My New Year began this past Monday morning with the following email from a client (a Giants fan): "Now that football season is over it’s time to get back to work". Not quite right for those of us here in New England, but I agree overall with the sentiment (albeit, with this year’s blizzard of year-end deals, not all of us were ever too far removed). Amid last week’s understandably slow news cycle appeared a story in Bloomberg on the growing desire in the private equity sphere for CRE mezz debt. Indeed, the stars seem to be aligning in a way that could mark 2011 as the beginning of a bull market for CRE mezz investors.
The late ’90’s and early Oughts witnessed an explosion in the popularity of mezz debt in CMBS structures. Up until that point mezz debt was uniformly rare and rarely uniform. Mezz lender rights varied widely from deal to deal and included significant restrictions on mezz lenders’ rights to sell or finance their positions or to foreclose on their collateral (leading to high origination costs and uncertain securitization execution). The promulgation of rating agency criteria with respect to mezzanine debt (all things being equal, mezz debt generally garners only about a third of the leverage penalty attributed to a B Note) and the introduction by CREFC (then CMSA) of a standard form intercreditor provided a level playing field for lenders, investors and rating agencies. And, ignoring for the moment certain recent legal opinions (Stuy Town), the industry became very confident in their understanding of the basic architecture (in short: the right to cure, purchase, foreclose, transfer to a QUIL and a really, really complicated section on the right to amend). As we all know, by the middle of the last decade, stacked mezzanine loans (huge, stacked mezzanine loans) became the norm, each layer then being further syndicated among large numbers of participants, setting the stage for the many battles of the guerre des tranches we’ve fought these past years.
The current lending environment is primed for a resurgence in mezzanine lending for a number of reasons. Despite a stabilization (if not a rebound) in property values, a vast number of owners will not be in a position to refinance their properties at maturity given the levels mortgage lenders are willing to lend to; mezzanine debt can erect a portion of the bridge to higher loan-to-value ratios. And notwithstanding LIBOR, yields should be able to attract private equity dollars. Oddly (and, again, Stuy Town notwithstanding) the downturn may have, in some ways, bolstered mezz investors’ confidence in the structural integrity of mezzanine debt. The extended go-go-cycle from the nineties through ’07 deprived mezz lenders of a proper laboratory to vet the effectiveness of their remedies en masse. Recent history, however, has shown the UCC sale to be the tool of choice for many savvy investors looking to purchase distressed real estate (for instance, see these posts on the mezzanine foreclosure of the Hancock Tower).
Mezzanine debt will be an important, desirable aspect of lending in 2011. And, one note in closing, as this first week of ’11 draws to an end – I realize, strangely enough, the client was right. There will be no football in New England this weekend. Tommy Brady drew the first round bye.
By Matt Clark.