The Case for Junior Capital (Last of Four Parts)

In early 2020, just before Covid came crashing down on our heads, we were in the middle of a Lead Left series called “Ten Top Myths About Private Credit”. Myth #5, published on February 20, was “No one uses mezzanine debt anymore.”

We felt compelled, after a decade of increasingly aggressive senior and unitranche financings, to point out how private equity sponsors had never stopped using junior debt as “patient capital” to help stretch leverage and provide a cushion to banks and other senior lenders.

The near-term environment offers many opportunities for both investors and issuers. Our team expects junior capital coupons to remain at or above current levels: “We want to make sure there’s an adequate spread relative to senior rates. We also think leverage will stay at these levels as recession concerns linger.”

There’s also upward bias on deal volumes heading into 4Q as sponsors feel pressure to generate LP returns. “It’s a circular problem for firms,” one banker noted. “They aren’t selling businesses, so until they do investors won’t have the cash to re-invest in successor funds.”