Thoughts on Mezz Financing

The below dashboard shows how mezzanine returns are highly sensitive to the underlying asset’s risk, even when the capital structure is identical. Project A, a low-volatility, high-quality asset, generates stable mezzanine returns close to the fixed coupon. In contrast, Project B, a higher-volatility, lower-quality asset, exposes the mezzanine tranche to frequent and severe losses.

Despite Project B offering higher average asset returns, the mezzanine lender’s fixed upside means that increased volatility mostly increases downside risk, leading to lower risk-adjusted returns. This underscores the importance of evaluating asset quality and volatility, not just capital stack position, when assessing mezzanine lending opportunities.

Users can adjust the blue-text figures to explore how changes in assumptions affect returns and volatility.