly raised with an equity warrant on the borrower’s parent.  Unlike public like high-yield bonds, it is a private instrument.

European mezzanine is senior secured debt that uses the same fixed assets as collateral as the senior secured lenders but as a junior secured creditor, it commonly structured over a six- to ten-year term with a bullet maturity occurring one year after the maturity of the senior secured debt.  By contrast, US mezzanine is unsecured subordinated high-yield fixed-rate debt with an equity kicker and a heavy prepayment premium.

As used in European leveraged financing, mezzanine debt is both contractually and structurally subordinated.  It is contractually subordinated by means of a subordination agreement or intercreditor agreement, where it is structurally subordinated to the senior lenders when senior loans are advanced to the subsidiary of the parent senior and mezzanine debt is advanced the subsidiary’s parent company.

The interest payments on mezzanine debt as well as loan notes of the parent often may be either in cash or in kind (capitalized).  Payment in kind (PIK) is interest payable on the debt that is capitalized under facility agreements such that it increases the outstanding debt by a corresponding amount, commonly “in kind” in the form of additional notes.

It is not uncommon for PIK interest to apply to certain subordinated leveraged debt: for example, mezzanine debt often has a PIK interest element.

Whether secured or unsecured, a higher credit risk is assumed by mezzanine lenders than by senior lenders.  Because of their junior position in the capital structure and as a result of the terms of any intercreditor agreement, mezzanine finance is more expensive than the senior facilities.

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