Mezz Debt & Capital Structure

Orchid's picture
Rank: Senior Chimp | 16

Oasisers,

I was looking at a capital structure that was comprised of 2 tranches of senior debt and 3 tranches of mezz below it. The interesting part is that the 1st piece of mezz after the 2 senior tranches has the lowest interest rate in the entire capital structure 6.10%(mezz 1), while the 2 senior above it have 7.04% (sr 1&2) interest rates. The other 2 Mezz pieces below the 1st Mezz rightfully have higher rates at 7.10%(mezz 2) and 8.41%(mezz 3). Can anyone explain how this is possible? To my understanding the more senior you are in the capital structure the lower the cost of debt. In this case the Mezz 1 which isn't senior to the 2 tranches above it has the lowest cost of debt.

Thanks
IS

Comments (8)

Feb 10, 2011

Is it possible that they were issued at different times? The senior debt could be old and the mezz could be issued later when the company had more stable cash flows and a greater margin of safety.

Feb 10, 2011

Seriously? Have you given any thought to the fact that risk-free rates are close to 0% now and was ~5% in 2006-07? I'm willing to bet Mezz 1 was issued in the past 18 months and the senior debt was issued 4 years ago.

Feb 10, 2011

do you have any info on the equity pieces that came with the mezz?

Feb 10, 2011
PT91:

do you have any info on the equity pieces that came with the mezz?

This, along with the the point about timing of issue, is the key. Mezz is often compensated besides just the coupon-the notes could have been issued at a discount, have mandatory amort, have warrants, etc.

Feb 10, 2011

Maybe Mezz 1 has more favorable convertability features than Mezz 2 and 3....also sub debt may be higher in the capital structure but has no upside other than a high IR and both typically share same risk as nothing will be left most likely in bankruptcy scenario as senior debt will most likely wipe it all out. Also could be what milkman said....

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Feb 10, 2011

As pointed out, the interest rate doesn't necessarily fully describe the cost of the capital. Additionally, you haven't mentioned the current market yields on the senior tranches. A bond could easily have been issued with a coupon of, say, 10% a couple years ago but be trading today in the 6-7% range.

Feb 10, 2011

Did you look at what the PIK component of the deal was? what percentage of the equity they can participate in when the term closes? you have too look into the subordinated docs it's really not as simple as just looking at the rate of cash interest bieng applied to principal.

Feb 10, 2011
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