The private debt market, particularly for corporate mezzanine debt, may present investors with an opportunity for higher returns.
The private debt market, particularly corporate mezzanine debt, has historically provided investors with attractive absolute yields. The current low-yield environment in the traditional credit markets accentuates these returns and highlights opportunities in the private debt market to achieve higher returns with lower volatility and less correlation to public equities, complementing traditional strategies in high-yield bonds and syndicated loans.
Mezzanine debt, which can be thought of as private high-yield for middle-market companies, is a niche, illiquid market, representing a fraction of the broader leveraged loan market. Mezzanine debt is typically used to finance leveraged buyouts, recapitalizations, refinancing, acquisitions and other transactions for middle market companies (those with less than $50 million in EBITDA).
Mezzanine debt is junior to bank debt and senior to equity, and typically structured as a senior or subordinated unsecured note, which is often paired with an equity component for additional upside potential. Most investors in mezzanine debt are institutional investors, such as insurance companies, pension funds, endowments and foundations. Individual investors would have to meet certain asset and income minimums to participate.
The supply-demand dynamics for capital in the middle market have supported the higher returns and premium of mezzanine debt compared to traditional leveraged finance markets. On the supply side, middle-market companies largely cannot access the high-yield and second-lien loan markets. Yet, the demand side for private debt has grown, driven by the expected deployment of uninvested private equity capital and by middle-market companies’ refinancing needs. Despite the refinancing wave that has reshaped a portion of the debt maturity wall, middle-market companies still have a significant amount of credit maturing in the coming years. Both of these factors are expected to drive demand for private debt.
This supply-demand dynamic has created a compelling investing environment in the private debt and mezzanine debt markets for investors seeking higher premiums and yields than the traditional credit markets offer.