How Does Rising Interest Rates Affect Mezzanine Debt Pricing

Posted on: July 15th, 2022

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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.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.